More downside than upside

Stress is building on corporate earnings on the back of higher inflation and interest cost. A slowing in investments, coupled with the threat of falling consumption, has led to growing concerns over demand. To look at the impact on valuations of companies in its universe of stocks, ENAM Securities carried out a case study under worst-case assumptions. These include crude oil prices remaining over $100 this financial year, high inflation and interest rates, weak foreign institutional investor (FII) inflows and capital raising issues for capex-driven companies.

Of the major sectors (see table) covered in the study, there are 13 companies which could lose an average of 36 per cent from their July 8, 2011 prices, if the stress case conditions are applied. Even in the normal scenario, these companies have an average downside risk of 13 per cent, considering that they are trading at higher prices compared to their respective target prices. Companies in the automobile, fast moving consumer goods (FMCG), engineering, infrastructure and metals sectors could be the most affected in the worst case.

THE LOSERS
Among the companies with significant downside is ABB. Analysts expect its margins to be lower and the stock is also trading at rich valuations of 35 times its calendar year 2012 earnings. In the case of Ashok Leyland, analysts are expecting volumes to shrink in the event of a slowdown in the economy, high interest rates and a rise in fuel prices. The stock is currently trading at 12 times its 2011-12 estimated earnings, but in a downturn such as the one in 2008, it had gone down to eight times its one-year forward earnings.

In mining, NMDC, the largest iron ore mining company in India, could feel some pressure if ore prices correct. Iron ore prices are already down by about 10 per cent to $180 per tonne. In addition, the stock is trading at 15 times its FY12 estimated earnings and nine times the enterprise value to operating profits, which is expensive when compared to other listed players in the metals and mining segment.

BETTER-PLACED BETS
On the other hand are companies which offer a better risk to reward ratio in terms of downside in the worst case scenario. For instance, the least affected 13 companies have a downside risk of 18 per cent if the worse case plays out. But in a normal situation, they could, on an average, offer 32 per cent upside, which is a good risk and reward combination as the upside is almost twice the downside risk.

Power Finance Corporation corrected almost 40 per cent in the past year, due to concerns over the poor financial condition of state electricity boards. However, the management says it has enough state government guarantees and escrow mechanisms to protect its financials. Also, various initiatives taken at the state level and at the Centre should help abate these concerns. This is a reason the stock (trading at about 1.1 times its FY12 book value) is considered attractive from a risk-reward perspective.

STRESS CASE VALUATIONS
Sector	Company	Worst case		Normal case
		TP (Rs )	Down(%)	TP (Rs )	(%) chg
Auto	Ashok Leyland	35	-33	49	-7
	Tata Motors	850	-19	1,254	19
Banking	Cholam Inv.	111	-36	163	-6
	Power Fin.	160	-17	274	41
Cement	ACC	753	-22	905	-7
	Grasim Ind.	1,942	-10	3,284	51
Eng.	ABB	397	-54	630	-27
	Voltas	148	-10	220	33
FMCG	Britannia	226	-53	338	-29
	Jyothy Lab	126	-42	264	21
Infrastr	Punj Lloyd	51	-34	60	-23
	GMR Infra	32	-2	40	23
IT	Mphasis	399	-14	398	-14
	Persistent	297	-20	490	32
Metals	NMDC	141	-45	228	-12
	Hindustan Zinc	99	-24	150	14
OIL & Gas	GAIL	295	-36	410	-11
	Reliance Ind	693	-19	1,155	35
Pharma	Ranbaxy	414	-25	444	-19
	Aurobindo	147	-14	232	37
Power	NTPC	117	-38	182	-4
	JP Power	32	-31	60	29
Real Est.