'India's long-term outlook is good; invest in these 5 stocks for double-digit returns'

Of the various factors needed for cyclical and mid and smallcap outperformance, we believe that quite a few are in favour, namely better-than-expected monsoon, government and RBI attention to turn around the flagging economy, favourable valuations, crude prices closer to $60, yields below 6.5 percent and last but not the least a stable government at the center.

Also globally, sentiments could improve, if a comprehensive trade agreement between US-China, which could be perceived to reduce worries on the much forecasted US recession in 2020.

Overall, the long term economic backdrop for the Indian economy looks good and we can expect the coming quarters having stability in the capital markets. It will be advisable for investors to buy in a staggered manner at these levels and also allocate a certain proportion of their corpus to good quality midcap companies.

Here are five buying ideas which could give 8-82 percent return in the next one year:

Sonata Software | Target Rs 390

IP-Led revenue on an upward trajectory, cash generation improves with the company’s continuous focus on platforms and IP-led solutions, 24 percent of IT revenue was IP-driven, which rose 12 percent QoQ.

Higher growth in domestic business led to low margins, Sonata's Q1 was in line with expectation. On the greater contribution from the domestic business, the EBIT margin slid 88bps QoQ to 9.2 percent, down 100bps YoY. No major revisions in earnings for FY20/21.

Better cash generation, DSO days came down sharply to 37 (weighted average) versus 44 in Q4 FY19. In-line quarter (except for the weak UK, a trend in IT services) with no major change in FY20e/21e as management guided to a sharper recovery in Q2.

City Union Bank | Target Rs 240

Backed by strong treasury gains and lower tax despite lower margins and higher opex, the strong headwinds of rising costs and lower yields pushed down City Union’s NIM. However, with its asset quality more stable than its peers, sturdy capitalisation and focused SME and retail lending strategy, we expect its good profitability to endure in the medium term.

Pressure on yields shrinks NIM, while profitability was intact. NIM was 3.91 percent, the cost of funds, however, also declined (14bps QoQ).

The expected lower cost of funds would counter further pressure on yields, supporting margins at current levels. With management’s intention to slow down deposits growth and improve the C/D ratio, NIM could expand in coming quarters. Higher Treasury gains and the lower tax rate counterbalanced the lower margins, keeping the RoA at ~1.6 percent.

We expect the overall asset quality to be stable. Besides, with 15.5 percent capital adequacy (15 percent tier-1), the bank is sufficiently capitalised for mid-teen loan growth in the medium term.

Our Nov 2020 target of Rs 240 is based on the two-stage DDM model. This implies a 2.8x P/BV and 3x P/ABV multiple on its FY21e book. The risks include higher slippages and lower-than-expected loan growth.

ICICI Lombard General Insurance | Target Rs 1,450

ICICI Lombard General Insurance Company registered a de-growth of 16.4 percent year-over-year (YoY) in gross direct premium income (GDPI) to Rs 29.53 billion in Q2FY20, reflecting the company's continued move to reduce exposure in crop segment.

Excluding the crop segment, the GDPI growth rate was 14.5 percent YoY. Net Premium earned increased 6.1 percent YoY Rs 23.57 billion in Q2. The company witnessed growth across its preferred segments including fire, marine, motor, liability and health.

Underwriting loss significantly narrowed to Rs 87.6 million in the quarter, compared to Rs 214.9million in Q2FY19. PAT grew 5 percent YoY to Rs 3.08 billion in Q2FY20. Notably, the previous year included the benefit of one-off reinsurance recovery of Rs 0.58 billion. Excluding the one-off impact, PAT grew by 20.6 percent in Q2FY20.

Management remains focused on expanding its distribution network with efforts to increase presence in tier 3 and tier 4 cities while continuing investments in technology and branding.

Management reiterated its ROE target of 20 percent on an annual basis. In terms of pricing, management noted that it sees continued stress in motor own damage pricing. Except for Motor OD, the pricing environment for all other segments remains largely reasonable.

On regulatory development, management believes the Motor Vehicle Amendment Act 2019 that went effect from August 9, 2019, is positive both for the insurers and the insured with increasing penetration in motor third-party segment.

Also, it believes that the introduction of a time limit for claim integration may reduce claim incidents. Additionally, management noted that the recent reduction in tax rate results in increased disposable income for the company which it plans to reinvest in the business in areas such as increasing headcount, technology, etc.

We have incorporated latest quarterly numbers for ICICIGI and have revised our estimates for the company. Given ICICIGI's continued premium growth in preferred segments (fire, marine, motor, liability and health), consistent efforts on driving retail business and management's expectations of maintaining ROE of 20 percent, we continue to remain positive on the company for medium-term with a target price of Rs 1,450 per share.

Sagar Cements | Target Rs 737 

Weak demand hit Sagar Cements’ Q2 operating performance, though better y/y realisations on the low base and continuing efforts on cost-saving initiatives drove overall profitability.

Despite the quarterly drop in realisation and volumes, we expect cement prices to rise on a pick-up in demand mid-Nov, which would lead to a better operating performance in coming quarters. The proposed expansions in the Centre and East are on track and would help the company diversify. However, this would keep leverage high.

The prolonged monsoon, slowdown in projects due to liquidity constraints and sand non-availability resulted in sluggish demand with volumes declining 0.9 percent YoY, whereas realizations stepped up 3.9 percent YoY to Rs 3,734/ton on the low base. This led to a 3 percent YoY increase in cement revenue to Rs 2.65 billion. We expect revenue to clock a 14 percent CAGR, backed by a 7 percent volume CAGR over FY19-21.

Several cost initiatives (thermal plant efficiency, reduced lead distance, and favourable fuel mix and pet coke price decline) brought some respite, resulting in Rs 596 EBITDA/ton, up 103 percent YoY on the low base.

On the ramp-up of the WHR plant, the 18 MW thermal plant commissioning and savings in logistics costs on account of sales reallocation, we expect EBITDA/ton to touch Rs 815 by FY21, versus Rs 428 in FY19.

With a better pricing scenario on a demand pick-up from mid-Nov and continuous cost optimization steps, the operating performance is expected to improve. Post-capex expansion in FY21, net-debt-to-equity will be 0.8x.

On completion of the ongoing expansion plans Sagar’s capacity is set to hit 8.5m tons in FY21, enhancing its access to the East and Central markets. We retain our buy rating, with a target price of Rs 737 (earlier Rs 823), valuing the stock at 8.5x FY21e EV/EBITDA and an EV/ton of USD 39.6.

HDFC | Target Rs 2,539

HDFC reported consolidated revenues of Rs 231,247 million in Q1FY20, registering a growth of 17.7 percent on YoY basis. The company witnessed growth in its businesses including life insurance, general insurance and asset management.

Consolidated net profit increased 5.2 percent YoY to Rs 30,944 million in the quarter. On a standalone basis, the company reported a 30.6 percent YoY increase in revenues to Rs 129,903 million. The NII for the quarter increased 11 percent YoY to Rs 30,420 million.

Notably, the quarter included a significantly higher amount invested in high-quality liquid assets given the current liquidity scenario. PAT jumped 46.3 percent YoY to Rs 32,031 million reflecting profit on the sale of investments on part stake sale of GRUH Finance.

As of June 30, 2019, the loan book stood at Rs 4,165,970 million, recording a growth of 11.2 percent YoY. The spread on loans over the cost of borrowings for the quarter was 2.25 percent, down from 2.28 percent in the previous year quarter, while NIM remained stable at 3.3 percent.

Management continues to see strong demand in the individual segment, particularly from middle-income group while the high-end market remains a bit challenged.

We believe HDFC will continue to benefit from its strong market position, continued growth in loans, healthy asset quality and stable spreads. Also, favourable government policies and initiatives focused on affordable housing creates impetus in the housing sector.

We have updated our estimates factoring in latest numbers and continue to remain positive on the company and maintain our buy rating with a target price of Rs 2,539 per share.

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