Promising Sectors

The year 2009 has already turned out to be an eventful year for India as it has not only marked the turnaround of the stock markets, but also reduced political uncertainty after the people of India voted for a stable government. Not many had foreseen this happening. In fact, while everybody was busy questioning the authenticity of the stock market rally the Sensex has sped past and provided returns of more than 75 per cent. With such brisk returns, did the investors miss the opportunity to make good money? We don’t think so since we believe that this may just be the start of a bull run.

Secondly, we are at the crossroads once again and the economy will take a turn for the better. It should be noted that for Q4FY09 the Indian GDP grew just at 5.8 per cent, similar to the growth witnessed in Q3FY09. Our reading of the situation says that this might be the lowest we could dip to and FY10 could be the year of recovery. The new government wants to make the most of the second chance they have got and has already given clear indications by giving key portfolios to ministers who will perform. Besides, one can also expect more action in the forthcoming budget as well. Thus, when there is a convergence of such factors as a rising market, stable government, free reign to the governing political party for taking quick decisions on reforms and improving corporate performance, it is time for investors to realign their investment strategies and hunt for sectors and companies that could turn out to be major beneficiaries of the current developments and government actions.

But Which Sectors To Choose?
Since March 2009 the sectors that have performed well are realty, metal, banking and capital goods with returns of 183.62 per cent, 140.40 per cent, 121 per cent and 114.36 per cent, while FMCG, healthcare and IT have been laggards with returns of 13.08 per cent, 35 per cent and 45 per cent respectively. However, it would be wrong to presume that sectors which have yielded the best returns will stay outstanding performers while the sectors that have been dull will not. Thus while realty is the best performer in the pack, it will not necessarily remain the topper as it will take some more time to reach its previous glory. Hence, one needs to do an in-depth analysis of the current state of the sectors in the light of the opportunities available and then select the best.[PAGE BREAK]

Selects And Rejects
In the interest of our readers we have done an analysis about which sectors are likely to do well in FY10. We scanned through a host of sectors and our analysis has thrown up five sectors viz. infrastructure, automobiles, banks, pharmaceuticals and power respectively, which we strongly believe will do well. However, before selecting these sectors we had to let go of some of other sectors, which were worthy of selection, but couldn’t be a part of the final five. These sectors include metal, telecom, real estate, FMCG, cement, fertilisers and chemicals. Factors such as volatility and uncertainty in prices, government intervention, excess supply, margins pressures, increasing competition and better growth prospects of the selected ones led us to ignore the rest.

As for the selects, there are certain sector-specific factors that make them attractive. For example, power and infrastructure would be on the top of the government’s agenda this year and hence would remain the favourite of investors. The targeted progress in the infrastructure sector has been delayed due to the coalition constraints, but these constraints are no longer an issue and therefore it can now move on the fast track. In power we have already seen a capacity built-up of around 10,000 MW per annum, but this is now expected to be pulled up to 15,000 MW per annum, thus helping government to achieve its target of ‘Power For All’ by 2012.

Besides, if we are talking about economic revival, banking will play a vital role. It is basically a lubricant which will help the wheels of economy to move smoothly towards recovery. Despite the global financial meltdown, the Indian banking sector has continued to perform strongly in all the four quarters of FY09. And with a larger role for it ahead through which it could help revive sectors such infra-structure and automobiles, among others, we expect it to perform better in the coming period. That apart, come what may, people won’t stop consuming medicines and healthcare products. The government and the companies globally are trying to lower the healthcare cost and this will given a natural advantage to the Indian pharma companies who are very strong with generic products. That is why the pharma sector assumes importance.[PAGE BREAK]

Last but not the least is the auto sector. Strong rural demand, expectation of better monsoon, reduced input cost, cut in duty cuts, new launches and lower interest rates etc will make it an attractive bet for FY10. Given ahead in the cover story is the detailed analysis of each of these sectors.

POWER
For any economy - developed or developing - the power sector acts as a catalyst and is primarily responsible for its growth. The increasing vibrancy and flexibility of the Indian economy is not matched by the power sector, which continues to be mired in mismanagement and poor governance. The key worry for investors is whether India can sustain the 6-7 per cent growth with an ailing infrastructure (power) network? Progress in the Indian power sector, with current electricity shortages of over 11 per cent of peak time, will be one of the key determinants to the future growth equation.

If India has to fulfill its power requirement of 3,15,000MW by 2017, the country will require a generation capacity of 4,15,000MW, after adjusting for plant availability. This implies a tripling of installed capacity from the current level of about 140 GW, which, in turn, translates into an annual addition of 20,000 to 40,000 MW. With such measures in place the country’s power consumption is expected to increase from an estimated 631 units in 2006 to over 1,000 units by 2012.

The government has adopted certain measures like increasing the Return on Equity (ROE) by 150 basis points (giving generating companies a breather) and introducing Ultra Mega Power Projects (UMPP) which attracts more investment in this sector. Ambitious programmes like the Rajiv Gandhi Grameen Vidhyutikaran Yojana (RGGVY) and the Accelerated Power Development & Reforms Program (APDRP) - a distribution reform identified to improve its efficiency – too have been initiated to electrify 120,000 villages.

For nine-month ended December 2008 NTPC took a hit in its profit mar-gin by 300 bps compared to the previous year and that of Tata Power was hit by 600 bps during the same period. On the T&D front, Power Grid revenues grew by 43 per cent during the period but on account of high interest rates their NPM dropped by 1,200 bps.[PAGE BREAK]

With revival now being witnessed in the economy and investment flow continuing in this sector we see an improvement in these figures in FY10. The companies to look out for in the power sector would be BHEL, Tata Power, Power Grid and REC which plan to disburse Rs 21,000 crore in FY10 (up 24 per cent) keeping in mind their large order book and investments’ strategy that will boost the power industry.

INFRASTRUCTURE
Readers may be surprised to see the infrastructure sector being included as part of the promising sectors for FY10 after the cover story we had done on the sector in December 2008. But before reaching to any conclusions, we would urge readers to recollect that our cover story had categorically said that it is better to have a wait and watch approach for at least 4-6 months before taking any exposure to this sector. And it seems that the wait will now pay off as things look brighter for the infrastructure sector.

To bring the economy out of the trough, the government has very little option but to increase its spend on infrastructure. Infrastructure investment as a percentage of GDP has been at a meagre 2 per cent during 2002-2007. Hence, in a bid to drive growth we expect the government to come out with progressive policies for the sector. Feedback Ventures’ Chairman, Vinayak Chatterjee, opines: “All the stops are going to be pulled out to see that infrastructure, particularly roads and highways, see a huge degree of energy and action on the ground.”

First and foremost is that the UPA government is back and this time it has returned with no ‘Left’ baggage. What this means is that it now has a free hand to implement its Bharat Nirman Program and hence infrastructure reforms will continue and that too with an extra pace. Secondly, this win means more to the UPA as it now gets a second chance to prove its mettle.

We expect that the UPA government will fasten this process as was seen in the third quarter of FY09 wherein the government cleared 37 projects worth Rs 70,000 crore. In fact, Manmohan Singh has already given an indication after Kamal Nath was handed over the key portfolio of roads and high-ways instead of the DMK ministers. It should be noted that Kamal Nath had done a commendable job with the commerce and industry portfolio in the last term.[PAGE BREAK]

That apart, the sector also faced a liquidity crunch as banks and financial institutions were averse to lending and those who did charged high rates of interest at 14-17 per cent. But things are changing and financial institutions, including banks, are seen revising their lending rates downwards. Thus, the interest rate scenario is expected to be more benign in the near future and it will not only increase the credit flow to the starved infrastructure sector but also reduce the cost of funds for those infrastructure companies.

That apart, what will also ease the pressure on the banks is the government’s initiative in the interim budget authorising India Infrastructure Finance Company (IIFCL) to refinance 60 per cent of commercial bank loans to public private partnership projects. As this move would ease the banks’ position compared to their exposure to the infrastructure sector, commercial banks would be induced to lend more.

Further, with the liquidity situation easing out, infrastructure companies would now be focusing on project execution that has been delayed due to want of funds. Though for 9MFY09 the revenues of infrastructure companies grew by 6 per cent, the bottomline dipped by 18 per cent. We believe that these companies have the potential to come out of the woods in the coming period. S Sivaramakrishnan, Managing Director, Consolidated Construction Consortium, states: “The performance of construction and infrastructure companies will start bouncing back from the third quarter of FY10 as schemes will start getting implemented from that quarter onwards.”

In fact, Larsen and Toubro (L&T) expects FY10 to be a better fiscal and has estimated 25-35 per cent growth in its order book. Its FY09 order book has crossed Rs 70,000 crore. Thus, with business still coming in, companies focusing more on execution, and the government expected to put infra on fast track, we expect this sector to certainly do well in FY10.

BANKING
The Indian banking sector has largely remained an island of calm in an otherwise volatile global financial market. It not only remained stable but managed to out-perform the broader market index. If we calculate the return of the Bankex from the start of October when all hell broke loose on the entire financial sec-tor globally after the bankruptcy filed by Lehman Brothers, it has outperformed the bellwether index Sensex by three times. While the Sensex is up by six per cent, Bankex in the same time period is up by 18 per cent, even in terms of year till date (YTD).

Bankex have marginally outperformed the broader market index. We were the first to spot the trend when others were worried about the asset quality, credit growth etc, and did a cover story on the banking sector in our issue dated March 15, 2009. The average return our recommended stock has given is a huge 71 per cent. So[PAGE BREAK]

has the sector run out of steam after the current rally? Put this question to B A Prabhakar, Executive Director, Bank of India, and he states: “The growth of the banking sector is very much tied with the revival of the economy and with early signs of economic revival being in sight we hope that the banking sector will witness a quick revival rate.”

The long-term growth story of the sector remains intact. The credit penetration in India is still at 69 per cent of GDP (FY08), despite the huge expansion in credit witnessed between FY00 to FY08 when our credit penetration increased from 36 per cent of the GDP to 69 per cent. But when we compare it with our neighbour China which has a credit penetration of 136 per cent of GDP, this means a lot of catching up has to be done by Indian banks to provide the required impetus. “The housing sector along with the SMEs may again be the key growth drivers,” feels Allen C A Pareria, CMD, Bank of Maharashtra.

The next boost will come from the reform process the government will start. With no Left allies to hinder the divestment of their stake in the public sector banks (PSB) or consolidation of banks, there is hope of a lot of activities building up now. With fiscal consolidation in the mind of the new government, divestment in the PSBs in which they have a holding of more than 51 per cent may be one of the options which might hot up activities in this sector. The consolidation of SBIs with its associates may again find favour with the government. Another long-term driver of growth for the sector is the huge capex plan lined up by India Inc and investment in infrastructure.

According to the CMIE’s capex database, over 1,000 projects involv ing total investments of Rs 4,90,000 crore are on schedule and will be commissioned in 2009-10. Projects worth Rs 7,90,000 have been announced in the quarter ended March 2009 itself. While India Inc has been struggling to perform, the banking sector has consistently increased its topline and bottomline. Out of 37 banks that have announced their Q4FY09 results till May 27, 2009, the aggregate total income has seen an increase of 24 per cent on a year-to-year basis with Axis Bank recording the highest increase of 51 per cent in the same time period. Its bottomline has increased by 28 per cent whereas Vijaya Bank performed the best with a 474 per cent increase.[PAGE BREAK]

AUTOMOBILES
In the year 2008, the Indian automobile sector was weighted down by factors like inadequate financing, concerns over the macro environment, continuing high interest rates and rising raw material prices resulting in lower margins. However, this was the story till December 2008 and afterwards the scenario has changed completely. The sector has started the year 2009 on a stronger note and the same can be seen from the fact that in past four months, sales volume has picked up in the passenger vehicles’ and the two-wheeler segment. There are various factors that have driven the demand, including the stimulus package announced by the government wherein the excise duty was cut by 4 percentage points, the rural demand which has occurred on account of the Rs 60,000-crore debt relief package and the demand from government employees who actually derived benefits from the Sixth Pay Commission.

Even Dr Pawan Goenka, President (Automotive Segment), Mahindra & Mahindra, agrees to the same. “This was a very good example of collaboration between the government and industry players to overcome the cri-sis, but the momentum must be sustained. It is important that excise duty and interest rates should not move upwards and a slight improvement in any of these three areas is welcome.” Now, let’s look at the factors that are expected to drive the demand for the automobile sector.

Financing cost is the major element determining the demand in the automobile sector wherein 30 per cent of two-wheelers, 80 per cent of passenger vehicles and 90 per cent of commercial vehicles being bought through financing. Last year, since skyrocketing inflation resulted in higher interest rates and made finance cost too stiff to buy vehicles, the demand lessened. However, with inflation touching a three-decade low, the RBI has, since October 2008, cut the repo rate by 400 bps and reverse repo by 250 bps. This has resulted in reduced lending rates and in turn is expected to benefit the sector. Further, the liquidity situation is also expected to ease up.

Secondly, a strong rural demand is expected to be sustained what with there being a prediction of a good monsoon season. The third advantage is that commodity prices have declined significantly from their peaks. We feel that this is a strong positive for the auto sector, as a decline in input cost prices should lower the pressure on margins. With companies having already consumed their high cost inventory, the margins are expected to be better going ahead. Further, with crude declining 60 per cent from a peak of USD 150 per barrel to USD 60 per barrel, the government has passed on the benefit by reducing petrol and diesel prices. Lower fuel prices means lower vehicle ownership cost. Although marginal in nature, this surely helps the automobile sector.[PAGE BREAK]

Further, the newly launched vehicles are also expected to drive the growth for the sector. New launches in the four-wheeler segment such as i10, Dzire and A Star have also witnessed a good response. With the macro factors favoring the sector we expect the demand for new launches to be good. With the automobile sector doing well, the auto ancillary sector is also expected to perform better. Further, the demand for fuel efficient cars is expected to drive the exports’ growth. If we take look at the financial performance of the automobile manufacturers, for 9MFY09 the topline declined by 9.19 per cent and with reduction in margins the bottomline declined by 33.50 per cent.

But we have compared Q4FY09 to Q3FY09 as the stimulus packages were announced in December 2008 and the impact was seen in Q4FY09. Here the topline has increased by 28.11 per cent and the bottomline has increased by 13.71 per cent, clearly indicting a revival in the sector. Considering all these factors, we expect the automobile sector to perform well in FY10.

PHARMACEUTICAL
India is the best place to be ill. No it is not for any other reason but for its world-class healthcare services and that too at very competitive prices. One of the silver linings of this global recession is that it has forced the governments and companies to take a serious look about lowering the prohibitive cost of healthcare. Moving towards generic consumption seems to be a logical move for these governments as they are sold at more than a 90 per cent discount as compared to the price of the original drugs. The domestic pharmaceutical companies (DPC) are best positioned to take advantage of this situation. Indian companies have a high presence in the generic market and cover approximately 20 per cent of the world generic market. They are present in all the major markets like the US, Europe, Japan and other emerging markets. Even spokesperson of Sun Pharma admits that “Consumption of generic drugs continues to grow, practically in every market across the globe. This should help Indian Pharma companies”.

With approximately USD 80 billion worth of drugs going off-patent by the next year it gives a good opportunity to capitalise on this. The stigma of ‘pharmacy of poor’ attached to Indian companies is working in their favour in the current situation. Emerging markets (other than the US, Europe, Japan etc) form for another important area which will act as a growth driver for the entire pharmaceutical[PAGE BREAK]

industry. Last year, the total growth in the global pharmaceutical market was approximately USD 50 billion out of which 85 per cent i.e. USD 42.5 billion came from the emerging market. Most of these markets have been dominated by branded generic, the structure akin to the Indian market. This gives Indian companies an edge over other international players.

Of the total Rs 30,000 crore worth of generics exported by India, more than 15 per cent is exported to these countries. Companies like Lupin, Cipla etc have already made inroads into Africa, Latin America and CIS countries either through acquisition or partnering with some local companies to help them exploit the opportunities. Apart from the international market, the domestic market too offers a good opportunity to Indian pharmaceutical companies. India is one of the least medicine-penetrated countries in the world. According to UN estimates, the population of India looks set to rise from 1.1 bn at present to 1.4 bn in 2020 and with annual growth rate of GDP by 6-7 per cent will see increase in the spending on drugs. With rising population and income we feel that domestic market is also going to give more avenues of growth.

As far as financials are concerned for the quarter ended March 31, 2009, 94 companies have declared results till now and topline for them grew by 12 per cent and bottomline dropped by sharp 72 per cent y-o-y basis. Such sharp fall was mainly due to extraordinary item which dropped by little more than five times. In Q4FY08 they contributed approximately Rs 268.24 crore to the bottomline but for Q4FY09 they suffered loss on account of these items to the tune of Rs 1092 crore. It was Ranbaxy Laboratories which alone suffered loss of around Rs 900 crores due to extraordinary item. This extraordinary item mainly consisted of forex loss due to foreign denominated liability and hedging loss to cover that. We feel going forward we may not find such volatility in rupee and things will settle down which will help in improving bottomline in coming period. Therefore one can look for those companies who have strong pipeline of generics and is also present in R&D space.