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Watch The Signals Closely
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Investing in equity is all about timing. And we believe the financial year 2009-10 is a time when you are better off investing more in the stockmarket than in other investment avenues. This is despite the fact that financials of the 30 Sensex companies are not expected to improve dramatically — Motilal Oswal Securities expects Sensex EPS (earnings per share) to grow by only 1 per cent to Rs 883 by end of FY10. The brokerage house, however, believes an economic recovery will lead to 16 per cent growth in Sensex earnings for FY11, led by commodity stocks. The long-term price-earnings (P/E) ratio for the Sensex (16) shows that the index should reach a level of 16,450 points next year, over 20 per cent above today's levels. To cash in on this expected rise, you need to cherry pick stocks in industries poised for growth even in these turbulent times. And equally, keep your money away from sectors that are not likely to give great returns. Here is our pick of 10 sectors — five for and five against. Power Infrastructure Engineering Fast-Moving Consumer Goods Real Estate Cement Information Technology Oil and Gas Metals With inputs from Venkatesh G. The objective of this special issue is to keep our readers informed about various investing options and their pros and cons. This issue should not be considered a substitute to investment research by our readers. BW will not be liable for any investment decisions taken as a consequence of articles in this issue.
Power for all by 2012, the Indian government's avowed objective, could throw up opportunities in different ways. For investors, opportunities could stretch beyond power utilities to include vendors selling their wares to power companies. While return on equity and return on capital for power utilities such as Tata Power, NTPC and Power Grid are below 15 per cent per annum, it is much higher for vendors such as KEC International, Bajaj Electricals and Havells India. "Power utilities earn fixed rates of return on their projects, which makes them unattractive from investment point of view," says Andrew Holland, CEO of equities at Ambit Capital. On the other hand, the vendors are witnessing bulging order books. "We have an order book of Rs 5,000 crore (1.5 times sales) and believe the rural electrification business is a one-time opportunity that would exist for the next four years," says Ramesh Chandak, KEC's managing director (MD) and CEO. Under the Rajiv Gandhi Grameen Vidyutikaran Yojana, KEC has an order worth Rs 700 crore, while Bajaj Electricals last year bagged two such rural electrification projects worth Rs 1,000 crore. While Mission 2012 looks improbable, the players are optimistic about the opportunity. "Historically, the government has achieved 60 per cent of its target (in terms of power capacity addition), and we believe this opportunity will definitely accrue, if not in four years, in the next seven years," says Chandak. Havells India is also buoyant. "Fresh orders have started coming since February and March, and many of our clients are stocking up," says Anil Gupta, joint MD of Havells India.
With the recent budget's expected thrust on infrastructure, this sector is hot for investing in. Bigger firms such as IVRCL, Patel Engineering and Punj Lloyd, which are already showing higher earnings visibility of two-three times FY09 sales, have the ability to take further orders. The improvement in capital market is a plus. Other factors also count. For instance, in the field of irrigation, re-election of Congress in Andhra Pradesh, which is the largest spender on irrigation, augurs well for IVRCL and Patel Engineering, which have higher exposure to Andhra Pradesh. "Patel Engineering enjoys higher margins than its peers, as it caters to technology-intensive businesses such as hydro power and upstream irrigation systems," Angel Broking's latest report states. The railways, though, is another matter. Arvind Gemini, director of Kalindee Rail Nirman, which is mainly into track-laying, says: "By October, we would be clear as to how the railway budget would affect us; there is a lot of ambiguity right now." Overall, though, at a sectoral PE of 22, infrastructure stocks may not appear value plays, but they are sure winners.
The Centre's thrust on infrastructure will have a direct impact on the engineering sector, but there is more to the sector. Recent IIP (index for industrial production) numbers show signs of an upturn in the capex cycle. India's industrial output expanded 2.7 per cent in May this year due to strong domestic consumer demand. This should be glad tidings for engineering firms exposed to the industries — such as Larsen & Toubro (42 per cent of order book comes from industries), Siemens (37 per cent) and ABB (38 per cent). The immediate beneficiaries over the next year would be those with better book-to-bill ratio and with a larger exposure to government projects. This is because as opposed to industrial projects, government projects could start spending on infrastructure soon. In terms of book-to-bill ratio, BHEL (4.3) and L&T (2.1) are comfortably placed; and BHEL, Crompton Greaves and ABB have high exposure to government-led projects. Also, higher PE valuations have to be factored in while investing.
It might seem strange that we are advocating investing in fast-moving consumer goods (FMCG) when the monsoon has not run its usual course. But why not, especially since the fundamentals of mid-sized FMCG companies — such as Godrej Group and Marico — look intact. And we did tell you earlier, the FMCG industry is less affected by monsoons these days (see ‘Blurring Lines Of Rural India', BW, 29 June 2009). Accordingly, in March 2009, the FMCG industry has sprung a surprise, showing improvement in volumes as well as margins — except for market leader Hindustan Unilever (which lost market share in soaps, detergents and toothpaste). "We maintained our pricing in the soaps segment, while our competitor resorted to aggressive price increase, which backfired," says A. Mahendran, director of FMCG Portfolio Cell at Godrej Group, which saw its market share in toilet soap increase from 9.1 per cent to 9.9 per cent over the past one year. Colgate-Palmolive, on the other hand, increased its market share in the oral care segment by resorting to aggressive marketing. The icing on the cake has been the softening of key raw material prices such as mentha oil, copra, wheat and safflower, which improved margins for Colgate and Marico. Marico has taken a beating in the skin-care segment, though. "Same store sales of Kaya clinic are flattening and we are introducing packages of smaller lots (Rs 14,000-15,000) and easy instalment schemes to improve affordability," says Milind Sarwate, chief of HR and strategy at Marico Industries. With a sector PE ratio of 27, valuations are obviously not cheap. Still, in these uncertain times, FMCG stocks could bring stability to your portfolio.
The first sector that we advise you to stay away from this year is real estate. Ever since demand for property — residential and commercial — fell after October 2008, realty firms have been in financial trouble and facing problems in paying their debt. Over April-May 2009, leading players such as Unitech, DLF and Indiabulls Real Estate raised $1.6 billion either through the QIP (qualified institutional placement) or stake sale. Many are in the queue to raise $3.8 billion more to tide over the liquidity problem. Another strategic shift witnessed recently is that many builders have shelved premium projects, and have instead started focusing on ‘affordable' housing projects. According to a report by Jones Lang LaSalle, there is oversupply in the commercial segment. It expects vacancy levels to increase from 12-15 per cent currently to 20 per cent by the year end. Retail segment is also suffering from weak demand as retailers are asking for revenue-sharing model with developers. In terms of valuations, the average sector PE today is 17, equal to that of the Sensex. A brokerage report mentions real estate stocks to be trading at 21 per cent discount to NAV (net asset value) excluding DLF. Despite that, industry watchers such as Holland of Ambit Capital are currently not comfortable investing in real estate stocks. "Also, there is little clarity as to its future revenues," he adds. We could not agree with him more.
This sector could spook you as well, particularly since the government's infrastructure spending logically should benefit cement makers. Why should you, then, stay away from the cement sector? For one, cement prices are at all-time high (Rs 260 per 50-kg bag), and are likely to go down considering that there will be huge capacity addition next year, which could tilt the demand-supply equation. The 200-million tonne Indian cement industry is adding 33 million tonne in FY10 — as per Enam estimates — which amounts to 16 per cent of its existing capacity. Over the period FY03-FY08, the industry made a fortune by improving capacity utilisation, and by not adding much new capacity. It often resorted to controlling supply to keep prices on the higher side. But now the trump card is gone. In fact, it could now prove costlier to resort to supply cuts since the cement makers would now have to pay higher interest and depreciation costs for the fresh capex investments made, which could dent their profitability. The Enam report expects higher cement demand in FY10 (8 per cent) as against 6 per cent seen earlier on the back of infrastructure investments. "However, even at 8 per cent growth, overcapacity situation is imminent in the second half of FY10," the report mentions. Valuation is another problem. While the sector PE at 9.9 might look very cheap, one has to use a different matrix to value cement companies. And as measured by enterprise value per tonne (based on FY10 estimates) the valuations of ACC ($124), Ambuja Cements ($123), Grasim ($139), and India Cements ($102) are hovering above the replacement value ($100 per tonne). A costly proposition.
Extension of STPI (software technology parks of India) Act benefits might be a positive for the Indian software industry, but the sector is under stress. Business volumes continue to slide with North America and Europe still under recession. The clients of IT companies, comprising financial and telecom firms, are delaying their IT spends for FY10, which is adding to the uncertainty. "Companies have to get a sanction from the core management for outsourcing-related orders and this typically results in a reduction in pace when it comes to making decisions," says V. Balakrishnan, chief financial officer of Infosys. Infosys reported a second consecutive quarter of volume decline in the April-June 2009 quarter results. Pricing pressure is adding to the woes. "The pricing decline for the whole fiscal will average at 5 per cent if we have same kind of pricing decline (in constant currency) of 1 per cent in the next three quarters too, but if demand weakens pricing pressure could mount," says Balakrishnan. Gartner Inc. paints a gloomy picture, expecting IT spending to drop 6 per cent, while Forrester estimates a steeper fall of 11 per cent. And with Infosys's bleak guidance for FY10 — it expects its earnings to grow at just 1.7-5.7 per cent in rupee terms compared to 30 per cent seen in the past — it is prudent to stay away from software stocks.
There is a lot of uncertainty in this sector — be it aligning petrol and gas prices to market rates or litigation over the rate at which gas would be supplied from the KG6 basin by Reliance Industries or whether cess would be levied for oil production from Rajasthan blocks for Cairn India. The rise in crude oil prices from a low of $30 per barrel to $60-plus levels has improved business fundamentals for oil firms. But for PSU oil marketing majors such as BPCL and HPCL, under-recoveries and their financing is a concern that could negatively impact profits. While ONGC would largely benefit from market-linked prices — thanks to lesser subsidies — little is known about the freeing of gas prices. The dynamics of oil refining has also changed with halving of gross refining margins. Benchmark Singapore complex average refining margins for the quarter ended March 2009 was $4.1/bbl as against $8.1/bbl a year before. The Arab light-heavy differential was down 77 per cent to $1.9/bbl for the quarter ended March 2009 compared to the previous year implying that the advantage of being a complex refiner — Reliance being one — is lost. The biggest uncertainty for the sector is the RNRL-Reliance litigation over the rate at which gas would be supplied from KG6 basin. The sector PE of 19 today is also above that of Sensex. Just stay away for now.
Despite talk of ‘green shoots', global economic recovery is still far away. And that is bad news for the metals industry. While the global fiscal stimulus packages by various countries (worth $2 trillion) are expected to boost demand for metals, the industry is today ridden with debt. As for Indian players, many of them are struggling with past acquisitions. Tata Steel, for instance, is doing well as far as its domestic operations are concerned, but recessionary trends in Europe are affecting sales of Corus. Similarly, for Kumar Mangalam Birla-owned Hindalco, the $6-billion acquisition of Canada's Novelis is proving to be a white elephant. Unlike steel, non-ferrous metals such as aluminium, zinc and copper have rallied quite a bit in the current calendar year improving viability of business. Hindustan Zinc and Nalco — with their lower cost of production — are better placed than their peers. Hindustan Zinc has a cost of production of $710 per tonne while zinc prices today are hovering above $1,460 a tonne levels. Nalco, again, is among the lowest cost producers, though its recent salary hike has been a drag. Sterlite, on the other hand, is grappling with the acquisition of Asarco. Overall, this sector is best avoided for now. Don't be lured by its (lesser than Sensex) PE of 14.
Investing in equity is all about timing. And we believe the financial year 2009-10 is a time when you are better off investing more in the stockmarket than in other investment avenues. This is despite the fact that financials of the 30 Sensex companies are not expected to improve dramatically — Motilal Oswal Securities expects Sensex EPS (earnings per share) to grow by only 1 per cent to Rs 883 by end of FY10. The brokerage house, however, believes an economic recovery will lead to 16 per cent growth in Sensex earnings for FY11, led by commodity stocks. The long-term price-earnings (P/E) ratio for the Sensex (16) shows that the index should reach a level of 16,450 points next year, over 20 per cent above today's levels. To cash in on this expected rise, you need to cherry pick stocks in industries poised for growth even in these turbulent times. And equally, keep your money away from sectors that are not likely to give great returns. Here is our pick of 10 sectors — five for and five against.
Fast-Moving Consumer Goods
Oil and Gas
With inputs from Venkatesh G.
The objective of this special issue is to keep our readers informed about various investing options and their pros and cons. This issue should not be considered a substitute to investment research by our readers. BW will not be liable for any investment decisions taken as a consequence of articles in this issue.