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Monday, May 15, 2006


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I-Flex - Equitymaster Stockselect

Hold (Target price: Rs. 1875)

Oracle takeover:
In August 2005, Oracle Corporation, the world's largest enterprise software solutions (ERP) provider, entered into a Memorandum of Understanding (MoU) with Citigroup to buy out its 41% equity stake in i-flex, held through OrbiTech, a 100% subsidiary. This move will benefit i-flex, as it can now sell its Flexcube suite of products to Oracle customers. Oracle counts as many as 17 of the top 20 global banks among its customers and serves as many as 8,500 North American banks and financial institutions.

i-flex can leverage the technology expertise and vast reach of Oracle in order to grow in size and scale, while Oracle will get the benefit of the company's deep domain expertise in the global BFSI space. It will also get greater access to the North American markets, which is the world's largest BFSI market. This move will thus, improve the already strong growth prospects for i-flex and the biggest benefit for shareholders of the company is that it will continue to be a publicly traded company, enabling them to participate in its future growth, with the same management team running it.

World-class banking solutions provider: i-flex's flagship product 'Flexcube' has been ranked as the world's number one selling wholesale as well as retail back-office banking solution for the fourth year in succession by IBS, UK. The company's products business continues to demonstrate strength and has witnessed a compounded growth in revenues of around 32% during the period FY02 to FY06. The company's 'tank size' (unbilled license fees) touched US$ 65 m at the end of FY06, in line with our estimates. Increasing revenues from annual maintenance contracts are also likely to benefit the company in growing its revenues in the future, adding an element of predictability to its revenue streams.

Given the fact that it is a well-established player, as well as the increasing brand equity and product visibility of Flexcube globally, this acts as a big positive in favour of the company and has the potential to win it a greater number of large marquee clients, going forward. We expect the product revenues to grow at a CAGR of 37.8% during the period FY06 to FY09, powered in some way by the Oracle 'parentage'.

Changing industry dynamics: As more banks merge globally, technology integration is expected to gain prominence and this will bring immense opportunities for i-flex. This is due to the benefits accruing from the implementation of a single platform for the combined entity and the scalability of Flexcube itself. Also, it is estimated that banks globally spend around US$ 70 bn on core transaction processing. Out if this, just around 15% is spent on packaged solutions like Flexcube, leaving a potential 85% market for

i-flex to tap. This 85% spending is currently being undertaken by banks on developing internal technology systems. Thus, the opportunity is huge. Going forward, we expect the spending on packaged solutions to increase. And we believe that i-flex, with its quality offerings, is likely to be the foremost beneficiary of the same.

Not just leveraged on Flexcube: Apart from its steadily growing services business, i-flex has been successful in de-risking its business model by launching new products on a consistent basis. This is evident from the fact that the company successfully migrated to Flexcube from its earlier flagship product 'Microbanker' (which was ranked by IBS as the top-selling wholesale banking back-office solution in the world in 1995). Then in FY03, i-flex launched its next product brand - Reveleus (related to various aspects of banking including treasury). Consistent initiatives on the R&D front have helped i-flex's to bring out globally competitive solutions for the banking and financial services industry and this is a big competitive advantage.

i-flex also acquired a company called SuperSolutions Corporation in FY04 and its product, Daybreak Lending Suite, a consumer lending and mortgage product. In FY05, i-flex acquired Equinox Corporation, a product-based BPO company. So far in FY06, the company has acquired a stake in Castek Software, a provider of insurance software for the global property and casualty (P&C) insurance market. It has also taken over an operational risk management tool, ORTOS.

High barriers to entry: The business of providing software solutions to the financial services industry has high entry barriers because of its expertise. i-flex's employees also have intricate domain knowledge of the financial services industry, which acts as a barrier to entry for potential competitors. This point is vindicated by the fact that i-flex has relatively fewer competitors on the global scale (Infosys, Temenos, Fiserv and Misys). This compares favorably with the high levels of competition that basic software services providers face globally.


The stock currently trades at Rs 1,288 implying a price to earnings multiple of 15.2 times our estimated FY09 earnings. Considering the strong benefits that are yet to fully accrue from the Oracle acquisition, the strong growth prospects of i-flex and its premier position in the BFSI solutions space, we recommend a HOLD* on the stock with a target price of Rs 1,875 from a long-term perspective.

*By this recommendation of HOLD, what we mean is that existing shareholders would be better off holding onto the stock with a long-term perspective. However, if an investor would like to BUY this stock, then the upside from the current levels is about 13% CAGR. Investors could take the investment decision based on this premise.

Hot Picks for this week

Punjab National Bank
Research: DSP Merrill Lynch
Recommendation: Buy
CMP: Rs 470 (Face Value Rs 10)
12-Month Price Target: Rs 600

DSP Merrill Lynch has upgraded PNB from `Neutral' to `Buy' with a price target of Rs 600, as they believe that post hike in its prime lending rates (PLR) by 50 bps and transfer of government securities to held to maturity (HTM) category, PNB, trading at 1.3 times FY07 adjusted book value, could arguably trade up to 1.4-1.5 times one year forward (FY08E) adjusted book value as it is amongst the best positioned banks in a rising rate environment.

PNB is amongst the best positioned banks under our coverage in a rising rate (lending rate) environment, owing to its very high proportion of low cost deposits (>45% of total deposits) and excess G-secs on its balance sheet (>35% of deposits v/s 26-27% for peer banks; minimum requirement is 25%).

PNB is also amongst the few government banks ahead on technology, providing it with greater leverage to enhance fees. Further, transfer of Rs 6,000 crore of G-secs to HTM category would make its reported earnings less vulnerable to rising G-sec yields which should positively impact stock sentiment and it has been the key reason for the stock's underperformance.

While forecast earnings would change owing to the transfer (Rs 300 crore charge required), DSP Merrill Lynch would reassess earnings on May 19th when PNB declares annual results. Currently, they are forecasting a 16% growth for FY07 and that does not capture any rise in lending rates or any transfer of G-secs to the HTM category.

Research: Angel Broking
Recommendation: Buy
CMP: Rs 528 (Face Value Rs 10)
12-Month Price Target: Rs 592

For the fourth quarter of FY06, Nirma's net sales grew 5.5% to Rs 483 crore. However, profits declined by 12% to Rs 95 crore. For the full year FY06, it posted a net sales and profit of Rs 1,917 crore and Rs 372 crore respectively.

While the topline grew 4%, net profit rose by a sharp 30.7% in FY06. Operating margin declined by 224 basis points during Q4FY06 due to a high rate of growth in the employee and other expenses. For the full year FY06, the OPM remains almost flat at 27.4%.

A higher tax provision during the last quarter of FY06 affected the net profit margin, which declined by 391 basis points to 19.7%. However, for the full year, the NPM expanded by 394 basis points to 19.4% due to a variety of factors which include higher other and interest income and reduced tax provision for the full year.

Nirma is eligible for set off of unabsorbed depreciation and losses of Core Healthcare, which it had acquired recently, and hence has made a lower amount of tax provision in FY06 in comparison to FY05. In key expenditures, power and fuel costs increased by a steep 21.5% YoY in FY06.

However, the backward integration strategy has aided the company in keeping a check on its raw material costs. At the current market price, the stock trades at 10.2 times FY07E (standalone) earnings. Taking into consideration the company's long standing, strong domestic demand for FMCG products and its recent foray into the pharmaceutical segment, Angel Broking expects the company to clock healthy growth rates going forward.

i-flex Solutions
Research: Enam Securities
Recommendation: Outperformer
CMP: Rs 1,288 (Face Value Rs 5)
12-Month Price Target: Rs 1,466

i-flex finished FY06 with a strong fourth quarter topline growth of 15.4% QoQ with FY06 topline at Rs 1,480 crore (30% YoY). EBITDA growth at 38.2% QoQ to Rs.130 crore was led by strong 25.4% QoQ growth in product revenues (Product OPM – 43.9% v/s 38.8% QoQ) with services recording a muted topline growth (4.3% QoQ).
Q4FY06 PAT at Rs 110 crore (FY06 PAT Rs 220 crore) was higher than our expectations, aided by lower taxes (61% QoQ). EPS growth of 6% YoY was impacted by the Rs 33-35 crore loss of KPO. Increased licence fee bookings have reduced the tank size from $7.25 crore to $6.5 crore, yet it is the second highest till date.

Stronger business traction for both FLEXCUBE and Reveleus coupled with higher visibility via Oracle parentage are expected to lead revenue growth. Higher deal flow is expected as the incentive structure is in place for Oracle's sales team, along with their ongoing training on i-flex's offerings.

Muted topline growth (4.3% QoQ ) was due to de-growth in offshore revenues (8% QoQ, 11.1% YoY) and 6% QoQ dip in utilisation. Both products are witnessing increased traction with demand for core banking replacement as well as risk and increasing compliance, e.g. FLEXCUBE's average. deal size from ~$0.09 crore to $0.16-0.17 crore YoY, coupled with leveraging Oracle's sales platform and parentage is expected to drive sales performance.

Nonetheless, higher services business growth (41% of consolidated FY06 OPBDIT) would be imperative for higher PAT growth. While current multiples appear rich at 29 times FY07E and 24 times FY08E earnings, the large addressable market for i-flex's products and robust business traction would continue to drive valuations.

Research: Edelweiss
Recommendation: Buy
CMP: Rs 242.50 (Face Value Rs 1)
12-Month Price Target: NA

Hindalco reported its Q4FY06 results, which were ahead of expectations. Notwithstanding the contribution of one-time gains (export incentives and tax adjustments), the key highlight of the quarter was the bouncing back of the copper business into the black.

On expected lines, copper business volumes improved post stabilisation of the refurbished smelters and higher TC/RCs aided profit growth despite high backwardation charges (YoY). The aluminium business maintained a stellar performance on the back of enhanced volumes, higher realisations, effective cost control and enriched product mix.
Topline received a thrust from higher realisations in both aluminium and copper due to a firm trend in LME prices. EBITDA growth (and higher EBITDA margins) was aided by effective cost control in operations despite higher cost of some key inputs like bauxite and energy.

With the copper business bouncing back in the black, expectations of robust performance from the aluminium business, and progress on its growth projects, FY07 should be a year of strong earnings growth for Hindalco. While the aluminium business continued to shine - with higher realisations, effective cost control and an enriched product mix - the copper business bounced back into the black.

Volume growth in copper was aided by refurbished Copper I (180 ktpa) and Copper II (70 ktpa) smelters and planned ramp-up of the Copper III (250 ktpa) smelter. For FY06, revenue rose 20% to Rs 11,390 crore. EBITDA in Q4FY06 rose 48% YoY to Rs 930 crore and EBITDA margins increased 40bps YoY (510bps QoQ) to 25.4%.

Net profit rose 40% YoY to Rs 630 crore (ahead of expectations). This includes a one-time gain of Rs 104 crore (export incentives based on the Target Plus scheme, which now stands withdrawn). Adjusted for this, net profit for the quarter grew 16% YoY.

For FY06, the company reported a profit of Rs 1,650 crore, a growth of 48%. Adjusted for the one-time gain, FY06 profit grew by 17%. In keeping with improved market fundamentals for the entire base-metals space, we have revised our metal price assumptions upwards.

Consequently, we have revised Hindalco's EPS forecast for FY07 28% upwards to Rs 23. At the current market price of Rs 229, the stock trades at a P/E of 10 times and EV/EBITDA of 5.1 times FY07 revised estimates and continues to look attractive.

The DLF Effect - Gaurav Sud

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Citigroup - Welspun

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DLF files for Rs 13,600 cr IPO

DLF Universal Ltd, which filed a draft red herring prospectus for itsinitial public offer with the Securities and Exchange Board of India today,aims to raise Rs 13,600 crore by issuing 202 million equity shares, eachhaving a face value of Rs 2. The shares will be offered at a premium to bedecided through a 100 per cent book building process.
 This will be the biggest IPO ever in India, comfortably overtaking the TCSfloat of Rs 5,000 crore in August 2004.
 The issue, if the green shoe option is exercised, will constitute 12.77 percent of the fully diluted post-issue capital of the company. That willleave about 87 per cent equity under the control of DLF Chairman KP Singhand his son, DLF Vice-Chairman Rajiv Singh.
 If the company is able to raise the money from the market, its total valuewill be pegged at Rs 106,499 crore. The notional value of the holding inthe hands of the father and the son will be Rs 92,899 crore, or about $20billion, placing them second in the list of the richest Indians, justbehind Mittal Steel Chairman LN Mittal.
 "Notional is a good word. We are looking to create an institution, one thatwill take its rightful place not only in India but internationally," saidRajiv Singh. The company's balance sheet includes Rs 848.9 crore of"goodwill" in 2006, up from Rs 52.2 crore in 2005.
 Of the targeted amount, the company intends to spend Rs 6,500 crore on landacquisition, Rs 3,100 crore on development and construction of existingprojects, and Rs 4,000 crore on prepayment of loans.
 Of the amount intended for land purchases, Singh said only a "smallportion" would flow into special economic zones. "Most of it will be onhomes, offices and retail," he said.
 The company has said in the prospectus that its has identified 62 citiesfor development of various projects. Until April 30, 2006, DLF Universalmade partial payments to acquire 2,893 acres of land across the country.All told, the company is evaluating residential, commercial and retailspace projects of over 118 million sq feet in the country. Real estateconsultants have valued DLF's land bank at Rs 100,000 crore.
 The company has said in the prospectus that it is adopting a new businessmodel, based on the development and sale of commercial and retailproperties. Earlier, it developed and leased properties. It believes thenew model will protect it from steep declines in asset values as a resultof market conditions.
 In the IPO, the company proposes to reserve 200,000 equity shares forallotment to employees. Of the rest, at least 60 per cent will be allottedto qualified institutional buyers, not less than 10 per cent tonon-institutional investors and not less than 30 per cent to retailinvestors.
 Kotak Mahindra Capital Company and DSP Merrill Lynch are the globalcoordinators and book running lead managers to the issue.

The turbulences

While the strengths and opportunities of the Deccan aviation offer are encouraging, investors will have to keep track of the following risk factors:

Possibility of price wars

The growth of the low-cost carrier market has attracted several new entrants into the market. Since the entry barriers are low, players such as SpiceJet, GoAir, IndiGO (from Interglobe), Yamuna Air or Kerala Airways, have filed flight plans. If they all do take off, the low-cost airline market may be heading into a price war. In effect, if the seat capacity grows faster than demand, the airfares generally weaken leading to lower revenues per customer. Similar trends are also in evidence when new carriers operate new routes.

Jet Airways set off the consolidation in the airline space recently with the acquisition of Air Sahara. Once complete, the integration process is likely to offer Jet Airways greater clout over operations.

ATF prices

Aircraft fuel expenses accounted for nearly 34 per cent of Deccan Aviation's total expenditure in the first eight months of 2005-06, up from 27 per cent for 2004-05. The surge in aviation turbine fuel prices over the past year is expected to have an adverse impact on the company's bottomline. Since November 2005, the ATF prices have appreciated 11 per cent, after marching up 17 per cent between April and November. The inability of the company to enter into price hedging arrangements for fuel supply owing to government regulations is likely to affect its financial performance.

This is likely to get compounded in the near term by congestion in airports, lack of landing facilities and parking slots as Deccan Aviation scales up capacity.

As the industry is also staring at a paucity of trained resources such as pilots and cabin crew the company may find it difficult to control staff costs.

Managing growth

For Deccan Aviation, a big challenge will be in terms of managing the new fleet growth. Unless the company is able to maintain high utilisation of aircraft and keep operating costs low, the financials will take a hit. For the eight months ended November 30, 2005, on total revenues of Rs 518.28 crore, the company incurred operating losses, with a net loss of Rs 123.68 crore.

External variables

The airline industry is impacted to a large extent by economic fundamentals, geopolitical variables and external events such as the SARS or the bird flu. Events such as an economic downturn, India-Pakistan political standoff or SARS have in the past led to a slump in passenger traffic and directly impacted the financial performance of airline companies.

Similarly, accidents or extensive government regulation can influence operational performance.

Deccan Aviation — Flying high at low cost

The initial public offering of Deccan Aviation, operating Air Deccan, is appropriate only for investors with a penchant for risk and a medium-term investment horizon. This low-cost, no-frills passenger airline is offering shares in the Rs 150-175 price band.

Exposure can be taken at cut-off, as that will make investors eligible for the offer even if the final price is fixed at a lower level in the book-building process.

We will be comfortable, however, if the final price is fixed at the lower end as that will provide greater scope for capital appreciation, especially given the highly capital intensive and volatile nature of the airline business and the risks associated with managing brisk growth.

First-mover edge

As the leading low-cost player, with a first mover advantage, Deccan Aviation is well-positioned to use the low-fare concept to stimulate demand in new and established routes alike. The upbeat economic environment, a growing leisure-spending class, a young affluent yet cost-conscious air traveller are all likely to sustain the buoyant growth rate of this sector.

The low-cost concept promoted by Deccan Aviation through Internet booking and cheap fares, paid in-flight services and single-class aircraft (such as Airbus 320 for trunk routes and ATR 42/72 for short-hauls) has caught the fancy of the air traveller in India.

The cheap fares are turning out to be competitive alternatives to premium class railway fares for the middle-class and the cost-conscious businessman.

The total aviation market that grew by 20 per cent in 2005 is expected to maintain the momentum in the 15-20 per cent range for the next few years.

On the flip side, however, the competitive pressures from a growing number of low-cost carriers, the operating losses in the core business as of November 30, 2005, the mounting unhedged fuel costs and the regulatory/infrastructure bottlenecks are challenges to contend with in the medium term.

Consolidating the core

Deccan Aviation has a fleet of 29 aircraft, operating 226 flights daily as of March 3s1. It had a market share of 14.2 per cent as of February. Operating out of six major cities — Mumbai, Delhi, Chennai, Bangalore, Kolkata and Hyderabad — the company services 52 locations. It plans to spread wings with the addition to the fleet size.

According to the offer document, in March, Delhi was the company's largest base measured by the number of passengers served. Apart from the six urban centres, it is establishing a base at Thiruvananthapuram. Outside this, it operates in 46 regional business, leisure and religious destinations.

To build scale and take on competition from other low-cost airlines such as SpiceJet and GoAir, as of March 31, 2006 Deccan Aviation had placed orders for 96 aircraft, which are to be delivered in a phased manner by December 2012.

Fifteen-nineteen aircraft are to be added in 2006-07. As part of its route strategy, Deccan plans to judiciously mix trunk and regional destinations, depending on the demand assessment and the availability of takeoff and landing slots.

Besides this, Deccan Aviation also operates as a chartered aircraft service provider with a fleet of ten helicopters and two fixed-wing aircraft.

Helicopter charter and other services contributed about Rs 30 crore out of the total revenues of Rs 518 crore for the eight months ended November 30, 2005.


First mover advantage: As the economic outlook for the economy remains buoyant, the demand for leisure travel and tourism will be substantial.

As airfares will drop further with competition intensifying in the low-cost carrier space, the scope for keeping the load factor above 70 per cent will be fairly high.

The first mover advantage and scale of operations will help the company wrest significant market share from low-cost competitors is well-proven in many high growth sectors, such as telecom, retailing or hotels.

Removal of regulatory bottlenecks: With the proposed moves to modernise the Mumbai and Delhi airports and the work on Bangalore, the infrastructure bottlenecks such as airport congestion, landing rights, or parking slots that have hampered the growth of aviation sector should be a thing of the past in a couple of years.

Companies such as Deccan Aviation, that proactively invest in building scale can benefit significantly from their growing fleet strength.

In the telecom sector, early investors such as Bharti, gained immensely from their focussed capital investment strategy.

Enhancing ancillary revenues: By allowing advertising on storage space, headrests, tray tables, baggage and outside surfaces of aircraft, the company aims to notch up 3-5 per cent of revenues from these ancillary sources. This will also provide greater leeway in improving the operating performance.

Valuation yardstick

Assuming the aviation market grows at 15-20 per cent annually, revenues earned per passenger at Rs 3,000 and keeping the load factor (level of filled seats in a flight) at 70 per cent, the implied value per share of the company works out to Rs 165-170 for 2006-07. This value will be pushed up.

If the company is able to either increase the revenues on a yearly basis or control its operating costs.

The market capitalisation based on the price band will be Rs 1,500-1,700 crore, working out to a price by revenues about two times.

Offer details

Deccan Aviation is offering 2.45 crore equity shares through this book-built offering at a price band of Rs 150-175 per share. The promoters are expected to hold 75 per cent of the post-offer equity of Rs 98 crore.

The offer size works out between Rs 370 crore and Rs 430 crore. The offer proceeds are to be used for setting up a training centre, a hangar in Chennai, infrastructure at airports, market development and debt repayment.

About 40 per cent of the offer proceeds will be used towards debt repayment to reduce the aircraft financing costs.

The lead managers to the offer are Enam Financial and ICICI Securities. The offer opens on May 18 and closes on May 23.

Citigroup - Tata Motors

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Asian Paints & KSB Pumps

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Thanks Ramesh