Moneycontrol
May 08, 2017 02:50 PM IST | Source: CNBC-TV18

Auto ancillaries & logistics may see good earnings; wary of hsg fin cos: Nilesh Shah

Envision Capital’s Nilesh Shah believes auto ancillaries and logistics firms could see better earnings compared to the overall earnings scenario. He finds IT and pharma to be fantastic long term investment bets.

Signalling a caution on the rally in midcaps, Envision Capital has called for a careful approach in making investments.

“The midcap index is trading at historically high valuations…PE multiples [of this kind] are something that we have never seen before,” Nilesh Shah, MD & CEO of Envision Capital told CNBC-TV18 in an interview. He also added that there could be value in some pockets and one could take contrarian calls as well.

Shah observed that the market could be looking to factor in a recovery in earnings, but is wary about the turnaround not being substantial enough.

Among the sectors, he believes auto ancillaries and logistics could see better earnings as compared to the overall results scenario. It still makes sense to look into these pockets and be invested in them, he said. Meanwhile, two-wheelers, technology and pharmaceuticals could be positive contrarian bets.

Simultaneously, Shah sees cement to be a good investment opportunity for a 3-4 year horizon. But, in the near term, he sees challenges based on volume growth.

Speaking on the rally in housing finance companies (HFC), he does not see these firms to be in a great scenario. HFCs are running ahead of their underlying value and there is an increase in competitiveness, he said. “Net interest margins (NIMs) are under pressure and valuations are at astronomically high valuations,” he told the channel. One could look at smaller private lenders, he added.

Meanwhile, he is very upbeat about the harrowed IT and pharmaceuticals space. “These are fantastic long-term investment opportunities. Valuations are cheap and no matter what the headwinds are, the companies are still growing,” Shah said. Post FY18, he expects the sector to grow well and it makes sense to have a contrarian approach.

Among banks, he likes tier-II private sector banks and suggests taking a look at the entire pack. “They have gone through a learning curve in terms of managing credit book and spreads. This will play out in 2-3 years,” he said.

Below is the verbatim transcript of the interview.

Anuj: Are you still buying midcaps after the kind of rally that we have seen or you think in general you would be a bit cautious?

A: The kind of run-up we have seen in the midcaps, it definitely calls for caution. I would like to highlight a couple of things here that if you look at the midcap index - that is trading at about 34-35 times trailing earnings. Those are historically high valuations. These PE multiples are PE multiples that we have never seen before even in the great bull market of 2006 to 2008, the valuations of the midcap index were more like 25-27 times versus that they are trading at 34-35 times. So it definitely calls for caution. I think one has to be even more careful in terms of making incremental investments - that doesn't mean that there aren't pockets of value. There are definitely pockets of value but that would require taking some kind of a contrarian approach but otherwise on the whole at a very aggregate level, the midcap pack is definitely expensive from keeping in mind especially what has happened in the past. I think what the market is probably trying to kind of factor in is a potential earnings recovery over the next one or two years and that earnings recovery will have to be substantial. If that doesn't happen then these valuations will not sustain.

Latha: Are you buying now. Have the earnings convinced you in any pocket that you are not buying too pricy stocks?

A: There are two ways to look at the opportunity there. So one for example pack like auto ancillaries, industrial consumables, quality logistics companies, these are the kind of companies where the earnings growth will be probably way ahead of aggregate earnings, way ahead of the overall earnings situation and it still makes sense to look at these kind of pockets and be invested into them. So that is kind of one pocket and these are essentially sectors which are more connected with the domestic economy. The second pocket is where you could turn a contrarian and we don't know how long the wait could be but if you look at technology, pharma pack, the two-wheeler pack, these are sectors which have underperformed significantly over the last one-two years but earnings are still in the band of 10-12 percent and valuations are at multiyear low and it is quite possible that a year down the line we might just look back and say things weren't as bad for them. It is quite possible yes, the last couple of years have been bad and the growth has been lacking but it is quite possible that in the next few quarters you could see some bit of recovery and the valuations at which they are trading at, it probably makes a compelling contrarian call.

Sonia: What about some of the space like cement? Today cement is in focus because of the proposed ACC-Ambuja Cements merger but in general how would you be positioned here?

A: One has to be constructive on the sector. If 2/3rd of cement demand comes from housing and if affordable housing gains momentum - that will be an important demand catalyst for the cement sector, so if one has three-four year horizon then cement is definitely the place to be but in the next two or three quarters there could still be pressure coming in, volume growth is till anaemic, it is low single digit, it's still below the long-term average, so that is one challenge and the other challenge is margins; raw material costs are going up for them therefore margins will be under pressure for the next two-three quarters. So we still believe that the first half of this financial year will be sluggish for the cement companies but post that if volume growth comes in which we believe volume growth will come in, it would gives some more pricing power, the ability to pass on margin pressures and therefore back to the cement companies generating good cash flows. We have to keep in mind that cement is one area where for the next two-three years they can have significant growth in profits if the volume growth happens because they do not need to expand capacity in a significant manner. So that is where operating leverage can come in significantly for the cement sector. So good from three-four year perspective but the next two-three quarters could still be challenging for the cement sector.

For entire interview, watch accompanying video...
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