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Monday, September 18, 2006

Movers & Shakers

* Bharat Earth Movers rose on entering into a deal with CCC for starting a joint venture company in Brazil.

* Southern Ispat hit the upper circuit breaker of 5% on its proposed plans to set up an integrated steel plant at Kannur in Kerala at a cost of Rs500 crore.

* Suzlon Energy moved up on bagging an export order from John Deere Wind Energy.

* Financial Technologies advanced after the MCX and the ZCE signed a MoU for working together that could mutually benefit both the exchanges.

* Wockhardt inched up on reports that it has signed a MoU with MIDC for setting up an SEZ at Aurangabad.

* Venus Remedies dropped despite announcing the launch of a new formulation, Fejet-od.

* Satyam Computer Services slipped despite signing a deal with the University of Melbourne for undertaking joint research projects.

* PBM Polytex inched lower despite announcing plans to set up a windmill power project.

Sharekhan Stock Idea - BASF

BASF India
Cluster: Ugly Duckling
Recommendation: Buy 
Price target: Rs300
Current market price: R220

Piggybacking on consumption boom

Key points 

  • We expect BASF India (BASF) to benefit from the changing demographics and the resulting consumption boom in India.
  • BASF's products are used in industries like white goods, textiles, home furnishing, paper, construction and automobiles all of which have been growing at a fast pace in contemporary times.
  • To capitalise on the resulting opportunity, BASF is expanding the capacity of its two key products, expandable polystyrene and polymer dispersion, which are used in the white goods industry and paper industry respectively.
  • We expect BASF's revenues to grow at a compounded annual growth rate (CAGR) of 31% and its earnings to grow at CAGR of 32.8% over FY2006-08E.
  • It has seen consistent return ratios in the past five years. It has RoCE of 24.8% and RoNW of 17.1% for FY2006; the same are expected to improve to 33.8% and 23.8% respectively by FY2008E.
  • BASF has a dividend yield of 3.3% and a high dividend pay-out of 40% which provide a margin of safety to the investment. 
  • At the current market price of Rs220, the stock is quoting at 7.6x its FY2008E earnings per share (EPS) and 4.3x its FY2008E EV/EBIDTA.
  • We believe that the stock is trading at attractive valuations given that:
    - the outlook for the company's business is very bright over next two years;
    - the return ratios, RoCE and RoNW, are likely to show sharp improvement; and
    - the dependence on agrinutrients business is likely to reduce substantially.
  • We recommend a Buy on BASF with a price target of Rs300.

Trading Call

Buy Reliance Industries above Rs 1143 for target of Rs 1159, support at Rs 1136.

Trade at your own risk

The story from 12K to 12K...

and what is driving the rally this time

Four months after it fell off the mark and five months after it firsttouched it, the Sensex is back at 12,000. Time to rejoice that all'swell with the world? Not really, if you take a close look at theunderpinnings of the rally that has taken the index back tostratospheric levels. The present rally appears to be selective interms of the participating stocks, and the market has turneddiscriminating in the mid- and small-cap spaces. There has been avirtual shake-out among the mid-caps that were in the vanguard of thelast rally till May. Ditto for the small-cap stocks, where, again, theparticipation has been minimal in this rally

Read here

Textile: Is it different this time?

Indian textile companies, across product categories (apparels, denim, home textiles) are today seeking to build scale, extend their footprint and access global markets. While their attempts are not without several hiccups, there is certainly a sort of rejuvenation in the sector, which was once written off as an old economy debt-ridden sector. This was primarily so when most companies in the sector sought refuge in the BIFR in the late 90s. With the textile majors today once again talking of expanded capacities and inorganic growth, we analyse whether the scenario is different this time.

The pros...
Yet to reap the fruits of capex: Most companies in the sector timed their expansion plans FY04 onwards, so as to avail themselves of the funding under TUF (Technology Upgradation Fund, offering loans at 6% subsidy) - due to expire in March 2007. This led to the capex-spending phase in the textile sector peaking in the last two fiscals. Against this backdrop, we believe most of the capex in the sector has already been incurred or is in the last leg of completion. We believe that the benefits of these expansions should start filtering in from FY08 onwards, once the new capacities stabilise and the utilisation levels get normalised.

Overseas alliances to help move up the chain: Several Indian textile companies have formed alliances with their global counterparts, particularly those with strong front-end capabilities, in a bid to access global markets, tap technological know-how, design skills and branding and retailing ability. The alliances have been struck in most cases by way of JVs or stake acquisition. The strategic rationale for the alliances could be as outlined below.

  • Branding and retailing capabilities: While Indian textile companies have the advantage of a cost competitive manufacturing base, they lack global branding and retailing capabilities. Tying up with overseas companies will help them move up the value chain and focus on the more lucrative branding and retailing business (Welspun India's stake acquisition in Christy).

  • Market access: Overseas alliances give Indian companies direct access to the US and European markets where their overseas partners have a distribution channel in place (Raymond's JVs with overseas partners).

  • Technology transfer: Transfer of technology and know-how for manufacturing the premium end products will become a possibility. Raymond through its JV with Gruppo Zambaiti has entered into a new line of business - high-value cotton shirting fabric. While Raymond will provide the low-cost manufacturing base in India, while its overseas JV partner will supply the technological know-how.

  • Designing capability: Overseas alliances will help Indian companies acquire international design capabilities and product development skills. This is true for all the three JVs entered into by Raymond in the recent past.

Retail footprint: Most large textile companies in India, realising the growth potential in domestic retailing, have drawn up aggressive strategies to expand their footprint in the domestic market (see table below). These include companies like Welspun and Himatsingka, which were traditionally export-oriented, as also Raymond, which has been the pioneer in domestic textile retailing. While Raymond has been reasonably successful with most of its domestic brands, its brand Color Plus is pegged as the most profitable apparel brand. Home textile (furnishing) companies like Himatsingka and Welspun have also taken steps in this direction with their outlets Atmosphere and Spaces respectively.

And the cons...
Home textiles-Over-supply concerns: Although home textile companies have recently been aggressive on the capacity expansion front, realisations have remained stable. But as new capacities come on-stream and utilisation levels pick up, this is unlikely to continue. This is because although India continues to feature amongst the lowest cost producers for the US and EU markets, competitors like Pakistan and Turkey are cannibalising its market share. Moreover, with the possibility of slowdown in the western economies looming large, a slowdown in demand cannot be ruled out.

Apparel-Rigid labor laws: India's inflexible labor laws have been a hindrance to investments in this segment. Unlike in home textiles, garment capacities are highly fragmented and leading Indian textile companies have been slow to ramp up their apparel capacities, despite strong order flows from overseas buyers who are trying to diversify out of China.

Denim-Excess capacity: Total denim capacity in India has nearly doubled over the past 12 to 15 months, resulting in a prolonged slump in the domestic market. Most new entrants (largely catering to the unorganised market) are incapable of producing export-quality denim and have resorted to dumping their produce in the domestic market resulting in nearly 15% drop in prices within a few months.

Firming cotton prices: As per the data for cotton production shown by the textile ministry of respective countries, cotton production is expected to rise by 2% globally. However, the new capacities in the textile industry seem to have to be falling short of sufficient raw material. While India continues to remain in surplus, the demand for cotton from across the globe is expected to keep cotton prices firm for the rest of the fiscal, thus impacting the operating margins of textile companies.

The scenario is... different this time! Excess capacity, pressure on realisations and raw material costs are as much of a concern today as it was half a decade back. In fact, dependence on exports for vending a large part of turnover has cost the companies foreign exchange losses (in their hedging account) with the rupee depreciation. Nonetheless, what needs to be acknowledged is that several companies in the sector have been pro-active in taking advantage of the regulatory and market opportunities (TUF, retail outlets, overseas JVs), which we believe will stand them in good stead in times to come.

Construction: The infrastructure push!

The Indian economy, with an expected growth rate of around 7.5% to 8% in FY07, is amongst the fastest growing in the world. In order to sustain this kind of growth rate, the country needs, among other things, robust and world-class infrastructure. It needs no repeating that the infrastructure in the country can, at best, be described as sub-standard, and at worst, pathetic. The country's financial capital, Mumbai, has, in some places, the kind of roads that you would not even find in a third-class village!  Thus, it goes without saying that if the country is to consistently grow at a good pace and attract investments, both domestic as well as foreign, then it will have to get its act together and consciously strive to improve its infrastructure - be it roads, power, ports, airports, irrigation, sanitation or telecommunications. In this regard, we briefly examine here, the kind of growth potential and investments that are there in the  infrastructure segment of the construction sector

Roads - Laying the route to prosperity!
The roads sector is one that is expected to see the maximum action in the infrastructure segment. Overall, infrastructure investments are expected to rise from Rs 1,700 bn in FY05 to Rs 2,200 bn by FY08. Of this, the roads sector is expected to contribute as much as 34%, or Rs 757 bn. A major part of this activity will be centred on the National Highway Development Programme (NHDP). This is the government's flagship project in its grand plan to give a facelift to the entire country's road network over the next decade. The project entails the building, upgrade and maintenance of 51,411 kms of roads at a cost of nearly Rs 1,900 bn.

Public-Private partnerships - Partnering for growth
With the pressing need to develop the country's infrastructure, the government has clearly realised that it cannot do it all on its own. It will have to involve the private sector, and the fact that a significant number of projects are being planned predominantly on a build-operate-transfer (BOT)^ basis is a strong indication of the government's intention to invite greater private sector participation in infrastructure creation.

Irrigation and water supply and sanitation (WSS)
Irrigation projects and urban infrastructure are expected to be other major areas contributing to the growth of the infrastructure segment. These 2 segments comprise 39% of the total outlay expected till FY08 at Rs 869 bn. Dam projects, water reservoirs, water treatment plants, desalination plants and sewage treatment plants are some of the project types that are expected to be awarded by state governments over the next few years. The state of Andhra Pradesh alone has envisaged investments of Rs 400 bn in irrigation projects over the next 5 years.

Power - Empowering India!
In India, the power infrastructure is in fairly poor shape. Power theft is rampant, and the quality of power supplied often leaves a lot to be desired. Thus, the need to accelerate power reforms cannot be understated. The government's capacity addition plans in the Tenth Five-Year Plan (2002-07) amount to 41,110 MW, while for the Eleventh Five-Year Plan (2007-12), the addition envisaged is to the tune of 60,896 MW. However, it should be noted that, given the past track record, it is unlikely that a great percentage of this addition will actually come on-stream during the plan periods. Nonetheless, construction investments are expected to amount to Rs 450 bn by FY10, giving significant scope for players operating in this sector.

The ones who matter!
  Sales EBITDA margins Net profit RoE Market price* P/E ratio**
(FY06) (Rs m) (%) (Rs m) (%) (Rs) (x)
Gammon# 14,851 13.0% 1,043 20.6% 374 34.9
Hindustan Construction 19,870 9.2% 1,248 20.1% 109 21.9
IVRCL 14,957 9.0% 930 24.8% 253 27.8
L&T@ 147,631 7.2% 9,424 23.7% 2,522 35.3
Nagarjuna Construction 18,404 8.9% 1,039 16.4% 312 26.7

As can be seen, all these players trade at reasonably high P/E multiples on a trailing 12-month basis, reflecting the high expectations that the market has from them. To their credit, so far, they have performed admirably, justifying the premium valuations that they enjoy on the bourses. However, we would say that while studying a construction stock as an investment, do not go by the order book size alone.

Factors like the duration of the order book, raw material costs, escalation clauses and the ability to protect margins are factors that, in our view, are more important than simply the order book-to-sales. Execution risks and, of course, finding adequate and qualified people to execute the projects, in our opinion, are the biggest risk factors.

^ In the BOT model, the vendor builds a highway or bridge, operates it for a period of time and later hands it over to the government. Here, it is important to note that this model rests on specialists who bring in the best knowledge and skill-sets for setting up such projects. The model works on outsourcing the early stages of project execution to specialist private players and once the project starts running smoothly, it is taken over and run by someone else like the government in this case.

Edelweiss - Praj Industries

Praj Industries going to make new moves ?

Edelweiss says ... here