What next for TCS? Just ahead of its numbers, it announced plans to consider a buyback. Clearly the large is getting large. Would you say TCS continues to be in the top spot in the pecking order?
Yes definitely and multiple drivers are there for TCS. Both the promoters or one promoter and the other group of Tata Sons would like some liquidity and that is also driving this. Overall, Indian IT costs are down with the travel cost having come down dramatically and there is a return of the digital revenues. So in the nearly $4 trillion dollar global IT pie, digital, automation, work from home, cloud and remote working are getting a lot of scope. The entire software as service, infra as service places are getting bid up and our IT majors are well positioned for that and TCS is at the top of the pack. This run up is more because of the buyback announcement and that means a good thing for shareholders.
On the cash lying on the balance sheet, you are getting a 5-6% pre-tax kind of return in safer instruments like bank deposits or liquid funds. Liquid funds are nearer to 3%, 3.5%. As against that, you are extinguishing that much of equity which is running at a very high return on equity. Clearly analysts like buybacks and companies that are buying back shares have tended to return a lot more in terms of total shareholder value. This is getting extended to the entire IT sector today because most of our IT majors have huge cash lying on their balance sheets and they had done this in a clump in 2017-2018 and the expectation is that Infosys and Wipro will also follow this example as their results come out. It is a full sector that is getting re-rated today.
For three companies in very diverse sectors — Reliance, TCS and HDFC Bank – -the return percentage is above 20% and below 25%.
That shows the opportunity in India. One banking major, one which till five years ago was a petchem major but in the last one year, has been doubling the stock because of digital and then FC Kohli’s experiment on TCS. I used to have an office in the Air India building in the 90s and again in the 2000s I worked there in a different company and we used to have the TCS office on the top of Air India building because of historical reasons, because it used to be Tata Air before Air India was nationalised by Mrs Gandhi. One used to run into Mr Kohli in the lift. I would say Faqir Chand Kohli was probably the earliest progenitor of the Indian IT sector.
I would say there is a lot of value in the mid tier IT companies and in the start-ups in fintech, health tech, edutech, insurtech. Everything that has got a tech and a digital added to it these days is really running by cloud itself.
If you carve out the cloud portions of these companies, those are growing at 35-40% year on year and still we have just touched the surface. Cloud is going to be so huge for each of these companies and software as a service is something they understand very well and value addition on top of it is going to come. So these three companies and a lot more will be there at the top of the order. Right now, I would say stick to the quality, stick to the big names and within the smaller companies, stick with the non-leveraged management. We are not out of the woods yet.
Where is money going to be made? Do you think TCS, Infosys or Wipro are priced to perfection or would they continue to give returns in line with their earnings growth?
I think it will be higher and the reasons are manifold; one, IT spends are increasing globally. I remember 20 years back, all the sectors taken together would spend $1 trillion on IT capex plus services in a year. Now it has gone to about $3.9 trillion.
People tend to use hardware for three to five years or more. It is more in software that you can really make the big bucks and we have very high margins in that. There have been some headwinds on the visa issues in the US and the cost went up but these six months have been a huge opportunity because when costs have gone down and you were forced to work in a very constrained environment, more and more innovations have come.
If you look at the way digitisation is happening, this week I was reading a report on a Chinese online broker which is now valued at 21 billion Euros and it has more valuation than Credit Suisse, a 150-year old Swiss bank with all the features of a bank.
So there are these challenges. Are our companies as swift? Not at all. They will take time. Have they gone up the value chain as say the Czech or the Israeli ? Not that much. So what has changed? One is the Cloud, the entire digital which has brought a mainstream to a lot of things that they can also take on. Now their competitors are Microsoft and Amazon as well as the Snowflakes and the Palantirs of the world.
So it is not easy, it is not a pushover but we have a lot of competitive advantages in this space and the business models have changed. I would say that 12-14% is not the growth you will get, you will get it higher and that is why the market is giving a higher PE to IT stocks. The market knows better than all of us. I do not think it is that frothy. As far as the IT part goes, you have clarity, you have companies with great managements, no debt, very solid business models and very centre of plate kind of offerings.
Now you add on Cloud, big data analytics, automation to it and it is rejigging the whole portfolio. It will happen faster for the smaller companies as we have seen with the recent IPOs and with midcap IT also doing so well. But the scale will eventually come in because if you are implementing a Finacle or a bank, you will get all the allied services also and the bank wants to migrate to the Cloud they will look at you at least for a right of first refusal.
Where do you stand when it comes to the metals basket?
Steel is looking good. There have been price hikes also and the trends coming from the Chinese market are looking good. In aluminium, we have seen Hindalco’s sale of one unit of Novelis going into arbitration and that has meant a little bit of a cloudy outlook but overall, metals are very strongly correlated to the Chinese economy and that has not had the trouble that the global economy had faced. We are expecting metals to perform well.
It has not been a great two months for metals overall given the slowdown in the global economy but a combination of infra growth, a combination of some import duties being put and some protections coming in as we saw on some of the specialised steel makers there was some talk that there could be some duty protections coming in. That could move the needle. But overall, we see growth on the metals pack. In terms of pecking order it would be IT, pharma, consumer and then you would come to metals in the Indian space.
Markets have run up in anticipation of an economic recovery. This is not the first time markets have run up ahead of economic recovery and economic recovery has not happened whether it was 2018, whether it was 2015 or 2016. Do you think we are in for some kind of a disappointment again?
We have an earnings free kind of a market recovery. Over the last five years, earnings have really lagged. The biggest risk right now is an uncertain US election outcome. That is really weighing heavily on the markets and I am expecting some kind of a correction in November because President Trump has said very clearly that he is expecting a lot of fraud and he has got an army of lawyers ready just like in 2000. That year, it was limited to Florida, this time around, it could be seen across seven, eight battleground states. And most of them have Republican majorities at the local congress levels as well as governors which are Republicans and so you could see a lot of lawsuits. What the market would like is either Biden or Trump win a clear mandate and if there is uncertainty and the election process gets delayed over one month or two months as we saw in 2000, then you could see a pretty sharp correction in the markets.
Coming to the economy, we do not foresee the economy getting to a semi normal process at least for the next two to three quarters. We have seen directionally that there is a good improvement, GST numbers especially are going higher year-on-year and that is a welcome improvement but it is also showing that the economy was decelerating over the last four quarters going into this Covid crisis.
The earnings revival is quite a bit of time away. It is the global liquidity — $9 trillion put in by central banks, $11 trillion of fiscal stimulus put in by governments in various things — and that is taking the markets up and holding the markets. The earnings revival is at least two to four quarters away.