IT sector way over-owned! Sandip Sabharwal explains how it should be played this year

Is the 6 per cent-plus fall in a good entry point? This is a stock that gave almost a 50 per cent plus return last year. My second question for you is would you tender shares in the buyback?

On the technology sector, I have a slightly contrarian view for 2022 which is based on two-three things. One is that the wage inflation is very high, so some companies have been able to hold on to some of the gains this year, but then what we are likely to see is that going forward those pressures are only going to grow. Although the companies are sounding optimistic, I think that is a real issue we have to grapple with. Secondly, it is an over-owned sector today. Everyone is very bullish, every portfolio is full of large cap and midcap IT stocks.

And thirdly, there was an expectation that the rupee will weaken and that will help their margins. But the rupee actually strengthened very substantially and today’s below-74 level is another margin headwind for them. Further, as the US Federal Reserve starts monetary tightening, we will see that growth will come off a bit in the US and some discretionary spending will go down.

So I would say that technology as a sector should be underweight for this year. I believe that at valuations which are 60-70 per cent higher than average last 10 year valuations combined with the over ownership makes it a sector which might not do very well this year.

IT is unlikely to give a 25-30 per cent return this year, but these businesses are still growing. Be it the management of Wipro or that of TCS, nobody is even using the term “cautiously optimistic”. Everybody is using the terms – bullish, confident, visibility, clarity, fat order book and resilience. What’s your view on this?

As I said, it is a very very over owned sector. Risks are not being factored in at this stage. The larger companies are going to grow only at 10-12 per cent going forward. TCS trades at around 38-39 times earnings. So now what are the valuations you want to give them is the question you have to ask. Obviously they are huge cash generating businesses and to that extent cash generating businesses should and deservedly get a premium in the market. But how much is the question. The run has happened. They have given abnormally higher returns over the market returns. Now the question we need to ask is whether that can continue or there could be other stocks and sectors which will do better. So if you have a strategy value, then keep on adding and you can hold 50-100 stocks. then I would say yes to keep on holding on to these stocks. But if you have a strategy where you only hold 15-20 stocks, then you need to realign and that realignment leads to better value we see in other stocks.

Let us look at the good thing which IT is going to do. Every company is hiring, every company is giving a wage hike, every company in a sense is now desperate to retain talent so serious wealth effect is getting created. A serious wealth effect means more cars would be sold, more travel will happen, more housing real estate demand will come back. How does one look at the prosperity in IT? How does one play the second derivative impact of the prosperity in IT?

Yes. What you are saying is absolutely right. I believe that wage hikes are happening not only in IT, but in other sectors also. That has an obviously positive impact on consumer demand in many sector so now it depends on most of these people who are in these sectors. I would see more of travel and entertainment. These sectors will get a fillip. Some people will end up buying a house too. But on the flip side, there is high inflation if you look at the prices of consumer durables, prices everywhere they have also gone up. So how does that get balanced out? In the IT sector, I think the wage hikes are so significant that these people are well off even after inflation, but that might not be true for some other sectors. Overall, given that overseas demand led wage inflation, not domestic, so it is positive for the domestic economy.

For a better part of 2021, metals have had their fair share of time in the sun. What next now for the pack?

I think for people who want to play the metal space, non-steel stocks will be better because I think the dynamics of aluminum, copper or even crude oil are much different from that of steel. I think steel has had its run. I would think that given the extreme weakness which is there in the Chinese economy, the fact that they might actually dip below 4 per cent growth this year, China continues to remain the biggest consumer of steel in the world. So in case of other base metals, there are different usages which are coming up which is leading to demand buoyancy being there despite the Chinese weakness. I think steel has had its run. The prices will go down further this year and to that extent any rally in steel stocks which we are seeing now will be more of a trading rally. Today there was some news that they are asking for some protection from the government. That may have contributed to the rally, I do not think there is any big upside. On the flip side, the user industries which had a tough time last year – be it capital goods or automobiles – might get some relief and to that extent outperformance could shift to those sectors.

We have not seen any stress of lockdowns impact on , and even Indian Hotels. Is the same play-book playing out that first the world discovers the virus then there is a government action and a market reaction then the unlocking starts and these stocks recover their previous lows?

Yes and it is so amazing if you look at Interglobe the day they announced that we are cutting down capacities because of low demand, the stock started to rally. Indian Hotels again people started cancelling some plans, and the stock started to rally. I think that is how the markets are reacting. This time the lockdowns one are not obviously as severe. There are no restrictions on people’s movements at least. Secondly, the other point is that there is a general belief that this Omicron wave will be short-lived and the reopening will happen very fast. I think that is the belief which leads people to bottom fish in these stocks I continue to own stocks like Indian Hotels or Inox Leisure or PVR – all these I think are still in value zone relative to the growth they will deliver. Interglobe, one can argue, at this price there is little value.