Mkt fall leaves a slew of undervalued stocks

Stocks available at a discount
It will be hard to find other spheres of human interest where the tide turns as fast as the stock markets. The India growth story ruled the roost till January '08. That seems like distant past. And, the present is marred by concerns of slowing growth and rising inflation. The difference between the immediate past and present is that the stock market has lost almost one-third of its market capitalisation. Surely, these are the toughest of times to say anything about the future course of the market.

However, every sharp fall leaves behind a slew of undervalued or discounted stocks. But, what it does not leave behind is the optimism, which was available in abundance when the market was scaling new highs every other day. A detailed ETIG analysis reveals that the latest downturn in the market has thrown up opportunities in the form of beaten-down stocks. We must warn investors that nothing can be said about the near term outlook of financial markets, as the general elections are round the corner, which may add to the volatility even further.

Therefore, investors are advised to stay put in these discounted stocks for at least three years to reap gains. We have considered large-cap and mid-cap stocks, which have shed more than 50% from their 52-week highs. A deluge of real estate and brokerage houses figured in this list. We have avoided these two sectors, as uncertainty looms large over their prospects.

The real estate stocks are extremely volatile, as they are still in the nascent stages and there is no consensus as to how to value such stocks. The stock prices of brokerage houses rose sharply last year after their initial public offerings (IPOs). The booming stock market added to their kitty, as volumes soared and a host of companies came up with new issues. But, the current outlook is weak, as volumes have dipped and IPOs have almost dried up. But is everything fine with other sectors?

The dynamics of sectors like petroleum, capital goods, banking, metals, auto, pharma and FMCG have also changed in the past few months. Petroleum is the most talked about sector these days, as crude oil prices have soared above $135 a barrel and are expected to touch $150 soon. But, the profitability of government-owned petroleum companies is determined by the government's policy, which is right now tilted towards keeping the prices low for retail consumers.

However, standalone refiners and private players, which stay out of the ambit of the subsidy mechanism, will continue to do well. Capital goods is another sector on the firing line. The market expects the sector's growth to be adversely affected as the investment cycle peaks. However, the slowdown may, in the worst case scenario, bring down the sector's topline growth rate from 30% over FY04-08 to 15-20%. This is backed by the fact that capacity addition in the power sector continues to move at a brisk pace.
Major capital goods companies such as Larsen & Toubro (L&T) and Bharat Heavy Electricals (BHEL) are still overflowing with bulging order backlogs. However, the rising prices of metal and other industrial commodities are a concern for the industry and may dent its profitability in the near-to-medium term. Banking is another industry, which was growing at healthy rates but has now hit a roadblock. Banks witnessed shrinking spreads in the fourth quarter.

They can no longer improve the spreads and, therefore, growth in the bottom line will be at par with the growth in business. Moreover, rising interest rates will adversely affect the balance sheet growth of banks. In such a scenario, only those banks will do well which can change their asset mix by focusing more on high-yielding assets and have well laid-out plans to reduce their cost of funds. The other victim of rising interest rates is the auto sector. It is passing through a sluggish phase, as rising input costs compress the margins in a stagnant or slow growing market. However, there are a few positives.

A lower effective tax rate and recent salary hikes for government employees are likely to cushion the sector to a certain extent from negative sentiment. The passenger car segment looks more attractive than the commercial vehicles and twowheeler segments, which are more negatively impacted by the higher interest rate and lower credit availability. With high metal costs contributing to rising input prices, steel is one of the few sectors which can boast of a positive outlook.

Average steel consumption in India stands at 40 kg per capita, which is far lower than the global average of 139 kg per capita. International Iron & Steel Institute (IISI) expects global steel demand to grow at around 7% globally and 10.5% in India for the next two years. Hence, it's no surprise that most Indian steel makers have large expansion plans. However, rising input costs and various government measures to cool down steel prices are acting as dampeners for the sector.

FMCG is another sector with a positive outlook. Since '05, this sector has recorded faster revenue and profit growth on the back of higher consumer spending and disposable incomes. Moreover, inflation has turned out to be beneficial for the sector, as rising prices provide ample opportunities for leading players to further beef up their profit margins. A portfolio of strong brands enables these companies to successfully pass on the cost inflation to consumers. Apart from FMCG, pharma is another defensive sector.

After a period of poor market performance over the past two years, the sector has outperformed the Sensex since the beginning of the calendar year. In the current bearish scenario, this is expected to continue over the next two years, as this sector will be an obvious choice for risk-averse investors. The not-so-good outlook of India Inc notwithstanding, investors should consider picking up reasonably discounted stocks.

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