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Apr 17, 2017 02:36 PM IST | Source: CNBC-TV18

Market valuations 'stretched but not scary'; see severe headwinds for IT: ICICI Pru MF

Manish Gunwani of ICICI Prudential MF sees IT acquiring the characteristics of a utility stock, but remains overweight on pharma due to fading regulatory issues going forward.

Even as higher valuations come in focus due to the current rally, ICICI Prudential MF believed that the market, on most parameters, is fairly valued.

“I would not use the word scary for the market’s valuations. But, on an earnings basis, they (valuations) are a bit stretched,” Manish Gunwani, Deputy CIO, Equity at ICICI Prudential Mutual Fund, told CNBC-TV18 in an interview.

From a sector perspective, Gunwani said he sees fairly severe structural headwinds for information technology (IT). Automation, movement to cloud, among others, are the structural headwinds for the sector, he said. The whole sector is now acquiring the characteristic of a utility…variations in topline growth is reducing, he told the channel.

“Currency will start playing a bigger role in the way you look at that sector,” Gunwani added.

On telecom, he placed a contrarian bet on telecom even on expectations of earnings pain to continue for 2-3 quarters. The rationale for the bet, he explained, that once capital infusion in such sectors peaks off, it starts to see consolidation and profits go up, he said. It may not happen immediately in 2-3 quarters. From a business cycle, this sector is now at the bottom, Gunwani said.

Meanwhile, there are some great structural stories in auto ancillaries and auto financing, he said. But he is being selective in the space and owns 2-3 names. One cannot call them necessarily cheap right now, but over the last few years, auto ancillaries and auto finance have become multi-baggers.

Gunwani remained overweight on pharma sector on the back of wearing off of US drug regulator’s issues over the next couple of years. The opportunity size is significant, he added.

Among banks and NBFCs, he was very selective in picking stocks from the latter as he did not see much of froth in the overall sector. Meanwhile, he liked small real estate firms, which are better governed. Some midcaps in the space were on his list.

Speaking on sectors of the year, he felt that niche spaces—general insurance, aviation and logistics—could be the ones.

Below is the verbatim transcript of the interview.

Latha: The earning season has kicked off. Market is very close to its all time highs, just about 100 points off. What is the feeling? Are you approaching with a desire to buy at all or are valuations scaring you?

A: I wouldn't use the word 'scary' at this point of time. However, on earnings basis maybe the valuation is a bit stretched but if you look at long-term history in terms of where we are in the corporate earning cycle. Hopefully we are at the bottom and picking up. So on a price to book basis, on replacement value basis or on a normalised earnings basis the market is fair. It is not very cheap but it is not very expensive either.

Latha: You saw the results of Infosys. What is the feeling in the IT space?

A: This sector has grown over the last 20 years and there is no denying that there are fairly severe structural headwinds in that sector in terms of automation of services, movement to cloud. So what is increasingly happening with that sector is its acquiring a kind of utility characteristic where a good year is 9-10 percent, a bad year is 6-7 percent. So the variation in topline growth is reducing and in that context what will keep happening with the sector is the currency will start playing a bigger and bigger role in the way you look at that sector. Therefore, from a portfolio perspective it is a good dollar hedge but it is not a sector which will lead the market in the medium to long-term.

Anuj: The space that you have taken a big contra call as a house or as a mutual fund is on telecom. Do you think with Jio continuing to announce aggressive tariffs, do you think there could be some more pain the space before they start to move or you think most of it is now fully underpriced?

A: The earnings pain is not fully through. I do not think next two-three quarters are going to look great on earnings. Essentially our philosophy there is when we look at capital hungry sectors, the rate of capital infusion into that sector, when it peaks off, it typically implies that slowly the sector will consolidate and profits will go up over a period of time. It may not happen over two-three quarters but most of the capital that has entered this sector is already in. I do not think incrementally players will commit huge amount of capital into these sectors. So we had two rounds - one, the 2G allocation, new players coming in and second, Jio. So after this I do not see any big capital coming into that sector which effectively we think over a medium-term it means that players at some point want to make RoE, want to make profits. So from that sense from a business cycle perspective, we think that sector is at the bottom.

Sonia: What about auto ancillary or auto financing space. You have been very bullish on names like Motherson Sumi Systems, Bajaj Finserv and they have given you great returns. You think the party is yet to continue in this space?

A: Some of these names are really great; structural stories, good stocks to own over long-term. I wouldn't call them necessarily very cheap at this point of time because as you pointed out, over last few years a lot of these stocks in auto ancillary space as well as in the auto finance space have already become multi-baggers. So we have been a bit selective in that space. We own two-three names in that space right now and whatever we own we think are good stocks to own over the long-term.

Anuj: Pharmaceuticals, as a space, do you think there are opportunities now at lower levels?

A: Definitely, in general, we are overweight that space. Basically, we think over the next couple of years, a lot of these Food and Drug Administration (FDA) related issues should wear off. From a top-down perspective, in terms of India's competitive advantages, it is a sector that suits that profile very well. You have very high quality managements, high quality companies and the opportunity size is quite significant, not only in the US generic space, but with the global pharmaceutical space overall.

So, from that perspective, we definitely think at this point of time, this is one of the largecap spaces we are positive on.

Latha: I am looking at some of your midcap funds. You have a substantial sector allocation in banking, finance, non-banking finance companies (NBFC) as well as cement. NBFCs have run up a goodish bit, even housing finance where of course, there is a lot of positivity because of this Pradhan Mantri Awas Yojna (PMAY). Would you still back that area?

A: We have been very selective in that space. I do think there is some froth there. Again, it is a space which has done very well, but ultimately, if you look at the underlying industries, typically NBFCs fund consumption primarily house and auto. Now if you look at those two large segments, they are not growing as fast as a lot of the NBFC books are. So, the pool of profit of the underlying industries is growing at a certain space and the NBFCs, all of them seem to be growing much faster.

Now obviously, logically this cannot last. A lot of it has come because A] they have squeezed out some unorganised players and B] maybe the loan-to-value ratio (LTV) has gone up or whatever.

Latha: Squeezed out maybe even the public sector banks.

A: Yes, but market share gain can only run for so much time. Right now, everyone is extrapolating very high growth rate for that space which I doubt will last for too long for everyone.

Latha: Will you rebalance to the public sector bank space?

A: Depending on the fund, we do have overweight on PSU banks. But yes, we are just trying to be as selective as we can.

Sonia: The stock that is now moving with a lot of volume is Indiabulls Real Estate on the upside. I know this is a space that not too many people are interested in, but now there are some developments taking place here, regulatory issues are getting solved, anything in this space that would interest you? You do not have too many of these stocks in your funds at all.

A: We actually like some small real estate companies which we think are relatively better governed and there is deep value in terms of discount to net asset value (NAV). It is not a space we are brushing off on a broad basis. We do like some midcaps in that space.

Latha: Cement?

A: At least largecap, we are not that positive because valuations are not cheap, but in midcaps again, there are some stocks we like a lot.

Latha: Last year's sectors of the year were metals in the big space and NBFCs in the midcap space. What may be your sector of the year?

A: There are a lot of these niche spaces like general insurance, aviation, logistics. Some of them can really scale up to being largecap spaces. So, it is very bottom-up at this point of time.

Reliance Industries, the parent company of Reliance Jio, owns Network 18 that publishes
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