The roller-coaster ride continued for the market.
Despite the last week’s upsurge, the Sensex and Nifty ended with losses of 3.8% and 4.4% respectively since our last monthly revision in the Top Picks basket on November 5, 2011. However, the Top Picks basket continues to outperform all the key indices over all the time frames.
With the monetary tightening cycle at its peak, and expectations of both a cut in the cash reserve ratio and moderation in inflation going ahead, we are adding BoB, which is our preferred pick among the public sector banks under our coverage. BEL is being added purely due to its compelling valuations. Moreover, BEL tends to show a robust pick-up in execution in the second half of a fiscal.
Following are 11 top value picks from the broking firm Sharekhan:
1. Bank of Baroda (Target Price: ` 850)
Remarks:
> Bank of Baroda stands out among the PSU banks as it continues to deliver strong earnings growth with improvement in key operational metrics. The bank’s business growth is expected to remain better than Industry’s (contributed by stronger overseas growth) with relatively stable margins which will lead to a healthy growth in the top line.
> While the asset quality of most PSU banks has deteriorated significantly over the past two to three quarters, BoB’s asset quality has remained healthy due to lower slippages. Although, the asset quality risks have raised due to weak macro environment and policy issues, yet BoB is expected fare better than the other PSU banks in terms of asset quality, resulting in lower credit cost and higher growth in earnings.
> The operating metrics of BoB has improved significantly led by strong focus on CASA, margins, fee income etc. The bank is expected to post RoE and RoA of around 20% and 1.2% respectively over the next two years.
> We believe BoB commands a premium over the other PSU banks due to a steady growth in its core income and a healthy asset quality. Currently, the stock is trading at 1.05xFY2013 book value, which is reasonable. We recommend a Buy on the stock with a price target of ` 850 (1.2x FY2013E BV).
2. Bharat Electronics (Target Price: ` 2,100)
Remarks:
> BEL, a public sector unit, is one of the leading defence companies in India. With the increase in the defence budget and the focus on modernization of the defence technology, BEL is best placed to take a size-able pie of the defence spend.
> The second half of the fiscal is normally the best period for BEL as the major decisions and delivery to clients happen in the third and fourth quarters of the fiscal.
> The company’s order book currently stands at ` 270 billion, which is around 5x its FY2011 revenues. This gives us a strong revenue visibility for at least the next two to three years.
> BEL has entered into joint ventures and technology collaborations to strengthen its position in the defence services space, reap the benefits of the offset clause (which it believes is worth USD 300 million in the next five to seven years) and enter into newer areas of operations.
> The key risk remains its execution: a delay in release of orders could lead to slower execution.
> At the current market price the stock trades at 12.8x and 11.5x its FY2012E and FY2013E respective earnings. The company has huge cash reserve of ` 58.75 billion, which translates into cash per share of ` 734 and gives the stock further support. We maintain our Buy recommendation on the stock.
3. Bharti Airtel (Target Price: ` 468)
Remarks:
> Bharti continues to lead the domestic telecom market in terms of both the subscriber base (21% market share) and the revenue market share (32.3%).
> In the last two quarters the subscriber addition for the industry has moderated with the return of rationality and players shifting focus to revenue earning customers. Thus despite a fall in the subscriber net additions, the overall revenue of the industry grew by 6% sequentially in the June 2011 quarter with Bharti gaining market share by 50-basis-point.
> On the back of its improving market share, Bharti has hiked its on-net tariff by 20%, reflecting the return of pricing power. This was followed by tariff hikes by the other GSM players. We view this development as a positive one for the industry especially for the incumbent players like Bharti. The benefits of the same are likely to be reflected in the company’s financials by the end of FY2012 and starting FY2013.
> An improving domestic 2G environment, a favourable regulatory regime, (New Draft Telecom policy, TRAI’s new set of recommendations on relaxation of M&A norms coupled with share spectrum sharing) are developments in favour of Bharti. Also, visible volume and margin progress on the acquired African operations, and a strong data opportunity in the form of 3G adoption awaiting in the wings coupled with the stock’s attractive valuation keep us bullish.
> The stock trades at a trailing EV/EBITDA of 10.0x, which appears attractive in view of the 21.7% EBITDA CAGR over FY2011-13E. The implied EV/EBITDA-to-growth is 0.52x which compares favourably with the average of 0.64x for the leading emerging market telecom companies (including China Mobile, Telecom, Indosat, Idea Cellular and Bharti). Thus we maintain a Buy on Bharti valuing it at an EV/EBITDA of 8x. This leads to a price target of ` 468.
4. Divi’s Laboratories (Target Price: ` 1,047)
Remarks:
> Coupled with an IPR-respecting and “non-compete with customer” policy, Divi’s has an unstained focus on the contract manufacturing (CM) space, thereby edging over its Indian peers.
> Its India-centric business model develops and produces all APIs/intermediates with a substantial cost advantage. Divi’s enjoys an EBITDA margin of about 40%, possibly the highest amongst its peers globally.
> After a full year of inventory downsizing, the outstanding results in H2FY2012 have re-affirmed our confidence in the company’s growth potential. The new facility at Vishakhapatnam started production from one of its blocks in June 2011. The remaining blocks are likely to get operational in a phased manner over FY2012-13, which will provide further thrust. The nutraceutical business could become a big opportunity with limited competition.
> A near debt-free balance sheet and a strong cash flow (free cash flow [FCF] likely to reach ` 230 crore by FY2013E) are likely to help build a war chest for pursuing strategic investments (bio-similars).
> The appreciation of the rupee and a slowdown in the research and development (R&D) allocation at the MNC clientele remain the key challenges for the company.
> With the order inflow picking up from H2FY2011 and its new plant getting operational, Divi’s has a strong revenue growth visibility and the operating leverage in the business will boost its margins. Consequently, we estimate the company’s revenue and earnings to grow at a compounded annual growth rate (CAGR) of 23% and 21% respectively over FY2011-13. At the current market price the stock trades at a price earning (PE) multiple of 20x and 16.1x discounting its FY2012E and FY2013E earnings respectively. We maintain our Buy recommendation.
5. GAIL (Target Price: ` 541)
Remarks:
> GAIL (India), a leading gas transmission company, is aggressively expanding its pipeline network and plans to invest more than ` 300 billion over FY2010-14 in a phased manner to double its gas pipeline network to over 14,000km and its transmission capacity to around 300mmscmd. This provides strong revenue visibility in its core gas utilities business.
> We also see value accretion from doubling of the petrochemical capacity by FY2014, and from the exploration and production (E&P) and city gas distribution (CGD) businesses going forward.
> A higher than expected fuel subsidy burden and regulatory risk in its core transmission business are the key risks for the company.
> Despite the subsidy burden, the strong growth visibility in its core gas transmission business would drive its earnings.
> At the current market price, the stock trades at a PE of 12.5x and enterprise value (EV)/EBITDA of 8.6x based on our FY2013 estimates. We have a Buy recommendation on the stock with a price target of ` 541.
6. Grasim (Target Price: ` 2,630)
Remarks:
> Grasim Industries is well placed to capture the growing opportunity in its core business of VSF in terms of both volume and healthy realisation. In addition, the performance of its cement business (i.e., its key subsidiary UltraTech Cement) has shown signs of improvement with an increase in the average cement price.
> Due to the improved demand environment, the performance of the VSF division continues to shine. The VSF realisation has increased by 7.1% YoY to ` 125 per kg in Q2FY2012 on account of a pick-up in the global demand with volumes up 17% YoY.
> The cement capacity of the company at the consolidated level is the highest among the other domestic players at 52.75MTPA. Hence the company will be the key beneficiary of a likely pick-up in the demand through Government infrastructure projects in the coming couple of months.
> On the other hand, the company is planning to expand its VSF capacity by another 120,000 tonne by FY2013 and its cement capacity by 9.2MTPA by FY2014. We believe the capacity addition will provide volume growth in the longer run.
> We believe the company will benefit due to its strong balance sheet as most of its capex will be met through internal accruals.
> However, in light of the upcoming capacity and stabilisation of the newly-added capacity, the cement prices are expected to come under pressure. Moreover, cost pressure in terms of coal prices and higher freight cost remains a key concern.
> At the current market price the stock trades at PE of 8.9x and 8.0x its FY2012 and FY2013 earnings estimates respectively on a consolidated basis.
7. IL&FS Transportation (Target Price: ` 330)
Remarks:
> IL&FS Transportation Networks Ltd (ITNL) is India’s largest player in the build-operate-transfer (BOT) road segment with 9,100 lane km in various stages of development, construction or operation. It has a pan-India presence and a diverse project portfolio consisting of 24 road projects, bus transportation and a metro rail project.
> It is well equipped to capitalise on the huge and growing opportunity in the road infrastructure sector due to its established track record in operating BOT road projects, its execution capabilities and the strong support from IL&FS. Though it has not bagged any project so far in FY2012, given the aggressive competitive scenario we believe the company has been bidding cautiously and it would pay off in the long run.
> It also has a fair mix of annuity and toll projects in its portfolio which provides revenue comfort. Further, it is present across the value chain except the civil construction services which it out sources to the local contractors. This helps the company to handle a large number of projects at a time and diversify geographically, reducing the risk of concentration.
> Thus, we expect the sales and the earnings to grow at a CAGR of 24% and 10% respectively over FY2011-13.
> At the current market price, the stock is currently trading at 7.0x its FY2012E earnings and at a price to book value (P/BV) of 1.1x. We maintain our Buy recommendation with a price target of ` 330.
8. ITC (Target Price: ` 227)
Remarks:
> ITC’s cigarette business, which contributes around 60%, continues to be a cash cow for the company. The company endeavours to make a mark in the Indian FMCG market and with successful brands such as Bingo, Sunfeast and Aashirwaad, ITC is already in the reckoning among the best in the industry. With the new portfolio of personal care products gaining market share, its FMCG business promises to compete with the likes of Hindustan Unilever and Procter & Gamble.
> After a sharp increase of 16% in Union Budget FY2010-11, the Government has spared cigarettes from an excise duty hike in the FY2012 budget. Also key states including Kerala, Karnataka, Andhra Pradesh and Maharashtra have kept VAT on cigarette unchanged in their respective state budgets. We expect ITC’s cigarette sales volume to grow at mid single digits in FY2012.
> ITC’s other businesses, such as hotel, Agri, non-cigarette FMCG business and paper, paperboard and packaging, are showing a strong up-move and will provide a cushion to the overall profit in FY2012.
> An increase in taxation and the Government’s intention to curb the consumption of tobacco products remain the key risks to ITC’s cigarette business over the longer term.
> We expect ITC’s bottom line to grow at a CAGR of about 21.2% over FY2011-13. At the current market price, the stock trades at 26.1x its FY2012E earnings and 22.0x its FY2013E earnings. We maintain our Buy recommendation on the stock.
9. Mahindra & Mahindra (Target Price: ` 842)
Remarks:
> M&M is a strong rural India story benefited by rising agriculture incomes. The farm equipment sector is estimated to grow by 17% in FY2012 due to an expectation of better monsoon and greater need for farm mechanisation following labour shortages.
> The automotive sector is expected to grow by 15-18% in FY2012. The new sports utility vehicle (SUV) XUV 500 as well as the existing utility vehicles (UVs) + pick-ups portfolio are expected to deliver a good volume growth for the year.
> The company is expecting partial roll-back of the Maharashtra VAT reversal decision shortly. While negatives have been factored in, any decision on the roll-back by the government will be positive for the company.
> Launches expected in FY2012: new SUV, Reva electric NXR, M&M-Navistar trucks and SsangYong SUVs in India.
> Our SOTP based price target for M&M is ` 842 a share as we value the core business at ` 689 a share and the subsidiaries at ` 153 a share. We recommend Buy on the stock.
10. PTC India (Target Price: ` 88)
Remarks:
> PTC India is the leading power trading company in India with a market share of around 33% in CY2010. Trading volume growth is secured by entering into long-term power purchase agreements (PPA) with power developers.
> Driven by a robust growth in its traded volumes and an uptick in the trading margins, we expect earnings to grow at a CAGR of 19% over the next two years.
> In the last few years, the company has also made a substantial investment in various areas like power project financing via PFS or taking direct equity stake, coal trading and power tolling which have great growth potential in the future. However, the deteriorating financial health of its main clientele, the state electricity boards (particularly that of Tamil Nadu and Uttar Pradesh), has put pressure on its working capital cycle and the company had to raise debt in Q2FY2012. However, after the recent steep fall in the stock price, its valuation is looking quite attractive on an SOTP basis.
11. TCS (Target Price: ` 1,250)
Remarks:
> TCS pioneered the IT services outsourcing business from India and is the largest IT service firm in the country. It is a leader in most service offerings and is in the process of further consolidating its leadership position through the organic and inorganic route as well by winning large deals.
> TCS has consistently increased its market share amongst the top 5 Indian outsourcers with market share in terms of revenues increasing from 29.2% in the March 2009 quarter to 30.3% in the September 2011 quarter.
> We continue to like TCS amongst the offshore IT vendors on account of its mammoth scale of operations and resilient cost model that allows it to withstand headwinds in the sector. On the other hand, at the current juncture TCS is well placed to garner incremental deals in the sector with the organisational structure in place, unlike Wipro and Infosys that are going through a phase of organisational restructuring.
> At the current market price the stock trades at 21.8x and 18.8x its FY2012E and FY2013E earnings respectively. We have a Buy recommendation on the stock with a price target of ` 1,250.
