Valueline - December 2007

Global factors likely to dictate markets

This Diwali, the fireworks were not along expected lines and the Sensex declined by almost 150 points on the Muhurat trading day—the day considered to be auspicious for trading. Since then, the markets have recovered 2.5% (till November 30, 2007). Going forward, global developments like unfolding of US subprime mortgage bail out plan and US Federal Reserve (Fed) meet on December 11, 2007 on further rate cuts are likely to influence the markets.

---

Sharekhan top picks

In the November 2007 issue, we had recommended the best 12 of our Stock Ideas as Sharekhan Top Picks. As on December 6, 2007, the basket of stocks has given an absolute return of 9.4% as compared with a 0.7% appreciation in the S&P Nifty and 0.9% decline in the Sensex.

---

STOCK IDEA

Housing Development Finance Corporation
Cluster: Evergreen
Recommendation: Buy
Price target: Rs3,362
Current market price: Rs2,700

In a sweet spot

Key points

• Subsidiaries hold significant value: HDFC has created significant value in its subsidiaries. Three of these—HDFC Bank, HDFC Life Insurance and HDFC Mutual Fund—are valued at Rs883 per share. These subsidiaries are growing faster than HDFC, the value contributed by them would be significantly higher going forward.
• Gaining market share, CRR hikes also helping the cause: HDFC has gained significant market share in the past couple of quarters. Also, continuous CRR hikes by the RBI have benefited HDFC the most, as banks are unable to bring down their lending rates to protect their margins. HDFC doesn't need to maintain CRR, hence its incremental spreads have widened as incremental borrowing costs have declined while lending rates have remained stable.
• Strong earnings visibility: Its core mortgage business is expected to grow at 25-30% over the next couple of years. In Q2FY2008, HDFC's margins expanded and the core operating performance was very strong (up 56% yoy). We expect the earnings before exceptionals to grow at 26% CAGR over FY2007-10E.
• Excellent asset quality despite strong asset growth: Despite the strong business growth the net NPA is almost negligible and the gross NPA is below 1%. Strong credit appraisal and risk monitoring techniques have helped HDFC to maintain a very healthy asset quality.
• Valuations look attractive: We have valued the core mortgage business at 22x FY2010E EPS and if we adjust Rs954 for the value assigned by us to its subsidiaries from the CMP of Rs2,700, HDFC is quoting at 15.9x its FY2010E earnings and 3x FY2010E book value. We feel the valuations look attractive considering HDFC's consistent above 20% earnings growth record, the potential value unlocking from its various subsidiaries and investments, and the superior track record of its management. We initiate a Buy recommendation on the stock with a price target of Rs3,362.

Ipca Laboratories
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs875
Current market price: Rs660

Vertical integration to change fortunes

Key points

• Domestic formulation business to outpace industry growth: Driven by steady new launches, a strong therapy-focused field force and good brand building abilities, Ipca Laboratories' (Ipca) domestic formulation business has been growing at above industry growth rates. With an enhanced focus towards chronic therapies and aggressive new launches, Ipca's domestic formulation business would continue to grow at 16-18% during FY2007-09.
• Strong thrust on exports: With steady performance on the domestic front, Ipca is increasingly focusing on its export business, which generates 30% of its total revenues. Driven by aggressive brand promotion in the emerging economies, a revival in the European business and a scale-up in the US business, the formulation exports are projected to grow at a CAGR of 14.5% over FY2007-09.
• API business to benefit from outsourcing contracts: A leader in several API products, Ipca's API business constitutes 33% of its total revenues. With its low-cost advantage, Ipca is set to capture a substantial chunk of the outsourcing business of global pharmaceutical companies. We believe Ipca's API business will grow at a 13.5% CAGR over FY2007-09, driven by a 9% CAGR in the domestic API business and a 15% CAGR in API exports.
• Earnings to gallop at a 23% CAGR: We estimate Ipca's earnings to grow at a CAGR of 23% over FY2007-09E on the back of a 20% CAGR in revenues. The revenues will be driven by a 15.3% CAGR in the domestic business and a 24.4% CAGR in exports. We estimate earnings of Rs59.9 per share in FY2008 and of Rs73.0 per share in FY2009.
• Compelling valuations: At the current market price of Rs660, Ipca is trading at attractive valuations of 11.0x FY2008E earnings and 9.0x FY2009E earnings. It has traditionally been getting PE multiple in low teens. But with the enhanced visibility of growth from the US and European markets, the sustained growth in the domestic business and the healthy return ratios, we believe that the stock should command higher valuations. We therefore recommend a Buy on Ipca with a one-year price target of Rs875, ie an upside of 33% from the current levels.

---

STOCK UPDATE

ACC
Cluster: Apple Green
Recommendation: Buy
Price target: Rs1,300
Current market price: Rs1,007

Q3 results below expectations

Result highlights

• In Q3CY2007 the total revenues of ACC grew by 22% year on year (yoy) to Rs1,679 crore. The growth was driven by a year-on-year growth (y-o-y) of 13% in the cement volume, a y-o-y growth of 8% in the realisation and a y-o-y growth of 23.7% in the ready-made concrete (RMC) revenues. The overall blended realisation grew by 9% yoy to Rs3,587 per tonne.
• As a result of the rising coal prices the company's power and fuel cost grew by 30% yoy. But as the raw material (RM) and freight costs reduced yoy, the variable cost increased at a slower pace, by 9% yoy, to Rs1,573 per tonne. On the back of a y-o-y growth of 39% in the employee cost and of 19% in the operating cost, the overall cost increased by 22.1% yoy to Rs1,229 crore whereas the cost per tonne increased by 11% yoy to Rs2,699 per tonne.
• The increase in the operating cost resulted in the operating profit growing at a slower rate of 22% yoy to Rs449 crore with the operating profit margin (OPM) remaining flat at 26.7%. The earnings before interest, tax, depreciation and amortisation (EBITDA) per tonne increased by a marginal 1% yoy to Rs888.
• The other income jumped by 30% yoy to Rs28.3 crore as the company deployed surplus cash.
• As the company has repaid debt in the last three quarters, the company's interest expense remained negligible at Rs0.9 crore against Rs14 crore in the same quarter last year. The depreciation provision increased by 19.3% yoy to Rs70.7 crore as the company added fresh capacities throughout the year.
• On account of the lower than expected performance at the operating level, the profit after tax (PAT) grew at a slower rate of 27.9% yoy Rs287.3 crore.
• ACC's capital expenditure (capex) programme is progressing well on schedule. As mentioned in our earlier reports, ACC will become a 24-MMT company by the end of CY2008. Taking cognisance of the year-till-date volume, we are keeping our volume estimate for CY2007 unchanged. Also, we are keeping our CY2008 volume estimate unchanged.
• Considering the sharp jump in the coal prices, we are lowering our CY2007 earnings per share (EPS) estimate by 10% to Rs73. Adjusting for the increase in the cost as well as the improved realisation, we are keeping our CY2008 EPS estimate constant at Rs79.5.
• Going ahead, ACC will be able to sustain the momentum in its volumes with the help of the incremental capacities that are scheduled to come on stream in future. The likely fall in the cement prices will have less impact on the profitability of the company from mid CY2008 since ACC is a calendar year-ending company. The higher operating leverage and lesser price should cushion against the increase in the power & fuel cost which would affect the company's profitability. Any price hike going ahead will be a positive trigger for the company's stock. At the current market price of Rs1,007, the stock trades at 12.8x its CY2008 earnings and commands an enterprise value (EV) per tonne of USD190. Taking cognisance of the positive earnings scenario as well as the rise in the benchmark asset prices, we maintain our price target of Rs1,300 per share.

Ahmednagar Forgings
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs300
Current market price: Rs225

Q1 results in line with estimates

Result highlights

• The Q1FY2008 results of Ahmednagar Forgings Ltd (AFL) are in line with our estimates.
• The company's sales for the quarter grew by 30.5% to Rs159.2 crore. The growth was led by a 16% increase in the domestic sales and a 62.5% surge in exports.
• The operating profit margin (OPM) increased by 100 basis points to 20.3%. As a result, the operating profit grew by 37.3%. Higher interest and depreciation costs led the profit after tax (PAT) to grow by 26.8% to Rs17.1 crore.
• The company continues to have a strong order book. The plan to expand its capacity to 165,000 tonne is expected to be operational by Q2FY2008.
• At the current market price of Rs225, the stock trades at attractive valuations of 7x its FY2009E earnings and an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 4.5x. We maintain our Buy recommendation on the stock with a price target of Rs300.

Aurobindo Pharma
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs914
Current market price: Rs534

Results in line with expectations

Result highlights

• Aurobindo Pharma's stand-alone revenues grew by a strong 34.8% to Rs611.6 crore in Q2FY2008 on the back of an impressive 17.9% rise in the domestic business and a stellar 44.7% growth in the exports. The sales growth was above our expectations.
• The export growth was largely formulation driven, with the revenues from formulations advancing by 63.0% to Rs214.6 crore (stand-alone). The consolidated formulation revenues stood at Rs240 crore, up by 33.3% on a sequential basis. The formulation growth was primarily driven by substantial improvements in the European formulations and the anti-retroviral (ARV) formulations.
• Aurobindo Pharma's stand-alone operating profit margin (OPM) improved by 240 basis points to 17.6% during the quarter. The improvement in the OPM was largely due to the 360-basis-point drop in the company's other expenditure, due to a transfer of Rs16.98 crore in product development expenses to the newly floated European subsidiary. On adjusting for this, the margins stood at 14.8%, down by 40 basis points year on year (yoy). Consequently, the reported net profit of the company rose by 56.0% to Rs107.8 crore.
• A strong top line growth and expanding margins enabled Aurobindo Pharma to deliver an impressive net profit growth of 84.7% to Rs100.9 crore. The profits were also boosted by foreign exchange (forex) gains of Rs19 crore (pre-tax). On excluding the impact of the transfer of product development expense and the forex gain of Rs19 crore, the net profit stood at approximately Rs55 crore, which was in line with our estimate.
• The launch of ten new products in the USA (for which approvals have been received in late Q2FY2008) along with increasing revenues from the ARV formulations (due to participation in an upcoming South African ARV tender) will drive Aurobindo Pharma's performance in H2FY2008.
• Aurobindo Pharma's consolidated net sales and net profit stood at Rs628.4 crore and Rs62.1 crore respectively in Q2FY2008. The consolidated profits are significantly lower than the stand-alone profits due to the build-up of significant inventory at the US subsidiary in preparation for the impending launches of ten new products, for which approvals were received during the quarter. The revenues from these should start reflecting from Q3FY2008 onwards, resulting in an improvement in the consolidated performance.
• At the current market price of Rs534, the stock is trading at 11.7x and 9.4x its estimated FY2008E and FY2009E earnings respectively. We maintain our Buy recommendation on the stock with a price target of Rs914.

Bajaj Auto
Cluster: Apple Green
Recommendation: Buy
Price target: Rs2,800
Current market price: Rs2,426

Demand robust; need to overcome constraints

Key points

• After a good festive season, we expect the sales volumes to turn positive and register a good growth in H2FY008 driven by the new launches.
• The company is facing capacity constraints for its new bike XCD, due to which we expect its target of selling 70,000-75,000 units to be achieved from January onwards.
• The product mix has been improving in favour of high-segment motorcycles. The contribution from the 125cc-plus segment improved from 37% of the sales volume in Q2FY2007 to 50% of the sales in Q2FY2008. However, with increasing sales of XCD, the operating profit margins will be maintained at 15% levels going forward.
• BAL acquired a 14.5% stake in Europe's second largest sport motorcycle manufacturer KTM Power Sports (KTM) for Rs300 crore.
• At the current market price of Rs2,426, the stock trades at 17.3x its FY2009E earnings and is available at an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 10.6x. We continue to value BAL on the sum-of-the-parts basis and maintain our Buy recommendation on the stock with a price target of Rs2,800.

Balaji Telefilms
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs427
Current market price: Rs358

Price target revised to Rs427

Key points

• Balaji Motion Pictures Ltd (BMPL) delivered two blockbusters in 2007—Shootout at Lokhandwala and Bhool Bhulaiya. Buoyed by the success of this venture, the management aims to produce and/or distribute at least ten movies a year from FY2009 as against five movies in FY2008.
• While Balaji Telefilms Ltd (BTL) is adequately funded for further ramping up BMPL's movie business and though the management has not affirmed news reports of BTL divesting its stake in BMPL, there remains a strong possibility of BTL unlocking value in BMPL.
• As expected, with the launch of new channels in Hindi entertainment genre, BTL is scaling up its TV content business. Kahe naa kahe was launched on 9x in November 2007, Kuchh is tara and Kya dil mein hai are to be launched on Sony (from November 26) and 9x (in December 2007) respectively.
• We have revised our estimates for FY2008 and FY2009 to factor the new show launches and the management's aggressive plans for ramping up the movie business. Consequently, we are also revising our price target on the stock to Rs427 based on the sum-of-the-parts method and maintain our Buy recommendation on the stock.

Bank of Baroda
Cluster: Apple Green
Recommendation: Buy
Price target: Rs500
Current market price: Rs375

Price target revised to Rs500

Result highlights

• Bank of Baroda's (BOB) Q2FY2008 profit after tax (PAT) grew by 13.5% year on year (yoy) to Rs327.2 crore. The PAT of Rs327.2 crore was in line with our expectation of Rs321 crore. The PAT growth was primarily driven by a higher non-interest income. The net interest income (NII) growth was better than most of its peers. The operating expenses surged due to a higher provisioning on account of transitional liability of revised AS-15 guidelines and restricted the overall profit growth.
• We have revised our FY2008 and FY2009 earnings estimates upwards by 5% and 4% to Rs1,372.7 crore and Rs1,640.9 crore respectively. The upward revision in the earnings is to factor in the higher non-interest income growth and higher AS-15 related expenses likely to be reported by the bank going forward, which were not envisaged at the beginning of the year.
• BOB's total assets grew by 19.5% yoy and 4.9% quarter on quarter (qoq), while the reported NII grew by 17.1% yoy and 8.5% qoq and the NII (adjusted for amortisation and AFS redemption loss) grew by 15.7% yoy, but remained stable on a quarter-on-quarter (q-o-q) basis. Its adjusted net interest margin (NIM) remained under slight pressure and declined by 11 basis points yoy and 9 basis points qoq.
• The non-interest income grew by 41.1% yoy and by 35.8% qoq to Rs454.1 crore, driven by higher treasury and foreign exchange (forex) incomes. The higher non-interest income growth has been an industry trend for all public sector undertaking (PSU) banks during Q2FY2008.
• The operating expenses jumped up by 33.8% yoy to Rs798.3 crore mainly due to a 38.6% year-on-year (y-o-y) jump in staff expenses. The surge in staff expenses was led by Rs90 crore of AS-15 related expenses charged during the quarter. Spreading the cost equally between the two quarters (Q1FY2008 and Q2FY2008) the operating profit should improve to 21.1% yoy from 13.2% yoy. However, the core operating profit growth was moderate at 6.9% yoy.
• Provisions and contingencies declined by 8.2% yoy and 30.7% qoq mainly on account of a decline in investment depreciation.
• The bank's business growth has moderated with global advances up by 27.1% yoy from a 40% y-o-y growth reported during March 2007. The deposit growth has also moderated from 33% to 22% for the same period. This moderation is welcome and should help in avoiding undue stress on the NIM and maintaining a healthy asset quality. The bank's asset quality has improved with gross non performing assets (NPAs) down by 45 basis points to 2.33%, while net NPAs declined by 12 basis points to 0.55% sequentially.
• We feel BOB is one of the public sector banks, which have exhibited maximum improvement in its earnings growth and return on equity (RoE). We expect BOB to deliver a compounded annual growth rate (CAGR) of 26.4% in earnings and almost a 400-basis-point improvement in its RoE to 16.1% between FY2007-09E. At the current market price of Rs375, the stock is quoting at 8.4x its FY2009E earnings per share (EPS), 4.2x pre-provisioning profit (PPP) and 1.3x FY2009E book value (BV). If we exclude the value of Rs40 per share of which Rs22 is from its 25% holding in the Unit Trust of India (UTI) mutual fund (which is likely to come out with an IPO [initial public offering] in CY2008) and the rest Rs18 is for its other holdings such as NSE and Reliance Petroleum etc, the stock is available at 1.1x FY2009E BV. The valuations are extremely attractive when we consider the strong earnings growth and the improvement in RoE. We maintain our Buy recommendation on the stock with a revised twelve-month price target of Rs500.

Bharat Heavy Electricals
Cluster: Apple Green
Recommendation: Buy
Price target: Rs3,289
Current market price: Rs2,725

Price target revised to Rs3,289

Results highlights

• Bharat Heavy Electricals Ltd (BHEL) had a spectacular order inflow in the past 18 months. In H1FY2008, the company's order inflow rose by 74% year on year (yoy). At the end of Q2FY2008, BHEL has an order backlog of Rs72,600 crore (4.2x FY2007 revenues), which represented a staggering increase of 59% yoy.
• In a strategic move, BHEL signed a memorandum of understanding (MoU) with the Tamil Nadu Electricity Board (TNEB) for a joint venture (JV) to set the first 2x800 mega-watt (MW) super-critical power project in Tamil Nadu. We believe this tie-up is positive for the company in two ways. First, the equity stake in the JV would ensure BHEL as a supplier for the super-critical project. Second, the deployment of surplus cash-on-book would yield better returns from the investments made in the JV.
• After National Thermal Power Corporation's (NTPC) Barh-II project, BHEL has emerged as the sole bidder for the AP Genco project at Krishnapatnam, which is a 2x800MW project based on super-critical technology. We expect the order flow in the super critical space to remain buoyant for the company going forward.
• The union cabinet has approved BHEL's proposal of taking over Bharat Heavy Plate & Vessels Ltd (BHPV), an engineering company catering to oil and gas sector. The company's current turnover stands at Rs150 crore, and the BHEL’s management believes BHPV's turnover has a potential to grow to Rs1,000 crore plus.
• For Q2FY2008, the nets sales of BHEL grew by 18.7% to Rs3,965.4 crore, which was slightly below expectations. The operating profit margin (OPM) improved by 380 basis points, which came in as a positive surprise. Led by better OPM and higher other income, the net profit (before extra-ordinary items) increased by 57.5% to Rs567 crore. The profit growth was above expectations.

Canara Bank
Cluster: Apple Green
Recommendation: Hold
Price target: Rs315
Current market price: Rs285

Margins continue to remain under pressure

Result highlights

• Canara Bank's (CANBANK) profit after tax (PAT) grew by 11% year on year (yoy) to Rs401.6 crore mainly due to a 92% year-on-year (y-o-y) jump in non-interest income possibly driven by higher treasury profits and cash recoveries. The core operating performance of CANBANK was disappointing with the net interest income (NII) down by 19.8% yoy.
• NII was down by 19.8% yoy and 12% quarter on quarter (qoq) to Rs786.9 crore. CANBANK is perhaps the only public sector bank (PSB), which has reported a y-o-y decline in its NII. The pressure on net interest margin (NIM) is visible for both large cap and mid cap PSBs. But for CANBANK, the NIM declined by 93 basis points on a y-o-y basis and 29 basis points on a sequential basis. The costs increased at a much faster pace than overall yields putting sustained pressure on the margins and the pressure is expected to continue for couple of quarters ahead.
• Non-interest income increased by a whopping 92% yoy and 50.5% qoq to Rs572 crore possibly from higher treasury income and cash recoveries as further details were not available. The bank has a higher portion of investments for sale (AFS) category compared with that of other PSBs. So the trading income component is likely to remain buoyant but the modified duration of the portfolio has been steadily reduced to 1.4 years as of September 2007. Hence significant windfall gains are not expected even if interest rates start to moderate going forward.
• Operating expenses grew by only 4.3%, as the bank has not yet provided for the revised AS-15 transitional liability expenses. Hence the AS-15 related costs are likely to keep the operating costs high in H2FY2008. The overall operating performance remained weak with the operating profit up by only 8.4% yoy to Rs650.3 crore.
• Business growth moderated with advances up by 15.4% yoy compared with 24% for FY2007. Deposit growth also slowed down to 19% from 22% in FY2007. The bank is targeting a business growth of 20%, which would be moderation from the 23% growth witnessed in FY2007. The moderation in the business growth will put less pressure on the bank to mobilise high cost deposits.
• Asset quality levels showed some marginal weaknesses, with gross non-performing assets (NPA) in absolute terms up by Rs110 crore to Rs1,585 crore and in percentage terms up by 11 basis points to 1.7% sequentially. Net NPAs were up by 10 basis points to 0.99% sequentially. The coverage ratio of the bank continues to remain low at 40% down from 43% sequentially.
• Core operating performance of the bank was disappointing during Q2FY2008 and the pressure on NIM is likely to continue for couple of more quarters before it stabilises. The operating expenses are likely be back ended as the bank is expected to provide for the revised AS-15 transitional expenses during H2FY2008, which would restrict earnings growth in the second half. Despite a higher portion of investments in AFS category the bank is unlikely to record windfall gains as the modified duration of the portfolio is 1.4 years only. At the current market price of Rs285, the stock is quoting at 6.5x its FY2009E earnings per share (EPS), 3.3x pre-provision profits (PPP) and 0.9x book value (BV). Despite cheap valuations the earnings growth is likely to remain weak for the bank (compounded annual growth rate [CAGR] of 12.1% for FY2007-09E). Hence we recommend a Hold on the stock with a price target of Rs315.

Ceat
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs250
Current market price: Rs198

Price target revised to Rs250

• The production has been lower in Q3FY2008 due to festive season holidays and capacity expansion undertaken by the company. To offset the production loss, the company is trying to push its replacement sales and exports and is realigning its strategies. The demand from the Original Equipment Manufacturers (OEM) of commercial vehicles is picking up and is expected to improve further from Q4FY2008. For FY2008, the company expects a volume growth of ~10%.
• Rubber prices have started rising from October 2007 onwards after continuously falling for the last ten months. In view of this rise in the cost of rubber (the main raw material) and rising crude oil prices, the company is expected to announce a price increase of 1-1.5% in the first week of December 2007. Prices have been increased in the export markets also.
• Profit margins in Q3FY2008 may get affected to some extent on a quarter-on-quarter basis due to lower production and higher input costs. However the profit margins are expected to improve in Q4FY2008 on the back of increase in prices, higher production and commencement of additional capacities for off-the-road (OTR) tyres at Bhandup and passenger car tyres at Nasik.
• Relocation of the Bhandup facility to Patalganga is expected to start from FY2009 onwards and will lead to cost savings of ~Rs 30 crore per year.
• The management is planning to outsource low value-added products such as two-wheeler, jeep and tractor tyres, but will continue in-house manufacture of all value-added tyres such as OTR and those for trucks and cars. This should further improve the profit margins in FY2009.
• The high court has recently approved the de-merger of its investments to a separate company named CHI Investments Ltd, with the core tyre business remaining with Ceat. The financial restructuring entails conversion of every 100 shares of Ceat to 75 shares of the existing company and 25 shares of CHI Investments. Thus, the equity capital of Ceat (core tyre business) will reduce by 25% enhancing its earnings per share (EPS).
• The currently listed entity Ceat is expected to get delisted in December 2007 and the relisting of both the new entities is expected in January 2008.
• We maintain our positive outlook on the company, given its smart turnaround and brilliant performance improvement. At current levels, the stock trades at 7.5x its FY2009E and at an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 3.3. We maintain our Buy recommendation with a revised price target of Rs250.

Corporation Bank
Cluster: Apple Green
Recommendation: Buy
Price target: Rs542
Current market price: Rs471

Price target revised to Rs542

Result highlights

• Corporation Bank's (CORP) Q2FY2008 profit after tax (PAT) grew by 27% year on year (yoy) to Rs161.3 crore. The growth was primarily driven by a higher non-interest income component. However, the net interest income (NII) growth was better than that of most peers. A surge in the operating expenses due to higher provisioning on account of AS-15 related staff expenses restricted the overall profit growth.
• We have revised our FY2008 and FY2009 earnings estimates upwards by 5% and 3.5% to Rs669.2 crore and Rs773 crore respectively. The upward revision in the earnings is to factor in the higher non-interest income growth and higher AS-15 related expenses likely to be reported by the bank going forward compared with what was envisaged at the beginning of the year.
• CORP's total assets grew by 18% yoy and 5% quarter on quarter (qoq) while the reported NII grew by 17.5% yoy and 7.3% qoq. The NII (adjusted for amortisation) grew by 15.3% yoy and 7% qoq. Its adjusted net interest margin (NIM) showed a sequential improvement unlike many of its peers as it was the only bank that aggressively reduced deposit rates after its dismal NII performance in Q1FY2008 (when NII had seen a growth of 7.8% yoy).
• The non-interest income grew by 62% yoy and by 32.3% qoq to Rs183.2 crore, driven by higher treasury and foreign exchange (forex) incomes. The higher non-interest income growth was the trend for all public sector banks during Q2FY2008.
• CORP's operating expenses jumped up by 25.3% yoy to Rs243.2 crore mainly due to a 39.2% jump yoy in the staff expenses brought about by a Rs47-crore AS-15 related expense charged during the quarter. Despite such a sharp jump in the operating expenses, the operating profit growth was robust at 33.4% yoy brought about by a higher non-interest income growth. However, the core operating profit growth was moderate at 8.7% yoy.
• Provisions and contingencies increased by 128% yoy mainly due to lower investment depreciation write-back and higher standard assets provisioning during the quarter compared with that in the corresponding quarter in the previous year.
• The bank's business growth moderated with advances up by 17% yoy from a 25% growth yoy reported during March 2007. The deposit growth also moderated from 28.8% to 20% for the same period. Its total assets grew by 18% yoy compared with a growth of 30% yoy reported in March 2007. The cut in the deposit rates and a moderation in the balance sheet expansion are welcome as the same would help in maintaining the margins, a task that many public sector banks are finding difficult at a time when credit growth is moderating and deposit costs are escalating.
• The bank's asset quality continues to remain one of the best in the industry with the gross non-performing asset (NPA) down by 21 basis points to 1.9% and the net NPA lower by 11 basis points to 0.35% sequentially.
• CORP has been the first bank to cut deposit rates and show some sequential improvement in its NIM in Q2FY2008. The non-interest income growth is expected to be much better in future. It will be driven by higher treasury gains that would help in improving the bank's return on equity (RoE) by 230 basis points to 17.3% in FY2009 from 15% reported in FY2007. The bank's earnings are expected to grow at a compounded annual growth rate (CAGR) of 20.1% between FY2007 and FY2009, which is much better than its past performance. At the current market price of Rs471 the stock is quoting at 8.7x its FY2009E earnings per share (EPS), 4.5x pre-provisioning profit (PPP) and 1.4x FY2009E book value (BV). We maintain our Buy recommendation on the stock with a revised twelve-month price target of Rs542.

Deepak Fertilisers & Petrochemicals Corporation
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs188
Current market price: Rs149

Price target revised to Rs188

Result highlights

• Net sales of Deepak Fertilisers & Petrochemicals Corporation (DFPCL) grew by 2% year on year (yoy) to Rs216.9 crore. The chemical division and the fertiliser division contributed 69% and 31% respectively to the net sales. The revenue from the chemical division increased by 29% yoy to Rs155.8 crore on the back of a strong contribution from isopropyl alcohol (IPA), while the sales from the fertiliser division dropped by 32% yoy to Rs70.7 crore due to reduced availability of phosphoric acid in the international market and lower availability of material for trading.
• Operating profit during the quarter grew by 26% yoy to Rs32.2 crore. A strong contribution from the chemical division expanded the overall operating profit margin (OPM) by 290 basis points to 14.9%. The segmental profit before interest and tax (PBIT) for the chemical division reduced by 0.3% to Rs37.3 crore with the margin declining from 31% to 24%. The loss in the fertiliser division reduced to Rs1.5 crore from Rs6.6 crore. The increased raw material cost including that of the outsourced ammonia and propylene decreased the segmental PBIT margin for the chemical division, while the higher price realisation reduced the segmental loss for fertiliser division.
• Interest expenses were higher by 7% yoy on account of the increased outstanding debt issued for new projects and capacity expansions. The depreciation charge also increased by 21% yoy during the quarter.
• The adjusted profit after tax (PAT) increased by 21.4% yoy to Rs21.9 crore with the margin expanding by 160 basis points to 10.1%.
• With the completion of retrofitting of ammonia plant, the company has increased its capacity to 130,000 tonne per annum (TPA) from 90,000TPA. This along with the increased natural gas availability and the additional ammonia storage tank would help the company in reducing its raw material cost as well as enhancing its nitric acid capacity.
• The completion of Dahej-Uran pipeline would improve the natural gas supply to Taloja plant from December 2007, which would help in replacing naphtha with natural gas for steam generation, depending upon its supply. Natural gas at around $8.5 per Million British Thermal Units (MMBTU) would cost almost half the price of naphtha.
• The company is expected to complete land acquisition process for its ammonium nitrate project in Orissa by November 2007. The plant with a 300,000TPA capacity is expected to be operational by November 2009.
• The company's specialty mall Ishanya, for interiors and exteriors, is expected to commence operations from the third quarter, ahead of the festive season. The company has already leased out nearly 80% of the 550,000 square feet leasable area at an average rental price of Rs46 per square foot.
• At the current market price of Rs149, the stock is trading at 8.7x its FY2009E earnings and at an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 6.5x. The improved supply of natural gas would benefit the fertiliser division in the coming years, while its ammonium nitrate project would also start contributing from H2FY2010. In view of future earnings visibility, Ishanya, the company's specialty mall for interiors and exteriors is valued at Rs28.7 per share. We maintain our Buy recommendation on the stock with a revised price target of Rs188 valued at 11.0x its FY2009E earnings.

Elder Pharmaceuticals
Cluster: Apple Green
Recommendation: Buy
Price target: Rs508
Current market price: Rs376

Growth momentum continues

Result highlights

• Elder Pharmaceutical's (Elder) net sales for Q2FY2008 grew by a strong 21.3% to Rs132.3 crore, thus maintaining the growth momentum seen in the previous quarters. The sales growth was marginally ahead of our estimates of Rs128 crore and was driven by the continued momentum in the company's star brands and new products and line extensions launched by the company over the past one year.
• Elder reported an expansion of 50 basis points in its OPM, which stood at 19.4% during the quarter. The expansion in the OPM was led by a 230-basis-point reduction in the other expenses incurred by the company. The decline in the other expenses was mainly due to the effect of increased productivity of the marketing spend incurred by the company.
• Consequently, the company's operating profit rose by 24.5% to Rs25.6 crore in Q2FY2008.
• Elder's net profit rose by 21.7% to Rs17.7 crore in Q2FY2008. The growth in the profit was marginally ahead of our estimate of Rs15.5 crore and was robust despite an increase of 50.8% in the interest cost and a rise of 53.2% in the depreciation charge during the quarter. The net profit growth was aided by a substantially lower tax provision made during the quarter.
• Elder is exploring new contract research and manufacturing (CRAMS) opportunities through its 29 alliance partners. Having executed one such project with its Italian partner, Angelini, the company hopes to get 3-4 more such manufacturing contracts from Angelini, which will enable it to scale up its CRAMS business.
• Elder has recently announced two acquisitions in Europe: a 20% stake in the UK-based Neutra Health PLC and a 51% stake in the Bulgaria-based Biomeda. These two acquisitions will provide Elder an entry into the European markets. Elder plans to complete the Biomeda acquisition by the end of FY2008 and also increase its stake in Neutra Health from 20% currently to 26% by December 2007.
• At the current market price of Rs376, the stock is quoting at 9.3x its estimated FY2008 earnings and at 8.3x its estimated FY2009 earnings. We maintain our Buy recommendation on the stock with a price target of Rs508.

Grasim Industries
Cluster: Apple Green
Recommendation: Buy
Price target: Rs3,950
Current market price: Rs3,627

Price target revised to Rs3,950

Result highlights

• Grasim reported a 25.3% yoy topline growth to Rs2,519.2 crore during Q2FY2008 on the back of robust realisations of the VSF division as well as pick up in the sponge iron and chemicals division.
• The overall EBITDA jumped by 51.3% yoy to Rs805.5 crore driven by a whopping 81% yoy growth in VSF profits which stood at Rs316 crore. The cement division’s profits grew by 24.2% yoy to Rs442 crore whereas the sponge iron and chemicals division’s profits jumped by 292% to Rs269 crore.
• Overall margins expanded by 550 bps to 32% mainly as the VSF margins expanded by 900 bps to 40%. The cement margins expanded by 110 bps to 32.3%.
• Interest expenses were up 13% yoy to Rs27.2 crore due to higher borrowings in the quarter whereas the depreciation increased by 15.8% yoy to Rs87.5 crore due to part commissioning of VSF expansion in FY2008.
• The other income increased by 14% yoy to Rs57.3 crore thanks to deployment of surplus cash. Consequently, the PAT was up 48.1% yoy to Rs500 crore, beating our expectations
• As we mentioned in our earlier reports, Grasim is expanding its cement capacity by 10.4 MMT including a 4.4 MMT plant at Shambhupura and 4.5 MMT Greenfield plant at Kotputli. The capex is progressing as per schedule whereby the facility at Shambhupura is expected to get commissioned by Q4FY2008 and at Kotputli by Q1FY2009.
• The company is expanding its VSF capacity by 94875 tonne to 366000 tonne including a 63875 tonne expansion at Kharach, Gujarat and 31000 tons at Harihar in Karnataka. Additionally, the company also has announced an Rs.840 crore Greenfield plant of 88000 tons at Vilayat,in Gujarat which is expected to be commissioned in the next 24 months.
• The VSF division is peaking at the right time for the company in the wake of an expected downturn in the cement cycle in the next one-year. Going ahead the strong volume growth for the VSF business coupled with better realisations and cost control, will drive the cashflows of the company more than offsetting the fall in the cashflows of the cement business. Also, any surprise on the cement prices will only be positive for the company. Consequently, we believe this is one of the most comfortably placed companies in our cement pack. At the current valuations, the stock trades at 13.7x its FY2008E EPS and 15.7x its FY2009E EPS. The company's cement business is trading at valuation of USD 125 on the expanded capacity which is cheap considering the fact that benchmark valuations have gone up as mentioned in earlier reports. Taking cognizance of the cheap valuations of the cement business coupled with the positive outlook for the VSF business, we are upgrading our SOTP price target to Rs3,950 per share.

Hexaware Technologies
Cluster: Ugly Duckling
Recommendation: Book Out
Current market price: Rs84

Book out
Hexaware Technologies (Hexaware) has reported that it has come to the management's notice that one of the officials from its treasury department has conducted fraudulent foreign exchange (forex) transactions over the past few months. There are a total of 11 such transactions spread across various currencies such as the US Dollar, euro, pound, yen and Swiss Franc. The board of directors has appointed an internal committee to investigate the matter and has suspended the official in question. Hexaware plans provisions of $20-25 million to cover any potential loss as a result of these transactions.

Though the scrip has corrected substantially in the recent past and is trading at attractive valuations, it is likely to continue with its underperformance due to lack of any positive triggers. Consequently, it is advisable to exit the stock.

Hindustan Unilever
Cluster: Apple Green
Recommendation: Buy
Price target: Rs280
Current market price: Rs200

Results below expectations

Result highlights

• Hindustan Unilever Ltd's (HUL) Q3FY2007 results were below our expectations. Net sales grew by 9.7% to Rs3,364.6 crore on the back of a 9.5% year-on-year (y-o-y) growth in HPC sales and a 16.8% growth in the sales of foods business.
• The overall operating profit margin (OPM) expanded by 16 basis points year on year (yoy) to 13.3% despite one-off adverse impact of the seven-week closure of the Assam unit that manufactures ~30% of personal products.
• The operating profit grew by 11.1% to Rs447.6 crore. However, the net profit rose by only 6.9% to Rs409.3 crore due to the higher tax rate of 20% in Q3FY2008 against that of 17.5% in Q3FY2007.
• Sales of soaps and detergents grew by a robust 12.8% yoy to Rs1,572 crore and the segment's profit before interest and tax (PBIT) margin improved by 440 basis points to 16.7%. The performance of the personal product segment was affected by the strike at the Assam factory that led the PBIT margin fall by 260 basis points yoy to 24.2%.
• Sales of processed food segment grew by 32.5% yoy to Rs128.9 crore. Modern Foods that was merged with the company contributed a major chunk to the sales growth with sales of Rs23.8 crore. Thus the organic sales of the segment grew by 8% yoy. While the margins in the processed foods business improved, the profitability of ice cream business declined sharply on account of costs related to setting a new factory.
• The quarter witnessed the launch of water purifiers in Delhi and Uttar Pradesh (UP) thereby expanding the water purifier business to eight states. Pureit, HUL’s in-home water purifier now serves three million homes. The business is gaining ground but being in initial stages we expect it to continue its losses for the next few quarters.
• At the current market price of Rs200 the stock is quoting at 24.9x its CY2007E earnings per share (EPS) of Rs8.1 and 21.9x its CY2008E EPS of Rs9.2. We maintain our Buy recommendation on the stock with a price target of Rs280.

Housing Development Finance Corporation
Cluster: Evergreen
Recommendation: Buy
Price target: Rs3,362
Current market price: Rs2,707

Value benchmarking in HDFC subsidiaries

Key points

• HDFC could see its subsidiaries, especially its mutual fund business, getting benchmark valuations after the issue of UTI mutual fund IPO. The IPO of UTI Mutual Fund is expected in a couple of months and would further improve valuations of HDFC Mutual Fund as both these funds are of similar size.
• Going forward, HDFC could also look forward to a stake sale in its life insurance subsidiary, which needs continuous injection of capital to maintain its growth momentum.
• HDFC has also sold 26% stake in its general insurance business to ERGO of Germany.

ICI India
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs581
Current market price: Rs530

Diwali sales deferred to Q3

Result highlights

• The Q2FY2008 results of ICI India are not comparable on a yoy basis due to divestment of several businesses in FY2007. The net sales for the quarter stood at Rs239.1crore.
• The paints business revenue grew by 5.6% yoy to Rs202.2 crore in Q2FY2008. The growth appears subdued due to high base effect as the festive sales on account of Diwali got deferred to Q3 as against most of it being registered in Q2 of FY2007. Thus we expect the paints division to record handsome growth in Q3FY2008.
• The continued chemical business grew by 21.9% yoy to Rs36.8 crore. Thus the overall revenues of the continued businesses grew 7.8% to Rs239 crore. The discontinued business (surfactant and advanced refinish) had contributed Rs22.8 crore to the company's total revenues in Q2FY2007.
• The PBIT in the paint business declined by 3.8% yoy with a 90 basis-point contraction in the margin to 9%. The PBIT in the continued chemical business grew 41.9% yoy with the margin expanding by 234 basis-points to 16.6%. After the sale of the Uniqema business, the chemical business now contributes only 15.4% to the top line as against 21.7% in Q2FY2007.
• Overall, the operating margin stood at 12.5% against 13% in Q2FY2007. With a higher other income at Rs6.5 crore for the quarter against Rs3.9 crore in Q2FY2007 the adjusted net profit grew by 3.5% yoy to Rs21.3 crore.
• Pursuant to the scheme of buy back, till the end of the quarter the company has bought back 15.87 lakh shares against a target of buying back ~36.7 lakh shares (worth Rs211.06 crore).
• The outlook for the business remains positive with the company following a strategy of divesting non-paint businesses and focusing more on growing the paints business. Further a cash pile of ~Rs700 crore leaves open inorganic growth opportunities for the company.
• We have realigned our estimates for FY2008 and FY2009 considering H1FY2008 performance. The buyback of shares and the expected open offer by Akzo make the stock attractive for investors. Thus we expect the stock to remain an outperformer. We shall revisit our numbers and target price on further moves by Akzo Nobel. At the current market price of Rs530, the stock trades at 18x its FY2008E adjusted EPS of Rs29.4 and 16x its FY2009E adjusted EPS of Rs33.1. We maintain our Buy recommendation on the stock with a price target of Rs581.

ICICI Bank
Cluster: Apple Green
Recommendation: Buy
Price target: Rs1,528
Current market price: Rs1,241

Price target revised to Rs1,528

Key points

• During Q2FY2008, the core earnings of ICICI bank remained under pressure as retail loans grew at a slower rate and the pressure on spreads continued due to higher deposit costs. However, a large portion of corporate bulk deposits would get repriced in Q1FY2009, which would ease the pressure on spreads going forward.
• The branch network of the bank increased to 950 branches from 755 in the first six months of FY2008 (post Sangli bank's merger with ICICI bank). The bank also received licences for opening 425 new branches over the next 12 months.
• The bank reported a 317-basis-point improvement in its current and savings account (CASA) ratio to 25.3% driven by higher current account balances during Q2FY2008. The bank is doing all the right things by building more branches and increasing its CASA base to reduce its reliance on high-cost bulk deposits.
• The improvement in the cost of funds resulting from the higher CASA ratio is expected only in medium to long term with the increase in branch network. A large portion of high-cost bulk deposits are expected to get repriced in Q1FY2009, which along with the improvement in the CASA ratio should help in improving the spreads going forward. Till then the spreads are likely to remain at current levels.
• The bank's return on equity (RoE) is likely to remain depressed at 10.5% for FY2008E and FY2009E after the massive capital raising (Rs20,000 crore raised from primary markets) undertaken by the bank. However, RoE is expected to improve steadily thereafter (likely to reach 15% levels by FY2011) with higher earnings visibility and no capital dilution in the next three to four years atleast.
• The low RoE has remained a concern for ICICI Bank, but we expect things to change going forward. Earlier, regular capital infusion in its life insurance subsidiary along with its low spreads on the banking business kept the RoE of ICICI bank depressed.
• With new preference share guidelines in place (more capital raising options available to banks in future resulting in lower equity dilution), a positive outcome on the holding company guidelines from the Reserve Bank of India (that would allow the subsidiaries to take care of their capital needs) and a change in its business model (more branch building expected going forward which should improve its spreads) will help ICICI bank in restoring RoE much faster and then improving the same.

Indo Tech Transformers
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs725
Current market price: Rs634

Sharp increase in margins

Result highlights

• For Q2FY2008, the sales of Indo Tech Transformers Ltd (ITTL) grew by a robust 58.1% year on year (yoy) to Rs51.4 crore against our expectations of Rs50.89 crore. The volumes grew by 44% yoy to 756 Mega Volt Ampere (MVA) as against 525MVA in Q2FY2007. The realisations improved by 9.6% yoy to Rs6.79 lakh per MVA.
• The operating profit grew by a staggering 117% to Rs14.8 crore. The operating profit margin (OPM) improved sharply by 780 basis points to 28.8% on the back of better realisations and lower operating costs. The raw material cost as a percentage of sales was reduced to 64.6% in Q2FY2008 compared with 69.5% in Q2FY2007.
• The interest expense stood at Rs0.15 crore, while the depreciation charge rose by 42.3% to Rs0.4 crore. Consequently, the net profit increased by 122.1% to Rs10.24 crore as against our estimates of Rs8.5 crore.
• The current order book of the company stands at Rs219 crore, which is 1.4x FY2007 revenues.
• The commissioning of the Kancheepuram large transformer plant has been delayed slightly and is expected to come into operation in Q4FY2008.

Jaiprakash Associates
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs2,000
Current market price: Rs1,655

Price target revised to Rs2,000

Key points

• Jaiprakash Associates (JP Associates) has started bookings for the residential complex that is being developed on the first parcel of its land at Noida. The initial response to the bookings appears to be very strong, as the average rate stands at Rs6,000 per square foot.
• According to media reports, ICICI Venture Funds Management is planning to invest about USD800 million (Rs3,148 crore) to pick up a stake in Jaypee Infratech, which is a unit of the Jaypee group's listed entity, JP Associates.
• Last week, Formula One Chief Executive Bernie Ecclestone confirmed that it would be holding the first ever Formula One grand prix in the National Capital Region, India in 2010. He struck an agreement to that effect with JSPK Sports Pvt Ltd, a unit of JP Associates.
• JP Associates has approved a stock split of its Rs10 share into five shares of Rs2 each.
• In Q2FY2008, JP Associates reported a net profit of Rs104 crore, registering a growth of 16% year on year (yoy).
• The company's overall revenue grew by 11.9% yoy to Rs860 crore on the back of a 13% year-on-year (y-o-y) growth in the construction revenues and a 7% y-o-y growth in the cement revenues.
• Considering the increase in the benchmark cement valuations from USD80 to USD100-110 per tonne, we had revised our price target to Rs1,350 per share. At that time, we had not factored the value of the coal mines, the power project and the remaining 5,000 acre of land the government would be allocating to the company over the next couple of years. Thus, JP Associates makes a strong case for value unlocking for the investors. We believe that as and when the investors get more clarity on the development of the company's land, the stock will get re-rated, as has happened in the past six months. Also, the Formula One deal will be a major trigger for the company in the future. Taking cognisance of the value from the coal and power projects as well as introducing the value of the 5,000 acre of undeveloped land into our calculation, we are upgrading our price target for JP Associates to Rs2,000 per share.

KEI Industries
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs125
Current market price: Rs79

Results in line with expectations

Result highlights

• KEI Industries' (KEI) Q2FY2008 results were in line with our expectations. The net sales increased by 45.1% year on year (yoy) to Rs198.4 crore led by a strong revenue growth in both power cable and stainless steel (SS) wire businesses.
• On segmental basis, the revenues of the power cable business grew by 49% to Rs176.2 crore. The profit before interest and tax (PBIT) for the business grew by 40.2% to Rs29.8 crore, while the PBIT margin declined by 110 basis points. The revenues of the SS wire business grew by19.6%, while the business reported a marginal loss due to volatility in nickel prices.
• The operating profit grew by 26.8% to Rs27.9 crore. The operating profit margin (OPM) declined by 200 basis points to 14.1%. The OPM declined on the back of a marginal loss in the SS wire business.
• The interest expense rose by 66.2% to Rs9.7 crore, while the depreciation charge increased by 23.8% to Rs1.8 core. Consequently the net profit increased by 14.7% to Rs11.6 crore.
• The current order backlog of the company (at the end of Q2FY2008) stood at Rs300 crore. Of this, Rs75-crore worth of orders came for high tension (HT) cables, Rs200 crore were for low tension (LT) power cables and the balance Rs25 crore were for SS wires and house wires.
• The 100% export oriented undertaking (EOU) plant at Chopanki scheduled to be commissioned by October 2007 has been delayed slightly due to the non-availability of power. The plant is now expected to be operational in a month's time. The HT cable capacity expansion at the current plant would be operational by April 2008.

Mahindra and Mahindra
Cluster: Apple Green
Recommendation: Buy
Price target: Rs900
Current market price: Rs760

Year of consolidation

Result highlights

• The Q2FY2008 results of Mahindra & Mahindra (M&M) are in line with our expectations. The stand-alone net sales of the company have reported a growth of 10.6% to Rs2,709.51 crore in the quarter. This growth was led by an overall volume growth of 8.3%. The automotive segment recorded a volume growth of 15.95%; the sales volume of the farm equipment (FE) segment declined by 5.5%.
• On a segmental basis, the automotive revenues rose by 13% to Rs1,709 crore (adjusting for octroi refund) whereas the FE division reported a revenue growth of 3.7%. The profit before interest and tax (PBIT) margin in the automotive segment declined by 40 basis points to 14.9% during the quarter. The PBIT margin of the FE division witnessed a higher drop of 180 basis points to 12.5%. The overall operating profit margin (OPM) declined by 260 basis points to 10.8%, leading to a decline of 11.2% in the operating profit to Rs292.47 crore.
• On account of higher other income, interest expenditure and depreciation, the adjusted net profit declined by 8.6% to Rs225.88 crore. After taking into account the extraordinary items (octroi refund, voluntary retirement scheme [VRS] expenses, special dividend income and profit on the sale of stake in Tech Mahindra), the reported profit after tax (PAT) declined by 26% to Rs285.94 crore.
• On a consolidated basis, the total income (including the other income) grew by 40.4% yoy to Rs6,482 crore led by the strong performance of the company's key subsidiaries. The consolidated PBT (before exceptional items and tax) grew by 12.8% yoy to Rs696 crore and the consolidated net profit (post-minority) before exceptional items grew by 10.0% yoy to Rs392 crore.
• We expect FY2008 to be the year of consolidation for the company as new product launches would take place only in FY2009. M&M's core business continues to remain under pressure due to sluggishness in tractor sales and the company's huge capital expenditure (capex) plans, which will lead to higher interest and depreciation charges. Segments other than automotive and FE contribute ~43% of the consolidated revenues and ~53% of the operating profits of the company. Thus, we believe M&M is more a play on its value accretive subsidiaries than on its core business.
• At the current market price of Rs760, the stock quotes at 10.9x its FY2009E consolidated earnings. We continue to value M&M on a sum-of-the-parts basis. In view of the higher interest and depreciation charges, and the reduction in the value of the subsidiaries, we maintain our Buy recommendation with a price target of Rs900.

Navneet Publications (India)
Cluster: Emerging Star
Recommendation: Hold
Price target: Under review
Current market price: Rs108

e-learning: Key to growth

Results highlights

• Navneet publications Ltd's (NPL) sales for Q2FY2008 grew by a robust 35.5% year on year (yoy) to Rs82 crore. The sales were primarily driven by the hefty sales growth of the publication segment.
• Sales of the publication segment grew by 47.7% yoy to Rs61.7 crore as the sales in Q1FY2008 got deferred to Q2FY2008. The sales were deferred to Q2 as the publishing of supplementary books by NPL got delayed due to late arrival of government books. The profit before interest and tax (PBIT) margin for the segment improved by 540 basis points to 26.4% due to higher volumes.
• The stationery division had a subdued growth of 8.8% for the quarter primarily on account of decline in exports and strong sales growth witnessed in Q1FY2008. The segment witnessed a PBIT loss of Rs91 lakh in the quarter on account of a one-time write-off of bad debts worth Rs2.57 crore and increase in the advertising expenses. The advertising expense rose on account of aggressive brand building exercise undertaken by the company for the paper stationery and the new non-paper stationery businesses.
• The operating profit margin (OPM) improved by 211 basis points to 16.5% despite a 45.2% year-on-year (y-o-y) increase in other expenditure, which was on account of aggressive advertising by the company. The operating profit thereby increased by 55.3% to Rs13.5 crore. Further, aided by higher other income and a lower tax rate at 24.9% in Q2FY2008 as against 32.9% in Q2FY2007, the adjusted net profit grew by a hefty 98.3% yoy to Rs9.4 crore.
• The company launched e-learning modules in Gujarat in August 2007 and aims at launching the same in Maharashtra by January 2008. To ensure that the product gains acceptability, the company targets installing the product in 500 private schools in each of the states. Post this, it would release the product for retail sales (to students) from March-April 2008.
• We believe, with curriculum changes in Maharashtra and Gujarat being over, NPL's growth prospects depend to a great extent on the success of its new initiatives specifically that of e-learning. However, this venture being in a nascent stage, we would like to monitor the company's progress towards making it an acceptable product for the students. We believe that the current market price of Rs107.6 captures the fair value of the existing business and that of the company's new initiatives (considering the existing visibility). We thereby maintain our Hold recommendation on the stock.

Network18 Fincap
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs651
Current market price: Rs452

Listing of Web18 to unlock value
Network18 group has grown by leaps and bounds over the last couple of years in the fast growing Indian media and entertainment space. Network18 Fincap Ltd (Network18) the holding company of the Network18 group controls TV18 that owns two premium properties in the business news genre CNBC TV18 and Awaaz. Network18 group also owns a majority stake in GBN, the company that runs the group's general news channels CNN-IBN and IBN7. GBN also represents the entertainment arm of Network18 with its planned entry in the general entertainment genre, the biggest segment in Indian television entertainment, with the launch of a Hindi general entertainment channel through Viacom18.

Punjab National Bank
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs675
Current market price: Rs550

Price target revised to Rs675

Result highlights

• Punjab National Bank's (PNB) Q2FY2008 profit after tax (PAT) grew by 6.6% year on year (yoy) to Rs538.5 crore. The PAT was higher than our expectations of Rs510.5 crore and was mainly driven by the higher non-interest income.
• The net interest income (NII) adjusted for amortisation expenses was stagnant at Rs1,368.5 crore as higher deposit costs put a significant pressure on the net interest margin (NIM). The NIM declined by 11 basis points (bps) on a year-on-year (y-o-y) basis to 3.75%.
• The non-interest income grew by 26.1% yoy to Rs467.8 crore mainly driven by the higher treasury income that grew by 67.2% yoy to Rs107 crore and a fee income that rose by 20.7% yoy to Rs262 crore.
• The operating expenses grew by 19.3% yoy to Rs855 crore mainly on the back of a 25.6% y-o-y increase in the staff expenses to Rs641.8 crore. The sharp increase in the staff expenses was on account of Rs200-crore additional provisions made by the bank to meet its shortfall in pension liabilities. The management has stated that the shortfall is likely to be around Rs900 crore and is to be written over the next five years. Thus, the operating profit declined by 5% yoy, whereas the core operating profit was down by 10.3% yoy.
• The bank's asset quality has deteriorated significantly both in absolute and percentage terms, however the management has indicated that a lot of these non performing assets (NPAs) are not financial but technical in nature and almost 75-80% of these loans would be recoverable over the next 6-12 month period.
• Despite the dismal performance on the core operating side, PNB continues to enjoy a high level of current account and savings account (CASA) at 44% and margins at around 3.8%. The bank owns a 25% stake in the Unit Trust of India (UTI) mutual fund. UTI is likely to come out with an initial public offer (IPO) in early CY2008. The stake in the UTI mutual fund contributes around Rs32 to each share of PNB. With its high return on equity (RoE) of around 17.8%, we feel the valuations are attractive at current levels. At the current market price of Rs550, the stock is quoting at 7.8x its FY2009E earnings per share (EPS), 4x pre-provisioning profit (PPP) and 1.3x FY2009E book value (BV). We maintain our Buy recommendation on the stock with a revised 12-month price target of Rs675. The upward revision is mainly due to the roll over of the price target six months forward coupled with higher valuations likely to be commanded by the UTI mutual fund IPO.

Selan Exploration Technology
Cluster: Ugly Duckling
Recommendation: Hold
Price target: Rs166
Current market price: Rs165

Q2 performance in line with expectations

Result highlights

• Selan Exploration Technology (Selan) reported a growth of 41.9% in its revenues to Rs8.9 crore during Q2FY2008. The growth was driven largely by an increase of 45% in its volumes (new wells commercialised over the past four quarters added around 10,000 barrels of oil [boe]). On the other hand, the appreciation in the rupee by close to 12% in the year so far (on an average) adversely affected the growth in the revenues (in rupee terms).
• The operating profit margin (OPM) at 64.1% was marginally lower than 65.8% reported in Q2FY2007 due to higher provisions of Rs0.84 crore for the development of hydrocarbon reserves (up from Rs0.37 crore in Q2FY2007) in the quarter. The operating profit grew by 38.1% to Rs5.7 crore.
• However, the earnings growth was relatively lower at 27.3% to Rs3.4 crore. That's because of the cumulative impact of the lower other income (down by 10%), increased interest outgo (up by 141%) and higher effective tax rate (up from 33.1% in Q1FY2007 to 35.6%).
• At the current market price the stock trades at 16.4x FY2008 and 11.9x FY2009 estimated earnings. The recent steep appreciation in the price largely factors in the positives (in terms of the significant scale-up in production volumes). Consequently, we maintain the Hold call on the stock with a price target of Rs166 (12x FY2009 earnings estimates).

Shiv-Vani Oil & Gas Exploration Services
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs480
Current market price: Rs380

Results ahead of expectations

Result highlights

• Shiv-Vani Oil & Gas Exploration (SOGEL) reported a healthy growth of 63.3% in its consolidated revenues to Rs97.4 crore in Q3CY2007. The drilling operations and seismic survey business contributed around 45% each to the total turnover, with about 10% coming from the other related services during the quarter.
• The operating profit margin (OPM) improved by 220 basis points to 37.6% primarily due to the improvement in realisations. The positive impact of the higher realisations is clearly reflected in the 190-basis-point decline in the drilling expenses as a percentage of the sales. The operating profit grew by 73.3% to Rs36.6 crore.
• The decline in the depreciation charges as a percentage of the sales and the lower effective tax rate enabled the company to report a relatively higher growth of 165.8% in its earnings to Rs19.8 crore. This is an exceptionally strong performance in a seasonally weak quarter.
• For the first nine months, revenues and earnings have grown by 32.8% and 74.4% respectively. The OPM has improved by 190 basis points to 37% during the period.
• In terms of operational highlights, the company further increased its asset base by adding two new onshore rigs in Q3. The order inflow was also healthy as the company has received orders of around Rs400 crore over the last three months and the order backlog has grown to over Rs3,000 crore. The outlook for Q4 is encouraging with the commencement of the much-awaited Rs650-crore coal bed methane (CBM) project awarded by Oil & Natural Gas Corporation (ONGC).
• To factor in the higher than expected Q3 results and robust outlook for Q4, we are revising upwards the earnings estimate for CY2007 by 15.3% to Rs14.6 per share. The earnings estimates for CY2008 and CY2009 are being upgraded by 4.4% and 1.1% respectively. At the current market price the stock trades at 11.1x CY2008 and 8.7x CY2009 estimated earnings. We maintain our Buy call on the stock with a price target of Rs480.

Shree Cement
Cluster: Cannonball
Recommendation: Buy
Price target: Rs1,625
Current market price: Rs1,417

Result marginally below expectations

Result highlights

• Fuelled by fresh capacities, Shree Cement's Q2FY2008 volumes grew by 34% year on year (yoy) driving its net sales by 48% yoy to Rs466 crore.
• The overall operating expenditure increased by 53% yoy to Rs264.8 crore on the back of rise in power & fuel costs and freight costs.
• On account of cost-push, the company's operating profit grew slower by 41% yoy to Rs201 crore. The margins fell marginally to 43.2%. The earnings before interest, tax, depreciation, and amortisation (EBITDA) per tonne expanded by Rs84 yoy and Rs55 quarter on quarter (qoq) to Rs1,348.
• The other income jumped from Rs4.3 crore in the last quarter to Rs29.1 crore this quarter, as the company booked Rs16 crore as revenues from the sale of certified emission reductions (CERs) accrued to the company under the Clean Development Mechanism (CDM).
• Interest costs jumped by 214% yoy to Rs8.1 crore, whereas the depreciation provision more than doubled to Rs68.7 crore due to incremental capacities commissioned by the company at Ras. Consequently, the profit after tax (PAT) growth slowed down to 37% at Rs106.6 crore.
• The company commissioned a 1.5-million-metric-tonne (MMT) line V clinker unit at Ras and a 2MMT grinding unit at Kushkhera in the first week of September. This will make available 2MMT of cement for the second half of the current fiscal.
• Taking cognisance of the commissioning of capacities ahead of schedule, we are upgrading our FY2008 volume estimate marginally by 2% and FY2009 estimate by 12%.
• Considering the higher volume assumption for FY2009, we are upgrading our FY2009 earnings per share (EPS) by 7% to Rs145.2. Also taking notice of the higher depreciation provision for the current year, we are downgrading our FY2008 estimates by 4% to Rs117.7 per share.
• Shree Cement has shown excellent project management skills by commissioning its capacities ahead of schedule. This has enabled the company to grow its volumes ahead of the industry. With the ongoing capital expenditure (capex), the company will be ramping up its capacity from 5 .6MMT to 9MMT by the end of FY2009. This will enable the company to sustain the momentum in the much needed volume growth. In the next couple of years, the company will become totally captive in its power consumption enabling it to exercise control over its power costs. Shree Cement's robust cash flows will aid the company in becoming debt free at the end of FY2009. At the current market price of Rs1,417, the stock trades at 12.0x its FY2008 EPS and 9.8x its FY2009 EPS. We continue to maintain our positive outlook on the stock with a price target of Rs1,625.

State Bank of India
Cluster: Apple Green
Recommendation: Buy
Price target: Rs2,625
Current market price: Rs2,209

Price target revised to Rs2,625

We have been mentioning that the banking sector would continue to remain an outperformer in the current market scenario and so it has, with the Sensex reporting a gain of 10% in the last one month and Bankex reporting a growth of 17% in the same period.
The public sector behemoth State Bank of India (SBI) remains one of our top picks in the banking space and we have stated below five reasons why we feel SBI should be a Buy at the current levels:

1. Upcoming rights issue—at a price far higher than envisaged earlier
2. Guidelines on holding companies by the Reserve Bank of India (RBI) expected in November 2007
3. New business initiatives—general insurance, private equity
4. Launch of PSU Bank Benchmark Exchange Traded Scheme (Bank BEES)
5. Other positive news flows and developments that are expected going forward.

Subros
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs340
Current market price: Rs200

Slowdown affects results but story intact

Result highlights

• Subros' Q2FY2008 results were slightly below our expectations due to a lower than expected topline. The net sales for the quarter declined by 5.3% to Rs157.1 crore on the back of a 4.1% decline in the volumes due to a slower offtake by Tata Motors.
• The operating profit margin (OPM) improved by 130 basis points to 12.3% in Q2FY2008 from 11% in Q2FY2007 due to higher efficiencies, savings in logistics costs and localisation benefits.
• Higher interest and depreciation charges led to a 17.4% decline in the net profits to Rs6.4 crore. However, with majority of the capital expenditure (capex) incurred and with the low-cost debt recently raised by the company, we expect the interest costs to rationalise going forward.
• The sharp improvement in the OPM has been a positive surprise and we believe that the company would be able to maintain the OPM at these levels going forward. The company has already bagged an order from Suzuki to supply compressors for its new export vehicle, which would boost Subros' FY2009 volumes.
• We are marginally reducing our volume estimates for FY2008 by 1.2%. On the back of slight changes in the volume estimates and higher interest costs, we are downgrading our FY2008E earnings by 6.7% to Rs25.9 and FY2009E earnings by 3.7% to Rs41.2. At the current market price of Rs200, the stock is available at very attractive valuations, discounting its FY2009E earnings by 4.9x and is available at enterprise value (EV)/earnings before interest, depreciation, tax, and amortisation (EBIDTA) of 2.6x. We maintain our extremely positive stance on Subros with a price target of Rs340.

Tata Motors
Cluster: Apple Green
Recommendation: Hold
Price target: Rs792
Current market price: Rs707

Results below expectations

Result highlights

• Tata Motors' performance for QF2Y2008 was below our expectations. The net sales for the quarter were down by 1.7% to Rs6,473.25 crore on the back of a 2.2% decline in volumes and a 4.1% growth in realisations.
• High raw material costs and lower volumes, particularly in the medium and heavy commercial vehicle segment (M&HCV), adversely affected the margins. Excluding the foreign exchange (forex) gain and fees received for the transfer of technology to subsidiaries, the operating profit margin (OPM) declined to 9.6% as against 11.5% in the same quarter last year. Hence, the operating profits declined by 17.4% to Rs626.15 crore.
• A higher interest and depreciation charge led to a 28% drop in the adjusted net profits for the quarter to Rs327 crore. After accounting for the forex gain of Rs30.85 crore and the fees received for the transfer of technology to subsidiary companies of Rs199.4 crore, the reported net profits for the quarter grew by 19.3% to Rs526.8 crore.
• The consolidated sales grew by 5.2% to Rs8,129.23 crore and profit excluding the forex gain rose by 7% to Rs976.2 crore. Profit after tax (PAT) after extra-ordinaries and forex adjustments grew by 6.4% to Rs570.71 crore. Performance of subsidiaries improved substantially, but their profitability was affected by high interest costs.
• We continue to take a very cautious outlook on the commercial vehicle (CV) industry considering the high base of last year, the lower availability of finance and the delinquencies in the sector. Some momentum has been witnessed with the beginning of the festive season, but high inventory in the system would restrict the growth in the current year.
• In view of the pressure on profit margins, we downgrade our consolidated earnings estimates for FY2008 by 9% to Rs49.2 and for FY2009 marginally by 2% to Rs63.5. At the current levels, the stock trades at 11.1x its FY2009E consolidated earnings and is available at an enterprise value (EV)/earnings before interest, depreciation, tax, and amortisation (EBIDTA) of 5.6x. We maintain our Hold recommendation on the stock with a price target of Rs792.

Television Eighteen India
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs571
Current market price: Rs500

Price target revised to Rs571

Result highlights

• TV18's Q2FY2008 performance is ahead of our estimates. The operating revenues for the quarter grew by a healthy 66.5% to Rs88.3 crore. All the businesses of the company—news, Internet, and newswire—registered high growth numbers ahead of our estimates.
• Revenues from the news business grew by 54.1% year on year (yoy) to Rs73.5 crore, reflecting the niche positioning of its channels CNBC TV18 and Awaaz. The operating profit margin (OPM) for the segment was up by 1,353 basis points quarter on quarter (qoq) to 42.8%.
• Web18 (the internet business) continues in the investment mode. Despite a stupendous 132% year-on-year (y-o-y) growth in the revenues to Rs12.3 crore, the operating loss stood at 5.7 crore, as the company writes off all the costs incurred (rather than capitalising the same). Thus Web18 is spending heavily for the growth of the internet business, the results of which we believe would be visible over the longer term.
• Revenues from Newswire18 grew by 179% quarter on quarter (qoq) to Rs2.5 crore on a small base of Rs0.9 crore. The operating loss in Q2FY2008 stood at Rs2.2 crore against Rs4.2 crore in Q1FY2008. We believe the business is witnessing rapid subscriber additions after the platform was made available on trial basis. We expect the business to break even by the end of FY2009.
• The consolidated operating margin stood at 26.7% against 44.3% in Q2FY2007 (and 15.2% in Q1FY2008). The overall margin continues to be affected by the heavy spend after augmenting the Internet and the newswire businesses. Thus the operating profit remained flat yoy at Rs23.5 crore.
• A much higher depreciation at 8.3 crore in Q2FY2008 against 2.8 crore in Q2FY2007 and a higher tax rate led to the adjusted profit after tax (PAT) (pre-ESOP charge) of Rs5 crore in Q2FY2008 against Rs16 crore in Q1FY2007.
• TV18 is building a corpus to further expand its presence in media and allied space, both organically and inorganically. The company raised Rs200 crore through a qualified institutional placement (QIP) in Q4FY2007 and has further allotted 50 lakh convertible warrants to the holding company Network18 (pre- bonus) that would bring in another Rs398 crore.
• We have revised our sum-of-the-parts price target to Rs571 taking into account better than expected performance of Web18 and rolling forward of our valuations of the news business to half year ending September 2010.

Transport Corporation of India
Cluster: Cannonball
Recommendation: Book Profit
Current market price: Rs130

Book profit

Result highlights

• For Q2FY2008, Transport Corporation of India's (TCI) profit after tax (PAT) declined by 26% year on year (yoy) to Rs4.8 crore on account of slack performance at operating level.
• The topline grew by a modest 10% yoy to Rs300.4 crore due to a slowdown in the transportation revenues and hiving off of the fuel stations.
• Following its performance trend in the previous quarters, the Express (XPS) division and the Supply Chain Division (SCD) division recorded a robust topline growth of 20.7% yoy and 35.8% yoy to Rs80 crore and Rs37.1 crore respectively.
• The margin of the transport division improved marginally by 10 basis points to 2.3% in the quarter. The margins of the XPS and the SCM division witnessed a sharp fall of 110 basis points and 40 basis points to 5.8% and 3.2% respectively. The margin of shipping division reduced drastically by 1,320 basis points to 7% as the company incurred higher expenditure towards the dry-docking of four ships. But on account of higher margin in the wind power division and hiving off of the lower-margin trading division, the overall earnings before interest and tax (EBIT) margin was reduced by 100 basis points to 4.5%. The EBIT grew by 9.6% yoy to Rs13.64 crore.
• The interest cost increased by 88% yoy to Rs4.4 crore as the company borrowed debt to finance its capital expenditure (capex). Whereas its depreciation provision increased by 47% yoy to Rs6.9 crore as the company added assets during the year.
• The tax provision stood much higher at 39.6%, which led the PAT decline by 26% yoy to Rs4.8 crore.
• The company placed Rs53 crore to Fidelity Investments International at Rs105 per share, whereas the next tranche is expected to be placed in the next couple of months. The capex will drive the revenues of the company going ahead.
• As the first-half performance of the company was much below our expectations, we are downgrading our profit estimate for FY2008 by 18% to Rs32 crore and that for FY2009 by 3.1% to Rs47.1 crore.
• As we know, TCI is transforming itself from a pure play transportation company to an integrated company in the logistics space. The company is incurring a capex of Rs440 crore over FY2007-10 to augment its warehouse capacity, to increase its truck fleet and to buy more ships. Currently the margins of its two new focus businesses—Express and Supply Chain—have not stabilised as the company is in the expansion phase. The courier business is still not profitable and is expected to break-even only in the next fiscal year. Therefore the numbers have been much lower than expected. At the current market price of Rs128, the stock trades at 29x its FY2008 earnings per share (EPS) and 21x its FY2009 EPS. We believe even after factoring the upside from real estate, the current valuations are expensive considering the historical price-earnings ratio (P/E) of the company. Thus taking cognisance of the steep valuations and lower than expected performance of the company, we recommend investors to book profits.

UltraTech Cement
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs1,300
Current market price: Rs974

Results below expectations

Result highlights

• UltraTech Cement's (UltraTech) topline grew by 17% year on year (yoy) to Rs1,173 crore on the back of a 19% growth in realisations, thanks to the price hike in Tamil Nadu during the quarter. Volumes declined by 2% yoy to 3.6 million metric tonne (MMT) as the company had to close its plant at Gujarat owing to monsoons.
• The total variable costs per tonne jumped by 9% yoy to Rs1,602 per tonne on the back of a 46% year-on-year (y-o-y) growth in the RM costs, whereas the freight costs declined marginally by 1% yoy. The other operating expenditure jumped by 58% yoy to Rs252 crore, thanks to the closing down of the Gujarat plant due to monsoons. The employee costs too witnessed a sharp jump of 54% yoy. Overall, the operating expenditure increased by 13% yoy to Rs844 crore, whereas the cost per tonne jumped by 15% yoy to Rs2,344, which was higher than expected.
• Due to higher realisation growth, the operating profits increased by 30% yoy to Rs329.6 crore, whereas the margins improved by 280 basis points to 28.1%. The earnings before interest, tax, depreciation, and amortisation (EBITDA) per tonne improved by 32% yoy to Rs915 per tonne.
• The interest costs fell by 21% yoy to Rs18.8 crore as the company repaid debt during the year, whereas the depreciation increased by 6% yoy in line with the capital expenditure (capex). The other income more than doubled to Rs25.8 crore, which led the profit after tax (PAT) increase by 46% yoy to Rs186 crore. The PAT rise was below our expectations.
• We are downgrading our FY2008 volume estimates by 4% considering the flat y-o-y growth achieved by the company, however we continue to maintain our FY2009 estimates.
• Taking cognisance of higher expenditure and lower volumes, we are downgrading our FY2008 earnings per share (EPS) by 5% to Rs76.6, whereas our FY2009 EPS remain unchanged at Rs91.5.
• Going ahead, the greenfield plant will drive the volumes of the company, whereas the captive power plants will aid in controlling the power costs. Though we have assumed a price drop of Rs5 per bag in FY2009, we expect the earnings to grow by 20% in FY2009 on the back of the volume growth and power savings. At the current market price of Rs974, UltraTech trades at 12.7x its FY2008E EPS and 10.8x its FY2009E EPS, and at an enterprise value (EV) of $149 per tonne. Considering the positive outlook for the company and the rise in benchmark asset prices, we are maintaining our price target of Rs1,300 per share.

---

SHAREKHAN SPECIAL

Broking companies have a lot to cheer

The stock prices of the listed broking companies have grown phenomenally in the recent past. We therefore decided to take a sneak peak into what actually is driving this upsurge. We feel that the significant increase in the market turnover, which would drive earnings growth for these broking companies and the re-rating possibilities of these companies based on valuations commanded by the ongoing initial public offer (IPO) of Edelweiss Capital are actually pushing their prices up.

Q2FY2008 earnings review

Key points

• In Q2FY2008, the Sensex earnings excluding oil and adjusted for one-time items grew by 26.5% year on year (yoy) vis-à-vis a 21.1% growth expected for the quarter.
• Foreign exchange gains and other one-time exceptional items contributed around 10% to the Q1FY2008 reported Sensex earnings. During Q2FY2008, the amount of such one time income was restricted to 4% of the reported earnings. This was in line with our expectations of one-time items contributing around 3-5% of the reported earnings during the quarter.
• Q2FY2008 earnings were driven by the strong performance of banking and financial services, capital goods, and telecom sector.
• Although the backdrop of Q2FY2008 earnings wasn't very encouraging with a lower export growth in rupee terms and some decline in Index of Industrial Production (IIP) numbers, the earnings growth continues to surprise on the upside and remains at a healthy 26.5% year-on-year (y-o-y) growth rate. On the back of higher-than-expected performance the consensus FY2008E Sensex earnings have been upgraded by 3-4% post Q2FY2008 numbers.
• Despite the healthy earnings growth, the interest rate environment hasn't softened as the Reserve Bank of India (RBI) again hiked the cash reserve ratio (CRR) by 50 basis points to 7.5% in its latest half-yearly monetary policy review meet. Domestic non-oil imports witnessed a slowdown (in dollar terms non-oil imports declined by 0.2% during September 2007 on a y-o-y basis) mainly due to lower demand for the import of capital goods. Low capital goods import is one of the leading indicators of slowing down of the investment demand. Domestic credit growth has also not picked up significantly but has shown signs of improvement. The Commerce Secretary expects exports to slow down in the second half of the current fiscal. RBI's half-yearly monetary policy review stated that the various surveys it conducted to gauge the business sentiment of the manufacturing and services sector have projected mixed signals about the business outlook going forward. Consequently, we feel that the upcoming economic data is important to see where the economy is heading. The festive season demand should help to perk up things to some extent. Going forward the base would remain high for Sensex earnings and significant outperformance of earnings compared to estimates is unlikely in the remaining part of the current fiscal.

---

SECTOR UPDATE

Capital goods

Q2FY2008 results review
At the end of the earning season, we present a review of the earnings of the companies under our capital goods and engineering universe.

• Q2FY2008 results for our coverage universe in the capital goods and engineering space have largely been in line with our expectations. However the revenue growth of frontline stocks like Bharat Heavy Electrical Ltd (BHEL) and Crompton Greaves Ltd (CGL) was sedate.
• The operating profit margin (OPM) was a mixed bag, with some companies reporting an improvement while others a decline in their margins. BHEL and Indo Tech Transformers Ltd (ITTL) posted a positive surprise in their OPMs. BHEL’s OPM improved by 380 basis points year on year (yoy) while that of ITTL expanded by 780 basis points yoy. The OPM of these companies improved largely due to better realisations and operational efficiencies.
• Order booking was at a record high for companies like BHEL, which posted a record growth of 59% yoy in its order booking taking its order backlog to Rs72,600. Order booking for all the companies under our coverage has been robust and provides strong visibility to their earnings.
• Driven by investment in the country’s infrastructure development, the capital goods and engineering companies have been witnessing robust growth in their revenues and earnings. Further, the demand outlook for the companies remains positive, which is much evident in their bulging order books.
• One of the major concerns for the companies in our coverage has been their ability to execute projects. However, majority of the companies under our coverage are undergoing capacity expansions and are gearing to meet the buoyant demand.
• The companies in the capital goods space have been outperformers in the recent past, as their revenues and earnings continue to grow at a robust pace. On the back of strong H1FY2008 results, in terms of improved margins due to better utilisations and operational efficiencies, we are upgrading our earnings estimates (except Thermax and KEI Industries) and price targets (except KEI Industries) for the companies. We believe with superior fundamentals and strong earning visibility, the companies in the capital goods and engineering space would command higher valuation.

Information Technology

Cognizant's Q4 guidance drags down tech stocks
In Q3CY2007, the revenues of Cognizant Technology Solutions grew by 8.2% quarter on quarter (qoq) and 48% year on year to $558.8 million. Though the performance was in line with expectations, the revenue growth was the lowest sequentially in the past ten quarters and lower than that reported by some of the other offshore peers like Infosys Technologies (Infosys), Satyam Computer Services (Satyam) and Tata Consultancy Services (TCS).

---

VIEWPOINT

Ahluwalia Contracts India

Strong order backlog bodes well for future growth
Ahluwalia Contracts India Ltd (ACIL) primarily offers construction services and specialises in construction activities. The company's clientele includes government and semi-government organisations, foreign agencies, corporate houses like IFCI Ltd, Housing and Urban Development Corporation, Tata Projects, DCM Daewoo, Santel Colour, JK Industries etc and spans various industries like hospitals, hotels, information technology, and retail.

DLF

Strong Q2FY2008 performance

Result highlights

• DLF sales grew by 5.7% quarter on quarter (qoq) to Rs3,249.9 crore in Q2FY2008 despite a reduced revenue contribution from DLF assets Limited (DAL-the promoter owned company involved in the management of real estate properties). The revenues from the sales to DAL declined by 16.0% qoq to Rs1,387 crore and contributed 42.7% to the total revenues in Q2FY2008 (down from 53.8% in Q1FY2008). The non-DAL sales grew by 33.7% qoq to Rs1,963 crore.
• The operating profit margin (OPM) declined by 205 basis points qoq to 69.7% in Q2FY2008. The OPM decline can be attributed to a fall in the margins of non-DAL business, which went down to 69.5% in Q2FY2008 from 77.9% in Q1FY2008 due to unfavourable sales mix (lower margin in retail segment and absence of super luxury sales in residential segment). Consequently, the company's operating profit grew by 2.7% qoq to Rs2,263.7 crore.
• DLF's bottom line grew by 33.2% qoq to Rs2,018.6 crore during the quarter, primarily due to lower tax rate and interest expenses. The company's effective tax rate in Q2FY2008 stood at 14.1% compared with 28.4% in Q1FY2008, mainly due to a favourable sales mix. Moreover, the company invested in wind power assets, which led to the reduction in tax expenses. Additionally, the company also utilised some initial public offer (IPO) funds for the repayment of long term debt. This led to a significant reduction in the interest expenses to Rs3.6 crore in Q2FY2008 from Rs107.7 crore in Q1FY2008.
• During the quarter, the company also issued a 100% interim dividend of Rs2 per share.
• At the current market price of Rs915, the stock trades at 25.1x and 16.6x of consensus FY2008E and FY2009E price-to-earning multiples respectively. In terms of net asset value (NAV), the consensus estimates range from Rs800-820 per share. The stock trades at around 10-15% premium to the NAV estimates. Given its leadership position, superior quality land bank (concentrated in tier I cities and National Capital Region [NCR]), and proven execution skills, DLF has emerged as a preferred investment option in the real estate sector.

Siemens

Forex gain boosts profit

Result highlights

• In Q4FY2007, on a standalone basis, Siemens reported a 46.2% yoy growth in the net sales to Rs2,193.2 crore led by 90% growth in the revenues of the transport business and 65% growth in the revenues of the power business.
• Adjusting for the mark-to-market gain of Rs128.5 crore. The operating profit grew by 73% yoy to Rs216.7 crore, resulting in an OPM of 9.9%. The OPM improved by 150 basis points.
• The net profit before exceptional items grew by 24.3% to Rs170.1 crore. The reported net profit grew by 125.6% to Rs308.6 crore.
• For FY2007 the net sales grew by 70.7% to Rs7,753.7 crore. The operating profit grew by 47.7% to Rs600.7 crore. For the full year OPM declined by 130 basis points to 7.7%.
• For FY2007 the net profit (before extraordinary items) stood at Rs432.1 crore which was up 20% yoy basis. The reported net profit grew by 65.6% to Rs596.5 crore.
• The company has announced a bonus issue in the ratio of 1:1 and a dividend of 240% (Rs4.80 per share).

Steel Authority of India

Quality assets (iron ore mines) commanding premium valuations

Result highlights

• For Q2FY2008, Steel Authority of India Ltd (SAIL) reported a net sales growth of 7% year on year (yoy) and 14% quarter on quarter (qoq) to Rs9,164 crore on the back of a 2% year-on-year (y-o-y) and a 19% quarter-on-quarter (q-o-q) sales volume growth. Net realisations jumped by 6% yoy and were down 4% qoq to Rs 30,545 per tonne.
• Operating profit grew by 13% yoy and 10% qoq to Rs2,629 crore with the margin expanding by 140 basis point yoy. The operating profit per tonne increased by 11% yoy and came down by 7% qoq to Rs8,764 per tonne.
• Interest cost reduced by 26% qoq to Rs59.4 crore as the company repaid a loan of Rs142 crore.
• Net profit grew by 18% yoy and 11% qoq to Rs1,700 crore. The net profit growth was marginally lower than market expectations. The company as on September 30, 2007 has a cash balance of Rs9,039 crore with a debt of Rs3,205 crore.

---