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Stocks / Cover Stories MAGAZINE | NOV 17, 2010

COVER STORY

5 Cool Stocks In A Hot Market

Even with the market on fire, here are a handful of stocks that could give investors good returns in the longer term
KUMAR GAUTAM , RAJESH KUMAR

R etail investors, hoping to make money quickly, typically find it difficult to resist the temptation to buy shares when
the stockmarket is rising. That temptation, anecdotal evidence suggests, is even stronger now than before as many of
them missed the rally over the last year waiting for a correction to enter the market. However, the fundamental problem
with investors in such a market is that they tend to pay too high a price for the estimated growth of the companies they
invest in, assuming, of course, that the companies can deliver according to expectation. Therefore, in conditions like
these, safety of investment assumes greater importance than commonly perceived.

It has been written at length, both in this magazine and elsewhere, that the current rally in the equity market is, to a very
large extent, being driven by liquidity in the global markets. The more money central banks around the world print to
boost their own economies, the greater is the inflow into markets like India. With the market at its current level, most
stocks have seen substantial appreciation and their prices are either on the edge of reason or beyond. One option for the
retail investor trying to enter this market, therefore, is to wait for a correction to enter the market, in other words, try to
time it. To get it right, however, the retail investor would need a liberal helping of luck, even though one school of thought
strongly believes that the stockmarket is likely to see deep cuts.

The other option is to look for value and find stocks with upside left even in this market. But one needs to be careful about
fundamentals and track record. The second exercise is what we have undertaken, and here are five good medium- to
long-term buys.

Jyoti Structures

Strong businesses are built, normally, when challenges are converted into opportunities. It is an accepted fact that
infrastructure is the biggest impediment to achieving the desired double-digit growth in India, and power shortage has
long been responsible for a low level of manufacturing activity. Thankfully, the government is taking the matter seriously
now. Activity in the sector has also gone up significantly with private sector entering the business. To put this in
perspective, India will require additional power supply of 100,000 MW by 2017 and, according to plans, an estimated Rs
2,40,000 crore will be spent on the sector during the Twelfth Five-year Plan period. It makes perfect sense for the

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investors to be part of this huge opportunity to enhance long-

term gains. Outlook Money in the past has recommended two
companies in power sector financing business—Power Finance
Corporation and Rural Electrification Corporation. This time we
highlight Jyoti Structures, a mid-sized company, in the business
related to the power transmission sector.

The company works in areas of transmission lines, sub-stations

and setting up distribution networks, with the capability to
execute turnkey projects in all areas of power distribution. It
has proved its credentials by clocking a five-year compounded
annual growth rate (CAGR) of 35 and 50 per cent, in topline
and bottomline, respectively. Also, the fact that it sitting on an
order book of over Rs 4,000 crore, roughly twice its fiscal year
(FY10) revenue, should give confidence to investors about its
future. From the order book of Rs 4,106 crore, 82 per cent is
from domestic companies. On the domestic side, Power Grid
Corporation of India, a public sector distribution company,
contributes about 35 per cent of the orders. In terms of
verticals, 68 per cent would be transmission, 21 per cent
distribution, while the rest will come from sub-stations. The
company remains upbeat on the further flow of orders.

In the quarter ended June 2010, the company’s revenues were

up 16.30 per cent, while the net profits increased by 17.69 per
cent. In the market, the stock is currently trading at 12 times earnings, and with a strong order book, proven track record
and earning visibility, it makes a strong case for a buy.

Shree Cement

The problems affecting the cement industry are well-

established. Despite a strong correlation between demand for
cement and economic growth, the industry has struggled to
achieve high bottomline growth. An overcapacity, which brings
down the cement price and thus the margin, is certainly the
biggest problem. The volatile price of power and fuel, which are
the major costs for cement companies, further makes it difficult
to maintain margins.

However, Shree Cement, north India’s largest cement

producer, has delivered strong growth both during the upturn
and the downturn of the cement cycle despite all these risks.
Overall, the industry’s capacity utilisation went up from fiscal
year 2003 (FY03) to FY08. Shree Cement also benefitted from
it and reported around 34 per cent and 107 per cent growth in
total income and profit, respectively. In the following years, FY
09 and FY10, the realisation for the industry declined.
Nevertheless, Shree Cement’s growth figures were still
attractive during this period. The topline and bottomline rose
annually by 27 per cent and 61 per cent, respectively.

All these years, the company rapidly ramped up its production

facility to boost its topline, but also took care that the margins
continue to improve, which is now the highest compared to its peers, to grow the profit. Several factors have allowed it to
do so. First, the gestation period of capacity addition is low, which help it react quickly to demand surge and avoid idle
capacity. The company also has the advantage of proximity of its plants to the market, which reduces freight cost. Also,
as Shree Cement’s market is mainly north India, which has traditionally been a high-value market, the realisation for the
company is high compared to players in other regions.

The most critical factor for Shree Cement is its venture into the power business. Building captive power units, which now
meet the entire power needs of the company, has not just helped reduce costs, but will also help it in times of downturn in
the industry. Shree Cement now sells excess power on merchant basis (market-determined price), and in FY10 this
contributed around 14 per cent of the company’s revenues. It is working towards commissioning more capacity, and when
the power business becomes a significant part of the overall business, it will cushion Shree Cement’s earnings in the
cement downturns. This suggests that even as the company can bank on construction activities in the economy, in the
down cycle, because of a utility business such as power, it will be impacted less. With the growth drivers in place, a price-
to-earnings ratio of 14 is not too much to pay for its shares.

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Allied Digital Services

Managing currency volatility has now become the norm for

information technology (IT) companies. Most of their revenues
come from exports and if the rupee appreciates against any of
the major currencies, such as dollar or euro, their revenue in
rupee terms is hit hard. However, if a company has delivered
high volumes, its growth in rupee-terms remains attractive even
after shedding few basis point growth on account of currency
movement. And that is the case of IT services provider Allied
Digital Services (ADS). Its growth is impacted by currency
movements, but high volume growth has ensured attractive top
- and bottom-line growth in rupees.

ADS has over two decades of experience in providing IT

services to its clients across several domains and geographies.
IT services is categorised under verticals such as infrastructure
management services, remote management services,
networking and communication solutions, and enterprise
consulting solutions, among others. In Q1FY11, around 70 per
cent of revenue was generated domestically whereas 30 per
cent came from exports to geographies such as the US and
Australia.

The services provided by ADS are similar to other IT

companies, but it has managed to deliver superior growth rates. Between FY07 and FY10, the total income has increased
over fourfold from Rs 156 crore to Rs 697 crore, or a CAGR of 64.71 per cent. The bottomline increased at a similar
pace. In FY09, when volume growth of the overall IT industry was low, ADS managed a topline growth of 26 per cent. A
higher growth in profit of 38 per cent indicate that unlike other IT companies, it was not impacted much by pricing
pressure in the downturn. One reason that allowed it to grow was that it took the inorganic route to growth, which was
reflected in high growth figures on the consolidated income statement. But even if performance of the subsidiaries is
ignored, in FY10 the company reported 32.30 per cent and 78 per cent growth in total income and profit, respectively.
Company’s focus on domestic market, which is 70 per cent of the revenue, was the major reason for it to sail safely
through recession in the developed nations.

In the coming quarters, the company is expected to report high growth. In post Q1FY11 analysts’ conference call, the
management has said the order book is to the tune of Rs 565 crore, which is over two quarters of total revenue. The
margin, which improved in the past few quarters, is expected to improve further, as the company focuses more on high-
margin value added services to its customers. At the end of Q1FY11, the company had a cash balance of Rs 180 crore,
and that helped it in taking inorganic routes to growth. With its annualised earnings-per-share for FY 11 is estimated at Rs
28 and price of its share of Rs 224.40, the stock certainly looks undervalued at a price-earnings multiple of eight.

EClerx Services

One parameter that went into selecting stock recommendations

for this issue was to judge a company’s performance even in
bad economic conditions, and eClerx Services—a knowledge
process outsourcing (KPO) services provider—stood out on it.
The KPO industry was in the doldrums in 2009. Though there is
no industry-specific data to support this as most of the players
are not listed, anecdotal evidence such as freezes in hiring and
salary cuts suggest so. However, it was an interesting time for
eClerx. It hired more that year (almost 30 per cent rise in
headcount) and the revenue went up by 62 per cent. It does
indicate eClerx’s differential nature of business in a cluttered IT
industry.

eClerx’s analytics, process and data management services is

divided into two verticals—financial services and sales and
marketing support. Services under financial services head
include back office services, finance and accounting and risk
management. Sales and markets support bundles services
such as competitive pricing and catalogue analytics and data
management. The company boasts of servicing 13 of the
Fortune 500 companies. What has really differentiated its
services from that of other KPO companies is that they support
the core activities of the clients that are non-discretionary in

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nature. So, during the financial crisis of FY09 and FY10, even as many of eClerx’s clients in the banking industry went
under, were desperately restructuring, or were acquired by stronger ones, eClerx didn’t lose its business. The company
also used the opportunity during the downturn to attract the best talents in the industry. Another factor that differentiates
the company is the nature of contracts it undertakes. Most of the companies in the KPO industry get revenue from
projects that are short-term in nature and comes at inconsistent intervals. However, eClerx undertakes projects that are 2
-3 years long, and are on an annuity basis. It also avoids “request for proposal” route to win projects. In fact, most of them
are repeat projects from the existing clients. These factors add an element of stability and predictability to its revenue.

eClerx just has a decade’s experience, and it got listed on the exchange as recently as 2007. It has shown a phenomenal
growth in the past few years. From 2006 onwards, the revenue rose at a CAGR of 51 per cent from Rs 47.8 crore to Rs
246.5 crore in FY10. During this period the profit grew at 32 per cent. The balance sheet is liquid with no debt and high
amount of cash.

The profitability ratio, such as return on equity, is also high at 40 per cent. You can rest assured that the company’s stock
has gained attention from investors, and has moved up 63 per cent in the past 12 months. However, if we ignore the
charts, at an annualised EPS of around Rs 40 and price of Rs 597, a PE level of 15 is still attractive enough for you to
buy the stock.

Supreme Industries

With rising activity in the economy, there are a few industries

that do not attract sufficient investor attention. The reason
probably is that their growth is derived. Plastic is one such
example. From industrial production, construction to consumer
durables, plastics play a vital role. Plastics consumption was up
16 per cent in India in FY10. PVC consumption was 1.8 million
tonnes, and with total installed capacity around 1.2 million
tonnes, demand clearly outpaced supply. Further, with rising
economic activity, the gap could widen. Supreme Industries,
the well-established brand in plastics, with a proven track
record, is well poised to reap the benefits. The company,
established in 1942, has registered revenue and net profit
growth of 12 and 35 per cent CAGR, respectively, in the last
five years. In the quarter ended September 2010, sales were
up 37 per cent, while the net profits registered a jump of 103
per cent. Supreme, with 19 production sites, derives revenue
mainly from four verticals—plastic piping systems, consumer
products, industrial products and packaging products—with
piping contributing the highest at 43 per cent.

Going forward, the company is investing in capacity creation

and intends to move up the value chain. In the current fiscal,
the company plans to invest Rs 180 crore for this. It expects
the replacement market to gain prominence in the coming years as more and more buildings go for renovation. To the
capture the opportunity, it is focusing on its pan-Indian retail network.

Also, to grab the rural market, the company plans to introduce budget-level plumbing solutions which are fit for single
storied building. One concern while investing on this counter could be the sharp runup in stock prices, which has more
than doubled over the last one year. Barring that worry, this stock is still available at about 12 times earnings. The
company also has a strong track record of paying dividends, an indication of a stable financial position. All of which
makes it an ideal buying option for the medium and long terms.

The Way To Go

Our research indicates that these five companies are inherently strong. That, coupled with the fact that they are still
available at reasonable valuations means that their prices may not appreciate substantially tomorrow, or in the short term.
To grow the invested capital, the investor will have to take a long-term view on these companies. There is also the
possibility that these stocks, too, would correct in the event of a wider market fall. Therefore, investors should enter these
companies with an investment horizon of at least three years. For, in the short term, there is no saying what will happen.

How We Did It
Finding undervalued stocks, especially when too much money is chasing too few stocks, is probably more difficult today
than ever. Our search began with first putting a lower limit of `500 crore market cap for the companies we looked at, as
we did not want to end up with small names, too small to trade and track. We than looked at five-year financial
performances for consistency, as in the past five years, companies have been subject to all the conditions of a business

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cycle.
Simultaneously, we also kept an eye on the valuation of the stock and compared it to the company’s performance, to
avoid even good companies at bad prices. After a looking at softer issues like management, a final list was arrived at.
However, we are still excluding some names from this list as they have recently been figured as our picks of the fortnight.

kumargautam AT outlookindia.com, rajeshkumar AT outlookindia.com

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