How much more steam does the metals rally have? .
If you look at the LME, the entire pack seems to be on fire. You have to be selective here. So one is catching the commodity cycle right and in this world of easy money with central banks expanding the balance sheet to probably $13 trillion in next one and a half years, commodity will be in a bit of an uptrend. But you have to avoid leveraged balance sheets and ensure that you do not get carried away.
Tata Steel still looks good. If you see their last quarter numbers, there’s about 5.2 million tonnes Indian output, and another 2.1-2.2 million tonnes on the European side. The margins will improve. There have been three-four price hikes. Even in Europe, the hybrid realisation should improve. Already the spot spreads are above $200 per tonne. You will see both operating and financial leverage playing out. They have already done almost a billion dollar debt reduction so that will play out.
Also they have reorganised themselves with the merger of Tata Metaliks and Indian Steel into Tata Long Steel which also gives them some cost and operational synergies. So do not just get carried away by the momentum, maybe some better price points would help.
TCS result comes today. What would you be looking for in the commentary?
So IT clearly is in the mid-cycle or early mid-cycle in the multi-year technology spend. What you are seeing right now is more cloud adoption and maintenance. The second leg would be spent on new age technologies like AI, virtual reality, data analytics, internet of things, etc. TCS’ ability to mine large complex deals is evident with the deals yhey have come up with Pramerica and some of the others. It is probably emerging as a platform and end-to-end provider. We are seeing vendor consolidation. I was looking at their $100-million client counts and that has doubled in the last five years.
So, the balance sheet strength, the ability to manage these large complex deals give them an advantage. The margin levers will remain. Low travel cost will ensure that their margins are maintained at 26-27% but commentary is important. Probably at Rs 3,000 in the immediate term, you could have limited upside. One can look at Infy and HCL from valuation perspective.
Besides IT, where do you think the earnings surprises will come in from? What are the dark horses that you are betting on?
I said there are very few now with the run up in the prices to be honest. A couple of private sector banks can surprise, especially ICICI. I am very impressed with the way they have managed their loan mix. They are not talking about growing the corporate loan book again. Their ICICI Stack which is the five layered digital app platform they have, has done very well for their retail customers both on liability and asset side as well as their third party products. The loan mix is 65% towards retail. Also 90% of their corporate disbursements are now A rated and above. We will probably not see much incremental shocks of which ICICI has been guilty of in the past. So there could be some rerating despite this run up.
I also like some niche financials which I think are long-term plays. Depository fee transaction charges have gone up, a number of demats continue to surge, market share of CDSL is already 57% and now online usage charges as a revenue stream is also picking up. E-voting, KRAs, virtual AGMs will add to the revenue kitty for them.
I like some pharma names despite the run up. The API space in particular maybe a multiyear growth opportunity. So something like a Divi’s, a Laurus Labs, Solara could still surprise.
What is your outlook when it comes to Reliance Industries?
There were multiple concerns and events around Reliance which has led to this near-term underperformance, largely triggered by the weakness in refining business. The oil and gas and petchem still accounts for more than 60% of EBITDA. This quarter you will see some recovery. Petchem already showed some glimpses of recovery. Refining should be better, may not be as good as the refining margins we are used to but the cracks are still weak but better than what was there in Q2.
Also the ARPU increase in Jio has not panned out the way the industry thought it would, but this is not just a pure ARPU play. It is a more integrated digital ecosystem platform play and I still think if I was to buy one stock at these high valuations, RIL would fit in. Also retail should see improved numbers.
Q2 saw some marginal recovery, we will probably see even the Reliance digital and electronics contribute other than the groceries. Their online e-commerce is doing quite well. Any correction and weakness is an opportunity to add on dips.
Do you expect positive commentary in TCS? What kind of outlook are you expecting on the margins, demand as well as the changes in delivery model?
The commentary is likely to be positive and a 26% plus margin would be maintained. The TCV will surprise on the upside. There is a very strong deal-win momentum and they have $100-million plus clients which have doubled in the last five years. But on a relative basis, I am more constructive on HCL and Infy in the large cap space and maybe MindTree in the midcap space. In HCL in particular, the margin gap should narrow with both Infosys and TCS. About 70% of their revenue comes from IMS and app modernisation and I think they are in a sweet spot. Also the ER&D business seems to be on the mend and recovering. In terms of relative attractiveness, it is HCL, Infy and TCS in that order in the large cap IT pack.
What happens to ITC? Is it a complete avoid?
It has been a bit of an enigma. Valuation-wise, it is possibly the cheapest consumption stock and there is this negative news on tobacco. Also there is a Budget around the corner and one has to be ready for more excise hikes. Secondly, right now, their FMCG business is shaping up well. There are a lot of their brands in hygiene, in biscuits, in eatables and fast moving consumption items are clearly doing well. Even the margin profile seems to be improving and the cash flow is very good.
On the other hand, the paper, hotel and tobacco businesses have been a bit of a laggard. ITC is a good stock for investors who want a debt plus 2-3% kind of a return, great dividend yield. Valuation-wise, there is some margin of safety at the price it is in. But if I want to pick up consumption stocks from a capital appreciation, growth perspective, I would go with something like a Tata Consumer where there are multiple growth levers in play including the coffee business, the Tata Sampann brand and tea business which has been very, very steady for them.
In the next couple of years, would you be looking at some of the FMCG majors?
I will club FMCG basically into consumption and fast moving electrical goods. I will probably cover building materials also. I like Tata Consumer and even the QSR story despite these fresh valuations. Anything on dips is good to add from a long-term perspective.
Within QSR, the preferred pick is Jubilant. They are adding different cuisines, they have changed their store formats into smarter and digital formats. They have done away with the minimum order, introduced a transaction delivery fee, the same store growth continues to impress me. There are 1,300 odd stores now and doing well. Tata Consumer is the other one.
In building materials, I like players like Polycab despite the run up. It is a clear leader in wires and cables, now the business mix is changing from B2C with the foraying into fast moving electrical goods like fans and water heaters and conduit pipes. So that is another one. There are some of the other adhesive players like Pidilite also. In general, I am positive on them but the valuations are very stressed and if you really enter at very high valuations, you might have a long period of time correction if not a price correction.