Over the last one week, a broader shift towards the cyclicals after hopes of a BJP-led government were reaffirmed with a strong election mandate compounded gains made by stocks from the banking, infra, capital goods, power and construction segments. An anticipation of recovery in the capex cycle has added to market interest in these stocks as investors try to grasp fairly valued scrips from these sectors.
An analysis of the BSE 200 universe shows that although half of the constituents outpaced the benchmark since mid-February, pushing the index to an all-time high, most of them are trading well below their record highs touched towards the end of the 2004-2007 bull run. In the last three months, while the BSE 200 index has gained 22%, about 115 of its constituents have outperformed the index with as many as 25 stocks rising more than 65%.
A third of the outperforming stocks, which belong to the cyclical sectors and demonstrated muted earnings growth in the last few fiscals, are trading at a more than 50% discount to their life-time highs. Names like Unitech, HDIL, DLF, Jaiprakash Associate, GMR Infra and Reliance Power currently trade 95% to 75% below their record highs touched in early 2010.
Most of these companies have faced operating hurdles in the last four years with some companies feeling the heat of their highly leveraged balance sheets on their earnings.
While the fundamentals, including a lurching capex cycle and elevated interest rates, are yet to change, the Streets enthusiasm after the BJP victory may benefit these stocks. Given that most strategists deem Indian markets to be looking at a mother of a bull run led by cyclical stocks, a further surge in these stocks cannot be ruled out.
According to Macquarie, despite the recent rally, cyclical stocks are still trading at about 10% discount to their long-term average valuations against defensives. Citing the focus of the new government on infrastructure, the brokerage recommended that investors buy cyclicals as it expects the pack to recover faster than consumption-based themes.
CLSA strategist Christopher Wood recently added JP Associate to its Asia ex-Japan long-only portfoilo, citing likely upside in industrial stocks if a new investment cycle commences in India.