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What will be the success story of 2023 and 2024? Prashant Khemka explains


IT services companies are almost as profitable as consumer staple companies. The cash flow to earnings conversion is close to 100%, 90% on average for the sector, says Prashant Khemka, Founder, White Oak Capital.

Among private financials, there was a blockbuster performance from ICICI Bank and of course IndusInd Bank. Just want to take the IT services part forward. Do you still hold on to that point of view that we have seen a considerable run up in share price and now margins are coming under pressure due to high attrition rates?
Attrition rates are a concern but I will come to that in a minute. Look at the longer term case for this. We are not investing from a top down perspective but since four and a half years ago when we started White Oak, I have had large exposure in this space. Investors had sort of written off the IT services space.

I am talking about the 2017 time frame when everything was booming. In 2017, these were considered export oriented and people were very gung ho on the domestic market. Secondly the fear was all this automation and machine learning and artificial intelligence will reduce the need for IT services or the kind that Indian players provide and Nasscom anyways always guides for companies in dollar terms high single rates 7% to 8% so people do not make the distinction between dollar growth and rupee growth, which I think is very critical.

In India nobody gets excited with 7% to 8% growth. Any company that does not grow double digit does not excite investors here but in the case of IT services, 7% to 8% dollar growth would very logically translate into low double digits or low teens rupee growth. It is logical to believe going forward that the rupee would depreciate over time in the 3% to 4% range given the inflation differential between dollar economies and Indian rupee economy.

So if a sector is growing at low double digit or low teen space which very few other sectors are growing, then within that you get a lot of individual companies which are executing a lot better like financial sectors. So overall credit growth is 15% but not all financials are doing well, there are financials which are executing very well. I do not need to name them. They are growing at 20% plus and in a risk prudent manner.

Similarly, in the IT services sector is growing at low double digits to low teens, there are individual companies that are growing at 20% plus on the back of very strong execution and the profitability of IT services is second to none. They are almost as profitable as consumer staple companies. The cash flow to earnings conversion is close to 100%, 90% on average for the sector.

People get focussed on PE multiples and that is also a combination of these things. People had written off the IT services matured sector with very mediocre single digit growth and focus on PE multiples that to suppress PE multiple led to a fantastic opportunity and even today while PE multiples have expanded in absolute terms and relative to the market terms when you look at cash flow multiples, these companies remain at a discount to the market and are growing much faster than the market.

There are a lot of other aspects that are a lot stronger than the average company in the market. Hence, we believe selectively obviously we own very few of these companies. There is a very huge universe of such companies. We barely own a handful. The team has done a very good selection job and we see that those remain multi year, if not longer than opportunities for us to be invested in. Obviously we will remain sensitive to valuation but as of now, the valuations are very much in their favour.

Right now markets are pessimistic, valuations are reasonable. The sector may not grow but some individual companies may grow and they are still cash generating machines. What will be the success story of 2023 and 2024?
2016-2017 was an extraordinary opportunity. The returns from there have been phenomenal. We are not expecting that because a certain amount of rerating has happened. We do believe further rerating will take place going forward as well because we still believe that the value, the cash flow multiples and on DCF valuation basis, there is still a lot of upside but a particular X, Y, Z company which has today become market darling and a largecap company, was a small to midcap company in 2017, trading at 11 to 12 times cash flow multiple.

On a metric of cash flow, we look at excess ROIC 11 to 12 times cash flow, at that time it was at 35 times. We believe this company merits to trade at a significant premium to the market. At that time, there was 100% upside. Today the market on the same metric, that we use excess ROIC cash flow multiple, something that we as a team has developed and focus on, today the market is at 45 times which is okay because lot of markets around the world have multiples on similar metric are in the similar zone.

This company has expanded its multiple and it is now in the high 30s. A lot of the gap has been narrowed. I do not disagree but still there are ways to go on the multiple and the growth is superior to that of the market. Markets are likely to grow on this metric over the long term in the low double digit range. When I say long term, let us say five to 10 years, whereas this company can still compound in 20% range.



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