Avoid diagnostic stocks now; play infra via sub segments: Siddhartha Khemka

“We do not have a very positive view on diagnostic players until we see some consolidation in the industry. Right now it is in an expansionary phase where a lot of new players are entering. There is no entry barrier which is impacting the pricing and margins for most of the players,” says Siddhartha Khemka, Head of Retail Research, MOFSL

What is your view on the diagnostic space? Pharma has not done much for a good part of the year and now there is a bit of a negative news flow coming in that the Delhi government might be providing some free tests for people. Do you think this could act as a negative trigger for the entire diagnostic space? What are your top bets?
The diagnostic players had a dream run during the Covid time when mandatory testing was there and they made the most of it. We saw a lot of large players getting into this space. The competition heated up and the realisation softened and on the back of all this, the volumes have also softened a lot from the peak Covid era.

On the back of it, we have always seen that healthcare as a space is influenced by a lot of government spending and that could be a case in the longer term. Specifically from the diagnostic players’ perspective, healthcare and testing is a good long-term growth visibility but in the near term definitely it is a negative. We have been avoiding this space or maybe one can say that we do not have a very positive view on diagnostic players until we see some consolidation in the industry.

Right now it is in an expansionary phase where a lot of new players are entering. There is no entry barrier which is impacting the pricing and margins for most of the players. Some of these private players have innovated in terms of the way they are delivering the services going to homes and collecting. The ease of doing this testing and the ease at which we are getting these reports mean this business should definitely pick up pace once this phase of expansion is over. Until that time, one should avoid this space as of now.

What about the entire real estate pack? Like the diagnostic space, they also saw a crazy run over the last 12 to 18 months but finally it seems that the demand is plateauing a bit and of course the interest rate upcycle does not really help. What is your take on real estate names and what are the stocks that you would like to recommend from that vertical?
Post the pandemic, when the interest rates went to record lows and on back of it, several state governments provided incentives by lowering the stamp duty registration charges in a bid to boost demand for real estate, which definitely helped the industry on a pan India basis.

The inventory levels for most of the real estate players, which had risen to record highs, have come down drastically. A lot of these inventories got absorbed and post that, we saw some cost pressure because of the rise in commodity prices.

Now again we are witnessing the increase in interest rates with margins flattening the demand. Our channel checks suggest that the overall demand supply scenario remains favourable on one side where demand has been pretty strong. Most of the real estate companies in their Q2 post result commentary said that they have done record pre-sales booking. That shows the set of demand these companies have.

On the other hand, these companies have been very cautious in terms of supply. They are gradually doing launches and letting the supply get absorbed before getting into another new project and that is kind of favourable. Some of the stocks had seen a run up and so there is a consolidation but from here on, the residential real estate space from a one year-two years perspective should definitely do well. In the Mumbai region, we like Oberoi and Lodha and from the Bangalore region, we like Prestige and Sobha.

Are there any signs of defence stocks getting overbought? Also, what is your view on the new trend of chasing railway stocks?
Public sector enterprise stocks have been doing well, especially given the fact that Nifty is reaching new highs and this has been mostly propelled by the private sector stocks. In an environment where the economy is expected to do well and has started doing well, we see strong growth in some of these government enterprises and that is also corroborating with the fact that a lot of these railway and defence stocks have received a lot of orders from the government.

So the focus has been on public spending which has seen an increase and we expect this trend to continue with the government having the last full Budget before the 2024 elections. Not only will the public sector companies benefit from government spending, but some of the private sector infra players like L&T, where we are seeing strong order book inflows, execution and some of the private players like KEC or road players like KNR Construction could see uptick in the order book, execution and profitability which should attract a lot of investor interest in the space which has of remained on the sidelines for a very long time.

In terms of construction a lot has changed. How should one play the infrastructure space? For the last 12 years, cement has been the best play because some of the other companies face execution challenges. Is that expanding now to roads, ports and various other sectors?
Yes. That used to hold true for a very long time and when people used to play the entire housing or infra construction space through cement but in between, we also saw some of the building materials coming into play because they are not pure or clean companies in terms of good balance sheets and execution challenges with respect to infrastructure companies but that is gradually expanding.

We have cement as a direct play or the most preferred mode of playing both housing as well as infra boom. Some of the building materials are now getting the support of lower commodity prices as well as some of these direct EPC players where they are helping in building. The order book is definitely increasing, execution has improved a lot and with softening of commodity prices, the margins would see an improvement.

One can play that in various sub-segments. In transmission, there is KEC International; in defence, there are a lot of players; in capital goods, there are a lot of players and in the roads infra side, L&T is the largest behemoth. Plus, there are some of the smaller players like KNR Construction which have a decent management track record, a decent balance sheet and a strong order book which gives enough visibility for the next two, three years.