KNR Constructions, Repco Home Finance and Ratnamani Metals and Tubes are Vinay Khattar, Associate Director & Head of Research, Edelweiss Financial Services’ three multibagger picks from the midcap space.According to him these are structural bets. Especially, with the economic cycle beginning to pick up in India, one need not hold on to these stocks with a price target but hold on till the structural story continues.He has a buy on KNR Construction with a price target of Rs 341. The company is well equipped for revival and has a strong track record for executing projects ahead of schedule, he said.The company is poised to growth on back of improved outlook for the road sector, he said.Repco Home Finance is standout amongst other finance companies because significant number of their borrowers are non-salaried and even then the defaults have been very low for the company so far. According to him Repco is a compounding growth story and would grow 20-25 percent its book size. The house has a price target of Rs 595 Repco has remained a buy call since it got listed and the price targets would keep getting revised upwards, said KhattarRatnamani Metal and Tubes, which is into manufacturing carbon steel pipes and stainless steel pipes competes with international players in India and abroad. It is in a tough business of supplying pipes to refineries, thermal power plants etc. He believes the stock is poised for re-rating driven by robust sales growth backed by strong order book.
Below is the transcript of Vinay Khattar's interview with CNBC-TV18's Menaka Doshi and Senthil Chengalvarayan.Menaka: First a comment on the overall midcap space and where you think that is headed before we get into your specific stock picks?A: If you look at the overall midcap space we have seen prior to the current year midcaps were trading at significant discounts to the largecap. There was a big valuation difference which has been catching up very significantly.The entire valuation gap which existed between largecap and midcap has mostly gone away and if you were to look at just basket to basket you are trading right now at neutral kind of valuation and this gap could become positive for midcaps. Normally during the bull market cycles midcaps tend to trade at a premium or at higher multiples as compared to largecaps. So, that is one vector which is playing out.Secondly across the sectors where you had significant beating down of smaller and midcap companies all that has begun to change in a significant manner because even for little bit of positive tailwinds you begin to see order traction, you begin to operating leverages playing out, you begin to see significant upticks on bottomlines beginning to happen.So, that is what is playing out currently. Market is expecting midcaps to do very well over next 2-3 years and that is where lot of small investors are putting their money in.Menaka: Of the three stocks that you are going to talk to us about today, first one if we can go to KNR Constructions, detail for us why you like that stock so much?A: If you look at KNR Construction it is in the road EPC business that means it executes road projects. Road sector has two models, one, EPC where you just execute and take your money and go off. Second is you bid for a particular road project, you build it at your own cost and then you transfer it back and then you put a toll on it.KNR has been into the EPC side of the business which is relatively asset light. You don’t have to put too much of capital into it.Secondly because of this reason its debt has been pretty low on the balance sheet and balance sheet has stayed much healthier as compared to lot of its peer group where the debt has been very high and balance sheet is stretched.If you were to look at what has happened in last two months NHAI has put almost 5000 kilometres worth of tenders out which are likely to be completed over next 3-4 months. Now because of these NHAI tenders almost 3000 kilometers of EPC projects are going to be out where KNR could be a very big beneficiary. So, a very good quality balance sheet, very high quality execution track record, large number of NHAI tenders coming out all are going to be significantly positive for KNR. Our sense is that this stock could trade much higher over next 2-3 years.Menaka: It also has a small irrigation business? Do you see big potential there as well?A: There could be some potential there as the government focuses on the rural parts of the country and irrigation is one of the key areas where the government would want to focus on. Irrigation could be a potential business for lot of companies including for KNRs business. However right now the overall influence and the heavyweight impact the company will see is on the EPC side of the business and that is where we are betting on.
Senthil: How is the management pipeline because the story of lot of companies like this is that they are great when they are operating in the space that they are in, the moment they start expanding into other areas and you pointed out in your report that they could bid for other new verticals, the management gets stretched. A: That is a risk that you carry in a lot of midcaps and smallcaps. If you find that management ends up diversifying too much or they go into non-contiguous area from their current businesses or fetter away their meagre resources you could find that the companies resources as well as balance sheet gets stretched and you may not necessarily get the returns. Having said that in case of KNR we find that the immediate triggers would limit KNR to the EPC contracts on the road side and hopefully KNR will stick to more on the road sector and continue to do well from here.Menaka: The stock is already up over 200 percent year to date. What is your price target on this? Do you think that from a valuation point of view there is much more to go?A: The way we look at it is that the stock is up and from the point we recommended it, it is up significantly but these are structural buy's. So, if you are going to be holding onto KNR for 2-3 years you would get significant uptick.If you were to just look at specifically the valuation it is trading at almost 10 times one year forward which is not necessarily cheap. However you don’t have to much of value available in the midcap space across sectors now given the kind of rally that you have seen in 6-9 months. So, are we looking at value picks or are we looking at good compounding stories? KNR would fall into the second basket of a very good compounding stories and that is what we are betting on.
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Menaka: The second stock that you have picked out is Repco Home Finance. This is a space that has been very interesting with regards to several companies in this space. Many people have been very attracted to this space. Why does Repco stand out for you?A: The space is extremely interesting and that’s what excites us. Repco is into small ticket home loan finance. There is a part of the book which is devoted to loan against property which is almost about 15-20 percent of their overall book size.Repco provides small ticket homes in the region of Rs 10-12 lakh which is the average ticket size in tier II and tier III towns. A significant number of borrowers are in the non-salaried segment and that is where we feel Repco differentiates against the competition. It is relatively easy to lend to a salaried individual but the moment you go to a non-salaried individual, a small business owner there is a higher degree of risk, that means your loan or your EMIs will not get paid back in time. That’s what Repco has mastered itself at.
If you actually look at the amount of write offs, the write offs that Repco has done over its history are extremely meagre. That means you have ended up giving loans to people who may not have been in a position to pay you in a timely manner but the actual default rates have been very low which shows off in Repco\\'s numbers. So, you have a RoE of almost 2.5 percent which leads to a higher return on equity.If you were to look at just the numbers part of it, it is quite comfortably placed in terms of capital. Capital adequacy ratio is more than 20 percent. Company could continue to grow at 25-30 percent its book size over the coming years and that’s what is very interesting in this company.
Senthil: It is trading at about 4.5 times book. As you pointed out it is in a riskier business than lending to pure salaried class. So, at 4.5 times you think it is not too expensive?A: There is not too much of value around there. I don’t think it is very expensive but neither cheap. It a great compounding story from this point forward.If you look at the last quarters numbers topline has grown by almost 30 percent odd. Disbursements have grown by about 27 percent odd. If you look at the overall space you are moving lower on the interest rates, it is anytime possible that the RBI would cut rates, which is going to be positive for the entire rate sensitive sector including Repco.The more we talk about smaller cities and urban development and 100 smart cities agenda of Modi government, players like Repco are going to be in a very sweet spot to have a higher disbursal growth rate and that’s what attracts us.Senthil: Your price target of Rs 595 is 10 percent away by when do you expect that to be hit and would you consider revising that because the growth in these housing finance companies has been mind boggling in stock prices.A: You are absolutely right. This has been our buy call from the time it got listed at about Rs 170 couple of years ago. The price targets would keep on getting revised upwards. These are structural stories that we want to advice our clients to retain irrespective of the price targets till the time the valuations remain in a limited comfort zone. These are structural stories that you would want to hold on to and play on as the economy grows and the sector grows.
Menaka: These new NBFC norms that RBI has announced will they impact the company negatively? It is a phased application of these norms but nonetheless. A: It is a phased application of the norms. So, in terms of standard asset provisioning which has moved up from 0.25 to 0.40 certain restrictions in terms of tier I capital and so on, a company like Repco is in a very sweet spot because it is much ahead of the curve. Given the easy timeline that the RBI has provided we don’t expect too much of an impact going forward. Menaka: Lets move to the third pick then which is Ratnamani Metals and Tubes, talk us through the investment case here? A: Ratnamani is a pipe manufacturing company. Like lot of its peers it is into carbon steel pipes which is a more commoditised kind of a business. These pipes are used everywhere. The second part of the business which is relatively smaller is the stainless steel pipe business. Stainless steel pipe business is a much more robust business. Here the company makes better margins. These pipes are used in very difficult environment, they are used in nuclear power plants, they are used in refineries, they are used in thermal power plants. So, these pipes are subject to very high degree of acidic environment, temperatures and so on and so forth. Hence the quality of the product here has to be very good. Ratnamani competes with major international players both in India and abroad and that’s what makes this company\\'s product proposition pretty strong. It is already registered with the major guys in the world. International opportunity on the stainless steel pipe could be very interesting for this company and that is one of the reasons why we picked it up. The second reason what makes Ratnamani attractive is that on the carbon steel pipe business because of the huge amount of headwinds that the economy was facing over last 2 or 3 years you saw utilisations were pretty low. Ratnamani had tried to stick to minimum margin wherever it could but it did not go and over bid just to use its assets. Now with the tailwinds coming in you are having a situation where the operating leverage is going to pick up, this will cause profits to jump up in a very significant manner which you have seen happening in this quarter. So, that is the bet on Ratnamani.
Menaka: At least a quarter of its business comes from exports. Much as that’s an opportunity has you spoke about because the market outside is much bigger than the market in India. It is also a bit of a threat at this point in time given where global demand is?A: It is a bit of threat given where the global demand is but if you look at the over all penetration which Ratnamani has achieved in the global market and the cost advantage it has over its peers we believe that Ratnamani will be able to face those headwinds even if they emerge in a appreciable manner. Overall if you look at the refinery capex which could be picking up in US though the Europe continues to remain very much down and the petchem capex which could be picking up in certain other parts of the world it is possible that Ratnamani would be able to face those headwinds in an amicable manner.Menaka: What is your price target on this one?A: These are structural bets. At this particular point in time you are just at the beginning of the economic cycle pickup happening in India. You won't really want to keep this stock in your portfolio with a price target in mind. You would rather just play the economic cycle as it picks up over the next 2-4 years and just hold on to this one till the time the structural story continues. Disclosures: It will be safe to assume that these stocks could be in my own or my client's portfolios.
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