This year too, bet on the shares of big companies

Who says large stocks can’t fetch fabulous returns? If last year’s market movements are anything to go by, it doesn’t really matter what the size of the company is. Large companies gained as much as the smaller ones; in some cases they actually did better. To set the record straight, the stocks of the top 10 private sector companies by sales gained an average 144.23 per cent in calendar year 2003. The market barometer, the Sensex, gained 72 per cent during the same period. The only poor performer was the share of tobacco major ITC – and guess what return it gave during the year: 49 per cent. That was 2003 for you. 

This year will not be the same, for sure. It won’t be the same because after such a euphoric rise, stock prices are unlikely to appreciate by a similar amount or anywhere close to that this year. Returns will be far more subdued at best, and in the worst case, equity returns will settle a notch above those of debt instruments.

But in some ways, 2004 may actually resemble 2003. For instance, large companies may continue to dominate the scene. There are two things going for large companies which were actually fundamental to the 2003 rally. The meteoric rise in stock prices last year was driven by foreign institutional investors (FII) which poured some $6.7 billion into Indian stocks. 

For them, large-cap stocks continue to be an attraction (most large-sized stocks belong to the large-cap category after the run in share prices, and large-caps attract a disproportionately high chunk of FII money). Though many hedge funds which are coming today are investing heavily in small-sized (also small-cap) stocks, the regular institutional investors stick to only large index-based stocks as they benchmark themselves against the MSCI index which includes the biggest stocks by market cap in the prominent sectors. That is point No. 1. 

The other leg of the rally is the very premise on which the 2003 bull run was built – that the Indian story is about the huge outsourcing opportunities and consumer-spending driven domestic growth. Ask which companies are best to be poised to benefit from this phenomena. The writing on the wall is clear and bold – the large ones. They are the ones that have restructured themselves thoroughly to become globally competitive, in terms of size, cost and products. That is point No. 2. So here, say cheers, to India’s corporate biggies. Hopefully, the cheer will show up in the stock markets too. 

The outlook for the largest private sector company Reliance Industries is pretty bright. Analysts say that there are multiple triggers for the stock. Firstly, its staple business – petrochemicals which accounts for 50 per cent of the company’s operating profits and 45 per cent of gross sales – is set to perform well on the back of a cyclical upturn. 

A look at petrochemical prices reveals that current prices are at a nearly 50 per cent discount to their peak levels. Analysts think that this itself lends scope for product prices to rise, given that demand in both domestic as well as international markets is quite buoyant. 
Interestingly, analysts point out that Reliance has been able to show a secular rise in exports despite the appreciating rupee. That means that margins will only rise going forward. Similarly, the Reliance-owned Indian Petrochemicals Corporation Ltd is also expected to gain from the cyclical upswing. Another trigger is Reliance’s telecom business which has finally kicked off and gained market share rapidly. 

With the company expected to break even in 2003-2004, the market eagerly awaits the Reliance Infocomm initial public offering (IPO). This again will give a boost to the Reliance counter. JP Morgan values Reliance shares at Rs 615, based on sum-of-parts valuations. The stock is almost there. 

Analysts are also bullish on the two major Tata companies – Tata Motors and Tata Steel. Tata Steel has witnessed a steady improvement in revenues and profits since 2002-2003, with steel prices rising on the back of good demand. The company’s efforts to improve the product mix and bring down interest cost and other write-off of VRS expenses have also aided its profitability. This year, too, analysts expect the company’s realisation to improve because of an improving product mix and further cost rationalisations. 

Domestic demand looks favourable for now, particularly in the domestic market as key user industries like the automobiles, consumer durables, auto ancillary and construction are booming. However, analysts expect steel prices to ease. Though Tata Steel has successfully repositioned itself from being a mundane commodity player to a niche player in the segment, steel prices will decide the course of Tata Steel this year. 
Though the stock price has jumped from the Rs 150 to Rs 450 levels, operators are active in the stock. If steel prices remain firm and the current sentiment prevails, the stock could settle at around Rs 600.
Similarly, Tata Motors is on the buy list of most analysts. So what if the stock price zoomed 180 per cent last year? Analysts expect Tata Motors to record earnings of Rs 28-29 in 2004-2005, which translate into a price-earnings ratio of 16 times 2004-2005 earnings. Not so expensive. 

The growth triggers are all well in place. The company is planning to ramp up its passenger car capacities led by strong export demand and the success of Indigo. Commercial vehicle sales are also likely to be strong this year with road traffic increasing. As per a report by CL, the Daewoo CV acquisition is timely and synergistic and will reduce the company’s time to market next generation trucks in domestic markets. With the topline likely to accelerate, the stock should also be on the fast track.

Hindustan Lever, a stock that analysts had almost written off in 2002 after two years of lag, is back in the reckoning. While the management continues with its efforts to get rid of non-core business and restructure its portfolio of brands in order to push sales, analysts also believe that the necessary conditions are in place for the company to show decent topline growth this year onwards. Analysts believe that price corrections in several segments have played out and are likely to result in market share gains for HLL from here on. 

Besides, the effect of good monsoons in 2003 will manifest itself in terms of rising rural demand this year, aiding HLL’s topline. “We believe the worst phase of reconciling FMCG price-value-brand dynamics is over and HLL has emerged successful by quickly adapting to the changed paradigm. 

With the best farm incomes in almost five years likely to rejuvenate the pace of penetration, per capita usage and eventually trigger uptrading, HLL is the best positioned to leverage on the upside with both EBITDA and earnings growth rate set to accelerate over FY04-05,” says a research report by ICICI Securities (I-Sec). The stock is expected to be ahead of the pack in 2004.

Another company that would benefit from higher disposable income is tobacco major ITC. ITC was a non-performer in 2003, so to speak. The stock price appreciated by 49 per cent last year, but analysts are a bullish tune now. The very fact that the stock underperformed last year is making analysts bullish on the stock. But their argument runs like this: for the second half of 2003-2004, cigarette volumes are expected to grow by 3-4 per cent versus just about 1 per cent in the first half. 
This will be propelled by rural smokers migrating from bidis to cigarettes with the rise in income levels. The focus, however, will be on the non-cigarette FMCG business. As per a report by I-Sec, a rapid expansion of the paperboard business and an upswing in the hotel industry will aid profit growth in the coming years. In fact, the paper board as well as hotels industry saw good growth last year. 

Analysts expect ITC’s hotel division to turn profitable and economic value added (EVA) positive over the next three years. This should help ITC’s return on capital improve as the hotels business has been dragging down returns in the past. Besides, the final decision on ITC’s luxury tax and excise cases will also be triggers for the stock. Currently, the stock trades at 13.7 times 2003-2004 earnings which is not expensive, analysts reckon.

If there is one stock where analysts would be cautious right now, it is Grasim. After a euphoric 218 per cent rise in its stock price last year, there is little justification for it to rise any further. A report by ASK Raymond James says that all the re-rating triggers for the stock are over: “Strong historical earnings growth, a steady improvement in the balance sheet on the back of a reduction in working capital, consistent reduction in the debt-equity ratio, a cyclical revival in all its businesses, the acquisition of L&T cement and extreme under-valuation combined to lead to a huge re-rating of the stock.” 

The fundamentals also look somewhat unfavourable. Earnings growth in 2004-2005 could slow down as cement prices are expected to remain weak. The company’s other major business, viscose staple fibre, is expected to face capacity constraints, according to ASK Raymond James.

Analysts are, however, upbeat on the other A V Birla group biggie, Hindalco. This metals major is among the lowest cost producers of aluminium in the world. Analysts say that while the long-term outlook for non-ferrous metals looks bright, the continuing demand-supply gap in Asia presents Hindalco with a great opportunity. 

Hindalco with sales of Rs 5,500 crore is emerging as a metals conglomerate with global size and competitive positioning. While the domestic demand cycle bottoming out, Hindalco is planning a brownfield expansion in aluminium which should help in ensuring volumes and cost savings. As a result, earnings are likely to grow at a compounded annual growth rate of 25 per cent through 2005-2006. The stock currently trades at 11 times fiscal 2003-2004 earnings, leaving enough room for expansion.

ICICI Bank is a perfect bet as far as retail growth goes. Analysts are bullish on the bank’s growth prospects. However, they believe at current prices the stock is fairly valued. The key driving force for the bank will continue to be its retail focus which forms nearly 50 per cent of total advances. 

Retail assets have grown by 110 per cent year on year as in September 2003, and the bank is adding nearly Rs 300 crore of retail assets assets every quarter. Thanks to the retail growth and falling cost of deposits, the bank’s margins are also on the rise. In the second quarter of 2003-2004, interest margins improved to 1.8 per cent from 1.2 per cent in the corresponding previous year. Analysts expect the bank to end the year with net interest margins of around 2 per cent. 
The repayment of erstwhile ICICI’s borrowing should also help in margins booming. While the legacy non performing assets (NPAs) continue to be high for the bank, analysts derive solace from the fact that the incremental NPAs have been low. The stock trades at 11 times projected fiscal 2005 earnings.