Cement, two-wheelers and building materials. Stocks you should avoid now

Kotak research says the pressure on equity multiples is likely to continue if current macro-economic conditions sustain, even without further deterioration

The steep increase in domestic and global bond yields may have stirred the market out of its complacency and into recognizing that the deterioration may be here to stay for longer than earlier, says Sanjeev Prasad, executive director and co-head, Kotak Institutional Equities in a recent co-authored report with Sunita Baldawa and Anindya Bhowmik.

Given the current markets, Prasad recommends avoiding stocks where price-to-earnings (P/E) multiples are high, such as in the building materials, consumer staples and discretionary sectors.

"Despite the recent price correction in consumer discretionary names and ‘time’ correction in several consumer staples as we find their valuations quite high and not fully factoring in the possibility of higher domestic and global bond yields; and/or lower profitability. We also avoid weak business models in the lending space," he says.

That apart, he suggests selling two-wheeler and cement stocks, which have generally been large under-performers over the past 12 months. According to Prasad, their valuations are either still too frothy (cement stocks are still trading at around 3X BV) or do not fully reflect the structural issues in the business.

STOCKS TO BUY

On the other hand, analysts at Motilal Oswal suggest using the current correction to accumulate stocks where valuations had turned expensive.
 
“The sharp correction in mid-caps makes stock-picking a bit less challenging, as valuation premiums have moderated from the recent highs. While we do not rule out further correction, we believe, given our earnings recovery thesis for FY19, this correction offers a good opportunity to accumulate quality ideas where valuations had turned expensive,” says Gautam Duggad, head of research at Motilal Oswal Securities.
 
Havells India, Emami, JSPL, Indraprastha gas, RBL bank, Exide, Repco, MCX and TeamLease are their preferred ideas. Among the large-caps, they like HDFC, ICICI Bank, Larsen & Turbo, Mahindra & Mahindra (M&M), Motherson Sumi, Titan, HPCL and NMDC.
 

CORPORATE EARNINGS KEY

Going ahead, Kotak believes the pressure on equity multiples is likely to continue if current macro-economic conditions sustain, even without further deterioration. The key monitorable, here is the growth in corporate earnings, the brokerage says.

"It is imperative that earnings do not disappoint in case India’s macro continues to be subdued or deteriorates further. The Street expects strong earnings growth in FY2019E and FY2020E, during which we expect 23% and 16% growth in the profits of the Nifty-50 Index," Prasad says.

The brokerage has made some changes to its model portfolio. It has removed Indian Oil (IOCL) from the portfolio (200 bps earlier) and reduced weight on ITC by 200 bps (300 bps now) and allocated 100 bps each to HDFC Bank (10%), Larsen & Toubro (500 bps), Maruti Suzuki (400 bps) and Reliance Industries (600 bps).

Kotak's Model Portfolio

MOSL's top stock ideas (Source: MOSL report)