Fit for a Maharajah

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India Rolling In Rupees - BW

Even by the standards of Lonavala, a mountainous outpost 70 miles from Mumbai where India's nouveaux riches like to spend the weekend, Rakesh Jhunjhunwala's country home is extravagant. The 15,000-square-foot "bungalow" features a swimming pool, jacuzzi, karaoke studio, and gym, as well as party rooms and terraces where Jhunjhunwala entertains family, friends, and business associates. Meanwhile, back home in Mumbai, the chain-smoking, 47-year-old founder of investment house Rare Enterprises has just bought a $5.4 million, six-bedroom duplex apartment in the tony Malabar Hill neighborhood. "I have far more wealth than I need," says Jhunjhunwala, whose estimated net worth is just shy of $1 billion. "But it gives me the freedom to do what I enjoy and enjoy what I do."

Although hundreds of millions of Indians still live in grinding poverty, the economy is growing at an 8% annual clip, and the ranks of the well-off and just plain loaded are ballooning. Some 83,000 Indians today have liquid assets greater than $1 million, up from 71,000 two years ago, American Express Co. AXP estimates, and their numbers are increasing by 13% a year. By AmEx' math, in 2009 there will be 1.1 million individuals with $100,000 in assets, a princely sum in India--up from 700,000 today. "I'm amazed by the wealth in this country," says Sujay Chauhan, who in April quit his job at technology researcher Gartner Group to found Aquasale, a boat dealer in Mumbai that already has seven orders for yachts worth a total of $10 million.

A lot of this is new money, not legacy Indian wealth. Up-and-coming sectors such as software services, telecommunications, finance, and real estate are minting new millionaires every day. And the Bombay Stock Exchange has more than doubled in the past two years, handing many investors tremendous capital gains. "India is the fastest-growing market for wealth creation," says Nicholas Windsor, head of personal financial services at HSBC India HSBC, which last year set up a private banking unit to cater to clients investing upwards of $500,000. Adds Ravi Trivedy, head of Business Advisory Services at consulting firm KPMG, which helps banks tailor services for rich clients: "For us it's a fabulous time."

The first place the new moneyed class typically shows off its cash is with a big house or plush apartment. While demand for homes over 3,000 square feet--palatial by Indian standards--was once confined to Mumbai and Delhi, more and more Indians in smaller cities want big houses, according to real estate consulting firm Cushman & Wakefield Inc. In September, Ambience Builders & Developers Inc. plunked down $120 million for a 60-acre parcel in Hyderabad, with plans to turn it into high-end homes. And each of India's large cities boasts 400 to 500 houses listed at $2 million-plus, estimates Mumbai real estate agency Knight Frank. "It feels good giving your family a comfortable existence," says Rohit Roy, an actor and talk show host who last year moved into a four-bedroom apartment facing the sea in Juhu, a posh Mumbai suburb.

Cars, of course, are another great way to get mileage out of your millions. Despite duties that effectively double the price of imported autos, sales of super-luxury models are gathering speed. National Garage, a nationwide chain of dealerships selling an assortment of brands, including Ferraris, says demand for the $200,000-plus machines vastly outstrips supply. To bolster the Ferrari image, it has turned away 700 customers that "didn't suit our product profile," says marketing director Farhad Vijay Arora. Across town at Navnit Motors, customers last year snapped up 200 BMWs for as much as $150,000 and 10 Rolls-Royces topping out at $600,000-plus--about quadruple the number five years ago. "We see a sudden surge of interest in these high-end luxury cars," says Navnit's marketing director, Sharad Kachalia.

To satisfy exploding demand, BMW next year plans to open an assembly plant in Chennai and hopes to expand its sales to some 1,800 Bimmers annually. That goal won't likely be hard to reach: Rival Mercedes-Benz DCX, which already has a factory in Pune, sold more than 2,000 cars last year.

Although well-to-do Indians have traditionally been wary of flaunting their money, more are wearing their wealth on their sleeves. Louis Vuitton CDI, Hugo Boss, Valentino, Gucci, and Fendi have all opened Indian stores in the past couple of years. And Kimaya Fashions Ltd., a high-end shop in Juhu that has long sold Indian-designed clothes to society highfliers and Bollywood stars, is stocking more global brands such as Roberto Cavalli and Giorgio Armani. "The Indian story has just begun to unfold, and now we know this is for real," says Kimaya managing director Pradeep Hirani.

There's plenty of potential growth. All told, the market for high-end luxury clothing and accessories in India is worth some $434 million a year and is apt to hit $800 million by 2010, estimates consultant Technopak Advisors Ltd. Indians last year spent $141 million on pricey wristwatches, a figure that's growing by some 40% a year, according to Technopak. "I'm not a gizmo person, but I like cars and watches," says Arun Mansukhani, 37, head of human resources at cellular carrier Hutch. His collection includes a Tag Heuer, a Mont Blanc, a Cartier--and a Porsche and a BMW. Wine sales are taking off, too, with help from the likes of the Wine Society of India. The group, established in September, held a tasting at Mumbai's stately Taj Palace Hotel, where society divas and Bollywood stars nibbled on chicken tikka and sipped $160-a-bottle Château Latour à Pomerol.

Not all wealthy Indians are comfortable showing off their newfound riches. Umesh Chadha runs an oil and gas services company, Luminus Energy, based in Mumbai with offices in the U.S. and three other countries. He has three cars but is also happy to get around town in a rickety three-wheeled motorcycle taxi. Although Chadha likes to vacation in the U.S.--he's planning an Alaskan cruise next year--he swears he hasn't changed much from his childhood days in Mumbai's Shivaji Park, a comfortable but not extravagant neighborhood. "I have maintained my middle-class values," he says.

Others are even more reluctant to show off. Three years ago eye surgeon Burjor Banaji bought a Mercedes C-Class sedan for his commute. He liked the Benz but sold it in September "to escape the attention, which was a nightmare." Today he drives an Octavia sedan from Volkswagen's Czech subsidiary, Skoda. "I love it," says Banaji, "because it's completely anonymous."

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SSKI Research : Results review Q2FY07: Full steam ahead

A 33.5%yoy growth in Sensex earnings for Q2FY07 (vis-à-vis our expectations of 27.5%) vindicates our view that India Inc's growth story is on track. Sectors driving the higher-than-estimated performance include metals, petrochemicals, telecom and software. SSKI universe earnings growth of 45.8% is also ahead of our expectations (43.5%). On the back of the strong performance, we have marginally upgraded our FY07 & FY08 Sensex earnings estimates by 2.2% and 1.4%.respectively. In October, we had upgraded our Sensex target range to 12,500 to 13,400 (17-18xFY08 earnings) factoring in reduced cost of capital. We further upgrade the range to 12,800 -13,600 factoring in earnings upgrade. Buoyed by strong growth earrings, the Sensex is approaching our target and is currently trading at 17.4x FY08 earnings. Our top large cap picks include BHEL, Bharat Forge, Grasim Industries, Infosys, ITC, ONGC, Tata Motors and Zee.

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IPOs Sifting through the sand

Rakesh Bhatnagar clicks on a button on his online trading portal and believes that he is guaranteed a handsome return. He now prays to the Lord at Shirdi to help him get allotment for the initial public offer (IPO) of the fledgling tech company. With a little bit of divine intervention, he will offload the allotted shares in the market and gain well -- all in a matter of 15 to 20 days.

Bhatnagar is not the only one queuing up for IPOs. There are many others like him. They are looking at making a quick buck through listing gains, by seeking allotment and offloading the shares on listing when the price is usually higher than the offer price. However, such manna seekers will see such opportunities thinning.


Experts reckon that listing gains will ease further as IPO offerings get priced according to market conditions. It was in 2004 and 2005 when average listing returns were in excess of 50%. Since November last year, listing returns have now averaged at around 23%.

Does this mean that the excitement of investing in an IPO will diminish?

Not exactly, say analysts. There is life beyond listing gains. Rakesh Jhunjhunwala, a savvy investor, when asked about his greatest investing regret said, "The epitaph on my grave will say that I missed out on investing in the Infosys IPO." Infosys, like many other companies, approached the stock market in 1993 with an offer price of Rs 95 per share to garner around Rs 13 crore. The rest, as they say, is history.

IPO revival

Now, while Infosys may be a once-in-a-lifetime story, there are others who have provided extremely lucrative returns to investors. At the same time, there are as many who have duped investors of their valuable monies.

Just about a decade ago, the IPO market was at its pinnacle. In 1995-96, there were 1,428 issues which hit the market. Offer applications of blue chip issues were actually sold in the black market. And after the heydays came hell days. Unscrupulous issuances, along with a faltering secondary market, saw IPOs drying up. The nadir was hit in 2002-03 when there were just about 14 issues.

It took a spate of some strong PSU issues to revive the IPO market. Improved market conditions and overall economic well-being aided the revival. Initially, companies were wary and offered attractive prices. So companies like Saksoft, Gateway Distriparks and Bharati Shipyard offered handsome listing gains. Plucking low hanging fruit became a profitable habit with the investing community. It was this same habit that tempted promoters to tap the market and leverage the euphoria to pass out flawed projects.

Old habits die hard, and ominous patterns are resurfacing. The past year has seen around 100 issues hitting the market. In the previous year there were around 34 issues. This is the highest number of issuances in the past four years. Importantly, the average issue size is the lowest over the same period.

A similar trend was witnessed a decade ago when the number of issuances had peaked and the issue size had dwindled. This trend indicates that there is a rush to gain from the IPO boom. In this rush, many atrocious issues slip through.

And when reality dawned on the investors, considerable wealth had been destroyed. Many of those issuers are nowhere to be seen today.

IPO metrics

It is therefore important for investors to sift through IPO issuances before taking the plunge. There will be opportunities for getting listing gains, but they will be few and far between.

The mantra for investing in IPOs is not different from that of the secondary market. Raamdeo Agarwal, Joint MD, Motilal Oswal, puts it in perspective, "Buying in the primary market is as good as buying in the secondary market." The same holds true in the case of the IPO. There are differences, though. One is that in a fresh IPO, there is no price history or behavior that investors can rely on to get a perspective.

Arun Kejriwal, proprietor of KRIS, and a sharp market observer says, "While investing in an IPO, one should keep his eyes and ears open. One should not fall prey to greedy promoters. One good way is to look at the details about promoters, the business, the revenue model, and the pricing of the issue."

FE Investor lists out some more areas that investors should look at before taking the plunge.

Promoter risk

The promoter is the biggest risk to any project. There might be great projects on the anvil, there will be stupendous opportunities. However, the execution of this project and the delivery of the promise totally depend upon the promoters. Here are some pointers:

• Investors need to look at the track record. Usually, unscrupulous promoters would see that the financial performance dramatically improves in the year of the IPO or just before it.

• Logic dictates that if the business and prospects are so lucrative, why would anybody want to share it with more people? It took many years for TCS to come to the public. And when it came, the reasons were strategic. Investors need to see the strategic need or reasoning in going public. Will the issue add value to the enterprise or simply give some free cash to the promoter?

• Promoters' stake after the issue is critical. A higher share after the issue shows belief in the project on the part of the promoters. A seasoned fund manager suggests, "See if the promoters are willing to eat what they cook."

• Many promoters use bonus issues to grow their own shares and issue bonus issues to themselves just before going public.

• Then there are promoters who have floated several firms and companies in the same line of business. A recent real estate developer from north India offering shares has more than 50 companies in similar businesses. This causes a severe clash of interest where promoters could actually divert high margin businesses to the privately owned firms.

• Where there are consistent performances, check for the return on capital employed. It should be better than the return available in the market at reasonable risk, say around 12 to 13% per annum. The reasoning, analysts believe, is that promoters could be better off lending money in the market at reasonable risk than building an enterprise.

Business outlook

Sound promoters have a knack of making ordinary projects deliver. However, they also need to operate in a business environment. There are several external factors that even peg the sound promoters down for a while.

Promoters take no time in tom-tomming the virtues of the business outlook to sell their wares. Investors need to look at these carefully for hype created by promoters. An entertainment company hit the markets in August 2000 at a price of Rs 165 per share for a Rs 100 crore self-appraised project. The promoter propounded the great future of the industry and indicated that global media companies enjoy a price to earnings (P/E) multiple of 75 plus and justified the issue price. The share currently trades at Rs 60.

Price and timing

The promoter may be sound, the business outlook exciting, but what should be the value attached to both these? Nilesh Shah, CIO, Prudential ICICI, gives an earthly insight into IPO pricing, “One should apply the same rule to IPOs while buying a car or any other requirement.”

He indicates the need to thoroughly compare each product offering and take an educated decision.

Age-old indicators like the ability of the company to generate cash or visibility of earnings, comparable P/E ratios and price to book value ratios also need to be looked at. The current and future state of the market sentiment will also provide a strong insight.

Importantly, investors need not be bothered about missing out the allotment in the IPO. Past experience suggests that after the debut trading hype, around 80% of the stocks underperform the Sensex within a period of three months. The secondary market will always offer the scrip at a competitive price.

In the coming days there are many more IPOs getting lined up. Just two companies are planning to mop up a hefty Rs 18,000 crore between themselves.

The IPO market offers substantial opportunities for investors. And for the likes of Bhatnagar, it would require more than divine intervention for gains.

Since the market place is getting crowded, investors will have to sift through the sand carefully to get to the gold.

Edelweiss Maruti Udyog & Lupin

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Young, And Restless

Reliance Communications

Sun TV

Suzlon Energy

Punj LLoyd

Take India's first global-scale, wholly export-oriented oil refinery, add to it India's only pan-Indian CDMA telephony service provider, throw in India's only, and one of the world's largest-and few-integrated wind energy players, bring on one of India's most diversified engineering and construction companies, top it with India's largest regional broadcaster with an international presence, and what do you have? Other than a very long sentence, you get an instant flavour of the new entrants that have pole-vaulted straight into the BT top 100. You also get a feel of the uniqueness of the business model of each of these companies-Reliance Petroleum (#15 on the BT 500), Reliance Communications (#9), Suzlon Energy (#11), Sun TV (#50) and Punj Lloyd (#75), just in case you haven't figured out yet-that listed on the stock exchanges in 2005-06. These five companies also illustrate how entrepreneurially-driven Indian business families are creating tonnes of shareholder wealth by aggressively growing in sectors few of their predecessors have ventured before. As per the BT 500, these five companies have collectively added a market cap of Rs 1,11,006.29 crore to the listing, whilst all the new entrants-29 in all-have chipped in with a market cap of Rs 1,35,060.23 crore.

Their uniqueness aside, the new entrants to the Top 100 list are also getting younger. Reliance Communications, for instance, began life in mid-2003 (as Reliance Infocomm, which was then a part of Mukesh Ambani's Reliance group. Now, after a family settlement and a demerger from Reliance Industries, it is headed by Anil Ambani). Reliance Petroleum too is a greenfield refinery project, on which work is under way. Now contrast this with TCS, a company that was set up in 1968 and entered the bt 500 list in 2004 at #2; or with Maruti, which commenced production of its cars in 1983, and entered the BT 100 at #18 in 2003 after listing on the domestic bourses.

The other entrants to the top 100 may not be as high-profile as the Ambanis, but don't let that take anything away from their pride of place in the BT 500. Any doubts about their stature can be quickly dispelled by their market cap figures-Tulsi Tanti, Chairman & Founder, Suzlon Energy, has managed to create a giant with a market value of Rs 32,000 crore in just two years. In 2004, Citigroup and ChrysCapital had invested Rs 50 crore each in Suzlon for a 9.6 and a 7.1 per cent stake, valuing the company at Rs 522 crore and Rs 707 crore, respectively. Says Ashish Dhawan, Managing Director, ChrysCapital: "Tulsi Tanti is a tiger, an extremely dynamic entrepreneur who dreams very big...he has traits similar to Mukesh Ambani. His burning ambition to play on the global stage, coupled with the fact that he is a hands-on leader, will see the company realise its dream of being among the top three players in the world."

That essentially is what Tanti has in mind for his company. He is sure that the increasing oil and gas prices coupled with concerns about global warming will present him an opportunity to grab a quarter of the global market for wind energy by 2010; this year, Suzlon's share is expected to touch 12 per cent. Tanti is setting up manufacturing bases in India, China and the US, and ramping up capacities at existing bases at an investment of about Rs 2,500 crore. "Besides, with the acquisition of Hansen (a Belgian maker of gearboxes, which are a key component in wind turbines, for m465 million, or Rs 2,697 crore, we should be able to grow more than the industry's compounded average growth rate of 25 per cent," says Tanti.

If Suzlon's business model is global, Kalanithi Maran's Sun TV is touted as a regional play, focussed on Tamil Nadu and Kerala (the Andhra Pradesh and Karnataka parts don't belong to the listed entity). Yet, this second-largest listed broadcaster (after Zee Telefilms) with a BT 500 market cap of Rs 8,000-odd crore, is fascinatingly global with its reach. As Maran, Managing Director, Sun TV, puts it: "We are a regional language television broadcaster, which is present across the UK, the us, Australia, New Zealand, South Africa, Malaysia, Singapore, Sri Lanka and the Middle East. And we are constantly endeavouring to spread our reach into new areas of operations in media." The Sun Network runs 14 TV channels, four fm radio stations, two daily newspapers and four magazines. Maran aims to make Sun TV the number one media company in India in five years. The company became a national player, Maran says, after obtaining fm radio licences for 45 cities across India.

Ambition and passion clearly aren't in short supply for the new entrants. Atul Punj, Chairman, Punj Lloyd says: "We have the potential to be a $10 billion (Rs 46,000 crore) top line company in 10 years." This year, he expects revenues to touch $1 billion (Rs 4,600 crore). Only three years ago, this appeared unlikely. The company was saddled with borrowings, and the debt-equity ratio was over four times. That's when the company raised Rs 225 crore by offloading a 28 per cent stake to Standard Chartered Private Equity, Temasek and New York Life. That's gone a long way in helping Punj Lloyd emerge at #75 on the BT 500 listings.

Investors, including the private equity tribe, have adequate reason for putting their money where the Indian promoter's mouth is. There's plenty of potential locked in these companies, and investors in turn expect plenty. This is reflected in the price-earnings multiples (P-Es) of the recently-listed bandwagon, which are in the 25-40 vicinity on forward earnings. The forward P-E for the 30-stock Sensex on the Bombay Stock Exchange, in comparison, is just 22.

That many of these companies are in high-growth sectors is for the great expectations from them. The telecom sector, for instance is growing at over 30 per cent, and Reliance Communications, in spite of being a late entrant in the Indian telecom space, gained size quickly and emerged as one of the dominant players by end 2003 (in less than a year from the launch) with a market share of a little over 20 per cent. "This was possible, in part, because of huge upfront investments which gave the company a wide coverage, as well as aggressive marketing and pricing (tariffs and handset bundling)," says Hitesh Kuvelkar, Associate Director, First Global. Besides the wireless market, the company established a strong presence across the enterprise services market and long distance telephony, he adds.

Reliance Communications may be largely an India consumption story (at least as of today), but Suzlon, for its part, has a hybrid model, centred as it is around the country's cost-competitive manufacturing base, yet targeting virtually the entire globe. Currently 40 per cent of Suzlon's revenues come from international markets. The company has an end-to-end integrated strategy: Not only does it make, market and install wind-generating equipment, it is also investing in pre-installation services like wind-mapping and post-installation activities like payment realisation from utilities. Says V.K. Sharma, Director & Head of Research, Anagram Stock Broking: "Two things going for this industry are that it is renewable energy and is pollution-free. Any player in this industry with these advantages, coupled with scale, will be able to pre-empt competition to a large extent." Adds Dhawan of ChrysCapital, which still holds a 3 per cent stake in the company: "Suzlon has made the right bet-backward integration has ensured supply of raw material (casting materials, forging materials, gearbox and bearings) in a business where the supply chain is creaking."

Another build-in-India-sell-overseas model is that of Reliance Petroleum, which is a pure play on the shortfall in global refining capacity. Reliance Industries, which operates the world's third largest single-location refinery in the world at Jamnagar, Gujarat (with a capacity of 33 million tonnes per annum), has embarked on setting up India's first export-oriented refinery through a subsidiary, Reliance Petroleum, at a cost of Rs 27,000 crore. The refinery will have a capacity of 29 million tonnes, and will be operational by December 2008. This high complexity refinery (measured on the Nelson complexity index at 14.0) will be among the top 10 refineries globally by capacity, and will enjoy enormous flexibility in use of raw material and product output. It will import crude and export to the West, where underinvestment in refining capacity over the last two decades has created a growing gap between demand for refined products and refining capacity. Remarkably, the company enjoys a market capitalisation of about $6.5 billion (Rs 29,900 crore)-not bad for an entity that is still in the project execution mode. Despite a high premium-the IPO was priced at Rs 60-the Reliance Petroleum issue was oversubscribed 53 times, mobilising $31 billion (Rs 1,42,600 crore). Interestingly, the world's largest company by market cap is from the energy sector-Exxon Mobil Corp., which at the time of writing had a market value of roughly $425 billion (Rs 19.55 lakh crore)!

Going global may be the buzzword, but it isn't as if the potential in the country-or even in just one of its regions-is saturated. Far from it. Consider Sun TV, which is riding high on its southern language broadcasting channels. These include Sun TV, KTV, Sun News, Sun Music (all in Tamil), Surya TV and Kiran TV (in Malayalam), which together dominate Tamil Nadu and Kerala television viewership. This is a clear delight for advertisers. Sun TV is today viewed as a great media platform, which will benefit from increasing ad spends-the ad spend to GDP ratio in India is at 0.39 per cent as against a world average of 0.98 per cent, according to the 2006 FICCI report on the Indian Entertainment and Media Industry. Higher subscription revenue will also have a role to play-currently 58 per cent of the satellite TV industry's revenues come from users; the figure is expected to increase to over 70 per cent by 2010. The best part for Sun, however, is that it's carved out a huge niche of its own. Says Phani Sekhar, a research analyst at the Mumbai-based Angel Broking: "Sun TV has shown consistent growth, a clean balance sheet and very good return ratios. Compare it with the national players, Star, Zee and Sony, who are all embroiled in a slugfest and have all sorts of programming issues. Sun has no competition in the areas it operates in, and that's an advantage in terms of cornering the advertising pie."

Consumer-oriented growth is one prong of a booming domestic economy. The other trigger is infrastructure-creation, and Punj Lloyd has earned its spurs in the engineering and construction space. Analysts consider it one of the few engineering and construction companies with a strong track record in the hydrocarbons space, especially pipelines. Says Vinod Nair, a research analyst who tracks the company at Brics Securities, "Punj Lloyd could be the best construction company going forward. It is best diversified and in my opinion comes second only to L&T." Its customer list includes global majors such as British Petroleum, Cairn, Saipem and Petronas and also Indian oil companies such as Reliance, Gas Authority of India and Indian Oil Corp. The company clearly hopes to make huge gains by tapping into the orders for an estimated 22,000 km of crude and oil pipelines which are likely to be built over the next five years. Punj Lloyd is also geographically well diversified, implementing projects across India, South East Asia and Middle East. Says Atul Punj: "The acquisition of Sembcorp e&c (a Singapore-based company) in June this year added to our verticals. Sembcorp has built the Changi airport, industrial parks, special economic zones, which are all areas that Punj Lloyd was never into; also its UK subsidiary Simon Carves has strong capabilities in the petrochemicals space." Punj Lloyd, however, didn't have an impressive report card to show shareholders at the end of March 2006, with margins coming under pressure. But that might have been an aberration. Adds Nair: "2005-06 was not so great in numbers because a major Rs 1,000 crore road project in the East was halted and that impacted margins. But the project is now under way and the fourth quarter of the ongoing year should bring some positive news."

They're all great companies doubtless-at least most of the 29 would be-but the slump of Punj Lloyd last year begs the question: How sustainable is the growth of these companies? Adds Prithvi Haldia, Managing Director, Prime Database: "One cannot break into the Top 100 unless you have a strong fundamental growth story. The valuations they have got are on strong fundamentals and the future outlook of their respective industries."

A list of companies that broke into the BT 100 in the recent years suggests Haldia may not be off the mark. All except three of the 13 new entrants over the last three years remain in our Top 100 this year. HT Media and J&K Bank may have slipped, but are not too badly off at #133 and #151 respectively. Nimesh Kampani, Chairman, JM Morgan Stanley, says, "Private companies today are very profitable and well managed and their valuations reflect that. As long as they maintain a good track record and profitability in this competitive scenario, they will do well and it will reflect in their market cap."

Yet, there are sceptics. Reliance Communications, for instance, will have to contend with, at some point, a slowdown in subscriber growth and continued intense competition for subscribers, which may impact margins. Then there's also the proposed foray into the GSM space. "The company has applied for GSM spectrum in 21 circles. We believe the strategy would entail huge investments and considering the already cluttered market place, it may be difficult for the company to generate adequate returns to justify these investments," says Kuvelkar of First Global. Suzlon, meanwhile, is dependent on policy support to wind energy. In India, 70 per cent of the industry's customers looked at depreciation benefit as a key criteria for investing. The regional nature of Sun TV's business makes it susceptible to swings in its relatively small markets. Shrinking crude refining margins (usually dependent on availability of surplus refining capacity and uncontrollable global factors) may impact the profit margins of Reliance Petroleum. And Punj Lloyd will need to manage the cyclicality of its business and high execution risks. Promoters of these businesses aren't exactly ignorant of such risks. But if these risks didn't exist, there would be few entry barriers to these businesses, which would negate their distinctiveness-and with it their valuations.

Bhagiradha Chemicals & Industries Ltd. (BHAC)

Bhagiradha Chemicals & Industries is one of India’s largest manufacturers of the best-selling insecticide, Chlorpyriphos. The company is reorienting its strategy and focusing on R&D to drive growth. It is foraying into contract manufacturing of high-value agrochemicals. We expect sales to grow at a CAGR of 22.50% from Rs 77.52 crore in FY06 to Rs 116.3 crore in FY08E, resulting in EPS growing at a CAGR of 44.20% from Rs 17.5 in FY06 to Rs 36.4 in FY08E. We rate the stock an OUTPERFORMER with a 3 to 6-month price target of Rs 189.

Background

Bhagiradha Chemicals & Industries was incorporated in 1994 to manufacture Chlorpyriphos, a new generation insecticide at that time. Chlorpyriphos is an insecticide used on a wide variety of crops such as cotton, chilly, rice, sorghun, soyabean, sugarcane, groundnut, vegetables, ornamentals and flowers. It is used for commercially important plantation crops like citrus, mango and grapevive. Chlorpyriphos also finds application in the preservation of wood and timber.

The promoters, Koteswara Rao and D Sadasividu were previously working at Indian Institute of Chemical Technology (IICT), which has developed several innovative technologies for chemical products (including Chlorpyriphos). The initial capacity of the plant was 300 tonnes per annum (tpa) and this was expanded to 2,000 tpa as on March 2006. The company diversified into producing herbicides in 2004, and has been launching a new product every year. It also has a facility to make bulk formulations of Chlorpyriphos. Its current product portfolio comprises of two insecticides – Chlorpyriphos and Imidacloprid – and two herbicides (Triclopyr and Fluroxypyr).

Investment Rationale

Differentiated business model
Selling agrochemicals in regulated markets requires huge sums for generating the data package required for product registration. Alternatively, the data can be purchased from the original inventor. However, inventor companies demand hefty amounts, making the business unviable. Most Indian companies have thus focused on the domestic market and developing nations where it is easy and cheap to register their products. But the consequence has been too players competing in the same markets. Apart from drastic price erosions, there is also lack of stability in the business since customers can easily switch suppliers. Overcapacity in the agrochemical sector in China has further exacerbated the situation.

In order to overcome these hurdles, Bhagiradha is now reorienting its strategy and focusing on R&D to drive growth. The promoters of Bhagiradha are technocrats who have strong R&D experience. The company has a state-of-the-art R&D center at Hyderabad, which employs 30 scientists and its expenditure on R&D is on the rise with Rs 45 lakh being spent on R&D in FY06 (55% Y-o-Y growth).

Manufacturing pact with Dow AgroSciences
Bhagiradha recently signed a contract manufacturing agreement with Dow AgroSciences for the herbicide Fluroxypyr. Bhagiradha is to supply minimum 250 tonnes of Fluroxypyr per year for the next 4 years. Dow AgroSciences is the original inventor of Fluroxypyr and was its sole producer till now. The global demand for Fluroxypyr is about 1,500 tpa. It is a high-value product and is mainly used in the developed markets. This deal is an important milestone for Bhagiradha since Dow AgroSciences chose it as its partner despite the fact that the two are competitors in the Triclopyr and Chlorpyriphos market. It also vindicates Bhagiradha’s new business strategy of R&D-driven growth since many other Indian companies were also in the race to be the first to develop a generic version of this product.

With an increasing trend of MNCs to outsource molecules that have gone off patent, Bhagiradha will now be the preferred option for Dow AgroSciences in case it decides to outsource more of its Fluroxypyr requirement in the future.

For FY07E, Fluroxypyr volumes are expected to be 250 tonnes, translating into revenues of Rs 35 crore. We expect Dow AgroSciences to increase the quantity to 370 tonnes in FY08E, and revenues rising to Rs 50 crore. Bhagiradha’s bottom line is expected to get a significant boost since contribution level in this product is about 50%. The total investment in the Fluroxypyr plant was only Rs 8.5 crore.

Broad-based product portfolio
For the first 10 years since its inception, Bhagiradha was only manufacturing Chlorpyriphos. In 2004, it decided to diversify into other products to mitigate the risks associated with a one-product. It launched Triclopyr (a herbicide) in 2004, Imidacloprid (an insecticide) in 2005 and Fluroxypyr (herbicide) in 2006.

Revenues from new products now constitute 30% of its total sales. They expected to rise to 61 % by FY08E. Since these are high-margin products, its NPM has also increased to 11.5% in FY06 from 9.5% in FY05.

Product Profile

Chlorpyriphos: This insecticide was launched in 1994 in the Indian market. Initially many companies set up plants for this product based on a breakthrough technology developed by IICT. Chlorpyriphos volumes have grown exponentially since then but its price has crashed from more than Rs 500/kg in 1994 to current price of Rs 260/kg due to intense competition. This led to many smaller companies stopping production. Currently, there are only a few companies still left in the field. They include Bhagiradha, Excel industries, Dow AgroSciences, Gharda Chemicals and Mitsu. Considering the low-margins, Bhagiradha plans to maintain current capacity of 2,000 tpa and use it as a cash cow. It will funnel fresh investments into facilities for new high-value products only.

Triclopyr: This herbicide accounts for 9% of Bhagiradha’s turnover and the entire production is exported. Dow AgroSciences originally developed this product and Bhagiradha, Aimco Pesticides and Punjab Chemicals & Crop Protection Ltd now produce its generic versions. Global demand is approximately 1,500 tonnes and major export destinations are Australia, New Zealand and South East Asia. Triclopyr sales are expected to reach Rs 11 crore in 2007 and Rs 12.9 crore in 2008.

Financials:

The full benefits of the Fluroxypyr deal will be visible from the current year onwards with sales expected to grow by 50% from Rs 77.52 crore in FY06 to Rs 116.3 crore in FY08E. However, net profit would soar by more than 100% from Rs 8.9 crore in FY06 to Rs 18.5 crore in FY08E. The shift towards high-value products will see NPM expand from 11.5% in FY06 to 15.9% in FY08E. RoCE, which was respectable 31.8% in FY06, is also set to reach impressive levels of 39.5% in FY08E. The free cash flow generated would be used to reduce debt through bullet repayments. Debt/Equity ratio is expected to fall from 1.1 in FY06 to 0.3 in FY08E, thus considerably de-leveraging the balance sheet.

Risks & Concerns

MNCs have an option to outsource products from their subsidiaries in developing nations. Syngenta has already done this by making its Indian arm a global sourcing base for the insecticide Thiamethoxam. Unless the patent holder considers Bhagiradha a serious threat, it may not be the preferred partner for its outsourcing deals.

Valuation

The company is currently trading at one of the lowest P/E ratios in the industry. We expect sales to grow at a CAGR of 22.50% from Rs 77.52 crore in FY06 to Rs 116.3 crore in FY08E and EPS to grow at a CAGR of 44.20% from Rs 17.5 in FY06 to Rs 36.4 in FY08E. At the current price of Rs 157, the stock trades at 8.97x its FY06 EPS of Rs 17.5 and 4.31x its FY08E EPS of Rs 36.4. The stock is available at an EV/EBIDTA of 6.39x FY06 earnings and 3.10x FY08E earnings. We rate the stock an OUTPERFORMER with a price target of Rs 189 with a 3 to 6- month timeframe.

Technical Outlook

The stock has formed a good support at the Rs 120 levels and has been in an accumulation mode since then. Stochastic has turned positive and the RSI indicator also signals a BUY. It faces a minor resistance at Rs 160 levels. Volumes have been picking up recently.

FII: + 526.90 MF - 71.06

FII Gross purchases Rs 2276.80 Cr Gross Sellers Rs 1749.90 Cr Net Purchases Rs 526.90Cr
MF Gross Purchases Rs 451.52Cr Gross Sellers Rs 522.58 Cr Net sellers Rs 71.06 Cr

Market is again trading at its highest level and this is certainly driven by liquidity inflow which shows that the foreign investors have keen interest in the Indian market. Fundamentally the markets are strong but at high levels profit booking is expected.

Renewed interest in select mid-caps

Positive news flow, strong quarterly results, and in some cases buying for the heck of it, boosted some small-cap and mid-cap stocks last fortnight (between 27 October and 10 November).

Some top gainers from the A group in the small-cap and mid-cap segment were Jaiprakash Associates (up 40% to Rs 638.25), Sterling Biotech (up 20.9% to Rs 146.75), Apollo Hospitals (up 20.6% to 537.70), Punj Lloyd (up 19.6% to Rs 925), Sun TV (up 18% to Rs 1424.35), HCL Infosystems (up 17.5% to Rs 158.30), GMR Infrastructure (up 15% to Rs 352.90) and Balaji Telefilms (up 14% to Rs 164).

A whopping 95 scrips from the B1 group rose between 10 -50%; UTV Software advanced 50% to Rs 267.40. Other top gainers were India Infoline (up 46.7% to Rs 288.20), TV 18 India (up 32% to Rs 932.25), Solectron Centum Electronics (up 30.8% to Rs 247.05), Jain Irrigation (up 25% to Rs 362.10) and KEC International (up 25% to Rs 382).

The trigger for the rally in Jaiprakash Associates was a court ruling which paved the way for a major land development project by the company in Uttar Pradesh. Punj Lloyd surged after it won three very large construction contracts, whereas Sun TV spurted after it announced pay rates for its flagship channel.

UTV Software surged even as the company termed media reports on News Corp eyeing a sizable stake in it, baseless. Solectron Centum Electronics was the centre of attraction after the company announced a restructuring of its services and products portfolio, transferring the services division to a separate company. Robust Q2 results boosted transmission towers maker KEC International.

A section of the market feels that valuations of small-cap and mid-cap stocks have become attractive vis-à-vis large-cap stocks, thanks to gains in the latter. While large-cap stocks have surged, a host of small-cap and mid-cap stocks are still away from their lifetime highs of May 2006.

What happened was a sharp fall in small-cap and mid-cap shares, when the market declined sharply in May 2006. But when the market staged a solid rebound since late-July 2006, it was select large-cap stocks which led the rally. Many small-cap and mid-cap stocks, although on the road to recovery, were not as prolific as the large-cap ones. The BSE Small-Cap index, currently at 6,504.60 (10 November), is quite far from its lifetime closing high of 7,812.84 of 10 May 2006. The BSE Mid-Cap index at current 5,596.21, is off its all-time closing high of 6,033.20 of 10 May 2006. The Sensex settled at a lifetime closing high of 13,282.91 on 10 November 2006.

Sensex riding on optimism

Continued strong corporate earnings growth remains the key driver of the market rally.

At a lifetime closing high of 13,282.91 (10 November), the barometer BSE Sensex is up 41.3% in calendar 2006 so far.

`The market sentiment is positive, as investors seem to have already revised the earnings' estimates upwards for FY07 and look poised to discount FY08 earnings, which is evident from a strong of 77% rollover of October futures to November’, notes Nilesh Shah, Chief Investment Officer, Prudential ICICI Mutual Fund in the latest October 2006 monthly fact sheet.

For Q2 September 2006, the aggregate net profit of 3,096 companies surged 46.7% to Rs 52,272 crore, on 30.8% growth in net sales (sales include other income for banking and finance firms) to Rs 5,14,841 crore.

With expectations that the momentum of earnings growth would be sustained, FIIs have stepped up buying. Strong global liquidity has aided the surge in inflows. By the first few days of November 2006, FII inflow has reached Rs 2,237.90 crore (till 9 November). In the month of October 2006, when the earnings poured in, their net inflow totaled Rs 8,013 crore compared to an inflow of Rs 4,643 crore in August and Rs 5,428 crore in September. FII-inflow in calendar 2006 so far has reached $7.14 billion. In calendar 2005, FII inflow was a record $ 10.7 billion.

A section of the market attributes the solid surge on the Indian bourses to increasing recognition of India’s long-term growth prospects. India’s growth drivers are a favourable demography (large share of young population), robust domestic consumption and acceleration in infrastructure creation. Prime Minister Mahmohan Singh has promised a complete policy on infrastructure, including regulatory and institutional framework, to make it attractive for private participation in the near future. The market has soared in the past two years. From 4,644 on 23 June 2004, it has galloped 186% in less than two and a half years.

Not only earnings but also corporate restructurings, demergers and foreign acquisitions, have lifted investors' confidence in India Inc. In recent months, some big ticket overseas acquisitions were made by Dr Reddy’s Lab and Tata Coffee. If Tata Steel’s planned $8 billion acquisition of Anglo-Dutch steelmaker Corus goes through, it will be the biggest acquisition by an Indian company overseas. Besides, there have been a slew of small and mid-sized overseas acquisitions by Indian firms over the past couple of years.

Indian markets continue to trade at a premium over its regional peers. The premier index, BSE Sensex, trades at a PE multiple of 21.7 based on its trailing 12-months September 2006 earnings.

Market men expected volatility to emerge on the bourses in the near term following a solid surge over the past few months. `Investors may encounter short-term volatility as the market tries to scale further highs or even sustain the current levels, and hence, investors should remain patient and have a long-term investment horizon’, says Prudential ICICI’s Shah.

In its October 2006 monthly fact sheet, HSBC Mutual Fund’s fund manager states that inflation remains the single biggest risk for the Indian equity markets. It was the data that showed cooling off of inflation for the last week of October, which boosted the bourses on Friday (10 November). Yet, the last week of October has been the fourth week in a row that wholesale prices-based inflation stood above the 5% mark. RBI raised its key short-term interest rate by 25 basis points in its latest credit policy on 31 October.

What could suck liquidity from the secondary market in the near term would be some large IPOs that are in the pipeline in the next two months, especially by DLF and Cairn Energy.

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Godfrey Phillips: Hold

Investors can consider retaining their holdings in the Godfrey Philips stock, which trades at about 15 times its expected FY-07 earnings.

Though the company is in a non-cyclical consumer business, which is at a near-mature stage, its cigarette segment is likely to maintain a consistent 20 per cent earnings growth over the long term.

Besides, a healthy and sizeable investment book adds confidence to the stock.

Tobacco products

Godfrey Phillips has a strong presence in the northern and western markets. Threat from competition is low, as consumers tend to stick to brands. Restrictions on advertisements also work to the advantage of such large players as Godfrey Phillips.

To garner a larger share of the domestic market, the company launched a new brand and refrained from passing the higher excise duties to consumers.

However, with ban on smoking in public, the scope for volume growth may be limited.

Consecutive hikes in excise duty are also a dampener as consumers of low-end cigarettes are likely to move to other forms of tobacco consumption.

Godfrey Phillips in recent years has ramped up activity in the relatively untapped cigar segment. The company is among the larger players in this industry.

Although this product line contributes only marginally, it provides an additional stream of revenue.

Tea

The company also has a presence in the tea packaging industry. Godfrey Phillips has a small basket of brands, which it markets in certain pockets of the country.

Though the tea business contributes only about three per cent of its revenues, this division has been growing at about 15 per cent annually over a three-year period.

This division is a dampener to Godfrey Phillips' growth prospects as intense competition in the branded tea market hampers potential for a turnaround in the medium term.

Financials

The company, which is the second largest player in the domestic cigarette industry, operates on lower margins compared to its peers owing to its manufacturing tie-up model.

Profitability of its cigarettes division is, however, higher than that of its smaller peers at about 55 per cent.

The company, stranded for avenues to deploy its funds, disburses a chunk of its earnings.

At current levels the stock has a dividend yield of about two per cent, Godfrey Phillips is likely to maintain similar payouts in the medium term.

Syndicate Bank: Hold

Investors can consider retaining their holdings in the Syndicate Bank stock. Though the bank appears comfortably placed in terms of capital adequacy, and valuations appear undemanding, concerns about resource mobilisation and quality of earnings compel us to take a cautious view on the stock.

Pressure on margins

Syndicate Bank's performance in the September quarter was rather disappointing. That the bank has been struggling to contain cost of funds is clearly reflected in the margins. The bank's balance-sheet, which has been growing at a scorching pace over the last 18-20 months, is putting pressure on margins. For the quarter ended September, Syndicate Bank's advances rose by 49 per cent and deposits by 51 per cent. These numbers are way above-the-average growth rate seen by the banking sector. Typically, in such a situation, rising yields on advances would contribute to improvement in net interest margins for banks. However, for Syndicate Bank, this has not been the case. While yields on advances have improved by 45 basis points to 9.07 per cent on a Y-o-Y basis, the benefit of this has been more than offset by declining yields on investment and the rising cost of deposits. Its net interest margins for the quarter have contracted by about 85 basis points to 2.55 per cent.

There has been a clear sign of deterioration in the bank's deposit mix. In this regard, two issues that need to be looked at are, the proportion of low-cost deposits and incremental deposit mix. The share of low-cost deposits has recorded a sharp decline from 41 per cent a year ago to about 30 per cent now. Further, more than 90 per cent of the incremental addition to deposits in the September quarter has come from term deposits.

This clearly shows that a high growth in balance-sheet has come at a higher cost. While the bank management has indicated that it is finding attractive opportunities, mobilising low-cost resources is likely to remain a key challenge over the medium term.

In the near term, we expect the cost of funds to remain high as the scramble among banks to raise short-term deposits is likely to intensify on concerns of liquidity constraint. However, the excess SLR of five per cent that the bank has, eases the concern to some extent as it can deploy the same in funding fresh advances.

Yield on investments also recorded a dip of 25 basis points in the quarter to 7.4 per cent as the bank sold off high-coupon investments and deployed the proceeds in low-yielding investments to take care of liquidity requirements. However, as about 15 per cent of the bank's high-cost deposits are set to mature by December 2006, we expect pressure on NIMs to ease off to come extent.

Key variable

Another key variable that needs to be watched out over the next few quarters is the non-performing assets (NPAs). For the quarter-ended September, the bank's level of net NPAs has remained stable at 0.9 per cent. However, absolute level of gross NPAs has gone up with increase in asset base to about Rs 1,700 crore from Rs 1,590 crore a quarter ago.

That recoveries are taking place at a faster rate is also a positive. However, with assets being added at such a scorching rate, the bank's ability to check fresh NPAs holds great significance from an earnings perspective.

With a capital adequacy ratio of about 11.7 per cent (Tier-1 at 6.5 per cent), the bank is likely to require additional capital to fund growth. The government's holding at about 66 per cent, leaves room for raising fresh equity. The bank is most likely to go for a hybrid capital issue next year before exercising the equity option.

From a valuation perspective, the stock of Syndicate Bank is quoting at a price-to-book multiple of 1.3 as against the peer-group average of 1.5. Even a profit growth of 10 per cent, which appears attainable over the next year, is likely to generate return on net worth of about 20 per cent. This appears healthy.

However, considering the challenges over the medium term, remaining invested appears the appropriate strategy.

Adlabs Films: Buy

We are re-initiating coverage on Adlabs Films with a `buy' on the stock. With strong financial backing from its promoter, the Anil Dhirubhai Ambani group (ADAG), Adlabs has the makings of a media conglomerate. It is making the transition from being a company focused on film processing and a budding interest in film exhibition to one that is involved in everything from production and distribution of films to multiplexes.

Scope for growth

Forays into providing television content, animation and home videos provide the company scope for broadening the revenue profile. ADAG's aggressive entry into the media space, which includes plans in the Direct-to-Home (DTH) and cable network spaces, is likely to provide an impetus to Adlabs' own growth plans. The de-merger of the radio business will free up Adlabs' balance sheet from the heavy investments in this space, besides unlocking value for the shareholders, who will get to hold a direct stake in the radio business.

Over the next two years, revenue and earnings growth is likely to be driven by rapid expansion of multiplexes. The stock now trades at about 30 times its annualised FY-07 earnings, on a fully expanded equity base (post conversion of foreign debt). This is at a discount to peers, such as PVR and Inox Leisure.

The commercial risks of the new segments such as production and theatre exhibition are, however, higher than that in film processing(where Adlabs has a stronghold), asthe revenue stream is more dependent on the box office success of films. Earnings could, as a result, display a lumpy pattern. This makes it an investment option for those with an appetite for risk. However, as film processing is likely to continue to be a source of steady cash flow, the company remains a less risky alternative to pure-film or pure-exhibition plays in the sector. Exposures can be considered from a two-year perspective.

Good show in Q2

Adlabs turned in a spectacular performance in the second quarter and also in the first half. Revenues more than doubled, and profits expanded three-fold in the September quarter.

There was a massive expansion in operating margins from 46 per cent to about 60 per cent. It has been a blockbuster year for the Indian film industry. A series of box office hits buoyed revenues of its exhibition business, which witnessed a rapid addition of properties over the past year. Revenues from the segment expanded three-fold. Adlabs is investing heavily in building multiplexes in metros and the smaller cities and towns. It expects to have more than 100 screens by 2008, thus retaining its size advantage, even as its competitors are putting through heavy expansion plans.

With the onset of the multiplex era, the success of a film is decided in the first couple of weeks of screening. This has increased the demand for more prints.

Hence the continued buoyancy in its processing business, which, till FY-06, contributed more than 60 per cent of the revenues.

Changing revenue mix

With the scaling up of the multiplex business, however,Adlabs' revenue mix has undergone a change. Revenues from the exhibition segment accounted for a third of revenues in the first half of the fiscal, while the share of processing fell to about 30 per cent. Production, content and distribution accounted for the remaining third, where Adlabs is a recent entrant.

Adlabs has set up offices in the UK and the US for overseas distribution . Overseas markets now contribute at least 10 per cent to a film's revenues, and offer better margins to distributors. Adlabs also has plans to expand its distribution presence in the domestic market.

Umrao Jaan and Jaan-e-man mark its entry into the domestic distribution market. The initial response to these films at the box office has been lacklustre. But the heavily marketed Umrao Jaan appears to have had a warmer reception overseas . The distribution segment is likely to act as a captive source of content once the exhibition business assumes scale.

Adlabs is also stepping up funding of films through co-production deals with reputed filmmakers such as Mr Ram Gopal Varma and Mr Prakash Jha. Its investments in production are not expected to exceed 15 per cent of its networth and will be spread over four to five films at least. Upcoming productions include Sarkar 2 and the Amitabh Bachchan-starrer Nishabd. It recently entered into a deal with Mr Ashok Amritraj's Hyde Park Entertainment — this marks its foray into Hollywood productions. While these are high-growth businesses, they expose the company to box office performances to a greater degree.

With multiplexes likely to lead revenue growth over the next couple of years, these risks are higher. Moreover, given the scale of expansion across multiplex-operators, there can be overcrowding in some pockets, and this can affect occupancy rates and therefore, profitability. Adlabs might be able to reduce some of these risks through the sale of satellite TV rights and the proposed entry into the home video segment.

Other ventures

The company is also trying to diversify into television content. It recently acquired a majority stake in Mr Siddharth Basu's Synergy Communications, the creators of the famous Kaun Banega Crorepati, and the popular reality-dance, Jhalak Dhikla Jha.

Given the significant resources at its disposal, Adlabs is likely to make forays into other segments as well.

It is likely to snap up some of the small fish in the business, which could fast-track growth across segments.

Ranbaxy Laboratories: Hold

Investors can retain their holdings in the Ranbaxy stock, which trades at about Rs 400. At this price, the stock would command a valuation multiple of 21 times its expected per-share earnings for Calendar Year-07 (on a fully diluted basis). We note that Ranbaxy's operational numbers are improving gradually as the benefits of the restructuring efforts are paying off. At this juncture, investors can wait for sustainability in these numbers over the next couple of quarters before considering an entry into the stock.

Operational highlights

Sales growth at 27 per cent has been strong. Ranbaxy has been working on its cost structure since the beginning of this calendar and the improvement has begun to show up in the numbers. Operating margins, at close to 18 per cent for the quarter, have improved compared to the previous quarter (we look at numbers on a sequential basis, as Y-o-Y comparisons are not very meaningful). Reckoned as a percentage of sales, cost of goods sold moderated, even as selling and general administrative expenditure remained flat. R&D expenses have risen on a sequential basis, but that can be explained by more filings undertaken by the company in the latest quarter.

The bottomline would have been better but for the loss on account of forex forward cover and an exceptional expenditure relating to settlement of a manufacturing arrangement. While the loss on account of the former was Rs 40 crore, the latter resulted in a one-time outgo of Rs 22.6 crore. Adjusted for this one-off item, Ranbaxy reported Rs 162 crore as earnings for the quarter.

Business performance

The US, India and CIS continue to account for a sizeable share of sales. Revenues from the key US market were up by 25 per cent compared to the year-ago period, but that has been driven largely by the exclusivity that Ranbaxy has been enjoying since late June on the 80mg dosage form of simvastatin.

Exclusive of the simvastatin effect, the numbers would point to a continuing pressure in the pricing environment in the US.

We expect growth to cool off in the next quarter in the run-up to the ending of exclusivity; Ranbaxy may launch the other dosage forms (on which Teva was the sole generic player) once the exclusivity period ends.

The ANDA pipeline is expected to be bolstered with another 9-10 filings expected in the ensuing quarter. We also note that Ranbaxy has exclusivity on a small-size product (sales of about Rs 110 crore) to be launched this quarter.

Both the Indian and the CIS markets turned in a strong performance. While sales in India were up 14 per cent, that in the CIS region trebled, with the Terapia acquisition kicking in.

In our view, these markets are likely to be more lucrative to Ranbaxy from a margin standpoint, compared to the US and other markets in Europe. A skew in the sales composition towards these geographies would be a significant positive, in our view. We expect the momentum in the Indian market to sustain on the back of product launches and in-licensing tie-ups. We also expect the strength in the Romanian market to sustain.

Other key markets in which Ranbaxy operates either saw a marginal growth (Europe) or a drop (as with South Africa and China). Good growth was seen in Brazil, though on a small base.

Key stock triggers

In the past, the US Food and Drug Administration had raised objection to Ranbaxy's facility at Paonta Sahib; Ranbaxy is in the process of addressing it.

While an early resolution of the issue and approval could act as a near-term catalyst, a protracted delay maybe an overhang on the stock. This, in our view, would be the principal trigger to watch out for.

Ranbaxy has consistently sought out inorganic growth opportunities and an acquisition in a key geography could lend the stock some pop. If the acquisition, as the management intends, focuses on technology or a niche in a key geography, we believe it would be a key positive.

We would also keep a close watch on the amortisation charges pertaining to the Terapia acquisition, a picture of which would emerge in the year-end numbers.

Valuation and view

It may be argued that scope for further reduction in costs exists, but we believe that most of the benefits of cost restructuring have already accrued to Ranbaxy; improvements are likely be incremental.

Improving pricing trends in the US market and an alteration in revenue composition may change our view on the stock.

With the issue to USFDA plant approval pending resolution, we prefer to be circumspect at the moment. At 21 times the expected CY-07 earnings, investors can retain their holdings.

Glenmark Pharma: Buy

Exposures can be considered in the stock of Glenmark Pharma, which trades at about Rs 460. Though the stock has appreciated 40 per cent over the past three weeks on the back of the out-licensing deal struck with Merck of Germany for its anti-diabetic molecule, we believe that there still is some more steam left in the story. We have remained consistently positive on Glenmark's prospects and continue to position it as a best play on the pharma R&D theme in the country.

The key driver of Glenmark's stock in the recent past has been its ability to monetise molecules in its development pipeline through an out-licensing arrangement. The latest deal with Merck is once again a vindication of Glenmark's forte in this space. The deal envisages an upfront payment of $32 million (about Rs 145 crore), which will be reflected in the latter half of the current financial. Another such deal could be concluded this fiscal (possibly on the anti-asthma molecule for the European geography). With four other molecules set to enter trials, we believe that news flow on out-licensing arrangements will remain strong and act as catalysts for the stock.

On the base business front, too, there are positive signs. The India business continues to grow at a rate that's higher than the overall market, on the back of product launches and sharper focus on physicians. In the key US market, with a front end in place, Glenmark is ramping up filings with the US Food and Drug administration through alliances with partners. We expect the traction seen in these markets, as well as in other geographies, to sustain, going forward.

Clearly, the street appears to be attributing significant value to the R&D business, as the sharp run-up in price suggests. Any adverse developments on the discovery front - more so in the case of the two molecules that have been out-licensed - would be a major reversal for the stock, and, as such, would constitute the principal risk to our recommendation.