| Be selective |
| Jitendra Kumar Gupta / Mumbai June 8, 2009, 0:41 IST |
As valuations of mid-cap stocks have risen, investors need to be more careful while picking stocks.
An investment of Rs 1,000 made in the BSE Sensex a month ago is today worth Rs 1,260. But, a similar investment in the BSE Midcap index is today worth Rs 1,430 and, translates into higher returns of 43 per cent. This turnaround in mid-cap stocks is partly on account of higher confidence as well as expectations of improving fundamentals in these companies. Besides, the risk appetite has increased after the elections, and the consequent infusion of fresh money into mid-cap stocks, which were then trading at depressed valuations, were among the key reasons that led to the rally.
Are current valuations justified?
Experts believe that the environment has now turned conducive for India Inc, especially for medium-sized companies, which have been suffering on account of lack of sufficient funds, higher interest rates and demand slowdown. Also, during the economic downturn, analysts were worried that the mid- and small-sized companies would be among the first and the most impacted, leading to erosion in their earnings as compared to their larger peers. However, they now expect the impact on their earnings to be far lesser, given the improving liquidity situation, declining interest rates, lower input prices and stability in demand.
“What is good is the changing environment in terms of improved liquidity and demand. And, if the budget is market-friendly and the monsoon normal, things should turn out even better. Keeping these things in mind, the growth next year could be stronger and thus, the valuations which these companies today command could be justified,” says I V Subramaniam, director & CIO, Quantum Advisors.
On the flip side, the high tide (the rise in markets) has lifted all boats in the ocean. Companies with not-so-promising prospects or weaker fundamentals have also seen their stock values go up. “Not all mid-cap companies are attractive,” says Amitabh Chakraborty, president equity, Religare Securities.
The faster rise in the value of mid-cap stocks has also led to a contraction in the valuation discount between the BSE Sensex and BSE Midcap indices. For instance, the Midcap index was quoting at a price-earnings (P/E) of 13.2 on May 31, 2009, reflecting a discount of 26.3 per cent as compared to the then P/E of 17.9 for Sensex. This discount has now shrunk to 17.3 per cent currently, though it is still higher than 5 per cent seen in January 2008.
What you should do
Some experts believe that it may not be the right time to invest in mid-cap companies and that there could be a correction in their share prices, which in many cases has risen too sharply. “It isn’t the case that there is no value in the market, but one will have to be selective as in many cases the prices have run up ahead of the fundamentals. Be cautious and remain on some cash,” says Chetan Parikh, director, Jeetay Investments, a portfolio management firm.
“Over the next two months, there could be a separation between the men and the boys within the mid-cap space and only those with good financials and sustainable business model will be rewarded,” says Chakraborty. In other words, investors should use this opportunity to exit undeserving stocks. They will also have to do their homework thoroughly by sticking to fundamentally strong companies besides, opting for an increasingly selective investment strategy. Also, a phased investment approach is likely to prove beneficial.
We spoke to a dozen experts to arrive at a list of investment worthy stocks in the mid-cap space, and importantly, where valuations are reasonable and the risk-reward equation is still favourable. The process also included selecting companies which operate in industries with fairly good growth opportunities. The outcome is a host of companies, which due to their inherent strengths are among leading players. Read on to know more on the individual stocks.
Bartronics India
Led by the recovery in the share price of mid cap companies in the recent past, the stock of Bartronics has gained almost 72 per cent in the last one month. Considering the company’s sound business model, attractive valuations, consistent growth rates and higher revenue visibility, analysts believe that the stock at Rs 162 is still not expensive and is trading at a price-to-earnings multiple of just 4.3 times its estimated 2009-10 earnings.
Bartronics provides products and solutions based on data-capture and radio-frequency related technologies (like AIDC and RFID). The demand for these products, especially in the areas pertaining to distribution and supply chain management has been strong.
Bartronics generates about 70 per cent of its revenue from the two segments, which have grown by 133 per cent in 2008-09 to Rs 411 crore as compared to a year ago. Going forward, the company’s order book of Rs 650 crore, which is executable over the next twelve months, provides decent revenue visibility for this segment.
The company’s other segment, smart cards, is growing equally fast and has promising prospects. During 2008-09, the smart card business reported an 85 per cent growth in revenue to Rs 172 crore. Currently, the telecom sector accounts for about 95 per cent of its smart cards business. However, the company is positive about the future growth, on the back of an expected rise in government expenditure on various social schemes and for identification cards.
Thus, expect the revenue share of the latter in the smart card-based business to improve to about 30 per cent in the medium-term. Additionally, the company is also eyeing new business from the banking sector. In terms of current year estimates, the company is expected to sell 80 million cards (100 per cent of its capacity) as compared to 55 million cards sold in 2008-09 (and 31 million in 2007-08). This should help in reporting a 70 per cent year-on-year growth in revenues to about Rs 1,000 crore in 2009-10.
CRISIL
Crisil, which is a leading player in the domestic ratings business, will be a key beneficiary of the country’s growing economy and developing financial markets. The gains would accrue on the back of the company’s diversified business model, which comprises products and services like rating, advisory and research. Besides, it has an added advantage in the form of the support of its parent, Standard & Poor’s (S&P), which is the leading global rating agency. Also, unlike many other businesses, the company is less dependent on capital to expand its business and generate high return ratios, which are among key attributes of a good investment.
| IS THE WORST BEHIND? | ||||
| in Rs crore | Jun ’08 | Sep ’08 | Dec ‘08 | Mar ’09 |
| Sales | 1,20,986 | 1,36,801 | 1,29,617 | 1,23,073 |
| % Chg (y-o-y) | 34.90 | 36.80 | 24.60 | 6.50 |
| PBIDT | 38,347 | 41,523 | 40,280 | 44,991 |
| % Chg (y-o-y) | 23.50 | 19.20 | 8.50 | 17.20 |
| PBIDT margin (%) | 31.70 | 30.40 | 31.10 | 36.60 |
| Interest | 22,225 | 24,346 | 26,143 | 27,312 |
| % Chg (y-o-y) | 37.30 | 35.10 | 35.30 | 30.50 |
| Adj. PAT | 9,057 | 10,662 | 8,421 | 9,842 |
| % Chg (y-o-y) | 1.80 | 7.80 | -18.10 | -11.70 |
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Going ahead, as per the Basel II norms, all borrowers (with banking facilities above Rs 10 crore) need to get a rating by March 2010 in phases. Many companies that haven’t been rated before are now seen availing the service of rating agencies like Crisil. So far, the company has rated about 2,000 companies. According to estimates, there are about 7,000 rateable entities, which itself indicates the business potential. The company is expected to tap this opportunity given its market share of about 50 per cent.
Crisil’s advisory business reported a 60 per cent decline in revenues in January 2009 quarter led by the slowdown in the capex cycle. The growth rates in this business are expected to improve given the government's increased focus on infrastructure spending as well as the gradual revival in the domestic economy. The research business also holds potential. However, stability in the financial markets is seen among requisites for an improvement in the prospects, which may take some more time to materialise. Meanwhile, at current price of Rs 3,521, the stock trades at a price-to-earnings multiple of about 16 times based on its estimated earnings for year ending December 2009.
Gateway Distriparks
A significant contraction in India's foreign trade has dimmed the prospects of one of India’s largest container freight station (CFS) operators. This is also a reason why the company reported a 20 per cent year-on-year decline in CFS volumes for the March 2009 quarter. However, considering its strong business model – it operates in some of the largest ports in the country such as JNPT, Chennai, Vizag and Kochi – the company could be a good long-term play on India's growing trade and economy.
In addition to the CFS business, the company's strategy to leverage its existing logistic business by way of backward integration into the rail freight and the cold chain businesses would drive growth in future.
The railway freight business contributes about 35 per cent of its total revenue. However, due to the lower utilisations and higher fixed costs, this business is incurring losses. The company currently own 15 rakes and runs 2 rakes on lease basis, which has helped notch up volume growth of about 70 per cent during the March 2009 quarter. Although it has been able to increase its volumes, profitability will remain an issue as the business is expected to be break-even only in 2010-11. Analysts are expecting the volumes and margins to improve going forward, on the back of an increase in the utilisation levels. Higher volumes will also lessen the impact of fixed cost.
The company is present in the entire logistics chain with presence in key trading and industrial regions. However, for the full benefits to accrue, it is crucial that the economy revive. At Rs 96.35, the stock is trading at 11.3 times its estimated 2009-10 earnings, and is suitable for investors with patience and some appetite for risk.
Patel Engineering
Patel Engineering, which is an established player in the infrastructure space, derives a large chunk of its revenue from government-backed projects, where growth visibility is still strong. Besides, it is also a leading player in hydro-power construction space as well as projects related to irrigation, which are good attributes given the vast opportunities in these segments.
That apart, the company has a presence in the construction of road and urban infrastructure. Post the elections, analysts are more convinced about the increased capex in these segments.
Apart from the long-term growth drivers, Patel Engineering currently has a strong order book of Rs 7,200 crore, which is 3.3 times its 2008-09 revenues and provides good visibility. Additionally, the relatively lower commodity prices as well as interest rates, and increased systemic liquidity should augur well for the sector and the company. To give an indication, for December 2008 quarter, the company reported an interest outgo of Rs 19.5 crore (Rs 2.9 crore in December 2007 quarter), which could trend down going ahead.
The company also owns real estate assets and plans to start power generation, as part of its long-term growth strategy. It has plans to set up 1,200 mw of power generation capacity in 3-4 phases, for which the company has acquired the land and is awaiting environment clearance. In the real estate space, the company has a land bank of 1,127 acres spread over cities including Hyderabad, Chennai, Bangalore and Mumbai. However, the benefits of this will only accrue over the next 4-5 years, as the company plans to develop this land bank in a phased manner. At Rs 404, the stock is trading at 14.4 times its estimated 2009-10 earnings.
Sintex Industries
Sintex Industries, a popular household brand in the plastic products space, is a proxy for the domestic consumption story. A large untapped market for its plastic products, which are used in the residential, public enterprises, hospitality and construction sectors for building temporary as well as permanent housing, make Sintex a good long-term bet. Besides, the compan
