These two companies are now trading at attractive valuations
22-Nov-2019 •Jugal Harpalani
In a recently published article, Two attractive blue-chip stocks in the large-cap space, we listed two large cap stocks that qualified under our criteria of blue-chip stocks trading at attractive valuations. Here two mid-cap stocks qualified as per the same criteria applied for large cap stocks.
A blue-chip stock is supposed to have a high ROE and should be able to sustain it. Hence, we filtered out companies having a five-year median ROE less than 20 per cent. In addition, the ROE should not have fallen more than 20 per cent during this five-year period. Next, we considered earnings for which, our threshold was a minimum of 15 per cent - five-year compounded growth rate. Once we found these companies, we checked for sound earnings and financial health. Therefore, we considered the interest-coverage ratio of more than two times and the debt/equity ratio under one. Finally, came the attractiveness of a stock or the valuation, for which we used the price earnings/growth ratio (PE/five-year earnings CAGR), which was set at a maximum of one time. The result was two companies: Sundaram Fasteners and Aurobindo Pharma.
Founded in 1964, Sundram Fasteners is a part of the TVS group, and is engaged in manufacturing fasteners (nuts, bolts, screws), oil pumps, water pumps, radiator caps and other components used in gears, primarily for automotive and industrial use. While the company began by producing just 450 tonnes of fasteners in 1964, today the volume has swelled to 80,000 tonnes. A majority of the company's revenue comes from the automotive segment, with fasteners accounting for a significant part of it, although the company's dependence on fasteners has reduced as a result of diversification efforts.
Despite requiring capital expenditure on a regular basis, Sundram Fasteners has rewarded its shareholders with consistent and increasing dividends, with an average dividend pay out ratio of around 30 per cent in the last 10 years. Over the years, it has also diversified its operations in multiple products and countries, including China and the United Kingdom. The company's third unit in Mahindra City, a SEZ, has commenced operations. In FY19, exports contributed more than 34 per cent to total revenues. In the last five years, the company has witnessed a rise in its margins from around 12 per cent in FY15 to 18 per cent in FY19. on the back of its focus on cost control and a favourable product mix.
However, 30 per cent of its portfolio will be impacted if there is a sudden shift towards electric vehicles, which is a potential risk for the company. However, the company feels confident about the auto sector turning around from its current slowdown and has hence carried on with its expansion plans. They spent Rs 442 crore in FY19 and plan to spend another Rs 350 crore in FY20 towards capital expenditure.
Over the years, Sundram has been a consistent dividend-paying company, with the return-on-equity standing at more than 25 per cent in FY19. It has also compounded investors' wealth at a rate of more than 25 per cent over the last five years. Currently, it trades at a price-to-earnings of 26 which is at its five-year median PE.
Aurobindo Pharma is the second largest Indian generic pharma firm by prescription in the US with an 8.06 per cent market share post its acquisition of the generics business of Sandoz pharmaceuticals (although this deal has not been given clearance yet by the US Fair trade commision).It is also the tenth largest generic company by sales in the world. Aurobindo Pharma commenced operations in 1998-99 with one facility in Pondicherry manufacturing semisynthetic penicillin. It now specialises in complex injectables and medicines for diabetes, AIDS, nervous system disorders and dermatological conditions. It operates 11 units for APIs (active pharma ingredients; intermediaries in drug manufacturing), and 15 units for formulations, of which ten units are in India.
Around 46 per cent of its business comes from the US generics market, with another 25 per cent from Europe. Hence, the company is under constant risk of any concerns raised by the US Food and Drug Administration (USFDA) - known as one of the strictest of regulating bodies of food and drug substances. Just last week, one of their units of the company came under the USFDA radar and was issued a warning letter with 14 observations. The stock hit its 52 week low following this news. In addition, the company was also named in a price manipulation lawsuit in the US earlier this year. Such risks continuously pose a threat to the company's future. Aurobindo Pharma is one of the largest spenders of R&D carried out in India. Further, the company is constantly looking to expand using inorganic expansion strategies, such as the acquisition of a portfolio of seven marketed oncology injectable products from Spectrum Pharmaceuticals earlier this year in January. They claim this acquisition brings in an experienced branded commercial infrastructure from the US and is expected to generate a revenue of around $100 million for the first 12 months post completion of the transaction.
Coming to the financials, the company's sales and earnings have compounded at a 5 year growth rate of 19 and 15 per cent respectively. Its debt stands at 0.5 times of equity (March 19). The stock is currently trading at a PE of 10 times which is at the lowest in 5 years and nearly half of its 5 year median of 19 times.
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.