Quality mid-cap stocks available at bargain prices

The Sensex and Nifty have been range-bound for quite some time. The Sensex is at a PE of 30x, which is well above its historic five-year average of 21x. Any investor needs to approach this overvalued market carefully by picking quality stocks at throw-away prices.

In this article, we look at the companies from the mid-cap space that have delivered an average return on equity of more than 15 per cent in the last three years. At the same time, these companies have recorded an EPS growth of at least 20 per cent compounded annually. Besides, the stock prices of these companies have fallen by more than 30 per cent during the last one year.

Natco Pharma
Specialising in cancer and hepatitis C drugs, Natco partners with other firms to sell its products in the US. This strategy helps it avoid marketing and litigation costs, keeping its focus on production. What sets it apart from peers is its niche in manufacturing complex drugs. It has two business segments: Formulations (70 per cent of FY19 revenues, including domestic and international) and API (14 per cent). A majority of its revenue is derived from India (46 per cent in FY19) and the US (40 per cent in FY19).

Slower-than-expected sales of Tamiflu, coupled with a slow market share gain for its generic Copaxone, weighed on the company, leading to a fall of over 33 per cent in its stock price over the last one year. As of March 2019, the company's overall sales and operating profit witnessed a decline of 0.8 per cent and 23 per cent, respectively. Amidst all, bringing a silver lining is its entry into a number of new markets, including Brazil, Canada and China. This move is expected to enable the company to generate more revenue from other markets, thus reducing its over-dependence on the US.

On the financial front, its earnings per share grew at a rate of 57 per cent compounded annually in the last three years. Although its stock has taken a beating in the last one year, it has been able to compound its investors' wealth at a rate of 42 per cent in the last ten year. Currently, the stock trades at a PE of 15.1x as compared to its five-year median PE of 40.8x.

Ashok Leyland
Headquartered in Chennai, Ashok Leyland is the second largest commercial vehicle manufacturer in India and the fourth largest manufacturer of buses in the world. This flagship company of the Hinduja Group commands a market share of 33 per cent. Its well-diversified portfolio comprises low to high gross vehicle weight trucks, 16-80-seater buses, defence vehicles, industrial diesel engines and marine applications.

The ongoing slowdown in the auto sector is a major headwind faced by the company. Volumes in the domestic medium and heavy commercial vehicle (MHCV) industry fell by 11 per cent in May 2019 as compared to its November 2018 levels. Besides, lower freight availability and pressure on freight prices because of subdued construction activities have taken a toll on the company. Further, a host of issues, comprising high crude oil prices, NBFC crisis and new axle load norms, have slowed down the growth of the MHCV segment, thereby sending the company's stock prices into a tailspin.

All is not bleak, though. The company can bank on several growth drivers, such as the government's scrappage policy (to curb the use of vehicles aged over 15), overloading ban, pre-buying for BS-VI-compliant vehicles and increased demand for higher tonnage vehicles to boost its revenue in the future.

In terms of its financials, ROE has been above 25 in the last three years, with an average of 26.7 per cent. Earnings per share have grown more than 43 per cent compounded annually over the last three years. However, its stock price has corrected by more than 35 per cent in the last one year, owing to various headwinds. The stock trades at a PE of 12.1 times, which is well below its median of 23.2x.

Balkrishna Industries
Founded in 1987 as a bicycle-tyre manufacturer, Balkrishna has gradually carved a niche for itself in manufacturing off-road tyres - primarily used in tractors, harvesters, cranes and other heavy construction vehicles. Backed by its market share of six per cent in the global OTR (off-the-road) tyre market, the company generates almost 85 per cent of its revenue from exports. Its products are sold under the brand name, 'BKT' and exported to more than 130 countries.

The company's distinguishing factor lies in the segment it operates in, where market requirements are very much specific or customised, which also acts as a barrier to entry. Besides, the manufacturing of these types of tyres requires highly labour-intensive techniques and thus, leading to higher margins as compared to those of commoditised and automated four-wheeler and two-wheeler tyre manufacturers.

Its stock has corrected by almost 30 per cent in the last one year, which could be attributed to low volume growth on account of drought in the key markets of Europe (contributed more than 50 per cent to its revenue in FY19). Since its products are linked to the agriculture sector, things like drought pose a risk to the company. However, it has lined up a capital expenditure plan of more than Rs 2,000 crore for capacity expansion over the next three years. This investment is meant for backward integration, which will improve the return ratios in the future.

Although the company's stock has taken a beating, it still has managed to compound the investors' wealth at a rate of 39 per cent in the last ten years. The average ROE and EPS growth rate in the last three years have been 19.9 per cent and 20.1 per cent, respectively. The stock is available at a PE of 19.2 times.

Disclosure: The intent of the article is not to recommend any specific stocks. If you wish to invest in any of the above-mentioned securities, please do thorough research.