Rakesh Jhunjhunwala, Ramesh Damani & Raamdeo Agarwal have revealed that their secret to finding multi-bagger stocks is to buy stocks that, because of temporary factors, are unwanted and are quoting at a discount, though the underlying fundamentals of efficient management, execution capability, order book and strong balance sheet continues unchanged (see Rakesh Jhunjhunwala, Ramesh Damani & Raamdeo Agrawal’s Investment Tips & Techniques).
The Infra stocks may be providing a good practical example to implement the timeless wisdom of Rakesh Jhunjhunwala, Ramesh Damani & Raamdeo Agarwal.
The cycle has turned 180 degrees for Infra companies. In 2008, Infra companies were the darling of the market and investors could not have enough of them even though they were quoting at handsome PEs. Today, Infra companies have become the pariah of the stock market and investors want to have nothing to do with them even though they are quoting at trough valuations.
All Infra & construction companies have taken a severe knock in their prices owing to poor & below-expected results for Q3 FY 2011.
If one analyzes the situation of the Infra companies, there are three reasons for this poor performance by Infra companies. The first is that the order book intake slowed down. This slow down appears to have happened because there was a change in key ministries at the State as well as Center level coupled with environmental issues spearheaded by Jairam Ramesh.
The second reason is the hardening of interest rates and liquidity constraints owing to working capital intensive nature of the sector. Infra companies have to incur the expenditure from their pocket, buy the material, pay the labour & sub-contractors, complete the work and then raise a bill on the customer. The customer will take his time to clear the bill and make payment. The high interest factor takes a toll on the margins & profitability.
The third reason is that the Infra sector appears to have witnessed a de-rating of valuation multiples on account of concerns related to order inflow, environmental issues as well as higher interest rates. In 2008, there was huge hype about the Infra sector and the stocks were commanding handsome valuations. All of that hype has disappeared now and the valuations are on more realistic lines.
However, the concerns about order slow-down and high interest rates affecting profitability are temporary and should not unduly worry the long-term investor.
The investor must remember that the current order books of the top-notch Infra companies continues to provide good visibility for the foreseeable future (2-3 years). Also, the valuations of these stocks have come down to attractive levels. The slow order-book syndrome has to change given that Infrastructure is a top priority for the Government and the economy. And if high interest rates persist, the Infra companies will have to pass on the increased costs to their clients.
It is best to focus on top-quality Infra companies which have efficient management, proven execution capability & good balance sheet position.
The usual picks in the Infra sector are Unity Infraprojects, JKumar Infra & IRB Infra & Pratibha Industries. Even IVRCL, which is quoting at trough valuations owing to poor Q2 & Q3 2011 results, is a good buy together with BGR Energy.
Of course, this is not to suggest that there will be miracles overnight. Rakesh Jhunjhunwala, Ramesh Damani & Raamdeo Agarwal are known for this immense patience and ability to wait-it-out and sweat-it-out. The interest situation will continue to be hostile for the next few quarters. Also, the order inflow will also take time to stabilize. However, the worst may substantially be in the price and it is best to start to start nibbling into Infra stocks now.