Is It Good Time To Invest in IT Stocks?

I have often found that Sectoral tailwinds make a difference to eventual outcome and investing results. Ceteris paribus, when you invest with the grain, rather than against it, you tend to reap a much better harvest.  

There are quite a few things that favour investing in IT stocks at the moment. I enumerate a few here:

1. Economic recovery in DMs: There are visible signs of growth forecasts improving for the US and recovery in Europe as well. Based on client feedbacks, management commentary from some of the leading Tech companies points to a much improved demand environment. Client mining in terms of greater wallet share is another aspect that will play out with application services and outsourcing opportunities.
2. Technology trends & Growth opportunities: Big Data platforms, Mobile applications, SMAC Stack services, Hybrid Cloud, Security systems, Business continuity planning are some of the growth areas. This is in addition to regular areas like Remote Infrastructure Management services, Enterprise applications and BPO/KPO opportunities. Another trend is outsourcing of some of the strategic areas to vendors with whom clients have longstanding relationship and integrated deals around such activities.
3. Not impacted by Election results: Investors are cautious to put cash to work in equities at the moment due to the overhang of General Elections in India in May 2014, the uncertainty over their outcome, stability of whichever formation comes to power, and what kind of policy stance the new Government will have on various issues including on markets and the industry. Going by experience of 2004 and 2009, Elections results can make a difference to the direction of equity markets.
4. Discretionary spend improving: During 2009-2012 period, Top corporates were holding back budgets in view of prevailing uncertainty in business environment. Some of that spend of discretionary type like say in BFSI, Energy, Utilities space is coming back in 2014. NASSCOM estimates are positive and vision is to take the industry to revenues of USD 300 billion by 2020. There will be further demand uptick going into 2015. This will surely benefit Indian IT companies.
5. Low cost hiring advantage: Notwithstanding the domestic slowdown, India will continue to produce large pool of technical manpower in the years to come. Since human resource is the principal raw material for IT services, the industry will continue to enjoy low cost hiring advantage and a large pool to choose from at the entry level. This gets more pronounced given the fact that other industries are not hiring big considering low growth business environment in old economy sectors.
6. Lower rentals on commercial property: Real estate sector, more particularly commercial property market, is going through pain in terms of lower offtake and consequently lower rates. Apart from manpower cost, next big cost for an IT services company is in terms of rental rate or cost of buying the office space. So in this respect also, the industry seems to be well placed.
7. Minimal impact of interest rates: In general due to low capital expenditure, IT companies are debt-free or carry small debt on their balance sheets. That being so, the burden of interest rates is also low, and in case the interest rates do not reduce in the near term, one industry that will not be impacted is the IT industry.
8. Favourable Currency: I have purposely kept INR depreciation as the last point in the list, so as not to cloud the overall judgment arising from a factor that in my view should not be the primary investment criteria for any investor. I don’t like when so-called fundamental investor projects currency as the main investment proposition. A 5 paisa day move in INR-USD starts changing the stock call of these analysts, without understanding the fine points of whether the company is going to benefit or incur a forex loss in next quarter due to its hedged positions. That said, it is an important contributing factor that cannot be ignored.  

 

Sectoral tailwind for the next few quarters/years does not mean we overlook the company and its business fundamentals. After all, we invest in a stock, and not in a sector, for the medium to long term. You can always combine it with stock-specific approach that I always profess. Large cap IT stocks like TCS, HCL Tech and Infosys are priced well, and it may be better to look at opportunities in midcap space, the likes of Zensar, Polaris, Hexaware and NIIT Tech. Vendors that can provide value to their clients in critical applications on an enduring basis

I end with the usual caveat that no part of this post is an advice to buy and sell stocks and readers should do their due diligence and home-work well in their own interest.

Does Long Term Investing Really Work in Indian Stocks?

As equity investors, we have been fed on over-dose of long term investing benefits, compounding wonders, those 16% kind of returns y-o-y on BSE Sensex, all Richie rich stories from the developed world etc. It’s very easy for me to do a post on any of these topics loading you with quotations from Buffett, Graham, Munger etc. Then you would find many stereo type equity blogs talking about legends who professed “Hold it forever” kind of approach if you get hold of a good quality stock. 

I want to however begin the year 2014 on a more sober note with some hard questions. The question is does it work in Indian context? Does your portfolio beat retail inflation rates?

Now see this link from the Business Standard with the headline – “Many blue-chip stocks fail the inflation test” - The marquee names include Colgate, Hindalco, three Tata group companies (Tata Steel, Tata Global and Tata Chemicals), Ashok Leyland, SAIL, BPCL.  Investors in these and many other stocks would be surprised to find that their returns have been trailing retail inflation rates. Sensex itself has given returns of 2.11% CAGR net of retail inflation over the 20-year period.

This thought is certainly very disturbing for all advocates of long term investing in Indian equities. 

Point # 1 is if 20 years is not the proverbial long term, then what is? In any case we have seen in last 5-6 years of recent market memory that returns in many so called blue chip stocks have been stagnating or even negative. So merely giving “time” to stocks is not enough. Just allowing businesses run their course and doing SIPs may or may not work. Don’t be blind about the process you are following. Your current SIPs in Infosys, TCS, ITC, Asian Paints etc may or may not be able to beat the inflation in 2033, who knows…

Point # 2 is stocks like Colgate, Hindalco and Tata Steel are quality businesses from respectable business houses if you are looking at a multi-year cycle that is long enough to smoothen out the effects of cyclical industries like metals. 

Point # 3 is we are talking with survivorship bias. Actually, this is the most significant aspect for me. In other words, we are talking only about those businesses that have survived all these 2 decades and still not been able to beat the high retail CPI inflation that is prevailing in the country. On top of that, these are marquee names in India Inc. These are not some down the road type of companies where the odds of beating the average returns would anyway have been low.

Point # 4 is the real purchasing power in hands of the shareholders in these companies has been diminishing when they intended to preserve or enhance it in their retirement years. That was the central idea of such long term investing horizon in first place, right? But believe me, none of the institutional or PMS guys would highlight such hard questions lest their income & interests get impacted.

Ok, what do we then do? 

That’s the logical question – what do we then do? Go back to fixed income securities and good old bank FDs. No, that is not the answer. By no means that is the problem diagnosis or the prescriptive remedy to cure the ill. 

Equities, in my view, are a great way to enhance your purchasing power (net of inflation) provided you are reviewing what is happening to the business on a regular basis. Watch it every quarter, monitor the results, and check whether things are working out for the business and fundamentals are supportive of your investment thesis or not. My humble advice is don’t be a slave of some dumb process of SIP, keep reviewing the results. After this reality check, we may end up holding for very long term, that’s fine. Then you won’t be disappointed after 5, 10 or 20 years. You’ll have solid returns for having done that ground-work. On the flip side, if business and stock is not working out for whatever reasons, let there be no attachments – emotional or financial – just get out of it. We are only human, and make our share of mistakes. I never believed in holding forever theory anyway.

In either case, direct equity investing is for seasoned investors who have the core skills, temperament and staying power to reap rewards in the longer haul. If you are saying you don’t have the basic knowledge and traits required, I would say it’s better to engage a pro or somebody whom you can trust rather than burning your fingers, besides capital and time. Even with that, monitor the results regularly, can't leave investments in auto-mode.

Another sedate, less glamorous, advice on first day of this new year is to keep learning more and more so as to emerge better investors. Let’s all grow as investors, our investment growth will take care of itself.

With best wishes to all of you for a happy and prosperous 2014 and beyond!

Festive Stock Picks

On the occasion of Diwali, let the cheer & festivity spread all around.

I give following 5 muhurat stock picks from different sectors for next Diwali, that is one year horizon of Nov-2014.

1. Accelya Kale Solutions (CMP on Nov 01, 2013 : Rs 585)
2. Tata Coffee (CMP: Rs 1124)
3. JB Chemicals & Pharma (CMP: Rs 100)
4. MCX (CMP: Rs 497)
5. Divis Lab (CMP: Rs 977)

I am not finding time to make a detailed post on these stocks.

Out of these, MCX is only for high risk takers due to all the uncertainty surrounding,  and to be added only on declines.

May you & your family have a bright Diwali and healthy & wealthy year ahead!

Best Wishes.

On Buy-Back and Bite-Back

You might have seen following announcement from NHPC...

NHPC Ltd has informed BSE that the Board of Directors of the Company at its meeting held on October 24, 2013, has unanimously approved the buyback of upto 10% of fully paid up Equity Shares of Rs. 10 each at Rs. 19.25 per share payable in cash for an aggregate amount of Rs. 23,67,89,29,832/- (Rupees Two Thousand Three Hundred Sixty Seven Crore Eighty Nine Lacs Twenty Nine Thousand Eight Hundred Thirty Two Only) through tender offer.

I try to briefly give my thought process on this buy-back as follows:

To give you a small background, Government of India holds 86% equity in NHPC. They did an IPO at Rs 36 per share in Aug-2009 and the stock has been downhill ever since. CMP is at Rs 18.40. With investors having consistently lost money here and buy-back price fixed at Rs 19.25, it is highly unlikely that any ordinary shareholder would tender in this buy-back. Only Government of India would tender at this price.

In-principle, Buy back is usually resorted to owing to one or more of following reasons:

 (A) Increase the underlying share value

(B) Support share price during periods of temporary weakness

(C) Return surplus cash to the shareholders

Why is it unfair to ordinary shareholders of NHPC?

1)     In case of NHPC, it’s clear that (A) and (B) are not the underlying reasons. 

2) As regards (C), since the price is unattractive to ordinary post-IPO shareholders, cash return will happen only to “promoters” and not to “all shareholders” as is the underlying objective of buy-back.

3)     Point to note is that same “promoter” already pocketed the premium of Rs 26 per share at the time of IPO in Aug-2009, so now promoter does not mind a lower buy-back price since whatever the buy-back price it anyway stands to gain. But it is the ordinary shareholders that lose as they entered at the time of IPO or post that. The stock has never crossed its IPO price in the last 4 years.

4)     On the contrary, say the buy-back price had been fixed at Rs 30, it would have given a fair chance to all shareholders to tender. But then, it would not have served promoter’s objective of grabbing the cash and still not lowering it’s stake much in the company (assuming 14% of the public shareholders do not tender, promoter’s stake will go down only by 1.5% after all this). I don’t think even LIC that holds 1.84% will tender.

5)    Sometime in future say after 2 years, Government will still have to resort to an FPO or secondary placement if it intends to bring down its holding to 75% level. It is anybody’s guess that such an FPO, as and when that comes, will be at even worse pricing, else who would come forth to invest seeing the spectacular capital markets track record of the company. Oops, I forgot LIC and its charity work…

Why is it unfair to NHPC the company?

1)    Under obligations of buy-back, it cannot issue fresh equity for the next 1 year and lower equity+reserve would also make debt raising more arduous. Can a company in power projects sector be confident that it will not have to raise capital as per its business plan or is the decision just being forced upon them because Government wants to take the cash out to meet its fiscal deficit targets?

2)    Cash of Rs 2,367 crore that is being stripped of NHPC balance sheet could have been used by the company to expand its business or may be enter into some related projects/business. It is not a FMCG or IT type of company where we can say they do not have any real use for cash.

3)   Buy-back price is fundamentally an indicator of intrinsic value that the company gives to the markets and all stakeholders. As things stand, in case of NHPC, it appears the company itself does not consider that it’s worth is more than Rs 19.25 per share. So the question is why should the market give it a better price multiple anytime soon. At the most, market will adjust the price for marginally higher EPS that it will have post-buyback due to reduction in number of outstanding shares.

4)  In other words, company’s stock will be fundamentally de-rated after this buy back is completed. Look at so many of the PSU stocks that are quoting far below their IPO/FPO prices.

Why is it unfair to other PSUs?

Is anybody concerned as to what signal such actions give to other companies belonging to the same promoter and about the fate of ordinary shareholders in those PSUs. Oh, you said they are already quoting dirt cheap, as if they’re going to shut down. So nothing much can happen to those - they have already come a long way from “nav ratna” to “no ratna”. What I meant was some of these companies are cash rich, debt free, free cash flow generators like Coal India, Engineers India, NMDC etc, at least they can be a given a fair chance to command a premium that market would otherwise assign to any respectable owner group.

But that seems like asking for too much at present juncture.

Disclosure: I don’t hold any shares in NHPC, neither held anytime in the past nor holding at present. Reading this, you’d get an idea that I don’t plan to have it in future either.

Is There a Price Bubble Building in Consumer Stocks?

All the time, I get the question consumer stocks are trading at such rich valuations and is there a bubble building up there? I did a post on same topic in 2011 here.

“Stay away” from these is the advice from some of the analysts. Graham worshippers and “Value investors” say these stocks are absolute no-no, and cannot be justified anyway you look at them.

There can be no two opinions about ultra-expensive valuations of consumer plays. At the same time, it can be intriguing to see every other investor taking shelter in these names despite such pricey tags. 

I, however, think it is important to appreciate the overall landscape in which consumer facing stocks are being evaluated by the markets:

1. Infra companies pack has been a disaster in their capital allocations and many of their acquisition and other decisions haven’t been financially prudent. Government alone cannot be blamed for policy paralysis and their sorry state.
2. Cash flows in power and capital goods companies are unreliable, or missing in some cases. Well established names of yesteryear are languishing at lows. A recent article on BHEL gave insight into the real situation, so much for a Navratna enterprise.
3. PSU stocks have not come out of overhang of OFS and dilutions, the woes of fundamentally strong companies like Coal India, NMDC and MOIL etc in mining sector are well known. Oil & Gas sector has some minor positive with reduction in diesel subsidy but it will take long before that makes any real impression on the stock prices.
4. Auto majors like Maruti have to stop production for a couple of days every now and then to cool off the supply mismatch. Entry of one Honda has changed the 2-Wheeler market dynamics for our Bajaj auto and Hero.
5. Pharma is a mixed bag. For an ace like Sun Pharma, we also have to live with a Ranbaxy that acts as dampener. Still, market is giving high multiples to well performing Pharma guys so long as they are performing.
6. Banks are somewhat of a divided house where many PSU banks are saddled with asset quality issues and trading well below book. Private peers are already priced in overvaluation zone in excess of 2-3 times book.
7. IT with some exceptions (HCL Tech, TCS, Mindtree) have failed to live upto promise of  volume growth. The stock uptick seem to be on account of currency moves rather than real operating performance.
8. No point discussing about real estate and the likes.

All the above tentativeness in market leaves us with consumer facing businesses in FMCG and Consumer durables. Yes, we are talking about the likes of Nestle, HUL, ITC, Colgate, Britannia, Bata, Asian Paints, Berger Paints, Pidilite, Dabur, Emami, Bajaj Corp, GSK Consumer, Tata Global, Godrej Consumer, Marico, TTK Prestige, Hawkins, P&G, Gillette and so on.

Now, question is what is distinguishing these from the rest:

a.  Consistent cash flows, debt free (most of them), incremental capex is funded internally, no dilution,  high capital return ratios and decent pay-outs.

b.     Market very well knows that Nestle cannot grow at 30%+ anytime in near future but still gives it PE of 40. Such companies are like oasis in desert where “Predictability of Earnings” is the real PE decider not just the earnings growth.

c.   Domestic consumption stories are here to stay. A large middle class and growing number of consumers add to it. They can reduce some discretionary spend in inflationary times, ultimately that has to be realized in the market. After all, Chinese folks may not succeed selling hair oil and toothpaste in India.

d. Established consumer companies have strong brand power, distribution network and geographical penetration. Most of this is irreplaceable moat.

e.   Gestures from the parent shareholders to hike their stakes even at current levels like in GSK Consumer and HUL boosts market sentiment for investors (why will promoters not raise their positions when they have business growth compared to home turf, they take away high royalty payments of 1-3% and of course the dividends).

f.     In this kind of scenario, where do you think an emerging market fund looking to put money to work in India will invest, if not in these consumer stories?

In short, these consumer stories may have their ups and down and occasional performance blips. Broadly, this theme will continue to deliver earnings and premium multiples accorded by the market may not significantly shrink going forward. These are uncertain times and the way macro-economic scene is panning out, there may be bouts of sustained selling. That will again make participants look for defensives. 

No wonder, consumer facing businesses will keep the markets interested!

Which stocks should you pick in current fall?

We have witnessed midcap carnage in last one month or so, with concerns looming over some companies having pledged shareholding and margin calls getting triggered. A non-event making Union budget and FIIs having concerns over TRC issue did not help the sentiment, and we may lose further stream on the way down. Rather than dwelling over the macro direction, it’s better to focus on the actionable for an individual investor in any given situation. Most midcaps and small caps are beginning to look attractive. Decision point for an individual investor therefore is what to buy, if at all.

I would divide the stock universe at present juncture into three categories:

1.      Quality stuff– Most blue chip stocks with formidable market position have not seen much price action. Their financials and business dynamics are what they were. To give you a flavor I’m referring to strong companies across market caps like ITC, Nestle, HDFC twins, Pidilite, Colgate, Asian Paints, Titan Industries etc. which have remained relatively stable. Argument for buying these stocks as a portfolio choice at this stage can turn out to be a good decision, in case indices drop another 10% from here, these stocks are not likely to suffer as much. The counter-argument for these stocks being a bad decision is that they are already quoting at very high valuations and upside here will not be much when market rebounds.

2.      Beaten down – Here I’m referring to stocks that are damaged price-wise in the last few weeks. There may be concerns over pledged shareholding of these stocks and sometimes of margin calls over these holdings. In few of them there could be issues of corporate governance and suspicion over some of the actions or transactions. As an indicator of this category, we have names like Arshiya International, Opto Circuits, Core Education, Alok Industries, ABG Shipyard, Zylog Systems, Onmobile Global, PC Jewellers, IRB Infra, GMR Infra etc. Market does not give benefit of doubt in many cases and price action has been pretty severe.

3.      Down but not out – These are stocks where price decline in the last few weeks has been significant but the fundamental strength and standing of the businesses are intact. In other words, these companies stocks have also fallen but more in solidarity with the markets and their midcap peers, rather than any specific negatives on part of their business, promoters or management. One of the beneficiary themes could be exporters who are benefited by a weakening rupee. Domestic consumption themes with strong earnings visibility and robust cash flows are the others that look attractive.

If you have been following posts on this forum for sometime, you would be able to make out stocks in which one of the above three categories I’m going to recommend to buy at the moment.  Yes, it’s the third “Down but not out” since I believe the positive surprise would be the maximum in this category over the next 1-2 quarters. There is a good likelihood that Q4 results would be favourable for companies where business quality has not deteriorated and bounce-back could be swift. It is this category that can beat the consensus estimates in a decisive manner, if not in the next few months certainly over the next few quarters. This is a good time to invest in equities, let’s not miss out on the opportunity.

Continuing Customer Businesses and Stock-picking

We discussed product characteristics of a consumer business, consumption pattern and what role it can play in stock investing in the last post. Taking the theme forward, this time we look at continuing customer businesses and their role in stock-picking. You must have observed that there are many businesses that do not toil that hard to get a large chunk of their customers, those customers are already there, and it’s only for the net incremental customers they focus their energies. Are you wondering what do I mean?

Let’s look at this dimension of assessing business advantage a little more closely.

1.      Housing Finance Companies – These are businesses where customers are continuing y-o-y and generate revenues for the company for a long time. Take example of a Gruh Finance. It gives loans for 10 years or longer. Once a customer is acquired, he/she is a source of income for Gruh for the next decade or so. No more investments needed in retaining this customer, except of course the right customer service & home loan rates. Isn’t it a great business to be in? Theoretically speaking, one can move his loan from one HFC to another, but that number is not so large. Compare this with a Videocon manufacturing TV sets or a Whirlpool doing refrigerators that has to toil hard, against all competitors, to acquire every single customer every year.

2.     OEM suppliers – In businesses like auto ancillaries and other OEM suppliers, we have companies with an assured customer and offtake. Take example of Motherson Sumi, Amtek Auto, Suprajit Engineering etc. In that sense, they have customer continuity with large auto companies or  industrial giant supply chains. The downside is however in their bargaining power. Supplier companies are the price-takers and at times, struggle to protect their margins. Having said that, there can be quite a few that enjoy premium positioning in their supplies, quality control and delivery schedules.

3.      Rating agencies – Here is a business where the companies stick with a particular rating agency (CRISIL, ICRA, CARE, Fitch), and then you have annual surveillance to get the rating refreshed. There are numerous instances when after many years of rating association, a particular rating agency “stopped” understanding their business model in a favourable light and the company goes for a new rating agency. Still, it’s a fairly stable business insofar as continuing customers are concerned with little investment involved in customer retention.

4.     Cable & Telecom operators – In theory, you are a fairly stable revenue generator for your cable TV operator (Dish TV, Tata sky, Sun TV, Hathway or whoever you’re with) or your telecom operator (Airtel, RCom, Idea etc) over a period of time. In reality, however, there is fair bit of switching occurring in these segments due to consumer preferences, cost considerations, service standards, package offerings and so on.

5.     Tollway companies – These sound great from continuing customer perspective. Daily commuters have to pay to cross that road or bridge. It’s a different matter that in Indian markets, two of the better known names in this business are having a rough weather – Noida Tollbridge for uncertainty over its concession agreement terms, PILs filed against toll hike and IRB Infra over corporate governance issues.

6.     Habit forming businesses – I could have done without including these businesses here. The category title I have given is also not very accurate. But customers keep coming back to cigarettes, tobacco & liquor companies, however bad their products may be from health point of view.

There can be many more ideas where customer continuity is far more assured than normal businesses. Obviously, this cannot be the sole criterion of stock-picking. A good combo of business & financial factors coupled with this aspect of investing can make a lot of sense and create enormous shareholder value over a period of time. Do share your stock ideas and themes that look attractive from customer continuity perspective.