Kotak Institutional Equities' latest report highlights companies with inflated market caps despite lacking profit margin opportunities. The report highlighted a clear disconnect between narratives and numbers, with certain stocks' market cap not matching their best-case profit projections.
While acknowledging themes like electrification and increased defence spending, Kotak questioned the high market cap of the 'beneficiary' companies.
Kotak cited BHEL as an example of inflated market cap. BHEL's stock surge added Rs 77,800 crore in market cap last year, far exceeding the thermal BTG industry's profit pool of Rs 32,000-64,000 crore, assuming India meets its FY2032 target of 80GW new thermal capacity. On an NPV basis or with lower margins, this profit shrinks further. BHEL's market cap implies it must execute 25 GW of annual thermal orders indefinitely, which is unrealistic.
BHEL's current market cap of Rs 1.10 lakh crore suggests 20-30 GW of annual BTG sales indefinitely. This implies an annual thermal capacity of 10-15 GW, with a 5% PAT margin. The implied PAT ranges from Rs 7,300-11,000 crore and annual sales from Rs 1,46,900-2,20,300 crore, based on Rs 80 bn per GW, suggesting BHEL needs 18-28 GW annual sales.
Kotak also cited Cochin Shipyard Ltd (CSL) as an example. CSL's stock price surged, adding Rs 67,300 crore in market cap over the past year and Rs 51700 crore in the past three months. This contrasts with a hypothetical profit pool of Rs 5,000-9,000 crore, assuming a new aircraft carrier costs Rs 40,000-50,000 crore with a 12-18 percent net profit margin. CSL's NPV-based value accretion is lower due to the long construction and delivery times for aircraft carriers. This situation may limit CSL's ability to pursue other opportunities. Kotak analysis suggests CSL would need to deliver 9-13 aircraft carriers. For context, the US has 11 aircraft carriers and China has three.
Kotak also highlighted Eicher Motors Ltd, Hero MotoCorp, and TVS Motors, which collectively added Rs 1.8 lakh crore to their market cap since March 2023. Kotak's reverse valuation exercises, factoring in current high profitability, suggest that India’s two-wheeler market must significantly expand beyond current levels to justify these stocks' combined market cap.
However, the Indian two-wheeler market is yet to recover to FY19 levels. The current elevated profitability and high return ratios are expected to be unsustainable in the long term. For instance, EIM would need to sell 3 million two-wheelers by FY35 and almost 6 million by FY40 to justify its current stock price, while HMCL and TVSL face similar challenges in scaling sales to meet market expectations.
Kotak also finds many PSU stocks' valuations bizarre compared to their fundamentals. Most trade at high P/E, P/B, or EV/assets ratios despite stagnant or declining fundamentals, with some even reporting losses. Significant operational and financial turnarounds would be needed for these companies to justify their current market cap.
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