Best stocks from the Worst Industries

Buying at the bottom and selling at the top is a universally accepted stock market rule, but few people have the courage or discipline to follow it. The rule becomes all the more important now with the market near its all-time high. Herd mentality is the biggest mistake investors make in bull markets like these. Since most stocks have already moved up significantly, well above what is warranted by their fundamentals, theres no point chasing them further. The best strategy right now is to identify sectors and stocks that are yet to participate in the rally in a big way. Another rule that investors need to keep in mind is about sector rotation. Each bull market rally brings its own sets of favourite sectors and stocks and rarely does a sector or stock, that leads one bull market rally, participates in the next. Why? First, it can be purely due to "investor folly". Since everyone starts chasing the same sets of sectors/stocks, valuations hit the roof. For instance, Information, Communication and Entertainment sector stocks (popularly known as ICE) were the darlings of 2000 rally with most stocks from this sector quoting at unrealistic valuations. Once the fancy goes, prices tumble, bringing valuations well below what is warranted. This is another extreme behaviour and it happens because investors, who are still nursing their wounds, totally desert these sectors irrespective of how the sector is or companies are performing. Though Indian IT companies remained fundamentally strong and continued to show decent growth, their market price rarely went up. For example, Wipro, a fundamentally strong IT major, is still quoting at Rs 430, 56% lower than its adjusted peak of Rs 980 (in February 2000). Once we consider the rise in markets (Sensex and Nifty trebled from the 2000 peak), we will know the level of underperformance of this stock since the "tech bubble". The comparative price chart of Wipro and Sensex since Feb 2000 will reveal this. This is despite the fact that Wipro outperformed Sensex in the recent rally that started from March 2009. Secondly, it isnt just investors' folly. The problem goes beyond overvaluation. Companies themselves get carried away with the hype, and take up projects beyond their means landing themselves into trouble. The problems can be due to over capacity, unrelated diversification, liquidity issues, etc. And since the companies themselves are in trouble, the investor steeper than in the first case.

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Investing in stocks that have not participated in the rally is a very small step. The main task is to identify the right sectors and stocks. The first step is to know why these sectors are underperforming the market now. If a sector is only going through a temporary cycle there's isnt much to worry. But one must avoid those facing fundamental problems.

Likewise, it is safer to avoid small industries that are in trouble, unless youre sure about their survival. The reason for this is that small industries can sometimes go out of business (like type writer industry did some time back as computers took over). Big industries that are essential for our economic well being (like cement, steel, telecom, real estate, oil and gas etc) tend to survive and come out stronger from the cycles. The second and the most important step is picking the best stocks in these industries. Here are six stocks worth investing in from sectors that have not been doing well recently. The data and analysis used in the story are based on market conditions prevailing between December 6 and December 10. Oil & Gas The sector's underperformance can be attributed to the non-transparent price control mechanisms. Things may worsen as the US dollar is expected to weaken, pushing global crude oil prices up again. But all companies from the sector are not affected uniformly. While PSU companies may continue to suffer, impact on private sector companies like Reliance will be limited due to huge exports. "Reliance Industries looks interesting because its refining margin has improved to around $8 dollar", says Deven Choksey of KRC Research. Further, its international expansion plans will also act as cushion. Another segment that is not affected by govt controls is the oil exploration sector, in fact, it will be a direct beneficiary of crude price increases. With an owned fleet of 19 rigs, Aban Offshore, the largest private sector offshore drilling company in India and among the top 10 globally, should be able to take advantage of high oil prices. A major concern for investors in Aban has been its high leverage (total long term debt as of Mar 2010 was Rs 13,946 cr against shareholders funds of Rs 2,181 cr). This concern too will subside once the company's long term fund raising plans go through.

AlternateEnergy The crash in crude prices from July 2007 has taken the sheen out of alternate energy producers and capital goods manufacturers catering to them. Suddenly their funding stopped, orders got cancelled and investors started doubting their viability. The quantitative easing plan from US Fed, however, has revived hopes of oil prices moving up. And that means good news for the industry. Praj Industries, the biggest Indian solution provider for the ethanol industry, is expected to benefit from the expected increase in crude prices. Though the company reported disastrous September quarter results (topline fell to Rs 138 cr from Rs 218 cr due to deferment of orders; net profit fell 80 percent to Rs 7.83 cr), things have started stabilising now. The company got fresh orders worth Rs 150 cr last quarter (60 percent of which are from international markets) taking the overall confirmed order book to Rs 600 cr. This needs to be executed over a period of 12 months. New enquires are also increasing significantly with ASEAN and Africa at the forefront of new orders. Domestic ethanol production is also seen to go up after the govt recently raised the ethanol price to be paid by oil marketing companies to Rs 27 from Rs 21.50 per litre. Sugar The market cycle suggests this isnt a good time to enter the sugar industry. The sugar cycle turned sour in Jan 2010 and is expected to remain like that for some more time. Unlike historical cycles, however, fortunes of sugar companies are being associated with international crude oil prices because of ethanol, oil blending programmes. The possible diversion of sugarcane for ethanol production in Brazil (primary producer of ethanol), is the main trigger. That explains why global sugar prices have started going up again. But the main trigger for the Indian Sugar sector will come from sugar decontrol, as and when it happens. Balrampur Chini, India's second largest sugar producer, is best suited to benefit if sugar prices continue to move due to the ethanol, oil linkage because of its strong fundamentals. Further, growing revenues from the power and counter weight against the sugar cycle.

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The real estate sector is not out of the woods yet, but things have started stabilising. Most real estate companies, for instance, are reporting good volume growth. Further, they are still quoting at reasonable valuations. "Since the sector weight right now is very low, this sector may get a structural re-rating once things improves further", says Tarun Sisodia of Anand Rathi Securities. HDIL is one stock that is expected to benefit immensely from the possible re-rating of the sector. Phase I of its Mumbai Airport Rehabilitation Project is nearing completion and shifting of 20,000 slum dwellers from the MIAL area is expected to finish by Mar 11. Completion on deadline will be major factor for HDIL's re-rating. Further, it has raised Rs 3,470 cr since May 09, including Rs 1150 cr QIP recently. The reduced debt level is likely to aid its land acquisition programmes in future.

Electronicmedia The sector is underperforming the market primarily because of the loss reported by several big players. Further, the September quarter results may not be that great for the industry due to the base effect (major festivals Navrathri/Dussera, which fell in the second quarter last year came in the third quarter this year). Zee Entertainment Enterprise is a strong company from this segment. It has smartly come out from the ad market slowdown and ad revenue has jumped sharply in recent quarters. Further, its subscription revenue also grew at a brisk pace largely due to the increasing contribution from the direct to home (DTH) subscriptions. The Dec quarter is expected to be good, for the media sector in general and for Zee, in particular says Apurva Shah of Prabhudas Lilladher. Still Zee has underperformed the broader market along with other media companies in the recent past. Once the focus comes back to the sector, this counter is expected to outperform again. Telecom Though mobile users are happy about falling call rates, investors are worried about its impact on profitability of these companies. This is why leading mobile operators grossly under performed the market in the recent rally. But analysts say that rates can't go down much from current levels. "Telecom tariff war is past", avers Deven Choksey, managing director, KRChoksey Securities. Bharti Airtel, the leading GSM player with 14.3 cr subscribers and a market share of 29% as on Sep 30, 2010, will be the biggest beneficiary if the tariff war ends and the industry gets into a consolidation mode. With its African operations to be consolidated for the whole of the second quarter, the uncertainty regarding the impact of call rates cut in Africa will also be over.