ET - Hot Picks for the week

Hindalco
Research: CLSA
Recommendation: Buy
CMP: Rs 159 (Face Value Rs 1)
12-Month Price Target: Rs 210

CLSA has recommended a 'buy' on Hindalco with a 12-month price target of Rs 210. During financial year '07-08, Hindalco should see growth in volumes for copper, as well as aluminium businesses. CLSA is also positive on the medium-term outlook for aluminium, although there could be some softening in base metal prices from current levels.

The management has expressed confidence about the ramp-up of copper output to 350kt in FY07 and scale-up towards full capacity in FY08. The 390-kt alumina refinery expansion at Muri should come on stream by end '06, implying 5% growth in alumina output and 3% higher aluminium output in FY07.

Product mix enrichment supported by higher supply of value-added rolled products from facilities acquired from Pennar Aluminium and control on coal cost will have a positive impact on margins. With rising risk aversion globally, base metals also look vulnerable to near term correction.

Last week, Hindalco cut domestic aluminium ingot prices by Rs8,000/tonne (6%), but with volatile LME prices and local prices above import parity, further adjustments could be forthcoming. Spot prices of alumina, a key input for marginal Chinese smelters, also appear to be weakening.

However, CLSA earnings model assumes average LME aluminium price of $2,300/tonne (13% below current price), LME copper price of $4,500/tonne (43% below current level) and lower copper Tc/Rc margins for FY08 (19c/lb, vs 24c/lb in FY07 ) implying sufficient cushion to the forecasts. After the sharp 36% fall from its peak in early May, Hindalco is trading in line, below historical valuations. In contrast, the broader market remains at a 25-30% premium.

Hindustan Construction
Research: Motilal Oswal
Recommendation: Buy
CMP: Rs 113 (Face Value Rs 1)
12-Month Price Target: Rs 193

Motilal Oswal has recommended a 'buy' on Hindustan Construction with a 12-month price target of Rs 193. HCC's order book in March '06 stood at Rs 9,670 crore v/s Rs 5,380 crore in March '05 (up 80% YoY). As of end March '06, HCC has submitted price bids for projects at over Rs 2,280 crore, while price bids worth Rs 12,250 crore are expected to be submitted in the near future.

The company also submitted pre-qualification bids for 11 projects of Rs 6,570 crore, and expects to submit pre-qualification bids for five new projects valued at Rs 5,500 crore in the near future. During FY06, the company forayed into gas pipelines and EPC hydropower projects.

Realty development is emerging as a key business vertical for HCC, and the company is seeking opportunities in township development. In Lavasa Corp, HCC's stake has increased to 60.5% (v/s 50%). HCC is likely to report net profit of Rs 200 crore for FY07 (up 138%) and Rs 260 crore for FY08.

Based on SOTP, Motilal Oswal's value of the core business of HCC is Rs135/share (14x P/E), Lavasa project is at Rs 33/share and investments at Rs 25/share (at book value) and arrives at a target price of Rs 193 per share. At current market price, the stock quotes at reported PER of 17 times FY07E and 13 times FY08E. Adjusting for value of real estate, subsidiaries and investments, it quotes at PER of 9.1x FY07 and 6.9 times FY08E.

Jindal Steel & Power
Research: Edelweiss
Recommendation: Buy
CMP: Rs 1,311 (Face Value Rs 5)

Edelweiss has put a `buy' on Jindal Steel & Power. Jindal Steel's Q4FY06 results were broadly in line with expectations. Impact of higher volumes across all product segments was neutralised to a large extent by lower average realisations.

Q4FY06 topline rose 7.1% YoY (and 7.7% QoQ) to Rs 670 crore despite higher output in sponge iron, steel products and power. EBITDA declined 4.2% YoY (but increased 17.1% QoQ) to Rs 270 crore and EBITDA margins compressed 470 bps (320 bps higher QoQ) due to additional expenditure on repair and maintenance and refractory relining.

Effect of high interest payments and higher depreciation was offset by high other income and low tax outgo, leading to net profit increasing 2.7% YoY (19.1% higher QoQ) to Rs 150 crore, in line with expectations. The company benefited from new capacities commissioned towards the end of last year, leading to 48%, 16% and 23% higher volumes in sponge iron, steel products and power, respectively in Q4FY06.

For FY06, volumes were higher by 34%, 19% and 16% for sponge iron, steel products and power respectively. However, lower average realisations capped topline growth. Hence, net revenues for the quarter were 7.1% higher (7.7% up QoQ) at Rs 670 crore and FY06 revenues rose 15% to Rs 2,590 crore.

EBITDA in Q4FY06 fell 4% YoY (but up 17% QoQ) to Rs 270 crore and EBITDA margins fell to 39.9% (vis à vis 44.6% in Q4FY05 and 36.7% in Q3FY06). FY06 was marked by a steep fall in steel prices on account of capacity build-up in China and inventory de-stocking.

From March '06, steel prices have started moving up, and the outlook for average realisations is encouraging. The stock price has corrected by 42% in the recent bout of market correction and looks attractive. The company will see increasing proportion of earnings from its power business in years to come.

Wipro
Research: Sharekhan
Recommendation: Buy
CMP: Rs 436 (Face Value Rs 2)
12-Month Price Target: Rs 552
Shareholding pattern

Sharekhan has recommended a 'buy' decision on Wipro with a price target of Rs 552. Wipro is witnessing strong traction in its existing information technology (IT) service business. In addition to this, the incremental growth from the recent inorganic initiatives has considerably improved the visibility of growth in its global software service business.

The margins are also sustainable at the current level, given the positive pricing environment and the other operating levers (like a higher offshore contribution and utilisation rate) that are likely to cushion any adverse impact of wage inflation on the company's profitability. The company has effectively addressed the two key concerns of a slowdown in its business process outsourcing (BPO) operations and a lack of focus on large outsourcing deals over the past few quarters.

Sharekhan expects the revenue of the BPO business to grow at a rate of 26% (up from 18.6% in FY2006) to Rs 961 crore in the current fiscal. The OPM is likely to improve by 400 basis points to a sustainable range of 17-18%, resulting in a 68% growth in the operating profit over the previous fiscal.

Over the longer term, the company has chalked out a growth strategy that largely involves setting up near-shore centres (non-India offshore centres in Latin America or eastern Europe) and improving the contribution of high margin revenues by introducing more higher value-added services.

Despite the obvious cost pressures like wage inflation and the need to invest in strengthening the domain expertise and geographical reach through organic and inorganic initiatives, Wipro is likely to maintain its profitability at the current level.

One of the key drivers of its profitability would be the turnaround in the performance of the acquired companies as more work is shifted offshore (most acquired entities are based in developed countries and have an onsite-centric business model). We expect the offshore revenue's (in US$ terms) contribution to improve by around 100 basis points over the next two years.