Expecting 10-20% upmove in banks in next 6 months; neutral to positive in IT, pharma: Aman Chowhan

“We have a two-year visibility and hence we are okay to give a normal multiple or a decent multiple to these IT companies. That is the space when this sector will start doing well. We are also pretty mindful of this and that is the reason we are neutral to positive and not aggressive IT or pharma buyers,” says Aman Chowhan, Fund Manager, Abakkus Asset Manager LLP

It is all-time high for the Bank Nifty, everything in the financial space is looking charged up now, so the template and thesis is looking interesting and strong but is the market pricing in FY23, FY24 or even FY24 earnings for the banking sector per se?
I think FY23 is priced in but the market is now focussed on FY24 which is what the current year would be in three months down the line. From FY24 basis, another 10-20% move can come in the banking sector over the next six months.

Why India is outperforming is not a new story but suddenly things are falling into place, the rupee is strengthening, crude is just moving in some kind of range and there is weakness in the dollar index. Could we be in a case of a buy the bad news and sell the good news kind of scenario?
Also, what is helping India is that we are doing well but our competitors at the peer group are in a bad shape. Sri Lanka is bust. Bangladesh and Pakistan are bust. Nobody wants to invest in China. Turkey and Greece are facing hyperinflation. Russia, Ukraine, the UK are out of the investment radar. If somebody has to deploy money, there are very few markets, maybe Thailand or Malaysia or Indonesia and India.

India stands out and that is the reason we are seeing a good amount of institutional interest and both global liquidity as well as local liquidity and that has charged up our market. The outperformance that we see YTD is predominantly because of these two factors. We are doing well no doubt but at the same time, competition has significantly weakened.

You just talked about banks and the kind of inherent strength that you foresee. While you had exposure to two of the biggest contributors year to date that is ICICI Bank and SBI, where within the mid-tier or smaller banks are you adding fresh positions right now?
When we last spoke, we mentioned that we see pockets of good growth coming into micro finance and that is something where we are focussed on. Incrementally, we are looking at non-fund based financials. So the broking company, the AMCs, which are still 30-40% below their previous highs and that segment is now looking interesting.

Bank Nifty is already at a high but these companies are not so. These companies got battered a few months back. The market volumes and market sentiment is down but with Nifty back to 18,000 in which the retail participation is still very strong, we do not see any demand impact on the market volumes, the broking companies and the AMCs and that now looks interesting to us.

Let us also understand the overall outlook in terms of where you are seeing potential as well within the entire capital goods space, given that there is a large focus on the overall manufacturing picking up. Are you seeing resilience here?
Definitely. This sector has started to look up after a long gap and it is going to be a multi-year theme. It is just that in the near term valuation, any of the MNC capital goods companies or large domestic companies, whether it is ABB Siemens, Honeywell or Cummins, Thermax and the like are all trading north of 40-50 PEs and that is something which investors like us are not very comfortable with. So, we like the space, we like the opportunity, it is going to be a multi-year theme but probably wait for a better entry point than just coming in right away.

We have also seen in recent times the outperformance when it comes to Sun Pharma vis-à-vis the other pharmaceutical counters and the way Divi's has been performing since those bad results. How are you approaching the pharmaceutical space?
We are positive on the pharma space. The last 12-15 months have been challenging and that is the time when we are not very aggressive on the pharma space, specifically because post Covid, there was a big bump up and post that, we had a YoY decline from a very high base.

Now the base effect seems to be tapering off over the next one to two quarters. I feel the base effect will be completely out and then these companies will start showing a steady 10% to 20% growth. That makes it a good rationale to look at these pharma names. But one has to be very selective because I also see that the chemical prices have been quite volatile. If somebody has been exporting to China, you could be at the receiving end, at the same time if somebody is importing raw material from China or from other parts of the world, they could be the beneficiary. One has to be very careful in what you look at but overall from a growth and valuation perspective, the next three to six months would be a good time to look at pharma.

Why do you like AMCs and brokerages? While the big picture argument is strong that Indians will open more demat accounts, there is a change in the way these companies make business. Sometimes what is good for consumers is not good for shareholders?
You are perfectly right in what you mentioned but this is something which is known, it is not something that has happened recently. The commission structure is already known and it is already there in the numbers, all the big wealth players have already moved away from the upfront commission structure.

What excites us is the operating leverage. This is almost a fixed cost kind of business and if there is a growth in volumes bulk of that flows into profits and low capex intensive business, high ROCE business and in a buoyant market the way India has been over the last few months and quarters now there is no reason for these companies to be derated the way they got derated

What has happened is that this sector has got derated post March when market was topped out and volumes are now going to be lower but that has not been the case so everything else seems to have recovered but this segment is still lagging, people are still not looked into it and maybe that is the reason we feel this can be an opportunity.

I was quite intrigued by your 15-15-15 discipline model that is ROE, earnings, growth as well as ratio. There is a part of the market which believes that the valuations are only fair and perhaps it is the Adani Group of stocks which is making it look all that richly valued. Where do you find opportunities to buy afresh in this market going by your investment discipline?
Just to clarify, according to that discipline, any two out of the three criteria you mentioned should be met because if all three criteria are met, then we are in a sweet spot, great company, great business, great value and practically speaking most of the time that does not happen.

Having said that, in the current scenario, I feel the domestic market is where people are focussed on, including us; manufacturing, construction, EPC companies, real estate, quasi real estate plays is something that is interesting.

We know financial markets are looking up. Banks have done well now. We expect that rally to spread into NBFCs also. These are the segments that we are excited about.

In IT and pharma, we are neutral to positive and we will see good opportunities over the next one or two quarters and this is where most of our focus is.

We are shying away from chemicals, especially the bulk commodity chemicals because it is going to be pretty volatile out there. Also, companies which have an export focus where they do not have a very strong competitive advantage and clearly Europe has slowed down. In the US also, the debate is whether it is going to be a hard landing or soft landing and there is also going to be some demand impact for the US markets. Companies which can navigate through this challenging time is something one should be focussed on besides local manufacturing.

A megatrend as well that you had flagged off is looking at digitalisation, this cloud migration, digital network trend that you believe could sustain for the long term. How do you see companies adopting to this? Where are you seeing an opportunity for capitalising on this megatrend?
For the digital theme, the best way is to look at the IT companies. During the Covid phase, there has not been a single day when a banking website was down or money did not move or online platforms were down. The Indian IT companies have proven themselves. Their business model, whether it is work from home or working from offshore models and now post Covid, everybody wants their network office, everybody wants cloud, everybody wants to be digital and that is a multiyear theme according to us. That is getting reflected in the IT numbers also.

So even in the last two quarters, stocks have not performed well. The top line growth of IT companies has been decent. What got impacted was the margins because the cost came back as people started coming back to office and also there was high attrition. Attrition seems to have topped out clearly and in the current quarter, margins were better for many companies. The Q2 margins were better than Q1. So if one has to play the digital theme, the Indian IT sector is the best way.

It is also very simple; what we are debating is slowdown and recession in Europe and America. What happens in this phase is while the companies are closing, the country is not closing but the top line is down. So what do you do in this phase? You cut costs and what is the better way to cut cost? It would be like giving business to Infy at $25 versus giving it to Accenture at $100. These companies are bound to gain market share and there is no doubt about it.

In the near term there can be some softness as people readjust their spending patterns, readjust their outlook, once this settles then again it is a clear steady 10-15% growth for these companies and that should be reflected in the stock price also.

When you see the headline coming from Apple or a Meta or Microsoft or even Alphabet, it looks like we are taking it easy. If the US tech stocks are in some kind of a downward spiral, then psychologically the Indian IT stocks will remain under pressure?
Exactly. What is happening is the PE is getting compressed, Nasdaq is near a 52-week and stocks which were trading at 30-40-50 multiples have become 10-15-20 multiples and that has had a bearing on Indian IT multiples also and that is what we are seeing. So the top line, the earnings still remain steady, it is the PE which has got compressed.

Now when will this reverse? This will reverse when people are clear that demand is steady. We have a two-year visibility and hence we are okay to give a normal multiple or a decent multiple to these IT companies. That is the space when this sector will start doing well. We are also pretty mindful of this and that is the reason we are neutral to positive and not aggressive IT or pharma buyers. But clearly, this is one space where our eyes are open. IT is on our radar and we are just waiting for the right opportunity.