Portfolio rejigs: Injecting high-conviction ideas amid changing investing landscape

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Moneycontrol Research Team

In our constant endeavour to enhance portfolio performance, capture valuation arbitrage opportunity and focus on high conviction ideas, we are making a few changes in our three key portfolios -- Diwali, Large cap and Mid cap while keeping our Electric Vehicle portfolio intact.

Large cap – Changing sectoral trends: Include HCL tech, ICICI Bank, and Dalmia Bharat

Source: Moneycontrol

In order to capture new sectoral flavours and insights, we are replacing Symphony and UltraTech with HCL Tech, ICICI Bank, and Dalmia Bharat.

Symphony reported a subdued set of numbers in Q1FY19 because of pricing pressure, inventory buildup across trade channels, unfavourable climatic conditions and a weak demand scenario. Such a weakness in an otherwise seasonally strong quarter is expected to have a cascading effect on the FY19 numbers as a whole.

UltraTech has delivered more than 15 percent return since inclusion in the Large Cap portfolio and the current valuations (FY19 EV/EBITDA of 18.5x) appear little stretched from a medium-term perspective.

In contrast, Dalmia Bharat is trading at a 25 percent discount to UltraTech. Dalmia Bharat, India’s fourth largest cement maker, delivered another quarter of strong double-digit volume growth for the third consecutive quarter. Stable cement prices and a richer product mix boosted revenue for the quarter gone by. Profit margin dipped marginally quarter-on-quarter (QoQ) as the company managed input price pressures with effective cost management.

Two other stocks which capture recent improving growth visibility in the IT and finance sectors are HCL Technologies and ICICI Bank.

Despite a moderate performance in the first quarter of FY19 and unchanged guidance for FY19, HCL Technologies' (HCLT) show was impressive due to the record deal wins and a positive commentary on the road ahead. While the company hasn’t yet reached the inflection point to meaningfully see the benefits of the virtuous cycle where the legacy business is more than compensated by next-generation offerings, it is directionally on the right track. We see little downside in the valuation of 12.9x FY20e (estimated) earnings. The stock, therefore, should form a part of investors’ portfolio.

ICICI bank has had a rough run in the past few years with bad loans from the corporate exposure piling up. With its 2020 vision in place, investors should expect much lower non-performing asset (NPA) formation and normalised credit cost in FY20, mid-teen loan growth and commencement of the journey to reach RoE of 15 percent. With a potential improvement in return ratios, the current valuation of its core book at 1.1 time FY20e price to book value (P/BV) is undemanding. In fact, ICICI bank is trading at a significant discount of over 30 -40 percent relative to its closest corporate lending peer, which is also facing asset quality issues and uncertainty over impending management change. While the asset quality pain might persist in the near term and FY19 may remain a year of consolidation due to higher credit costs, the risk-reward is extremely favorable. We add the stock as a long-term bet as it is attractively priced and the end to asset quality woes seems certainly near.

Midcap portfolio rejig: Replacing Sanghi with Automotive Axles

Source: Moneycontrol

Sanghi Industries, the Gujarat-based cement manufacturer had a subdued Q1FY19 due to multiple problems at the same time. The earnings visibility looks weak for the short term as raw material availability, fuel prices and other cost pressures (external factors) will continue to weigh on margins and earnings for at least 2 quarters. We, therefore, find it prudent to exclude it from the midcap portfolio for the time being and will evaluate it again after next quarterly results as we have a positive view on the cement space.

We are replacing this with Automotive Axles (AAL), which has corrected by 27 percent from its 52-week high despite a very strong set of quarterly numbers and positive outlook.

AAL manufactures drive axles, non-drive axles, front steering axles, specialty and defense axle. It also manufactures drum and disc brakes. The company caters to major original equipment manufacturers (OEM) in both domestic and export market in M&HCV, off-highway and aftermarket segments. With strong clientele in its kitty, industry tailwinds on the back of focus on infrastructure, increase in mining activity, and good monsoon coupled with reasonable valuation (16x FY20 projected earnings) earns it a place in our mid cap portfolio.

Diwali portfolio: Bringing Reliance Nippon and Dilip Buildcon in place of Tata Sponge and SpiceJet

Source: Moneycontrol

We are exiting Spicejet and Tata Sponge. While Tata Sponge continues to do well riding on the strong cycle in the steel industry lack of immediate growth calls for an exit. It is operating at over 110 percent capacity utilisation and there is no major capex in the near term.

In the case of SpiceJet, the headwinds confronting the industry makes us cautious. Passenger yields pressure on the back of fever pitch competition, a significant rise in air turbine fuel (ATF) prices and rupee depreciation are near-term challenges. While we like a couple of aviation stocks, we believe it will take some time for the industry and company to come out of these challenges.

We are adding Reliance AMC (RNAM). The company, with an 11 percent market share, strong retail brand, and well-diversified sourcing platform, will continue to be one of the key beneficiaries of the rapid growth in the mutual fund industry. Current valuation looks compelling given RNAM’s track record and financials. At the current market capitalisation of Rs 14,700 crore, RNAM is trading at 6 percent of its trailing asset under management (AUM), which is more than 50 percent discount to HDFC AMC’s current valuation. While HDFC AMC will always trade at a premium valuation, we expect valuation gap to narrow down and see more upside to RNAM’s stock price in the medium term. The financial problems of the ADAG Group—of which RNAM is part of, has hurt sentiment for the stock. But Nippon Life being an equal partner with 42.88 percent stake in the asset management firm, helps assuage the concerns.

Further, we incrementally prefer Dilip Buildcon (starting with a weightage of 2 percent), which has got good earnings visibility led by a strong order book. The stock is trading at 12 times its FY19 estimated earnings despite 30 percent return on equity, 25-28 percent earnings growth over the next two years.

For more research articles, visit our Moneycontrol Research page