Pick midcap IT now; bullish on Divis, Sun Pharma: HDFC Sec

Market is likely to maintain its upward momentum on sustained liquidity flow near term, feels Dipen Sheth, head-institutional research, HDFC Securities.

"In June we are going to be at the mercy of the central bankers - Reserve Bank of India (RBI) as much as the Bank of Japan (BoJ) or the Federal Reserve. But in market is not facing any short-term downside pressure," he said in an interview to CNBC-TV18. The March quarter earnings season failed to give market any positive direction, but the market could get another leg up if the Reserve Bank of India (RBI) obliges with a 50 basis points rate cut in June monetary policy given that inflation has slid to a 41-quarter low, he added. Investors can now consider investing in IT stocks as valuations of midcap IT companies are enticingly cheap. From the pharma space, he is bullish on Divis Labs and Sun Pharma. Sheth says they are standard currency plays and run by quality managements. "On the flipside, players like Ranbaxy, who haven’t done their home work well, will face issues on the regulatory front going ahead as well," he cautions. One should steer clear of capital goods stocks as their earnings clearly reflect the impact of local and global slowdown that these companies are facing. "Macros don’t suggest anything would change for these companies soon. Ex- L&T all other majors like BHEL, Crompton, Thermax, Voltas will see fall in margins and multiples will keep going down for another few quarters. They are in a terrible spot right now." Meanwhile, he sees the rupee trading at current levels going forward. Below is the verbatim transcript of his interview on CNBC-TV18 Q: From where we have reached after the volatility of the last couple of weeks, how would you approach the market now? Is it still a comfort zone for buying or are you expecting some reaction? A: Reaction would come only if there was a significant risk of the inflows coming into the market, tapering off in any way and that by itself is a function of how global macro or liquidity easing plays out. There was a bit of sense that the US was going to withdraw some of its quantitative easing (QE), the additional comfort came in from Japan, so I do not see that drying up in any way. Therefore, momentum definitely suggests that we are headed for an upmove. In June, we are going to be at the mercy of the central bankers; Reserve Bank of India (RBI) as much as the Bank of Japan (BoJ) or the Federal Reserve (Fed) Q: How do you get your head around this dichotomy between currency versus what the market has done through all of May? A: Some of the appreciation in the rupee was people merely playing the commodity softening trade and the gold falling trade. However, a little bit of reality has caught up again, there is no structural change in the trade deficit likely to play out over the next few quarters. Hence the currency gave some ground. It is a very important time to look at IT stocks because they have been the drastic underperformers in this calendar year so far and they are very good businesses notwithstanding the regulatory concerns around them in the US right now. On currency, some kind of reality has come back and this is where it is going to hang around. Q: Just stepping away from liquidity for a second though, for most people, their takeaway from earnings season seems to be either that the earnings estimates have been cut or earnings per share (EPS) estimates have been cut. Would you say it has been a quarter of more misses than hits and that’s the way we are stepping into FY14? A: The quarter has been neither here nor there. You had hits, you had misses but if you were looking for a broader direction in terms of giving us some great news at an aggregate level, I don’t think that has happened barring the financials and that too very selectively or the consumer companies. I don’t think there has been any kind of breakout in numbers as such and that’s quite reflective of what’s happening on the macro front. I don’t think this quarterly results season has given us any great direction going forward. Q: If we are presented with an ugly sub 5 percent GDP number on Friday, do you think that will come in the way of the market’s upmove or will the markets be able to shrug it off and move forward? A: A sub 5 percent for Q4 in terms of the reported numbers, I don’t think is a big concern right now because it is in the price, it is in the dynamics and we all know it is going to be sub 5 percent or thereabouts. What is more important is what happens from here on. However, so but will liquidity continue, will the monsoon be fine, I think early indications are that monsoon is going to be fine. This is one of those times when the Reserve Bank of India’s (RBI) moves are going to be very keenly watched; you have IIP at 20 year low, the governor has been saying that he is not going to be swayed by arguments of falling growth but this is getting to be troublesome now. More importantly, inflation has cracked to a 41 quarter low. So, his big concern that inflation was getting out of hand is now very much a positive in terms of if you want to anticipate a rate cut. If a significantly rate cut of say 50 bps happens then that would give the next leg up to the market and inflows would continue.
_PAGEBREAK_ Q: How do you approach pharmaceuticals now? You spoke about IT because of the rupee but they have been moving in opposite directions, Sun Pharma continues to hit new highs every week, Ranbaxy is collapsing, there has been so much talk with regards to the US FDA off late. Is it becoming a minefield or do you sense a lot of opportunity there? A: What is happening in pharma is pretty much what is happening in IT - there is a disparity or divergence in performance, there are problems coming up in players who are not so well prepared and who have not done their homework well enough. So, you will see problems at companies like Ranbaxy or a few other scares in some companies whereon the regulation side where they haven't done their homework well.  On the other hand, companies like Sun Pharma, and I have a lot of hope in Divi's Laboratories and these are standard currency plays. They are global beaters at their business; any currency tailwind will help them. They are under very high quality managements, clean cash flows. So the divergence that you are seeing in this sector is quite reflective of the difference in quality of the businesses. Q: You were making the point about IT. What would you pick from there, not from the front liners but from some of the midcaps would you say there are interesting opportunities now? A: Yes, we think midcap IT is right now enticingly cheap and for some reason this kind of discounting is justified because there is this scare about how easy is it going to be to deploy people in the US from India - caps on visas and caps on hiring and so on. So structurally, the margins could fall and we have had lots of analysts downgrading some numbers. It is important to get a slightly longer term picture here because IT has been a sector that has created lot of wealth over the last couple of decades in this country. It has attracted the best of talent, it's a sector where we can beat the rest of the world and we have shown that repeatedly. This is one of those times when IT is facing a challenge and it had better live up to its reputation. If it does, some of the midcap names or the largecap names and the kind of multiples they are trading at look alluring as of now. So, this is a very good time to look at IT because for example you have some large midcaps like MindTree trading at sub 10 and NIIT Tech, which is a slightly smaller company for sub 7. So there is no lack of business traction in these companies.  Q: No such luck for capital goods, ex-L&T was there anything that stood out as a positive number, one that you would get optimistic on going into the next couple of quarters? A: Absolutely no, there is nothing in the macros which suggest that capital formation is picking up for all the stimulus that the government wants to do or has done so far. There is absolutely no sign that order books are overflowing. You were right, Larsen and Toubro is an honourable exception but it is an exception. So, whether you look at Thermax, you look at BHEL, you look at Voltas, you look at Crompton - you have local and global slowdown reflected more than adequately in their numbers. Margins will fall from here for another few quarters, multiples will keep going down and they are in a terrible spot right now. Q: Recent numbers for public sector banks have also been quite bad, at best mixed but are you spotting some amount opportunities there because of the valuation compression? A: We do not think that public sector banks are fantastic businesses and that their valuations should dramatically re-rate from here.  However, if you look at the kind of discounts at which they are trading with respect to the private sector peer set then an IndusInd Bank trading at 3-3.5 times adjusted book looks very costly in front of a Canara Bank, which is trading at just around book. These are on FY14 numbers.  What is important at this point of time for this trade is that we might have the timing right for a change. Public sector banks have been on the receiving end of investors for all the right reasons. If interest rates fall then a lot of them are holding excess statutory liquidity ratio (SLR) investments, they will get headroom to book mark-to-market (MTM) or treasury gains and will use that to clean up their books a little bit. That could lead to a little bit of upmove in PSU banks from here. _PAGEBREAK_ Q: What are your expectations from the policy front over the next few months because yesterday the prime minister ruled out Goods and Services Tax (GST) till the next government is formed. Is that a sign that slowly things are coming to shut down phase in preparation for the next leg, post elections or in the next few months do you think the market will get anything from New Delhi? A: I am a little bit sceptic here. When elections were not looming on the horizon, this government could do precious little on the policy front. We had a couple of years of complete policy paralysis, you had scams breaking out and you had virtually no evolution on the policy front. Around last August or September is when we got a new finance minister and suddenly hopes got rekindled and the markets reacted to that. India got re-rated, money came in and the markets moved up. Right now, there is no room to have significant policy changes. The elections are close and they might get closer we think. So, I don’t think policy changes will happen in anyway to inspire markets. If the markets are holding steady, it is because of inflows and because of slightly improving macros. Q: Whatever the market maybe doing, the dial just doesn’t seem to be moving on domestic flows. Domestic institutional investors (DII) of course have been selling consistently but even the mutual funds seem to have a huge redemption problem on their hands. What exactly is happening there? A: Retail investors have not made money over the last three-five years in the markets and one cannot blame them for pulling money out. They have made super money on gold and so they continue to buy gold on dips. I think some of that may taper off for sure. Gold has also held up after that one time crack and it is around USD 1,390-1,400 per ounce levels right now. I don’t think there is any thing that tells retail investors that on the ground things are changing so much in the economy that the stock market is going to give them some terrific returns over the next few years. But things can turn on a dime. If policy changes do play out, if the new government comes in and takes some dramatic steps. The honeymoon phase for this new government would certainly usher in confidence in the markets and DII or mutual fund inflows might come back. Q: What about fixed income instruments, basically bonds, fixed deposits? Is that still big competitor to attracting flows? A: If you notice, the assets under management (AUM) of mutual funds are going up but equity AUMs are cracked. So, the obvious inference is that debt funds are attracting all the money and with a reason. Interest rates have been heading down, and will continue to head down and this to my mind is a very safe place for retail investors right now for the next year or so at least. Q: What would be a good way to approach the market from here on? Just treat it as a trading market and play these 10-12 percent kinds of cyclical rallies which come about every few months or do you start building core investment positions for a multiyear cycle? A: You can never get the timing perfectly right but on core investments building up for a multiyear cycle, I would be a little sceptical at the margin right now. We are very strongly vulnerable to outflows given the recent inflow history of last 17-18 months. However, I continue to believe that markets do not face short-term downside pressure so it’s a slightly iffy situation out there. While we remain vulnerable, I don’t see a short term downside playing out but if the money gets out, we might well see a crack.