The CPI (combined), which is a measure of consumer inflation hit 5.54% in November 2019 and has considerably breached the RBI’s medium-term target of 4%. Experts are divided on the effectiveness of measures like corporate tax cut and bank mergers. While some believe that benefits of such reforms will be channeled over a period of time, others believe that for economic recovery, additional structural reforms like change in labour laws and alleviation of banking sector stress is needed.
The weakness in the economy has led to increased volatility in the stock markets as evident from 11.1% average increase in the NSE-VIX in 2019 relative to 2018. The average NSE-VIX was 16.7 in 2019, compared to 15.1 in 2018. Moreover, if this depressing trend continues, the stock market volatility might increase. Thus, it is advisable to look for stocks whose prices have a weak (or negative) correlation with macro variables. The prices of such stocks tend to move with a lower intensity (or those with negative correlation move in the opposite direction) relative to the macro variables.
To identify such stocks, the Pearson Correlation or linear correlation coefficient is applied to a set of stock prices and the macro economic variables. Last 20 quarters’ data (latest September 2019 quarter) for the real GDP y-o-y growth and IIP index y-o-y growth is extracted from the RBI database. Similarly, the quarterly price returns data for 864 companies with market cap greater than Rs 500 crore are extracted for the similar time period. Out of these, there are 672 companies of which price returns data are available for all of the past 20 quarters.
The Pearson Correlation coefficient is worked out between the quarterly returns of the sample companies and the IIP growth and the sample companies and the real GDP growth. Next, the two sets of companies are ranked in ascending order of the correlation coefficients with the lowest value getting the higher rank. The average rank is computed for each company and finally, the companies are ranked in the ascending order of the rank (low ranks imply low average correlations with the macro variables and vice-versa). For example, if a company has a rank of 23 in terms of correlation with IIP and 32 in terms of correlation with real GDP, the average rank is 27.5.
The top 10% of the companies (low correlation companies) in terms of average rank had generated 24.4%, 62.04%, and 112.7% average returns in the past one, three and five years respectively. On the other hand, the bottom 10% of the companies (high correlation companies) in terms of average rank had generated -31.2%, -7.9% and 47.3% returns in the past one, three and five years respectively. BSE500 index generated 9.4%, 35.5% and 41.3% returns in the same period respectively. All returns are absolute and point to point. The numbers clearly show that companies with low correlation with macro variables have outperformed the general market.
The top 10% or low correlation companies are further evaluated in terms of their future potential by including only those that are covered by at least five Bloomberg analysts and with a one-year forward price potential greater than 10%. Let us look at seven such companies:
1. J Kumar Infraprojects
Potential upside: 89%
This construction sector player that designs and constructs roads, bridges, flyovers, subways, overbridges, and skywalks has reported good half-yearly numbers. Its management has retained the revenue and margin guidance for 2019-20. SEBI has recently given a clean chit to the company and cleared it from the charges of misrepresenting the books of accounts. Anand Rathi is bullish on the stock due to its lifetime high order book, manageable debt, bright prospects and the strong pace of execution. With the execution of the recently bagged orders, the company’s finances and its return ratios are expected to improve.
2. Apollo Hospitals Enterprise
Potential upside: 20%
This integrated healthcare services provider has a presence in hospitals, pharmacies, primary care & diagnostic clinics and several retail health models. The company reported strong growth across segments in terms of its consolidated EBITDA that grew 25% year on year in the September 2019 quarter. The management has guided for debt reduction of `500-600 crore in 2019-20 aided by cash generation, proceeds from pharmacy business and M unich stake. Elara Capital expects strong EBIDTA growth of 21% CAGR over 2018-19 and 2020-21 led by better case mix and reducing losses from its subsidiary Apollo Health and Lifestyle and increasing profit from the new hospitals.
Potential upside: 38%
This low fare airline has operations across eight international destinations in South Asia and Gulf, including Nepal, Sri Lanka and UAE. The company reported 51% y-o-y growth in September 2019 quarter helped by increased PAX yield and other operating income. According to a report by SBICap Securities, benign crude prices and stable currency are likely to improve profits in the third quarter. However, early resolution on 737 MAX is important to derive benefits from its cost-reduction measures. The stock has corrected owing to uncertainty around MAX aircraft returning to service and linked pressure on profitability. The research house maintains its buy rating with reduced EPS estimates for 2019-20 and 2020-21.
4. Transport Corporation of India
Potential upside: 27%
It is an integrated multimodal logistics and supply chain solutions provider with an extensive network of over 1,400 offices and 12 million sq. ft. of warehousing space. In the September quarter, the company impacted by sluggish demand reported a mere growth of 1%. The management expects demand recovery in the forthcoming quarters helped by BS-VI pre-buy in the CV segment. Moreover, regulations like the implementation of GST and E-way bill will provide an opportunity for larger organised players to capture higher market share on a sustained basis. ICICI Direct is bullish on the stock and believes that with multi-modal capabilities, the company has developed a strong moat around its business and thereby delivering sustainable growth rates. According to the Bloomberg consensus estimates, the stock currently trades at 2019-20 estimated PE of 13.02 times compared to an estimated average PE of 21.7 times of the BSE500 index.
5. VA Tech Wabag
Potential upside: 49%
The company is a player in the water treatment space, offering a range of solutions focused on conservation, optimisation, recycling of resources, directed at addressing water challenges across the world. The company received orders worth `3,050 crore in the first half of 2019-20 and its healthy order book of `11,500 crore provide strong revenue visibility. Chola Securities is bullish on the stock as the company has improved balance sheet position in the first half of 2019-20. It is likely to show improvement in the working capital due to its focus on collections, billings and faster execution of the ongoing projects.
6. Gujarat State Petronet
Potential upside: 19%
The natural gas infrastructure and transmission company is engaged in the gas transportation business with a pipeline network of about 2,692 km. In the September quarter, the company’s gas transmission volume jumped 11.9% y-oy. Further, NGT ban on the usage of coal gasifiers has helped the company’s city gas distribution business that jumped 31.4% y-o-y on the back of increased demand from power and other industries. HDFC Securities is bullish on the company due to the robust volume growth, diminishing cyclicality in the earnings post-acquisition of a controlling stake in Gujarat Gas, and steady cash flows from the transmission business.
7. Adani Ports and Special Economic Zone
Potential upside: 22%
This business conglomerate has interests across coal mining, ports and logistics, shipping, rail, energy, and agro-commodities. The company reported inline results for the September 2019 quarter. Its market share was 22% for all India cargo and 35% for the container volume. Dolat Capital remains positive on the long-term prospects of the company on the back of steady growth in exim trade, commissioning and ramping up of new ports, sourcing of new cargo, and market share gains. Consistent improvement in volume and cargo mix and greater utilisation are likely to improve the company’s margin and return profile going forward. According to Bloomberg consensus estimates, the stock is likely to deliver RoE of 17.7% in 2019-20 relative to the average 11.2% by the BSE500 index.
Current price as on 17 December 2019. Estimated PE for 2019-20. BSE500 index estimated PE: 21.7. Source: ACE Equity & Bloomberg.
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