Sandip Sabharwal sees limited upside in Avenue Supermarts amid tough market conditions

"So, the company is facing a challenging face after a very aggressive growth for nearly a decade. For the last two-three years, if you see, earnings growth is hardly 5-6%. Last year, earnings growth was 5-6%," says Sandip Sabharwal, asksandipsabharwal.com.

And now it seems that it is going to be global weakness which is going to perhaps pull us even further down.
Sandip Sabharwal: So, at least in the short term, writing is on the wall, slightly longer-term valuations have come back now to more reasonable levels after the frenzy which we saw last year. So, largecap valuations are looking better than small and midcap valuations because both the indices have fallen almost similarly from the top and the valuation on small and midcap had run up very substantially. So, the trend in terms of how well India will do vis-a-vis the rest of the world, etc, will depend on monetary policy, fiscal policy, etc, where we will have a lot of clarity over the next two-three weeks. But the corrective move is fine.

I do not see it as a big threat in terms of the overall bull market ending because those indications do not seem to be there. So, these sort of valuation corrections happen at periodic intervals and that is something which is happening now.

But other than that what is your list like and would you be looking to add positions anywhere or make fresh purchases in this current decline?
Sandip Sabharwal: As the result season plays out, then we will get a more fairer idea of how various companies and sectors stand. But the decline in the rupee obviously will help the exporters and to that extent, export-oriented companies, IT, pharma, many other companies which have reasonable export presence and now getting hurt because of the unnatural strength of the rupee, those could benefit.

The other companies which could potentially benefit just because of the valuation correction would be the consumer names which we have been talking of that consumer names are more near the bottom and to that extent, they should be accumulated now and they always tend to outperform in a risk-off mode in any case.

And then, the overall capex industrial cycle, growth cycle in India is still there, and to that extent that cycle although has slowed down, but it still should be there for the next few years and there also we are seeing valuation correction in many companies, so that is where we should be looking to buy. And the last place obviously are the financials where if the asset quality holds up as the quarterly results come out, then many of the financials do look reasonably valued.

What is it that you have made of Avenue Supermarts’ earnings? I mean, it is a mixed bag from brokerages. Some continue to hold their outperform rating. Some have cut the price targets as well. But having said that, they have missed the earnings estimate pretty much on all count and then there is that management rejig as well. Neville Noronha steps down after almost a decade and it is Anshul Asawa who is going to be taking over, although Neville stays put for another one year.
Sandip Sabharwal: So, the company is facing a challenging face after a very aggressive growth for nearly a decade. For the last two-three years, if you see, earnings growth is hardly 5-6%. Last year, earnings growth was 5-6%. This year, they will end up with a 5-6% earnings growth. Next year, most analysts are expecting it to revive to 12% to 15%. So, in that context, the valuations of the company obviously are excessive because even if we take the most aggressive estimates for next year, it still trades at between 75 to 80 times earnings.

For a company which is not going to grow at 30-35%, a lot of analysts had built in that they will continue to grow at a trend rate because they will take a lot of market share, etc. Now, it is moving in the reverse direction where they are facing market share issues from quick commerce operators, etc, and they are slow to adapt to technology.

So, I would think that there is more downside than upside in the company. When the initial sales number had come out, those seemed encouraging, but it clearly is visible now that the sales numbers were achieved at a significant cost to the margins and to that extent, the valuations no longer remain attractive. So, I would think that we will still see a prolonged phase of valuation correction.

The other gaming part in the market is what is happening in the IPO market. Buy in the pre-IPO, apply in the IPO, sell on the day of listing or sell when the lock-in opens. Given how market conditions have deteriorated, do you think this entire madness in the IPO market could come to a stall?
Sandip Sabharwal: It should come to a stop and that is also important for to sustain the overall strength of the market because many of these IPOs are coming at very-very crazy valuations. Then, they get listed, then the price gets ramped up even more. So, if you look at many of the IPOs of the last few months, they trade at valuations even now which are more than two times of well-established comparable companies who have been listed for many years and even very small companies are getting 50-60 times price-earning ratio and because they get lapped up by anchor investors and then because the IPO investors have made so much money on the listing pop, so it is an established thing that you just apply in that and you will make money. But it is not sustainable. I do not think these kinds of valuations which are there in the IPOs are sustainable.

Where do you mind in the market right now the risk is still dawning on us whether it is valuations or participation or the earnings?
Sandip Sabharwal: So, overall, market given that it has already corrected 11-12% from the top, I would think it is reasonably valued simply given the fact that there is pessimism around earnings growth policies both monetary and fiscal as well as the fact that there is a global fear also now getting built up.
So, let us see how long it takes for any durable bottom to be made, but I would think that the downside risk from the current levels should not be more than 3% to 4%.

On IT, what has been the read-through after TCS' numbers purely because of the positioning, the expectations are so low this quarter and I guess that is what explains the entire sector moving up on Friday.
Sandip Sabharwal: TCS, the key thing which at least I thought was positive was that the comments of the management that discretionary spending seems to be coming back and their view that under the new US administration discretionary spending should now start to pick up further, this is something which was lacking for the last two years and we were actually seeing cuts in discretionary spending.

If this actually plays out and that gets combined with the rupee-dollar support which is coming in now, which was also missing for the last one year where till November last year rupee was down just 1% for the year while the US dollar index was up nearly 6-7%.

The rupee has also fallen and it has caught on to other emerging market currencies, so that could be helpful obviously in the profitability growth of many of these companies.