Expensive, but hold on to them

Rising valuations may be a concern for stocks with poor fundamentals. But for companies that have shown resilience and delivered a strong earnings growth, it is more a case of money chasing few good quality stocks.

As the economy recovers, these companies are likely to see a substantial jump in earnings. Despite valuations climbing higher, there is still scope for upside.

Niche focus pays off Stocks that offer compelling growth profiles and sound corporate governance trade at a hefty premium and Gruh Finance fits that bill. A subsidiary of Housing Development Finance Corporation (HDFC), market leader in the home financing segment, the company’s distinct and niche target market complements HDFC’s market.

Gruh Finance is one of the pioneers in the rural housing finance segment, providing small-ticket home loans to low-income groups in semi-urban and rural areas. In what is perceived as a risky segment, the company has been able to maintain a very low loan delinquency through good appraisal process and deep understanding of the local market.

Gruh’s loan book has been on a breathless run, growing 27 per cent annually over the last decade. But given its tiny market share in the Indian mortgage market, and the government’s focus on affordable housing segment, the company is likely to grow its loan book by 20-25 per cent over the next couple of years as well. The company has also been able to keep bad loans under check — gross non-performing assets (GNPAs) stood at 0.28 per cent of loans as of March 2015. The company sports an enviable 30 per cent return on equity, far superior to the 16-19 per cent that its peers report.

The stock is now trading at a steep 10 times one year forward book, double the valuation of its peer Repco Home Finance and almost 5-7 times what Dewan Housing and LIC Housing Finance trade at.

In the event of a fall in real estate prices, the odds are stacked against investors who have placed their bets on housing finance companies, as they run the risk of erosion in the value of their loan portfolio. But given that a fall in prices is unlikely to have a major impact on low-ticket homes, rural lenders such as Gruh Finance will continue to sustain growth.

The company has reported an annual profit growth of 28 per cent over the last decade, and with 25-30 per cent expected growth in earnings over the next two to three years, valuation might not weigh down its stock price.

Betting on buoyant demand The stock of Whirlpool of India has zoomed in the last one year, rallying about 220 per cent. On estimated earnings for 2015-16, the stock trades at 46 times now.

Voltas, Havells and V-Guard Industries trade at about 25-30 times, one year forward earnings. Compared with its historical average too, the stock is expensive. Between 2009-10 and 2013-14, Whirlpool has traded at 13-25 times.

Though expensive, the stock holds potential. After a weak show in the first half of 2013-14, Whirlpool has been steadily improving its performance.

For the nine months ending December 2014, the company has reported a 16 per cent sales growth and 78 per cent jump in profits. Sales volumes as well as realisations were up, buttressed by improved demand and higher sales from premium products. Operating margins also expanded by about three percentage points to 10.3 per cent, thanks to the stable rupee and lower crude oil prices.

Now with interest rates heading south, makers of consumer goods should benefit. Whirlpool’s strong brand, all-India reach and aggressive marketing holds it in good stead, and the company should benefit from a revival in demand.

One risk, though, is the possible slump in demand, owing to weak macros. Investors may need to watch out for a correction.

Indisputable market leader Since the 2009 market lows, Wabco India’s top and bottom-line growth has moved up and down in tandem with the auto sales cycle. But the stock had no such roller-coaster ride.

From a low of about ₹100 in March 2009, the stock has only been on its way up, trading at around ₹5,318 currently. In the last one year, it has more than doubled. A weak profit growth during this period (about 6 per cent for the nine months ended December 2014), though, has resulted in valuations expanding quite generously.

Wabco now trades at about 82 times its trailing-twelve month earnings.

This is much higher than its three and five-year historical average PE of about 30-35 times.

But the confidence reposed by investors in the stock is not without reasons. The company is the market leader in supply of air and air-assisted brake systems for truck and buses and has for its clients almost all manufacturers such as Tata Motors, Ashok Leyland, Mahindra and Volvo. It also has sizeable exports and caters to replacement demand for these components in the secondary market.

Realisations in these two segments are much better than domestic sales, helping the company enjoy high margins.

In the last few years, Wabco India has expanded its product line to include air compressors, electronically controlled air suspension systems and the high-margin anti-lock braking systems (ABS).

It received a shot in the arm last year when the government made ABS compulsory for all new models of commercial vehicles from April 2015.

It is also one of the few auto component players that is debt-free and enjoys operating margins of 16-20 per cent. With the parent company Wabco being a technology leader in braking and transmission systems, its multi-national lineage also helps the company command a premium. Though valuations have expanded, given that the auto cycle is looking up now, a healthy double-digit earnings growth is expected over the next two years. Existing investors can hold on to the shares.

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