Want to protect value? Consider these 5 midcaps: Girish Pai
The markets are going to be fairly volatile with a downward bias over the next year or two largely and investors should focus on value protection and protection of capital, Girish Pai, Head of Research, Nirmal Bang Institutional Equities, tells ET Now. Within the midcap space, consumer durable stories like Whirlpool and IFB Industries and consumer discretionary stocks like PVR, Inox are good plays. In financial space, one should be very selective in and City Union Bank can be considered.
Do you think the deal for select IBM products would add much excitement to HCL Tech stock price today?
Yes, it does. In terms of value accretion, I am not too sure in the immediate term because the IP story of HCL Tech has been playing out over the last three years or so, when they started acquiring assets from IBM in 2016. This is basically Mr Shiv Nadar, the risk-taker, coming into play. Ten years ago, precisely in December 2008, he bought Axon in a bidding war with Infosys. That was to add enterprise application solutions business.
HCL Tech was largely an engineering and R&D services play and more an infrastructure services player. They added Axon and HCL Tech an outlier in the sense of investing such a lot of money in IP. With the latest acquisition, it would have probably invested close to $3 billion. But if I look at the return ratios that could potentially come through from these acquisitions, they are not too very high.
My sense is probably it is a single digit to very low teen kind of a number versus the services business where the pre-tax ROIC is closer to 30-40-50%. To that extent, this is a business which is in its nascency. It is margin accretive but return dilutive. We need to see how this plays out. We still do not have clarity on some of these acquisitions that have been done in the past or whether they are actually adding value at this point in time. The growth has been fairly decent. Last quarter, the IP part — mode 3 – grew about 10% quarter on quarter. Margins are a little better at 24-25% versus 19.5% for the company. It is a little early to say whether it is adding value. But yes, there is going to be a lot of excitement today on the stock.
What is making the broader markets so nervous?
The markets are nervous largely because of global factors. Domestic factors have actually turned positive. Crude has come down from $75 level to sub-$60. The rupee has started to behave well. We have had 10-year yields come off from something like 8.2% to sub-7.5% . Domestic factors have been playing out fairly well in the last 10 days or so.
The issue is to do with global situation. Global growth is a big factor. Over last 10 years, we have had very strong monetary stimulus from the US Fed, ECB and the Bank of Japan. As it has gone on for very long period of time, you just do not know where the bubbles have got built up and which will probably burst somewhere down the road. It typically does. You really do not know which asset class it is going to hit. You only know in hindsight.
The market is a little worried about what is going to be the collateral damage of those bubbles right now bursting on Indian markets — be it from FII pulling back money from India, or earnings cuts that may probably come through for some of these companies going forward.
As a house what are the top two-three names from midcaps that you are recommending to your clients amidst this volatility?
The markets are going to be fairly volatile with a downward bias over the next year or two largely due to global factors and not so much due to domestic factors. The key thought investors should have is value protection and protection of capital in one sense.
We are leaning more towards consumer oriented companies. Within the midcap space, we like certain consumer durable stories like Whirlpool and IFB Industries. These are consumer electrical/consumer durable stocks. We like consumer discretionary plays like PVR, Inox. From a consumer discretionary standpoint, I would probably think these are slightly cheaper.
Within the financial space, one should be very selective in picking up banks which have seen multiple cycles. So a City Union Bank,which is probably a 100-year-old bank, which has delivered you 1.5% plus ROA over multiple cycles, is a decent bet to take right now.
Then one can look at autos selectively., I would not call Eicher a midcap company. We have to look at companies where we will not see a great deal of earnings crunch over this two- to three-year timeframe. While there could potentially be a PE multiple contraction, after this turbulent phase, the same PE multiples will probably come back up.
Good play could be a consumer staple play where you could potentially see a big crunching of PE multiples in the next two- to three-year timeframe but the same multiples can come back up after this turbulence. So that is the kind of set of companies that we would want to invest in.
Is Eicher your big hope trade right now? What makes you so confident that growth will come back for Royal Enfield?
Growth has come down pretty substantially. The market has repriced its expectations on growth for Royal Enfield over the last many quarters and months now and that is reflected in the PE multiples that it is trading at. We believe that Royal Enfield can potentially deliver low teens kind of volume growth over the next two- to three-year timeframe because it has got the ingredients to do that.
The installed base of two-wheelers in India is probably 80 to 100 million and there is an aspirational element to that. People want to move to the cruiser bike category. We think that that is a fairly small market share within the overall two-wheeler space and the other thing we believe is as Indians become slightly richer, they will move towards a cruiser bike situation.
If you look at states like Punjab, Kerala or Goa, which are slightly more prosperous, one in three bikes sold are Royal Enfield bike. So as incomes go up, there is going to be a migration there. We believe that there is going to be the aspirational element to this 100 odd million bike install base so to speak right now who will potentially move up. So broadly these are the elements which make us believe that you will probably see a low teen kind of volume growth which should be among the best in the industry in our opinion.
Among the banking names, is your pecking order still the same? Should one stick to safer bets and do not venture out?
Yes, being with the retail private financial banks would probably be the best strategy to go by right now. HDFC Bank, IndusInd should be our top picks out there. A lot of poison has been taken out of the system as far as the private corporate banks are concerned be it ICICI Bank or Axis Bank. I would think those are fairly good bets in the next one to two years. We have not actually seen any kind of meaningful corporate lending being done.
Even if we go into a economic slowdown driven by global macro factors in the next couple of years, I do not think these companies are going to be impacted meaningfully. I would think that private corporate and retail banks represent fairly good bets. I would think there is more value in corporate banks right now. I am talking about ICICI Bank specifically.