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Sunday, February 25, 2007 & Newsletter

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Deadpresidents Most Popular Pages - Feb 2007

(Updated Feb 25)



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Anand Rathi

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Morgan Stanley Reports

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Mastek: Buy

Investors can consider taking exposures in small lots in the Mastek stock with a medium-term perspective. At the current market price, the stock is trading at a price earnings multiple of 11 times its likely per share earnings for 2006-07. We have a `buy' recommendation outstanding at Rs 360 made in mid-September 2006 and this is a reiteration of that call.

Investors can use any price weakness linked to the broad market to step up exposures. Considering that the stock has been locked in a narrow band for a few months, the returns from the stock will be sedate vis-à-vis other mid-sized software stocks of a similar genre. Investors may need to keep their return expectations to 12-15 per cent.

The two key levers that are working well for Mastek are the contribution from the European geography and steady build-up of revenues and clientele from Elixir.

Elixir, its enterprise platform addressing the life insurance, annuity and pension segment, has added four clients in the second quarter ended December 31, 2006.

The European geography, which accounted for 67 per cent of its revenues, grew by 8.2 per cent in the latest quarter. The improvement in order book to Rs 405 crore - after two sluggish quarters - and operating profit margin improvement in the latest quarter are added kickers to the overall growth.

The relatively upbeat revenue and post-tax earnings guidance at 8.5 per cent and 10 per cent for the third quarter lend confidence to the underlying fundamentals.

The slow traction in the US geography and high exposure to discretionary development spending represent downside risks to the stock. Application development revenues accounted for over 70 per cent of its total revenues in the latest quarter. The high client concentration (88 per cent from the top ten clients) linked to development spending and long lead-time in client acquisition also remain key risks to the business.

Punjab Tractors: Hold

he Punjab Tractors Ltd. (PTL) stock is in play. With more than half-a-dozen suitors lining up for the equity put on the block by two major shareholders, private equity firm Actis and the Burmans of Dabur, the stock has gained about 27 per cent since February 1. After touching a peak of Rs 342, the stock now trades at Rs 316. Shareholders can continue to hold the stock for reasons elucidated below. Fresh exposure, however, can be avoided as returns from current levels may not be significant enough to justify the risks assumed.

Up for grabs

Actis, which holds 29 per cent in PTL, has decided to exit the company and so have the Burmans, who hold 14.5 per cent. Bids are currently on and the biggest and the best companies of the vehicle manufacturing industry have been attracted to the sale. Tractor market leader, Mahindra and Mahindra, Ashok Leyland, Tractors and Farm Equipment Ltd (TAFE), International Tractors (Sonalika), and Escorts have confirmed that they are in the race.

Tata Motors, in association with Ford New Holland of the Fiat group, is also said to be interested though the company has not officially confirmed if it has put in a bid. Apart from these, a private equity combine headed by the former head of PTL, Mr Yash Mahajan, is also trying its luck at picking up the stake on offer.

What makes the sale significant is that the successful bidder will get management control over PTL. The stakes of Actis and Burmans together add up to 43.5 per cent and the acquirer will have to make an open offer, which, assuming it is for the minimum 20 per cent and successful, will take his stake to at least 63.5 per cent.

Why the rush?

PTL is an established and strong player in the tractor industry and its Swaraj brand commands big royalty in the major tractor markets of Punjab, Haryana, Rajasthan and Uttar Pradesh. Though in recent times its market share has whittled down to just 9 per cent from over 15 per cent a few years ago, it remains a formidable player in the industry.

But those are not the only reasons why PTL is in such demand. PTL owns 14 per cent of light commercial vehicle manufacturer, Swaraj Mazda's equity, and 33 per cent stake of engine manufacturer, Swaraj Engines. Swaraj Mazda is passing through a rough patch with sales growth in the negative terrain at a time when commercial vehicle sales are booming, but it is attractive nevertheless for a bidder such as Ashok Leyland.

Swaraj Mazda presents Leyland with a line of models where it has no presence in presently; in the long run, Leyland could also be eyeing the manufacturing facility of Swaraj Mazda, in combination with Swaraj Engines, as a foothold for itself in the North .

For M&M, acquisition of PTL will catapult it to unassailable No.1 in the tractor market with a wide and deep geographic presence. TAFE is keen because it will rise to be almost on a par with leader M&M if it is able to get control over PTL. Besides, TAFE can leverage PTL in terms of product and geographical diversity as well. The logic for Tata Motors is much the same as for Ashok Leyland with the additional motivation of enabling entry into the one segment of the automobile industry where it has no presence now.

Why hold on?

And that brings us to why shareholders should hold on to the PTL stock till the logical denouement — of the bid culminating in sale. Given the strong motivational factors driving each of the bidders, the price bids are likely to be extremely competitive reflecting their desire to gain control over PTL. There will also be a control premium to the bids because the successful bidder will gain management control over the company.

Besides, PTL is a well-run company with a strong goodwill in the market and there may not be other similar capacities coming up for grabs in the near future.

Finally, what also generates confidence is that the top four bidders have deep pockets and could be willing to go the extra mile given the boom time in the automobile industry.

Given that the stock was trading at around Rs 240 before the news of the two shareholders putting up their holdings for sale came out, and accounting for the above factors, including the control premium, it is likely that the share will be valued closer to the prevailing market price.

But is there no fall side at all? Yes, there is and that is the possibility of either one or both the sellers deciding to withdraw their offers. Such an unlikely prospect could lead to a precipitous fall in PTL's stock as the current market price cannot be justified by fundamental factors alone.

The fizz in the stock in recent times is due to the stake sale and it could dissipate in no time if the sale process runs into a snag.

It will be prudent for shareholders to watch the developments closely in the run up to the sale over the next couple of weeks and act accordingly.

Thermax: Hold

trong demand, burgeoning order-book and improved operating margins spell good times for Thermax, a leading player in energy and environment management. Further, an increase in capacity and the planned manufacturing foray into the Chinese market on the back of good demand from user industries are expected to add to earnings growth.

At the current market price, the stock trades at about 20 times its likely FY-08 per share earnings. Investors with a one/two-year perspective can hold on to the stock, while any price weakness linked to the broad market can be used to build fresh exposure.

Investment rationale

Increase in input costs due to the rise in crude oil price has forced many industries to go on an energy diet. This augurs well for Thermax, which specialises in energy conservation systems and captive power projects. Further, anticipating this rising demand scenario, Thermax has chalked out a capacity expansion plan. The new capacity is likely to become operational in two phases — the first by October 2007 and the second by January 2008. This would, however, effectively contribute to the earnings from late FY-08. Thermax also plans to set up a manufacturing base in China for which it has obtained licence.

This would cater to the demands of only the Chinese and the export markets, thus helping it contain the operating cost. The manufacturing foray is also likely to widen the reach of Thermax's products in the export market.

hermax's order-book has grown steadily, thanks to a favourable demand environment and increased industrial capex. For the quarter ended December 2006, the order-book was pegged at Rs 3,024 crore, up 94 per cent (year-on-year). Given the capex plans lined up by various user industries — steel, textiles, chemicals — we believe these growth rates are likely to be sustained. Backed by this strong demand, both the energy and environment segments of Thermax registered impressive revenue growth of about 50 per cent for the December quarter. The energy division continues to be the major contributor to the bottomline (about 80 per cent). The operating profit margin too has improved by about 1.07 percentage points on a year-on-year basis. Better realisation for its products, coupled with higher volumes, has helped Thermax enjoy higher margins.

Thermax is likely to gain significantly from the closure of the hitherto loss-making subsidiary, ME Engineering. That apart, it also stands to gain from the increased thrust on biomass cogeneration. However, the company's thrust on R&D and new product development is likely to be the growth driver.

Further, its focused foray into South-East Asian markets such as China and Hong Kong and the planned expansion of its product range also hold significant upside potential.


Though the stable raw material cost in the recent past has helped Thermax improve its margins, any unprecedented rise in the input cost could pose a risk to the earnings. While Thermax has successfully managed to navigate through a rising input cost scenario, its ability to sustain the same could be of concern.

Nevertheless, the company's continuous efforts to prune costs by increasing its sourcing from China is a positive. Further, any unexpected slowdown in the industrial cap expenditure also poses a downside risk to our recommendation.

Pratibha Industries: Buy

Pratibha Industries is in the process of de-risking its business profile and moving to more lucrative segments. Better operating profit margin, the ability to forge joint-ventures to enable technical and financial qualification and the improved debt situation add to the company's earnings visibility.

We reiterate a buy after our `invest' recommendation on the company's public offer in February 2006.

At the current market price, the stock trades at 8 times its expected earnings for FY-08. We have not factored in revenues, if any, from the spiral-welded pipes business, capacities for which are expected to go on-stream from FY-08.

Moving up the value chain

Pratibha is a unique play among the small-cap infrastructure players as its revenue streams are markedly different from peers of similar size.

While a number of small players now ride on the huge spending in the road space, the company has traditionally derived a bulk of its income from water supply and distribution and waste management systems. Roads and mass housing and commercial projects contributed about 25 per cent.

The company has now moved up the value chain to more underground water tunnelling and storm water pumping stations independently and through joint-ventures.

Recent projects from the Rajasthan Government and the Airports Authority of India appear to be a way forward to becoming an integrated player in the infrastructure business.

Pratibha has already forged ties with an Austrian company for tunnelling and appears to be looking for avenues to enter the lucrative oil and gas pipeline project segment. This new segment will also be a natural extension of its existing business. As a backward integration strategy, the company is setting up a spiral-welded pipe division, which is likely to go on stream in FY-08. These pipes, typically used in water and oil and gas pipeline projects, are likely to bring better margins from the pipeline projects.

While the company had originally planned a joint venture for the spiral-welded pipes, it now intends to source the required knowhow from the equipment manufacturer itself and, therefore, proposes to retain the full profits from this unit.

Improving financials

The IPO proceeds have significantly ramped up the shareholders funds, thus financially qualifying it for bigger orders. The company's current order backlog of over Rs 1,200 crore is about seven times its revenues for FY-06. This is likely to be converted to revenues in about two-and-a-half years and lend visibility in the medium term. Operating margin, maintained at over 12 per cent, is superior to similar sized players.


Benefits from the pipe division are likely to be substantial only if the company forays into the oil and gas pipeline division. The company, however, can utilise the pipes for its water projects and to sell in the market, as the demand is high.

Further, we expect the company to benefit from its core business — water projects — on the back of water supply systems being implemented under the National Urban Renewal Mission.

Investment Nuggets

Challenging conventional thinking on investing has been Michael Mauboussin's leitmotif in an investment career spanning over one-and-a-half decades. Michael Mauboussin is currently the Chief Investment Strategist of Legg Mason Capital Management, joining them in 2004. Prior to that, he served as Managing Director and Chief US investment strategist at Credit Suisse First Boston. He has brought a multidisciplinary approach to investing that draws ideas from strategy, psychology, finance and complexity theory. Something that he has dwelt at length in his latest book, More Than You Know: Finding Financial Wisdom in Unconventional Places.

"Once we've established a belief — most of which come from people around us — we are loathe to change it. Social psychologist Robert Cialdini offers two deep-seated reasons for this. First, consistency allows us to stop thinking about the issue — it gives us a mental break. Second belief, consistency allows us to avoid the consequence of reason — namely, that we have to change. The first allows us to stop thinking; the second allows us to avoid acting."

"The logic of diversity requires that we constantly develop new tools if we hope to be successful in consistently solving complex problems. Constant learning and open-mindedness are the best ways to achieve this goal, but are cumbersome and generally not innate tendencies."

"I want to leave you with the notion that we humans are still not very good at dealing with risk or uncertainty. We are still linear thinkers; we have a nearly insatiable need to link cause and effect, and we assess probabilities poorly. However, we do now better understand some of the mechanisms that underlie complex systems, and that knowledge can be very helpful in preparation for future catastrophic events."

"When allocating capital, portfolio managers need to consider that unexpected events do occur."

"As networks increasingly dominate the business landscape, it is crucial for investors to understand network effects — how the value of a network increases with more users. Network effects can be classified along a spectrum, with stronger and weaker forms. As investors, we seek companies where network effects are strong and can be captured through superior financial performance."

"We spend a lot of time comparing. In many cases the stakes are not too high. But under some conditions, including investment decisions, good comparisons are essential. It's important to recognize when you add complexity to the problem of comparison — a temporal dimension, probabilities, and vast, often-ambiguous information — people make many more mistakes. Awareness of the pitfalls and taking some steps to mitigate them can go far in making you better at comparing — and investing."

Page Industries: Avoid

Page Industries, a licensed manufacturer of the popular `Jockey' brand of innerwear in the country, is entering the market with a public issue of equity shares. On offer is a fresh issue of capital by the company along with an offer of sale from the promoters. The company plans to raise between Rs 50 crore and Rs 55 crore depending on the eventual price fixed which would be used, among other purposes, for brand-building and for setting up additional manufacturing facility.

The company's sales have been growing at an annual rate of roughly 28 per cent in the last four years. The net profits have seen an even better rate of annual growth of nearly 60 per cent. There is, thus, little doubt that the company's brand of innerwear has gained market acceptance as evident in the growth of its sales and net profits. On the face of it, therefore, the company's claim to pricing its shares at an earnings multiple of between 22.5 and 25 (depending on the price within the band indicated by the company) based on the annualised profits of first half of fiscal 2006-07, appears reasonable.

A general rule of thumb in investment valuation is that an equity is considered an attractive candidate if the ratio of its P/E multiple to the annual growth rate in profits is below one. In the instant case, it is in the region of 0.5. On a comparison to its closest competitor, Maxwell Industries, manufacturer of the VIP range of innerwear whose current share price values its latest earnings by a multiple of around 22 too, the company's indicative price band for its share does not appear unreasonable.

Competitive parameters

But despite such attractive parameters of valuation, we are of the view that investors are better off avoiding the public offer for the following reasons. One, the market for innerwear is a highly fragmented one with a number of regional players in the branded segment, besides innumerable small players in the unbranded category.

While Page Industries' positioning as a premium product would limit the scope of competition, it must be admitted that the market is characterised by the existence of competing offerings at various price points and there is always the risk of `down trading' — customers settling for an offering at a lower price point — and this must exert some pressure on margins.

There are limits to premium pricing strategies to shore up profit margins, considering that innerwear by its very nature cannot command super luxury positioning that allows consumer to make a life-style statement.Two, the market is also seeing the entry of large apparel manufacturers with established brand equity entering the innerwear market. They are likely to pose a stiff competition to Page Industries, which has no presence in the traditional apparel market. It has a limited presence in the leisure wear segment.

Success at a price

Three, the entry of a number of players in the organised retail trade is likely to be marked by the advent of store brands both in the mass and premium segments across all consumer product categories. Innerwear cannot be an exception to this phenomenon. Even if the likes of Page Industries manage to hold their own amidst the clutter, the success will come at a price.

Historically, pricing power has tended to shift to the players in the organised retail trade with a chain of stores, given the volumes that they can muster. The company is trying to counter this with its own exclusive retail outlets besides a sharp hike in advertising outlays. The success of such a strategy is, however, fraught with uncertainty.

Offer details

The offer, lead managed by IL&FS Investsmart, opens on February 23 and closes on February 27. The net offer to the public is 27.89 lakh shares.

Emkay - Weekly Technicals

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Debuting scrips in the green

Both IPOs listed in the week were trading in the green compared to their IPO prices.

Two scrips were listed on the BSE during the week ended 23 February 2007. One was a BPO firm, Firstsource Solution, while the other to the power sector public financial institute, Power Finance Corporation. By 23 February 2007, both were trading higher than their IPO prices.

Of the two newly-listed companies, Power Finance Corporation surged the most, 30.76% to Rs 111.15, by 23 February 2007 compared with the IPO price of Rs 85. The stock clocked an average daily volume of 4.06 crore shares since the day of debut. The scrip was listed on the BSE at Rs 104.

Firstsource Solution rose 22.46% to Rs 80.05 by 23 February 2007, compared with the IPO price of Rs 65 on 22 February 2007. The stock clocked an average daily volume of 1.99 crore shares from the date of debut. The IPO was listed on the BSE at Rs 75.10.

During the period under consideration, the market declined amid high volatility. Factors like the CRR-hike, rising inflation, concern over rising domestic interest rates, unwinding in derivatives ahead of expiry of February 2007 contracts on 22 February 2007, and fear that short-term capital gains tax may be hiked in the Union Budget 2007-08, were the major triggers for the fall. Caution was also partly due to worries of a possible interest rate hike by the Bank of Japan (BoJ), which was raised to 0.50% on 22 February 2007.

The BSE Sensex shed 723.02 points for the week ended 23 February 2007, to settle at 13,632.53 compared with the previous week’s closing of 14,355.55 on 15 February 2007. The S&P CNX Nifty lost 207.30 points, to settle at 3,938.90 compared with the previous week’s closing at 4,146.20.

Firstsource Solutions has highest average daily volume for week

Firstsource Solution posted the highest average daily volume for the week ended 23 February 2007.

The average daily volume for the BPO firm, which debuted at Rs 75.10 on the BSE on Thursday (22 February 2007), stands at 1.99 crore shares for the week ended 23 February 2007. The IPO price of the scrip was Rs 64, and had settled at Rs 79.60 on the day of debut.

IFCI, Zee News, Redington India, Cinemax India, Reliance Natural Resources, Pochiraju Industries, Global Broadcast News, Himachal Futuristic Company, Bellary Steels, Sail, and Aptech were the other average daily volume topper for the week ended 23 February 2007.

IFCI was the volume topper on most of the days during the week under consideration. The scrip dropped 4.63% for the week ended 23 February 2007, to close at Rs 27.80. The scrip’s average daily volume for the week ended 23 February 2007, stands at 1.86 crore shares, compared to the average daily volume of 65.58 lakh shares in the past 1 year.

The scrip with the third biggest average daily volume for the week ended 23 February 2007 was Zee News. The scrip surged 15.34% during the week, to close at Rs 41.35, on an average daily volume of 1.06 crore shares, compared with the company’s average daily volume of 27.60 lakh shares in the past 1 year.

Redington India stood fourth in the average daily volume toppers for the week ended 23 February 2006. The scrip dropped 11.61% to close at Rs 144.30 on 23 February 2007, compared to the closing price last weekend. The scrip, however, was traded heavily in the market. Its average daily volume for the week ended 23 February 2007 stands at 45.33 lakh shares compared to the average daily volume of 81.89 lakh shares during the past 1 year.

The other high average daily volume gainers were Cinemax India at 43.71 lakh shares (86.71 lakh shares was its average daily volume in the past 1 year), Reliance Natural Resources at 39.90 lakhs shares (41.25 lakh shares), Pochiraju Industries at 36.20 lakh shares (70.20 lakhs shares), Global Broadcast News at 33.57 lakh shares (40.60 lakh shares), Himachal Futuristic Company at 31.52 lakh shares (26.41 lakh shares), Bellary Steels at 31.47 lakh shares (18.35 lakh shares), SAIL at 28.97 lakh shares (33.69 lakh shares), and Aptech at 28.48 lakh shares (4.30 lakh shares).

The market had declined through the week amidst high volatility. Factors like the CRR-hike, rising inflation, concern over rising domestic interest rates, unwinding in derivatives ahead of expiry of February 2007 contracts on 22 February 2007, and fear that short-term capital gains tax may be hiked in the Union Budget 2007-08, were the major triggers for the fall. Caution was also partly due to worries of a possible interest rate hike by the Bank of Japan (BoJ), which was raised to 0.50% on 22 February 2007.

The BSE Sensex shed 723.02 points for the week ended 23 February 2007, to settle at 13,632.53 compared with the previous week’s closing of 14,355.55 on 15 February 2007. The S&P CNX Nifty lost 207.30 points, to settle at 3,938.90 compared with the previous week’s closing at 4,146.20.