We believe the coming multi-year boom in infrastructure and capex spending in India will drive earnings and valuations not only for the direct and obvious beneficiaries among large-cap construction and equipment players but also for their supply chains. It is with this idea that we have gone looking for relatively undiscovered stories in the mid-cap space, and we have found what we believe are four solidly profitable Buy ideas that offer much more potential upside than the large-cap primary plays.
We initiate coverage of Triveni Engineering, Voltas, Maharashtra Seamless and Sterlite Technologies with Buy ratings. These companies are strong derivative plays on the expected inflection in infrastructure and capex spending, and market leaders in their respective niches. We think their valuations will be re-rated to reflect high projected earnings growth in the next few years, catalysed by strong order flows. All these companies are likely to see a significant and sustained jump in EPS (earnings per share) growth from FY12, according to our estimates.
Despite some short-term delays, the story on both infra and corporate capex is expected to be strong in India. We believe that 2012-13 will see a significant inflection point in investment capex in India.
On the corporate capex side, while the picture is becoming more positive, companies with dependence on large and late-cycle industrial capex have not recovered fully. Overall, strong demand, high capacity utilisation and a relatively stable macro environment present a positive environment for a revival in corporate capex. Metals & mining, oil & gas, cement and autos are some of the sectors contributing to the revival in corporate capex. Ferrous and non-ferrous capex is also picking up as cheaper raw materials and labour present a strong economic rationale for setting up plants in India.
Voltas: Voltas is one of the few globally competitive services companies from India that has the capability and expertise to execute world-class projects. The company is likely to be a significant beneficiary of a pick-up in the capex cycle and likely to see a 20% EPS CAGR (earnings per share/compound annual growth rate) for several years after FY12E. The company has zero long-term debt, produces significant free cash flow every year and enjoys relatively high ROCE (return on capital employed) and ROE (return on equity.) We initiate coverage with a price target of Rs 270 [P/E (price-to-earnings) of 18x FY12E EPS (earnings per share) of Rs 14.9].
Triveni Engineering: We initiate coverage of Triveni Engineering with a Buy rating and a price target of Rs 154 as the company?s turbine business is top quality in terms of growth potential and margins, and is likely to get listed at much higher valuations than currently implied by the combined entity. Triveni?s turbine business has a dominant position in the <30 MW segment, and is likely to get a big boost after the recent technology and marketing tie-up with GE. This turbine business is likely to be hived off into a separate listed company by December 2010, according to the management.
Maharashtra Seamless: We initiate coverage of MHS with a Buy rating and a price target of Rs 505, offering potential upside of 33% from current levels. MHS has a strong competitive position in both seamless and ERW (electric resistance welded) pipes and has been able to maintain profitability despite being exposed to business cycle risks (user industries and raw materials). At 7.5x FY12F EPS of Rs 50.5, we find its valuation inexpensive. MHS is a direct play on the capex of both the industrial (oil & gas) and power-generation sectors. The company has been able to maintain Ebidta (earnings before interest, taxes,depreciation and amortisation) per tonne in a narrow range despite wide fluctuations in steel prices and has been able to grow EPS consistently (a 15% CAGR over the past four years).
Sterlite Technologies: We initiate coverage of SOTL with a Buy rating and a price target of Rs 143. The company has a dominant position in the optical fibre and power conductor businesses, both of which have strong demand drivers in place. The company has recorded an EPS CAGR of above 45% over the past five years (2005-10) and expanded the capacity of both its product lines recently.
SOTL is a play on industrial (largely telecom) and power transmission capital expenditure in India and other emerging countries.