IIFL’s stock picks include Amara Raja, Bajaj Finance, Shriram City Union, MindTree, Info Edge, Havells, and Torrent Pharma which are expected to show continued good growth over the medium term, while their valuations remain reasonable. Crompton, Biocon and Sobha are expected to show improved earnings traction in coming quarters as the outlook for growth and margins improves.
The top mid-cap stocks buys and the rationale for the same is as follows:
Amara Raja (CMP Rs. 329)
– Amara Raja is gaining market share from the market leader Exide across the Auto replacement and OEM segments. Industry volumes are expected to grow 10‐12% in FY15‐FY16 and Amara Raja to grow faster.
– Amara Raja’s industrial segment growth was impacted in FY14 by weak industry and capacity constraints. Amara Raja’s new capacity will come online in early 2014 and it should result in market share gains. This coupled with an improvement in the economy will drive growth in both the UPS and Telecom segments.
– Amara Raja boasts of a superior cost structure, higher margins, better capital efficiency, and greater growth potential compared with market leader Exide.
Crompton Greaves (CMP Rs. 122)
– Steady improvement in standalone power systems margins indicates that the business is on a recovery path. INR‐depreciation‐led export growth would support domestic power systems revenue trajectory.
– Healthy traction in consumer products segment (22% of consolidated revenues) and steady margins.
– 1HFY14 results provide first signs of turnaround in overseas subs. Despite lower revenues, subsidiaries posted positive Ebitda after four quarters. While problems persist in the US and Canada, management is confident of reporting profit for the full year for overseas subs.
– The overseas business trajectory provides confidence to look beyond the losses in these subs in the near term and value Crompton Greaves on standalone basis.
Havells India (CMP Rs. 750)
– Havells’ strategy of growing through new product launches, expanding into new geographies, and widening distribution channels, has resulted in strong 14% revenue CAGR and 21% earnings CAGR in the past five years for its domestic operations. Revenue and earnings growth are expected to remain robust going forward.
– Sylvania’s (Havells 100% European subsidiary) profitability dipped in FY13 due to a sharp fall in the prices of a key raw material resulting in de‐stocking by dealers; we believe that the margins have bottomed out, since a few producers are already facing losses.
– At 16x FY15 earnings estimates, Havells India is valued reasonably from a medium term perspective.
Bajaj Finance (CMP Rs. 1,459)
– Bajaj Finance has successfully evolved a growth strategy based on product diversification, geographic penetration, and cross‐selling. This is supplemented by top‐notch execution in establishing a strong origination infrastructure and laying down strict processes of due diligence and loan recovery.
– Bajaj Finance’s ability to defend product pricing, its strong brand recall and parentage, and efficient operations will aid in generating a 22% earnings Cagr through FY13‐16ii. As a standalone NBFC, BAF will be able to deliver +3.5% ROA and 20% ROE
– It is a strong contender to receive a bank license and is best placed to transition smoothly into one. Some of Bajaj Finance’s loans already classify for priority sector and Bajaj Finance has an existing branch infrastructure and strong brand recall.
Shriram City Union (CMP Rs. 1,060)
– Shriram City Union promises to deliver sustained 23% AUM Cagr driven by increasing penetration, niche product focus and small market share. Retail loans and loans to small businesses will remain key drivers. Warrant conversion has added to the already healthy capitalisation.
– Despite marginal increase in NPAs, 17% earnings CAGR is expected, driven by improving loan growth and stable margins.
– Shriram City Union’s stock currently trades at 1.9x FY15ii BV. Given reasonable visibility of 2.7% ROA, 18‐20% ROE, and strong capitalisation, the stock should trade at a premium.
MindTree (CMP Rs. 1,396)
– Strong account mining and robust growth in infra would continue to result in revenue growth being one of the best in the sector. Deal wins and management commentary continue to be healthy.
– Performance at the hi‐tech business unit has also improved as the company is seeing success in crossselling IT services to its hi‐tech customers.
– Mindtree’s low employee utilisation (~65% ‐ lowest in four years) is a key margin tailwind in the near term. Although furloughs and wage increases are not likely to result in margin expansion in 3QFY14, we see margins expanding from there on. Info Edge (India) (CMP Rs437)
– While the hiring conditions remain tight, management indicated that hiring in its largest segment, IT services, is showing signs of improvement. Naukri’s traffic share among job portals remains high and the new product pipeline is among the best ever.
– Mgmt of portfolio companies like Zomato and Policybazaar has indicated that focus on profitability is high. For instance, while Policybazaar’s revenue will likely grow more than 80% in FY14, its employee headcount has not increased. Zomato has already become profitable in certain geographies.
– Given a wide portfolio of internet‐related business, InfoEdge is the most diversified company to benefit from the increasing internet penetration in India. At 27x two‐year forward PER, its valuations are cheap.
Biocon (CMP Rs. 387)
– Legacy biopharma business will be driven by immuno suppressants and insulin’s geographical penetration.
– Domestic pharma business (now contributing 14% to top line) is growing at 30%+ Cagr; new launch of trastuzumab adds to visibility.
– Syngene (contract research subsidiary) is growing at mid‐to‐high teen Cagr; listing could unlock value.
– Biocon is one of the front‐runners to the regulated biosimilars market in the US and Europe. Global phase III trials have been initiated for Herceptin and are completed for rh‐Insulin. The stock is trading at 15.5x FY15ii core earnings, without pricing in any significant option value for biosimilar products. Valuation is expected to build in biosimilar upside as visibility improves over next 12‐24 months.
Torrent Pharma (CMP Rs. 483)
– Torrent has a strong business portfolio with longest growth potential; >60% revenue comes from the emerging markets and more than 70% of domestic revenue comes from specialties; Torrent has a fast ramping US business.
– A low base and high number of product launches will keep growth in the US above 30% for the next 3 years. Pickup in domestic growth and ramp up in Mexico would enhance growth rates.
– The stock is trading at 11.6x FY15ii core earnings, at 20‐50% discount to large‐cap pharma. A growing revenue base, improving growth outlook, high contribution from branded markets and steady and high free cash flows make medium‐term re‐rating a strong possibility
Sobha Developers (CMP Rs. 335)
– Strong improvement in operating cash flows ahead. Cash collections were up 30% YoY in 1HFY14, well ahead of the 18% YoY growth in revenue. Doubling of operating cash flows and 2.5x increase in profit is expected over FY12‐16 as Sobha Developers recognises higher‐margin new sales.
– ROE should improve 400bps to 14% by FY15. Free cash flow to interest will turn increasingly favourable, allowing Sobha Developers to plough back more money into the business/pay dividends. Sobha Developers doubled its dividend payout to 37% of PAT in FY13.
– Valuation remains cheap. Stock trades at a 30% discount to our one‐year forward NAV of Rs440/share.