Stock ideas: Know these companies with high profit margins

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The post-pandemic period saw many companies take a big hit on revenue and profitability. While many have recovered since, at a faster pace than expected, it’s not business as usual for all.

Continuing with the Do-It-Yourself (DIY) series, this week we select companies from the S&P BSE 500 Index that have registered consistently high profit margins.

 

Using the Capitaline database, we have shortlisted companies that have maintained operating profit margins (EBIT or earnings before interest and tax margins) and net profit margins of at least 20 per cent and 15 per cent, respectively, for five years until March 2020. Also, given that profit margins can vary across sectors, we have picked companies that are among those with the highest margins within an industry. Additionally, these are companies that have also grown their sales revenues at a reasonable rate during this period. While margins are important, so is the growth in sales for driving the overall profit.

These companies have managed to keep up their margins in the latest June and September 2020 quarters too, though revenues declined in many cases.

 

 

Why margins matter

Operating profit margin (OPM) is simply the top metric any business owner would use while choosing one industry over another. It captures the profit a company manages to retain after accounting for all the costs associated with producing or rendering a service. OPMs are calculated before interest costs, taxes and other one-off items are accounted for. A high OPM, if sustained overtime is a sign of a company enjoying strong pricing power and ability to weather ups and downs in the business cycle. It can also be a sign of a tight ship run with a strict rein on costs. When applicable for an entire industry, it may show lack of competition due to high entry barriers or the specialized nature of the product.

Companies that keep their debt and interest costs in check can then see their high OPMs percolate down to what ultimately matters to investors — high net profit margins (NPM).

Companies that can combine consistent and solid profit margins with healthy sales growth are worth looking at for investing. Here we highlight a few such companies as a starting point for further research.

More than ‘margin’ally better

Advanced Enzyme Technologies (Advanced Enzyme) is a ₹3,800-crore market cap company engaged in research and development, manufacturing and marketing of enzyme products in India and other countries. It caters to three demand segments — human healthcare and nutrition (accounts for three-fourths of company revenue), animal nutrition and industrial processing.

Though not completely comparable, with operating profit (EBIT) margins of 38-44 per cent (FY15 to FY20), Advanced Enzyme has among the highest margins versus other chemicals companies in the BSE 500. The company grew its revenue nearly 15 per cent (CAGR) between FY15 and FY20. It has a strong balance sheet with almost no debt and positive free cash flows.

The increasing focus on healthcare spending post-Covid should benefit the company in long term. At a trailing twelve-month price to earnings multiple (TTM P/E) of 28 times, the stock trades above its 3-year historical average P/E multiple of 21 times.

State-owned Power Grid Corporation of India (PowerGrid), with its near monopoly in inter-state power transmission, is another high margin company with OPMs of 56-61 per cent. PowerGrid operates largely under an assured return model – tariffs set by the Central Electricity Regulatory Commission allow a pass-through of costs and a 15.5 per cent return on equity on its completed transmission projects. This provides revenue visibility and makes it a safe bet compared to many power generating companies. Power Grid posted revenue growth of 16.4 per cent between FY15 and FY20. The stock is reasonably valued – at 9 times TTM P/E, it trades below its 3-year historical average P/E of 11 times.

The country’s largest private port operator, and an integrated logistics provider, Adani Ports & Special Economic Zone (SEZ) too has generated high profit margins – OPMs of 36-54 per cent during the five year until FY20. The company’s revenue grew 14 per cent (CAGR). Adani Ports & SEZ’s focus on diversification, both geographically and product-wise should serve it well. Its recent acquisition of Krishnapatnam Port Company is expected to add ₹1,200 crore to its operating profit in FY21. Do note though that as of September 2020, almost 31 per cent of the company’s promoter shareholding was pledged. This is, however, down from 58.25 per cent in the March 2020 quarter. Valuation-wise, at 25 times TTM P/E, the stock trades above its 3-year average P/E of 19 times.

NESCO (earlier known as New Standard Engineering Company) which started as a manufacturer of forging hammers and presses in 1957 and later diversified into the realty sector in1986, derives revenue largely in the form of rental income. This comes from the company’s two properties, Nesco IT Park and Bombay Exhibition Centre, both in Mumbai.

The high OPMs are reflective of likely low operating costs of running these properties. The company reported revenue growth of 17.3 per cent (CAGR) between FY15 and FY20 and despite capacity expansions (and more planned in future), has been debt free. At a TTM P/E of just under 19 times, the stock trades close to its 3-year historical average P/E.

Apart from these companies, others such as Castrol India and Caplin Point Laboratories, which had showed up in our earlier ‘return on equity’ screener too, were some of the other high profit margin companies.



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