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Four stocks to ride out the market volatility

The second Covid wave has unleashed fresh uncertainties for the equity markets. Here are four stocks to ride out the volatility

Tech Mahindra: As good as top-tier IT players

Investors looking for a differentiated IT stock to seek refuge in these volatile times can consider buying shares of Tech Mahindra (TechM). A top 5 Indian IT offshore services company, TechM is not valued like its top-tier peers despite having a strong balance sheet, good management and a proven track record of executing transformational projects.

Based on consensus one-year forward EPS estimates, TCS trades at a price-to-earnings multiple of around 30 times, Infosys roughly 26 times and Wipro, about 23 times. But TechM trades at 16.5 times. This implies a 30-50 per cent valuation discount, which offers both the scope for upside as well as a safety net on the downside. TechM 's net cash at around 10 per cent of market cap provides great comfort. Also, the stock is less volatile than tier-1 rivals Wipro and HCL Technologies, and mid-sized tech firms such as Mindtree and Larsen & Toubro Infotech. This has earned TechM a slot in the Nifty Low Volatility 50 stock list.

 

A good diversification

TechM has a long history of doing large-scale projects for telecom vertical (which accounts for 40 per cent of sales) and engages with virtually every large provider, ranging from British Telecom, Hutch, AT&T etc. After acquisition of Satyam, the company has successfully increased its non-telecom business over the last decade. Thus, TechM is an attractive option, especially if you are looking for a diversification opportunity away from companies with heavy exposure to BFSI, such TCS, Infosys and Wipro who have over 30 per cent exposure to the sector.

The company has grown its EPS by 13 per cent CAGR over last 10 years, which is in line with or better than tier-1 IT companies. In the nine months of FY21, revenues have remained flattish; the company, however, has generated higher free cash flows through cost control, optimisation and benefits of currency appreciation. The company seems well-placed to take advantage of underlying business spending drivers for 5G. The importance of 5G has only risen post the pandemic, which has accelerated digitisation. TechM has guided for high single-digit revenue growth for the communication business in FY22. Other verticals are also anticipated to to show a healthy recovery in coming quarters. BPO has driven revenue growth for the company over the last few years. A rebound in growth is on the cards as the Covid-19 situation globally improves. Small acquisitions such as Perigord, a digital workflow and artwork, labelling & BPO services firm, help augment domain capabilities and also expand overall BPaaS offerings.

Though Tech Mahindra has not stated any formal dividend payout policy, historically the company has invested 30-35 per cent of cash generation into M&A while returning excess cash to shareholders.

Key risks to our call are weaker-than-expected margin, delays in 5G capex, slow growth in other verticals and unfavourable currency movements.

Marico: Added flavour for your palate

FMCG stocks are a conservative bet in volatile or uncertain stock market conditions, thanks to the essential nature of the goods produced by these companies. In this category, Marico is a good choice for long-term investors. A foods portfolio that has shown resilience since the lockdown of last year, a sturdy double digit growth in volumes since the September 2020 quarter and the presence in premium and underpenetrated segments in personal care – hair nourishment, male grooming and skin care - which have good long-term prospects, bode well for the company.

The stock is per se not cheap, valued at about 46 times its trailing 12 month earnings. However, this is still at a discount to peer FMCG players such as Hindustan Unilever (74 times), Nestle (74 times), Dabur (62 times) and Britannia (48 times). Thanks to the stock’s defensive tag, it finds a place in the thematic low volatility Nifty indices, making it suitable for those with a slightly lower appetite for risk.

 

Strength from foods

FMCG companies with edible/foods portfolio and hygiene products have been able to do well in the Covid-induced disruption vs. those

in the discretionary consumption space, and Marico is no exception. For instance, domestic volumes in the quarter ended March 2020 fell just 3 per cent year-on-year for the company, while HUL, with its personal care focused portfolio, recorded a 7 per cent dip. Higher offtakes in Saffola edible oils and the foods portfolio led by Saffola Oats during the lockdown, helped Marico.

This trend continued into FY21, with the Saffola portfolio driving overall domestic volume growth to double digits in the September and December quarters (11 per cent and 15 per cent growth, respectively). The company’s operational update for the fourth quarter indicates a continuation of this trend. Marico cashed in on the demand for immunity-boosters last year by introducing honey, kadha mix, turmeric milk mix and chwayanprash under the Saffola brand.

In the last few months, Marico has started firing on all cylinders, with its Parachute coconut oil portfolio and the value-added hair oils (VAHO) segment beginning to see volume growth. While foods is fast growing, these two segments still constitute about 62 per cent of the domestic business for the company. Strengthening its rural footprint has helped Parachute. For VAHOs, the company has taken corrective action in terms of pricing and positioning of products and expects the growth momentum to continue.

Financials

For the nine months ended December 2020, revenues grew by 4 per cent to ₹ 6,036 crore and adjusted profits, by 10 per cent to ₹ 924 crore. EBITDA margin for the 9-month period stood at 21 per cent, up 60 basis points y-o-y. However, the company has been facing margin pressures beginning the September quarter due to rise in prices of raw materials such as copra, liquid paraffin, packaging material and rice bran oil. While it did hold on to margins initially through cutting back on advertising and other cost control efforts, a 5 per cent price rise in Parachute as well as 15 per cent rise in Saffola edible oil has been effected over the last few months. Though margins may be impacted in the short-term, tailwinds from higher volumes as well premium products in its portfolio will aid earnings growth. Marico expects pressure in input prices to cool off from Q2FY22.

Coal India: More steam left

The stock of Coal India has been a laggard in the last couple of years like most other PSU stocks; more so, since the market fall in early 2020.

Though most of the Nifty 50 constituents have almost recovered from the lows witnessed last year, Coal India is still below the peak price of ₹ 211 seen in January 2020. Fear of Coal India losing monopoly following the government’s decision to allow private players into coal mining, lower demand from the industrial and commercial sector consequent to the Covid outbreak and the lockdown, and the company not ticking the boxes in the growing interest in ESG (Environmental, Social and Governance) investing, have been factors pulling down the stock.

 

But the concerns seem overplayed given that the economy is expected to slowly recover (despite near-term headwinds). About 57 per cent of commercial energy produced in India is coal-based. And Coal India accounts for around 83 per cent of India‘s overall coal production .The company’s major consumers are power plants, accounting for 70-80 per cent of its off take. Its other consumers include steel, cement, fertiliser, brick kilns and a host of other industries.

Given Coal India’s major role in power production and the increasing electricity demand in the country, the company is not expected loose its sheen in the near to medium term.

Considering the procedural hurdles such as land acquisition and EC/FC clearances and high capital requirement, producing output from private commercial mines is easier said than done. Similar is the case with set-up of renewable energy capacity. These factors, therefore, may not pose an immediate threat.

Coal India is attractively valued at about six times its trailing 12-month earnings, lower than about 16 times it traded at, on an average, over the past three years. Investors with a medium- to long-term perspective can consider buying this stock.

The stock is a dividend player as well, with the dividend yield ranging between 5-10 per centin the last five years.

Post-Covid recovery

The recovery in electricity consumption after the re-opening of industrial facilities since mid-2020, has helped improve offtakes

In fiscal 2021, both production volumes (596 million tonnes) and offtake (573 million tonnes) were flattish, compared to previous fiscal.

However, during the nine-month period ended December 2020, the revenues and net profit of the company were at ₹ 65,844 crore (down 9 per cent y-o-y) and ₹ 8,113 crore (down 32 per cent y-o-y), significantly impacted by lower offtake and higher cost in the first half.

A key concern is the huge trade receivables from customers, especially State-owned power discoms. At the end of January 2021, net debtors balance stood at about ₹ 21,600 crore. This outstanding has increased sharply only in the last 14-15 months, pressurising the operating cash flows of the entity. To put it in perspective, the latest receivable amount is slightly higher than the total operating revenue of the company recorded in the third quarter of FY21.

However,the management is confident of recovering the amount since the most dues are from the government. They stated, in the Q3 FY21 earnings call, that the dues will be recovered from the current fiscal onwards by regulating the supplies, among other measures.

This, along with company’s earnings gradually stabilising on the back of recovery in coal demand, is expected to ease the cashflow situation.

HDFC: A solid foundation

During volatile markets, the stock of HDFC, with its stable business metrics, can be a good buy for long-term investors.

After correcting 16 per cent from the February high of ₹2,895.35, the stock currently trades at three times its consolidated book value on a trailing basis.

This is slightly lower than its three-year average of 3.18 times.

Although HDFC’s valuation is at a premium to peers such as LIC Housing Finance, which trades at less than one time its price-to-book, the current valuation is at the lower end of the historical price-to-book ratio band of 3 to 5 times.

During the market carnage of March 2020 and in the aftermath of the 2008 crisis , the stock had fallen to 1.5 to 2 times its book value; but recouped within months, with the broader markets inching up sharply.

The company’s strong fundamentals, leadership position, good asset quality and healthy return ratios justify the premium valuation.

Any price correction from correct levels due to broader market volatility could also prove a good entry point for investors.

Growth drivers ahead

Loans to individuals constitute about 76 per cent of the loan portfolio of the company. Construction Finance (11 per cent), Lease Rental Discounting (7 per cent) and Corporate Loans (6 per cent) comprise the remaining. During the period between FY17 and FY20, HDFC’s outstanding loan book grew at a compounded annual growth rate (CAGR) of 15 per cent to ₹ 4,50,903 crore. With 3 per cent plus NIMs (net interest margins) and stable asset quality (GNPA less than 2 per cent), the company’s consolidated profits grew by a strong 34 per cent CAGR during the same period.

The company is also poised for growth in the current scenario of low interest rates. The Centre’s continuing thrust on affordable housing too can augur well for HDFC—about 17 per cent of loans approved in the first nine months of FY21 were to EWS and LIG categories. Besides, increasing share of subsidiaries in the consolidated earnings is also a key driver for the stock.

In the first nine months, despite the lockdown and a much larger base, the company still managed to demonstrate a good 9 per cent y-o-y growth in its outstanding loan book (₹ 5,52,167 crore). Its ability to grow in adverse markets (when bank credit grew by a meagre 5-6 per cent)while bringing down the cost to income ratio by 40 basis points (y-o-y), demonstrates the inherent resilience in the business model. HDFC’s cost-to-income ratio (at 8.1 per cent currently) is the lowest in the industry. During the same period, while the company reported 18 per cent rise in its standalone net profit, on a consolidated basis, however, profit was down 23 per cent y-o-y, due to a one time gain on sale of GRUH business, worth ₹9,799 crore, in the corresponding period last year.

Published on April 24, 2021

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