A Weak Start To Trade | IT Earnings Are Currently Seeing Tailwinds: Kotak Institutional Equities

[00:00:00]Priti Gupta is with us CEO and co-head at KODC institutional equities. Pritiki good morning great to have you with us here. Thanks for joining in. What is the uh sellside view on this farmer news which has come through this morning?

[00:00:12]What are you telling clients Pratik? One view is that well it's it's it's negative and raises uncertainty. The other way to look at it is well removes uncertainty right two years you got a clean run and in two years it's going to be campaign time and uh you know President Trump will be about 5 months away from finishing his term. So uh will all of this come really happen right that's the other way to look at it uh suggest your thoughts >> uh good morning Prashant so I think uh the farmer tariffs firstly given that it's a 100% tariff and not a more realistic 10 or a 20% tariff so therefore this doesn't seem like a very serious issue at this point in time we don't think the market will take it too seriously because this is more of a posturing and pressure tactics to try and get the manufacturing operation ations to move to the US which again is not an easy thing for you know the companies to do. They have to move the entire supply chains. Uh easier said than done. So this is more like a pressure tactic. Uh so we think this will have some sentimental negative impact but uh this will as you rightly said this will drag on for a bit. Uh if it was a straight you know 10 15% tariff that would have been far more realistic.

[00:01:23]So we think this will blow over after some time. There will be negotiation.

[00:01:27]this will drag on you run into the midterm elections uh and then let's see what happens. So this is probably uh just sort of sentimental impact for the timing. It is negative of course for companies the US generic companies which are exporting straight to the US and do not have any manufacturing presence.

[00:01:44]There are a handful which have some kind of a manufacturing presence in the US they'll be less impacted but by and large we're not taking it too seriously at this point in time.

[00:01:52]>> So what's the call on pharma at KOTC IE?

[00:01:55]Are you bullish and you'll stay bullish?

[00:01:58]>> Farmer selectively bullish but more on the domestic pharma sector and that was the case even before this uh tariff news overnight. Uh we think uh the generic space as it is apart from the tariff risk there's intense competition margins still haven't stabilized uh and and we think the outlook is much better for the domestic farmer companies. The growth runway is much uh longer and and uh more sustainable. So our preference has always been for the last say at least a year or so for the domestic farmer companies. Praik what's the call on HDFC bank now the stock's been a rank underperformer not for one year close to 5 years now and most mutual funds have held on to it as a large weight despite the underperformance uh how should you know what's the call now >> so uh we can't make any stock specific comments but I let's just say in general uh that's also true with some of the other private sector banks and there have been obviously stock specific issues in the case of HTFC bank in terms of uh various one is obviously it was a very well-owned uh uh stock by foreigners and as foreigners were selling India as they were rotating out of India into other markets uh that was one big reason but apart from that I think in general uh the banking sector got hit with various issues in the last uh last few years uh foreign selling was one factor slow growth n pressure loan growth all of that the economy went through a lot of shocks as such but at these valuations given the rental performance of most of these private banks including the HTFC bank were actually quite constructive if you have a one-year plus time frame. Uh there are actually from a valuation perspective these stocks have come down to very reasonable uh levels. Uh and frankly these are the big plays on India's economic recovery as and when assuming this oil price uh issue doesn't blow up once again. Uh so we think we're actually quite positive from here on. Hi Pratik uh good morning good to see you Ben if that's that one theme that you're betting on that you believe that's probably in a structural bull trend which one would that be and why >> so I think uh the themes there are many of them like defense uh capital goods uh power tnd etc but the problem is valuations so some of those themes are already extremely well discovered and the valuations are very very high so therefore if you look at as a as an investor you need to also look at valuations you can't just look at the growth prospects. You have to figure out what is already priced in. Uh from that perspective, we like some of these themes, but they're already priced in to a very large extent. We think the upside is quite limited at least over the next year or year and a half or so. So therefore, we're back to looking at some of the more cyclical uh economic recovery plays which have been sort of underperforming and where valuations are a little bit more reasonable. So that brings us back to you say the banks, the NBFC's um I would say some of the u the hotel and hospitality companies the hospital space you know telecom sector and so on.

[00:05:04]So it's it's really more valuation focused rather than where the themes might be from a growth perspective alone.

[00:05:12]>> Yeah. Uh [clears throat] no absolutely point taken there.

[00:05:19]lots of action. I mean there's almost FOMO in mid and small camps. Uh Pritik you would agree right?

[00:05:25]Uh stocks >> I'm saying there's there's there's just FOMO. I mean stocks are ripping 40 50%.

[00:05:32]Uh you know we were talking with a sellside analyst and I was asking him whether you know he told us he's working on initiating coverage. He's postponed it. He's saying there was stocks run up.

[00:05:41]Uh so would you agree with that characterization? Absolute FOMO.

[00:05:47]Uh yeah that's that tends to happen with these small caps. The liquidity is much lower. So a little bit of buying does tend to result in a outsized returns in the short term and valuations do tend to get out of hand pretty quickly which is the case in our view right now. Uh these these small caps obviously the growth prospects in many of these companies are far superior compared to the average of the nifty50.

[00:06:12]uh uh but uh at the same time I think you again you have to keep in mind valuations uh you have to when you're investing you have to maintain the valuation discipline and that's where at this point in time I would agree with whichever small cap analyst that was that generally speaking a lot of these small caps are becoming expensive again and again you got to take a really long-term view like five sevenyear view uh to to sort of get in at these valuations but otherwise we'd prefer the large caps once again and also given once again you're having the sort of geopolitical uncertainties emerging again. Oil is back to $90. Uh the the uh monsoon outlook obviously is a bit you know uncertain. You've got the trade tariffs looks like this time it's farmer to begin with but even our India US trade deal still has a need fil. So a lot of uncertainties out there and obviously not forgetting the AI risk so on. So you got to be a little bit careful. uh we don't think we're in a raging bull market uh as yet and and I would be a bit cautious on the small cap stocks in general. By the way uh just one question fundamental question Pratik what is the minimum market cap criteria for most for most institutional investors you know after which they you know is is the minimum and only then they start to look at companies is it 5,000 cr 6,000 how's it has it changed uh it's actually increased over the years as the fund sizes have grown over the years so even a small midcap fund for a local mutual fund that they would probably not look at anything less than a few thousand crores to begin with. Uh the as far as the foreign institutional investors are concerned for them their definition of small cap is like typically 2 to5 billion in some cases even as much as$2 to10 billion. So the universe is uh somewhat limited but but I think the other criteria is not just market cap it's also the actual liquidity in the stock and that means you look at the free flow you look at the average trading volume and not just the headline trading volume the actual delivered volume because you tend to have a lot of intra speculation which is not real liquidity. So when you look at liquidity unfortunately a lot of these uh small caps they they they don't make the cut. So if someone wants to buy even a small midcap fund wants to buy let's say 50 crores 100 crores of a position in a stock that's not easy to do in many of these small caps without impacting the price quite significantly.

[00:08:34]M uh but there is liquidity in midcaps you know um Pratik are we seeing increased interest or inquiries from the foreign investors the FBI you know are sort of back in the Indian markets at least when we track the data in early July and in the past whenever we spoke about foreign inflows it was always concentrated in large caps but now increasingly the money that they're putting in is either in IPOs or some of these midcaps where we are seeing earnings delivery does that create sort of a structural tailwind for midcaps over large caps.

[00:09:06]>> So uh I think you're right to some extent that we have seen foreign investors broadening their investment universe when they look at India. So for example historically the banks, consumers and the IT services talks were the really the focus areas and that two mainly the large caps. uh what we've seen over the last say about 2 three years or so is that foreigners are sort of focusing a bit more on expanding their coverage going beyond the the let's say the top say 100 odd companies and and yes in some of the larger IPOs coming out of India there is likely to be more foreign interest uh we are seeing that happening partly because of valuations as well where IPOs tend to come in a little bit of a discount to the prevailing uh peers already listed in the market uh so there is some definitely some interest but Again foreigners care about one is valuations especially relative to regional valuations there unfortunately most Indian midcaps don't qualify most of our midcaps are quite expensive compared to the rest of the region even though some of them may offer slightly better growth and second is liquidity which again matters a lot uh like I said even for our domestic mutual funds and insurance funds some of the midcaps they may appear big market cap wise but the liquidity wise it's not easy to make take a meaningful position The same is actually true for the foreign investors as well. And in many of these IPOs, the allocations tend to be a problem whether it's in the anchor or in the main book. The the sizes are too small for them to bother with. So we don't see many of them participating.

[00:10:36]Not because uh the market cap is not big enough. It's just the position sizes they can get is not meaningful enough for them to bother with. For them and almost every institutional investor, you have a pretty detailed investment process. you to write an investment thesis, get it cleared through your investment committee and so on. So that tends to be quite uh painful uh and requires a lot of effort. So therefore they don't bother with companies which are beyond a certain which are below a certain cutoff.

[00:11:04]>> You briefly mentioned about IT companies. I think we were discussing this the last time as well. It appears the street is getting over pessimistic on some of those companies and select opportunities could emerge. What's your positioning right now?

[00:11:16]Uh so as I said the last time as well if you take a slightly longer term view a three four year view then I think uh we we believe that these companies these businesses will survive they will adapt and they will change but we are going through a transition which is quite painful both from an earnings standpoint as well as from a valuation standpoint u uh the from an earnings perspective obviously there are some temporary headwinds temporary tailwinds in the form of the rupee uh which is out there and and some large deal wins etc. But the fact remains that the AI theme is not over as yet. We are seeing AI adoption spread. Eventually we believe our Indian IT companies will be required. They will be required to do the especially for the enterprise level IT implementation of AI. That's where their role will come in. But retraining reskilling let's say you know hundreds and thousands of engineers in each of these large IT companies that will take some time. uh you will see customers putting pressure on margins. There's obviously a little bit of a uh trade-off in terms of how much you can use AI yourself as an IT services provider.

[00:12:23]There is a cost of the tokens and you have to compare that against the human cost. So there's a little bit of a rebalancing underway right now. So we're going through a transition period. We will see likely somewhat weak earnings growth for the this year and perhaps even next year as you go through the revenue deflation uh cycle. But eventually we'll come out of it. Having said that, in the short term we are still cautious. We would recommend we have been recommending an underweight.

[00:12:47]That stance hasn't changed. We think valuations need to come off a little bit more. Uh we've come we've come down a lot but maybe especially given the uncertainty and the uh risks out there, we're still not turning positive as yet.

[00:13:00]>> Uh Pratik, great conversation. Thank you very much for joining in.

[00:13:04]>> Thank you.

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