India’s equity benchmarks, the S&P BSE Sensex and NSE’s Nifty 50, continue to scale towards pre-Covid levels amid low rates and record liquidity in the system. Yet, there’s apprehension around valuations while picking stocks.
One strategy can be to look at the net profit margin, a measure of profitability. Businesses with higher net profit margins generate higher profit on every Rs 100 of sales.
Companies that improve their net profit margins over a period of time enjoy pricing power and are cost-efficient, according to VK Vijayakumar, chief investment strategist at Geojit Financial Services. A rising profit margin, he said, indicates the ability to control operating, overhead, and interest costs.
“If the net profit margins are high, profits can rise disproportionately when the business is scaled up,” he said. “Businesses with high net profit margins, rising demand, and operational leverage have the potential to multiply profits.”
Of the 220 companies from the BSE 500 index that have so far declared earnings for the quarter-ended June, 11 have seen their net profit margins, adjusted for extraordinary or abnormal items, double in the last five quarters.
Selection Criteria
- BSE 500 constituents that have reported April-June 2020 earnings.
- Covered by at least five analysts.
- Improvement in adjusted net profit margins in each of the last five quarters.
- Net profit margins at least doubled during the period.
Of these 11 companies that saw net profit margin double, five have run ahead of analyst expectations—the current price is higher than the average of 12-month targets tracked by Bloomberg.
The other six lagged. Analysts, however, still expect an upside of 10-26% for the remaining six. Here’s why:
Coromandel International
The maker of phosphatic fertilisers and specialty nutrient products fared better than peers in the quarter ended June because of robust demand in the crop protection segment. Backward integration in fertilisers helped the company improve margins and contain volatility in profits.
Emkay Global is positive on the stock citing the company’s robust balance sheet, structural improvement in the margin profile, lower exchange-rate risk than the historical trend, and aggressive new launches in the crop protection segment. The brokerage sees supply chain efficiency as one of the key reasons for improvement in Coromandel’s market share April-June 2020.
Risks: Upward movement in raw material prices, adverse weather and delay in capex due to Covid-19.
Dhanuka Agritech
The agrochemicals maker's operating income and net profit grew by 227% and 250% year-on-year in the quarter ended June, helped by operating leverage and control on other expenses.
Dolat Capital is bullish on the stock because of the company’s asset-light model that focuses on brand building and marketing and with no manufacturing, Rs 167 crore free-cash flows in 2019-20, and a net cash balance sheet. New product launches, the brokerage said in a report, will help the company to continue its growth momentum.
Risk: Limited upside potential in the stock due to recent increase in the stock price and valuations.
UPL
The crop protection business of the agro, industrial and specialty chemicals maker has been strengthened by the Arysta acquisition that was completed earlier this year, according to a JPMorgan report. The deal augmented UPL’s portfolio with specialty crop products, bio-solutions, and patented/proprietary products. Growth from a complementary portfolio, cross-selling opportunities in core markets, and cost synergies are likely to support Ebitda even in the current uncertain environment, the report said.
Risks: Any impact on growth is linked to Latin American markets and reduction in net debt.
Just Dial
The local search engine saw its Ebitda margin contract 370 basis points to 23.1% in April-June 2020 as realisation fell because of the Covid-19 outbreak. Net profit, however, rose 45% over a year earlier on the back of mark-to-market gains on bond investments as interest rates fell.
According a JM Financial report, the macro challenges will continue to weigh on the company’s performance in the near term. The brokerage, however, maintains a ‘Buy’ rating on the stock, saying that valuations continue to remain attractive and the company has a strong cash buffer of Rs 1,420 crore.
Risks: Discounts, relaxed payment terms to several customers offered may weigh on operating performance in the near term.
Max Financial Services
According to a report by Emkay Global, operating leverage and new product launches at increased prices are likely to support its margins and profitability of the holding company of Max Life Insurance Co. The management expects the share to protection plans to rise and the company’s distribution network will improve after Axis Bank acquired a 30% stake.
The report maintains a ‘Buy’ rating citing the company’s diversified product profile, comfortable valuations, and expects its of new business to grow at an annualised rate of 14.2% till the fiscal ending March 2023.
Risks: Overdependence on bancassurance for which the company is already ramping up its agency network.
Alkem Laboratories
The drugmaker’s Ebitda and net profit rose 92% and 114% year-on-year, respectively, in June quarter, helped by 38% growth in the U.S. generics business. Other costs declined 920 basis points (as a percentage of sales), helping offset the decline in domestic formulation sales.
Motilal Oswal is bullish on the stock citing cost cuts, outperformance of chronic therapy in domestic formulations, trade generics segment, and healthy drug filings pipeline for the U.S. market.
Risks: Slower than expected recovery in domestic formulation sales.
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