These quality mid-cap stocks are available at reasonable valuations
13-Mar-2020 •Rajan Gulati
Coronavirus has already taken a toll on the global markets, with the Sensex having corrected by more than 15 per cent within a few days. Although it is too early to say how long this pain will last and what long-term impacts of this pandemic will have on the global markets, we, long-term investors, can only look for good companies and try to buy them when they are available at reasonable valuations.
Amid this panic-selling on the street, we zeroed in on quality mid-cap stocks that are now trading at reasonable valuations. We followed some basic criteria to pick good stocks. These companies should be fundamentally strong and therefore, their ROE should be more than 15 per cent in each of the last five years. At the same time, these companies should be resilient to an economic downturn and here comes the strength of their balance sheet. They should have a debt to equity of less than one. Finally, the stock price needs to justify the value we get from it. In our valuation filter, the price-to-earnings ratio should be less than its five-year median. Finally, we arrived at these two stocks:
This Mumbai-based company provides a gamut of IT, BPO and consultancy services, comprising application development and maintenance (~40 per cent of Dec'19 quarter revenue), quality assurance and testing services (~15.6 per cent), infrastructure management (15.8 per cent), analytics (10.6 per cent) and others. Its customer base spans across geographies, with the Americas (primarily the USA) contributing ~75 per cent to Dec'19 quarter revenue, followed by Europe (~17 per cent) and Asia Pacific (8.1 per cent). It primarily caters to sectors like banking and financial services (BFS), manufacturing, insurance, healthcare and travel and transportation.
A reduction in client concentration at the top driven by higher low-ticket-size deals and a lower attrition rate was a key positive for the company in 2019. Nevertheless, talent acquisition issues amid visa restriction in the USA, an on-site revenue decline owing to a reduction in a key BFS account and uncertainty over the impact of coronavirus remain some key challenges.
In June 2019, Hexaware acquired digital consultancy company, Mobiquity, for $182 million. This move was in line with its strategy to provide cloud and customer experience-related services. In terms of financials, its revenue over the last three years until Dec'2019 increased by 16 per cent, while its profits increased by around 15 per cent. The company remains debt-free and has given a ROE of around 20 per cent in the last three years. The stock currently trades at a PE of 15 as compared to its five-year median PE of 18.
Headquartered in Pune, it is involved in metal forging through its ten manufacturing facilities spread across India, Germany, Sweden, France and the USA. While the company primarily caters to the automobile sector, it has also created a significant presence in the industrial sector, including defence and aerospace, power, oil & gas, construction & mining, railways and others. Its main products include steel forgings for industrial customers and crankshafts and axles for commercial and passenger vehicles.
In terms of the geographical distribution of its revenue, the company derives significant revenue from the USA (~42 per cent on a standalone basis), followed by India (~41 per cent) and Europe (~15 per cent). It also operates through 22 subsidiaries and associates, which account for around 35 per cent of the total revenue.
The company has been facing various headwinds in all its business segments. A slowdown in the domestic economy, along with the transition from BS-IV to BS-VI compliance, has affected the domestic commercial and passenger vehicles segments. Also, the falling oil price is likely to affect the shale oil industry in the USA, thereby affecting the industrial segment.
Looking ahead, the company has ventured into three new business segments: light-weighting of vehicles through the use of aluminium instead of steel, e-mobility (took a strategic stake in two electric vehicle startups for gaining e-powertrain expertise: Tork Motors and Tevva Motors) and transmission.
The company performed poorly in the most recent quarter, with the standalone revenue falling by around 36 per cent in Q3FY20 YoY, owing to a sluggish domestic economy. However, in the last three years, the standalone revenues grew by around 11 per cent, while the profit grew by around 16 per cent. Operating at the utilisation of around 50 per cent, the management doesn't expect much capex, going forward, while it is focussing on cost control. The company's balance sheet remains strong, with around Rs 1900 crore as cash and a debt-to-equity ratio of around 0.32 as of Q2FY20. The stock currently trades at PE of 23 as compared to its five-year median PE of 32.1.
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.