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    Sandip Agarwal's 4 top bets from IT sector for near term

    Synopsis

    ​I think now the attrition rates are under control. Margin should expand because margin is a direct factor of where your attrition is, utilisation is. So, I think the revenue growth I do not see will pick up very substantially immediately, because if at all the ECB rate cut has happened, now in US also we are expecting some cool off to happen on the rate front.

    Sandip Agarwal--1200ETMarkets.com
    And if all those things play out, then revenue growth will pick up with a lag effect. So, I think at least we are two quarters away from where the growth rates will pick up.
    "I think the sector when it went down, it went down with a higher attrition and lower margins. When the sector is coming back also, it will come back with lower attrition, higher margin, and then revenue growth will follow, so that is the way I look at it," says Sandip Agarwal, Sowilo Investment Managers.

    What is your sense, anything material that one should actually look at the IT sector positively or is it just a one day move?
    There are two ways to look at it. One is the expectation of very high spurting growth suddenly, I think that I do not think anyone has. But you also have to look at in this perspective that this sector has undergone both time and absolute price correction for the last one-and-a-half, two years. When COVID started receding, the attrition rate was the first one to hit the sector very hard because with a very substantial jump in attrition rate, what happened was margin had come down substantially and since then the sector has not done well.

    I think now the attrition rates are under control. Margin should expand because margin is a direct factor of where your attrition is, utilisation is. So, I think the revenue growth I do not see will pick up very substantially immediately, because if at all the ECB rate cut has happened, now in US also we are expecting some cool off to happen on the rate front.

    And if all those things play out, then revenue growth will pick up with a lag effect. So, I think at least we are two quarters away from where the growth rates will pick up.

    But the margin should start expanding. We saw some bit in the last quarter numbers also and I think further expansion will happen in the current quarter and it will further accelerate in the upcoming quarters because with attrition falling the cost will come down.

    Growfast
      So, I think the sector when it went down, it went down with a higher attrition and lower margins. When the sector is coming back also, it will come back with lower attrition, higher margin, and then revenue growth will follow, so that is the way I look at it.

      Also, remember that the customer markets have done phenomenally well. If you see the Nasdaq, it is up 70% in one year and in a way that we are definitely related to them. So, if they are doing well, the follow-on growth will come for us also, that is the way we look at the sector.

      But this is an argument you have been making for a while that the margins are expected to improve. We did see a part of it, to be honest, in some of the earlier quarters. But with growth not coming back, the operating leverage continues to be amiss and that is the problem and even two quarters down the line, there is nobody who is committed about recovery.
      No, you are absolutely right. So, this is not a sector where you will see very high growth immediately and remember that the kinds of TCS, Infosys, all these big names, you should always build in an 8-9% revenue CAGR over a long term.

      There will be years when they will do 13-14% and then there will be years when they will do 4-5%. So, I believe that you should not build more than 8-9% for the largecap and some margin improvement because of operating leverage.
      So, it will lead to 12-13% EPS growth. But remember, these are cash generating companies with very high dividend distribution and buybacks, so the multiples will always be closer to two times price earning growth.

      I think that is where the rationale is. In the midcap and smallcap, you will see 4-5% higher growth and almost double EPS growth than revenue growth. But at the same time, the price earning growth ratios will be also 2, so they are trading at 30-35 times.

      I think that is the new norm with which we have to live. If you think that the stocks can double or triple, I do not think that is the case. These are stable 15-16% compounding stories in terms of stock returns and not more. If that compounding does not happen for a year, then it will come back as a bundled one in some other.


      Within the scenario that you talked about, the margin plays and the fact that the multiples are still around 30-35 times, where do you see value then within the sector because today it is the midcap IT which is doing a lot better. Even, of course, Wipro, etc, is reacting to that order inflow. But if you had to take three top bets within the IT sector, which names come to mind?
      I will say that we are in a situation where we should prefer largecaps right now because largecaps have been able to train people at a faster pace than the midcap and smallcap in the AI and we have always seen when the cycle starts largecaps suffer and then largecaps recover also faster.

      And this time will be no different. So, I would propose likes of Tech Mahindra, HCL where the valuation comforts and now even Infosys and TCS because valuation comfort is very good.

      And I think largecap will do better than midcap and smallcaps. Although midcaps have also corrected quite reasonably from the peak, but I would still prefer largecap and with a gap of two-three quarters when we see growth coming back, I think we will take a re-look look at the midcaps. I think midcaps will have one or two challenging quarters compared to largecap, that is the way I look at the sector.



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      (What's moving Sensex and Nifty Track latest market news, stock tips, Budget 2024 and expert advice, on ETMarkets. Also, ETMarkets.com is now on Telegram. For fastest news alerts on financial markets, investment strategies and stocks alerts, subscribe to our Telegram feeds .)

      Subscribe to The Economic Times Prime and read the Economic Times ePaper Online.and Sensex Today.

      Top Trending Stocks: SBI Share Price, Axis Bank Share Price, HDFC Bank Share Price, Infosys Share Price, Wipro Share Price, NTPC Share Price

      ...more
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