Three mid-cap stocks trading at a discount to the median PE

For most investors, the price-earnings ratio acts as a go-to-valuation metric to decide whether a stock is overvalued or undervalued. This ratio is calculated by dividing the stock price with the earnings per share of the company. Generally, investors tend to compare the PE ratio of a company with that of a peer company or the market. Nevertheless, at times, certain unique characteristics of a company make such comparison misleading. Some of these characteristics include an exclusive brand value of the company, its market leadership, certain corporate governance measures and earnings visibility because of which, the market gives it a higher valuation.

We looked up mid-cap stocks trading at less than their five-year median PE. We restricted our search to stocks with return on equity above 15 per cent in each of the last five years and their return did not dip in FY19. Also, we weeded out stocks with a debt-to-equity ratio of more than one. Finally, we have zeroed in on three companies that reported the highest compounded earnings growth in the last five years.

L&T Technology Services
Incorporated after the restructuring of its parent company, Larsen & Toubro, it received the integrated engineering services business of L&T and the product engineering services business of L&T infotech. Today, its clientele boasts 69 of the Fortune 500 and 51 of top engineering R&D companies, who are mainly involved in manufacturing various industrial products, medical devices, transportation, telecom and hi-tech products.

Out of its five verticals where it has marked its presence, 55 per cent of its revenue came from the transportation and telecom verticals. Geographically, 62 per cent of its revenue came from the US and neighbouring countries.

In the past year, the company secured some major deals, including a three- year contract to provide engineering services to a global technology conglomerate based in the US and a strategic partnership with a European automotive manufacturer for building its electronic powertrain. Contribution from top five clients reduced from 26 per cent last year to 22 per cent in Q2FY20.

A key challenge faced by the company is immigration laws in the US. With 44 per cent of its services onsite as of FY19, the tough stance by the US on immigrant workers can prove to be worrisome. Besides, foreign exchange fluctuations are another concern as most of its business comes from abroad. This has been highlighted as a key concern in the audit report.

Coming to financials, the company's earnings and sales have increased at an annualised 10 per cent and 18 per cent, respectively in the last three years. The cash-equivalent on the books stands at Rs 780 crore. The company trades at 19 times earnings, below its three-year median of 23 times.

Alembic Pharmaceuticals
The flagship company of the 103-year-old Alembic Group, Alembic Pharmaceuticals houses six formulations and three API (active pharmaceutical ingredient) manufacturing facilities. Around half of the company's revenue is derived from the generics and its branded portfolio contributes another 35 per cent, with APIs contributing the remaining. Generics are drugs that are not protected by patents and hence, are available at lower prices with lower profit margins.

It is one of the many Indian pharmaceutical companies that derive most of its business from the US generics market (currently contributing around 40 per cent to the total revenue). The business from this segment grew at a healthy 35 per cent year-on-year in the first half of FY20. However, outside the US market, the company achieved no growth, including in the Indian market where it sells branded pharmaceuticals (protected by patents, unlike generics).

The company has investments in new projects, which are not yet operational, to the tune of Rs 1500 crore. Its expansion plans have resulted in a capex spend of over 1,700 crore since FY17 and it plans to spend a further 500 crore as per the latest guidance. Over the years, its R&D spend has increased from six per cent of its sales in FY15 to 14 per cent. The company launched 10 products in the first half of this fiscal and plans to launch another 10 by the end of the year.

Debt stands at 1, 432 crore, translating into a debt-equity ratio of 0.48 times. Debt has doubled from the FY18 levels. Sales and earnings have increased at a five-year compounded rate of 16 and 20 per cent, respectively. The company trades at a PE of 16 times, down from its five-year median of 24 times.

Endurance Technologies
This auto component manufacturer commenced its operations in 1986 by manufacturing aluminium castings, which account for more than 50 per cent of the aluminium used in cars. Starting with just two aluminium casting machines, today it operates 26 plants across India, Italy and Germany, along with four R&D sites. It claims to be the largest aluminium die castings manufacturer in the country. It is also involved in manufacturing other products, such as aluminium alloy wheels for motorcycles, shock absorbers for scooters and transmission products for motorcycles, to name a few. In Europe, its focus is mainly on four-wheeler component manufacturers and around 30 per cent of their total revenue is derived from there.

Around 75 per cent of the company's business is derived from its top six clients, namely Bajaj Auto, Fiat Chrysler, HMSI, Volkswagen Group (Porsche and Audi), Royal Enfield and Daimler. Even with a concentrated client base, the company enjoys a certain stickiness with such OEM clients. Some of its other high-profile clients include Kia Motors, Hero MotoCorp and TVS. The company shelved its plan to venture into tyre manufacturing on reservations from various stakeholders. In addition, it is expanding into the electric vehicle space by manufacturing aluminium forgings. It has also strengthened its partnership with KTM to increase its presence in the space of e-motorcycles as well as scooters. However, the auto industry is facing a major slowdown and has impacted Endurance's sales. This, however, has not deterred the company from organic and inorganic expansion plan, as it recently acquired an Italian aluminium die-casting firm, thereby adding 6500 metric tonnes per annum to its total capacity.

Sales and earnings have grown at a five-year compounded rate of 12 and 19 per cent, respectively. The company trades at a PE of 30 times - down from its median PE of 37 times.
Data as on 7/11/2019

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.