Here are some fundamentally sound stocks trading lower than their five-year median PE
23-Aug-2019 •Rajan Gulati
The father of value investing, Ben Graham, once mentioned, "In the short term, the market is like a voting machine, but in the long term it is a weighing machine." It means that in the long run, a company's business performance ultimately matters, instead of paying heed to the public's fickle opinion about its prospects in the short run. In the present context, when investor sentiments are turning sour for the Indian stock market every day, his words seem to be befitting.
But as mentioned by Ben Graham, in the long run, it's the underlying business performance that will make investors their return. Given this, we have looked at mid-cap companies whose price to earnings are currently lower than their five-year median PE (more than 20 per cent lower), depicting negative sentiments but their last five-year average return on equity (ROE) is more than 15 per cent, reflecting strong fundamental performance. Also, with the intent to remove companies having a weak balance sheet, we have filtered companies with low debt to equity (less than one). Finally, to account for recent growth, we have taken companies having delivered more than 10 per cent sales and earnings growth in the last one year. Here are our findings:
Founded in 1907, it is involved in branded formulations, international generics and APIs. In 2011, the company was demerged from Alembic Ltd. to concentrate on the formulations business and reduce its dependence on the commoditised Active Pharmaceutical Ingredient (API) business. Its formulations business (including the US generics) accounted for 80 per cent of its FY19 revenues, with the domestic: export ratio pegged at 44:56, while the rest from the API business.
Export formulations, on the other hand, contributed ~45 per cent to the total revenue in FY19, wherein ~70 per cent was contributed by the US generics. In this category, the company is mainly present in oral solids and derma and is all set to enter into oncology injectables and oral solid dosage on the back of its two new facilities in Gujarat. On the domestic front, the company's domestic branded portfolio is gradually shifting to the speciality business segment, which accounted for ~63 per cent of domestic branded formulations in FY19 as against 54 per cent in FY14 and made up for 91 per cent of the new launches in the last five years.
Over the years, its R&D spend increased to 12.7 per cent of the total revenue in FY19 from 6.3 per cent in FY15. This translated into a cumulative ANDA filing at 161 at the end of FY19, of which 77 have already received approvals.
The company is undertaking both organic and inorganic growth strategies. It acquired US-based Orit Labs to expand its oral liquids and oral solids footprint in the US. Its capex plan of Rs 1,100 crore for manufacturing facilities for oral dosage is expected to add to its revenue in 2019. Recently, the company has entered into a joint venture with two Chinese pharma companies to sell its portfolio of oral solids in the Chinese market.
The Indian government's National Health Protection Scheme and growing expenditure on healthcare are some significant tailwinds for the company. Nevertheless, it needs to navigate through headwinds like increasing price pressure in the global market, growing competition and customer consolidation.
In the last three years, its earnings per share decreased by 6.7 per cent year-on-year, but the company had a consistent ROE of more than 20 per cent. Its debt to equity rose to ~0.4x in March 2019 from ~0.05x in March 2017. However, it is expected to narrow down on the back of the company's expansion plans. Its stock currently trades at a PE of 15.3x as compared to a five-year median PE of 25x.
Bharat Electronics Established in 1954 by the Government of India, the company has evolved from being a specialised electronics manufacturer for Indian defence services to a multi-product and multi-technology manufacturer, catering to diverse customers. The company's core capability lies in manufacturing radar & weapons systems, defence communication & electronic warfare. As of FY18, the defence segment remained the mainstay for the company, contributing 85 per cent to its total revenue.
In the last three years till FY18, the company maintained its R&D spend at around nine per cent of its total revenue (9.8 per cent as of FY18), leading to an increase in patents filed to 25 in FY18 as compared to 20 filed in FY17. Also, around 89 per cent of the revenue as of FY18 came from indigenous products, while the rest came from technology transfers from original equipment manufacturers, showing an increase in the company's in-house technological capability.
As per IHS Jane's, the global military spending stood at US$ 1.67 Tn in 2018 as compared to US$ 1.57 Tn 2017 and this number is expected to increase on the back of growing inward-looking politics around the world, anti-globalisation sentiments and rising geopolitical tensions. India is one of the biggest importers of defence equipment and to reduce its import dependence, the government is now pushing for partnership between Indian private and public companies and global players. This is both a threat and an opportunity for the company. Although an increase in the participation of private players will intensify competition, the company is well-positioned to benefit from the rising expenditure, supported by a strong execution track record, relationships with defence agencies and in-house R&D capabilities.
As of March 2019, the company's order book stood Rs 51,798 crore (More than four times FY19 revenue), which was an increase of 30 per cent year-on-year. During the year, the company successfully delivered electronic voting machines and VVPAT, along with other supplies. Going forward, it expects to receive orders related to Akash missile, coastal surveillance system and the Samyukta upgrade. In the last three years till March 2019, the company grew its sales by 17.2 per cent, while its earnings per share grew by 15.1 per cent, impacted by a decrease in other income and higher tax outgo. The company remains debt-free and currently trades at a PE of 12.5x as compared to a five-year median of 21.9x.
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.