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Tuesday, May 16, 2006


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Asian Paints

Performance summary
Asian Paints, the market leader in the domestic paint sector, has announced strong results for the fourth quarter and full year ended March 2006. The consolidated topline grew by 17% YoY, much of which was on account of impressive show in the domestic market (standalone topline was higher by 18% YoY). Despite raw material cost esclations and foreign exchange fluctuation, operating margins at the consolidated level were stable, which in our view is commendable. At the PBT level, profit growth was 36% YoY. However, the financial performance is not equally comparable because the company closed operations in two countries (a part of Berger International). Nevertheless, we believe that the company is well on its way to turnaround its international operations from a long-term standpoint.

Consolidated results
(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Net sales 6,307 7,650 21.3% 25,739 30,210 17.4%
Expenditure 5,600 6,729 20.2% 22,387 26,293 17.4%
Operating profit (EBIDTA) 707 921 30.3% 3,351 3,917 16.9%
Operating profit margin (%) 11.2% 12.0%   13.0% 13.0%  
Other income 58 117 103.5% 324 320 -1.1%
Interest 17 23 35.1% 108 114 5.7%
Depreciation & amortisation 170 203 19.9% 691 682 -1.2%
Profits from associate company 0 (4) - 2 (9) -
Profit before tax 579 808 39.7% 2,878 3,431 19.2%
Extraordinary items (1) 2 - (5) (10) -
Tax 182 353 93.6% 1,061 1,323 24.7%
Profit after tax 396 457 15.5% 1,813 2,098 15.8%
Minority interest 29 (9) - 72 (23) -
Net income 367 466 27.0% 1,741 2,121 21.9%
Net profit margin (%) 5.8% 6.1%   6.8% 7.0%  
No. of shares (m) 95.9 95.9   95.9 95.9  
Diluted earnings per share (Rs)         22.1  
Price to earnings ratio (x)         29.0  

What is the company's business?
Asian Paints is the market leader in the Indian paint industry. It has an overall market share of around 49% in the decorative paints segment. It has benefited from steady transition in the industry towards consolidation, with top four organised players eating into the market share of the unorganised segment that controls 50% of the Rs 65 bn paint industry. Asian Paints, through a 50:50 joint venture with PPG Industries, US, also has presence in the automotive paints segment. The company has significant global presence through acquisitions, which are being restructured. The management of the company is acclaimed for consistently outperforming industry and its peers in the last decade. Though conservative in nature, the company is well focused on its core business of paints and has posted a CAGR of 14% over the last six years in topline (PAT CAGR at 16% in the same period).

What has driven performance in FY06?
Volumes robust, price hike helps: Total paint volume sales in FY06, on a consolidated basis, increased by 15% YoY, which was largely driven by higher demand in India. Apart from decorative paints, for the third year in succession, industrial paint sales grew by over 20% YoY. As we have mentioned earlier in our analysis, we expect the company to gain market share in the industrial paint segment (excluding automotive paints). In automotive paints, though Asian Paints is the second largest supplier to auto manufacturers, we expect Goodlass Nerolac (the market leader) to consolidate its share in the next three years. Apart from volume growth, price increases during FY06 also helped matters (overall price increase in FY06 works out to 6% in India).

On the automotive front (a joint venture with PPG, US), sales increased by 18% YoY in FY06 on the back of higher volumes sold by the likes of Hyundai and General Motors in India. Powder coatings, which was another key focus area for the company, increased by 36% YoY (this application is in consumer durable and select auto components). As far as the international operations are concerned, investors have to remember that the turnaround involves two pronged approach. One, to consolidate the company's market share in countries like the Carribean, Middle East and Egypt by launching new products. Second, restructuring some of the South Asian operations (including closure of some facilities). While the first leg of the approach is progressing well, in our view, and like we have mentioned in the past, the second leg is likely to be time consuming. With the implementation of the ERP system, we believe that the consolidated balance sheet will strengthen (lower working capital is the first benefit).

In a nut shell…

(% sales) Standalone Consolidated
FY05 FY06 FY05 FY06
Raw material 57.7% 58.3% 58.4% 59.3%
EBDITA margin 16.6% 16.7% 13.0% 13.0%
PBT margin 14.1% 14.6% 11.5% 11.6%
Net margin* 9.1% 9.5% 6.8% 7.0%

*excluding extraordinary items

Margins - Good show: Despite higher raw material costs (including higher packaging cost in light of the petrochemical cycle), the company has managed to maintain operating margins at the consolidated level. This, in our view, is commendable. We continue to repose faith in the company's ability to turnaround international operations of Berger International over the next three years. To that extent, investors have to attune their investment horizon. Of the international operations, the South Asian operations witnessed a EBDITA level loss as compared to a profit in the same period last year.

EBDITA & RoCE - International operations
('000 US$) EBDITA RoCE
2004 2005 2004 2005
Carribean 2,487 2,493 13.0% 13.0%
Middle East 2,267 3,273 14.0% 21.0%
South Asia 18 (304) -6.0% -18.0%
South East Asia 918 (3,209) 1.0% -33.0%
South Pacific 1,256 1,218 9.0% 9.0%

Subsidiary losses impact at the net level: Though PBT grew at a faster clip of 36% YoY on a consolidated basis, net profit growth was impacted due to losses in the South Asian operations of Berger International. As we go forward, we expect the company's net margin to improve in light of the restructuring, albeit steady over the next two to three years.

What to expect?
At Rs 642, the stock is trading at a price to earnings multiple of 29 times FY06 earnings. We expect paint demand in India to grow at 12% to 15% over the next three years, led by favorable GDP growth and housing sector. Even if the housing sector were to slow down, in our view, there is a huge market opportunity in the replacement side. But the replacement side is again a long-term story, as organised sector has to become competitive on the cost front on a relative basis to gain customer acceptance. We shall soon update the research report of the company

BRICS - Punj Lloyd , Murdeshwar Ceramics

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Sharekhan - Investor's Eye

Sundaram Clayton  
Cluster: Apple Green
Recommendation: Buy 
Price target: Rs1,550
Current market price: Rs1,178

Br(e)aking new ground 

Key points 

  • Sundaram Clayton Ltd (SCL) would benefit from the buoyancy in the country's commercial vehicle (CV) industry. The shift from hydraulic brakes to air brakes expected in the CV industry augurs well for SCL.
  • WABCO, holding a 39.17% stake in SCL, is scouting for a low-cost producer of brakes in India and SCL would be the ideal choice. We expect SCL to become a major sourcing hub for WABCO and meet its global requirements of brakes and machined castings. Such an arrangement would increase SCL's business opportunities significantly. 
  • We believe that the much-awaited demerger of SCL is about to take place. A demerger would enhance the business focus of both the divisions and lead to the unlocking of the value of the company's investments in group companies.
  • SCL has introduced anti-lock braking systems (ABSs) in India. It would get a boost from the government's move to make the use of ABS in CVs mandatory from January 2007. Also, the margins in ABSs are higher than that in the conventional braking systems which should further boost the company's margins.
  • The value of SCL's total investment in group companies works out to Rs1,930 per share. While computing SCL's value, we have assumed a 75% discount to the company's total investment. After adjusting for this, the SCL stock is currently trading at around 8.8x its stand-alone FY2008E earnings and around 7.1x its stand-alone FY2008E earnings before interest, depreciation, tax and amortisation (EBIDTA). We believe the valuations are attractive and hence recommend a Buy on SCL with a one-year price target of Rs1,550.


Cluster: Ugly Duckling
Recommendation: Buy 
Price target: Rs552
Current market price: Rs453

Wockhardt to launch ceftriaxone
Wockhardt has announced that it has received the approval of the US Food and Drug Administration (USFDA) to market the Ceftriaxone sodium injection in the USA.



Concerns overdone
In the wake of the continued rise in cement prices, in an unexpected move the government has intervened and asked cement manufacturers to reduce the price of cement. On Friday, the Commerce Minister Kamal Nath had given cement companies time till Monday (ie May 15, 2006) to decide on the pricing of the commodity. If their proposal fails to meet the government's approval, the government might come up with its own measures to curb the huge rally in cement prices. These may include the banning of cement exports and a cess on cement manufacturers. Meanwhile cement manufacturers are slated to submit a proposal by 6:00pm today. The government is of the view that the rise in cement prices has been much higher than the increase in the input cost.


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HDFC Bank - Anand Rathi

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Wealth Creation - Rakesh Jhunjhunwala

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Refining: Now and then

Over the past couple of years, the price of crude oil and oil products has risen significantly. Reasons and views cited for it range from 'peak oil theory' to deficient investment in upstream and downstream capacities globally (this is on the supply side), even as the appetite for oil continues to increase (this is on the demand side). Given this backdrop, we analyse the prospects of Indian refineries – opportunities and risks in the long-term.

Indian refining – Current state
Currently, India has 18 refineries out of which 17 are owned by the public sector undertakings. The only private refinery in the country is owned by Reliance (the world's biggest gross-root refineries). Currently, domestic refining capacity is in excess of domestic demand, which has resulted in export of products over the last few years. Petroleum product exports, in FY06, stood at US$ 6.8 bn, which is likely to touch US$ 10 bn by next year.

In the last five years, the downstream sector has witnessed significant capacity additions and the trend is expected to continue. By 2007, as per the planning commission estimates, the domestic refining capacity is expected to touch 141.7 MMTPA (million metric tonnes per annum) as compared to 133 MMTPA currently. Reliance Petroleum is establishing a refinery at Jamnagar with capacity of 29.4 MMTPA, which will commence operations by 2008. While Essar Oil's refinery will commission this year (capacity of 7 MMTPA), the company expects to raise capacity to 10.5 MMTPA by January 2007 (to 12 MMTPA later).

As far as the PSU's are concerned, IOC is building a refinery at Paradip with installed capacity of 15 MMTPA, along with expansion of its Panipat refinery by 6 MMTPA. BPCL is building a new refinery at Bina with a capacity of 6 MMTPA. HPCL is building a refinery at Bhatinda with installed capacity of 9 MMTPA (though in early stages). ONGC, in an effort to be wholly integrated, intends to increase refining capacity by 35 MMTPA (including MRPL). Even new players like Nagarjuna Oil are building a refinery with a capacity of 6 MMTPA.

Likely capacity in 2010-2011
Particulars (MMTPA)
Installed capacity (April 2005) 127.4
Brown-field expansion 14.3
Green-field expansion 113.1
Total capacity 254.8

This signifies a CAGR in the range of 14% to 15% during FY06 and FY10. As a matter of fact, over the past 7 years, domestic refining capacity grew at a CAGR of 10.7%.

Consumption of the crude and petroleum products…
(MMTPA) FY00 FY01 FY02 FY03 FY04 FY05 CAGR
Crude 86.0 103.4 107.3 112.6 121.8 127.1 8.1%
Petroleum 97.1 100.1 100.4 104.1 107.8 111.6 2.8%
Source:Ministry of Petroleum and Natural Gas

The consumption for petroleum products in India grew at a CAGR of 2.8% (FY00 to FY05), which was far below the rate of capacity expansion. Extrapolating the growth rate for consumption of petroleum products, we can say that demand in 2010-2011 is likely to be in the range of 135 to 145 MMT. If one considers the capacity expansion plans by then, the country will have excess capacity of over 100 MT, which will be exported. Reliance Petroleum is leading from the front and is establishing a wholly exported-oriented refinery (to commence production in FY09).

Oil: Outsourcing wave…
The US, a major consumer of petroleum products (21% of world consumption), imported 173 MMTPA of petro-products in 2004 (1.3 times India's total refinery). Even as US refiners have expanded capacity in the last five years, demand has grown at a faster rate, which has resulted in the US replying heavily on imports to meet domestic demand.

US capacity, consumption over the years…
('000 barrels per day) 2000 2001 2002 2003 2004
Capacity 16,595 16,785 16,757 16,894 17,042
% of world capacity 20.2% 20.3% 20.1% 20.1% 20.1%
Consumption 19,701 19,649 19,761 20,033 20,517
Surplus/(deficit) (3,106) (2,864) (3,004) (3,139) (3,475)
Deficit as % cons. 15.8% 14.6% 15.2% 15.7% 16.9%
Source: BP Statistical Review, 2005

Looking beyond the US, the demand for petro-products worldwide grew at a CAGR of 8% (1999 to 2004) while refining capacity expanded by 3% during this period. According to the IEA, even if demand continues to grow at 2% a year, by 2010, the total refining capacity in the world has to increase by at least 450 MMT. Global management consultancy, ICF Consulting, states, "In the past year and over the next roughly 5-year period, the ability to meet forecast demand for oil will be driven by refinery capacity issues, not crude availability." This, being the case, will benefit refineries in terms of higher margins. The excess global refining capacity, which was about 35% in early 1980s, now stands at less than 3% as the report. As per the BP Statistical Review (2005), the spare capacity in 1994 was 10%, which fell to 5% in 2004.

Though the Indian Petroleum Ministry is studying the prospects of India emerging as a regional refining hub for exports, this is a long shot. In our view, if this materializes, it can open up new growth avenues for Indian refineries. Firstly, Indian refineries will be able to diversify revenues, thereby insulating them from the risks perpetuating from domestic markets, albeit to an extent. Exports of petroleum products can alter the energy matrix for India as well. Export earnings from refining could end up paying part of the country's ballooning crude oil import bill. This in turn, will provide cushion to the country's BOP situation (balance of payment). All said and done, we need a government with a vision. If we continue to focus on the 'Aam Aadhmi' without adhering to the scruples of economics, investments will be hard to come by!