I saw your medium-term outlook for Nifty is 26,200, which means around 1,100 to 1,200 points rally from here. How do you gauge the market currently and when do you think that level will be achieved?
Nikhil Ranka: We have put out a fair value of close to 26,000, 26,200 on Nifty. If you go back for the last seven-eight years and if you look at the broad trading range, the multiples at which indexes have traded, you will find that markets have traded between 19 and 20 times one year forward earnings. Now, we ended FY25 at closer to Rs 1,020 EPS and if you build in the consensus estimates for the next two years, we are somewhere closer to Rs 1,150 for FY26 and Rs 1,300 for FY27. Therefore if you put that same 20 times earnings to that EPS of Rs 1,300, you are potentially looking at 26,000 on the Nifty.
Now, the only thing we have to look out for is these estimates build in a 12% to 14% earnings CAGR for markets over the next two years and we have started to a very slow start. So, this quarter and next, we will have a single-digit earnings growth for Nifty stocks predominantly because the banking sector is facing a lot of NIM compression given the uncertainty around tariffs, decision making has got delayed. We are banking on a recovery in the second half of this year for us to get to that Rs 1,150 of EPS for FY26 and then the earnings recovery continuing into FY27 for us to get to that 26,000 levels over the next 9 to 12 months.
Markets are performing, but there are ups and downs and there is a lot of volatility which is, of course, the nature of the market, but we are still waiting for an absolute constant bullish phase. Having said so, what are the next triggers? Is it the earnings that will help the market and in particular what are the top compounding themes? You did touch base on the banks and financials, but will it be the consumption theme that will help the market? Will the automobile make a comeback? What are the themes and is the investment philosophy at present?
Nikhil Ranka: Two sectors where we are relatively bullishly positioned are cement and telecom. Both the sectors are in an oligopoly structure. In telecom for example, Reliance and Bharti together account for close to 80% of the market share and global uncertainty has very little impact on the earnings for these sectors. We had a tariff hike nine months back that has more or less got absorbed and in the next three to six months, we are looking forward to one more tariff hike and the incremental flow through of EBITDA for telecom companies is almost 70% because the costs are more or less fixed in nature. For telecom, infrastructure cost is the major cost which does not change so much and therefore, we believe that it is one of the sectors where earnings visibility is high and multiples should sustain.
Secondly, in cement, the replacement cost is close to $120. If you add some working capital requirements, you need the sector to make close to Rs 1,500 of EBITDA to get to that 13-15% ROCs and it is closer to Rs 1,000-1,100 and it has got consolidated between UltraTech and the Adanis, close to 350 million tonnes between these two players. My sense is the same thing that we saw in telecom 9 to 12 months back, slowly pricing has started increasing, and the same thing is likely to pan out for the cement sector also. So, we feel that there will be earnings as well as multiples rerating for that sector.
Coming to the earnings outlook, the market is waiting with baited breath as to what happens on 1st of August because we will get a clarity on what will be the tariff outlook going forward because what has happened is given that companies had this three-month window from April to August, a lot of shipments would have taken place in these three months and if we have a high tariff structure coming through, then Q2, Q3 could have some challenges for exporters in that sense. We are looking at single-digit earnings growth for Q1 and Q2. If something goes wrong on that front, then even Q3, Q4 become uncertain in terms of recovery. My sense is if we have clarity in August on tariffs and they are not very bad. The market should take heart from that because markets do not like uncertainty. Once we have certainty on tariffs coming through, the market should start the next leg of upward journey.You mentioned earnings season and Infosys is one of your top holdings, with results due in a couple of days. Other IT majors have posted the results which the Street has not liked much. But overall, Nifty IT has not fallen as much as the bad earnings they have posted. What is your view on it?
Nikhil Ranka: We did this study for IT companies even during Covid when there was a lot of uncertainty and we saw was that during the period of initial uncertainty where there was no visibility as to how earnings would come through, for the rest of the sectors there was a 50-60% earnings downgrade, but eventually IT was one sector where revenues were more or less flat and there was very little earnings downgrade.
My view is the same is happening with IT even this time around. Given the uncertainty around tariffs, Q1 and Q2 are likely to be weak because a lot of decision making has got deferred. But my sense is Q3 onwards, these stocks will start performing because we will have a visibility on revenue growth coming back and the good part about it is none of these companies are levered in terms of their balance sheet.
IT is always a P&L issue which is a very short-term issue and very easy to repair. The problem comes with stocks where there is a big hole that happens in the balance sheet, things get levered and then it takes three-four years for the entire repair balance sheet repair to happen. That is not our base case in IT.
We feel Q3 onwards, things should start coming back. Even if you look at the consensus estimates for Infosys, for rest of the players, we have seen a constant currency decline that has happened in Q1, Q2 outlook is also subdued but for Infosys the broker estimates are suggesting that they should have a closer to 2% constant currency growth this quarter and if that happens, in most probability, there will be an guidance upgrade for Infosys because they had guided for zero to 3% constant currency growth when they had come out with their outlook. That could get upgraded if we see a 2% constant currency growth in this quarter for Infosys.
One of your famous market quotes is that it is not whether you are right or wrong in markets that is important, but how much money you make when you are right and how much you lose when you are wrong. I completely second the thought. What is your advice to the market participants? What should be the strategy, be it the broader markets, be the benchmarks, the midcap and smallcap while they are drawing their portfolio?
Nikhil Ranka: Longer-term, markets have given returns which are more or less in line with the nominal GDP growth. One of the only things that you have to watch out for is to avoid the flavour-of-the-season stories and not get into stocks where the euphoria is built more on hype and actual numbers are just not visible.
We will look for a philosophy of growth at a reasonable price. Stocks and sectors, which even if on a near-term basis look a bit expensive, but which still have the longevity of earnings. The worst case that can happen is probably for one year you do not make returns and as earnings catch up, next year onwards you still get back to your compounding of that 12% to 15% growth. We do not want stories where there is a risk of permanent loss of capital and so investors should look out for core fundamentals, cash flows, earnings visibility when they are constructing their portfolio.
In terms of guidance, you should keep expecting 10% to 12% earnings growth from largecaps because our nominal GDP growth is around that 10-11% and if you do some sort of decent stock selection and sector picking, then investors can expect 12-15% compounding to happen from markets over the medium-term.
Reliance has posted earnings on Friday. What is your view on the oil and gas sector?
Nikhil Ranka: Reliance can be broadly dissected into three broad segments. One is oil and gas, one is retail and the third is telecom. Telecom that is where the key stock price driver is there because they have now close to 45-47% market share on the telecom and the street is looking out for some signs of tariff hikes to come through. If we get some clarity on when the Jio listing would come at the AGM somewhere in August, that will be one of the triggers that the Street is looking out for.
In terms of oil and gas, there is not much expansion happening. So that is a steady state Rs 60,000 crores EBITDA the segment is delivering for them. In terms of retail also, across the sector, be it Trent, be it DMart, growth has slowed down a bit. We have seen contraction in growth rates across the sector and it was visible for Reliance as well that retail did not grow as much as expected and that is where the disappointment of the Street is.
Secondly, you have to understand that the base has become quite big for Reliance. So, we are at close to Rs 1,70,000 crore of EBITDA base for Reliance and the management has guided that by end of the decade, they will look to double their EBITDA. So, if you hold patiently for five-six years, in line with what the growth will be, one could probably look at 12% to 15% returns in the stocks from here on out.
