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India Equity Research Reports, IPO and Stock News
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What to SELL despite the decline
Investors need to SELL stocks to BUY into the correction
"Administrative" suppression of commodity prices potential risk
Companies without pricing power could face disproportionate margin pressures
Pure “sector beneficiaries” could be at risk
Sell after a sharp correction? Isn’t it too late?
Asking investors to sell after a 16.2% correction in the market (and 30-50% in some stocks)
may sound like locking the stable door after the horse has bolted. But to buy fundamentally
good stocks available now at attractive valuations (which we highlighted in our February 2nd
note: “What to Buy”) investors may need to free up cash in their portfolios.
Which stocks to sell?
Investors need to move away from potential underperformers, which, we believe, belong to
four baskets: 1) Stocks which have responded to the prevailing concerns but valuations
don’t discount the potential negatives fully; 2) Stocks which may suffer from potential
administrative measures to control inflation; 3) Companies in sectors facing structural pricing
pressure and companies facing disproportionately high pricing pressure; and 4) Stocks that
have outperformed purely by virtue of being in an outperforming sector, not any fundamental
reason.
Concerns on interest rate, asset quality, corporate governance persist
Upward pressure on rates impacts wholesale funded banks and financial institutions more
than banks with strong deposit franchise. HDFC, REC and PFC appear destined for more
underperformance from this perspective. A second concern in the banking sector arises
from potential credit cost increases – which we believe would affect BOI, REC and PFC in
the near term. Similarly, Reliance Power, despite recent underperformance versus Sensex,
may continue to be affected by these concerns.
Potential “administrative” suppression of commodity prices
India’s history of “moral suasion” by the Government to control commodity prices in
inflationary times worries us about companies that don’t have backward raw material
linkages. JSW Steel and SAIL appear most vulnerable over the near term. Similarly, upward
adjustment of domestic oil prices seems unlikely for now, and the budget may throw up
another uncertainty for oil marketing companies – with a very low initial allocation to oil
subsidies.
Disproportionately high margin pressure for some sectors and stocks
Cement, power equipment, merchant power are sectors facing pricing pressure and likely to
suffer in the medium term. Some auto and consumer stocks (Hero Honda and HUL) are
facing a much higher degree of margin pressure than their sector peers.
Pure “sector beneficiaries” are risky
Some stocks have benefited purely by being in a sector in favour – without any fundamental
stock-specific reason behind their outperformance. HCL Tech comes across as a prime
example.
Even after major correction, stocks should be sold tactically
In our recent note “What to BUY” dated 2 February, we highlighted our best Buy ideas
after the recent market correction. We considered these suggestions to be top-tier wellresearched
companies with good management quality and corporate governance.
However, feedback from several investors indicates that:
(i) They need to sell some stocks from their portfolio to make way for the BUY ideas.
(ii) Some investors expect some more downside to the market from present levels, and
are concerned that stocks that have not declined much could be the next set of
“victims”.
In this context it is important to focus on why the Indian market has declined, and which
of the reasons for decline are likely to continue to prevail. For each of these themes,
some stocks have underperformed more than some others, and it may now be time to
consider selling the relative outperformers, in case there is no further fundamental
positive driver for them.
Our starting point, therefore, is the list of outperformers over the past three months (i.e.
from the early November market peak).
It is not surprising that most of the outperformers are from IT, resources (metals and
mining, oil), power utilities and consumers (ITC, HUL). We are surprised by the fact that
cement and select capital goods stocks have outperformed. These are the sectors
facing maximum pricing pressure, and therefore, potentially the highest degree of
margin pressure.
When we look at the themes that have driven the market down and the ones that are
likely to sustain for some more time, some notable ones immediately become apparent.
Pressures of inflation and interest rates, and margin pressure on commodity users are
likely to sustain for some time, and some of these drivers could influence government
policy in the near term. Companies influenced by such policy measures could be prime
candidates for near-term underperformance.
A word of caution about our SELL ideas would be in order. Some of the stocks in our
list have declined significantly and their valuations may appear attractive relative to their
own historical valuation ranges. Consequently, they may not decline much from the
present levels. Indeed, on some of these stocks our long-term fundamental
recommendation is BUY. But we are convinced that these stocks could underperform
the market in the near term, and therefore, from a tactical perspective an investor would
be better off staying away from these names and investing in our fundamentally sound
basket (see our note dated 2 February).
Inflation, interest rates and asset quality of banks
That interest rate hikes are coming is obvious, and is by and large reflected in the
recent underperformance of the rate-sensitive sectors – banks, property and autos.
However, upward pressure on rates impacts wholesale funded banks and financial
institutions more than banks with strong deposit franchises. HDFC, REC and PFC
appear destined for more underperformance from this perspective. A second concern
on the banking sector arises from potential credit cost increases. Banks having
relatively higher exposure to the “risky” sectors (e.g. BOI in Airlines) and financial
institutions exposed to generically risky sectors (e.g. REC and PFC in power utilities
and distribution companies) appear to be candidates for underperformance.
No doubt, all these stocks have underperformed of late. But we do not think that is
reason enough for the underperformance to stop. Valuations of these banks and
financial institutions, we believe, do not fully reflect fundamental concerns yet.
Inflation control may translate into “administrative” suppression of commodity prices
In India there is a history of “moral suasion” by the Government to control commodity
prices contributing to inflation. Steel (8% of WPI basket), non-ferrous metals (1%)
appear to be prime candidates for such control. There are prior instances (cement in
2007, steel in mid-2008) of such indirect price controls. If we overlay this concern with
concern about lack of backward raw material linkages (and hence concern about
margin pressure) for some companies – JSW Steel and SAIL appear most vulnerable
over the near term. Similarly, till the state elections in May, there seems little possibility
of upward adjustment of domestic oil prices. The budget may present another
uncertainty for OMCs – with a very low initial allocation to oil subsidies – contained in
the budget for FY2011. Our reason for reducing Sterlite is different. Two of the biggest
businesses – Zinc and energy – are facing cost pressures. Moreover, in the energy
business Sterlite is facing significant project delays.
Companies that have been pure “Sector beneficiaries”
Some stocks have benefited purely by being in a sector in favour – without any
fundamental stock-specific reason behind their outperformance. In this category, HCL
Tech comes across as a prime example. The entire IT sector has outperformed and
HCLT has outperformed the most, even though the fundamental reasons for
outperformance – good corporate governance, and order book quality (and hence
ability to sustain margins) – seem to lie with the larger peers: Infosys, TCS and Wipro.
Investors seem to be paying for a sharp about 200bps EBITDA margin recovery over
the next few quarters, but we are not fully convinced the company can deliver on this -
more so when our BUY ideas are trading at valuations that do not factor in such benefit
of doubt.
Are these companies well-owned? How liquid are they?
Out of our suggested 18 potential underperformers, only five trade less than USD10m
per day. Only three have combined institutional holding of less than 10%. These are
reasonably well-owned stocks which investors can reduce without significant impact
cost to free up their portfolio for what we view as better stock picks.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
What to SELL despite the decline
Investors need to SELL stocks to BUY into the correction
"Administrative" suppression of commodity prices potential risk
Companies without pricing power could face disproportionate margin pressures
Pure “sector beneficiaries” could be at risk
Sell after a sharp correction? Isn’t it too late?
Asking investors to sell after a 16.2% correction in the market (and 30-50% in some stocks)
may sound like locking the stable door after the horse has bolted. But to buy fundamentally
good stocks available now at attractive valuations (which we highlighted in our February 2nd
note: “What to Buy”) investors may need to free up cash in their portfolios.
Which stocks to sell?
Investors need to move away from potential underperformers, which, we believe, belong to
four baskets: 1) Stocks which have responded to the prevailing concerns but valuations
don’t discount the potential negatives fully; 2) Stocks which may suffer from potential
administrative measures to control inflation; 3) Companies in sectors facing structural pricing
pressure and companies facing disproportionately high pricing pressure; and 4) Stocks that
have outperformed purely by virtue of being in an outperforming sector, not any fundamental
reason.
Concerns on interest rate, asset quality, corporate governance persist
Upward pressure on rates impacts wholesale funded banks and financial institutions more
than banks with strong deposit franchise. HDFC, REC and PFC appear destined for more
underperformance from this perspective. A second concern in the banking sector arises
from potential credit cost increases – which we believe would affect BOI, REC and PFC in
the near term. Similarly, Reliance Power, despite recent underperformance versus Sensex,
may continue to be affected by these concerns.
Potential “administrative” suppression of commodity prices
India’s history of “moral suasion” by the Government to control commodity prices in
inflationary times worries us about companies that don’t have backward raw material
linkages. JSW Steel and SAIL appear most vulnerable over the near term. Similarly, upward
adjustment of domestic oil prices seems unlikely for now, and the budget may throw up
another uncertainty for oil marketing companies – with a very low initial allocation to oil
subsidies.
Disproportionately high margin pressure for some sectors and stocks
Cement, power equipment, merchant power are sectors facing pricing pressure and likely to
suffer in the medium term. Some auto and consumer stocks (Hero Honda and HUL) are
facing a much higher degree of margin pressure than their sector peers.
Pure “sector beneficiaries” are risky
Some stocks have benefited purely by being in a sector in favour – without any fundamental
stock-specific reason behind their outperformance. HCL Tech comes across as a prime
example.
Even after major correction, stocks should be sold tactically
In our recent note “What to BUY” dated 2 February, we highlighted our best Buy ideas
after the recent market correction. We considered these suggestions to be top-tier wellresearched
companies with good management quality and corporate governance.
However, feedback from several investors indicates that:
(i) They need to sell some stocks from their portfolio to make way for the BUY ideas.
(ii) Some investors expect some more downside to the market from present levels, and
are concerned that stocks that have not declined much could be the next set of
“victims”.
In this context it is important to focus on why the Indian market has declined, and which
of the reasons for decline are likely to continue to prevail. For each of these themes,
some stocks have underperformed more than some others, and it may now be time to
consider selling the relative outperformers, in case there is no further fundamental
positive driver for them.
Our starting point, therefore, is the list of outperformers over the past three months (i.e.
from the early November market peak).
It is not surprising that most of the outperformers are from IT, resources (metals and
mining, oil), power utilities and consumers (ITC, HUL). We are surprised by the fact that
cement and select capital goods stocks have outperformed. These are the sectors
facing maximum pricing pressure, and therefore, potentially the highest degree of
margin pressure.
When we look at the themes that have driven the market down and the ones that are
likely to sustain for some more time, some notable ones immediately become apparent.
Pressures of inflation and interest rates, and margin pressure on commodity users are
likely to sustain for some time, and some of these drivers could influence government
policy in the near term. Companies influenced by such policy measures could be prime
candidates for near-term underperformance.
A word of caution about our SELL ideas would be in order. Some of the stocks in our
list have declined significantly and their valuations may appear attractive relative to their
own historical valuation ranges. Consequently, they may not decline much from the
present levels. Indeed, on some of these stocks our long-term fundamental
recommendation is BUY. But we are convinced that these stocks could underperform
the market in the near term, and therefore, from a tactical perspective an investor would
be better off staying away from these names and investing in our fundamentally sound
basket (see our note dated 2 February).
Inflation, interest rates and asset quality of banks
That interest rate hikes are coming is obvious, and is by and large reflected in the
recent underperformance of the rate-sensitive sectors – banks, property and autos.
However, upward pressure on rates impacts wholesale funded banks and financial
institutions more than banks with strong deposit franchises. HDFC, REC and PFC
appear destined for more underperformance from this perspective. A second concern
on the banking sector arises from potential credit cost increases. Banks having
relatively higher exposure to the “risky” sectors (e.g. BOI in Airlines) and financial
institutions exposed to generically risky sectors (e.g. REC and PFC in power utilities
and distribution companies) appear to be candidates for underperformance.
No doubt, all these stocks have underperformed of late. But we do not think that is
reason enough for the underperformance to stop. Valuations of these banks and
financial institutions, we believe, do not fully reflect fundamental concerns yet.
Inflation control may translate into “administrative” suppression of commodity prices
In India there is a history of “moral suasion” by the Government to control commodity
prices contributing to inflation. Steel (8% of WPI basket), non-ferrous metals (1%)
appear to be prime candidates for such control. There are prior instances (cement in
2007, steel in mid-2008) of such indirect price controls. If we overlay this concern with
concern about lack of backward raw material linkages (and hence concern about
margin pressure) for some companies – JSW Steel and SAIL appear most vulnerable
over the near term. Similarly, till the state elections in May, there seems little possibility
of upward adjustment of domestic oil prices. The budget may present another
uncertainty for OMCs – with a very low initial allocation to oil subsidies – contained in
the budget for FY2011. Our reason for reducing Sterlite is different. Two of the biggest
businesses – Zinc and energy – are facing cost pressures. Moreover, in the energy
business Sterlite is facing significant project delays.
Companies that have been pure “Sector beneficiaries”
Some stocks have benefited purely by being in a sector in favour – without any
fundamental stock-specific reason behind their outperformance. In this category, HCL
Tech comes across as a prime example. The entire IT sector has outperformed and
HCLT has outperformed the most, even though the fundamental reasons for
outperformance – good corporate governance, and order book quality (and hence
ability to sustain margins) – seem to lie with the larger peers: Infosys, TCS and Wipro.
Investors seem to be paying for a sharp about 200bps EBITDA margin recovery over
the next few quarters, but we are not fully convinced the company can deliver on this -
more so when our BUY ideas are trading at valuations that do not factor in such benefit
of doubt.
Are these companies well-owned? How liquid are they?
Out of our suggested 18 potential underperformers, only five trade less than USD10m
per day. Only three have combined institutional holding of less than 10%. These are
reasonably well-owned stocks which investors can reduce without significant impact
cost to free up their portfolio for what we view as better stock picks.
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