Mumbai: On 22 December, Michael J. Enabler, chief investment officer at Franklin Templeton Investments’ Mutual Series, wrote in a note: “We are seeing some of the best companies in the world trading at prices that we thought we could never get to see as value investors.”
Given the performance of the sectoral indices on the Bombay Stock Exchange (BSE), the note from Enabler, whose unit looks at undervalued stocks, distressed securities and other opportunities from deals such as mergers and acquisitions or restructurings, could well have been written about India.
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All but two of 12 sectoral indices on BSE have lost at least 50% in value as they took a relentless beating from the global financial crisis and economic slowdown, with the 30-stock Sensex shedding at least 54% of its value in 2008.
While investors are often advised to spot low-cost, high-value opportunities in firms with solid credentials when the markets are being pummelled, analysts this time are telling them to adopt a defensive approach given the volatility that is likely to continue into 2009. “The markets will continue to be volatile next year, too,” said Sandeep Kothari, a fund manager at Fidelity International’s India arm, who manages three equity funds, in a research note.
Worse, a 17 December note on the global emerging markets fund manager survey by Merrill Lynch and Co., Inc. ranks India as its least preferred market among the Bric (Brazil, Russia, India and China) countries.
The best bets in 2009, or at least the early part of it, are likely to be traditionally safe sectors such as health care and consumer care products, analysts say. In fact, these two sectors have, at 34.64% and 14.69%, registered the lowest declines among the sectoral indices of BSE. “In the present environment, we prefer to remain defensive. Staples, pharmaceuticals and two-wheelers are our preferred defensive sectors,” said a report prepared by Nilesh Jasani, head of equity research at Credit Suisse Securities India Pvt. Ltd earlier this month.
Indian banks have been watched closely for exposure to overseas toxic assets such as subprime mortgage-based derivatives since the September collapse of US investment bank Lehman Brothers Holdings Inc. But Anup Bagchi, executive director of ICICI Securities Ltd, says they are likely to be the first off the block as soon as markets return to a semblance of normalcy.
With interest rates starting to cool off, and falling inflation paving the way for more interest cuts by the Reserve Bank of India, banks, which have 24% of their deposits statutorily parked in government securities, will have huge gains in their investment portfolios. In fact, a report from Macquarie Research names HDFC Bank Ltd among its “diamonds in the rough”, meaning that the bank offers huge upside potential.
But some naysayers advise investors to avoid bank stocks. Credit Suisse recommends staying away from bank stocks despite the monetary easing, basing its assessment on a likely rise in non-performing assets (NPAs), which are currently at a historical low of 2.3%.
Two sectors that until recently were seen as icons of the “India story”—real estate and retail—are now being shunned. In fact, the two sectors are believed to constitute a large chunk of the banking sector NPAs and are to be kept at arm’s length, analysts said. BSE index representing the real estate sector has fallen the most during the year, having lost 82.71%.
“One can cannot write off real estate, but the sector will take two-three years to realign itself,” said Bagchi, who added that the immediate concern for companies in this sector is to generate cash flows to meet interest payments in a market where demand for new projects has slackened.
Real estate stocks, which thrived during the height of the bull run in 2007 because of valuations based on the land the companies held, suffered in 2008 as investors started focusing on the speed of execution of projects.
Retail, too, will have to realign and renegotiate rentals and contracts with suppliers before it can get off the block, Bagchi said.
Ironically, the fortunes of India’s most respected, and recognized sector globally, information technology (IT), are umbilically bound to the dollar, the currency of the country where the financial crisis originated, and to which investors flocked as they invested in US treasury bills, seen as the safest bet in an uncertain world.
This led to a sudden hike in the dollar’s value even as the US economy officially entered recession, pushing the IT industry’s earnings down, given its largely export-oriented business model.
While most analysts say the recent dollar appreciation is an aberration waiting to correct, there is little clarity on the extent of the correction or when it will take place. “Longer term, we expect the INR (rupee) to marginally strengthen, but the timing of the reversal is difficult to estimate and depends on the normalization of global risk appetite,” said Rohini Malkani, economist at Citigroup Global Markets Inc., in a research note.
The energy sector, especially oil refining and marketing companies, may benefit from lower crude prices, but Bagchi warns that the sector will likely continue to contend with political volatility, something it has been doing for long. Reliance Industries Ltd, which last week commissioned its 590,000 barrels per day refinery at Jamnagar in Gujarat, may be the best positioned to capitalize on any gains for the sector. “Despite assumed margin squeeze, we expect profits to double over three years, purely from massive gas volume growth priced at only $25 (Rs1,197.5)/bbl,” said a Macquarie Research report.
As for the auto industry, which until earlier this year held out promise but has experienced a slowing in sales of both commercial and passenger vehicles, analysts suggest steering clear of the sector. “Auto companies are stuck with inventories, and they need to clear that first to perform,” said Bagchi.