Market valuation not expensive at 16x earnings: IIFL

Latha: A word on Tata Consultancy Services (TCS) and what will you make of the IT packs itself? Do you have a buy on TCS and what is the overall weight of IT after listening to the TCS management?

A: TCS results are analysed well, basically the results are below expectations. TCS has been having a few bad quarters, so consecutive 4-5 quarters have been bad for TCS. Overall IT pack we are positive. We believe that the fourth quarter results for most IT companies are bad. Many companies had clients specific issues or they had cross currency headwinds etc but that should not be recurring thing.

FY16 should be a much better year so overall we believe that the revenue growth should be strong in FY16. EBITDA margin should hold up and the biggest positive for IT sector could be the potential rupee depreciation. I believe the rupee could depreciate by 3-4 percent as we go ahead. That will provide a big tailwind for IT companies so as a sector as a whole that is one of the non consensuses call that we have where we are bullish on the sector.

Sonia: You are bullish on the markets as well as I was going through your note where you say that the Indian market as not expensive given a 5-10 year growth story. Just take us through what the slightly more near-term observation is? Say from now for the next 1 year what could be the positive triggers and what could be the market growth?

A: The key thing while there are lots of extraneous factors which are at the top of many investors mind and that continues to have an impact on day to day kind of price movements. However, I believe the key thing for the Indian market over the next year would be domestic factors like earnings pick up, some clear direction on macro indicators, some indication on the passage of key legislations. I guess these are the things which will provide direction in the 6-12 months. We believe that all these parameters would sort of gradually improve. If you take earnings, last year was probably the worst year in the last 10 years for corporate earnings. Net profit growth was low, revenue growth hit a low. Even the EBITDA and the profit after tax (PAT) margins were at a significantly lower level last year.

However, starting first quarter we expect improvements to start. Now the first quarter headline numbers may suggest that things are not really picking up or the overall Nifty earnings may be in a low single digit. However, it is actually important to segregate the results and look at more bottom-up. I believe few sectors will start showing good results from first quarter itself for example private banks, four-wheelers, auto-ancillaries, pharma and consumer now all companies in these sectors will have a evenly spread out quarter during FY16.

Whereas for a few sectors, the earnings growth may be more back-ended for example cement or industrials or telecom or two-wheelers so again I would think that it is not right to say that the entire earnings growth would be back-ended. If you look at on the key legislation front while there is a near term headwind for key legislations like land bill or the goods and service tax (GST) it is likely that it will not get passed in the monsoon session. In fact many investors are getting prepared for that. I would think that even if it is delayed by one session or by couple of months we have to take that into stride the market will take that into stride and move on. May be the GST implementation could be delayed by three months. So, instead of April 1st we could be looking at a July 1st kind of time line which again should be okay from the investor’s point of view.

Valuations as you mentioned I really believe that the valuations are not expensive after the 10 percent odd correction that we have seen. The market rates at about 16 times one year forward which is slightly above the long-term average of 14.5. For people who are inclined to look at more historical numbers on a trailing basis the Nifty trades at above 19 times which is slightly again above the long-term average of 18 times, again not too expensive. So it is a matter of time before the earnings growth pick up and then in hindsight the valuations would look much more reasonable.

Latha: Do you think there can be better opportunities to buy. We still don’t have a very good clarity on the monsoon; the MET is sticking to its deficient monsoon. So is it that in the near-term we are going to get better levels to buy?

A: That is possible, what I said was these are more structural arguments but if you look at tactically then it is possible that the market could weaken in the near term. That depends upon many technical factors as well for example foreign institutional investor (FII) selling and so therefore it is possible that one may get a buying opportunity slightly lower than current levels in the next three months. That is very much possible.

Latha: What is the floor, is 8,000 the floor like we saw some four weeks back?

A: I would say that yes the market could have another 5 percent downside or so. Market could fall more depending upon how many of these extraneous factors turn out to be or if there is bunching of negative news on the domestic front the market could fall. Then I would think that the bounce back could be equally sharp so instead of looking at a floor price if the market falls for example by 8-10 percent the bounce back could be very sharp. It is unlikely to sustain at that levels for a very long. Already we are seeing some buying interest.

One thing which I must point out here is that the very positive thing in the entire last three or four months of correction has been consistent buying by the domestics. That is a very big positive from the market point of view and also gives a big comfort for the FIIs that the domestics have been consistently buying. That will provide support so I would think that as soon as FII selling stops the domestic buying itself can support the market and stabilise the market.

Sonia: One sector that you are optimistic on is the industrial space and in the last couple of weeks we have seen names like Larsen & Toubro (L&T) and BHEL do reasonably well. In fact as of this morning CLSA has upgraded BHEL. What do you think is turning in the cycle and when do you expect the first signs in recovery of earnings to come through?

A: That is an interesting point and what I observe is that many capital goods and infra companies their commentary as turned positive. If you look at the fourth quarter management guidance for many of these capital goods companies as well as our interaction with these companies over the last 1 or 2 months that suggest that majority of capital goods companies the names that you mentioned and a few others are all now talking about two things. One they are talking about increase order inflow and we have seen that the order inflow picking up for a whole lot of capital goods companies and road builders and companies in the power transmission and distribution (T&D) segment in the last 3-4 weeks.

So almost every day or couple of days we are seeing some new order inflows happening that is one. Second is that the companies are indicating that the order execution is picking up. So again order execution in the industrial space, in the T&D space, in the road space, in the railway space is picking up so we do expect that many of these capital goods companies will show a stronger revenue growth. The margin expansion may be slower. The margin expansion would be more of a FY17 story but the stronger revenue growth itself would mean that the bottom line growth could be very strong.

Latha: If I were to give you 100 points how would you sectorally allocate it on the Nifty stocks?

A: You are asking me for my model portfolio, basically I will give you 5 sectors where we are positive where bulk of the new investment would go. One is private banks; the second is the consumer discretionary space which includes autos, paints and miscellaneous companies like tile manufacturers or the adhesive manufacturers etc, so consumer discretionary. The third sector would be industrials including capital goods and infra companies. The fourth sector would be cement and the fifth sector would be IT. These would be the bulk of my portfolio but then of course there would be some allocations towards others sectors like telecom and energy. We would still continue to avoid PSU bank and utilities.