Good entry point in ITC, BoB, Idea

Owing to the all-round rally after the election results, most stocks are trading at rich valuations. Surprisingly, however, some prominent stocks haven’t participated in this rally— between May 16 and June 25, ITC, United Breweries, Adani Enterprises, Bank of Baroda (BoB) and Idea Cellular (Idea) were the top losers among BSE 100 stocks. Three of these—ITC, BoB and Idea — are among the top picks of brokerages and, therefore, offer a buying opportunity.

Owing to the all-round rally after the election results, most stocks are trading at rich valuations. Surprisingly, however, some prominent stocks haven’t participated in this rally— between May 16 and June 25, ITC, United Breweries, Adani Enterprises, Bank of Baroda (BoB) and Idea Cellular (Idea) were the top losers among BSE 100 stocks. Three of these—ITC, BoB and Idea — are among the top picks of brokerages and, therefore, offer a buying opportunity.

Despite recent news reports suggesting excise duty on cigarettes could be doubled or additional duty equivalent to Rs 2 a cigarette stick (irrespective of the length) could be levied in the Budget, most brokerages remain bullish on ITC, given the reasonably strong demand inelasticity in the cigarettes segment and the attractive risk-reward equation. So far, ITC has been able to pass increased taxes to end users, maintaining its profitability. Also, the company is considering increasing sales of 64 mm cigarettes, which will support volumes.

On Thursday, Morgan Stanley upgraded the stock from equal-weight to overweight and raised the target price from Rs 360 to Rs 400. The research house has considered three scenarios. The base case scenario assumes a moderate cigarette tax environment (20 per cent rise in excise in FY15 and, therefore, a three per cent fall in volumes). It estimates ITC posting a compounded annual growth rate (CAGR) of 16 per cent in cigarette earnings through the next three years and assumes profitability in the fast-moving consumer goods (FMCG) business will improve, hotel returns equal to cost of equity through a complete cycle, and higher returns in the paper and agri business, led by the improving macroeconomic environment. Therefore, it estimates FY14-FY17 earnings before interest and taxes growth for non-cigarette businesses will accelerate to 28 per cent CAGR, against 12 per cent through the last three years. Most analysts polled by Bloomberg so far this month have a ‘buy’ rating on the stock, with an average target price of Rs 390 (23 per cent higher than current levels).

At 69.3 times the FY15 estimated earnings, United Breweries is trading at a significant premium not just to Indian FMCG players, but also to its global brewery peers. While the company could benefit from a pick-up in discretionary demand, an unfavourable tax regime and a strict regulatory environment are key concerns, say analysts at Nirmal Bang.

Also, the company’s return ratios aren’t significant (return on equity of 14.1 per cent) compared to global peers, and these are unlikely to pick up soon, given the lack of triggers. Most analysts remain bearish on the scrip and expect a downside of 14 per cent from current levels, with an average target price of Rs 598.

The Adani Enterprises stock had run up significantly on hopes of a Modi-led government at the Centre; since May 16, it has seen a correction. Most analysts remain positive, but say the current stock valuations are fair. However, a few believe there are gains to be made. “We raise Adani Enterprises target price from Rs 291 to Rs 575, driven by upgrade of Adani SEZ’s target price to Rs 255 (from Rs 189); valuing Adani Power at Rs 50/share; better coal trading prospects, led by industrial recovery; and addition to SOTP of Rs 124 for domestic coal mining (earlier part of our option value),” says Gaurav Pathak of Standard Chartered Equity Research.

While its SEZ (special economic zone) business could benefit from higher sales of containers and LNG (liquefied natural gas) terminals, favourable rates will boost Adani Power’s profitability. Trading business will get a boost from a recovery in the coal sector. Analysts expect the company’s debt-to-equity ratio to fall from four to 3.2 by FY16, on strong growth in earnings before interest, tax, depreciation and amortisation. The consensus target price (Rs 433) of analysts polled in the recent past, however, indicate a downside of three per cent.

BoB is also a top pick (among public sector banks) of analysts, as the bank has continuously outperformed its peers on the key parameters of loan growth, asset quality and profitability. At a time when most mid-level and small public sector banks are struggling to cope with higher capitalisation needs (to comply with Basel-III norms), BoB seems well capitalised. Not surprisingly, the stock rallied to Rs 1,009 levels early this year (1.2 times the estimated FY15 book value), outperforming its public sector lender peers. Given the bank’s healthy fundamentals and the expected improvement in economic climate, analysts expect the bank’s stock to fare well. The recent average target price of Rs 980 indicates an upside of 15 per cent from current levels for the stock, being traded at a reasonable 0.9 times the estimated FY15 book value.

Recently, Idea raised funds through a qualified institutional placement (QIP). This will be followed by a preferential equity issue to Malaysia-based Axiata. While the Street cheered the fund-raising plan (enabling Idea to bid effectively for additional spectrum) of Rs 3,750 crore, analysts believe spectrum prices could rise. A potential price war by new player Reliance Jio will increase competition in the sector. Analysts, however, are optimistic about Idea due to its revenue market share gains and strong execution. Most analysts remain bullish on the stock, with a recent average target price of Rs 161 (19 per cent upside). The fact that Axiata paid eight per cent premium (over the QIP price) instills confidence.