Five Best Promising Sectors

After a fantastic run-up in 2009, the stock market seems to be facing a lull in 2010. In fact, the first six months saw the market going nowhere. On a year-to-date basis the Sensex is actually down by around 3 per cent and is seen reacting to global events. This is creating jitters among investors who seem to be questioning the logic of parking any more funds in the markets. In our opinion, the problem lies with the fact that investors are watching the Sensex performance more than the performance of their own portfolios. Though the Sensex hasn’t gone anywhere, the fact remains that there are still good bargains available to pick and choose and with earnings’ expectations increasing these bargains would soon catch up with the valuations. We at DSIJ have had a similar experience with most of our scrips recommended this year having indeed yielded good returns despite the Sensex remaining stagnant.

Please note, barring global events that are currently taking a toll on the stock market, the domestic factors seem well in place. Thus, may it be the GDP growth, which is 7.4 per cent for FY10 and estimated at 8.5 per cent for FY11, or India Inc ending the last fiscal on a high note with yet a better performance expected this fiscal or may it be the latest Index of Industrial Production (IIP) numbers at 17.6 per cent (close to its 20-year high of 17.7 per cent) – these are all clear indications that the domestic story is intact and it is only about time that the markets will give pay their dues. Hence, investors should focus on hunting for value than anything else.

And though this is easier said than done, we at DSIJ have taken up the task to analyse and hunt down five sectors which we strongly believe will do well in FY11. The final list includes pharmaceuticals, IT, textiles, infrastructure and logistics. However, this wasn’t an easy assignment to accomplish as we had to let go of some worthy contenders who could not make it to the list. These include oil & gas, auto, auto ancillary, cement, metals and paper.

As for the selected ones, they certainly look quite promising. For example, in the pharmaceutical sector, with most of the drugs expected to go off-patent by FY15, it will create a whopping opportunity of USD 240 billion and innovative drug makers continuing to outsource is bound to benefit the Indian companies. Considering the fact that planned expenditure on infrastructure is expected to increase to around 8 per cent of GDP from 5.1 per cent and with increasing execution capabilities of private players makes this space a very attractive one.[PAGE BREAK]

Our readers’ expectations always keep increasing and we at DSIJ see to it that we match them. But this time we are happy that we have not only matched such expectations but have also surpassed them by quite a mile. We recommended ten stocks from the short-listed sectors last year and they have yielded average returns of 30.59 per cent. This achieves higher significance for two reasons. First, the Sensex has provided appreciation of just 19.07 per cent during the same period. And second, this performance has come despite having a majority of the Sensex stock in the list – up to 60 per cent. Thus, we have actually ended up selecting the right Sensex stocks with those that have posted good returns. The only disappointment has been in the form of Power Grid Corporation, which is down by 18.57 per cent and HCC at 0.56 per cent. But one can continue to hold them, while contemplating booking profits in Ranbaxy, Cipla, Bosch, Hero Honda and SBI.

The economic bounce-back will also help the logistics sector, which as a thumb rule grows by 1.2x GDP growth. Besides, if we are talking about revival, then the textile industry and the IT domain cannot be ignored. Textile has seen the worst and FY10 results are an indication that there is only going to be an upside from here on. IT has been slow to catch up. However, with clients steadily coming forward for their IT demands, we may not only see volume growth, but increased price realisations as well.

Infrastructure - On Strong Foundations

With the Indian economy moving on to a high growth trajectory facilitated by a consistent and steady increase of 8-9 per cent in recent years, there is a critical need to accelerate investments in the infrastructure sector. Inadequate and inefficient infrastructure not only adds to transaction costs but also prevents the economies from realising their full growth potential. Further, estimates show that Re 1 invested in infrastructure projects translates into seven times the revenue generation. As a result, infrastructure has emerged as a key driver for sustaining the robust growth of the economy and the government has been focusing on its development.

Several projects such as power for all by 2012, construction of at least 20 kilometres of road every day, airports, oil & gas and ports are an indication of the government’s serious efforts on the infrastructure front. Further, this is also visible from the fact that the planned expenditure for the XIth Plan (FY08-12) has been more than double at USD 514 billion as compared to the Xth Plan (FY02-07). The best part is that the investments in the first two years of the XIth Plan have been more than the estimates by 12.4 per cent and 11.70 per cent respectively. What is further encouraging is that this is being driven by higher contribution from the private sector. Based on this, private participation in the XIth Plan is expected to touch the 36 per cent level as compared to earlier estimates of 30 per cent.

However, although there has been progress in attracting private investments into infrastructure, it has hovered at only around 5.10 per cent of GDP. The XIth Five Year Plan (2007-2012) has envisaged raising the level of investment in infrastructure to 7.6 per cent of GDP, thereby matching the levels obtaining in some of the Asian economies. Not only this, the initial investments for the XIIth Plan (FY13-17) are estimated at USD 1,025 billion which is around 2x of the XIth Plan and 4.40x of the Xth Plan. This actually translates into 9.95 per cent of GDP. Further, private participation in the XIIth Plan is estimated at 50 per cent.

With so many opportunities lined up, the order books of the companies have also swelled. The order inflow for E&C companies grew by 46 per cent in 4QFY10 and this will also drive revenue growth in FY11. Just to quantify, the order book of IVRCL Infra is at Rs 17,500 crore, L&T at Rs 90,000 crore and BHEL at Rs 1,34,000 crore. This a clear signal of where the infrastructure sector is headed toward. The XIth Plan will create a further opportunity of USD 300 billion. So the improved margins will help the companies perform better. Meanwhile, as we dwell upon the possibility of growth in the infrastructure sector, there is one major issue to be taken into consideration and that is of long-term financing. In our opinion, the issue will be addressed as the government has taken steps like higher viability gap funding for the central as well as state government projects, incorporation of IIFCL, appointment of a standing committee on infrastructure finance and tax benefits of up to Rs 20,000 for investment in long-term infrastructure bonds etc. Further, the proposal to set up a fund to raise Rs 50,000 crore to refinance the debt of large infrastructure projects is also a good idea.[PAGE BREAK]

If we are looking for promising sectors for the year 2010, the list would be incomplete without the inclusion of the IT sector. Though many might still be a bit skeptical about the sector, we feel otherwise. First and foremost, investors ought to understand that the scenario has completely changed from what it was during 2008 and one has also to accept that it has also brought the best out of the Indian IT companies with them not only managing their costs well but also being successful in improving efficiencies. During 2008 the sector faced various challenges such as pricing and volume pressures, global economies sliding into recession, the BFSI segment getting impacted due to the sub-prime crisis and the sharp appreciation of the rupee.

However, these concerns are already seen fading away with new opportunities springing up. Now, economies globally are expected to perform better. The US economy will hopefully grow at around 3.2 per cent while the UK and the rest of Europe are expected to grow at 1.2 per cent and 1.1 per cent respectively. It’s a known fact that the US accounts for 60 per cent of the total business of IT companies and with it leading the recovery process, this entails good growth prospects in the coming period.

Besides, the worst hit BFSI segment has bounced back quite strongly in the second half of 2009, indicating the eagerness of financial service companies to spend on IT requirements. This augurs well for the Indian IT industry as BFSI is a major segment and accounts for 41 per cent of the total IT export revenues.

That apart, with volume growth taking place, price realisations are also expected to improve with demand for IT services improving steadily. Hiring is back too and biggies such as Infosys and TCS have already planned an intake of 30,000 each in FY11. The very fact that the IT companies are hiring aggressively despite the increased utilisation levels is a clear indication that they expect better business ahead.

That apart, Indian IT companies are also seen hiring locals overseas. Infosys, TCS, Wipro are already hiring local candidates even for top level positions. This, we believe, is a good strategic move, enabling Indian IT companies to garner more business in sensitive sectors such as government, defence, aviation, etc. using an experience well-networked local citizen than an Indian one.

All these will only help create better growth opportunities for Indian IT companies, thereby pushing the growth curve higher in the coming quarters.[PAGE BREAK]

The Indian pharmaceutical sector, we believe, has the potential to feature among the top ten of the world pharmaceutical markets in terms of value. At present, India’s pharmaceutical industry is the third largest in the world in terms of volume and 14th in terms of value. Going forward, we believe that the there is a golden path laid ahead for the Indian pharmaceutical industry which is likely to ride high on the patent expiry of the large patented drugs which has begun in FY10 and is likely to carry on till FY15. The total amount of drugs that is going off-patent in these five years, i.e. FY10-FY15 is estimated to be around USD 240 billion.

An average of USD 48 billion of drugs is estimated to be going off-patent per year in the span of the next five years ending FY15. According to McKinsey & Company, of the top 20 pharmaceutical companies, the average patent expiry is likely to fall by 58 per cent from USD 48 billion to USD 16.5 billion per annum in the period 2016-2020. We expect 2010-2015 to be an ideal period for the Indian generic companies to gain from patent expiry. Sailesh Raj Bhan, Sr. Fund Manager with Reliance Mutual Fund, feels that “India is well-positioned to capture the patent expiry wave that is going to happen in the developed and regulated markets in the span of the next three to four years.”

The US president’s new healthcare reform programme aims to provide coverage for the nation’s 32 million uninsured, to improve the quality of care, and constrain the growth of healthcare spending. The US government plans to spend USD 940 billion over the next ten years for making the system more efficient and cost-effective. With respect to the Indian pharmaceutical industry, the new programme will expand the market by extending access to the presently uninsured. Additionally, the plan will seek to achieve savings by focusing on cost-effective therapies determined through new comparative analytical tools. In general, this approach should lead to greater utilisation of generic drugs instead of more expensive formulation medicines.

The increasing number of drugs going off-patent in the next few years  is likely to bring in more opportunities for the Contract Research and Manufacturing Services (CRAMS) companies. The top innovator drug companies are looking forward to India to outsource their research and development (R&D) activities based on the reasons of cost-competitiveness and the Indian companies’ superior knowledge in chemistry. The CRAMS players in India have been enjoying a good relationship with top innovator companies and have been time-tested by them. Most of the CRAMS players are vertically integrated and are well-placed to serve them with superior knowledge-based programmes.

In the past we have seen promoters such as Ranbaxy Laboratories selling off its entire operations to Daiichi Sankyo and in the recent past Piramal Healthcare has followed suit by selling its healthcare solutions business to Abbott. It would thus be left with its CRAMS, critical care, API and the OTC business. These two deals can be an eye-opener for all as more consolidation cannot be ruled out in this space. In our opinion, both Indian drug makers and CRAMS players are likely to benefit in the long run and the pharma sector has the potential to be one of the best emerging sectors in terms of both domestic and export markets. We feel that stocks like those of Dr Reddy’s Laboratories and Jubilant Organosys will add value to your portfolios in the coming months.[PAGE BREAK]

Logistics, which in a narrower sense means movement of goods right from the procurement of raw material to the reaching of finished goods to the ultimate customer, derives its growth from “growth in underlying businesses” says S.Suryanarayan, GCFO, Allcargo Global Logistics Therefore, the logistics sector’s performance directly depends upon the GDP growth rate. And if the recent numbers are taken as a pointer of sorts, we feel that the logistics sector will be firing on all cylinders going forward. For the quarter ending March 2010, the GDP growth rate has reached to a pre-crisis level and is within striking distance of 9 per cent. It increased by 8.6 per cent for the quarter ending March 2010 and 7.4 per cent for the entire year.

It is believed that the logistics industry grows about one to one-and-a-half times of the GDP growth and therefore is expected to grow at rate of 10-14 per cent in the coming period. In terms of actual numbers, the logistics industry is currently of around USD 105 billion and may reach USD 125 billion by the next year. Another factor that is helping the logistics’ companies in India to move into the higher orbit of growth is the shifting of the manufacturing base to India.

India produces one of the largest number of engineers and has one of the largest English-speaking populations for easier transition of the base. It is not only the automotive industry that is fuelling this growth but “the auto, pharma, hi-tech and retail sectors is fueling strong growth for logistics service providers” claims Vineet Agarwal, ED, TCI. Interestingly, all this is despite the high cost of logistics in India. Compared to other countries, the cost of logistics in India is at a premium. For example, in the US logistics costs 8 per cent of the GDP while in India it is 13 per cent of its GDP. However, this is likely to come down with the growing involvement of 3PL (third party logistics).

This means that one company acts as an agent to look after the logistics aspect of another company. There is also 4PL (fourth party logistics) under the terms of which the logistics of a company are controlled by a service provider that does not own assets to carry out logistics activities but out-sources to sub contractors like 3PL. Also, the huge spending lined up in the infrastructure sector will usher in the much required efficiency in the sector. This sector will get a further boost by the introduction of FTWZ (free trade warehousing zones) that will function more like SEZs and will act as ‘international trading hubs’ to help service supply chains both domestically and globally.  Moreover, the complex Indian tax system that acts as a hindrance factor for warehousing will be done away with the likely introduction of GST from the next fiscal. All this certainly bodes well for those in the logistics space.[PAGE BREAK]

The textile sector, which has the distinction of being the largest employer after agriculture, is also one of the few industries to have recovered early from the economic meltdown of 2008. Textile exports that witnessed signs of buoyancy since June 2009 have started increasing on a yearly basis since November that year. It increased by 16 per cent in November and by 24.8 per cent for the month of February 2010. We feel that exports will continue to maintain its momentum despite the sovereign debt crisis in Europe.

The US and the EU27 together constitute approximately 60 per cent of India’s textile exports.  And in the recent month both areas have witnessed their retail sales growing, albeit marginally. Since December, the volume of textiles, clothing and footwear in EU27 has increased consistently on a yearly basis and clocked 6.6 per cent for the month of March, whereas in the US retail market sales have increased by 0.4 per cent in March – an increase for the seventh month consecutively. Therefore, the situation is not as grave as it seems. To further diversify its market, the government launched a ‘Look East Policy’ last fiscal to tap markets like Japan, South Asia, Australia, etc.

Apart from extending their geographical reach, Indian textile companies are diversifying their product offerings too. Higher margin products like technical textiles which find their application in sport shoes, luggage, special military dresses, automobile, healthcare, etc. now form part of their product mix. The market for technical textiles, which was USD 5.09 billion during FY06, is slated to touch USD 19.76 billion by FY15. Taking into consideration this opportunity, the government on its part has set up four centres of excellence to provide R&D support.

Additionally, the huge capex projects lined up by the leading textile companies in India completes the circle and makes it one of the most promising sectors. Companies like S Kumars will invest Rs 1,000 crore in the next five years to set up new technical textile facilities, Ackruti City plans to set up a USD 65.19 million textile park on 60 acres in suburban Bhiwandi near Mumbai and on the retail front, Raymond is planning to launch 300 more retail shops by March 2011. India accounts for only 4 per cent market share in the global textile market while China has 33 per cent. Even Manish Mandhana, MD, Mandhana Industries admits that “lot of foreign buyers who were buying from China coming to India for better supplies”. This clearly shows the huge opportunity lying ahead for the Indian textile industry.