Some good midcap stocks to buy

Ketan Karani, VP Research of Kotak Securities, discusses midcaps from the tyre industry. He says that though raw material prices have been a problem for this sector, it still looks promising.

Ceat, JK Industries, Goodyear India and Kesoram Industries are his top picks in the sector. He also says that Century Textiles is a good story to be in, and could definitely appreciate by another 40-50-% over next 12-18 months.

Excerpts from CNBC-TV18's exclusive interview with Ketan Karani:

You have been studying the tyre industry very carefully. Can you tell us what you like in terms of business prospects, and what you see in terms of their key raw material, which has been pinching them, rubber?

Yes, the raw material side has been very sluggish and problematic for the tyre sector. But in the last one and a half month there has been a dramatic change in the entire scenario for the raw material side of tyre industry.

The rubber prices, which were around Rs 12,000, have come down to almost Rs 7,700. The other two main raw materials, Carbon black and Nylon tyre coat fabric, have also corrected quite significantly.

So QoQ, we see that there could be a saving of cost of almost 7-10% in the September quarter. Overall, there could be a saving of almost 10-15% in the next quarter for the tyre sector, raw material side.

Having said that, the tyre sector had increased prices in line with increase in the raw material prices for quite sometime. This was reduced by some of the tyre manufacturers some 15 days ago.

But, compared to the March to September quarters, the tyre prices are still high by almost 3-4%. So this is a clear-cut scenario where there is a huge volume growth in the sector.

Pricing power to some extent is coming back to the manufacturers. Tyre prices are up by 2-3% over the last year, and on the raw material side the cost is almost lower by 7-10% this quarter and could be lower by 10-15% next quarter. We don't see the raw material costs running away now.

Therefore this could be a very good turnaround for the sector, which has been languishing for the last 2-3 years. It did not participate in the entire rally, and we believe that this could be a multi-bagger story from here on to the next 18-24 months.

What do you expect Ceat to deliver in terms of a financial performance? What sort of price target do you have on this one?

We are just getting into the bull run cycle of the entire tyre sector. All these stocks, be it Ceat, JK Industries, Goodyear India, which we like, are the three top picks. All these tyre companies are quoting around 0.2 times their sales, which is abysmally low.

This sector was absolute neglected. It never participated in the rally, and for the first time in this September quarter, we see them coming back to the good bottomline growth.

So rather than talk about targets, I want to say that this would be a 6-18 months story, where this sector could really fly off and could become a sort of multi-bagger from there.

Coming back to the numbers, we would like to see the September quarter deliver numbers, which are reasonable- on the cost saving side- 7-8%.

Breaking them up in the cost sector, in last quarter JK Industries had a raw material cost at Rs 475 crore (Rs 4.75 billion), Ceat at Rs 360 crore (Rs 3.60 billion) and Goodyear at around Rs 107 crore (Rs 1.07 billion) raw material cost. So any saving of 5-7% should comeback to the bottomline in this quarter itself.

So there could be a huge upside for the entire sector. Another company, which we like is Kesoram Industries. Kesoram Industries is a tyre as well as cement play. So these are our top four picks in the tyre sector.

What about JK Industries? What sort of price have you set out for that one and why do you like it?

It is one of the largest tyre sector company in the country with around Rs 2,400-2,500 crore (Rs 24-25 billion) worth of topline, where bottomline should grow with the entire savings in the cost cycle as well as somewhat of pricing power coming back.

We would refrain from giving any price targets, as we believe that this is just the beginning of the entire positive run for the sector. We would like to wait and watch and then come out with targets. But as I said 0.2 times sales is abysmally low.

The market cap of JK Industries is somewhere around Rs 550 crore (Rs 5.50 billion) and the sales are around Rs 2,500 crore (Rs 25 billion). We could see 0.5 times sales in the next one-year. So that could be definitely a big leg-up in the entire revaluation or re-rating story of the tyre sector coming up.

You also like Century Textiles. Is it the fundamental business that you see turning around or is there a whole lot that goes into making this stock?

I think fundamental reasons are very much in favour of being in this stock. If you look at the cement side, it will be 8 million tonne by December'06. It is expanding its paper capacity to 240,000 tonne. All this expansion will be in place by December'06.

It is expanding by another 3.5 million tonne on the cement side. It is expanding the textile business and also shifting it to a new area. With the pricing power coming back to cement and paper, we believe that this could be a good stock to hold on to.

We are not calculating anything from the property story, which has been floating around for quite some time. We believe that property will be a sweetener as and when it comes. On the fundamental side also this stock seems to be on the right footing.

It is in sectors, which are booming in the economy -- be it cement or paper. In textiles too it has got a cost advantage, and is one of the best exporters in this country from the manufacturing-cotton textile side. So this is a good story to be in and could definitely appreciate by another 40-50-% over next 12-18 months.

So what would that make you price target and EPS estimates on Century then?

I think Century Textiles' 07 EPS should be somewhere around Rs 30-31. Next year again it could be another Rs 40 EPS. We are refraining from giving any price target, but we continue to believe this would be a good story to hold on for quite some long time.

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