Why Aishvarya Dadheech is a contra buyer in midcap IT

"In our portfolio, we have players like Persistent and Mphasis. Initially, in the next couple of quarters, there will be low growth but over the next two to three years, they can do more than 10-12% kind of revenue growth because the headwinds of rising wage hike and other related costs are almost behind us. That will also help us to get higher earnings growth of close to 12-15% minimum from the next two to three years," says Aishvarya Dadheech, Director & Fund Manager, Ambit Asset Management

I am quite surprised to see that you have a very contrarian view on midcap IT. The infotech sector is in the eye of the storm right now –particularly midcap IT, which you like from a portfolio perspective for the next two to three years. What kind of names do you have in your portfolio or what kind of superior earnings growth do you expect these midcap names to provide over the next two-three years?
What we try to do at Ambit here is always try to stay ahead of the curve right, we saw because of the Fed rising rates by more than 400 bps in a very short period of time, there was a cascading impact on the IT sectors and growth stocks globally as well as in India; We have seen deep cut into IT stocks of more than 35% and the valuations which stretched to very high levels in 2021 are coming back to senses now.

We somehow believe that there is an opportunity in the IT space. The growth angle will remain under pressure for at least a couple of quarters and that is why we are getting these stocks at these attractive valuations. So we are very selective on IT names.

In our portfolio, we have players like Persistent and Mphasis. Initially, in the next couple of quarters, there will be low growth but over the next two to three years, they can do more than 10-12% kind of revenue growth because the headwinds of rising wage hike and other related costs are almost behind us. That will also help us to get higher earnings growth of close to 12-15% minimum from the next two to three years.

That is what we see as an opportunity in space right now. Any investors who want to make a healthy allocation to IT, possibly this is the right time to add to the high quality IT stocks over the next couple of quarters and stay put for the next two to three years.

This is the same strategy which we applied into the banking and financial services two years ago when we expected credit growth to pick up. The kind of cleanliness which we witnessed in the balance sheets of the banks and NBFCs and the valuations were very attractive at that point of time and the Street was not very vocal or excited about BFSI two years back. That is the time we went ahead and increased our allocation to BFSI.

That is what we except for IT stocks as well and we should not forget that we are at the fag end of the interest rate hike cycle right possibly by middle of CY2023, people would have better clarity about peaking interest rates and there will possibly be a time when we will see a pause in further hikes because inflation is expected to moderate from the second half of CY2023. So that could also be the time when we will see reversal in the valuations of technology stocks whether it is Nasdaq or even in the Indian IT stocks.

So there is the possibility of a couple of quarters of pain but if we have a 2-3-years timeframe, that could be a good opportunity to get into IT names.

I also see a lot of mid-tier financiers in your portfolio, especially the low cost targeting financiers. How is the growth there? What kind of cost of capital are these financiers facing? Bajaj Finance is being massively punished in the market because the market did not like the sequential growth which they have posted though the yearly growth is 26%?
Yes, that is correct. We believe that the majority of investors are riding on very high hopes in the BFSI space and any disappointment in numbers is punished heavily because of the recent valuation stretch up that has happened in the largecap banks and NBFCs.

But if you look at the midcaps and smallcaps, we have not seen much rerating because if one look at the kind of credit growth which is happening, even the large players are getting mid teens kind of a growth which majority of the other smallcap or midcap players are showing us. We have not seen much valuation rerating for them and from the cost angle either, because they are not as competitive as compared to the large base.

They have been able to manage their deposit franchise and are not getting punished in a big way. So what we understand from our perspective is that rerating is due for midcap NBFCs, banks and smallcap NBFCs and banks and that is about to follow over the next two to three quarters because in spite of all the excitement we still believe that the BFSI including NBFCs and banks are expected to report very strong numbers.

We believe this because of the higher credit growth of almost 17% for the last fortnight which we witnessed and the ability to reprise their asset book which will not have any adverse impact on NII. The NII growth for this quarter should be 20% plus. The credit growth is going to be strong and because of the lower credit cost, your PAT growth should be upward of 20-25%.

There is a big opportunity for those midcaps and the smallcap banks’ valuation to get reiterated for the next two quarters and that is what we are playing through. Having said that, we are very watchful about entities which have slightly stronger liability franchises. So we do not want to be with players which are adversely impacted by the rising rate scenario.

We are very selective in assessing the kind of stocks we have in our portfolios across mid and smallcap. We believe there are three to four names, which are doing phenomenally well from a growth perspective as well as managing their NIMs and growth in NII for the next two to four quarters. That gives us a lot of comfort from that perspective.

You have moved a lot of positions away from auto OEMs to auto ancillaries. What are the auto ancillary stocks you own and which category of auto ancillaries do you like – two-wheelers, CVs or bus or tractor? What kind of ancillaries or EVs do you like?
We normally do not follow fads and stay away from trends and mega trends and things like that. It is very counterintuitive for fund managers to say that but we used to like auto a lot and that is why we went ahead and got TVS Motors into one of our funds. It is an OEM which we believe is doing phenomenally well in tough times and for a smallcap fund, we got into players like Sundram Fasteners and Suprajit Engineering, which we believe are pretty diversified and a play on growth in two-wheelers and PVs.

We are not very inclined towards CV as an entity because that is more related to economic growth but we are more comfortable from PVs and two-wheeler side and that is why we are playing through this. We also understand that normally the auto ancillary does well with the lag of two to four quarters after the moment or traction we see in OEMs. We believe that though the last couple of month’s data is not very encouraging, there is a lot of cushion in growth from a two -wheeler perspective as well as the PV perspective from OEM growth side.

I believe that will start to have a positive rub-off on the auto ancillary side over the next two to four quarters and that is why we are holding on to those names.

Second, we always try to stay with leaders in the respective fields. Sundram is a big player in the fastener space; Suprajit is doing a phenomenal job in its niche area and that gives them the pricing power and ability to manage margin in tough times. These are the kind of players we are holding in our funds in the auto ancillary side.