ONGC a value trap; earnings visibility strong in IT: Lokapriya

As long as no big negative comes out of the Budget, we should expect to see some amount of cyclical economic revival which is necessary for the midcaps to sustain over the next let us say one or two years, says Chakri Lokapriya, CIO & MD, TCG AMC. Excerpts from an interview with ETNOW. Is it back to risk-on trade again?Yes, if you look at the charts, in the last one month or so, the broader market has begun to outperform the Nifty and the largecaps in the first two days of this year. The reason is, if you look back, a couple of steps taken by the government like corporate tax cut, RBI Operation Twist, are helping incrementally. Second, it is important to understand that midcaps underperformed because a) their carrying costs are higher; b) their operating leverage is lower. When you have a corporate tax cut and you ease the burden, the revival becomes easier for them and markets being forward looking are all trading at multi-year low valuations. It is time to start looking at the broader market and that translates into what you call a risk-on trade, because rather than sticking with a narrow bunch of few stocks, the market is beginning to look outward. The problem with this prognosis is we have often seen a false start in mid and smallcap stocks, Every time, mid and smallcap stocks have been on course to give a clean run, those theories have fallen flat. What are the chances that the action in mid and smallcap stocks is real and here to stay?That is a very good point. We have had a number of false starts in the last 2-3 years, simply because, in various areas policy action has been wanting. In some cases, there has been an over-bearance of policy actions. Today, you have the media industry refusing to be micro managed. They are saying do not set our tariffs, we know how to price for the customers. Plus, there are various global and general economic factors. Look at the telecom industry. The AGRs dues are not just a problem for three telecom companies. The telecom suppliers down the chain are all midcap companies. One big policy action impacts the entire value chain, going down the curve and that has been one big factor. Second, there has been the domestic economic slowdown. It needs to revive and for that revival, some kind of a policy push is needed. As long as no big negative comes out of the Budget, we should expect to see some amount of cyclical economic revival which is necessary for the midcaps to sustain that over the next let us say one or two years. Most of the Adani Group companies have been rank outperformers. Do you think for 2020 and beyond, Adani Group stocks could be in a sweet spot because economic recovery will lead to size and scale?For last 2-3 years, Adani Group has been buying out ports and troubled utility companies. These are all companies with good assets and are in the midst of an economic downturn. Financial difficulties led them to getting acquired by Adani. Against that backdrop, all that has not translated into earnings yet for the Adani Group of companies, including Adani Ports. As and when the economy turns, the operating leverage which is inherent in each one of these companies will clearly play out and from that perspective, the stocks of Adani Port and other Adani companies will do well. We have got oil on the uptick today. We have also got some positive commentary coming in on ONGC, OIL . What is your take on the oil and gas space and what would you suggest as a strategy when it comes to ONGC?When it comes to oil and gas, I would stick to Reliance Industries for the simple reason that while ONGC is clearly one of the most inexpensive stocks not just in India but across the region, the overhang of the past has pulled it down. The same thing happened to GAIL in 2019. The company lost nearly 70% of its market cap and in spite of being a hugely attractive asset because of the timeline of the disinvestment not being certain. Against that backdrop, we have BPCL now, right up there on the shelf which the government wants to disinvest. I do not think there is room for anything for them to do with ONGC from a disinvestment perspective. While the valuations are hugely attractive, it looks like a value trap rather than a value buy for me. What has been your last acquisition in December or in this year?Some of these companies like L&T has significantly underperformed and not just the Nifty. At the end of the day, the company’s order book is very strong, its earnings outlook is very strong and there has been some amount of doubts about the execution for the industry at large. That has put a lot of overhang on the stock, which we think is an undervalued stock. Even at current levels, L&T looks very attractive. Would you buy IT stocks? These stocks have not been massive outperformers. Right now, IT could be called a mild market underperformer, but given where macros are moving and where oil is, rupee could remain under pressure. Is that great news for IT stocks?Yes. Last year, TCS and Infosys both had their own fair share of issues and that led to IT as an index underperforming the Nifty for last year in spite of a good economic outlook for IT companies which is largely the US and other export markets. Going into 2020, the outlook for IT companies in the US and the main European markets remains to be fairly strong. Against this backdrop, the companies are not that expensive. HCL Tech is very inexpensive, Infosys and TCS are pretty much in their ranges. So earnings visibility is strong and new order outlook is also improving. Against that backdrop, IT will return 12-15% with a fair degree of certainty which the other sectors lack. From that perspective, we like IT. The rally is now spreading to tier-2, tier-3 names and also in speciality chemicals. What looked like a rally for the bigger boys is now broadening out?Look at the inflation trend and take steel, cement or other commodity companies. Last year, cement saw some amount of volume increase but not really any price increase. The price hikes were less than the inflation. This year, assuming that inflation does increase a higher than estimated 4-5%, I do not think it is baked into the cement outlook in terms of their price volume mix. The same thing applies to steel companies. Last year, they got impacted by low automobile demand, low real estate demand which held back both steel volumes and steel prices. If there is some amount of mean reversion domestically when demand normalises, then cement, real estate, automobile sectors will see some amount of earnings contribution. In FY20, more than 50% of the earnings of the Nifty came only from financial services. Some amount of normalisation in other sectors will help the market go forward. Insurance has been the story of the second half of 2019. Would it remain the big story for the first half of 2020 as well?It would because it is a long secular story and India is still hugely underpenetrated in terms of market share. But of course, there has been this overhang lately about cutting down the 30% stake which RBI has talked about. Now if that indeed comes true, then it creates some amount of supply and it pulls down the ROE for SBI Life, ICICI Pru and ICICI Lombard among others. That reduces the valuation a little bit. But that being a technical factor, with the long term fundamentals and outlook for the sector remains pretty much intact.

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