In our stock recommendations for 2021, our focus was on identifying companies that had the ability to steadily compound earnings over the medium to long term. Valuations were the other key factor against which we balanced earnings. But as we explained in our annual prime stocks performance review a good many of our recommended stocks trailed the bellwether Nifty 50.
While we don’t see this underperformance to be very alarming, we did assess how earnings have panned out so far for these stocks and what could have led markets to push them down. More importantly, we looked at whether the earnings performance has invalidated our original investment thesis for recommending that stock and what the outlook can be. Here’s the outcome of this exercise. We have gone by our defined Prime Stocks categories in this explanation. This list has only those stocks that have crossed at least 3 months since we recommended.
Earnings Compounders
Coromandel International
The first half of FY22 proved tougher for Coromandel than the two preceding years, with a sharp global spiral in both fertiliser and agro-chem input costs depressing profit margins, even as good demand and a hike in fertiliser subsidies raised revenues. Consolidated revenues were up 25% in H1FY22 at Rs 9811 crore while EBIDTA dipped 2% to Rs 1226 crore and net profits grew just 2% to Rs 854 crore. While NPK demand remained strong in kharif 2021, sharp spikes in input costs and global prices prompted Coromandel to cut back on imported sales volumes for phosphatics. With price caps impeding full pass-through of costs on fertilisers, the company took a hit on sales volumes which dipped from 19.5 lakh tonnes in H1 FY21 to 18.9 lakh tonnes in H1 FY22. Crop protection too was hit by margin pressure though exports helped the segment report 25% sales growth and 7% PBIT growth in H1.
With elections around the corner and the fertiliser subsidy bill for FY22 likely to substantially overshoot budget estimates, producers like Coromandel are likely to face curtailed pricing power and margin pressures over the next few quarters. On agro chem, India’s proposed ban on 27 commonly used molecules creates near term uncertainties. While these factors may contribute to muted stock performance in the near term, with its portfolio of fertilisers, nutrients and crop protection products, Coromandel remains one of the top choices to play the theme of Indian agriculture and the structural uptrend taking shape in global food prices. The trailing PE of 16.4 on the stock, slightly lower than our recommended levels offers valuation comfort.
HDFC
The HDFC stock has underperformed the markets with a near 7% fall since our buy date. We believe that elevated valuations at which we gave our call (a premium over conservative sum-of-the parts) and the underperformance of key subsidiaries such as HDFC Bank led to this underperformance.
Our investment thesis relating to HDFC’s core housing finance business is playing out well. One, record low interest rates, improving IT hiring and incomes are providing a good foundation for a residential housing market revival and HDFC is a good proxy to this theme. The 80% growth in HDFC’s individual loan disbursals in H1 FY22 is evidence of this. Two, unlike peers with a higher wholesale exposure or smaller rivals who lend to the non-salaried segment, HDFC’s asset quality didn’t see material deterioration on the lifting of the standstill on NPA recognition, with Gross NPAs moderating from 2.24% in end-June 2021 to 2% in end-September 2021 and restructured loans at 1.4% of loan book.
Capital adequacy at 22.4% offer sufficient cushion to fund growth. Three, despite continuing competition on residential loans that kept yields under check HDFC managed to maintain loan spreads at 2.29% in H1 FY22 through sharp reductions in cost of funds. Profit growth before one-offs was at 16%. Costs could rise in future but HDFC’s status as a prime market borrower will lead to competitive rates.
Subsidiaries such as HDFC Bank, HDFC Life, HDFC AMC and HDFC Ergo have traditionally accounted for nearly two-thirds of the market valuation of HDFC. This past year, all of these stocks have been laggards, weighing down HDFC’s performance. Rivals such as ICICI Bank have beaten HDFC Bank on digital adoption while the latter had run-ins with the regulator. Going ahead though, we believe HDFC Bank’s ability to deliver above-market loan growth, long-standing relationships with prime corporate borrowers and superior underwriting will help it recoup lost ground.
Despite the outlook, we’d not like to repeat our earlier mistake on valuation and will alert you to averaging opportunities in HDFC when its market valuation reaches our comfort zone.
Mahanagar Gas (MGL)
A 29% jump in trailing 12-month (to September 2021) sales and a 55% jump in reported PAT of MGL over similar period a year ago, did not help assuage the concerns building up in the gas sector. A significant jump in global gas prices, high spot-LNG prices and local APM (administered price mechanism) price hikes still due have dented margins of city gas distributors like Mahanagar Gas even as they try to pass the price hikes in a calibrated manner. But we think from a long-term perspective, the 22% correction by the market in MGL is exaggerated.
Healthy jump in volumes to over pre-Covid levels, weighty price advantage over alternative fuels (savings of 62% and 35% over petrol and diesel respectively for CNG and 27% savings of PNG over LPG, even after the price hikes) and the conversion of petrol and diesel public transport to CNG all provide support to the long-term prospects of Mahanagar Gas at the current trailing price earnings ratio of just 10 times (below its 3-year average PE). With 86% of the volumes for MGL coming from city gas, the disruption from the EV story also appears overdone. The fall from our buy price indicates our entry point was not good enough. We will try to make up for this by averaging our call in the upcoming months, linked to market corrections. Please look for such alerts.
Tactical Buys
Balrampur Chini
It has been something of a mixed bag for Balrampur Chini in the past couple of quarters. While sugar prices and realisations improved, a lower domestic sugar quota and damage due to pests and unfavourable weather hit production. The lower cane availability in the just-concluded sugar season also impacted ethanol production. Revenue for Balrampur Chini, therefore, shrunk 13% in the first half of FY-22 over the year ago period while EBITDA dipped 21%. There has been some margin improvement in the September quarter, however.
As a player in the sugar sector, Balrampur Chini remains in good stead. It has already expanded distillery capacity (ethanol) and aims to double it by November 2022. Production of higher-margin B-heavy ethanol helped offset some of the volume loss in this sugar season. The capacity additions and the ethanol blending programme will help sustain demand, improve margins, and reduce the impact of any inventory build-up. The major greenfield project at Maizapur (~30% of capacity) can take both sugarcane juice and grains as feed stock thereby offering flexibility to switch feed stock and ensuring capacity utilisation. Debt levels continue to be in check with interest outgo dropping significantly.
As far sugar prices go, the outlook continues to be healthy. Lower supplies from Brazil due to droughts, leading to depleted inventories, higher exports of surplus production in domestic markets, reduced cyclicality of the domestic production besides ethanol demand are all likely to keep sugar prices up.
Balrampur Chini is gearing up to build a resilient business independent of subsidies and prepare for a scenario post 2023 when there will be no government export assistance (pursuant to WTO intervention). As we explained in our report, the stock is still best accumulated on dips; we will keep a watch on this and alert you on any significant price points at which you can average your prices down.
Tata Steel Long Products (TSLP)
Post our recommendation in June 2021 the stock was inching up on the back of a positive outlook for the sector. But, since August 2021, steel stocks have taken a deep correction to the extent of 30-40% on some profit taking. TSLP corrected on the back of weak results in Q2FY22 with a net profit of Rs.134 crore against Rs.331 crore in the preceding quarter while sales remained flat.
We do not see any long-term concern from this earnings dip. The key reason for the earnings fall was that the company was sourcing some raw material from Tata Steel and pursuant to amendment to certain regulations, Tata Steel had charged Rs 219 crore on TSLP for June and September quarters. as additional royalty. There was another one time expense of Rs.15 crore. But for these, the net profit would have been higher at Rs 300 crore. Management is looking to address this issue by sourcing more from captive mines which will aid in earnings recovery. To us, it is a temporary period of shift in the company’s material planning strategy.
On the brighter side, TSLP has further reduced debt in the first half of FY22 and is left only with long term debt of Rs.685 crore compared to Rs.1,320 crore and Rs.2,644 crore respectively at the end of FY21 and FY20. On the much-awaited merger of Tata Metaliks with the Company, the timeline is getting extended for want of approvals while it is expected to sail through in FY23. We remain sanguine on the company’s prospects as detailed in our rationale and report available here, given the current attractive valuation of 3 times trailing earnings.
Dividend earners
Engineers India
After a pick up in the June quarter, Engineers India once again slipped in earnings for the quarter ending September 2021, with a steep 37% drop in PAT for the quarter over a year ago. With this, the trailing 12-month earnings (upto September 21) is down 29%, hampered by slow execution. While order inflows have picked up by 115% for the first half of FY22 compared with a year ago and is also higher by 30% over the first half of FY-20 (pre Covid period), the lack of earnings growth does bother us. We are pinning our hopes on the shift in order book in favour of the high margin consultancy business (66% now from 49% a year ago). This holds potential to up earnings significantly as consultancy earns upward of 25% margins as opposed to 2-3% in turnkey projects.
The order book of Rs 8030 crore (September 21) is 2.6 times FY-21 revenue, and the multiple is the lowest in 4 years. We will watch for pick up in execution and decide further course of action. Dividend yield at 2.7% is higher than blue chip companies but does not compensate at present for the poor earnings growth. While the pick up in earnings over the next 2 years is imminent based on order book, investors need to keep in mind that this is not a high growth play and has therefore been classified as a dividend earner with a solid balance sheet. We will watch for 1-2 quarters of earnings before further deciding on the stock’s prospects.
Hero MotoCorp
Hero Motocorp took much of the heat in the automobile sector slowdown. What also did not help was an 11% drop in sales volumes for the April-November 2021 period over the year ago, a loss of market share in Hero’s stronghold of the entry-level motorcycle segment, and the lockdown-induced demand hit. Slackening rural demand and delayed festive demand were other detractors.
But even in this gloom, there are a few bright spots. Revenue growth held up at 13% for the first half of FY-22 thanks to product price increases of about Rs 3,000 over the year and an improving product mix. The price hikes and other cost savings also supported EBITDA margins as input costs spiraled. Second, Hero focused on increasing financing opportunities to entice demand especially in the rural segment; financial penetration markedly improved in the latest quarter and Hero’s own subsidiary has a good share of the retail financing. Third, the delay in monsoons and crop sales that hurt rural demand appears to be abating. Four, Hero continued to make inroads into the premium end of the motorcycle market, gaining market share.
In our view, Hero is at an inflexion point and could turn onto a different trajectory over the medium to long term. Apart from pushing into premium motorcycles, Hero is also introducing premium variants in its other segments that can improve realizations. It has a clear focus on exports, concentrating on 8-9 markets where it has established its market and strategy – export volume contribution has risen to 6% now from less than 2% two years ago. Accessories and spares are the third focus area to diversify revenue which has grown swiftly, accounting for just over a tenth of revenue. Hero’s electric vehicle foray is due to be launched from March next year besides its stake in established premium segment Ather. EVs are more likely to be disruptors in the scooter segment than motorcycles. Hero has a small presence in the scooter segment – its EV move may, for one, help it gain an edge in this market due to an early-mover advantage and strong established distribution network. Two, Hero may also suffer a lower cannibalization of its scooter customer base to EVs.
Finally, Hero remains a healthy dividend payer. It has maintained a payout of about 50% of its profits over the years, with FY-21 dividend at Rs 105 per share. That, together with the price drop, have brought dividend yields to attractive levels of about 3.8%. For those looking to build a dividend-generating stock portfolio, this stock is a good fit.
Early Movers
Advanced Enzymes
Despite being in a niche high margin business, Advanced Enzymes has struggled to grow over the past 2 years and hence it was not an easy pick when we brought this into our recommendation list. In the latest quarter, the struggle came on the back of an unprecedented hike in input costs as well as logistics and fuel costs which can be expected to continue next quarter as well. Responding to this, stock has sharply corrected from our recommended price and is 15% lower now. But there was some positive news as well.
On 15th December, 2021, Advanced Enzymes signed an exclusive agreement with AZELIS, a major global player in specialty chemicals and food ingredients, for the distribution of food enzymes and probiotics for the food & dietary supplement industry in Indonesia, Malaysia, Philippines, Singapore, Thailand & Vietnam. AZELIS is a $2 billion company that went public in Europe recently in one of the major IPOs in the region in 2021. This may provide some support to its overseas market growth prospects.
In the last 3 years, the company has consolidated its leadership in human nutrition, acquired new capabilities in product delivery, expanded reach in overseas markets and more recently stitched a partnership to expand the market. All these initiatives are expected to accelerate growth from FY23.
Valuations at 5X sales and 25 PE, don’t appear high for a niche high margin business. The PE is also lower than its own historical averages. While we will keep watch over this stock, we are aware that we have entered this stock a tad too soon (classified as an Early mover) given the huge potential and unique human and animal nutrition spaces that this company is into. The stock may need a patient hold.
Greaves Cotton
Greaves Cotton started FY22 on a weak note and this streak continues. For the first half of FY22, the company reported revenue of Rs.600 crore and EBITDA loss of Rs.27 crore. Its core engine business saw a 50% decline in revenue (vs. first half of FY2020, a normal, pre-Covid period) as 3-wheeler sales are yet to recover from a 66% slump in volumes in FY21. Non-auto engines compensated for some of the volumes.
On the bright side, the company’s electric 2 & 3-wheeler business has crossed Rs.100 crore revenue mark in first half of FY22 (out of which Rs 89 crore was in Q2 alone) gaining significant traction in sales. This streak appears to be continuing in Q3 as well. The company has emerged as one among the top-3 players in the value segment of E-scooters so far in CY21, with the shift from petrol underway. Greaves is also now a full-fledged player in the electric 3-wheeler space with two acquisitions. The traction in EV business appears strong enough to contribute to a quarter of revenue in FY22 itself. We expect profitability with economies of scale and at this point, we would rather focus on the company’s ability to catch the emerging demand at the right time.
All the 3 players – Hero Electric, Okinawa and Greaves – are now looking to raise money from PE investors (in the range of $100 to $300 million) for growth in FY22/FY23. This will set the benchmark for valuation in this space and likely trigger a re-rating of the stock. Besides this 3-wheeler sales recovery will be key to earnings growth and signs of this are visible since October 2021.
Disclosures and Disclaimers
The following Disclosures are being made in compliance with the SEBI Research Analyst Regulations 2014 (hereinafter referred to as the Regulations).
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3. PrimeInvestor Financial Research Pvt Ltd has not received any compensation from the subject companies in the past twelve months. PrimeInvestor Financial Research Pvt Ltd has not been engaged in market making activity for the subject companies.
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General disclosures & disclaimers
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