You track a lot of sectors, but let us talk about the sector that is perhaps going to be most impacted or is already because of the global turmoil and that is IT. Given the uncertainties around, what is your view on the sector and from a valuation perspective, does it appear reasonably priced at this juncture?
Kunal Tayal: Firstly, answering on the business outlook side of IT. Our view on the business part is that companies have seen a little bit of deterioration since the announcement of the tariffs. The good part is that this is just a little bit of deterioration. It seems to be much lesser than what was widely anticipated or viewed in the context of how the sector has performed in the last two years, that is number one.
The second point is that the feedback also is that the uncertainty is here to stay. The movement you have seen on the tariff situation so far does not seem to be enough to clear all of that away and which is why the viewpoint is that the slight impact you are seeing is probably going to be around for another two to three quarters, so that is a view on the business side for the IT services sector.
On valuations, in times like these, when growth is slow, there is also the conversation around what will be the impact of AI on a go forward basis. Very recently we took a back to the basics approach on valuation where our finding was that a DCF valuation for these names if one assumes high single-digit growth rate for the next few years is actually very supportive of a forward PE multiple give or take in the early 20s sort of a range and the stocks are actually not too far from that.
Therefore, when we look at our picks in the sector, for us this is really a combination of companies that can emerge as relative winners on the growth rates, valuation across the sector seems to be in a pretty attractive zone.
Since you spoke about the high single-digit growth rate for the sector for the next few years when it comes to the IT space, will that apply for FY26 as well and for a sector as a whole, what is your commentary so far that you have been tracking? Will FY26 be much better than FY25 and will the margins expand?
Kunal Tayal: Mid to high single-digit growth rate is probably not something that the sector will see in FY26. This year, we are going to get the impact of the tariff related uncertainty. Companies that have already laid out a guidance for the year essentially are telling you that growth will be in the zip code of low single-digit or maybe go up to mid-single digit at best. So, about 3% or so is our estimate if we see the growth rate across the top names in the sector. The trajectory within that, of course, that we are hoping for is, as you come to the end of the year and the uncertainty has reduced, that is when you can start to see a buildup or an acceleration in the growth rate as you step into the early part of FY27. To your question on margins, again, a thumb rule that we have seen play out in the sector is that when growth is on the lower side, lower than the 5% mark, margin management is a bigger challenge than in a typical year because these companies do rely on managing the employee pyramid which becomes a tough ask if the growth rates are low and therefore, our view is that this year margin management also is going to be tougher than usual. Of course, there are companies within our coverage universe where we think that despite growth not being on their side, because of company specific reasons and the initiatives that some of these are undertaking, they should be in a position to expand margins at least a little bit versus F25 levels.
While we are talking about the IT segment, let us talk about what the management of individual companies had to make of the quarter gone by because they were not very optimistic after their earnings for the quarter gone by. What is the sense you are getting from your engagement with the management with respect to the order inflows over the last couple of months? Has it deteriorated further, or do we have good days in it ahead of us?
Kunal Tayal: The commentary from the management teams what we spot is broadly similar to the lines that they laid out in the April earning season. The description we have had is there has been pressure on some pockets of discretionary spends especially in the so-called challenge vertical of automobile, CPG, retail, as well as travel.
But then the management teams are also maintaining a stance that when it comes to cost takeout projects, operating model transformation projects, and in sectors like banking, financial services, energy and utilities, they have pretty much seen business be as close to normal levels of performance, which is where I was highlighting earlier that between management commentaries and some of the other checks/work that we have done, there does not seem to be much of a step down versus the activity levels that there were in the month of March.
Let us shift focus from a sector that is impacted by the global factors which is more domestic focused now and that is cement. If you look at the broader term trend, we have barely seen any price appreciation now that the competition seems to be intensifying and consolidation is still the name of the game, where do you see the industry headed in terms of pricing?
Kunal Tayal: It has been a tough two to three years on the pricing front. There are a couple of parameters that we are looking at. After the sharp down tick which has already played out, there are signs and this is as recent as what we saw in the last quarter which is the March quarter that incrementally some uptick is starting to come by and some news flow might carry forward into the ongoing quarter as well.
There are early signs that the pricing environment might be getting less intense versus how it has been. On a more sustainable basis, if one were to take a view ideally, the utilisation rate for cement capacity in the country in our view will have to hit 75% and that a sustained trend in price increase could come by for the sector. As of now, our view is there is more near-term/opportunistic price increases that the sector is getting which is good news after the trend of last two years and, if the utilisation rate is moving in the right direction, there is a chance that this could have a sustainable element to it as well.
Along with that, let us talk about the real estate sector because we saw a boom for the luxury apartments during Covid and the post Covid era. With price uptake still continuing, where are we in the big fat real estate cycle and how is the industry positioned at this juncture?
Kunal Tayal: The property sector or the residential sector is potentially in year five of an upcycle. One of the things that we like about the current upcycle is the fact that, as you have gone through this phase, demand has typically exceeded supply, meaning that there has not been too much of a buildup of inventory. The participation of investors in the demand has been on the lower side than typical.
Pricing has gone up, but again it has still not gone up at a pace which makes housing unaffordable and therefore, our view is that even as you have had some serious compounding happen in the last three to four years for several of the large developers, from the current basis as well, there is a potential for the companies to grow bookings at a pace of about 10% to 15% for the next few years and, of course, our view is that because pricing has been quite supportive as well, the growth rate that we can see coming out of these companies at least for the next two to three years if not all the way up to next five to seven years could be ahead of the growth in bookings that that they witness.
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