How To Approach The IT Sector? Nilesh Shah's Take On Tackling The Headwinds In IT
Transcript
00:00 It's an absolute delight to have in Nilesh Shah, MD and CEO of Envision Capital joining us on the show.
00:05 I got confused earlier when I mentioned that Nilesh Shah of Kotak AMC is joining in. So Nilesh
00:10 Shah, Envision, excuse me for that, but you know it's a pleasure to have you always. Thanks for
00:14 taking the time out today. Thank you Nilesh, thank you so much. So Nilesh, there's a lot of
00:20 talk around how there are telltale signs which point to market exuberance and therefore there
00:27 being a possibility of a very large gash in the markets. You would have heard of many of these
00:32 and probably more. I'm wondering if you are concerned about valuations and a possible downtick
00:39 or do you believe growth will take care of the valuations? Yes, so Nilesh, clearly it looks like
00:46 that over the last few weeks or maybe over the last couple of months the markets seem to have
00:52 moved on to a bit of a risk-off kind of mode, especially with concerns around the kind of
00:59 up moves that we have seen in the mid and the small cap segment of the market. The broader markets have
01:04 been a lot weaker, but what I believe is that you clearly see that a lot of the froth which was there
01:13 is out of the way. A lot of stocks have corrected by 20 to 25 percent from the recent highs and
01:22 our view is that if growth sustains then it takes care of the valuation. As long as we have
01:27 growth, we have premium growth, then valuations become less of a concern because equity markets
01:34 is all about buying into growth. Clearly believe that the next financial year as well is likely to
01:41 be a strong year for the economy and for our GDP and therefore growth for corporate India. So
01:48 clearly believe that post this recent correction, the markets now seem to be relatively well balanced
01:55 if I may kind of use that word and probably we might see some bit of time-wise consolidation.
02:02 I clearly believe that post a few weeks from now we will be back on the upward trajectory.
02:09 Hi, it's Samina as well joining and I'm of course talking to you after a number of years,
02:15 but nevertheless what is your stand in terms of your portfolio? How much cash are you currently
02:22 sitting on? Are you aggressively allocating? Are you looking at lump sum allocations on big falls?
02:29 Is it more SIP? And I'm assuming it could be STP largely because you think
02:33 there is a time-bound correction around the corner.
02:35 So we're not sitting on any significant cash. We probably have about five to ten percent cash
02:41 levels on an average in individual portfolios. Maybe for some of the more recent investors
02:48 portfolios in the last few months, maybe the cash levels are that higher than
02:52 the single digit. So we honestly don't take too much of a cash pause, especially when it's on,
02:58 unless we are yet in the process of building a portfolio. So those are the kind of situations
03:03 where we would have cash, but otherwise we clearly believe that the markets have become
03:10 relatively attractive versus where they were a couple of months back or maybe where they were
03:15 at the end of last calendar year. So clearly continue to be very constructive, see several
03:21 opportunities in the broader market and the fact that we are seeing a very broad-based economic
03:27 growth, that's translating into broad-based opportunities in the broader market. So that's
03:34 essentially what our view and our stance is. Aneesh, also the bigger sort of returns over the
03:42 last year or plus has come in from the broader markets and no one can deny the fact that that
03:47 is probably the most tempting space to be in. But for the last few months, we've been consistently
03:53 talking about how large caps should be carrying the beating going ahead. Do you feel if an
03:59 individual or an investor should be looking at rebalancing his portfolio and if he does
04:05 rebalance his portfolio, should the bias now shift to large cap stocks?
04:09 So I mean, I probably think that would hold out for the short term. If you're really taking maybe
04:17 a three-month view or a six-month view, that can still play out. There could be a bit of
04:23 tiredness or fatigue in the mid and small cap space because of which they may not deliver
04:30 the kind of relative outperformance over the next three to six months. And in that eventuality,
04:36 the large caps may outperform for the very short term. But the bottom line is that
04:42 large caps as a basket, especially if I were to kind of really look at the large cap IT services
04:48 companies or the large cap FMCG companies, unlikely that they will be able to grow at a rate which is
04:55 more than single digits. So clearly believe that ultimately it's going to be more about growth. And
05:03 I believe that the broader segment of the market or the mid to small caps will be displaying or
05:10 exhibiting much stronger and higher growth versus their peers in the large cap space. So yes, for
05:15 the next three to six months or maybe for the very short term, large caps can outperform. And as long
05:20 as we believe in a kind of a quasi risk-off mode. But once we've seen price-wise consolidation,
05:26 if there's some bit of time-wise consolidation, it's quite possible that the broader market will
05:31 kind of get back into its trajectory of outperformance. - Okay. Nilesh, the other aspect
05:39 is just before we dwell into specific pockets, but before the break, one aspect is the macro
05:45 situation. Are you constructive on macros? A lot of talk around CAD coming off and the resultant
05:52 impact on the currency and what it could do for stability, so on and so forth. Any thoughts here?
05:57 - So Nilesh, macros have never been as good. In the past, we've had situations where the economy
06:04 has grown at 7% to 8%, but that's kind of led to higher inflation. Clearly believe that the macros
06:11 continue to be extremely robust. Macros are benign. I think the government has taken
06:18 essentially a very well-balanced approach of having relatively high growth with an eye on
06:25 inflation. So to that extent, I think it's a great situation to be in. Most of the big institutions
06:33 or economists are still kind of upping their estimates or forecasts for economic growth,
06:39 and I would tend to concur with that. So we seem to be in a period of maybe about 7% to 8% growth
06:46 and about maybe around 5% of inflation. And I don't see a cause of concern for that. In fact,
06:52 that's a great situation to be in. We seem to be the standout nation, the standout economy
06:58 from a global context. Second is again on the currency, and I would actually believe that,
07:03 yes, currently there is still that inflation differential of about 2% between the targeted
07:10 inflation rates between India and the US. And so to that extent, you could basically see the
07:14 depreciation of the currency to that extent. But over the medium to long term, I wouldn't be
07:20 surprised that with the initiatives on localization, indigenization, import substitution, the huge
07:28 focus on manufacturing, all of these factors are going to probably lead to at least a more measured
07:36 depreciation and who knows, maybe an appreciation of the Indian currency. In addition to that, of
07:41 course, flows coming in from FBIs, flows into bonds. These are all the kind of developments
07:48 which at least will lead to a relatively benign scenario on the currency side, which will have
07:53 a positive spin-off effect on imports and inflation. In addition to that, of course,
07:58 this whole drive towards energy security is probably for the first time we are seeing it,
08:04 and I believe that that itself is going to be a significant game changer for India, maybe for the
08:10 rest of this decade. So I think on the whole, India's macros are great. India's macros are
08:16 very compelling, and that in turn is likely to result into a fantastic investment climate.
08:22 Nilesh, a question that comes to mind is what will benefit going ahead? We are at the cusp of
08:30 an earning season. We're looking at possibly some earning revisions on the downside after the pace
08:39 of earnings growth that we've seen in the last two, three years. Where is it that Nilesh Shah is
08:43 most constructive on? Clearly, from a very longer-term perspective, Nilesh, I clearly believe
08:53 that there are three very, very strong phenomena which are expected to play out. First, of course,
09:01 is the whole journey towards digitalization. So to that extent, if I may use the word that India is
09:08 basically transiting towards a digital economy, and therefore this is likely to be India's decade.
09:14 So that's one big kind of theme, and therefore one very large kind of pocket of opportunity.
09:23 The second is being our traditional stronghold, which is the consumer economy, and there are
09:31 phenomena like higher penetration and then premiumization as well are the kind of twin
09:38 forces which are driving the consumer economy, aided by support coming in from the digital economy
09:44 and an aspirational India. The third big opportunity is around the physical economy, and this typically
09:51 would entail the energy security, which I was alluding to earlier, and the whole shift towards
09:56 renewables and decarbonization. The second is manufacturing with a drive to have import
10:04 substitution, localization, and eventually exports. And third, of course, is the whole
10:10 infrastructure built up, the public sector CAPEX, the private sector CAPEX. So I'd broadly say that
10:16 the opportunities are going to be around the digital economy, the consumer economy,
10:21 and the physical economy. These three are essentially going to be
10:24 the big sources of opportunities from an investment perspective.
10:29 Dinesh, while bulls aren't yet ready to give up on the potential of PSU bank stocks given the
10:37 earnings turnaround, the case of the underdogs is getting louder, at least at a valuation level of
10:43 PSU banks as they, of course, traded historical highs, while private banks are the ones that are
10:48 languishing near decade-long lows. Where do you think the trade is? It's a tale of two opposites.
10:53 Which one are you betting on? Well, for now, I probably believe the trade is more skewed in
11:01 favor of private banks. The private banks are emerging out of a long period of stagnation
11:08 from a stock price performance or a relative performance as well. It's probably been maybe
11:14 three years of underperformance and still believe that going forward, the private sector banks will
11:22 continue to sustain a double-digit growth rate on the balance sheet side, especially on the loan
11:28 side. Yes, there could be a bit of challenges on the NIMS, but I guess the franchises are very
11:35 strong enough to be able to navigate through that. Versus that, the PSU banks, probably a lot of the
11:43 capitalization and the balance sheet strengthening is factored in into their stock prices.
11:49 So I probably believe that the private sector banks have a better chance of outperformance.
11:56 The only caveat here being that post the general elections, if there is a privatization initiative
12:04 and one or two banks have been lined up for privatization, that's at least been the intent
12:10 and the policy announcement. If that materializes into action, that could lead to the next round of
12:17 re-rating for PSU banks. But otherwise, purely on a very steady state standalone basis, I probably
12:23 think that for the short to medium term, it's very likely that the private sector peer group will
12:29 outperform their public sector peer group. Okay. The other thing, Nilesh, like the UBS note today
12:40 for example, talks about a very expensive capital goods stock and says that the margin uptake and
12:46 the earnings uptake will make sure that the premiumness and valuation stays. How to best
12:52 play the CapEx theme now? Because the CapEx which will unfold over the next five
12:59 is arguably going to be very different from what happened in 2003-2008. So how to best play the
13:06 upcoming CapEx cycle? So clearly continue to be very positive on the CapEx cycle,
13:13 but it's quite possible that going forward, the private sector or the CapEx play led by the
13:21 private sector will essentially at least be as good or will do a catch up with the public sector
13:26 CapEx. So I probably believe that actually the CapEx oriented opportunities will only expand.
13:31 Traditionally, at least over the last one or two years, we've really seen the public,
13:36 the government take the lead. And therefore it has been pockets like railways and defense,
13:41 which have done extremely well. But going forward, clearly believe that it's going to be a lot more
13:48 broad based. I earlier alluded to the energy side and the kind of investments which are happening
13:54 on the energy side. So clearly believe that companies or businesses which are a proxy for
14:01 the huge investments which are expected in renewables and this whole drive towards
14:07 decarbonization will essentially probably take the lead or at least be a pocket of strong
14:12 outperformance versus the rest of the pack. The rest of the pack will essentially do well. We've
14:19 seen some bit of price correction in terms of their stocks. It's quite possible that maybe they
14:24 would probably consolidate for maybe a quarter or two before the markets get again confident about
14:29 their higher growth trajectory. Once there is evidence of that, I expect even the rest of the
14:36 CapEx pack to basically catch up. So I think across the board, be it railways, be it defense,
14:42 or be it energy or some of the other private sector led CapEx, clearly believe that it's going
14:48 to be again a basket of opportunities out there. Nilesh, you are probably the best voice on the IT
14:57 sector. Tell us what you think about this space. The last 10 years, this is one sector which has
15:02 been the best performing sector. It's done double digit returns. But the fact remains, business is
15:08 slowing down. There were days when you'd see the rupee move weaker and IT stocks would actually
15:13 react positively. I know very naive in that sense. But even those sort of trades have now become
15:17 history, right? With the changing landscape, AI, digitization, cloud, politics in the US,
15:26 how does one approach the IT pack? Is it time to go overweight or is there still some time to go
15:31 before an investor can make such calls? So there are surely headwinds for the large cap
15:38 IT sector and IT services. There are clearly headwinds out there. Even over the last decade or
15:45 so, these are companies which probably have grown at best 10% in terms of their revenues or their
15:52 earnings. Maybe the earnings have been a tad higher. But I probably think the revenue growth,
15:57 especially on the organic side, has been single digit. And I don't think over the next decade or
16:02 so or over the next five years or so, I don't see the growth rates for the large cap IT services
16:08 companies to kind of trend higher. Probably the best case situation would still be single digit
16:13 growth rate. And I don't think you should be in equities for a business growing only at single
16:18 digit. So probably believe that the large cap IT services companies will at best be kind of
16:24 short term trading opportunities or short term investment opportunities, but you probably buy
16:28 them when there's a sell off and then you kind of play for that mean reversion. However, with the
16:34 caveat, of course, that if any one of them announces something really big on the generative AI side,
16:41 then that's obviously a very, very different kind of development. But otherwise, clearly the
16:47 opportunity in the Indian IT services side continues to be very bottom up, continues to be
16:53 more around the tier two, tier three names, or maybe the mid to small cap companies, where given
16:59 the limited size, they probably be more fleet footed to get incremental business and deliver
17:04 cost efficient solutions to their enterprises, their enterprise customers. And these could be
17:10 companies which are focused around engineering, R&D services, software defined vehicles, mobility,
17:18 a whole bunch of opportunities, including, of course, implementing AI. So I probably believe
17:24 that the bias would be or the preference would be for the tier two, tier three IT services companies,
17:30 which are very specialized, and are going to be a lot more fleet footed versus the large cap years.
17:37 Nilesh, very lastly, for the next one to two years, your top sector to bet on,
17:42 from the larger sectors, give me one sector and the smaller ones, maybe like an insurance,
17:47 anything that you'd like a diagnostic play, because those are two teams that have been,
17:52 you know, ruling the headlines in the last 24 hours, but two sectors, one big one and one
17:57 small one where you're seeing value and one can buy. So clearly believe, you know, the whole
18:03 drive towards digital India, India's decade, and the fact that we are having a huge
18:08 formalization and financialization of the economy. So clearly the online fintech segment
18:16 continues to be a very, very kind of an attractive opportunity. Clearly, be it online
18:22 broking platform, be it an online insurance platform or an online credit platform. Clearly,
18:27 that's a great opportunity to be in, or it could even be a very normal home lender,
18:33 but using technology to kind of deliver loans in the affordable housing segment. So that I think
18:40 as a pack continues to be very great. So I'd probably say that the online financial or the
18:45 fintech space continues to be very attractive from an investment point of view. And the second
18:52 would be around the premium consumption side, still believe that there's a huge opportunity
18:56 for premium consumption, and that would probably be the second area of preference.
19:01 Okay. Nilesh, such a pleasure talking to you. Thanks for taking the time out and being with
19:06 us today and look forward to seeing you in the studio soon.
19:09 Thank you. Thank you, Nilesh and Samina. Always a pleasure.
19:13 Thank you.