Stock Picks

SHOCK-PROOF!
Sandeep Singh
Posted online: Monday , August 20, 2007

Barely a week ago, this market could do no wrong. Now, it seems, it can do no right. The newest word in the Indian investor lexicon, sub-prime, has had a domino effect on all financial markets. It has gobbled up mortgage companies in the US, and hedge funds in the US and Europe. It has caused a credit squeeze and a flight of foreign funds from emerging markets of alarming proportions.Every market is down. Worse, it’s difficult to ascertain how deep and long this damage can run. Says Abheek Barua, chief economist, HDFC Bank: “India is not directly exposed, but we can’t avoid the contagion effect.” Indeed, there are businesses in India, or aspects of it, that are at risk from this complex tangle. Says Sanjay Sinha, chief investing officer, SBI Mutual Fund: “The financial sector is affected. If companies there reduce their IT spend, Indian IT companies with an exposure to the BFSI (banking, financial services and insurance) sector will lose business.” Adds Suman K. Bery, director general, NCAER: “Overseas financing will take a hit, which will hurt companies funding overseas acquisitions.”However, there are several businesses that are insulated or affected only marginally in an indirect way by the sub-prime mess. Says Sandeep Nanda, head of research, Sharekhan: “The long-term story is intact in engineering, capital goods and consumer goods.” With share prices being marked down indiscriminately, you will get juicy opportunities to buy these businesses.Perhaps, the best place to look for them is in the infrastructure space. We have identified five such shock-proof picks. Business for them is good and plotted out for two to three years, order books are flowing and they are shielded from the sub-prime fallout. There are risks like a squeeze in foreign capital and investments, but these companies can manage them. On to our picks…

Areva T&D
One infrastructure area still lagging is power. In the eleventh five-year plan (2007-12), the government is looking to add 68,869 mw of capacity; it also states a fund requirement of Rs 2,37,000 crore in the transmission and distribution (T&D) segment. Those numbers, and the investments unfolding in the power sector, should electrify French multinational Areva T&D, which supplies a range of T&D products and provides a range of T&D services.The sub-prime blowout is unlikely to scuttle these investments. In the T&D space, Areva competes with the likes of ABB and Siemens. Says Ajit Motwani of Emkay Stocks and Share Brokers: “Their parents do a lot of product research, which they are using to grow.” Valuations are high (the stock is quoting at a PE of 47), but justified by the pace of growth. Net profit has increased at a CAGR of 86 per cent in the last three years and, this year, it is looking good for 60 per cent at least.

Bharat Earth Movers Limited (BEML)
You might recognise it by the wagons that move on the Delhi Metro, but BEML is better known as the second-largest manufacturer of earth-moving equipment used in diverse sectors like defence, railways, mining, construction, power, steel and cement, among others. Several of these sectors are a beehive of activity. That’s rubbing off on BEML, which is growing this side of its business at 40 per cent a year.Rail wagons is shaping up to be a strong growth segment for BEML. The Delhi metro is expanding, projects are at various stages of clearance in Ahmedabad, Bangalore, Chennai, Hyderabad, Kochi and Mumbai, which BEML is likely to bid for. The company recently raised about Rs 500 crore through a follow-on public offer (FPO), of which, it has earmarked Rs 215 crore to expand its metro coach facility. With the objective of becoming more cost-efficient, Rs 90 crore each is assigned to upgradation of current facilities and for a VRS.As of February 2007, BEML had pending orders of Rs 824 crore in mining and construction, of Rs 236 crore in defence, and of 300 coaches worth Rs 102 crore and a letter of intent for another 875 coaches. The BEML stock has appreciated about 31 times in the past three years,but its PE has only doubled to 23.4, which reflects strong earnings growth. Its user industries are diverse. Even if some of them start to flag, BEML should still manage to sustain strong growth in the coming years.

Noida Toll Bridge
Even if sub-prime woes intensify, the 100,000 vehicles — and growing — that do a Noida-Delhi or Delhi-Noida via the Noida Toll Bridge every day will continue their to and fro. The toll road is a 30-year BOOT (built, own, operate, transfer) project, which means IL&FS should manage the project till 2031 and then hand it over to the New Okhla Industrial Development Authority (Noida).However, the transfer is unlikely to happen in 2031 or even the years after that. The concession agreement between the stakeholders assures the company a 20 per cent return on investment over the life of the project. The company retains control of the toll road till it earns that return, which is a long way away, as the shortfall every year gets added to the project cost.Meanwhile, traffic on the road is increasing at 15 per cent a year. At present, it’s about 90,000 vehicles per day, which is about half its designated capacity. Meanwhile, toll charges are increasing — the toll for a car has increased from Rs 15 to Rs 20 in six years, and yet the number of vehicles has increased. The new link road to Mayur Vihar will add more vehicles, as will the increasing occupancy in Greater Noida.The company also has 235 acres of land, which presents additional revenue possibilities. All in all, it’s a steady road.

Patel Engineering
Another company riding the infrastructure boom. Patel has an order book of Rs 5,000 crore, or about five times its 2006-07 revenues. About half of this is from hydro-power projects, a high-margin segment because of the complexities involved and where it is the second-largest player after Jai Prakash Associates. Patel does projects mainly for state irrigation departments, NHPC and NEEPCO. The government has fixed a hydro-power generation target of 15,285 mw for the eleventh five-year plan.Besides hydro-power, Patel also builds roads, tunnels, dams and bridges, among other things. More recently, the company has ventured into the real estate business, with a land bank of 500 acres. At its current PE of 22, Patel trades cheaper compared to competitors Jai Prakash (PE of 40) and Gammon (34.6) — and offers good scope for growth.

UltraTech Cement
Formerly part of L&T and now a Grasim subsidiary, Ultratech has a capacity of 17 million tonnes. Together, UltraTech and Grasim are the leading combine in India, controlling about 20 per cent of the installed capacity. Cement makers have posted triple-digit increases in net profit in the last three years, helped by strong demand and inadequate supply. Cement prices have soared, even withstood government moves to bring them down (from Rs 130 per 50 kg in March 2004 to 200 in March 2007).Projects that will lead to an overall increase of about 50 per cent in capacity are currently underway, must of which are likely to come up in mid-2009. That will bridge the deficit, even check prices. But if construction demand stays robust, as is expected, the cement cycle should stay up — as should UltraTech.


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