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Bargain basement prices

This month we bring you stocks that have been inexpensively priced by the market, but whose fundamentals are sound

In any market situation, some stocks will always be inexpensive on certain yardsticks - price-to-earnings ratio, price-to-book value ratio, etc - compared to the broad market. These stocks make a good buy even when the market at large has been rising relentlessly, provided their fundamentals and their prospects are sound. Such stocks also tend to fall less when the market witnesses a correction. Their high earnings yields also make these stocks interesting buys.

When you evaluate these stocks closely, you will find that near-term sentiments about them are usually negative. In many cases, these near-term issues might not be too relevant in the long run. If you have a long investment horizon, you might find it worthwhile to invest in these stocks whose intrinsic worth is equal to a rupee but which, for a variety of reasons, the markets have priced at just a few paisa.

Screening criteria
A composite of PE ratio and PB ratio was used as the primary filter to find these bargain stocks. Using the PE-PB multiple allows even those companies to figure in the list where a low PB ratio compensates for a high PE ratio, and vice versa. In addition, another criterion that we have applied is a high free cash flow yield.

In addition, to ensure that these companies have been growing their per share earnings and are financially sound, we have also tested them for continuous growth in EPS, adequate interest-coverage, and not-too-high debt-to-equity ratio.

Increased allocation to infrastructure spending in the budget and rising demand have improved the prospects of a number of sectors - construction, automobile, and consumer durables being the foremost. Our list has four companies that will directly benefit as a consequence of the budget announcements. Besides, a technology company and a shipyard company also figure in our list.

Madras Cement. The fifth-largest in its sector, this flagship company of Ramco Group is one-fourth the size of the market leader, Grasim Cements. The concern for the cement industry as a whole is increasing capacity addition, particularly in South India. With construction activities picking up, demand is expected to be strong. But excess capacity could exert pressure on realisations.

In the third quarter of FY10, the company's operating margin fell from 37 per cent to 20 per cent, while net sales dipped 28 per cent QoQ. Gains are likely to accrue from cement prices bottoming out late in February and from the increased allocation to infrastructure in the budget.

Graphite India. It is the world's fifth-largest electrode manufacturer and commands more than 50 per cent of the electrode market in India. While graphite electrodes account for about 85 per cent of its revenues, now it is also focusing on high-margin, large-diameter, ultra-high power electrodes.

Electrodes are an important input for the steel industry. And with the auto, construction and consumer durables industries witnessing a turnaround, the future of the steel industry, and consequently that of Graphite India, looks better. It was operating at 100 per cent capacity utilisation before October 2008. The figure now stands at close to 70 per cent. At the end of Q3FY10, the company had cash levels equivalent to its outstanding debt. Tight working capital management, cost curbing measures, and better realisations helped it improve its net profits despite no year-on-year rise in quarterly sales.

The company has consistently distributed at least 25 per cent of its profits to investors as dividend.

Unity Infraprojects. It is a Mumbai-based infrastructure company. It is one of India's largest civil contractors. Up almost six times over its 52-week low, this is the most expensive company in the list.

But the stock still trades at a PE multiple of close to 10x and a PB multiple of about 1.6x. Its current order book stands at 3.67 times its FY09 revenue, which is about Rs 4,100 crore.

Monnet Ispat and Energy. Steel and power are its two core businesses. The steel industry's fortunes depend on those of auto, construction and consumer durables. Demand for power is also expected to grow in tandem with economic growth. During the first half of FY10, the power generation business accounted for more than 30 per cent of the company's revenues and more than 50 per cent of its gross profits. Power is also the company's faster-growing business segment.

The infrastructure sector is poised for fast growth in the coming years. At its facility in Raigarh, Chhattisgarh, the company is developing a 1.5 MTPA steel plant that will produce heavy structural plates.

Its expansion plans also include a cement plant that will require an investment of Rs 2,400 crore. This will create value from forward integration as the company's steel making and power generation facilities generate huge amounts of ash and slag that will act as inputs for the cement facility.

Rolta India. Over the past five calendar years, Rolta India has been growing its revenue continuously. It has also increased its per share earnings by more than two-and-a-half times over the same period.

Rolta India is an engineering solutions and technology company having operation across 35 countries. Its strong domestic revenue base (more than 50 per cent of total revenues) and clientele, which are mostly government institutions and large core engineering industries, give it fairly long-term visibility on earnings. Moreover, the nature of services that the company provides requires constant upgradation and maintenance. It recently won an engineering design project for a nuclear reactor system from the Government of India. Rolta has also been eyeing public and private spending in defence, infrastructure, homeland security, power and telecom to boost its order book.

Screening Criteria

  • PE x PB < minimum (PE x PB) of Sensex companies
  • Interest coverage ratio > 2x
  • Debt-equity ratio < 2
  • Continuous EPS growth for past three years (trailing quarter basis)
  • Double-digit free cash flow yield

    P/E  P/B  PE x PB  3 Yr EPS  DE Ratio  FCF  Price
Company Name  Industry  (Times)  (Times)  Factor  CAGR (%)  (Times)  Yield (%)  (Rs)
Bharati Shipyard Shipping 5.53 0.91 5.03 25.81 1.44 31.87 264
Graphite India Welding machinery 5.64 1.26 7.11 31.09 0.35 18.35 88
Rolta India Computer hardware 6.73 1.61 10.84 39.74 0.6 15.81 178
Monnet Ispat & Energy Sponge iron 8.42 1.39 11.7 13.89 1.1 15.24 428
Madras Cements Cement 6.43 1.84 11.83 18.48 1.98 21.54 119
Unity Infraprojects Construction 10.87 1.58 17.17 22.38 1.13 16.11 586
FCF: Free Cash Flow Price related data as on March 23, 2010