Picking sectors that are underperforming or out-of-favour currently (due to some short term issues) and hence are quoting at cheap valuations (compared to their historical averages) is dicey. Sectors that have been underperforming due to macro or industry specific reasons may not have bottomed out and may have some more downside in store. Hence, margin of safety may not be as high as desired in such cases.
Contra picks are by definition not likely to perform in the near term. Hence they could test the patience of investors who could start questioning their decision if things do not seem turning in their favour even after 1-2 quarters. These calls are riskier than regular investment picks. The investor’s call can go completely awry. The investor needs to analyse his risk-appetite before investing. There are times when a sector takes a long duration to turn around; there’s also the possibility that it never finds favour in the market. Hence it would be advisable to take three-four such contra calls so that atleast two-three out of them work out and compensate for the underperformance in the balance.
Here the investor needs to keep sufficiently long-time horizon of about 6-8 quarters. For low risk investors, SIPing over 4-6 quarters in these may also be a good way to reduce risks.
In the current circumstances, three sectors could be looked at:
Here the sector has come under severe pressure due to a multiple headwinds like price erosion in generic portfolio in US due to competition and consolidation of buyers. non-compliance warning letters by US FDA to most of the Indian Pharma majors, volatility due to Trump Presidency and appreciating rupee.
Effect of most of these seems to be in the price in some companies. Strong product pipeline and increasing product launches over next couple of years by pharma companies will help the sector overcome these issues over the next few quarters. Lupin remains one of our top picks in the sector.
2) IT Services
The sector is going through structural changes, with change of spends from traditional to digital and global protectionism. IT companies face slower recovery in the BFSI vertical, retail and healthcare verticals. The transformational initiatives can increase costs and the currency-related headwinds can negatively impact the margins in the near term, despite efficiency gains (from automation and non-linearity). Negative news flow in terms of lay-offs and pricing pressure from clients have impacted sentiment.
Indian IT firms have been gearing-up for transition for some time now, and the speed has gained momentum in the recent months. There is a higher focus on internal efficiencies, local hiring, retraining and optimising the workforce for the new areas of spend, and reducing the visa dependence. Indian capabilities in the IT space are undoubtedly recognised globally.
How these will be exploited under the changing times remains a question. However, a few among the well-known names may succeed in this. Here Infosys remains our top pick among the largecaps.
3) PSU Banks
Stressed loans in India are estimated at about 17% of total loans. In the banking sector, the bulk of the problem lies in the state-owned or PSU banks. PSU bank loans are only growing by 1% YoY whereas private sector banks are enjoying loan growth running at 12% YoY. All these has meant that the valuations of PSU banks has sunk to historically low levels.
The purpose of recent issuance of ordinance amending the Banking Regulation Act is to empower the Reserve Bank of India to intervene in specific cases of default as well as to give the central bank the authority to require specific defaults to be sent to the insolvency court if lenders and borrowers cannot reach resolution. Once the NPA issue is resolved, the way will be clear for the public sector banks to raise capital, post which consolidation of the public sector banks is also likely. All these could lead to rerating of the PSU banking space with some Banks benefitting more than others. Among largecap PSU Banks, SBI is our top pick.