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Three sector picks for 2011
| If the stock market were to resume its upward journey in 2011, which sectors will lead the charge — those that led the race in 2010 or the underdogs? Here are a few potential winners for 2011. . |
Pharma - Outperformer
Expiring patents of global pharma companies
Strong pipeline of drug applications
Rising competition in domestic market
Likely increase in licensing and supply deals
Telecom -
Dark horse
Realisations stabilising across board
Integrated players available at discount
BWA, 3G to drive broadband growth
Tower business to see substantial value unlocking
Infrastructure-
Looking up
Road asset owners offer opportunities
Water-related infrastructure to see growth
Interest rates could hurt profit margins
Pharma
Pharma stocks have seen their valuation multiples expand over the year and not without good reason as companies have managed to deliver on the earnings front. While the coming year may not see such a massive re-rating of the sector again, the strong earnings potential of companies in the space offers adequate investment opportunities.
Continued benefits from an increased generic incursion in global markets and a robust domestic market are likely to translating in to steady growth in core businesses and exports for the drug companies. Investors nonetheless may have to be meticulous in choosing stocks as the sector does not offer value picks.
Growth triggers
Patent cliff: The next few years promise to be among the most action-packed for generic drug makers as global pharma majors stare at significant drug patent expiries. In 2011 alone as per IMS Health, products having sales of more than $30 billion are estimated to go off-patent.
Regulatory steps taken by the developed countries such as US, Japan and UK towards limiting growing healthcare budgets too would spur the demand for generics. These in turn are expected to fuel the growth prospects of the Indian pharmaceutical sector, which boasts of a growing product pipeline, regulatory-compliant manufacturing facilities and cost advantages.
While the extent to which Indian companies stand to gain depends on regulatory approvals and favourable litigation and court outcomes, growth opportunities seem aplenty. For instance, the expiry of Pfizer's cholesterol-lowering drug Lipitor in November 2011 (had generated $8.1 billion in sales in the first nine months) opens up a significant money-making opportunity for India's Ranbaxy, which being the first-filer would have a six-month period of market exclusivity starting November 2011. It's another matter than Ranbaxy would need to necessarily resolve its pending issue with the US FDA over its manufacturing facilities before then.
Strong domestic market: A robust domestic market too is expected to provide a growth thrust, with both Indian and MNCs drug makers increasingly focusing on the domestic market (esp. tier II and III cities). Companies such as Ranbaxy, IPCA Labs, AstraZeneca India and Cadila Healthcare have also aggressively added on to their field force.
Industry estimates peg the domestic market growth at about 16 per cent. The year therefore may see improving penetration and productivity of field agents, as also competition. Larger companies with strong product portfolios and presence across major therapeutic areas (such as Sun Pharma, Cipla, and Lupin) and Indian arms of MNCs (such as GSK Pharma) might have an edge.
Revival in CRAMs: CRAMs companies have had a forgettable year so far following destocking by global pharma, rationalising of R&D pipelines and M&As.
The coming year however promises to be much better with industry trends now pointing towards a pick up in this demand towards the second half of the calendar year. While the revival would benefit all companies in this space, Jubilant Life Sciences and Divi's Laboratories may be the leading beneficiaries.
Expanded capacities, firm trends in capex and a growing pipeline of new drug applications in the US too promise to fuel the sector's growth. For instance, Sun Pharma alone has a more than 363 products filed in the US, of which 146 await FDA approval.
Among other significant stock-specific growth triggers are — Allegra D 24 and Arixtra for Dr Reddys Laboratories, Docetaxel for Sun Pharma, AllerNaze and oral-contraceptive products for Lupin.Another earnings trigger during the year would be the resolution of FDA overhang on Ranbaxy and Sun Pharmaceuticals; Sun would also see benefits accruing from its now completed acquisition of Taro.
If 2010 saw Indian drug makers forge global alliances and deals, 2011 promises to be the year when these companies would begin reaping the benefits therefrom. Companies such as Aurobindo Pharma (Pfizer and AstraZeneca), Dr Reddys (GSK) and Biocon (Pfizer) will begin monetising their licensing deals with the big pharma in the next few years, thus providing support to valuations. Similar deals that are struck by other companies (Cipla rumoured to be next) therefore may bear a watch.
SRIVIDHYA SIVAKUMAR
Infrastructure
It would only be appropriate to classify the infrastructure and construction sector among the underdogs of the 2010 equity markets. Over two-thirds of our 40 infrastructure stock universe delivered negative returns in 2010.
Erstwhile stock market favourites such as IVRCL Infrastructures & Projects and B.L. Kashyap & Sons nosedived in 2010 declining about 30 per cent.
With a median return of -15 per cent (up to December 27) for a universe of about 40 stocks, the sector was way off the Sensex performance of 15 per cent. Slower execution of projects in some segments and resultant drag on revenue growth and tepid order inflows have all resulted in the markets viewing stocks from the sector unfavourably.
Tailwinds
However, new regulations in the road space, more funding channels besides the compulsion to achieve at least a respectable part of the targeted twelfth plan which ends in FY-12 are macro factors that may turn the tide in favour of infrastructure companies in certain business segments in 2011.
The first half of FY-11 has already shown proof of this: earnings of companies expanded 20 per cent. More importantly, higher working capital suggests reasonable project implementation, albeit at early stages. Infrastructure developers who own a portfolio of highways, contractors in the road and water management space as well as technology providers for water may be the key beneficiaries of the turnaround expected in the sector in 2011.
Portfolio owners
Road developers, such as IRB infrastructure Developers, IL&FS Transportation Network, Jaypee Infratech or Sadbhav Engineers who own portfolio of roads on a build-own-operate-transfer basis could emerge as good bets in the road space.
The dual combination of a steady stream of annuity/toll revenues besides revenue from project execution provide these companies with a model that also helps combat slowdown; as against the pure execution contractors.
With pick-up in economic activity, toll revenues of players such as IRB have already seen a 22 per cent increase, largely driven by higher traffic.
With modest traffic estimations done initially, the higher traffic for many of the players in the industrial belts have made their projects more lucrative. Trailing price-earnings multiple of anywhere between 10-16 times also offer attractive entry points.
On the macro front, the government has stated its intent to award the remaining 5000-5500 km planned this year by the end of this fiscal. This could mean a higher level of order inflow in the next few months than what was seen in the last eight months. Contractors such as C&C Constructions or Unity Infraprojects with presence in road work too may benefit from the sudden surge in order inflows.
That said, the first half of this year has seen marginal pressure to operating profit margins (an average of 19.5 per cent now) despite lower input costs as a result of higher labour and subcontracting costs.
While the net margins remain intact, higher interest costs could be an irritant. A healthy spurt in the top line, higher than an average 15 per cent clocked in the latest ended half-year would be crucial to avert any pressure on margins.
Activity in the irrigation segment, dominated by spending in States such as Andhra Pradesh have seen diffused focus as a result of political turmoil. Besides lull in order inflows, execution of existing projects too suffered as a result of slower payments to contractors. Players such as IVRCL Infrastructure & Projects, Nagarjuna Construction and Hindustan Construction consciously slowed their activity in this space but have seen higher levels of debt in their balance sheets. These companies may therefore need to be kept on the watch list for any positive developments.
However, another large state-expenditure area - water supply and sanitation- though, has seen brisk business in areas of sewerage treatment, water recycling and desalination.
Companies such as Pratibha Industries, Ramky Infrastructure which execute significant projects in the water and waste management space besides water-related technology providers such as Hindustan Dorr Oliver and VA Tech Wabag can also be expected to ride the infrastructure wave.
VIDYA BALA
Telecom
The telecom industry has witnessed one of its most turbulent years in 2010, with the likes of Bharti Airtel and Reliance Communications (RCom) underperforming in the markets, faced as they were with a decline in ARPUs and margins. Barring Idea Cellular, that has outperformed the indices, all the others including Tata Teleservices Maharashtra (TTML) and MTNL have languished at the bourses.
Much of it can be explained by the continued de-rating of telecom stocks which started in late 2009 as a result of the tariff war started by several new entrants and led to erosion in popular metrics.
Recent concerns arose on the regulatory environment, both in the matter of future 2G spectrum allocation and on any levies due to the under-pricing in the past too kept the sector under pressure. But given that whatever could have gone wrong has indeed happened on the tariffs front future prospects don't seem to be as weak as it is made out to be.
For one, the competitive intensity on tariffs seems to be abating as witnessed by stabilising realizations.
Besides, other businesses of these companies such as broadband (through 3G and BWA), enterprise services and passive infrastructure (towers) are seeing an increase in contribution to revenues and adding to margins as well.
These may well be key drivers going forward. The sector thus has many a dark horse bets for investors.
Declining parameters
For mobile operators such as Bharti, Vodafone, Idea and RCom, the average revenue per user (ARPU) has fallen by 20-25 per cent over the past year to Rs 121-200 levels. ARPUs however may no longer be the best indicator of a telecom player's performance what with the new subscribers increasingly coming from the less lucrative semi-urban and rural regions. As a result revenue growth has lagged subscriber additions by 15-20 percentage points. .
However, the more representative metric, revenue per minute has been stable at around 42-44 paise per minute across operators. Even so, operating margins have slid 2-5 percentage points across operators. The top 7 operators including BSNL, Tata Teleservices and Aircel nonetheless have held their own in terms of subscriber market share. More importantly, they hold an estimated 98 percent revenue market share . Of this Bharti, Vodafone, Idea and RCom together command more than 77 percent of the revenue market share, points at their sustainable leadership.
The likes of MTNL and TTML with loss-making operations and limitations in scalability face serious challenges going forward.
Non-mobile growth
Businesses other than mobile telephony contribute over 15 percent of Bharti's revenues, while for RCom the proportion is nearly 40 percent. The operating margins in this segment have increased over the past year.
Both these companies have won licenses in strategic circles on the 3G front, with Bharti also winning bids in the broadband wireless (BWA) segment.
Since auctions have been won in circles where there is no direct competition, barring very few, tariff intensity is not likely to be significant. And the choice of circles that companies have made in bidding too have a compelling logic to them. Idea, for instance, has won 3G licenses from circles where it currently derives 80 per cent of its revenues.
Options such as 3G data cards can help increase broadband penetration. The 3G services are also likely to augment revenues from value-added services. On the voice front though pricing may not be at a huge premium since Tata DoCoMo and BSNL, who have commenced operations already, have priced calls only slightly higher than 2G rates. Then, there is also the rapidly growing DTH market.
This will be an important driver for RCom and Bharti, with ARPUs set to witness a significant rise and acquisition costs stabilising. These two are also well placed to tap the expanding domestic corporate IT and telecom connectivity market with their enterprise offerings.
Unlocking of tower value
The passive infrastructure business could see significant value unlocking too. Indus Towers (co-owned by Bharti, Vodafone and Idea) and RCom's tenancy factor has been on the rise.
Rentals from these towers too are increasing as operators, both captive and several new ones, seek to expand.
Earlier in the year TTML divested its entire stake in its tower subsidiary to Quippo-WTTIL, an independent tower company for an enterprise value of Rs 1,318 crore for its 2535 towers. Clearly Reliance Infratel, expected to make an IPO offering, Indus Towers and Bharti Infratel may look higher valuation and significant value unlocking given their much higher tenancies and larger footprint.
K. VENKATASUBRAMANIAN
Business Line
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