Time to look at cyclical stocks?

"Tata Steel is trading at a multi-year low but I am unsure when it will turn around," says the head of investment at an asset management company.

The same story is being played out in many stocks in the metals, mining and other cyclical sectors. The situation is tricky for even investment experts because one does not know when things will improve. So, many say it is a good time to look at these due to the cheap valuations of many blue-chip companies but are unwilling to put money where their mouth is.

For a good reason. The metals index has been the worst performer in the past five years, with annual return of minus 16.9 per cent. Even over a 10-year period, it has returned only 5.7 per cent annually.

Cyclical stocks are those which move in tandem with economic activity - mining, metals, automobiles, financials, electronics, shipping and infrastructure.

Good time to invest?

Ravi Shenoy at Motilal Oswal Securities Cyclical says automobiles, cement, engineering, metals and public sector banks are still seeing stress. Global economic weakness, correction in global commodities, a poor monsoon and high interest rates have cut consumer demand, caused price deflation (reflected in a negative wholesale price index movement) and sluggish corporate investment appetite.

Things are beginning to change, believes Mihir Vora, director & chief investment officer, Max Life Insurance. "Interest rates and inflation are headed downwards in India. We are, thus, positioned for a slow cyclical upturn in the economy, with government spending leading the way, and followed by private sector participation in due course," he says.

Agrees Shenoy: "It might be too early to expect an improvement in corporate investment appetite. However, markets are witnessing bargain hunting in some of these sectors as investors start looking forward and traders take up short-term bets. Short covering in some of these sectors is also adding to the up-move. However, we consider some of these to be high-risk sectors for the normal investor."

Deven Choksey, managing director (MD) at KR Choksey, says up-moves in these stocks have started. Particularly in sugar, metals, automobiles and infra. That is, the metals sector has bottomed out and can see some upturn when India's capital expenditure (capex) programme starts happening. From the agri commodities segment, the sugar sector is likely to maintain a rally for the next two to three years. He suggests being stock-specific for value buying.

For a long while, investors have been chasing information technology (IT), pharmaceuticals and fast moving consumer goods (FMCG). Over a five-year period, pharma and FMCG's category average annual returns have been 23 per cent and 20 per cent, respectively. Category returns of IT funds have been 13 per cent. Over a three-year period, the category average returns of FMCG, pharma and IT funds have been 16 per cent, 35 per cent and 26 per cent. In other words, a smart investor who put money in a good pharma fund would have doubled it by now.

On the other hand, many have suffered. Over five years, the category average returns of infra and banking funds have been 3.3 per cent and 4.4 per cent, annually.

Strategy?

"Our investment philosophy is to buy good quality stocks with visible growth triggers, at a reasonable price. We are positive on non-leveraged construction companies, private sector banks, finance companies and automobile and auto parts manufacturers. We have identified sectors likely to be growth leaders - road building, railway, defence, multiplexes, mining equipment - and have focused on these segments of the market," says Vora.

G Chokkalingam, MD at Equinomics Research & Advisory, thinks companies that are most tilted to domestic demand, balance sheet comfort, no leverage issue and cash-rich or zero debt should be looked at.

A word of caution, though. A small shift in allocation to cyclicals from high price-to-earnings bellwethers would be the recommended approach but even ones with a high risk appetite should look at cyclicals as a bargain hunting appetite, with strict stop-losses.

Go for bigger firms

Most feel that bigger is better, as of now. Some like Shenoy believe for companies in the preferred sectors like automobiles and cement, one should go for Maruti, Hero or ACC and UltraTech. "As a house, we prefer the safety of larger companies, as earnings tend to be less volatile. Also, from a small investor perspective, the larger companies are more investor-friendly," he says.

The investment strategy should be to play on cyclical stocks, still the best in the under-performing sectors. So that if the economy turns around, they can give good returns and the downside risk will be limited.

Value in mid-cap?

There are a few companies with good financial discipline that look more interesting to add into from the mid-cap space, says Choksey. Mid-caps over the past 12-18 months have rallied sharply as investors have taken a fancy to the markets. As a result, valuations in mid-caps across sectors have become expensive, as earnings are yet to catch up with the inflated prices. It would be wise to wait for a jump in earnings on cost savings or lower interest rates before taking aggressive bets in this space.

K Subramanyam, co-head of equity advisory at Altamount Capital, feels it is always difficult to catch scrips at rock-bottom but easier to go with popular consensus. "Cyclical stocks are not fancied currently. If contra bets are to be placed, energy and infra stocks probably offer value."