DSIJ Mindshare

Cherry Picking

In recent months, domestic political upheavals, policy inaction on the monetary front and developments around the globe are keeping market participants on the sidelines. However, rather then shying away from the market, investors should pick the opportunities that it presents. DSIJ brings to you 5 stocks which still have good potential.

Legendary economist John Maynard Keynes once said, “Markets can remain irrational longer than you can remain solvent”. Waiting for the markets to turn rational could well turn out to be a wait until eternity. The most prudent strategy is always to play the markets as they behave, but carefully, especially when there is too much of volatility and uncertainty around. Staying off does not necessarily mean that you are doing a service to your portfolio.

The reason why we began this discussion so is that the markets today are in a state of flux. After a good beginning to the year (2013), the events, both domestic and global, have confused investors. Is this the right time to buy? What happens if the government falls? Will the Euro zone come to haunt the markets again? What if the US economy does not maintain its growth momentum? Will the Koreas go to war, triggering a much bigger scare? All these questions have left investors at sixes and sevens.

But we at Dalal Street Investment Journal have always helped our patrons come out of such circumstances, and have in fact, led them to profit from such situations. So, while the voices of caution are clamouring for attention and pushing investors away from the market further, we would rather stick to what we do best – helping you discover opportunities even in adversity and in turn aid in building your wealth.

To put it simply, we are looking at achieving two things. One, to see how the factors that we have tracked closely so far to draw a conclusion about the future course of the market are poised in the current circumstances. Two, we present you with five stock opportunities which are compelling buys for their fundamental strength, despite having taken a beating on the bourses.

First, let’s round up the key factors.

India Inc: Performance & Valuations

Valuations play a pivotal part while investing in the stock markets and are largely dependent on the financial performance of companies. We had taken a very clear-cut call on the future performance of India Inc. right from the end of the June quarter of 2012. An improvement in the financial performance of India after the June quarter of 2012 has been one of the major driving factors for the markets. After the June quarter, most of the leading research houses, including us, had done away with downgrades in the EPS estimates of Sensex-based companies.

In September 2012, we upgraded our Sensex EPS estimates. From the earlier levels of INR 1213, we had increased the FY13 EPS estimate to INR 1310. For FY14, we had increased the EPS estimates to INR 1490 from the earlier levels INR 1380. We had also anticipated that factors like declining commodity prices, expected rate cuts by the RBI and a revival of the capex cycle should help India Inc. put up a better financial performance. These expectations took the indices to new highs and the Sensex zoomed past the 20000 mark – a target we had predicted earlier.
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However, the December quarter of 2012 came in below street expectations as certain factors didn’t quite pan out the way we thought they would. Non-revival of the capex cycle, consistently higher interest costs and higher inflation played spoilsport. No wonder then, that some amount of profit booking was seen. With the Small and Mid-Cap indices witnessing a free fall, there was some sort of panic among investors.

The March quarter of 2013 is not expected to be a fantastic one either. But again, downgrades are a thing of the past, and hence, we would rather continue with our EPS estimate of INR 1310 for FY13 and INR 1475 for FY14 (adjusted for the 10 per cent surcharge).

What also should be borne in mind is that the current repo rate cuts are likely to make their impact felt from Q2FY14 onwards. Thus, we expect a round of upgrades to start in the second quarter of FY14. Even the EPS of INR 1475 discounts the Sensex by 12.80x. With a historical average of 14.50x, the Sensex can easily cross the 21000 mark by year end. If upgrades happen as expected in the second quarter of FY14, one can expect the Sensex to zoom past the 22000 mark by the end of December 2013.

FII Inflows: A Strong Showing

As far as FII inflows are concerned, FY2013 remains one of the best years for the Indian equity market. Approximately INR 139000 crore of FII money has flown into equities in FY13, surpassing inflows in any previous financial year. To put this number in perspective, the FII money that has come in during FY13 accounts for 22 per cent of the total flows that we have received since FIIs were allowed to invest in Indian equities in FY93. This will hardly come as a surprise to many of our regular readers, as we have mentioned over various issues and stories that FIIs are here to stay. Moreover, such a record inflow has come against the backdrop of a falling GDP growth rate (which declined to 4.5 per cent for the third quarter of FY13 from a high of 9.4 per cent recorded for the second quarter of 2010).

So, what is the reason for FIIs to have stayed put in Indian equities despite the shrunk growth rates? As we have explained in the past, the reason is an uneven reaction of FIIs to market situations. That is to say that they tend to bring in more when the situation is even slightly better, but sell less when it worsens. In addition to this, although the growth rate in India has halved, it is one of the best among the major economies, second only to China. Moreover, foreign investors are convinced about the growth potential of the Indian economy and the opportunities it provides their investments to grow at a decent rate.

Going forward, we believe that the FII money flow will be determined more by how reforms unfold in the coming months and the political scenario that emerges post the union elections in 2014. If we do not see any major hiccups in terms of an early election, FIIs will keep investing at a normal rate. Nonetheless, the intensity will only pick up (or drop) once the union elections are over and depending on what new political equations emerge at the centre.
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FDI: Waiting In The Wings

The trend in foreign direct investment (FDI) does not look to be as good as that in FII flows. For the first 10 months of FY13, we have seen major declines in FDI inflows. In rupee terms, this is down by 15 per cent on a yearly basis, whereas in USD terms, the fall is sharper (27 per cent). One of the reasons for such a stark difference between these two foreign flows is the factors that attract such flows. While FIIs are primarily driven by liquidity and the relative attractiveness of the local equity market, FDI is attracted by the overall investment environment. Last year, a gush of liquidity infused by loose monetary policies adopted by the various central banks led to such high portfolio investments. However, poor investment climate (read:various approvals required and taxation issues) and slowing economic activity has led to a fall in FDI.

Going ahead, the investment climate is slated to change after the government has taken various initiatives to resolve some of the issues important to attract FDIs (for example, the various clearances required before one can invest). Therefore, we might see higher inflows from this quarter in FY14.

Global Factors: On A Stable Recovery Path

Nine months ago, when we had first pointed at brighter days ahead, global factors posed a major cause for concern. The US economy was not in the best of shape, and the Euro zone was under the clouds of a major crisis which posed a grave problem of whether the European region will continue to remain a unified economic force. The Chinese economy too was slowing down. These factors were being looked upon as major threats for the Indian equity markets. However, we had maintained even at that time that the circumstances will improve. Sure enough, the situation has improved since then, and barring the Euro zone all the other major global economies are in better form today.

The US economy, without any major disruptions has averted the ‘fiscal cliff ’. It is steadily gaining strength, which is reflected in the strong auto sales, reduction in unemployment and the continued recovery of the housing sector. Similarly, a few hiccups aside, the situation in the Euro zone has improved after Mario Draghi, President of the European Central Bank, pledged to do whatever it takes to protect the region from disintegrating. Even in China, concerns of a hard landing have faded out and the economy is again picking up, albeit at a slower rate.

All these positives are well reflected in the way the markets in these regions have been doing. The US indices have touched lifetime highs and the European region has recovered well even from the worst of the adversities. These markets are currently trading at their yearly highs and have been consistently rising over the past four months.

The Currency Factor:To Remain Range-Bound

After witnessing a sharp depreciation and touching a low of INR 57.37 per USD, the Indian rupee has stabilised and is trading in a range of INR 52-56 per USD. We had clearly stated (DSIJ Vol. 27, Issue # 16, dated July 29, 2012) that the worst is over for the rupee. This has come true, as in the last eight months the rupee has held on to its levels and has been trading between INR 52-55 per USD.

In the month of July last year, CRISIL had predicted that the rupee will hit INR 50 per USD, but it ended up turned around after hitting a high of INR 51.6185. As predicted, however, FIIs have been pouring in a record amount of USD, which helped the rupee sustain.

India’s Current Account Deficit (CAD) has ballooned to USD 32.63 billion in the quarter ending December 2012. This marks a rise of 61 per cent as compared to the CAD of USD 20.2 billion witnessed in the same quarter last year. As a percentage of GDP, the CAD has touched a new high of 6.7 per cent in Q3FY13. This is strongly up from 4.4 per cent in Q3FY12 and 5.4 per cent in Q2FY13. This remains the only concern on the currency front. A higher CAD means that there will be a higher outflow of the USD, which in turn may negatively impact the rupee for the time being.

But all said and done the situation isn’t as bad as it seems. An improvement on the CAD front will surely be a priority for the government.
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Government: Sustainability & Policy Making

The most important factor that has driven the markets – on either side – has been the government and its policies over the past nine odd months or so. The return of Chidambaram to the Finance Ministry set the ball rolling on the reforms front. Despite all opposition, reforms took centre-stage and key bills were passed.

However, the more recent developments aren’t looking as encouraging as one would want them to be. First, a rather insipid budget and then the DMK pulling out support have cast a shadow of doubt on the overall situation. Talks of an early election have been hitting the markets hard. So, how bad is the political situation? Well, it may temporarily impact the markets, so to speak, but this would not stretch beyond a point.

Having summarised the situation on the ground, which we feel may have some short-term impact on the markets, here are five stocks that we suggest you should be buying in order to build strength in your portfolio. These stocks may be beaten down as of now, but have very good potential to do well going forward. After all, buying when stocks are down and selling when they go up is what investment wisdom is all about. Cherry pick now and savour the fruit over time.

Larsen & Toubro

BSE CODE - 500510 | CMP - INR 1380

Most investors would be surprised to see an engineering company in our recommendations. In a scenario of higher interest rates impacting the overall capex cycle, not many would in favour of recommending an engineering company. Apart from this, a drastic decline in the L&T’s share price from INR 1715 in November 2012 to INR 1350 also adds to investors’ worries.

However, we feel that a fall in the prices has made it more lucrative for investors and we have compelling reasons to recommend L&T at this level. The first and the foremost factor is that L&T has a robust order book position resulting in a good revenue visibility for the next eight quarters. The company has a total order book of INR 162300 crore as on December 31, 2012. This is 11 per cent higher as compared to the December 2011 quarter despite higher executions. The best part is that even in a difficult scenario the company has kept the order inflow ticking. For the December 2012 quarter, the order inflow stood at INR 19500 crore, up by 22 per cent on a YoY basis.

Going ahead, the infrastructure segment is expected to drive growth. The management also expects the international business to bring some growth. Currently, the international business order book stands at 10 per cent and with orders expected from CIS and Saudi, the management is quite positive about the order flow from the international markets.

On the margins front, L&T is yet to be out of the woods and for 9MFY13, its EBITDA margins stood at 9.08 per cent as compared to 10.80 per cent in 9MFY13. We however feel that the softening commodity prices and an expected improvement in the value of rupee would help the margins improve. The margins also fluctuate from project to project and once they improve once they reach the completion stage. Even the 50 basis points repo rate cut that took place in the last quarter of FY13, is expected to show its impact from the first quarter of FY14. This will help capex cycle revival in the Indian markets, ultimately helping L&T. The public orders are also expected to flow with CCI clearing many pending infrastructure projects.

The fall in prices has made the scrip look good on the valuation front as also with the CMP discounting its trailing four quarter earnings by 19x. We recommend investors to buy the scrip at the current levels with a target price of INR 1800.
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Jammu & Kashmir Bank

BSE CODE - 532209 | CMP - INR 1194

The shares of JKB, along with the broader markets, have fallen by approximately 14 per cent from its recent peak. Nonetheless, looking at the strong fundamentals of the bank, this provides the right opportunity for an investor to pick up the shares at an attractive valuation. JKB’s advances grew at a CAGR of 18 per cent over the past ten years and even for the nine months ending December 2012 the loan growth was 20 per cent, higher than the industry average which is in the lower teens. However, such a growth has not come at the cost of asset quality. The bank’s gross NPA stood at 1.6 per cent and NNPA at 14 basis points for the third quarter of FY13 while its provision coverage ratio improved to 94.2 per cent, one of the best in the industry. The bank is also adequately capitalised with a capital adequacy ratio of 13.62 per cent (Basel II) with Tier 1 capital of 11.8 per cent, once again the best in the industry. The bank’s shares are currently priced at an attractive 1.2 times of its book value at the end of 9MFY13, discounting its annualised EPS of the same period by 5.45 times. What make the shares even more striking are its healthy return ratios. JKB’s RoA of 1.78 per cent and RoE of 23.88 per cent at the end of 9MFY12 once again beat most others in the industry. We therefore believe that you can bank on this scrip to build a profitable portfolio.

Bajaj Finance

BSE CODE - 500034 | CMP - INR 1201

Promoted by the renowned Bajaj Group, Bajaj Finance is a subsidiary of Bajaj Finserv and is a leading diversified NBFC in India. What has lured us to the stock is its well-diversified portfolio bouquet and a loan book spread across nine business lines. The company’s loan books are balanced in terms of scale and profitability. It has built a pan-India presence, covering 225 points across India and more than 4000 distribution partners and dealers. The other factor that comes to the fore is that the company has been able to maintain a strong growth momentum with a 75 per cent CAGR growth in AUM (Assest Under Management) over the last three years and is trying to maintain the balance between profitability and growth. Bajaj Finance is the largest lender for two-wheeler loans. Its market share has improved from around 24 per cent of Bajaj Auto’s domestic sales in FY12 to 30 per cent as of 9MFY13. The company has witnessed some growth in its consumer lending business as the market share increased to 14 per cent as of 9MFY13 as against 11 per cent in FY12. Also, in the last four years, the return ratios have improved significantly. Its RoA has improved from 1.3 per cent in FY09 to 4.2 per cent in FY12. The company has maintained a healthy asset quality with a gross and net NPA of one per cent and 0.2 per cent respectively as of Q3FY13.On the other hand, if we look at the financials, the topline has been witnessing an upward trend since the last six quarters and the bottomline has been impressive too.

Let us take a look at the financial performance of the company. For the recently concluded Q3FY13, the topline witnessed a growth of 42.72 per cent on a YoY basis to stand at INR 791.68 crore as against INR 554.72 crore for Q3FY12. The bottomline has witnessed an impressive growth of 33.42 per cent on a YoY basis for the same period to stand at INR 160.09 crore. On the valuation front, the company discounts its trailing twelve-month earnings by 10.99x. The price to book value stands at an attractive 2.16x. We feel that in these turbulent times, the stock looks to be an ideal candidate for an investor’s portfolio.
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Mahindra & Mahindra

BSE CODE - 500520 | CMP - INR 844

The automobile industry has not been faring too well owing to the macroeconomic conditions lately. However, segments like Utility Vehicles (UV) and Light Commercial Vehicles (LCV) have a robust demand and have been providing a substantial support to the overall automobile industry.

Companies that have a stronghold in the above segments have been outperforming others by leaps and bounds. Mahindra & Mahindra (M&M) has been a strong player in the UV segment because of top-selling models like Bolero and XUV500. UVs contribute to about 50 per cent of the volumes of M&M and have thus supported the company’s growth even during turbulent times. Moreover, the company has managed to keep its sales buoyant by launching new models for the Indian markets that have received an overwhelming response. Moreover, it has managed to grab a large share of the thriving LCV market with products like the Gio and the Maxximo range.

M&M’s presence in the tractor segment is humongous. This industry has been subdued due to delayed monsoons and high interest rates and has had an obvious negative impact on the revenues and profitability of M&M. However, its outperformance in other segments has led to a reversal in this downturn.

It is also present in the two-wheelers and medium and heavy commercial vehicles segments. However, it hasn’t been able to gain traction in these areas. Over time, and improvement in the overall macro environment, these segments are expected to unlock value and further benefit M&M.

The automobile giant has recently seen a few dips owing to factors like tractor sales and raised excise duty on UVs. It has come down from a high of INR 975 per share to INR 850 per share. However, the prospects of the company remain high. While other companies have struggled to show growth, M&M’s volumes have grown by 16.60 per cent, indicating resilience and potential.

Wockhardt

BSE CODE - 532300 | CMP - INR 1990

Despite Wockhardt’s sharp run up on the bourses, we are recommending the stock to our readers. Some readers may be surprised with this. But hold on, here are the reasons. The stock is still available at a cheaper valuation compared to its peers and the financials of the company have improved largely.

The promoters of Wockhardt have set an example of how a near bankrupt company can make fortunes. Wockhardt at one time was reeling under a huge debt burden and there was a possibility of winding up the business. But with help from its lenders, the company has achieved a feat which is no less than a wealth creating phenomenon. The company’s shares have rocketed since the dramatic turnaround began in 2011. The steam in the stock however has not cooled off yet as the stock is available at a price to earnings of 13.5x of FY13’s expected EPS of INR 150, which is quite economical as compared to its peers. With the continuation of re-rating the stock, we expect it to garner more than 30 per cent returns by December 2013. Isn’t that a strong enough reason to buy the stock?

Well here are a few more reasons too if you are not convinced yet. After the company began reporting hefty profits, it is very close to exiting the corporate debt restructuring which it had entered in 2009. This means that the company will be financial independent soon. The net debt to equity ratio has also come down to below 1x, providing relief to investors. Besides, the company is witnessing a strong operating performance with one of the best EBITDA margins in the industry. The US business, which forms 50 per cent of its revenues, has also shown signs of recovery and the growth momentum will therefore remain intact. The balance sheet will also continue to remain healthy as the company is not looking at any acquisitions right now.

Wockhardt has not declared any dividends in the last five years due to the CDR and financial losses. Once it leaves CDR, it may also announce a dividend as a good gesture towards investors, giving further some benefits to them.

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