Presenting three blue-chip stocks that are trading at a discount in terms of their earnings
04-Jun-2019 •Jugal Harpalani
Blue-chip stocks refer to the stocks of large companies having renowned brand names and high investor awareness. Most of these companies are well established and fundamentally sound, with decade-long presence in the market. Quite understandably, these stocks usually command a valuation premium.
We, however, have identified a few attractive blue-chip stocks that are trading at a slight discount in terms of earnings.
Market cap above Rs 7,000 crore
Five-year earnings CAGR greater than 15 per cent
PEG ratio (price earnings ratio/five-year CAGR in earnings) less than 1.5
Interest coverage ratio greater than two times
Debt/equity between zero to two
Five-year median return on equity greater than 20 per cent
Five-year ROE maintained consistency - sustained without losing more than 20 per cent in any year
Eicher's Royal Enfield bikes is India's answer to the iconic American made Harley Davidson. Royal Enfield was at one point, on the verge of being sold or closed by the management because of its dismal performance in 2000. Fast forward to the present time, it is the largest two-wheeler manufacturer in India in the 250 cc and above segment, with more than eight lakh motorcycles sold in 2019. It has a presence in more than 50 countries. The company also runs the commercial vehicle business through a JV with Sweden's AB Volvo.
The last financial year did not fare well for the company, with the ongoing slowdown in the auto sector being one of the main reasons. More importantly, the massive floods in Kerala - which happens to be its biggest market - sent a serious blow to its sales. Adding to the woes were the new safety regulations and increased costs of the third-party insurance, which the company had to pass on to its customers. Making matters worse was the labour strike at its Chennai plant. All these events resulted in flat volumes for its motor division for the year and a lower-than-industry growth of 11 per cent for its commercial vehicle division.
As a silver lining, the launch of its new bikes after years of development, establishment of a new manufacturing facility in Thailand and its foray into new markets, such as South Korea, are expected to provide a strong impetus to the company in the coming time. The stock is currently trading at 24 times, which is slightly higher than peers but is significantly lower than its five-year median of 42 times.
This 20-year-old information technology arm of the Larsen & Toubro group is the sixth largest Indian IT services company in terms of export revenues. Having expertise in providing technology consulting and digital solutions, it now has 66 Fortune 500 companies in clientele.
Like many other IT majors, the company's revenue is concentrated in North America, which contributed 66 per cent to its total revenue. This grew 15 per cent year-on-year in constant currency terms in Q4FY19. In addition, its growing clientele contributed positively to its growth, with the number of active clients standing at 343 at the end of FY19 as against 300 at the end of FY18. Another positive fact was its reduced dependence on the top five clients for revenue, from 35.2 per cent in Q4 FY18 to 32.2 per cent in Q4 FY19.
In terms of its financials, the company's operating margins have been consistently increasing over the last four quarters after facing a dip in March 2018. Revenue grew at an impressive 29 per cent in FY19. When it comes to vertical-wise growth, year-on-year growth was led by the media and entertainment and insurance segments, which grew at 33 and 11.5 per cent, respectively. On the other hand, when it comes to service-wise growth, enterprise solutions and analytics and enterprise solutions were the main growth drivers, registering a y-o-y growth of 24, 14 and 42 per cent, respectively, in Q4FY19.
Nevertheless, a majority of its revenue is generated from the banking and financial services, insurance and manufacturing spaces, which went through a slowdown in terms of earnings in FY17. And again in today's time, the possibility of such a slowdown is looming large, as the economy is facing several macro headwinds. Besides, the company is always prone to tighter regulatory norms, such as the recent change in H-1B norms in the US, which led to more visa denials for Indian IT majors. The stock is currently trading in line with its peers at 20 times but slightly below its median of 22 times.
Bharat Petroleum Corporation
With an approximate brand value of $675 million*, this public sector enterprise (53.29% government stake) has interests in the fields of refining oil and marketing petroleum products. It is also involved in the exploration and production of hydrocarbons. It is the third largest refining company in India, with a total capacity of 36.5 million metric tonnes per annum (as per June 2018 investor presentation)
In terms of its financials, the average gross refining margins came in at $4.85 per barrel in FY19 as against $6.05 per barrel in FY18. Since FY16, its debt levels have consistently increased from Rs 23,387 crore to Rs 42,913 crore in FY19, while its debt to equity is currently standing at 1.1 times. Operating margin for the year came in at 4.43 per cent as against 5.43 per cent in FY18.
When it comes to the industry landscape, Brent crude prices have fallen almost 20 per cent from their 2018 peak in April. This, coupled with the end of the election season, has decreased a lot of uncertainty. But high volatility in crude prices cannot be ruled out, owing to macro uncertainty in the US and higher production in OPEC, which may fill in the supply deficit in Iran and Venezuela.
The stock is currently trading at 11 times, which is in line with its PSU peers who usually trade at a discount as they are public sector enterprise. Also, it is currently trading at its five-year median.
Disclosure: The intent of the article is not to recommend any specific stocks. If you wish to invest in any of the above-mentioned securities, please do thorough research.