Motilal Oswal’s 10 stock picks for September 2020

stock market, stock market investment, stocks, top stocks, top 10 stock picks, Motilal Oswal, Motilal Oswal's 10 stock picks for September 2020, TCS, Infosys, HDFC BankThe key aspects considered for creating this basket are – 1) Strong businesses with visibility of revenue for the next 12 to 24 months, and 2) Relatively lower impact of post-Covid consumer behaviour.

Renewed investor interest is being witnessed in the equity market, which is evident from the performance of the Nifty and the Mid-Cap Indices during the past 12 months (Nifty up 5% and Mid-Cap Indices up 8%). We have also seen higher retail activity on the exchanges (retail share in the cash segment is at an all-time high – 72%).

Here’s a stock basket curated by the MOFSL Research Team to help retail investors participate in the market.

The key aspects considered for creating this basket are:

1. Strong businesses with visibility of revenue for the next 12 to 24 months.
2. Relatively lower impact of post-Covid consumer behaviour.

One can also consider building such basket through the SIP route:

1. TCS

Deal wins were stronger for TCS. More importantly, continued traction in large deals, a healthy pipeline, and better resilience in BFSI are encouraging factors. Management believes the worst impact of COVID-19 is behind (both in terms of revenue and profitability) even as some variables such as pricing and working capital cycles warrant a close watch. TCS has a historical track record of adapting to multiple business challenges and technology change cycles. Additionally, it has consistently maintained its market leadership, best-in-class operational metrics, and high return ratios. While the peak of COVID-19-led uncertainty may be behind, near-term negative surprises related to demand, pricing, and collections cannot be ruled out. Nevertheless, TCS should be able to better navigate through these challenges (v/s the rest of the industry). Over the medium term, we expect TCS to be a key beneficiary of the COVID-19-driven increase in technology intensity across verticals.

2. Infosys

Infosys delivered strong beat on both revenue and margin front in its Q1FY21 earnings. Notwithstanding the higher variable payouts, the company delivered robust margin expansion. Notably, this was witnessed in a quarter that has faced significant disruption on both the demand and supply fronts. Deal wins (~USD1.7b, ex-Vanguard) and the deal pipeline both remains healthy. The reinstatement of revenue (0–2% YoY, CC) and margin (21–23%) guidance is a key morale booster. We expect Infosys to be a key beneficiary in terms of recovery in IT spends in FY22. Additionally, as the COVID-19-led disruption eases, we expect further expansion in margins as investments stabilize and back-ended productivity benefits kick in. This should translate into strong outperformance on EPS growth (v/s the sector). As its outperformance v/s TCS continued in this quarter, we expect the valuation divergence to narrow (to 10%).

3. Dr. Reddy’s

Dr Reddy’s (DRRD) delivered strong 30% YoY growth in 1QFY21 earnings, led by a superior show in Pharmaceutical Services and Active Ingredients (PSAI) / EU and other emerging markets. We expect a 21% earnings CAGR over FY20–22, led by a sales CAGR of 6% in the US, 19% in DF, and 23% in PSAI, supported by 340bp margin expansion. DRRD is well-placed, supported by: a) limited price erosion in the base business, b) robust ANDA launches for the US segment, c) improving benefit from cost rationalization, d) a favorable demand-supply scenario in the PSAI segment, and e) synergy benefit through the addition of the Wockhardt portfolio.

4. Laurus Labs

After a long wait, the efforts towards product development/ building manufacturing base are reflected in the phenomenal financial performance of Laurus Labs. In fact, 1QFY21 redefines the earnings assessment over near to medium term. LAURUS has shown strong improvement in performance, with PAT doubling to INR2.5b in FY20 and coming in at INR1.7b in 1QFY21. We expect 2.7x FY20 earnings for FY21, primarily led by a doubling of formulation sales, 30% YoY growth in each API and CDMO segment supported with ~780bp margin expansion. We expect the API business to have a 20% CAGR in the API segment over FY20–22. We remain positive on Laurus on the back of superior execution across revenue segments, resulting in expansion of ROE to 32% and sufficient levers to sustain the earnings momentum over the medium term.

5. Bharti Airtel

BHARTI has delivered strong execution in the last few quarters, with industry leading revenue growth, ARPU increase and 4G subscriber adds. This should help Bharti generate healthy FCF/subsequent deleveraging in the future. However, any tariff hike or change in the structure of price plans would be to leverage increasing data growth, which remains the key growth lever and may stretch beyond 1-2 quarters. With SC verdict out on AGR payment timelines, we expect Bharti to be able to manage the payment with FCF post-interest of >INR100b/INR200b in FY21/FY22, with no tariff hike built-in and net debt of INR1,095b in FY21, including the AGR liability (net debt to EBITDA of 2.8x on pre-Ind-AS 116). With this verdict, balance sheet would weaken. We believe that with the Smartphone market largely settled and prevailing low ARPUs, there is a strong case for price hike. We believe that Bharti has the best hedged position. In order to survive, if VIL triggers a price hike or if the market turns duopoly, Bharti would benefit significantly in both cases, with a potential EBITDA increase of >100–120b.

6. Reliance Industries

RJio enjoys market leadership position in a 4-player industry with stretched balance sheet of competitors. Thus, it could leverage its position as a price maker to drive ARPU. Furthermore, the company is in the process of transforming from a telecom player to a digital company with an ability to expand revenue stream to multiple categories. The higher multiple captures the digital revenue opportunity, expected gains from any potential tariff hikes, growing market share and possible rationalization of tax levies for the sector, which are not built into our estimates. In a deal that could well shape the Organized Retail sector in India, RIL, through its retail subsidiary, Reliance Retail Venture Limited (RRVL), announced the acquisition of Future Group’s Grocery and Apparel Retail formats on slump-sale basis at INR247b recently. We expect robust revenue/EBITDA CAGR of 27%/49% over FY20-22E. Jio Platforms has raised INR1,520.6b across 13 investors with RIL holding ~66.48% equity stake on fully diluted basis. Of the total funds raised, INR229.8b would be retained in Jio Platforms while the rest would be used for optionally convertible preference share (OCPS). Our premium valuation underscores Reliance Retail’s aggressive footprint addition and the recent Jiomart led online opportunity, which could offer huge growth potential over time.

7. Hero Motocorp

HMCL has posted a notable operating performance in these tough times. The narrative around rural demand is positive, but supply chain ramp-up and broad-base demand are important for demand sustainability. Considering the favorable outlook for rural, HMCL should continue to see good demand recovery. However, considering sharp price increase over the last two years, we see the risk of an adverse mix restricting margins and EPS growth (8% CAGR over FY20–23E). Our target multiple is at a ~13% discount to the five-year average PE of 18.4x, factoring a changing growth profile, competitive positioning, and changes in the RoE profile. Sustained market share gains in Premium Motorcycles and Scooters could act as re-rating drivers. We upgrade our EPS estimate by 9% for FY21 to factor faster volume recovery.

8. HDFC Bank

HDFCB has been able to deliver its usual earnings growth trajectory. However, the COVID-19 pandemic has induced volatility on certain operating parameters like fee income and opex. This in turn has heavily dented loan origination across retail segments. Overall performance of the bank should remain steady and we expect the bank to offset near-term pressure on other income via tight control over opex. RBI approving the appointment of Mr Sashidhar Jagdishan as new MD & CEO addresses a key overhang. Moreover, succession by an internal candidate augurs well to boost investor confidence and continue the immaculate performance experienced by the bank under the leadership of Mr Puri. We expect HDFCB’s strong liability franchise and the fixed-rate nature of the book to support margins even as the bank maintains higher liquidity to navigate through the crisis. On the asset quality front, slippages are likely to pick up in 2HFY21 due to the COVID-19-led disruption, which could keep credit costs elevated. However, higher provisioning buffers should limit the overall impact on earnings. We estimate HDFCB to deliver 17% earnings CAGR over FY20-22E and RoA/RoE of 1.9%/16.9% in FY22.

9. SBI Life

SBILIFE’s strong parentage and wide branch network provides it with a distinct distribution advantage over its peers, helping it to maintain low cost ratios and capitalize on the large clientele of SBI (449m), thus, providing it with a long-term structural growth story. SBILIFE has reported an improvement in persistency trend over the years, led by focus on garnering a better quality business and need-based selling. 13th month persistency improved to 86%. It maintains the highest 61st month persistency at 60% (v/s peers), and thus, is supported by healthy growth in renewal premium. SBILIFE is also looking to optimize its product mix and is focused on improving its competitive positioning in the Protection/Annuity business. This should aid VNB margin expansion to reach ~21% by FY23E, which should drive 17% CAGR in VNB over FY20-23E. SBILIFE is in a sweet spot given its strong distribution network, cost leadership and access to its parent SBI’s large customer base. Overall, we expect operating ROEV to normalize toward 18% levels with Embedded Value (EV) reflecting 16% CAGR over FY20-23E.

10. Ultratech Cement

UTCEM’s result highlights the execution of its planned cost rationalization and de-leveraging roadmap. Despite negative operating leverage (volumes down 32% YoY), the company reported the highest ever EBITDA/t of INR1,416, led by cost reduction across heads of expenditure. Net debt also declined by INR22b (13%) QoQ to INR147b (1.7x EBITDA). UTCEM’s market mix has improved post acquisitions, with the stronger markets of northern/central India contributing ~45% to volumes. Besides strong FCF, non-core asset sales should further aid de-leveraging. The stock is also trading 35% cheaper than peer Shree Cement v/s the historical average of 10%.

(By Hemang Jani, Head Equity Strategist, Broking & Distribution, Motilal Oswal Financial Services)

Disclaimer: These stock recommendations have been made by Motilal Oswal Financial Services. Readers are advised to consult their financial planner before making any investment.

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