Why Is Motilal Oswal's Gautam Duggad Overweight On The IT Sector & What Are His Top IT Picks?
Category
🗞
NewsTranscript
00:00Gautam Duggar is joining us now, Head of Research at Motilal Oswal Institutional Equities and we're
00:05talking to him about what Q2 is looking like. Gautam, hi, great to have you on.
00:13Good morning. Let's start with the numbers that we have seen. Of course, we'll review
00:17sector-wise but let's start with, are you disappointed with the way things have
00:22started off with TCS? Not really. Yes, it's a bit of a dampener on margins but I think
00:30there can be some segment-specific reasons for it. On the contrary, we are very excited with IT.
00:37We have doubled down our weight. We used to have underweight till April and July made it
00:43overweight and now in this quarter's revision of model portfolio, we have further increased our
00:50weight in IT. However, we don't have TCS in the model portfolio. We have Infosys, HCL Tech,
00:56Persistent and Coforge. But yeah, I mean, we are significantly overweight on IT now.
01:01In an overheated market, we think IT provides a lot of stability top-down. At the same time,
01:06from a bottom-up basis, the narrative around IT will improve in next three to six months,
01:11that's our view. And relative valuations in the context of the market are still quite reasonable
01:16given the kind of balance sheet cash flow characteristic these companies have over the
01:20years demonstrated in terms of almost on a combined basis, if you look at last six, seven years,
01:26cumulatively they've returned 80% of total profits to shareholders through buybacks or dividends.
01:35Okay, so Gautam, good morning. What's the base case assumption for quarter two on IT?
01:44Are you even thinking of Q2 results or are you more focused on what they say about what will
01:49happen in quarter three and maybe quarter four because by then the US election overhang will
01:55be truly out of the way? Sure, Neeraj. So when we upgraded IT to overweight back in July,
02:02we just upgraded it based on our construct on valuations. The risk reward then looked very
02:07attractive. We've had underweight on IT for more than a year. In fact, almost two years. We thought
02:14a situation is now reaching a stage from where risk is less and reward is more,
02:19especially in large cap because mid-cap anyways has been doing well given the growth differential,
02:24which has lasted for such a substantially long period of time. I mean, Neeraj, if you look at
02:29last 20 years relative valuation chart of mid-cap versus large cap IT, you will find that in the
02:36past, every two years, mid-cap IT used to slip into discount and then going to premium. In this
02:42cycle for last four years, the premium of mid-cap IT versus large-cap IT is sustained.
02:48And I think one of the reasons is the big growth differential that mid-cap IT is demonstrating.
02:53So our view changed particularly on large-cap IT in July, which is where we thought in a market
02:59where every segment, every sector is looking at richly valued exo-financials, IT offers
03:06a reasonable risk reward construct. We didn't expect any significant improvement in
03:12operational performance immediately. So to that extent, you're right. I think the numbers and
03:18the rest of the operational commentary should start looking better as you move into December
03:23and March. But our call was predominantly led by relative valuation construct on IT.
03:29Okay. So Gautam, the other question is really, and just rounding off this question on IT,
03:35the commentary that we hear is that we know that ER&D will perform well, but it's expensive.
03:40Large-cap IT will have a sluggish Q2. Maybe the commentary ahead might be constructive mildly,
03:46that things are picking up, but no definitive moves there. And thus far from TCS and LXC,
03:50we've kind of heard the same. The commentary is very good from LXC. The commentary is reasonably
03:54okay for TCS. Where do you park your money? I mean, what is the first amongst equals? Is it
04:00mid-cap IT? Is it large-cap IT? Or is it ER&D? No, of course, see, Neeraj, IT sector is still
04:06predominantly large-cap heavy. If you split the market cap of IT sector and profitability,
04:13roughly 90% of the profits come from top five or top six IT companies, which are
04:18basically nifty IT companies. All the other IT companies put together, mid-cap, small-cap,
04:23everything, contribute just 10% of the total profit pool, but they're growing very fast.
04:28So for example, I agree that mid-cap IT is expensive, but they were expensive at one-third
04:35the prices too. You go back a year and a half, look at how persistent was valued then. Nobody
04:41then said that persistent is cheap. Persistent is up almost, I think, 20X in the last five,
04:46six years. You can make the same argument for Cofor, you can make the same argument for KPIT,
04:51for that matter. Look at the numbers of KPIT. In three years, the profits are up 4X.
04:56And our view is that some of these ER&D niche plays, which are a play on very specific category
05:03or domain, they can continue to demonstrate a stronger growth differential versus large-cap IT.
05:08So you have to have a blend of both mid-cap and large-cap so that you're not putting all your
05:13eggs in one basket, because large-cap IT also has very strong balance sheet and free cash flow
05:18characteristics, which you perhaps do not get in mid-cap IT. But mid-cap IT compensates that by
05:24providing you higher growth. Even this quarter, as per our own estimates, we are expecting
05:28persistent to put 4 to 4.5% constant currency quarter-on-quarter revenue growth. So you have
05:35to have a blend of both so that you're not going overboard on either side.
05:42Gautam, let's just go sector-wise. And I want to understand how you're looking at all the
05:47IT, the auto companies, because big hopes on festive season are coming in. But are you
05:56expecting a little bit of a disappointment this quarter? Yes. In fact, see, Daman, let me go back
06:01two years. We had a big overweight stance on auto for almost two years, which we changed to underweight
06:08in July. And we are continuing with that underweight stance. In fact, this year,
06:12we are expecting moderation in auto earnings growth. And this particular quarter, we are
06:16just expecting 7% earnings growth, which will be the lowest in last 12-13 quarters. Do remember
06:22that auto earnings have tripled between FY21 to FY24. If my numbers are correct, in FY21,
06:29the auto profits in Nifty were 18,000 crores. In FY24, they were 62,000 crores. This year,
06:36we are expecting 7% growth. And in anticipation of that, we had downgraded auto from overweight
06:41to underweight. Our construct was very simple that we have a very high base on both volumes
06:46and margins, and which is what is playing out now. Within that overall underweight stance,
06:52we have two names in our model portfolio. We have been very positive on M&M for the last three
06:56years. In fact, we might be one of the few houses which has no Maruti in model portfolio. We only
07:02have M&M. And now we have added TVS Motors too. So we have tried to keep one four-wheeler, one
07:11two-wheeler. And so far as two-wheeler is concerned, relatively, they are better off right
07:16now in terms of monthly volume provision. If you look at TVS itself, they are one of the few
07:22companies in auto universe, or for that matter, the entire coverage universe of ours, which is
07:26printed 20% plus earnings growth for last 12 out of 12 quarters. So they have been very consistent.
07:33Their monthly volumes have been pretty fine. I agree. That stock is also richly valued,
07:38but which is not richly valued today. Any stock which is demonstrating good growth
07:42in India is hardly coming at a reasonable valuation. But if this growth continues,
07:47and this margin performance remains stable, I think there is still more upside to be had,
07:52and which is why we have added TVS. But overall view on auto remains underweight for now.
07:56We are expecting FY25 to be a very low growth here for now.
08:01Gautam, hi. It is also Samina joining in. While I will, of course, talk to you about the umbrella
08:05and the earnings as whole, but from what we understand from your report,
08:09you believe that most companies, while expected to show moderate earnings,
08:12you have identified six companies that are likely to report a 35% surge in net profit.
08:18I think SBI Life, Apollo Hospitals, Trent, Bharti Airtel make up that list.
08:23You want to quickly tell our viewers, where does your optimism sit?
08:28Yeah. So Trent has been a favorite idea for us for a long time now. In fact, if I remember last
08:32row, we extensively discussed Trent, Zomato, and Varun Beverages with Neeraj. So any company in
08:39India which is demonstrating growth differential in the sector, the market has been very, very
08:44charitable with the kind of valuation it has been ascribing to those companies. For example,
08:49if you look at Trent itself, they are growing top line at 50% to 60% for last many quarters now,
08:55whereas the sector is struggling to grow at 50%, 20%. Of course, profits have doubled or tripled.
09:01And therefore, at every price, the stock looked expensive at 2000,
09:05at 4000 about 10 months back, and now I think 8000. So as long as growth continues at this pace,
09:12I think valuations are going to remain very, very demanding there. But yeah, this quarter also,
09:17we are expecting very strong performance from Trent, and we expect that to get better again
09:22in the festive season. And so far as Bharti is concerned, Samina, I think telecom sector is
09:28going through a very different level of consolidation right now, where Bharti has
09:32demonstrated in the last 4-5 years that despite high competitive headwinds and low flux in the
09:39sector as far as the regulatory cholesterol is concerned, they've been able to manage their
09:46market standing very well. Now, we are reaching a stage where ARPUs are also going up. And
09:51consequent to that, you're also seeing some bit of softening in capex intensity. So both put
09:57together essentially means that your balance sheet and fixed cash flow characteristics for
10:01Bharti will also improve. We think that Bharti can continue to grow well from here as well.
10:07But do remember, last 3 years, they've had a phenomenal run as far as stock is concerned.
10:12Market cap is somewhere close to I think 9 lakh crore now. On that base, of course,
10:17you cannot expect stock to double like it has doubled in the last 2 years. But still,
10:22given the kind of market share ARPU and fading off of capex intensity is there, I think
10:29this stock can remain a big part of allocable portfolio. I think for insurers, you don't have
10:35to look at that. You can perhaps look at VNV, where both SPI Life, HDFC Life are demonstrating
10:43good numbers. We have upgraded HDFC Life recently. Now, we have added HDFC Life in
10:47our model portfolio too. Just one quick one on cement. And I'm talking about cement because
10:54the stocks have also been under tremendous pressure. It seems, Gautam, that they are
10:58going to report a 41% decline year on year. I mean, this is concerning, I would imagine.
11:04No, but this is how cement always behaves. Last quarter was also bad. This quarter is also
11:09expected to be very weak. And we are expecting next quarter, which is December, to also have
11:14a 30% earnings decline. The concerning thing this time, however, is that volumes are flat
11:20on a YOI basis. This flatting of volumes is happening after a very, very long time. I've
11:25not seen a 1% YOI volume growth in cement in the last 4 to 5 years in any quarter,
11:31maybe except COVID. So that is more concerning. Second, of course, the price increases that
11:36they've taken have not been holding. So we're just creating a double whammy on EBITDA margins.
11:43So if you look at EBITDA per tonne for this quarter, we are, I think, expecting somewhere
11:47about 647 rupees, which is at a multi-quarter low. Now, the hope is that at some point of time in
11:53this year, around March, those numbers will improve. But at the moment, we have zero allocation
11:58to cement and we're expecting a very weak quarter across the board for all cement companies.
12:03You are not buying into the valuations of some of the cement names because a lot of those
12:08have been flatlining now for not just quarters, but years as well. And with all these development
12:14projects that are announced in South, Amravati, Citi, etc., specific pockets of cement,
12:21even that is not attractive enough. No, so they would definitely be
12:25attractive at some point of time, Neeraj. However, we are in a market which is a performing market.
12:30So you have to be cognizant of your capital. You cannot have a dead capital sitting in your
12:36portfolio for a long period of time. I'm not saying we cannot make mistakes, but all I'm
12:40saying is the attempt is to try and find ideas where the growth is looking good. And we've been
12:46growth investors. So what we are trying to do is that whole theme that you said on infrastructure,
12:52we're trying to play it through multiple other names. Like real estate, we've been having a huge
12:56overweight, which we are continuing. We have a big overweight on industrials. Now, we've also
13:02added Dixon in our model portfolio. We continue to have ABB. You also increase weight on L&T,
13:07where the valuations have become far more attractive now. But cement with 30-40%
13:12kind of an earnings decline, which is visible right now and even for the next quarter, I think
13:17you might get better price or you might get better time to buy those stocks.
13:21So, Gautam, here's therefore the question. If the earning season shapes up exactly as your
13:29note has penciled it to be, you know what, and let's assume that the prices don't move too much
13:35from where they are currently. Where is the best bang for the buck? Where is the best value and
13:41growth proposition within the coverage universe? So I think there are two segments, Neeraj. I
13:48think there are two segments, Neeraj. I hope that market remains or rather consolidates for
13:53some more time, because we've had a phenomenal run in the last 12-18 months. I'm also in mid
13:58and small caps. We're finding ideas becoming extremely difficult. And if growth slows down,
14:03which is what is happening, FY24, if you look at nifty earnings was up 26%, our broader coverage
14:09universe reported 32% earnings growth. So that's why last year, we were very positive on mid and
14:14small cap because we could see growth sustaining in FY24. This year, growth is moderating from 30
14:20odd percent. This year, we are expecting 7% for our broader coverage universe and 7% for nifty
14:27as well. So it is very important for market to consolidate, spend some time in the zone,
14:32allow the earnings to catch up. Now, if that were to happen, and let's say we get nifty at 25,000
14:37again in January or March, then again, valuations at least for large cap become slightly more
14:42attractive. Even today, large caps are quite fairly valued in my view. It's a mid cap and
14:47small caps where there are a lot of problems on valuation. Your mid cap index is trading at 35 PE,
14:52which is a 60% premium to nifty PE. The small cap is usually, if you look at a 10-year average,
14:57trades are at 24%, 25% discount to nifty, is today trading at a 10% premium. So in this kind
15:03of a backdrop, what we've done, one of the big calls we have taken in our model portfolio is
15:08we have moved private banks from underweight to overweight. So we've increased weight in ICICI,
15:13HDFC Bank. We've also introduced Kotak Bank in our model portfolio. We've added HDFC Live.
15:19We've added some of the niche alpha plays in NBFC like 5-Star Business. We've increased weightage
15:24on Angel. So overall financials have gone to a chunky overweight for us. And all three segments
15:30of financials are overweight, private bank, PSU bank, diversified financials, NBFC. So that is
15:36one thing we've done. IT is already a big overweight. So both top-down and bottom-up,
15:40you can say, or rather you can conclude that our portfolio today is slightly more defensive than
15:45what it has been. We are, of course, still overweight on industrials, healthcare, but
15:50we've gone underweight on auto. And consumption also, we've gone from overweight to neutral now.
15:55Some of the high flyers and discretionary names like DMart, Kalyan, we've taken out. We have
16:01doubled down our allocation on names like Metro and Celo, which have not performed,
16:06and which if the festive season is good, and discretionary demand recovers a little bit,
16:12with that perspective, we've added further weights in both Metro and Celo. So staples,
16:16we are underweight. We still have only Hughes Sun Leader in staples. So that's how we are trying to
16:21juggle around in this kind of a market where valuations are very, very punishing in mid
16:26and small caps right now. So in fact, our bias is predominantly toward large cap now.
16:30If you look at our model portfolio, 75% of our weight resides in large cap now,
16:36only 25% is mid and small caps. You know, from your report, we understand
16:41you've cut your Nifty EPS for FY25 and FY26, and you believe this is one of the worst quarters
16:47you've seen in the recent past. Let's keep this quarter behind us now. When do you think,
16:51do you think the rebound from the next quarter is a fair expectation for street participants to have,
16:55or do you think this quarter is going to be followed by very aggressive downgrades?
16:59You know, actually, let me qualify that downgrade by just explaining the nuance behind it. So 4%
17:05on our headline basis looks very big downgrade, which it is, but you have to just layer it down
17:11and see which are the stocks which have driven those downgrades. So out of the 4% downgrade,
17:1580% of that 4% has come from just four stocks, which is Reliance ONGC, Tata Steel and JSW Steel.
17:23Rest 46 companies, their earnings revision has been very flattish. If you look at the broader
17:29markets also, for our coverage universe, XOF Nifty, there are about 225 stocks, there also
17:34the earnings revision has been flattish, maybe minus 1 to minus 1.2%. So while that 4% number
17:40looks a bit scary, if you see through the details and take a deep dive, it's not a very broad-based
17:47downgrade. We have seen a cycle of 2015 to 20, where every year we used to see across the board,
17:54across the sectors downgrade. So no, this is not that kind of a situation. And we do expect
17:59this to change in FY26, where our expectations are still pretty healthy. We're looking at 17%,
18:0518% growth. So in fact, Samina, if you see last five years of earnings trend,
18:10every alternate year, we've got a slight moderation in the growth. So FY22 was a 40%
18:16earnings growth year for Nifty. FY23 was 10%. Then FY24, again, we saw 26%. This year it is 7%.
18:25And then again, FY26, our expectation is about 15% to 18%. The thing is when earnings changes,
18:32either on the upside or on the downside, are disproportionately led by commodities,
18:37the market tends to see through them. When you saw 40% earnings growth in FY22,
18:43market didn't get too excited in FY22, because except commodities, the growth was still 21%
18:48only that year. So Gautam, I'm just going to come to an important point you made, that 4% EPS cut
18:55is being contributed by four major companies. Let me come to the biggest of them, RIL. Let's get
19:01into a little bit of a detail by what you're expecting in Q2. And is there a bit of worry
19:06there? Where is it? Which vertical is it coming from? So it's coming across the board actually,
19:12Ramanna. So standalone, we have seen that Singapore GRMs have been very flattish QOQ.
19:18So there's been change in estimates around that on a full year basis. We've also cut retail
19:23estimates by about 8% to 10%. And we've also marginally tinkered around with the GEO estimates
19:29too, where we've cut by 3% to 4%. So Net Net Reliance itself on an aggregated consolidated
19:35basis has seen about 8% of earnings downward, which is pretty big for a company of that size
19:40and that weight in the index. Okay, thank you so much, Gautam for speaking with us. I mean,
19:47you know, it's always fun chatting with you. And we can go on and on so much more to ask you,
19:51but we will see you back for the review of Q2. And we look forward to hearing from you then.
19:59Gautam Duggar of Motilal Oswal on what Q2 is setting out to be and could be disappointing for