THE STOCK market is one place which never tires of spouting clichés. In the past three years, India’s growth story had become an omnipresent cliché to such an extent that no analyst missed reminding his/her clients about how lucky they were to be a part of that great growth story.
But in January ’08, the Indian stock market lost nearly a quarter of its value (in intra-day trades) in just two trading sessions. Suddenly, there was a scramble to dig out a new growth trigger to replace the tired cliché of the India growth story. The marketmen suddenly rediscovered sectors like FMCG and pharma, which are considered to be less risky than sectors like capital goods, banking and auto. And a new mantra was coined: Invest in defensive stocks.
The market is abuzz with defensive sectors, as their sensitivity to economic turbulence is lower than that of other sectors. For instance, Hindustan Unilever (HUL)’s product line includes toothpastes, soaps and similar products, which are of daily use. It is interesting to note that the stock prices of these companies fall as much as the stock market, despite the defensive nature of their business. This is typical of bearish markets when the index starts falling; all the constituents bear the brunt, irrespective of the nature of their businesses. However, when sanity returns, these stocks outperform the market. To ascertain this, we created an index of stock prices of defensive companies from FMCG, pharma, packaging, utilities and other such defensive industries. We observed that from January to May ’08, the defensive index mirrored the Nifty. However, the defensive index started outperforming the Nifty from the beginning of June ’08 (see chart above). In the past seven months, enough has been written about how investments in companies like HUL, Nestle and Ranbaxy Laboratories are safer than that in other stocks. We, at ET Intelligence Group, have tried to find out companies whose business is defensive, but not as hyped as that of HUL, Nestle and Ranbaxy. The performance of these companies in the first quarter of FY09 was in line with their historical performance, which clearly establishes their resilience to the slowdown to a certain extent (refer table above). Take the case of Noida Toll Bridge Company (NTBC). Its stock price more than doubled in ’07 due to speculation over the value of 200 acres of land in Delhi and another 30 acres the company has in Noida. Speculation was that once the company gets the development rights from the government for that land, it would bring enormous value to the company. The stock has shed almost half its value since January and at current prices, it reflects only the company’s operations and not the expected windfalls from its land bank. NTBC operates the Delhi-Noida toll bridge, and such a business is slowdownproof as motorists are not likely to cut down commuting because of an economic slowdown. Besides, NTBC’s assets are now highly depreciated and there’s hardly any recurring cost in the business except a small maintenance cost. The average daily traffic (ADT) increased by more than 30% in FY08. As per the estimates of Halcrow Consulting India, the ADT is expected to witness a compound annual growth rate (CAGR) of 12% till FY11, while toll rates are estimated to increase by 6% year-on-year (y-o-y) during the period. So, going forward, the earnings will easily grow in excess of 20% and the current price-to-earnings (P/E) multiple of 27.5 only reflects the expected earnings growth. If the going is expected to be smoother for FMCG companies in tough times like these, then obviously, the suppliers of such companies should also be enjoying the smoother run. Cosmo Films is one such company. This Delhi-based company is the country’s second-largest manufacturer of biaxially oriented polypropylene (BOPP) films used as packaging material by manufacturers of food, toiletries, confectionaries and cigarettes. The company plans to more than double its BOPP capacity by FY10. The expansion plans have a sound financial basis, as the company’s return on capital employed (RoCE) stands at 23.2% and it has an interest coverage ratio at 5.1 in FY08, which is much higher than that of Jindal Poly Films, the leader in that industry. The stock is trading at a P/E of just 3.7 times, completely discounting the defensive business and expansion plans of Cosmo Films.
Like Cosmo Films, Bilcare is one of the leading players in the packaging industry. With its core business of manufacturing pharma packaging and research, the company has grown to become an integrated service provider to global pharmaceutical industry. It also offers global clinical trial supplies services, design laboratories and anti-counterfeit technology. As a leading resource for healthcare companies, Bilcare provides solutions on counterfeit drugs, compliance, costs, communication and convenience. The company has manufacturing and research facilities in India, Singapore, the US and UK and has regional offices in Brazil, Germany, China and Australia. Operating in the recession-proof healthcare segment, Bilcare has grown by leaps and bounds in recent years. Over the past five years, its revenues have increased at a CAGR of 37%, while earnings have grown at a faster rate of 48%.
Much like spending on food and toiletries, medical expenditure is non-discretionary in nature. Worsening of the macro-economic conditions has little impact on companies providing drugs and medical services to the population.
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THE HEALTHCARE business is considered to be defensive, despite the fact that it is capital-intensive in nature. Apollo Hospitals is one of largest and oldest players in the private sector. The company has maintained consistent growth in the past decade irrespective of business cycles, which is proof of the sector’s defensive nature. The hospital chain has over 8,000 beds spread across 41 hospitals, as well as a string of nursing and hospital management colleges. It also runs pharmacies and diagnostic clinics, making it the country’s largest private hospital group. Its income from services has increased at a CAGR of 21.3% and profits have witnessed a CAGR of 32% over the past five financial years. The company has maintained its growth momentum in the June ’08 quarter, despite the general slowdown in earnings across India Inc. Like healthcare, insurance, too, has defensive streaks. For an insurance company, the initial years involve incurring costs on penetrating the market, selling costs and agent commissions. However, as years goes by, costs decline and recurring premiums turn it into a cash flow business. With more than 80% of its revenues contributed by the insurance business, Max India is a strong contender among the listed players in the insurance segment. Besides insurance, the company is into plastic packaging, hospitals, clinical research services and healthcare staffing services. While still being a loss-making venture, the insurance segment is its fastest growing business after the company forayed into the sector in FY04.
Though we may face an economic slowdown, buses, cars and autos won’t stop plying and people will still cook meals, which shows that demand for fuel for basic necessities will not go down beyond an extent. Such is the business of Indraprastha Gas — the Delhi-based supplier of natural gas to 1.25 lakh households and 2.25 lakh automobiles — which is sure to result in growth, despite adverse economic conditions. After establishing a strong foothold in Delhi, it is now expanding into nearby geographies such as Noida, Ghaziabad and parts of Haryana. The company still has some 20% extra allocation of gas than what it currently sells; so gas supply will not become a constraint for its growth prospects. Over the past five years, it has always generated around 45% RoCE and paid out a third of its profits by way of dividends. In view of its sound financials and nature of business, Indraprastha Gas can be considered a safe bet in difficult times. It is an irony that there were numerous takers for these stocks when the market was at its peak. Today, these same stocks find few takers, despite the fact that the market downturn has taken away the froth from valuations. We sign off with another cliché which, despite its nature, happens to be time-tested: You should buy when others sell…
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