Sharekhan Investor's Eye

HCL Technologies
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs670
Current market price: Rs602

Price target revised to Rs670
Overall, HCL Technologies appears to be well poised for the vast opportunity in the large outsourcing deals that are due for renewal over the next couple of years. The innovative offerings and its ability to generate large outsourcing deals from the mid-market segments is also encouraging. The move towards value-based pricing seems to be the right strategy going forward. But this will test the company's ability to deal with the higher risk involved in such a strategy. In the near term, the company is expected to show a robust performance in the second half of the current fiscal, on the back of a healthy order book and the ramp-up in the BPO business.

We maintain our Buy recommendation on the stock with the revised one-year target price of Rs670, which is 17x its FY2008 estimated earnings. This amounts to an appreciation of 11.3% from the current level.

Satyam Computer Services
Cluster: Apple Green
Recommendation: Buy
Price target: Rs900
Current market price: Rs753

Price target revised to Rs900
Satyam Computer Services (Satyam) has shown a consistent performance in the past few quarters. It has also taken inorganic initiatives to built capabilities in niche areas and expand into newer geographies. Though the Satyam scrip has been re-rated on the back of its improved performance, there are triggers for further re-rating of the stock. The two key potential triggers are the ability to catch up with its peers in terms of bagging large-sized outsourcing deals and the possible turnaround in the performance of its subsidiaries.

JM Financial
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs516
Current market price: Rs435

JMSPL merger impact
We attended the extraordinary general meeting (EOGM) of JM Financial (JMFL) with respect to the merger of JM Securities Private Limited (JMSPL) with JMFL. We present here the key takeaways from the meeting.

Cipla
Cluster: Cannonball
Recommendation: Buy
Price target: Rs600
Current market price: Rs543

Cipla benefits from bird-flu
Tamiflu could provide a good positive for Cipla. We will wait for more visibility about the market size and revenues generated from Tamiflu before we factor the incremental revenues in our estimates.

For Cipla we estimate a net profit of Rs847 crore for FY2008. At the current market price of Rs543, the stock is trading at 19.2x its FY2008 earnings estimate. Considering the company's strong growth prospects and the de-risked business model, we are basing our price target on our FY2008 estimates. We believe that due to the partnership model that Cipla uses, it can benefit from the future generic approvals of its partners and this is the hidden potential for the company. Hence we believe that Cipla should command a FY2008 multiple of 21x. Keeping in mind the huge growth potential of the company we reiterate our Buy recommendation on Cipla with the price target of Rs600.

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SECTOR UPDATE

Information Technology

Improved growth visibility
A combination of internal and external factors has considerably improved the growth visibility of the domestic front-line companies. Over the past couple of years, the domestic companies have not only enhanced their range of service offerings, but also attained a critical scale of operations and maturity in some of the new offerings like consulting, remote infrastructure management and business process outsourcing (BPO). Thereby making them well poised to exploit the vast emerging opportunities in large-sized multi-year outsourcing deals that will be renewed over the next couple of years. Moreover, the growth guidance recently declared by Cognizant has also set a reasonably healthy benchmark for growth over the next four quarters.

JK Cement - FPO

Focusing on reducing power cost

The price band tries to factor in benefits of lower power cost more than a year in advance

JK Cement (JKC) is one of the largest cement manufacturers in north India and second largest white cement producer in India. The company has two grey cement plants in Rajasthan, with production capacities of 2.8 million tonnes and 0.75 million tonnes per annum, respectively, and a white cement plant in Rajasthan with a capacity of 0.30 million tonnes per annum.

Catering to the northern region (13% market share for grey cement), JKC holds leadership position in Haryana, with a market share of 18.4% (nine months ended December 2005). Its other markets are Delhi, Rajasthan and Punjab, where it ranks in the top six players.

JKC’s cement manufacturing facilities and operations were originally owned and operated by JK Synthetics (JKSL), which had two businesses: man-made fibre and cement. In 1990s, the man-made fibre division accumulated losses while the cement division was still profitable. Under the rehabilitation scheme, JKSL’s cement division was demerged into JK Cement from 4 November 2004.

The proceeds of the current issue are to be used to (a) install waste heat recovery power plant of 13.2 MW capacity; (b) set up a 20-MW pet coke-based captive power plant; (c) replace a 7.5-MW steam turbo-generator set at its existing captive power plant with a 10- MW steam turbo-generator set; (d) increase the grinding capacity; and (e) scale up the white cement plant capacity by 0.10 million tonnes to 0.40 million tonnes.

Strengths

1. JKC has a presence in the lucrative northern region. The demand for the region in the first nine months (April-December 2005) has grown by 8% and is expected to grow at the same rate in FY07 as well.
2. On implementation of the proposed projects by June 2007, the total captive power capacity of the company will increase by 43.2 MW, resulting in a substantial saving in power cost, which is currently one of the highest among cement plants.

Weaknesses

1. We expect a capacity build-up in the northern region of about 8-10 million tonnes by FY 2008, thereby reducing the demand-supply gap, which could pressurise prices. This is the year when JKC’s power costs will come down. So the benefit of lower power cost may not inflate profit to the extent perceived now.
2. Promoters (Gaur Hari Singhania and Yadupati Singhania) have a poor track record.
3. JKC does not own or have registered trademarks and logo under which it operates and sells its cement.
4. JKSL owes Rs 62 crore to JKC. Its recovery is doubtful.

Valuation

JKC will not enjoy any significant volume growth in future. For earnings growth, it will be solely dependent on better price realisation in FY 2007 and fall in power cost in FY 2008.

The scrip currently trades around Rs 170 with a 52-week High/Low of Rs 101 to Rs 200. At the offer price band of Rs 145 – Rs 155, JKC’s PE works out to 60 – 65 x H1 FY 2006 annualised earning on the post-issue equity. TTM PE for the Cement -- North sector is 29. Market leaders of the northern region and highly cost-efficient players Shree Cement and Gujarat Ambuja are trading at a TTM PE of 30.3 and 26.5, respectively.

Nitco Tiles IPO

Look behind the shine

Sourcing from China is not a sustainable USP

Nitco Tiles provides flooring solutions. Its range of tiles is at various price points. The company’s products include mosaic tiles, ceramic floor tiles, vitrified tiles, paving tiles and imported marbles. It currently has an installed capacity of 0.8 million sq meters of mosaic tiles and 4.03 million sq meters of ceramic tiles.

Even while other manufacturers of vitrified tiles were fighting to block imports from China, Nitco went ahead and tied up for sourcing 15 lakh sq meters of vitrified tiles from a Chinese manufacturer. In fact, this is the main USP of the company. Imports of vitrified tiles from China attract a preferential import rate of 6.45%, without anti-dumping duty. As a result, Nitco derives an EBIDTA margin of 18% compared to 13% for tiles manufactured by the company in India.

Nitco has a distribution network of 550 direct dealers and about 5,000 outlets across India for retail sales. Its ratio of institutional to retail sales is 1:1.

The proceeds from the current issue are to be utilised to (a) expand the existing ceramic floor tiles capacity by 2.28 million sq. meters. to 6.31 million sq. meters by June 2006, (b) acquire/ set up a wall-tile capacity of 1.75 million sq. meters by April 2007, (c) install six wind mills to be completed by March 2006. The assessed funds requirement is Rs 95 crore, but the company is raising Rs 140 to Rs 168 crore.

Strengths

Increased thrust on housing and retailing augurs well for the tiles sector.

Weaknesses

1. The sector is dominated by the unorganised sector due to the easy availability of raw materials and low capex.
2. Nitco Tiles’s sourcing advantage is not a sustainable advantage and other players are likely to catch up in some way or the other. Or the government may plug the loophole, which is helping the company avoid the anti-dumping duty.
3. With additional capacities planned by industry players, prices of tiles are expected to decline. Increased imports from China are directly or indirectly affecting prices.
4. Nitco Tiles is not as strong as competitors in the retail segment.
5. There was a negative cash flow from operating activities in FY 2005 on increased inventory due to the build-up of imported tiles from China.

Valuation

Unlike other players, Nitco Tiles’s manufacturing sales is very small. Traded (mainly sourced form China) sales accounted for 65% of total sales in the first-half of FY 2006.

In FY 2005, manufactured sales fell 3% to Rs 97.22 crore and traded sales shot up 63% to Rs 105.13 crore. These traded sales are driving the company’s financials.

With a price band of Rs 140 – 168, Nitco Tiles’s PE on FY 2005 EPS ( post-issue equity) works out to 41.4 – 49.7 times and 16.7 – 20.1 times H1 FY 2006 annualised earning on the post-issue equity.. Comparable players like Kajaria Ceramics trade at a TTM PE of 11: Murudeshwar gets a multiple of 8.