Invest in new-age defensive stocks

[suguhopes]

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 2008, the
defensive index mirrored the Nifty. However, the defensive index
started outperforming the Nifty from the beginning of June ’08.

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 slowdown-proof 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%.

Bet on these hidden gems

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.

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.

N.Sukumar
Research Analyst