BETTER DAYS AHEAD

The auspicious festival of lights, prosperity, and opulence is just around the corner. However, the way the equity markets have been rallying in the past one year it seems that the investors’ fraternity have not come out of the festive mood since last Diwali. This is evident from the kind of returns the equity markets have generated since the previous Diwali. To quantify, in Samvat 2070 the Sensex has provided returns of 29 per cent - a lot has changed not only on the domestic front but also on the global canvas. If we take a look at the past one year, there has been considerable movement since the last Diwali.

If investors will recollect, the macro economic data was disappointing in the previous year. Inflation was consistently high; the rupee was depreciating fast against the dollar; the current account deficit was soaring; and the fiscal deficit was also alarmingly high. Policy paralysis was taking its toll on growth parameters and no wonder even the financial performance of India Inc. was not that great with higher interest cost and volatile INR impacting the bottomline. But despite these negative factors the mood on Dalal Street was upbeat. The simple reason behind this was the consistent flow of FIIs and secondly the expected change on the country’s governance front. In Samvat 2070 the FIIs have poured in more than Rs 1,23,139 crore in Indian equities which took the indices to a completely new orbit.

The combination of factors like BJP coming to power with clear majority, consistent FII inflow and positive cues from the global markets took the benchmark indices to an all time high level in the month of September 2014, providing 29 per cent returns. Small wonder then that with such kind of returns investors have enough reasons to be cheerful this Diwali as well. However, the readers of Dalal Street Investment Journal have more reasons to celebrate as our portfolio of Diwali 2013 has created astonishing returns of 50 per cent (See Table: A Hat-Trick of Significant Outperformance). This clearly indicates our standard of research, which has always been at the core of wealth creation for our readers.

A Visible Change

The only constant thing in life is ‘change’. And the way the Indian economy has witnessed a significant change in the past one year, it vindicates the saying. While a year back the scenario was looking gloomy with sub 5 per cent GDP growth, increasing CAD and fiscal deficit, consistently higher inflation, slower industrial production growth, policy paralysis and most importantly, the steeply depreciating INR against the USD, things have certainly changed for the better. The scenario now is such that the International Monetary Fund in its recent estimate has increased the India GDP growth expectations for FY15 to 5.6 per cent from earlier estimate of 5.4 per cent made in June 2014, while it has reduced the global GDP growth targets.

The FY16 estimates remain unchanged at 6.40 per cent. While the IMF has increased the estimate for India, it reduced growth rate expectation for 2014 to 3.4 per cent and for 2015 it is being reduced to 3.8 per cent. The possibly weaker performance of Japan, Europe and Latin American countries is seen as a reason behind the cut in growth rates. A more heartening factor that emerged from the report is that in the world economic growth calendar IMF has said that India is now a USD 2 trillion economy - making it the 10th largest in the world. And hopefully in 2016 it will overtake Russia and Italy.

Macro Economic Factors Improve

If we take a look at the various macro economic factors, there has been a lot of improvement over a year. The IIP, which was displaying a negative trend previous Diwali, has improved and registered smart growth in the months of April, May and June 2014. However the recent two-month data (July and August IIP) has been below the street estimates. There are fears that a consistent drop in industrial activity may affect growth prospects. In our opinion, this is a temporary blip and with the government focusing on infrastructure, improvement is expected going ahead.

While the IIP has improved (notwithstanding the recent temporary blip) the other important factors like CAD and fiscal deficit have also shown a marked improvement. With corrective actions from the government in sync with the RBI, the strategy has paid off with the CAD declining under the tolerance levels. It is now at just 1.70 per cent in FY14. Even the fiscal deficit is lower at 4.50 per cent in FY14. With prudent strategies implemented by the government, we do not expect any threat in the near to medium term. In addition, the fiscal consolidation road map is already laid down and the fiscal deficit is estimated at 3.6 per cent in FY16 and just 3 per cent in FY17.

Inflation: Gradual Contraction Witnessed

Inflation has remained a major concern for the Indian economy resulting in the RBI maintaining a hawkish stance. However, over the period in consideration the headline CPI inflation has witnessed a consistent decline. Though it is not yet completely under the comfort levels of the RBI, the gradual contraction has been really helpful. Thus the inflation is moderating and with the monsoon reviving towards the end of the season food and vegetable prices are also likely to witness some cool-off. A sudden and sharp drop though is not expected on the inflation front. We do believe that the RBI will continue to keep rates on hold till the CPI trajectory moves into its comfort zone. As for the inflation trajectory, our view is that with crude coming to below USD 90 per barrel, the positive rub-off impact across the value chain could be quite strong.

Also, the food inflation basket is moving into a period where the base effect could work in its favour. This could lead to a sharper leg down in inflation and thereby set the tone for an easing cycle. We are of the opinion that the interest rates have peaked out and hence the only way for the interest rates from here would be downwards. With the inflation remaining sticky the RBI is not yet in a position to cut repo rates but we feel there is no expectation of any rate hike. The RBI sounded a bit cautious on attaining the inflation target of less than 6 per cent in 2015 as it felt that the complete impact of below than estimated monsoon is yet to be seen. We are of the opinion that though inflation is still higher than the comfort levels, there is hardly any possibility of a hike in interest rates.

Japan, China & US – Flood of Funds

As stated earlier, our prime minister means business and he has made sure that he showcases India as a great investment opportunity. And to boost prospects he has given a new mantra of ‘Make In India’. He launched the campaign in the month of September in Delhi where more than 3,000 global CEOs were present. The programme has been quite successful and its effectiveness can be seen from the fact that many large economies have committed funds towards India. While first it was Japan which promised an investment of more than USD 35 billion, it was followed by another USD 100 billion being committed by China. What proved to be the icing on the cake was the PM’s visit to the US which would again bring a flood of funds in the Indian markets. At the current levels capital is scarce and hence while these three countries committing capital provides a much needed impetus, the kind of technology these countries would bring will only add to the advantages.

Global Factors – Short-Term Concern

If we take a look at the markets at the current juncture it is seen that profit booking has been happening since the last few trading sessions. Rather, the equity markets globally have witnessed some amount of selling pressure. The primary concern for the same has been the expectation about a possible hawkish stance taken by the US Fed in its recent Federal Open Market Committee meet. In the meeting, though, the overall tone was dovish even though analysts stated that the undertone was quite hawkish. Therefore, many expected the US Fed to increase the interest rates sooner. This sparked fears of foreign funds taking a flight back to safety. The leading equity indices declined and India was no exception.

What has added to the worries is the expected slowdown in the European economies and slower than expected growth in China. According to some analysts, the decline in crude prices only indicates towards slower growth going ahead. We feel these factors may affect the markets over a short-term period but the correction would be an opportunity to create a long-term portfolio. Agrees Ambareesh Baliga, who says: “The correction is overdue as the international headwinds as well as domestic macro woes start to affect the sentiment. Already there are worries about the pace of implementation of the new government’s intent. I expect this disappointment to play out first which could see the markets closer to 24,000 before the next move up.”

Earnings & Valuations 

Here we would like to reiterate our stance on what we had stated in one of our preceding stories. We are of the opinion that with green shoots visible the performance of India Inc. is expected to be better in the coming quarters. While the September quarter might be a muted one, H2FY15 would see some real fireworks. As for the impact of June 2014 quarter’s performance on the Sensex EPS estimates, there are not very significant changes in the expected EPS numbers. To put figures in perspective, while the FY15 EPS increased by 0.50 per cent to Rs 1,532, the FY16 EPS increased by 1 per cent to Rs 1,854. This clearly results into a growth of 14 per cent for FY15 and 21 per cent for FY16.

On the valuation front, the Sensex is trading at 17.21x of its FY15E EPS and this provides some scope for upward movement as it is lower than the long period average. Even if we consider the forward valuation of 19.50x, the target of 29,900 - 30,000 is achievable in the next one year. Considering these factors we are of the opinion that short-term issues like geo-political factors, QE taper, and hike in interest rates by the US Fed may take the markets southwards.

However, it should be taken as an opportunity to invest for the long term. Going ahead in the story we are recommending a portfolio of seven stocks to our readers. We advise to buy the same in a staggering manner. We believe the portfolio would be able to generate better than market returns. To sum up, Dalal Street Investment Journal team wishes our readers a very Happy Diwali and Prosperous New Year.

BEML | BSE CODE: 500048 | FACE VALUE: Rs.10 | CMP: Rs.582

Here Is Why:

• Company turned profitable and its future outlook remains strong. 
• The defense segment has a robust order book outlook and the company is eyeing high margin products.
• The company is also optimally placed on the mining business’ front.

BEML (BEML), a ‘Mini Ratna’ public sector unit, seems to be a buying opportunity at its current levels since the financial performance of the company has improved significantly with the company’s bottomline returning to black after occurring losses in the past few quarters. Apart from strong financial performance, there are certain other factors in its advantage such as strong order book in the rail segment, strong outlook in the defense sector order book (in addition to opening up of the defense segment for FDI) and being optimally placed to ride the opportunities in the mining segment as well. We recommend our readers to add the counter to their Diwali portfolio.

Let’s first try to understand the business of the company. Its operations are divided into three main segments viz. construction and mining (C&M) equipment, defense and railways. Under the C&M equipment segment it manufactures a wide range of heavy earthmoving equipments catering to the construction and mining industry. Under the defense segment the company manufactures and supply equipments and vehicles to the Indian defense services and under the rail and metro segment it manufactures coaches and other related equipments for various city metros and Indian Railways. In an attempt to diversify its revenue base the company recently set up an aerospace facility at Bengaluru aimed at manufacturing aerospace components and sub-assemblies. This facility will help the company to address potential opportunities in the defense offset industry. 

If we take a look at the growth opportunities for its different segments, BEML has a robust Rs 1,800 crore order book in the rail segment, around Rs 1,500 crore in metro and Rs 300 crore in railways. The company has an order for manufacturing and supplying 12-14 rakes of metro coaches, 120-130 metro coaches and 5-6 rakes in the DEMU category per annum. We are of the opinion that the Indian Railways’ bright investment outlook and meaningful traction in metro projects in many cities will augur well for BEML’s topline. However, in its recent statement the management has stated that its EBIDTA margins are likely to sustain at a steady 6-7 per cent level. The reason is that EBIDTA margins are often capped at other state-managed entities like ICF, RCF, etc. BEML has indicated that the Railway Board will incrementally cease to award projects on a nomination basis and in future embrace the competitive bid route.

We are quite bullish on its defense segment also with a robust order book outlook and the company’s sights on high margin products. The management expects the issue revolving around the Tatra vehicles to be resolved soon, post which BEML will start negotiations with OEMs for future projects. The company has tied up with BAE Systems for light armoured multipurpose vehicles (LAMs), which are expected to be awarded by the Ministry of Defense soon. With an eye on 40 per cent gross margin in the defense business, BEML is focusing on higher value-added products like the Pinaca launcher-mounted Tatra trucks.

The company is also optimally placed on the mining business’ front. Armed with an Rs 1,600 crore order book, BEML expects the mining segment deliveries to pick up over the next 3-5 quarters post a weak FY14. It also expects fresh orders to pick up incrementally and is already L1 in Rs 630 crore worth of orders. All in all it seems that BEML with a diversified business presence in high growth verticals like mining, railways and defense is favourably placed to ride strong volume growth.

On the financial front, the company has given better guidance. BEML has guided for sales growth of Rs 3,400 crore (up 17-18 per cent YoY) led by strong traction in railways, mining and defense. Further, the spares’ business also provides earning visibility. BEML’s spares business (mostly mining) grew at a strong 33 per cent YoY in FY14 to Rs 600 crore led by higher volume growth as buyers’ deferred buying decisions for equipment. The company makes a high double-digit EBIDTA margin in the spares’ business and expects it to sustain. We recommend a buy with a target price of Rs 725-750.

BIOCON | BSE CODE: 532523 | FACE VALUE: Rs.5 | CMP: Rs.475

Here Is Why: 

• Major growth driver for Biocon is expected to be its bio-similar product portfolio.
• Malaysian facility key to unlock insulin opportunity.
• With eight products in late stage trials, research services would continue to remain a key growth driver.

There are many reasons to add India’s largest biologics company and the fourth-largest insulin player in the world to your portfolio. Although complex in nature, its business provides long-term growth prospects. If we take a look at the business of the company, Biocon has been able to develop and market some breakthrough products in the domestic as well as emerging markets. It is also one of the largest end-to-end research service providers in India having key relationships with various global players. Rest apart, a major growth driver for Biocon is expected to be its bio-similar product portfolio. Biocon is working on eight bio-similar products under an exclusive arrangement with Mylan besides the Rh-insulin, which the company is expecting to file in the US and EU once the Malaysian facility comes on stream.

Apart from bio-similars, it is also working on its own set of novel products which could open up out-licensing opportunities over a period of time. We are of the opinion that pending the opening up of the bio-similar market (especially in the US), a market of around USD 71 billion of biologics going off-patent, and high entry barriers for new players places Biocon at the forefront to monetize the lucrative opportunity and support growth over the long run. All in all the company is best placed to tap the bio-similar opportunity. In addition, the Malaysian facility seems to be a key to unlock insulin opportunity. Let’s take a look at its growth parameters in detail.

The core biopharma business of the company includes all its businesses, except the research services business, where small molecules form more than 70 per cent of the business. The growth in this business over the last three years has been on the back of traction in immunosuppressants/insulin and its branded formulation business in India. A report suggests that the bio-similar business (insulin exports) will grow at a steady pace, before taking off by FY17E post regulatory approvals for the Malaysian facility.

We believe that since growth in the statins’ business is likely to be muted owing to limited growth opportunity in a crowded market, growth in the core biopharma business would continue to be driven by branded formulations in the near term. Going forward, a strong pipeline of bio-similar product launches supported by the exclusive tie-up with Mylan coupled with the company’s initiatives to move up the value chain in the small molecules’ business by filing of ANDAs in the US gives us enough visibility on the company’s sustainable high growth in the future.

The Malaysian facility is an important strategic initiative for the company. Biocon is building it at the cost of around USD 200 million in the first phase. This facility is expected to be commissioned by the end of FY15, but it will start contributing to the topline from FY17E onward. Biocon has received a good deal from the Malaysian government with various tax breaks and incentives. Biocon offers end-to-end contract research services to its strong base of more than 150 clients spread across various life science sectors through its subsidiaries, Syngene and Clinigene. The company has three multi-year contracts with dedicated R&D facilities and scientists exclusively assigned to them, giving us comfort on a steady revenue flow going forward. As a result, research services would continue to remain a key growth driver for the company with eight products in late stage trials. Along with long-term contracts, the contract research business provides enough visibility to sustain its historical growth rate of more than 20 per cent. 

On the financial front the company has been performing well. After witnessing a setback in FY14 as a whole where the bottomline declined as compared to FY13, the first quarter has started on a positive note. For June 2014 quarter the company has posted a topline of Rs 725.32 crore and bottomline of Rs 102.91 crore as against Rs 700.69 crore and Rs 93.50 crore posted in June 2013. At its CMP of Rs 490 it is trading at 23x of its trailing four-quarter earnings. However, with growth drivers in place we expect acceleration on the bottomline front. We recommend a buy with a target price of Rs 650.

BOSCH | BSE CODE: 500530 | FACE VALUE: Rs.10 | CMP: Rs.14562

Here Is Why: 

• Auto industry revival in passenger vehicle cycle is expected to give boost to auto ancillary companies.
• ZF Lenksysteme will give synergy benefit to expand Bosch’s product portfolio in the steering business.
• Shrinking net import raw material content is expected to sustain in the near future, thereby improving Bosch’s profitability.

An improvement in market sentiment coupled with new launches and lowered fuel prices have helped passenger vehicle manufacturers post good sales numbers in September. Domestic sales of nine of the country’s leading automobile companies during the month stood at a combined 2,08,923 units, 7 per cent more than the 1,95,339 units they sold in the same month last year. This good growth in automotive sales has now turned the spotlight on auto ancillary companies. Here is such a technology-driven multinational company – Bosch India – which is poised to reap a good harvest in the wake of this revival.

Bosch has been present in India for more than 80 years and has here the largest development centre outside Germany for end-to-end engineering and technology solutions. Bosch is the flagship company of the Bosch Group in India. It recently broke ground for its new plant in Bidadi, Karnataka. The relocation of the existing Bangalore plant from Adugodi to the Bidadi industrial area will facilitate future business expansion and growth.

Bosch is planning to increase its stake in ZF Lenksysteme GmbH (ZFLS) to 100 per cent. On September 15, 2014, Robert Bosch GmbH and ZF Friedrichshafen AG signed an agreement to this effect. Up to now, ZFLS, based in Schwäbisch Gmünd, Germany has been a 50:50 joint venture between Bosch and ZF. ZFLS develops, produces, and sells steering systems for passenger cars and commercial vehicles worldwide. With its complete takeover of ZFLS, Bosch is strengthening its ability to actively shape the future of mobility. The company is a technological leader in the growth area of electric power steering, and precisely this is the core technology for automated driving for more efficient vehicles, and also for electric cars. This will further create synergies for Bosch in Indian markets also and is expected to boost its performance.

Bosch reported a PAT of Rs 306 crore, up 22 per cent on a yearly basis during Q2FY15. The company’s revenues were flattish at Rs 2,394 crore, up only 4 per cent on a yearly basis, on the back of continued weak domestic growth of 2.4 per cent. The company’s exports, which amounted to 11 per cent of revenues in the past few quarters, rose almost 17 per cent on a yearly basis and was almost 13 per cent in Q2 revenues, thus pushing up the overall revenue growth. The management is confident of sustaining the export revenue levels and growing it on this base in time to come. Bosch’s EBITDA margin increased 240 basis points on a yearly basis at 18.1 per cent, led by shrinking net import content.

With the commercial vehicle cycle undergoing a period of consolidation at present, we believe it is poised for a turnaround from CY15, along with recovery in passenger vehicle markets. With visibility of rising domestic demand and export base, and shrinking net import content, we are of the opinion that Bosch is in the best place to take benefit of the business cycle revival in the automotive industry in the near future.

COX & KINGS | BSE CODE: 533144 | FACE VALUE: Rs.5 | CMP: Rs.292

Here Is Why:

• Modi's announcement of easing of visa rules for US tourists will increase tourists from the US. 
• Reduction in its debt burden is expected to improve the profitability of the company.
• The stock is trading at just 10.99x its trailing EPS of Rs 27.58, which is attractive compared to that of its peers.

After Prime Minister Narendra Modi’s announcement of easing of visa rules for US’ tourists during his visit there, all the travel-related companies rallied the most. The investor fraternity expects more tourists to come after this announcement and the easing of rules for Indians living abroad may also lead to more travel activities. The direct beneficiaries of this event are all the travel-related companies. Further, on the domestic front too the attractive travel offerings all through the year is gradually influencing Indian customers to travel beyond the busy summer holiday season. Nowadays customers have a choice to travel to domestic and international destinations over short weekends throughout the year.

Here then is a travel company which has a strong legacy of delivering value for over 250 years. Cox & Kings (CK) has built a travelling business that can stand the test of time - maintaining growth, profitability and sustainability despite the travelling business being cyclical traditionally. For the last one year CK has been facing an issue of high debt burden on the balance-sheet and in turn eating its profitability. However, the management is continuously making efforts to reduce its debt on an ongoing basis. The company recently received sales proceeds of its camping division and utilised the same to repay Rs 800 to 850 crore debt. Further, the management has approved raising Rs 1,200 crore to reduce debt. It has a debt of around Rs 4,800 crore and most of the amount was due to financing the purchase of UK travel company Holidaybreak in 2011. The company’s acquisition of Holidaybreak (HBR), which is a leading European education activity and leisure specialist travel company, has incorporated good synergies in the form of its expanded reach, expanded product portfolio, and a more resilient business model. This also enables the company to mix fast growing and defensive business segments such as leisure and education.

CK now has a great mix of fast growing markets such as India, Australia, New Zealand and the Middle East alongside the mature markets of Europe. With HBR’s leadership position in niche travel segments such as education travel and camping business, the acquisition has had a transformational impact on its business. Additionally, CK operates across four continents and 25 countries. The company has various popular brands include Duniya Dekho, Bharat Dekho, Flexihol, Gaurav Yatra, Anand Yatra and Luxury Escapades. CK’s market share in outbound travel among organised players has increased from 20 to more than 30 per cent over the past five years. The company management expects India’s outbound leisure to post CAGR of 25 per cent till FY16. Further, the number of franchisees has increased from zero in FY09 to 158 to capitalise this huge growth. The company also offers various services to corporate organisations to cater to all aspects of conference organising, business meetings, event management, seminars, exhibitions, product launches and incentives. The company also specialises in trade fairs and is a leading MICE operator out of India. There have also been indications of demand uptick in MICE and corporate travel/training.

Further, on the valuation front the stock is trading at a price to earnings ratio of just 10.99 times its trailing 12-month consolidated EPS of Rs 27.58. This is clearly attractive valuation compared to its main peer Thomas Cook which is trading at a price to earnings ratio of 46.96 times its trailing 12-month EPS of Rs 3.11. With increasing per capita income, higher workforce mobility and increasing proportion of working parents, travelling is fast becoming routine in the developing world too. Further, with the expected increasing tourist inflow from the US due to relaxation in visa rules, the company is in better shape today than ever before with an excellent mix of growth and stability across both products and geographies. Hence, we recommend investors to buy the stock over a one year time frame.

NIIT | BSE CODE: 532523 | FACE VALUE: Rs.5 | CMP: Rs.475

Here Is Why:

• Strong order book gives good earning visibility.
• Margins to improve as utilisation levels are going to pick up.
• Available at attractive valuation of PE of 10.5x.

Someone who sees a direct co-relation between size of the market and success rate stand a chance to miss the opportunity to serve a niche market profitably. NIIT Technologies (NIITT), one of the mid-cap IT companies, without spreading itself thin has identified key strengths in verticals like transport and logistics (TTL) as one of their niche markets to grow profitably. It has top‐tier clients in aerospace (British Airways, Lufthansa, Emirates) and earns 37 per cent of total revenues (Q1 FY15) from this segment. It is second only to TCS in absolute terms and the largest among mid-caps. Besides, unlike its peers, NIITT has created solutions and platforms to seize the opportunity on revenue as well as cost side of its clients’ business.

This niche service helps to create a sticky relation with its clients and improve its chances of mining its existing client base and maintain an upper hand while negotiating rates for future projects. This structure has already helped the company to win some large deals earlier such as the AAI project (worth USD 70 million) and the Changi International Airport project (USD 50 million) and will help in getting bigger deals in the future too. The company has even aligned it organisational structure to gain leadership in the TTL segment and has spun off it into an autonomous business unit. This will help NIITT to win mega deals of more than USD 100 million each in the segment.

Besides, there are other triggers that will help NIITT to chart higher growth trajectory going forward. NIITT, which currently earns 42 per cent of the entire revenue from Americas, is one of the lowest among the Indian IT companies. An improvement in the US economy along with the advent of disruptive technologies (SMAC) and transformation in business models will necessitate cost rationalisations that will increase IT spends in these markets. To grab this opportunity, the company’s management in its commentary has indicated that it will now focus more on the US market and will try to achieve 50 per cent of their total revenue from there. The company has also created an organisational eco-system for capturing opportunities in SMAC technologies and has gained domain expertise.

The order book of NIITT is another reason that gives us confidence in the future performance of the company. It had strong deal wins in FY14, adding 16 fresh orders worth USD 750 million in total contract value (TCV), a growth of 103 per cent over FY13. At the end of Q1 FY15, the executable order book of company over the next 12 months is USD 295 million, up from USD 290 million in the previous quarter. NIITT signed deals worth USD 124 million during Q1 FY15. This also included a large multimillion dollar contract with a major airline in the Asia Pacific region.

Moreover, NIITT continues to execute its target of winning one large deal every quarter and the company is confident of winning a large deal in the second and third quarter as well. In addition to this, there are other levers that will help the company improve its margin going forward. Currently NIITT is operating at a utilisation level of around 77 per cent, much lower than peak utilisation of around 80 per cent. Going forward, with its strong project pipeline the company has the potential of reaching peak utilisation level in the next few quarters. The improvement in utilisation level will be both EBITDA as well as EPS accretive as every 1 per cent change in the utilisation level adds approximately 4 per cent of EPS.

NIITT kicked off FY15 on a disappointing note caused by the scaling down of the business of two BFSI clients in the US and hence the revenue of the company dropped by 1.9 per cent sequentially to Rs 577.6 crore and EBITDA margins shrunk by 170 basis points to 13.4 per cent. Nonetheless, from the second half of FY15 the situation will improve for NIITT on the back of an improved order book and better utilisation. The shares of NIITT are currently trading at PE of 10.5 times, which is one of the lowest among IT companies. Looking at this attractive valuation along with multiple triggers for the company going forward, we advise our readers to take exposure in the counter with a one year target price of Rs 500.

SUPREME INDUSTRIES | BSE CODE: 509930 | FACE VALUE: Rs.2 | CMP: Rs.626

Here Is Why:

• Demand for plastic will double over the next five years.
• The company has its focus on high margin value-added products.
• New and innovative products will help to capture more business opportunities.

The rapidly increasing population in India will demand more houses, more food grains, and hence better irrigation infrastructure going ahead. All this will lead to a growth in demand for plastic products in both housing as well as agriculture sector. The per capita consumption of plastic in India stands at 8 kgs, well below the world average of 29 kgs. However, this is all set to double in the next five years due to the strong focus on irrigation, infrastructure and agriculture sectors by the government. One of the companies that is going to benefit from such high demand for PVC piles is Supreme Industries (SIL). It is a leading player in the plastic piping sector and operates in four segments, namely plastic piping (55.4 per cent of revenue), packaging products (21.8 per cent of revenue), industrial products (16.1 per cent of revenue) and consumer products (6.7 per cent of revenue).

SIL is a dominant player in the packaging products segment where it earns its highest margin at 18.38 per cent among four segments. SIL continues to shift its focus towards high-margin value-added products (VAP). The company has categorised that category as VAP which has EBIDTA margin of more than 17 per cent. Supreme’s revenue share from VAP has increased from 15 per cent during FY07 to 32.30 per cent during FY14. The management expects the share of VAP to further increase to 35 per cent by FY17.

SIL has sustained its growth trajectory despite a challenging FY14. It was able to pass on the increase in raw material prices across segments despite muted demand due to its strong brand equity. In FY14 the company’s total operating income grew by 15.2 per cent to Rs 3,902 crore led by 21.82 per cent growth in plastic piping segment’s revenue and 15.7 per cent growth in the packaging segment. The industrial segment’s revenue declined by 1.15 per cent due to poor demand from the automotive and consumer segments which declined by 9.64 per cent due to reduced sales of commodity furniture (low-margin).

SIL has continuously introduced new and innovative products from time to time and is also planning to introduce more products in the next two years. These new and innovative products would help it to capture more business opportunities and also increase its profitability. The company has already launched new products like bathroom fittings, second generation cross laminated films, composite LPG cylinders, gas moulded chairs, overhead tanks and septic tanks, etc. Many new innovative products are in the pipeline such as industrial valves, fusion furniture, PPR pipe system for industrial application, fire sprinkler system pipe sizing, protective packaging, etc.

Besides, SIL has a commercial real estate complex at Andheri in Mumbai. Currently, 1.42 lakh square feet of this premise is unsold, which we assume will be sold over FY14-16 at about Rs 230 crore. Going ahead, we believe that the revenue of SIL would continue to grow within the range of 15-20 per cent CAGR over the next three years. Its operating margin may deliver within the range of 13-14 per cent for FY15. The capex for FY15 is estimated at Rs 200 crore of which Rs 135 crore would be invested towards capacity expansion of plastic pipes by around 30,000 MT. This new capacity is expected to be commercialized from FY16. The company will maintain ROC at around 35 per cent in FY15.

SIL’s diversified product portfolio, pan-India presence through a wide distribution network and focus on new product development have enabled the company to maintain its dominance in the industry. With huge investments in irrigation infrastructure focusing on water and sanitation management and recovery in the real estate sector, SIL will grab the opportunity in plastic space. Lower crude oil prices will also help in the forthcoming quarters. We recommend our readers to take an exposure in the stocks as long-term investment.

UPL LIMITED | BSE CODE: 512070 | FACE VALUE: Rs.2 | CMP: Rs.335

Here Is Why:

• One of the best players in the agro-chemical industry in India.
• UPL’s revenue in the last 10 years has grown 25 per cent and its CAGR is 3.9x the global industry’s average.
• Available at attractive valuation of PE of 13.8x.

The rising population and limited availability of cultivatable land poses threat of shortage of food grains in India. One of the ways to tackle this is to increase the agricultural yield. According to an estimate, the agricultural yields in India need to grow at a CAGR of 1.7 per cent for the next decade to meet this shortfall in food grains. Against this background, agro-chemical companies and especially companies engaged in the crop protection area will see a better demand for their products going ahead. UPL, the 12th-largest agro-chemical company in the world, remains one of the best players in the sector.

UPL is engaged in producing crop-protection agro-chemicals with a manufacturing presence in 23 countries, and a sales and marketing presence in 124 countries. UPL’s product portfolio includes both pre-harvest products such as insecticides and fungicides and post-harvest products such as grain fumigants, cleaners and sanitizers. The company’s presence in multi-product and multi-geography segments has helped it to mitigate the seasonality factor associated with agricultural products. An analysis of the revenue pattern of other crop-protection companies’ shows that typically 65-70 per cent of their annual sales are derived during the April-September quarter due to the sowing season. For UPL, however, revenues are almost spread across all the quarters. This is because of varied sowing and harvesting seasons in the different geographies it operates in along with its diverse product portfolio.

This has really helped the company to grow above the industry average not in any particular market but in every market where it is present. For example, for the five years ending 2013, the Indian crop-protection chemical industry grew by 4 per cent whereas UPL witnessed growth of 17 per cent in the same period. The above average growth rate of the company has helped it to post better financial numbers. The company’s 25 per cent CAGR in revenues in the 10 years leading to 2013-14 was 3.9x the global industry’s average. Going forward we believe UPL will continue with its superior performance.

The growth of the company will be also aided by the lower use of agro-chemicals in India, which contributes one-fifth of the total revenues of UPL. This is among the lowest in the world. The consumption of crop-protection products in India is 0.6 kg/ha compared to 13 kg/ha in China and 7 kg/ha in the US. This presents an immense opportunity for the crop-protection industry to grow in India and UPL with its diverse product portfolio is better placed to exploit this opportunity. Another trigger for the company is the off-patent market. According to industry bodies, USD 6.3 billion worth of patented products are expected to lose patent status between 2014 and 2020 - that provides a significant growth opportunity for generic companies. UPL invests judiciously in R&D leading to periodic introduction of innovative products that will help to tap this opportunity.

UPL has also adopted an inorganic strategy over the years to grow. Since 1994 the company has acquired more than 40 companies and turned them around. Such a strategy has helped it to circumvent the time-consuming process of product registration, which can take anywhere between four to seven years. As such, UPL continues to generate cash after incurring capital expenditure. For example, during the year FY14, despite having incurred a capital expenditure of Rs 577.44 crore, it has reported a cash profit of Rs 1,563 crore. Therefore, going forward this cash might be used by the company to make further acquisitions and grow.

For FY14 the company achieved topline growth of 17 per cent and bottomline growth of 23 per cent on a yearly basis to Rs 10,579 crore and Rs 934 crore respectively and its ROCE increased by 413 basis points to 18.93 per cent. The shares of UPL currently discount its trailing 12-month earnings by 13.8x, which looks quite attractive and will be re-rated looking after the strong product portfolio, above average growth, and improvement in return ratios. Therefore we suggest our readers to buy this stock with a price target of Rs 400 in the next one year.

A Hat-Trick of Significant Outperformance 

Diwali, the festival of lights and prosperity, is here and with the Indian equity markets zooming past many psychological levels since last year, there is more to celebrate for the investor fraternity. While investors are celebrating, readers of Dalal Street Investment Journal have even more reasons to celebrate. Our Diwali 2013 portfolio has managed to outperform the benchmark index by significant margins. To put the figures in perspective, our portfolio has generated returns of 49.21 per cent appreciation while the Sensex is just 28.67 per cent. Here we would like to credit our consistent focus on research to find fundamentally strong counters for our readers when the scenario was quite shaky and not many on the street were advising to invest in Indian equities.

What adds to confidence of our readers is that this is the third consecutive year when we have managed to beat the benchmark index with significant margins. In 2012 while our portfolio appreciated by 29 per cent as against 11 per cent returns provided by the Sensex, in 2013 too our portfolio generated returns of 21 per cent as against 11.50 per cent of the Sensex. In our portfolio, Maruti Suzuki almost doubled, providing 108 per cent returns while the likes of Shriram City Union Finance and JSW Energy generated returns of more than 60 per cent. The only stock which generated single-digit returns was IPCA Laboratories. However it was our strategic decision to provide stability to the portfolio by adding a pharmaceutical company. Another factor is that these figures are without considering the dividend payments made by the respective companies. If we add the dividends of respective companies, the portfolio returns rise to 51 per cent.

Needles to say it is important to review one’s own performance as it allows you to gauge yourself and also set a higher benchmark for future performance. This time also we are recommending a model portfolio to our investors and expect another round of stellar performance for next Diwali.