Short-term picks

Analysts are bullish on metal, sugar and IT sectors in the short term

With the Sensex at all-time high levels, it is becoming a stock pickers' market, if not already. Most equity fund managers prefer to go 'bottom up' rather than 'top down' in terms of their portfolio allocation.

However, while conceding that the current rally has been more broad-based than previous ones, some sectors are said to be more attractive than others, at least in the short term.

For a better perspective, let us look at the top sectoral performers during August. According to a report by analysts Sunil Jain and Mithun Banarjee of domestic securities firm, Edelweiss Capital, metals and mining (up 44 per cent) was the top outperformer during the month, followed by cement and construction (16 per cent), and travel and tourism (15.40 per cent). Sensex returns for the month amounted to only 2 per cent, while CNX 500 Index gained nearly 5 per cent.

Nearly 36 per cent of the rise in the CNX 500 Index was contributed by metals and mining counters. Another 35 per cent came from IT, and oil and gas stocks.

Given the current market conditions, Edelweiss analysts note that the risk-reward to staying long does not look favourable at these levels. The firm recommends metals, IT, sugar and cement counters, which continue to have robust growth outlook for the next quarter.

But it has to be borne in mind that these recommendations are based on recent events and as such the outlook is only for the current month.

Firm prices are a positive for metal sector

According to the report by Edelweiss, firm metal prices make the metal sector look attractive. Non-ferrous metal prices on LME have been rising over the last month and the ground is prepared for the domestic players to follow the trend.

Average aluminum and copper prices on LME for August are 5 per cent higher than the previous month's average. "We expect domestic aluminum producers to hike prices in the first week of September. Our outlook on non-ferrous metals remains strong,"says the report.

The outlook is good for the steel sector also. Steel prices have started moving up, with a few domestic players hiking prices modestly. This bounce-back in steel prices shows that the floor of price fall has been hit and prices have started turning as consumer de-stocking of inventory is over.

According to Edelweiss, this will act as a positive driver for the sector. "However, the threat of oversupply looming from China can act as a dampener in the medium term." Tata Steel, Nalco and Hindalco are Sunil Jain's top picks from the sector.

Demand-supply mismatch augurs well for sugar stocks

Sugar is also poised to do well. The report notes that the continued 'low stock' scenario in the domestic sugar industry, despite strong recovery in output, along with the approaching festive season, is likely to keep prices firm.

Four of the last five years saw higher average consumption in festive seasons compared to the full-year average. Production of sugar this year at 18 million tonnes is 40 per cent higher than 2004-05 but will still fall short of the demand which is expected to be around 19 million tonnes. Inventory levels depleted over the last two years and are expected to remain tight.

According to the report, sugar prices have climbed substantially even globally, in response to a deficit in the world sugar crop in 2003-04 and 2004-05 and import demand from mid-east Africa and Asia.

Further, alternative revenue sources for sugar firms such as production of ethanol and compensation for carbon credits, remunerative sugarcane prices for farmers, prompt payment and repayment of past arrears, too, are positives. "Dwarikesh Sugar, Blarampur Chini and Bajaj Hindustan look the best bets,"says Jain.

Downward pressure on rupee is positive for IT

Edelweiss is also positive on the IT sector. In one of the biggest global IT outsourcing deals, TCS and Infosys have clinched a total of $400 million worth of business from ABN Amro recently.

According to the report, this enhances IT sector's already robust growth. There is also a likelihood of a run-up in anticipation of the second-quarter results, which are expected to be on track.

Additionally, the downward pressure on the rupee is a positive trigger for the IT sector as a whole. "Fundamentally, we are bullish on the sector and it could act as a natural hedge for investors exposed to sectors adversely affected by a fall in the rupee,"says the report.

Keeping in mind the leverage from the ABN Amro deal, Jain selects TCS and Infosys as the best picks from the sector. While Edelweiss is positive on the above-mentioned sectors, it has expressed concern on auto, and oil and gas sectors, due to the high oil prices apart from the rise in metal prices.

Rising oil prices a concern for auto stocks

Typically, the July-September quarter is a strong period on account of fresh bookings ahead of the festive season commencing in October.

However, rising crude oil, steel and aluminium prices (and a possible rise in fuel prices) could affect margins as the current high levels of competition in the passenger and commercial vehicles segments would make it difficult to pass on cost pressures.

"These factors should have a lesser impact on the two-wheeler segment, as two-wheelers are less sensitive to fuel prices. With a historical double-digit growth trend between August and September, the outlook for two-wheelers remains positive compared to the other commercial vehicles and cars,"notes the report.

According to Jain, while two-wheeler companies should be able to weather the storm, it is not so in the case of four-wheel makers, as their margins could get squeezed.

Uncertainty in oil and gas continues

"The landscape in the oil and gas sector does not offer much clarity at present,"says Jain. The government is slated to take a stand on fuel prices in the first week of September.

The sector does not have any positive triggers per se and the performance of the stocks would be driven by the assessment of the government's decision. "We recommend caution in taking fresh exposures in this sector as it would remain an underperformer till the time any action is taken in this regard," says Edelweiss.