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Rediff.com  » Business » A stock specific guide for cautious investors

A stock specific guide for cautious investors

By Priya Kansara
July 16, 2007 11:46 IST
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The first quarter of this fiscal has been one of the most challenging quarters for India Inc in recent times as it was fraught with problems like rising interest rates, appreciating rupee, cooling down of metal prices and threat of price controls on cement.

As a consequence, the Sensex earnings growth in excess of 30 per cent reported in the past few quarters is expected to moderate. Then, why is the Sensex taking great strides (it touched all-time level of 15,330 on Friday) when the earnings are slowing down and there are concerns about valuations getting stretched?

Says Amitabh Chakraborty, president-equity, Religare Securities, "We believe that interest rates have peaked and hence earning estimates that were based on higher interest rates need to be revised upwards." Accordingly, analysts are looking beyond the first quarter estimates and feel that Indian companies are likely to end the year with a robust earnings growth of 20 per cent.

Growth will primarily come from sectors such as telecom, banks, engineering and cement. While telecom is experiencing robust growth in the subscriber base, the macro environment for banks looks favourable. Similarly, engineering companies are riding on the capex cycle and attracting huge orders to sustain growth much beyond this year.

Cement companies, while attracting the wrath of the government, are profiting from the tight demand-supply situation. Thus as growth is likely to happen in select pockets, analysts suggest a stock specific strategy. Here is a synopsis of how the first quarter numbers are likely to be and more importantly, what is in store beyond this quarter. Also check out the best picks.

Information technology

Looking at the Infosys results, investors must have got a sense of how the results of other IT companies are going to be. The rupee's rise across major currencies in Q1FY08 (up 7 per cent, 5 per cent and 4 per cent against dollar, pound and euro respectively) took a toll on Infosys' financials.

The same can be expected of other technology companies as well. Revenues are expected to increase 1-3 per cent quarter-on-quarter, thanks to volume growth of 5-8 per cent and price improvement of nearly one per cent. Operating profit margins are likely to decline by at least 2-3 percentage points due to wage hikes, visa costs and rupee appreciation. Flat sales and declining operating margins will have an impact on the net profit margins as well.

However, investors have punished IT stocks enough. BSE IT index is down 9 per cent since January 2007 as compared to the Sensex gain of 9.8 per cent. The current valuations reflect the downward revision in the rupee earnings guidance given by Infosys and expected from other key players.

Analysts are now recommending front-line IT stocks due to their attractive valuations. Moreover, the business outlook still looks bullish with other levers of growth like volume and pricing remaining strong. Says Chakraborty, "With Sensex having touched fairly high levels, money will now start chasing beaten down sectors like auto, IT, pharma and FMCG."

Top picks

  • Infosys: Reasonable valuation and sustained growth prospects
  • TCS: Broad based revenue growth and strong margin levers

Automobiles and auto components

Auto has been another beaten down sector after IT, and is down 11 per cent since January 2007. The reason for the huge underperformance is well known. Interest rate hikes and pricing pressures have impacted demand for autos, mainly two-wheelers where volumes were down 7.6 per cent in the April-June 2007 quarter.

While heavy commercial vehicle volumes were up marginally (0.06 per cent), there was reasonable growth in other segments like passenger cars (12.8 per cent), utility vehicles (12.4 per cent), and light commercial vehicles (15.2 per cent).

As a result, revenue growth of the auto sector comprising two, three and four-wheeler major is likely to be muted at around 7 per cent but profits are likely to decline by 7 per cent due to competitive pressures and rising input costs especially for two wheeler majors.

However analysts feel that the worst is over for the auto sector as interest rates have peaked. But it may take some time to have a positive impact on the sales volumes.

Top picks

  • Maruti: Better product mix, strong growth despite tough quarter
  • M&M: Diversified product portfolio and value in subsidiaries

On the other hand, auto component companies are likely to do well due to exports especially to non-US markets like Europe. Moreover, acquisitions done in the past by companies like Bharat Forge, Amtek Auto and Apollo Tyres are likely to start contributing results. While revenues are expected to grow over 10 per cent, profits are expected to grow at 20 per cent.

Top picks

  • Bharat Forge: Strong profit growth due to forex gains offsetting currency losses on exports
  • Amtek Auto: Integration with subsidiaries to expand margins
  • Apollo Tyres: Strong volume and profit growth thanks to stable natural rubber prices

Telecom

Telecom companies are going to be the biggest earnings drivers for the Sensex. Robust subscription growth (about 6.1 million per month) will take care of the slow growth or marginal decline in average revenue per user. Margins may remain flat or expand a bit because of economies of scale and operating leverage.

The subscriber growth has grown over 4 per cent q-o-q in the June 2007 quarter, and low-cost entry level phones have expanded the market. Rajat Ragharia, head of research, Motilal Oswal expects telecom companies to double their profits in the first quarter. Going forward, volume growth will continue as and when companies penetrate in the rural areas.

Top picks

  • Bharti Airtel, Reliance Communication, Idea, VSNL: Robust growth in subscription and substantial profit growth

Banks

Banks are expected to be the second best performers after telecom. Strong macro environment is enabling higher advances and stable yields on investment portfolio and firm net interest margins.

The key thing to look at is the non-performing assets, as a fallout of interest rate hikes undertaken by banks. Private banks might see some pressure on margins due to their aggressive deposit raising exercise and higher provisioning on consumer loans.

On the other hand, public sector banks might fare better on this count. ASK Securities expects margins of public sector banks to ease off in this quarter due to PLR hikes of 50-75 bps in February 2007 and 50-75 bps in April 2007. However, they lag behind their private counterparts in non-interest income growth.

Banking stocks had a significant run-up on the bourses in the last quarter, which reflects the turnaround in sentiment in these stocks. Moreover, investors have paid little attention to the recent big bang capital raising plans of banks and the resultant dilution in equity as over the long term it will benefit in terms of higher business.

Also the outlook is positive as interest rate are expected to remain stable with inflation going down. Any dip in stock prices can be considered as good buying opportunities, say analysts.

Top picks

  • Private banks: HDFC Bank, ICICI Bank, UTI Bank: Robust growth in interest and non-interest income
  • Public sector banks: SBI (capital raising plans), Bank of India (consistency in performance even in challenging environment)

Engineering and power equipment

Capital goods has been the best performing sector till date in year 2007 with the BSE Capital Goods index gaining 42 per cent. And the reason is obvious. Robust economic activity and huge capex plans is leading to huge order inflows. After a stupendous rise however valuations of many stocks look stretched.

But analyst cannot resist the robust pace of growth in companies like L&T, BHEL, ABB, Siemens and Crompton Greaves. As a result, these stocks still remain the best buys. Says Sandeep Nanda, head of research, Sharekhan, "Being one of the principal sectors, liquidity will continue to flow in the sector."

In Q1FY08, analysts expect a top line and bottom line growth of at least 30 per cent and 40 per cent respectively, followed by a double-digit growth in order backlog.

Top picks

  • BHEL: High earnings visibility (current 3.1x FY07 order book to sales)
  • L&T: Focus on margin expansion, efficiency and better priced orders
  • Suzlon: Sharp rise in overseas sales, consolidation of Hansen

Oil and gas

Crude oil price rose by 18.6 per cent during the quarter to $68.6 and the Indian basket of crude oil increased by 17.6 per cent to $66.8. However, the rising rupee mitigated the impact of higher crude oil prices to some extent. Though ONGC is expected to gain due to higher crude oil prices, it will suffer due to the heavy subsidy burden and rupee appreciation.

Pure refining companies like Chennai Petroleum are likely to gain from volume growth as well as stronger refining margins though it might be offset partially by a stronger rupee. Refining margins bounced back significantly, to $9 a barrel during the quarter (compared to US$6.8 a barrel in the March quarter).

Oil marketing companies are likely to report losses due to under-recoveries pending clarity on oil bonds. Till date there has been no official announcement on the same. Moreover gas transmission and distribution companies are likely to fare well due to bounce back in volumes thanks to gas availability.

Top picks

  • RIL: Rise in margins especially refining; higher crude throughput; new exploration success.
  • GAIL: Growth in LPG and petrochemical business.
  • Aban Offshore: Increase in fleet size and higher day rates on rigs.

Cement

The performance of the cement sector is expected to be robust. Revenues are expected to grow at a strong 20-30 per cent thanks to higher volumes growth (10-20 per cent) and increase in realisations (10-15 per cent). Operating margins are expected to improve by over 100 basis points.

Southern players like India Cements are likely to perform better as cement prices have risen by Rs 3-5 per bag in the South compared with Rs 2-3 per bag in other regions. Going forward, analysts do not foresee any substantial rise in cement prices.

The cement sector has underperformed the Sensex due to price curbs and concerns of oversupply in FY09. Most cement stocks especially in the mid-cap space are quoting at single multiples and EV per tonne of $40-60.

However Nanda of Sharekhan thinks differently: "Cement stocks look attractive though there will be one year of pain due to supply glut in the next financial year." But looking at India's requirements for augmenting infrastructure and ongoing developments in commercial and residential complexes, cement demand would be robust, he adds.

Top picks

  • ACC: Will better industry growth rates.
  • Madras Cements, India Cements: Beneficiary of the price rise in South
  • Grasim: Diversified business, strong growth in cement and VSF business

Pharma

The performance of pharma companies is likely to be a mixed bag. Since most of the companies have significant exposure to the US and Europe, there could be some currency impact. Sales and profits are expected to grow in the range of 20-30 per cent.

Overall, the outlook for the sector is slightly cautious as most of them are in the generics market where pricing pressure still continues, though the domestic formulations market continues to be strong. However, nobody seems to be interested in the pharma sector story despite its defensive nature as market participants prefer to be more focused on individual companies.

Top picks

Divi's Labs: Increasing traction in contract research and API growth

Metals

Steel companies are expected to fare better than non-ferrous metal players like aluminium. Aluminium price cuts due to weaker international prices as well as stronger rupee, will impact realisations for Nalco and Hindalco.

International aluminium prices have been down by around 1 per cent in Q1FY08 compared to the March 2007 quarter. On the other hand, steel prices have risen 9.7 per cent.

Moreover, appreciating rupee will have an impact on the realisations across the board. As a result, profit growth could be in the range of 5-10 per cent except JSW Steel and SAIL on good growth in top line. Investors need to be cautious going ahead about metal prices in general.

Top picks

  • Tata Steel: Financials of Corus to be included in this quarter (profit of Rs 900 crore).
  • JSW Steel and SAIL: High volume growth of over 20 per cent due to increased capacity utilisation on expanded capacities during FY08.

FMCG

The performance of FMCG companies is not going to be extraordinary. Net sales and operating profits are likely to grow between 10-15 per cent each.

While some analysts think that one could see pressure on margins for players like Hindustan Unilever and Nestle due to rise in input costs (palm oil and milk prices), others debate that margins will be maintained due to price hikes.

Top picks

  • Hindustan Unilever: Personal care products to resume growth.
  • ITC: Less dependence on cigarette volumes-a positive
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Priya Kansara
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