Earn more than the Sensex

Size doesn’t matter. While blue-chip companies have performed dismally, small- and mid-caps are showing how profitable they are.

R. Sree Ram        Print Edition: October 2009

After a dismal year, the Sensex looks like it’s back in business. The benchmark index has risen 96% in the past six months. However, some market watchers are concerned about stretched valuations. Analysts estimate a low earnings growth for the 30 blue-chip companies that constitute the Sensex. Global research house UBS predicts a 4.5% growth in consolidated earnings per share (EPS) of these firms, while Prabhudas Lilladher feels the growth will be 8.1%. The numbers are expected to pick up only from 2010-11. Although the bulls believe that the Sensex will cross 20,000 by June 2010, this cannot happen unless the 30 companies have higher growth rates. So, what should investors do, with the opportunity cost of investments not earning returns for a year?

The answer lies in the less flamboyant indices. The BSE Smallcap and Midcap indices have outperformed the Sensex by a wide margin because of the robust earnings by smaller firms. Looking for companies that can grow faster than the benchmark is profitable. We consider eight stocks that are expected to grow at over 18% and are cheaper than the broader market.

Bajaj Auto
India’s second largest two-wheeler manufacturer has seen a remarkable pick-up in volumes over the past few months. Total volumes grew by 6% in August 2009, while motorcycle sales have gone up by 53% over December 2008. The company has also benefited from low prices of raw materials. According to estimates, raw material cost as a percentage of sales dropped to 66.2% in the April-June quarter this year from 75.7% a year ago. This improved the operating profit margins by 7.5% as they rose to 19.5%. “We have revised our earnings estimate for 2009-10 to Rs 82.1 (from Rs 75.8) and for 2010-11 to Rs 91.1 (from Rs 81.3) owing to the better-than-expected operating performance,” says Vaishali Jajoo, analyst at Angel Broking. Based on revised estimates, the stock is trading at 13 times the 2009-10 and 12 times the 2010-11 EPS estimates, and offers a good opportunity.

Hindustan Dorr Oliver
This is a small-cap engineering procurement and construction services provider. The company has registered a 53% average annual growth in the past three years. Although the stock has run up substantially since March this year, strong earnings expectations and relatively low valuations continue to attract investors. The company’s order backlog of Rs 1,460 crore (in early August) provides a good earnings visibility. Analysts expect revenues of around Rs 750 crore in 2009-10. With more than 50% of the orders from government or public sector, they expect very few cancellations or delays in execution. The stock is a good bet considering the improving business environment and its high growth rates. The company reported an EPS of Rs 7.80 in 2008-9, expects to increase this to Rs 13.70 in this financial year and to Rs 18.50 in 2010-11—an average growth of 55% over the next two years.

Jyothy Labs
With its core brands—fabric whitener, Ujala, mosquito repellent, Maxo, and dishwasher, Exo—registering better growth than their peers, Jyothy Laboratories is looking at becoming the market leader in its businesses. With its homecare business returning to profitability, the company reported robust earnings in the last financial year, with profits rising 195% in 2008-9. Analysts expect that the company will report better return ratios in the next couple of years.

According to estimates, the company will close this financial year with Rs 120 crore cash in its books, 20% higher than the current levels. Analysts expect the company to report an average annual growth of 30% in sales and around 24% in profits over the next two years. With comfortable and sustained high growth rates, they expect Jyothy Labs to reduce valuation gaps in the FMCG space. At a PE of 13 times, it is the cheapest stock in the FMCG sector. Companies like Colgate-Palmolive, HUL and Nestle are trading at PE multiples of more than 20.

Dishman Pharma
Although its first quarter results were below analysts’ expectations, Dishman Pharma’s profits are expected to grow at an average rate of 26% over the next two years. The contract research and manufacturing services (CRAMS) player is expected to get a revenue boost when its Chinese facility becomes operational later this year. According to Manoj Garg and Akshat Vyas, analysts at Emkay, the company is targeting a business of Rs 80-100 crore this year. It expects the generics business to bring in $10 million in 2009-10 and $20 million in 2010-11. Over the past two years, Dishman has grown in scale as well as diversified its customer and revenue bases. At the current market price, the stock trades at 10 times the 2009-10 EPS. “The generation of business from the China facility and the oncology unit in 2010-11 are some of the growth drivers,” says Tushar Manudhane, analyst at Prabhudas Lilladher.

Opto Circuits
A formidable player in the niche medical devices market, it manufactures and exports pulse sensors, cholesterol monitors and stents used in cardiac surgeries. Its strong brand equity and proven track record have helped its average annual profits grow by 70% in the past three years. The non-invasive devices market is estimated to grow to $5.7 billion by 2011, and 40% of this market is accounted for by patient monitors. Opto Circuits, with 30 types of products, has a strong presence in this space. This apart, governments across the world are increasing healthcare coverage and are looking for cost-effective alternatives. This is expected to push up the demand for medical devices. “We expect the company to post revenues of Rs 1,100 crore in 2009-10 and Rs 1,400 crore in 2010-11,” say Sandeep Shenoy and Amol Rao, analysts, Antique Stock Broking.

United Phosphorus
United Phosphorus is a global agrichemicals company. The company’s revenues have grown at an average annual growth rate of 37% in 2005-9. With a number of agrochemical products going off patent in the next couple of years, generics companies like United Phosphorus are expected to gain significantly.

Also, improving productivity in the agriculture sector is expected to result in robust revenues for the company. According to a Sharekhan research report, the company is planning to shift its high-cost manufacturing facilities in Australia and Argentina to India. This is expected to help its profits grow at an annual rate of 28% in 2009-11. The stock trades at a huge discount to its one-year forward average EV/EBITDA multiple of 9.4 times, leaving scope for substantial upside, says the report. Low-cost manufacturing and a strong generics pipeline make it a good investment.

Bayer CropScience
Bayer CropScience is the leader in the Indian agrichemical business, with a market share of around 23%. Apart from a steady domestic business, which saw an average revenue growth of 15% per year in 2005-8, it earns a substantial chunk of sales from exports. In 2005-8, its exports rose by 20.5% per year. Around 80% of the export revenues are generated from its parent group companies. “Bayer AG has a revenue base of Euro 33 billion, of which 17% is from crop protection. If Bayer AG were to outsource 10% of its requirements from its various global subsidiaries, Bayer CropScience would benefit immensely,” says Sageraj Bariya, research analyst, Angel Broking.

Another advantage is the company’s ability to tap its parent’s R&D. This helps it launch three to five products every year. Although the current drought is expected to dent its topline, its continued thrust on exports and ability to introduce new products is expected to help it increase revenues. “We expect the company’s net profit to register a 24.2% CAGR and rise to Rs 145.6 crore in 2010-11 from Rs 94.5 crore in 2008-9,” says Bariya.

Lupin
Over the years, Lupin has successfully transformed itself from a maker of intermediaries to a formulations manufacturer. In the last financial year, the formulations business accounted for 81% of total sales, from 56% in 2005-6. The company has recorded a robust revenue growth of over 30% in the past three financial years. It generates around 35% of total revenue from the domestic market and the rest from exports, and is the only company among its peers to have a significant presence in Japan. Its business in the US grew five times in 2006-9; analysts expect the US business to grow by over 22% per year to Rs 1,768 crore in 2009-11. With the company consistently delivering robust performance in the past 13 quarters, analysts expect its stock to be re-rated in the next one year.

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