Gautam Duggad, Head of Research – Institutional Equities, Motilal Oswal, says “there is a possibility that we might see continued strong performance of midcap IT. But the stock prices may lag a little bit now to allow the earnings to sort of, to allow the valuations to sort of catch up, whereas large cap, we find risk-reward more attractive. So while we have an overall underweight stance on IT, within that all our allocation is currently drifted towards large cap, so HCL Tech being our top idea.”
You have seen big upgrades and if I look at your note as well in autos, that is a meaningful sector, it is a very large contributor. How should one look into this sudden uptick in demand in autos? Do you think it will sustain? Should one build up on this auto theme, whether it is exported to domestic or EV now?
Gautam Duggad: Let me give you one context on auto. Between FY18 to FY23, the auto earnings were absolutely flat in Nifty at about 30,000 crores. FY18 was the earlier peak, when auto earnings in Nifty were 30,000 crores. In FY23 also, it was about 28,000 crores. FY24 is the first year of a big auto earnings growth. We have seen auto earnings doubling in FY24, which is why a year and a half back, we had gone overweight on auto from underweight.
Having said that, now we are entering FY25, where you have to contend with a very high base and management commentaries on auto have been very mixed. Nothing is taking away from the great delivery for the last five quarters in auto. In fact, I would go one step ahead and say auto has been the best performing sector on earnings in our coverage universe for the fifth quarter in a row.
In fact, for this quarter also, we have seen a 60% earnings growth, while our expectation was 34%. And as you rightly mentioned, it is a sector which has seen the highest quantum of earnings upgrade at about 7% within Nifty, so much so that all the six Nifty auto companies have posted numbers which are either in line or ahead of expectations. That being said, I must also point out that FY25 can be the year of normalisation for auto.
While it will remain healthy, but the quantum of growth that you might see will not be similar to what you have seen in FY24, because the outlook on various segments as far as volume is concerned is very modest, anywhere between 4% to 8% volume growth, CV, a lot of the managements have highlighted that the growth is moderating there.
The best performing segment will be two wheeler in so far as volumes are concerned. And then you are also contending with a high base of margin in FY25. So our expectation for FY25 earnings growth is about 10% to 15%, and which is why in the January revision of our model portfolio, we have again reduced auto from overweight to neutral.
What is your outlook when it comes to the IT sector because in Q3, we saw weakness in a lot of key verticals as well. Do you believe that the softness is going to persist when it comes to key verticals and geographies?
Gautam Duggad: If you go by the management commentaries of the last nine months, you have seen a situation where for two or three quarters in a row, we have seen guidance is getting revised downwards by some of the large companies.
Second, the expectations are very muted. In fact, if I were to talk about the current quarter, we were expecting flat earnings and flat earnings is what we got. So they met our muted expectations, but the commentary on demand, the discretionary spending, decision making cycles, net hiring, I mean, this quarter, we have seen a net hiring number at a negative 16,000, which was negative 18,000 in the second quarter. That is giving us some semblance of idea as to what the future holds, at least in the short term. But the business can remain slightly more challenging in the short term. But stock prices are now factoring that in, which is why if you look at the last six to nine months, the IT sector has not corrected much.
In fact, we have written multiple notes on banks versus IT as a comparison on strategy last year. And we have seen that for 12 years in a row, the banks and IT, the relative alpha between these two sectors, the divergence is huge. On an average, there is a 35% to 37% alpha. So basically, if you have to take one call right at the beginning of the year, it better be between banks and IT.
In fact, CY23, despite all the narrative about IT slowing down etc., etc., IT index gave 24% return while the bank index gave you 12% return and the Nifty was up 20%. IT has not only outperformed banks, it has outperformed the Nifty as well. I expect midcap IT to now catch up with the earnings because the valuation premium over the large cap IT has gone up significantly.
There is a possibility that we might see continued strong performance of midcap IT. But the stock prices may lag a little bit now to allow the earnings to sort of, to allow the valuations to sort of catch up, whereas large cap, we find risk-reward more attractive. So while we have an overall underweight stance on IT, within that all our allocation is currently drifted towards large cap, so HCL Tech being our top idea.
