Valuation in the information technology sector is favourable but challenges in terms of earnings and uncertainty on Trump’s policies make them good picks only on bad days, says Nischal Maheshwari, Head - Institutional Equities at Edelweiss Securities.
Maheshwari, however, feels risks in the pharmaceuticals sector may not be fully priced in. Most large cap companies have significantly scaled up businesses and are now struggling on compliance issues with US Food and Drug Administration, which could be a long-drawn pain, he says.
He expects decent corporate earnings growth this quarter. Topline growth of around 9 percent is likely to be driven by metals and PSU banks, largely due to base effect more than return in growth, he says.Below is the verbatim transcript of Nischal Maheshwari's interview to Latha Venkatesh, Sonia Shenoy and Anuj Singhal on CNBC-TV18.Anuj: Before we talk about the larger market set up, I wanted your thoughts on two of these spaces, which till 3-4 years back were the biggest support for our markets, IT and pharma, how things have turned, would you be a buyer in any of this space now?
A: Both these spaces are at interesting time. If I look at IT basically, valuations are in your favour but there are a few challenges on the horizon. At the moment, basically the way I would play IT is look for bad days and accumulate them because this could be one of the years where you have more fear basically because of what is happening in the US and in a couple of quarters, even Donald Trump's policy is going to come out clearly which way the things are moving.
Having said that, I don’t think that these policies would be very difficult for India even if we take that USD 100,000 salary, which has been talked about in the last week. The impact on most of the company is anywhere from one percent to three percent on the earnings. So it is not a very big impact if you look at the companies but the market seems to have reacted much more negatively. So on a down day it could be good place to look at.
In case of pharma, I am not very sure because still most of the largecaps companies, which have scaled up their business dramatically are still struggling. Sun
, you name any company basically and there are issues as far as compliance with the USFDA norms is concerned, they still continue to struggle. So that sector we need to get our arms around basically because anybody who gets US import alert or warning -- warning at least one to one and a half year goes away but for US alert or import alert at least two-three years have taken up. So I think the risk is still not factored in fully as far as pharma is concerned.Sonia: Apart from IT and pharma, where are the pockets of strength that we could see in this earnings season, any positive trends that you are seeing?
A: After a long period of time, we are seeing a good toplline growth of around 9 percent. Now obviously, this is being driven by two sectors -- one is the metals and the other is the public sector undertaking (PSU) banks and a year back, both these sectors in the same quarter last year basically had to take in a severe beating and this is more to do with the base effect rather than growth coming back basically into them.
So yes, on the topline and bottomline, the current quarter earning seems to be okay but if I strip away the PSU and the metals then the topline is pretty muted and so is the bottomline at around 2 percent.
This I am talking ex-OMCs. So we have to look into that perspective.Anuj: I am looking at your last strategy report and among your top picks the two names that stand out for me are Ashok Leyland and LIC Housing Finance. We have seen headwinds of both the companies, the stocks have also corrected but what makes you bullish on these names?
A: If you look at Ashok Leyland in the last two years, the company has done phenomenally well. It continues to increase their market share, in the last two years it has gone up -- almost 600 bps has increased and we continue to believe given that the leader is still under stress in the domestic market because of par losses and focus may not be as pronounced for the leader. So they will continue to increase their market share both in terms of product as well as in terms of penetration. The stock has corrected quite a bit from around Rs 100 to around Rs 80. So it is a very good place to be in. Secondly, balance sheet improvement, ROE improvement -- I think Ashok Leyland seems to be just at the right spot at the moment.
Similarly, for LIC Housing Finance, our check on the ground basically still continue to see that around 15-20 percent kind of growth is there as far as housing finance companies is there and LIC stands out close to around two time book with around 18-19 percent ROE. So both these stocks, we still continue to like even after the demonetisation impact.Sonia: Talking about the paint space, your top picks in this space are Asian Paints, Berger Paints etc, we spoke to the management of Asian Paints and a couple of these others like Kansai Nerolac over the weekend and they have said that although November was bad, December sales have picked up quite a bit. Are you confident that the worst could be over and the worst is already in the price for some of these paint companies?
A: We have seen double digit kind of growth. We were speaking to the management of Berger Paints and they said that in case of December, they have already seen a double digit kind of a growth in terms of volume. So it seems to be catching up very fast. The bounce back has been pretty strong. The only thing which we want to still wait for is another quarter to see that the second round impact of the demonetisation, will it impact the volumes further or not?Anuj: In the cement pack, you have chosen the two largest ones, Shree Cement and UltraTech Cement, what is the rationale for that and would you look at smaller names as well?
A: Cement as a pack we like and the stocks have corrected quite a bit. It is very interesting saying that the November volumes were flat. It was not down what market was expecting 10-20 percent, I have heard any kind of numbers on the street but it was flat.
Again in case of December, we have seen price fall basically, which was more than what we had expected. The prices came down anywhere between 5 percent and 7 percent whereas we were expecting 3-4 percent. Come January, basically most of these cement companies have been talking about the price increase and I believe by the end of January or February we will see the full recoup happening.
Now the long-term story still doesn’t go away where you are saying that the demand is growing at around 5-6 percent whereas the capacity utilisation still continues to remain at 2-3 percent. So that still continues to remain and the third important thing is the focus of the prime minister and this government on housing finance. If you look at the December 31 announcements, almost all announcements were about these housing finance companies whether it was loans or whether it was tax breaks basically which are coming on the housing side. So when 65 percent of the cement is getting utilised in the housing space, this is going to be positive for the cement industry.Sonia: Divi's Labs is one stock that has given you a lot of heartache lately because this is the stock that has been one of your top picks for a while. How did you manage the kind of halving that we have seen in the stock over the last two months and how should a long-term investor who has perhaps made a lot of money in the past react to this newsflow?
A: Divi's was one of the stocks, which have stood out for a long period of time and they were getting their compliance through with USFDA, UK Medicines and Healthcare products Regulatory Agency (MHRA) but I think the last one has been a disappointment and if I go through the details of the USFDA warning letter, it is pretty strong. There has been fudging of data which has been called for. So I think this is a disappointment as far as we are concerned.Sonia: Is there still a fear of a potential escalation of the USFDA action or after the kind of comments that we have got from the management now would you be a little assured?
A: I am not an expert on this and I would wait for at least a month before I would say that everything is fine and it is only going to be a warning letter and not escalate further to an import alert.Anuj: Do you track some of these PSU names like BEML and BEL which are now surging, you have them under coverage?
A: BEL under coverage.Anuj: What is your view on that?
A: We continue to remain positive. If you look at BEL, the order book remains to be three to three and a half year and secondly the cash on hand is almost close to around 30 percent of the current market prices but the issue is basically the advances, which the government give for doing the work. That is coming in a bit slow though off late it has improved but the 11-12 percent kind of a topline growth after having a three and a half year of order book that doesn’t seem to be getting sorted out. So yes, a very good strong company but topline still continues to be a worry basically as far as BEL is concerned.