8 Stocks For 2007

Investors, who can pick the right stocks at the beginning of the year, stand to make good gains in the months ahead. But it is not just the right stocks that matter; they have to be picked at the right time. After all, Warren Buffett dropped a billion dollars in 2005 because his bet about the falling US dollar was wrongly timed. That is the pitfall we have attempted to avoid while identifying stocks for 2007 at a time when the Sensex is almost at 14000 and could experience a sharp correction. We have done this because there is usually a collective fear of heights and fundamentals, such as interest rates can also change suddenly.

To take care of the timing issue, we have picked six growth stocks that seem to show little price momentum (see Methodology) in 2006. We also have looked at a couple of stocks with robust growth in fundamentals as well as price.
A combination of domestic growth and cheap financing has turbo-charged growth of the auto sector in the last three years. As a direct consequence, companies that are suppliers to the auto sector are doing well too. One interesting case is that of Ennore Foundries, an associate of Ashok Leyland. EFL is the largest automotive jobbing foundry which makes grey iron castings (production capacity of 48,000 MT) and aluminium gravity die castings (3,000 MT) for automobiles, industrial engines, power generators, tractors and defence applications. EFL has an impressive list of customers including Ashok Leyland, Hindustan Motors, Hyundai, Maruti, Swaraj Mazda, Simpson & Co., Caterpillar and Mahindra. Its operational income has been growing at an average of 34% for the past five quarters while profit was up 22% during the same period. The company operates at an average margin of 9%. This stock has been languishing for the last one year and was down 10% in 2006 -- there is no indicator of its potential. The market could take cues from its plans to expand and modernise as well as set up a greenfield project near Chennai at an estimated investment of Rs144 crore.

Its products power almost every two-wheeler hitting the road, its sales have been growing handsomely and yet the stock price has been languishing for all of 2006. Minda Industries, a flagship of the Minda Group, designs, develops and manufactures switches for two- and three-wheelers and off-road vehicles. On an average, the company manufactures 140 distinct products across various categories, servicing the entire set of OEMs in the two- and three-wheeler industry and also in other segments.  Among its clients are companies like Yamaha, Bajaj, Hero Honda, M&M, Toyota, Tata Motors, Ford, Honda, GM, John Deere, etc. Its operating income has been rising by an average 38% over the past five quarters while the operating profit rose 11%. Minda has an average operating margin of 11%. The price, however, has been lagging the broad market in a major way and was down almost 35% over the past year. While the low margins of Ennore and Minda would have made us less enthusiastic about these two scrips, their growth prospects more than compensate for it. If it is worth betting on the auto sector, the time to do so is now, when the sector is down.

We have been bullish about this sector for its growth potential, based on fundamental factors. Logistics and transportation companies have been doing extremely well, given the growth of the domestic economy as well as the rise in international trade. One company that is worth watching in this lot is Sical Logistics, an integrated multi-modal logistics services provider, handling all types of bulk cargo and project equipment. The company serves almost all industry segments and has an impressive client list which includes BEML, BHEL, Hindustan Aeronautics, HLL, HPCL, etc. With more than 65% of its revenues derived from the logistics business, the company is in the process of hiving off its non-core operations to create a focused logistics company. Sical is likely to benefit from the fact that both its business segments have a bright future. Dry and liquid bulk constitutes more than 80% of the total foreign trade handled and India is the seventh largest dry bulk exporter with a huge growth potential.

Opportunities for companies like Sical also arise from the fact that India is one of the fastest growing exporters of iron ore and steel whereas the higher demand for energy has resulted in huge imports of coal and oil. Sical is finally emerging as a key player in the domestic infrastructure business. It has been short-listed as one of the partners for the cargo and logistics hub coming up in Nagpur overseen by the dynamic RC Sinha (see interview). That is a great endorsement of its capabilities. Sical’s revenues have been stagnant while operating profits have been on the decline too. But don’t let that mislead you.

The stock kept a low profile last year but will bounce back once the restructuring is complete and revenues from new projects start flowing in.
We are bullish on the leisure & lifestyle segment (see cover story December 21) thanks to changing demographics, rising income levels and a large young population that is about to enter the workforce. One company that may take advantage of this macro trend is Titan Industries, which began as a watch manufacturer but went on to pioneer the branded jewellery business in India. This Tata Group company is the sixth largest manufacturer of branded watches. It transformed the Indian watch market by offering quartz technology with international styling. Titan has a wide portfolio, which includes brands like Sonata, which is positioned as a value brand for the cost-conscious Indian consumer. It has also entered the premium segment by acquiring a licence to sell Tommy Hilfiger, a global brand. Titan’s share of the domestic watch market is over 60%.

But watches are a dated business. The real value of Titan lies in its network of shops to sell branded jewellery, most notably under the Tanishq brand, which has redefined India’s jewellery market. It plans to expand its retail network from 87 stores in 64 cities to 100 stores by the end of 2007. This should have translated into faster revenue growth but consumers have been slow to adopt the value proposition offered by Titan (the purity of gold used), partly because Tanishq has always been positioned only as a high-end fashion product. However, the branded jewellery segment is growing fast; with rising income levels, Titan will be a big beneficiary of this trend. That apart, Titan plans to open what could be its first company-owned exclusive outlet in the US to sell Tanishq jewellery. Titan also has a third string to its bow: Fastrack sunglasses for the fashion eyewear market -- however, competition from global brands is strong in that segment.

The fundamentals of Titan have been strong. Its operational income grew at an average 37% over the past five quarters while operating profit was up 43% over the same period. The only problem is its margins. It operates at very low margins. Its average operating margin during the past five quarters stood at 9%. Keep an eye on this stock in 2007 and beyond; it has barely budged in the last one year, rising just about 3% in 2006. With retailing the new buzzword and foreign investment in the sector being allowed, Titan, with a strong distribution network, could find favour among foreign suitors.

Pharma companies have not had a great year on the bourses. Though general bullishness prevailed, the sector has lost favour among investors due to the changing dynamics of the overall business worldwide. Companies servicing the largest generics market, the US, have been facing the heat of price competition while those launching generic versions of off-patent drugs have been clobbered by legal battles. Companies that have sidestepped these trends are those with a strong focus on bulk-drugs, and contract manufacturing. This explains why a company like Cipla has done better than a company like Ranbaxy, as we had predicted in our issue dated 14 September. One company that has a more versatile business model is Cadila Healthcare. Cadila is in the business of formulations, active pharmaceutical ingredients, vaccines, diagnostics, health and dietetic foods, animal healthcare and ‘cosmeceuticals’. Additionally, the company also focuses on research in areas of new chemical entities, new drug delivery systems and biotechnology. It has been a pioneer in the introduction of several therapies in ‘life-style disorder’ segments like cardiovascular, diabetics and neuropsychiatry. It expects to be among the top 10 global generic companies with a strong R&D pipeline and sales in excess of $1 billion by 2010.  The company recently received the USFDA approval for the launch of Simvastatin tablets in various dosage strengths and has already launched the drug in the US market, the size of which is estimated to be nearly $4.6billion.
Its operational income has been growing at an average of 19% over the past five quarters, but its real attraction is the strong growth in operating profits. Cadila’s operating profit has averaged a growth of 117% with an average margin of 17%. The stock will probably do well in 2007, especially against the background of the marketing rights it has received from the USFDA recently.

The next stock worth giving a thought to in the coming year is a lesser-known chemicals and pharmaceuticals manufacturer, Punjab Chemicals and Crop Protection (PCCPL). Jointly promoted by the Punjab State Industrial Development Corporation and Excel Industries, the company specialises in Oxalic Acid, Di-ethyl Oxalate, Ethyl Oxalyl Chloride, Oxalates and a range of new herbicides, which it sells nationally and internationally. The company has been recording a robust revenue growth with operational income rising at an average 87% over the past five quarters while its operating profit was up 31% over the same period. However, it has a low operating margin, averaging 7%. The stock has been lying low and was actually down 16% during the last year. The company has now taken the inorganic path to growth having acquired Argentina-based Sintesis Quimica SA through its wholly-owned subsidiary SD Agchem Europe NV for $10 million. SQ manufactures agro-chemicals, formulations and industrial products and had sales of more than Rs60 crore last year. This is likely to add to the bottom-line of PCCPL and give it a base overseas.

After these, if you are in a mood for risky bets in 2007, here are two stocks. One is Electrotherm, an engineering company that manufactures various kinds of furnaces. It has a good market share for its core business both in India and in the African and Asian regions. But the most interesting aspect of this company is its manufacture of electric and hybrid-electric vehicles. Of this, it currently manufactures, YObykes, its range of hi-tech electric two-wheelers. Electric three-wheelers, four- wheelers and hybrid electric low-floor buses are being planned. Its operating income averaged a growth of 82% over the last five quarters and operating profit rose an average 165%.

Himadri Chemicals is focused on coal tar and its derivatives, with a market share of more than 70%. It has gradually diversified into corrosion protection and coal tar-based pipe coating products. Its expansion plans include, doubling the current capacity and setting up  satellite units close to user points. It also plans to set up a plant for byproducts. Himadri's operating income has been growing at an average of 68% while its operating profit has been growing even more robustly, rising an average 379% over the last five quarters with a healthy operating margin of 22%.  The stock has risen more than 240% over a year.  Both these stocks are high-risk return bets for the next year, unlike the other six.

The Methodology

For the basic sample, we have selected all stocks that have traded on the two premium exchanges (BSE & NSE), for a minimum of 80% of the days in the last six months. This yielded a list 2342 companies from which we have eliminated those which have either not declared their results for the September quarter or have been irregular in declaring their quarterly results. The result was a list of 2221 companies. Size of operations is a crucial parameter for building a portfolio. Small companies can give high returns but are very volatile and are not the best serious bets for retail investors. So, we have excluded companies with an average operational income of less than Rs50 crore over the last eight quarters. This left us with a list of 708 companies. Fundamental strength of companies is determined, among other things, by their steady operating profits and we have, therefore, applied a screen of consistent operating profit for the last eight quarters to the 708 companies. This led us to our final shortlist comprising 569 stocks. Finally, we have used the recent lack of price momentum to pick stocks that have been mostly down for 2006, never mind their growth record and growth prospects.

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