Nalanda Capital’s Latest Contrarian Stock Pick Is Top Quality “Make For India” Co Backed By Whiz-Kid Nemish Shah

Pulak Prasad and his team of wizards at Nalanda Capital are very astute stock pickers. Their stock-picking is also process-driven. In an earlier piece, I pointed out that in order for a stock to be considered by Nalanda for investment, it has to fulfill the following criteria:

(i) High return on capital: The company must have a consistently high return on capital because return on capital is a very good indicator of the quality of the management team and the competitive advantage of the business.

(ii) Attractive industry: The industry structure, the conduct and performance of the companies therein is analyzed to determine the long-term prospects for value creation.

(iii) Quality management with good credentials: The entrepreneurs must be clean and transparent and have an outstanding track record. Also, the management must be open to external ideas, discussion and debate.

(iv) Risk-reward ratio must be in favour of the investment: The stock must quote at a value significantly lower than its intrinsic value.

By following this process, Nalanda Capital has picked top-quality stocks like Mindtree, Page Industries, Cera Sanitaryware, AIA Engineering, etc. Each of the stocks in its portfolio is a big winner.

Nalanda’s latest stock pick is Elgi Equipments. Today, it (Nalanda India Equity Fund) bought 34,55,588 shares at Rs. 121.50 per share, making an investment of Rs. 42 crore.

Incidentally, Elgi Equipments has a number of savvy shareholders on its rolls, one of which is the reclusive Nemish S. Shah of ENAM fame, who holds 26,80,000 shares in the Company. It may be recalled that Rakesh Jhunjhunwala, the Badshah of Dalal Street, paid Nemish Shah the ultimate compliment by calling him “the best analyst of the Indian stock market“.

It is easy to see why Nalanda Capital is enamoured by Elgi Equipments. The company is a top-quality one and fulfills all the stipulated criteria.

The best way to understand Elgi Equipments is to read the initiating coverage report by Spark Capital.

Spark Capital has called Elgi Equipments a “High quality equipment player witnessing near term headwinds”. The report explains that Elgi is a key manufacturer of air compressors with a market share of ~22% in India. Elgi’s total revenues grew at a healthy CAGR of 20% in the past 5 years, but witnessed muted growth in the domestic market over the past three years (2% CAGR in FY11-FY14) on the back of weak demand environment. It is also pointed out that the EBITDA margins have been under strain due to increased competition, lack of operating leverage in domestic markets and losses in international subsidiaries and that Elgi is looking at increasing the contribution of high margin after sales service and shift sourcing for its international operations to low cost destinations (India and China) to improve its overall operating margins.

It is also pointed out that increasing growth momentum primarily by increasing focus on international markets (>15% y-o-y growth expected), expanding product range and strengthening sales traction in new products (oil-free screw compressors) are the key focus areas.

Spark emphasizes that Namo’s “Make For India” credo will be to Elgi’s advantage because it has a strong product portfolio to compete against the global players. Spark also points out that demand recovery in the domestic market will begin from FY17E and that it will translate to ~18% CAGR in FY15-FY17E.

At the end, Spark Capital recommends a buy of Elgi Equipments with a target price of Rs. 170. Given that the CMP is Rs. 135, there is still a potential upside of about 25% from the stock.