IT, FMCG stocks could help overcome PNB-driven market volatility

In the past month, a post-Budget correction turned into a rout for the banking sector after the PNB (Punjab National Bank) scam emerged and other scams were unearthed in its wake. The PSU Bank index is down by about 11 per cent in the last one month, while the Private Bank index is down 1.3 per cent and the Nifty Bank (which combines private and PSU banks) is down 2.4 per cent. Financial Services overall are down 1.5 per cent.

Banking has been the worst-performing sector and the worst sub-sector is of course, PSU banks. But, problems in banking translate into problems across the entire economy. There have been no sectorial winners in this period since every sector has seen losses. The index performances suggest that smaller stocks have been hit harder, which has interesting implications.

The Nifty has lost 1.1 per cent in the last 30 days. If we take that as a benchmark, the Nifty Midcaps 50 has done worse since it has lost 2.5 per cent. It may indicate that domestic institutions and foreign portfolio investors (FPIs), which hold the bulk of Nifty free-float, have sold less than retail investors who track smaller stocks.

This situation gives the long-term investor a filter for defensive value. Credit is likely to be tight across the next fiscal. Banks have problems lending due to high NPA levels. Government borrowing will soak up the bulk of bond market resources. Interest rates are therefore, likely to stay high.

Under the circumstances, corporates which have high working capital needs and high debt-equity ratios will come under pressure. They will pay more for borrowings. In contrast, corporates with low working capital requirements and low debt-equity ratios will find themselves better positioned to ride out this unpleasant period.

In a broad sense, this hurts capital-intensive sectors more. It also hurts corporates which have been relatively inefficient in the use of capital. Certain sectors are capital-intensive and working-capital-intensive by their nature. Metals, cement, automobiles, for instance, fall into this category. Other sectors, such as information technology (IT) and pharmaceuticals and FMCG have lower working capital needs. Many IT companies are debt-free and quite a few pharma companies have low-debt balance sheets. Efficiently managed FMCG companies also have low working capital needs.

There may be rising demand for metals, cement and automobiles since economic growth seems to be on the recovery path. But, these businesses will also see their cost of financing rising through the next fiscal. This will cut into margins.

On the other hand, IT and pharma have suffered from other problems. The strong rupee has impacted their returns since both those industries depend on forex earnings. Pharma has been under pressure due to stringent inspections by the American FDA (Food & Drugs Administration) which has spotlighted problems in export facilities. IT has been hit by more stringent US visa rules, which have driven up their costs since they have been forced into high-cost hires of US citizens. But, a combination of a weaker rupee and low-debt could make these businesses look more attractive. Incidentally, IT is probably the best-performing sector in the last month. The Nifty IT index is up 2.8 per cent. Pharma has underperformed with the Nifty Pharma index losing 6.1 per cent.

FMCG is an interesting sector. The better-managed companies have relatively low working capital needs. The industry has struggled to cope with goods and services tax. But, Q3 results indicate that the bigger companies have stabilised compliance across value-chains. The industry index performance is slightly better than the Nifty with losses of about 0.4 per cent in the last month. If there is growth in domestic consumption, especially in rural consumption, FMCG stands to benefit.