Long Ideas in Indian Markets

A good company is a good investment if purchased at reasonable valuations. In a previous post, I had looked at several good Indian companies from the Dow Jones BRIC 50 Index and the Dow Jones India Titans Index. In this post, I am looking at a few more of the Titans. In addition, I am also looking at 3 liquid stocks from the mid cap universe in which I see opportunity. You can look at my quantitative analysis here. You can also assume that I have positions in all stocks which I have rate a buy.

Satyam (SAY): This lists as the 18th from amongst 30 Titans. The management team is strong and access to a talented work force is an added advantage. Like all good companies, it too has its risks. The biggest overhang for Satyam is the Upaid patent dispute. Over the five years ended 3/31/2008 its earnings grew at 25% annualized. During the coming economic expansion, I expect earnings to continue to grow albeit at a slight lower rate of 22%; for the purpose of valuation I have used a 19% earnings growth rate in order to allow for earnings deterioration arising from the Upaid dispute.

There is considerable upside to this growth estimate because it includes a presumption of a considerable slow down in the US financial services spend; this is a very important vertical for the company. Personally, I believe that IT services will be a beneficiary of the turmoil in the financial services market - the extensive M&A activity will likely result in significant IT integration investment. In addition, after significant head count reduction, the focus on enhancing productivity will be huge. IT services plays a critical role in enhancing productivity and integration. The company is largely un-leveraged. It trades at a price to book of 2. The multiple applicable to expected average earnings during the upcoming business cycle assuming growth at 19% for 7 years with a terminal growth rate of 9% is 14.9 for an investor targeting an annual return of 20%. A 22X multiple was paid for the past five years peak earnings when the stock hit its 52 week high.The average earnings over the past 5 years was Rs 16/share. My bear target is Rs 243.

On the upside, I have a bull target of Rs 471. I view a fair price of the share at Rs 265.

TCS: This company is the 20th Titan. I like this company. While management lacks the suaveness and panache of an Infosys, it is solid; it is led by the Tata Group which has over 100 years of history in creating shareholder value. Mr. Ratan Tata who heads the group is a Titan. The revenue streams are diversified; yes dependency on US cannot be denied, but it has a solid European presence too. It has also seen much recent success in developing its India business. In addition, I like its position as an acquisition target. Over the past few years, the Tata Group has made several acquisitions overseas in the Steel & Motor Industry. These businesses are heavily leveraged.

They also have solid potential which will likely lead to a reluctance to reduce debt through fresh capital infusions. One way to capitalize these over-leveraged businesses could include a disposition of TCS, with Tata Sons then using the funds realized to inject additional equity or debt into Tata Steel and Tata Motors. On its own TCS has good growth potential; however, I believe that Steel & Motors offer even stronger growth opportunities due to the urbanization and industrialization in India and China. Over the five years ended 3/31/2008 its earnings grew at 22% annualized. During the coming economic expansion, I expect earnings to continue to grow albeit at a slight lower rate of 20%.

There is considerable upside to this growth estimate because it includes a presumption of a considerable slow down in the US financial services spend; this is a very important vertical for the company. Personally, I believe that IT services will be a beneficiary of the turmoil in the financial services market - the extensive M&A activity will likely result in significant IT integration investment. In addition, after significant head count reduction, the focus on enhancing productivity will be huge. IT services plays a critical role in enhancing productivity and integration. The company is largely un-leveraged. It trades at a price to book of 4.2. The multiple applicable to expected average earnings during the upcoming business cycle assuming growth at 20% for 7 years with a terminal growth rate of 9% is 15.45 for an investor targeting an annual return of 20%. A 22X multiple was paid for the past five years peak earnings when the stock hit its 52 week high.The average earnings over the past 5 years was Rs 33/share. My bear target is Rs 512. On the upside, I have a bull target of Rs 1006. I view a fair price of the share at Rs 579.

Sesa Goa: This company is a subsidiary of Vedanta (UK Listed). Vedanta owns several diversified companies in the basic materials space and a broad global geography. The management capability is well established for this rapidly growing group. A word of caution; the management has associated with it an element of notoriety in respect to its dis-respect for the environment and the company ethics. In the past, minority shareholders have felt under-served by actions of the management.

More recently, Vedanta planned a re-organization of its several listed Indian businesses which were not appreciated by the minority. The company backed down from its planned re-organization, which is indicative of a new willingness to hear the concerns of the minority shareholders. The entity also has a risk because the Indian authorities tend to protect the domestic market through high export taxes; however, I see India as one of the great sources of demand for commodities so this does not concern me over-much - Sesa Goa is well positioned to compete with global suppliers to the Indian market - cost of transportation alone gives them a major competitive advantage as does locale knowledge.

The entity is largely un-leveraged, which is a big plus in this environment. It does have ambitious growth plans and there is a good opportunity to benefit from the sensible use of leverage. It trades at 2.49 times book. Over the past 5 years it grew at 56% annualized. Because of the market perception of risk, I have assumed an 18% growth rate over the coming 7 years and a terminal growth rate of 9%. At this rate of growth, an investor looking for a 20% annual return can expect to pay a multiple of 14.3. I believe that there is significant upside to growth potential to 30%; however, I do have a strong conviction on continued elevated demand as consequence of the industrialization and urbanization in India. Over the past 5 years, average earnings came in at Rs 9/share; with a maximum of Rs 20/share. At its peak price, buyers paid a multiple of 17. My bear target for this share is Rs 123 (the share recently traded far below this level); the fair price is Rs 186 and a bull target is Rs 279.

Biocon: This is amongst my favorite companies. The management is strong and as time goes by, I believe it will gain skills in delivering shareholder value. The company has strong skills in bio-generic and bio-similars. Evolution of generics in the Biotech space will be a pain for the global biotech industry who have been better able to protect their business post patent because of a lack of generic product availability. The company also has a very interesting R&D portfolio; including an oral insulin drug which I believe has major global potential. Its pipeline, which includes cardiology, oncology, diabetes and Rheumatoid Arthritis potential, could also make for an interesting out-licensing agreement to big pharma who are facing significant patent expiry over the next few years and thus hunting for new products.

Indeed the company could also be a very interesting acquisition target. Its major risk is the slow pace of FDA approvals (now down to a mere 19 annually). Attributing no value to its intellectual capital and using a 7% growth rate, an investor looking for a 20% annualized return can expect to pay a multiple of 9. The stock trades at 87% of book value. At its peak, buyers of the stock paid a multiple of 15. My bear and fair price targets were both at Rs 176 with a bull target of Rs 201 - this includes only its existing business. Any success in its pipeline could take valuations to the realm of the uncontemplated. This is a stock I personally do not expect to sell on achievement of the bull target because the future, while uncertain, is incredibly bright.

GMR: Finally, we have GMR. The company trades at 93% of book value. It is a well run company with a strong backlog. As an infrastructure development company, it can expect several years of growth as India urbanizes and industrializes. Unfortunately, over the last business cycle a high degree of leverage (256% debt to equity) has arisen on account of massive capacity expansion. I believe a growth rate of 40% in the coming years is achievable, but I have used a 20% growth rate to take account of dilution which may arise as a result of a need to reduce leverage.

While the existing business and capacity expansion can be expected to generate cash flows to service and repay debt, there is a risk which needs to be priced. For an investor targeting a 20% annual return, a multiple of 15.6 applies for 20% growth during the coming 7 years with a terminal growth rate of 9%. At its peak price, a multiple of 20 was paid by buyers. I have a bear target of Rs 96 (the stock is trading well below this level), a fair price of Rs 104 and a bull target of Rs 157 on this stock.

With better visibility on growth without dilution, these targets can be expected to be significantly outperformed. Industrials in India are somewhat over-valued; amongst the Titans I like BHEL and JP Associates as they did approach my fair price; unfortunately they never made it. GMR remains my favorite industrial on valuation.

Disclosure: Long GMR, SAY, Biocon, TCS

Comments

[hownow:]

You picked a winner in GMR.

Did 49 FII really invest at Rs.250 :-)

indiaplay.blogspot.com...

2008 Oct 15 09:10 AM

[Atul Hajela:]

Shiv,

How can one take exposure to sensex index or the nifty index, from US markets? Are their any ETFs which are linked to these indexes?

Thanks,

2008 Oct 26 05:20 AM

[Shiv Kapoor:]

Atul - I think the best way to get exposure to the Indian market is through IIF & IFN. It is not necessary exposure to Nifty and Sensex, but it is exposure to a selection of quality listed stocks. Closed ended funds tend to trade at a discount to NAV, so if you intend to hold long term, this is a decent entry strategy.

2008 Oct 27 09:15 AM