Looking to invest in record-high markets? Here’s what Anil Rego of Right Horizons has to say

Information technology majors Tata Consultancy Services (TCS), HCL Technologies and Wipro are slated to announce their June quarter results this week. In an interaction with Business Today, Anil Rego, Founder and CEO of Right Horizons, said the current weakness in demand for the IT sector is expected to continue in the first quarter as clients mainly focus on cost and efficiency-driven projects. He also spoke about other sectors, market outlook and asset allocation strategy at record-high levels. Edited excerpts:

BT: What are your expectations for the Q1 earnings season? Which sectors do you think will surprise markets, and why?

AR: In financial year 2022-23 (FY23), the corporate profit to GDP ratio for the listed Indian companies had contracted by 20 basis points, a marginal decline to 4.3 per cent led by volatility commodity prices and a slowdown in exports. BFSI contributed positively while metals and oil and gas were laggards. The earnings have been healthy so far and are expected to grow with BFSI, auto ancillaries, building materials segment and selective consumers to drive the incremental earnings in FY24 driven by robust credit growth, healthy macros, range-bound oil prices, strong domestic demand, deleveraged balance sheets and stable raw material prices.

BT: What do you expect from IT stocks ahead of Q1 results?

AR: Deal flows were robust in Q4FY23, showing some softness but lower than anticipated. The pipeline remains healthy, but a weak macro environment will likely put pressure on revenue conversions in the short term. Demand for select verticals remains intact, but recovery overall is expected to be gradual and is expected in the second half of FY24. We will be keeping an eye on the demand outlook, deal TCVs and pipeline, vertical and geography commentary, vendor consolidation opportunities, attrition and margins outlook. Quality names in the midcap IT space will likely do better than large-cap peers and witness sequential growth in revenues on a constant currency basis and improvement in margins. Since digital transformation is a multi-year growth driver for the Indian IT services industry, making it a secular growth story for the sector, we are optimistic over the longer horizon.

BT: How do you see Indian equity markets by December 2023?

AR: India’s economy has grown nearly 7 times in 20 years and will be one of the fastest-growing major economies. The domestic macro environment is stable, with inflation moderating, a manageable current account, healthy balance sheets of corporates and a robust trend in credit growth with strong domestic demands. All these dynamics make India an attractive destination with relatively better fundamentals than other advanced economies that are likely to face a slowdown. This ongoing investment-led economic cycle and conducive policies to make India a global manufacturing hub and the FTAs signed with major economies presents the economy with the opportunity to grow domestically and contribute to global exports.

The domestic macro data points paint an optimistic picture, and corporate profitability is growing at a healthy pace. We believe Indian companies are to benefit from a multi-decadal growth opportunity domestically that will have a multiplier effect across sectors. We expect the bull run to continue, and valuations are comfortable from the perspective of growth in future earnings.

BT: How investors should accumulate their wealth at record-high levels of the market? In simple words, can you tell us how one can invest Rs 1 lakh in this environment?

AR: During a period of equity bull cycle, exposures to debt and gold will likely drag the performance of the overall portfolio. However, based on an individual’s risk profile and tolerance, exposure can be adjusted dynamically based on the macro environment. Considering the multi-decadal growth outlook on the domestic economy, moderating inflation and expected rate cuts, we recommend being overweight on equities with 75-80 per cent allocation, 15-20 per cent in debt and 5 per cent in gold.

BT: Which sectors do you believe have the potential to outperform in the next 12-24 months?

AR: We continue to see opportunities in financials, auto ancillaries focused around the EV play, building material segment, structural tubes and consumer. The strong domestic macro fundamentals, investment-led infra cycle and strong domestic demand will be tailwinds for the sectors driving the healthy earnings trajectory. Selective names within the space with relatively better growth will likely outperform peers.

The auto sector is in a cyclical uptrend supported by a sharp recovery in urban demand and a shift in preference towards EVs. Long-term fundamentals remain intact, and we expect a gradual recovery in rural demand.

The banking space is witnessing robust credit growth momentum driven by the continued traction in the retail and SME segments. On a segmental basis, home loans, auto loans and credit card outstanding continue to grow and corporate loans are recovering gradually. The corporate segment is gradually recovering and a pick-up in capex would be crucial to maintaining growth momentum.

As far as the building material segment is concerned, we are optimistic about the demand outlook due to increased investment towards infrastructure, urbanisation and a recovery in the housing and commercial real estate markets.

BT: How do you compare the prospects of NBFCs to those of banking stocks?

AR: Typically, during a rate hike cycle, banks with strong CASA franchisees and a higher share of floating loans will benefit as the companies witness improved net interest margins and steady asset quality. NBFCs in this case, will witness an increase in their cost of funds; however, with interest rates domestically at peak and stable and expected to be cut from the last quarter of FY24 would benefit.

Systemic loan growth in banks will likely remain healthy in the first quarter, with healthy credit growth driven by continued traction in the retail and SME segments. Slippages are expected to remain under control, which, along with recoveries, should aid the ongoing improvement in asset quality.

In the case of NBFC, the disbursement momentum is expected to be buoyant and asset quality to remain largely stable. Cash flows have contributed to relatively better collection efficiencies and should lead to benign credit costs. We are optimistic about both banks and NBFCs and expect it to contribute to incremental earnings growth.

BT: What is your view on mid- and small-caps amid their ongoing outperformance?

AR: India’s economic growth is likely to continue above its long-term trend and stay ahead of its major peers in 2023. The conducive government policies, revival in services and pick-up in private capex are tailwinds. Further, rate cuts are expected in the last quarter of this fiscal year and will benefit equities unanimously. The domestic macro data points paint an optimistic picture, and corporate profitability is growing at a healthy pace. We believe the small caps are better positioned relative to large caps since the outlook for a multi-decadal growth opportunity domestically will have a multiplier effect across sectors that will have selective pockets in the SMID segment to likely register superior earnings trajectory surprising the markets and have a re-rating. The outperformance of the segment was due to the availability of the businesses at relatively better prices compared to value as they were discarded in the previous year over volatility induced due to weakness surrounding the global environment.

We are overweight in the SMID segment and expect selective names with a strong order book, superior earnings growth and return metrics, and a sustainable business model will be a good investment opportunity for the next three years.

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