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2007 on the charts

It was an exemplary climb for the Sensex from the low of 2900 in 2003 to the current 14000 levels. The correction in May, though short, was significant, as it made the Sensex withdraw 30 per cent from its peak.

The point that is unresolved at this juncture is whether the correction that started in May is extending or we are in a new bull phase.

This issue will be resolved only if the Sensex rallies past 15400. A reversal from 15400 will make the index remain in a broad range between 11000 and 15400 in 2007.

Such a sideways move would be conducive to the bull market extending for a few more years.

A rally beyond 15400 would mean that we are in the fresh leg of a long-term bull market that can take the Sensex to 17600 or 19550.

Such a move would be accompanied by speculative excesses that will be the harbinger of a long-term bear market.

Our preferred view is that the Sensex will remain in a sideways range between 15400 and 11000 in 2007.

The intermediate-term trend will reverse only on a fall below 12500.

The level that long-term investors need to watch is 11000

FII: - Rs 1049 cr, MF + Rs 677 cr

FII Gross purchases Rs 2188 Cr Gross Sellers Rs 3238 Cr Net Sellers Rs 1050
Cr. MF Gross Purchases Rs 1014 Cr Gross Sellers Rs 337 Cr Net buyers Rs 677 Cr.

Our View:

This could be arbitrage trades where the FIIs would have been long in cash and short in futures to take advantage of the premium. So these should be seen in conjunction with FII action in FNO. Today was last day of year...some profit booking was seen. Markets is headed towards result seen and that will be seen as trigger ahead.

2006 - Discovery of India and the rally of disbelief !

2006 is now passe and we are heading into 2007. This year has been a year of India really. Indian Markets have rallied 47% based on the 30 stocks based Sensex where as a broader Nifty 50 gained by 40%. Certainly whopping gains and more creditable after they came over the 42% gains made last year. It was the discovery of India this year and India as an investment destination became the household name. A fund not investing in India didnt know its business. FIIs now registered in India exceed 1000 in number. The five-year, unbroken winning streak has seen the index appreciate 10,525 points from 3,262 at close in 2001 to 13,787 today. And has zoomed 323% in last 5 Years

Sensex started off the year with 9000 crossed and there were only few who would not find the the markets expensive. It was free flow of money and no level could prove a tough hurdle. Starting with 10000 it moved to 11k and 12k but it also suffered a shock in May. Markets had not had any level of consolidation and that created a vaccuum when the sellers came in. Valuation sheets came out and again numbers were looked at ..but then markets slowly and steadily climbed up. However an interesting part about this was that the gains continued to be led by the large caps. ICICI bank., Reliance, State bank of India, HDFC bank, HDFC, Larsen, Reliance, Bharti Airtel, Telco, TCS were the leaders in the Index driving it up to 14000 in the last month of the year. This was followed by profit taking and worries of a May encore !. However things have been stable bringing in some level of comfort and value buying.

It was a year of change at as well. We had our biggest client break this year. It would enthrall you to know that now advises and FII fund which is called Shanti Gestion and is based out of France. The quality of research has improved and we are diligent and objective as ever in our analysis. We have started working on DCF models amongst other things and the impact of that will be seen over the longer term.

It was a year of the BSE capital goods this year taking the cake with 56% gains. This was a sector which seemed highly overvalued but if you were not here you missed the big gains whether it was in BHEL, Siemens or ABB. The laggard was BSE FMCG index which gained only about 18%. BSE Teck index including the media sector was up 50%. . The BSE infra index was up 39%. BSE auto index with 29%, BSE Bankex up 38%. this year and BSE healthcare index saw smaller gains of 22%. However the BSE Mid cap index was up only 30% for the year leaving many investors with not such a positive feel in the pockets.

It was a super year for the world markets as well. China brought in big land reforms and there was no rival to its growth. The markets saw gains.. China +120%, Indonesia + 54%, India + 47%, Hang sang up 35%, Nikkei up 7%. Straits Times + 27%, Taiwan Weighted + 18%, Seoul Composite + 3.9%, DAX + 21%, FTSE 100 + 10%, CAC + 16%.

It is important to note that these performances have come in the face of high crude prices. Crude prices threatened to cross over $ 80 per barrel and this performance was in the face of adverse conditions of rising crude prices and also rising interest rates in US. However it was the later half of the year where it was benign conditions set in with a wait and watch approach by almost every Central bank. This was the sweet spot and many markets have been making all time highs.

GDP growth for India was placed at 8% plus and the only blip came in October where Industrial production numbers showed some drop in growth. Agriculture has been a problem area but increasing disposable incomes across cities and the change in mindsets towards taking EMIs has fuelled consumption. This economy will grow. As we said the economy is doing well and will continue to do well. As we head into 2007 we believe that there are many pockets which are still undervalued and thats where the valuation gaps will get filled.

Among the index gainers.. Reliance Comm gained 127.9% for the year after it got listed in Sensex on June 12 2006.. Followed by ACC 103% , Grasim 101%, Bharti 82%, Guj Amb Cem 78% who made the big gains.

This year it was a sector of the capital goods. BHEL, Siemens, ABB did extremely well not to mention the power companies. Crompton, Voltamp, Emco, Indotech , Jyoti structures et al. The Indo US nuke deal was signed this year. Though the final deal has still the T's to be crossed and Is T be dotted to the satisfaction of bothsides, it has created a big step forward for the Power sector. The other big step was the Ultramega power Projects and the successful bidding and awarding for the same.

Telecom sector was the sector of the year with amazing growth recorded in terms of penetration and growth. The penetration now has increased to about 14% and this is expected to double in a year. Bharti and Rel com were the biggest gainers of this. Hutch continued to hog the limelight about its probable suitors where as Bharti made a high on its Walmart tie up talks. MTNL continues to be a laggard where as BSNL was mired in controversy after awarding some contracts.

Cement sector was the other which never had it such easy in life. The Government at one point even threatened to bring in some price controls. The Developers were crying hoarse but that stopped as they made huge gains on the property prices shooting up. Cement stocks, ACC, Ambuja, Ultratech, Grasim, Kesoram, Century and every company in the cement sector hit gold as cement prices were hiked. The view remains positive as new addition will only be delayed if at all and that the going will remain good for next 12 months at least. We had our clients enjoying our research on the sector.

However it was the best year for the developers Bombay Dyeing, Unitech, Indiabulls, Prajay Engg et all had a ball with stocks doing exceptionally well. Atlanta, Ansal Housing and anything to do with realty flared up.

The media stocks also found flavour. Zee was a find our clients will not forget in a hurry. Hinduja TMT also was another big mover not to forget TV 18, NDTV HT Media.

All in all the mid caps had selective runs and there were some from the IPOs. It was Atlanta, AIA Engg, Sun TV which put on mind boggling gains. We missed most though some gains were realised in Hanung and Sun TV. Though it was a year for the air travel travellers the airlines had a tough time with high oil prices and increasing competition. There were more budget airlines launched and competition was intense. Its likely to remain so.

Investment Nuggets

President of the Chicago-based Acorn Fund, run by investment firm Harris Associates, Ralph Wanger adopts theme-driven investment approach in smaller companies for the medium-to-long term. The Acorn Fund returned 17.2 per cent annually between 1970 and 1998, against a return of 14.4 per cent from the S&P500 index during the same period. Wanger recently summarised his stint at the fund in his book A Zebra in Lion Country. The book examines the virtues of staying with smaller, lesser-known companies. As the book explains, if a zebra hopes to find the best grass — the stuff that is not trodden by the world — the zebra must selectively stray from the safety of the herd on occasion. Investors must take a cue from this.

"Since the Industrial Revolution began, going downstream — investing in businesses that will benefit from new technology rather than investing in the technology companies themselves — has often been the smarter strategy.""Deciding on an investment philosophy is kind of like picking a spouse. Do you want someone who is volatile and romantic and emotional, or do you want someone who is steady and trustworthy and down to earth? If you want a successful investment career, you'd better bind yourself to a style you can live with."

"Trying to sell an illiquid stock in a down market brings to mind the galley slaves in Ben-Hur, chained to their bench while the ship sinks."

"Rather than build a broadly diversified stock portfolio, I believe in determining themes...and then identifying groups of stocks that reflect those themes .The Rubenstein Rule dictates that either a stock group is worth playing or it is not worth considering at all. (Arthur Rubenstein, the late, great pianist, was once asked to be a judge for a competition held in London. Told to use a scale of 1-20, Rubenstein gave all the students' recitals either a zero or a 20. There were no intermediate scores. When asked about this, Rubenstein replied, "Either they can play the piano, or they cannot." Wanger invokes the `Rubenstein Rule' as important to his own investment philosophy.)"

"Don't overpay, no matter how much you like a company. Invest in themes that will give a company a long-term franchise. Invest downstream from technology. Think and invest globally. Find stocks to own, not trade."

"What I don't want are me-too companies that rank fifth or sixth in their industry, because their profit margins will rarely be as good as those of the industry leaders."

"Assume that one of your eccentric friends who runs a large bank has just offered to lend you a great deal of money at about 10 percent interest, with which you may tender for all the stock of the company you are studying at the current market price. If you study the company and say `Boy, this is terrific! Give me the loan and I'll do it. I'll quit my job and go run that company. It's a tremendous bargain,' then, you probably have a good stock."

The thrills and spills of year 2006

Another year has drawn to a close and, much like the previous three, it has been a blow-out year for investors. Having used up every conceivable superlative to describe the market movement of the earlier three years, trying to do so this time around would be an exercise in repetition. Investors in large-cap stocks have reason to be happy, as both the Sensex and the Nifty recorded returns of more than 40 per cent over the year.

In a sense, the performance of the equity market in 2006 is both strikingly similar and sharply different to its showing in 2005, on two key counts. The rally in the year just ended belonged to large-cap stocks, as was the case the earlier year; in contrast, the returns have been accompanied by significantly higher volatility year-on-year.

But 2006 will definitely score high in terms of thrills and spills. While it did prove exciting for those on the sidelines to watch the market action unfold, the same cannot be said for investors holding the wrong kind of stocks. In the first four months of the calendar, the indices moved up inexorably on the back of strong liquidity and a solid performance form India Inc; but what happened over the next two months would have been difficult for even a Nostradamus to predict.

In May and June, the market went into a free fall, shedding close to 40 per cent and raising fears that the bears — who have taken a mauling over the past four years — would finally have their moment in the sun. But that was not to be. The market staged a remarkable recovery, as dramatic as the fall, seemingly effortlessly soaring past earlier highs, with the Sensex and the Nifty crossing the magical milestones of 14000 and 4000 respectively.


Foreign institutional investors have been the key catalysts of the market since they went bullish on India from mid-2003. Admittedly, FII flows in 2006, at about $8.5 billion (around Rs 38,000 crore), were lower by 20 per cent than in 2005. But this was due to the markets tanking in May and June. But for this, the inflows would have been much higher and the market would perhaps have ended on a stronger note.

The buttressing effect of FII liquidity apart, the market also underwent significant re-rating on the price-earnings front. Now, the Sensex trades at about 20 times expected earnings for FY07 — significantly higher than a couple of years ago.

Seen in isolation, the P-E multiple might seem stretched; but viewed against the stellar growth in earnings over the past three years, coupled with a high return on equity, that multiple becomes quite justifiable.

Even as the market scaled new peaks, reports from leading brokerages flew thick and fast that the indices were overvalued and a case was being made out for a steep correction. Did the diffidence of these proponents of gloom do anything to impede the bull stampede? Not a chance. With a mind of its own, the market simply continued its relentless upward march.


Obviously not wanting to miss the party, mutual funds, too, were busy raising serious money. As of end November, net inflows into equity funds, at Rs 32,000 crore, outpaced by 40 per cent the receipts in the corresponding previous period.

The jump in inflows was propelled in no small measure by a sharp rise in the allocation of household savings to funds.

With marquee names such as JP Morgan, Dawnay Day and Credit Suisse announcing their intent to enter the fund management business, this space promises interesting times in the year ahead.


Though over 70 companies went to the market in 2006 to raise funds (about 40 per cent more than in 2005), the number of issues that disappointed investors outstripped those which hit pay-dirt. In the latter category were Educomp Solutions and Atlanta (both multi-baggers), Tech Mahindra, Parsvanath Developers, Info Edge and DCB; on the flip side, several issues, notably that of low-cost pioneer Air Deccan and of a clutch of other mid- and small-cap outfits, dashed investor expectations.

As a consequence, scepticism about IPOs was distinctly manifest towards the year end, when even an issue such as Cairn Energy was under-subscribed by retail investors. One can expect a clutch of offers in the year ahead too, led by the big boy in the real estate space, DLF.


It is quite amazing how quickly investor perception of a sector can change in just one year. Sugar, for instance.

Last year, it was basking in the glory of high prices, which led to every sugar company being marked up sharply, the way tech stocks were in 2000.

At the end of 2006, however, sugar stocks had lost flavour as falling prices left a bitter aftertaste, with stocks trading at 30-50 per cent of their yearly highs.

At the other end of the spectrum is cement, a commodity that well and truly rocked in 2006.

With demand growing briskly enough to outpace supply — on account of the boom in housing and infrastructure — and leading to higher prices, 2006 will go down as a watershed year for cement manufacturers.

With capacity addition still some time away, we expect to see continuing strength in stocks from this sector.

Other sectors that had a good outing in 2006 include alcoholic beverages, capital goods/engineering, infrastructure/construction and real-estate, and select stocks from the telecom, media and the IT pack.

Pharma, ferrous metals, FMCG, oil and gas, and auto components did not have much to write home about in 2006, though there was still money to be made if one were to stick to a disciplined, bottom-up stock-picking approach.

Sectors that are likely to be out-performers in the year ahead are outlined in the accompanying story below. Also presented is the technical analyst's view on what the charts portend for 2007.


We will round off with a facet of the market that is featured here because it is conspicuous by its absence. In earlier years, investors' dalliance with penny stocks was a recurring theme despite warnings against such a bias.

Unheard-of stocks with dubious businesses were punting favourites for hordes of investors, who were lured by their low absolute price and the prospects of making a quick buck.

Several such stocks acquired a veneer of respectability by posting manifold gains; in 2006, the tide turned and quite a few stocks slipped into the penny category.

With this, investor bullishness turned into apathy and that meant fade-out time for such stocks. Year 2006 will thus also go down in history as one in which the penny dropped!

7 ways to get savvier, wiser in 2007

There are two kinds of people: Those who wish they had invested in the stock market and those who wish they hadn't. Do you regret not investing when the Sensex fell to 8,800? Do you wish you had booked profits on those dicey small-cap stocks? Wonder why you did not listen to all the advice on prudent investing that experts spell out on TV and the papers ad nauseum? With the New Year just a few winks away, it's time to stop torturing ourselves about what we did and did not do. How about resolving to be wiser, savvier investors in 2007 instead? Here is a list of seven investment resolutions for 2007.

Resolution 1: I will invest only in sound stocks

How hard is it to resist the voice in your head (the broker's, that is) telling you that there is a fortune waiting to be unearthed in an unheard of penny stock? Very hard, we agree. But an 80-90 per cent drop in the stock price might just give us a little more perspective. That is how much one could lose if one does not know how to play the penny stock game. The odds of winning are almost always against you.

Forget penny stocks. There are several purported real-estate plays, turnaround stories, acquisition candidates and `proxies' that promise to be tomorrow's bluechip stock, with not an ounce of fundamentals to back them up. Remember how they sank when the market corrected? That memory is enough to ensure that we keep this resolution.

Resolution 2: I will do my own research

Now who has the time to do research except those who make a living out of it? True, but a weak argument. Nobody cares for money that is not theirs, so it is each one for herself when it comes to investing in the market. A quick glance through the annual report and recent earnings and steadily tracking news developments pertaining to the company are necessary at the most basic level. But if you have ambitions of beating the market, you will have to do more than that, which means more time, effort and resolve.

Resolution 3: I will stick to stocks that I understand

Even legendary investor Warren Buffett does not claim to understand everything. He stayed away from tech stocks during the bubble. We know how well that worked out for him!

So lets make things easy for us. Doing the spadework is much easier when we understand the industry. If you already work for the software industry, pick up some software stocks, even if it means buying shares of your employer's competitor. Think how well you would come off sounding if you ever were to go for a job interview with that company!

In the long term, buying stocks we understand will help us make good investment decisions. We probably will know when to buy or sell a stock ahead of the market and will not give in to temporary panic (or temporary insanity) and dump a good company when the market crashes due to some extraordinary event.

Resolution 4: I will not be influenced by market rumours

Buy the rumour and sell the news is the popular market adage. But fall for a baseless rumour and you could get burned. The worst of the market buzz these days are the absurd price targets. "Psst, the stock of ABC is trading at 50. The three-month price target is Rs 1,500. It is the next Unitech". If you have heard that, remember that there are vested interests behind these rumours and you could end up holding a lemon.

Resolution 5: I will not fret over my investments

Ever kept willing a stock to go up, only to find that the stock had a mind of its own and refused to budge from your buy price? Once you buy or sell a stock, stop fretting over your decision. Be clear on your investment rationale and objective. If you have invested on the basis of fundamentals, for instance, do not get influenced by a contrary technical view. Fundamental and technical analysis can be at odds from time to time. Similarly, if you decide to invest with a one-year perspective and are convinced about the fundamentals, stick to your guns. If the company performs contrary to your expectations, then you can review your decision.

Resolution 6: I shall cut my losses

A lesson we all would have learned from this year's market correction is to cut positions before we slip even further into losses. If you follow technical analysis, resolve this year to adhere strictly to your stop-losses. If you follow fundamentals and find you have gone wrong in your estimates, remember that it is impossible to be right every time. In a market such as ours, there are plenty of investment opportunities. When the market falls steeply, we are better off booking losses on momentum stocks and buying bluechips that are available for a song.

Resolution 7: I will stop procrastinating

"I spotted the stock at Rs 30 and thought of buying it but did not. The next time I saw it, it was at Rs 60". Sometimes, we experience a rare moment in the market when we actually know what to do. Then, we spoil it by not acting on our instinct. To succeed in the market, we need to be actively involved.

Sceptics among you may wonder if anyone will abide by these resolutions for more than a couple of months. But let's sharpen our pencils in all earnestness anyway and put down these promises. Keeping them could ensure that we all have a "happy and prosperous" new year indeed.

Mere blips or serious dips?

The past couple of months have seen stock market players swing from shock and pessimism to business-as-usual, with the indices correcting sharply before staging a recovery. With so many developments to mull over, opinions were, as usual, divided across market-watchers. Here are some optimistic and pessimistic views on key developments:

Hike in Cash Reserve Ratio

The RBI finally stepped in to address the issue of excess liquidity by hiking the cash reserve ratio (CRR) by 50 basis points to 5.5 per cent in two stages (December 8 and January 7, 2007), sucking out about Rs 13,500 crore from the banking system. The move is to check inflation, which is hovering well above the 5 per cent mark.

Point: Some analysts feel that the era of cheap money is over. Already, the majority of banks have hiked their prime lending rates, which could squeeze the excess liquidity chasing assets such as equities and property.

Counterpoint: The move may not make a significant difference to liquidity. Though the increased CRR could impact banks' profit margins, there is enough excess liquidity to keep the market moving.

IIP worries

The October quick estimates of the Index of Industrial Production (IIP) from the Central Statistical Organisation (CSO) came as a surprise to many. Industrial production growth dipped unexpectedly to 6.2 per cent in October after recording remarkably high growth rates of close to 10 per cent for the first six months of the financial year.

Point: This is only the tip of the iceberg. The overheated economy could see further cooling off on the back of higher interest rates and inflation.

Counterpoint: It is not appropriate to read too much into numbers for a single month. The timing of the Diwali sales and the holiday season in October this year, instead of the usual November, may have caused the blip. Nothing is wrong with the economy and next month's IIP numbers will bear this out.

High market valuations

The BSE Sensex is quoting at a forward price-earnings multiple of about 18 times and a trailing multiple of about 23 times earnings.

Point: Indian valuations are stretched and the BSE Sensex is trading at a significant valuation premium to other emerging markets. There are several opportunities outside of the Indian market, available at cheaper prices.

Counterpoint: Though the valuations seem stretched, the quantum of funds waiting to enter India is huge and with robust fundamentals and one of the strongest growth rates, India still looks attractive for long term.

US Slowdown

US economic numbers, as well as indicators such as housing starts and industrial production, suggest a slowdown.

Point: The US economy, which is witnessing stagflation and showing signs of weakening further, could pose a threat to the global equity markets.

Counterpoint: the Indian economy and its companies do not rely too much on the US for growth. As India is relatively insulated from happenings in the US, there will be no significant impact on liquidity flows.

Thailand's policy flip-flop

Thailand imposed restrictions on foreign investments which required that investors retain all sums not linked to trade or foreign direct investment within Thailand, for at least a year. This move forced a 17 per cent decline in the Thai stock market and a sharp reversal in the Thai baht, the strongest Asian currency this year.

Point: This move could make FIIs more cautious about allocating funds to the emerging markets, including India, as several countries with appreciating currencies could use such measures to improve their export competitiveness.

Counterpoint: It is unlikely that other countries will adopt this strategy, as this could be counterproductive. That fact that Thailand had to reverse these moves and exclude equity investments from its restrictions could serve as a deterrent to others.

Weak commodity prices

The prices of crude oil, gold and select metals have retreated from their peaks.

Point: Weak commodity prices are a precursor to similar trends in equity market. With increasing cross-border investments and investors moving between asset classes, the weakening of one asset class in the portfolio should impact other assets too.

Counterpoint: Weaker commodity prices may ease margin pressures on companies and bolster earnings. As to allocations, even if commodity prices decline further, the funds originally slated for commodity investments will be reallocated to other asset classes, particularly equities.

Larsen & Toubro: Buy

Larsen & Toubro's expanding geographical footprint, entry into niche businesses, consistent order flows and buoyant growth by subsidiaries enhance the company's earnings prospects.

At the current market price, the stock trades at 23 times its expected earnings for FY-07 on a consolidated basis, assuming a 15 per cent earnings growth. Possible unlocking of values in key subsidiaries through divestment of stake may also support valuations. The stock's premium valuation compared to other players in the sector appears justified on the back of a solid order-book and a business mix that positions the company as a unique engineering and infrastructure player in the country. We reiterate a buy on the stock with a two-three year perspective. Returns can, however, be moderate in contrast to the manifold gains over the past couple of years.

With a sound track record, L&T has not only managed to capitalise on the domestic infrastructure and industrial capex boom, but also successfully expanded its geographical footprint through strategic tie-ups. Further, the company's timely moves to equip itself for new opportunities, coupled with a relatively strong balance-sheet, gives it an edge over other infrastructure players in the country.

Momentum in order book

L&T's order-book continues to remain robust with a backlog of Rs 30,700 crore for the half-year ended September 2006. This translates to a 52 per cent increase on year-on-year (Y-o-Y) basis. The current order mix is skewed in favour of infrastructure, with the same accounting for 34 per cent. While the company's electrical and industrial divisions have traditionally contributed better margins, the engineering and construction segment, given the nature of projects, has kept the margins lower than other core engineering companies. However, with an increasing presence of the lucrative oil and gas segment in the order-book (24 per cent as of September), we expect the margins from the infrastructure segment to improve.

The company is also trying to optimise utilisation of resources by cutting down on orders below Rs 50 crore, which accounted for less than 40 per cent of the total orders in the last quarter against 70 per cent in the quarter-ended September 2005. Better utilisation of assets through selective order accretion is also likely to lend some support on the margin front.

Expanding on strengths

L&T has taken giant strides in expanding its geographical presence. L&T Oman, a joint venture between L&T India and Zubair Corporation, one of the largest industrial houses in Oman, appears all set to consolidate its position in the region. The venture bagged a greenfield township project in October and expanded its presence in the residential space. L&T Omanrecently tied up with Sohar Industrial Port Company for establishing Oman's first facility for large oil rigs and structures, a major milestone in its hydrocarbon trail. While the venture is already positioned as an integrated construction and electromechanical systems solutions provider, we expect the recent projects (realty and oil rigs) to make L&T Oman's business mix more lucrative in terms of returns and also increase its presence in the gulf region.

In China, the recently inaugurated switchgear facility will cater to the local needs and may well be a potential outsourcing hub, thus bringing cost benefits. The credibility built by L&T in China is evident from its bagging orders of about Rs 1,500 crore over the last two years in the critical equipment category (such as reactors and coal gasifiers), amidst international competition. Unlike Oman, where L&T inked a venture with a local player, foraying into manufacturing in China can be risky. Given the company's track record in doing business with China, there are unlikely to be hiccups in its venture. Our valuations, however, do not factor the revenue from this stream for now.

On the domestic front, L&T has been ramping up capacity of its automation facility scheduled for completion by May 2007. The control and automation facility business of the company provides electrical and automation solutions for oil and gas, water and infrastructure segments and is a natural extension of its core businesses. With increasing demand in the user segments, the expanded capacity in automation is likely to see sustained demand.

Holding potential

L&T also appears to be gearing up for the huge power project investments coming up in the country. Its recent tie up with Japan's Mitsubishi Heavy Industries will give L&T access to produce super critical boilers to meet the requirements of the mega power projects planned. BHEL is now the only local player equipped in this power range. While this venture holds huge potential with ultra mega power project orders starting to flow, we expect stiff competition as a number of bidders are tying up with overseas companies which can offer cost-advantages. L&T's success in this segment will depend on its pricing strategy.

A possible divesting of stake of key subsidiaries in future may hold value for investors. L&T's fully-owned subsidiary — L&T Infotech — has been growing at a scorching pace with the bottomline more than trebling in the last half. L&T has plans to further strengthen this company through the inorganic route before divesting stake through a possible listing in 2008. As a step forward, it recently acquired a US-based electronic design services firm with presence in US and India.

Another subsidiary, L&T Finance, has seen capital infusion of Rs 100 crore in the first half year alone even as L&T recently made a move to acquire about 10 per cent stake in City Union Bank. We expect this subsidiary to emerge as a key business in the company's portfolio and a possible divesting candidate in future.


For the September quarter L&T's operating margins expanded by 380 basis points to 6.4 per cent, but remains lower than typical infrastructure players. There is also the risk of hike in raw material costs and absence of price escalation clauses in some overseas projects.

We, however, expect volume growth to provide some support to margins. Huge capital expansion may result in subdued per share earnings in the near term. Delay in the take- off of new forays may also result in sub-optimal capital and resource utilisation.

Lakshmi Machine Works: Buy

A long-term investment with a two/three-year perspective can be considered in the stock of Lakshmi Machine Works (LMW), the largest maker of spinning machinery in India. An established presence in the market with a strong revenue growth visibility, a hefty order book, and the company's thrust on technological upgradation underscore our recommendation.

At the current market price, the stock trades at about 16 times its FY-08 per share earnings. Market corrections, if any, may also be used as good entry opportunity.

Investment Argument

The company operates in three business segments — textile spinning machinery, CNC (Computer Numerical Control) machine tools, and high precision machine castings (foundry). The textile machine division, which caters to about 60 per cent of the domestic market, provides cost competitive solutions to the spinning industry. The division operates with an 80 per cent capacity utilisation, contributing nearly 91 per cent of revenues. With the upgradation of its existing plants, installation of high-tech mother machines and the merger with erstwhile Jeestex Engineering (JEL), the installed capacity is set to increase from 1.8 million spindles to 2.7 million by the end of March 2007. This would, however, contribute to the earnings from FY-08 only.

The machine tools and foundry division, though not as significant as its textile division, contributed to about 10 per cent of the total sales during the first half of FY-07. Despite the pricing pressure that the CNC machine tools division faces from its competitors, we believe the company's plan to roll out customised products in this segment would pay-off in the future, given the growth in user industries driven by by the manufacturing boom. The foundry division, apart from meeting most of its captive-consumption demands, supplies international companies, such as General Electric, Siemens and Armstrong, with critical castings.

LMW's order-book, which is around Rs 4,500 crore, has recorded a growth of over 65 per cent over the past year.

Despite the higher waiting period for delivery of textile machinery of 22-26 months, demand continues to outstrip supply. This is reflected by LMW's healthy growth in the order book. Moreover, it faces no significant threat from its competitors and given that most of the parts and processes in the industry are patented, the possibility of a new entrant is remote. This again provides further revenue visibility to the company. Further, we have not taken into account the savings due to lower sales tax on VAT implementation in Tamil Nadu from January 1, 2007.


LMW charges its clients a 10 per cent advance against booking, irrespective of the order size. Its zero-debt position plus these cash advances have ensured a comfortable cash flow position for the company.

This apart, its thrust on both R&D and plant modernisation has helped de-bottleneck manufacturing capabilities and hence improve overall productivity. During the current fiscal, about 2 per cent of the net turnover was earmarked for R&D expenditure. The introduction of assembly line manufacturing has also augured well for the company.

For the quarter ended September, revenues increased by 43.5 per cent on a year-on-year basis.

The operating profit margins increased by about 350 basis points, largely driven by volume growth in the textile division. The company's efforts to continuously upgrade its technology have also helped it contain cost.


Since the nature of its business is cyclical, any recession in the textile sector would affect LMW's business. Moreover, the stretched delivery period can also prompt the mill owners to import second-hand machines (not cost-effective now), leading to a loss in LMW's market share.

In addition to this, the relatively lower liquidity of the stock is likely to be a cause for concern during exit.

Slowdown in capex plans of textile companies, rise in raw material cost and increase in competition from international suppliers of textile machines could also pose a downside risk to our recommendation.

Bihar Caustic: Buy

Investors can consider taking exposure in the Bihar Caustic stock, which trades at about six times its trailing 12-month earnings. Attractive valuations and the company's cost-competitiveness make the stock an investment opportunity. Higher volumes and the shift to membrane technology are likely to scale down the impact of lower caustic soda prices on earnings.

Membrane technology

Bihar Caustic is among the cost-competitive producers in the chlor-alkali industry. The industry is a power guzzler with energy costs accounting for a chunk of operating expenditure. Thanks to a coal-fired captive power plant, the company's energy costs are lower than its peers.

The company is set to further increase its competitive advantage by shifting to the power-efficient membrane cell technology. Energy costs per unit of production are likely to lower by about 20 per cent compared to a year earlier.

Caustic soda and chlorine, by-products in the electrolysis of brine, find application in a range of industries such as organic chemicals, paper, aluminium, textiles and soaps and detergents. The diverse profile of its user industries provides the company a cushion against downturn in a particular industry. The hydrogen bottling facility provides an additional stream of revenue. Global prices of caustic soda have dropped by about 30 per cent from the peaks of December 2005. Although lower caustic soda prices are a cause of concern, volume growth is expected to soften the impact on revenues.

In February 2006, Bihar Caustic expanded its chlor-alkali capacity by about 50 per cent. The government's focus on education is likely to increase the demand for writing and printing paper which, in turn, would trickle down to the caustic soda industry.

Growth in the poly-vinyl chloride and paper industries is likely to translate into volume growth for chlorine. While better realisations from chlorine are expected in the long term, the company plans to foray into the manufacture of aluminium chloride, which is used in aluminium manufacture.

Though this foray is likely to increase Bihar Caustic's reliance on its holding company, Hindalco, it would be better equipped to face the vicissitudes in the chlor-alkali industry.

Compared to peers in the merchant business, Bihar Caustic enjoys better off-take prospects for caustic soda. Hindalco contributes about 65 per cent of its overall revenue. With Hindalco planning to set up an aluminium smelter plant, the prospects for volume growth for Bihar caustic in the long term appear bright.

Anti-dumping duty

Unlike in India, where caustic soda is the more significant of the two by-products, chlorine is the main product in developed countries. As a result, most countries seek to dump their excess caustic soda production in the export market. The domestic industry, however, enjoys the benefit of anti-dumping duty on imports from China, South Korea and eight other countries. A key risk to our recommendation is the phase-out of this duty, a review of which has been initiated.

Kirloskar Brothers: Buy

Investments with a long-term perspective can be considered in the stock of Kirloskar Brothers (KBL), which manufactures and exports pumps and takes up turnkey water management and irrigation projects.

At current market price, the stock trades at about 18 times its FY08 per share earnings. Given that KBL is a leading player in the EPC (engineering, procurement and contractor) pump segment, it is likely to be a direct beneficiary of the upsurge in corporate and government infrastructure spending. Increased outlays in State budgets for irrigation and water projects also bode well for the company.

KBL's joint venture with Japan-based Ebara has not only widened its product offerings, but also helped it cater to the entire needs of user industries in the power segment. Besides meeting the requirements of refineries, petrochemical and fertiliser industries, it also indigenously manufactures pumps that are used by nuclear power plants. Further, since KBL and KSB Pumps are the only pump manufacturers who can cater to the requirements of nuclear power stations, the Indo-US nuclear deal, when it takes-off could expand demand and propel revenue.

The Government's initiatives toward water treatment and supply schemes would also augur well for KBL, which derives nearly 50 per cent of its revenues from lift irrigation projects. The company's domestic pump business, especially submersible pumps used in bore wells, has bright prospects in light of the real estate boom and receding ground water levels. Agricultural pumps, however, might face pricing pressure owing to the presence of many unorganised players.

For acquisitions in areas that include pumps for paper and pulp industry, KBL has set aside about Rs 250 crore. Further, its recent acquisition of Aban Constructions is likely to supplement its established presence in the EPC segment. On the exports front, KBL's focus on African and South- East Asian markets is likely to pay off, given the market potential and the absence of established players.

Access to the UK markets through SPP Pumps (its subsidiary) and a recent foray into the US could also help widen market access. Any slowdown in the capex plans of the user industries and the entry of MNC players into this segment, remain primary risks.

Marico Industries: Buy

Marico Industries has transformed itself into one of most the promising `growth' plays in the fast-moving consumer goods (FMCG) sector through a significant shift in strategy and a changing product profile. Investors with a three-year horizon can consider adding the stock to their portfolio, given the several growth engines- a healthy pipeline of new products, an expanding presence in the beauty and wellness space and a string of overseas acquisitions. However, the stock may be more suited to aggressive investors, as the acquisition-led strategy and the stock's current valuation levels (30 times trailing 12 month earnings), peg up risks.

Improving product mix

Brands such as Parachute (coconut oil) and Saffola (edible oil) traditionally made up the lion's share of Marico's sales, leading to strong commodity influences on the company's earnings and high sensitivity to input cost increases. However, the company's forays into less price-sensitive segments such as value-added hair oils (Hair & Care, Parachute Advansed, Mediker anti-lice), high-end hair care products (Parachute after-shower cream) and categories such as baby-care products (Sparsh) and soaps (Manjal) have helped improve its overall margin profile. Marico's operating profit margin has improved steadily over the past two years, from about 8.8 per cent in 2004-05 to 12.6 per cent in 2005-06, and further to 15.6 per cent this fiscal. Current margins, which are in line with those for Marico's peers, may be maintained as the company expands further into the beauty and wellness segments.

Why inorganic growth?

The company has embraced an acquisition-led strategy to expand its brand portfolio and geographic reach. Over the past year, it has bought out two domestic brands (Manjal soap and Nihar coconut oil) and made three cross-border acquisitions — soap brands (Aromatic and Camellia) in Bangladesh and hair-care brands (Fiancee and HairCode) in Egypt. These cross-border forays are not Marico's first ones; it has already made two overseas acquisitions — Sundari LLC and Kaya Skin — in previous years and markets its brands in West Asia, Bangladesh and the SAARC countries. The company plans to secure a gateway into new markets through its recent acquisitions.

With the domestic FMCG market expanding at a fast clip, the time does not seem particularly opportune to venture overseas. Moreover, acquisitions are bound to bring accompanying challenges of integrating operations, managing cross-border trade and foreign currency exposures.

However, the factors cited by Marico in favour of its inorganic growth strategy appear to hold water. One, since the acquired brands are ones with established market shares, the company expects the acquisitions to be earnings-accretive within a short time-frame.

Second, overseas acquisitions enable the company to add brands at lower multiples (10-14 times profits) than it would have otherwise paid within India. Third, the acquisitions are only being made in categories (hair care) where Marico has experience in managing domestic brands.

Track record in buyouts

The company's track record in managing and scaling up its previous acquisitions is also reasonable, though not an unqualified success.

The Kaya Skin Clinic business has made significant progress, with revenues rising from Rs 9 crore to Rs 54 crores in three years,with positive earnings expected this fiscal. But Sundari LLC (a US-based spa)has been making slow progress. Of the recent acquisitions, `Nihar' has made a significant contribution to sales growth, but there has been a nine-10 month hiatus in the relaunch of the Bangladeshi soap brands.

The company's focus on exploring overseas markets is also vindicated by its earlier successes in these markets. In the years from FY-04 to FY-07, Marico's international operations have seen sales doubling from Rs 78 crore to an annualised Rs 160 crore, registering a much faster pace of growth than the domestic business. These changes have helped the company's performance, with consolidated net sales growing by 38 per cent (including acquisitions) and profits by over 80 per cent, in the first half of FY07.


Though it does improve growth potential, the recent strategic shift at Marico does entail a few additional risks for investors in the stock:

Integration issues and the overseas exposures derived from the acquisitions may make for lesspredictable earnings.

The increased appetite for funds to finanace buyouts has drawn down the cash chest, making increases in interest costs and equity expansion a definite possibility. Already, a ramp-up in borrowings has changed Marico's zero-debt status (debt:-equity of 0.44:1), while the recent qualified institutional placement has diluted the equity base by about 5 per cent.

However, for investors with an appetite for risk, the stock remains a good addition to the portfolio.

Cairn India Allotment

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