Dipen Sheth: NDA's politics and economics to converge;how it will benefit mkt

With regards to Infosys, he said concerns raised by the founders are valid but Infosys is too big a company to collapse under the weight of the allegations. With all the news of consolidation happening in the telecom sector– Bharti -Telenor, Vodafone-Idea, Sheth said the broking firm does not have active coverage on the telecom space for a while now "because it is difficult to analyse them".

"There seems to be a lot of disruption happening in the telecom space and the pricing too is not right."Below is the verbatim transcript of Dipen Sheth’s interview to Latha Venkatesh & Sonia Shenoy on CNBC-TV18. Latha: Will you buy Bharti Airtel and Idea Cellular? A: Let me start with the disclaimer, we don’t have telecom stocks under coverage right now. We haven’t had them for a while because we have figured out that it is difficult to figure them out, let me tell you very clearly. It is not that we don’t have other sectors which apparently lack pricing power under our coverage for example we are gung-ho on airlines. That is another sector that consumes a lot of capital and doesn’t seem to generate returns, but we think that airlines are where telecom was maybe 10-15 years ago. So, we took that call for covering the airlines. In telecom, I suspect that there is a tech shift happening which is happening much faster than we can imagine and that is the hope that Reliance Jio is holding out. So, Bharti and the others if you will remember had this Minute Factory model of running the voice business. There is only so much of minutes factory selling that you can do and the additional non-linearity in the revenues, the non-linearity of profits with additional revenues happens only when you pump out more data. Here was Bharti holding out little pieces of 1 GB and 2 GB data a month for what it was claiming were attractive prices and Jio comes and says I will give you 1 GB a day. So, the pricing is completely wrong if you ask me but it is disruptive. What has Jio done, Jio has invested closed to Rs 2,00,000 crore in the business. At even a 15 percent EBITDA on that they need to generate Rs 30,000 crore of EBITDA to come anywhere close to creating value in that business and I think that is a really long stretch. The fact that they announced pricing – good, bad or ugly was itself seen as so positive by the market. If you look at our SOTP for Reliance, we recognise that they have invested closed to Rs 600 per share of Reliance in the telecom business as their equity contribution and we are valuing that only half book. We thought we were being aggressive. But it looks like people are willing to give them the entire Rs 600 valuation now. Rs 600 is what the book value is so remember fair returns on that book value if you strip down the EBITDA of depreciation and of course the interest and so on and so forth - the spectrum pay-outs and the amortisation on that bit, the marketing cost, the manpower cost; I don’t know what kind of revenue you need to earn that kind of EBITDA even Bharti’s margins are at 40 percent. Sonia: Would you buy Reliance or not? A: We have had a target price, if you will allow me to do this mental anchoring we have had a target price of Rs 1,225, I don’t know where the stock is right now. We have always had this thing that Reliance is drifting in a range and certainly that big 10 percent move where it add an Idea or something in market cap yesterday if I am not mistaken, right, so it certainly makes me feel that things are bit looking toppy here and people are just fantasizing and imagining too many things here. But that is what momentum in the markets is all about. In a broader sense you have seen domestic flows pick up and markets are running away and surely I get the feeling that we are getting a little toppy but that is how pendulum swing. Latha: You are not just toppish on Reliance or Bharti you have a felling generally the market is toppish? A: It is not that I can see a crack coming up; I can’t see a very big bear thesis playout from here. But, the sheer momentum makes me a little cautious. A lot of people even now want to get into behaviour that signifies the urge to participate in the market and that to my mind is not a healthy thing that is how bubbles build up - the left out feeling, the fear of being left out and it can happen at the institutional investor level as well. People who have been waiting on the side-lines will suddenly notice momentum and participate and that can lead to distortions in the market which are not necessarily sustainable. Does it mean the India story is over? Of course not. So, despite all this cribbing that you guys do about the demonetisation shock and all we are still going to grow at something like 6.5 percent this year and we will probably top that by another 100-150 basis points next year. So, I don’t think the macro story is broken, I think markets are running a little ahead of reality but they can run a little more ahead of reality. Latha: I wanted to ask you about the NBFCs, all the housing finance companies are up today debt mutual funds can put a little more money. We understand the total bounty would be about Rs 35,000 crore and the GIC Housing Finance, the Repco Home Finance and I think I saw even LIC Housing Finance all of them are up and about, basically NBFC that is where lot of action you will buy them? A: If you will remember our bullishness on NBFCs through most of last year. This kind of, so it is related and it is not related because they supplies only to the slice of NBFCs which are called housing finance companies (HFCs) and that too the officials HFCs. So, you might have housing book doesn’t make you have HFC. So, if the National Housing Bank (NHB) recognises you as a HFCs and that is how you are legally recognised so there is a little more headroom for debt mutual funds to lend to them in terms of their sectoral caps on exposure. This opens up an additional flow or tap of liquidity for them. I think the structural change that we are looking for has already happened in the way the government is encouraging the housing sector and indeed providing subsidies at the lower rate. You must understand that we are now into the last two full years of this government’s tenure and I love saying this the politic will overtake the economics. I think with this government the politics and the economics will actually converge, it is required. So any theme that addresses the lower strata of society and god knows we need it, I might be a capitalist at heart, but there is no denying the fact that a whole lot of people, a whole lot of consumer segments, a whole lot of citizens need to be pulled up by giving them the right kind of subsidy mix, by giving them right kind of encouragement incentives. So, housing subsidies are just part of that. I think agriculture will see increased allocation, rural infrastructure will see increased allocation and that is to my mind a very good theme to play out over the last two years of this government. Sonia: I was going through your note and in that you said that you met some of these big IT companies in Bangalore and you have also turned bullish on Tech Mahindra, so tell us why you see further prospects here? A: At a broader level the IT sector is being panned for not doing enough to sustain its profit and its growth leadership. You had the Indian big four or big five IT companies growing at something like 4-4.50 times the sector average at a global level. In the last one or two years those growth rates have now collapsed to something like 1.50 or may be 2x the biggies the Accenture, The IBM’s the HP’s, so certainly an industry which was comfortably growing at 12 to 18 percent kind or 12-15 percent dollar growth is now struggling to do even high single digit. So, there is digital disruption, there is automation, there is products and platforms, there is mobility, there is cloud and there is whole lot of disruptions are playing out and we are being fed all these stories about how Indian IT is going to collapse in five years and all that increased employment is just translating into a low quality workers and back offices in India, some of that is surely true. We have drawn what we call is a non-binary conclusion on this sector which is that it is not that everything is going to collapse or that these guys are really the best companies that were ever invented. Typically, you will notice that whenever there is a crisis in a sector the truth lies somewhere in the middle of the extreme views. One must concede that the IT sector has consistently employed some of the smartest brains in this country. If we don’t like this stuff they do is probably because we are jealous of their ESOPs, to put it mildly. We went and met some four or five companies in Bangalore two weeks ago – all the large ones the Infosys, Wipro, Mphasis, Mindtree etc. and we also caught up with two of the ex key employees of Infosys. So, specifically on Infosys I think we will get into a situation where I must concede they have raised some valid concerns ex-employees or whether it is ex-promoters or the founders have raised some valid concerns. I think Infosys is too greater company to just collapse under these allegation and I don’t think there is a big scam or something brewing there. I think it is constructive criticism it has been taken in the right spirit and they will put it right. That is good way to look at it. Valuations are good, capital allocation has been horrendous and they have been panned for it. Starting right with Cognizant and then now TCS doing this aggressive buyback; Rs 16,000 crore that is more than USD 2 billion. Infosys is sitting on something like USD 5.5 billion or something and I would be very surprised if they didn’t put that to use somewhere, so net-net we are constructive on the sector. Valuations are somewhere between 12x and 14x for most of these biggies. Someone like Wipro is cheap, but it has been punished for not growing despite being very aggressive on capital allocation and spending more than a USD billion in the last two years on acquisitions. So, they will find a way out of this whether it is Trump’s immigration policy whether it is the automation stuff, whether it is work moving to the cloud and they are going through a little bit of churn. They are going through little bit of an existential dilemma if I can call it that. They are smart enough to come out of it. We are quite constructive on IT I must say.