The stock market is on steroids since September 2013, lifting the CNX 500 almost 78 per cent in this period. But as more investors tried to join the rally, the prices of many stocks have been pushed far beyond their fundamental worth.

The rally, however, appears to be running out of steam as the euphoria generated by the new government wanes. It is, therefore, time to take stock of companies whose stocks have rallied despite weakening fundamentals.

Here are some stocks whose prices may be overheated.

A shaky edifice Delhi-based property developer Ashiana Housing has seen its stock price soar 140 per cent in the last year, compared with an 11 per cent gain in the BSE Realty index. The stock currently trades at 110 times its trailing twelve month’s earnings. There could be at least three reasons why investors took a favourable view of the stock.

One, the company raised ₹266 crore in two different funding deals to finance its expansion plans. Two, it entered into a joint development agreement to foray into Chennai with a housing project for seniors. Three, with interest rates easing, the mid-income housing segment — the company’s mainstay — is expected to pick up.

But the going can get difficult in the months ahead. Sales growth is slowing in its primary markets such as Bhiwadi, Jaipur and Lavasa. Sales guidance was lowered by 15 per cent to 2.05 msf for 2014-15; this is lower than the 2013-14 sales area of 2.2 msf. Cash collection fell to ₹140 crore in the December 2014 quarter, down from ₹454 crore in the December 2013 quarter. Slow sales have led to build-up in unsold inventory — over half of the completed saleable area in one of its projects in Bhiwadi remains unsold. Also, average sale price dropped to ₹2,871 per sq ft in the December 2014 quarter from ₹3,340 in December 2013.

Revenue in the nine months of 2014-15 decreased 13 per cent y-o-y to ₹73 crore while net profits dropped 10 per cent to ₹17 crore. Add to this a recent round of QIP increasing the outstanding shares by around 10 per cent, diluting earnings. Also, the company’s small market capitalisation — ₹2,300 crore — increases the investor’s risk.

Bloated beyond reason Despite the fall last week, the stock of city gas distributor (CGD) Gujarat Gas has nearly tripled since January 2014. The ‘Gujarat’ prefix helped last year. But the stock broke out after the company’s announcement last February that it, along with other State Government-controlled gas companies such as GSPC Gas, would merge with Gujarat Distribution Networks Limited (GDNL). Shareholders get one GDNL share for each share held in Gujarat Gas. After the merger, the combined entity with volumes of 7-8 mmscmd will be the country’s largest CGD. It should benefit from wide reach in Gujarat and economies of scale.

But the run-up in the Gujarat Gas stock seems overdone. At ₹708, the stock discounts its trailing twelve month earnings by 29 times, far higher than the 10 times it traded at before March last year. The company also faces challenges with declining volumes for many quarters now. Domestic gas is scarce, so the company’s reliance on costlier imported liquefied natural gas (LNG) has risen. Price hikes saw price-sensitive industrial customers — its largest segment — shifting to cheaper alternatives such as naphtha and fuel oil. Reducing prices to win back volumes could impact margins.

Next, the chunk of the volumes of Gujarat Gas and the proposed merged entity’s volumes come from industrial customers. So, there could be pro-rata cuts on domestic gas supplies — the government is allocating domestic gas on priority basis to CNG vehicles and PNG households.

Finally, the merger may benefit in the long run but could be a near-term drag for Gujarat Gas shareholders. Gujarat Gas is debt-free, but the debt of ₹2,400 crore taken by GDNL to finance the merger will pass on to the merged entity. And unlike Gujarat Gas which is profitable, GSPC Gas is in the red.

Unwarranted optimism The regulatory issues of Indian drug maker Wockhardt with US drug regulator, the Food and Drug Administration (FDA), are yet to be resolved completely. But the stock of Wockhardt has risen three-fold in the past year, already factoring in a very positive resolution outcome. The stock currently trades almost 31 times, implying a 22 per cent premium to its bluechip peer Sun Pharma, which may not be justified for two reasons.

The big jump in the stock price followed the company’s announcement that two of its new anti-infective drugs — WCK 771 and WCK 2349 — currently under development have qualified for fast track approval by the US FDA.

These being innovative drugs, once approved, may take substantial time for revenue scale-up.

Second, supplies to the US market from the company’s manufacturing facilities at Waluj and Chikalthana, which were stalled after the US FDA scanner in 2013 for data integrity and quality issues, have not resumed yet. In an optimistic scenario, even after assuming that both the facilities are back on track by 2015-16, the revenue potential from its key products in the US such as the hypertension drug Toprol will be significantly lower, thanks to price erosion.

Wockhardt, which was holding about 10 per cent share in this drug in October 2013, has lost out to peers such as Mylan, Par Pharma and Dr Reddy’s. Many of these products would be less attractive due to price correction and competition. Also, new product approvals from these facilities may not happen immediately. Hence, it may be some time before the company is able to scale back to its 2012-13 peak revenue and profit of ₹5,610 crore and ₹1,594 crore, respectively. The company reported over 12 per cent fall in revenue (₹3,321 crore) and about 52 per cent fall in profit (₹369 crore) during the first nine months of 2014-15.

Given that the stock price has already factored in all the positives, any negative development such as delay in resolution of the regulatory issues may lead to underperformance of the stock.

Store expansion back-fires Customers cutting back on spending have sent the once-high growth of pizza and doughnut maker Jubilant FoodWorks crashing. Net profits shrank steadily between the December 2013 and September 2014 quarters. The fall has, however, not been noticed yet, going by the stock’s 57 per cent one-year gain. Its trailing 12-month price-earnings multiple stands at 79 times now against the 48 times last April. The three-year average PE is around 63 times.

For several years now, Jubilant FoodWorks has been on an aggressive expansion drive, a path it is still firmly on. Dominos Pizza and Dunkin’ Donuts chains number 894, from 586 two years ago.

It is only this expansion that kept sales growth above 15 per cent for the past several quarters. Growth in sales of stores open for a year or more, an indicator of sustenance in sales growth, was very slow; the figure was negative between September 2014 and 2015 quarters, and revived in the December 2014 quarter only due to a hike in product prices.

Opening more and more outlets cannibalises the existing ones, besides compressing profit margins as they take a year or so to break even.

Dunkin’ Donuts also weighs on margins as it is a new venture and is still scaling up. With existing stores already facing customer slowdown, the squeeze on margins is greater. While prices of some inputs such as wheat or vegetables are gradually moving lower, those such as cheese and meat are still high. Profit margins may thus not improve much. With customer sentiment also still poor, earnings growth for Jubilant FoodWorks may not match the high valuations demanded.

Not fairly valued The maker of Fair & Handsome and Navratna Oil shot into the limelight last year, marking an all-time high of ₹1,140 last month.

Emami’s run was tamer than others in the FMCG basket ever since the sector found favour from 2012. The stock’s 112 per cent one-year gain is in part because most peers were already sharply up.

But Emami’s valuations rocketed right alongside; its PE multiple is at 39 times the consensus earnings estimates for FY-16. At this level, the stock is pricier than larger rivals such as Dabur India, Marico, and Godrej Consumer.

Emami has clocked revenue and net profit growth of 21 and 19 per cent in the nine months to December 2014 with improvement in volumes, reviving from a slow growth in 2013-14.

Market share gains in the key Navratna portfolio, new launches, and cooling menthol prices helped. Growth rates are also better than most FMCG peers, save a few such as Marico.

But the positives seem to be factored into Emami’s stock price. The once-strong rural market is set to lose strength on lower farm incomes and minimal hike in support prices for crops. Urban discretionary spending is also yet to pick up. Despite the room offered by cheaper inputs, the hike in ad spend sent profit margins down by four percentage points to 24 per cent for the nine months to December 2014.

The higher ad spend was needed to support new launches, which will continue to be required, given that the launches are in the hotly competitive deodorant and personal hygiene categories.

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