US market recovery to boost Indian tech stocks: Manish Sonthalia

"Size of the opportunity is very good. In retail, and this be true for any form of retail, you got to get your unit economics right. And if you get your unit economics right, that is to say per unit order or per unit quick commerce transaction, more than cost of capital, then the sky is the limit for you and I think Zomato has the first mover advantage, they have got the unit economics right, they have broken even, they are making contribution margin which are positive and now it is only about expansion into tier I, getting economies of scale," says Manish Sonthalia, Emkay Investment Managers.

And while we are talking about the entire consumer space, one name that I am seeing in a portfolio of yours as a top holding is Zomato. Not really surprised to see Zomato, but also not expecting to not see Swiggy make it to this list. What is making Zomato much more attractive than Swiggy because Swiggy has also been innovating if not at a higher pace, then largely at the same pace that which Zomato has. They have also had a couple of recent rollouts. The stock seems to be doing well over the last one month and ever since it is listing we have very bullish brokerage notes coming in for Swiggy as well. What is making Zomato more attractive than Swiggy to hold in your portfolio right now?
Manish Sonthalia: So, not specifically commenting on Swiggy because regulation prohibit us from commenting about stocks that are not a part of our portfolio, but I would look at the entire space like this, that the TAM, the size of the opportunity is humongous. There is room for everybody.

You have many more players apart from Zomato actually enter both the quick commerce space and the food delivery space and the fast food delivery space also, the Cafe Zeptos of the world so to speak. And even Zomato has come out with a Bistro and likewise for Swiggy and you will have many more come through in the form of let us say JioMart or Flipkart also announcing their quick commerce model.

Size of the opportunity is very good. In retail, and this be true for any form of retail, you got to get your unit economics right. And if you get your unit economics right, that is to say per unit order or per unit quick commerce transaction, more than cost of capital, then the sky is the limit for you and I think Zomato has the first mover advantage, they have got the unit economics right, they have broken even, they are making contribution margin which are positive and now it is only about expansion into tier I, getting economies of scale.

The other players have not really got that right just yet. And even as we speak, the turnover on these companies are that let us say Swiggy is also 50% market share in food delivery or let us say 45% market share and Zomato is a 55% market share.

You have not got your unit economics right, then you will have a tough time going forward, so that is not to say that they cannot get it right, but we would like to bet on players which have already got it right. Because the size of the opportunities available for everybody and the tam is just too big.

So, anybody and everybody can win who can get the supply chain and the unit economics right, but more comfortable in public portfolios in companies which have already demonstrated profitability and growth, so that is the reason why we have Zomato as a preferred pick in this space.

I am very intrigued to ask you the question on IT because you talked about how you are positive on the sector. Now on one hand, you are talking about how it is going to be a year of only 10-15% kind of earnings growth. Nifty is going to be range bound between 22,000 to 25,000. When it comes to IT, the earnings are going to be sombre, maybe let us say very low double digit to high single digit and at the same time valuations are not comfortable either, plus the disruption of Gen AI. In all of that context, how does IT stack up to your buy list then?
Manish Sonthalia: So, we are talking everything relative out here that these are sectors which are relatively going to outperform the rest of the sectors in terms of both the earnings growth as well as the valuations.

One key parameter on the macro side is your currency and you are right that IT companies will at best report mid to high single digit sort of a constant currency revenue growth in calendar 25, but this is coming on the back of a low base. And the last two-three years has been bad for the IT space. There has been a lot of order book position that was built in, but it was never getting translated into revenue. For the first time after the elections in US which are getting over, you will see a lot of discretionary spend come through.

And obviously we are hearing that, tax cuts are also going to happen in the US, a lot of impetus on technology spending is going to happen in the US. And of course, a rub off effect of all these things will also come to Indian IT vendors as well as the global capability centre, GCCs, in India. So, on a relative basis, if you combine all these three things, constant currency, revenue growth which is actually going to see an increment, we have heard that from Accenture that they have upped their guidance.

The guidance is going to be relatively better than what we saw in the previous quarter. A whole lot of that peak into discretionary budgets of clients of IT vendors will come through January to March quarter. But nonetheless, the commentary would signal a lot of things. You are looking at currency depreciation, you are looking at tax cuts come through in the most developed market, which is US and technology spend boost, which is coming through.

So, it is not lights on, it is basically discretionary spend, the environment changes for the better and on a relative basis when we compare this year to last year, it is much better.

Of course, valuations are relatively full, but valuations are relatively full for almost all sectors in India. There is not even one sector in India which is not full in terms of valuation if you take it from a sectoral point of view. On a relative basis, when you are looking at the currency depreciating another 3% to 4% in the next six to nine months, this offers a high margin of safety when it comes to your sectoral picking is how I look at it.

But then what about the entire public sector kind of entities in the sense that this year start was great for them, then they cooled off a bit. Do you expect of a bit of a revival in some of these names come 2025? How does the risk reward look like?
Manish Sonthalia: See, the government is talking about heavy lifting in terms of expenditure comes through in the second half of this year and maybe even after the budget all of this spend is going to happen through the public sector entities and public sector as a whole is relatively very cheap in terms of valuations.

And from that point of view, I think the risk is to reward is very-very few. On top of that, these guys are actually going to pay very good dividends. So, if you are looking at some island of safety in terms of valuations, this is one space. Of course, the idea is to be with those spaces in the public sector where there is a monopoly or monopolistic companies and I would even look at public sector banks because even though the growth rates in NII, net interest income, for the second quarter was lower than the private sector banks, in terms of relative valuation also they are much cheaper than private sector banks and of course, the banking sector as a whole looks very favourably suited in terms of valuations and growth.

The public sector banks plus monopolistic public sector entities, I think that the margin of safety is very high given that all the government spending is going to happen through the public sector units and that is why, plus high dividends, so this is one area to be kept on mind selectively.

Also, want to get your sense on the entire FMCG space because I am not seeing any pure play FMCG names or a couple of consumption names, yes, but not seeing pure play FMCG names across your portfolio. What is your outlook on the likes of HUL, Tata Consumer, GCPL? GCPL has rather already given a very weak quarter three update even before the quarter has ended. Do you think recovery is still a little far away for a bunch of these names given that rural is recovering but urban demand has now started slowing down?
Manish Sonthalia: Absolutely, I mean, consumption as a whole is weak. On most of the categories in the discretionary side and even staples have been quite weak because we are really looking at very little value growth come through and even lesser volume growth.

And yes, rural is recovering at the margin but urban is getting suppressed. So, from that point of view, the risk is to reward in terms of valuation still seems very unfavourable.

If the valuations were to correct, of course, this is one area to look at, but I would believe that given the growth on most of the FMCG names, the high single digit sort of a revenue growth so to speak and of course the whole story is about premiumisation, but we are also looking at an inflationary scenario.

Please understand that if rupee was to depreciate, then we are going to import a lot of inflation and margins is going to be one area to be concerned about going into the future.

And given the way the things are, it looks like that rupee is likely going to depreciate. From that point of view, margin headwinds will be one area for all the corporates and particularly so even in the case of FMCG, they will be a headwind to your net profit numbers.

And given the valuations, of course these are high quality cash flows but there is no growth. So, from that point of view, significant underweight on the FMCG space.