You still have a chance

Sept 21 2005   - Sharekhan

After nearly fifteen consecutive sessions of gains (barring a marginal dip of 4 points on September 15, 2005) the BSE Sensex saw a major fall in the morning only to recover subsequently. The day started with a downward slide that went all the way to a negative 230 points in the Sensex. However the index managed to close with meagre losses of 13 points. The fall in front-line stocks was accompanied by a sharper fall in mid-cap and small-cap stocks.

A couple of stocks in our coverage were also amongst the ones that saw a sharp correction. We believe that the correction presents one more buying opportunity

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Sharekhan - Reliance Industries

Reliance Industries

GRMs to surge post-Rita
If further shut-downs happen and the supply of petroleum products remains under pressure, the gross refining margins (GRMs) shall shoot up. For the week ended September 2, 2005, after the crisis caused by Hurricane Katrina, the Singapore refining margins had moved up by nearly $4.5 to $10.95 over the week previous to that. A similar situation is likely to develop after the looming catastrophe.

Reliance Industries Ltd (RIL), which runs a complex refinery that has the ability to process heavy/sour crude, will be the prime beneficiary of the spurt in the refining margins. RIL further commands a premium over the regional refining margins in Asia.

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Alps Industries - Analysis

After failing to market its natural dyes, venturing into producing value-added fiber dyed yarns

Alps Industries's business model is focused on production and marketing of home furnishing and fashion accessories produced by its textile division. The company manufactures fabrics and made-ups and a range of fashion accessory products like shawls, stoles, mufflers, wraps, and scarves. Besides, the company has a range of interior decorative products such as window coverings (venetian and vertical blinds, and drapery rods), awnings, garden umbrellas and wooden floorings. In the domestic market, the products are marketed under the brand, Le Pashmina and Vista. It has its presence in the overseas markets,too. In FY 2005, exports contributed around 27% to the sales.

Alps Industries's exports to reputed stores like Park B. Smith; J.C. Penney; House of Fraser, UK; Marks & Spencer, UK; Pablo Panicker, EU; Springs, US; Habitat, UK and France; Sanders, Germany; and L'eclere, France. The company signed a license agreement in July 2005 with Walt Disney Company (India) Private Limited to use certain Disney characters on the specified product groups to be manufactured by it.

Alps Industries proposes to set up a 50-tonne per day plant for cotton yarn spinning. The unit will also have fiber dyeing facility. The dyed fiber will be used to produce value-added yarn. The Rs 139.51-crore project will be financed through this public issue and term loans from various banks, aggregating Rs 87 crore.

Strengths

The new plant will also have a dyeing facility will use natural dyes, a process on which Alps Industries has done considerable research over the last 14 years. Thus, by using this in-house developed technique, the company will manufacture higher value-added fiber dyed yarns with uniform colour consistency. The yarn will retain its premium eco-friendly appeal.

The project is nearing completion and will commence commercial production by October 2005.

Due to the housing boom, the domestic market for Alps Industries's existing products is growing at a healthy rate.

Weakness

Alps Industries had come out with an IPO in April 1995, offering shares at around Rs 54 per share. At that time, it had envisaged selling natural dyes in powder form. But it did not find a market. Now, it plans to produce dyed yarn using natural dyes.

A large portion of the production from the new project will have to be marketed outside. This will add to the already large number of product lines that Alps Industries markets.

Alps Industries's financial health improved substantially only in FY 2005, after three years of sluggish-to-adverse performance.

Valuation

EPS for trailing 12 months ended June 2005, on post- issue equity, works out to Rs 14.5. Currently, Alps Industries's shares trade around Rs 155. However, the scrip had crossed the offer price of Rs 120 only early June 2005. The shares are offered at a P/E of 8 times, which is reasonable considering that the project is set to be commissioned shortly amid a positive business environment on the domestic and export fronts.

Suzlon Energy - IPO Analysis

Suzlon Energy is India's leading manufacturer of wind turbine generators (WTG) since seven years with a market share of around 44.5% of the total installed capacity. The company, its 100% subsidiaries and associate companies provide services like the wind resource mapping, identification of suitable sites and technical planning of wind power projects and operation and maintenance (O&M) services.

Suzlon Energy's IPO comprises 29,340,000 equity shares, consisting 26,762,680 fresh shares and 2,577,320 existing shares owned by Citicorp International Finance Corporation Inc. Citicorp and Chrys Capital, were allotted 25,77320 and 20,49,180 equity shares at Rs 194 per share in 2004. On an ex-bonus basis, the price works out to Rs 48.5 and Rs 61 per share, respectively.

The main objective of the public issue is to set up and expand Suzlon Energy's manufacturing capacity in India. Nearly Rs 195 crore has been earmarked for the new facilities and expansion of existing facilities. The company is looking at locations such as Daman, Bhuj, Hyderabad and Dhule in India for setting up new manufacturing plants. It wants a complete backward integration over the next five years so as to increase profitability and reduce dependence on outside suppliers. Currently, more than 50% of components are imported in euro and nearly 30% procured domestically.

Suzlon Energy will spend nearly Rs 353 crore to set up a plant to manufacture rotor blades and towering facilities in the US, marketing offices in Denmark, R&D facilities in Germany through its 100% subsidiaries. The company has completed one international project in the US. It is aiming at international energy-growth markets like Australia, Europe, North America, China, Denmark, Newzealand are aimed at.

Further, Suzlon Energy plans to redeem its preference shares of Rs 100 crore and to establish new corporate offices at Pune and in New Delhi.

Strengths

The Electricity Act, 2003, specifies that a minimum percentage of power generation should come from non-conventional energy sources. For example, the Karnataka government has mandated 5% from non-conventional sources, and the Madhya Pradesh government 0.5% from wind power by 2007. This reflects the government's intention of reducing the dependence on fossil fuels and cut down carbon-dioxide emission. Moreover, perennial power shortages assure a sustained growth in demand for power generation.

According to the Ministry for Non-conventional Energy Sources, the gross wind power potential in India stands at 45000 MW. With 875-MW installations in 2004, India recorded the highest year-on-year growth rates in installed capacity and contributed 10.7% of the total new MW additions globally in 2004 and 6.3% in 2005. Suzlon Energy has completed the installations of 507 MW in FY 2005. Till June 2006, the company's order book position stands at 312 MW in the domestic market and 80 MW in the international market.

The WTG sales are higher in the second and fourth quarters of every year and sluggish in other quarters. However, with its focus on international growth markets such as Australia, Europe, North America and China, where the government is encouraging the development of renewable energy sources, Suzlon Energy can leverage its business model and, in the long run, can reduce its seasonality.

The global WTG installations have grown at a CAGR of 26.9% since the four years ended 2004. The International Energy Agency has estimated that wind power's share in electricity generation will grow from 0.2% in 2002 to 3% in 2030. It will be the second largest renewable source of electricity after hydroelectricity. The US is targeting 2,200 MW of electricity to be generated through wind power.

Suzlon Energy enjoys various tax benefits like income-tax deductions under section 80-IB, exemption from excise duty including countervailing duty (CVD) for WTG and concessional rate of customs duty for major components used in the manufacture of WTG as well as raw materials for rotor blade. The effective income-tax rate is hovering around 8-11% as the company is taxed only under the minimum alternate tax (MAT) regime, which will continue till 2008. Also, the user industries generating power through windmills can avail benefits like accelerated depreciation (80%) and carbon credits.

Weaknesses

The company is fully dependent on promoter Tulsi Tanti. In fact the board of directors have only two Tanti brothers as executive directors. Three other board members are non-executive independent directors.

Wind power projects require high upfront capital investment per kWh of energy. So demand will be sensitive to interest rates.

Suzlon Energy is dependent on associate companies (fully controlled by promoters) in many respects, reducing the transparency in operations. As a group, it offers integrated solutions. But, at the same time, takes up lot of risks and makes large investments, which a power equipment producer will not make.

The viability of the wind power is dependent on the wind patterns, which are not constant and can vary significantly. Excessive as well as very low winds can be detrimental. As Suzlon Energy gives performance warranty for one to three years, substantial changes in wind patterns could lead to large claims. Moreover, excessive wind can destroy/damage the installations or work-in-progress, causing financial losses.

Changes in government policies can affect Suzlon Energy. Tax incentives and supportive policies of the state electricity boards are essential for continued growth. The Central and state governments are, however, known for frequent changes in policies. Any adverse changes could derail the growth plans of the company. Due to reduction in depreciation rate from 100% to 80% and the consequent uncertainty regarding the future government policy, the company's FY 03 sales had halved and profits fell 80%.

Suzlon Energy is expanding overseas, where major players have established markets. The advantage of new markets and new orders may take time, while marketing, personnel and other initial costs could jump. Hence, this may put pressure on the margin in the short run. Risks involved in overseas business are also higher.

Valuation

The FY 2005 EPS on post-issue paid-up share capital comes to Rs 13.4. At the lower price band of Rs 425 and the upper price band of Rs 510, the P/E comes to 31.7 and 38, respectively. Suzlon Energy compares its P/E with the likes of Bhel, ABB, and Siemens. However, these companies not only have mature business models but also strong promoters, and are capable of growing at healthy rates without any special government support. Suzlon's continued high growth rates will be dependant on sustained favourable government policies and protracted high P/E multiples will be dependant on prolonged market fancy for 'renewable energy' and 'carbon credits'.