Sectors to watch in 2020: Keep your powder dry for these stocks

Amit Khurana

Has the economy bottomed out?

That’s the crucial question everyone is seeking answers to. We believe that data over the next couple of quarters will offer some insights into the direction it is headed in.

Rural stress continues to pose a key headwind to the resumption of trendline GDP growth as does the slowdown in real estate. We see evidence of real estate players beginning to unwind their inventory at heavy discounts, but it’s sporadic yet. Also, the significant consolidation that the sector is seeing will only accelerate, going forward.

The next vital point to watch is the trajectory of growth -- In the base case scenario, and being safer in our assumptions, we expect the pace to be gradual. As this is increasingly confirmed, we expect investor confidence to grow, favouring more allocation to India.

Are financials over a barrel?

The NBFCs (non-banking financial companies) remain the vulnerable block here, and that does have a bearing on the banks as well. Beyond this, we expect banks to be better placed as incremental slippages are lower than averages of the past few years, and the RBI extends its easing policy. Further, resolutions and the resultant inflows could help drive better earnings, and more importantly, because of more confidence in the IBC (insolvency and bankruptcy code) mechanism. The measures to include financial entities (ex-banks) in the IBC mechanism will, to an extent, address the concerns from a systemic angle. However, the real evidence that markets will be watching for is the pace at which recoveries take place, and how much.

Push for growth and demand

The sharp slowdown presents a tough choice for the government -- to stick to its agenda of a tight fiscal road map even when adjusted for corporate tax cuts, or favour growth at the cost of letting fiscal goals slip. In our view, the government urgently needs to address the twin challenges facing the economy -- rural/farm stress and the sharp contraction in overall demand.

Some measures expected by investors include meaningful reductions in income tax rates at the lower to mid income segment. Also, the tweaking of taxes for investors (read equity) will be high on radar. The concomitant rise in deficit can be part funded by the divestment proceeds.

In that context, the divestment of PSUs (public sector undertakings) and the budget (due February 2020) will be keenly watched for government’s response. As for the deepening rural slowdown, support needs to come from the fiscal spending to generate employment, failing which this may turn out to be a protracted contraction.

Financials

As the resolution process for NPAs (non-performing assets) accelerate and banks strengthen their balance sheets, we expect better performance from them next year. Our preference is for large private banks and then SBI among state-owned lenders.

Our FY21 estimates project a 16 percent income growth and 40 percent plus net income growth for our universe of stocks. These will be driven by lower provisions and better credit growth.

Top Picks - ICICI Bank, HDFC Bank, SBI, Axis Bank

Cement

The sector has been facing multiple headwinds, hurt by muted volume growth and price issues. We expect these factors to turn better marginally, with the advantage of lower cost of inputs accelerating operating profitability.

Top Picks - ACC , JK Cement, JK Lakshmi

Chemicals

It’s one of the structural stories at play for India. The sector and companies are back on the table after almost two decades of wilderness! And the ordinary driver for the change is tighter environmental regulations in China. That is leading to major cutdown in capacities and shifting of some of the demand to India. Historically, Indian companies have had strong chemical skills. And, the Chinese developments are leading to a revival of India-based supply chains. The notable factor is that there is a wide universe of well-managed companies to choose from.

Top Picks - Atul / Navin Fluorine

Telecom

It may seem that returns have already been generated in this sector over the past few weeks. We are in agreement but only partly. There are still some more gains that could accrue in the next 12-18 months. First, the recent price hikes, after a long time, establish the intent of the players to turn their focus on profitability.

Our base case is that three private players will survive, of which two will generate decent profits. Even if one of the players were to shut down, we expect the gains to accrue to the other two and add to their returns. The government has clearly stated its intent to support with necessary steps. We expect players to raise fresh capital to be able to manage their liability payouts and then set out to generate normalised ROE (return on equity).

Top Pick - Bharti Airtel

Amit Khurana is CFA, Head of Equities, Dolat Capital. Views are personal.