Why it's a good time to invest in these 5 manufacturing sector stocks

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There is only a limited increase in the competitiveness of exporters due to the recent fall in the rupee.
The fall in the rupee has put short-term pressure on the stock market: Foreign portfolio investors, who count their gains (or losses) in dollars, are hurriedly exiting their positions, and have send the stock market in a turmoil—the Sensex has tanked 9.6% over one month.

In this turmoil, investors should avoid companies that stand to be adversely impacted by the fall in the rupee—companies that are directly or indirectly impacted by the rising cost of imported raw materials. For instance, the auto sector is likely to face troubling times. “While the increase in raw material prices will put pressure on the margins of auto companies, demand may also come down because the jump in fuel price is also increasing the cost of owning a vehicle,” says Sandeep Nanda, CIO, Bharti Axa Life Insurance. Auto component companies, on the other hand, won’t be impacted much because they also export significantly.
Exporters have little to cheer about
Higher fall in other currencies limit Indian exporters’ competitive advantage
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*Fall in comparison to the US dollar. Data as on 3 Oct 2018. Source: Bloomberg; Compiled by ETIG Database

There are also sectors that stand to benefit from the fall in the rupee. “Exportoriented sectors such as IT and pharma will be the biggest beneficiaries of the recent rupee depreciation,” says E.A. Sundaram, Executive Director and CIO,Equities, DHFL Pramerica Mutual Fund. However, much higher depreciation in other currencies vis-à-vis the US dollar will limit the benefits of the fall in rupee for exporters. “The rupee did not fall much compared to other currencies in the past, making our exports less competitive. Though past competitive levels have been restored due to the recent sharp fall, it has yet not made things very competitive,” says Shailendra Kumar, CIO, Narnolia Financial Advisors.

In other words, there is only a limited increase in the competitiveness of exporters due to the recent fall in the rupee. Also, it is well-known that exporters gain when the rupee falls, so investors need to focus on sectors where the benefits of the fall have not been fully factored in. “Besides exporters, manufacturers who mostly use domestic resources stand to benefit from the rupee depreciation because the price of their products (linked to import costs) will go up,” says Sankaran Naren, ED and CIO, ICICI Prudential Mutual Fund.

Metals and minerals is one sector that will benefit. “Companies manufacturing metals such as steel, zinc, aluminium, etc., will be big beneficiaries because the domestic prices of metals are related to the price at which they are imported.

More importantly, their import component is also less,” says Nanda. Despite being large exporters, oil refiners such as Reliance won’t gain because they import crude oil, refine it and then export finished products. So, the positive impact of rupee depreciation is nullified by the negative impact of importing crude. “However, upstream oil companies will be in a sweet spot as they are in the import substitute basket (they can replace foreign upstream oil companies),” says Sundaram.

Increase in import duty by the government on electronic goods to check the rupee’s slide will benefit domestic electronics companies. “Due to the increase in domestic production, companies that provide inputs to branded electronics companies will be major beneficiaries. They will also be able to get a higher price because of the increased import duty on electronic components”, says Kumar.

Let’s look at the most promising companies from the metals and minerals, upstream oil and electronics sectors.

ONGC
Despite the rally in international crude oil prices and the fall in rupee, the ONGC counter crashed in the past few days because of concerns about a possible subsidy burden on upstream oil companies. The situation has worsened since the government asked oil marketing companies (OMCs) to absorb Rs 1 on petrol and diesel.

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The market fears that this trend of forcing PSU companies to bear oil subsidy may continue in the future. Also, the government budget allocation for cooking fuel subsidy is quite small and the subsidy may have to be shared equally by the government, OMCs and upstream oil companies.

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However, experts are not worried about this small subsidy burden, if it happens. “We prefer upstream companies for their greater EPS cushion even with subsidies. For ONGC, higher Brent price and the 10% hike in domestic gas prices are tailwinds,” says a recent Jefferies India report.

Oil India
Oil India’s net oil realisation was up 49% to Rs 5,330 ($72) per barrel in the first quarter of 2018-19 and its gas realisation rose 25%. With international crude oil prices reaching Rs 6,292 ($85), oil and gas realisations will rise further in the coming quarters.

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The revenue in rupee terms will also grow because the US dollar is now trading at Rs 74. However, the fear of the subsidy burden has kept Oil India’s market valuation low. Stagnant oil production is another worry for the counter—sales volume remained flat during first quarter of 2018-19.
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With relative calm in the north-east—94% of its oil blocks are located there—Oil India is making efforts to increase its production and any positive news on this front can be the next trigger for the counter

Dixon Technologies
With 9% market share, Dixon Technologies is the second largest electronics manufacturing services (EMS) provider in India and will be a major beneficiary of the boom in electronics production.
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Besides increasing capacities and entering new categories, it is also investing in backward integration for cost and quality control. Industry-beating 5-year revenue CAGR of 30% makes it a growth stock.
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Several other factors make it a good long-term bet. “Light balance sheet, healthy return ratios, low working capital cycle, disciplined capital investment with a payback period of 18 months, and rising prominence of original design manufacturer model makes Dixon Tech an attractive play,” says a Nirmal Bang report.

Nalco
Among metal companies, analysts favour National Aluminium (Nalco). It has almost everything an aluminium producer can dream of—captive bauxite mines, coal linkages, better logistics due to strategic locations, etc.
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To raise production, Nalco is increasing its bauxite and coal mining capacities. It has also got coal mining blocks at Utkal where production may start from the second half of 2019-20. Firming up of alumina and aluminium prices in international market is another favourable factor.
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“Nalco is the key beneficiary of strong alumina pricing and depreciating Indian currency as most of its production cost is fixed in rupee (only 10%-15% of its production cost is incurred in US dollar),” says a recent Motilal Oswal report. Due to better quality, Nalco has also been able to charge a premium of around Rs 3,700 ($50) in international markets and Rs 14,800 ($200) in domestic markets compared to London Metal Exchange prices.

NMDC
Indian iron ore mining major NMDC will be a major beneficiary of the rupee depreciation because domestic iron ore prices usually move in tandem with international ore prices. Steel companies are ramping up production due to increased domestic steel prices amid the likelihood of iron ore demand going up.
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Volume pick up is expected from the third quarter of 2018-19 because most of the rail infrastructure issues have been resolved now. To boost its earnings further, NMDC is also setting up pellet and steel plants. “We are positive on NMDC’s prospects on recent price hikes and estimated volume recovery. Earnings from pellet and steel plants will be additional sweeteners in 2019-20,” says a recent Edelweiss Securities report. NMDC is also into mining of diamonds through its Majhgawan mine at Panna, Madhya Pradesh, the only mechanised diamond mine in the country and the largest in Asia.

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Index values and stock prices across charts normalised to a base of 100. Source: ETIG Database

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