Jun 10, 2004|
Stay focused on long term fundamentals
Markets have lost around 15% in the last one month and one of the most important factors is the unexpected result of the Indian general elections. Other factors were rise in crude prices and an expected rise in US interest rates both of which have led to the weakness in other global markets. Keeping this as the background, we conducted a poll asking our audience the question "In your view, which sector is likely to get more adversely affected from the change in government?"
The opinion poll results are shown below and indicate that a substantially large majority of the audience feels that the banking sector is the biggest loser post the change in the central government. The power sector according to our audience is the second most likely to be affected by the change in government. The rest of the votes have gone to the energy sector. To an extent the audience is justified to name these three sectors as likely to be the most affected, however only to an extent. The banking power and energy stocks are still dependent on the government policies, however one needs to ascertain the strength of this dependence.
In a power deficient country like India (peak shortage stands at around 13%), the earlier government had introduced fundamental reforms measures in the Indian power sector. To name a few, privatization of State Electricity Boards (SEBs), securitisation of the power dues, stopping free supply of power to farmers were among the major ones. As a result, the power sector turned out to become one of the favorite sectors for investment in last one year, thus stocks gained substantially based on the expected future potential of the sector.
But with the change of government, investors have lost confidence in the continuation of power reforms, as the allies of the new government are demanding review of some of the sections of the Electricity Act 2003 (like privatization of SEBs, continuation of free power to farmers), which if initiated may delay the inevitable reforms process of the sector. Apart from reforms in the sector, a fundamental issue to be addressed at this point is that irrespective of the government at the center, until new capacities are set up, India will remain a power deficient country. While Indian companies are going forward with their proposed capacity addition, it will take a while before these capacities come on line and by then the demand supply gap may have increased.
Hence reforms, both to ensure profitability of the power generators and further investments in the sector are sorely needed at this point of time and any delay in the same will only affect the overall growth of economy. Remember, electricity is one of the prime movers of economic growth for any country. While the prospects of the overall sector are still blurred, individual companies may still continue to outperform over the long-term. Hence the investment in the sector needs to be selective and long-term in nature.
* Period between 6th May to June 9th
Over the last three years banking stocks have had a strong run on the stock markets. This was due to the improving fundamentals of the sector, mainly due to portfolio gains, Securitisation Act and the government's intention to carry out further reforms in the sector. The government had gone to the extent of proposing a further increase in the FDI limit in the sector and the reduction in the government holding in PSU banks to 33%. However, the new government has raised doubts over the disinvestment, voting rights and FDI liberalisation in the sector. This has led to significant amount of weakness in the sector.
However we would still like to maintain our view that the core business fundamentals of the sector have not changed. Though consolidation in the sector may be delayed, business growth in terms of credit growth is expected to pick up. Most banks with better technology and improved asset quality are in a better position to cater to the new credit demand growth. We believe that the market participants overreacted toward bank stocks post the change in the government at the center. There are still banks with strong fundamentals that are looking attractive from a valuations perspective. Thus here again the investment rationale must be selective and long-term.
Energy majors like HPCL and BPCL gained substantially on the bourses as the previous government decided to push ahead with the divestment of these companies. Supported by improving bottomlines, refinery and oil exploration stocks rose further due their cheap relative valuations as compared to international peers. With the change in government, the issue of divestment has been put on standby mode. Also, there can be some change in the profitability of energy companies, unless the government decides to hike the domestic oil product prices. Refinery companies on the other hand are likely to benefit, as their margins are dependent on crude prices, so higher the crude prices, higher the refinery margins. Thus the impact on the sector has been mixed, however the prospects of the sector within a growing economy are still strong. The benefits of the same, however will accrue only over the long-term.
The message is clear, do not expect phenomenal gains like that seen in 2003. Also it pays to be invested in fundamentally strong companies, as in case of such surprises these are the stocks that will help the investor to tide over difficult times.
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