Top defensive stock picks for 2012

If you are a compulsive equity investor , but one with a low risk appetite, you must be feeling the jitters. As 2011 comes to a close, the equity market picture does not appear to be as rosy as it seemed to be not long ago. The immediate future appears to be uncertain. Your equity portfolio, in all probability, does not give you a happy feeling as it is mostly likely to have fallen in value along with the broader market.

But you still love equities because you feel that it is perhaps the only asset class likely to give returns that beat inflation. You may not be off the mark. However, going by the current indications, that seems to be a possibility only in the long run.

While this might be one of the best times to take some risk and build an equity portfolio for the long term, what if you, as we said, are one of the risk-averse kinds? Is there a strategy that can protect the downside and keep your capital from giving negative returns if the markets slide further in 2012? Are there some 'safe' stocks, if at all equities can be categorised as 'safe'?

Here, the word safety is used with caution, as it has different meaning for different people. In the investment world of India, bank fixed deposits are tagged as 'safe.' However, in this article we explore stocks and sectors considered 'relatively safe,' that is, those that have limited downside for those who wish to be safe and yet do not want to miss the bus in case the markets rise in 2012.

This is especially true since there is widespread talk of further downside in the coming months under the effect of inflation, which hits companies' margins, high interest rates, rupee depreciation, lack of policy reforms and global factors that are making investors across the world flee from risky assets. The gloomy situation seems to point out that safety can be ensured only in the long term with a lot of pain still to be factored in.

Safety First
Amid such a gloomy picture, pockets of safety have been defensive (which fall less than the market most times) sectors such as fast moving consumer goods, pharmaceutical, banking and healthcare. Companies with exposure to rural and semi-urban cities have done very well, according to fund managers and analysts. This is because of government schemes such as NREGS (National Rural Employment Guarantee Scheme), higher minimum support prices for farm produce and appreciation in land prices, all of which have ensured a higher disposable income in the hands of the rural population. "If someone wants safety, companies in the traditionally steady consumer staple and pharmaceutical sectors as well as private banks continue to look good despite somewhat high valuations," says Anand Shah, chief investment officer, BNP Paribas Mutual Fund.

Here we look at some top stocks that may keep your money afloat even if things take a turn for the worse in 2012. Some of these stocks have an overlap with the top picks in our previous report, perhaps making them the top bets for 2012. You may choose to churn your portfolio to include some of them, just in case you want to be in a comfort zone.

BANKS
Experts are betting the banking sector will perform well in 2012. "We see recent declines as an opportunity to buy shares of some of the stronger players, given that India remains under-served in terms of financial services and income levels are increasing," says Siva Subramanian, chief investment officer, equity, Franklin Templeton Investments.

Some are placing higher bets on private sector banks. "We prefer private sector banks over public sector banks. The valuation of ICICI Bank looks attractive. The bank is well capitalised with a Tier-1 capital ratio of more than 13%, which essentially means it will not need to raise equity over the next two-three years," says Mahesh Nandurkar, executive director, research, CLSA India.

HDFC Bank
HDFC Bank is among the favourites. "HDFC Bank has stable earnings growth. It's a safe bet for conservative investors," says Vinay Khattar, research head, retail capital markets, Edelweiss Securities.

Neelkanth Mishra, executive director, research, Credit Suisse, prefers to play safe with HDFC Bank given that retail lending accounts for its 50% loan book. The bank's earning visibility is a high 26-27% plus given its higher coverage for non-performing loans and ability to gain market share, in addition to a lower share of infrastructure and project loans, according to a Bank of America Merrill Lynch (BofA-ML) research report.

ICICI Bank: "ICICI Bank is likely to be the least hit on the asset quality front due to lower exposure to infrastructure and MSMEs," said BofA-ML. Moreover, the risk of higher slippages was unlikely due to a high 35-40% share of retail loans, it said, naming the bank as its top pick. "It looks reasonably priced. The quality of earnings has gone up and its growth rate looks good," says Edelweiss' Khattar.

CONSUMER PLAY
The consumer discretionary sector comprises companies that are into goods and services which are considered as non-essential. The spending on such products and services varies at lot. Companies into retail, automobiles and their components, and luxury goods fall into this category. "It is a beneficiary of favourable demographics and rising per capita income. The middle class population of India (according to the National Council for Applied Economic Research) is expected to grow from 160 million at present to 267 million by 2015 and 547 million by 2025, which will be a major driver of consumption," says Shah of BNP Paribas MF.

With growing population and rising incomes, the demand for consumer discretionary goods is increasing. "Consumer discretionary companies which focus on semi-urban and rural areas are doing very well. If you look at the growing sales of tractors, twowheelers and utility vehicles, you will get a fair picture of how these markets are performing," says Lakshmikanth Reddy, executive vice president and head, equity, ICICI Prudential Life Insurance.

Nandurkar of CLSA says he likes ITC and Mahindra & Mahindra among the large-caps and Godrej Consumer Products among the midcaps. JP Morgan also prefers ITC. ITC: ITC continues to be a favourite of fund managers and market experts. "Demand from Tier-II and Tier-III cities for ITC products continues to be strong. So, stocks which get a significant part of revenue from these cities will continue to see reasonable growth," says Nandurkar of CLSA. "In the current volatile market, we think it (ITC) should do relatively better than peers," JP Morgan said in a recent note. The brokerage said ITC remained its preferred pick. The shares of ITC have risen 15% in the first 11 months of 2011, outperforming the market.

Mahindra & Mahindra: "M&M is a play on demand for tractors and utility vehicles from Tier-II and Tier-III cities and rural areas. The demand remains attractive. We have not seen competitive activity in segments that Mahindra operates," says Nandurkar. JP Morgan said in a note that M&M continued to guide for 11-13% growth in tractor sales over the medium term, with near-term sales growth in healthy double digits. While demand for utility vehicles is likely to moderate given the macro-economic headwinds, new product launches will continue to drive growth.

Godrej Consumer Products: "We like Godrej Consumer due to its revenue visibility," says Nandurkar. On the other hand, JP Morgan said in a note that it would wait for a better entry point. The stock rose 4.2% during January-November 2011.

PHARMA/HEALTHCARE
"We expect the domestic market to be the growth engine for pharma and healthcare companies," says Reddy of ICICI Prudential Life. Fund managers see safety in pharmaceutical stocks but have a selective approach. "It will be better if their earning growth is also defensive and continues to grow in this difficult macro environment," says Shah of BNP Paribas MF.

Dr Reddy's Laboratories: Nandurkar is betting on Dr Reddy's among the large-caps and Lupin among the mid-caps. Citi said it was overweight on Dr Reddy's Laboratories. "About 15% of Dr Reddy's revenue comes from the domestic market where demand will be stable. A significant part of revenue comes from the US market where we will see some good launches," says Nandurkar. In its India strategy report for 2012, Citi said Dr Reddy's was best placed to capture generics and biosimilar opportunities and had a strong US product pipeline with niche opportunities and a wellestablished business in Russia/Commonwealth of Independent States.

Sun Pharmaceuticals: Credit Suisse and BofA-ML have named Sun Pharmaceuticals as a safe buy on the back of its superior business model and better margins than peers. "We believe Sun Pharmaceuticals will continue to trade at a premium given its revenue visibility," says Mishra of Credit Suisse. Sun Pharmaceuticals deals in chronic drugs which are related to lifestyle diseases and therefore its sales are resilient even in a recessionary environment, says Credit Suisse. The European market accounts for just 2-3% profits.

Lupin: Lupin is BofA-ML's top buy. It prefers the stock due to its high and sustainable growth rates (23% sales CAGR and 24% profit CAGR) and scale of operations. "There will be earnings growth of 18-20%. So, the stock still has an upside," says Nandurkar of CLSA. Lupin shares have lost 1.7% value in January-November 2011.

While these stocks seem to be relatively safe bets, the broader market outlook does not seem bright. As any stock investor will know, there is no fool-proof safety in equities. In a bad market, these stocks may also be pummelled. As we said, they just provide relative safety or rather carry a relatively lower risk.

In hindsight, there are many things you feel you could have done better in 2011. Nobody can change the past but you can definitely plan for the future and do your best.