It's the Q3 results season. What has been released so far suggests that there has been some improvement in consumption, but not in investment. Profitability seems to have improved a little. In the broadest terms, the interest rate cycle may also have peaked, which means that interest costs should reduce through the next several quarters.
Fundamentally speaking, results so far don't indicate a turnaround in construction, automobiles, infrastructure development and capital goods. That's not surprising. India Inc. has put expansion plans on hold. Also intractable policy issues have also led to a slowdown in the infrastructure sectors from which construction generates the lion's share of revenues.
Some other trends can be extrapolated and two sectors could yield out-performances over the next 12 months if the current trends hold or strengthen. One prime case for capital appreciation would be in the oil and gas PSUs. The other investment case is IT-ITES.
One has to make some assumptions about policy consistency in case of the oil and gas PSUs, and that's where the risk lies. Let's hope that the policy of allowing gradual hikes in diesel prices will not be rescinded, and also that the cap on the number of subsidised gas cylinders will not be hiked again. A third assumption is that the Rangarajan Committee's recommendations on the new gas-pricing formula will be accepted.
If these assumptions hold, the entire PSU oil and gas segment should do much better. The balance sheets of BPCL, HPCL, IOC make sad reading. This measure of gradual price hikes won't really repair the damage incurred over the past three years of mindless price control.
However, things will get better, if the government doesn't lose its nerve. Positive revaluations of this segment have already become evident. We could see loss-makers producing multi-bagger capital appreciation over the next year. The situation also improves for GAIL, OIL and ONGC, which are profit-making concerns. They will no longer have to bear such a large subsidy burden on behalf of their downstream siblings.
The private sector concerns in the same O&G space should also do well. Cairn and Essar Oil have already seen some investment. Essar Oil had a strong turnaround in Q3 and it could consolidate those gains over the next several quarters.
Reliance Industries is more nuanced. The Q3 results show that refining is improving, as is confirmed by Essar's results. Margins are good and RIL is well-placed to capitalise on that. However, the mega-problems with the KG-D6 offshore block remain, and those cast a shadow.
The new gas-pricing formula would approximately double the price of KGD6 gas in April 2014 (RIL has asked for thrice the current rate). But even if pricing is renegotiated in RIL's favour, the block has massive technical problems and it's an open question if output will decline further. RIL's business model depends on it being vertically-integrated. The stock is likely to be volatile, rather than developing a clear uptrend, though it should gain over the next 12-15 months.
The elephant in the bedroom is of course, international prices. All the indications are, barring more wars in the Middle East, or trouble centred on Iran, prices should remain range-bound at close to current levels. The US has reduced its import dependency by developing shale assets. Europe is in recession, and so is Japan, which means global demand won't spike.
Infotech is the other sector that could see big gains. Here, the investor has to take a call on a few broad trends. One is the USD -INR rate. If the rupee strengthens to below 51 and stays below 51 for an appreciable time, rupee-reported turnovers and earnings would drop below projections.
It's possible the market would ignore the exchange factor, however, if the other broad trend held good. The results and advisories of Q3 indicate US demand for IT services is rising, if slowly. Since the industry's fortunes are tied to the US, a recovery or even a partial recovery, is good news.
The IT industry has usually been a good hedge in times of trouble. It has often been counter-cyclical to Indian trends. Since its revenues are more or less independent of domestic demand and it is cash-rich, it has been free of the vagaries of high rupee interest rates and local recession.
In periods when the domestic economy has done well, and IT has also done well, the industry has delivered spectacular out-performances in terms of capital appreciation. This could be one of those years if everything goes right.