Think IT is toast? Nilesh Shah says climb down the mcap ladder

With the recent downslide in the IT sector, one should keep an eye out for Tier-II stocks in the midcap space which are likely to grow at the cost of some of the large players, says Nilesh Shah of Envision Capital.In an interview with CNBC-TV18, Shah listed his sector picks and market outlook.He said that between now and December 2016, global factors are likely to play an important role in the volatility ad ensure that the market stays range bound at current levels.Below is the transcript of Nilesh Shah’s interview to Anuj Singhal, Latha Venkatesh and Sonia Shenoy on CNBC-TV18 Latha: What would be your go to stocks in the IT space? A: In the IT, one should definitely be more focused on the Tier-II names, the midcap names. They could be very interestingly poised. They could essentially be growing at the cost of some of the larger players, given that their size is relatively small versus the big boys. They could be more nimble, they could be more adaptive to a newer strategy in a very dynamic market place. So, the full focus should be on looking out for Tier-II companies. Anuj: Like we saw with Cyient yesterday. A: Exactly, that was one example of how smaller companies can do. And interestingly, the whole technology sector could pretty much be like the consumer sector 5-6 years back. On one hand, you had the choice of going for the big boys like Hindustan Unilever (HUL), ITC, etc. or you could have gone for the Tier-II names like Marico or Godrej or Emami. And over the last 5-6 years, you can clearly see the difference in terms of the returns and the wealth creation which some of these Tier-II names have given. It is quite possible that the Tier-II technology names could be at the cusp of a similar opportunity. May not be exactly in terms of those kind of returns, but from an outperformance, they could outperform significantly. So, that is one. Two, is even if you look at it in terms of context of valuations, these Tier-II names are trading between 10 and 15 times trailing earnings. So the choice is you go for that or you go for the Tier-II cement or the consumer stocks which are trading at 35-45 times. So, that is the kind of trade-off and I clearly see that there is immense value in the Tier-II technology companies. Latha: Let me come to this financial story. There have been a couple of goods news overnight. The inflation number is lower than we thought, so we should get the one more rate cut, maybe even more if the trajectory continues this way. As well, Essar Oil, now getting sold off probably lock, stock and barrel means also that somewhere in the system, there is a deleveraging which is material. How are you approaching financials? A: These are really some of the more short-term tactical kind of stuff, the challenges on the asset quality front remain. There will always be, in between, one good news or the other which will make you believe that things are getting better, but I am not quite sure whether things are really getting better in terms of asset quality. There is still some more pain to go and this pain will last for a few more quarters. I do not think we have seen the worst of it in FY16 or maybe this might even extend beyond FY17 and even spill over into FY18 because the size, quantum, etc. is huge. To some extent, the asset quality issues will get buffered by the treasury gains which some of these banks could have as yields go down. That is a huge saving grace. This was a scenario which would have been very difficult to envisage six months back. But with the latest policy statement that we have seen and the decisions taken by the Monetary Policy Committee (MPC) and the governor, it looks like there will be more rate cuts along the way and they seem to be far more confident about that. So, that is the good part of it. But I believe that all this is played out in terms of the stock prices. I would be really surprised if there was significant upside to the public sector undertaking (PSU) banking space from the current levels. The real thing to bet on would be growth and that growth, you are clearly seeing it is on the private side, on the housing finance side or the new generation banks or the microfinance institutions, non-banking finance companies (NBFC). That entire pack is showing some strong growth and as long as that growth sustains, they would be the better place to be. The PSU banking space, etc. would be at best, some short-term trading or tactical plays where you can go in and go out at your own peril. But really from a structural long-term growth opportunity, it is the non-PSU space in the entire financial services is where really the big structural opportunity is. Anuj: I wanted to take the Bank Nifty point across to you. What do you make of the kind of selling we have seen in Axis Bank? Clearly, there is this Specified Undertaking Of The Unit Trust Of India (SUUTI) overhang, but would you buy this stock at current levels? A: It is best at this stage, it should still be left on a watch-list, but not really acted upon, because I think there is better value in the entire private banking space or the NBFC and the microfinance institution (MFI) space. Clearly, because Axis Bank currently would have a bit of the SUUTI overhang as well as some challenges yet on the asset quality front and the growth may not end up being very strong like the kind of growth that you see with home finance companies (HFC) or MFIs or some of the new generation banks which has got set up. So, clearly, at this stage, it is still best avoided. Obviously needs to kept on a watch-list if there is further shave-off in the markets or in the Bank Nifty itself, there could be some selling pressure which could drag the stock price even lower. Maybe at that point of time, one should look at it in a more kind of constructive manner, but at this stage, there are relatively better opportunities. Sonia: What about your view on the market? We did not get a chance to ask you that. It has reached a point where there is a lot of volatility, people are awaiting decisions from the Fed, from the elections, etc. How should retail investors approach this? A: We seem to have now got into a kind of a range. This range of 8,500 to about 8,900-9,000, these are those 400-500 point range in which the market is and it will remain in this range for quite some time. And that is because obviously, over the next 2-3 months, till the rest of the calendar year, you are going to get driven more by global factors. I do not think there are enough tailwinds on the local end to basically, drive this market. And so clearly, the US Fed’s decision, outcome of the US presidential elections and some of the developments in the Eurozone, these are a bunch of factors which could play an important role in terms of direction of the markets. It is only when we step into 2017, January to March quarter, that should be a very important quarter from the local factor, a lot of important events in terms of whether RBI goes ahead with further rate cut. The goods and services tax (GST) roll-out, what the Budget has in store, especially on things like fiscal deficit and all of that, outcome of Uttar Pradesh (UP) elections and post December, you will start to see those pre-poll surveys and all of that. That essentially should be some of the macro things that one needs to really monitor then. But between now and December, it is clearly going to be global factors which will play an important role in the volatility and ensuring that the market remains in this kind of a range.