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A guide to hot stocks from each sector
Priya Kansara in Mumbai | October 16, 2007
There is a clear indication that India Inc has been cooling off since the past few quarters as the growth rates are slowing down. In the September 2007 quarter, it is expected to happen more sharply.
While net sales are expected to grow at 12 per cent year-on-year (y-o-y), net profits are likely to rise by 17-20 per cent. In the same period last year, it was more than 30 per cent for both sales and net profit.
However, not all sectors are to be blamed. High growth sectors like telecom, cement, construction, capital goods and to some extent banks, which are led by domestic factors, are going to continue their breakneck speed as they did in the past.
But sectors like auto, pharma, non-ferrous metals and partly oil and gas (except Reliance Industries [Get Quote]) are likely to drag down overall growth due to factors like interest rates, appreciating rupee and global markets.
For investors it is more important to know whether this cooling off will turn into a slowdown or the economy will pick up again due to festive season and busy second half. This is because the meteoric rise in the Sensex till now has been caused by the huge foreign institutional investments, as India has emerged as a pocket of growth in a world that's slowing down.
Says Rajat Rajgharia, head-institutional research, Motilal Oswal Securities, "In the next couple of quarters, growth rates can slow down as the lag impact of interest rates and the current trend of rising currency will come into play. Also, last year, second half was very strong leading to a higher base."
However, this can be seen more as a mid-cycle correction rather than a change in trend, assures R Srinivasan, portfolio manager, Principal PNB Asset Management. "A lot depends on the movement of interest rates and exchange rates," adds Sandeep Nanda, head-research, Sharekhan, who prefers to wait and watch till the RBI's policy announcement on October 31.
On an annual basis, the Sensex is expected to report a growth in earnings at 18-19 per cent and 15-16 per cent in FY08 and FY09 respectively, which will still be one of the highest growth rates among peer countries. But valuations of 21 times estimated FY08 earnings and 18 times FY09 earnings look expensive, thanks to the phenomenal jump in the markets levels.
The advice to existing investors is that they should hold on to their portfolio. Incremental investments are advised on dips and with a multiple year perspective to maximise returns. Market participants prefer domestic growth-led sectors.
The Indian auto industry continued to face problems like higher interest rates, last year's high base, rising input costs and competitive pressure in the September 2007 quarter.
As a result, the sector is likely to repeat its dismal performance with an overall growth of just 4 per cent in sales and a decline of 5 per cent and 10 per cent in operating profit and net profit respectively. Thus, there is no doubt that there will be pressure on margins.
Two-wheeler majors are going to be significant contributors to the poor performance. Between April to September 2007, volumes in the two-wheeler segment including motorcycles has declined by over 9 per cent. Further, net profit of two-wheeler companies will decline by more than 20 per cent in Q2 as they face a double whammy of cost push and competitive pricing.
Commercial vehicles (CVs) are going to be a mixed bag. While volumes of medium and heavy CVs have declined by nearly 8 per cent in the same period last year due to challenges like lower demand and the high base of FY07, light CVs saw a growth of over 10 per cent largely attributable to Tata Motor's Ace.
On the other hand, the quarter was relatively better for passenger vehicles and utility vehicles manufacturers as volumes grew by 10 per cent, thanks to new product launches.
The BSE Auto index has significantly underperformed the Sensex-declining by 3 per cent vis-a-vis Sensex gain of 32 per cent-- since the beginning of calendar year 2007. However analysts feel that the negatives of the auto sector have been priced into the stocks.
Broking firms like Motilal Oswal and Sharekhan are positive on the sector, while Macquarie Research is bearish. While key factors like interest rates and inputs costs are likely to cool down, higher crude oil price still remains a major risk.
The BSE Bankex has gained 31 per cent since the beginning of 2007 in line with the Sensex largely due to good financial performance inspite of obstacles like rising interest rates and inflationary conditions in the last two quarters.
The strong growth witnessed in June 2007 quarter is expected to continue in the September 2007 quarter with an overall profit growth of roughly 20 per cent. This will be largely supported by higher non-interest income and treasury profits (with declining bond yields and robust equity markets).
Private banks are again likely to score better than their public sector counterparts on most parameters. However provision for bad loans is a key thing to look at as private banks have a larger exposure to retail loans.
But this does not seem to be a major risk if the quarterly result of HDFC bank [Get Quote] is taken as a benchmark.
Net interest income growth of most public sector banks is expected to grow at a lower rate of around 15 per cent, thanks to low credit growth and high deposit cost.
Credit growth slowed down to 23 per cent as on September 14, 2007 from the robust 30 per cent between FY04-07 and 26 per cent in June 2007. This is a result of the 150-200 basis point hike in prime lending rate of banks between January and May 2007.
On the other hand, banks continued to mobilise funds, especially term deposits at higher rates and capital raising. Net interest margins are expected to be flat to declining as higher yields on loans due to previous rate hikes will be compensated by slower credit growth and higher deposit costs.
Says a Motilal Oswal report, "While the higher costs of resources continue for the banking system, lending rates have peaked out." Thus, going forward, NIMs will improve for those, who cut down their deposit rates or have a high current and savings account (CASA) ratio. Broking firms advise you to be selective in choosing banking stocks. They are positive on banks having a large branch network, high CASA ratio and better technology.
The story of demand-supply mismatch of cement in India leading to robust growth in volumes and increase in realisations is once again expected to be reflected in Q2 FY08. Net sales are expected to grow over 20 per cent due to a growth of 10 per cent in volumes and about 15 per cent in prices despite the monsoon season except in the North, which is unlikely to see any major jump in cement prices. Moreover, a rise in the operating profit and net profit is expected to be higher at 35-40 per cent each.
Indian cement sector's outperformance vs the Sensex is likely to continue for another year as prices are expected to remain firm and volume growth will be robust due to no additional supply till H2 FY09.
Like cement, construction companies are also expected to report robust growth due to huge rise in order intake and backlog despite a seasonal quarter. Net sales are likely to rise at 20 per cent while profits are expected to grow faster at 25-40 per cent.
The outlook for the sector is positive due to high earnings visibility (order book to sales of players ranging between 2.5-4.5 times FY07 sales) and huge potential in the infrastructure development.
Besides robust growth in the core business, there is an opportunity for investors to benefit from unlocking of value for construction companies, which have plans to divest and subsequently list their subsidiaries, mostly in real estate. The latest example is the listing of IVR Prime Urban, a 62 per cent subsidiary of IVRCL Infrastructure. However, valuations look on the higher side.
Top picks: Nagarjuna Construction, IVRCL Infrastructures
The engineering industry is yet another beneficiary of the robust demand for infrastructure development, which is reflected in strong order intake and backlog of the past few quarters. According to market participants, the sector is likely to repeat its growth story in Q2 FY08 with sales growing at 25-35 per cent, and operating profit rising faster in most cases at 40 per cent.
However, net profits are likely to grow at a slower rate in most cases partly due to the rupee appreciation as companies like Crompton Greaves [Get Quote] have started focussing on exports due to robust demand scenario especially in the Middle East and Africa.
Though the robust outlook for the sector is maintained, analysts feel that the near term positives seem to factored in the prices and valuations look stretched.
Top picks: Larsen & Toubro, Crompton Greaves, Bhel, Thermax
Players are likely to witness muted growth in profits in Q2 FY08 though revenue growth will be high. Net sales are likely to grow at 10-20 per cent, thanks to higher growth in tariffs and robust growth in volumes.
However, growth in net profits will vary from player to player depending on the extent of the rise in fuel costs.
Power utilities are going to benefit from the incremental capacity addition of 78,000 MW in the Eleventh Plan. Moreover, the announcement of the Ultra Mega Power Projects (UMPPs) has accelerated the pace of reforms. Further, if the Indo-US nuclear deal goes through, it would open yet another huge opportunity for the players.
The Reliance Power IPO announcement has led to a re-rating of power stocks. Even at current levels, investments can be considered taking a long term view of four to five years.
Top Picks: NTPC, Reliance Energy [Get Quote]
The beleaguered Indian pharma sector is expected to continue to face pricing pressure in the US generics market even as the domestic market is likely to clock double digit growth. Thus top line growth will be muted for large generic players such as Ranbaxy [Get Quote], Dr Reddy's and Cipla. Overall profitability will be marred due to rupee appreciation and higher costs.
However, some broking firms are cautiously optimistic about the sector as they feel that the worst is over and the negatives of pricing pressure are already factored in the stock prices. Investors can look at the sector when the performance starts improving.
The baton of robust financial performance will be passed on to the steel companies driven by strong volume growth and supported by firm prices despite a rising rupee. On the other hand, non-ferrous metals players are likely to report a muted performance.
Prices of metals like zinc and aluminium declined quarter-on-quarter in response to rupee appreciation and decline in import duties from 7.5 per cent to 5 per cent. Though copper prices remained firm, TC/RC margins fell.
The steel sector is likely to continue its robust growth as factors like pricing power and consolidation will benefit the players. However, non-ferrous metals will continue to report muted growth as pricing pressure is likely to continue.
FMCG companies are expected to report strong volume growth across product categories. While traditional growth categories like soaps and detergents are likely to post single digit growth, premium and less penetrated categories like food products and personal care are expected to post strong double digit growth. However, margin improvement will depend on price hikes, spend on advertising, product category and raw material costs.
Companies like Glaxo Consumer and Godrej [Get Quote] Consumer are likely to show margin expansion. Input cost pressure will vary depending on the raw material used. Except milk and sugar, prices of other inputs like palm oil and soda ash are up over previous year while wheat prices are firm. Past acquisitions are also likely to boost results.
Companies focussed on enhancing the share of high growth categories and entering new product segments (ITC and Godrej Consumer) will see better growth. Moreover, the outlook for agricultural commodities and crude oil-based inputs continues to be bullish.
Top Picks: ITC, Nestle [Get Quote], Godrej Consumer
Q2 FY08 will be yet another milestone with skyrocketing growth in sales driven by strong growth in subscribers (33 per cent q-o-q and 50 per cent y-o-y) for the telecom sector. However, margin expansion will be restricted by declining ARPUs (average revenue per user) thanks to competition, attractive offers and a larger proportion of lower income users especially in the rural areas.
The scenario of robust topline growth due to continued rise in subscriber addition and flat margins on account of stronger penetration in rural areas is expected to continue.
Top picks: Bharti Airtel [Get Quote], Reliance Comm