Buy On Dips During Market Lows As Economy Looking Strong: Emkay Global's Nirav Sheth

Over the last several years I don't think that we ever invested in a market where you know, you are moving from one concern to another concern. You always need to be cognisant of what can impair the structural growth story or inflation outlook or your interest rate outlook and many of the cases aren’t very easy. 

The way to look at it is there are two things that have happened over the last you know, maybe a fortnight or so. One thing that is increasingly seen is that the pivot that the US Federal Reserve took was probably premature, in a sense that your inflation is moderating but is not moderating fast enough and this is largely around services part of the economy. Second thing is obviously the escalation that we are seeing on the Middle East front. To me, this is probably, I’m  talking about geopolitics. It is not a happy situation, a lot of human lives are involved, but this is of a degree considerably lower in intensity than what we're seeing with Russia-Ukraine and we're able to live through it. Russia is a far more dominant player in the oil market. Europe was completely dependent for energy on Russia. So the dislocation in the global energy market was of a degree significantly higher. We aren’t very close to that as far as the Israel-Iran thing is concerned and also as an offsetting implication. So every time you get an escalation in geopolitics, you will see that people are rushing to bonds and therefore you've seen about 10 bps (basis point) rollback in the bond deals. I think that this will keep a lid on the risk assets for some period of time, I don't see a significant escalation. I don't see a significant risk of trade right now from what it looks like.

Nirav Sheth: I am super bullish on the Indian economy and by that definition, it is always you know, these are the times that you want to go and buy and when I'm talking about these are the times, maybe the stocks could be down another 5-7%. To me, that is the base case scenario and given the fact that if we look at the economic narrative in India, if you look at the political narrative in India, and if you look at the macro scenario in India, these are very, very strong dynamics playing out and therefore, you need to be buying equities with an horizon which can extend into two-three-four years I believe that you will have a probably a lifetime opportunity, pre elections buying into Indian equities.

Nirav Sheth: No, I don't believe that you're going to see a significant drawdown because you need to cut the earnings for markets to go down. There are two levers to the market. First is the evolution of the earnings, second thing is your discount rate. You  are slightly hazy around how my risk free rate is going to behave. But if we look at the earnings evolution, if you're looking at the ROE evolution, you're talking about a four and a half trillion dollar economy, which is growing at about 6.5% I mean, the earnings are going to be compounded at 14 or 15%. I don't know if we will see a meaningful correction. 

Nirav Sheth: Well, it depends upon why the rates (cuts) are being pushed out. So if you look at since December last year, in the first four months, you're essentially had an unusually resilient U.S. economy, essentially the payroll number they're holding up very well. The wage growth was moderating. But the U.S. economy was growing better than expected and if your economy is growing better than expectations, which is why you're pushing out the rate cuts, that is risk asset positive, as far as I'm concerned.

If the inflation print doesn’t moderate in line with the expectations, then you need to be slightly worried about the impact of the risk assets. So the question is why are the bond yields holding up higher? Is it because of my higher economic resilience, which means that I'm looking at long term higher growth rates, or is it because of a saturation scenario. If it is the latter the risk asset will sell off. I don't see inflation so much to be a concern. You will never have a linear disinflation anywhere in the world. It is always a bumpy ride. I will still believe that this is more of a noise. You should be seeing rate cuts  sometime in September onwards. Do keep in mind if you look at the expectations for headline inflation in the U.S. and core inflation in the U.S. at 2.5%. They are 2.3% and 2.1%. So even if I reduce the rate by 50 basis points, you'll come to somewhere around 5% or 4.75% which is very restrictive. We are not talking about whether you go back to two % or not. But I think the process will start.

Nirav Sheth: So in one of the scenarios that I try to build into. So right now it seems to be certainly an escalation between Israel and Iran. Now whether that gets other Middle Eastern countries into it and therefore it becomes, you know, a wider Middle East conflict, then  obviously, there will be a significant impact on oil prices and your dollar inflows and stuff like that and therefore, you could have a potential 5 or 7% rate cut. That is a scenario that you build in. To me, there are reasonable odds but it is not the best case scenario. The reason I'm willing to take these lines of thinking is because Israel seems to be isolated in its attack on Iran. The allies have not been necessarily supporting Israel in terms of escalating this thing with Iran. But we have to wait and see. It is a possibility with lower odds, which can create a 5-7% cut  in the markets. 

Nirav Sheth: So, I am keeping valuations aside right now because I am talking about the macro. So I’m very constructive on how the capex repo is going to come back and the entire chain from power to renewables to electric vehicles and green hydrogen and generally investment in cement and steel, stuff like that. So there is a big tail over there. So very constructive on how the Capex recovery happens. We are also instructive on the discretionary part, anything that is leveraged to the Indian economy at large and that includes financials within that and obviously constructive on the PSUs as well and even the NBFC space. Thirdly, I am particularly excited about what I would call the shunned sectors for long and still trading at very, very, very interesting valuations, which is something like ONGC or Coal India.

The free cash flow yields even today are about 9-10%. I also would like to believe that I would expect the Prime Minister to use his political capital in the third term to dramatically change and raise resources through the public sector units, as far as the ideology is concerned they are very, very good in terms of their fiscal prudence. You still have to raise resources to try and do some serious pumping of our infrastructure. Countries like India are asset heavy and income poor. So you can potentially raise billions of dollars through the public sector assets that have been created and if you're not going to do it now then when are you going to do it. I am willing to take that call that you will see, you know,  they have let the template for it. They run very well, they have grown very well. Valuations have started to catch up. Now it's time to monetise them and raise resources to recycle those into more and bigger Infra projects and therefore you're going to see unlocking as PSUs, as a space.

Rucha: Infosys has given very muted guidance but the management has mentioned that the first half of next year will be strong on the back of ramp up in the BFSI sector, which means that the second half will largely be soft. Second, the deal wins are highest ever but does that really matter because that was the case with TCS as well and that is not getting converted into the top line and lastly, clients are opting for more of cost optimisation deals and these kinds of deals generally come with tighter budgets, which can impact the I.T. company's margins this implies that there is still pressure on discretionary spends which even the TCS management has noted on last Friday.

Rucha: Yes. That's correct. 

Nirav Sheth: Well, one/my sense is, you know, it's a bit of a difficult call and I believe that the things that are impacting the software sector are not only cyclical but also structural. Not just look at how the captives are building up their base in India. So if you look at broad evidence in terms of the real estate space that are being signed up by captives, I would like to believe that captives are outperforming the traditional outsourcing Indian I.T. companies. So that is a part of the growth that is being redirected towards captives away from our home grown Indian companies. If you look at the midcap I.T. companies, they are all performing the large cap I.T. companies. So my sense is that you got a growth distribution that seems to be happening because there is not too much differentiation left. 

So part of the smaller leads are being taken away at the bottom by mid cap I.T. companies which are probably going at twice the rate of my large cap I.T. companies, and obviously the captives themselves are insourcing a lot of the work ideally would have gone to the I.T. companies.  So you need to adjust for that. If you ask me, I don't have a great view in terms of what my long term growth rate in free assets is going to be. Today its going to be 2-3% the minimum expectation that the constant currency growth in U.S. dollar terms will be roughly about 6-7%. Whether it is going to be 5%, 6% or 4%. At least to me it is a bit hazy. To me a bigger problem also is the fact that when I look at the next three or five years, I believe that the Indian Rupee will be a significantly stronger outperformer. 

We’re already seeing that right now. We are one of the best performing currencies here today after U.S. dollar, and this is despite the fact that you are still a current account deficit country. Just look at the latest print, we had a trade deficit which is roughly about $15.5 billion. I think our service exports are close to about $15.5 billion. So there is a dramatic change in my current account situation and I try and forecast over the next couple of years. So you're potentially looking at a significantly lower depreciation of the rupee. It could even be flattish as you move forward and that has implications in terms of how you look at the market outlook for lot of these I.T. companies because it is implicit building of rupee depreciation going forward. All told. I am negative on I.T. companies given the valuations they are trading at this point in time.

Nirav Sheth: No, I think I like the entire space. One way, like  I said, is you know, I will never argue that the markets are cheap. But you can’t buy a great story cheaply, it is not possible.If the big corrections come, they will come because there is a dislocation in earnings and by definition that the outlook is not too great and therefore maybe the investment may not be great as well. To me, I always believe that one way to look at this is that you are bullish on India. You are putting 95-90% of your portfolio constructively looking at oil companies as an insurance play. Only thing that can derail India's story in the near term is an escalation in oil prices, which impacts my balance of payment problems.

Eventually rupee depreciation and stuff like that resulted in inflation. This is an insurance to that portfolio that you are creating and instead of paying a premium, you're getting premium because they are aiding you 8-9%  in terms of recast. In many cases the dividend is about 5-6% and therefore it is a no brainer. Secondly, I think markets routinely overestimate what you would call this transition away from dirty assets into renewable assets and we overlook things like Coal India and stuff like that. It is not possible to win away of Coal for a long, long time in the future. So usually that gives you very, very solid entry points, in terms of valuations.

Nirav Sheth: To me a large part of trade or investment in the telecom sector is behind us. Logically, you should expect significant resetting tariffs as we move forward and therefore all of us know the investment case, it is a perfect duopoly and you know, there are two large players and they have passed their heavy capex phase and therefore the outlook looks to be good. But you also want to keep in mind that this is finally an X growth market. So once you get a tariff which is getting reset and your earnings reset are at a higher level,  there is no growth. It is not a compounding machine by nature. Therefore I'd be very circumspect about giving high valuations to these kinds of assets.

I haven't looked at Vodafone in great detail  but I have always believed that when the sector turns around, you know, you also make money with the laggards. Vodafone, to the best of my knowledge, will not be a price setter, it will be a price taker.  So, it’s a high tide and we will benefit from that as well and it is great that they will be able to raise money and therefore we can restructure our balance sheet which has been a great pain point. If I could think out loud  maybe at some point of time after a couple of years there will be even a significant takeout value sitting over there.