The Hindu Business Line : In a long bull market

ABAN Loyd Chiles, Balkrishna Industries, Bharat Bijlee, Gammon India, GMM Pfaudler, Manugraph Industries, McDowell, Mercator Lines, Sintex Industries and Vimta Labs: This portfolio would have been a 20-bagger had you picked up these stocks in January 2003, just ahead of the bull market in equities. A portfolio of one share in each company is now worth about Rs 5,000; adjusted for stock-splits and bonuses, the effective cost of this basket of stocks would have been just Rs 250 in January 2003.

Of this high-power set, the ones that packed the maximum punch are Balkrishna Industries and Mercator Lines, which zoomed over 50-fold; GMM Pfaudler, which also made the cut, may appear a laggard with a mere eight-fold price rise.

In the bull market, now 30 months running, Business Line's coverage of this set of stocks was quite inadequate though about 500 stocks were analysed during this period. These big gainers did not for long figure prominently in institutional investor preferences either. Foreign institutional investors and domestic mutual funds now hold about 25 per cent in Sintex, Mercator Lines and Vimta Labs, but only a few made an early entry to lock into manifold gains.

That there are missed opportunities in a bull market too goes without saying, especially when action is happening across a swathe of sectors and stocks.

There are a number of other reasons too. Lack of transparency of operations, low comfort level with the quality of information available, valuation levels that are at a substantial premium to peers, and failure to zero in on the less-than-obvious backward linkages explain why certain mid- and small-cap stocks often do not figure in many an analyst's list. So what are the lessons?

Belated recognition

One, a relatively high premium commanded by a stock compared to its peers with similar attributes often sets an investor against a particular stock.

One stock that was a `buy' at several points over the past couple of years is Gammon India. Construction has been the big story of this bull market; as highlighted last week, this bull market has been a watershed for the sector, as investors bought construction stocks enthusiastically. This re-rating is likely to last awhile.

Larsen & Toubro has, for a variety of reasons, figured on our buy list for several years now — even after the sale of its cement business last year. This was not the case with other stocks from this sector. We had, however, initiated coverage on the sector in detail in December 2003 with `buy' calls on Nagarjuna Construction and IVRCL Infrastructures; Madhucon Projects and Hindustan Construction, too, made the grade at levels that would have ensured manifold gains.

There were no doubts about Gammon's strengths; its order-book, too, was growing at a pace that ensured a high degree of revenue and earnings visibility. That it traded at a substantial premium to Nagarjuna Construction, Hindustan Construction and IVRCL Infrastructures did play a crucial role in deterring a `buy' call.

Gammon is now on the verge of graduating to large-cap status. If you happen to own the stock, retain your exposure, as there is room to be covered on the upside, especially after the decline in prices over the past few weeks.

A story in spirits

Then there is the argument of a company being tainted by the adverse reputation (from an investment perspective, that is) of an industry. McDowell is one industry leader that never made it to our `buy' list. Its domination of the spirits market is well-known. It is only set to get stronger, as a consolidation process is under-way.

Concerns over governance, transparency, regulatory issues and vested political interests at play in the industry at a macro level, apart from such aspects as intra-group transactions, high levels of debt and forays into new lines of business at a group-specific level, weighed over the positives.

These factors prevented coverage of the UB group stocks as well as other plays in the spirits business such as Radico Khaitan, which, too, has been a multi-bagger. It was only when the Vijay Mallya group acquired Shaw Wallace and indicated its intent to consolidate the business under the banner of `United Spirits' that we cut to the large picture and suggested that shareholders retain exposures in the homestretch to the consolidation.

The first stage of this process is under-way and, when it is completed, only the merger of Shaw Wallace will be pending. United Spirits may become a reality next year and is likely to be value accretive. So stay invested McDowell.

There is also the possibility of an upside linked to an easing of the regulatory stranglehold, as the European Union — at the behest of global majors such as Diageo and Pernod Ricard — recently urged New Delhi to liberalise the operating environment for the liquor industry and remove policy distortions among the various States.

Niche plays skipped

Manugraph, GMM Pfaudler and Vimta Labs operate in businesses with no competition of note in the domestic market. The explosion of activity in the print media — English as well as language — should, however, have alerted us about Manugraph Industries. The company makes equipment widely used in the print media and has been a major beneficiary of investments into this sector. It also has a vibrant presence in the export market aided by its tie-up with MAN Roland of the US. This story still seems to be unfolding.

A rebound in the chemicals sector and a scaling up of activity and investments in pharmaceuticals — especially the bulk drug segment — should have drawn us to GMM Pfaudler. This company makes specialised equipment that find widespread application in these two industries. In these cases, there are also no issues of concerns of the kind that has bothered us in McDowell or Aban Loyd Chiles.

GMM Pfaudler is a miss that ought not to have happened, as the stock (then known as Gujarat Machinery Manufacturers) had been covered in the late 1990s. Such is also the case with Bharat Bijlee (a supplier of power equipment) and Balkrishna Industries (a diversified small-cap play with a presence in paper, synthetic textiles, and tyres and tubes).

Vimta Labs falls in a different category. As the only player in contract research and testing for global pharmaceutical majors, this stock gained prominence the past couple of years. The new patent law in India and the rising costs of research and testing in the developed markets opened up opportunities for Vimta Labs.

We did zero in on this stock early in the bull market; we were not, however, comfortable with the breadth and quality of information available then on the company.

This was also the case with Mercator Lines though it operates in shipping, a mature industry where industry-level information should have been adequate to alert us to the opportunity.

Skipping a brand

Sintex Industries is perhaps the most visible of the ten stocks. As a brand, Sintex has acquired near-cult status, the word becoming almost a generic term for storage tanks. Its brand extension, from storage tanks to other products used in homes, has also been successful.

This company has benefited from the boom in the construction sector.

Take on the ten

AS the markets expand in depth and variety in terms of sectors, the missed opportunities could become steps in the learning curve. There will be companies such as Vimta Labs, where the nature of the business will limit availability of information.

Several companies have been beneficiaries of robust growth in a user industry, which has witnessed a revival and/or change in business environment.

Most of them are the only listed plays in the respective space.

In general, we will retain our cautious approach on business groups that have acted in a manner detrimental to shareholders in the past.

Here is our take on what strategy investors could adopt in these stocks:

Manugraph Industries, Bharat Bijlee and GMM Pfaudler appear to be attractively valued even after the substantial upward trend over the past couple of years. Buy them with a one- to two-year perspective, especially on declines linked to the broad market;

Aban Loyd Chiles and Vimta Labs trade at rich valuation levels but earnings growth may lend support.

Mercator Lines may well be headed for a period of consolidations and gains are likely to be moderate over the next couple of years. Take profits partially (on at least 30-40 per cent of your holdings, especially on an upward trend, though it has emerged as one of the two big opportunities in shipping alongside Great Eastern Shipping; eye this stock for re-entry at lower levels or at a later date.

A similar strategy of partial profit booking may be used in Balkrishna Industries, too, to capitalise on the manifold gains as a period of only moderate gains appears likely;

Aban Loyd Chiles and Sintex Industries appear to be growth stories with promise, going by their performance in the first quarter; remain invested in these two stocks;

Shareholders of McDowell and Gammon India could retain their exposures, as indicated in the accompanying story.

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