IT fairly valued, but juicy margins a thing of past: HSBC Global

Despite concerns over stressed assets, banking is an interesting sector, feels Tushar Pradhan, CIO of HSBC Global AMC (India). While investing, it is all about how you look at the sector, he says. “It is not about what is the best stock, but what it is valued at,” he says. If one considers that stressed asset issue is overdone and normalcy will return at some point, then investing opportunities exist in the sector, he says. There continues to be worries over global growth especially in relation to the US, says Pradhan. As far as IT sector is concerned, significant headwinds exist in Europe and Japan. The fluctuating global growth too can weigh on the sector, he says. Pradhan believes that while IT is appropriately valued, growth and margins are not likely to come back to historical levels. It is a strong franchise, but growth is expected to be muted. Below is the verbatim transcript of Tushar Pradhan’s interview to Latha Venkatesh, Sonia Shenoy and Anuj Singhal on CNBC-TV18.Anuj: The banks have lead this market higher, do you still see this as a leadership sector for the market going forward?A: I think there is going to be a healthy rotation across the sector, so, I don’t think there is just one sector which is going to continue to lead any market. I think we have seen significant interest coming into the banks only because the fear is around what the asset quality was likely to come, is now getting a little subdued and people do seem to believe that there is a bottoming out in terms of where the provisioning for especially the public sector banks are likely to be.So, I think that might just be some relief which will bring some valuation back to the sector. However, I don’t think any one sector just generally kind of leads the market all the time.Latha: There are two separate arguments I wanted to make with you. One, would you be dipping into any of the public sector banks precisely for the argument you said and secondly the IT stocks, are they now at mouthwatering levels?A: Two questions, two different answers. I think the banking sector is pretty interesting considering the fact that on the one hand the largest chunk of assets which the public sector banks hold are under some stress and the debate is what is the level of stress. So, one is the fact that you get some valuations around what the assumption of this weakness in the assets are likely to be and if you buy that argument, then I think you would be very much where you are and there may not be much upside from here.However, if you believe that the asset situation is a little overdone and there might be a lot more relief coming either by way of extra capital or the fact that the turnaround in the economy will actually make sure that the assets are not as bad as the market seems to be pricing it at as of now, I think then there is some opportunity there. So, it is not a fundamental call whether these banks are good or bad, I think it is just a matter of how any investor should look at valuation given the controversy around these stocks at any given point of time.Coming to IT, that is an interesting question. Globally, I think there is some sort of hesitation surrounding whether the buoyancy in the US economy is going to last. There are significant headwinds in terms of where the eurozone is and where Japan is and generally global growth is a little bit under question. The market seems to be discounting at the moment but I think on the ground, data continues to remain not really very rosy. IT spends especially coming out of the US is always dependent on how buoyant the economy seems to be and how discretionary budgets gets allocated. So, in a sense I think of course the IT companies today trade at a discount to their historical multiples but I think that is again with a healthy measure of respect for the fact that maybe the margins will not come back to historical levels, maybe the growth that we expect also may not come back to historical levels.So, I think there is some kind of tempering. I would think that they are appropriately valued; they are pretty much close to where they think they should be trading given the fact that the growth from here on given the base that they have is likely to be pretty muted. However, we have seen that this industry has bounced back around countless headwinds that it has faced in the past, they have a very strong franchise and in a sense if you think that the quality of management here is a very long-term thing, then it just might be an opportunity to kind of stay invested in the long run in this sector. Sonia: I was going through your HSBC Midcap Equity Fund and one of your top holdings is Welspun India; that stock has been in the radar for the last three or four days. What do you as an investor do at a time like this when such a big relationship with a large company gets scrapped, would you move out of stocks like Welspun India or do you keep the faith because these are companies that have given returns to investors over the years? A: We will not be able to comment on any one stock specifically but I would give you a little bit of a bird's-eye view in terms of how our portfolio manager looks at portfolio stocks. As you know that portfolio construction is more of risk control exercise rather than a return maximisation exercise. Each of the stocks are chosen for their own potential versus what the overall risk that any portfolio can carry. As you know that if you concentrate your bets in one direction, then that direction if it goes against you it will hurt the entire portfolio. However, it is always good to have risk spread across sectors, spread across various parts of the economy, spread across potential even outside the economy so that if one headwind hits you in one area, you have some counter to it by having a bet which is a little different than the one that you have taken. In a case like this which is likely to always happen in stock markets that we do get unexpected results or unexpected events which really are an expected in that sense, your diversification, your ability to control risk in a portfolio really helps you out in the long run. So, while you have very good successes also which also are different than the normal return you are getting in any stock will also be part of your portfolio and lower than expected return will also be part of the portfolio. So, the eventual bet that you take is more on the probability that more bets that you take actually do better than the market than the rest. So, that is really the call that a portfolio manger takes. Yes, these are things which do hit portfolio managers from time–to-time but I don’t think that something which is very strange to us or the fact that it may not happen again. However, as long as we ensure that the overall risk is undertaken by way of diversification and non-consensus calls at times and contrarian calls, we generally tend to do well. Anuj: You have Cholamandalam, Manappuram, Motilal Oswal, so, a lot of NBFCs and that has been the hot topic off late that is this a bit of a bubble or maybe over exuberant space right now, what are your thoughts on that? A: What has happened in this sector especially in the financial sector that we have and we talked about it at the beginning of my discussion is that we have a very diverse range of companies available so you have very large established banks which are facing pretty significant asset issues. On the other hand, you have these very nice clean balance sheets, high growth companies which are trading at a significant multiple premium to what the rest of the market or even the average of the sector is trading at. As always, there is a reversion to the mean so clearly that is where the opportunity is and I think people who understand this revision will be able to take advantage of this. So, very difficult to call when that reversion happens and as you know, the reversion is actually over a mean and that mean may have a term which is as long as maybe two or three years, no one knows but I think the direction is very clear that there has been some variation in terms of away from the mean and investors can take their bets on the basis of that. Latha: One set of NBFC stocks that are missing in your portfolio are these potential banks, the Ujjivan’s and the Equitas’s I don’t see, at least they are not there in your top holdings. What are your thoughts on that space as well you have got I think 8.5 lakh shares of RBL Bank, would you still bet very strongly in the private sector banks? A: This is an emerging area so many times what happens is your traditional valuation metrics when it comes to return on assets or kind of profitability that you are generating is somewhat to be taken with a pinch of salt because the potential is very much in the future. So, basically the stock price what it is telling you is nothing to do with the current metrics obviously because that is why it is appearing expensive. However, the expectation that this sector or this one company is going to do so much better and again I keep coming back to the example in IT companies where when they were very young and fresh and new, they used to trade at multiples which were unheard of. However, obviously the promise of where these companies were likely to go in the next 10-15 years was getting priced in and you would argue that you made a very decent and a healthy return in those stocks as well. So, I think that is where the debate is, whether all of these companies are going to do well, obviously not, so, it is just a matter of then again pricing or finding out the right mix to think that what is a comfortable bet to take and then hopefully ensure that these companies realise their potential in the next 5-10 years.Sonia: Let us talk a little bit about the pharmaceutical space where you do have exposure in names like Aurobindo Pharma which has done very well this quarter. However, these are still companies that are small compared to some of the bigger ones. So, Aurobindo Pharma has reached a Rs 50,000 crore market cap but it is still small compared to the likes of Sun Pharmaceutical, etc. Do you see this becoming a big wealth creator say over the next three to four years and reaching the stage that some of the larger companies are in?A: Again I would like to emphasise the fact that when we look at a portfolio, it is actually the sum of all the parts and while there might be one or two gems in hindsight where you think this is the thing that really made portfolio run, I think at this time it is very difficult for us to have any conviction to say which is the one that is going to do well. As a matter of portfolio construction, we do look at the index, we look at the total potential of the economy in various pockets as we see it. We try to make some calibrated guesses in terms of how is that we think given the valuation we will be able to kind of justify the potential we think in each of these stocks are likely to come.So, I think in the past what we have tended to do is to find out companies which are trading at valuations which we believe do not justify fully the kind of potential that these companies have. What tends to happen is once the potential starts getting realised in a stock, the prices start to move up and generally there is a tendency to overshoot the potential at some point of time and that is the portfolio action that we try to tend to focus on. So, it is not about a company which is great, so, we know that stocks which are excellent, they are run very well, they have fantastic track record of management may not make you money. So, it is not really so much about what is the best stock but the other frame of reference is always what is it valued at and what is it discounting at any point of time. So, as I said, it is very difficult to make an absolute statement about any stock or sector for any time, it is about how the picture is for us at that time.