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5 stocks worth investing in

May 12, 2008 10:31 IST

The Indian markets had fallen by almost 30 per cent between January and March, 2008. Since then, they have recovered half the lost ground. The impact of the fall was so hard that many stocks were beaten down to levels disproportionate with their fundamentals and growth prospects.

Interestingly, even as the markets have risen, many stocks are still quoting well below their worth and provide investment opportunities.

The ways of identifying value stocks are many, including looking at ratios like price-to-earnings and price-to-book-value besides, factors like replacement cost and dividend yields. But if factors like company management and track record, healthy growth prospects and sound business model, are also considered, it only increases the margin of safety.

To put it differently, a low PE or low P/BV does not necessarily mean cheap but, it only helps in keeping a lid on the price one pays vis-à-vis a company's past earnings or book-value. Thus, it makes sense to look for stocks that offer a good combination of value and growth.

In a bid to identify such stocks, the Smart Investor looked at companies by considering factors like market capitalisation (over Rs 250 crore), PE (under 15), financials, return ratios and cash flows (should be positive).

While companies with a dividend track record were preferred, their growth prospects were given utmost importance.

Many of these companies are from sectors that have underperformed in the past (even before the markets crashed) due to different reasons, including change in macro environment and cost pressures, which typically, are not permanent in nature.

This also means that the worst is already reflecting in their stock valuations. And, since the long-term growth prospects of most of these companies look healthy, there is potential for their stocks to deliver decent returns.

Apart from the companies mentioned below, there are many public sector banks that are quoting at a good discount to their true values.

Additionally, stocks like Aurobindo Pharmaceuticals, LIC Housing Finance, Wanbury and Lok Housing, which are quality buys, continue to look good and merit attention.

Alok Industries

In the last four years, Alok Industries has taken advantage of the textile upgradation fund (TUF) to backward integrate (from yarn to home textiles and apparels) as well as expanded capacities in a big way.

The fruits are visible in its numbers including the healthy operating profit margins (22-25 per cent in the last eight quarters).

The last phase of the expansion will get commissioned over by March 2009, and should help sustain revenue and profit growth in excess of 20-25 per cent in the next two years. The company's focus on value-added products and thrust on retailing should also help maintain profit margins.

In the retail space, Alok is consolidating all its activities under Alok Homes & Apparels, where it is targeting to operate 400 stores (20 now) over the next two years. 

Alok is also looking at real estate as agrowth driver, wherein it has signed up for a few projects (a township in Vapi, a million sq ft commercial project in Bhandup (Mumbai) and two projects in Central Mumbai).

In a bid to mitigate risks, it has chosen the joint venture route and aims to be selective with focus on large projects. 

Among key risk factors is the high leverage (but, largely low-cost loans under TUF), which should gradually come down as the last phase of expansion starts contributing, post the conversion of two crore warrants into shares (at Rs 102 per share) over next 15 months and a planned private equity placement (in 1-2 months).

To sum up, Alok should report robust growth rates over the next two years, while additional triggers will come from the progress in real estate and retail businesses. At Rs 68, the stock trades at 6 times its estimated FY09 earnings.

Amtek India

Amtek India manufactures castings and machined auto components for companies. Like others, Amtek too, has been facing input costs pressures.

For quarter ended March 2008, operating profits grew at a slower pace as compared to revenue growth. Analysts though say that the company has cost escalation clause with its customers and is already negotiating for price hikes.

Over the years, Amtek India has done backward integration to emerge as a fully integrated castings player. It is now expanding its foundry capacity by 60 per cent, which will go on stream by 2008-09.

Besides, Amtek is shifting capacity (45,000 tonnes) of its subsidiary Sigmacast, UK to its Indian facilities this year, which will lead to better utilisation of the assets and expand operating margins due to lower costs in India.

These moves should help sustain volume and earnings growth of over 15 per cent for the next two years.

Funding its expansion and inorganic growth plans is not an issue, given the low leverage, cash and bank balance of Rs 265 crore, and the sale of its stake in a group company in April 2008 for about Rs 300 crore. The stock quotes at just one time its book-value and at a PE of 8 times it's estimated FY09 earnings.

Grasim

Including its subsidiary, Ultratech, cement accounts for 70 per cent of Grasim Industries' consolidated revenues followed by viscose staple fibre, sponge iron and textiles.

Currently, higher input prices across its businesses has seen its operating profit grow at a slower pace than revenue growth in Q4 FY08. Not surprisingly, the stock has underperformed the Sensex by a huge margin; valuations are now close to historical lows.

While the near-term outlook is not exciting, Grasim's expanded cement capacities (6.6 million tonnes per annum commissioned recently and another 2.7 MTPA expected by December 2008) will result in strong volume growth over the next 18 months, whereas cost rationalisation measures should help report a reasonable growth in profits. Capacity expansion in other businesses too, has been taken up and should contribute to the kitty.

Notably, Grasim is among few cement companies that will have the advantage of early commissioning of capacities, given that an over supply situation is expected by end-2009. Some analysts though expect that project delays by players may postpone any possible glut situation to 2010.

All these indicate that Grasim is well placed to shore up volumes across its businesses, while its earnings should grow by 12-15 per cent annually over the next two years (estimated EPS of Rs 320, PE of 7.5 for FY09). And, if there is any realignment (reduction) in excise duty rates, it will only provide a boost to the industry's volumes.

As per analysts' estimates, the stock is quoting below the combined replacement cost of its businesses. Based on its growth prospects too, the stock is being valued between Rs 2,950-3,100. In short, Grasim has the potential to deliver good returns, as it rises to its true value.

HPCL

Quite an exception to the other four stocks, going purely by numbers, this one needs little brains to call it a value play; HPCL's stock quotes below its book value and its dividend yield is 7.3 per cent.

The reasons for the same, too, are well known. While the situation is unlikely to change any time soon or may not change at all, this stock is for those with an extraordinary high level of patience and an appetite for risk.

The dividend yield may also not hold this year as it is based on last year's dividend (2006-07). But, even if turns out to be lower considering that Hindustan Petroleum Corporation has reported a 26 per cent decline in net profit at Rs 750.37 crore (annualised EPS of Rs 29.5) for nine months ended December 2007, it would still be decent. The other risk relates to the assumption that the subsidy burden does not increase in future.

Regards its business, among long-term drivers is the company's investment (10-20 per cent stake) in 21 exploration & production blocks in consortium with other companies besides, some with ONGC.

The company also owns a 16.95 per cent stake (29.72 crore shares) in MRPL worth Rs 2902 crore or Rs 85 per share of HPCL. Adjusting for this, the stock quotes at a PE of 5.4 times its estimated FY09 earnings.

Royal Orchid Hotels

Most of hotel stocks have underperformed the broader markets in the last one year and, Royal Orchid Hotels is not exception. In fact, its stock performance has been relatively worse, thanks to subdued growth in revenues and marginal dip (by 5 per cent) in profits in the nine months ended December 2007. This may be attributed to its presence, primarily in Bangalore (80 per cent of revenues)–four out of its 10 hotels are in the city, including a 200-room 5-star business hotel and a 200-room 4-star business hotel. Bangalore has seen room rents remain stable to weak in the recent past.

However, the new international airport, increasing international events, development of new convention centres and corporate conferences (like held by Microsoft and IBM) could provide some triggers to drive demand in the future.

Overall, the company has 10 hotels with an inventory of about 830 rooms in Bangalore, Mysore, Pune and Jaipur. Positively, by 2009, it will also have presence in Hyderabad, Shimla, Delhi, Noida and Mumbai (includes foray into budget hotels category), which in turn should mitigate the concentration risk.

Last month, the company acquired a 50 per cent stake for Rs 17 crore in a company that owns a 65-room beach resort in Goa.

The company plans to spend Rs 10 crore towards renovating the property, which is expected to be completed by October 2008 thus, indicating that the time-lag to its revenue contribution will be minimal.

At a one-year forward PE of 7 and a reasonably high dividend yield of 5.8 per cent, and considering its growth prospects, the stock can deliver good returns in a year's time.

Vishal Chhabria
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