Market watch- Don’t say we didn’t tell you

ONE SECTOR THAT GAINED THE most from the favourable macro-economic environment in the past was real estate. The sector became a sunrise industry, with companies commanding stratospheric valuations. But now that the central bank has slammed the brakes on money supply and raised interest rates, the sector is facing a meltdown.
Since October 2010, the market value of real estate developers has halved and the street expects more turmoil going forward as demand takes a hit because of rising mortgage rates.

IN THE PAST 12 MONTHS, automobile stocks have outperformed the broader market, with the BSE Auto Index up by 17% since April 2010, against 2% in the Sensex during the same period. But sales are likely to fall, with rising interest rates making it expensive to own a vehicle.
The sector may also face heat from rising crude oil prices and poor industrial production, which will lead to lower cargo movement and low demand for trucks. The worst hit are likely to be commercial vehicle makers such as Tata Motors, Ashok Leyland, and Mahindra & Mahindra, while two-wheeler and small car makers including Bajaj Auto, Hero Honda, and Maruti Suzuki are expected to be hit the least.

Metal manufacturing is a capital-intensive business and companies in the sector carry significant amount of debt in their books. SAIL, the largest steel producer in the domestic market, reported a 28% year-on-year decline in net profit in the first quarter while revenues were flat. Results for Hindalco, the country’s largest aluminium maker, were equally tepid with just a 7% growth in standalone net profit despite a healthy 26% year-on-year jump in revenues.

METALS MANUFACTURERS SUCH AS Tata Steel, Hindalco, National Aluminium, Steel Authority of India (SAIL), JSW Steel, Sterlite, and Jindal Steel & Power are likely to see a fall in their product price and demand.

The market is aware of this and most construction company stocks such as IVRCL, Nagarjuna Construction (now NCC), HCC, and Gammon India have underperformed the broader market in the past one year. This is also
visible in the valuation of BSE Capital Goods Index, which we have taken in the absence of a sectoral index on
construction sector.

Meanwhile, the rising fiscal deficit will constrain the government’s ability to fund or launch new infrastructure projects. Construction is a working capital-intensive sector, so a rise in interest rates may force many companies to limit the number of sites they work on simultaneously.

THE GROWTH AND INVESTMENT DEMAND and construction activity go hand in hand. As banks raise their lending rates to accommodate the hike in benchmark interest rates by the RBI, many industrial and commercial projects may no longer be viable, leading to a contraction in new orders for construction firms.

A slowdown in GDP growth also means a rise in bad loans, which forces banks and NBFCs to make provisions in their profit and loss accounts to make up for potential losses. This was visible in the first quarter results of the country’s largest lender, State Bank of India: a 99% plunge in net profit due to provisioning to account for bad loans, shrinkage in net interest margin, and a slowdown in credit offtake.

While the RBI’s tight monetary policies have made it expensive for banks and NBFCs to raise capital, the expected slowdown in the country’s economic activity will lead to lower demand for loans.

FOR BANKS AND NON-BANKING FINANCIAL companies (NBFCs), cash is the basic raw material. The sector’s financial performance depends on the spread between the cost of funds and the rate at which they lend money (called net interest margin), as well as the level of credit or loan demand in the economy. At present, both these factors have turned hostile.

However, given the corporate and economic diversity, the impact of a hostile macroeconomic environment will vary from one sector to another. While some companies will experience a decline in profits, many will escape with small dips in the pace of growth. The following five sectors are likely to be hit the hardest over the next 12 months.

While the rise in interest rates will make it costlier for companies to borrow to fund their growth plans, curbs on public expenditure, coupled with dearer loans, will pull down demand in interest rate-sensitive sectors. All this translates into poor corporate earnings and revenue and a bearish trend in stock prices.

The skill is especially crucial in the current environment, where policymakers are busy dousing the flames of inflation rather than inducing growth in the economy. This means rising interest rates, tighter money supply, and brakes on public expenditure.

IT IS BELIEVED THAT INVESTMENT in equity isn’t different from betting on horses in a derby. In both, financial gains depend on one’s ability to avoid lemons rather than run after potential winners.