What are your thoughts on the Q1 numbers? Can one safely say that we are on the road to recovery?
Economic recovery is evident in all sectors. While sectors like metals and cement have done well at the top line and bottom line levels, sectors like auto are struggling at the profitability level. But even there, the top line recovery which is the main indication of an economic recovery, is evident. The difference is that in the case of manufacturing oriented sectors like auto, FMCG and consumer durables, input cost pressures are coming through and this is true across the world. I have been saying for the last 9-10 months that because of the breakneck pace of the global economic recovery, and the strong recovery in our country, demand is outstripping supply for everything from semiconductors to shipping containers to truck drivers.
Demand outstripping supply leads to inflationary conditions and that is helping the operating margins of manufacturing oriented countries, But as the economic recovery is evident in the results, we will have a global environment flushed with cash. The Covid unlock is also kicking in. The pattern for the year ahead has been set. Top line growth will be abundantly available for all sectors. What will separate the men from the boys, women from the girls is the ability of companies to protect their bottom line in an incredibly strong inflationary environment.
Thanks to high input costs, there is a good possibility of margins being under pressure for most of these companies. Do you foresee that while recovery is coming, the protecting margins could be very difficult in the subsequent earning season?
This is familiar territory for India. We saw a very similar boom earlier. The 2004, 2005, 2006, 2007 boom was very similar when the economy was roaring and input cost inflation and labour cost inflation was coming through. If you look at a sector like IT services, even a large company like Cognizant is saying that it is becoming impossible to get the number of programmers and software engineers they need. So we are living through the strongest demand environment in many sectors that I have seen in 20 years. History shows us this is when the sector leaders pull away.
Look at quality stocks or sector leading stocks like
, , HDFC Bank, Bajaj Finance. Thes stocks show operating margin robustness at a time whereas the rest of the market sees operating margin contraction. That is why in the next three quarters of this fiscal, we will see a widening gap in share price performance between the broader market and sector leaders. I reckon the sector leaders pull away because their operating margins hold up as they pass on the input cost pressures to their customer base, whereas the rest of the sector will necessarily have to sacrifice operating margin because they would not have that sort of a pricing puzzle.
Indian data over the last 20 years clearly shows that when CPI inflation goes above 6%, there is a sharp polarisation in corporate performance as market leading franchises like Asian Paints, Pidilite and HDFC Bank, Kotak Bank or Bajaj Finance pull away from the rest of the pack courtesy their pricing power. A disclosure: we own these stocks.
Brian Humphries, CEO of Cognizant has talked about how he had to let business go the last quarter because he was not able to hire enough people for the projects that were coming in. In that kind of an environment, how do you see things shaping up?
The IT sector is facing a shortage of software engineers and programmers. Each of the top four IT companies will hire lakhs of programmers this year. That is the demand requirement they have and the indications we have from the western Fortune 500 companies in the next four years. The next four years of order book for Indian IT services is just flowing with excess.
There is a similar problem with truck drivers. We are not even properly into the economic recovery and we already have a shortage of truck drivers. By December, we could start hearing about the shortage of skilled factory workers. An IT company like TCS trains 2 lakh workers a year. It is one of the world’s largest fresh training and retraining programmes. Companies ought to have that kind of strength in HR and robust training programmes to be able to flourish in such a climate. There are not more than three or four IT services companies in our country which have training programmes that can operate at TCS scale. The rest of the IT pack will get lots of work but they will give up a lot of their top line benefits as they have to give hefty pay rises to their workers to keep talent from leaving.
How do you see the financial space? This time, retail slippages had been a point of concern for some of the NBFCs, PSU banks and private banks as well. How soon do you see that pain easing for the financials?
There are no surprises here because the Covid second wave hit the economy really hard in April up to around say May 20-25. For two-thirds of the first quarter, the economy really was struggling and all of us felt it in our personal lives and also the second wave hit the financial services space. The commentary has been that collections have normalised through July and August and therefore the second quarter results will be solid across the board, given that the economy seems to have picked up quite nicely.
There is every indication that collections have normalised fully through July and August and the second quarter should be fine across the board. The more prudent lenders, who provisioned aggressively for Covid, could give some provisioning release. My reckoning is there is a good chance of that. I reckon by Christmas or the quarter ending December, we will get good news. I am optimistic that we will hear from some of the higher quality lenders — the Marcellus Investee firms such as Kotak, HDFC Bank, Bajaj Finance — that they over provided and they will start releasing some of the NPAs some of the provisions back to shareholders through higher profits in the second half of the fiscal.
