Standard Chartered has released a report on ‘India emerging companies’ in which it has identified companies that can generate superior returns by applying certain filters. These are the weighted average of the well-recognized four parameters viz. RoE, PB/RoE, EPS growth and RoE momentum. StanChart claims that selecting the top quartile stocks based on the above four-factor merit order would have led to a 20 per cent CAGR over five years from 2008 to 2012.
Applying these filters, StanChart has identified seven small-cap and mid-cap stocks (SMID) which are likely to give investors good returns in the long term.
Aditya Birla Nuvo:
Aditya Birla Nuvo has an outperform rating with a price target of Rs 1,465 based on a 20 per cent discount to NAV. Aditya Birla Nuvo is transforming itself from an asset aggregator to an asset allocator. Recent management decisions suggest a focus on improving portfolio returns. ABNL is in the top quartile of the SMID universe.
Aditya Birla Nuvo’s P/B valuation (ex-Idea) is near an all-time low, while returns (ex Idea/financial services) are near all-time highs.
Multiple catalysts ahead: (1) new banking licenses, (2) improvement in telecom tariff, (3) turnaround at Pantaloons and (4) asset sales. No upside from these factors have been assumed in the base case valuation.
Motherson Sumi Systems:
Motherson Sumi Systems is evolving into a preferred full-system solutions provider for global OEMs. With the bulk of its capex behind, the management is expected to focus on executing its robust combined order backlog of EUR 3.8bn at SMP/SMR.
The Free Cash Flow is expected to improve while the debt burden is likely to decline from here on. Valuations at 10x FY15E earnings appear attractive given improving return ratios over FY13-15E. Motherson Sumi Systems has an Outperform rating with a price target of Rs 270. The stock remains one of the top picks in the auto space.
Amara Raja Batteries:
Amara Raja is well-placed to capitalise on growth opportunities, given leadership in the telecom/UPS segments and strong No. 2 in autos. Driven by sustained demand in both the auto and industrial segments and improved pricing power, Amara Raja is expected to post 18% earnings CAGR over FY13-15E.
Valuations appear favourable post the recent correction, given robust earnings growth, strong return ratios and negligible leverage. Amara Raja Batteries has an Outperform rating on attractive valuations (10x FY15E earnings), with a 12-month PT of Rs 325, implying 22 per cent upside potential.
Mindtree’s pedigreed promoter-management team, strong clientele and a defined dividend policy differentiate it from other mid-cap IT services players. Its ROE grew 16ppt over FY11-13 after it exited the capex intensive white label handset manufacturing + a strong margin expansion in core services (+880 bps).
However, the structural positives are priced-in (PER at 17% premium to 5-year median). Thus, the target is in-line at Rs 850. FY14 margin management is the key challenge. Pick up in product engineering services demand (31% of revenue) + new large deal wins are key upside risks.
Indraprastha Gas, a monopoly gas distributor in the National Capital Region, is the preferred play on rising traffic with stable margins. Its sales volume trajectory is likely to pick up, led by the introduction of 2,500 buses and 45,000 new autos.
The year-long suspense on the IGL-PNGRB case is to end soon as the Supreme Court hearing nears completion. The Supreme Court order will be a key trigger and the court is expected to uphold the Delhi High Court order and keep pricing to consumers outside the regulatory control.
The PNGRB council, in its appeal to the Delhi HC, also contended that there is no specific provision in the PNGRB Act to regulate selling price to customers. The stock price is expected to claw back to pre-tariff order levels and also factor in improved fundamentals. Target price Rs 451.
Gujarat State Petronet:
The current price factors in extreme pessimism of (1) c.22 mmscmd volumes (same as 4QFY13) over the next two years, (2) conservative tariffs of Rs 850/tcm to perpetuity and (3) sub-par returns on cross country pipelines.
GSPL’s core Gujarat transmission network value is believed to be largely intact as take-or-pay aided tariff uptick would largely compensate for weak transmission volumes. To generate 12 per cent post-tax adjusted RoCE.
Complete value destruction from cross-country pipeline given the weak gas supply situation as also the extremely back-ended nature of the project is factored in. The volumes are moderated but the tariff assumptions are increased. Gujarat State Petronet is an Outperformer with a price target of Rs 94.
IRB Infrastructure Developers:
IRB Infrastructure Developers is the dominant toll road operator in the high-density, high-growth corridors of Gujarat-Mumbai and Mumbai-Pune. Its toll collections are expected to grow 2.5x over FY13-17E to Rs 35 billion. Strong in-house EPC capabilities and a healthy balance sheet place it in a leading position in the road space.
IRB has picked up pace in 4QFY13: (1) traffic grew 5-10 per cent across all key projects, (2) two new projects commenced tolling, and (3) it guided to three more ongoing projects becoming operational in FY14.
IRB is attractive on both NAV and earnings-based methods: (1) the stock trades at FY14E P/E, P/B and EV/EBITDA of 6.2x, 1x and 6.7x, respectively, and (2) the price target of Rs 233 is based on a 20% discount to NAV.