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Sunday, December 17, 2006

Cairn IPO saved by last-minute heroics

The Rs 5,260 crore initial public offering (IPO) from Cairn India suffered a jolt on the last day of its issue, but managed to scrape through in the end with a minor subscription.

According to merchant bankers, a couple of hedge funds withdrew their applications at the nth hour, which saw the subscription dipping first to 1.12 times at 4 pm and to 0.93 times an hour later. On Thursday, it had been subscribed over 1.35 times.

As a consequence, the earlier subscription deadline of 5 pm was extended to 9 pm.

Inside sources indicated that hedge funds were uncomfortable with the IPO build-up. Finding valuations too high, some of them withdrew, though some were cajoled into rebidding at lower prices. ABN Amro and DSP Merrill Lynch, two of the merchant bankers to the issue, are also said to have used their prop books to support the faltering issue.

With the majority of applications coming in at the lower end of the price band, the issue price is expected to be fixed at Rs 160. Interestingly, mutual funds decided to stay clear of the 32.88 crore-shares offering from the Edinburgh-based oil giant Cairn Energy Plc’s subsidiary.

Volatility in the secondary market has been labelled the primary culprit for the lukewarm response that the IPO generated. Besides, with Mangalore Refinery & Petrochemicals Ltd (MRPL) alleging inadequate disclosures in Cairn’s prospectus, the pitch was queered in the run-up to the issue. MRPL’s contention was that there was ambiguity about the evacuation of oil from Cairn India’s Rajasthan field.

According to an analyst, the high probability of Cairn India getting entangled in legal hassles with MRPL later would have dampened investor sentiment for the issue. In addition, Cairn India’s oil discovery at the Mangala field is said to contain heavy and waxy oil, requiring additional transportation costs for heating up the oil during transportation.

Will the lukewarm response to Cairn’s IPO have any impact on the secondary markets?

“Not really,” says independent investment analyst Arun Kejriwal. “Only if 2-3 IPOs flop in succession will there be a negative impact on the secondary market,” he explains. 2007 has the stage set for two major IPOs - DLF’s Rs 10,000-15,000 crore issue and Idea Cellular’s Rs 2,500 crore issue. Spice Telecom IPO, too, is expected to hit the markets soon.

Raising Cairn

Issue subscriptions dropped towards last day as hedge funds grew skittish

Managers of issue are believed to have chipped in with money

Near failure of issue could cloud market prospects in coming weeks

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Various Research Calls

ABG Shipyard

Anand Rathi Securities has given a ‘buy’ recommendation on ABG Shipyard with a target price of Rs 320. The company had a healthy order book of Rs 2,360 crore as on November 15, 2006.

This is the highest amongst the private sector shipyards in India. These orders are expected to be executed by the end of FY09. The order book is expected to continue to remain strong in the coming years. ABG Shipyard’s new facility at Dahej is expected to be commissioned in FY09.

The facility will consist of two dry docks capable of accommodating eight bulk carriers up to a maximum weight of 1,20,000 Dead Weight Tonne (DWT). The closure of orders for the facility are expected to begin in FY08.The company is also expected to leverage this facility to build jack up rigs as there is demand in E&P activities worldwide.

The company is expected to operate at sustained operating margins of 28-30 per cent (including subsidy) in the future. This is on account of the company’s raw material policy, state of the art technology and repeat orders.

The government has initiated measures to promote the shipyard industry and make it internationally competitive. The government’s attitude is expected to remain favourable towards the industry.

Going forward ABG is likely to show a robust growth. At the current price of Rs 224, the stock trades at 6.2 times its expected FY08 earnings.

At the target price of Rs 320, the stock would be trading at a P/E of 8.8 times its expected FY08 earnings, thus providing an upside potential of 40 per cent from current levels.


Edelweiss Securities has given ‘accumulate’ rating on ICICI Bank on the back of the merger with Sangli Bank.

The merger will be of strategic benefit to ICICI Bank for increasing its presence in semi urban and rural areas and for aggressively embarking on its rural banking strategy as a key growth driver going forward. The deal valuation seems slightly on the higher side considering Sangli Bank’s ailing financial condition.

The swap ratio agreed upon by both the banks is 100 shares of ICICI Bank for every 925 shares held of Sangli Bank, valuing the deal at around Rs 300 crore. Consequently, 34 lakh additional shares will be issued by ICICI Bank, diluting its equity capital by 0.4 per cent.

This implies deal valuation at 3.7 times book value of Sangli Bank with each of its branch being valued, on an average, at Rs 1.53 crore. Sangli Bank’s branch network is primarily concentrated in the interiors of Maharashtra.

ICICI Bank will leverage on this wide rural network to distribute its rural and retail loan products and grow the asset base and productivity at Sangli Bank. The network in metros and urban areas will be tapped to garner retail low-cost deposits.

The proposed merger is not likely to have any material impact on the financials of ICICI Bank in the near term. The effect of merger on ICICI Bank’s earnings, book value, and asset size will be less than 1 per cent.

ICICI Bank, with adequate capital at its disposal, will be able to extract full potential of Sangli Bank’s distribution network to push its rural and retail products and possibly turnaround Sangli Bank.

Everest Kanto Cylinder

HDFC Securities has given a ‘buy’ recommendation on Everest Kanto Cylinder with a price target of Rs 970. The company is the market leader in high-pressure gas cylinders with over 90 per cent market share in CNG cylinders in India. The Supreme Court mandate for 28 cities to shift to CNG will benefit the company to a great extent.

Till date, only 15 cities have shifted to CNG, leaving ample scope for the remaining 13 cities. CNG consumption in Mumbai has risen over 374 per cent over the past three years. The demand for CNG cylinders has been growing exponentially at over 40 per cent per annum for the last three years.

The linking of additional cities through CNG pipeline will enhance the market for ONGC cylinders by over 3 lakh cylinder per annum, from 1.78 lakh sold in FY06. The company’s manufacturing facility at Dubai caters to the demand for CNG cylinders in other countries like Pakistan, Iran, CIS and Egypt. Everest Kanto enjoys economies of scale and hence is cost competitive compared to its peers.

On completion of expansion programs, Everest Kanto will become the second largest in the world next to Faber Industries, Italy. The topline is expected to grow at a CAGR of 43 per cent and the bottomline, at a CAGR of 59 per cent over the next three years.

Deepak Fertilizer

Anand Rathi Securities has recommended a ‘buy’ on Deepak Fertilizers and Petrochemicals Corporation with a price target of Rs 120. The stock’s current price is around Rs 78. The company remains the only domestic producer of isopropylalcohol (IPA), which until recently was fully imported to cater to domestic demand.

IPA is expected to add significantly to contribute around 20 per cent to FY09 revenues. The supply deficit of natural gas has hit the division hard, with capacity utilization lying low at around 24.5 per cent for FY06. This has also forced the company to use higher cost naphtha for reducing steam consequently causing a serious dent on the margins of the company.

However, the completion of the Dahej-Uran gas pipeline by H2FY08 could lead to resurrection of margins enjoyed earlier. The company has been fractionally unlocking large land bank it has at prime locations in Pune and Ishanya, a specialty mall, which is a unique venture by the company are expected to add some stability to its revenue base.

The stock is trading at P/E of 8.5 times and 6.4 times and EV/EBITDA of 3.8 times and 2.8 times for FY07 and FY08 earnings respectively.

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China, India Will Be IT Superpowers in 07

"Explosive growth" will continue into next year, according to an IDC report, with the two countries expanding locally as well as globally

Asia's two rising stars, China and India, will continue to shine in the IT market next year, with GDP growth expected to hit 8.3 percent and 7.7 percent, respectively, predicts IDC.

In a statement released today which outlines key predictions for the new year, the research house projected that China will maintain its position as the largest IT market in the Asia-Pacific region, excluding Japan--making up 32 percent of the region's IT spending. The Chinese market will be trailed closely by India at 23 percent, IDC said. Both countries are expected to account for the lion's share of the region's IT spending at more than 43 percent.

According to IDC, information and communications technology (ICT) spending and growth for the Asia-Pacific region will be largely driven by "continued economic growth and increasing market demand across the region".

In addition, the IT market in this part of the world will grow at 10 percent over 2006 to reach US$132 billion next year, IDC projected.

Eva Au, managing director at IDC Asia-Pacific, said in the statement "The region's astounding rates of economic and IT market growth have resulted in dynamic and rapidly evolving corporate and consumer markets. This is a role the region has gradually accepted, but the growth is now taking off explosively."

While the major economies are expected to continue to deliver strong results, IDC believes that both China and India will begin "a more serious look internally, focusing on bridging urban-rural divides and developing infrastructure".

"As economic growth rates cool slightly, [China and India] will be pushed to look at domestic markets as recent years of prosperity drive IT infrastructure build-out and the closing of domestic urban-rural gaps" the research company said.

As such, Au noted, vendors will need to have specific knowledge of domestic markets in order for them to successfully compete.


IDC is also projecting a new model in business process outsourcing (BPO), focusing on vendor-customer relationship to emerge in the coming year.

Companies in Asia planning to outsource their business processes are likely to "test drive" short-term pilot projects first, before taking the plunge into a long-term commitment, IDC said. This will ensure that the vendor is sufficiently capable of meeting the needs of the customers, the analyst noted.

This business model contrasts with the structure typically used to "serve Western clients, who are more willing to transit to BPO based on compelling economics", IDC said.

The researcher also predicted that 75 percent of midsize and large companies in the Asia-Pacific region will plunge into early-stage service oriented architecture (SOA) adoption in 2006, completing the first phases of their projects in 2008.

However, IDC advised organizations to address SOA deployments with caution in terms of internal process assessments and re-engineering--an area in which, vendors and systems integrators could find new business opportunities, it said.

Punjab National Bank: Buy

An investment may be considered in the stock of Punjab National Bank (PNB) at Rs 507. Strong fundamentals, ability to protect margins, well-capitalised balance sheet and attractive valuations make it a preferred pick among larger public sector banks (PSBs).

PNB enjoys the highest net interest margins of over four per cent among PSBs as it has a higher proportion of low-cost deposits at 49 per cent when compared to about 40 per cent for its peers. Further, unlike many other banks, PNB has adopted a selective approach in raising bulk deposits and this has worked to its advantage.

For the first half of FY 07, the bank's cost of funds has dipped marginally on a year-on-year basis. While the recent hike in CRR may have a marginal impact on its margins, we believe the re-pricing of credit is likely to improve credit spreads, thereby protecting the margins. Also, its strong focus on rural areas and recent initiatives aimed at financial inclusion should help it in attaining the target of 51 per cent for low-cost deposits by FY 08.

Business outlook for the bank appears healthy. Advances are likely to grow in the range of 20-22 per cent over the next 2-3 years. The moderate growth is unlikely to put pressure on its balance sheet. Excess investments in SLR along with adequate capital are likely to offer sufficient room for funding growth over the medium term. The asset book also offers a great deal of comfort with proportion of bad loans at 0.2 per cent. Provision coverage, which is high at 95 per cent, is likely to keep provisioning charges low over the next few quarters.

Fee income is also picking up and is expected to show healthy double-digit growth. PNB has also invested in technology platforms that are likely to help lower its operating costs. The stock is available at a price-to-book multiple of 1.5 times. As the bank is likely to generate and sustain a return on equity of 18-19 per cent, it is likely to sport a better multiple.

However, an element of risk stems from higher duration of bond book (slightly above three years). Should the bond yields rise sharply, the treasury book is likely to be exposed to market risks.

HLL: Buy

Despite the increasing visibility of India's consumption story, Hindustan Lever is among the laggards in the Nifty basket over the past one year. The stock sports a one-year return of 17 per cent against the Nifty's 33 per cent. Worries about competitive pressures on earnings and the stock's relatively rich valuation levels have trimmed its valuation premium over smaller rivals in the FMCG space.

However, for investors looking for a low-risk investment option, the stock offers a good entry point at the price levels of Rs 220-230. At this price, the stock trades at about 30 times its trailing earnings.

Lever's earnings growth has accelerated in recent quarters on the back of resurgent demand for FMCGs, good cost management and an improving product mix.

A deep brand portfolio that endows the company with pricing and bargaining power and newfound aggression in product launches promise steady earnings growth. Lever's business model is strongly focussed on organic growth in the domestic market and this makes for greater predictability in earnings than an acquisition-led strategy.

More growth drivers

Lever's sales growth rebounded strongly in the September quarter of 2006 after a blip in June. Topline growth (for continuing businesses), at 11.8 per cent in the first nine months of 2006, compares well against smaller competitors.

In a healthy trend, sales growth is becoming more broad-based. Categories such as beverages and processed foods have been contributing more actively to growth in recent times; the home and personal-care portfolio is no longer the sole growth driver.

After devoting the past few years to pruning and focussing its portfolio, the company has stepped up the pace of product launches and brand extensions in recent months.

The September quarter alone saw product launches/relaunches under major umbrella brands such as Lux, Sunsilk and Lifebuoy, with over 40 new extensions/variants unveiled during the quarter.

While renewed launch activity has sharply expanded outlays on advertising (adspend grew by 34 per cent in 2006, against a sales growth of 11.8 per cent), the aggression appears necessary in the face of heightened competition.

Payoffs from recent brand extensions and launches can be expected to flow in over the next few quarters.

Recent rollouts in cosmetics, personal wash and shampoo have also improved the company's product mix. A large premium portfolio may translate into greater pricing power in an inflationary environment and improve the overall margin profile.

Several FMCG companies faced pressure on profit margins in the September quarter on account of rising input costs, but Lever's profit growth managed to keep pace with its sales, as a result of price increases in a few categories and an improving product mix.

An expanding suite of offerings may also allow the company to garner more shelf space in modern retail stores and capture a higher share of wallet from young urban consumers.

Focus on domestic market

Lever's continued focus on the domestic market, at a time when other FMCG players are on an overseas acquisition spree, is also a point in its favour.

Though an acquisition-led strategy can deliver disproportionate payoffs, overseas acquisitions also bring with them issues of integration and managing cross-border trade, which enhance earnings uncertainty. Lever's earnings growth stems clearly from strong volume offtake from domestic consumers.

Given that the shift in the demographic profile of Indian consumers that is now underway, a focus on the domestic market should deliver secular and predictable earnings growth.

Problem areas

Despite strong earnings numbers, there are quite a few problem areas for Lever. One, the company has lost market share in categories such as fabric wash, soaps and skin care over the past year, due to the onslaught of focussed competitors in the respective categories. With the new entrants to FMCG space steadily expanding, Lever may have to continue making heavy adspends and spend on new launches to protect its turf.

A presence across categories and price points gives Lever the flexibility to offset market share losses in one category through gains and price increases in another. But a continuing slide in market shares will be a cause for concern. The next couple of quarters will bring solid evidence on whether the frenetic pace of new launches in recent months has helped the company make up the slippage in market shares.

Second, the possibility of an increasing share for modern organised retail with the entry of retailing giants such as Wal-Mart into the Indian markets, may also pose a threat to the entrenched FMCG companies.

Indian FMCG players have traditionally enjoyed considerable clout with their distributors, given that the latter are highly fragmented. Strong retailers could wrangle higher distribution margins from FMCG companies and launch private label brands, which could eat into the market shares of organised FMCGs. However, there may be mitigating factors for Lever.

Even if modern organised retail does make significant inroads into the Indian market, Lever, with its large brand portfolio straddling categories and price points, may be better positioned to wrangle favourable terms on shelf space and margins, than local competitors operating in just one or two categories.

An extensive distribution reach outside of the urban centres may also help the company weather the onslaught of modern retail better than its urban-centric competitors. As to private labels, it will certainly take time and significant investments for them to garner market share in the Indian context and the threat may be muted in brand-conscious categories such as personal care and shampoos, which are the key growth drivers for Lever.

Overall, despite problem areas and a relatively rich valuation for the stock, Hindustan Lever appears a reasonable investment option within the FMCG space on account of its improving earnings prospects and ability to piggyback on the domestic consumption theme.

However, given the valuation levels, the stock would only be suitable for investors with a 12-15 return expectation.

Lumax Auto Technologies: Invest

An investment can be considered in the initial public offering of Lumax Auto Technologies (LAT); it is being offered at Rs 75 per share. At this price, the stock would trade at a multiple of 15-16 times its expected per-share earnings for FY-07 — not too demanding in our view — after factoring in the expansion in equity, post the current offer.

Company background

The promoter group of LAT is also the one behind Lumax Industries (LI), the automobile lighting major. LAT's principal customers are Bajaj Auto and LI, which account for about 90 per cent of its revenues. LAT also has a 100 per cent subsidiary, Lumax DK Auto Industries (LDK), which caters to requirements of certain components for Maruti, apart from manufacturing corrugated boxes for LI.

Proceeds from the offer would be used to part-finance the expansion plans of LAT and its subsidiary. Plans include a lighting plant in Uttaranchal, a levelling motor plant in Haryana, a chassis assembly unit in Pune, expanding existing facilities at Pune and Aurangabad, and modernisation of the R&D centre at Pune.

Investment argument

While excessive reliance on one customer for a sizeable chunk of revenues poses a risk, such revenue concentration is inevitable given the swathe of component players angling for business from just three principal two-wheeler manufacturers.

We view LAT's business profile positively given that its principal customer — Bajaj Auto — has consistently demonstrated its understanding of the domestic market with a series of successful launches across product categories in recent years. We expect the momentum at Bajaj to be sustained. That should rub-off positively on the prospects of LAT.The subsidiary company, which accounted for 20 per cent of revenues but 30 per cent of earnings in FY-06, should act as a cushion in case of a downturn in the two-wheeler market.

An increase in the subsidiary's contribution would also be positive, as it enjoys better margins than the parent company (13 per cent in FY-06 versus 5.5 per cent for the parent company on a standalone basis).

For the quarter ended June, the subsidiary chipped in with about 30 per cent of consolidated revenues; as a consequence, consolidated margins have inched towards the 9-per cent mark (7.7 per cent in FY-06).

Also, given the nature of relationship that the company enjoys with leading players (Bajaj and Maruti), it could be expected that LAT will parlay the experience gathered through these engagements with other OEMs (original equipment manufacturers) as well.

Valuation and view

At 15-16 times expected per-share earnings for FY-07, the stock appears not to be too stiffly priced.

Coupled with other metrics such as a return on shareholder funds of close to 30 per cent, a market cap-to-sales ratio of 0.7 at the offer price and a consistent dividend paying record (even a dividend of 20 per cent post expansion would translate into a reasonable yield of about 3 per cent), we think there is scope for upside.

Key risks to our recommendation would include an escalation in input costs and LAT's inability to pass on the same to its customers, apart from a sharp demand deceleration in the two-wheeler segment.

Offer details: About 30-lakh shares are being offered at a fixed price of Rs 75 though an initial public offering, which opened on December 14, and closes on December 21. Centrum Capital and Bigshare Services are the lead manager and registrar to the offer respectively.

Shree Ashtavinayak Cine Vision: Avoid

nvestors can avoid the initial public offer of Shree Ashtavinayak Cine Vision (SACVL).

At the upper end of the price band, the offer values the company at 15 times the FY-06 per-share earnings, on an expanded equity base. Although the valuation is not too demanding, the short track record of the company reveals little on the likely hit rate of its future releases at the box office.

Given the high-risk nature of the business, investors should wait and watch the company's perfomance before taking an exposure.

SACVL began as a content provider for television. It discontinued that business and ventured into film production in FY-04.

It has produced four films so far, of which Maine Pyar Kyun Kiya and Golmaal — Fun Unlimited were moderately successful.

It began film distribution in 2004 and has since built a presence in the Mumbai territory.

Film production accounted for about half the revenue in FY-06 and is likely to remain the mainstay of the business.

Objective of the offer

The offer will fund the production of three films, expected to be released in the first quarter of 2007. If successful, there could be a substantial revenue ramp up.

The company has tied up with Studio 18 (broadcasting major, Television Eighteen's new production venture). The duo will produce four films with a budget of Rs 100 crore, 40 per cent of which will be funded by SACVL. Studio 18, however, is a new player in the film production business.

The four films produced by SACVL have had modest budgets and predominantly explored the comedy genre with the aim of appealing to the masses.

The strategy has paid off so far, as the company has either broken even or made a reasonable profit.

A few of the future projects appear to be along similar lines. Bhagam Bhag, a comedy starring Akshay Kumar and Govinda, is to be released shortly.

Revenues from the distribution business could reduce the risks of unsuccessful productions.

But the performance of this division also depends on Bollywood's ability to pull off another blockbuster year. The company also operates in a highly competitive Mumbai territory and its clout is likely to improve only with scale.

As a smaller player, it is at a relative disadvantage to players such as Yashraj Films, and corporate houses, such as UTV or Sahara that have better financial muscle to hire the best talent and can afford a marketing blitzkrieg.

Pre-release marketing is playing an increasingly important role in creating box office hits.

Offer details: SACVL will raise Rs 60 crore at the upper end of the price band. The major part of the proceeds will go towards funding production of three films.

About Rs 15 crore will go towards equipment for film production. The promoter's stake, post offer, will be 67 per cent.

The offer closes on December 20. The lead manager is Allianz Securities.

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