Top Picks

The Budget has left investors watching a market that seems decidedly nervous. Budgets come and go, but smart investing does not change due to one event. What is central to the process is to review one’s portfolio and if stocks are available at good prices, or their growth story is intact, consider including them in your kitty.

ET Investor’s Guide brings you a cross-section of companies carefully chosen by its analysts. The stocks have been selected from industries such as banking, petroleum, engineering and FMCG. We have selected stocks that have either directly gained from the Budget, or look attractive despite the negatives.

The fall in the prices of these stocks thus translates into an opportunity. Since these are not riskless investments, we have attempted to capture the risk-return element too. So, you can choose the stocks according to your risk-return appetite. Also, bear in mind that these shares can slip further as nervousness builds up. Keep spare cash handy, so that you can average out your investments if that happens.

AIA Engineering

AIA Engineering makes abrasives, operating in a niche segment and commands significant advantage in terms of engineering and metallurgical capability. Its share price has doubled in one year, against 22% return for the Sensex. Its profit grew by 35% during FY04-06 and 88% for nine months till December ’06.

Since most of its customers are industrial (power, mining) the pricing is mostly on a cost-plus basis, with a nearly constant operating margin. Currently, share of exports in total sales is about 50%.

Outlook for the user industry looks bright with infrastructure sectors growing well. Large projects are under implementation in roads, ports and power sector. Further, since 70% of sales are from replacement demand, uncertainty in sales is significantly low.

The company’s 65,000 mt capacity is running at 100% utilisation and the new 50,000 mt capacity addition will give it additional revenue of about Rs 250 crore during FY08. Phase II expansion of equal capacity will be over by ’07-end.

Since the new facility is an export-oriented unit, it will enjoy income-tax exemptions for FY08 and FY09. Its current order book is Rs 370 crore, up from Rs 240 crore over last year, with an average execution time of eight months, sales may reach about Rs 550 crore in FY08. Net margin in FY07 (nine months) is 15%, which is attractive and is attributable to its engineering capability.

Valuations: Its current P/E is about 40, which is reasonable, considering the outlook in the near term. With commissioning of new capacity and benefits of export-oriented unit, margins are expected to improve in FY08.

Asian Paints

Asian Paints will benefit slightly from the cut in duty on imported items, as prices of key raw materials like solvents and pigments vary, based on landed costs of imported products. The company’s share price has declined by 13% in the past one month.

The company sells paints to the decorative and industrial segments, while it sells automotive paints through its JV with PPG. This venture recently acquired the automotive refinish business of ICI India for Rs 52 crore, adding Rs 50 crore to the group’s turnover.

The Asian-PPG JV is expected to post 20% growth in FY07 sales to Rs 340 crore. It could grow at the same rate in FY08, given strong growth in its user industries. Asian Paints’ sales and profit growth in the current year have been very healthy.

The company is a key beneficiary of growth in the construction, industrial and automotive sectors. Since the structural story of the Indian economy is still robust, demand for the company’s products should continue to remain strong.

It has recently added a new plant for its industrial products, which is likely to contribute to growth in FY08. A cause for concern could be if rising interest rates cause a slowdown in construction, particularly in the real estate market.

Valuations: While earnings growth in FY07 is over 30%, justifying the P/E multiple of 25 times, it could slow a bit in FY08. Still, the company is a worthwhile addition to investors’ portfolio, as it is de-risked to the extent it targets industrial, decorative and automotive sectors.

Bajaj Auto

Bajaj Auto is best placed to make the most of the bike market, which is growing at a healthy 15%. In FY07 so far, total two- and three-wheeler sales have risen by 22%, against the industry growth of 17%. This above-market growth is expected in ’07-08 too.

The company’s new plants will be operational in early-April, easing supply constraints and enabling its share to go up from 34%. Sales of the new 200cc Pulsar bike will also contribute to growth in FY08.

Bajaj Auto’s models have lower risk compared to Hero Honda, its biggest rival. Its overall exports grew 83% to 4 lakh units in April-February ’07. The aggressive expansions in Indonesia, Sri Lanka and Latin America have put Bajaj Auto in a position to ride out blips in domestic sales.

Operating margins have been under pressure during the past five quarters — they fell from 18% in December ’05 quarter to 14% a year later — but analysts believe margins have bottomed out now. Moreover, Bajaj has a product mix that is well-tuned to market demands and is driving sales.

Even without the new variants and styles of FY07, it realised Rs 35,612 per bike in ’05-06, up 4.8% from the previous year. In FY08, the 200cc bike is expected to drive up realisations. That, along with economies of scale, will help ride out higher input costs.

Valuations: At a P/E of 21.1 on March 2, ’07, Bajaj Auto was still expensive compared to Hero Honda (13.6) and TVS Motors (16.9). However, given its overall long-term prospects, the stock is still a good buy, specially at lower levels. The company’s demerger, when it takes place, is a positive earnings trigger.

Bank of India

Bank of India (BoI) is among our top picks in the PSU banking space and is now quoting at attractive valuations. As of December 31, ’06, BoI had total assets of Rs 130,000 crore and total advances of Rs 93,932 crore.Net interest margins (NIMs) were at the higher end of the peer group, at 3.7% for its domestic operations.

Consolidated NIMs were lower at 3.21% on account of lower profitability in its international lending. BoI could see sharp improvement in RoE from 16%, led by an increasing share of low-cost funds in the deposits portfolio. This could result in an improvement in NIMs.

Low-cost funds were around 41% as of December ’06, posting a growth of 17% over the previous corresponding period. Current and savings account (CASA) growth could be much higher in FY08 and FY09 as it will benefit from core banking implementation.

BoI has already brought around 80% of its business under core banking. Yields have also moved up on higher lending to 7.96%. Margins could be impacted to some extent due to higher funding costs since the start of Q4 FY07.

To combat higher costs, BoI has already hiked interest rates and will receive further aid in the form of interest on cash reserve ratio (CRR) balances. This will help BoI to maintain its current level of profitability. With government holding at 70%, the bank has enough room to fund growth through further dilutions.

Valuations: BoI is trading at 1.49x book and 8.6x its trailing 12 month earnings, offering new investors an attractive entry point, and giving existing investors an opportunity to consolidate their holdings.

GSPC

Gujarat State Petroleum Corporation (GSPC) will be a beneficiary of the 80 I (A) exemption as profits on cross-country gas pipelines have been exempted from tax for 10 years. Though details are not out, it’s quite possible that new pipelines will get the benefit.

Then, GSPC is based in Gujarat, which is expected to see a surge in natural gas consumption. The additional supply will come from capacity additions by Petronet LNG and Shell LNG, which will bring in additional 7.5 million tonnes (mt) per annum (30 million cubic metres/day) of natural gas.

GSPC is an infrastructure provider, so it doesn’t have to find customers for gas or supplies. It owns the infrastructure and collects the fees. So, any new gas supply coming into Gujarat will lead to some business for the utility.

Demand for gas is already there and additional supplies are also coming in. GSPC is currently transporting 18 mmscmd of gas, against 14 mmscmd in the previous quarter and 12 mmscmd in Q4 FY06.

Volume increase doesn’t have a 1 to 1 correlation with revenues since distance is also a factor. But the company has seen consistent growth in earnings. At current volume and operating margins, EPS could be Rs 0.70-75 for Q4 (Rs 2-2.1 for FY07).

Valuations: FY09 earnings could be up sharply because the company has an agreement with Reliance to supply 11 mmscmd of gas to the Jamnagar refinery. Trailing four quarter P/E multiple looks steep at 30, but margins were depressed in the first half of the year due to one-time expenses. Though the downside is limited, the stock is unlikely to be a multi-bagger either.
India Cements

Contrary to general perception, India Cements could be a major beneficiary of the dual excise duty slapped on cement. Post-budget, its duty outgo will decline by Rs 46.5 per tonne to Rs 360.50 per tonne. With major cost heads unchanged, its operating and net profit margins will rise.

Its operating profit is expected to rise by Rs 3.3 crore during the March ’06 quarter and Rs 38 crore during the whole of FY08 due to a lower duty outgo. This could push-up its earning per share (EPS) by as much as Rs 1.70 next fiscal.

The budget has proposed to cut the excise duty to Rs 350/tonne from 400/tonne earlier, if cement is sold below Rs 190 per 50 kg bag. If MRP is higher, it will be taxed at Rs 300/tonne.

To avail of the cut, cement makers have to reduce their net sales realisation to Rs 2,490/tonne, against Q3FY07 average of over Rs 3,100/tonne. But during December ’06, India Cements’ net cement sales realisation was Rs 2,341/tonne, much lower than the threshold limit needed to avail of lower duty.

This not only reduces its duty outgo but also gives it head room to further increase its sales realisation without incurring additional excise duty.So, investors should use the recent correction in India Cements’ stock price as a buying opportunity. In the past month, the stock declined by 29% against an 8% fall in the Sensex.

Valuations: At Rs 168.6, the stock is valued at 11 times its trailing EPS. This is attractive compared to ACC’s 14.7 and Gujarat Ambuja’s 11.4, even though the latter are more vulnerable to pressure on cement prices.

ITC

ITC’s non-tobacco FMCG business will get a boost from the excise duty exemption on food mixes, including instant mixes. The ‘Ready to Eat’ segment under the ‘Ashirwaad’ brand will benefit in terms of operating margins due to the excise duty and customs duty exemptions on food processing machines.

The ‘Sunfeast’ biscuit range will get an incentive to launch variants at lower price points to expand its rural base, aided by excise duty exemption for packs priced lower than Rs 50/kg. The customs duty cut on plastics and other packaging material will boost operating margins as ITC spends a lot on packaging and branding.

The agro business will benefit from sops provided to the agricultural sector. Expansion of integrated oilseeds, oil palm, pulses and maize development programmes may boost supply of oil seeds, in particular soya seeds, which are one of the biggest raw materials for ITC’s soya division.

Its e-choupal initiatives may also benefit from higher allocation to e-governance initiatives. ITC’s hotel division will gain from increase in focus on tourism.

But, excise duty hike on cigarettes may hit the tobacco unit. Passing on additional costs to consumer for two successive years could hit topline growth, which is currently at 12%.

Past trends indicate the possibility of a slowdown in cigarette volumes after 3-4 years of robust growth. But, considering the GDP growth outlook of 9-10% and favourable demographics, ITC may sustain 8-10% topline growth in this division.

Valuations: The stock is trading at a price-earning multiple (P/E) of 24x, which appears slightly cheaper compared to other FMCG stocks.

Punjab National Bank

Punjab National Bank (PNB) is our other preferred pick in the banking space. It is the third-largest bank in the country. PNB’s margins are among the best in the industry; its net interest margins (NIMs) stand at 4.21%.

Higher margins are mainly due to the strong low-cost franchisee of the bank, which is around 43% of its deposits portfolio. PNB’s core business performed well in Q3 ’07, with a 21% rise in net interest income (NII).

Higher NII was led by sharp improvement in yields to 9.11%, supported by strong asset growth of around 30%. Non-interest income (mainly fees) has also moved up sharply, driven by gains on the commission and exchange front, leading to an overall 21% growth in other income.

Operating expenses declined by 10%, adding to the bottomline. However, net profit was capped on account of higher provisioning requirements. Asset quality is robust with net non-performing assets (NPAs) at just around 0.43% of total portfolio.

PNB has sufficient leeway to fund future growth, with government holding at around 57%. It is looking at diluting the government’s stake further to beef up its capital. With a credit deposit ratio of 67%, PNB has more than sufficient leeway to grow its advances without diluting margins.

Valuations: PNB has corrected steeply from its highs and offers investors a good entry point. It is trading at 1.3x book and 7x its trailing 12-month earnings.