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Published on 13/01/2020 4:59:59 PM | Source: JM Financials

List of 10 companies which are good candidates for compounding returns by JM Financial

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Below is a list of 10 companies, which we believe are good candidates to earn compounding returns driven by their strong business model, sustainable moat and good management pedigree. We recommend investors to BUY into these stocks with a medium to long term view.

 

Aditya Birla Fashion & Retail (CMP 235, Market Cap: INR 23,515 crore)

ABFRL combines Madura‟s portfolio of leading power brands along with one of the largest departmental store, value fashion retailer chain Pantaloons. The combination positions ABFRL as India‟s fashion powerhouse offering 5000 styles and 200+ brands. A pan-India distribution network of 2544 exclusive brand outlets (EBOs) & 331 Pantaloons stores spanning across 7.9 million sq ft. ABFRL enjoys a supreme positioning in its men‟s portfolio built over wide offerings across price points (mass to luxury), broad categories (men‟s, women‟s and kidswear & accessories) and diversified market channels (MBO+EBO+SIS).

Strong sustainable growth along with operating leverage to boost future growth profitability

We expect ABFRL‟s revenue, comparable EBITDA (non-IND AS-116 adjusted) & PAT to witness CAGR growth of 13%, 20% & 52% respectively over FY19- 22E. Comparable EBITDA margin is expected to improve to 8.3% in FY22E from 6.9% in FY19. Consistent expansion in gross margin over FY19-22E would be mainly led by increased private label share from Pantaloons along with better mark-ups and discount management. Also going forward, we expect better operating efficiencies from matured Pantaloons stores and reduced in losses in Fast Fashion and Innerwear segment.

 

Dalmia Bharat (CMP INR 805, Mcap INR 15,400 crore)

Dalmia Bharat Limited is part of the Dalmia Group, one of India‟s oldest industrial houses with operations in areas such as cement, sugar, travel, magnesite, refractory and electronics across the country. The cement business was founded in 1935 and is now housed under Odisha Cement Limited, which is the third largest cement player in India, with total installed capacity of 26.1 MT under control through subsidiaries.

The company is among the market leaders in East and South India with a sizeable market share. 15.7MTPA of expansion potential: Odisha Cement has capacity expansion potential of 15.7MTPA, of which 13.1MTPA is greenfield, while 2.6MTPA is brownfield. The company has clearances available in c.80% of its greenfield potential. Its 11MTPA brownfield potential is constrained by clinker availability, resulting in a feasible capacity of 2.6MTPA. Rajputana Properties‟ (earlier a subsidiary) bid for Binani Cement has been approved and recommended to the NCLT. Rajputana Properties has additional greenfield expansion potential of 5MTPA in Rajasthan.

Most of its projects have received clearances, providing comfort on execution. Leverage in the comfort zone despite acquisitions: The company significantly reduced its net debt from c.INR 60.2bn at end-Mar‟16 to INR 33.24bn at Jun‟19 end. Its net debt-to- EBITDA dropped from 3.8x to 1.60x over the same period. By repaying a large portion of the high cost debt, the company also successfully brought down its interest cost down to 7.9% in 1QFY20. Going forward, significant free cash flow generation will further help bring down the company‟s net debt significantly. Management is comfortable with a net debt-to-EBITDA ratio of 3.5x. Acquisition of stressed assets; value contingent upon execution: The company acquired Murli Industries (3MTPA in Chandrapur) and Kalyanpur Cement (1.1MTPA in Bihar) through an auction under Insolvency & Bankruptcy Code (IBC) proceedings.

The company acquired these assets at a relatively low valuation of USD 55/t for Kalyanpur and USD 20/t for Murli Industries. Company is currently operating Kalyanpur asset at 45% utilization. Company is still in the process of acquiring Murli Industries. The company is slated to incur additional capex of INR 4bn for the asset ramp-up. However, management is confident that the acquisitions will be EBITDA positive from the first year of operations. Embarked on next phase of expansion: Odisha Cement Limited is setting up 7.8MTPA of capacity in East which is expected to be operational by FY21. The execution of this expansion will assist in next phase of growth for the company

 

HDFC (CMP: INR 2457, Market Cap: INR 4,24,950 crore)

With the subsidiaries coming of age, we believe the solid core HFC story of HDFC has got lost in translation. Currently, the core HFC is trading at its historical low valuation of 1.4x one-yr fwd PBV. HDFC is a compelling BUY opportunity given a) superior liability franchise with the largest deposit base within the NBFC space, b) best placed to benefit from lower rates and normalization of credit spreads going ahead (c.130bps credit spreads on 3yr paper vs 90bps two years ago), c) poised to maintain retail home loan market share while selectively increase market share in corporate segment especially developer finance as 35% of the overall market (incl. banks) is either defocusing/recalibrating their strategy/reeling under capital constraints, d) ability to maintain spreads over the years despite increase in share of low yielding individual loans by 400bps over the last two years to all time high of 76% and e) best in class asset quality in a challenging environment with possible monetisation of investments providing adequate cushion against asset quality shocks (for eg. Bandhan Bank stake is valued at INR 84bn which is 2.2x NS3 assets as of Sep‟19).

Best placed to benefit from lower rates and credit spreads going ahead: HDFC currently has a borrowing base of c.INR4 trillion with the mix moving YoY in favour of term loans – from banks, institutions and NHB and deposits (31% of mix vs 28%) as capital markets remain choppy. With its AAA rating, proven underwriting track record, comfortable ALM position and strong Tier 1 capital levels, HDFC remains best-placed to benefit from a softening rate cycle – the cost of 3yr NCDs has witnessed successive moderation since Mar‟19 declining in the range of 17-59bps with the most recent issue in Sep‟19 happening at a rate of 7.28% - which is lower than pre-IL&FS levels.

Largest deposit base within the NBFC space : In terms of stickiness, HDFC has one of the largest deposit bases with over 2 million account holders with a healthy retail renewal ratio of 67%. As of Sep‟19, outstanding deposits stood at INR1.2 trillion.

Retail home loan dominance to continue given strong brand, distribution: HDFC currently controls 15% of the total retail home loan market (incl. banks) given core competencies such as a) strong brand name/ trust, b) competitive funding costs, c) underwriting expertise, d) deep, panIndia distribution via ~570 own branches and 5,300+ branches of HDFC Bank and e) faster TATs.

 

HDFC Bank (CMP INR 1280, Mcap INR 6,96,100 crore)

HDFC Bank remains one of the best compounding machines in the sector and we expect it to deliver average RoAs/ROEs of 2%/19% during FY19-21E and an EPS CAGR of 28% (post factoring in the tax cuts). Unlocking value from HDB Financial- Currently HDB Financial is being valued at INR 90,000 crore in the private market, which translates into value per share to HDFC Bank of INR 160/Share, we believe this value is currently not fully reflected in the share price of HDFC Bank and can help provide upside consensus estimates Renewed Aggression of the management to drive loan book growth- Having slowed down branch additions (only 500 branches i.e. 12.9% growth in last 3 years), HDFC Bank will now accelerate network expansion and is looking to add 600-700 branches per annum (50% expansion over 3-3.5 years).

The management highlighted following key strategies focused on customer acquisition and efficiency : 1) Re-imagining the branch network through smaller/efficient branches 2) Virtual RM-driven customer service model (already operational for 6mn customers) now being scaled up to service 20mn customers in 3 years 3) Focus on deposit mobilization by tapping pockets of liquidity in smaller towns 4) Consolidating its position as payments leader in the country – double the merchants to 2mn by FY20 and 4mn by FY21 5) Rolling out distribution of bank‟s product bouquet through its tie-up with government‟s CSC program and 6) Revamp of the digital banking interface to enhance customer experience We continue to be impressed with bank‟s unrelenting focus on driving its growth strategy based on the customer vs. individual products. Importantly, all these initiatives will also drive cost income ratio lower 35% medium-term as per the management.

As the bank scales up its presence in tier3/4 towns we see benefits of scale coming through and the bank‟s growth engine should continue on full steam without dilution in risk parameters. On succession planning, the bank reiterated its stance of having deep bench strength for individual businesses and will announce the successor to current MD & CEO by early FY21 We believe large private banks) with better economies of scale, strong liability franchises and lower exposures to weaknesses in mid-corporates and SMEs, will continue to gain market share and we prefer them over PSUs and smaller private banks.. HDFCB remains the undisputed leader in retail lending, and we continue to prefer it, given comfortable valuations Provisional loan growth numbers for 3QFY20 was strong at 19.6% YoY and it reinforces our belief that HDFC bank will continue with strong growth in coming quarters.

 

Muthoot Finance (CMP: INR 749, Market Cap: INR 29,908 crore)

Muthoot Finance is the flagship company of the 131 year old Muthoot Group. It is a pioneer in the gold loan space and is currently the country‟s largest gold financing company with gold AUM of ~INR 32,000 crore (~2.5x its immediate peer). The company has >23,000 employees & serves >2,00,000 customers every day via its pan India branches of 4,300+. We expect the company to maintain its leadership position with its strong business model & revival in asset growth. This would help maintain strong RoEs of >20% & RoAs of ~5.4% by FY21E. Recent sharp rise in gold prices to enable healthy asset quality and loan traction.

Leadership in gold financing space to stay – Mid-teens growth ahead is sustainable

One of the major concerns impacting re-rating of gold loan companies was the weak asset growth. This was due to various reasons such as abrupt regulatory changes, fall in gold prices, one–off events like demonetisation and implementation of GST. With these events behind the company has seen a revival in gold loan traction.

Low cost model is a significant competitive advantage

One of the key strength of Muthoot is its low cost of operations relative to its peers. The company‟s cost-to-income ratio is ~32% while cost-to assets ratio is at ~4.2% levels. This is a key advantage in the opex intensive gold loans business.

Best-in-class margins and negligible asset quality risks

On account of high yields of ~20-24%, the gold loan companies enjoy strong margins of ~11-14% . Muthoot‟s margins have stayed at a high range of 11-12% across cycles. Asset quality has not been a major issue for gold finance companies due to a secured book with highly liquid underlying asset. Muthoot‟s GNPA ratio at ~1.9% is well provided for.

Subsidiaries to add value going forward

The company has 4 subsidiaries (micro finance, affordable housing, consumer finance in Sri Lanka and vehicle finance). The consolidated AUM as of Q1FY20 stood at ~INR 40638 crore. Of these, nongold is ~13.5% that is expected to rise to ~18-20% levels by FY20E.

 

Solar Industries (CMP: INR 1115, Market Cap: INR 10085 crore)

SIL, with a market share of 26%, is India‟s largest manufacturer of Industrial explosive and initiating systems. Over the years, it has transformed itself from a domestic company catering to a single market, to a global multinational player with products consumed across 51 countries. It has also leveraged its expertise in explosives by venturing into the defense sector (order book of INR 365Cr as on Q2FY20) investing ~INR 420Cr over last 5 years.

New capacity addition along with expansion in global footprint to drive future growth

SIL starting from modest capacity of 6000 MTPA at a single location in 2000 to the current domestic capacity of 426,300 MT spread across 25 locations in India. We expect domestic industrial explosive volumes to grow by CAGR 13% FY18-21E which would majorly driven by expansion in capacity from current 426,323 MPTA to 700,000 MTPA by 2020. In overseas markets it has manufacturing facilities in 6 countries which it plans to expand to 10 in the next 2-3 years (Overseas and Exports contributes ~35% of overall revenues in FY19). Going forward we expect overall revenues and PAT to record a CAGR of 12% and 15% FY19-22E. Higher growth can be attributed to Overseas segment (CAGR 14% growth FY19-22E) while defense revenues to multiply to INR 350Cr in FY22E from INR 170Cr in FY19. Domestic revenues expected to record a CAGR of 9.2% FY18-21E.

 

Sundram Fastener (CMP: INR 485, Market Cap: INR 10,100 crore)

Leading auto component manufacturer Sundram Fasteners Limited (SFL) is a part of the USD 8bn TVS Group headquartered in Chennai, India. It has an established track record of 40 years in the manufacture of auto parts..

Diversification into other auto categories and non-auto segment to de-risk the business

SFL is the largest player in the domestic organised fasteners market with ~40% market share. Over the years, SFL has reduced its dependence on the fastener business (currently ~35% as against 65% in FY01), with continuous portfolio diversification to de-risk its business. SFL is focussing on increasing its contribution from other non-auto segments such as aerospace, defence, industrial machinery, wind turbines and increasing its after-market revenues (currently 10%) through an expanded dealer network.

Exports to be a key growth driver going forward

SFL‟s exports form ~35% of its overall revenues catering to products such as hubs & shafts and pump assemblies and engine components being exported to the PVs in Europe and North America. The North American region contributes almost ~75% of export revenues, while the top 3 clients account for ~80% of the exports. Currently, although exports are under pressure, management‟s long-term strategy is to garner 50% contribution from exports over the next 5 years spurred by the addition of prominent customers and expanding its product range supplies to existing clients.

Strong Outlook

In the few years, SFL has managed to increase its margins by 760bps to >17%. Margin expansion has been on the back of a) an increase in mix of specialised fasteners b) an increase in exports from 20% to 35%, c) hiving of the loss-making German subsidiary Piener and d) reduction of power and employee costs. Going ahead, we expect the increase in contribution from specialised fasteners, exports and nonautomotive (mainly defence and aerospace), which are high margin segments. SFL, in our view, would continue to command premium multiples because of its strong management and promoter pedigree, constant focus to improve ROCE and high FCF generation of INR 10bn over FY20E22E. SFL in our view is set for consistent compounding on the back of an increase in its top line from demand revival, increase in capacity utilisations and higher non-auto contribution. We forecast a revenue/PAT CAGR 11%/21% during FY20-FY22E.

 

Tube Investment (CMP INR 498, Mcap INR 9,170 Crore)

Tube Investments of India Limited (TII) is a flagship company of the renowned Murugappa Group, and is one of India‟s leading manufacturers of a wide range of products for major industries such as automotive, railway, construction, mining, agriculture, etc. The company‟s 3 main verticals are engineering, metal formed products and bicycles. We initiate coverage on Tube investment with a BUY rating. Tube investment is a preferred pick to play the revival in manufacturing sector, automobile volumes and exports in India. Strong management bandwidth (Mr. Vellayan as CEO), efforts to diversify revenue mix towards non-cyclical businesses, continuous margin expansion, and soon to be net cash status are reasons we like the stock. We forecast a revenue / PAT CAGR of 2.5% / 24% during FY19-FY22E, with our FY22E ROE forecast being 24% (up from 17% in FY19). We maintain our BUY rating on the stock. TII in our view is set for consistent compounding with initial years witnessing profits growth led by higher PBT margins. Later years would see benefit to topline from demand revival, capacity augmentation, higher exports and full benefit of new product launches.

Well entrenched strategy in place

Mr. Vellayan Subbiah took over the helm as CEO of TII in August of 2018. His excellent credentials and track record remains a key reason for our bullish stance on TII. Mr. Vellayan has well articulated his plans for TII, and wants to focus on 4 key areas „revenue growth, profitability, return on capital employed and free cash flow‟, he has formed 70+ teams to focus on improving these 4 metrics. The company has restructured each of its business segment for greater agility and empowerment, and is also looking to grow its addressable size by adding customers globally and enter into adjacent products/segments. Management aims for a 17% CAGR on revenues in the medium to long term which will be led by 13-14% growth in its existing business and 3-4% growth contribution by new product launches. It also desires to reach a 10% PBT margin (in the next 3 years) by lowering fixed costs and debt repayment. We remain skeptical on it achieving 17% growth rate for the next 2 fiscals due to weak outlook for the auto industry and as it consciously cuts down on non-profitable businesses like cycles / automotive chains. However, we remain convinced about its ability to meet its margin guidance.

Drivers in place to boost margins

Ability of TII to expand margins is central to the stock price outperformance in the near term, and we believe enough levers exist to achieve higher margins. Some of the levers are better product mix, currently cycles and auto chains contribute in excess of 30% to its overall topline. Both these businesses have low margin, and hence is not a focus area for the management. In the next 2 years their contribution to overall topline will drop to 20% which will boost overall margins. Exports are a high margins business whose contribution will almost double from current 7-8% levels. Some of the other cost savings measure that management is focusing on are better sourcing of raw material like steel, logistic and power cost optimisation, manpower and fixed cost reduction, and higher yields on its products. Combination of all these measures along with reduction in interest cost led by debt repayment should get it close to its target of 10% PBT margin by FY22 in our view. KEY RISKS: Prolonged slowdown in automobile sector, failure of new product launches, inability to scale exports business, higher steel prices, escalation of trade war / imposition of duty on exports.

 

V-Mart Retail (CMP: INR 1670, Market Cap: INR 3,050 crore)

V-mart has been one of the leading value retailer in organised retail space in smaller towns & cities in India. Its unique business model operates with a principle of “Price Less fashion” mainly in northern & eastern states like UP, Bihar, Jharkhand, MP, Orissa etc. The company is the key beneficiary of increasing discretionary spending as well as potential shift in the spending pattern from unorganised to organised retail chains. Its amongst very few retail companies consistently operating at debt-free level generating free cash flows with best in class return ratios.

Strong growth visibility on the back of aggressive expansion plan

V-Mart current store network comprises of 258 stores spread across 189 cities and 19 states. Going forward it aims to expand 60 new stores every year for the next 2-3 years. Its focus continuous to remain debt free & expand from internal accruals. Its future expansion strategy continuous to be cluster based approach with increasing its presence in new geographies. In FY20 it has forayed into North eastern states of Assam, Mizoram and Nagaland. We continue to bullish on V-Mart long term growth prospects. Its aggressive store expansion strategy, debt free status, best in-class return ratio‟s along with consistent FCF generation provides comfort We expect V-mart revenues and PAT to grow at CAGR 23% and 27% respectively FY19-22E.

 

Voltas (CMP: INR 687, Market Cap: INR 22,600 crore)

Voltas Limited, part of the Tata group, is one of the largest air conditioning companies in India and one of the world's premier engineering solutions providers and project specialists. Voltas offers solutions for a wide spectrum of industries. Voltas has broadly maintained both its outlook and margin guidance (11% EBITDA margin for UCP) for FY20 and has been, so far, relatively immune from the general economic slowdown.

EMP segment outlook improving: For the EMP business, while there is pressure in some export geographies such as Middle East, domestic business has seen good traction with the company receiving healthy inflows from Water, Metro and Rural Electrification space. Voltas recorded strong order wins of INR 26b (+125% YoY) in 2QFY20, thus, order book jumped 38% YoY to INR 65.7b, with the OB/rev ratio improving to 1.9x from 1.3x in 1QFY20. The company expects strong order wins in 3QFY20 as well, given its L1 position. EMP segment is seeing good traction in inquiries for water treatment projects (ticket size INR 1-1.5bn) in North and East India, metro projects and airport modernisation of smaller cities. Mumbai Metro project likely to be delayed but impact will not be meaningful as it contributes only INR 3bn. Current order book can help deliver 10-12% CAGR in EMP segment, with margins in 7-7.5% range.

UCP business continues to do well: As far as the UCP business is concerned, the company indicated a positive start to the onset of festive season with a decent performance during Onam (though floods had some dampening impact) with the overall inventory (company + channel) at normalized levels. Management expects strong momentum in the AC business to continue in 2HFY20.

Voltbek JV to gather momentum in FY21: Voltas-Beko JV is still in the investment phase and is expected to gradually ramp up as the Sanand plant gets commissioned and the company is able to expand product portfolio directly targeting the domestic market. The company targets to reach INR 100bn sales by 2025 with 10% market share in each of the categories it is present in. Currently Voltbek sales remain subdued, but as it rolls out its prodcuts garnering more shelf space, thus paving way for a healthy growth in next festive season. Management expects to achieve breakeven by 2024 as it aims for a 10% market share in new categories (WMs, refrigerators). Over FY19-22E, we forecast a 13.5% and 21.2% CAGR in sales and net profit as we expect operating leverage to drive margin expansion in UCP segment.

 

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