The risky cyclicals

S. Vaidya Nathan

IF THE IT sector can be expected to turn in fairly good growth rates of around 60 per cent at the aggregate level, the automobile sector can be expected, with the exception of Hero Honda, to turn in a dismal showing. As the October-December 2000 earnings announcements begin from tomorrow, the focus will be on technology stocks.

More so in the light of the sharp decline in the valuation of these stocks.

Equally important will be the focus on the economically-sensitive stocks. As indicated last week, sectors such as paper would do well. Though the cement sector numbers may be better, their sustainability may be doubtful. Steel numbers may be more muted, with the exception of Tata Steel. Much the same may be true for the petrochemicals sector. What is in store for some of the other economically-sensitive sectors? It would be a mixed fare with the automobile sector set to take a big knock.

Automobile sector: After a bounce-back of sorts in 1999-2000, the automobile sector has done quite badly in the first nine months of fiscal 2000-01. This time, the decline cuts across various segments, two-wheelers included. The big story, however, is in the commercial vehicles sales numbers. Through the first nine months, there was a steady decline in volumes in the medium/heavy commercial vehicles segment. Neither Telco nor Ashok Leyland have been able to break out of the mould.

A couple of end-user-specific factors such as the slowdown in demand in the cement, automobile and steel sectors and the lower output of agricultural products have reduced the freight traffic to be carried. But exports have shown a fairly healthy growth rate. Beyond these trends, a more structural change appears to be in play.

The rising levels of containerisation and the increasing use of pipelines has led, and will lead, to a decline in the demand for commercial vehicles. For instance, last week the longest LPG pipeline in the world was commissioned by Gas Authority of India from Kandla. Almost 3,000 km long, the line has the potential to stifle demand in a big way.

As the use of pipelines and containerisation (still at a nascent stage in the Indian context) picks up, it is quite likely that structural factors may impinge on demand growth in the commercial vehicles sector. In this context, what is now happening to Telco and Ashok Leyland may be of a long-term nature.

Telco has had a poor first six months. It may well end up more in the red in the October-December quarter since there has been close to a 50 per cent decline in its car sales. Though much has been made about a cash break-even for the car project, the lower revenues from this segment may prove a burden on the earnings stream in terms of financial costs. The pricing power is also unlikely to improve in such a situation and Telco may have to absorb the costs of the Cummins Engine that it now uses. Expect Telco's numbers to be bad and Ashok Leyland's slightly better.

As far as the tractors segment is concerned, there has been a 11 per cent decline in volume. Though Mahindra and Mahindra and Escorts have managed to weather the overall trends better, this has not helped their profitability. An unimpressive showing from this segment for the quarter, cutting across all players, seems to be very much on the cards.

Though the two-wheeler segment still shows double-digit growth rates, much of it comes from Hero Honda marketing in a normal mode and Bajaj Auto almost dumping its products by offering big discounts. The growth in motor cycle volumes for Bajaj Auto has been naturalised by the downtrend in the scooters segment. However, the pricing strategy used has not proved favourable for earnings growth.

Only Hero Honda may be able to live up to the billing with growth rates of around 40 per cent as in the previous quarters. TVS Suzuki may report a muted show as in the July-September quarter. And these trends in the automobile sector are obviously a pointer to a bad quarter for the auto-ancillary and tyre companies. A few such as Sundram Fasteners, which has a good export volume, and Munjal Showa, which rides on Hero Honda, may be among the exceptions this quarter.

Oil: The oil sector has seen some improvement in crude prices. There has also been a price hike effected in the Indian markets and this could have improved cash flows.

The oil refining companies such as BPCL, Reliance Petroleum and HPCL can be expected to come up with better numbers. But there may still be the effect of the stress on the oil pool account which could lead to higher financial costs and dampen profitability.

Engineering: The July-September quarter was not a good one for the engineering sector, with even big banner companies such as BHEL and ABB performing indifferently. The October-December quarter may not be much different, though BHEL's performance could improve. With the slowdown in the broad economy, the absence of fresh investments and imports, the engineering sector may have some disappointing numbers in store. A lot of interest may be riveted, apart from BHEL, on Cummins India which has bucked the overall trends in the last few quarters with its thrust on exports paying-off. Will the Cummins story get stronger? The odds on that are fairly high.