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Half of the sharp rise in stocks in 2014 was driven by re-ratings - rise in price-to-earning ratios on hopes the new government would turn around the economy which will reflect in corporate earnings. While valuation of the broader market is close to long-term averages, mid-caps are in an exuberant territory. For the broader market to re-rate further, earning growth has to pick up. That is yet to happen. Against this backdrop, investors are likely to seek more action from the government in the New Year. Until then, the market could consolidate.
While the government has started taking its first reform measures - higher foreign direct investment in defence, railways and insurance, diesel price regulation and an ordinance to ease land acquistion by industry - the market has to contend with some external risks as well.
The world economic growth, barring in the US, remains fragile. While slower global growth has brought down prices of commodities and is beneficial for India, it will also hurt our exports, besides pulling down the overall Sensex earnings and limiting FII (foreign institutional investors) flows from oil-rich nations. Corporates, though, are slowly deleveraging, but the pain area - power and infrastructure - has hardly seen a significant improvement.
The good part is that India's fiscal and current account deficits have improved, and inflation is down. But with US seen raising interest rate in mid-2015, an act that could bring volatility to emerging markets like India, the Reserve Bank might not cut its policy rate in a hurry. Interest costs for companies, therefore, might not come down meaningfully anytime soon.
Given these, and even as the markets are expected to rise 9-20 per cent from their current levels - Sensex could rise from 27,500 to the 30,000-33,000 level - investors will have to be selective in picking stocks for higher returns.
Experts advise against high-beta, highly indebted firms and vulnerable mid- and small-caps. A rise in global risk could see FIIs slow down purchases. But some experts believe an improving domestic environment could bring high inflows from local investors, providing some cushion.
Here are the top 10 stocks according to India's leading research houses, such as Morgan Stanley, Macquarie, Ambit, Credit Suisse, IIFL, Angel Broking and Religare. These stocks have been selected on the basis of being recommended by more than one research house, potential returns and earnings growth.
Gujarat Pipavav
The ports operator will benefit due to growth of EXIM volumes as well as business growth in the Western corridor benefitting Gujarat-based ports. As per Credit Suisse, Gujarat Pipavav would also gain from limited spare capacity (in near-term) at JNPT leading to a spill over. The strong rail linkage and upcoming capacity would also increase its importance for shipping lines. Gujarat Pipavav also remains a top pick of Deutsche Bank in the Indian Infrastructure space; the research firm estimates a CAGR of 33 per cent for earnings and 61 per cent for free cash-flows over CY13-CY16 as the company turns debt-free. Volumes are expected to grow annually at 18 per cent on timely expansion and ramp up in its bulk and liquid business.
HCL Tech
It is a play on high-growth area of infra management services (34.5 per cent of revenues). Well diversified growth across its businesses is another positive. HCL's software services business (60.5 per cent of revenues) has witnessed improving deal wins and revenue growth in recent quarters, while BPO business is turnaround. Analysts expect it to post high teen operating profit margin over the next three years. Strong deal wins, confident management commentary, improving margin profile provide confidence given the outlook shared by some peers. The company continues to invest in infrastructure, engineering and digitisation to drive growth. Valuation at 13.8 times FY16 estimated earnings is attractive vis-a-vis peers.
ICICI Bank
The bank stands to gain from economic recovery and reforms push to infrastructure sector. At 12.2 per cent tier I capital adequacy ratio, the bank is well-funded for strong growth ahead and better placed to meet Basel III norms. It will have an edge over its PSU counterparts as they dilute their equity to comply with Basel III norms. Higher focus on retail loans will drive market share gains as well as lead to faster profit growth for the bank. Strong earnings growth in turn will boost return on equity (RoE) ratio by 190 basis points over FY15-17. The bank also has multiple value-unlocking avenues through listing/stake sale in its various subsidiaries (insurance, AMC, Securities, etc) at its disposal which could boost its overall valuation.
L&T
Most analysts agree that Larsen and Toubro is the best play to ride the Indian growth story. Emkay Global believes that L&T’s diversified presence across infrastructure segments puts it in a sweet spot against weaker peers, allowing it to take advantage of the trend reversal. The consolidated order flow that stood at ~92,461 crore in FY13 is likely to touch ~128,908 crore in FY15 and rise further to ~1,82,053 crore by FY17, estimates Kotak Institutional Equities. Despite the slowdown and the difficulties witnessed by its hydrocarbon business, L&T has been able to maintain margins in 17-18 per cent range over FY11-14. Macquarie finds it to be a top pick among industrial segment, which is likely to outperform post fall in crude oil prices.
Maruti Suzuki
Return of the first time buyers, higher sales enquiries and lower operating costs for customers, indicate a revival in car volumes. a Volumes are expected to grow annually at 17 per cent over the next three years not just from the uptick in entry level segments which the company dominates but also Maruti's traditionally weak segments. These include mid-sized sedans (Ciaz) and new segments such sports utility vehicles, crossover, large sedans and light commercial vehicles among others. Margins are also expected to see a sharp 250 basis points uptick over the next three years. This is due to higher operating leverage, increased localisation, higher proportion of premium products and lower discounts.
Shriram Transport
Stable freight rates coupled with declining operating costs for truck operators, pick up in industrial activity and gradual rise CV sales are catalysts. This will improve cash-flows of Shriram Transport’s borrowers and rub off favourably on its asset quality, which has bottomed out. As macros improve, analysts expect RoE as well as asset (AUM) growth to pick up. The AUM annual growth is pegged at 10-15 per cent over FY14-17. However, adopting a 90-day NPA recognition norm versus 180 days prevailing (draft NBFC guidelines) could mean that NPA levels will rise gradually. Strong provision coverage though provides comfort. Going ahead, falling interest rates would lower funding costs and boost profitability.
Sobha
Launch of products in the lower ticket size segment is expected to improve volumes. This will help the company achieve its pre-sales target of seven million square feet by FY17-18 from current annual
rate of about four million square feet. Higher ticket size projects are in Gurgoan, Kozhikode and Coimbatore and should help it diversify its product basket further from its predominantly Bangalore-based projects. Pick up in new launches is expected to improve cash flow and reduce leverage further to 0.6 times by the end of current fiscal from the current levels of 0.7 times. Lower interest rates (company and consumer) and strong demand in its core Bangalore market continue to be key triggers for the stock.
Sun Pharma
The key trigger would be the merger of Ranbaxy Laboratories with itself which will make Sun Pharma the largest player in the Indian pharmaceutial marke. In addition, product synergies across key markets, cost savings and research pipeline should aid margins and growth for the merged entity going ahead. The stock will continue to gain on twin themes of strong India growth led by fast growing chronic therapy sales and profit boost from niche product sales in the US from Taro and
Sun stables. The valuation premium (23-25 times FY16 estimates) of the company vis-a-vis peers is justified given the company's stellar track record of inorganic growth, excellent execution and cash on balance sheet.
TVS Motor
The stock continues to get rerated on expectations of strong volume growth (25-30 per cent over FY14-17) which is double sector growth, market share gains and improvement in margins. It has lined up new launches/refreshes which should keep volume momentum going over the next year. The success of the refreshed executive segment bike Victor is key, as it will not only establish its presence in executive segment but also boost TVS’s current market share of about six per cent. Operating leverage, healthier product mix (three wheelers, premium segments) and price increases should drive a 300 basis point margin gain over the next two to three years which will help bridge part of the margin gap with peers.
UltraTech Cement
The pan-India leader having added capacities both organically as well as inorganically will benefit from the expected surge in cement demand and realisations. Its current capacity of 60.2 MTPA will reach 70 MTPA by 2015. Cement volume growth, which has picked up to 6-7 per cent in FY15 (three per cent in FY14), is pegged at 7-8 per cent by FY16/FY17 while prices are seen rising 7-8 per cent annually, say analysts at India Infoline. Macquarie estimates profits to grow at CAGR of 26.7 per cent over next three years versus 17.7 per cent in past five years. Ambit analysts, however, say that UltraTech’s growth targeted organically or inorganically could restrict RoCE expansion even though it may enjoy superlative volume growth.
The ports operator will benefit due to growth of EXIM volumes as well as business growth in the Western corridor benefitting Gujarat-based ports. As per Credit Suisse, Gujarat Pipavav would also gain from limited spare capacity (in near-term) at JNPT leading to a spill over. The strong rail linkage and upcoming capacity would also increase its importance for shipping lines. Gujarat Pipavav also remains a top pick of Deutsche Bank in the Indian Infrastructure space; the research firm estimates a CAGR of 33 per cent for earnings and 61 per cent for free cash-flows over CY13-CY16 as the company turns debt-free. Volumes are expected to grow annually at 18 per cent on timely expansion and ramp up in its bulk and liquid business.
HCL Tech
It is a play on high-growth area of infra management services (34.5 per cent of revenues). Well diversified growth across its businesses is another positive. HCL's software services business (60.5 per cent of revenues) has witnessed improving deal wins and revenue growth in recent quarters, while BPO business is turnaround. Analysts expect it to post high teen operating profit margin over the next three years. Strong deal wins, confident management commentary, improving margin profile provide confidence given the outlook shared by some peers. The company continues to invest in infrastructure, engineering and digitisation to drive growth. Valuation at 13.8 times FY16 estimated earnings is attractive vis-a-vis peers.
ICICI Bank
The bank stands to gain from economic recovery and reforms push to infrastructure sector. At 12.2 per cent tier I capital adequacy ratio, the bank is well-funded for strong growth ahead and better placed to meet Basel III norms. It will have an edge over its PSU counterparts as they dilute their equity to comply with Basel III norms. Higher focus on retail loans will drive market share gains as well as lead to faster profit growth for the bank. Strong earnings growth in turn will boost return on equity (RoE) ratio by 190 basis points over FY15-17. The bank also has multiple value-unlocking avenues through listing/stake sale in its various subsidiaries (insurance, AMC, Securities, etc) at its disposal which could boost its overall valuation.
L&T
Most analysts agree that Larsen and Toubro is the best play to ride the Indian growth story. Emkay Global believes that L&T’s diversified presence across infrastructure segments puts it in a sweet spot against weaker peers, allowing it to take advantage of the trend reversal. The consolidated order flow that stood at ~92,461 crore in FY13 is likely to touch ~128,908 crore in FY15 and rise further to ~1,82,053 crore by FY17, estimates Kotak Institutional Equities. Despite the slowdown and the difficulties witnessed by its hydrocarbon business, L&T has been able to maintain margins in 17-18 per cent range over FY11-14. Macquarie finds it to be a top pick among industrial segment, which is likely to outperform post fall in crude oil prices.
Maruti Suzuki
Return of the first time buyers, higher sales enquiries and lower operating costs for customers, indicate a revival in car volumes. a Volumes are expected to grow annually at 17 per cent over the next three years not just from the uptick in entry level segments which the company dominates but also Maruti's traditionally weak segments. These include mid-sized sedans (Ciaz) and new segments such sports utility vehicles, crossover, large sedans and light commercial vehicles among others. Margins are also expected to see a sharp 250 basis points uptick over the next three years. This is due to higher operating leverage, increased localisation, higher proportion of premium products and lower discounts.
Shriram Transport
Stable freight rates coupled with declining operating costs for truck operators, pick up in industrial activity and gradual rise CV sales are catalysts. This will improve cash-flows of Shriram Transport’s borrowers and rub off favourably on its asset quality, which has bottomed out. As macros improve, analysts expect RoE as well as asset (AUM) growth to pick up. The AUM annual growth is pegged at 10-15 per cent over FY14-17. However, adopting a 90-day NPA recognition norm versus 180 days prevailing (draft NBFC guidelines) could mean that NPA levels will rise gradually. Strong provision coverage though provides comfort. Going ahead, falling interest rates would lower funding costs and boost profitability.
Sobha
Launch of products in the lower ticket size segment is expected to improve volumes. This will help the company achieve its pre-sales target of seven million square feet by FY17-18 from current annual
rate of about four million square feet. Higher ticket size projects are in Gurgoan, Kozhikode and Coimbatore and should help it diversify its product basket further from its predominantly Bangalore-based projects. Pick up in new launches is expected to improve cash flow and reduce leverage further to 0.6 times by the end of current fiscal from the current levels of 0.7 times. Lower interest rates (company and consumer) and strong demand in its core Bangalore market continue to be key triggers for the stock.
Sun Pharma
The key trigger would be the merger of Ranbaxy Laboratories with itself which will make Sun Pharma the largest player in the Indian pharmaceutial marke. In addition, product synergies across key markets, cost savings and research pipeline should aid margins and growth for the merged entity going ahead. The stock will continue to gain on twin themes of strong India growth led by fast growing chronic therapy sales and profit boost from niche product sales in the US from Taro and
Sun stables. The valuation premium (23-25 times FY16 estimates) of the company vis-a-vis peers is justified given the company's stellar track record of inorganic growth, excellent execution and cash on balance sheet.
TVS Motor
The stock continues to get rerated on expectations of strong volume growth (25-30 per cent over FY14-17) which is double sector growth, market share gains and improvement in margins. It has lined up new launches/refreshes which should keep volume momentum going over the next year. The success of the refreshed executive segment bike Victor is key, as it will not only establish its presence in executive segment but also boost TVS’s current market share of about six per cent. Operating leverage, healthier product mix (three wheelers, premium segments) and price increases should drive a 300 basis point margin gain over the next two to three years which will help bridge part of the margin gap with peers.
UltraTech Cement
The pan-India leader having added capacities both organically as well as inorganically will benefit from the expected surge in cement demand and realisations. Its current capacity of 60.2 MTPA will reach 70 MTPA by 2015. Cement volume growth, which has picked up to 6-7 per cent in FY15 (three per cent in FY14), is pegged at 7-8 per cent by FY16/FY17 while prices are seen rising 7-8 per cent annually, say analysts at India Infoline. Macquarie estimates profits to grow at CAGR of 26.7 per cent over next three years versus 17.7 per cent in past five years. Ambit analysts, however, say that UltraTech’s growth targeted organically or inorganically could restrict RoCE expansion even though it may enjoy superlative volume growth.
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