Biocon merger is earnings dilutive, avoid EMS sector for now, says Dharmesh Kant

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Market expert Dharmesh Kant has voiced a cautious outlook on Biocon following its recent merger, and has recommended avoiding the electronics manufacturing services (EMS) sector for the time being. Speaking with CNBC TV18, Dharmesh Kant, Head Research at Chola Securities, said that while the street may have anticipated the move to make Biocon Biologics a 100% subsidiary, the deal is likely to be dilutive to earnings per share (EPS).

Delving into the Biocon deal, Kant pointed out that the company has historically been 'over-hyped', with its performance not always matching expectations. He highlighted that over the last decade, Biocon's profitability growth has been modest, at around 9-10%, while its return on equity (ROE) has remained in the mid-single digits. He believes the current merger is not value accretive. "With this merger coming into play, it's not that it's value accretive or EPS accretive, I think it's EPS dilutive," he stated. The dilution is expected to come from two primary sources: the upcoming qualified institutional placement (QIP) and an increased debt burden that will lead to higher expenses.

According to his analysis, it could take a year to a year and a half for the synergies from the merger to fully materialise. He also suggested that the company pursued this route to prevent 'value dilution' that might have occurred with an initial public offering (IPO). Consequently, Kant anticipates a correction in Biocon's stock, which he believes could persist for about a year until the company demonstrates a return to a double-digit growth trajectory.

Shifting focus to the EMS space, the expert addressed the recent pressure on stocks like Kaynes Technology and PG Electroplast. He clarified that the issue is not isolated but rather a sector-wide phenomenon. "There has been a deceleration in the entire EMS space that we have seen, be it PG Electroplast or the others in the play like Kaynes, Dixon, Amber. Everybody is facing the heat of decelerating business growth trajectory," he observed.

Two major headwinds for the sector are uncomfortable valuations, which he described as 'pretty high', and the prospect of intensifying competition. He specifically mentioned the potential for increased competition from Larsen & Toubro (L&T) as it plans a significant foray into the EMS market in the coming years.

For PG Electroplast in particular, a significant factor is the pending approval for a technology transfer tie-up with a Chinese firm for air conditioner compressor technology. He noted that if this permission is granted, it could be a 'different story' for the company, as this technology is currently elusive for Indian manufacturers. However, pending this development, his overall call for the EMS sector is one of avoidance. He suggested that while some stocks might see a bounce-back, it would likely be a temporary rebound rather than a structural recovery, advising investors to stay away from the space for some time.