Seven gems of indian stock market

Priya Kansara / Mumbai March 31, 2008

These seven companies should see their earnings double in the next three years, which in turn should positively reflect on their respective stock prices.

The steep fall in stock valuations, the day-to-day gyrations in the market and increased uncertainties globally, have all sent shivers down the spine of domestic investors, while largely keeping foreign investors at bay.

While there aren't any conclusive signs of market sentiments turning positive, the current scenario provides long-term investors the opportunity to take a plunge into the market and buy high-quality stocks at far cheaper valuations.

Although the current turmoil is more to do with global events and to some extent due to the fears pertaining to earnings slowdown, one can still pinpoint companies capable of delivering an earnings growth of 25-30 per cent annually for the next three years. In other words, their earnings should double over the same period.

While experts have always suggested investing in the domestic growth story including in sectors such as FMCG, retail, media, financial services (including banking), telecom, infrastructure and, oil and gas, the answer to superior returns lies in one's ability to pick the right stocks.

A good investment would ideally be a combination of robust fundamentals, sound promoter/management, market leadership in the business (preferred), healthy growth prospects, reasonable valuations and minimum downside risk, all of which put together should help achieve above-market returns.

The Smart Investor brings to you a few of such stocks, which with the exception Reliance Petroleum (due to no past track record as it is yet to commence operations), largely meet the criteria.

The current market turmoil is only making things more attractive. Even if the market goes for a toss, their relatively high-quality characteristics should act as a cushion.

Aban Offshore The record high crude oil prices, worldwide shortage of rigs and investments to spruce up domestic oil production will benefit Aban Offshore, which provides rigs and allied equipment to the oil and gas industry.

The company's well-timed fleet expansion in a tight supply, high demand scenario and renewal of longer-duration contracts at higher day rates would boost earnings over the next few years.

Aban is set to add five assets (four new jack-ups and a recently acquired semi-submersible rig) between CY08 and CY09 to its existing fleet of 16 offshore assets (post the acquisition of Sinvest).

Further, the company has renewed its longer duration contracts at much higher day rates, which means higher growth in profits.

For example, its two contracts with ONGC for three years each – one commencing from March 2008 and another already commenced from December 2007 – have been renewed at $150,000 per day each as against $45,000 and $28,000-$56,000 a day respectively, reflecting a more than three-fold rise in value of contracts.

Another contract, for six years, with Oriental Oil, which commenced from October 2007, was renewed at $87,000 (as compared with $40,000). Analysts expect this kind of supply tightness to continue till CY10.

The company's acquisition of Sinvest, gave it access to premium jack-up rigs and quicker supply of rigs, which otherwise would have taken about three years.

Thus, the expected strong operational cash-flows will help Aban bring down the huge debt on its books (high debt to equity ratio of 1.7 in FY07) and boost earnings.

Lastly, while the growth in earnings in FY09 is steep as compared with the EPS of Rs 40 for trailing 12 months, it comes on the back of a loss in FY07 (due to five-fold rise in interest costs).

Nonetheless, after adjusting for the low base effect, Aban's expected growth in earnings is more than healthy and its future prospects continue to be good, all of which make it a good bet.    ON HIGH GROWTH TRAJECTORY   Price as on EPS P/E ROCE 28-Mar-08 Rs CAGR (%) FY05-07 TTM Rs FY09E Rs FY10E Rs CAGR (%) FY07-10E TTM (x) FY09E (x) FY10E (x) FY09E (x) FY10E (x) Aban Offshore 3,032.40  NA  40.00 442.00 582.50  132*  75.80 6.90 5.20 20.00 23.00 Titan Industries 1,114.65 135.00 27.10 48.00 60.00 35.70 41.10 23.20 18.60 27.50 30.00 Voltas 173.60 92.00 8.23 8.70 10.70 46.50 21.10 20.00 16.20 60.00  NA  Reliance Petroleum 161.70  NA   NA  8.00 20.00  NA   NA  20.20 8.10 11.00 25.00 IDFC# 160.90 17.40 44.00 53.00 63.00 34.00 3.70 3.00 2.60 19.00 21.00 HDFC Bank# 1,401.05 17.50 330.00 373.00 436.00 30.00 4.20 3.80 3.20 17.00 20.00 ABB@ 1,195.95 49.20 23.20 32.30 42.90 40.20 51.50 37.00 27.90 36.20 36.50 TTM= Trailing Twelve months ending December 2007   * FY08-10E# EPS=Book Value P/E=Price to book value   ROCE=ROE   TTM=FY08E  @ TTM= CY2007   FY09E=CY2008   FY10E=CY2009   CAGR CY07-10e  Though EPS for FY11 is not mentioned, prospects beyond FY10 remain healthy, and EPS should double by FY11

ABB ABB, a leading player in the power equipment (transmission and distribution) and industrial automation technology businesses, reported strong growth for the year ended December 2007, wherein revenues shot up by 39 per cent to Rs 5,930 crore and order backlog was up 49 per cent at Rs 5,020 crore followed by a 100 basis points improvement in operating margins to 12.2 per cent.

Such robust growth is expected to continue and orders are expected to flow in for the next few years, given growth in the power sector (in India as well as globally) and investments in sectors such as minerals, energy, oil and gas in emerging markets, driving demand for its automation division.

The Indian power sector is expected to witness investments of Rs 6,16,300 crore during the Eleventh Plan period (ending 2012), out of which the transmission and distribution sector – the target market for ABB – is allotted Rs 1,74,300 crore.

After completing its $100 million capex and augmenting its manufacturing facilities, ABB has announced yet another investment of a similar amount, spread over the next 18 months. ABB's parent expects the business from its Indian operations to double by 2010, which is an indication of robust growth for ABB going forward.

HDFC Bank HDFC Bank, the second largest private bank in India, trades at a premium to other larger private and public sector banks due to its ability to sustain its superior financial track record, especially in areas such as net interest margins, return ratios, profit growth and asset quality, irrespective of the interest rate scenario.

Going forward, the bank is expected to continue its robust organic growth – 42 per cent, 40.5 per cent and 31 per cent in advances, net interest income and net profit respectively, reported in the past four years.

Its recent acquisition of the relatively smaller private bank, Centurion Bank of Punjab (CBoP), should help expand its geographical reach. Its branch network would jump by 52 per cent to 1,148 branches, ahead of its larger peer ICICI Bank, with greater concentration in northern and southern states.

HDFC Bank's balance sheet size, total advances and total deposits will shoot up as well, by 37 per cent, 43 per cent and 43 per cent, respectively.

However, its CASA (current and savings bank account) ratio will decline from 58 per cent to 50 per cent, which will impact margins, while its overall asset quality is also expected to be impacted slightly.

However, these concerns are only short-term in nature and should be offset on account of the long-term benefits from better synergies, rationalisation of employee and branches as well lower expenditure on technology.

Also, CBoP's dominant position in the retail (two-wheelers and cars) and SME (small and medium enterprise) segments, distribution of third-party products and substantial non-resident client base will strongly complement to that of HDFC Bank.

IDFC Infrastructure Development Finance Company (IDFC) has been a preferred lender to infrastructure projects due to its long track record and age old association with the government in policy formulation.

However, due to pressure on margins in this wholesale financing business, IDFC has formed its strategy of stepping up its fee-based income by acquiring stakes in various businesses including brokerage firm SSKI, buyout of Standard Chartered Mutual Fund, and private equity along with debt finance and syndication opportunities.

Nevertheless, infrastructure financing would remain a key revenue stream for the next few years due to the astounding (around $500 billion) opportunity in infrastructure spending.

Moreover, with India's economic growth still one of the highest in the world, even after the expectations of a mild slowdown, and favourable demographics (leaving more disposable income in the hands of people), the financial services industry is expected to experience buoyant times.

For example, the Indian asset management industry has grown over 40 per cent in the last four years and is expected to grow at a rapid clip in the future as well. All this suggests that IDFC is not only set to grow at more than healthy rates, but should also emerge as a formidable financial institution.

Reliance Petroleum Apart from the promoter company, Reliance Industries (RIL), Reliance Petroleum (RPL) also offers a good investment opportunity as its 29 million metric tonne per annum (580,000 barrels per day) refinery, the world's sixth-largest is likely to come on stream before the scheduled December 2008.

The commissioning of capacity is well timed, given that the outlook for gross refining margins (GRMs) is bullish till FY12.

Globally, refining margins are likely to remain buoyant between $5-$10 per barrel from 2008 to 2012, thanks to the huge demand-supply mismatch and the time lag of three to four years for new capacities to come on-stream.

Also, increasingly stringent environmental standards leading to demand for light and cleaner products, and thus, high prices are further strengthening the case for higher GRMs.

The company's promoter, Reliance Industries' gross refining margins improved by 380 basis points in nine months ended December 2007 to $14.9 a barrel, almost double of the benchmark Singapore complex margins of $7.7 a barrel. Since RPL will be able to process even complex crudes it will earn relatively high refining margins.

The key thing to look in this case is the movement of the rupee against the dollar, which is bullish, though it would be partly offset by low cost incurred by the company due to its plant location in a special economic zone, benefiting from incentives like zero duty on imports of plant and machinery and fiscal benefits like a tax holiday (no minimum alternative tax; 100 per cent for first five year followed by half that for another five years).

Titan Industries Titan's focus on branded products, and its strategy of capturing less penetrated market segments and catering to every income group will help it reap rich fruits.

The company is a market leader in the organised watch segment with a 40 per cent share with brands like Titan, Sonata and Fast Track. It braced up its branded jewellery business and today, its Tanishq brand enjoys a strong recall in the organised market.

Organised jewellery retailing business has a meagre share of 3-4 per cent, but with a growth of 25-30 per cent, it is expected to gain higher share, thus benefiting Titan. Further, it has rightly identified new markets with strong growth potential.

It has also entered the $450 million Indian eyewear market with its Fast Track brand and precision engineering equipment business catering to automobile, medical and aerospace industry (global size of $35 billion). It has also ventured into the Rs 2,500-3,000 crore Indian prescription eyewear business under the brand Titan Eye+.

All these indicate that Titan is set to report high revenue growth driven by its branded jewellery business and supported by new segments.

Although profitability will trail sales growth due to lower margins in the jewellery business, it is still expected to be substantial. Moreover, periodic introduction of brands and ability to identify new segments boosts confidence about the company's prospects.

Voltas Voltas, the engineering and air-conditioning major, is expected to gain immensely from the rising capital expenditure across sectors like retail, IT and entertainment, and higher infrastructure spending in India and other emerging markets such as West Asia.

Being the second largest player in the Indian organised heating, ventilation, and air conditioning (HVAC) market after Blue Star, the company is expected to reap benefits of immense opportunities in the air conditioning market, especially the non-residential segment, which is expected to almost triple to Rs 37,600 crore in the next five years.

Apart from HVAC, Voltas will also gain from the growth in the construction activities, which in turn throw up opportunities in the fledgling MEP (mechanical, electrical and plumbing) industry.

The company has established itself in its MEP business, which is growing at 40 per cent year-on-year, which had an order book of Rs 3,500 crore (international orders worth Rs 2,700 crore and Rs 800 crore worth of domestic orders) as on December 2007.

To its credit, the company has executed orders at nine out of the ten domestic airports, and is currently working on the upcoming international airport at Hyderabad.

The total investment of Rs 40,800 crore planned towards airports over the next five years reflects a huge market and hence, growth potential for players including Voltas and Blue Star.

Also, Voltas, which commands a 17 per cent share in the air-conditioner market, should benefit from increased consumer spending. All this put together indicate strong growth prospects for Voltas.