Hope rally over: Why you should go back to 'boring sectors'

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26 Aug, 2025 12:21

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Moneycontrol BureauThe first four months of the Narendra Modi government, which brought in a new ray of hope for the beleaguered economy, carries an eerie “could-have-done-more” note to them and so investors would be well-advised to stick to sectors with long-standing fundamental strength such as IT, pharma and consumers while staying away cyclical sectors such as power, oil&gas, metals and real estate which were first thought to benefit the most from an upturn.That’s the view from a report published by Elara Capital, which believes that the stock market has now moved beyond “anticipation and consensus” and that there are several tail risks to the ongoing market rally.“The Street is building in a capex cycle of the likes in 2004 and 2008,” Elara says, adding, “while we do not dispute the recovery signals, we are circumspect of the relative outperformance of cyclicals over the medium term (12 months).”According to the firm, economic growth for the rest of the year could remained constrained as government expenditure comes off in the months to come to contain the fiscal deficit, the rupee could trend a tad higher, while a final round of interest rate hike could still be in the works thanks to inflationary risks to the upside.“Our counter-consensus view on potential rate hikes, a weakening currency bias and a steep valuation threshold will be the potential challenges for the market and suspect that a time correction if not a price correction will follow,” Elara said. “We are keeping the Nifty trading range intact between 7400 and 8200 for the year-end and see no reason to change it yet.”Here are Elara’s views on various sectors.Oil & gas: Unfounded optimism has resulted in oil marketing companies (OMCs) outperforming the Sensex by 20-100 percent over the past year. We differ from the Consensus as we believe OMCs may not only lose market share, but also marketing margin may be threatened. Additionally, poor refining margin would cloud earnings. Reliance has underperformed the Sensex by ~20 percent over the past year.We believe the underperformance will continue for another year. The core sectors would be EPS-accretive only in H2FY17 at best. Additionally, margin would be under pressure due to low-cost, shale gas-based expansions in the US Although LNG prices have softened, it remains to be seen if Petronet LNG is able to benefit from it. GAIL would continue to witness poor natural gas transmission and trading volume, due to weak volume growth, poor ROCE and concerns on its petchem profitability, owing to a gas price hike.Elara has underweight/neutral on all oil & gas stocks under its coverage barring Oil India and MRPL.Capital Goods: The sharp rally in the BSE CG Index in the past six months, which outperformed the broader market by 19 percent, is on the backdrop of renewed optimism and hopes of a sharp economic revival. While the initial euphoria post the Elections has faded away as the CG index underperformed in the past three months by 12 percent, we think the investment cycle will recover gradually and see 15-40 percent downside to current prices within our coverage. Order inflow is likely to continue from sectors like oil & gas, power T&D, textiles, pharma and food processing, but core sectors like cement and steel would take 12-18 months to reflect on order inflows. Spend in defense and rail is also likely to take some time to pick up. Challenges like eliminating structural bottlenecks in execution, fuel supply concerns and a benign investment climate would cast a shadow on execution, affecting FY15 revenue and earnings.The firm has a sell rating on all the stocks in the sector.Power: India’s power sector continues to face multiple headwinds, owing to fuel shortage, lower PLF (YTD 66 percent for All India, 82 percent for NTPC coal), lower demand, uncertainty over compensatory tariff, risk of cancellation of coal blocks and widening SEB losses, which have led to 18 percent underperformance in the past three months vs the broader market. Public IPPs’ (NTPC, Power Grid, SJVN, NHPC and NLC) have continued with their capex plans but private IPPs have struggled either with stranded assets or operate at a low PLF and post losses due to mispriced PPAs. The government’s proposal of FSA for all projects becomes operational by March 2015 and a cut in e-auction quantity is still to be finalized, but coal supply from Coal India remains constrained (YTD offtake up just 3 percent). Recent deals (RPWR acquiring JPVL’s hydro assets and ADANI acquiring Lanco’s Udupi) have raised hopes of more transactions, but valuation need to be watched. We await further clarity on coal block deallocation, penalty and potential auction. Also, IPPs want a review of new bidding documents, delaying fresh capex.Elara has sell/reduce rating on all power stocks under its coverage barring PTC, SJVN, NTPC and NHPC.Metals: The metals sector volume growth would improve as demand grows. However, as India is a price taker, we rule out any uptick in steel prices as the problem of overcapacity and low cost base remains at global levels. Ambiguity persists on captive coal & iron ore, and we believe captive minerals may provide an assured supply, but costs will be highThe recent surge in non-ferrous metal prices (mainly aluminium and zinc), which are traded on the exchange, reflects improved demand but ignores high inventory. Downside risk remains on prices with strengthening of the US dollar and possibility of rise in interest rate We believe the CMP already factors in FY16 earnings and we could see a time correction in the stock prices. We may see upside in a few stocks like Tata Steel, Hindustan Zinc and Coal India once we rollover to FY17 earnings. Overall, we remain Seller in stocks under our coverage, primarily on a valuation basis.Elara has a accumulate rating on Hindustan Zinc and GMDC.Pharmaceuticals: After reaching new highs this past year, the CNX PHARMA index has generated returns upwards of 50 percent. We believe this structural bull run is set to continue as the companies are well geared to take advantage of the final lap of the profitable patent cliff. We also expect benefits from investments towards a differentiated pipeline to pay out as the regulatory pathway for complex generics opens up. Strong earnings and favorable currency are further expected to boost market performance despite the slowdown in the domestic market and increased regulatory risk.Elara has ‘accumulate’ on Cadila, Cipla, Dr Reddy’s, Glenmark, Lupin, Sanofi and Sun.Auto and ancillaries: India’s auto sector is seeing a demand revival with PVs (volume up 4.5 percent YTD), 2Ws (up 15 percent YTD) and CVs (down 13 percent YTD) posting an improvement, led by low base, change in sentiments post government change and high pent-up demand. Our channel checks indicate cautious optimism at the dealer end, with the upcoming festival season likely seeing a strong demand recovery.However, given the still nascent stage of recovery, we expect firms with strong distribution reach and promising launches to post a better show than the rest. Given the sharpest decline seen in the past two years, the CV sector is expected to post the strongest volume recovery, followed by PVs and 2Ws. Within segments, M&HCV, petrol models and scooters are likely to outpace industry growth on favorable demand dynamics. While OEM valuations at ~16–20x FY16E earnings look stretched in the near term, we see room for further re-rating as demand recovery gains more strength.Elara has accumulate on Hero MotoCorp, Maruti Suzuki, M&M and Tata Motors.FMCG: The medium- to long-term growth potential of the FMCG sector in India is positive. With expectations of an economic recovery and a pickup in consumer spending, the industry is likely to see a recovery in volume growth. Despite the near-term challenges emerging from a weak Monsoon & its impact on raw material prices and spending power of rural populace linger, we are optimistic of the prospects of FMCG companies in India. However, sector valuations of ~30x FY16E earnings are high.Britannia, Marico, Emami are Elara’s top buys in the sector.Banking: In the near term, the banking sector faces challenges in terms of a possible rise in stressed loans from some known chunky loans accounts, further deferment of a lower policy rate and dwindling credit offtake pace. Prevailing premium valuations (after factoring in FY16 estimates) do not justify the banks’ immediate fundamentals; we foresee a downward adjustment in valuations. Nevertheless, our view on the banks’ fundamental performance remains positive for the longer term, Over the past three years, the banks’ balance sheet expansion dragged in the mid-teens, well below its potential & normalized growth. Close to three-quarters of the banking industry (PSU banks) is highly levered with average leverage at ~20x. The fall in balance sheet growth and a rise in delinquency led to a sizeable dip in spread and return ratios. We expect these two fundamentals to reverse in the long term and witness a unidirectional upward trajectory in the banks’ balance sheet expansion along with credit quality improvement. There are noticeable factors for consistent upgradation in earnings estimates & re-rating in multiple, led by traction in return ratios from end-FY15. Our longer-term positive outlook stems from improvement credit costs and possible margin expansion led by write-back of interest income reversals. Also, improvement in business sentiments would increase the banks’ risk appetite, and therefore their profitability. We believe in a weak economic times, the banks reduce their risk appetite to contain credit cost.Elara’s top buys are Axis Bank, ICICI Bank, IndusInd Bank and Punjab National Bank.Cement: Moderate volume growth of 3 percent in FY14 would improve to 7 percent in FY15E and 8 percent in FY16E. Demand acceleration coupled with slowing capacity additions are likely to result in bottoming out of the utilization levels in FY15. Improvement in the utilization levels should improve pricing power and margin of the industry. However, rich valuations would result in limited upside from the current levels.Elara has buy on JK Lakshmi Cement, JK Cement and Orient Cement.Media: India’s media sector is emerging from a two-year slowdown in ad spend, with early signals in the broadcasting and print spaces pointing towards double-digit ad growth in FY15 (ad growth up 11 percent and 10 percent, respectively). For the broadcasting and distribution space though postponement of DAS rollout by one year is a major negative and likely to dampen subscription revenue growth for major companies (~35-45 percent of total revenue). The print sector, with low base in ad revenue (single-digit ad volume growth over FY12-14), tight cost controls and start of ad spend by national advertisers (~35 percent of total ad pie), seems to be on a strong footing and is likely to see strong top-line growth and margin expansion over FY14-16E (~13 percent revenue CAGR and ~200bp margin expansion). Valuations (~13x for print,~10x EV/EBITDA for Dish TV & Den Networks and 16-20x for Sun TV & Zee) are attractive on FY16 earnings and offer room for further upside as recovery gains more ground.Elara has a buy on DEN, Dish TV, Sun TV, HMVL, HT Media and Jagran Prakashan.