Understanding Valuation Measures

Valuation is at the heart of all fundamental investing in stocks. It is a science as much as it is an art. The subject is vast and fit for writing a book rather than a small post. For the moment, I will do the easy stuff, a short post for the benefit of new investors.

Let us briefly look at some important valuation measures:

1. P/E: defined as CMP/Diluted EPS where CMP is current market price & EPS is the earning per share. 

Getting it:

Price-to-Earning (P/E) ratio or P/E multiple is the most commonly used indicator. It shows the number of times that the price of a stock is trading relative to its earnings. You can generally find the PE of listed stocks in business newspapers or journals. The best however, is to work out the EPS oneself from the published financial results so as to understand the nuances. Price quote of the stock can be easily found on daily basis from NSE/BSE website or other media sources. Alternatively, EPS can be checked from financial results and/or annual reports published by the company, and P/E can be computed dividing current price by the EPS. For example, Infosys had EPS of Rs 119.40 for FY11, so at a price of Rs 2,906, P/E multiple works out to 24.3.

Making sense of PE:

Low PE ratio stocks are characteristic of either mature companies with low growth potential or companies that are undervalued or in financial distress. Conversely, high PE stocks could be characteristic of high growth companies or very expensive or risky stocks. In that sense PE gives a broad indication of how expensive a stock is, relative to its earnings. Low PE by itself is rarely a sufficient ground to consider a stock undervalued or vice versa. Above discussion is generally for earnings in past financial year or for last 12 month period (trailing twelve months referred as EPS ttm), both of which are rear view mirror.

Remember, markets are forward looking and generally discount the future – the earnings, the growth, the sustainability of earnings etc. So, drawing inferences merely on basis of trailing P/E is not proper. Forward P/E estimates for next FY are quite prevalent. In bull markets, it's not uncommon to see analysts stretching it further and justifying valuations of a stock as acceptable talking about PE on basis of 4 years into the future, say 15x FY2015 earnings estimates.

I will not comment on how high is high PE. Suffice to say, currently the PE of BSE Sensex is 21.02 and that of NSE Nifty is 21.94. Their historical values are also available on exchange websites.

Linking P/E to Growth brings us to PEG ratio that is obtained by dividing P/E by expected growth. Stocks with a low PEG Ratio of say below 1 are seen as better value, even if their P/E is higher, by virtue of the implied value of future earnings. On the same example of Infosys, if the growth rate is 10% (just for illustration), then PEG would be 2.43.

I realize covering each of the valuation measures in some depth will require a very detailed write-up or multiple posts. So I just give the definition for the rest.

2. P/BV: defined as CMP/Book value per share where denominator is Shareholder's equity/Actual number of shares.
3. P/S: defined as CMP/Sales per share where denominator is Annual sales turnover/Actual number of shares.
4. EV/EBIDTA: defined as Enterprise value /EBIDTA where Enterprise value = Market Capitalisation + Net debt + other long term liabilities like pension liabilities, deferred tax etc.
5. EV/Sales: defined as Enterprise value/Sales
6. Dividend yield: defined as Annual dividend per share/CMP.
7. FCF yield: defined as FCF/Market cap where FCF or free cash flow is Cash flow from operations – Total capex.

By no means, above list is exhaustive, and as I mentioned before this is a subject by itself. But as we say if investing could be reduced to mere ratios, quants or mathematics, everyone plugged into numbers would have been super-rich. But that's far from reality simply because valuation is not a number game. Sometime later, I will make a post on sectoral perspective to valuation. 

I conclude with a quote from Philip Fisher:

"The greatest investment reward comes to those who by good luck or good sense find the occasional company that over the years can grow in sales and profits far more than the industry as a whole".

Bajaj Electricals Ltd

I find Bajaj Electricals Ltd (BjEL) a formidable play in the consumer electrical space, and a good long term investment bet.

Business Operations:

1. Bajaj Electricals is a 72 year old company with a turnover of over Rs 2,000 crore. It has 6 strategic business units:

(i)                  Appliances

(ii)                 Engineering and Projects

(iii)                Fans

(iv)                Luminaires

(v)                 Lighting

(vi)                Morphy Richards

 

2. Bajaj Electricals has wide presence in different parts of India through 19 branches, and supported by 1000 distributors, 4000 authorized dealers and 4 lakh retail outlets and 282 customer service centres.

3. Excellent distribution network and tie-ups are a source of competitive advantage for BjEL. It has distribution arrangement with Trilux of Germany for Luninaires, tie-up with Delta controls of Canada for Building Management systems, with Morphy Richards of England and Nardi of Italy for Appliances segment, with Secuiton of Switzerland for Security systems, with Midea of China and Disney of US for Fans, with Starlite for CFL.

4. Domestic Appliances include a range of products like Water Heaters, Mixers, Food Processors, Microwave Ovens, Air Coolers, Steam and Dry Irons, Electric Kettles, Water Filters, Toasters, Rice Cookers, OTGs, Microwave Ovens, Juicer-Mixer-Grinders, Hair  Dryers, Chimneys, Gas Stoves, Room Heaters, Home UPS.

5. Demand for  lighting products like  Lamps,  Tubes and Domestic  fittings is round the year growing by about 10% y-o-y.

6. Luminaires Business Unit is developing energy-efficient consumer luminaires, and also launched LED based luminaries for landscape, commercial and retail lighting applications. Sales of CFL (Compact Fluorescent Lamps) have recorded increase and crossed the Rs.150 crore mark in FY2010.

7. Engineering & Projects division of BjEL achieved a turnover of Rs.755 crore in FY 10 registering a healthy growth  of  39% over FY09.  E&P Unit produced 4,600 Highmasts and 33,255 Poles besides manufacturing 17,446 MT of transmission line towers. BjEL has in-house facilities for civil, structural and product design. This SBU's order book position at over Rs.1100 crore is decent.

8. BjEL has manufacturing units at Chakan which is mainly into fans and Ranjangaon-Pune unit that manufactures high mast and transmission line towers.

Industry prospects:

1. Power sector development and Infrastructure growth continue  to  be  the Government's focus areas, which offers good long term opportunity for BjEL, in particular for future growth of its Engineering & Projects SBU.

2. Domestic appliances market is estimated to be over Rs 6,000 crore with a large part of it controlled by the organized players. BjEL has an impressive trackrecord to exploit this business opportunity.

3. Peers: Havells and Kalpatharu Power.

Management:

1. BjEL is a part of the Bajaj Group which is a reputed business group with an established history and brand recall.

2. High promoter's holding 68% is a positive.

3. BjEL is led by Shekhar Bajaj who is the Chairman & Managing Director of the company with Mr R.Ramakrishnan and Mr Anant Bajaj as the EDs.

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Financial summary:                                                    

                                                                       

Particulars	FY2008	FY2009	FY2010	FY2011E	FY2012E
Revenue (Rs crore)	1381.60	1765.70	2228.6	2724.10	3115.60
EBIDTA (Rs crore)	143.20	176.80	220.90	260.70	310.05
PAT (Rs crore)	73.10	89.30	125.40	146.85	172.30
EPS (Rs)	8.45	10.32	13.40	15.04	17.65
NPM (%)	5.29	5.05	5.62	5.39	5.53
ROE (%)	44.34	37.86	24.14	24.19	23.10
ROCE (%)	35.60	41.41	37.55	33.90	33.30

Auditors: Dalal & Shah

Investment Rationale: 

1. Strong brand backed by excellent business model and distribution network.

2. On the back of increasing investments in T&D space, Engineering & Special Projects division of BjEL will be an important growth driver for next 3 years, estimated to grow by 20%.

3. CFLs will register good volume growth in current environment.

4. Our estimate is that fans division will post a revenue CAGR in excess of 25% over the next few years, since this company has presence both in premium and lower priced segments.

5. BjEL has nicely complemented its appliances segment by entering into the Pressure cookers market which will reap benefits of its strong distribution network.

6. Consumer appliances is a highly competitive industry. Given its brand and established systems, BjEL commands some pricing power and can also pass on the rise in raw material price to the end-consumers.

Risks:

1. High inflation scenario can impact consumer spending and result in slowdown.

2. Delay in closure and/or execution of engineering projects.

Stock parameters:

CMP: Rs.270 (FV: Rs 2); Market cap: Rs.2,656 crore; 52-wk Hi/Low (NSE): Rs.345/188; 200DMA: Rs.256; Free Float: 34.80%

Valuation parameters:

PE: 17.95; P/BV: 4.1; Dividend yld: 0.89%; EV/EBIDTA: 8.4 (all based on FY11 estimates).

Outlook:

1.     BjEL combines the best of Consumer stories that attract lot of market fancy and Engineering infrastructure which can give significant growth in coming year.

2.     30% capital appreciation with a time horizon of 15 months looks reasonable.

Hinduja Global Solutions Ltd

I analysed Hinduja Global Solutions Ltd (HGSL) and share it below:

One of the pillars of successful investing is buying share in a good business when current market price is at a large discount to its underlying business worth. HGSL combines investment case for both value and growth prospects.  

Business:

1. HGSL operates in the BPO space. It is a leading provider of Outsourcing Solutions that include Back Office Processing, Contact Center services and customized ITES solutions to established companies including many Fortune 500 companies.

2. It serves industry verticals like BFSI, telecommunications, pharmaceuticals, life sciences, consumer electronics/products, media and entertainment, energy and utilities, transportation and logistics.

3. HGSL is headquartered in Bangalore and has over 30 delivery centers in the US, Canada, U.K., Mauritius, Philippines and India.

4. Bharti is among the top clients of HGSL.

5. About 73% of HGSL's revenues are generated from voice-based services based on FY10 financials.

6. The Company employs 18,730 people worldwide. As per press reports, company is increasing the hiring in this fiscal by another 2000 or so.

Industry outlook:

India continues to be the leader in global sourcing with a 55% market share in 2010 as compared to 51% in 2009. The Indian IT/BPO industry grew by 19% in last year as revenues were approximately USD 76 billion. BPO exports increased 14% to USD 14.1 billion.

Management:

1. HGSL is part of the Hinduja Group which is a conglomerate having diversified business interests.

2. High promoter's holding 68% gives it stability.

3. Top management team of HGSL has strong academic background, industry experience & performance trackrecord in the area of its operations.

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Financial summary (consolidated):                                                     

                                                                       

Particulars	FY2008	FY2009	FY2010	FY2011E	FY2012E
Revenue(Rs crore)	637.05	797.57	892.34	1076.70	1189.43
EBIDTA (Rs crore)	94.06	132.82	162.80	193.80	209.87
PAT (Rs crore)	87.42	93.77	130.11	118.43	143.75
EPS (Rs)	42.50	45.50	63.20	57.50	69.80
NPM (%)	13.72	11.75	14.58	10.99	12.08
ROE (%)	12.20	10.00	14.00	11.70	13.00
ROCE (%)	8.00	9.50	11.50	11.20	13.00

Investment Rationale: 

1. HGSL's business is repetitive and spread across verticals; total client count is on the up at over 80. The company has demonstrated high stickiness with clients due to its delivery and capability.

2. No reason why the cost advantage will not sustain, it's kind of a non-discretionary spend for the large clients.

3. Can see some acquisitions in coming year which will be earnings accretive.

4. Strategy to have operational centers in Tier III cities like Durgapur in West Bengal, Guntur in Andhra Pradesh and another at Siliguri will improve cost efficiency of the company in next phase of its expansion.

5. Free Cash Flow positive as can be expected from such a business. Operating margins at 17-18% are good. Strong revenue & earnings visibility backed by comfort of valuations.

6. Net Cash per share is about Rs 238 per share. (not a big positive at the moment since they are sitting on cash for quite some time now, and it majorly depresses ROE, ROCE).

7. High dividend yield (above 5%) with DPS of Rs 20 for FY2010 limits the downside.

Concerns:

1. Company has not been able to deploy cash in any meaningful way like business acquisitions for far too long now.

2. It is not into high end high value-add businesses.

3. Stock is illiquid, so problems associated with entry/exit of low volume stocks.

Stock parameters:

CMP: Rs 376 (FV Rs 10); Market cap: Rs. 779 crore; 200DMA: Rs.392; 52-wk Hi/Low: Rs.520/295; Free Float: 31.80%

Valuation parameters:

PE: 6.54; P/BV: 0.75; Div. yld: 5.31%; EV/EBIDTA: 1.82 (based on FY11 estimates).

Valuation looks comforting with good margin of safety.

Outlook:

1.    It is a steady dividend payer. DPS of Rs 20 for FY 2010 was impressive. I expect it will maintain, and increase, dividend pay-out for FY 2011.

2.    Any developments with regard to potential acquisitions will re-rate the stock.

3.    Around 50% capital appreciation with a time horizon of 16-18 months looks reasonable expectation.