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Investing? 6 hot stocks to watch out
Priya Kansara in Mumbai | November 12, 2007
Since the December 2006 quarter, the year-on-year (y-o-y) growth has been slipping every quarter.
The overall growth rates in net sales, operating profit and net profit for 951 companies (excluding public sector oil and gas companies, banks and financial services) in the September 2007 quarter are much lower than what they were in the previous three quarters and less than half compared with the same quarter last year. Are we heading for a slowdown? What's in store for the next half of this financial year?
According to market experts, the outlook for the next few quarters is uncertain as there are many challenges like record high crude oil prices, rising rupee and fears of the US economic slowdown.
However, none of the market participants have a negative tone or have revised their year-end targets for Sensex companies as yet. But to be on the safer side, they advise investors to have a stock specific approach and be invested in domestic growth stories.
In this analysis, apart from a report on who did well and who did not in Q2 FY08, we also have a list of stocks representing the domestic growth story theme.
These six stocks belong to the engineering, construction and power sectors and are comparatively cheaper than their large-cap counterparts, and can deliver decent returns.
The performance of corporate India in September 2007 quarter, has been more or less in line with the analysts' estimates.
"There have been no serious surprises on the positive or negative side," says Shriram Iyer, head of research, Edelweiss Capital. Net sales, operating profit and net profit of 951 companies have grown at 15 per cent, 16 per cent and 20 per cent respectively, the slowest pace in the past four quarters.
However, there is both good and bad news. Though the revenue growth has slowed down since the last few quarters, companies managed to grow their profits a little higher than sales, which means that profit margins are protected.
Also, the growth has come on a high base. In September 2006, sales of these companies had grown at nearly 30 per cent, while operating profit was 40 per cent higher and net profit had grown 50 per cent.
But the bad news is that the expansion in margins continues to be slower as in the previous three quarters. For example, operating profit margin expansion has shrunk from 212 basis points and 184 basis points in December 2006 and March 2007 quarter respectively to 8.6 basis points in the last quarter.
The single largest factor affecting operating profit growth in each of the last three quarters has been a higher increase in employee costs. In the December 2006 quarter, both raw material and employee costs have risen at a high rate of 25 per cent y-o-y.
The ripple effect of the operating profit margin contraction has trickled down to the net profit level but to a lesser extent. For instance, net profit margin expansion of 190 basis points and 115 basis points in December 2006 and March 2007 quarter respectively has come down to 50 basis points in the last quarter.
The support has largely come from other income, which has grown at a robust rate of 32.7 per cent in Q2 FY08.
In the September 2007 quarter, domestic growth stories have once again supported India Inc's performance.
Sector like construction (Punj Lloyd [Get Quote], Nagarjuna and IVRCL Infrastructure), telecom (Bharti Airtel [Get Quote] and Reliance Communications [Get Quote]), cement (Grasim [Get Quote] and ACC) and engineering (BHEL, Thermax and Larsen and Toubro) have delivered one of the highest growth rates for all the parameters--net sales, operating profit and net profit.
The infrastructure spending by the government has perked up the performance of cement, construction and engineering companies. Further, rising disposable incomes and changing lifestyles have helped telecom companies prosper.
However, as said earlier, the performance in Q2 when compared with that in earlier quarters looks dull.
Almost every sector has shown a consistent deceleration in net sales growth. Growth in net sales in the last quarter has more than halved for most sectors as compared with the September 2006 quarter.
However, construction is the only sector which has stood the ground showing a rise in net sales as compared with the previous three quarters. On the flip side, non-ferrous metal companies' growth has slipped in the negative zone due to volatile prices of copper, aluminium and zinc in the quarter.
For the entire universe, the growth in operating profit has been only slightly better than the growth in sales during September 2007. Lower prices have resulted in declining operating profit for non-ferrous metal companies.
Pharma too has posted a disappointing performance. Power generation companies, which have had to bear the brunt of higher costs, also saw a much lower growth in operating profits. Autos and non-ferrous metals posted a y-o-y drop in net profits, while the net profit growth in IT and FMCG was disappointing.
How will the next half be?
The outlook for corporate India is challenging and cautious in the next few quarters.
Market participants fear that high crude oil prices, which is nearing $100 a barrel, poses the biggest risk and could impact the fundamentals. This is in addition to the current problems like the appreciating rupee and firm domestic interest rate scenario.
Sandeep Nanda, head of research, Sharekhan has a different point of view. Says he, "Outperformance by significant margin is unlikely in the remaining part of the current fiscal due to higher base particularly for Sensex earnings."
However, a relieving fact is that none of the market participants have yet revised the Sensex earnings target upwards or downwards, which means their growth target of about 16 per cent for Sensex earnings over the next two years remains unchanged.
Nevertheless, it has become important to watch the movements in the key indicators of Indian economy like growth in credit and exports and IIP data.
What should investors do?
After crossing the historic 20,000-mark in the first week of November, markets have slipped back to below the 19,000 levels. Intra-day swings have been wide over the past few trading sessions.
The short-term is surely uncertain, and a correction is still possible. Prospective investors having a fairly long term view can enter on declines.
To be on the safer side, it is better to adopt a bottom-up approach in domestic growth stories such as engineering, capital goods, power (including power equipment), construction and financial services.
Stocks to look at:
Though investments in frontline stocks of the above mentioned sectors will do well, they appear slightly expensive. But they are worth buying on declines.
However, short term investors can also leverage the huge opportunity of the infrastructure-related sectors by investing in mid-cap companies (market capitalisation less than Rs 2,500 crore), which are trading at relatively attractive valuation compared to their large-cap peers and provide less downside risk. Read on to find out which are those stocks.
Power and power equipment
Indo Tech Transformers [Get Quote] (market cap: Rs 720 crore): After clocking a CAGR of over 40 per cent and 80 per cent in net sales and net profit between FY04 and FY07, analysts expect this transformer-manufacturer to continue to report robust growth of more than 30 per cent a year over the next three years.
The company has a decent order book to sales ratio of about one times its estimated FY08 sales.
Like other power equipment stocks, Indo Tech has also seen a sharp run-up in its stock price in the last few months. Still, the stock is quoting at an attractive valuation of 15 times and 12 times its estimated earnings for FY09 and FY10 respectively.
Bharat Bijlee [Get Quote] (market cap: Rs 1850 crore): Bharat Bijlee has also had a free run on the bourses. The company trades at 16 times its FY09 estimated earnings. Bharat Bijlee manufactures transformers and electric motors used for power generation.
Besides the demand for transformers, the outlook for its motor business also appears bright as the company has enhanced its presence in large motors, which are a preferred choice of the industry.
Greaves Cotton [Get Quote] (market cap: Rs 1550 crore): Greaves Cotton manufactures diesel engines for three-wheelers and various infrastructure equipment. The company's financial performance has been hit due to slowdown in the auto industry in the past two quarters.
However, the company has undertaken measures like twin engine cylinder used for four-wheeler light commercial vehicle. The demand for such vehicles has been high in the recent times and is expected to be strong in future.
Further, its infrastructure division will continue to provide huge scope for growth. Greaves Cotton, which has been a major underperformer since the last one year, trades at 12 times its estimated FY08 earnings.
Sanghvi Movers [Get Quote] (market cap Rs 830 crore): Crane-hiring company Sanghvi Movers trades at 12 times its estimated FY09 earnings, which is reasonable for a market leader with 50 per cent share.
Further the company is spending Rs 200 crore (Rs 2 billion) each in FY08 and FY08 to expand its current fleet of 260 cranes. Demand for cranes is buoyant due to capex boom across various user industries like power, steel and refineries.
Madhucon Projects [Get Quote] (market cap Rs 1250 crore): This construction company is focused on highway, irrigation and water supply, sewage treatment, engineering and property development projects.
The company provides strong earnings visibility as it has an order book of Rs 4,000 crore, executable over the next two and a half years. The stock, which has been a major underperformer, trades at 24 times and 11 times its FY08 and FY09 estimated earnings respectively.
Gayatri Projects [Get Quote] (market cap Rs 305 crore): The company executes major civil works including construction of dams, national highways, bridges, canals and aqueducts.
The company is sitting on a robust order book position of Rs 3,400 crore (Rs 35 billion), translating into an order book to sales ratio of a whopping seven times its FY07 revenues.