High risk, high reward? Decoding the rally in ITI

If you look at the company's financials, however, you get no indication that you are looking at a multibagger. (Pixabay)
If you look at the company's financials, however, you get no indication that you are looking at a multibagger. (Pixabay)

Summary

  • Why are investors betting big on this state-run telecom equipment maker?

10 trillion is the amount of wealth that was lost on Monday this week as fear of the outbreak of a new virus i.e. Human Metapneumovirus (HMPV), gripped the market.

There was a joke going the rounds that while the first few patients were on their way to full recovery, the virus had sent the stock market into an ICU.

Of course, the markets recovered some lost ground yesterday, and hopefully, things should be back to normal in a few days.

Also Read: Indian fund managers buy 3% stake in this multibagger smallcap stock, world’s top sal fat producer

There was one stock, however, that was abnormally up even as most other stocks were bleeding profusely on Monday.

I am referring to ITI Ltd, the state-run telecom equipment maker, which surged 20%, defying the overall bearish trend.

In fact, the stock is up more than 2.5x from its 52-week lows, outperforming both the Sensex as well as the BSE Smallcap Index by a significant margin.

If you look at the company's financials, however, you get no indication that you are looking at a multibagger.

The company has incurred losses in FY23 and FY24 and has been making losses for the last 12 months as well.

Also Read: Mukul Agrawal picks stake in multibagger stock that’s up 400% in a year

Its 10-year average return on equity (RoE) is a poor -1%, with the three-year average even worse at -12%.

The balance sheet also has a fair amount of debt with a debt-to-equity ratio exceeding one.

Hence, given the fundamentals, the valuations seem to be a tad baffling.

The company trades at a price-to-book value of almost 30x, whereas the price-to-earnings (P/E) ratio is non-existent because of its loss-making operations.

Speculative bet

So, given the poor fundamentals, what exactly has made investors warm up to the stock? Why did it go up on a day when the rest of the market had gone the other way?

Well, an article on our own website , i.e. Equitymaster.com, spills the beans.

Apparently, the company is playing an important role in transforming India's telecom and electronics sector.

Beyond telecom and electronics, ITI is getting into defence, the internet of things (IoT), and IT projects to transform business.

Also Read: Veteran investor Ramesh Damani has bought shares of this multibagger IT stock. Should you?

It is no secret that the current government is firm on its resolve to boost domestic manufacturing. And ITI, by virtue of being in a strategically important sector like telecom and electronics, will be at the forefront of this transformation.

Therefore, it is this turnaround in its fortunes that the investors seem to be banking upon. It is for this reason that the stock price is seeing a huge amount of buying interest.

The strong orderbook position of the company lends further support to the turnaround story.

As of June 2024, ITI had a robust order book of 11,200 crore. This is almost five times the company's trailing twelve-month revenue of 2,400 crore.

Besides, given the ambitious plans that the government has outlined, the number is only likely to go up in the near future.

Thus, there is certainly a good amount of revenue visibility on offer.

What about the valuations, though? Haven't they already run well ahead of fundamentals?

There is no doubt that if we go solely by past performance, ITI is significantly overvalued. On the other hand, there is also the question of how much of its future performance should we take into consideration, especially when there is no improvement seen in the current financial performance just yet.

To be honest, going strictly by the principles of value investing, ITI is more of a speculation than an investment based on its current operations.

The company will have to show a sustained improvement in its profitability for at least three years for it to be called investment worthy.

The stock can certainly be worth considering if it demonstrates that it can grow sustainably and profitably for a long enough period.

Absent the same, forget the current price, it was speculation even when it was trading at 210, its 52-week low.

I term those businesses as speculative where I can't estimate the fair value of the company with a decent degree of reliability. ITI falls into this category.

Please note that the stock is outside my circle of competence. However, it does not mean that it should be outside your circle of competence as well.

If you have a deep understanding of the industry, and if you can get a good handle on the future earnings of the company and believe that there is ample margin of safety at the current price, then you can certainly give the stock a more serious consideration.

For me, though, the risks seem to outweigh the rewards.

In fact, I'd like to have more certainty with respect to the company's topline and bottomline before I take a serious look at the stock.

Also Read: Big whale Ashish Kacholia trims stake in this multibagger jewellery stock

It needs to start generating consistent profits for me to start considering it as a potential investment candidate.

Happy Investing.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.

This article is syndicated from Equitymaster.com.

 

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