Stocks you can pick up this week

MOST OF THESE REPORTS ALREADY AVAILABLE ON DP.

Hindalco
Research: Citigroup (March 22, ’07)
Rating: Sell
CMP: Rs 136 (Face Value Rs 1)
12-Month Price Target: Rs 142

Hindalco is a low-cost integrated aluminium producer with access to captive power and bauxite. It paid a high valuation for Novelis, whose profits are not expected to improve substantially over the next couple of years. Hence, the profits will not be able to compensate for Hindalco’s high interest outgo, resulting in earnings dilution.

In copper, TC/RC margins averaged US37c/lb in H1 FY07, benefiting from high copper prices and price participation. But these are already trending down and are expected to average US15c/lb in FY08 and FY09. For a copper smelter like Hindalco, profits are determined largely by TC/RCs rather than copper prices.

For aluminium, average prices are likely to decline 7% YoY in FY08 to $2,480/tonne and remain around that level in FY09. The target price of Rs 142 is based on: (1) 7x FY08E earnings (Rs 128); and (2) adding the value of Hindalco’s investment holding in associate companies and discounting it by 25. The proposed acquisition of Novelis raises its risk profile, increases gearing and reduces consolidated margins.

Based on consensus earnings and preliminary analysis, Citigroup sees no substantial improvement in Novelis’ earnings in ’07 and ’08. Additionally, Citigroup does not see any upside trigger to the stock price based on its outlook of falling global aluminium prices and substantial decline in copper TC/RCs.

Canara Bank
Research: HSBC (March 21, ’07)
Rating: Overweight
CMP: Rs 202 (Face Value Rs 10)
12-Month Price Target: Rs 312

As for most Indian banks, the first three quarters of FY07 saw a fall in the net interest margin (NIM) of Canara Bank. Yield on loans rose by 56 bps YoY, but interest expense grew faster than interest income. The bank reported a 22 bps fall in NIM, relative to FY06. The weakness in NIM is partly due to slow growth in low-cost deposits compared to new private banks.

HSBC lower its forecast for Canara Bank’s FY07 net profit by 8.5% to Rs 1,308 crore (-2.6% YoY). The revision is driven by decrease in forecast of net interest income and non interest income. For the nine-month period ended December ’06, the latter decreased by 9.6% YoY.

This revision pulls down HSBC’s DCF-based target value from Rs 327 to Rs 311. During ’06, the bank’s P/E ranged between 5.7x and 10.7x with a mean of 8.3x. Its P/B ranged between 1.0x and 1.7x with a mean of 1.4x. Applying the mean P/E and P/B to the forecasts for FY08 results in target prices of Rs 324 and Rs 300, respectively.

The blended target price of Rs 312 is a weighted average, where the DCF is assigned a weight of 50% and the P/E and P/B derived forecasts are assigned weights of 25% each. It values the stock at 8x FY08f EPS and 1.5x March ’08f book. The stock has underperformed the Sensex over the past quarter. The discount in the P/E of Canara Bank, relative to the Sensex P/E, has deepened to 65% — near a two-year low.

VSNL
Research: Merrill Lynch (March 22, ’07)
Rating: Neutral
CMP: Rs 407 (Face Value Rs 10)
12-Month Price Target: NA

VSNL carries ~3.6bn incoming ILD minutes annually on a standalone basis. Assuming one quarter of full ADC savings on incoming ILD, Merrill Lynch estimates VSNL’s FY08E earnings upside at ~13% (i.e. ~Rs 54 crore). Over the medium term, however, VSNL may pass the entire ADC cut to customers via lower tariffs.

Trai has announced cuts in ADC across services — for incoming ILD, ADC from April ’07 has been lowered to Re 1/min, compared to Rs 1.6/min currently. Media reports suggest the government is reviewing its options with regard to surplus real estate of ~773 acres that it controls in VSNL. Reports suggest that the revenue department has recommended auction of the land.

Merrill Lynch recognises that there have been several false starts with regard to value unlocking of real estate and believes its valuation is conservative. Pricing pressures in VSNL’s core business of wholesale carriage (data & voice) and low visibility on cost synergies from Tyco & Teleglobe drive Merrill Lynch’s 12-month ‘neutral’ rating.

National Aluminium
Research: Citigroup (March 22, ’07)
Rating: Sell
CMP: Rs 231 (Face Value Rs 10)
12-Month Price Target: Rs 241

Nalco has a smelter capacity of 345,000 tpa in eastern India. It has enough deposits of bauxite to meet more than 50 years’ requirements of its expanded alumina capacity (2.1m tpa from 1.58m tpa by end-’08). Good quality bauxite, open cast mines and low bauxite transport costs make Nalco one of the lowest-cost producers of alumina in the world.

The company sells its surplus alumina (27% of FY06 sales) in international markets and it is India’s largest alumina exporter. In the power-intensive business of producing aluminium, Nalco’s 960-mw thermal power capacity meets all its in-house requirements at 33% of the grid cost, and surplus power is sold to the state grid.

Low costs for power, alumina and labour make Nalco one of the lowest-cost aluminium producers in the world. Prices have recovered in recent weeks due to a strike and martial law in Guinea, the world’s second-largest bauxite producer. Nalco is already operating at full capacity and there is limited scope for volume growth until FY10. In the past six years, the stock has traded at a P/E range of 6-8x.

During this period, it has decisively crossed 8x only three times. Merrill Lynch has valued Nalco at 8x, the top end of its historical P/E band, which gives a target price of Rs 241. This appears justified based on Nalco’s position among the lowest-cost producers of alumina globally.

Hotel Leelaventure
Research: Macquarie Research (March 21, ’07)
Rating: Buy
CMP: Rs 57 (Face Value Rs 2)
12-Month Price Target: Rs 79.9

The analysis of average room rates (ARR), occupancy and revenue per available room (RevPAR) of the company’s hotels from April 1, ’06 to March 15, ’07 shows that the company’s average RevPAR is likely to rise 16.6% YoY to Rs 8,794 for FY3-07. Its ARR is likely to improve by 17% YoY, while occupancy is likely to remain at 77%, the same as last year.

Leela’s Mumbai hotel is likely to be the star performer, with RevPAR up 43.2% YoY to Rs 7,454. Leela’s Bangalore hotel is likely to show only 6.8% YoY growth in RevPAR to Rs 13,481 because occupancy may decline by 5.7% to 74%. The company is sacrificing occupancy at the expense of higher ARR for its Bangalore hotel.

Hotel Leelaventure’s capacity is set to rise from four luxury hotels with 1,015 rooms to nine luxury hotels with 2,565 rooms in the next two years. Macquarie expects its 81-room Udaipur hotel to come on stream by January ’08; the 419-room hotel-cum-service apartment in Gurgaon is expected to come on stream by October ’07; the 300-room Hyderabad hotel, 380-room Chennai hotel and 260-room Pune hotel are expected to come on stream around April ’09.

Leelaventure trades at 12.1x its FY3-08E earnings, versus the hotel industry consensus average of 16.9x FY08E earnings.