BofA-ML offers 7 Fallen Angels for Contra Bets

BofA-ML offers 7 Fallen Angels for Contra Bets

Jaiprakash Associates,Infosys,DLF,SBI,BHEL,Adani Enterprises, RIL

BofA-MLin its latest report of ‘Fallen Angels’ released on Tuesday identified seven stocks that would appeal to the contrarian investor which are long term plays.

Broadly, the market has been flat over past 2 years. But most economy related plays have performed badly. Hence, our “Fallen Angels” have a pronounced biased towards rate sensitive, economy plays

The brokerage firm identifies ‘Fallen Angels’ as those stock which are under-valued as they are cheap relative to their trading history; secondly, they should have under-performed the market over past 2 years and lastly these stocks are under-owned in FII portfolio.

Fallen Angelsthat BofA-ML is positive on:

**Jaiprakash Associates:**BofA-ML thinks that the company’s shares have substantial upside potential, as the company is set to monetize resources (coal, hydro and realty) to improve profitability as it peaks capex, generate FCF and reduce leverage.

The brokerage firms believe that over FY12-15E, JPA will sweat the assets it accumulated over the past decade to demonstrate its superior profitability - Karcham (RoE 23%), JP Infra (EBITDA Margin 55%) and cement (bottom-cycle in EBITDA/ton of Rs750/ton despite start-up losses)

**Infosys:**The IT major is regaining traction in the market after underperforming for a long time. This is reflected in the large and transformational deal wins at highest ever in past 6 quarters. It is also using acquisitions like Lodestone to expand offerings.

We see early signs of recovery in improved volume growth, uptick in large deal wins and acquisition of a strategic asset during Q2.

The stock is trading at 18 per cent discount toTCSat 13xFY14e PE, attractive given our forecast of narrowing revenue differential and EPSCAGRof 12% over FY12-15. Pick up in discretionary spend would provide upside.

BofA-ML has a target price of Rs 2900 onInfosys

**DLF:**Strong operational performance will drive stock price as the company accelerates new residential project launches. A trigger would be reduction in debt as the company sells non-core assets like Aman properties.

BofA-ML identifies stocks which are awaiting trigger for upside

State Bank of India:BofA-MLdoes not expect a sharp decline in SBI’s slippages in the near-term. As asset quality shows signs of improvement, we could see material down shift in credit costs and rise in profitability.

Turnaround in asset quality may provide justification of its banks premium over other Govt. Banks. Current valuations are at a +20-25% discount to the 5- year average, which should normalize back, as worries onSBIdiminish.

**Reliance Industries Ltd:**Better refining, petchem margins and positive newsflow in E&P like significant discovery along with higher than expected hike in KG D6 gas price are likely triggers for the stock to outperform the markets.

RIL’s E&P has been de-rated since mid-2010 due to declining KG D6 gas production, sharp cut in KG D6 reserves and production guidance, said the brokerage report.

KG D6 gas price is due for revision in Apr’14 and BofA-ML feels that the prices may be hiked to US$8/mmbtu. A decision on KG D6 gas price is likely in FY14 for implementation from FY15, added the report.

**BHEL:**Govt is able to give coal linkages toBhelJV with states and restore purchase preference will be a key positive for the stock. The government should be able to fix coal supply problems and start linkage window.

**Adani Enterprises Ltd:**The Company should reduce power losses due to tariff hike or cheaper coal for its PPAs with Maharashtra and Gujarat. The company should also improve corporate governance and honor inter-group contracts.

Adani Enterpriseshould also cut group capital expenditure, especially Australia mine capex to control leverage.

Good for Bofa-ML to sell this to their investors abroad. Not for us small investors. I will stick to my consumer theme.

The bets are mainly for institutional investors (and even they would be sceptical investing in these companies) and not for investors like us…

Personally, I am +ve on BHEl. On a 2 year perspective, BHEL should do well, provided the coal linkages for power plants are sorted out, which I am sure will be.

I would disagree, Ankit.

Institutional investors are perceived to be “smart money” though their returns speak otherwise. All of the 7 stocks mentioned are worth consideration in an individual portfolio if they satisfy your investment criteria.

BHEL specifically, as mentioned above by Abhishek will likely be a bumper trade over a 2 year timeframe. In addition to new coal plant commissions, the number of issues/complaints for player who bought chinese equipment is increasing. Anil Ambani is the only one who seems committed to the Chinese but then, I would too if they loant me $1.3bn to refinance my FCCBs.

I agree with you Raja, that its upto an individual to decide whether these stock fits an individual’s investmentcriteriaor not. However, what I was saying is that there are stocks discussed in this forum where an individual might generate better returns. But as you had indicated in your intro that you focus on large cap stocks, these stocks fit into your criteria. Since you have so much experience in the equity research and investment banking, which other large cap stocks are you bullish upon for long term?

The bets are mainly for institutional investors (and even they would be sceptical investing in these companies) and not for investors like us…

Hi Ankit

I absolutely agree with you, alpha generation on lesser known names will always be higher. At some point though, valuations on beaten down Nifty 50 stocks become hard to ignore.

A rate cycle change is hardly a non-consensus view. Its worth noting that today’s RBI statement, for the first time in 2 years, is very dovish and pro-growth.

I’m structurally bullish beaten down cyclicals like BHEL and Tata Motors as a one year investment from current levels. I don’t profess expertise (that would be hubris) but these two stand out on valuations.

Re: TTMT, the CV cycle rebound is not priced in though it is purely a JLR revival play now. Base effects on JLR volume will definitely creep in next year, around June. Both stocks are at 8x P/E and would still be cheap on an absolute valuation basis if you feed in a hefty EPS downgrade so the risk-reward is worth it, in my view.

I must add, it’s wrong to call Tata Motors beaten down, given the one year stock performance.

Hi Raja,

How do yourecognize that a cycle is turning and we have reached the bottom in case of a cyclical stock like BHEL/any metal stock (Tata Steel, Hindalco)/Infrastructure companies?

Hi Ankit,

Generally, its a call on the back of GDP bottoming out and investment sentiment improving (private/corporate investment in fixed assets) aided by interest rate cuts. Valuations at this point are generally at troughs reached in past cycles. The issue is, most Indian stocks (cyclicals included) went to crazy valuations in 2007 (BHEL peaked at 45x forward P/E) so the through-cycle average is really misleading. To illustriate, BHEL reached a low P/E of 13x in 2008 which is what most analysts used as a trough. You have to go only a little back (2001-2) to have seen the stock trading at 5-6x P/E.

Generally the EPS impact of a cycle change will only be seen 1-4 quarters hence. The markets usualy start to re-rate the stocks at the end of the EPS cut cycle (which would be the next 1-2 quarters if we have bottomed out now) as analysts are late to turn bullish. We will only know if we have bottomed out ex-post.

Specifically for BHEL, its bottlenecks in the power sector being released (coal contract linkages and environmental clearances). The investment risk is, as we head into 2013 and elections, the government will be more bothered about vote banks, rather than project clearances. There is also a divestment risk from the government, which I am waiting for to buy into (shares would trade weak around then).

Base metals are trickier, given base metal prices are linked to global prices which is driven by China’s consumption.

Infrastructure is also tricky, with the debt load being carried. I would not invest in any one of them till the system leverage comes down.

You can also invest in the cycle change via. banking stocks. I’d wait for the upcoming recapitalisations to be done (and look at what valuations are being paid and the extent of dilution from the recaps) to play it this way. This itself depends on the government’s divestments being on target, else the fiscal deficit goes > 5.3%.

Hi Raja,

Thanks a lot.



I would much rather prefer the PSU banking stocks as contra bets for the following reasons.

1). The avg price to sales ratio for such banks ( allahbad bank , andhra bank etc ) are like .5 which is really low and they do deserve such valuations cause of the way they are governed .

2). Banking in particular is a great business and rbi being the regulator and govt being the saviour , the downside remains protected .

3). With the RBI changing its stance from Jan onwards the business will witness growth ( both from the side of the growth and reduced npas as business enviorment (debt repayment ) improves.

4). Private sector banks are quoting at PSR of ( yes bank 2.7 , indusind 4.2 etc…)and at high PE .

5). The oppurtunity according to me will arrive sometime in fy-13 when the psu banks as a lot will take the last hit cause of populist measures by the govt as political tactic.

would request fellow board members for their thoughts …




Just my 2 cents to the discussion:

I would advice using P/BV instead of price to sales ratio of banks. The problem with PSU banks is they are run not for wealth maximization of shareholders or for value creation but largely as per the whims and fancies of the government. They are not as prudent in lending because they have safety cushion of the government supporting them. It is reflected in their asset quality as compared to private sector banks. You can also see their Return on assets which lag behind private sector peers.

I recall a telephone from a mid sized PSB asking me to come to the bnk branch. When I asked them why, the fellow said manager had asked him to sell insurance and hence he was calling me…LOL

But if you still want to look at public sector banks then look for names with low NPAs, high provisioning, decent ROA, ROE and NIMs and reasonable valuations in terms of price to adjusted book value.


thanks for your inputs . you have bought out some important points which one must look into before entering the psu banks.

i do agree with your views that psu banks are not run for wealth maximization but still they are profitable ,…RBI being the regulator (chances of things going grossly wrong are less probable)

but all their concerns i think would be less or more priced in after the populist measures the govt will surely take before the coming national polls ( and the market is pricing in the event ) and after the national polls for a period of 3-4 years we can expect no stress atleast from the govt side .

Also a cycle has been observed with the psu banks which tend to outperform once such events ( read polls or populist measures )are out of their way. and with the interest rate cycle reversing growth too will kick in .

i caught the idea of psr as if we are able to pick up a bank whose balance sheet is growing at a healthy rate can be a big winner if with the changing scenario npm increases with reducing npas (high prob of that happening ).



One could easily add an SKS Micro to this lists…it is now doing all the rights things and the wind seems to have turned around for this cos…