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Talking to ETNow, Girish Pai, Nirmal Bang Institutional Equities, talks about the his views on the market and the IT sector.

Edited excerpts:

Considering you turned positive on the IT sector just last month but IT was seen outperforming markets. Do you think there is still some steam left and would you be selective henceforth?

Yes, we have turned tactically positive last month but we dont intend to go whole hog positive on the sector. The reason: we still think there are structural pressures in the sector and that it is not a structural buy especially in comparison to the financial sector which is a very large overweight segment for the institutional investors. Therefore, we think that though fundamentals have improved a tad, it has not shown any dramatic figures. For now, valuations will remain on the lower side for the tech sector.

On the financial side, be it private financials like NBFCs or private banks, the valuations have been two standard deviations above the mean and that has created a dichotomy between one seriously underweight sector from an institutional perspective and other overweight sector. This as per our view has been the reason behind the outperformance. Thus, keeping this in mind, we have shifted our target prices upwards but 80% of the upside has come for target prices driven by PE multiple expansion and only 20% has come from an earnings upgrade.

Hence, we are still concerned about growth but in the near term, it is just this interplay between financials and IT which is giving a leg up for IT, meaning that there could be bit more run up in the IT services sector from a aggregate perspective.

What is the best way to look at the IT outsourcing pie because for 2017 when the US economy was growing, IT companies did not come out with very rosy or very optimistic kind of growth. Now we are trying to connect the global economic growth at IT spending but in last two years if that pattern has not played out why do you think this time it could be different?

One of the key drivers in 2018 will be the US tax reform which will lead to a fair bit of savings in the taxation front. Also, we believe that S&P 500 company related taxation is going to go down and the effective tax rate will be down by anywhere between 300 to 400 bps in 2018 calendar year versus the previous year and it will continue to glide downwards. Therefore, there will be fair bit of savings plus some of the cash has been sitting along with the tax havens that will convert into the incremental spending largely capex related.

In other words, we think that there is going to be some pickup in the growth, I do not concur with the broad consensus street view that there is going to be very strong growth pick up and that is going to continue in FY20. I still think that the growth pick up is going to be very modest and it is not going to be a well spread out.

It is going to be concentrated to couple of companies like TCS and HCL Tech which will probably deliver 150 to 200 bps higher growth in FY19 versus FY18 on an organic basis. So, we do not subscribe to the view that it is going to be a huge kicker.

What are the stocks within IT where you still believe that there is a buying opportunity and what are the stocks that you are still staying away from?

So, when we upgraded the sector, our pecking order has been that TCS and HCL Tech are in the top from both the growth and a valuations standpoint. I think TCS is yesterdays run up and HCL Techs run up kind of covers a lot of ground. So, we still like these two companies the most. Below that would come Infosys, Tech Mahindra and Wipro. We do not like the midcap space, considering the kind of expensive valuations that they stand on.

We think that the business risk that are connect with these midcap companies are far higher compare to the tier one companies. The client concentration levels are far higher and if even one or two of these clients shift away from these midcap companies, the growth can see a potential downside. So TCS, HCL Tech is what we like at this point from growth and a valuations perspective and midcaps is something we would want investors to avoid.

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