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15 Quality Stocks for YOUR Portfolio in 2006 -
January 8th, 2006
15 Quality Stocks for YOUR Portfolio in 2006
Mantra for 2006 - quality first
As bull runs progress, mid and small caps tend to outperform their bigger peers. In several sectors the valuation gap between large and small companies has narrowed considerably making a strong case for investing in established companies with a track record than those which are driven by hope and faith.
With this in mind we have drawn out a portfolio which should beat the Street this year. We have picked stocks hoping that the two main driven of the domestic economy - consumption and infrastructure will continue to do well this year too. Besides, we have also picked some stocks because we think they are ripe for a re-rating or have some hidden value which can get unlocked.
A V Birla Nuvo
Nuvo was born after the three way merger between Indian Rayon, Indo Gulf and Birla Global. The idea of integrating these diverse businesses under one umbrella was to ensure that the value businesses or its cash cows are used to feed the cash hungry high growth business.
Currently, the company houses value businesses such as insulators, VFY, fertilizers, textiles, carbon black and high growth business like garments, financial services, telecom and IT and IT enabled services.
Analysts peg the valuation of the telecom and insurance at roughly Rs 200 each. Stripping that part off the current price of Rs 667, the stock looks cheap.
Amtek Auto seems to be a good play on the auto ancillary industry which is touted to be the next big outsourcing beneficiary after software services. Amtek Auto is the only player in the country with strong presence in both forgings and casting and with capacity to supply finished components to global original equipment makers.
The company has acquired seven companies in the past five years, which helped it attain critical scale and geographical spread. The company is likely to end the year with Rs 2800 crore of revenues and Rs 220 crore of profit after tax. Based on the current market price Rs 297, the stock trades at price multiple of 14 times FY07 earnings.
Compared to that, Bharat Forge, the leader in the business and darling of the bourses, enjoys a P/E of over 20 times. The reason why the Amtek Auto stock is going cheap is that the market perception about the company's management isn't anything to write home about.
But like Warren Buffet, when the reputation of the management and the reputation of the business are pitched against one another, it is the reputation of the business that prevails. Amtek may not deserve the same valuation as Bharat Forge but the differential should begin to narrow as business dynamics continue to remain strong.
Clariant is an indirect play on the textile sector. The Indian arm of the global leader in specialty chemicals, Clariant is a market leader in dyes and specialty chemicals and caters to catering to textiles, leather and paper industries.
While the textiles sector looks to be on the fast track, most textile companies have only disappointed in terms of financial performance. One way to capture the growth in textile sector may be through key suppliers with good market position like Clariant.
Recently, the parent approved the merger of Clariant and three other subsidiary companies with Colour Chem. The swap ratio for Clariant shareholders is 1:1. The combined entity called Clariant Chemicals (India) will have sales of around Rs 800 crore and net profit of Rs 44 crore in FY06. Share of Clariant in the profitability of the combined entity is expected to be the highest, though in the terms of sales, share of Colour Chem in the combined turnover will be a tad higher.
Given government's ambitious goal of growing Indian textile exports to a level of $50 billion by 2010 from the current $14 billion and number of global players like Walmart making a beeline for sourcing Indian garments, a lot more efforts will have to diverted to augment India's capability in processing and finishing of fabrics.
Also India's leather industry has also been emerging among the top 10 export earners and they are more into value added products like footwear, garments etc. Thus analysts believe that the company is likely to cash in on this opportunity due its leadership position.
While the analyst perception of big pharma currently not too positive, it is the mid-cap pharma segment that is coming into focus. Hyderabad-based Divi's Laboratories is said to be among the most attractive in this segment. A big chunk of company's business is derived from active pharmaceutical ingredients (APIs).
The company enjoys a leadership position in some of the products by virtue of being one of the top three global suppliers of Diltiazem and Naproxen. Divi's is focussing on filing more DMFs (drug master files) as it tries to enhance its offerings.
The company's strategy is to target only few compounds and be a major player in them. The company is also trying to enter into long - term sourcing contracts for some of the bulk drugs which are expected to enhance topline. Apart from APIs, Divi's also provides custom synthesis services in all three phases of clinical trials to leading global innovator pharmaceutical companies.
Analysts note that this is a high-margin business and has large potential for upside. The company has also entered into an agreement for contract manufacturing for seven years.
However, future growth drivers are expected to be peptides and carotenoids (recognised for their usefulness in treating cancer and heart diseases). Given the limited competition and higher margins in these segments, Divi's head start is expected to stand it in good stead.
Management expects a 15 per cent topline growth in FY06E and FY07E, excluding the contribution from carotenoids. Though analysts expect Divi's to grow at a steady pace, they note that it could surprise on the upside. The stock trades at Rs 1525, on a trailing 12-month P/E of 28x.
State-owned Engineers India has a strong foothold in the business in which it operates. An engineering and technical service provider with predominant focus on the oil and gas sector, Engineers India's performance is linked to the growth in the sector. Growth in demand for petroleum products is resulting in a shift from surplus refining capacity in the country to projected shortages in the medium term.
New refinery projects at Paradeep, Orissa, Bhatinda, Punjab and Bina along with a slew of other expansions are expected to take-off in the near future. Even around the world, the refining sector is marked with capacity constraints and shortages.
Further, major investments in the gas sector including the gas exploration and production in Krishna Godavari basin, LNG terminals, cross country pipelines and the expansion in the downstream petrochemicals sector will also usher more growth opportunities.
The company is also diversifying into several new areas including highways and bridges, airports, mass rapid transport systems, ports, power projects etc. This should ensure that the company will benefit from the continued thrust on infrastructure too. Last fiscal the company booked new orders worth Rs 652 crore. The company should be a steady performer.
With the US generics markets getting tougher, domestic pharma companies have suffered a serious setback. On the contrary, multinational pharma companies look well poised to take advantage of the vast domestic market. Glaxo SmithKline Pharma looks interesting with a strong parent to support and some product launches in the pipeline.
The company's growth will be driven by in-licensed brands and two launches from its own global product portfolio. GSK India has been exploring opportunities for licensing new products which will suit to its currently focussed product portfolio.
The company is also exploring options like brands and company acquisitions in the domestic as well as overseas markets. Moreover, parent company Glaxo SmithKline Pharmaceuticals Plc is planning to make GSK India's Thane manufacturing facility a global sourcing hub for active pharma ingredient (API) for its top selling steroid -'betamethasone'.
Analysts expect the company to grow about 15 per cent in the next couple of years but there could well be positive surprises. The company is cash rich and cash per share amounts to Rs 130 per cent. Stripping this cash off its prices, the stock trades at Rs 1121.75. Based on an estimated FY07 EPS of Rs 44, the commands a P/E of 25x.
ICICI Bank, the largest private sector bank in the country, looks like the best retail banking play. The bank seems to have transcended its turbulent times with non-performing assets now down to 1 per cent. With 2600-odd branches and ATM networks, the bank is a household name and has the biggest retail book of Rs 60000 crore on a total loan book of Rs 1,89,000 crore. Retail loans would continue to be the main growth driver for the bank.
That apart, the bank has built a strong technology backbone which has helped it keep its costs low. More than 70 per cent of the bank's transactions are done through the internet which helps to keep its manpower requirement low.
Having raised $1.8 billion through the public issue last month, the company is unlikely to be constrained for capital to feed its future growth. Currently, its capital adequacy stands at close to 17 per cent. Another significant driver for the bank is the three subsidiaries - its insurance, broking and asset management businesses.
When the markets look overheated, ITC is usually touted as a good play thanks to its defensive strengths. But that is not the only reason we are recommending the stock in our 2006 portfolio. ITC has undergone a transformation from a tobacco major to a fast growing consumer company.
The company is a play on the consumer sector and has a good chance of capturing the growth in the foods segment in which it has been increasing its presence steadily.
On top of this, its e-chaupal strategy should bear rich fruits in the long haul as it will help the company reduce its procurement costs (of farm inputs) apart from developing an alternative revenues stream through distribution. The investments it is making in real estate though fairly small as of now, has the potential to appreciate significantly over time.
The company's mainstay, the tobacco business is seeing steady growth even as its three other businesses, paper, hotels and foods are also showing good momentum. Both the hotels and paperboards business have seen a cyclical upturn in the past year and are expected to do well this year too. According to analyst estimates, topline is likely to grow around 15 per cent while better margins should ensure that bottomline grows at a faster clip.
Maruti has been an outstanding performer in the past three year with tremendous improvement in productivity. The success of its newly launched Swift which sells about 5000 cars a month has also effectively addressed the issues with its ageing portfolio.
Over the past three years the company has improved its operating margins from four per cent to 13 per cent, on the back of higher volumes, better product mix, significant productivity improvements. With its new diesel plant to be commissioned in end 2006, Maruti will see even more exciting times as its small diesel car should be a roaring success.
This is especially true in a situation where oil prices remain high and the differential between petrol and diesel remains high. Based on an estimated FY07 EPS of Rs 46, the stock (Rs 635.80) trades at a P/E of 13.8x.
The worst seems to be over for software and back-office service firm MphasiS BFL has delivered decent growth in the second quarter of the FY06 beating analyst estimates. the reason why MphasiS is in this list is because the stock appears to be a value play, considering that the stock trades at a trailing price-earnings ratio of around 18x, which is attractive compared to its peers like Aztec Software (41x), 3I Infotech (32.05x) and Polaris Software (21.51).
MphasiS has an impressive client list that includes Citigroup, ING, BNP Paribas, Compaq, and many other Fortune 500 clients. MphasiS expects to add 1500 more employees in the BPO division in the near future. The telecom re-configuration is expected to assist the company in sustaining the operating margins in the coming quarters.
Of late the non-voice based services contribute about 21 per cent of the overall BPO revenues. Going forward the company plans to increase this to 25 per cent, to improve its utilisations and consequently its margins.
The IT growth is expected to continue while the BPO division is expected to record double-digit growth mainly due to growth from two large customers, Bharti Tele-Ventures and a North American bank.
The 16-year old Pune-based Sanghvi movers is the largest crane hiring company in India and the fourth largest in Asia with a fleet of about 200 medium to large size Hydraulic and Crawler Cranes with lifting capacity ranging from 20 tonnes to 800 tonnes. It is planning to add some more cranes worth Rs 160 crore by FY06.
Besides, it also provides an entire range of services like movement of materials, erection of equipment, and assistance in fabrication apart from engineering services. Currently wind mills contribute about 35-40 per cent of total revenues from cranes, with Suzlon being the biggest contributor.
Higher contribution of wind mills in crane hiring augurs well for the company as India is supposed to be the fastest growing market for wind power. The government's focus on infrastructure development has facilitated huge investments in infrastructural and core industries like steel, cement, oil and gas, construction, power projects etc who are major users of cranes. The stock currently rules at Rs 443, on a trailing 12-month P/E of 16x.
State Bank of India
Devina Mehra of First Global started telling the story of State Bank of India quoting Lou Gerstner, the man who changed the way business was done at IBM. "Who says elephants can't dance?" Gerstner had quipped about IBM. Some of the things that SBI has done made her wonder why this elephant can't dance.
Mehra concluded that there were three reasons why it could not - one it has a huge investment portfolio which will make it difficult to survive when interest rates were rising, capital constraints as its adequacy level were hitting the floor and the imminent peak in the credit cycle which has seen a long expansionary phase. Mehra concluded that SBI could at best be a market performer. But we differ and think the elephant still is the closest proxy for Indian economy.
Even if it is tired in the near future, it will keep up the good performance over the long term. Valuations still looks pretty attractive, especially compared to several other banks. At the current price of Rs 907.45, the stock is trading at 1.14 time price to book (Rs 651) which is reasonable. Q3 results are likely to be disappointing with pressure on margins as funds would have been parked in short duration securities due to the IMD redemptions in December. But that could precisely be the time to go bottom fishing.
SREI Infrastructure Finance is a good way to play the infrastructure theme. Despite the rapidly changing industry environment, declining industry margins and increasing competition the company has been able to maintain its growth momentum.
In the last fiscal the company reported a 50 per cent increase in disbursements, and a 38 per cent increase in net. SREI seems to be transforming from a pure finance company to an equipment provider cum financier. Some of innovations the company has done recently sound interesting.
The company directly liaisons with the original equipments suppliers to ensure that customers get what they want. In a booming economy where demand exceeds supply, several serious users face delays in product delivery resulting in loss of profitable opportunities.
The company has set out to address this by organising bulk purchases. In April 2005, SREI signed a landmark deal with Tata Motors for the purchases of 10,000 heavy transport equipment, the largest such instance in India. Similarly, the company has pioneered a system of auction of interest rates for infrastructure equipment.
So instead of the company dictating the rate of interest that customers would need to pay as a part of the financed acquisition, it enables them to decide the rate influenced by the prevailing demand and supply of the equipment. Obviously, these strategies should work well for the company till infrastructure growth continues to strong.
With more money in the hands of youngsters, consumer spending is likely to remain strong. So all businesses which thrive on the consumer spending should do well, say our colleagues from the BS Motoring team. Two wheeler sales have been racing ahead over the past few years with no signs of sluggishness yet despite the higher base. All the three top two-wheeler makers namely Bajaj Auto, Hero Honda and TVS Motors should do well.
However, we are inclined to favour TVS Motors purely because of the progress the company has made in terms of sorting out its product portfolio which was inhibiting growth for a while. Now the company has presence in all the key segments. Its new product Apache which is pitched against the Bajaj Pulsar is also expected to do well.
There is no reason to believe that the company should not be able to sell more numbers with a superior product and more competitive pricing. Assuming that the company is able to clock a modest 20 per cent growth in earnings in fiscal 2007, the stock trades at 12.5 times at the current price of Rs 100. That looks attractive compared to Bajaj Auto which trades at 20 times FY07 earnings. '
Last edited by ViJiT; January 8th, 2006 at 08:33 PM..