Good times will roll on

It may not have ended with a bang, but the financial year 2009-10 has brought cheer to companies as the fourth quarter results have turned out to be better than expected. The metal sector has contributed significantly to the earnings growth, owing to higher realisations. Though some areas have been disappointing because the results were below expectations, on the whole there is optimism in the markets. We expect the Nifty companies to post a year-on-year profit growth of 25-28 per cent in the fourth quarter.

Apart from the metal sector, earnings in automobiles, banking and IT have also seen an uptrend. One of the key factors for better-than-expected fourth quarter results has been the rise in top line growth, which had been a cause for concern during the first half of 2009-10. Profits in the first two quarters of the previous financial year were driven by low raw material costs and lower interest expenses.

However, we are now witnessing signs of a pick-up in top line growth due to the strong industrial activity and credit off-take. Given the low base effect in the first half of 2009-10, when revenues were low across all sectors due to the downturn, we expect this growth to be strong till the December quarter. After this, the base will become higher, resulting in a moderation of top line and bottom line growth.

There may be some pressure on margins since the prices of raw material have increased sharply over the past 15 months. However, companies have been able to pass on some of the increase in costs to end-users. This is evident from the higher realisations for the metal and auto sectors. Also, the uncertainty in demand from developed nations, coupled with the cooling off of the Chinese economy in the second half of 2010, is expected to cap the commodity prices, thereby easing pressure on input costs. So, though margins may come under pressure, companies will be able to shift the rise in cost
to end-users.

Currently, the stock market may look expensive based on the 2009-10 earnings. However, it is trading at 13.6 times the 2011-12 estimated earnings, which, by historical standards, is not expensive. Therefore, given the strong earnings growth expected from corporate India, we believe good companies will still offer attractive returns in the next two years.

With volatility levels having risen in the past couple of weeks, any correction in the markets must be used prudently to buy into the Indian growth story. We have been recommending a thematic approach to build a stock portfolio of those companies that are likely to profit from the country’s expected economic growth. Investors should diversify and consider multiple themes, such as consumption, asset creation, financial inclusion and technology innovation.

The sectors to focus on in the consumption theme are agriculture, FMCG, pharmaceuticals, retail and automobiles. Some of our recommendations in this area are Jain Irrigation, ITC, Cipla, Pantaloon Retail and Maruti Suzuki. All these companies are leaders in their respective sectors. In the asset creation and infrastructure space, which is poised for exponential growth, investors could consider industry leaders such as Bhel, Larsen & Toubro, IVRCL Infrastructure and Reliance Industries. The banking and financial services sector is one of the best long-term investment options. Some of our best picks are Axis Bank, Bank of Baroda, HDFC Ltd and Punjab National Bank. Top IT companies have also provided a positive outlook for 2010-11.

Investors will gain good returns from these stocks as long as they are patient and invest with a time horizon of 2-3 years.

Pallav Sinha is MD & CEO, Fullerton Securities and Wealth Advisers