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Prized midcap picks you shouldn't miss

Published on Tue, Nov 06, 2007 at 16:01 | Source : CNBC-TV18

Updated at Fri, Nov 30, 2007 at 15:38

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ESS DEE Aluminium | Linc Pen and Plastics | PG Foils |

The midcap index is buzzing with the power, fertiliser and banks sectors witnessing broad based buying. Investment Analyst Mudar Patherya has found Linc Pens and PG Foils to be two interesting stocks from this space.

Commenting on PG Foils, he said that it has been thoroughly discounted on the earnings basis valuations. He feels there's going to be a very sharp earnings rebound and that the company could see earnings in excess of about Rs 12 crore.

Excerpts of CNBC-TV18's exclusive interview with Mudar Patherya:

Q: First your outlook on the midcap space and the way we have been moving on over the last few sessions. Do you think the attention is now going to shift to the broader segment?

A: The terms 'will the attention shift towards the midcaps' is perhaps a little erroneous because I feel the attention in India is always going to be on midcap. People are always going to be look at the next Infosys or next this or the next that. So I think the attention is always going to be on the midcap and even the smallcap.

Q: First start with PG foils that is the stock that you had like for a while. It has lost some ground since last time we spoke to you. What would your call be currently on it?

A: I recommended PG Foils over the last couple of months and I decided not to speak about the company again. But something changed my mind last evening when I read about Emco. It is also into the same business and it was acquired by Ess Dee Aluminum yesterday, the deal size was Rs 35-40 crore. I immediately looked up the results of Emco , I thought it must be a good company, a profit making company otherwise why would Ess Dee be buying it. I was very intrigued by the fact that Emco is a loss making company and that set me thinking. I said if Emco is a loss making company with pretty average turnover and the deal is being pegged at Rs 35-40 crore, then what's wrong with good old PG because PG foils is an equity which at the moment is worth about Rs 7 crore with a stock price of about Rs 70, that makes it a market cap of nearly Rs 50 odd crore for the moment.

I'm saying look at PG because I feel that PG foils could be reporting a post tax profit of nearly about Rs 9-11 crore in the current financial year. This is post tax, post depreciation, post interest, which is a fair amount of money. You have got a market cap of Rs 50 crore and post tax profit of Rs10 crore and discounting of Rs 5 crore.

Now it appears that there is a very big divergence in the valuations. There are some companies that you would actually pay a premium if you wanted to buy them out right and there are some companies you would discount despite the fact that they are earning fairly good money. This is a divergence, and in this divergence you have to see your opportunity, because sooner or later in this sector, if Ess Dee starts scouting around for properties and for capacities, you're surely going to have a scenario where your earnings based valuations would start moving towards acquisition based valuations. That's the opportunity I think PG clearly represents firstly.

Secondly, even on the earnings basis valuations, I think PG has been thoroughly discounted. There are couple of interesting things that you are going to look at in PG. Firstly there is going to be an equity dilution. The Rs 7 odd crore equity that you are seeing now will probably move up to Rs 10 crore. I have the feeling that there's already going to be a very sharp earnings rebound. My estimate is that anything between Rs 9 to Rs 11 crore post tax for the current year and for the next financial year which is 2008-09, we could see earnings in excess of about Rs 12 crore.

So you have a growth scenario coming up, plus you are thoroughly discounted as far as the co-operate valuation is concerned. This makes it a very interesting play.

Q: Give us an idea what is the risk that's really involved because like you said, acquisition valuation, before we see those kick in, it went to just a shade under Rs 100, slid from there to stand at about Rs 74 today, it's has gone up roughly 4%. What are the risks that one need to be weary of before stepping in?

A: I think the big risk is obviously going to be the quality of the management. I think the fact is we don't yet know what the management is going to do in these circumstances and how it is going to grow the business. It's talking a lot of potential, it's talking a lot of promise and I think we need to see that being consummated, we need to see that happening in reality.

The optimism comes from the fact that the last two quarters have been very good. The company is paying tax and whenever you see a company paying a good amount of tax, a high proportion of tax, you can always rubbish it on the ground that they haven't done the tax planning so to speak. But I think, on the other side, you have to start looking into the possibility that the profits are genuine.

Q: The other company that you are recommending is Linc Pens. Essentially the company has a thin margin business, not too much excitement on the financials as we see but it is into writing instruments. What is it that excites you about the business and again if you could highlight the risks involved?

A: In Linc the first thing that comes to mind, obviously whenever you are looking at companies, you got to see whether there is an earning momentum. This means that, if the earnings are gradually beginning to move up, that's good news.

Secondly, the better news has to be that the market hasn't seen and you are the only person having looked at it. In this particular case, I would say that I belong to the minority because in Linc's case, the market cap would be not more than Rs 28 crore. Think for the fact that Linc is a prominent brand and it has reasonable amount of market share in it's space. Agreed that the industry is competitive, but when you look at a brand like Linc and you see that the market cap is Rs 28 crore, I mean if I had Rs 28 crore and a little amount of money in spare cash, I would probably go and buy the entire company.

Rs 28 crore and also looking at the possibility that they have already earned Rs 3.3 odd crore as EBIDTA for the second quarter, annualize that. Obviously annualization is not so easy as the business is little seasonal, in some seasons you can buy pens and in some season you don't buy so many pens because there is a school factor and an academic calendar factor involved.

Financially my estimate is that it should report a post tax of somewhere around Rs 6.5 crore, which is an Rs 8 EPS. Now, a very simplistic perspective is that if you have a stock which is Rs 35 with Rs 8 EPS, that's a P/E of less then Rs 5, that's after paying tax. If you take the EBITDA into account then you have a market cap of Rs 28 crore and EBITDA of about Rs 10 to 12 crore which I think is the straight bargain.

Despite the fact that the industry is the low margin business you have got a great valuation so there you are.

Disclosure:

Yes, I have invested. I won't stand here and recommend it to the world if I haven't put my money where my mouth is.