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Finding quality in the worst of times

Here are two quality stocks in the mid-cap space

Finding quality in the worst of times

Economies across the world have come to a standstill, probably for the first time in history. With country after country announcing the COVID-19-led lockdown, economies are under stress, with the Indian economy being no exception. As predicted by global rating agencies, India is likely to witness one of the slowest GDP growth in decades in FY21. Certainly, the stock markets have reacted, with the S&P BSE midcap index having corrected by more than 25 per cent from the top over the last three months. Against this backdrop, staying with quality stocks seems to be the right mantra for investors.

While screening the mid-cap listed space for quality stocks, we have picked up companies that have delivered value to shareholders and have given three years' ROE of more than 15 per cent, on average. Besides running their operations efficiently, these companies have also grown their earnings per share by more than 20 per cent, year-on-year, over the last three years, without incurring losses in any year. Despite this, the markets have heavily punished these stocks. They have corrected by more than 30 per cent in the last one year.

Endurance Technologies
Even though the ongoing lockdown led by the Covid 19 pandemic will have a severe medium-term impact on the auto sector, maintaining social distancing and using individual vehicles out of the apprehension of sharing space are likely to become a norm in the coming time, which will result in an increase in auto sales. And it will augur well for this auto ancillary company. Endurance Technologies is involved in manufacturing aluminium dry casting (the largest player in India), suspension, transmission and braking system parts for 2W, 3W and 4W OEMs (original equipment manufacturer). Anurag Jain, promoter of the company, is related to Bajaj Family. This relationship has helped, as Bajaj is one of the closest customers (along with Royal Enfield) of the company.

Having a presence in India (72 per cent of its FY19 revenue) and Europe (28 per cent), the company was able to grow its revenue by seven per cent over the last three years till December 2019, while its net profit grew by 23 per cent on the back of falling input costs and tight fixed cost control during the same period. The company has a reasonably strong balance sheet with net debt (total debt minus cash) to equity of 0.03 as of December 2019 and doesn't foresee capex in the near term. Also, working capital as per cent of sales has hovered around, which is a sign of efficient operations. Further, the threat of EVs (electric vehicles) is not much for Endurance Technologies in the longer run, as only its clutch business (eight per cent of its India revenue) will be affected. Over the last one year, the stock has halved and currently trades at a PE of 13.5 compared to the three-year median of 37.0.

LTTS
Indian IT companies, especially the smaller ones, will definitely be hard hit because of the economic slowdown. But when things do bounce back, LTTS - a mid-tier IT firm in the niche engineering research and development domain - will surely be the one to emerge as a winner. The company has moved swiftly to counter the business impact of the lockdown led by Covid-19 by allowing 90 per cent of its employees to work from home. Although it is too early to predict changes that the lockdown will bring in the business environment, the transportation and plant engineering segments are likely to be negatively affected. However, offsetting the impact will be the company's medical business, which has displayed promising growth over a period of time.

Having 51 of the top 100 global R&D spenders as its clients, the company boasts a strong balance sheet. As of December 2019, LTTS had net cash (after short-term borrowings) of Rs 208 crore. In the nine months till Dec'2019, the company generated free cash (cash left with the company after capex) of Rs 423 crore. During the last three years till Dec'19, it grew its revenue by 19 per cent YoY, while net profit grew by 22 per cent. Margins improved on the back of more work getting done offsite. It has delivered an ROE of more than 30 per cent consistently.

In the near term, the company is likely to witness slow-paced revenue growth, owing to clients delaying discretionary expenses and visa restrictions in the US because of rising domestic unemployment. Further, the working capital cycle (~54 days as of FY19) could get stretched as some of the clients may delay their payment obligations. However, in the long run, LTTS can strengthen its relationships with its clients. Also, clients can offshore even more R&D services to cut down on costs.

Over the last one year, the stock has corrected by more than 30 per cent and currently trades at a PE of 15 as compared to its three-year median of 23.

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.