Why Shankar Sharma Is Bullish On Indian IT And Metal Stocks

“There are global cyclicals stocks that we have played successfully. In India too, there are your steel and aluminium and the copper plays,” Sharma, co-founder of investment advisory First Global, said in BloombergQuint’s series Navigating Through Uncertainty. “We’ve had them in good measure from June last year, much before the commodity cycle became the flavour of the month or the quarter.”

“So, a JSW Steel Ltd. or Tata Steel Ltd. or Hindalco Industries Ltd. have done actually better than a lot of the IT and the pharma names,” he said. “We’ve had all of them in our portfolios from the middle of last year. We continue to own them, we continue to like them.”

While Sharma has drawn better returns from metals than from IT, he still remains “very bullish” on the sector. More specifically, the midcap IT space.

According to Sharma, there are a slew of companies apart from the big names like Tata Consultancy Services Ltd. and Infosys Ltd. that have been “fabulous” performers for his portfolio. “So, while we have bought a bit of Infosys, TCS and some of the larger ones, we played the tier just below that.”

What Sets Midcap IT Apart

There are two key reasons that set the mid-cap IT stocks apart from midcaps in other sectors. The first is that they can offer higher growth than their larger counterparts. “A $100 million deal doesn’t move the needle for a TCS or an Infosys but for the second or third tier, it can completely alter their growth trajectory,” Sharma said. “In general, mid and smallcaps in any space will trade at higher valuation because there is greater growth potential. That part is pretty axiomatic in investing.”

The second, and more important reason, is that IT companies in the midcap space offer a very high degree of governance.

“The biggest challenge you have with smallcaps and midcaps of other industries is, you don’t know what’s going to happen. In IT, fortunately, because of the effect of these five major companies on the whole industry, and the governance and the disclosure standards for over 25 years you have companies which are very well managed, with a great system, a great structure, good boards and good accounting,” Sharma said.

“So, that one big risk—and I’m not saying it’s uniformly applicable—but in general, say a Happiest Minds Technologies Ltd., you can trust them blindly on their governance,” he said. “Growth is a different point. But at least you will not have a risk that tomorrow they will just blow up in your face like many other midcaps do.”

Cutting Down On Banks, Financials

Risk, in fact, has played a crucial role in Sharma’s investing decisions over the past year. He’s reduced his holdings in banks and financial stocks as, by their very nature, they’re highly leveraged.

“Right now, the risks that we see in Indian equities tell us this is no time to be aggressively chasing stocks which derive their businesses from the real economy. Which means that banks and financials fall in that category,” he said.

“If you were to have a market cut of some kind, you will see the branch falling squarely on the leveraged end of the market, which is banks and financials. So, we’ve cut back significantly in the last couple of months on our exposure.”

Sceptical Of Auto Recovery

Besides financials, there are other sectors that Sharma feels will be in a bit of a pickle.

“Automobiles could be in a spot of bother for sure because we don’t know how long this phase itself lasts,” he said. “Anybody who thinks this is going to get over soon, I think is being really super optimistic because what we’re seeing right now is a problem that really has no immediate solution.”

The economic situation right now is such that all discretionary spending can be put off the table by consumers. he said. “In any case, a lot of these things have already been consumed by whoever wanted to consume them. You’re now looking for the marginal consumer. I think that you can safely say that we will have a problem for these kinds of companies.”

Online Threat To FMCG Big Boys

Legacy consumer goods companies will also take a hit too, according to Sharma.

“You should not exclude the FMCG companies from this pack because there too, you have the scope to down trade,” he said. “It’s not as if you necessarily need a Sunsilk shampoo to wash your hair. There are many cheaper brands out there. And this was our argument last year when we chose not to own Unilevers and the Britannias and the Nestles of the world because e-commerce is basically poison for these companies.”

Sharma said that e-commerce has created a level-playing field for smaller private label brands who no longer have to spend as much on advertisements to sell their products.

The first few lockdowns last year portrayed how e-commerce could cut growth rates for these consumer goods makers that rely on offline retail. “If you look at the stock price movements, they have been absolutely at the worst end of the market in the last 12 months’ time. I see that trend not changing, I see that it is a major threat.”

“The economics are a no brainer for an online brand. I think that's a serious threat to this whole industry, so-called consumer stocks with great moats. I don't think that moat is secure anymore,” he said.

No Time For IPOs

A spate of recently successful initial public offerings has failed to enthuse Sharma.

“On the IPO front, markets have been buoyant globally and people are right in their desire to go and sell stock to the public. I don’t think you’ll make a lot of money as an investor buying IPOs because I have never been a believer in IPOs,” Sharma said.

“Very few of them are reasonably priced most of the time and most of the juice has been taken out by the bankers,” he said. “So, I’m not a believer in that but it’s good for the companies and it’s a buyer-beware situation.”

Watch the full interview here: