Aditya Sood of InCred PMS
InCred PMS believes that the valuation multiples are much more reasonable in the IT space, after a sharp correction last year, and most of the stocks have priced in a slowdown. Hence, it is worthwhile to note that the Indian IT sector is a market share gainer should continue to do well over the medium term, Aditya Sood, Head Portfolio and Fund Manager – InCred MultiCap Portfolio, says.
Also, valuations are much more comforting after the price correction in consumer durable stocks and gives a good entry point to position in sector which has attractive growth prospects.
Sood, with over 17 years of experience in equity markets largely spanning fund management and research believes that profitability of healthcare sector is likely to improve over the next four quarters with raw material prices are stabilizing or coming down. Excerpts from an interaction with Moneycontrol:
Do you think the healthcare sector is the cheapest in valuation terms?
The Q3 revenue growth for healthcare companies has been healthy at 8-12 percent. However, gross margins continued to remain under pressure as geo-political issues impacted raw material prices. Lower gross margins along with normalisation in traveling, marketing and promotional expenses, and elevated energy cost further impacted EBITDA margins.
However, we believe that profitability is likely to improve over the next four quarters with raw material prices are stabilising or coming down. India-focused companies will further get benefit from WPI-linked price increase in NLEM (national list of essential medicines) portfolio (by 10.8 percent) and non-NLEM portfolio (up to 10 percent).
Additionally, come April 2023, the average WPI of January 2022-December 2022 would be announced (12-12.5 percent) by NPPA (National Pharmaceutical Pricing Authority) as the price increase allowed for NLEM portfolio. US business is likely to remain lumpy depending on niche products and new launches in the complex/specialty segment.
BSE Healthcare is trading near its 10-year average of 4.2x P/B, however, RoE (return on equity) are at 12 percent, as against 10-year average of ~14 percent. As RoE start to improve, the healthcare sector will likely see trading multiples re-rating.
Is the opportunity emerging in the IT space now?
IT service companies largely reported better-than-expected results with the tier-1 reporting 2-3 percent on-quarter growth in a seasonally weak quarter in IT services. EBITDA (earnings before interest, tax, depreciation and amortisation) margins also improved by 50-100bps on average on a QoQ basis. The tier-1 pack has relatively outperformed the tier-2 set in Q3 both in terms of topline growth and margins.
Reduced attrition, increasing utilisation and lower subcontracting could further drive margins upwards in the near term. Managements across companies noted cautiousness by clients on IT spends largely driven by macroeconomic factors, but remained confident about the medium-term demand for IT services. Deal wins continue to be strong, despite the impact of a muted macro environment globally.
We believe that the valuations multiples are much more reasonable after a sharp correction last year, most of the stocks have priced in a slowdown, it is worthwhile to note that the Indian IT sector is a market share gainer should continue to do well over the medium term.
Recently a big corporate said the rate hikes by central banks will continue for longer. What do you think about India?
The surge in energy and food prices, coupled with still severe albeit easing supply constraints, has dealt a major blow to the global economic outlook. While prices for energy and food erode consumers real purchasing power, the rise in inflation to 40-year highs in Europe and the US is forcing central banks to tighten monetary policy sharply – at a time when economic growth is already losing momentum.
We believe the phase of ultra-loose monetary policy is over and the new normal would be a reset of the risk-free rate. With the risk-free rate having increased in the recent past, the narrowing gap between earnings yield and bond yield has impacted market valuation multiples.
There is a significant correlation between the M2 growth and the CPI, the money supply growth has tapered down sharply inflation should taper down, core inflation would be a key monitorable. In India both the consumers and RBI have had considerable experience of managing periods of high inflation.
Do you expect possibility of earnings disappointment in the current calendar year?
Corporate earnings for Q3FY23 were impacted weak demand environment and macro headwinds. Slowdown in discretionary consumption is a material concern impacted by the interest rate hikes.
Considering the multiple headwinds, market valuations have witnessed a significant correction in the recent past, P/E multiple dropping from a consensus estimate of 23x earnings to 19x FY24. This is a modest 10 percent premium to the long-term average. Since we are now trading close to the long-term average earnings growth trajectory would support market levels.
We are currently in the phase of earnings readjustment on account of the near-term headwinds. We expect earnings for the Nifty50 to grow at 15 percent and 12 percent for FY23 and FY24, respectively.
Do you think valuations are attractive in consumer durables space now after correction since September last year?
Most durable companies posted weak Q3 results and exhibited trends similar to Q2 on account of margin erosion and intense competition. The AC space, continued to witness the pricing aggression on account of heightened competitive activity. There has been muted demand for refrigerators and washing machine. Washing machines and refrigerators revival especially the economy segment is likely to improve as rural demand recovers. Over the medium term, we believe the AC companies margins could structurally get reset at lower levels, with companies likely to chase revenues to achieve PLI targets.
During the quarter, commodity costs showed signs of stabilization, with the full effect of price hikes kicking in, a few companies reported gross margin expansions this would eventually trickle to EBITDA margins mean reverting.
Valuations are much more comforting post the price correction in durable stocks and gives a good entry point to position in sector which has attractive growth prospects.
Is it the time to be a cautious on the equity markets given the current global environment?
We believe equities markets are in mid cycle with market multiples not being cheap although they are well supported by the superior ROE profile of the Indian corporates and earnings growth – India would be one of the fastest growing emerging markets.
The Indian economy is intertwined with the global economy. Post the global financial crises, the central bank policy actions have had a large bearing on the performance of financial assets, hence a case of decoupling is difficult to be made.
We have a constructive stance on the markets, particularly on small caps after 18 months of underperformance vis-à-vis large caps. The earnings growth in small caps would be higher that of the NIFTY, as we see revival in corporate earnings this provides ample opportunities to pick stocks on a bottom up basis.
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