Home Safe Home

Stocks may plunge because of the crisis in global markets and political moves back home. But the India growth story is still tenable and promises gains for the patient investor.

First it was the yen carry trade, now the subprime crisis and the following credit crunch. The jitters in the American mortgage crisis are felt across the globe. Most indices around the world are witnessing rampant volatility because of selling pressure from speculators, and hedge funds which are selling all they can (especially liquid Asian securities) to meet margin calls.

Ergo, Indian bourses too, could not save themselves from being subprimed in this situation as the credit crunch of the west appears to be getting plugged using the profits from the east.

The Sensex has lost more than ten per cent over the past four weeks, taking a free fall from its recent peak of 15,794 on July 24. Add to this, the conditions back home have been a mixed bag on all fronts "� corporate earnings, interest rates, inflation, rupee exchange rate as well as politics.

Although the growth in corporate earnings across sectors has been decent, the first quarter of FY08 for a number of companies has jolted severe blows on their profitability due to the appreciating rupee, especially for those from the information technology and export oriented sectors.

Interest rates have been high in an effort to curb inflation while in the recent past inflation has hovered below 5 per cent, putting to rest the fears of further rise in interest rates in the near future.

However, high liquidity in the domestic markets does not deny the possibility of tightening in the monetary policy, thus keeping investors on their toes.

Without doubt, it becomes increasingly difficult to find avenues to invest profitably, when markets are directionless and the prospects appear bleak. Dig a bit deeper, and one finds that there is little reason for optimism to completely fade away. And if you are a long term investor, the current crisis is a great opportunity to accumulate stocks.

Still shining
India's economy has been growing at a phenomenal rate of over 8-9 per cent for the past couple of years, and consensus suggests that even though the growth may slow down a little, the economy is expected to grow at over 8 per cent in FY08, and between 7-8 per cent in FY09.

The slowing down of growth in the gross domestic product (GDP) is being attributed to a number of factors such as high interest rates, the inflation targeting stance of the central bank and the potential end of capital spending cycle in domestic capacity expansion as well as acquisitions.

The consensus of 7-8 per cent growth in GDP holds good in spite of high interest rates, concerns over inflation and an appreciating rupee.

Says Abheek Barua, chief economist, HDFC Bank, "I do not see any problem with the GDP growth at 8.3 per cent in 2007-08 and between 8-9 per cent over 2008-09, even though there are some signs of a mild moderation in growth as a response to the high interest rate regime we have been following for the past 12-18 months."

This is largely because of the widely held belief that interest rates have nearly peaked out, and inflation is more or less under control.

Andrew Holland, executive vice president and head - strategic risk group, DSP Merrill Lynch says, "Interest rates are likely to remain steady until the end of the year," adding that "there would not be any significant impact on GDP growth."

"In the short term, there could be a possible upside in the interest rates if the global credit crunch becomes acute, otherwise there is no significant upward pressure on interest rates," says Abheek Barua.

"Further, the slowdown in growth of GDP could be attributed to a slowdown in export growth, rather than interest rates and inflation," he adds. Of late, the contribution to incremental export growth has been increasing to the growth in GDP, even though the absolute contribution of exports to GDP is fairly low (at about 12-15 per cent).

Talking business
So far, the corporate earnings growth has not shown any significant downtrend, barring some sectors like information technology and export oriented companies.

"However, high interest rates and commodity prices have left some negative impact on consumption, manufacturing and investment oriented sectors," says Barua.

Going forward, although the growth in earnings may slow down a little in the short term, it is expected to remain secular over a longer time horizon.

"Even though there appears no risk to earnings growth, one may wait for some clarity whether there is a slowdown in the US or not, which would further dictate the trend of earnings, and hence, the markets," says Shriram Iyer, head of research, Edelweiss Capital.

What does this mean for the stock markets and valuations? Globally, the appetite for risk has receded in the past few months. This has led to a contraction in price-earnings ratios across all sectors. Therefore, valuations may still continue to be battered depending upon what route the global markets take.

Homeward bound
A fairly stable macroeconomic outlook, in spite of a global turmoil suggests that the domestic growth is not at risk. An 8-9 per cent GDP growth over the coming couple of years paints a decent picture of domestic consumption growth and makes a compelling case to look at sectors which rely less on exports and more on domestic consumption.

Sectors like automobiles and consumer goods have underperformed over the recent past owing a slowdown in consumption growth.

On the other hand, rising infrastructure spending has triggered a boom. Sectors which are likely to benefit more from the domestic consumption growth are likely to be winners in the long run.

The only risk with these stocks is that they have been the darlings on the bourses for quite some time now and most global investors have substantial holdings in these stocks. Thus, if global funds continue to face liquidity crunch, there could be further selling in these stocks.

But this would precisely be the opportunity to make purchases.

POCKETS OF STRENGTH

The past few months have stripped the sheen off a number of hot favourite sectors on the bourses like automobiles, capital goods, cement, commodities, information technology and the likes, which have a relatively higher sensitivity to changes in interest and exchange rates compared to other sectors.

On the other hand, sectors like banking and financial services, construction, consumer goods, media, power, real estate and telecommunications are largely driven by surging domestic demand, rising disposable incomes, low penetration and scarcity of supply within the country.

Banking and financial services
Although the US subprime crisis has taken a toll on the sector over the past one month (the BSE Bankex lost about 13 per cent over the past one month), thanks to high interest rates and large public offerings, the sector has been plush with liquidity.

On the one hand, growth in loans slowed down to 22 per cent y-o-y versus 27 per cent in the previous fiscal, deposits grew by 26 per cent, highest in ten years owing to high interest rates. 
 

BANKING ON INDIA
	P/E(x)			Remarks
	FY07 (TTM)	FY08E	FY09E
ICICI Bank	26.8	22	16	Strong retail growth, massive expansion  after the recent fundraising
Axis Bank	29.1	21.5	15.8	Increasing market share, strong earnings  growth and stable margins
SBI	14.4	14.2	12	Strong balance sheet, stable operating  performance
IndiaInfoline	57.6	-	-	Good earnings growth, increasing market  share with a wide presence

The central bank reacted with a hike in cash reserve ratio (CRR) to 7 per cent and tightening of norms for fresh external commercial borrowings (ECBs) by corporates for their rupee spends as a measure to keep the dollar inflow under check.

Strong demand for credit, peaking out of interest rates, rising revenues and better operating efficiencies for banks are likely to keep the going good for this sector.

For other financial plays, such as asset management companies and financial services firms, a growing asset base and a surge in demand for financial services indicate the imminent growth.

Construction and engineering
Dire need for developing quality infrastructure across the country and the continuing infrastructure spending will mean strong business flow for this sector for the next few years.

Most infrastructure companies are sitting on significant order books which grant the sector an assured stream of earnings. 
 

WELL ENGINEERED
	P/E(x)			Remarks
	FY07 (TTM)	FY08E	FY09E
Simplex  Infrastructures	23.7	11	10	Improving profitability and increasing  international project mix
Punj Lloyd	26.7	22	16.5	Strong growth from subsidiary  SembCorp, robust order book
GMR Infra	158.3	290	-	Specialised project mix, project returns spread over a long term horizon
IVRCL Infra	27.9	25	19	Low leverage, rising asset turnover  and improving profitability

However, the effect of high interest rates may show in the form of higher cost of funding after a certain lag, as the funds which firms have already raised at lower interest rates get exhausted.

On the flipside, the slowdown in growth may not show as much, since the industry will be growing from a higher base this year, compared to the previous fiscal. Political uncertainty is a risk for this sector as projects could get delayed. But a fall in prices could provide a good opportunity to log on to these stocks for the long term.

Consumer goods
Consumer goods have been beaten for long, and the sector's valuations are almost at their historic lows, owing to a slowdown in growth, high competitive pressures and price wars among the players.

However, with consumer spending on the rise and easing pressures on the cost front for consumer goods companies, most players have reported decent growth in earnings in the last quarter. 
 

THE UNDERDOGS
	P/E(x)			Remarks
	FY07 (TTM)	FY08E	FY09E
Asian Paints	29.4	25.8	21	Demand growth exceeding 20 per cent  CAGR, robust international business mix
ITC	21.4	20	18	Strong earnings growth, better realisations  and margins in cigarettes
Tata Tea	14.1	16	12	Accelerated branded tea volume growth, aggressive growth plans
United Spirits	23.2	21	17	Dominating position in the markets,  integration of acquisitions to bring gains

The first quarter of FY08 witnessed the highest rise in operating profits and net profits of consumer goods companies in the past couple of years.

Further, with raw material prices softening, margins are likely to improve. Hence, with low valuations and an optimistic outlook for the sector, it is the time to buy.

Media and entertainment
Figuring among the high growth sunrise industries, media and entertainment sector has been delivering phenomenal growth on the back of factors such as solid growth in advertising revenues, advertising rate hikes, increased revenues from pay television for television broadcast companies, declining newsprint costs for print media firms as well as high operating and net margins. 
 

MORE BLOCKBUSTERS
	P/E(x)			Remarks
	FY07 (TTM)	FY08E	FY09E
Adlabs Films	26.2	20	18	Expansion of multiplexes, growth in content  production business
Deccan Chronicle	24	20	14	Value unlocking potential through subsidiaries,  strong growth profile of core business
Prime Focus	42.7	22	16	Integration of VTR Plc and domestic  expansion, quality project mix
TV Today	22.1	23.5	17	25 per cent market share in Hindi and  English news markets, high viewership  resulting into strong advertising

Multiplex companies too, are riding high on expansion plans, rising average spend per consumer and higher footfalls. Improving quality of content, increase in programming hours, robust advertising revenues and better operating efficiencies pave the path for the sector continuing to remain an outperformer.

Power
Phenomenal demand and lagging supply means a huge shortage of power across the country.

In India, the peak power shortage amounts to about 13 per cent, while the total energy shortage is about 8 per cent. The Central Electricity Authority has assessed that a capacity of around 100,000 MW is required during the 10th and the 11th plan periods, while the actual capacity addition during the 10th and 11th plans is only to the tune of 21,180 MW and 78,000 MW. 
 

POWER PACKED
	P/E(x)			Remarks
	FY07 (TTM)	FY08E	FY09E
Reliance  Energy	19.1	16	14	Fast revenue growth due to high volumes, new capacity additions in pipeline
BHEL	33	27	21	Strong order backlog, imminent capacity  expansion to 15 GW
Emco	22.2	17	12	Robust order inflow, integration of UEL acquisition
NTPC	17.1	16	15	Low fuel costs leading to better margins,  capacity expansion to 51 GW

As a result, the sector is looking at a grand opportunity of volume growth domestically for years to come. High volumes, coupled with better realisations are likely to drive growth for the entire sector.

Real estate
Again, with a huge demand-supply gap, the Indian real estate is expected to grow at a compounded annual rate of 20-22 per cent "� commercial and retail real estate being the drivers of growth. The residential front is not dull either "� the country is facing an estimated shortage of 22 million homes by FY10.

In the recent past, the sector has seen prices bolstering to unrealistic levels across the board and there appears to be a correction in the prices of underlying real estate prices in tier-II and tier-III cities. 
 

GROWING REALTY
	P/E(x)			Remarks
	FY07 (TTM)	FY08E	FY09E
HDIL	18.9	16	10	Quality land reserves, more land acquisitions
Omaxe	37.5	16	9	Cheap valuations, quicker project turnout
Parsvnath  Developers	15.5	15	9	Increasing presence in the south, robust project pipeline
Sobha Deve.	33.7	21	15	Good project mix, expanding footprint

Therefore, the sector would largely rely on volumes, and developers will be compelled to improve operating efficiencies. However, rising income levels, greater penetration of housing finance and growth in services "� mainly IT/ITES industries in tier-II and tier-III cities will continue to be the key drivers.

Telecommunications
Robust volume growth in terms of number of subscribers which drive revenues, and expanding margins have kept the sector buoyant for a long time now.

Although price competition among players is leading to lower average realisations per user (ARPUs), companies have been able to maintain or improve profitability. 
 

A GOOD CALL
	P/E(x)			Remarks
	FY07 (TTM)	FY08E	FY09E
Bharti Airtel	33.7	27	22	Value unlocking from tower subsidiary, planned DTH and IPTV rollout
Reliance  Communications	25.7	19	13	Tower business, valuation among  the lowest
Idea Cellular	67.2	32	22	Potential launch in Mumbai and Bihar,  lookout for acquisitions
Spice Comm.*	-	13.8	13	Potential acquisition target
*Year ending December

Further, the additions in the number of subscribers have been strong, and are likely to remain strong due to low penetration. Macquarie Research predicts the wireless subscriber base to grow at a compounded rate of 37 per cent annually between FY07 and FY10.

The recent hikes in tariffs by large operators like Bharti Airtel and Vodafone Essar may trigger a rising trend in ARPUs, and in turn help companies improve profitability.

Add to this, a huge value unlocking potential is imminent in the form of telecommunication towers in case of large established operators like Bharti Airtel and Reliance Communications.

A word of caution in conclusion "� given the current volatility, it would not be advisable to make your purchases at one go. But keep a buffer to make purchases in case prices go down further making quality stocks more attractive from a long term perspective.