The year 2008 has been one of the worst years in the history of Indian stock markets. The BSE Sensex has fallen 56 per cent and individual stock by as much as 75 per cent from their peak levels in January. Globally, many countries are in a recession and domestic growth rates, too, have plummeted.
India's industrial production has decelerated significantly due to slackening demand, and many companies are cutting production, laying-off employees and postponing capacity expansions. The once robustly growing IT services sector, too, is faced with a gloomy outlook as its major customers are in recession. Export-oriented sectors like textiles, gems and jewellery, leather and apparels are also facing the heat on this count.
While the impact of these developments on financials of companies will only get clearer over the next six months, analysts have already started reducing earnings estimates. For FY10, earnings estimates for the 30 Sensex companies is projected between (-) 10 per cent and 12 per cent. In short, the year 2009 is starting with lots of uncertainties. In this scenario,The Smart Investor spoke to experts to gauge the undertone and what they anticipate in 2009, investment strategies to follow and sectors that will do well.
The silver lining is that most of the bad news is already factored in. Says Abhay Aima, head, Equities and Private Banking, HDFC Bank, "The gloom-and-doom scenario is overhyped as risks are built into valuations with the exception of political risk."
"Indian markets could trade up to 12 times FY10 estimated earnings. The band of 8,000-11,500 should continue till June 2009, by when the markets would bottom out. As such, there is no substantial downside from this range," says Aneesh Srivastava, CIO, IDBI Fortis Life Insurance Company.
Most experts believe that an improvement in economic and corporate numbers will start from mid-2009, led by the various policy measures undertaken.
What will click
In the aftermath of economic slowdown and fall in markets, and also uncertainty over the next few quarters, it is advisable to play safe and stick to large companies with a consistent track-record. Additionally, says Sandeep Shenoy, strategist, Pinc Research, "Companies with integrated operations, strong balance sheets, low leverage or ability to complete financial closure for capex, and low working capital requirements are preferred."
Beyond that, interest rate sensitive sectors are finding favour. Says Srivastava, "We are favourably inclined towards rate-sensitive sectors like banking, auto or even in real-estate on a selective basis. But, as the market is expected to be range bound, a trading strategy could prove helpful."
Defensive plays like FMCG and utilities, too, figure among the preferred lot even as there is already some amount of premium built in their valuations, due to the stability they provide. Additionally, users of commodities are expected to outperform. Says Manish Sonthalia, senior VP Research & Strategy, Motilal Oswal Securities, "Now, the consumption side, like auto (two wheelers) will get more importance. Among other preferred sectors are FMCG and telecom." Commodity user industries like construction, which may get a fillip on account of increased infrastructure spending, also figure in the list, although there are some issues pertaining to funding of projects.
The laggards in 2009 will be commodities (metals), capital goods (due to order slowdown), real estate and IT (weak demand).
With respect to return expectations from the market (Sensex), it ranges 10-12 per cent on the conservative side to as much as 35 per cent, by December 2009.
Regarding investment worthy companies, The Smart Investor looked at the BSE 500 (94 per cent of total market capitalisation) and excluded companies with high debt levels or weak financials. Only those with a proven track record, good earnings visibility, strong cash flows and ability to raise debt were considered, as they will be in a better position to withstand tough times. Notably, many of them are leaders in their respective businesses, and their stocks capable of delivering 18-20 per cent returns over the next one year.
Apollo Hospitals
Apollo Hospitals has been growing its sales at an annual rate of 21 per cent in the last five years. The company has leveraged its core healthcare services business to launch pharmacies, and testing centres, and is now looking at manufacturing its own drugs and offering clinical trials. A focus area will be the growing medical tourism market (current market size of Rs 2,000 crore, and expected CAGR of 55 per cent till 2012). For Apollo, while foreign patients account for 17 per cent of the total patient volumes and roughly a third of revenues, the company expects this to improve to 25 per cent and 40 per cent, respectively.
The pharmacy segment, which accounts for a fifth of the revenues, is expected to grow at a much faster pace as the company ramps up the number of centres to 1,000 in FY09 from 750 currently. While operating margins are hovering around 17 per cent, numbers will improve going ahead, when the pharmacy segment (yet to make a profit at the EBIDTA level) turns corner and the company's asset light strategy (manage hospitals rather than build) comes into play.
With strong demand for quality medical services, Apollo, a leader with a network of 43 hospitals (10,000 beds) will be able to grow its current revenues of Rs 1,123 crore by about 30 per cent over the next two years. At Rs 429, the stock trades at a reasonable EV/Ebidta of around 11. Expect returns of about 18-20 per cent over the next one year.
Bharti Airtel
While Bharti is not growing as fast as an Idea or a Vodafone, which have rolled out their services in new circles, the market leader with a share of 25 per cent, continues to add about 2.7 million subscribers every month. Although revenue growth for Bharti is a given, the problem is the declining margins (mainly in the wireless business on account of falling average revenue per user and per minute numbers; Rs 350 and 67 paise, respectively).
With 77 per cent of the population covered, expect these figures to stabilise or dip slightly from these levels offset by the upward movement (based on expansion of subscriber base) in broadband/internet services where the average ARPUs are around Rs 1,250.
Although there are investments to be made in the 3G license fees (reserve price at Rs 2,020 crore for an all India license) and the company has net debt of about $402 million (Rs 2,010 crore), strong cash flows (Rs 3,365 crore cash profit for Q2, FY09) will enable Bharti rollout its 3G network without having to stretch itself.
At Rs 686, the stock is trading at 12.25 times its estimated FY10 EPS and should offer about 22 per cent return over a one year period. For aggressive investors, Reliance Communications could be considered. The stock is trading at Rs 205 (FY10 P/E 8.9). Lower valuations are largely due to concerns on large scale investments on GSM infrastructure and additional funds needed for 3G rollout.
HDFC
Growing urbanisation, rising disposable incomes and favourable demographics would ensure that demand for housing continues to remain robust. Housing Development Corporation of India (HDFC), is a market leader in the housing mortgage space. Retail mortgage accounts for around two-thirds of its total loan book.
In the retail segment, more than 90 per cent of the individual borrowers are in the salaried class, where default rate is nominal. Strict monitoring and lower loan-to- value allowed to borrowers, has enabled HDFC to its assets quality. Says Keki Mistry, VC and MD, HDFC, "We have always focused on loan quality and not market share, ensuring that the loan appraisal systems and loan recovery processes are aligned to achieve this objective."
The company's gross income and net profit have grown at a CAGR of 27 per cent in the last five years, which reflects a consistent track record. The recent RBI initiatives of hiking the priority sector lending limit to Rs 20 lakh for housing loans should further ease liquidity. Reduction of risk weights on loans and advances to commercial real estate, along with cut in CRR and repo rate would lead to lower cost of funds.
Leveraging the distribution network of its subsidiary, HDFC Bank, to source loans in Tier 2 and 3 cities would ensure greater business from these regions. Among other subsidiaries are HDFC Standard Life and HDFC Mutual Fund, which also have huge growth potential. Together, they are valued at Rs 700 per share of HDFC. Currently, the stock trades at 2.7 times its FY10 price-to-book value (standalone). Overall, HDFC's track record of sustaining earnings in all the business cycles and an underpenetrated mortgage market, would ensure healthy returns for many years to come.
Hero Honda
The country's largest two wheeler maker has not been as badly hit by the slowdown as its peers. Its year-to-date sales volume growth at 13 per cent is twice the two wheeler sector growth helping the company increase its market share in motorcycles (62 per cent) and scooters (14 per cent). The company has been able to perform better than its peers (Bajaj Auto, TVS Motors) by focussing on the high growth rural markets, which now constitutes 55 per cent of its sales. Secondly, 90 per cent of its overall sales are cash purchases, while both its peers are dependent on vehicle finance.
Going ahead, growth in the second half, is expected to be muted as the slowdown drags down purchase activity. Operating margins, now at around 13 per cent, might move up due to reduction in raw material cost and excise duty cut. Once volumes move up, the doubling of capacity at its Uttaranchal plant to 1.2 million units and increase in sub-contracting to 60 per cent levels in the current fiscal would help.
While its focus continues to be the 100 cc segment and the company aiming for six new launches over the next one year, expect volume growth to trend down to about 10 per cent in FY10. At Rs 813, the stock can deliver 15-18 per cent returns over the next 12 months.
Despite the current trend of falling sales, lower demand and lack of credit financing (up to 70 per cent of sales), another stock in the auto space that can be looked at is Maruti Suzuki; trading at an attractive 8.7 times FY10 EPS estimates.
ITC
With three out of four cigarettes consumed in India coming from its stable, ITC is a clear leader in the business. Together with paper, agri commodities and hotels, these businesses generate annual cash flow of Rs 3,600 crore. The last two years though have cigarette volumes remain under pressure (down 2-3 per cent in H1, FY09) thanks to adverse changes in duty rates (excise duty raised, VAT imposed in FY08, duty on non-filter cigarettes introduced). Even then, ITC has managed to grow its sales and profits in this business, led by cost cutting measures, upgrading customers to filter-cigarettes and price hikes.
On the other hand, ITC has been deploying its cash flows towards promising businesses like non-cigarette FMCG (processed foods, personal care, etc). Even as they are in nascent stages and continue to report losses, ITC's consolidated profits have steadily risen (except in H1, FY09, when they were flat due to a 35 per cent rise in other expenditure to Rs 1,612 crore). These losses are expected to decline in the coming quarters, as most of the product launch expenses (reflected in other expenditure) are through.
Importantly, cigarette volumes are seen rising by 2-5 per cent in FY10 and rub off positively on ITC's profitability; sufficient to offset the recent pressure in the hotel business (9 per cent of profits). The paper business (11 per cent share in profits) is also expected to do well, due to easing of raw material prices and expanded capacities. Overall, with improving prospects in the FMCG business (cigarette and others; accounts for 76 per cent of profits), expect ITC to deliver healthy earnings, and the stock to return 18-20 per cent.
IVRCL Infrastructures
In the infrastructure and construction space, IVRCL Infrastructures & Projects is better placed given its low leverage. According to analysts, the company will require a minimal Rs 270 crore as funding gap for its pending projects. The company's debt-equity position is also comfortable, allowing it space to raise funds and continue with its growth plans. IVRCL recently raised Rs 200 crore (Rs 2 billion) by issuing debentures (interest rate of 12.5 per cent) to Life Insurance Corp of India.
IVRCL's order book of Rs 15,000 crore (Rs 150 billion) is four times its FY08 revenue, and provides strong earnings visibility. Estimates suggest that its revenue should grow at 33-35 per cent and earnings by 25-27 per cent over the next three years. Besides, the company will benefit from the government's emphasis on infrastructure, related to irrigation and water management. IVRCL is a leading player in water and irrigation (about 69 per cent) segments and importantly, most of its projects come from the government sector.
Going forward, lower commodity prices and interest rates along with improving liquidity suggest that the business environment should improve for the sector. At Rs 143, the stock is reasonably priced on a PE basis. Even on a sum-of-parts basis (assigning different values to its core business, real estate subsidiaries, BOT projects and stake in Hindustan Dorr Oliver), IVRCL's per share value, as estimated by analysts, works out to Rs 200-250.
RIL
Reliance Industries (RIL), India's largest private sector company, is an integrated player in the oil and gas sector, with interests in Exploration & Production (E&P), refining, marketing and petrochemicals. In the recent past, RIL's gross refining margin (GRM), although superior to Singapore benchmark GRM, have been under pressure due to the global slowdown.
While the benchmark GRM is expected to see some recovery, the start of refining operations of its 70.4 per cent subsidiary, Reliance Petroleum (RPET) will help offset the decline in margins. RPET has a capacity to refine 0.58 million barrels of oil per day (BOPD), and would take RIL's consolidated capacity to 1.24 million BOPD in the refining business, which accounted for 56 per cent of profits.
The start of gas production from RIL's KG-D6 block, which is estimated to reach peak production levels of 80 mmscmd in the next 6-8 quarters, will also significantly contribute to the consolidated financials of RIL. Although, EBIT contribution from E&P is at around 12 per cent as of Q2 FY09, analysts expect this figure would reach up to 50-60 per cent by FY11E. In the near-term though, there are issues like those pertaining to the pricing of gas, which would weigh on stock valuations, until they get resolved.
The fortunes of the petrochemical business (33 per cent of profits) have been subdued in the last few quarters. Here, analysts expect the polymer cycle to bottom out by June 2009. Overall, with expanded capacities and production from new oil and gas blocks, expect RIL's profits to rise in the next two years. The stock can deliver 20-22 per cent in one year.
SBI
State Bank of India (SBI) is often compared to an elephant for its size. Although earlier, it has lost some share to private banks, its aggressive stance now, to shore up its business when most of its peers are cautious is noteworthy, is helping SBI enhance its market share. SBI's market share in terms of business volumes has been on an ascendency (around 16 per cent in deposits and advances) from its lows in 2007. Well-diversified loan portfolio, strict monitoring and risk management measures, would help it to tide over the current economic slowdown.
SBI's presence in rural and sub-urban regions is a distinct advantage over its private peers. A large branch network and improving distribution network would sustain greater volumes from rural areas. Greater propensity to mobilise low-cost deposits and technology-driven connectivity would ensure profitability, besides volumes from these regions.
State Bank of Saurashtra's amalgamation with the parent could pave for another round of consolidation with its associates. Together, the SBI group in terms of scalability and size has a large 15,000-branch network and balance-sheet strength of over Rs 10 lakh crore, which would help tug competition, when the banking sector is eventually opened to foreign competition.
SBI also has interests in financial services businesses like life insurance, asset management through its subsidiaries. Conservatively, analysts put the value of these businesses at Rs 220 per share. SBI is trading at an estimated P/BV of 1.3 times its FY10 standalone book value, and can deliver 20-25 per cent in the next one year.
Sun Pharmaceutical
A presence in lifestyle and chronic therapy categories such as diabetes and neuro-psychiatry ensures higher growth and twice the margins for Sun Pharmaceutical vis-à-vis peers. The company has a consistent growth track record with sales growing annually by 36 per cent over the last four years and net profits by 47 per cent during the same period. While the domestic formulation sector is growing at 11 per cent, Sun Pharma has managed to grow its domestic business by 19 per cent for H1, 2009.
In the international segment, expect the US (40 per cent of sales) business to grow at about 25 per cent for the current fiscal. While the company is awaiting approval on the 96 ANDAs it has filed with the US FDA and plans to file 30 more, FY10 might see a slight correction as generic sales move down due to the recessionary trends in the Top 8 global markets.
While uncertainties on Taro acquisition and FDA queries on its Caraco plant are negatives for the stock, expect these to be resolved in the next one quarter. The comfortable cash position at $500 million (Rs 2,500 crore) ensures that Sun Pharma can tide over the tight liquidity conditions prevailing currently and also look out for acquisitions at attractive valuations. At Rs 1,057, the stock can deliver returns of about 25 per cent over the next one year.
Tata Power
Tata Power scores high on the yard sticks of business model and execution capability and offers both, growth and value. The company is expanding its power generation capacity from 2,474 mw, to about 12,861 mw by FY 2013, translating into a CAGR of 40 per cent. Though this provides good visibility, there could be challenges in terms of funding these plans, given that its parent company recently decided against conversion of warrants (worth Rs 1,340 crore) allotted to it.
Tata Power currently has about 5,660 mw (including the 4000 mw Mundra UMPP) of power projects under execution. According to estimates, the company would need to infuse equity in the range of Rs 3,500-4,000 crore (Rs 35-40 billion) during FY10-11, including for its Mundra project. Barring this, which could be an issue in the short-term, the company is trading at attractive valuations of 1.3 times FY10 estimated book value.
Analysts have put a price target of Rs 850 per share based on the sum-of-parts, including the value of different investments like Tata Communication, Tata Tele (Maharashtra), Tata Tele and Indonesian coal mines. "On standalone basis, the valuations might not look attractive, but if we exclude the value of its stake in the Indonesian coal mines at about Rs 300-350 per share, the stock becomes more attractive," says Mohit Kansal, analyst, KR Choksey Shares and Securities.
Within the power space, which is relatively a safe haven providing stable growth, investors looking for high safety, could also look at the India's largest power utility, NTPC. The company's execution capability, strong cash flows, low leveraging and huge expansion plans, make it safer bet. However, the stock trades at a premium valuation of about 2.3 times FY10 estimated book value.
