Speaking to CNBC-TV18 Nilesh Shah, MD & CEO of Envision Capital, said that events like expectations around the Pay Commission and monsoon are priced in all ready. “Market is waiting for cues from US Fed.”
Earnings outlook for the next two years looks stronger, he said, adding that it is going to be a lot better for companies.
Falling interest rates are adding to margins of the companies, he said. He flagged concerns over top line growth. “What is required is a strong top line growth…that is important. We are already seeing it in the auto sector.”
He spoke about the recent high-level exit from Infosys, saying that the Street is preoccupied with the growth outlook. “As long as Vishal Sikka is around, I don’t think the Street needs to be concerned,” he said. The bigger challenge for the sector would be to grow north of 10 percent.
In the consumer or staples space, he said Britannia is a better pick than Jubilant for two reasons. One, valuations of Britannia are lower and 2) one owns the brand, and the other Jubilant is a pure franchise. Otherwise, both stocks are an avoid for him.
He doesn’t think it is prudent to put incremental money in PSU banks. The reality is it has become more of cyclical bets.
Consumer discretionary space is one of the most attractive, he said. “I think travel tourism, hospitality are good from a medium-to-long-term.”
The entire opportunity in pharma stocks will play out over the next five-seven years.Below is the verbatim transcript of Nilesh Shah's interview to Latha Venkatesh, Sonia Shenoy & Anuj Singhal.
Anuj: What could you make of the recent consolidation? Do you think it is just buying time ahead of the big event, do you see one more round of upside post the Fed event?
A: That would be a function of what the US Fed does, but probably it's going to be one of the most important events to look forward to for the rest of the year. If there is one trigger left in the market place, it is definitely going to be that because the earnings by and large seem to have kind of adequately been priced in or discounted, by and large some of the expectations around the Seventh Pay Commission or good monsoon, a strong rural economy. I think these are some of the events or triggers which seem to have got priced in. I think the market is waiting for that big cue from what the US Fed actually does towards the end of this month and that is going to be an important event.
Latha: What kind of earnings growth are you seeing in the market? I mean we saw for the first time the Q1 earnings come a little better after almost 12-16 quarters of flat performance to even negative performance in some quarter. Are we in for some kind of a decent recovery or is it going to be flattish for a longish bit. What is the earnings outlook?
A: I think it is going to be a recovery. It is going to be a lot better than how it has been in the last two quarters or last two years. I think all of us have been expecting a very strong broad based earnings recovery and that has not been happening. There have been pockets of excellence or strong outperformance in terms earnings but that is not something which is broad brushed across the board - that is not yet happening and if at all that is an important concern for the market because that actually in a way limits or narrows the choice of sectors or the choice of companies that you would want to be. So that is one and second, the moment you see a recovery in a sector or in earnings, you see gush of liquidity just flowing in there and virtually in a shortest possible time span you see a huge rerating which happens. So these are some of the challenges which are there in the market place but our broader sense is that earnings will get into the more normalised mode from here onwards. I think there were a lot of sectors which weren't doing too well. I think for them there is a going to be a bit of a recovery, balance sheets are beginning to get streamlined a little, interest rates -- we can clearly see the falling interest rates adding to margins for companies. A bit of gross margin improvement has been there and that seems that that will continue to sustain. I think what is required now is a strong topline growth and that's something that is going to be of tremendous importance going forward. We are beginning to see that in some way in the auto sector but it is yet to spread out to some of the other sectors and therefore, what is going to be most important of all is a strong growth in revenue, strong growth in volumes. I think if that happens then you could say that there could be a very broad based recovery in earnings.Sonia: Let's talk about Infosys because it doesn't go out of the news. The street is divided on Infosys. Some believe it is a great opportunity and some are writing off the story. Which camp would you belong to now?
A: I think it is an opportunity, not necessarily about people leaving and therefore the stock correcting. I think right now the street seems to be more preoccupied with the growth outlook. I think in these kinds of companies you would always see a few exits and then you would also see some high profile entries happening. In a way it is a game of musical chairs, you hire from someone else and then you let go off some of the people which are part of your team. So the big rerating in Infosys over the last couple of years has happened because they had Vishal Sikka come in and as long as he is around, I do not think the street needs to be too concerned.
However, I do not think that if the tier two level or the senior level exits which are happening, is something which is going to rock the boat because we do not even know whether some of these exits are in a way part of Infosys plan to continue to restructure and make them more future ready, as I would say.
I think the bigger challenge right now is that will the sector in general be able to grow north of 10 percent. I think 10 percent growth rate in dollar terms had become base for the sector for the last many-many years. So the simple kind of matrix or template was 10 percent revenue growth in dollar terms and 20 percent operating margins. These were two kinds of floors, so to say - that seems to be in question and that is the big challenge for the entire sector. If companies kind of deliver these kinds of numbers in terms of template, they should be fine and therefore there should be an opportunity but otherwise if that doesn't happen then the sector could be in for a very big round of trouble and I believe that companies like Infosys should be able to catch-up maybe with a lag of one or two quarters but finally they should be there.
Anuj: So right now it's at a good price?
A: I think this broadly should be a good price. The only joker in the pack and that could be a bit of contrarian bet is in terms of how the dollar rupee equation, currency changes. So right now that is a much divided camp whether the rupee dollar goes to 68-69/USD or it goes to 64-65/USD. However, if it were to go to 64-65/USD - that would be an added dampener on the sector on whole bunch of exporters and especially of course for the technology sector but if that doesn't happen and if the rupee dollar equation remains around these levels, they should be fine._PAGEBREAK_
Latha: I want to ask you about second tier IT companies. If I remember right, some time back you had even spoken about Tata Elxsi and Persistent Systems kind of stocks. Do they become more attractive or any second tier stock?
A: I think so and that has been the big opportunity in the sector. On one hand if you look at over the last five-ten years, optically it has made sense to be with the largecap companies, the tier one companies and of course the tier two companies, which do the plain vanilla application, maintenance, development kind of work, I think that's history. They are going to find it difficult to remain in business and the only upside that you could have from those kind of stocks, could be in terms of consolidation where some there are some PE funds or any of these buyout funds come in, buy out, consolidate, put two or three of them together make them a larger company and therefore create value but if you leave out that proposition and look at a company from its organic growth opportunities then in the tier two, in the midcap space, it has always made sense to bet on some specialised plays there.
The tailwinds that those kinds of companies enjoy for growth are significantly higher given that they are relatively small, they are more efficient, they are more agile and are able to address the requirements of their customers and offer solution - that provides them the growth opportunity. In addition to that given the size is relatively small, they can identify other newer growth opportunities and sustain a higher growth rate. So, in tier two midcap spaces, you need to identify specialised players and be with them for several years and that is where the wealth creation happens.
Anuj: A broad question on consumer space or some of these fast moving consumer goods (FMCG) names. You have Britannia Industries which keeps making new highs, keeps trading at higher multiples, 45-50x and you have Jubilant Foodworks; completely different stocks but there we have seen quite a bit of derating and the news keeps getting worse. How will you approach these pockets and these stocks from here on?
A: I think based on the fact that these are stock trading at 50 PE multiples, I would probably say that one should avoid them but if you have to make a choice between the two, I still think Britannia is a better bet versus something like Jubilant because even optically the valuations of Britannia are lower than that of Jubilant, so that's one. Second, the difference is one owns the brand, the other is a pure franchise and you could always be expose to black swan event where the principal suddenly comes up and say great job done so far but we want to skip and jump on to another boat and you could be left stranded in middle of the ocean. So that is a serious black swan event. So I am just that for us both the stocks are avoid, but if you have to make a choice then Britannia would be a better bet versus Jubilant Foodworks.Sonia: Your view on some of the public sector undertaking (PSU) banks that have done extremely well, SBI is up 60 percent from its lows in May and there are talks now of rate cuts before the end of the year etc. Would you put incremental money here?
A: I do think it would be prudent enough to put incremental money, not just before the run-up has happened but the reality is that they have become now more of cyclical bets where you take call on the interest rate cycle and you ride them. It is as good as betting on a steel company and believing that iron ore prices will fall and therefore margins will get better. I think PSU banking space is no different. You take a call on interest rate movement and you could get the delta, so we have seen fair bit of fall in the bond yields, which has been a fantastic ride for these companies. I am not too sure whether there is tremendous incremental scope for yields to fall further from where they are right now given that the economy is getting into a growth mode, there is an early sign of pickup in the investment cycle. You could have one rate cut or so maybe for the rest of the year but I doubt if there is more potential beyond that given that inflation is also not significantly falling off the cliff. Therefore, my sense is that by and large for the time being it looks like that the rally in PSU banking space is done with. However, if one is looking at kind of investing here, you should wait for a correction in the stock price.
Latha: Any of themes which now look like multi bagger?
A: The consumer discretionary space looks still one of the most attractive. Be it you are betting on high value discretionary spending or you betting on consumer appliances. I think this whole bunch where you do not consume daily but you kind of take these purchase decisions maybe once a year or once in five years or once in a decade. I think that is the big opportunity and across the board. To us the two-wheelers probably are good opportunity, consumer appliances are good opportunity. I think travel, tourism, hospitality - that whole bunch is in good from a medium to long-term perspective though of course in the short-term stock prices have run up and you could wait for better entry opportunities but from a three-five year perspective, this looks to be a strong, durable opportunity.
Anuj: Where do you think we are in terms of the pharmaceutical cycle? We have seen a couple of bio similar stocks do well like Biocon or Jubilant Life Sciences. Where are we in terms of the rally in pharma stocks now?
A: I believe that this entire opportunity is yet to play out. However, what we have seen over the last five-seven years is just the first phase where companies have gone and been able to get into the US markets and anchor themselves there. In the process they have had some regulatory issues and that is not of course for the entire sector but yes, a fair number of companies have faced those headwinds but what will happen over the next five-seven years is that companies will get even larger in the US and that is a multibillion dollar opportunity. I think what we are seeing are Indian companies still selling generic drugs worth even few USD 100 million. I think companies are yet to get into a situation where the US itself becomes a billion dollar business for them and that is still about five-seven years away. So that is the big opportunity. Second, there are lots of companies which are making very important strides in the emerging markets, rest of the world, outside US and Europe. So markets like Latin America, Asia and Africa is a big opportunity. Third, so-far all companies who have tried with new drug discovery, have failed but it is quite possible that in the next five-ten years we will possibly see a company being able to launch its own drug in a regulated market. I think the probability of that is very low right now but if that happens that would be a movement of glory for Indian pharma sector and there are still three very strong trigger which are there for the pharma sector and the best is yet to come for them.
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