Notwithstanding a strong run by the S&P BSE Information Technology (up 60 per cent) and S&P BSE Healthcare (up 22 per cent) indices in 2013, most brokerages are still positive on these two sectors in 2014.
While the Street view on consumer sectors remains weak, given peak valuations and slowing volumes, they remain optimistic about these two defensive sectors, on a favourable demand scenario in domestic and export markets, along with the likelihood of a weaker rupee.
“We expect divergence between the investment cycle and middle-income consumption on the one hand, and low-end consumption on the other, to continue.
“Indices are reflecting this divergence, with consumption and exporters gaining weights from industrials, materials and banks. Our model portfolio stays defensive,” says Neelkanth Mishra, head-Indian equity strategy at Credit Suisse.
Many believe the domestic investment cycle and policy reforms will take another year or two to gather pace.
In 2014, the Lok Sabha election, rupee moves and the US Federal Reserve’s tapering of its expansion programme are other overhangs.
“We believe private capex is still 12-18 months away, as overall capacity utilisation of various sectors in India is around 70 per cent and the private sector can wait for the new government to firm up policies,” says Rakesh Arora, managing director and head of research, Macquarie Capital Securities.
These issues, along with better growth visibility and reasonable valuations, will mean IT and pharmaceutical stocks will continue to do well.
IT An improving US economy (60-65 per cent of Indian IT companies’ revenues), continued upticks in discretionary spending (due to higher corporate profits) and US Fed tapering (leading to pressure on the rupee) are the key reasons driving performance of this sector in 2014. Large-scale deal renewals in Europe will provide a further boost.
Consequently, most IT companies and analysts remain confident of the deal pipeline and believe FY15 will be better than FY14.
“The IT sector continues to see earnings upgrades and we believe the sector would likely benefit further from the early signs of demand revival in the US,” adds Rakesh Arora.
Key risks remain passing of a stricter version of the US Immigration Bill (containing the outplacement clause) and sharp rupee appreciation.
Recently, Nasscom, the IT sector association, also said it expected better revenue growth for Indian IT in 2014. It believes FY15 growth could be slightly better than the 12-14 per cent expected in FY14.
Among the key picks of analysts are HCL Tech, Tata Consultancy Services and Infosys. The strong performance of Infrastructure Management Services (IMS) has more than offset the weakness in HCL Tech’s core software services business (62 per cent of revenue) so far.
While IMS is unlikely to slow down, the re-rating of the stock is likely once core business picks up. Analysts say this could happen sooner than later.
TCS has been firing from all cylinders and outpacing peers for many quarters.
The consistent performance has made a stock a safe bet in the sector, a trend likely to continue.
The Street remains fairly optimistic on Infosys, too, expecting it to benefit from the ongoing restructuring.
Cheap valuations and pick-up in discretionary spends are other positives.
Notably, Infosys and Wipro are trading at a 12-13 per cent discount to their historical average one-year forward price-earnings multiple.
While HCL trades at 14.5 times, similar to its average, TCS is trading at slight premium valuations of 21-22 times versus its historical average of 20 times.
This premium, however, is likely to continue due to the company’s superior and consistent performance.
Health care Healthy traction in the US generic market (about 40 per cent of revenue for large Indian generic players) and market share gains is likely to drive 19-20 per cent export growth for the sector in 2014.
Aiding the profitability are launches of limited competition products and niche therapies, as well as products under exclusivity.
While a large part of the pharma outperformance in 2013 came from markets outside India, the domestic segment (30-40 per cent of large health care companies’ revenue), hitherto a laggard, could revert to normal growth.
The sector was impacted by the new drug pricing policy and issues on share of commission with channel partners, largely resolved now.
“In our view, sector valuations still yield a decent upside from current levels and we expect average potential upside of 25 per cent for our top picks (Lupin and Glenmark),” says Balaji Prasad, pharma analyst, Barclays Capital.
The sector currently trades at 18 times FY15 estimated earnings, in sync with its historical forward valuations.
Outbound acquisitions by Indian companies are also likely to increase, as it will help these strengthen foothold in the US.
Key risks include compliance with regulations of the US regulator, the FDA, and other regulatory bodies, beside sharp rupee volatility.
Sun Pharma is likely to reap near-term gains from a delay in relaunch of Doxil (a cancer treatment drug) by Johnson & Johnson.
Strong traction in Taro has boosted Sun’s performance and analysts expect this to continue. Its premium valuations vis-à-vis peers are likely to sustain, given the differentiated US pipeline and domestic performance, with the presence in the high growth chronic ailments segment.
Dr Reddy’s continues to see strong growth in the US generic market.
The company has benefited from US FDA issues for its key competitor, Wockhardt.
The latter’s (25 per cent market share) exit from the Toprol-XL segment provides it a chance to raise market share in this segment.
The stock trades at a 10-20 per cent discount to peers and analysts believe this gap could reduce.
Lupin is witnessing strong traction in the therapeutic areas (oral contraceptives, opthalmics) and is expected to post at least 20 per cent annual revenue and profit growth over the next two years.
Analysts believe its return ratios are likely to improve and drive re-rating of the stock.
