Generative AI To Drive IT Industry Revival, Says Renaissances' Pankaj Murarka
A resurgence in private capex is expected to unfold over the next decade in the IT sector as generative AI reshape the the sector in the coming years.
The IT space emerging from a prolonged slowdown is expected to experience a revival as generative AI reshape both industry practices and consumer experiences worldwide, according to Renaissance Investment Managers' Pankaj Murarka.
Significant efforts need to be undertaken by businesses to transform themselves to meet the generative AI expectations, the chief investment officer told NDTV Profit's Niraj Shah in an interview. The sector will witness the largest investment cycle globally, surpassing any previous investments seen over the past 30-40 years, he said.
This investment wave is expected to unfold over the next decade, Murarka said.
Nifty IT index has witnessed a jump of over 30% in the past 12 months, according to Bloomberg data.
Pocket Of Opportunities
A strong revival of India's investment cycle is expected as evident from the signs of resurgence in private capex, he said. This significant rebound in private capex would come after the election, he said.
Murarka is positive on the entire engineering and capital goods sector, his preferred theme, as they will benefit from the investment cycle.
Healthcare sector will continue to grow in the future as has been demonstrated strength in the past, he said, while financials that have underperformed are anticipated to stage a comeback in the second half.
Corporate balance sheets are in robust health, while banks and financial institutions are in good shape, he noted.
Outlook On Markets
The ongoing market correction is beneficial and indicative of a healthy market environment, Murarka said.
"We find more value in large caps versus, small and mid caps," he said. "Large caps looks more attractive on risk-to-reward ratio perspective versus small and mid caps."
Watch The Full Interview Here:
Edited Excerpts From The Interview:
Pankaj, the last few days or the last month and a half has been marked by severe volatility and downsides that have come in at the broader end of the spectrum. Is this the end of the small-cap story for the time being?
Pankaj Murarka: No, not really. I don't think so. Just to put the broader views in context, I firmly believe that we continue to remain in a bull market. Having said that, this is a mature bull market, which is now four years old. This bull market started in the middle of Covid lockdowns in March of 2020. In that context, I think, and given the fact that it's a mature bull market and equities and asset classes tend to be volatile, I think that's the nature of the beast. There will be volatility.
Last year, calendar year 2023, we had euphoric moves in mid caps and small caps. So we're seeing some pullback of that. Obviously, there are pockets of markets and more so in mid caps and small caps where there's a significant diversion or gap between fundamental valuations of stock prices. And there will be a mean reversion. So I think we're going through that.
I think it'll be a good and healthy correction in the market that we are undergoing and I still think that the broader bull market from the equity perspective remains very much intact.
My view is that we are somewhere mid-cycle in this bull market. So I still think that this bull market has a long way to go.
Would the bent of an investor like you be towards larger stocks now, considering that there is a bit of a pressure at the broader end of the spectrum or not quite?
Pankaj Murarka: Yes. So, from a related value perspective, you're absolutely right that we find more value in large caps versus mid and small caps.
Just to put in context, what typically happens in every bull market—and this happened in this bull market also—is that at the start of the bull market, so on March 28, when markets started, mid caps and small caps were trading at 20-30-40% discount to the large-cap indices.
Today, we are at a stage where the mid-cap and small-cap indices are trading at a premium to large-cap indices, which is very normal in a bull market. So obviously, valuations in mid caps and small caps are extended. From a relative value perspective, we find more value in the large caps. Having said that, we find enough mid caps as well as small caps, which are far more quality-oriented with solid business models and which will still do well over the next 3-5 years.
So we find value on both sides. But from a relative value perspective, you're right that large caps look more attractive at this point of time from a risk-reward ratio perspective versus mid and small caps.
Okay, well one more reason for stress in the mid caps and the small caps is several fund houses declaring the results of the stress test. Now, Alex joins us with some very quick details of the same.
I was speaking to the chief risk officer of one of the mutual funds to get clarity on some of the aspects. One of the most important points of course, is that cash is included in the calculation. The other aspect to remember is that what they are using to calculate this methodology is days to liquidity, which means that the 80% of the portfolio that they are taking is the most liquid stocks, how much time does it take for the least liquid of that to complete?
So what that means is, suppose you get a day of 56 days to liquidate that 80%, you divide that by half and you get 50%. So what that means is that it takes you 28 days to liquidate the half point. I hope that I'm explaining this correctly.
What that means is that you can actually have what is called a days-to-cash, which means that you can sell both your most liquid and your least liquid stock on an ongoing basis on a pro-rata basis and you can liquidate actually on a daily basis quite a considerable chunk of the AUM. So the chief risk officer was explaining that while on the face of it, some of these numbers might look stark, it may not necessarily present the exact picture on liquidity. First of all, they can meet up to 5% in cash and then on an ongoing basis, 2-4% and 5% in some situations, they can meet basis selling on an ongoing basis.
Pankaj, you have past experience of being such a manager in a large AMC. Is this stress test a big nervous development or is this something that is acceptable?
Pankaj Murarka: Not really. I think it's a good development that the regulator is being proactive and asking fund houses to disclose some statistical details about the funds so that investors have access to this information and more importantly, they can take informed decisions.
I believe, because there have been some of the conversations around big bubbles and mid and small caps, there are pockets of markets obviously where there could be froth, but I don't see overall, at the aggregate level, there's a bubble in the indices, which can correct but I don't see them collapsing, or being at the peak of the cycle or anything of that sort at this point of time.
The other thing I want to highlight is that that is the nature of the beast. Equity markets inherently are prone to bubbles, manias and busts. Every decade you get one such cycle, because equity markets are driven by greed and fear. So, some of those things will happen because that's the nature of the beast.
So I think incremental information disclosure is pretty good, because it gives investors more information at their disposal and probably they can make more informed decisions.
While people are betting on emerging themes, the most sure short bet seems to be the ability to spot where the pie is which is the government's focus on capex, maybe manufacturing and pulling all stops out, while private capex hasn't come in.
So among the safe bets, if you will, valuation taken into account, would you believe that all things considered, it still remains this capex or manufacturing piece or are you at other things being the number one priority for you?
Pankaj Murarka: No, I completely agree with you. We are seeing a very strong revival or comeback of India's investment cycle. Primarily, obviously, public investments or, as you said, the government investments have been very strong. But I see very strong incipient signs of revival of private sector capex as well and I see post elections we should see a very significant rebound in India's private sector capex, because corporate balance sheets are very healthy and profitability is at all-time highs. Corporates are making huge profits…
More importantly, banks or financial institutions are in good shape and their balance sheets are healthy with strong profitability and low NPAs, which is important because they are the ones who are going to fund the capex or investments through the debt by lending.
So I think, overall, we have reached an environment where underlying demand in the economy continues to remain strong. Most of the companies are reaching capacity utilization, which are north of 70%. It effectively means that they have to start planning their capacity and execute those capacities and I see that across sectors. Sector after sector, in each of the core sectors, I see very strong investments.
Also, as you rightly said, this is driven by a revival of India's manufacturing sector, which is driven by the China Plus One and PLI incentives that the government is rolling out across sectors.
So I think, a combination of all of these—Indian manufacturing revival story and the capex story or investment cycle story—look very compelling. I am firmly in the camp that all of us are underestimating the potential growth impetus due to the revival of the investment cycle and revival of India's manufacturing sector. So I think this cycle will surprise on the upside, big time.
We have spoken at length about some of the themes that you've liked. Now the reason why it is important to rehash or highlight some of those again is because valuations may have actually become reasonable in some of the broader market themes for sure.
So, post Q3, post commentary, post the shakeout in the mid-cap and the small-cap space, what stands out as numero uno among the emerging themes?
Pankaj Murarka: As I said, the whole engineering and capital goods space riding on back on investment cycle continues to remain one of our preferred themes or bets and companies within the sector because we think some of the fastest growing companies of India over the next five years will emerge from that sector.
Apart from that, we have been fairly positive on healthcare and IT as a sector, because we think that IT is coming out of a prolonged slowdown in the last 18 months. And we see strong signs of revival of IT investments by global companies in the second half of this year and Indian IT companies should be a big beneficiary of that. So we have turned pretty positive on IT as a sector.
We like healthcare as a sector, because we think it has done well in the last nine months or so. But we still think that there is still strong growth ahead of the sector primarily because pricing pressure in the U.S. is off the table. We have seen significant price improvements in the U.S. generics market, which will significantly benefit Indian companies.
We also think that financials, which have underperformed for a broader part of last year, should make a comeback in the second half of this year. So these are some of the things or companies within these themes that we like in terms of what we are own.
We are underweight on the consumer sector. We think the economy has gone through a cyclical consumer slowdown over the last 12 months and it got accentuated because of a poor monsoon last year. Probably, it is time to revisit it post monsoon, in the second half of this calendar year. Having said that, the sector also had headwinds of very expensive valuations and on top of that, when you have a cyclical slowdown—which is what we've seen—consumer companies have actually underperformed over the last two years. So we still continue to remain underweight on consumers as a sector.
Interesting, when you're betting on IT Pankaj and you track this so closely that I find it difficult to debate with you at all. But there was this Naukri JobSpeak IT index, which showed that hiring is also not picking up. So what gives you this confidence about a change in trend at all?
Pankaj Murarka: There is a very fundamental shift that is undergoing in the world and probably we maybe four quarters ahead of the cycle and that's all driven by this generative AI. I think, in my professional career of 26 years, this is the biggest transformation that I'm seeing that is going to take shape in the IT industry worldwide. And it will change the lives of each and every industry, and consumers all over the world. Businesses will have to prepare for that and they'll have to make significant investments to transform themselves to meet the expectations of the consumers, as consumers transform themselves by adopting AI solutions.
So I think we are at the cusp of a point, maybe probably 4-6 quarters ahead, where we will see the biggest investment cycle in the IT sector which will play out globally.
Typically IT spending cycles, when you get a new technology that wave lasts for probably anywhere between seven and 10 years, which is what I've seen in the past which led to the enterprise wave or the cloud digital wave and so on and so forth. I think this wave of IT spends that we'll see over the next decade will be bigger than any of the previous IT investments or IT spend cycles that we've seen in the last 30-40 years in the world.
So when I look at the IT industry from a slightly medium term to longer term prism, I feel very excited about the prospects of this industry. As I said, we could be probably four quarters ahead of the street or of these all of these actually translating into business growth for companies. But I think it's certainly coming. We as investors tend to make a slightly more medium term, longer term view. So we like to be four quarters ahead of the actual business cycle turning around. So we like to be slightly ahead of the street in terms of making or placing our investment bets and then wait for the tide to turn and then reap the benefits of growth in underlying businesses. So it's in our DNA to be slightly ahead of business and investment cycles.
