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Recommendations
Sunday, January 14, 2007
Research Calls
| BRICS PCG recommends a "Buy" on Infosys Technologies at Rs 2183 with a revised target of Rs 2806 (earlier target price of Rs 2217). The stock trades at 32.1 times and 25.7 times its estimated FY07 and FY08 earnings respectively. |
| The strong growth recorded in the December 2006 quarter with a 9.7 per cent growth in total billed volumes and a 10.1 per cent growth in revenues in dollar terms was in line with expectations. |
| Though the rupee appreciation led to a fall of 200 basis points in margins, it was offset to the extent of 80 basis points by an improvement in revenue productivity, 30 basis points by lower SG&A expenses and 80 basis points by higher license fees from banking product Finnacle. |
| Though BRICS has marginally revised its FY07 EPS estimates down to Rs 68 from Rs 69, it has kept its FY08 estimates of 85.1 unchanged. Moreover added offshore effort and continuing Client growth are key positives. |
| Gujarat Gas |
| Angel Broking recommends a “Buy” on Gujarat Gas at Rs 1,274 with a 12 month target price of Rs 1,653. The stock is valued at 17.2 times, 14.4 times and 11.9 times its estimated CY06, CY07 and CY08 earnings, respectively. |
| The corresponding EV/EBITDA ratios are 9.9 times, 8 times and 6.4 times respectively. The company which has operations in gas distribution in the industrial retail, PNG and CNG domains. |
| The high margin industrial retail and CNG are expected to grow by over 15 per cent, while PNG is likely to grow by over 35 to 40 per cent. The company also has plans to add to its existing 2,100 km gas pipelines entering newer industrial areas of Jagadia, Kim-Karanj and Vapi. |
| In addition, about 5-7 new CNG stations will be set up, with an investment of Rs 70-100 crore a year. The power co-generation business too, would remain under focus with a scaling up of capacity by 20 MW each year until 2010, adding to the existing 18 MW. With stable revenues ensured, the business appears to be on a steadily upward trend. |
| Bartronics India |
| HDFC Securities Retail research recommends a “Buy on decline” on Bartronics India (BIL) with a price range of Rs 98 to Rs 111. The stock closed at Rs 123 on January 12 and trades at at 13.8 times and 8.9 times FY08 and FY09 estimated earnings. |
| BIL, which is the only integrated player in the AIDC/RFID solution market in India, planning to establish a manufacturing facility near Hyderabad for smart cards and/or RFID tags with an investment of Rs 262 crore. |
| HDFC securities expects the company to achieve a topline of Rs 71 crore, Rs 210 crore and Rs 280 crore respectively in next three years from FY07 on the back of rising output. |
| The new project brings with it the benefits of the first mover in a fast growing industry, faster rollout, backward integration and change in orbit for BIL. However, it exposes to the risks of project completion, gestation issues, operating risk of low utilisation in a capital-intensive industry and an entry into a commodity business. |
| Kalpataru Power Transmission |
| Edelweiss Capital recommends a “Buy” on Kalpataru Power Transmission at Rs 1043. The stock trades at 20.4 times , 14.8 times and 11.1 times its FY07, FY08 and FY 09 estimated earnings, respectively. |
| The corresponding EV/EBITDA ratios for FY07, FY08 and FY09 are 13 times, 10.9 times and 8.5 times. Kalpataru Power has interests in power transmission line towers, transmission equipment and gas pipeline infrastructure projects with approximately 25 per cent of the market share in domestic power transmission and distribution towers. |
| By the end of H1FY07, the company had domestic orders worth about Rs 130 crore and is expected to grow further, thanks to the rise in the power transmission capacity in India. Further, the revenues from the company’s gas pipeline business are growing at about 60 per cent year on year. |
| Tanla Solutions |
| Emkay Private Client Research recommends a “Buy” on Tanla solutions at Rs 395 with a target price of Rs 613. The stock trades at 15.9 times and 11.5 times its estimated FY08 and FY09 earnings respectively. |
| Emkay believes that an impressive business model and the robust industry environment as also Tanla’s future plans to enter new geographies and extending the services and product offerings make its growth prospects very positive. |
| Revenue is expected to grow at an CAGR of 92 per cent and net profits at a CAGR of 79 per cent over FY06A-FY09E. |
Bullish moving averages
The sharp uptrend, which started from a low of 13303 on Thursday, took the Sensex past 14,000 and Nifty past 4000 on Friday.
HDFC Securities expects a bullish market once the Sensex crosses 14,180 and the Nifty over 4100. The Sensex has a long way to go on the upside and will have a potential target in the 14724-15289 range.
According an analyst with Anand Rathi Securities, based on the chart pattern developed to date, the support level for Nifty is at 3830 levels and for the Sensex at around 13,300 levels.
Violation of these levels will have bearish implications and, hence, one may use these levels as stop-loss levels for long positions for the time being.
Indices are trading above the five-week simple moving average, which is above the 20-week simple moving average and the 20-week is itself above the 50-week simple moving average. This indicates that the trend as signified by the moving averages is bullish.
Results Calendar - Jan 15 2007
| an 15 2007 | Axis Capital Markets (India) Ltd |
| Jan 15 2007 | Aztecsoft Ltd |
| Jan 15 2007 | Bajaj Auto Finance Ltd |
| Jan 15 2007 | Bliss GVS Pharma Ltd |
| Jan 15 2007 | Dalmia Cement (Bharat) Ltd |
| Jan 15 2007 | Fine Line Circuits Ltd |
| Jan 15 2007 | JHS Svendgaard Laboratories Ltd |
| Jan 15 2007 | Kamdhenu Ispat Ltd |
| Jan 15 2007 | Krishna Lifestyle Technologies Ltd |
| Jan 15 2007 | L T Overseas Ltd |
| Jan 15 2007 | Madhusudan Leasing & Finance Ltd |
| Jan 15 2007 | Madhusudan Securities Ltd |
| Jan 15 2007 | Maharashtra Scooters Ltd |
| Jan 15 2007 | Nicco Parks & Resorts Ltd |
| Jan 15 2007 | Rajesh Exports Ltd |
| Jan 15 2007 | RPG Transmission Ltd |
| Jan 15 2007 | Sanwaria Agro Oils Ltd |
| Jan 15 2007 | South Indian Bank Ltd |
| Jan 15 2007 | Sundaram Multi Pap Ltd |
| Jan 15 2007 | Suryodaya Plastics Ltd |
| Jan 15 2007 | Triveni Engineering and Industries Ltd |
| Jan 15 2007 | Tulip IT Services Ltd |
| Jan 15 2007 | Typhoon Holdings Ltd |
| Jan 15 2007 | Venus Remedies Ltd |
| Jan 15 2007 | Wipro Ltd |
Market Outlook: All eyes on Nestle
All eyes are set on January 15 when the board of directors of Nestle India will meet to consider a scheme formulated under Sections 391 to 394 of the Companies Act, 1956 read with Sections 100 to 102 of the Companies Act, 1956.
Under this Act, the board will utilise part of the reserves of the company for distribution to shareholders.
This triggered speculation in the market that the company may offer a buyback to shareholders. The stock jumped 6.36% to close at Rs 1,245 during the week ended January 12 with volumes rising three-fold at 2.17 million shares.
For the current year thus far, the company has declared two interim dividends - Rs 2 per share on April 17 and Rs 18 a share on December 4.
Of the total equity capital of Rs 96.42 crore, the promoters hold 61.84%. Including profit for the current year ending December 2006, the company has reserves of around Rs 400 crore. The non-promoters' market capitalisation was at Rs 4,500 crore.
Stock of the week: IFCI
IFCI zoomed to its 52-week high of Rs 23.50 and closed at Rs 21.82, recording a gain of a 67 per cent in just a week with a phenomenal jump in volumes.
The spectacular run on the counter was on the company's decision to sell its 7 per cent stake of the total 12.44 per cent it holds in the NSE to Goldman Sachs, NYSE, General Atlantic and Soft Bank for about $161 million (or Rs 724 crore).
The company, which was reeling under bad loans and high cost of borrowings, is looking at ways to improve its business. Its stock price has almost doubled in the last one month after underperforming for most part of 2006.
Zandu: Bonus issue prop
The stock rose 33.7% after the company fixed January 20 as the record date for the bonus issue. The board had earlier approved a bonus issue in the ratio of 1:3.
The equity capital of Zandu Pharmaceutical, which has always been a thinly traded scrip, is 6.05 lakh shares, of which promoters hold 41.87%. There are 43 investors who hold 91,955 shares or 15.20%, and 7,488 investors holding 1.93 lakh shares or 31.87%. The company's book value per share was Rs 1,046.30, as on 31 March 2006.
The company manufactures a range of ayurvedic products, specialising in rheumatology, gynaecology and central nervous system. The company has more than 300 products in the form of ghritas, medical oils, churnas, quath, tablets and pills. It enjoys a very strong brand presence with products such as Zandu Balm, Zandu Pancharishta, Trisun and Zandu Kesri Jivan.
The company had reported 67.3 per cent rise in profit for the Q2 September 2006 to Rs 5.37 crore compared with Rs 3.21 crore in Q2 September 2005. Net sales rose 24.5 per cent to Rs 37.24 crore (Rs 29.90 crore).
Sensex Review
The Sensex, which began weak at 13,856, tumbled to a low of 13,303 in early Thursday trades. Unabated buying, thereafter, saw the index zoom to a new high of 14,071 before ending the week with a gain of 196 points at 14,057.
The bull run was so strong that the index, which shed 653 points in five sessions following a record close of 14,015 on January 3, gained 695 points in just two trading sessions.
Oil and gas, bank, consumer durable, FMCG and small cap stocks made healthy gains during the week ended January 12.
The FMCG sector bounced back after three consecutive weeks of underperformance, gaining 2.81%. ITC was up 5.85% at Rs 171.35, while Hindustan Lever was up 6.90% at Rs 219.60.
Nifty Snapshot
Nifty futures closed with a premium to spot Nifty - the first time in the last three weeks. After trading at a discount in the first three days, Nifty futures closed at a premium of 10.85 points on Thursday and 6.25 on Friday as bulls cornered bears after Nifty hit a low of 3830 on Wednesday. The Nifty had support and resistance at 4000 levels as Nifty calls and puts were bought at 4000 levels
Emaar does a DLF, set to float Rs 13000 cr IPO
| Emaar MGF, the Delhi-based real estate major, is set to do a DLF. The company, a joint venture between Delhi-based MGF Developments and Dubai-based Emaar Properties, is planning to raise around Rs 13,000 crore from the capital market to fund its rapidly growing property development business in India. |
| DLF recently filed a draft red herring prospectus with the Securities and Exchange Board of India for an initial public offer of Rs 13,500 crore. |
| This is the country's largest IPO till date. Sources close to the development said the Emaar MGF IPO is expected to hit the markets in the second half of 2007. |
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| Emaar MGF has projects in over 30 cities in residential, commercial, infrastructure, hospitality sectors and special economic zones across India. | |||||||||||||||||||||
| According to company estimates, it would require $4 billion to fund these projects, of which $1 billion was brought in through foreign direct investment (FDI) last year. The company is hoping to raise the rest of the capital through the IPO and private placement. | |||||||||||||||||||||
| MGF Developments is a subsidiary of the Motor General Finance Group, which has five other companies in its fold. | |||||||||||||||||||||
| The group has diversified into areas such as merchant banking, insurance, housing finance, stock brokerage, asset management, corporate advisory services, single-point fund management for corporate clients and extension of factoring to both consumer and industrial debts. | |||||||||||||||||||||
| It has other JVs as well — one with the International Finance Corporation, a World Bank affiliate, and the other with Citicorp Securities and Investments (CSIL), an associate of Citibank. | |||||||||||||||||||||
| Prime Database CEO Prithvi Haldea expects real estate companies to raise about Rs 25,000 crore from the primary markets this year, with 30 companies expected to hit the market depending on the DLF issue's success. | |||||||||||||||||||||
| The companies, which are expected to hit the capital market this year include Akruti Nirman, Omaxe, Gammon Infrastructure, Purvankara, Ansal Buildwel and Ansal Properties, Goel Ganga group, IJM India infrastructure (a Malaysian developer with developments underway in and around Hyderabad), IVRCL and Simplex. | |||||||||||||||||||||
| In 2006, real estate companies like Parsvnath and Sobha developers raised Rs 3,400 crore from the market through their public issues. | |||||||||||||||||||||
Yogindera Worsted: Avoid
Investors may avoid subscribing to this offer as it is not a preferred exposure in the textiles space; the company's focus segment of acrylic yarn is not particularly attractive from an investment perspective.
At the offer price of Rs 24, the stock is priced at about 11 times its likely per-share earnings for FY-07 on an expanded equity base.
Within the textile space, there are superior options in the secondary market that trade at more attractive valuations.
Yogindera Worsted is a manufacturer of acrylic and blended yarns, which find application in terry towels, apparel, furnishing and industrial fabrics. Based out of Ludhiana, Punjab, a woollen-textile hub, the company's products have access to a good domestic market. Exports account for 20 per cent of its sales.
The object
The proceeds of the offer will fund a 50 per cent expansion of its yarn facilities as well as the setting up of a new garment facility that will have an annual capacity of 2.5 lakh pieces.
The new capacities are expected to come on stream by March 2007. While the forward integration could enhance margins, the company does not have any experience in garment design.
The capacities are also not significant enough for the company to emerge as a major player in this segment in the near-term.
Yogindera has recorded an annual growth rate of 15 per cent in revenues between FY-02 and FY-06. Profits grew at 35 per cent over the same period, although on a small base.
Operating margins are at a healthy 15-18 per cent range. The offer opens on January 16 and closes on January 22.
Akruti Nirman: Avoid
Investors can refrain from subscribing to the initial public offer of real-estate player Akruti Nirman. The risks stemming from some of the company's current business segments outweigh the prospects arising from the real-estate boom in the country. With the stage just getting set for unlisted real-estate players to make an entry into the capital market, we believe there could be better opportunities for investors.
In the Rs 475-540 price band, the offer is priced at 45-51 times the company's consolidated FY-06 earnings on the existing equity base. We believe that the complex structuring of transactions and the uncertainties and risks driven by slum clearance policies in Maharashtra call for a valuation discount for Akruti Nirman. The offer price band, however, is at a premium to peers.
Profile
Akruti Nirman is a Mumbai-based real-estate developer of commercial and residential properties and recently forayed into retail real-estate. The company is primarily into real-estate development, under the Slum Rehabilitation Scheme (SRS) initiated by the Maharashtra government. The offer proceeds of Rs 320-360 crore (in the given price band) are to be used for land acquisition and getting development rights as also for development and construction costs of projects.
Business risk
Though Akruti's focus on slum rehabilitation projects in Mumbai holds much potential in the city and States such as Rajasthan and Karnataka which are coming up with similar schemes, they are also fraught with risks and uncertainties. As compensation for constructing new residential buildings for former slum dwellers, the Maharashtra Government grants the company either the right to develop a portion of the slum-cleared land for its own purpose, or offers transferable development rights (TDRs) which will permit the company to develop land elsewhere in Mumbai or sell such rights.
The positive of this model is that the company may get land in prime areas, which can be used to develop commercial or residential property or sell the same. On the flip side, before starting the SRS, the company must evacuate the dwellers after obtaining their consent. This can delay the process of construction and, as a result, receipt of land as compensation (which is the revenue stream). This is visible from the fluctuating revenues over the last five years.
Further, if these schemes are changed, the company will have to buy more land from third parties possibly at higher rates to continue as a realty developer. At present only 30 per cent of the total land area available is acquired or leased, the rest belonging to SR authorities.
Further, any change in land use regulations can render TDRs less valuable and affect revenues in future. In 2006, the sale of TDRs accounted for 17 per cent of Akruti's revenues.
About 33 per cent of sales for the eight months ended November 2006 came from commercial projects. The company's joint ventures with such leading players as DLF are likely to improve visibility and provide qualification for similar projects.
Akruti has securitised its future rental income in respect of most of its commercial properties with banks.
Consequently, the company would receive a lumpsum payment from the banks on its let-out properties and the banks would receive the rental amounts directly for a term of 11 years.
While this means income upfront, Akruti may lose out on any significant appreciation in rentals during the said period. The effect of this may be felt if the company adopts more lease models.
Land procurement
The company plans to use Rs 114 crore of the IPO proceeds to procure land. This transaction, however, involves acquisition of a company, which will not be controlled by Akruti directly. Such a complex transaction structure does not inspire confidence in this offer.
The company also buys TDRs for its own development projects. One such agreement for a consideration of Rs 113 crore involves acquisition of TDRs now under dispute.
The above transactions are likely to delay the plans of the company, which already has project cycles of three-five years.
The offer is open from January 15 to 19. JP Morgan and Enam are the lead managers.
Pochiraju Industries: Avoid
Investors can give the initial public offering (IPO) of Pochiraju Industries a miss. The company, which is in the floriculture business, is diversifying into the pharma/biopharma space, for which it is raising funds through the IPO.
We note that given the low absolute price at which shares are offered — in the Rs 25-30 band — the possibility of listing gains cannot be ruled out, as investors have had a tendency to gravitate towards such offers in the past.
Our view, however, does not factor in such gains, and is more of a longer-term call.
In the offer price band, the stock would be available at about six-eight times its expected per-share earnings for FY-07 on an expanded equity base.
As of now, the company is purely in the floriculture business, with the pharma and biopharma ventures likely to start contributing (to revenues) later this year and next year respectively.
Given the company's small size and its positioning at the lower end of the market-cap curve, there is attendant volatility that investors will have to contend with.
Sticking to larger, established names would be a better option to play the pharma and biopharma theme, in our view.
Background to the offer
Pochiraju intends raising Rs 37.5 crore through the book-built offer. The offer proceeds are to be invested in setting up a couple of plants dedicated to manufacturing biotechnology-based products, apart from funding working-capital requirements of the pharma business.
For the latter, the company has entered into a loan licence agreement with a Hyderabad-based outfit for product manufacturing.
Recommendation rationale
While on a price-earnings basis, the stock might appear to be priced low, these are multiples that are normally accorded to companies in the floriculture space.
In the new areas that the company intends to enter, there are several key factors that drive success: The ability to scale, customer engagement skills and expertise in regulatory affairs, especially when it comes to cracking open overseas markets.
While the offer document mentions that the company enjoys good relationship with its customers (though no names have been given), there is no demonstrable evidence on the other two counts.
Even in the pharma and the biotech space that Pochiraju is eyeing, the marketplace is intensely competitive, more so in the former with regard to the domestic market.
In the biotech space, while the domestic market has recently seen the launch of human insulin, the action is more likely to take place in the European and American markets, as the roadmap for launching follow-on biologics is gradually falling into place.
While the market size would undoubtedly be large, we would rather stick to established names to capitalise on this opportunity as and when the market opens up.
Offer details
Of the total proceeds intended to be raised, Rs 3 crore would come in as promoter contribution; the rest would be raised from the public. Post-offer, and assuming that the issue is priced at the lower end of the band, the company's equity would almost quadruple to Rs 20.3 crore (about Rs 18 crore if priced at the upper end).
Allbank Finance is the lead manager to the issue, which opens tomorrow and closes on January 18.
Global Broadcast News: Avoid
Global Broadcast News (GBN), broadcaster of the CNN IBN and IBN7 channels, is raising Rs 105 crore from its initial public offer and offers a new investment alternative in the television broadcasting space. Investors can, however, give the offer a miss for now. At Rs 250 — the upper end of the price band — the company will have a market capitalisation of about Rs 650 crore, more than 10 times its likely FY-07 revenues.
The valuation is at a significant premium to that of the market leader — NDTV. While the English news channel, CNN IBN, has managed to make a strong impact in a short period, and emerged as a strong contender in this genre, we are less optimistic about the prospects of its Hindi news channel, IBN 7 (formerly Channel 7), given the significant competition in that space. Over the medium term, in our view, the stocks of NDTV and Television Eighteen are likely to offer superior exposures in news broadcasting. Our recommendation does not factor in gains upon listing. The offer is likely to attract investor interest, given the bright industry prospects and the strong promoter backing and brand presence the company enjoys. However, conservative investors can consider picking up the stock once clarity emerges on the prospects of its Hindi news channel.
A strong show
GBN is part of the TV18 group that operates business channels CNBC TV18 and Awaaz (Hindi business channel) and a clutch of web portals. CNN IBN, the company's English general news channel, was launched in December 2005.
In a little over a year since its launch, it has managed to make a strong mark for itself. Its brand licensing and news services agreement with CNN and Turner appears to have helped it capture viewer attention.
The channel scores high in terms of news coverage, presentation style and quality of news and offers some serious competition to NDTV 24x7, which has been the leading news channel since its launch in 2003.
Going by TAM Viewership data, the channel appears to be neck-to-neck with the latter in terms of market share. We believe that the English news channel space can accommodate two prominent players and that NDTV 24x7 and CNN IBN will be the dominant channels for some time to come. In this context, the channel's decision to turn pay from free-to-air also augurs well, as it offers an additional stream of revenue by way of subscription.
But the contribution from subscription will be significant only if the conditional access system (CAS) takes off and investors consciously opt for new digital platforms.
IBN7, a weak link
In keeping with the trend of having a presence in the Hindi and regional news space, GBN recently acquired a 49 per cent stake in BK Fincap, the holding company of Jagran TV, owner of Channel 7. The Hindi news channel has been re-christened IBN 7. A chunk of the proceeds (Rs 46 crore) will be used to partly fund the acquisition cost of Rs 68 crore and infuse a loan of Rs 11.50 crore in the company.
Unlike NDTV, which has a strong contributor to revenues in NDTV India, GBN has a comparatively weaker link in IBN 7. With a market share of about 10 per cent, it will be a long haul for IBN 7 before it attains its objective of being the No.1 Hindi news channel.
Hindi news is a growing genre but is getting overcrowded with Aaj Tak, STAR News, NDTV India and Zee News all clamouring for the top slot. With a strong competitor in NDTV India at No. 3, we believe that it will be a tough fight to secure a slot in the top three.
Valuation and outlook
On a relative valuation basis, GBN is at a premium over NDTV that does not appear fully justified.
The latter has a business channel in its fold and is equally, if not better, placed to capitalise on the growth opportunities afforded by this space.
We can expect GBN to record strong revenue growth on the back of new subscription revenue and growing advertising income as CNN IBN attracts more advertisers in its second year of operation.
However, it is unlikely to repeat NDTV's spectacular financial performance in the year after its listing, which was at a time when the race for advertising revenues was virtually uncontested.
GBN will now have to compete with NDTV for advertiser's attention, with channels such as Times Now and Headlines Today also in the game. Even if GBN turns in a performance that is comparable to NDTV in its year of listing, the pricing of the GBN offer leaves little on the table for investors.
GBN is yet to make profits at an operational level. In the first half of FY-07, it recorded revenues of Rs 25 crore but incurred losses of an equal amount.
At this point, with investments also being directed towards IBN7, we do not expect the company to launch any new channels that could offer a fresh source of revenues, in the near-term.
Offer details: About 40 lakh shares are on offer to the public. The price band is Rs 230-250. About half the proceeds will help fund the acquisition of Channel 7 owner, Jagran TV; Rs 25 crore will be used to repay a loan from ICICI Bank and the balance Rs 35 crore will meet issue expenses and be used for general corporate purposes.
The offer opens on January 15 and closes on January 18. The lead managers are ICICI Securities and Kotak Mahindra Capital.
Markets and beauty contests
Observe the nature of the beauty contest. It is not who you think is beautiful. You win only if your pick matches that of others. So, you had to guess what other people were guessing. And other people were doing the same thing. So, the contest was essentially about which face most people thought was beautiful! Confusing?
If you buy only on fundamentals, you pick a beautiful face without bothering about what others are thinking. You "know" that other people will eventually come to realise that the face you picked is indeed the most beautiful. So, they will also pick that face.
What about technical traders — those who use charts — to buy/sell stocks? The price charts are footprints of human behaviour. If your entire neighbourhood buys a stock and the price moves up, the technical trader may buy the stock as well as depend on the chart pattern.
In terms of the beauty contest, the speculators are those who pick a girl they think is beautiful and wish others would also do the same! Which group do you belong to?
Frontline software players: A peek at headline trends
Infosys Technologies, the software services bellwether, has delivered earnings numbers for the third quarter that are broadly in line with market expectations. Relative to the frenzied trading activity of the two previous quarters, following the upward revision of guidance by Infosys, this quarter proved a quiet one. Traditionally, as the October-December period has fewer billable days, the earnings expectations are usually subdued, with fewer surprises in store.
The conclusion of this quarter, however, is far more significant strategically for IT service companies as it helps them take stock of the headline trends for the coming year. In our view, for frontline software players, 2007 may be defined and dominated by three key trends:
Strong lead indicators: According to software outsourcing advisory firm TPI, in 2006, India-based service providers nearly doubled their market share to 7 per cent in contracts above $50 million vis-Ã -vis a 4 per cent share in 2005. And the biggest losers in market share were the Big Five in Europe. This was revealed by TPI in its fourth quarter TPI Index announced last week. This clearly is a reflection of the scalability of the business model of the frontline software companies.
As high-profile Fortune 1000 clients start firming up their IT budgets for 2007, the initial indications from the top managements of Infosys and iGate in their conference calls were positive. Preliminary estimates suggest that IT budgets are likely to expand by 2-3 per cent during the year, dispelling fears of a slowdown in IT spending during the year. In their financial guidance, Nasdaq-listed Cognizant and Hexaware, which follow the calendar year as their financial year, are likely to provide further colour to growth projections.
Offshoring shift from labour to value: There is likely to be a keen tussle between the clients and frontline software vendors to move offshoring from a pure labour arbitrage equation (primarily time and material) to value-based pricing. In the quest to maintain their margins, Indian software vendors are likely to demand a greater proportion of the new service offerings pie from the clients, as application development and maintenance (ADM) contracts are getting somewhat saturated.
TPI in its latest briefing has added that in the ADM space, the market share of Indian service providers is touching 36 per cent, within striking distance of the 38 per cent share of the Big Six in this service offering. And clients, on their part, are likely to demand a share of the productivity gains.
The first phase of this tussle will be linked to old contracts coming up for renegotiation, where frontline companies are likely to drive a harder bargain for billing rate increases. So far, a predominant chunk of billing rate hikes has been confined primarily to new clients. Considering that these vendors will be facing a third successive year of 12-15 per cent salary hikes, billing rate demands are likely to intensify.
Multinational march and consolidation: In the backdrop of the recent Cap Gemini acquisition for Kanbay, it is becoming obvious that the top-rung European service providers are also jumping onto the offshoring bandwagon.
While this is likely to help them protect their eroding market share, the battle between domestic frontline vendors and MNCs (both North American and European) for business volumes and human talent is set to reach a feverish pitch this year. As the number of unbundled large deals is mushrooming, increasingly, MNC and Indian vendors are competing head-to-head on several of these deals in the IT services space.
To top it all, if there is a big bang acquisition by an MNC vendor (such as IBM or EDS) for any domestic software vendor in the Nasscom top ten (by revenues) this year, it can dramatically alter the competitive dynamics in the high stakes battle for market share.
Investment Nuggets
Walter Schloss is considered one of the investment greats, a value investor in the same league as the Oracle of Omaha, Warren Buffet. Like Buffett, Walter Schloss was also trained under the legendary Benjamin Graham. For a brief while in the 1950s, Schloss and Buffet even shared the same office.
For sheer uninterrupted performance record, few investors can match Walter Schloss. For 45 years from 1955 to 2000, he managed the investment partnership, Walter J. Schloss Associates and delivered an astounding compound annual return of more than 15 per cent per year compared to a gain of S&P 500 of just over 10 per cent.
And this is what Buffet had to say about Walter Schloss: "He knows how to identify securities that sell at considerably less than their value to a private owner: And that's all he does. He owns many more stocks that I do and is far less interested in the underlying nature of the business; I don't seem to have very much influence on Walter. That is one of his strengths; no one has much influence on him."
"One of the things we've done is hold over a hundred companies in our portfolio. Now Warren (Buffet) has said to me that, that is a defence against stupidity. And my argument was, and I made it to Warren, we can't project the earnings of these companies, they are secondary companies, but somewhere along the line some of them will work. Now I cannot tell you which ones, so I buy a hundred of them. Of course, it does not mean you own the same amount of each stock."
"I'm not very good at judging people. So I found that it was much better to look at figures rather than people. I didn't go to many meetings unless they were relatively nearby. I like the idea of company-paid dividends, because I think it makes management a little more aware of stockholders, but we did not really talk about it, because we were small. I think if you were big, if you were a Fidelity, you wanted to go out and talk to management. They would listen to you. I think it is really easy to use numbers when you're small."
"Timidity prompted by past failures causes investors to miss the most important bull markets."
"We did not get involved in many companies that turned crooked. I know there were a few people that had poor reputations and their stocks were low, and when we did buy some of those we were sorry afterwards because they figured out a way of taking advantage of you, and you were always worried that they'd do something that didn't like."
"When companies have problems they often like to have their annual meetings in cities and states where there are not too many stockholders."
AIA Engineering: Hold
Investors can retain their exposure to the stock of AIA Engineering Ltd (AIAEL), a manufacturer of impact, abrasion and corrosion-resistant high chrome parts — which find application in the crushing and grinding operations in cement, coal-based power generation and mining industries. At current market price, the stock trades at about 38 times its FY-07 expected per share earnings on a fully diluted basis. Though the growth prospects of the company are robust, the valuations appear pricey. Moreover, given that the benefits due to the enhanced capacities and the proposed backward integration would effectively accrue from FY-09, short-term investors can consider booking partial profits and re-entering the stock at lower levels. However, the medium-to-long-term investors can remain invested.
Investment Rationale
Encouraged by increasing demand, AIAEL is expanding capacity over the next two-three years. Its recent addition of about 50,000 tonnes is likely to contribute to the revenues from the current quarter (January-March). The facility, being an export-oriented unit, could enjoy tax benefits. Further, about 50,000 tonnes of new capacity installation is expected by October 2007. With a robust demand outlook, AIAEL is planning a further addition of 1,00,000 tonnes of capacity. This, however, is likely to contribute to the revenues from FY-09 only. The capex plan, if executed on time, would result in the total installed capacity to 2,65,000 tonnes in FY-09.
Exports form a significant part of the company's revenues (roughly about 48 per cent of its total consolidated sales in FY-06). It has presence in the US, the UK and West Asia through its subsidiaries. Furthermore, it enjoys a decent visibility in the overseas market — Holcim, Lafarge and Cemex are among its clients.The company's focus on the export market is likely to drive revenues in the future, given the higher realisation from them.
Cement continues to be the highest revenue contributor for the company. For the second quarter FY-07, cement, utilities and mining contributed about 62 per cent, 26 per cent and 13 per cent respectively of the total domestic revenues.
However, in the overseas market, cement contributed to 100 per cent of the revenues. As a result of this, AIAEL plans to expand focus on global mining and the utility segment. Though the decision is a positive, it could take a couple of years before significant contribution starts pouring in from the segment.
Strategies
More than 70 per cent of the total revenues of AIAEL comes from replacements, which rules out the possibility of any significant drop in demand during times of recession in the capital spending cycle. Further, AIAEL's value-add services that improve its client's productivity and product quality have also helped it create a niche market. To get a better grip over its raw material cost, it is considering the possibility of backward integration (either by acquisition or setting up a new plant) for sourcing Ferro chrome, an important raw material.
Additionally, its strategy of building in an escalation clause into most of its contracts is likely to reduce the risk of any increase in raw material prices. It also plans to set up a 30 MW plant for captive consumption, which could result in significant cost cuts.
However, we have not taken into account any savings that might arise due to the proposed power plant.
Delay in expansion plans, lower than expected capacity utilisation and an extreme rise in raw material cost are principal risks to our recommendation.
Balrampur Chini Mills: Buy
The prospect of an earnings slowdown for sugar companies due to weakening sugar prices has triggered a 60 per cent decline in the Balrampur Chini Mills stock since April 2006.
This has trimmed the price-earnings multiple for the stock from about 15 times the FY-07 earnings to about 8.5 times, presenting a good buying opportunity for long-term investors at the current price level of Rs 84. A significant slowdown in earnings growth from a scorching pace during the past two years is already factored into the stock price.
Going forward, Balrampur Chini Mills appears on course to deliver double-digit earnings growth over the next couple of years. The company's ongoing capex programmes, which will bolster volume growth, and an increasing contribution from power and distillery operations, are likely to offset the impact of flat or marginally lower sugar realisations on earnings. The lifting of the export ban on sugar is likely to lead to a tighter domestic supply scenario and provide support to domestic sugar prices at current levels.
Sugar scenario
Expectations of comfortable sugar supplies in the sugar season 2006-07 (October-September) have triggered a 15 per cent decline in sugar prices over the past couple of quarters. With sugar output expected to recover to about 227 lakh tonnes in the current season on top of opening stocks of about 36 lakh tonnes, total sugar availability is expected to be of the order of 263 lakh tonnes. Assuming domestic consumption of about 200 lakh tonnes and no exports, this would have resulted in the closing stock of about 63 lakh tonnes or four months' consumption by end of this season, a much higher inventory than in 2005 or 2006. However, the lifting of the export ban may lead to a significant draw down in the forecast inventories. The re-export obligations of mills and the freight advantages of shipping to neighbouring markets suggest that exports of about 20 lakh tonnes are likely, though they may not fetch a significant premium to domestic realisations. Sugar prices may find support at Rs 1,700-1,750 a quintal, on the back of higher consumption due to a buoyant economy, combined with depleting inventories due to exports.
Upside from diversification
Among the frontline sugar companies, Balrampur Chini Mills appears better placed to deliver reasonable earnings growth in a scenario of flat or marginally declining sugar prices. The company controls cane crushing capacities of 57,500 tcd (tonnes crushed per day) spread over seven locations in Eastern Uttar Pradesh, distillery capacities of 320 kilolitres per day and generates about 86 MW of surplus power from baggase.
For one, the company has managed to rein in increases in procurement costs over the years by virtue of its location. With few large players in this belt, Eastern Uttar Pradesh has not witnessed the intense competition for cane seen in the other belts. The sharp expansion in cane acreage in the current season could thus reduce procurement costs and provide relief on margins, while expanding revenues from by-products such as power and ethanol.
Second, significant capacities in downstream products have enabled the company to diversify its revenue stream outside of its sugar operations; this makes earnings less sensitive to small swings in sugar prices. Co-generated power and alcohol alone contributed 23 per cent of Balrampur Chini's operating profits in 2005-06 and this proportion is likely to rise over the next couple of years on the back of expansion projects.
Third, the company has already made significant investments in fresh capacities for sugar and by-products, which may boost volumes and revenues over the next couple of years. The ongoing projects are expected to expand sugar capacities by about 50 per cent, power generation by about 80 per cent and double distillery capacities by FY-08; a big portion of the earnings from these projects will flow in during the current financial year ended September 2007.
Though the undemanding valuation for the stock (at eight times forward earnings) reduces the downside risk at current levels, investors in the stock should take note of the risks arising from the commodity nature of the business. An upward revision in domestic sugar production estimates and any further policy intervention to curtail sugar prices are the key sector-specific risks, while any delays in stabilising production at the new facilities would be the key company-specific risks to earnings.
GlaxoSmithKline : Buy
Strong growth prospects for the health drinks business and improving pricing power make GlaxoSmithkline Consumer Healthcare a good investment proposition for investors with a medium-term outlook. At its current price of Rs.577, the stock trades at a price-earnings multiple of about 18 times its trailing 12-month earnings and just about 16 times its likely FY07 earnings. This places the stock's valuation at a significant discount to other FMCG companies, which enjoy multiples of between 25 and 28 times forward earnings.
Sales growth for categories such as malted food drinks have accelerated to double digits in recent months, on the back of higher promotional activity, improving income levels and higher offtake of FMCGs from the non-urban centres. As the dominant player in the health drinks business (Cadbury India being the only competitor of note), GSK Consumer appears a direct beneficiary of this trend. Over the past year, the company has made packaging innovations in its flagship brand, Horlicks, and rolled out new ad campaigns for brown drinks - Boost and Maltova. The company has also acquired a significant presence in the out-of-home segment through its vending machines in schools, railway stations and other high traffic areas. Rising input costs have been a problem area for the company in the first nine months of 2006, with rising prices of milk, wheat and sugar. However, imminent increases in output of wheat and sugar this year could moderate input price pressures on these commodities in the months ahead. In any case, GSK Consumer reported a 19 per cent growth in earnings in the first nine months of 2006 despite the margin pressures. This was on top of a 46 per cent expansion in earnings the previous year.
On the flip side, with its presence restricted mainly to health drinks, GSK Consumer's product portfolio continues to be limited and would justify a valuation discount to other FMCG companies. However, the significant valuation gap with other FMCG majors and reasonable growth prospects still offer scope for a 15-20 per cent return on the stock price from current levels.
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