In an interview to CNBC-TV18, Adrian Lim, Investment Manager-Asian Equities at Aberdeen AMC spoke about Indian IT sector at length.
He said that Indian IT sector has de-rated for the last 15 years with regard to valuations.
Below is the verbatim transcript of the interview:
Anuj: I want your thoughts on India's IT sector because you have a large overweight here and you have been invested for decades here and have made a lot of money. Do you think the current trend that we are seeing is a bit of a reversal for Indian It in terms of fortunes or is this just another buying opportunity? In short, do you think Indian IT sector is getting de-rated or will it overcome the current challenges?
A: If you take a long-term view, in terms of ratings wise and valuations, Indian IT has de-rated over the last 15 years or so and the reason for that is as it grows it moderate to more modest level and you get these ratings that follow suite and that is quite normal for any company in the technology sector which scales up. The other challenge that is more crucial rather than the de-rating and I do not think it is going to substantially de-rate from here. I think these levels are comfortable for what it has. The other thing that is more important is its business models - there has been a lot of change in the Indian IT sector offering over the last five-eight years and we see many of these companies try and change to adapt and adopt and become increasingly more relevant or at least as relevant as they were before to their customer base. We hear terms of automation, we hear terms of digitisation, disrupted technology and these are interesting things that the IT companies which used to do slightly different work in the past, will have to adapt to.
They do have to be more proactive with customer needs, they do have to anticipate their customer needs and not just fill out request for proposals or auction bids for jobs and that is the thing that will challenge them and will stretch them over the next five years or so. Having said that they do have a huge talent pool, there is a lot of training and recalibration going on especially among some of the stronger players in the industry. They still have a lot of cash and resource as backup to fund this transition. So we think that they will come out on top. In what form and how, the specifics of that is difficult to pin down at this stage but we think there is a lot of quality in the IT companies and this de-rating is within the range of valuations we have seen for the last few years.
Latha: Valuations are still for the big boys between 150 and 20 times and earnings growth is in single digits, probably even in middle to high single digits, if that. Would you worry that therefore, at this point in time, till they once again show double digit earnings growth or till valuations come down closer to their earnings growth, would you stay away from them or even tweak some of your holdings?
A: We always tweak at the peripheral of our holdings but our core thesis remains the same. We have quite a bit in Tata Consultancy Services (TCS), we have a bit in Infosys, we have a bit in MphasiS and that is the three key players that we have decided to take exposure within the IT market.
On your question on whether deratings come down to meet current levels of expectations of growth or whether growth inches up to validate what the market expectations of growth are, in the medium-term it will be a bit of both. The difficulty and the challenge is that there are parts in almost all the key players' profit and loss (P&L) that are growing in excess of single digit numbers. So in excess of 20 percent and that is the key issue here.
Not all in IT is the same, there are bits that are growing very quickly, there are bits that are cannibalising some of the old business and there are old business bits that seem like they are on their last legs but are still growing reasonably well. So the interesting thing is to actually understand the landscape behind the revenue drivers and having a clearer view over the next 2-3 years in the medium-term, how those pan out.
But to answer your question, shortly, the growth rates will inch up from here and valuations in the short-term could see some weakness from here. But as a business model, these are players that we think will do well in the disruption that is currently going through.
Sonia: We will come back to individual stocks in a bit, but what is your view on what kind of upsides emerging markets and India could see over the next 12 months because generally when the US growth is strong and when the Fed raises rates, that bodes very well for emerging markets, similar to what we saw in the 2004 period. What would your view be?
A: There is scope for positive improvement, but as you can see, looking at valuations and some of the resilience of the capital markets in emerging markets, some of that uptick will have to wait a little longer for where there are clearer signs of more sustainable levels of recovery or strength from the US economy. We are at a stage where it is very soft in the emerging market space. There are segments that will do well but it is extremely difficult to call exactly and give you data point on what growth expectations exactly should come in the end of December this year.
Anuj: Coming back to India and your own positioning in Indian market, two sectors where you have decent weights have been materials and healthcare. Now materials have done well as we all know and that is globally. Now healthcare has seen a bit of a decline once again in India, in line with IT. Incrementally, how would you approach both these sectors?
A: Healthcare and materials are not our largest positions. They are not even in the top-three of our exposure weights, to give your viewers context. IT, banking are by and far the two largest positions. But you are right. Healthcare and materials, we do have an overweight to the benchmark exposure although they are much smaller than our IT and our financials position. Within pharmaceuticals itself, there are periods of time when - it is an industry where implementation or regulatory risk is actually pretty high.
There is a lot of competition in the space and there is a lot of protectionism, especially when economies are not doing well. So what we see within the pharmaceutical segment is some of that stress over the last 1-2 quarters or so. It does not mean that it is a bad sector to be in. we have key positions, larger positions in Sun Pharmaceutical Industries, we have some position in Lupin as well. These are companies that we think, will be able to withstand some of these short-term or medium-term stress points. But you do have to do your homework and get comfortable with what you are buying.
So I think it is a time to have a look and see whether they meet your requirement and you feel comfortable with it. But it does not ring the demise of the healthcare industry at any point in India.
With respect to your question on materials, actually we have a quite skewed position there. It is in cement and in paint. It is not in mining materials or construction materials as such other than in cement and that feeds into the general strength of the construction and renovation markets and a little bit more broad-based, not just driven by infrastructure projects or by public sector spend but a deeper, wider base into the private sector into retail and individual consumption as well.
And cement, unlike most of the materials is not so much driven by global economics as it is by domestic economics. And cement as you know, you do need to have a strong effective, efficient, physical distribution infrastructure and that is the thing that we think will give the cement players that we have invested in a leg up or a strength within an environment like this one in India, not so much the global market play.
Latha: Your consumer pack, what would that include? Would you now want to change that into perhaps including some of the outstanding performance in auto ancillaries as well? They are not strictly consumer durables but feed into them. How are you looking at the entire consumption basket? Does the India rural consumption story excite you? How do you think about consumers?
A: The Indian consumer is very exciting. But the Indian consumer does not consume – cars is a big ticket item, it is visible. Like most consumer items, people have an emotional appeal and they think they can pick the winners and that is actually quite tricky in the auto segment in India. The four-wheeler market has got 2-3 big groups in India that do very well. But it is a very competitive market space. The two wheeler markets has more oligopolistic strength but it is still a very competitive market.
So what we do have is we have some auto ancillary in the form of Bosch. We have auto like Hero Motocorp and we held it with Honda and without Honda as well and we think that in the give and take of the auto and auto ancillary segments, these are two segments that we feel confident that they have the resource as well as the technology and the people to continue to compete. There are periods of time when you will get a rush into the auto segments and there will be big winners and big losers at different points in time. But given our long-term view and we tend to hold things with a five-year view onwards in mind.
We think that these two examples will stand in good state. We have a lot more in consumer staples. We do have in consumer discretionary and that is a somewhat diversified basket as well. We have the multinational companies (MNCs) like Hindustan Unilever (HUL) and Nestle India, but we have quite a bit in the local champions or the now ex-Indian champions as well in Godrej Consumer Products and Emami and all that.
Sonia: You have liked fast moving consumer goods (FMCG) for a while, you have not only HUL, you have liked Asian Paints and now, you have recently added Emami into your portfolio too. Do you see a lot more value in some of the smaller FMCG companies compared to the bigger ones?
A: Value is quite difficult to come by in consumer staples. If you look at the price-earnings ratio (P/E) on a nominal P/E basis, it is a sector that is well-priced. It is a sector that investors like, they empathise with and they identify with. It is also a sector that people do like in this part of the cycle where demand is soft and you look for a resilient businesses.
I do not think there is so much value in terms of pricing. You can find hot spots of it if you go down the scale. But there is a compromise as well. We need consumer companies that have got strong brands, strong distribution, strong development resource and have a proven ability to market and communicate those values to their consumer base. They need to understand stocking, they need to understand pricing, competitive environment and they need to keep a strong, relatively stable team of senior managers that know their work.
I would not buy a cheap stock just for the sake of getting something lower priced. It has to be of decent quality good quality and that is something that you can find in India. But valuations, not so much at this point.
Latha: But there is no question of a cheap stock now, isn't it? The question that we are asking you generally, macro, are you buying at all in India now or are the valuations scaring you?
A: We are maintaining our weights in India. The thing is we pick stocks and stocks move in relative valuations to each other and there are points in time when you can take profit from certain counters. By and large, we have not been taking much profit from India at this point in time. It has been sideways for a while now. We like the quality of what we hold so, at this stage, looking back even over the last six weeks or so, we have been maintaining these weights. We have not been aggressively adding or deleting from our positions in India.
Anuj: One stock which done remarkably well for you is Piramal Enterprises. It has doubled since your entry. What are the triggers here? Are you looking to add more?
A: It is interesting. I think Piramal is an exciting group. Ajay and his family have gone through evolution of the group's businesses and has, at points in time, been able to do deals which really optimised the opportunities available to it. It has morphed over the last decade or so from a healthcare provider to pharmaceuticals into a business that is now well positioned for the evolution of the financial sector so that is something that is interesting, that excites us and we are watching closely some of the events that happen at the group.
But at this point in time, it has done well. I do not think we will be adding to it aggressively. It is now time for it to deliver, it needs to deliver on its plans to make sure that they do have a level of management resource and bandwidth to absorb all these changes and to deliver on some of the aspirations that they have talked about.
Latha: You have always held HDFC and Kotak Mahindra Bank as your favourites, more lately Kotak as your best investments. But India is growing financially in several other areas. The biggest craze now is housing finance. You have HDFC of course, but there are a bunch of other smaller housing finance companies that are reaching for the skies and likewise insurance, only one listed player, but there are other conglomerates like State Bank of India (SBI) and Kotak which have insurance companies within them. Any of these plays will be an incremental target for you?
A: They are all on the watch list. We look at the sector with great interest. But you have got quite a few issues there and challenges within the financial space. We do have HDFC, we do have Kotak. We also have ICICI Bank for example and we trim and evolve our portfolio for different reasons at different points of time. The insurance opportunity is interesting, but it is expensively valued. I suppose you can make a case for having some exposure to get to the growth.
But it is still evolving quite a lot. It is not evolving as dramatically as it used to about five years back. The players are more stable now. You have players that are far more focused on medium-term objectives and growing a proper business instead of just earning commission. So we think it is a healthier space to be in but it is still not a cheap space to be in and we will watch this space with interest. The other bit that is interesting that you mentioned about is housing finance.
We have a lot of exposure in HDFC. But we also have mortgage exposures through our other holdings as well. We have had a look at the other financial companies and just because there is a lot of choice does not mean you need to buy five companies. Ideally what we try and do is we try and buy one, one for a particular idea. We try to come to a clear decision on which is our preferred holding. There is tendency in markets like India to expand your holdings and hold 200 companies because there is so much choice. But I think it is far more useful to be very clear about what you want and far more difficult to come to that decision.
Sonia: I want to get one more sector in, a sector which you have been bullish on for a while which is cement and within that, you have liked stocks like Grasim Industries. But there has been so much wealth created in some of the non-index largecaps like India Cements, HeidelbergCement India, Shree Cements of the world. Anything else that interests you in that space?
A: We hold Grasim, but the purest play we have is in UltraTech Cement. We do have a bit in Ambuja Cements as well and we have a small bit in ACC. Those are the four holdings that we have that have cement exposure. So Grasim UltraTech, ACC and Ambuja, those would be the names that we would hold.
Latha: When you ponder, look at the markets, you have billion dollars invested here and your company will have many more billions in other markets. All markets are challenging their previous valuations. What fears do you have? What is one big fear that might poop this rally?A: It will be anything. It could be a tweet in the middle of the night.