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00:00Well, Sandeep Agarwal, fund manager and co-founder of Soilo Investment Manager joins in.
00:04Hi Sandeep, thanks for joining in.
00:08Earnings season is on the verge of getting kicked off with TCS and INFI reporting soon.
00:13Do you feel like this will mark the end of the downgrade cycle for the IT sector?
00:20Hi, good morning and thanks for having me on the show. So, you know, I am fully confident that this
00:26quarter will start the upgrade cycle. I am not even thinking of stopping of the downgrade cycle.
00:31I think it will start the beginning of the upgrade cycle and I will tell you key reasons why.
00:36See, in last four or five quarters, if you see, attrition has been consistently falling.
00:42The sub-con cost for attrition from a peak of, you know, 28-29%
00:48for even TCS for four or five quarters back has now again come back to 12-13% level.
00:53Second, the sub-con cost which had crossed 10% even for TCS are now back to, you know,
01:00mid-single-digit kind of numbers. So, all these things have huge contributed to margins and if
01:06your margins start going up, then what happens? The comfort on executions comes significantly and
01:12also it gives you a more leeway to, you know, get more business. So, I think we, in my view,
01:19the stocks have made a bottom in the last quarter from a stock price perspective because
01:24markets are always forward-looking so they discount all the negative and positive very quickly
01:28and I think this is the quarter when you will actually see upgrades led by margins.
01:33I don't see this sector, at least the large caps are in such a shape or the industry is in such a
01:38shape where you can see big upgrades in growth because growth numbers are going to be, you know,
01:428-10% for the large names. In some good quality mid-cap names, you can see 12-14% kind of growth
01:48but the margins are the key thing and I think margins will start picking up from this quarter.
01:52That is the way I look at the sector. Okay. Sandeep, good morning. Neeraj here.
01:58Lest you think we only talk to you about IT, today, yes, we will, but very soon we'll have
02:03conversations across the market too. But let's focus on today on IT. It's a big statement you're
02:07making that it marks the beginning of an upgrade cycle. Now, since Accenture numbers came out,
02:14we've seen a bit of an uptick in IT companies and the valuations are no longer what they were
02:18maybe a month and a half ago. You reckon the best is yet to be priced in? Yes, I think, see,
02:27this is a very interesting sector. You have to see that last 20-30 years, so it is a mature
02:31industry. It is no more at a stage where, you know, you can see very good growth, very high
02:36growth rates and all. Exclude the COVID year. COVID year, what happened is that the demand
02:40came up in a very big way because prior to that three, four years, the growth was low
02:45and there was a disruption which started late by digital. So there was a pent-up demand and
02:49there was a demand because of people preparing for work from home for an unknown period of time.
02:53So everything got bunched up and you saw that 20-30% kind of growth. I don't think that can
02:59happen regularly because you have to remember that global spend on tech goes up by 2-3% and
03:04outsourcing goes up by 5-6% and we gain market share every year. So our industry grows at 8-9%
03:10and within that, the large players will grow, let's say, 1-2% higher and the good quality mid
03:14cap can grow at 4-5% higher and the smaller, very small ones, unorganized ones actually can decline.
03:19So that is the trend. So in this industry, we have to expect a steady state growth rate of 8-10%
03:25and that is where it is. So I don't see a very big jump, but I think that 15-20% upside in the good
03:31quality large cap name is very much imminent and it will happen very quickly. It doesn't take a
03:36year for that to happen in tech. If you see, whenever good news or positive things, momentum
03:40comes, everything gets discounted in just a month's time. So this time will be no different,
03:45but I will be a little cautious on the good quality mid cap names because they are priced
03:49to perfection. So I don't know how much more upside will be there, but I can tell you the
03:53whole sector will see a good margin upgrade and because of that, the EPS will see a good upgrade
03:58across the sector. Sandeep, just to play devil's advocate, while we take your point that the run-up
04:04may be very quickly and immediate almost, the fact remains that there is still no immediate
04:10signs of demand recovery. I mean, sectors like BFSI, retail, telecom continue to face challenges.
04:17Do you feel like that could be a little bit of a concern? I mean, that could be a risk
04:22that we are staring at as the leaders will announce numbers soon?
04:27No, it is a very valid question, but let me give you two anecdotal evidences. Post Lehman crisis,
04:32one of the largest Indian IT company at that time gave a decline guidance of 5% to 7% and
04:37they ended up the year with 15% to 20% growth. Similarly, in 2021 post COVID, most of the
04:43companies which started with a negative guidance for the outlook for the next year, they all ended
04:49up at 20% growth. So this is a B2B business, 30-40 clients give you 85-90% of the business. So
04:56the first sign of recovery or first sign of positive you should draw is when your attrition
05:02is almost at bottom, which indicates that no one is hiring. And second is that, you know,
05:07when there is a stability. So if you read in between the lines for Accenture numbers,
05:12as already rightly mentioned by the previous speaker on your channel, we saw that, you know,
05:18managed services was quite strong and also the discretionary spend was showing a sign of
05:24stability. So this is the first sign, which means that there'll be no decline, at least there'll be
05:28no project cancellation, there'll be no deal cancellation. So I think that is the first sign.
05:32And in my view, as I would repeat that, you know, the stocks have made a bottom in the previous
05:36quarter, this quarter, next quarter, probably they will make a maximum out of those 15-20%
05:41return, which is expected. And post that again, you will see time correction for maybe six to
05:45nine months. That is the way I look at the sector. And I think, you know, in a B2B business, it is
05:49very hard to even for the chairman or the promoter of the company to call out that, you know,
05:53there are signs or not, who are interacting with the customers every day, because the size of the
05:57deals are so big that one or two deals can make a big difference to everything. Okay, Sandeep,
06:03so where are you constructive on? I mean, are you constructive on TCS, Infi, HCL, large IT service
06:11vendors? Are you constructive on the mid-sized ones? Because some of them have stated that they'll
06:17be a lot more nimble and agile for the generative AI or the AI piece. Or are you constructive on the
06:24ER&D names? Because those stocks are not seeing any sunset. Most of them, KPIT, etc., or product
06:30companies like Persistent are really doing well. So, you know, all the three very interesting
06:36questions, I will answer one after another. So, first of all, you know, I am very constructive
06:40in the large cap space in the names which are not expensive and where there is some turnaround.
06:45So, Techcam and HCLtech, I think there is good upside. HCLtech will always have one or two bad
06:51quarters out of four quarters. So, it is not a company which will give you all four quarters
06:55very good or stable. So, compared to that, HCLtech will always give you stable to decent quarter.
07:00Infosys will have one bad quarter, three decent quarters. HCLtech can have two bad quarters, two
07:05very good quarters. So, these companies have different kind of, you know, business models. But
07:09I think at current valuation, Techcam and HCLtech, both are good bets. I won't say that, you know,
07:14if Infi and TCS can give you 10-15% from here, these stocks, if you keep for a year, can give
07:19you 25-30%. So, that is number one. Coming to your second question, that good quality mid-cap. So,
07:24you are absolutely right. In the mid-cap also, you have to bifurcate based on their offerings. So,
07:30the IT services ones, I would be a little cautious because, you know, they are, I think they are very
07:35expensive right now. And even if good growth comes and margin improvement happens, they don't become
07:39cheap. So, there would be a 10-15% upside because of their small size and lesser liquidity, but
07:45they are not at all one which you should look at. The third space, which is ER&D. I think that is
07:51the most interesting space and the reason for it. See, last 30 years, what we have achieved is
07:56massive penetration in the developed market, particularly the US and to some extent in UK
08:01and Europe in the IT services space. Now, if you see the whole world, because of this smart products
08:08uptake which is taking, every product is becoming smart, everything is getting connected,
08:11generative AI and everything. So, you need connected world, you need connected data.
08:16So, for that, what is happening that every product which anyone is making, even the
08:20washing machines, the refrigerators, the coolers, the ovens, every equipment, household equipment,
08:27everything which you use in office, home, everything is now connected and data is
08:33continuously monitored and controlled. So, for that, you need a smart product and that smart
08:37product means that when you are developing the product itself, you need someone who can bridge
08:42the gap between an electronics engineer or mechanical engineer or metallurgical engineer
08:47and a software engineer. So, that is the reason ER&D is picking up in a very big way. In my view,
08:52there is much more shortage of a software engineer with mechanical engineering knowledge and other
09:00engineering field knowledge. And because of that, ER&D is now picking up in a big way and the
09:05penetration level is very, very low. So, I think that 10 to 15 years ER&D outsourcing could do
09:10very, very well for India and that is the reason, you know, Persistent, KPIT, Tata, LXC, LTTS,
09:16all these names which you mentioned, despite not delivering good numbers in one or two quarters,
09:20they don't go down much. There is always a buyer who stands because they understand that
09:24what they have seen in the last 20-30 years in IT services, they will be seeing that in the next 20-30
09:29years in the ER&D space. So, it is a long term, very substantial return bet in my view.
09:37Okay. Okay, Sandeep, this is great. Lovely talking to you today on IT, but
09:44we'd love to have you to talk about the wider market as well one of these days.
09:47Thanks for your time today. Thank you. Thank you so much.