Deven Choksey, MD, DRChoksey FinServ Pvt. Ltd, says “L&T on one hand, shows extremely high competitiveness in bidding and winning the contracts. On the other hand, the input cost control has to be there. In a given situation, which remains quite fluid, it is difficult for companies to maintain the margin beyond a point. Of course, they have got a pass over clause in most of their contracts. But all said and done, there are certain challenges in the margin. As a result of which, the margins have remained relatively more competitive. That is where they are probably not getting a higher valuation.”
Do you think a large part of the rally in the capex theme is done because in the last few weeks, we have seen sideways moves from the likes of Siemens and ABB. The big rally that we were witnessing a few months ago seems to have subsided, with the exception of L&T?
I guess a few things need to be observed. While most of the companies are continuing to take advantage of a good capex cycle in the country because of the government spending, the spending by the industry, etc. I feel the more important part is that these companies would have a probability of growth rate moderated between 15% and 20%.
If the economy is growing at 6.5%-7%, probably 15-20% kind of a growth rate would be a sustainable growth rate for most of these companies. Comparatively, most of the companies which are quoted in the market, have been driven by the euphoria and they started commanding the PE, particularly the mid and small-size companies, apart from the MNC companies. They started commanding the PEs of 40, 50, 60, 70s, I think that is where probably the problem lies.
On one hand, the good business situation continued but on the other hand, the valuations are far more advanced as far as the ability to invest in this kind of valuation for a longer period of time. They are far more advanced in discounted futures, far too early in advance. From that perspective, some amount of moderation or correction in the price is necessary in the capital goods segment fully concurring in the demand scenario and the business outlook remains absolutely convincing. But the growth rate probably would be limited between 15% and 20% on a sustainable basis. That is where I am expecting some correction in valuations in the market.
Despite all the business moving in the right direction, balance sheet moving in the right direction, buyback moving in the right direction, why is L&T still available at 25 times one year forward? Why is it so cheap?
Yes, L&T is available at a compelling valuation. The growth rate for L&T remains very convincing. In fact, never before in past years, in three to four years’ order visibility, which L&T is currently commanding. One of the reasons for which, as I see, is a challenge pertaining to margin maintenance.
On one hand, they show extremely high competitiveness in bidding and winning the contracts. On the other hand, the input cost control has to be there. In a given situation, which remains quite fluid, it is difficult for companies to maintain the margin beyond a point. Of course, they have got a pass over clause in most of their contracts. But still, all said and done, there are certain challenges in the margin. As a result of which, in the respective results that you see, including last quarter’s, the margins have remained relatively more competitive.
That is where they are probably not getting a higher valuation. In my viewpoint, even if the company gets 25 times valuation, which is still okay because you are growing at a speed which I explained just now, of around not more than 15% to 20%. So 25 times could be justified valuation, as I see it.
Another stock which is worth revisiting, I guess, is Federal Bank. This bank has the highest profit outside Nifty50, yet in terms of market recall, Federal Bank is right back there. Do you think now, in the next six months, they belong to the mid-tier PSU banks?
My understanding is that PSU banks have a better time now because of the balance sheets that they have corrected, prepared, whatever you call it as. And at the same time, the SME, MSME segment will belong to maximum as far as the lending books are concerned. They are relatively more stable compared to what they were before
So no questions asked on this particular aspect about the prospects going forward for these banks. However, in my viewpoint, the size would matter. Some of the larger banks would probably be having larger advantages, both in the form of cost of funds. At the same time, they would possibly cornering the good accounts for lending purpose. I am talking about the corporate segment first.
The retail segment, the corporate banks and the NBFCs have taken over compared to most of the PSBs. If I look at it, the PSE becomes only a value play and not a growth play at this point of time. The moment you find most of the PSBs available at the price-to-value discounted below 1.5, you would find some amount of buying interest emerging into them. But the moment you look at the growth, you will probably find your preference going towards the corporate banks and some of the larger public sector banks like SBI and Bank of Baroda.
In my viewpoint, I would still stay with the larger banks because we believe that the growth in this country, which is now happening and happening at a rapid speed, probably the size of the balance sheet would matter. Some of the larger banks would be taking the biggest advantage of this situation. So even if in the near term, you get relatively smaller returns from the corporate and the larger banks, it is worth staying with them for the long-term opportunity in this sector.