Even though the sector has been a rank underperformer in the past, Indian telecom stocks are very attractive from a three-year perspective, according to S Naren, Executive Director at Chief Investment Officer at ICICI Prudential.
The country’s telecom sector seems to be undergoing a lot of churn with the entry of a new player and merger talks between two incumbents. Even though the sector has been a rank underperformer in the past, Indian telecom stocks are very attractive from a three-year perspective, according to S Naren, Executive Director at Chief Investment Officer at ICICI Prudential.
Naren said the valuations of telecom stocks look well placed from a three-year horizon, which makes the outlook for the sector very good.
Indian financial and telecom circles are abuzz with news of a possible merger between Vodafone India and Idea Cellular. Meanwhile, Tata Teleservices and Reliance Communications-Aircel-MTS combine are reportedly considering joining forces to counter the tough competition from Reliance Jio Infocomm.
In the current set-up the market doesn’t have many contrarian bets barring IT. He cautioned that growth rates for the sector may be slow which may trigger buybacks by companies.
Below is the verbatim transcript of S Naren's interview to Latha Venkatesh, Sonia Shenoy & Anuj Singhal.
Anuj: I am tempted to start with telecom because that was your big contra call last time and we have seen a huge rally play out in telecom. Do you think these stocks will return more from here on, if you stay invested?
A: The fact is that if you are looking at the short run, it would depend on how different players in telecom act in the next month or two in terms of merger, in terms of tariff plans etc, but if I take a three year view, Indian telecom marketcap are very reasonable compared to the world and you are actually looking at rock bottom prices and rock bottom valuations in marketcap terms. So, if I take a three year view, the outlook still looks good because you have to remember that the rallies of the last three months, if you look at 10-year price charge, you will find that the sector has done extremely badly. Therefore, I do agree that because of the last three months you can have a situation where the sector can take a break for a short period of time but if I look at the next three-four years, the outlook for the sector looks good because of very low valuations.
Latha: The other call that you gave us last time that fixed income is still a very worthwhile investment. Is that over now? Is it clear after what the RBI said that there isn't so much money to be made in fixed income. Rush to equities?
A: I think the fixed income market was approaching late cycle and from late cycle the fixed income market has been brought back to mid cycle to no rate cut monetary policies and sudden increase in cash reserve ratio (CRR) in early December on the extra money collected. So I believe that the way the government operates is that they want to give a big fillip to financial savings because any money invested in physical savings in India whether it is in gold or real estate, the returns are very low and to the economy and to some cases investors as well. So this big fillip given to financial savings and continuing to keep fixed income attractive in the last three months is pretty positive for both debt and equity. Having said that if you look at equity upsides over a period of two years, they can be much higher than that of debt primarily because if you look at the last two years particularly largecaps haven't done much, so the out for the next two years for equity appears to be better than the outlook for the next two years in debt, but both asset classes are attractive relative to the physical asset classes.
Sonia: After that bull's-eye you hit with the telecom sector, any other sectors where you see some contrarian buy calls or some value for the medium-term?
A: I think right now there aren't that many contrarian sectors. The only contrarian sector in recent times has been IT. If I look at IT as a sector, growth rates are going to be much slower than what they were. The balance sheets of the top IT companies are so attractive that there is scope of buybacks and increased dividend payouts. So the trigger for ensuring that the sector doesn't fall, is going to depend on capital allocation policies because if we do not see growth increasing significantly in the IT sector, I mean as such if I look at it over the last five years, too many largecap sectors have got derated, telecom, mining, banking, IT, healthcare due to a lot of foreign direct investment (FDI) problems. So when I look at value over the next two years particularly on a relative framework and keeping the fixed income interest rates, which are currently prevailing in mind, the outlook for the next two years for largecaps looks to be good but it is not a deep contrarian opportunity; it is a reasonable opportunity and at this point of time there is no panic. If you want mega returns, you need panic and that panic which was there in telecom three-four months back is missing now. So, I would say there is no panic in any sector at this point of time.
Anuj: Any call on infrastructure as a space?
A: We have been extremely positive on infrastructure over the last three-six months. We believe that when you are investing in any theme, you have you invest after substantial underperformance both infrastructure and telecom made that test because you had nine years of no returns in both the sectors and we think that over the next two years it is one of the themes to invest in. The challenge of course is you cannot have concentrated portfolios because many of the companies are small now.
However, what is interesting in infrastructure sector is if there were Rs 100 companies almost 50 have gone bankrupt in the last ten years. So outlook for the remaining 50 companies which have survived over the last ten years and are doing okay, the outlook for them has certainly improved for the next five years.
Latha: Coming to the biggest sector - banks. Would you touch any of the corporate banks now? They do not even have the advantage of rising bond prices?
A: One thing to remember that equities is not an asset class, you invest when everything is looking good. If you look at banks today compared to two years back, many of the non-performing loans or most of the non-performing loans have been recognised. Margins have fallen substantially. There is no scope for treasury profits of the scale that happened last year. So I would say that corporate banks are attractive from a contrarian point of view and one has to invest in it for the next few years because we think that the non-performing loan cycle in corporate sector is likely to get over in the near term and the peak is around the corner and if you look at it from a two-three year view depending on the resolution of NPLs, you are likely to see improved situation. We are at the point of time where people do not factor in too much of resolution but if sectors or few companies get resolved, you are seeing upside in reduction in NPLs and that is why the outlook for the next two-three years for banking also looks good particularly corporate banks. I do not think that is really true of retail banks because retail banks have rallied significantly over the course of the last three-five years. So it is much more in corporate banks than in retail banks at this point of time.
Sonia: What about the pharmaceutical space because some of your funds have exposure to names like Sun Pharmaceutical Industries, Cipla etc. Sun Pharma has been a wealth deteriorator over the last three-six months. Have you at any point thought of churning out of these stocks?
A: Two years back the sector was very costly and we underweighted a number of our strategies. In the last two years we have had specific Food and Drug Administration (FDA) issues in almost crème de la crème of the pharmaceutical sector and we have used the FDA issues to pick up positions in these companies because these companies are very strong from management perspective and over the next two years many of the FDA issues in some of these companies is likely to get resolved. We will see one of them get, at least there is a likelihood that it will get resolved last week and if we take a two year view many of the companies are likely to resolve the FDA issues and that is the reason we think that the sector is headed for a good period over a two year period but I must warn you that the sector is not dearth cheap like 2007. In 2007 when we had invested in pharma and our value funds, the absolute marketcap and the valuations were deep value at that point of time whereas today I would say they are just below fair value and you can get a pop due to resolution of problems but you cannot mega returns at this point of time because the sector is not dearth cheap.
Anuj: I wanted your thoughts on fund flows because from the peak that we had seen in terms of mutual fund inflows, we have seen that come off a bit over the last few days and weeks. What do you think is the reason for that?
A: I do not think investors have to look at what is coming in balanced funds, what is coming in arbitrage funds, what is coming in equity funds and what is coming in tax plans and if I look at the aggregate of all these flows. I do not think there is any slowdown per se and we believe that the outlook for flows continue to look good because of good thrust on financial savings that the government has been doing for the last three years. So we think the outlook for flows continue to be good and till the market gets meaningfully overvalued, there is a big opportunity for financial savings in mutual funds to accelerate from here and we are big believers that it will accelerate from here.
Latha: Growth has still been elusive. We did get some good metal numbers this time and probably bank numbers because of the bond prices, maybe both of them cannot last forever. How is FY18 looking to you in terms of earnings growth?
A: Through this conversation we have been talking about two year view. The reason is what we think is that capacity utilisation in Indian corporate sector is pretty low and we think over the next two years the capacity utilisation in Indian corporate sector likely to go up. You have to remember that this will happen without any capex, so there is no chance of private sector capex accelerating in the next one year or so and we think that the operating leverage story will contribute to earnings over the next two years and coupled with it you have a situation where the goods and services tax (GST) will get implemented this year and we would see a number of organised sector companies benefiting over the next two-three years - that is likely to help over the next two years.
The bank interest rate cycle, many of the marginal cost of lending rate (MCLR) interest rates have gone down since January - that will help many of the leverage plays in infrastructure and many of the solvent leveraged companies and they are likely to see benefit out of lower interest cost. So across I would say that the two year outlook on earnings is good, two year outlook on equities is good, will the ride be straight forward, it will not be. We do expect that there will be volatility from here but the trend is upward - that's our view for the next two years.
(Disclosure: Reliance Jio Infocomm is part of Reliance Industries, which also owns Network18 Media and Moneycontrol)