Companies heading for upgrade could yield better returns for investors
According to current consensus estimates, the net profit of India Inc. should grow 12% and 18% in 2016-17 and 2017-18 respectively.
A good monsoon in 2016, predicted by the meteorological department, is also a key reason behind the positive outlook, as is the expected improvement in the nominal GDP growth rate. “Our nominal GDP is expected to grow from 8.7% in 2015-16 to 11% in 2016-17 and, whenever such a turnaround happens, corporate earnings grow significantly,” says Aneesh Srivastava, Chief Investment Officer, IDBI Federal Life Insurance. Not surprisingly, analysts are getting increasingly bullish on several counters.
“Considering the fourth quarter numbers of 2015-16, the downgrade season seems to be a thing of the past,” says Rajesh Agarwal, Head of Research, AUM Capital. And, if things play out as expected—normal monsoon and passage of the GST Bill in the Monsoon Session of the Parliament—we may be getting into an upgrade season. We have identified sectors and stocks that are heading for further upgrades and, thus, are likely to generate better returns for investors.
The likely winners
“There is scope for further earnings upgrades in consumption-related sectors,” says Srivastava. Colgate-Palmolive is among the top 10 stocks with the highest upgrade in ratings. Other stocks from the FMCG (fastmoving consumer goods) space should also benefit from a good monsoon. Auto stocks too should ride a good monsoon because of increased rural demand spurred by better rural incomes.
Non-banking financial services companies (NBFCs) have seen major earnings upgrades. “Demand for loans from the NBFCs should go up in the future, given banks are tied down with asset quality issues and are reluctant to lend,” says Agarwal. RBI’s ontap licencing policy—making issuing of licences to new banks a continuous and not an intermittent process—is another positive for NBFCs. “Though most NBFCs applied for banking licence last time, they did not get it. So, many NBFCs will be interested now,” says Agarwal. M&M Financial Services is keen on securing a banking licence and, when it happens, the counter will get a major boost.
While Kotak Mahindra Bank, a retail consumer-focused bank, got into the top 10 ratings upgrade list, PSU banks languish at the bottom. However, some experts feel that ratings cut for PSU banks is overdone. “Since the expectation levels are very low, there could be some positive surprises from PSU banks,” says Kartik Mehta, VP, Institutional Research, Sushil Finance.
The cement and steel sector is also expected to better its performance. Jindal Steel, JSW Steel and ACC are among the companies that have seen the highest ratings upgrade. “Cement and steel companies should do well because of the government’s continued infrastructure and developmental push—housing for all, smart cities, roads, etc.—which should increase their demand,” says Agarwal. Since cement is a domestic commodity, manufacturers should be able to reap the benefits of increased demand. However, the situation for steel companies is a bit tricky because of excessive steel capacity in China—its dumping in India can’t be ruled out.
While the government is moving ahead with a large number of infrastructure projects, most infrastructure companies continue to struggle with a huge debt. However, this can also be an opportunity for infrastructure firms with sound fundamentals. “Being a fundamentally strong company, Larsen & Toubro should continue to do well,” says Mehta.
Surprised that there is no IT or pharma companies in this top 10 list? IT continues to do well but the sector hasn’t seen a ratings upgrade largely because of the high base effect. The Indian pharma firms, on the other hand, are going through a tough period—especially, the large players. “Large-cap pharma stocks may not report earnings growth as seen in the past due to a high base and high R&D and compliance costs (several companies have received notices from the US FDA),” says Mehta. However, Mehta is bullish on select mid-cap pharma companies such as Biocon. “Most of the R&D spend has already happened for Biocon and the results should start coming out soon,” says Mehta.
Finally, a word of caution: “The current consensus estimate for 2017-18 is on the higher side,” says Vinod Nair, Head, Fundamental Research, Geojit BNP Paribas Financial Services. While the expectations for 2016-17 are moderate, and this gives scope for further upgrades, analysts have not left that scope for 2017-18.