A mixed bag

While the Union Budget 2007-08 has been positive for rural development and inflation control, it has done little for industry.

Finance Minister P Chidambaram has left no stone unturned to promote investment in agriculture and education, but he hasn’t been as friendly to industry. In order to control inflation, he has cut excise duty on petrol and diesel and raised excise on cement.

The stock markets found nothing to cheer about and the Sensex tanked 4 per cent on Budget day unfortunately timed with a global sell-off, and closed on Friday 4.4 per cent lower than the pre-Budget session.

Says Dinesh Thakkar, CMD, Angel Broking, “The overall direction of the market remains neutral as far as the impact of the Budget is concerned.”

There are various reasons affecting the sentiment. First, dividend distribution tax and education cess have been raised, which will adversely affect the profitability of all companies, though to a small extent.

Further, the Budget has introduced minimum alternate tax on all exporting companies including the IT sector, thus impacting margins of software exporters.

Also, the Budget has been harsh on companies that issue employee stock options by bringing it under fringe benefit tax. Construction companies have been denied Section 80IA benefits.

However there is a silver lining. The government’s focus on boosting the rural economy and infrastructure will help sectors like power and power equipment, FMCG, tractor, textiles and education-based sectors.

Let us take a look at what broking firms have to say about the sectors and stocks that have been favoured or knocked out by the Union Budget 2007-08.

Agriculture-related: Positive Proposals

An additional 900,000 hectares irrigation will be created. The investment will go up from Rs 7,100 crore to Rs 11,000 crore. Higher capital allocation and farm credit of Rs 2,25,000 crore to improve productivity of agriculture area and availability of better seeds. The reduction of custom duty on sunflower oil from 65 per cent to 50 per cent as well as the removal of 4 per cent countervailing duty.

Impact Broking firms feel that the increased allocation on agriculture activity will help companies operating in agriculture equipment and pump manufacturer. Jain Irrigation, which makes irrigation implements such as drip irrigation system, sprinklers, valves and water filters will be the major beneficiary. There is also good news for Kirloskar Brothers, which is a leading player in pumps. Analysts feel there is an increased focus on augmenting the productivity which will help companies operating in seeds and pesticides in the long run. Monsanto India manufactures agro chemicals and hybrid seeds. The company is well-placed within the crop protection industry and its focus on herbicides and hybrid seeds will give it more advantage to capitalise on agriculture drive. ASK Raymond James feels that the removal of specialised duty and reduction of customs duty on sunflower oil will modestly benefit edible oil companies. It would have a positive impact on Ruchi Soya, which is leading player in branded edible oil. Further, the withdrawal of the excise on food processing and the reduction of the duty on plastic will have positive impact for the company.

Cement: Negative Proposals The Budget has introduced a graded excise duty structure. For cement bags sold over Rs 190 per 50 kg bag (retail price), the excise duty stands reduced from Rs 408 per tonne to Rs 350. For cement sold above the Rs 190 per bag mark, excise has been increased to Rs 600 per tonne.

Impact While cement companies have already hiked prices by Rs 12 per bag and are passing on the increased excise to consumers, broking firms feel that the reduced differential with import prices as also an anticipation of future government intervention may restrain future price hikes. Overall, while companies may pass on the rise in costs and hence sustain margins in the near term, the finance minister’s proposal is largely seen as a negative for investor sentiment. With a pre-budget retail price of around Rs 240 and realisations of around Rs 205, Gujarat Ambuja has very little scope for further price increases given the thin differentials with imported cement in its key western market. This was also reflected in its fall of over 7.7 per cent in what was the greatest post-Budget correction among frontline cement stocks. But on the upside the fallen prices have made its valuations more attractive at about 12 times its estimated FY08 earnings. ACC with its pan India presence, and a pre-Budget retail price of Rs 230 per bag should have more room for increasing prices. The recent Rs 12 hike should impart more sustainability to its margins especially at a time when it is undertaking an expansion of its capacity by 35 per cent over the next three years to 27 million tonne. At about 13.7 times its estimated FY08 earnings, however, the stock is expensive compared to most of its peers. South-based companies like India Cements and Madras Cements will be less impacted by the Budget measure as retail prices for these companies would remain comfortable at Rs 215-225 per bag even after the hike of Rs 12. At about 7 times and 8 times their estimated FY08 earnings respectively, India Cements and Madras Cements look quite an attractive option. CONCRETE LOSS Company name Pre-Budget price (Rs) Post-Budget price (Rs) % chg Price as on March 2 (Rs) P/E (FY08E) ACC 961.05 900.05 -6.35 855.55 13.66 Gujarat Ambuja 125.70 115.95 -7.76 109.60 12.30 Ultra Tech 946.40 891.10 -5.84 872.00 12.00 Shree Cement 1235.30 1147.25 -7.13 1190.00 9.30 India Cements 191.85 179.05 -6.67 168.95 7.25 Overall, analysts are still pessimistic about the cement sector and expect a further correction.

Construction: Negative Proposals Section 80IA withdrawn for companies with retrospective effect Withdrawal of tax exemption for real estate developers under section 80IB Provision for National Highway Development Programme (NHDP) increased Corpus of Rural Infrastructure Development Fund (RIDF)-XIII raised Separate window for rural roads to continue Capex under the Bharat Nirman infrastructure project hiked by 32 per cent

Impact Broking firms believe that the removal of section 80IA benefit will have a negative impact on EPS and future cash flows of construction companies besides the retrospective effect of eating into FY07 profits significantly. ASK Raymond James estimated earnings of companies to decline in the region of 10-25 per cent. According to Emkay Shares and Stock Brokers, the effective tax rates will increase from the current 15-20 per cent to 30 per cent. Accordingly, it estimates increased cash outflows for past liabilities for companies like HCC (Rs 26 crore), IVRCL (Rs 43 crore), Nagarjuna (Rs 35 crore) and Patel Engineering (Rs 38 crore). CRUMBLING STRUCTURE Company name Pre-Budget price (Rs) Post-Budget price (Rs) % chg Price as on March 2 (Rs) P/E (FY08E) Nagarjuna Constrcution 193.45 155.90 -19.41 159.00 15.90 IVRCL 344.45 290.65 -15.62 301.60 24.13 Hindustan Construction 122.00 102.50 -15.98 107.90 23.98 Patel Engineering 385.25 347.55 -9.79 312.60 15.10 Madhucon Projects 235.25 200.90 -14.60 213.60 11.55 Broking firms, however, believe that the government’s thrust on infrastructure spending by way of higher allocation to schemes like Bharat Nirman, NHDP and RIDF will lead to more construction activities and thus high order flows and earnings visibility

FMCG: Neutral Proposals Specific excise duty on cigarettes was increased by 5 per cent. Excise duty on biscuits priced below Rs 50 per kg, and instant food mixes reduced from 8 per cent to nil. Customs duty on food processing machinery reduced from 7.5 per cent to 5 per cent. Customs duty reduced from 12.5 per cent to 10 per cent and from 12.5 per cent to 7.5 per cent for chemicals. Central sales tax (CST) cut from 4 per cent to 3 per cent.

Impact Man Financial and Sharekhan see the reductions in peak customs duty and excise duty as a positive for a host of industries, such as food processing, personal care products, footwear, ceramics, paints, and watch industry. The hike in specific duty on cigarettes does not seem to have any impact on companies as the increase will be passed on to the consumer, according to Kotak Securities. Morgan Stanley Research finds the 1 per cent education cess increase to be negative for all FMCG companies, while with a reduction in customs duty on food processing machinery it expects FMCG companies to expand operations. A POSITIVE MIX Company name Pre-Budget price (Rs) Post-Budget price (Rs) % chg Price as on March 2 (Rs) P/E (FY08E) ITC 165.20 171.85 4.03 166.50 19.41 Nestle 941.75 958.35 1.76 935.05 22.28 Britania Industries 1257.35 1235.80 -1.71 1300.00 21.47 HLL 185.30 176.15 -4.94 178.85 14.73 Colgate Palmolive 319.75 321.40 0.52 307.00 18.31 ASK Raymond James sees input costs of FMCG companies reducing modestly due to low packaging and material costs.

Information Technology: Negative Proposals Extension of minimum alternate tax (MAT) to income in respect of which deduction has been claimed under sections 10A and 10B. Inclusion of employee stock options (ESOPs) in fringe benefit tax (FBT) ambit. Service Tax of 12 per cent applicable on commercially rented or leased immovable property.

Impact Morgan Stanley Research and Deutsche Bank expect cash flows of software service firms to be impacted negatively but reported profits to remain neutral. Brokerage firms like Emkay and Sharekhan expect the effective tax rate to go up by 4-5 per cent, margins to decline by 1.5-4 per cent and EPS to decline by 1.5-5 per cent as a result of MAT. SOFTWARE, HARD TAX Company name Pre-Budget price (Rs) Post-Budget price (Rs) % chg Price as on March 2 (Rs) P/E (FY08E) Infosys 2187.85 2078.35 -5.00 2093.50 17.60 TCS 1265.20 1188.45 -6.07 1202.10 29.37 Wipro 605.25 560.85 -7.34 574.20 22.03 Satyam 450.45 412.50 -8.42 427.30 18.03 HCL Technologies 660.40 596.10 -9.74 631.95 16.89 Sharekhan finds the inclusion of ESOPs in FBT net a negative as stock options as an instrument to retain talent would turn unattractive. Deutsche Bank expects a less than 1 per cent negative impact on FY08 expected EPS of service tax on lease rentals for software companies.

Metals: Neutral Proposals Removal of import duty on coking coal of any ash content Export duty of Rs 300 a tonne on iron ore and Rs 2000 a tonne on chrome ore exports Halving of import duty on defective steel to 10 per cent

Impact Exemption of customs duty on coking coal will have a neutral effect as players import coking coal with low ash content, which attracts zero import duty and coking coal forms a small portion of revenues of manufacturers. However, according to Brics Securities, the key beneficiaries would be Tata Steel and SAIL. Export duty on iron ore will have a marginal impact as there are not many iron ore exporters except Sesa Goa and NMDC. According to Kotak Securities, reduction in customs duty on defective steel will benefit those companies with electric furnaces and which use steel scrap as feedstock for steel like Bhushan Steel and Mukand.

Oil and Petrochemical: Positive/Marginally negative Proposals Cut in excise duty on petrol and diesel from around 8 per cent to around 6 per cent Extension of 80IA benefits (infrastructure status) to pipelines Cut in central sales tax from 4 per cent to 3 per cent Cut in customs duty on polyester and polyester intermediaries from 10 per cent to 7.5 per cent

Impact Analysts believe that the cut in excise on petrol and diesel should bring down losses on retail sales and benefit oil marketing companies like HPCL,BPCL and IOC. Moreover, with their price to earnings ratio ranging between 6.9-8 times their estimated FY08 earnings, the OMC stocks look quite attractive. RIL took a hit of nearly 3.6 per cent in the post-Budget correction as the cut in duties on polyester intermediaries was expected to have a marginally negative impact on integrated players. Kotak Securities feels that the extension of 80IA will positively impact companies like GAIL, Gujarat State Petronet and RIL in the form of tax benefits and lower cost of borrowing OIL’S WELL Company name Pre-Budget price (Rs) Post-Budget price (Rs) % chg Price as on March 2 (Rs) P/E (FY08E) HPCL 274.75 270.80 -1.44 263.30 6.95 BPCL 309.60 310.95 0.44 299.85 7.80 IOC 418.40 413.95 -1.06 407.85 7.97 RIL 1404.95 1354.60 -3.58 1317.35 18.20 ONGC 817.35 790.60 -3.27 800.00 8.75 Sharekhan feels that the cut in CST would be a positive for purely refining companies like Chennai Petroleum, which faces under-recoveries on CST when selling outside the state. Based on consensus estimates the stock trades at an attractive 5 times its estimated FY08 earnings.

Pharmaceuticals: Positive Proposals Allocation of funds to AIDS control to the order of Rs 969 crore. Increase in allocation to polio eradication to Rs 1.3 crore. Tax incentives for Research and development expenditure extended for another five years up to March 2012. Fringe benefit tax on free samples has been excluded. Exemption of service tax for clinical trials.

Impact Broking firms feel that the AIDS control focus should benefit companies with strong manufacturing capabilities like Ranbaxy, Cipla, Wockhardt, Aurobindo and Novartis. Pharma giant Ranbaxy fell over 4 per cent on budget day. At 16 times estimated FY08 earnings, valuations however remain reasonable, especially given that it would be one of the chief beneficiaries from the Budget proposals like extension of R&D benefits and greater focus on AIDS control. While Sun Pharma’s valuations appear at a significant premium to other major players, some analysts have also factored in a slightly negative impact accruing from the extension of MAT. The company could, however, benefit from the extension of tax benefits on R&D spends. Another beneficiary with a strong R&D focus would be Dr Reddy’s which is valued at about 18 times its estimated FY08 earnings. Analysts believe that the emphasis on polio eradication will benefit with strong capabilities in oral polio vaccines like Panacea Biotech. Sharekhan expects the service tax exemption for clinical trials to benefit companies like Nicholas Piramal, Vimta, Jubilant and Biocon. Nicholas Piramal with a valuation of less than 15 times its estimated FY08 earnings appears attractive as compared to many other frontline peers.

Power: Neutral Proposals Seven more Ultra Mega Power Projects (UMPPs) under process and at least two to be awarded by July 2007 Allowing merchant power plants to be set up by private developers and more private participation in transmission projects Budgetary support for APDRP (Accelerated Power Development and Reforms Project) increased by 23 per cent to Rs 800 crore Allocation to Rajiv Gandhi Grameen Vidyutikaran Yojana (RGGVY) increased by 33 per cent to Rs.3,983 crore

Impact Broking firms feel that the UMPPs and private participation of transmission will lead to higher demand for power equipment. While Emkay is positive on BHEL and Siemens, ASK Raymond James is optimistic about Crompton Greaves and ABB. Besides it will also benefit companies involved in power generation (NTPC, Tata Power and Reliance Energy). Analysts feel that higher allocation to schemes like APDRP and RGGVY will speed up transmission and distribution activities and hence benefit transmission (KEC International, Jyoti Structures, Kalpataru) and transformer manufacturers (like EMCO and Indotech).

Textiles: Positive Proposals Provision for integrated textiles parks increased by 2.2 times to Rs 425 crore Technology Upgradation Fund (TUF) scheme extended with a higher provision of Rs 911 crore Duty cut from 10 per cent to 7.5 per cent on polyester yarn, fabric and intermediates like PTA, DMT and MEG

Impact Kotak Securities feels that allocation for integrated textiles parks will lead to better technology and efficiency in the textile sector leading to higher exports and increasing profitability. Broking firms believe that the increased allocation and extension of TUF scheme will lead to further investments in the sector. Accordingly it will also lead to higher demand for machinery, which is positive for Lakshmi Machine Works. STRONG FABRIC Company name Pre-Budget price (Rs) Post-Budget price (Rs) % chg Price as on March 2 (Rs) P/E (FY08E) JBF Industries 111.10 108.70 -2.16 108.00 3.90 Lakshmi Machine Works 3082.15 3010.75 -2.32 3107.00 16.10 Rajasthan Spinning 97.30 94.00 -3.39 94.00 3.62 GHCL 167.10 165.25 -1.11 165.00 8.25 While analysts feel that the duty cut on PTA and MEG will reduce raw material costs of polyester manufacturers, Emkay estimates that PSF and VSF prices will come down. The reduced customs duty is positive for companies like Rajasthan Spinning, Banswara Syntex, JBF Industries and to some extent Indo Rama Synthetics.