There's a misconception about IT being a low growth sector: Prashant Khemka

Very few sectors in India are able to grow at 11% to 14%, at a sectoral level, and IT is one of them. Prospects of IT cos good from a long term as well as 2-4 year perspective, says Prashant Khemka, Founder, White Oak Capital Management. Fed meeting was one of the most anticipated events. They did talk about taper and perhaps the market was already factoring all of that in but how would you analyse the data points? You have said before that macro data points are just observations and stocks and micro do not really get impacted a whole lot but still this one was clearly an important one from the liquidity point of view. What are your thoughts?It is very well anticipated and not sudden or shocking for the market. The Fed is observing the data and in the near term the inflation numbers are coming in higher. Fed is of the belief that it is transitory in nature, I would like to believe they know better than us and better than most others. We also are in the camp that because of the supply chain dislocations related to the pandemic, there is a certain transitory element to inflation. Now how much of the inflation is a transitory element and whether there is any structural element or not, it is impossible to say as of now. What the financial markets and the Fed as well would be wary of if there is a reset higher to long-term inflation expectations. What the inflation is over the next 12 months, 24 months, three years is not that material for the financial markets. It is what the inflation expectations could be for longer term inflation, which has been very benign. This inflation expectation is very benign for the last several years. If there is any change to that, then that could have greater repercussions and to address that in time, the Fed might increase the rates or taper to keep a check on inflation expectation. Right now there is no material risk of inflation expectations running away but that is something that the Fed and other market participants are always wary of. You have a large holding of private banks both corporate and retail. In fact, retail centric private banks have underperformed in a big way in the last eight months and corporate banks have really taken the lead. What is your hypothesis on both sides of the allocations as the economy opens up going forward?While the team believes in a very bottom-up stock-selection based portfolio, they consciously like to have a balanced portfolio. In that we do not take a view on the direction of the market nor do we take a view that is materially significantly different on the economy front from what the consensus might be. That is our style, that is the approach. We like to have a balance in the portfolio. There are certain areas of the cyclical segments such as industrials and materials segments like cement and autos where the team struggles to find good investment opportunities. At the same time, amongst the domestic cyclicals, the team found quite a few attractive opportunities in financials and for a very long time, held large allocations in private sector financials. It is not much different at this time, more particularly, the retail versus corporate as these were terms that were true in describing the character of some of the private sector financial asset side maybe 10 years ago. But the banks that were considered 10 years ago to be more corporate, might today be more retail, while banks that were 10 years ago considered to be retail are more corporate today. So the distinction between retail and corporate is no longer as applicable today as it was many years ago. These banks that you are referring to all have very strong retail liability franchises and it would be extremely difficult for new banks in the future to be able to replicate and on the asset side. Also all these banks are now within very comparable percentages in terms of the retail to corporate book. So, the distinction is more a matter of perception now than reality. Let us talk about some of the electronic manufacturing quasi consumer durable plays which you hold. These companies got listed in no time and have gained a lot of market share as well as market capitalisation and now they are talking about expanding their product base and opportunities. How would you see this evolve in the next three to five years now that PLI is taking shape?The team has been early in identifying these opportunities. Many other countries in Asia, led by China, for decades have honoured the manufacturing hubs or have been the manufacturing playground for global requirements. India was left quite far behind on that front. However, over the last five to seven years, there has been a concerted effort to gain back our fair share. Policies have been put in motion -- a carrot and stick approach; carrot in terms of incentives, stick in terms of higher tariffs. Compared to decades ago, the ease of doing such kinds of businesses has certainly improved and as a result we are seeing companies setting up electronic manufacturing services where people outsource the manufacturing of TVs or LED lights or even consumer durables. That industry is taking hold in India. The earliest movers have a decade or two of advantage in terms of time advantage. They have already scaled up the curb. There are foreign players coming in and setting up shop as well. The PLI scheme is one of the most successful schemes and so far has been implemented in a very efficient manner. Companies in this industry have lived up to the expectations of the market and we expect them to continue market share in an industry which is gaining market share from regional peers or in the global context. When one is gaining market share in a fast growing segment, growth rates are very robust and the profitability is good. Hence the price movements have been quite rewarding as well. Let us talk about the IT space. Are you seeing higher growth for Indian technology companies?There are two elements here – the structural aspect and then more near term, next few years aspect. By structural I am talking of decades kind of timeframe. Our team has always had good success in identifying great investment opportunities. I cannot talk about specific names here. The opportunity is also there because from a structural perspective, we find an entrenched misconception or myth amongst investors that IT services is a mature sector and a low growth sector which cannot be farther from the truth. We have never believed in that. The reason many investors and market participants have misled themselves into believing this is because they hear about these growth rates that IT companies talk about or industry bodies like Nasascom talk about where they talk of 7-8% growth or high single digit growth and that sounds in the Indian context somewhat low because double digit growth seems to be the birth right of every company in India because the nominal GDP is growing double digit in India. But an important distinction that analysts and investors fail to make is what IT services companies and industry bodies are talking about are dollar growth. So when they have 7% to 8% or 7% to 9% dollar growth, in rupee terms, over time that translate into 11% to 14% growth because of 3-5% rupee depreciation or 3% to 4% rupee depreciation over longer periods of time. That has been the experience and it is reasonable to expect that given the inflation differential between India and the dollar economies, 11% to 14% growth is no small change. A very few sectors in India are able to grow at 11% to 14%, at a sectoral level. Obviously within that, there are companies which grew much faster in any sector -- be it banking, consumer or pharma. There are companies that grow faster structurally and there are companies that grow slowly. Our team is able to find companies that are growing in the midteens or higher or even 20%. We expect them to grow at valuations that are extremely attractive because people have kind of labelled the whole sector as a mature or a growth sector. That is the structural aspect of why we find very attractively opportunities in this fast growing misunderstood sector. From a near-term perspective, despite a lot of negatives about the pandemic, there are certain positives as well from an economic growth perspective, not only in India but globally and one is much faster adoption of technology not only in our day-to-day lives as is happening right now but also driven at the largest of the global enterprises. What was discretionary IT spend, till a year-and-a-half ago, is in many situations a necessity now. So the shift to many of these technologies which was happening at a steady gradual pace over the years has been accelerated. CEOs of companies ranging from Accenture to TCS to Microsoft have mentioned that moving to the cloud was happening at a certain pace. Business case was being made at the boardroom levels and in many companies it would have taken a decade but post pandemic this acceleration is happening within 1-3 years. Then all the ancillary services and related services and products that have been supplied to accomplish that and the IT services sector is in the midst of it all. They are seeing a rapid rise in the demand environment. The worry, if anything, is on the supply side and not on the demand side. So the prospects not only from a longer term, but for next 2-4 years look very promising for IT services companies in general and particularly the companies we own in the portfolio.

from Economic Times https://bit.ly/35xe8ZR
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