The search for value

Barely four days after the P-note scare that triggered a panic Monday shutting down the stock markets for an hour within minutes of the first trade, the Sensex is back again at a new alltime high of 19,243 points.

It’s not the first time the market has recovered so nicely, neither have we seen the last of panic selling bouts. But behind all the mayhem, and a comfortably poised stock market for now, what’s perhaps uncomforting is the rising valuation.

At a PE of 25.49 on current earnings, this valuation is third highest the market has reached—the previous two times the valuation went higher were during the Harshad Mehta bull run and the tech-led rally of 2000.

If you are looking for stocks to invest in now, it’s a good time to look at the undervalued gems with a valuation that is lower than the market and those that are a play on the growth themes in the economy.

The economy is growing from many quarters—particularly infrastructure as investments increase, consumer sector as disposable income rises, and equipment manufacturers that are taking off due to the growth in the corporate sector.

Many of these companies are smaller and have been putting in stellar performances growing at a good clip. Many undervalued companies are in the mid- and small-cap space with PEs below 18 compared to the bellwether Sensex’s of 25 plus. Some of these companies have the potential to emerge big winners in the medium- to long-term.

Infrastructure soars

There’s a lot of action in the infrastructure space—order books of construction and engineering companies have been rising, increasing the earnings visibility of these companies. Total investments in infrastructure during the 11th plan is estimated at Rs 20,18,709 crore in segments such as electricity, roads, telecom, ports, and water supply among others.

These investments will increase the demand for welding products and Ador Welding, India’s largest welding equipment producer, is well-placed to ride the boom. Says Prakash Kapadia, Analyst, Edelweiss Securities, “We like Ador’s business model. The company is debt-free and its strong cash flows are channeled towards new product development.

Ador has consistently maintained a dividend payout of over 45 per cent of its profits resulting in an attractive dividend yield.”

Another undervalued company is Pratibha Industries —a construction company that specialises in water transmission and distribution projects, water treatment plants, housing and road construction. Says Hitesh Agrawal, vice president research, Angel Broking, “A robust order book of Rs 2,000 crore gives it earnings visibility. We estimate PIL’s net sales and net profit to grow at a compounded growth rate of over 45 percent over the next three years.”

Pipe manufacturers are also seeing rapid growth in demand and Jindal Saw, a SAW (Submerged Arc Welded) pipe producer used to transport oil and gas, has diversified from a single product company to a multiproduct company, and is investing Rs 700 crore in new capacities. Says Sandeep Nanda, head of research, Sharekhan, “There’s a growing demand from the oil and gas sector for pipes, not only domestic but also global, which is worth almost $12 billion.”

The consumption wave

As disposable incomes increase, Indians have been spending more at malls, on white goods, housing, apparels and consumer non-durables. This consumption story has been playing out in the rising demand for financial services, including retail loans. Therefore, investors should look at some undervalued stocks in the sector— three of which are Oriental Bank of Commerce, Godrej Consumer Products and Bajaj Electricals.

Oriental Bank of Commerce has a strong branch network in western and northern regions, but the acquisition of the erstwhile Global Trust Bank has given it a major presence in the southern region. It has low cost to income ratio and bad loan recoveries have been good. Its loan book is increasing and going forward the bank is expected to build on its low-cost deposit base, which will help improve net margins.

Bajaj Electricals is another stock to watch out for. Its products home appliances, luminaries, fans, high mast poles have been selling well lately on the back of rising housing sales. The company has a strong distribution network and can capitalise on the opportunities that lie ahead, while its stock is trading cheap at 13.9X its FY07 earnings. Analysts believe it can provide significant returns over the next two to three years.

Consumer non-durables are selling like hot cakes, and Godrej Consumer, a leader in personal hair, household and fabric care segments, has among the best brands in its product portfolio such as Cinthol and Fairglow. It’s also the largest player in the hair colour category, which is growing fast and has better margins. Says Agrawal, “The margins are expected to remain stable due to a better product mix and a price hike.”

Volume growth

On the back of the increasing capital expenditure boom, companies that cater to original equipment manufacturers as engineering and also raw material suppliers are witnessing a broad-based volume growth for their products. Phoenix Lamps, manufacturer of automobile halogen lamps, is among those well-poised for growth. It’s planning to capitalise on its existing relationships with OEMs like Suzuki, Renault and Hyundai.

Says Kapadia of Edelweiss Securities, “Given the rapidly growing CFL industry, capacity additions, and high quality management, we have a positive view on the company.”

Other companies in this space include Philips Carbon Black, which is a leading producer of carbon black used to manufacture tyres. The company is adding power capacities which will reduce its power bills. Says Agrawal, “Net profit will grow on contribution from the power division which will reduce costs and also provide an additional source of revenue.”

While commercial tyre major, Apollo Tyres is planning to spend about Rs 400 crore in expanding capacities this year, including a new green field plant in near Sriperumbudur in Tamil Nadu, to manufacture radial tyres for trucks and buses. The stock is another good addition to your portfolio.

The P-note scare

It came as a bolt from the blue for Dalal Street. As SEBI announced its intention of curbing capital inflows into the Indian bourses through the participatory notes route (it allows foreign investors who are not registered with SEBI as an FII to invest in an indirect way), the markets went into a tailspin.

So what exactly is on SEBI’s agenda that spooked the markets? FIIs now will not be able to issue P-notes against derivatives. What’s more, P-notes with stocks as underlying assets will be subject to a limit of 40 per cent of the overall assets under the custody of an FII.

Given that the current bull run has been FII driven, any move to restrict foreign capital flows has a negative effect in the short-term. Says Shriram Iyer, Head (Research), Edelweiss Securites, “Flow of foreign funds will be impacted as a large part of capital in the last few months was coming through the P-note route.” SEBI says its move is an attempt to encourage foreign investors to enter the Indian stock markets directly by registering themselves as FIIs. This, it feels, would make the markets safer and more transparent.

SEBI’s new guidelines could make markets tentative and volatile in the short term. But analysts point out that given India’s growth story, which remains unchanged, markets are unlikely to be severely affected in the medium to long term.