Why ITC may get valued at 35-40 PE multiples over 3-5 years

Liquidity playing X factor in market rally, says Yogesh Mehta, Founder, Yield Maximisers

What do you think is lending exuberance to the equity markets? Is it earnings that is taking precedence because so far India Inc has not disappointed?
So far, the earning season which has kickstarted with the IT bellwethers have not disappointed at all. But it is liquidity that is playing the X factor in the entire rally from below 7,500 to 12,430 onwards. This liquidity driven rally has given India a strong position. FIIs are still looking very positively at India and growth is visible now. I am projecting 20-22% growth rate for FY22. The growth is driving more attractive valuations towards India and that is why the liquidity is coming into this segment.

Also redemption from China and its reallocation to emerging markets is also playing out very well. It seems the result season and the Budget fever both are strong plays and we are at new highs.

Don’t you think that we are in an expensive zone? Do you think the PE that the Nifty is commending currently is okay?
There are two aspects to this. One, if you evaluate the entire Nifty basket and look at the average PE multiples, then it is higher. But if you take the top 10-15 contenders out of that, which are at much higher PE level, then you will see that in the bottom 25, the valuations are still attractive or reasonable. So everything is not expensive. The entire FMCG basket is still available at 45-50 PE multiple which is the average PE multiple of the last 10 years long-term average.

IT companies are also near 35 PE multiples right now based on FY22. The imbalance of the PE multiple is why there is a confusion regarding Nifty PE but I would say that rather than PE numbers, one should look at growth-oriented companies and chase growth.

There’s a lot of investor interest around ITC. How is it trading even when it comes to the valuations?
ITC balance is distributed 45:55 between the cigarette and the non cigarette business. If with a price hike in cigarette business and a volume growth of 3-4%, the EBITDA level rises 5-8%, it will not be significant on the balance sheet numbers but it will be positive because every time in the Budget, everyone is expecting the sin tax to be increased and that is a burden ITC carries every year. Tobacco products are out of the GST regime but overall ITC is a great value company and still available at 20 PE multiples,

So there’s a valuation gap within the peer sector and the growth is more than that of the other peer companies but this is the only laggard which is pulling the valuation down. Two, three, four years down the line, the moment we see that the balance or the distribution is in favour of the non cigarette business over the cigarette business, then it will have a much better valuation to command. I do not have any doubt that this company can again be valued at 35-40 PE multiples over the next three, four, five years, if not immediately.

So, it is a great company with a great balance sheet, good dividend payout, higher ROE and ROCE numbers and the growth rate is also commendable. This company can be looked at by an investor with a 3-5 year timeframe.

How are you looking at the overall story of Tata Motors? Do you think that Rs 240 is a good entry point?
It is too difficult to predict right now because almost everything is priced in, There may be some headroom left for Tata Motors from the current levels and I am expecting the profitability to return soon. It will be Rs 100 crore but then also it seems that the commercial vehicle contribution would be around 56% in the Q4 numbers as well. India business losses are now trimmed down further and the JLR mix is also improving continuously. Higher sales in China are showing some good traction.

The volume upgrades of CVs and PVs both together have already been priced in and even if we compare the FY22 numbers, and it is too difficult to predict right now because the losses will halve from FY20 to FY21 on an annual basis but FY22 may see a breakeven. Overall, Rs 300-320 would be a fair valuation for Tata Motors. It leaves hardly 10-12% upside from the current level.

Where within the midcaps are you finding quality companies? Saurabh Mukherjea recently said that we need more companies like IndiaMART, Info Edge. What would define a strong midcap company and which are these companies within the broader markets?
There’s a lot of value still in midcap companies. The ROE numbers should be at least 15% to start with and be in the 15-20% bracket. ROCE should also be 15-20%. I would say that each and every company cannot be evaluated on the promoter basis; transparency and the balance sheet quality should be better indicators. So in the midcap space, specialty chemical, even pharma companies can be looked at and the valuations are not so much attractive but they are reasonably priced right now.

But the growth for next two-three years can be decently played at around 25% to 30% growth rate. So rather than looking at only the largecap companies, HNI and retail investors should look into the midcap space where there is a lot of quality. That’s why we have seen a good runup in the last two months in many of the companies and right now, they are just consolidating into a higher range. To name a few in the pharma space, in API field, Granules and even Laurus Labs are ideal to invest in. Over the next two years, the growth rate would be more than 30% and the top line number will double in the next two to three years, particularly in Laurus Labs. So, one can look into CDMO space.

In real estate, post this the new laws have been incorporated and implemented and the inventories are almost cleared. One can look at the debt-free companies from here. Among Mumbai-based companies, Oberoi Realty and Godrej Properties can be considered. These are the two companies which can be looked at and even if somebody wants to play on commercial property, it will be DLF.

We have seen a remarkable rally over the last one month. It has been up by almost 40-50% and precision is there. But there’s still way to go for these companies and these are a few names to be looked at in the midcap space.