FUTURE STARS..MID-CAPS.!!!

30 stocks with potential for strong RoE gains

Mid-caps in cyclical sectors such as Cement, Financials and Capital goods are estimated to earn higher profit for every rupee of shareholders' funds invested in the business

Sheetal Agarwal  |  Mumbai  

October 26, 2014 Last Updated at 15:20 IST

The S&P BSE 500 index has rallied by about 29% in 2014 so far fuelled by improving global scenario and formation of a stable government in India. Expectations of a revival in macroeconomic growth and hence better performance by corporates have made investors incrementally positive. Pick up in macroeconomic growth, improving profitability of corporates and potentially lower interest rates are likely to rub off positively on India Inc’s earnings as well as Return on Equity (RoE) ratio.

Return on Equity ratio, a key valuation parameter the Street tracks, is calculated by dividing net profit by shareholders' equity. It indicates how much money or return a company is earning on the shareholders' funds. Business Standard identifies some of the companies having potential for strong RoE expansion of over 300 basis points in each FY15 and FY16 and robust earnings per share (EPS) growth, based on consensus Bloomberg estimates. Most of these companies belong to beaten down cyclical sectors and hence are likely to witness significant RoE expansion on the back of revival in macroeconomic growth which in turn will boost their prospects.

Of the BSE 500 companies, about 30 are likely to witness RoE expansion of over 300 basis points each in FY15 and FY16. Of these, 12 are likely to turn profitable over the period of FY14-16 versus a loss in FY14, while four are likely to report high earnings per share (EPS) CAGR over FY14-16 - namely, JaiPrakash Power Ventures (up 334.1%), Ramco Cements (up 311.9%), Motilal Oswal Securities or MOSL (145.6%) and Gujarat Fluorochemicals (118.6%).

Barring Lanco Infratech, all other companies are expected to post earnings CAGR of 26% to 94.6% over FY14-16. Lanco Infratech, though will continue to post losses, albeit at an improving pace (losses are expected to decline). Its EPS is estimated to move from -Rs 10.2 in FY14 to -Rs 4.8 in FY15 and -Rs 2.4 in FY16. However, given the uncertainty surrounding various sectors, especially infra and power, investors would be better off avoiding companies in such sectors and await for clarity before taking an investment call. In fact, there are many well-known names with reasonable valuations outside these two sectors that investors may want to consider.

There could be multiple reasons for RoE expansion. Premal Madhavji, Head of Equities, Espirito Santo Securities, says, "The key reason for expansion in RoE is that most of these companies are unlikely to raise fresh capital in the next couple of years and management will focus on delivering stronger earnings. Also, if a company can issue debt at a lower interest rate than the rate of return on its investments, its ROE can increase."

Improving prospects
	Return on Equity (%)		EPS CAGR (%)	FY16E P/E (x)
Company	FY15E	FY16E
Bajaj Electricals	16.5	22.6	LTP	14.1
Birla Corp	10.9	14.5	66.7	9.7
Blue Dart Express	22.7	26.4	26.0	62.9
Capital First	8.3	13.1	68.7	13.9
Carborundum Universal	12.3	15.9	50.7	17.0
Crompton Greaves	12.0	16.0	67.1	17.4
Gujarat Fluorochemicals	12.3	20.1	118.6	9.1
Hathway Cable	-3.7	3.2	LTP	116.0
HSIL	7.3	11.4	94.6	20.1
India Cements	3.1	6.6	LTP	12.9
Indiabulls Power	2.5	7.0	LTP	7.2
Jain Irrigation	8.3	12.6	32.5	12.5
Jindal Saw	7.6	10.8	LTP	4.4
JK Cement	8.4	12.5	81.2	15.2
JK Lakshmi Cement	11.2	15.2	58.3	17.2
Jubliant Life Sciences	10.7	15.8	105.9	5.2
Mahindra CIE Automotive	8.0	12.5	LTP	16.2
Motherson Sumi	36.4	40.4	53.6	19.0
Motilal Oswal Financial	12.5	18.6	145.6	12.7
Oberoi Realty	10.9	14.8	54.8	9.7
Phoenix Mills	11.1	15.4	60.4	16.2
Prism Cement	4.4	18.3	LTP	17.2
PVR	18.0	22.2	45.9	23.3
Ramco Cements	12.5	18.3	311.9	3.7
Shoppers Stop	4.8	12.0	LTP	67.5
Tata Communications	21.2	32.3	85.8	30.4
Trent	5.9	10.2	LTP	32.8
Tribhovandas Bhimji Zaveri	16.1	20.0	43.1	12.8
TVS Motor	28.0	36.1	49.4	27.7
United Spirits	9.0	15.0	LTP	50.3
E:Estimates; LTP is Loss to Profit; EPS CAGR is over FY14-16
Source: Bloomberg, brokerages

Pick-up in industrial/consumer demand and consequently, capacity utilisation is another factor that can lead to better return ratios. Softening input costs (particularly crude oil prices and its derivatives) for companies with better pricing power will also rub off favourably on their return ratios through higher profitability.

Market experts believe domestic cyclicals such as banks and cement companies have high potential for RoE expansion from here on.

Pankaj Pandey, Head of Research, ICICI Securities, says, "Based on the theme of RoE expansion, we like sectors like cement, banks, capital goods, auto and telecom. In these sectors our key stock picks include UltraTech Cement, JK Cement, Larsen & Toubro, Greaves Cotton, SKF India, State Bank of India, Federal Bank, Bharti Airtel, Maruti, Bosch India and Exide Industries."

Madhavji, too, believes that the cement sector has scope for sustained RoE expansion in the next two years. "The recent uptick in demand and stable pricing is a positive sign. We expect a gradual recovery in cement demand on the back of our analysis of central plan and state spends in key states. We like JK Cement and Prism Cements in this sector", he adds.

The valuations of some of these companies, however, have partially captured the improving prospects. 13 of these 30 companies are trading at 15 times or less their FY16 estimated earnings - at par/below Sensex which is trading at about 15 times estimated FY16 price/earnings. Of the rest, seven companies are trading between 16 times and 20 times FY16 estimated earnings, and nine companies are trading at 20 times and above. While Lanco is expected to report losses, Hathway Cable and Datacom, Shoppers Stop and Blue Dart Express have the highest valuations of 63-116 times.

"We believe that valuations as of now do offer opportunities to make reasonable returns over a three to five year period. If the required reforms do happen as per expectations then the recovery may be stronger, which would further propel earnings’ growth rate/RoE expansion. This would then make the current valuations more attractive", says Pandey of ICICI Securities.

http://www.business-standard.com/article/markets/30-stocks-with-potential-for-strong-roe-gains-114102600340_1.html