Gurmeet Chadha on how to play in contrarian bets in IT, chemicals & NBFCs
Synopsis
“There is some lack of opportunity in small and midcaps. A more balanced approach is needed. I made this point two months back also. Today, the 10-year bond in India has gone down from 730 to 715 since the Fed pivoted. We will see multiple rate cuts next year. The Fed is indicating three rate cuts, which means the bond yields will come off anywhere between 50 to 100 basis points.”
It is a tough call. There was valuation comfort till about two weeks back. I think the Nifty IT index is already up more than 10% in less than three weeks. Some largecap IT names still have valuation comfort. So, the quarter might still be soft. I will be more interested in seeing the commentary from management. Infosys in particular has been more conservative in terms of upfronting the, let us say, the bad news. We would like to see how the commentary changes around AI deals now.
I think the bigger impact will probably come once the Fed officially starts cutting rate. There was a pivot and they have already been talking of three rate cuts. So, my sense is I would like to wait it out for the commentary as far as largecap IT is concerned. For example, companies, even in largecap tech, HCL Tech, which have a fairly balanced portfolio between discretionary and non-discretionary tech spending, one of the larger ERD plays, software businesses actually done quite well. It is almost at Rs 1,500 level.
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In the markets, we freak out if the valuation becomes uncomfortable, but no PE applies to IPL auctions. But, that aside, for the market per se, where are you getting uncomfortable now on valuations?
Some pockets in smallcap and microcap space, the kind of oversubscription in some of the IPOs. Too many IPOs hitting the street now. I think this week itself, you have almost a dozen and a few pockets in defence and companies where stocks are just running up on order books. A lot of the orders have very long gestation periods.
We have seen in the past 2003 to 2007 how if the commodity cycle turns, interest rate turns, the impact it has on margins and working capital. So, the execution ability for a lot of companies is still in uncharted territory. So, be careful, I think there are good names there. For example, Siemens, which is now demerging the energy business and L&T, has 12-13% EBITDA margin. But if you go down, level two, some of the mid-tier names, you have to be a little careful. I am not saying all names are bad and I am getting a little ahead slightly on the NBFC front.
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Another very beaten down space is this agrochemical space. My personal view is that the sowing has been pretty good after a good crop. If you see the two-wheeler sales, I think, as of the farm equipment sales, it tells you that there is some pickup in the rural economy. As we approach general elections next year, I expect more money spending on rural infrastructure, whether it is related to irrigation, Gati, the Jal Shakti programme of the government, as well as on fertilisers, etc.
I also have a slightly contrarian view on housing finance NBFCs. There is some pulldown across the theme after the post RBI action. HFCs are in a secular housing upcycle and that is going to last for probably a much longer period of time.
I think the government would be a seller, especially if you see two-three years back, the entire market cap of PSUs was, I mean, $100 billion excluding PSU banks and since then, it has been almost like three-and-a-half times down to market cap, so that overhang will always remain and that is actually happening with most private names as well.
We have seen a lot of PE and promoter exits at high valuations. But I think the entire space has run up. One mistake which happens in the bull market is that X has run up, so Y should follow and I think when you start giving that hypothesis, you are entering into a zone where accidents can happen and that should be avoided.
I have seen so many guys saying that since HAL has run up, the others have run, so should the other defence stocks. I think that should be avoided. I still find some value in PSU banks. That space has not done as well. There is a change in the way credit underwriting is done. I have not seen a 0.7-0.8% NPA in Bank of Baroda for a long time, Rs 10,000 crore plus kind of an NII growth, good fee income as well, very good adequate provisioning, guiding for like 15-16% credit growth and maintaining NIMs at about 3.2-3.3%.
Some of the large PSU banks like SBI, Bank of Baroda which trades at six times earnings one-time book, SBI at nine-time earnings, 1.1-1.2 times books. There is some comfort there. I would not like to go level two and selectively in some PSU, especially in railways where we are seeing the current order book to sales is like 10 times. So, there is decent visibility with Vande Bharat launches with more wagons getting added and backward integration on mobility as well. So, there are some value pockets there. But in general, the space looks a little expensive to me.
It is getting more and more difficult for people to perhaps deploy money. There are reports talking about how a lot of these funds and PMS managers have stopped taking money as well. Do you also feel that constraint right now, lack of opportunity in the broader market?
I would selectively agree. I am seeing there is some lack of opportunity in small and midcaps. A more balanced approach is needed. I made this point two months back also. Today, the 10-year bond in India has gone down from 730 to 715 since the Fed pivoted. We will see multiple rate cuts next year. The Fed is indicating three rate cuts, which means the bond yields will come off anywhere between 50 to 100 basis points, which means if you buy a bond today at, let us say, 715, 720, and you take like a 50, 100 bps drop, you will make a mark to market gain between 5% to 6% with 7% running yield.
So that is a good double digit return on, let us say, a bond GSEC portfolio, which is a very low risk portfolio. So be a little more balanced. But there is a lot of value still in largecap names, a lot of them, for example. Look at the largest private bank, they are still available 15 times. Large IT are still reasonable. The likes of HUL, et cetera, have not done well at all. Kotak has not moved. Half of the Nifty in my view is still at about 17,000 Nifty levels.
When one talks about energy transition and it is in its pure basic, how do we understood it? The first phase is EVs, the entire supply chain as well comes into focus, a case in point being Ather. Any interesting plays here?
There should be a very, very constant play on energy. There was news on sugar constraint, on sugar syrup and juice being used for ethanol. And we saw Praj dropping, a very good clean energy play, we call it a bioengineering, bio-energy engineering play. You have got an opportunity there. India is going to add almost 60, 70 gigawatts of capacity every year.
If, for example, there are already tenders of 50 gigawatts for thermal, coal-based thermal alone and that is why BHEL has run. NTPC alone plans to add around 12 gigawatts next year on coal-based thermal plants. So imagine the demand it will have for transformers, insulators, cables and wires. It is a very, very strong secular trend. And I think this should be played.
There are opportunities on the EV side. See the run-up in Tata Power after languishing at about 200 to 220 levels for a long period of time. So starting from generation to the entire ecosystem including transformers, cables, etc we are extremely bullish. I am extremely bullish on even traditional energy. I think because of this ESG bandwagon, a lot of that got ignored. Just look at the way Coal India and TPCs of the world have gone up in the last few times. There is so much valuation comfort there. We are taking it as the entire energy basket. We are not really differentiating between renewable and let us say non-clean or whichever terms these days you know you call them to be.