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Defensive stocks outperform again

Beat benchmark indices for the fourth year but most analysts still caution one must be careful while investing in this space

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Stocks from the health care and fast-moving consumer goods (FMCG) sectors are set to outperform the market for a fourth year, as investors turn to safe-haven amid economic uncertainty, both at the global and domestic levels.

In the past three years, these shares performed well, delivering handsome returns compared to the benchmark indices. This year has been no different, despite intermittent rounds of ‘risk-on’ trade that brought high-beta stocks back into focus.

So far this year, the S&P BSE healthcare, and IT indices have gained about 13 per cent each, against a 2.4 per cent rise in the benchmark S&P BSE Sensex. Last year, the IT sector had underperformed the market, primarily due to a poor  performance by Infosys. The segment had performed well in the two preceding years.

“In the last three-five years, we have had pressure not only from domestic factors (interest rates, growth concerns, inflation, current account deficit, etc), but certain global environment (problems in the Euro zone, crude oil prices, etc) have also played spoilsport. So, a series of such domestic and global factors have seen investors rush to safer havens such as defensive stocks,” says G Chokkalingam, executive director and chief investment officer, Centrum Wealth Management.

Steep valuation
Despite the run-up in most of these stocks and the valuations these are available at, investors continue to flock to these. In a surprise move, the Reserve Bank of India raised the repo rate by 25 basis points (bps) to 7.5 per cent last week to check inflation. Analysts say interest rate-sensitive sectors such as real estate, infrastructure, automobile and banking may see correction, amid concern hardening interest rates would hit demand for new loans, housing and vehicles.

Currently, FMCG stocks are available at an average price-to-earnings multiple of 40.78, while pharmaceutical stocks are at 28.84, much higher against the BSE Sensex’s 17.88.

Jyotivardhan Jaipuria, managing director and head (research) at Bank of America-Merrill Lynch, says, “Over the past month, the have rallied strongly, led mainly by financials and domestic rate-sensitive sectors. We think as the markets correct, we will see a correction in some of these sectors and software and pharma, which have under-performed past month (though strong performers so far this year) will outperform the market again.”





Among individual stocks, Sun Pharmaceutical Industries, Lupin and Ipca Laboratories from the pharmaceuticals pack, HCL Technologies and Tech Mahindra from IT and ITC, Hindustan Unilever and Dabur India from the FMCG space have gained about 80 per cent each since December 2010, against a 1.2 per cent drop in the benchmark indices.

Top picks
Most analysts feel though these stocks remain good bets, one must be careful while investing in this space.

“In terms of where we are today, the valuation premium these defensives enjoy is at its highest versus the cyclicals. However, for a long-term stock picker, defensive stocks are not a space that would generate value creation. If anything, there are chances a number of these stocks will disappoint,” says Gaurav Mehta, strategist at Ambit Capital.

“Though it is difficult to find stocks that have a good balance of good quality and valuation, HCL Technologies (in the IT space) and Cadila Healthcare and Torrent (in the pharmaceuticals segment) look good. From the consumer space, we don’t think there are any stocks right now that fulfil these two criteria,” he adds.

Dhananjay Sinha, head of institutional research, Emkay Global Financial Services is overweight on sectors benefiting from the rupee’s depreciation and a recovery in developed economies. “Therefore, remain overweight on IT, pharma and companies that have significant export/external presence. We like Infosys and Wipro in large caps and MindTree in the mid-cap space,” he says.

Chokkalingam of Centrum believes till the outcome of next year’s general elections is known, defensives would fare well. ITC, Colgate-Palmolive, Britannia and Tata Coffee are his top picks in the FMCG basket. “We like JB Chemicals and Indoco Remedies. Lupin and Sun Pharma are also good bets, but have run up sharply. One should buy them only on a major decline. However, one can look at Apollo Hospitals and Biocon. Those with appetite for risks could also buy Wockhardt,” he says.

“I don’t think the can slip much from its current levels. It can, at best, touch 64-65 levels against the dollar. By the end of 2013, it should settle around 60-62 levels. In this backdrop, one can look to invest in mid-cap information technology stocks such as OFSS, MphasiS, CMC and Zensar Technologies,” says Chokkalingam.

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