There are signs of recovery. So which are the cos in big sectors, best poised to cash in on the next bull run?

IT'S finally time to make some money. The big bad bear seems to have taken a hiatus. After a year of agonizing uncertainty, equity markets are finally making a strong comeback. Major equity indices, which represent the markets, have recovered more than 30% from the losses they made a year ago.
    Blame it on the business cycle, say pundits. Business moves in cycles — creation, growth, maturity and decline — and so does the equity market. During the creation phase, stock markets start consolidating and as soon as the economy enters the growth phase, the bull run starts. And by the look of things now, the bull seems to have already sprinted.
    But before investing, the challenge lies in identifying the companies that are best equipped to take advantage of the good times because once the sluggish phase ends, demand picks up and companies that are able to meet it emerge winners.
    So, what sets these companies apart? These companies can be identified by their operational and financial capabilities. Operational capabilities can be judged based on several parameters such as debtors' turnover ratio, working capital cycle and cost ratios.
    And as far as financials are concerned, during a slowdown companies usually face a cash crunch. So, a company that has high cash balance and low debt has a better chance than the one that has high debt and low cash balance. But the parameters differ from industry to industry as each sector has its own pros and cons.
    So, SundayET brings to the table an indicative portfolio of companies that are well trenched to cash in on the next bull-run.
    CONSUMER GOODS
Volume growth, rising input cost and supply chain management are the three major concerns for companies in the FMCG space. Agrees Abhijit Kundu, VP-research at Antique Stock Broking. "Companies in the premium category face volume growth during the downturn, whereas, in the economy class the main concern is increasing input cost," he says. Companies in the consumer durables space have more or less similar concerns, apart from the fact that some products are cyclical in nature. Hence, companies with higher sales and volume growth, operating and net margins and higher market share are certainly preferable.
    Case in point: Nestle India registered net sales growth of around 300%, however this is also due to a low base in the last year. The operating and net profit margins stand at 20% and 12%
respectively, which will give a cushion to it in case the inflation goes up and so the input cost. According to Hitesh Agrawal, head of research at Angel Broking, Nestle India is extremely efficient as indicated by its zero debt balance sheet, high return ratios (in excess of 100%) and negative working capital requirements. Also according to DK Aggarwal, MD at SMC Wealth Management Services, it has the best technology support from its parent. Also, economies of scales due to its ability to increase the volume, and increase in products prices by focus on premium products will help the company to show a comparatively good performance in the coming quarters.
    Similarly, Colgate-Palmolive (India) commands half of the market share in both toothpaste and toothpowder segment. Most of its brands such as Colgate Dental cream, Max Fresh, Active Salt and the economy variant, Cibaca are market leaders. This gives it cushion from any rise in input cost. It has an extensive distribution network and is constantly gaining the market share. Interestingly, according to to Hitesh Agrawal, while the debtor days and inventory days in FY2009 stood at 2 and 19 respectively, it enjoys 81 days of credit with its creditors.
    CAPITAL GOODS
Simply put, factors such as growth of the economy, need for infrastructure, fund raising capability and raw material cost affect the growth of capital goods companies. During a slowdown their fund raising ability decreases and so does infrastructure development, which in turn affects the order book of these companies. Steel and copper are used as raw materials and an upsurge in the prices of these materials affects these companies negatively. However, prices of steel and copper have come down. A company, which has a high order book size, right working capital management and high return on equity gets higher valuation in the equity market. However, other than these, a company must be able to execute the project on time because any delay in completing the project increases the cost considerably.
    Companies such as BHEL and Larsen & Toubro have a proven track record as far as execution is concerned and have posted more than 20% return on net worth. According to an analyst from Jaypee Capital, BHEL's order backlog at end-March 2009 stood at Rs 117,000 cr, around 37% higher than the previous year. "In the next fiscal we expect orders worth Rs 50,000 cr. Also, bulk orders from National Thermal Power Corporation (NTPC) and Damodar Valley Corporation (DVC) are expected to be placed in Q2FY10," he said. Since 2005, net sales and net profit grew by around 29% and 34% respectively. Reduction in the raw material cost will add to the bottom line.
    Similarly, L&T's order backlog is of Rs. 70,000 cr. Net sales and net profit have grown by more than 26% and 37% respectively. Also, the margins have been improving for the last four years from 10% to 15%. Says DK Aggarwal, "The margins are expected to remain firm and emphasis on Ultra Mega Power Projects (UMPP) and a shift towards super critical technology would help the company to increase the profit."
    IT & TELECOM
Major challenges for IT companies are demand contraction due to global economic slowdown and unfavourable fluctuation of currency. According to Pankaj Pandey, head of research, retail at ICICI Securities, the current environment demands IT companies to be innovative not only in its processes but also billing. "Clients around the world are increasingly looking at vendors to cut costs. Going ahead we expect large cap IT companies, with better cost management systems to lead the pack," he says.
    Infosys is known to be a premium-priced player that does not compromise on rates and instead focuses on value delivered to the client. It is a debt free company and has a cash balance of more than almost Rs 9,039 cr. Says Hitesh Agrawal, "Infosys generated nearly Rs 3,000 crore in free cash flows in FY2009, and cash as a percentage of total assets stands at a high 53%. Based on the proven management capability and efficient cost management system, we expect it to scale up business once revival takes place."
    And as far as the telecom sector is concerned, competition is increasingly led by expansion plans of existing players and new licensees. This is also visible in the attractive plans and aggressive tariffs that telecom companies are offering. All this has a bearing on the average revenue per users (ARPUs), which have been declining for sometime. But according to Sonam Udasi, VP-research & group head, consumer sector at Brics Securities, there are a lot of uncertainties in the telecom industry — uncertainty of 3G spectrum auctions, 2G spectrum allocations, mobile number portability as well as mobile virtual network operator (MVNO) policies. "We maintain underweight rating on the sector, however, we feel Bharti Airtel is in a better position to brave the challenges as compared to peers like Idea and Reliance Communication," he said.
    But still there is a huge untapped market; particularly rural penetration would drive growth. Also, with the introduction of 3G, ARPUs may improve.
    Bharti Airtel is expected to lead the pack in the telecom space based on the financials that it has and the market share it enjoys. It commands around 24% of the market share in terms of number of mobile subscribers. In fact, in terms of revenue its market share is as high as 30%. Also, lower EPS is needed. According to Hitesh Agrawal, Bharti Airtel is undoubtedly the best-placed telco in the country across major parameters, including net debt-equity ratio, net debt-EBITDA, average revenue per user (ARPU), return ratios, profitability and working capital management. Also, its ARPU is highest at Rs 325. The debt to equity ratio is also very good and stands at only 0.23 in FY2009. The expected merger with MTN will further strengthen its position.
    POWER/ENERGY
The power sector has been considered a defensive sector as the regulator has guaranteed returns. According to Pankaj Pandey, regulator in the new tariff policy (2009-14) has improved the guaranteed return on equity from 14% to 15.5% and an additional benefit of 0.5% of ROE if the projects are completed within the prescribed time limit. "Now with a stable government in place, we expect the investment activity to pick pace", he said.
    Power is a capital-intensive industry. Last year, many companies had difficulties in raising funds, however, with easing liquidity condition funds may not be a constraint. But in general, companies, which already have funds and have also signed power purchase agreement with the buyers, would be in a better position.
    Nevertheless, there is a robust growth in the transmission segment of the industry, especially in the companies that enjoy monopoly in this segment. For instance, Power Grid has the potential of a winner in the next bull run given the fact that it enjoys near monopoly in the power transmission segment. It churns out almost 45% of the total power generated in India. It plans to invest around Rs 30,000 cr over the next 3 years. According to Amitabh Chakraborty, president (equity) at Religare Capital Markets, the company is expected to see improved earnings in the coming year on back of margin expansion and reduced interest burden. Interestingly, it has a strong order book size of almost three times of its sales during FY09.
    In the energy sector, movement of crude oil price plays a vital role. While, north-heading crude oil prices benefits upstream companies such as Cairn India, when crude oil prices fall it helps downstream companies — companies engaged in marketing of oil. ONGC is a typical case of a company which get affected by any extreme movement of oil prices because when crude oil price comes down its sales get affected and when crude prices go up its subsidy burden goes up. Since it is difficult to forecast the crude oil prices, putting money in such companies becomes a risky bet.
    But companies such as Indraprastha Gas, which is into gas distribution, can benefit due to low cost of natural gas in comparison to liquid fuels.
    BANKING
Last year was a difficult year for Indian banks, as the interest rate hike affected their net interest margins (NIMs). In 2008, PSU banks outperformed their private sector counterparts. According to Pankaj Pandey, trading gains from G-sec remained a major contributor to bottom line. "We believe with improved liquidity, going forward credit growth should pickup and core net interest income and fee income should drive profits," he says. Restructuring has saved banks from reporting high NPA numbers, but indications from bankers is that 10-15% of these turning bad cannot be ruled out.
    Since, private sector banks have a higher exposure to the retail category, there can be higher NPAs. And expected disinvestments in the banking industry would aid growth prospects.
    A bank with good asset quality, high net interest margin and capital adequacy ratio and low NPAs is certainly preferable. Union Bank of India enjoys a high NIM of around 3%. Also, the return on equity (ROE) stands at around 29%, which is beneficial in a declining interest rate environment. Moreover, it focuses on quality assets and maintains high loan loss coverage ratio. According to an analyst from Jaypee Capital Services, Union Bank of India is the most technosavvy bank and is one of the front-runners amongst public sector banks in the field of technology. It is one of the pioneer public sector banks, which launched core banking solutions in 2002. Union Bank is amongst the large state owned banks with balance sheet size of over Rs 1 trillion. It plans to enter into a joint venture with a Belgium-based company to foray into mutual funds business with 51% stake to be held by Union Bank. The bank's huge branch network will be an added advantage.
    AUTO
Stimulus package, cut in excise duties, improvement in financial lending, increasing exposure of public sector banks and falling interest rates are fully in place to bring volume growth back on track. This has been witnessed in the past 4 months, industry seeing revival in sales volume barring few companies such as Bajaj Auto and Tata Motors. Maruti Suzuki and Hero Honda continued the high ride and for past few months notching up record high sales performances.
    Financially, companies such as Hero Honda Motors and Maruti Suzuki are sound companies with less dependence on borrowings and good leverage ratios.
    Mahindra & Mahindra (M&M) has also registered a decent growth. The top and bottom line of M&M posted a CAGR of 18% and 14% since 2005. Net margin stands at well above 11%. Currently, M&M is the largest tractor and utility vehicle manufacturer in the country, having manufacturing facilities spread across the country. According to an analyst at Geojit BNP Paribas Financial Services, besides automotive, M&M through its subsidiaries and associates has presence in a diversified portfolio, which includes automotive components (Systech), information technology (Tech Mahindra), infrastructure, hospitality (Mahindra Realty) and financial services, steel (Mahindra Ugine), among others. "It has all the recipe for achieving decent growth in future with upsurge in economic activity," the analyst from Geojit BNP Paribas Financial Services, said.
    Hero Honda Motors has the more compelling story. It is India's largest motorcycle company with a market share of more than 57% and strong technological backup from its Japanese parent Honda Motors. It is almost a zero debt company with a debt amount of Rs 102 cr and a net worth of Rs 38, 000 cr. According to Hitesh Agrawal from Angel Broking, it has been able to maintain a dominant share of the Indian two-wheeler market since 1990. Also, it has a strong dealership network with good penetration in the rural areas as well.
    anand.rawani@timesgroup.com 

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