Automotive: JBM Auto

Green ride but valuation signals red

After a bull run from the March 2020 lows, markets are beginning to look nervous and small-cap stocks may be more vulnerable to a downturn, if any, from hereon. It is hence prudent for investors to book profits in this segment so as to pocket the gains, though prospects for some may still seem bright. One such stock where you can take some money off the table when the going is good is JBM Auto.

From our ‘accumulate’ recommendation at ₹456 in the Portfolio edition dated September 5, 2021, the stock has been a multibagger, touching ₹1,499 at close last Friday. At the time of our recommendation, the stock was trading at 24 times its trailing 12-month earnings. It now trades at a rich 77 times its trailing 12-month earnings. Market volatility in recent times has already seen the stock correct over 10 per cent from its one-year high of ₹1,689.95 recorded on January 25. 

Green theme

Starting out as a sheet metal supplier to the auto industry, JBM Auto has slowly been graduating into a vehicle manufacturer, making electric buses apart from CNG ones. The government has been pushing the use of greener vehicles, especially in public transport, time and again. The latest instance is the announcement in the Budget last week that the government will promote a shift to use of public transport in urban areas, complemented by the use of electric vehicles.

Announcement on the formulation of a battery swapping policy too is a positive for e-buses as this reduces the charging time and improves the turnaround time for these vehicles that ply on fixed routes.

As of FY21, JBM Auto derived 65 per cent of its revenues from the component division (sheet metal), 11.5 per cent from its tooling division and 25 per cent from the bus division. The tooling division is currently the most profitable with segment margins of over 20 per cent, compared with the low to high single-digit margin in the other two. Its clients for auto components include VE Commercial Vehicles, Toyota, Tata Motors, Royal Enfield and Honda.

The bus division turned EBIT positive in FY20. In FY21, EBIT for this division grew three-fold year-on-year to ₹36.1 crore. Revenues for the bus division stood at ₹459 crore in FY21, almost equally divided between CNG and EVs. The company had a strong order book of over 1,000 buses (comprising over 350 electric buses) as of end-FY21 and has continued to win orders this year. For instance, since our recommendation, the company won orders for the supply of 500 CNG/electric buses to Delhi, Bengaluru, Jhansi and other municipal clients in September last year. In November, it again won orders for the supply of 200 e-buses for Delhi.

Stock price up over three times from our call
Rich valuation of 77 times trailing earnings
Small-cap player, more vulnerable to market correction

E-bus requirements of State governments are now being aggregated through the government-run Convergence Energy Services making terms and conditions uniform for manufacturers to adhere to, as well as help State governments realise good prices. In January this year, Convergence Energy sought bids for procuring 5,580 e-buses to be deployed across five major cities. Along with Tata Motors, Ashok Leyland, Olectra Greentech and PMI Electro Mobility, JBM Auto is among the key supplier of e-buses in the country and can be expected to participate in this tender.

With the theme of green vehicles having a long runway, investors can consider re-entry to the stock at lower levels when the risk-reward is in favour.

Information Technology: Tata Elxsi

A marathon run at sprint speed

Investors can book profits in the stock of IT company Tata Elxsi . With an impressive 600 per cent stock returns from its levels pre-Covid (February 2020), risk-reward is not favourable anymore. While the company’s fundamental performance too has been impressive, the stock performance has more than adequately factored this.

During the same time when stock has given more than 600 per cent returns, the company’s revenue and net profit are up around 105 and 139 per cent respectively. While higher rate of increase in stock price than earnings growth (although 600 per cent increase in stock against 139 per cent increase in earnings is well beyond what fundamentals justify) is par when interest rates are low and earnings growth is accelerating, both are facing headwinds now.

Earnings growth likely to taper
Globally, environment for high-priced tech stocks getting wobbly
Current valuation leaves no margin of safety

After its year-on-year (Y-o-Y) earnings growth in FY22 (based on estimates for Q4) of around 40 per cent, the growth is expected to taper to 22 per cent in FY23. As against this, the stock is trading at forward PE of 74 times. A PE of 74 times against earnings growth of around 20 per cent implies frothy valuation and is unsustainable.

The second headwindTata Elxsi and other richly-valued tech stocks face is that from higher interest rates in FY22. Globally, the environment for high-priced technology stocks has been getting wobbly in recent weeks post indications from the US Fed that the priority now is to rein in inflation. In such an environment wherein interest rates are expected to go up and maybe even aggressively, the risk is skewed to the downside.

Tata Elxsi valuation is at such levels now, leaving absolutely no margin of safety for macro or company-specific risks that can materialise. When, globally, the valuation of tech stocks faces pressure from high interest rates, Indian tech stock valuations cannot stay at elevated levels in a vacuum for too long.

The call on Tata Elxsi is purely a valuation call. The underlying business performance and execution by management remains robust. As mentioned above, the company’s revenue and net profit growth over a 2 year period (FY20-22) is impressive and the company has capitalised well on the digitisation trend. As a leading provider of design and technology services across industries, Tata Elxsi as a company with niche focus is well-differentiated from many of the other IT companies in India whose business is split between legacy and digital business.

Tata Elxsi has client relationships with some of the leading players in the trending themes in technology, like mobility (autonomous cars), internet of things, cloud, artificial intelligence, etc. The company’s scope involves partnering with clients from research and strategy, to electronics and mechanical design, software development, validation and deployment.

For the recently concluded December quarter, the company reported revenue of ₹635.4 crore. In constant currency terms, revenue was up 33 per cent Y-o-Y. EPS at ₹24.24 was up 43.5 per cent. Margins were also good with EBITDA margin at 33.2 per cent (higher than many of the peers in the IT sector). Business is predominantly export-driven, with revenue outside of India accounting for around 84 per cent of revenue. North America accounts for around 42 per cent.

Investors can book profits now. However, they can continue to track the stock/company performance and look to enter at lower levels.

Infrastructure: IRB Infrastructure

Positives are priced in

The focus on infrastructure and the push for higher capital expenditure (₹7.5 lakh crore for 2022-23, up 24 per cent from the 2021-22 revised estimate) in the Union Budget has buoyed construction company stocks. The government’s ambitious plan to expand the national highway network by 25,000 km next fiscal, if implemented, will translate into an influx of new orders for these companies.

Unlike in FY21, when labour and supply issues held up project execution and Covid lockdowns impacted toll collections, construction companies have done well in recent quarters. This is reflected in the sharp up-move in their stock prices.

Stock above historical valuation
More expensive than peers
Toll revenue subject to traffic risk

The stock of IRB Infrastructure Developers (IRB Infra), which is focused largely on BOT road projects, has surged 530 per cent since the March 2020 market low and 176 per cent over the past year.

At ₹300 apiece, the stock discounts its FY23 estimated earnings by 31.7 times, significantly higher than its three-year average P/E multiple of 11.3 times.

While there are positives for the company, the current stock valuations appear to adequately price them. Investors can, therefore, consider booking profit in the stock. The IRB Infra stock is also trading at an expensive valuation when compared to its peers - PNC Infratech and KNR Constructions are trading at a forward P/E multiple of 14 and 21 times, respectively. The stock of diversified engineering and construction major, Larsen & Toubro is trading at around 22 times.

IRB Infra’s business encompasses EPC (engineering, procurement, and construction) work and its seven fully-owned assets - the Mumbai-Pune TOT (toll-operate-transfer), 3 BOT (build-operate-transfer) and 3 HAM (hybrid annuity model) projects. Apart from this, as a sponsor, IRB Infra holds stakes in two InvITs owning 16 BOT road projects, the operation and maintenance for which is managed by it. Under BOT, the entire project finance is arranged by the developer compared to only 60 per cent under HAM. In case of EPC, the developer is involved only in construction and does not own the asset.

As of January 2022, the company had an order book of over ₹19,000 crore which provides 3 years’ revenue visibility.

While a major capital infusion into IRB Infra in December 2021 has bolstered the company’s balance sheet and put it on a strong footing to pursue future projects, it has, at the same time resulted in a significant 72 per cent equity dilution. The stock is up 38 per cent since the fund raise which happened at ₹212 per share, more than adequately reflecting the long-term benefit of having a healthy balance sheet.

Thanks to the ₹5,347 crore raised through a preferential allotment of equity shares, of which ₹3,250 crore was used to pay off debt, the debt-to-equity ratio has come down to 1.2 times (based on news reports) as against 2 times in September 2021. The rest is for funding growth and general corporate purposes.

Financial performance

Helped by continued momentum in execution of construction projects and higher road toll collections, IRB Infra grew its operational revenue 44 per cent (year-on-year) to ₹3,091 crore for the half-year ended September 2021. During the same period, EBITDA rose 37 per cent y-o-y to ₹1,418 crore and net profit to ₹114 crore (loss of ₹50 crore last half-year). Between FY16 and FY20 (non-Covid year), IRB Infra grew its revenue at a compounded compound annual rate of 7.5 per cent to ₹6,852 crore and EBITDA and net profit each at 3 per cent to ₹2,971 crore and ₹721 crore, respectively. The FY20 numbers are not comparable with earlier years due to asset transfers to IRB Infra’s private InvIT.

.Speciality Chemicals: Clean Science

Too fizzy for comfort

Clean Science and Technology Clean science and technology is a leading speciality manufacturer of performance, pharma and FMCG-related chemicals (70, 16, and 12 per cent of FY21 revenues, respectively). The stock has returned close to 150 per cent from the upper end of the IPO price band of ₹900 (IPO in July 2021), owing to strong revenue growth, niche portfolio and high margins.

The iInitial concerns of high management compensation were resolved post listing, as management will now be compensated at 4 per cent (cumulatively) from FY22 compared to 10 per cent earlier. But high valuations continue to be a worry, with the stock trading at 82 times FY23 earnings (Bloomberg consensus). Considering the run-up in the stock price and as well as the high valuation, investors can book profits.

Peers at lower valuations

Peers at lower valuations

Other speciality companies with the same IPO vintage, are trading at lower valuations and higher earnings growth estimates. For instance, Ami Organics, Rossari Biotech and Tatva Chintan with FY21-23 earnings CAGR in a range of 32-49 per cent are trading in a range of 34-45 times FY23 earnings, compared to Clean Sciences’ CST’s 82 times for 27 per cent FY21-23 earnings CAGR

The company’s 14 per cent revenue growth in FY19-21 has been driven by a volume growth of 22 per cent (actual production). The lack of pricing power may impact growth when volume growth is hindered. In Q2-FY22,Clean Scienceit reported a revenue growth of 9.5 per cent even as price pass-through seems to have been held back, as evidenced by gross margins of 70.3 per cent compared to FY21 gross margin of 77 per cent..

In line with inflationary pressures across industries, raw material prices increased by 60 per cent from pre-Covid levels, according to the company. The gross margin squeeze indicates only a marginal price pass-through, if at all, to retain volume growth. Its backward integrated model supporting an EBITDA margin expansion to 50 per cent in FY21 from 35 per cent in FY19 was one of the key factors in favour of the company at the time of IPO. The margin has softened even beyond initial expectations (2-3 percentage points softening expected by FY23 from FY21 level) to 45 per cent in Q2FY22 itself.

High valuation compared to peers 
Inflationary pressure on margins
Price pass-through may be tougher

Over the long term though, the backward integrated model , which has driven margin expansion, is still a positive for the company; so is its scope for volume-driven growth. While the margins have slipped only in the recent two quarters, volume growth can still come by, based on ongoing capex plans across Unit-3 (brownfield expansion) and Unit-4 (greenfield). This is expected to increase the capacity by 50-60 per cent in the next three years. Unit-3 will increase the capacity of existing products and add a new stabiliser product as well, which is not produced domestically, at a total outlay of ₹100 crore. Unit-4 , planned on 34 acres (land acquired), will be utilised for new products, set for FY23-24 time frame at a total outlay of ₹300 crore.