Valueline - November 2007

Breaking the October jinx

Traditionally, our stock market hits the lows in October. Over the past 17 years, the benchmark index, Sensex, has given negative returns in October as many as 11 times with an average return of -1.2% per year. In market parlance, this phenomenon of stock returns being lower in October compared with the other months is known as the Mark Twain effect, so termed after the following quote of Mark Twain: “October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February.”

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Sharekhan top picks

In the October 2007 issue, we had recommended the best 12 of our Stock Ideas as Sharekhan Top Picks. As on November 2, 2007, the basket of stocks has given an absolute return of 9.8% as compared with a 15.3% appreciation in the Sensex and a 17.0% rise in the S&P CNX Nifty.

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STOCK IDEA

Shiv-Vani Oil & Gas Exploration Services
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs480
Current market price: Rs370

Stepping on the gas

Key points

• Largest player in onshore drilling and seismic survey services: With a fleet of 25 onshore drilling rigs and six seismic survey crew, Shiv-Vani Oil & Gas Exploration (SOGEL) has emerged as the largest onshore service provider catering to the needs of oil and gas exploration companies. The augmentation of assets by the company is well timed in the industry upcycle. The heightened exploration activity has resulted in severe shortage of resources with service providers, leading to firming up of day rates (or billing rates per km in case of seismic survey) for various services.
• Healthy order book provides growth visibility: In addition to the favourable business environment, the existing order backlog of Rs2,950 crore itself provides a strong revenue growth visibility over the next two years. Almost 70% of the order backlog (excluding the Oman order) is executable over the next 24-30 months. The company also has a healthy order pipeline with planned bids worth over Rs5,000 crore for global tenders over the next few quarters. Moreover, to further consolidate its leadership position and effectively tap the huge opportunity, the company has planned an aggressive capital expenditure (capex) of around Rs1,000 crore over the three-year period CY2006-09.
• Margins to improve: SOGEL has reported a healthy operating profit margin (OPM) of 35% in CY2006, which is expected to improve by 300 basis points to 38% by CY2009. The improvement in its OPM would be driven by higher realisation (day rates or billing rates per km) and more efficient utilisation of its assets.
• Attractive valuation: The consolidated revenues and earnings are expected to grow at compounded annual growth rate (CAGR) of 60.3% and 72.7% respectively, over the three-year period CY2006-09. Despite the robust growth prospects, the stock is available at attractive valuations of 11.3x CY2008 and 8.5x CY2009 earnings estimates. We recommend Buy call on the stock with a price target of Rs480.

Torrent Pharmaceuticals
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs260
Current market price: Rs185

At an inflexion point

Key points

• Strong domestic formulation business: Torrent Pharmaceuticals (Torrent) is a well-known name in the branded formulation market in India, with a strong focus on the fast growing chronic lifestyle segments. We believe Torrent's domestic formulation business will continue to grow at above-average industry rate of 17.5% CAGR over FY2007-09 on the back of aggressive new products and increased geographical penetration.
• Investment phase in Brazil and Russia is over: Torrent's operations in Brazil and Russia turned around in FY2007. The company is expanding into newer markets in these regions. With the investment phase now over, these businesses should start contributing to Torrent's profitability from FY2008 onwards.
• Heumann to break even in FY2009: Torrent's Heumann acquisition has been incurring huge losses due to the stringent regulatory scenario in Germany. Going forward, Torrent plans to turn around Heumann through a strong top line growth by introducing new products. Further, Torrent plans to shift 60% of its production to India by FY2009, which will result in a margin improvement of 6-8%. We expect the Heumann business to grow at a CAGR of 6% with a strong margin expansion over FY2007-09.
• US foray in FY2009: Torrent has filed seven ANDAs and five DMFs in the USA. It expects to make additional 14 ANDA and nine DMF filings in FY2008. Even though the company is confident of starting its US business in early FY2009, we have not factored in any upside as the marketing arrangements for the products have not yet been finalised.
• Compelling valuations; upside of 40%: We expect Torrent's earnings to grow at a 29.7% CAGR to Rs157.4 crore in FY2009 on the back of a 14.8% growth in revenues and a 270-basis-point expansion in the margin. At the current market price of Rs185, the stock is quoting at 13.0x its FY2008E earnings of Rs14.2 and 9.9x its FY2009E earnings of Rs18.6. We initiate coverage on Torrent with a one-year price target of Rs260.

Zee News
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs73
Current market price: Rs54

Breaking news

Key points

• A compelling bouquet: Zee News Ltd (ZNL) operates a unique bouquet of channels comprising six regional entertainment channels and four news channels. The key revenue contributors are Zee News, Zee Marathi and Zee Bangla, with the latter two channels having made tremendous gains in viewership to achieve and consolidate their leadership positions. While Zee Gujarati is being revamped, the new businesses of Zee Telugu, Zee Kannada, Zee 24 Taas and Zee 24 Ghanta are making steady progress.
• Strong traction in ad revenues: ZNL is focusing hard on improving programming of the existing channels and gaining a much higher contribution from the new channels as they stabilise and gain traction in viewership. Powered by these efforts ZNL's ad revenues are expected to grow at a CAGR of 33% over FY2007-10.
• Being part of the Zee group is an advantage: Of the ten channels that ZNL operates eight are pay channels. The packaging of the ZNL channels with Zee TV, the flagship channel of the Zee group, allows ZNL to garner higher pay revenues. Also, the infusion of addressability in television distribution system on account of the digitisation of CAS and the expansion of DTH is likely to ensure sustained improvement in the pay revenues of ZNL.
• Margins to improve substantially: As the new businesses achieve a critical mass of viewership, we expect a substantial growth in the revenue contribution from these channels. We expect the company to achieve operating profit margin of 20.6% by FY2010.
• Attractive valuations: We expect ZNL's revenue and net profit to grow at CAGR of 30% and 125% respectively over FY2007-10. We value ZNL at 4x Mcap/Sales FY2009E, which gives a price target of Rs73 per share. That is an upside of 35% from the current price of Rs54.3 a share. At our price objective ZNL would be valued at a price/earnings multiple of 35x FY2009E EPS of Rs2.1.

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STOCK UPDATE

3i Infotech
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs180
Current market price: Rs140

Revenue growth hit by European business

Result highlights

• For Q2FY2008 3i Infotech has reported a revenue growth of 6.8% quarter on quarter (qoq) and 91.6% year on year (yoy) to Rs277.9 crore, which is lower than our expectations of Rs283.7 crore. The flattish revenue growth in the recently acquired entity, Rhyme Systems, and the overall slowdown in the European business seem to be the key reasons for the lower than expected growth in the company's overall revenues.
• The operating profit margin (OPM) improved by 30 basis points to 24.3%, despite the increase in the selling, general and administration (SG&A) cost as a percentage of the sales (to 21.9% as compared with 21.5% in Q1FY2008). The margin improvement was largely driven by the 150-basis-point improvement in the gross margin of the service business to 38.8% in Q2FY2008. Consequently, the operating profit grew by 8.3% qoq and 98.5% yoy to Rs67.6 crore.
• However, the steep jump in the minority interest to Rs3 crore dragged down the earnings growth to 2.3% qoq and 78% yoy to Rs40.1 crore, which is much lower than our expectations of around Rs43-44 crore.
• The company has upgraded the revenue guidance to Rs1,150-1,250 crore (up from Rs1,000-1,100 crore earlier) and the earnings guidance to Rs165-175 crore (up from Rs145-155 crore earlier). The upgraded earnings guidance is in line with our estimate of Rs172.3 crore.
• In terms of operational highlights, the revenue mix remained largely constant on a sequential basis with the product business contributing around 46.7% of the revenues. The order backlog continued to show a healthy growth with an increase of 11.2% qoq to Rs728.4 crore.
• At the current market price the stock trades at 13.7x FY2008 and 10.9x FY2009 earnings estimates. We maintain our Buy call on the stock with the price target of Rs180.

Aban Offshore
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs4,400
Current market price: Rs4,010

Price target revised to Rs4,400

Result highlights

• For Q2FY2008, Aban Offshore has reported a growth of 28.3% quarter on quarter (qoq) and of 29.6% year on year (yoy) in its stand-alone revenues to Rs165.3 crore. The growth is higher than expectations even after factoring in the revised day rates for its floating production unit Tahara (day rates of $87,500 effective from July 2007, up from around $27,000 earlier) and incremental revenues from Aban II.
• The operating profit margin has declined by 410 basis points yoy to 50.8% largely due to the jump in the staff cost as a percentage of the sales (10.4% of sales as compared with 6.9% in Q2FY2007 and 9.2% in Q1FY2008). The operating profit grew by 23.4% qoq and 18.7% yoy to Rs82.4 crore.
• The other income jumped by 241% to Rs22 crore, enabling the company to report a 122.6% increase yoy in its stand-alone earnings to Rs47.2 crore. Sequentially, the earnings grew by 66.5% due to a 42.9% jump in the other income component.
• It should be noted that the stand-alone results do not provide the complete picture as the valuations are based on the consolidated earnings estimate of FY2010.
• In terms of key events, the company has announced a contract for three of its jack-up rigs (Aban III, Aban IV and Aban V) with Oil & Natural Gas Corporation for a period of three years. At the renewed day rate of US$156,600 the total value of the contract works out to around Rs2,000 crore. The three rigs are being redeployed at an effective day rate of US$156,600, which is ahead of our earlier assumption of US$145,000. In addition to this, the company has recently announced contracts for two assets: Deep Driller 4 (a newly built jack-up offshore rig under Sinvest) and Aban VI (a 250-feet jack-up rig built in 1975). The contract for Deep Driller 4 would generate $80 million over the one-year period, translating into a day rate of $220,000, higher than $201,000 reported for DD5 in the last quarter. On the other hand, the existing contract for Aban VI is extended for three years (with an option to further extend for three more years) with Oriental Oil, Dubai and is estimated to generate $95 million (amounting to a day rate of $88,500) over the firm contract period of three years. The company's ability to negotiate long-term contracts at higher than expected day rates is quite encouraging and has led to significant re-rating of the stock over the last quarter.
• At the current market price the stock trades at 10.2x FY2009 and 7.9x FY2010 estimated earnings. We have fine-tuned the earnings estimates to factor in the recent developments. The impending listing of its Singapore subsidiary is an important trigger for the stock going ahead. We maintain the Buy call on the stock with a revised price target of Rs4,400 (10x FY2010E consolidated earnings discounted backwards by one year).

Ahmednagar Forgings
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs300
Current market price: Rs222

Price target revised to Rs300

Key points

• Ahmednagar Forgings Ltd (AFL), a subsidiary of Amtek Auto, manufactures small- and medium-sized forged components such as connecting rods, gear blanks, shafts, transmission components, flanges and hubs. AFL is a tier-1 supplier to large domestic original equipment manufacturers (OEMs) like Tata Motors, Ashok Leyland, Eicher Motors, Force Motors, Bajaj Auto and Maruti Suzuki.
• In Q4FY2007 AFL’s sales grew by 52.7% to Rs150.7 crore, which was below our expectations. The profit after tax (PAT) grew by 61.9% to Rs16.6 crore in the same quarter. The profit growth was lower mainly due to the slowdown in the domestic market and the impact of the strengthening rupee on its exports.
• For the fiscal ended June 2007, the company has reported a 59.9% growth in its net sales to Rs600.3 crore and a 75.3% growth in its net profit to Rs68.2 crore against our expectations of Rs67.5 crore of PAT.
• Though the company has a strong order book, we would like to take a cautious view on the domestic sales in FY2008 in light of the slowdown in the OEM segment. The outlook on the exports remains bullish with the commencement of the additional lines and increase in the utilisation levels. However, the margins may be hit due to rupee appreciation as around 40% of its exports are in US dollar terms.
• Considering the slowdown in the domestic market and the delay in commencement of the export lines, we are downgrading our FY2008 earnings per share (EPS) estimate by 30% from Rs36.5 to Rs25.3 and introducing our EPS estimate for FY2009 at Rs32.2. At the current market price of Rs222, the stock trades at attractive valuations of 6.9x its FY2009E earnings and an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 4.4x. We maintain our Buy recommendation on the stock with a slightly reduced price target of Rs300.

Allahabad Bank
Cluster: Cannonball
Recommendation: Buy
Price target: Rs125
Current market price: Rs95

Margins remain under pressure

Result highlights

• Allahabad Bank’s net profit increased by 14.2% year on year (yoy) to Rs239.8 crore in Q2FY2008. The growth was driven by a moderate growth of 13.3% yoy in the net interest income (NII) and a strong 32.3% growth yoy in the non-interest income component owing to a good increase in both treasury and core fee income.
• During the quarter the bank’s NII increased by 13.3% yoy but declined by 2% on a sequential basis. The bank had slowed down its growth momentum in Q1FY2008 and maintained the net interest margin (NIM). But the constant high deposit cost and lower advance growth of 16.7% yoy have dented the core performance. The bank had deployed most of its incremental deposits into short-term treasury bills. This resulted in negative spreads and a decline in the NIM. The NIM of the bank was down by eight basis points yoy and 21 basis points sequentially at 2.76%.
• The positive takeaway for the quarter has been the 36% growth yoy in the non-interest income driven by a 23.1% growth in the core fee income and a 40.9% growth in the trading income yoy.
• The operating expenses grew by a moderate 11.1% yoy which helped the bank in reporting a better operating profit growth of 23.2% yoy. The core operating profit growth was at 19.3% yoy but declined by 13% sequentially.
• There had been a net write-back of Rs19.7 crore in provisions and contingencies during Q2FY2007 (due to a write-back of Rs38.4 crore in the investment depreciation) compared with a charge of Rs31.8 crore during Q2FY2008. The asset quality remained stable on a sequential basis with the net non-performing asset (NPA) at 0.75% as in September 2007.
• The current valuations of the bank are attractive considering it is available below its FY2009E book value (BV) with a high return on equity of 21.5% and decent asset quality with net NPA of 0.75%. At the current market price of Rs95, the stock is quoting at 4.4x its FY2009E earnings per share (EPS), 2.8x pre-provision profit (PPP) and 0.9x BV. We maintain our Buy call on the stock with a price target of Rs125.

Alphageo India
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs645
Current market price: Rs515

Price target revised to Rs645

Result highlights

• Alphageo India (Alphageo) has reported spectacular results for the seasonally weak second quarter. Its revenues stood at Rs20.4 crore as compared with Rs0.4 crore in Q2FY2007. In the past, the company had suffered due to its high dependence on the North-East region where it is practically impossible to operate during the monsoon season. Consequently, the performance in Q2 used to be lacklustre traditionally. However, this year, Alphageo was able to fully deploy one of its crew in Q2 due to the recently bagged contract from Oil and Natural Gas Corporation in Cauvery Basin, south India.
• The operating profit margin (OPM) at 65.1% was the highest ever reported in any quarter, despite the fact that two of its crew were largely idle during the quarter. Consequently, the earnings stood at Rs5.8 crore as compared with a loss of Rs2.3 crore in Q2FY2007.
• On half-yearly basis, the revenues grew by 252.7% to Rs41 crore. The OPM stood at 51.7%, up from 47.4% in H1FY2007. The earnings stood at Rs8.3 crore as compared with a loss of Rs0.7 crore at the net level.
• The company had an order backlog of Rs70 crore as on September 2007, of which almost Rs60 crore worth of orders are executable in the current fiscal. In terms of growth visibility for FY2009, the company has a strong order pipeline and has bid for contracts worth over Rs200 crore.
• To factor in the higher than expected performance in Q2 and a strong order pipeline, we are revising our earnings estimates for FY2008 and FY2009 by 8.5% and 3.6% respectively. At the current market price the stock trades at 15.9x FY2008 and 9.6x FY2009 earnings estimates. We maintain our Buy call on the stock with a price target of Rs645 (12x FY2009 earnings estimates).

Apollo Tyres
Cluster: Apple Green
Recommendation: Buy
Price target: Rs52
Current market price: Rs40

Price target revised to Rs52

Result highlights

• Apollo Tyres has rendered a brilliant performance for Q2FY2008 on the back of a strong topline growth. The quarterly performance has been further fuelled by an improvement in the operating profit margin (OPM) due to lower raw material prices.
• The topline has grown by 10% to Rs844.3 crore for the quarter, which has been led mainly by a volume growth of 9% and a realisation growth of 1%. The slowdown has continued in the original equipment (OE) business, whereas the replacement market has grown by a high single digit.
• The OPM has improved substantially to 12.8% as against 7.8% last year on the back of softer raw material prices, improvement in price realisation, and increasing operating efficiencies. Consequently, the operating profit marked a growth of 81% to Rs108.1 crore. A higher other income has enabled the net profit for the quarter to grow by 164.2% to Rs51.1 crore.
• On the consolidated basis, the net revenues have been flat at Rs1,085 crore, while the profit has improved to Rs57.6 crore (up 216% year on year [yoy]). The sales of its subsidiary Dunlop has been affected during the quarter due to a shutdown in September 2007, however the profitability has improved.
• Dunlop is performing very well and the earnings before interest, depreciation, tax, and amortisation (EBIDTA) margin has reached the 12% level during the quarter.
• The sales volumes in the OE segment should improve in the second half, whereas the replacement sales will continue to maintain good growth rate. The lower rubber prices are helping the tyre makers maintain these levels of margins.
• We are revising our earnings estimates for FY2009 by 10% to Rs5.2 consolidated earnings per share (EPS).
• At the current market price of Rs40, the stock discounts its FY2009E consolidated earnings by 7.6x and quotes at an enterprise value (EV)/EBIDTA of 4.9x. We maintain our Buy recommendation on the stock with a revised price target of Rs52.

Axis Bank
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs1,054
Current market price: Rs815

Price target revised to Rs1,054

Result highlights

• Axis Bank's Q2FY2008 numbers are much above the market's and our expectations with the profit after tax (PAT) reporting a growth of 60.4% to Rs227.8 crore compared with our estimate of Rs199 crore. The high growth was driven by a robust increase in both interest and non-interest income segments. Due to the excellent set of numbers reported during Q2FY2008 we have upgraded our earnings estimates by 15.7% and 16.7% for FY2008 and FY2009 respectively.
• The net interest income (NII) was up by 72.9% year on year (yoy) and 39.9% quarter on quarter (qoq) to Rs588.7 crore. However the bank had raised capital of Rs4,534 crore during the quarter and excluding the possible interest income earned on such float funds, the quarter-on-quarter (q-o-q) NII growth would moderate to 15.7%.
• The reported net interest margin (NIM) expanded by 36 basis points yoy and by 56 basis points qoq. Our calculation suggests that around six basis points were added to the NIM due to the possible income earned on the follow-on public offer (FPO) float funds. A marginal sequential increase in the NIM was expected as the asset yields were expected to improve after the low yielding priority sector advances taken on the books during Q4FY2007 had run off. However, the substantial portion of the expansion in the NIM was due to the improvement in the cost of funds brought about by the retirement of high-cost term deposits with the capital raised by the bank.
• The bank's assets grew by 39.8% yoy and 5.6% qoq, driven by a strong advances growth of 53.5% yoy and 8.3% qoq. The deposits grew by 30.9% yoy and 8% qoq with an improvement in the savings deposits, which grew by 48% yoy and 17% qoq. The term deposits declined by 7.9% qoq, which helped the bank to improve its reported cost of funds by 25 basis points sequentially to 6.18% from 6.43% in June 2007.
• The non-interest income was up 87% yoy and 4% qoq to Rs382.9 crore, driven by a higher trading income of Rs102.5 crore, which grew by 339% yoy and 6% qoq. The core fee income was also up by a robust 69% yoy and 7.1% qoq.
• The operating profit was up 85.3% yoy and 25.8% qoq to Rs368 crore while the core operating profit was up 70.8% yoy and 37% qoq to Rs368 crore. Provisions and contingencies grew by 236.3% yoy and 13.4% qoq to Rs114.5 crore. Despite the strong asset growth, the asset quality improved with the net non-performing assets (NPAs) at 0.55% of customer assets, down four basis points sequentially.
• Axis Bank raised capital to the tune of Rs4,534 crore through a combination of global depository receipt (GDR), qualified institutional placement (QIP) and preferential allotment during the quarter. This helped to improve its capital adequacy ratio (CAR) to 17.6% (from 11.5% in June 2007) with the Tier-I CAR at 13%. This substantial capital-raising programme (almost 25% of the pre-issue equity) has depressed its return on equity (RoE) to 13.6% from 19%, which is along the expected lines.
• The bank has also recently decided to foray into the mutual fund business. It has already set up its wealth management business and planned a private equity fund to invest in the infrastructure segment. We feel these are the building blocks that the bank management is putting in place and that would adequately complement its banking business. This strategy would also open up a new channel of steady fee income. Thus, its robust fee income growth could help in restoring the fall in its RoE much sooner than in the past occasions when it had raised capital. It has been registering a phenomenal asset growth without compromising on its margin and asset quality. All these developments make Axis Bank one of the best growth stories available in the private banking space.
• We have upgraded our earnings estimates by 15.7% and 16.7% for FY2008 and FY2009 respectively. The upward revision in the earnings is mainly because of the improvement in the core net interest income prospects with a decline in the term deposits during the quarter, the robust trend in the fee income and higher trading profits than envisaged at the beginning of the financial year. This has also resulted in our estimated RoE improving by 90 basis points and 150 basis points for FY2008 and FY2009 respectively.
• At the current market price of Rs815, the stock is quoting at 21.6x its FY2009E earnings per share (EPS), 10.1x its FY2009E pre-provisioning profit (PPP) and 3x its FY2009E book value (BV). We maintain our Buy recommendation on the stock with a revised 12-month forward price target of Rs1,054.

Bajaj Auto
Cluster: Apple Green
Recommendation: Buy
Price target: Rs2,800
Current market price: Rs2,512

Price target revised to Rs2,800

Result highlights

• Bajaj Auto Ltd's (BAL) second quarter results have been much ahead of our expectations, mainly due to a richer product mix and control on costs that led to a substantial improvement in its operating profit margin (OPM).
• The company has reported a decline of 3% in its net sales to Rs2,362.3 crore. Despite the 12.7% decline in the volumes, the average realisation of the company improved by 11.1% during the quarter.
• The OPM for the quarter improved to 16% from 15% in the same quarter last year. The margin improved mainly due to a richer product mix and control on costs. The contribution from the 125cc plus segment improved from 37% of sales volume in Q2FY2007 to 50% in Q2FY2008. Consequently, the operating profit for the quarter marked a growth of 3.6% to Rs378.5 crore.
• Lower taxes, and stable interest and depreciation costs aided a 3.8% growth in the company's net profit to Rs344.1 crore. However, there was an extraordinary item of Rs7.74 crore relating to the closure of the Akurdi manufacturing operations during the quarter; this took the net profit after the extraordinary items to Rs336.4 crore.
• The decline in the volumes witnessed in the first half is expected to get arrested with the commencement of the festive season and pick-up in the sales volumes of the recently launched XCD DTS-Si. The improved profitability should also be maintained in view of the higher contribution expected from the 125cc plus segment.
• Considering the higher than expected improvement in the OPM in Q2FY2008, we upgrade our earnings estimates for FY2008 and FY2009 by 15% each to Rs126.7 and Rs140.7 respectively.
• As mentioned earlier, the worst is over for the stock and things should improve going forward. At the current market price of Rs2,512, the stock trades at 17.9x its FY2009E earnings and is available at an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 11.1x. We continue to value BAL on the sum-of-the-parts basis and maintain the Buy call with a revised price target of Rs2,800.

Bank of India
Cluster: Apple Green
Recommendation: Buy
Price target: Rs432
Current market price: Rs357

Price target revised to Rs432

Result highlights

• Bank of India's (BOI) Q2FY2008 profit after tax (PAT) grew by 100% year on year (yoy) to Rs425.1 crore, much above our expectations of Rs304.3 crore. The growth was driven by a strong operating performance on both the interest income and the non-interest income front, and controlled expenses.
• We have revised our FY2008 earnings estimate by 11.2% to Rs1,550.8 crore to factor in the better than expected non-interest income growth reported by the bank. Our FY2009 estimate was on the lower side but in light of the bank's excellent H1FY2008 performance and strong ability to improve margins, report above industry growth rates and show excellent earnings quality, we have upgraded our FY2009E earnings by 8.8% to Rs1,874.6 crore, mainly in anticipation of an improvement in the net interest income (NII).
• The reported NII grew by 16.1% yoy and by 4% quarter on quarter (qoq) to Rs986.7 crore. However the NII adjusted for amortisation expenses also maintained the same growth rates at 15.7% yoy and 3.9% qoq. The reported domestic net interest margin (NIM) showed a decline of five basis points yoy to 3.04% but improved by 14 basis points qoq. The improvement in the NIM was driven by a higher yield on assets, primarily driven by improvement in the advances yield. The improvement in the yield on advances was driven by a 10% sequential growth in the high yielding advances compared with a stable quarter-on-quarter loan growth in Q1FY2008.
• The non-interest income grew by 49.3% yoy and by 38.6% qoq to Rs528 crore, driven by treasury, fee and forex incomes, and recoveries. We had expected a higher trading income during this quarter due to the Rs42-crore gain from the stake sale in IL&FS Investment Managers. However, the 148.6% year-on-year (y-o-y) jump in the trading gains is beyond expectations and we feel that the gains from the sale of Nigerian Oil Bonds could have also boosted the trading income.
• The operating expenses declined by 6.8% yoy to Rs674.4 crore (as centenary celebration expenses had inflated the other operating expenses in Q2FY2007). As a result of this and a strong growth in the net income, the operating profit grew by 75% yoy to Rs840.3 crore. The core operating profit also grew by a strong 70.6%.
• Provisions and contingencies increased by 88.7% yoy on account of higher non-performing assets (NPAs) and other provisions which rose by 43.4% and 63.8% respectively. The bank had also utilised floating provision of Rs200 crore towards Tier-II Capital and excluded the same from calculation of the net NPA. This withdrawal of floating provision could have necessitated higher NPA provisions during the quarter to maintain the healthy asset quality. The gross NPA was down by 22 basis points sequentially to 2.07% while the net NPA stood at 0.75%, up six basis points sequentially.
• The bank has increased its Tier-II capital by Rs732 crore after undertaking revaluation of its properties and also raised Rs500 crore of innovative perpetual debt to bolster its Tier-I capital. Despite exploring hybrid options, we feel the bank would need to come out with a follow-on issue in FY2009.
• We feel BOI continues to remain one of the best performing public sector banks in terms of earnings growth, return on equity (RoE) and asset quality. In a time when most public sector banks are facing problems in maintaining margins, BOI has improved its margins and delivered excellent earnings quality. Despite the capital raising expected in H2FY2008 (7.8% of the current equity base), the RoE has improved by 60 basis points to 21.8% on the back of a 38.1% y-o-y growth in the earnings. With a consistent RoE above 21%, strong earnings growth of 29.2% for FY2007-09E, healthy asset quality and headroom to dilute government holding for future growth, we believe BOI deserves to trade at a premium compared with most of its peers. At the current market price of Rs357, the stock is quoting at 10x its FY2009E earnings per share (EPS), 4.9x pre-provisioning profit (PPP) and 2x FY2009E book value (BV). We maintain our Buy recommendation on the stock with a revised twelve-month price target of Rs432.

BASF India
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs300
Current market price: Rs249

On track

Result highlights

• BASF has reported good results for Q2FY2008. In Q2FY2008 its top line grew by 16.8% to Rs255.1 crore, mainly driven by a strong 31.4% growth in the sales of agricultural products and a 13.9% growth in the sales of performance products.
• The operating profit margin (OPM) remained almost flat year on year (yoy) but rose by 120 basis points on a sequential basis to 15.4%, driven by better profitability in the agricultural product division. Consequently, the operating profit grew by 16.1% to Rs39.3 crore.
• Stable interest and depreciation charges aided the company to grow its net profit by 18.3% to Rs24.1 crore in the quarter.
• We remain optimistic on the prospects of the company, considering the ongoing consumption boom in the company's user sectors, such as white goods, home furnishings, paper, construction and automobiles. To cater to the resulting demand, BASF has already expanded its polymer dispersion capacity at Mangalore from 20,000 tonne per annum (tpa) to 65,000tpa in March 2007.
• We believe the company is trading at an attractive valuation of 6.3x FY2009E consolidated earnings and an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 3.7x. We maintain our Buy recommendation on the stock with a price target of Rs300.

Bharat Heavy Electricals
Cluster: Apple Green
Recommendation: Buy
Price target: Rs2,450
Current market price: Rs2,236

Step closer to super-critical project
During the past few days we have seen positive news flowing in for Bharat Heavy Electricals Ltd (BHEL). Hereby we bring to you the highlights and the implications for the company in the future.

• BHEL is close to winning its first order for super-critical boilers for National Thermal Power Corporation's (NTPC) Barh-II project. This could well be a break through for the company in the super-critical boiler space.
• The company is in talks with global power equipment firms Siemens, Areva, and General Electric (GE) to set up a joint venture (JV) in the country to manufacture nuclear power plant equipment. The proposed JV will give BHEL a head start in the competition after the nuclear power market in India opens up with the operationalisation of the Indo-US nuclear deal.
• The company plans to scale up its manufacturing capacity to 20,000 megawatt (MW) per annum by 2012 at an investment cost of Rs6,500 crore.
• BHEL is considering taking equity in the Koradi Thermal Power Station near Nagpur. The plant would undergo a 1,600MW expansion in the generation capacity based on super-critical technology and would involve a capital outlay of Rs8,000 crore.

Bharti Airtel
Cluster: Apple Green
Recommendation: Buy
Price target: Rs1,100
Current market price: Rs1,010

Non-mobile business drives growth

Result highlights

• Bharti Airtel Ltd (BAL) reported a revenue growth of 7.3% quarter on quarter (qoq) and 45.4% year on year (yoy) to Rs6,337.4 crore during Q2FY2008. The sequential revenue growth was driven by a strong growth of 11.1% in the non-mobile business, whereas the revenues from the mobile business grew by 7.7% qoq to Rs5,057.9 crore.
• The operating profit margin (OPM) improved by 140 basis points to 42.8%. The OPM improvement was the highest ever reported in any quarter. In terms of segments, the margins of the mobile and the non-mobile businesses improved by 40 basis points and 160 basis points respectively. The operating profit grew by 10.7% qoq and 59.1% yoy to Rs2,709.7 crore.
• The consolidated earnings grew by 6.8% qoq and 72.8% yoy to Rs1,613.9 crore, which is ahead of market expectations. The growth in the consolidated earnings is remarkable especially when seen in the backdrop of the fact that the company had accounted for the foreign exchange (forex) gains of Rs239 crore and a write back of Rs40-45 crore in the other income component during Q1FY2008. As compared with this, there was a forex loss of Rs35.9 crore in Q2FY2008. Thus, after adjusting for the one-time non-recurring items in Q1FY2008, the growth in the consolidated earnings stood over 21% on a sequential basis.
• In terms of operational metrics for the mobile business, BAL reported a record net addition of 6.2 million subscribers during the quarter, taking its subscriber base to 48.9 million as on September 30, 2007. The average revenue per unit (ARPU) declined by 6% qoq to Rs366 on the back of the full impact of the pre-paid lifetime scheme at reduced activation charge of Rs495. The total minutes of usage increased at a lower-than-expected rate of 12.7% qoq to 64.4 billion minutes due to reduction in the free airtime offered in certain schemes. Consequently, the average revenue per minute declined to Rs0.79 (down from Rs0.82 in Q1FY2008). However, the spread per minute was largely stable at Rs0.32 (compared to Rs0.33 in Q1FY2008). The company's overall market share stood at 23.4%, largely in line with 23.5% reported in Q1FY2008.
• In terms of key highlights, the court's approval for the formation of a separate wholly owned subsidiary Bharti Infratel is expected over the next few weeks. Bharti Infratel would be among the largest tower company (for passive infrastructure) globally. The company has received license and spectrum in Sri Lanka and would rollout services in early CY2008.
• To factor in the better-than-expected performance, we have fine tuned our estimates by 1.2% and 0.7% for FY2008 and FY2009 respectively. At the current market price, the stock trades at 29.8x FY2008 and 23.7x FY2009 estimated earnings. We maintain our Buy call on the stock with a price target of Rs1,100.

BL Kashyap & Sons
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs1,620
Current market price: Rs1,450

Price target revised to Rs1,620

Result highlights

• BL Kashyap & Sons (BLK) reported a growth of 118.1% in its revenues to Rs372.3 crore during Q2FY2008.
• The operating profit margin (OPM) improved by 110 basis points to 11.8%, resulting in a 141.6% growth in the operating profit to Rs44 crore. The jump in the other income to Rs4.5 crore enabled the company to report 154.9% growth in its earnings to Rs27.1 crore (in spite of the jump in the tax rate).
• Even on a sequential basis, the performance is commendable with the growth in the revenue and operating profit at 23.1% and 24.9% respectively. In spite of the salary hikes, the OPM improved by 20 basis points sequentially.
• The order backlog stood at around Rs1,900 crore in the second quarter. The management is confident of posting a growth of around 80-85% in its stand-alone revenues during the current year. In term of subsidiaries, BLK Lifestyle (involved in interior and furnishing business) is expected to report revenues of around Rs10 crore in FY2008. The realty subsidiary, Soul Space, would follow a lease model in the six projects under its consideration.
• To factor in the better than expected performance in Q2 and the healthy order pipeline, we have revised upwards our earnings estimates by around 16-18% for the next three years. At the current market price the stock trades at 18.9x FY2008 and 14.1x FY2009 estimated earnings. We maintain our Buy call on the stock with a price target of Rs1,620 (based on the sum-of-the-parts valuation method).

Cadila Healthcare
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs425
Current market price: Rs300

Results in line with expectations

Result highlights

• Cadila Healthcare's (Cadila) total operating income (consolidated) grew by a healthy 28.4% year on year (yoy) to Rs609.7 crore in Q2FY2008. The growth was driven by a 12.3% growth in the domestic business and a 64.0% growth in the exports. The sales growth was in line with our estimates. The consolidation of the recently made acquisitions also contributed to the overall growth. Excluding the impact of these acquisitions, the like-to-like growth stood at around 18.1%.
• Cadila's domestic formulation business grew by a subdued 6.6% to Rs316.3 crore in Q2FY2008. The growth was low during the quarter due to the high base of Q2FY2007, when the company had recorded strong sales due to the outbreak of monsoon-related diseases like malaria and chikungunya. However, as per the secondary sales data complied by ORG-IMS, Cadila's sales have been growing at 15%. The company believes that it is on track to achieve a 14-15% growth in this business in FY2008 and hence expects an acceleration in the growth in H2FY2008.
• The improved performance of the French business (a growth of 38.1% yoy) and the US business (a growth of 122.9% yoy) contributed largely to the robust growth in the exports. The growth in the US business was largely driven by three new product launches during the quarter. Building on the break-even achieved during Q1FY2008, the French business recorded profits of Rs2.4 crore in Q2FY2008 (as compared with Rs0.5 crore in Q1FY2008).
• Cadila's operating profit margin (OPM) shrank by 140 basis points to 21.6% in Q2FY2008. The contraction in the margin was largely due to a 49.9% rise in the staff cost due to the consolidation of Nikkho, which has a higher staff cost component. On the other hand, the gross margin improved by 190 basis points to 67.3%, once again due to the consolidation of Nikkho, which enjoys a gross margin of up to 80% as it operates in the branded product space in Brazil. Consequently, Cadila's operating profit grew by 20.8% to Rs131.7 crore in Q2FY2008.
• Despite a doubling of the interest expenses (due to the acquisitions), the pre-exceptional net profit grew by 17.0% to Rs82.5 crore. The net profit was affected by a foreign exchange (forex) loss of Rs2.2 crore recorded during the quarter and was marginally above our estimates. The earnings for the quarter stood at Rs6.6 per share.
• The future of Cadila's joint venture (JV) with Altana has been uncertain, with generic companies receiving approval from the US Food and Drug Administration (USFDA) to launch the generic product in the US market. However, since the USA constitutes only 20% of the global pantoprazole market, even in the worst case scenario, the JV's revenues and profits would be affected by a maximum of 20% (that can potentially affect our FY2009 earnings estimate by approximately 10%). However, the management is gearing up to sustain its existing profitability through the expansion of the scope of the JV for the supply of the pantoprazole active pharmaceutical ingredient (API; in addition to the intermediate) and other products.
• At the current market price of Rs300, the company is trading at 13.4x its FY2008 and 11.4x its FY2009 estimated earnings. With all the growth drivers in place, we reiterate our Buy recommendation on Cadila with a price target of Rs425.

Federal-Mogul Goetze (India)
Cluster: Emerging Star
Recommendation: Book Out
Current market price: Rs148

Book out

Key points

• Federal Mogul Goetze Ltd’s (FMGI) performance was much below our expectations. For H1CY2007, the sales grew by 34% to Rs296 crore, however the profit was below our expectations. Despite the fact that the company made a turn around from a loss making company to a profit making company, the profit margin was much below our expectations.
• There was a substantial delay in the ramp up of the exports to the parent company. The export profitability has also been affected by rupee appreciation.
• FMGI has high exposure to the medium and heavy commercial vehicle (M&HCV) and the two-wheeler segments. The two segments were hit the most due to a slowdown in the domestic market as a consequence of the high base of last year and due to the rise in the interest rates.
• Higher costs of raw materials such as aluminium and nickel affected the earnings before interest, tax, depreciation and amortisation (EBITDA) margin. The company was unable to pass on the rising raw material cost to the full extent due to a slowdown in the domestic vehicle sales.
• The rights issue was to help the company to improve its capital structure and financial gearing has been delayed by more than six months. The price band of the proposed rights issue has been revised downwards leading to a 25-30% higher equity dilution than our estimates. Consequently, the profits have been affected by a higher interest cost. The higher dilution will impact the earnings.
• The company’s management has revised its guidance downwards for 2008E. The profit before tax (PBT) guidance has been revised down to Rs30 crore in June 2007 from Rs100 crore in September 2006, in a span of just nine months for the reasons discussed above.
• In view of all the above-mentioned disappointing factors, we advise investors to book out of the stock.

HCL Technologies
Cluster: Apple Green
Recommendation: Buy
Price target: Rs395
Current market price: Rs309

Strong growth in core business

Result highlights

• HCL Technologies (HCLT) has reported a revenue growth of 6% quarter on quarter (qoq) and 23.9% year on year (yoy) to Rs1,709.2 crore for the first quarter ended September 2007. In dollar terms, it has reported a sequential growth of 8.4% in its consolidated revenues to $429 million. The sequential growth in the revenues was driven by an 8.1% growth in the volumes, a 1.4% improvement in the blended realisations and 0.3% hedging gains. On the flip side, the offshore shift had an adverse impact of 1.3% on the revenue growth in dollar terms.
• The earnings before interest, tax, depreciation and amortisation (EBITDA) margin declined by 27 basis points to 21.3% on a sequential basis, due to the cumulative impact of salary hikes (172 basis points; offshore salary hike of 15% and onsite hike of 3-4%) and lower utilisation (an impact of 39 basis points). The effect of the salary hikes and lower utilisation was partially offset by the improvement in the blended realisation (a positive impact of 121 basis points) and other scale benefits (of 92 basis points). The operating profit grew by 6.2% qoq and 21.4% yoy to Rs295.3 crore.
• However, the foreign exchange (forex) fluctuation gains declined by 94.3% to Rs14.3 crore. The accounting policy on the forex hedges (away from the mark-to-market method to the cash flow accounting method) resulted in $55.7 million getting accounted in the balance sheet and only $3.6 million was reflected in the other income component. If accounted by the mark-to-market method, the forex gains reflected in the other income component would have been $60.8 million (in line with $61.5 million reported in Q4FY2007). The lower forex gain has been the key reason for the 36.6% sequential decline in the consolidated earnings to Rs308.4 crore in Q1FY2008.
• In terms of operational highlights, the company has signed two large deals (multi-million, multi-year) during the quarter, including a $250-million deal (the third deal of over $200 million in the past 24 months). It has a strong pipeline of large deals especially from Europe. The company added 3,625 employees in Q1 and the attrition rate continued to decline for the third consecutive quarter.
• We have maintained our earnings estimates. At the current market price the stock trades at 16.7x FY2008 and 13x FY2009 estimated earnings. We maintain our Buy recommendation on the stock with a price target of Rs395.

HDFC Bank
Cluster: Evergreen
Recommendation: Buy
Price target: Rs1,694
Current market price: Rs1,433

Strong performance under difficult environment

Result highlights

• HDFC Bank's Q2FY2008 results have been better than the expectations. The profit after tax (PAT) grew by 40.1% to Rs368.5 crore compared with our estimate of Rs345.8 crore. The PAT growth, of 40.1%, for the quarter was also much higher than the steady 31% growth in the PAT the bank has been delivering quarter after quarter.
• The net interest income (NII) grew by 47.6% year on year (yoy) and 18% quarter on quarter (qoq) to Rs1,162.7 crore. However excluding the income on float funds the quarter-on-quarter (q-o-q) growth would be at 14%. The year-on-year (y-o-y) growth in NII was due to an average asset growth of 39.4% yoy and a 20 basis points improvement in the core net interest margin (NIM) (adjusted for HTM amortisation expenses) to 4%. However, the core NIM was down sequentially by 20 basis points.
• The non-interest income grew by 21.3% year on year (yoy) but declined significantly by 15.7% qoq mainly due to a 73.6% q-o-q fall in the foreign exchange (forex) and derivatives income. The core fee income grew by 24.8% yoy and 5.3% qoq.
• The operating profit grew by 36.3% yoy and 5.5% qoq to Rs826.7 crore, while the core operating profit (operating profit excluding treasury) was up 33.3% yoy and by 6.2% qoq to Rs774.9 crore.
• Provisions and contingencies were up 16.6% yoy but declined by 5.8% qoq to Rs289.4 crore mainly due to a lower general and specific loan loss provisions on a sequential basis. HDFC bank had a higher component of general provisions during Q1FY2008 as a spillover effect of increased provisioning norms stated by Reserve Bank of India on certain category of standard assets which was to be maintained by Q4FY2007.
• The bank’s advances grew by 45.6% yoy and 15.7% qoq to Rs62,278 crore and the deposits (adjusted for IPO [initial public offerings] float funds) grew by 38.8% yoy and 7.9% qoq. The bank's business growth remained robust in a difficult environment where the industry has shown a slowdown. The bank's retail loan exposure stood at 55% from 57% in September 2007, which could be a deliberate strategy to slightly rebalance the loan portfolio, as asset quality remains a key concern on the retail loan book.
• The bank reported a 40.1% PAT growth for the quarter, which is much higher than the steady 31% growth in the PAT the bank has been delivering quarter after quarter. The business growth continues to remain robust with superior asset quality and margins compared with that of the industry. The bank has delivered a strong set of numbers and maintained or improved on most parameters in a difficult environment where the industry loan growth has slowed down, the asset quality has become an issue and the margins have been under pressure.
• Due to the reasons stated above we continue to like HDFC Bank a true evergreen stock under most circumstances. At the current market price of Rs1,433 the stock is quoting at 26x FY2009E earnings per share (EPS), 10x FY2009E pre-provision profits (PPP), and 3.8x FY2009E book value (BV). We maintain our Buy recommendation on the stock with a 12-month price target of Rs1,694.

ICICI Bank
Cluster: Apple Green
Recommendation: Buy
Price target: Rs1,173
Current market price: Rs1,062

Q2FY2008 results: First-cut analysis

Result highlights

• ICICI Bank's Q2FY2008 results were above our expectations. The bank's profit after tax (PAT) grew by 32.8% year on year (yoy) and by 29.5% quarter on quarter (qoq) to Rs1,002.6 crore against our estimate of Rs909.2 crore. The core operating profit was, however, marginally lower than our estimate.
• The net interest income (NII) was up by 34% yoy to Rs1,786 crore. The reported net interest margin (NIM) improved by 28 basis points qoq and by ten basis points yoy to 2.23%. During the quarter, the bank raised capital through a follow-on public offer (FPO) and an American depository receipt (ADR) issue. Our calculations suggest that around 29 basis points were added to the NIM due to the possible interest earned by the bank on the FPO proceeds.
• ICICI Bank reported a loan growth of 33% yoy and of 4% qoq in Q2FY2008 on the back of a 146% year-on-year (y-o-y) growth in the international loans. However, the growth in retail loans was lower at 22% yoy. The deposit rate also moderated further to 20% yoy as compared with 26% in Q1FY2008.
• The asset quality deteriorated with the gross non-performing asset (GNPA) up by Rs646 crore on a sequential basis and the net non-performing asset (NNPA) at 1.41% compared with 1.38% in Q1FY2008. The non-performing assets (NPAs) increased mainly because of higher defaults witnessed in the non-collateralised segments, which include credit cards and personal loans.
• ICICI Bank is taking the right steps to address the concern of low margins. With the recently obtained approval of the Reserve Bank of India (RBI) the bank would be increasing the number of its branches to 1,625 in the next 12-18 months. This would help it to improve its current account and savings account (CASA) ratio. However, this improvement in its earnings would be visible only over the next two to three years. The management has guided that its existing expensive corporate deposits would be repriced in Q1FY2009. We expect the margin to stay at the current level till then.
• We maintain our Buy recommendation on the stock with the price target of Rs1,173. At the current market price of Rs1,062, the stock is quoting at 23.3x its FY2009E earnings per share (EPS), 11.3x its pre-provisional profit (PPP) and 2.4x FY2009E book value (BV).

India Cements
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs330
Current market price: Rs287

Earnings upgraded

Result highlights

• India Cements has reported a profit after tax (PAT) of Rs222 crore for the second quarter of FY2008 and the same is higher than our expectations.
• At Rs760 crore the company's top line was higher than expected owing to a 16% year-on-year (y-o-y) growth in the volume and a 17.4% y-o-y growth in the realisation, which stood at Rs3,352 per tonne.
• The variable cost per tonne increased by 12% year on year (yoy) on the back of an 11% y-o-y growth in the power cost and a 19% y-o-y growth in the raw material cost. The employee cost jumped by 111% yoy to Rs53.3 crore, mainly on account of a one-time provision of Rs24 crore in the quarter. The overall cost per tonne increased by 14% yoy to Rs1,998.
• But on the back of a higher realisation growth, the earnings before interest, tax, depreciation and amortisation (EBITDA) per tonne jumped by 53.4% yoy to Rs1,353.6 per tonne, whereas the operating profit margin (OPM) expanded by 700 basis points to 40.4%.
• The interest cost was lower yoy at Rs28.3 crore on account of the repayment of debt whereas the depreciation provision was higher yoy on account of higher capacities due to the merger of Vishaka Cement with the company.
• The company continued to enjoy the minimum alternative tax (MAT) during the quarter. Consequently, the tax provision was lower at 12.5% in the quarter. On the back of a robust growth at the operating level, and lower interest cost and tax outgo, the PAT stood at Rs222, which was higher than expected.
• The capital expenditure (capex) programme of the company is as per schedule. Consequently, we are keeping our volume estimates unchanged for FY2008 and FY2009.
• We are revising our realisation assumption on the back of higher realisation enjoyed by the company. We are upgrading our FY2008 earnings estimate by 7.7% to Rs32.3 per share and our FY2009 estimate by 4% to Rs29.6 per share. We have assumed an effective tax rate of 20% for the current fiscal and a marginal tax rate for FY2009. Our estimate for FY2009 could be higher depending on the effective tax provision by the company.
• At the current market price of Rs287, the stock trades at 8.9x its FY2008 earnings per share (EPS) and 10.1x its FY2009 EPS estimates. We maintain our Buy recommendation on the stock with a price target of Rs330 per share.

Infosys Technologies
Cluster: Evergreen
Recommendation: Buy
Price target: Rs2,375
Current market price: Rs1,985

Price target revised to Rs2,375

Result highlights

• Infosys Technologies (Infosys) reported a revenue growth of 8.8% quarter on quarter (qoq) and 19% year on year (yoy) to Rs4,106 crore during the second quarter ended September 2007. The sequential growth in the revenues was contributed by the volume growth of 7.7% in its consolidated IT services business and an increase of 1.9% qoq in its blended realisation. On the other hand, the rupee appreciation of 1.2% qoq adversely affected the revenues growth during the quarter.
• The operating profit margin (OPM) improved by 255 basis points sequentially to 31.3% in Q2FY2008. The OPM expanded due to the cumulative impact of an improvement in the blended realisation (a positive impact of 110 basis points), visa charges (120 basis points gain due to visa charges accounted in Q1), and scale benefits (90 basis points). On the other hand, the rupee appreciation has a negative effect of around 50 basis points on the OPM. The company reported a healthy improvement in its OPM despite the one-time earn out payment (of around $12 million) to the senior management of its consulting subsidiary during the quarter.
• The other income component declined sequentially to Rs154 crore in Q2 from Rs253 crore reported in Q1, as the company posted only a marginal foreign exchange (forex) fluctuation gain of Rs5 crore as against the gain of Rs68 crore reported on this front in Q1. On the other hand, the effective tax rate was higher at around 15% in Q2 as compared with just 9.7% in Q1 (due to tax write-back of around Rs51 crore). Consequently, the consolidated earnings grew at a relatively lower rate of 1.9% qoq and 18.4% yoy to Rs1,100 crore. After adjusting for the tax write back in Q1, the earnings growth stood at 7% on a sequential basis.
• The revised guidance for FY2008 is in line with the expectations. In dollar terms, the revenue growth guidance has been upgraded to a healthy rate of 34.5-35% (up from 29-31% guided in July) and the earnings growth guidance has been upgraded by 2.5-3% to $1.98-1.99 per share (up from $1.92-194 per share in July). In rupee terms, the revenue growth guidance has been upgraded by around 1.8% to Rs16,588-16,648 crore, despite the fact that the exchange rate assumption for H2 is taken at Rs39.5 per USD (as against Rs40.58 per USD in July). The earnings growth guidance in rupee terms has been upgraded to Rs79.49-79.88 (up from Rs78.2-79 per share given in July). The guidance does not factor in the possible upside from the pipeline of large deals and the expected improvement in its blended realisation in the coming quarters. But it does include the inflow of around $14 million from the Philips deal.
• For Q3, the management has guided to a sequential growth of 3.2-3.7% in its consolidated revenues and a growth of around 4.4% qoq in the earnings per share (EPS) to Rs20.11 as compared with the EPS of Rs19.26 in Q2FY2008. The Q3 guidance is relatively muted as the quarter has lesser number of working days due to the festive season.
• In terms of operational highlights, the robust growth of 11.4% in the banking, financial services, and insurance (BFSI) segment was encouraging and the management re-iterated that the demand environment continues to be strong. However, it added a word of caution in terms of a possible cut in the discretionary IT spending in the US geography during CY2008. The pricing remains stable with upward bais and the management sounded more confident about maintaining the margins in spite of the cost pressure and the rupee appreciation. It indicated that the decline in the OPM would be limited to 50-100 basis points during FY2008 (as compared with 100-150 basis points indicated in July) even after over 11% appreciation in the average realised exchange rate to around Rs39.9 per USD (as compared with Rs44.98 per USD in FY2007) in the current fiscal.
• To factor in the change in the exchange rate assumption (Rs39.8 per USD in FY2008 and Rs39 per USD for FY2009), we have revised downward the earnings estimates by 1.2% and 5.5% for FY2008E and FY2009E respectively. At the current market price the stock trades at 24.5x FY2008 and 20.4x its FY2009 earnings estimates. We maintain our Buy recommendation on the stock with a revised price target of Rs2,375.

ITC
Cluster: Apple Green
Recommendation: Buy
Price target: Rs200
Current market price: Rs180

Maintains momentum

Result highlights

• ITC’s operating performance for Q2FY2008 was slightly below our expectations. The sales growth of 13.4% year on year (yoy) was in line with our estimate. This was despite lower volumes in cigarettes and a decline in the revenues of the agri-business on account of a ban on the export of some commodities that had to be disposed of below the procurement price.
• The operating profit margin (OPM) for the quarter stood at 31.5% against 33.7% in Q2FY2007 primarily on account of the one-off loss in the agri-business. However, the margins expanded in the cigarette and hotel segments. Thus the operating profit grew by 6.1% to Rs1,032 crore.
• The jump of 162% in the other income to Rs208 crore was much above expectations on account of substantial treasury gains and one-time dividends. Thus, after tax (at a higher rate) the net profit increased by 13.4% yoy to Rs770.9 crore.
• As expected, the cigarette segment saw a dip of ~3-4% in volumes due to the 20%+ price increase undertaken by ITC in response to the hefty levy of indirect taxes (up 29% per pack yoy). We expect the growth in the volumes to recover to the normal rate of 5-7% in FY2009. The gross revenues for the segment increased by 5.5% and the profit before interest and tax (PBIT) rose by 9.8% yoy.
• The non-cigarette fast moving consumer goods (FMCG) business continues its remarkable progress with a 43.3% revenue growth. Even more pleasing is the fact that the PBIT margins, which have been improving quarter after quarter, registered a gain of 574 basis points yoy despite the launch of several new products.
• We like the way ITC’s business model is shaping up and the company is morphing from a cigarette major into a full-scale FMCG player. The management has demonstrated its skill in channelising the strong cash flows generated from the cigarette business into the other businesses of FMCG products, hotels, paperboards and e-Choupals. We also derive comfort from the fact that the non-cigarette FMCG business is delivering results as per expectations. At the current market price of Rs180, the stock discounts its FY2009E earnings per share (EPS) of Rs9.6 by 18.6x and trades at FY2009E enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 11.9x. We maintain our Buy recommendation on the stock with a price target of Rs200.

Jindal Saw
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs830
Current market price: Rs787

Maintains strong growth momentum

Result highlights

• Jindal SAW Ltd's (JSL) Q4FY2007 numbers were ahead of our expectations on the back of a higher topline and stronger margins.
• The topline grew by 27.2% year on year (yoy) to Rs1,428.6 crore on the back of a high growth both in the ductile iron (DI) pipe and the seamless pipe segments.
• On the back of a favourable product mix, the operating profit margin (OPM) expanded by 300 basis points to 11.9%. Consequently, the operating profits surged by 70.4% to Rs169.9 crore.
• Lower interest cost led the profits to grow by 89.3% to Rs90.1 crore for the quarter.
• JSL's order book at the end of the quarter stood at $715 million and the same is executable by May/June 2008. Of this, orders worth $565 million are for submerged arc welded (SAW) pipes while the remaining orders were for DI and seamless pipes.
• The capital expenditure (capex) plan is on schedule and the company plans to raise its longitudinal submerged arc welded (LSAW) pipe capacity by another 200,000 tonne and the helical submerged arc welded (HSAW) pipe capacity by 350,000 tonne. The seamless pipe capacity is being raised to 250,000 tonne by mid-CY2008.
• We maintain our positive outlook on the company considering its leadership position in the industry and the scope for margin expansion. We believe the stock is trading at attractive valuations at 9.4x its CY2008E earnings and 4.4x its CY2009E earnings. We maintain our Buy recommendation on the stock with a price target of Rs830.

Lupin
Cluster: Apple Green
Recommendation: Buy
Price target: Rs840
Current market price: Rs631

Strong performance continues

Result highlights

• Lupin's consolidated revenues increased by 36.2% year on year (yoy) to Rs659.0 crore in Q2FY2008. The growth in the top line was above our expectations and was driven by a 22% growth in the domestic formulation business and a 126.2% rise in the export of formulations to the advanced markets of the USA and Europe.
• The consolidated performance of the company, however, paled in comparison with the standalone performance due to significant inventory build up in Lupin's US subsidiary to prepare for the increased offtake of the existing products and the impending new launches. The standalone revenues grew by an impressive 45.5% to Rs714.3 crore, while the profits jumped by 102.5% to Rs118.1 crore in Q2FY2008.
• The formulation sales from the USA were driven by the newly launched Cefdinir and a 54.5% jump in the revenues from Suprax. Going forward, Lupin plans to launch few more products in the USA in H2FY2008. Further, the company expects an increased offtake of its cephalosporins (which form the major chunk of the USA product portfolio) in wake of the flu season setting in the USA. We estimate Lupin's US business to generate revenues of Rs612.8 crore in FY2008E and Rs735.3 crore in FY2009E.
• Lupin launched Cefpodoxime Proxetil in France during Q2FY2008. The company has garnered a strong market share of 80% for this product, as it is one of the two suppliers in the French market. The company is expecting six additional product approvals in Europe in H2FY2008, which will be extended to other European markets in FY2009 through the mutual recognition procedure. This will strongly drive Lupin's European business. We estimate the European business to touch the revenues of Rs48 crore in FY2008E and Rs72 crore in FY2009E.
• Lupin's consolidated operating profit margin (OPM) expanded by 230 basis points yoy to 17.1% in Q2FY2008, led by a 180-basis point drop in the research and development (R&D) spend. The R&D spend incurred during the quarter was unusually low at 4.8% of the sales, as the company made only one Abbreviated New Drug Application (ANDA) filing in the quarter. However, the R&D spend is likely to increase to 6-7% of the sales as the company has a target of making 15 filings in H2FY2008. The operating profit grew by 57.2% to Rs112.6 crore in the quarter.
• Despite a 13% reduction in the other income, Lupin's net profit grew by a handsome 46.0% to Rs75.6 crore in Q2FY2008. The strong profit growth was largely driven by a robust performance on the operating front and a 14% decline in the interest expense. The net profit reported by the company was above our estimates.
• We are revising our estimates for Lupin based on the company's H1FY2008 consolidated performance and the impact of the Kyowa and the Rubamin acquisitions. We expect Lupin's consolidated revenues to grow at a compounded annual growth rate (CAGR) of 27.4% to Rs2,636.2 crore in FY2008E and to Rs3,270.6 crore in FY2009E. The profits will grow at a CAGR of 29.3% to Rs316.1 crore in FY2008E and to Rs389.3 crore in FY2009E, yielding fully diluted earnings of Rs35.8 per share in FY2008E and Rs44.1 per share in FY2009E.
• At the current market price of Rs631, Lupin is trading at 17.6x its FY2008E and at 14.3x its FY2009 estimated consolidated earnings. Keeping in mind the strong business fundamentals and the growth potential of the company, we reiterate our Buy recommendation on Lupin with a price target of Rs840.

Marico
Cluster: Apple Green
Recommendation: Buy
Price target: Rs70
Current market price: Rs63

Oil on the boil

Result highlights

• The Q2FY2008 results of Marico were as per our expectations. In Q2FY2008, the net revenues of the company grew by 22.7% year on year (yoy) to Rs463.8 crore. The growth was driven by a 16% organic growth and a 7% inorganic growth.
• The operating profit margin (OPM) declined by 81 basis points to 13.95% on account of a higher raw material cost, which as a percentage of sales increased by 210 basis points to 51.6%. Consequently, the operating profit grew by 16% yoy to Rs64.7 crore.
• A substantial decline of 49.3% in the depreciation charge due to a write-off of intangibles in FY2007 along with a tax incidence of just 19.3% (compared with 30.9% in Q2FY2007) led to a 63% jump in net profit to Rs42.2 crore.
• The quarter witnessed a good volume growth across products with Parachute coconut oil growing by 8%, focus segment products growing by 15% and Saffola growing by 21% yoy. The international consumer product business grew by a strong 73% aided by the Egyptian business. Also, the chain of Kaya clinics expanded to 51 as the company added three new clinics during the quarter.
• We maintain our positive outlook on the company and expect its turnover to grow by 21% in the current financial year. The stock is trading at valuations of 18.8x FY2009E earnings per share (EPS) and enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 12.4x FY2009E. We maintain our Buy recommendation on the stock with a price target of Rs70.

Maruti Suzuki India
Cluster: Apple Green
Recommendation: Buy
Price target: Rs1,230
Current market price: Rs1,088

Price target revised to Rs1,230

Result highlights

• Maruti Suzuki’s Q2FY2008 results are marginally below our estimates owing to a slight dip in its margins.
• The net sales for the quarter grew by 33.2% to Rs4,529.7 crore, backed by a volume growth of 21.3% and a realisation growth of 9.8%. This growth was possible due successful new launches and improving product mix towards the B and C segment cars.
• The operating profit margin (OPM) is marginally lower than our expectations. The OPM has declined by 76 basis points year on year (yoy) to 13.15%. It has declined due a higher raw material cost (RMC)/sales ratio, higher marketing and promotion expenses, rising royalty charges and higher exports. The operating profit for the quarter increased by 25.7% to Rs597.8 crore.
• Supported by other income, the profit after tax (PAT) grew by 27% yoy to Rs466.5 crore.
• We estimate the outperformance witnessed in H1FY2008 with a strong volume growth of 19.3% will get decelerated to some extent in H2FY2008 as the high base effect catches up. We estimate the growth in H2FY2008 at 13.9%.
• In view of the improving product mix and higher non-operating income, we upgrade our estimates for Maruti Suzuki by 4.3% for FY2008 to Rs67.4 and by 2.4% for FY2009 to Rs76.8.
• At the current market price of Rs1,088, the stock is quoting at 14.2x its FY2009E earnings and at an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 9.2x. We maintain our Buy recommendation on the stock with a revised price target of Rs1,230.

Network 18 Fincap
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs651
Current market price: Rs411

Files amended rights issue document

Key points

• After the transfer of Studio18’s business to Viacom18, Network18 has filed the amended draft offer document for its rights issue. The old draft document stated the earlier objects of the issue to raise a part of the funds for film projects under Studio18.
• We maintain our valuation of the right issue at Rs133.6 per share.
• Network18 proposes to use a part of the rights issue proceeds towards capex on television content production. We believe, the investment in content production business will cater to the content requirements of the forthcoming channels of Viacom18.
• HomeShop18 is going great guns with business spreading over 2000, towns and cities across India, and with average sales of approximately 20 lakh per day just a few months after its launch. A full-fledged home shopping channel is in the offing.
• Issue of preferential warrants in TV18 and GBN will lead to increase in Network18’s holding in TV18 to 53.3% and in GBN to 45.1%.
• We maintain our buy recommendation on the stock based on our sum-of-the-parts price target of Rs651.

Nicholas Piramal India
Cluster: Apple Green
Recommendation: Buy
Price target: Rs377
Current market price: Rs300

Price target revised to Rs377

Result highlights

• Nicholas Piramal India Ltd's (NPIL) results for Q2FY2008 were ahead of expectations. The top line reported a growth of 20.1% year on year (yoy) to Rs764.6 crore and the pre-exceptional profit grew by 89.8% to Rs87.5 crore. The growth was broad-based, with strong traction in the Indian custom manufacturing (CMG) operations and the path labs business.
• With normal Phensydyl sales, NPIL's branded formulation business grew by 13.2% to Rs354.3 crore. The growth in the branded formulation business was more or less in line with the industry growth of 12.4% (ORG IMS MAT September 2007).
• While the overall CMG revenues grew by 22.2% yoy to Rs342.3 crore, the CMG business from India saw a 3.5x jump to Rs69.4 crore. Having already garnered Rs96.8 crore in H1FY2008, NPIL is well placed to exceed its guidance of Rs150 crore for the Indian CMG business. NPIL has also commenced shipment to a significant new customer during the quarter.
• NPIL's path labs business grew by 76.9% to Rs31.2 crore. The growth has been contributed both by the organic expansion of centres and the acquisition of labs. We have modeled a 50% growth for FY2008E and a growth of 30% for FY2009E.
• The operating profit margin (OPM) improved by 230 basis points yoy to 17.4%. The OPM improvement was arrived after charging off NCE R&D expenses of Rs24.6 crore and was driven by a 90-basis point reduction in the staff costs and a 250-basis point drop in the other expenses. On adjusting the NCE R&D expenses, the margin expansion was even more robust at 550 basis points to 20.6%. Consequently, the operating profits grew by 38.4% to Rs132.9 crore.
• Despite a 45.3% jump in the interest expense, the sharp decline in the tax incidence caused the company's pre-exceptional net profit to jump by 89.8% to Rs87.5 crore. The reported net profit of the company (after adjustments of extraordinary items) however showed an increase of 57.9% to Rs87.8 crore.
• The management has raised its FY2008 earnings per share (EPS) guidance by 3% (to Rs17.5 from Rs17.0 earlier) to account for the higher margins (18.7% excluding the NCE R&D spend as per the new guidance vis-à-vis a 17.7% excluding the NCE R&D spend earlier). This is despite a lower sales growth guidance (20% now as compared with 25% earlier) to take into account the appreciation of the rupee.
• In order to incorporate the savings arising out of the NCE demerger and the revised guidance provided by the management post Q2FY2008 results, we are upgrading our revenue and earning estimates for NPIL. We now expect the company to register a revenue growth of 18.5% in FY2008E to Rs2,927.5 crore and of 16.0% in FY2009E to Rs3,248.1 crore. The profits are expected to grow by 56.3% to Rs363.4 crore in FY2008E and by 20.9% to Rs439.3 crore in FY2009E, on the back of a 340-basis point expansion in margins over FY2007-09E. Our revised earnings stand at Rs173 per share in FY2008E and Rs20.9 per share in FY2009E.
• At the current market price of Rs300, Nicholas is discounting its FY2008E earnings by 17.3x and its FY2009E earnings by 14.3x. With strong traction expected across all the businesses, we maintain our positive outlook on NPIL. Hence, we maintain our Buy recommendation with a revised price target of Rs377. At our target price, NPIL would discount its FY2009E earnings by 18x.

Nucleus Software Exports
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs370
Current market price: Rs300

Product business drives revenue growth in Q2

Result highlights

• Nucleus Software Exports reported a revenue growth of 5.6% quarter on quarter (qoq) and 27.8% year on year (yoy) to Rs70.4 crore. The sequential growth in the revenue was primarily driven by an 11.3% sequential growth in the product business. The revenue from the projects & services business declined 5.5% sequentially.
• However, the operating profit margin (OPM) improved by 250 basis points sequentially to 25.6% (after adjusting for the Q1FY2008 foreign fluctuation loss of Rs1.3 crore taken above the operating level). The margin improvement was driven by the cumulative impact of the favourable revenue mix (the product business contributed 69.8% of the revenues, up from 66.3% in Q1FY2008) and leverage in the overheads cost as a percentage of the sales (down by 60 basis points to 12.9% of the sales). Consequently, the operating profit grew at a healthy rate of 11.8% qoq to Rs18 crore.
• The jump in the other income to Rs3.2 crore boosted the consolidated earnings growth to 15.7% qoq and 17.1% yoy to Rs16.2 crore, which is ahead of our expectations of around Rs15.5 crore.
• In terms of operational highlights, the company added five new clients and bagged orders for 13 product modules during the quarter. The pending order backlog has declined marginally to Rs280 crore (down from Rs289 crore in June 2007). However, the order pipeline is strong with bids for a record number of deals (40 deals) in the last quarter.
• At the current market price the stock trades at attractive valuations of 13.8x FY2008 and 11.3x FY2009 estimated earnings. We maintain our Buy call on the stock with a price target of Rs370.

Orchid Chemicals & Pharmaceuticals
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs375
Current market price: Rs230

A stellar performance

Result highlights

• Orchid Chemicals' (Orchid) top line grew by 20.0% year on year (yoy) to Rs295.1 crore in Q2FY2008. The top line growth was above our estimate of Rs282.3 crore and was driven by the full quarter impact of Cefdinir and Cefepime revenues.
• Orchid's operating profit margin (OPM) expanded by 340 basis points year on year (yoy) to 35.1%, driven by a significant decline in the raw material cost (due to the higher margin gained on Cefepime where Orchid is the sole generic player) and Cefdinir (which has lesser competition). However, the other expenses incurred by the company increased by 20% yoy due to the relatively more complex Para IV filings made by the company during the quarter. Consequently, the operating profit grew by an appreciable 33.3% to Rs103.7 crore.
• The reported net profit jumped by 115% to Rs63.3 crore, powered by foreign exchange (forex) gains (on outstanding foreign currency convertible bonds [FCCBs]) recorded during the quarter and the reduction in the interest expense. On the other hand, the net profit was adversely affected by the increased tax outgo due to the imposition of the minimum alternative tax (MAT). However, on excluding the net impact of the forex gain of Rs11.3 crore, the adjusted net profit of the company (derived solely from the operations) stood at Rs52 crore, up by 76.5% yoy. This was way above our estimate of Rs40 crore.
• Orchid maintained its pace of regulatory filings in Q2FY2008. The company's cumulative filings stand at 47 drug master files (DMFs) and 42 abbreviated new drug applications (ANDAs) till date in the USA. Further, the company has also made one additional Para IV filing with first-to-file (FTF) status during the quarter, taking the total tally of Para IV filings to four. These four filings are for products in the non-antibiotic space, with a combined market potential of $1.8 billion currently. The market for these products is estimated to grow to $2.3-2.4 billion by the time Orchid actually launches the products into the market.
• At the current market price of Rs230, Orchid is quoting at 9.8x its estimated FY2009 earnings, on a fully diluted basis. The valuations at these levels seem absolutely compelling when viewed in context of the strong growth potential that awaits the company. We retain our positive stance on the stock and maintain our Buy call with a price target of Rs375.

Orient Paper and Industries
Cluster: Vulture’s Pick
Recommendation: Buy
Price target: Rs800
Current market price: Rs634

Price target revised to Rs800

Result highlights

• Backed by healthy realisations in cement and paper divisions, the top line of Orient Paper and Industries grew by a robust 32% year on year (yoy) to Rs302.5 crore.
• On account of higher realisations, the paper division's margin jumped to 16% against 5% in the previous quarter and a loss in the same quarter of last year. Supported by healthy margins in the cement division, the overall earnings before interest and tax (EBIT) margin expanded by a healthy 1,525 basis points yoy and 280 basis points quarter on quarter (qoq) to 32.5%.
• The other income component for the quarter stood higher at Rs11.4 crore on account of Rs8.67 crore booked towards the realisable value of carbon credits obtained by the company from United Nations Framework Convention on Climate Change (UNFCCC).
• Thanks to the repayment of debt, the interest cost declined to Rs4.6 crore whereas the depreciation provision remained flat yoy at Rs5.6 crore, as the company has not added any asset in the last one year.
• On the back of the stellar performance of the paper and cement divisions, and a higher other income, the company's profit after tax (PAT) grew by 155% yoy to Rs58.3 crore, beating our expectations.
• The capital expenditure (capex) programme of the company is progressing well. The company will be able to get an additional cement volume of 0.3 million metric tonne (MMT) for the second half of the current fiscal. It is foraying into manufacture of CFL lamps at a capex of Rs40 crore.
• Taking cognisance of the higher margins in the division and adjusting for the income accruing from the sales of Certified Emission Reductions (CERs), we are upgrading our FY2008 earnings per share (EPS) estimate by 11.5% to Rs112.8 and the FY2009 EPS estimate by 12.8% to Rs113.2.
• The outlook for the company's business, especially cement and paper businesses, is very positive. Even though the cement cycle is expected to reverse in the next one year, the higher volume growth will partially compensate for the drop in the prices. With the industry scenario looking bright for the next couple of years, we expect the company's paper margins to remain attractive, providing a cushion to the earnings of the company. The stock is currently trading cheap at 5.1x its FY2008 EPS estimate and 5.6x its FY2009 EPS estimate whereas the cement business is trading at an EV per tonne of USD49 on the FY2009E capacity and USD29 on the FY2010 capacity. In view of the bright prospects for the paper industry and cheap valuations of the company's cement business, we believe that the stock deserves a re-rating. Hence, we revise our price target to Rs800 per share.

Ranbaxy Laboratories
Cluster: Apple Green
Recommendation: Buy
Price target: Rs500
Current market price: Rs417

One-time items boost Q3CY2007 profits

Result highlights

• Ranbaxy Laboratories (Ranbaxy) has delivered a mixed performance for Q3CY2007. While the revenue growth and margin performance have been disappointing and below estimates, the net profit has been ahead of estimates due to large foreign exchange (forex) gains and extraordinary income received from the sale of surplus land and buildings.
• During the third quarter, Ranbaxy's revenue grew by 15% year on year (yoy) in dollar terms to $406 million, which was below our estimate of $430 million, largely due to the poor performance in Romania and India. However, with the 12-13% year-on-year (y-o-y) appreciation in the rupee, the revenues in rupee terms stood at Rs1,641.4 crore, up by just 0.9% yoy. The growth was derived on the back of the healthy performances in the emerging markets, which grew by 17% yoy, and a steady growth of 12% in the developed markets.
• The company's operating profit margin (OPM) remained under pressure during the quarter and declined by 710 basis points yoy and by 20 basis points sequentially to 9.2%. The margin declined partly because of the higher base of Q2CY2006, when Ranbaxy had earned a higher margin from the launch of Simvastatin in the USA under 180-day exclusivity. Further, the appreciation in the value of the rupee against the US Dollar also took its toll on the OPM. Consequently, the operating profit of the company declined by 43% to Rs151.5 crore.
• During Q3CY2007, the company recorded substantial forex gains of Rs45.5 crore on its forex liabilities. As a result, the pre-exceptional net profit rose by 31.8% to Rs185.1 crore. Further, the company sold off its surplus land and buildings during the quarter and recorded an extraordinary income of Rs22.3 crore as proceeds from the sale. This caused the net profit after extraordinary items to rise by 47.7% to Rs207.4 crore.
• Ranbaxy believes that it has a First-to-File (FTF) status on approximately 20 Para IV abbreviated new drug application (ANDA) filings, representing a market size of about USD26 billion. It expects to monetise at least one FTF opportunity every year during CY2008-10. While the opportunities for CY2009 and CY2010 (generic Valtrex and generic Lipitor respectively) have already been lined up, the management is confident of winning an FTF for CY2008; the details of the same will be announced in January 2008.
• Ranbaxy has decided to de merge its new drug discovery research (NDDR) operations into a separate entity effective from January 1, 2008 and list it subsequently. While the specific framework and other details of the de merger will be finalised by the end of the year, the management has indicated that the company will save about $20-25 million of expenses incurred on NDDR projects annually from CY2008 onwards. This will boost the overall profitability of the core business and also unlock value in the discovery research and development (R&D) assets. The announcements of further details on the demerger scheme will act as a near-term trigger for the stock.
• We will upgrade our CY2008 estimates after the disclosure of the details relating to the demerger and the announcement of the FTF opportunity for CY2008.
• The management has maintained its revenue growth guidance for CY2007 at 20% (in dollar terms) and the earnings before interest, tax, depreciation and amortisation (EBITDA) margin guidance at 16%. In M9CY2007, Ranbaxy has grown by 20.5% in dollar terms and reported an EBITDA margin of 14.9%. The confidence of the management in achieving its guidance for the full year implies a revenue growth (in dollar terms) of 18.6% yoy and 11.33% sequentially in Q4CY2007.
• At the current market price of Rs417, Ranbaxy is trading at 22.5x its estimated CY2007 and 23.6x its estimated CY2008 earnings. We maintain our Buy recommendation on the stock with a price target of Rs500.

Ratnamani Metals and Tubes
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Under Review
Current market price: Rs1,279

Q2FY2008 results: First-cut analysis

Result highlights

• For Q2FY2008 Ratnamani Metals and Tubes Ltd (RMTL) has reported a year-on-year growth of 46.1% in its net revenues to Rs209.1 crore. The net revenues are in line with our expectations.
• The operating profit grew by 38.2% year on year to Rs44.9 crore, resulting in an operating profit margin (OPM) of 21.5%. The OPM fell by 121 basis points year on year, mainly on account of a change in the product mix and an increased raw material cost. The raw material cost to net sales ratio stood at 64.7% in Q2FY008 as compared with 63% in Q2FY2007.
• The other income increased sharply to Rs6 crore as compared with Rs0.4 crore in the corresponding quarter last year. The other income component was high on account of foreign currency translation gains on the raw material imports.
• The interest cost rose by 24.2% to Rs5.4 crore while the depreciation charge was up 78.3% to Rs5.9 crore. Consequently, the net profit increased by 59.7% year on year to Rs26.8 crore.
• The current order book of the company stands at Rs368 crore and is executable over the next five to six months. Out of the total order backlog, orders worth Rs163 crore are for exports and deemed exports (exports to special economic zones).
• Driven by the demand for the company's products from key user industries like the oil & gas, power and sugar (which are implementing capital expenditure programmes), the outlook for RMTL remains positive. The strong order backlog provides visibility to its earnings. We shall be back soon with a detailed analysis of the results and a revised price target. At the current market price the stock is trading at 13.3x FY2008E earnings and 9.5x FY2009E earnings. In terms of enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA), it is quoting at 6.2x FY2008E and 4.5x FY2009E EV/EBDITA.

Sanghvi Movers
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs219
Current market price: Rs195

Price target revised to Rs219

Result highlights

• For Q2FY2008 Sanghvi Movers Ltd (SML) has reported a revenue growth of 20.9% year on year (yoy). The same is in line with our expectations. In the same quarter, the operating profit of the company grew by 25.1% yoy to Rs42.9 crore, translating into an operating profit margin (OPM) of 75%. The OPM improved by 250 basis points yoy on a decline in the repairs and maintenance cost on account of the addition of new cranes to the fleet.
• The other income growth came as a surprise with a six fold increase to Rs1.1 crore, as the company sold two cranes in the quarter.
• The interest expenditure increased by 21.1% yoy while the depreciation charge rose by 34.2% yoy. Consequently, the net profit reported a growth of 27.9% yoy to Rs16.75 crore.
• SML will now be adding a 1,350-tonne crane to its fleet. This high-capacity crane would be useful in the construction of larger and more complex projects like a nuclear power plant.
• In the recent conference call, the company indicated its plan to invest Rs200 crore in FY2008 and FY2009 each. The proposed capital expenditure is higher than our earlier estimate. Therefore, even though we are maintaining our earnings estimate for FY2008, we are revising the same for FY2009 by 4.9%. Our fully diluted earnings per share (EPS) estimate for FY2009 now stands at Rs18.3. Hence, we are revising our price target for the SML stock to Rs219.

Satyam Computer Services
Cluster: Apple Green
Recommendation: Buy
Price target: Rs538
Current market price: Rs460

Results ahead of expectations

Result highlights

• Satyam Computer Services reported a growth of 11% quarter on quarter (qoq) and 26.8% year on year (yoy) in its consolidated revenue to Rs2031.7 crore. The consolidated revenue growth is ahead of the market expectations. In dollar terms, the consolidated revenues grew by 12.7% sequentially, primarily driven by a robust 9.1% quarter-on-quarter (q-o-q) growth in volumes.
• The operating profit margin (OPM) during the quarter declined by 260 basis points to 19.8% in Q2FY2008, primarily due to the adverse impact of the annual salary hike (450 basis points), the appreciation in rupee (100 basis points) and the increase in onsite contribution. On the other hand, the decline in the OPM was partially mitigated by the improvement in its blended realisations (a positive impact of 120 basis points), leverage in the selling, general and administration (SG&A) cost as percentage of the sales (a positive impact of 110 basis points) and better cumulative performance of its subsidiaries (a positive impact of 60 basis points). Consequently, the operating profit declined by 1.9% qoq to Rs403 crore.
• However, the other income jumped by 74.8% qoq and 291.3% yoy to Rs110.5 crore. Consequently, the earnings grew by 8.1% qoq and 17.9% yoy to Rs409 crore, which is ahead of street expectations.
• In terms of outlook, the earning guidance for Q2 is bit muted. Though the revenue (in dollar terms) is guided to grow by 5.6-6.1% sequentially (which is in line with the guidance given by some of its other peers), the earning is expected to grow marginally both in dollar and rupee terms. This is despite the fact that the company expects the margins to improve in the coming quarters and consequently implies a decline in the other income component in Q3.
• For the full year, the revenue guidance is revised upwards by around 4-5% both in dollar as well as rupee terms. In dollar terms, the revenue guidance is increased close to 5% to $2.07-2.08 billion (41.5-42% growth) and the earning per share (EPS) is upgraded by around 5% to $1.24 (36% growth). In rupee terms, the revenue guidance is revised upwards by 3.5-4% to Rs8,189-8,220 crore (26.3-26.7% growth) and the average EPS guidance is upgraded by 3-3.6% to Rs25-25.1 per share (16.5-17% growth; despite the lower exchange rate assumption of Rs39.5 as against Rs40.5 per US dollar taken in July). In terms of margins, the company has guided for a decline of 170 basis points in the OPM for the full year FY2008 to 22% (as compared with 23.7% in FY2007). The guided decline in the OPM has been increased to 170 basis points from 125 basis points indicated earlier due to continued appreciation of the rupee and aggressive wage hike.
• Satyam's overall performance in Q2 is encouraging. It was able to maintain a healthy volume growth in the range of 9-10% for the past five consecutive quarters. The revision in guidance is also higher than street expectations. It is targeting an employee base of 52,000 in FY2008, which works out to an increase of over 31% in its employee base as on March 2007 and reflects the management's confidence in the revenue growth visibility in FY2009 as well.
• We have fine-tuned our estimates to reflect the strong Q2 performance. At the current market price the stock trades at 18.3x FY2008 and 15.2x FY2009 earning estimates. We maintain our Buy call on the stock with a price target of Rs538.

SEAMEC
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs300
Current market price: Rs202

Results ahead of expectations

Result highlights

• SEAMEC has reported a revenue growth of 34.8% to Rs45.3 crore for Q3CY2007. The revenue growth was driven by higher fleet days and an increase in the day rates (higher day rates for all three vessels deployed).
• The operating profit margin (OPM) almost doubled to 27% due to the lower base effect (as the company had incurred abnormally high expenses of stores consumed in Q3CY2006; also all the vessels were not fully deployed in Q3CY2006). In Q3CY2007, the company accounted for Rs7.2 crore of dry docking charges pertaining to SEAMEC I (which is lower than our expectations of Rs10 crore).
• The lower than expected dry docking charges coupled with the steep jump in the other income component (to Rs2.3 crore) enabled the company to report higher than expected earnings of Rs8.9 crore in Q3CY2007 (as compared with just Rs0.5 crore in Q3CY2006).
• On the flip side, the outlook for Q4 is not very encouraging with SEAMEC II's dry docking (which would get extended due to the accidental damage from fire in the vessel's front portion). Moreover, the contract for SEAMEC III has been terminated prematurely (due to payment related issues) and the deployment of SEAMEC IV has been delayed further to the latter half of Q4 now. This essentially means that SEAMEC I would be the only vessel fully deployed in Q4CY2007. On the expenditure side, the company would account for dry docking charges of SEAMEC II during Q4CY2007.
• However, to factor in the better than expected performance in Q3 (largely due to lower dry docking charges and higher other income), we have revised upwards the earnings estimates by 3.3% and 2.8% for CY2007 and CY2008 respectively.
• At the current market price the stock trades at 12.4x CY2007 and 6x CY2008 estimated earnings. We maintain our Buy rating on the stock with a price target of Rs300 (8.5x CY2008E earnings).

Selan Exploration Technology
Cluster: Ugly Duckling
Recommendation: Hold
Price target: Rs155
Current market price: Rs154

Downgraded to hold

Key points

• Selan Exploration Technology Ltd's (SETL) efforts to develop and monitise its oil fields have resulted in a 36.7% growth in its production volumes to 100,963 barrels of oil in FY2007. Encouraged by the results, SETL's management plans to undertake the second phase of development activity and expects to show a similar growth in production volumes in FY2008. However, the huge expenditure on the development of its fields has not only consumed all the cash generated by the company from its operations but has also added to the overall debt on its books.
• The company has made an adhoc payment of Rs1.6 crore to the government towards the claim for profit petroleum in its oil field at Lohar. The provision for the same has not been made in the financial results as the company has filed an arbitration case against the claim. If the company losses the arbitration case, it could result in a significant hit on its earnings.
• SETL has successfully scaled up the production volumes in FY2007, and it can potentially double the production volumes by FY2009 (assuming a favourable scenario resulting in an equally encouraging outcome of its forthcoming development efforts). However the recent steep appreciation in the share price already factors in the positives, with the stock trading at 15.3x FY2008 and 11.1x FY2009 earnings.
• There are triggers that could result in a further re-rating of the stock as the management intends to undertake appraisal and valuation of its oil fields from one of the globally reputed agencies. The idea is to induct a strategic partner that would fund the company's ambitious plans in future. Consequently, given the fact that the stock appears to be fully valued but has re-rating triggers, we are downgrading our recommendation to hold on the stock and not to book out (in spite of the appreciation of 167% since our recommendation in March 2006).

SKF India
Cluster: Apple Green
Recommendation: Buy
Price target: Rs500
Current market price: Rs375

Splendid performance

Result highlights

• SKF India's Q3CY2007 results are ahead of expectations on account of better margins.
• The net sales have risen by 14% to Rs387.0 crore. We believe that the company benefited from the buoyancy in the industrial division where it was able to report a healthy top line growth against a slowdown in the automotive segment.
• The operating profit margin has improved by 620 basis points to 17.6%, leading to a brilliant 76.5% growth in the operating profit to Rs68.3 crore. We believe that a better product mix in favour of industrial bearings and greater operational efficiencies triggered the margin growth.
• The company is raising its ball bearing capacity to 110 million units and taper bearing capacity to 22 million units by the end of this year. Further, the company is spending close to Rs150 crore to set up a manufacturing unit at Haridwar.
• The net profit has grown by 92.5% to Rs43.1 crore against our expectations of Rs37.2 crore. In view of the company’s brilliant performance, we are upgrading our CY2007 estimate by 9.2% to Rs30.1 and CY2008 estimate by 7.2% to Rs35.8.
• At the current market price of Rs375, the stock discounts its CY2008 earnings estimate by 10.5x and its earnings before interest, depreciation, tax and amortisation (EBIDTA) estimate by 5.7x. We maintain our Buy recommendation on the stock with a price target of Rs500.

State Bank of India
Cluster: Apple Green
Recommendation: Buy
Price target: Rs2,282
Current market price: Rs2,118

Weak operating performance, likely to improve in H2FY2008

Result highlights

• State Bank of India's (SBI) results have been way above the market's and our expectations with the reported profit after tax (PAT) growing by 36% year on year (yoy) to Rs1,611.2 crore compared with our estimate of Rs1,405.8 crore. The results are significantly above estimates due to a higher than expected trading income component and lower than expected provisions.
• Due to the sharp increase in SBI's non-interest income, especially in the treasury income segment, we have revised our FY2008E earnings upwards by 5.1% to Rs5,428.7 crore. Even then, there remains significant upside risk to our earnings estimates if the bank decides to utilise some of the issue proceeds towards meeting the transitional shortfall in the AS-15 expenses. That's because we have assumed the transitional shortfall in the AS-15 expenses would be equally spread over five years at around Rs900 crore each year. However, the price target would not be affected much as the book value (BV) would not get altered significantly.
• The core performance remained weak with the reported net interest income (NII) rising by 6.3% yoy but falling by 10.4% quarter on quarter (qoq) to Rs3,762.7 crore. However, adjusted for the amortisation expenses, the NII growth is higher at 10.5% yoy and lower by 3.6% qoq. The reported cumulative net interest margin (NIM) for H1FY2008 showed a decline of 18 basis points yoy to 2.84%. However, the Q2FY2008 adjusted NIM for the amortisation expenses showed a 33-basis-point decline both yoy and qoq at 2.98%.
• The non-interest income was the major surprise, which grew by 42% yoy to Rs2,041.9 crore, driven by a very high trading income component of Rs434.7 crore compared with Rs8.2 crore in Q2FY2007. The core fee income growth was moderate at 11.8%. However, the forex income increased by 108.4% yoy to Rs264.2 crore.
• The operating expenses grew by only 7.9% yoy to Rs3,091.6 crore, mainly due to a decline of 0.2% yoy and 6.8% qoq in the staff expenses. A good net income growth of 16.6% yoy coupled with lower operating expenses helped the operating profit to increase by 28.4% yoy and 22.7% qoq to Rs2,713 crore. However, the core operating profit growth was weak at 5.3% yoy and declined by 13.7% qoq to Rs2,171.4 crore.
• Provisions declined by 73.5% yoy as no new loan provisions were made during the quarter. The bank had provided Rs200 crore over and above the requirement of regulatory provisions during Q1FY2008 and hence decided to utilise the same. There were also some write-backs of Rs16.5 crore related to government accounts. Thus due to lower provisions the bank's provision coverage declined but asset quality remained healthy with stable net non-performing asset (NPA) of 1.63% on a sequential basis.
• SBI's business growth was strong with net advances up 26.7% yoy and deposits up by 23.3% yoy. The pressure on the NIM is expected to ease with a pick-up in the credit demand, deposit repricing and accrual of the benefits of float funds from the proposed capital issue. New business areas and the upcoming capital issue are likely to further boost sentiment for the stock. Hence, we remain bullish on the stock and at the current market price of Rs2,118, the stock is quoting at 19.3x its FY2009E earnings, 7.8x pre-provision profit (PPP) and, 2.5x stand-alone and 2x consolidated FY2009E BV. We maintain our Buy recommendation on the stock with a price target of Rs2,282.

Sun Pharmaceutical Industries
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs1,287
Current market price: Rs1,042

The Sun continues to shine!

Result highlights

• Sun Pharma reported a strong top line growth of 24.6% year on year (yoy) in Q2FY2008 to Rs667.9 crore. The top line was significantly higher than our estimate of Rs632 crore. The strong growth was driven by an increase of 26.3% in its domestic business and a 19.2% growth in its exports.
• The domestic formulation business grew by 31.2% to Rs372.0 crore. This quarter was phenomenal for this business, which saw the highest ever revenues and growth rates. Going forward, the company expects the growth to moderate to more sustainable levels. We believe Sun Pharma's domestic formulation business will continue to outpace the industry and grow at a compounded annual growth rate (CAGR) of 20% over FY2007-09.
• Caraco Pharma, Sun Pharma's US subsidiary, continued with its impressive performance by registering a 46% growth in the revenue to $41.4 million (against our estimate of $37 million) and a 100% jump in the net profit to $4.6 million in the quarter.
• Sun Pharma demonstrated excellent cost control during the quarter, with margins expanding by 420 basis points to 36.1%, the highest operating profit margin (OPM) reported by the company so far. The sharp margin improvement was driven by a broad-based cost reduction: a 260-basis-point reduction in the raw material cost due to an improved product mix; a 30-basis-point decline in the staff cost; and a 240-basis-point dip in the other expenditure. The margin expansion caused the operating profit (OP) to grow by a robust 41.0% to Rs240.9 crore in Q2FY2008.
• Despite a robust operating performance, Sun Pharma's net profit growth was restricted to just 17.2% at Rs218.6 crore during the quarter. The profit was in line with our estimate of Rs213 crore. The profit growth slowed down due to the sharp 72% reduction yoy in the other income.
• Sun Pharma's recent wins in the Para IV patent challenges indicate the future potential of its US business. The company has recently announced favourable outcomes on four Para IV challenges, generic Protonix, generic Trileptal, generic Effexor XR and generic Exelon, thus winning a 180-day exclusivity (in certain cases, the same is shared with a few other players) for supplying these products in the USA. While the company is still evaluating its launch options for generic Protonix and generic Exelon, it has already launched generic Trileptal and is awaiting the US Food and Drug Administration's (US FDA) approval for generic Effexor XR. Upon receiving the approval it will evaluate the latter's launch and/or settlement options.
• Taro has further pushed its shareholders' meet until after the announcement of its audited results for 2006 and H1CY2007. There is no clarity on the timeline of the result announcements. With a 25% stake in Taro, Sun Pharma's management remains confident of closing the transaction after the shareholders' meeting.
• At the current market price of Rs1,042, Sun Pharma is valued at 23.3x FY2008E and 19.6x FY2009E fully diluted earnings. We maintain our Buy recommendation on the stock with a price target of Rs1,287.

Sundaram Clayton
Cluster: Apple Green
Recommendation: Book Out
Current market price: Rs751

Book out

Key points

• The performance of Sundaram Clayton is largely dependent on the commercial vehicle (CV) sector performance. The CV sector has been witnessing a slowdown, and any substantial recovery in the second half of FY2008 appears difficult.
• As per the annual report of FY2007, the company has tripled its capital expenditure (capex) plans for FY2008. It proposes to make additional investment of Rs96 crore in the brakes business and Rs95 crore in the die-casting business.
• The company has announced the demerger of its air brakes division into a subsidiary. The new entity will be called WABCO-TVS and will be listed on stock exchanges. The demerger would help both the companies to focus on their core areas, and a significant growth is expected in both the businesses in the long term.
• For Q1FY2008 sales grew by 6.1% to Rs201.4 crore and the profit after tax (PAT) was flat at Rs18.2 crore.
• The performance in FY2008 could be affected due to the slowdown in the auto sector and due to the higher interest and depreciation costs because of high capex. We advise to book out of the stock.

Surya Pharmaceutical
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs205
Current market price: Rs106

Results in line, strong growth ahead

Result highlights

• Surya Pharmaceutical (Surya) reported a massive 90.1% increase in its top line to Rs118.1 crore in Q2FY2008. The growth was driven by the increase in the company's existing active pharmaceutical ingredient (API) business and a 6-7% contribution from the new business of menthol and its derivatives. The sales growth was in line with our estimates.
• Surya's operating profit margin (OPM) shrank by 280 basis points to 17.8% in the quarter, primarily due to a 100.4% increase in the raw material cost. The increase in the material cost was due to the rising Penicillin-G (Pen-G) prices worldwide. However, going forward, the management has indicated that Pen-G prices have now stabilised and the raw material cost should show a marginal improvement in the coming quarters. Consequently, the company's operating profit grew by 64.0% to Rs21.0 crore in the quarter.
• Surya's net profit grew by an impressive 83.7% to Rs11.7 crore in Q2FY2008 and was in line with our estimate. The net profit growth was strong despite a 48.1% increase in the interest expense and an 11.3% rise in the depreciation charge. The earnings for the quarter stood at Rs8.1 per share.
• Surya began exporting menthol and its derivatives only in mid-August 2007 and hence the Q2FY2008 results do not reflect the full quarter impact of the menthol business. We expect Surya to deliver a stronger performance in H2FY2008 on the back of steady revenues from the existing API business and growing revenues from the menthol business.
• At the current market price of Rs106, Surya is trading at 4.6x its FY2008E diluted earnings of Rs23.2 and 3.3x its FY2009E diluted earnings of Rs32.1. At the current prices, Surya offers a remarkable combination of strong growth at cheap valuations. We view this as a strong buying opportunity and hence maintain our Buy call on the stock with a price target of Rs205.

Tata Consultancy Services
Cluster: Evergreen
Recommendation: Buy
Price target: Rs1,425
Current market price: Rs1,073

A decent performance

Result highlights

• Tata Consultancy Services (TCS) has reported a growth of 8.4% quarter on quarter (qoq) and of 25.8% year on year (yoy) in its consolidated revenues to Rs5,639.8 crore during Q2FY2008. The sequential growth in the revenues was contributed by an 8.2% overall growth in the volume, an 85-basis-point improvement in the billing rates (including productivity gains) and a hedging profit of 86 basis points (around Rs45 crore). On the other hand, the appreciation in the rupee and offshore shift adversely affected the revenue growth by 51 basis points and 99 basis points respectively, on a sequential basis.
• The earnings before interest and tax (EBIT) margin improved by 77 basis points to 23.8% sequentially during the quarter. This was contributed by the cumulative impact of the overall productivity gains (of 109 basis points), offshore shift (of 36 basis points) and hedging gains (of 79 basis points). On the flip side, in addition to the rupee appreciation (a negative impact of 30 basis points), the incremental wage cost of 117 basis points resulting from the promotions affected the margin during the quarter. The operating profit grew by 12% qoq and 18.5% yoy to Rs1,343.9 crore.
• The other income declined by 27.2% qoq to Rs110.5 crore, largely due to a lower foreign exchange (forex) fluctuation gain of Rs57.7 crore (compared with Rs107 crore in Q1). However, despite the higher tax rate (14% as against 11.3% in Q1FY2008) and a lower other income component, the company showed a sequential growth of 7.8% to Rs1,246.9 crore (after adjusting the Q1 earnings for the one-time write-back of Rs29.3 crore of provision made earlier). On an annual basis, the consolidated earnings have grown by 25.9%.
• In terms of the outlook, the company doesn't give any specific growth guidance. However, it has re-iterated that the demand environment continues to be robust with no signs of any slowdown in banking, financial services and insurance (BFSI) space and the US geography. The company signed three large sized deals of over $50 million (including one in the BFSI vertical) during the quarter. It also entered into master service agreements with three other clients (a couple of them from the banking space) that can potentially generate revenues equivalent to any other large deal. The pipeline of the large orders is also healthy with around 20 deals of over $50 million each. In terms of margins, the company expects to maintain the EBIT margin at around 25% in FY2008 (in line with the same as reported in FY2007).
• In terms of key operational highlights, the net addition of 9,268 employees is higher than expectations. This coupled with the campus offers of 22,295 fresh graduates this season (up from around 11,500 in the last fiscal) clearly reflects the management's confidence in the growth outlook of the company. Another noticeable point is the healthy double-digit sequential growth in all the relatively new service lines (such as consulting, engineering, assurance, business process outsourcing [BPO] and enterprise solutions). Moreover, the BFSI vertical showed an 11.3% sequential growth during the quarter.
• At the current market price, the stock trades at 20.9x FY2008 and 17.3x FY2009 estimated earnings. We maintain the Buy call on the stock with a price target of Rs1,425 (around 23x FY2009E earning per share [EPS]).

Tata Elxsi
Cluster: Emerging Star
Recommendation: Book Profit
Current market price: Rs280

Book profit
Tata Elxsi reported a growth of 9.2% quarter on quarter (qoq) and of 34.6% year on year (yoy) in its revenues to Rs100.9 crore in Q2FY2008. The revenue growth was driven by the low-margin system integration business (up 42.4% sequentially) whereas the software service business grew by a muted 3.6% sequentially.

Given the muted performance in H1 and the higher base effect in H2 (due to the exceptionally strong growth in H2 of FY2007), the company is likely to end up with a decline in its earnings during the current year. The subdued performance of the company would continue to be a drag on the stock's valuations and result in continued underperformance. Thus, it is advisable to Book profit.

Tata Motors
Cluster: Apple Green
Recommendation: Hold
Price target: Rs792
Current market price: Rs790

Downgraded to hold

Key points

• Tata Motors' total sales for September 2007 stood at 48,347 vehicles. The total sales declined by 1.3% on year-on-year basis and grew by 7% on month-on-month (m-o-m) basis.
• The commercial vehicle (CV) sales for the month grew by 2% to 30,051 vehicles. The sales growth in the CV segment continues to be driven by the sales of light commercial vehicles (LCVs). The LCV sales grew by 9.2% year on year (yoy) on the back of new launches--Magic and Winger. The medium and heavy commercial vehicle (M&HCV) sales declined by 4% to 15,299 vehicles as low demand continued in the segment.
• Lower cargo availability during the monsoon led the freight rates to fall by about 1.2% yoy. With the advent of the festive season, the truck rentals in October 2007 have recovered by 5%-7.5%. However any recovery in the CV sales is dependent upon a double digit growth in the manufacturing sector and some restraint on overloading of trucks.
• The passenger vehicle sales in September 2007 continued to remain weak and declined by 6.3% to 18,296 vehicles. Indica sales grew by 6.4%, while Indigo sales declined by 34.8% to 2,328 vehicles. Sumo and Safari sales dropped by 24% yoy during the month. Lack of new product offerings has been the prime reason for the decline in the passenger vehicle sales.
• Export sales for the month registered a growth of 15.5% yoy, but on m-o-m basis the sales declined by 15.5% to 4,305 vehicles. Export sales as a percentage of the total sales volume was down to 8.9% the lowest in the year as compared with 12.4% in June the highest in the year.
• We are revising our Q2FY2008 estimates released earlier to account for the actual sales numbers. Consequently, the sales estimate for the quarter now stand at Rs6,653 crore from the earlier estimate of Rs6,557.8 crore. The profit after tax (PAT) is estimated at Rs356 crore as against the earlier estimate of Rs349.2 crore.
• The company’s management has said that it is planning to offer discounts on its vehicles to jump start the sales that have been hit by rising interest rates. Rising raw material prices, appreciating rupee and expanding capacity is not expected to substantially improve the company’s profitability.
• In view of the recent run up in the stock price very close to our price target of Rs792, we downgrade the stock to a Hold. At the current market price of Rs790, the stock discounts its FY2009E consolidated earnings by 12.2x and is available at an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) by 6.1x. We would review our recommendation on the stock after the announcement of Q2FY2008 results.

Unichem Laboratories
Cluster: Apple Green
Recommendation: Buy
Price target: Rs300
Current market price: Rs200

Price target revised to Rs300

Result highlights

• For Q2FY2008 Unichem Laboratories (Unichem) has reported a sales growth of 2.6% to Rs153.1 crore, which is lower than our expectation of Rs160 crore. The growth was subdued largely due to a 3% year-on-year (y-o-y) decline in the company's exports on account of the appreciation in the rupee. Moreover, even the flagship domestic business of the company recorded a growth of just 5.5% year on year (yoy), due to the price cuts imposed on Ampoxin and the high base of Q2FY2007.
• On account of the rising rupee, the management did not push its exports during the quarter. Instead, it chose to re-negotiate the pricing terms with its key clients. The negotiation process is currently on and the management is hopeful of improving its export realisations in the future quarters.
• The performance of Unichem's domestic formulation business moderated during the quarter, with the business growing by 10% to Rs118.1 crore. Going forward, the company expects to improve the growth seen in the domestic formulation business on the low base of H2FY2007. Also, the new prices of Ampoxin came in towards the end of Q2FY2008; the impact of the same will be felt in the improved performance in H2FY2008. However, we have modeled a conservative 12.0% growth in this business in FY2008 and we remain optimistic about the company's ability to beat our estimates.
• Unichem's active pharmaceutical ingredient (API) business declined by 16% in Q2FY2008, largely due to the 49% decline in the domestic bulk business. The management has indicated its low focus on the bulk segment. Going forward, we can expect a pick-up in the bulk business on the back of new contract research and manufacturing (CRAMS) orders in Europe (for which the talks are currently on). However, until then, we expect the bulk business to report a sluggish growth.
• Unichem's operating profit margin (OPM) contracted by 180 basis points to 20.2% in the quarter. The rising research and development (R&D) cost (on account of higher abbreviated new drug application [ANDA] filings) and an increase in the staff cost (due to the addition of new employees) adversely affected the margin. On the other hand, the gross margin showed an improvement despite the lower export realisations. The margin reported by the company was, however, ahead of our estimate of 19.7%. The shrinking margin caused the operating profit to decline by 3.8% to Rs30.3 crore.
• Unichem's reported net profit declined by 17.5% to Rs21.2 crore in Q2FY2008. The decline was due to a 58% reduction in the other income, a 29% increase in the depreciation charge and a 630-basis-point increase in the tax incidence over Q2FY2007.
• In the wake of the slowdown in the exports and the bulk business during H1FY2008, we are revising our revenue and earnings forecasts for Unichem. We have downgraded our FY2008 revenue and earnings estimates by 5% and 11.2% respectively, and our FY2009 revenue and earnings estimates by 4.2% and 9.7% respectively. Our revised earnings estimates stand at Rs25.3 per share for FY2008 and at Rs29.0 per share for FY2009.
• At the current market price of Rs200, Unichem is trading at 7.9x its estimated FY2008 earnings and at 6.9x its estimated FY2009 earnings. At these levels, the stock is very cheap when compared with its peers. We maintain our Buy recommendation on Unichem, with a revised price target of Rs300.

Union Bank of India
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs230
Current market price: Rs162

Price target revised to Rs230

Result highlights

• Union Bank of India's (UBI) net profit increased by 41.9% year on year (yoy) to Rs275.5 crore in Q2FY2008. The growth was mainly driven by a 77.4% year-on-year (y-o-y) increase in the non-interest income category, as the net interest income (NII) growth at 7.2% yoy was weak. Lower operating expenses, which grew by 6.2% yoy, also helped to improve the earnings growth at to 41.9%.
• During the quarter, the bank's NII increased by 7.2% yoy but declined by 12.8% on a sequential basis. The net interest margin (NIM) of the bank was down by 20 basis points yoy and by 55 basis points sequentially at 2.56%. The sequential decline in the NIM was mainly due to the 61-basis-point increase in the cost of funds. The substantial sequential jump in the bank's cost of funds was mainly due to a higher cost of deposits arising from a decline in the low-cost deposit base and a rise in the high-cost term deposit base.
• The positive takeaway for the quarter has been the growth in the non-interest income but that too was driven by higher treasury income and recoveries as the core fee income grew by a moderate 11.3%.
• The operating expenses grew by a moderate 6.2% yoy that helped the bank in reporting a better operating profit growth of 35.8% yoy and 0.6% qoq. The core operating profit growth was however much lower at 18.4% yoy and declined by 11.2% sequentially.
• The provisions and contingencies dropped 36.9% on a sequential basis mainly due to the absence of investment depreciation on IFCI bonds and a Rs35-crore write-back in excess non-performing asset (NPA) provisions during the current quarter. However, the provisions are up by 18.1% yoy, in line with the business growth. The asset quality has improved on a sequential basis with the net non-performing asset (NNPA) at 0.65% as in September 2007 compared with 0.78% in September 2006.
• Currently, the low credit growth seems to be the main concern as the NIM is likely to stabilise as banks have already started to cut deposit rates. UBI has been one of the better performing public sector banks with a 23.6% compounded annual growth rate (CAGR) in earnings for the period FY2007-09E and a high return on equity of 21.5%. At the current market price of Rs162, the stock is quoting at 6.3x its FY2009E earnings per share (EPS), 3.3x pre-provision profit (PPP) and 1.3x book value (BV). We maintain our Buy recommendation on the stock with a revised 12-month price target of Rs230.

Universal Cables
Cluster: Ugly Duckling
Recommendation: Book Out
Current market price: Rs96

Book out

Result highlights

• For Q2FY2008, Universal Cables reported a 24.7% year-on-year growth in the net sales to Rs113.5 crore.
• The operating profit went up 19.3% year on year (yoy) to Rs12.4 crore translating into an OPM of 10.9%. The OPM decline by 50 basis points yoy was mainly due to the increase in the other expenses. The other expenses as a percentage of sales increased by 280 basis points to 16.5% as against 13.7% in Q2FY2007.
• The interest cost went up sharply by 121% to Rs3.6 crore, while the depreciation charge jumped by 82.8% to Rs3.2 crore. Consequently the net profit declined by 17.4% yoy to Rs4.7 crore.
• For H1FY2008 the company reported a 31.3% growth in the net sales, while the operating profit declined by 13.8% to Rs18.4 crore mainly due to the increase in the raw material cost. The raw material cost as a percentage of sales went up by 340 basis points in the first half to 70.4% from 67%.
• Considering the lacklustre performance in the first half, we advise the investors to book out of the stock.

Wipro
Cluster: Apple Green
Recommendation: Buy
Price target: Rs590
Current market price: Rs495

Price target revised to Rs590

Key points

• The Q2FY2008 performance of Wipro has been boosted by the incremental revenues from the recent acquisitions: Infocrossing in the global information technology (IT) service business and Unza in the consumer care business.
• The margin improvement of 150 basis points in the global IT service business is higher than expected and largely driven by the leverage in the overheads cost.
• The Q3 revenue guidance of around 6.9% sequential growth after adjusting for the inorganic revenues is healthy, given the lower number of working days in the quarter.
• We maintain our Buy call on the stock with a revised price target of Rs590.

Wockhardt
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs552
Current market price: Rs416

Acquisitions boost Q3 performance

Result highlights

• Wockhardt's net sales increased by 68.6% to Rs738.1 crore in Q3CY2007. The growth was achieved on the back of a 6.3% growth in the domestic business and a 121.1% growth in the international business. On a like-to-like basis (excluding the impact of the acquisitions made during the year), the growth stood at an approximate 9.0% during the quarter. The sales growth was above our estimates.
• Wockhardt's domestic sales grew by a subdued 6.3% to Rs213.2 crore in the quarter. The growth was subdued due to the high base of Q3CY2006 because of the increased sales of its acute therapy brands on account of the spread of monsoon-related infectious diseases. Wockhardt is confident of accelerating the domestic growth in Q4CY2007 on the back of a steady performance of the power brands, the ramp-up of the oncology portfolio and the growing contribution from the in-licenced products in the dermatology space. We estimate Wockhardt's domestic business would grow by 17.0% in CY2007 and by 12.5% in CY2008.
• Wockhardt's European business almost doubled during the quarter to Rs433.0 crore, driven by a healthy double-digit growth of 14-15% across the existing markets of the UK and Germany, and the consolidation of Pinewood Laboratories and the recently acquired Negma Laboratories.
• The performance of the US formulation business was disappointing, with a growth of just 16.3% yoy, despite the launch of three new products. The launch of three to four additional new products in Q4CY2007 and an increased offtake of the existing products with the onset of the flu season in the USA should see a pick-up in the sales in Q4CY2007.
• Wockhardt has acquired US-based Morton Grove, a leading liquid generic and specialty dermatology company in the USA having revenues of US$52 million and losses of $3-4 million. The acquisition was made at a cost of 0.7x sales, amounting to $38 million. Wockhardt expects to turn the company around in the next six to nine months through strong top line growth and stringent cost rationalisation measures. Being a lower-margin business compared with Wockhardt and due to the additional expenses incurred in integrating the business with itself, the acquisition is likely to put pressure on Wockhardt's margins in CY2008.
• Wockhardt's reported operating profit margin (OPM) expanded by 230 basis points to 24.5% in Q3CY2007. This was driven by a 300-basis-point reduction in the other expenses and a 230-basis-point dip in the research and development (R&D) expenses. The sharp decline in each of these expenses was due to the deferral of certain R&D and selling/administrative expenses to Q4CY2007. The company reported an operating profit (OP) of Rs180.9 crore, a growth of 86.3% year on year (yoy).
• Wockhardt's net profit stood at Rs108.3 crore in the quarter, growing by 46.4% yoy. The profit growth was ahead of our estimates, despite a 50-fold increase in the interest expense (due to acquisitions), a 39% rise in the depreciation charge and a 360-basis-point increase in the tax incidence.
• In order to account for the Morton Grove acquisition and for the trends seen in the M9CY2007 performance, we are revising our revenue and earnings estimates for Wockhardt. We are marginally downgrading our CY2007E revenues by 0.3% to Rs2,709.9 crore and upgrading our CY2007E earnings by 3.2% to Rs31.4 per share. Our CY2008E revenues have been upgraded by 5.1% to Rs3,256.7 crore, while our CY2008E earnings have been marginally downgraded by 0.8% to Rs35.0 per share.
• At the current market price of Rs416, the stock is available at 13.3x its CY2007E and 11.9x its CY2008E earnings, on a fully diluted basis. The valuations seem very attractive at these levels and should be viewed as a strong buying opportunity. We maintain our Buy recommendation on the stock with a price target of Rs552.

Zee News
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs73
Current market price: Rs60

Gaining traction

Result highlights

• Zee News Ltd's (ZNL) Q2FY2008 results are in line with our expectations. The revenue from operations grew by a robust 46.2% year on year (yoy) to Rs79.8 crore while the net profit zoomed by 154% to Rs5.6 crore during the quarter.
• The advertising revenues soared by 57% yoy to Rs60.8 crore but the growth in the subscription revenues was a moderate 9.5% to Rs15 crore. A break-up of its channels into the existing and new businesses shows that revenues from the existing businesses grew by a handsome 42% yoy whereas the new businesses recorded an 80% growth in their revenues.
• The operating profit margin (OPM) for the quarter stood at 13.3% against a dismal 1.5% for Q2FY2007. Thus the operating profit grew to Rs10.6 crore against Rs0.8 crore in Q2FY2007. The existing businesses continued to maintain a good margin, which stood at 33% for the quarter. The operating loss of the new businesses was almost constant yoy at Rs13.1 crore.
• While Zee Marathi and Zee Bangla improved their leadership position during the quarter, the new channels, Zee Telugu, Zee Kannada and Zee 24 Ghanta, achieved commendable improvement in their Gross Rating Points (GRPs) yoy.
• At the current market price of Rs60.3 the stock trades at 28.8x its FY2009E earnings per share (EPS) of Rs2.1 and at FY2009E market cap/sales of 3.3x. We maintain our Buy recommendation on the stock with price target of Rs73.

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SHAREKHAN SPECIAL

Monetary policy review

The Reserve Bank of India (RBI) decided to hike the cash reserve ratio (CRR) by 50 basis points to 7.5%, while keeping other policy rates unchanged. The decision to hike the CRR is more of a policy decision to manage the liquidity condition in the banking system rather than that arising from inflationary concerns. RBI has mentioned that the inflationary expectations have been contained and the decision to hike CRR is mainly to moderate the surging money supply growth resulting from excessive net capital inflows. Liquidity management seems to be the key focus area of RBI, hence further CRR hikes cannot be ruled out if capital flow doesn’t moderate resulting in a more acceptable money-supply growth.

Sebi approves curbs on PNs

Indian securities regulator, the Securities and Exchange Board of India (Sebi), has approved the draft proposals (for a detailed report on the draft guidelines, please refer to our Investor’s Eye dated October 17, 2007) and simplified the registration procedures for foreign institutional investors (FIIs). However, hedge funds (which are not regulated entities in their home countries) may find it difficult to invest in the Indian stock market through the participatory note (PN) route as Sebi has said that only regulated and non-registered entities will be allowed to invest via the PN route. This will definitely affect the short-term hot money that was finding our market very lucrative. Sebi's actions are definitely in the long-term interest of our equity markets. The positives include the inclusion of pension funds, foundations, endowments, university funds and charitable trusts or societies, which do not come under any regulatory authority in their respective countries, as a special or separate FII category for investing in India. This would be long-term money and beneficial to our markets. That FII registrations are now valid till perpetuity is another positive development.

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MUTUAL GAINS

Sharekhan's top equity fund picks

We have identified the best equity-oriented schemes available in the market today based on the following 3 parameter : the past performance as indicated by the one and two year returns, the Sharpe ratio and Fama (net selectivity).

The past performance is measured by the one and two year returns generated by the scheme. Sharpe indicates risk-adjusted returns, giving the returns earned in excess of the risk-free rate for each unit of the risk taken. The Sharpe ratio is also indicative of the consistency of the returns as it takes into account the volatility in the returns as measured by the standard deviation.

FAMA measures the returns generated through selectivity, ie the returns generated because of the fund manager's ability to pick the right stocks. A higher value of net selectivity is always preferred as it reflects the stock picking ability of the fund manager.

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SECTOR UPDATE

Capital goods

The star performer
Companies in the capital goods space have been outperformers on bourses in the recent past as robust growth in their revenues and earnings continue. The growth of capital goods companies has been driven purely by large investments in the infrastructure, specifically the power sector. We believe that India has entered the “Infrastructure super cycle” and there is a long way to go before we see a slow down on this front. This in turn provides greater visibility to the earning of the companies in the capital goods and engineering space. The bulging order books for all the companies under our coverage universe supports our contention. This has compelled us to bring to you new valuation for our coverage universe assigning them new price-earning (P/E) multiples. Bharat Heavy Electricals Ltd (BHEL) remains our top pick in the large cap space while in the mid cap space Indo Tech transformers remains our top pick.

Information Technology

Higher vulnerability
In this note, we have revised the earnings estimates and recommendations for mid cap tech stocks under our coverage. The revision factors in the changing external business environment in terms of continued rupee appreciation and signs of a slowdown in the US economy.

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VIEWPOINT

ABB India

Robust growth
The growth of ABB has been robust and the company has reported an increase of 51.4% in its profits for the first nine months of CY2006. Overall, the outlook for the power sector and power equipment companies remains positive. What adds to ABB's advantage is its global parentage giving it access to a better technology. ABB India today stands as the seventh largest contributor to the ABB's global volumes and has planned a capital outlay of Rs2,500 crore over next two years. In the last analysts' meet the company also mentioned its intention to tap potential in new areas of business like water projects (lift irrigation and destination projects), special economic zones, port harbour systems, wind energy, railways, automobiles, and asset management. Led by the buoyant demand in the power solution space, the outlook for ABB remains positive. The stock currently trades at 57.6x CY2007E and 40x CY2008E consensus earnings, which is at a premium to its peers like Bharat Heavy Electricals Ltd and Crompton Greaves.

Hindustan Zinc

Q2 results in line with market estimates
Hindustan Zinc Ltd (HZL) reported a 19% drop year on year (yoy) in its revenues to Rs1,984 crore in Q2FY2008. The revenues declined mainly due to lower average zinc prices (down 4% yoy and 12% quarter on quarter [qoq] to $3,238 per tonne) and strong appreciation in the rupee during the quarter. The sales volume of zinc and lead concentrate dropped by 20% to 95,000 tonne during the quarter. The company reported a 20% growth yoy in zinc refined metal production and a 38% growth yoy in lead refined metal production. The average lead prices rose by 159% yoy and 42% qoq to $3,094 per tonne during the same period.