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5 GOOD mid-cap stocks to buy
Vishal Chhabria, Outlook Money | September 18, 2006
Like in life, stock market clouds too, usually, have a silver lining. The BSE Sensex rose to its all-time high of 12,671 points on May 11, 2006, and then fell drastically to 8,800 levels in a matter of few weeks.
Today, the Sensex is hovering around the 12,000 levels. Though the over 8 per cent fall in the Sensex is bad news, the silver lining is that individual stocks, especially in the mid-cap segment, have fallen even lower and are now highly attractive.
While short-term worries like high crude oil prices, rising interest rates and geopolitical tensions have subdued the market sentiment a bit, they have also thrown up many investment opportunities. Investors can now comfortably choose and buy shares of good companies at reasonably lower valuations. What's more, they can also expect good returns from such investments.
However, it is still uncertain which direction the markets will take in the medium term. In this scenario, it is important to channel all investments, especially those in mid-caps and small-caps, only to good quality companies.
If the business fundamentals of the company are good, it is well managed and its financials are healthy, your investment would not only survive weak markets but also give you sound returns.
In this backdrop, we crunched some numbers to arrive at a list of investment worthy mid-cap companies. In our analysis, companies with a profit (annual and June quarter) growth of at least 15 per cent cleared the first test. We also looked at the drop in their share prices.
Companies whose share prices had fallen by at least 15 per cent, almost twice the fall in the Sensex as compared to its May 11 peak, and whose valuations looked attractive were considered. This, to some extent, helps in keeping a tab on the price one pays for a stock -- basically to ensure that one does not end up paying a huge premium for growth.
To restrict the list to quality companies, we gave higher weight to factors like the company's business segment, its standing in the industry, its management, entry barriers, and scalable business model.
Quantitatively, key financial parameters like debt-equity ratio (we considered companies for which this figure was less then one), return on capital employed (greater than 15 per cent) and positive cash-flow from operating activities were analysed. (In Dishman's case, the actual debt-equity ratio is higher than one since it raised FCCB of $50 million last year for expansion and acquisition. A good part of that -- Rs 124 crore -- was kept in cash till March 2006, which when adjusted for, gives a net debt-equity ratio of less than one.)
Finally, only companies with good growth prospects were considered. Given below are five companies from the mid-cap category which we believe have the ability to grow at a fast clip and the potential to deliver healthy returns.
1. Blue Star
It is India's largest central air-conditioning and commercial refrigeration company, well-known for delivering quality products, and has a six-decade-long history.
The company has a network of 23 offices, four modern manufacturing facilities and around 1,800 employees. Blue Star supplies large central air-conditioning plants, packaged air-conditioning systems, split and window air-conditioners, cold storages and water coolers for commercial and residential use.
The boom in sectors like IT and IT enabled services, healthcare, entertainment, retail, hospitality, telecom, power and banking has created a strong demand for Blue Star products in the commercial air-conditioning space. The prospects are good too, as this segment is expected to grow at over 20 per cent, at least over the next few years.
Rising demand from relatively smaller segments like coffee and ice-cream parlours and restaurants has also boosted demand for light commercial air-conditioning products. No wonder, the company has clocked a compounded annual growth in sales and profit of about 23 per cent each in the last four years. Leveraging on its product design knowledge and manufacturing expertise, Blue Star has also started providing its services to customers in North America, the Middle East and Japan.
The boom in the retail sector (malls, for example), rapid expansion in the telecom and power sectors, upcoming airport projects, increasing industrialisation, strong growth in IT and BPO segments and growth potential due to thrust on food processing (formation of agro-export zones and food-parks) are some of the factors that should keep Blue Star's growth rate at over 20 per cent for the next 3-5 years.
2. Clariant Chemicals
Clariant Chemicals (India), earlier Colour-Chem, now represents the merged operations of the five companies of Switzerland-based Clariant in India. A specialty chemicals company, Clariant Chemicals enjoys dominant positions in pigments (used by manufacturers of paints, printing inks, plastic, rubber, detergents and cosmetics, among others), dyes and speciality chemicals (used to manufacture textiles, leather, pape and, personal care products) and diketene-based intermediates.
Dyes and speciality chemicals account for 57 per cent of revenues, the other two categories 41 per cent and the balance comes from master-batches. The company's strategy of working closely with its customers and its ability to innovate and deliver new products that meet their requirements has helped it achieve a dominant position.
While topline growth rates in the past (CAGR of 6.2 per cent in the three years up to 2004-05) have not been very exciting, profits have grown at a healthy 19 per cent.
The future is promising too, as, with the global chemical industry focused on consolidation and cost reduction, the prospects for the speciality chemicals industry look bright. On the other hand, India is also evolving from being a manufacturer of basic chemicals to a producer of cost-efficient innovative products, which in turn is helping it emerge as the sourcing hub for speciality chemicals for certain industries.
A McKinsey report has estimated exports to grow six-fold from $2 billion in 2002-03 to $12 billion by 2015. Domestically too, big expansion plans of large players in segments such as textile, paper brighten up growth prospects.
Together, these opportunities augur well for Clariant Chemicals, which has a strong parentage and already derives 25 per cent of its revenues from exports. At Rs 220, Clariant is a good bet.
3. Dishman Pharmaceuticals
This Ahmedabad-based company manufactures intermediates, APIs (active pharmaceutical ingredient -- the ingredient with the curative property) and quaternary compounds (Quats, catalyst compounds).
Since 1998, Dishman has diversified its interests to the contract research and manufacturing (CRAM) sector. Within a span of five years, Dishman has achieved several CRAM projects and is a contract manufacture outsourcing organisation. As a business strategy, Dishman typically establishes relationships with MNCs through sales of low-margin Quats and later tries to move up the value chain by entering into high-margin CRAM for intermediates and APIs.
Europe-based Solvay, its key CRAM client, came into its fold through this strategy.
To boost its CRAM revenues further, Dishman is now acquiring specialised R&D boutiques with MNC clients. After two acquisitions last year, Dishman recently acquired Carbogen Amics AG, a research-based company with sales of about Rs 310 crore and three facilities in Switzerland for making products of high potency and value, from Solutia Europe, for $75 million (inclusive of around $9 million for working capital).
Apart from expansion at existing units, Dishman is also setting up a Rs 45-crore unit in China, which will start manufacturing Quats and intermediates next year. This unit will help Dishman lower costs as basic commodity chemicals are nearly 20 per cent cheaper in China. Power costs are also lower by as much as 50 per cent.
Lastly, Dishman has entered into a joint venture with a Saudi company to manufacture API (production to start in 2007-08), where it will be the supplier of intermediates. To sum up, Dishman has aggressive growth plans. Estimates suggest that the company should clock standalone revenues of Rs 300 crore for 2006-07 and Rs 400 crore for 2007-08. Looks good.
4. Kirloskar Oil Engines (KOE)
Even after 60 years KOE is going strong and figures among the largest manufacturers of engines in the country with a broad product portfolio -- engine capacity ranges from 3 horsepower (HP) to 1,100 HP.
The company's engine business can be categorised into three separate strategic business units that service different market segments. While the smaller engine segment (3 HP up to 30 HP) caters primarily to the agricultural segment, the medium engine segment (30 HP up to 600 HP) addresses the industrial, tractor and power generation industries.
The company, which has a technical collaboration with Pielstick of France, also manufactures larger engines with capacities exceeding 1600 HP. These engines find use in marine applications and power generation.
KOE has been experiencing strong demand from nearly all the user segments, which is one reason for its robust performance -- net sales at Rs 1,470 crore for 2005-06 represent a CAGR of 17.8 per cent during the last three years, while net profit (adjusted for non-recurring items) stands at Rs 93.2 crore and has grown by 63.2 per cent over the same period.
Demand from a majority of users of KOE's products is expected to remain strong. KOE also has an auto component business, which manufactures engine bearings and valves. Here too, demand is expected to remain buoyant given the huge investments planned by auto majors.
To prop up growth rates beyond industry numbers, the company has increased its thrust on exports (up 42 per cent to Rs 128 crore in 2005-06). KOE's earnings growth should average 25 per cent (given the high base) over the next two years. At Rs 216, the share discounts at 12.8 times its 2006-07 earnings after excluding investments worth Rs 500 crore (or value of Rs 50 per share) in KOE's books. Buy.
5. Taj GVK
It is no secret that the Indian hospitality sector has been booming over the last two years, occupancy levels have been rising and room rates have been moving up year after year. For Taj GVK, which operates three hotels in the rapidly growing Hyderabad, the boom has been even better.
Revenues have grown at a scorching pace from Rs 70 crore in 2002-03 to Rs 188.7 crore (in 2005-06), while net profit has jumped from a measly Rs 9.2 crore to Rs 46.2 crore during the same period.
In order to tap the growing demand and to diversify into other cities, the company has drawn up aggressive expansion plans. Taj GVK is setting up a Rs 125-crore hotel in Chennai (it will begin operations around March 2007) and a hotel each in Hyderabad (expected to be operational in 2008) and Bangalore.
It is also planning to expand two of its existing hotels in Hyderabad. This will keep the growth rates ticking at a fast pace. Given that not many new projects are due to go on stream in the near future (two years), even as demand continues to grow, occupancy rates and room rentals should remain strong for hotel companies. For Taj GVK, which is aiming to expand in high growth cities in south India, it should only become better.