Sunday, April 22, 2007
CMP: Rs 164.10
Target price: Rs 220
Deutsche Bank’s global markets research has initiated coverage on Karnataka Bank with a ‘buy’ and price target of Rs 220.
In its recent research note, Deutsche said, “We like KBL’s strategy of controlled loan growth, effective use of excess SLR securities and shedding of high-cost liabilities — features which further much-needed stability in the current volatile interest rate scenario, and potentially continued good asset quality.”
Deutsche estimates Karnataka Bank’s earnings per share (EPS) for 2006-07 at Rs 18.49 and for 2007-08 at Rs 20.59. In 2004-05, its EPS was at Rs 14.52.
CMP: Rs 244.75
Target price: Rs 270
Motilal Oswal Securities has initiated coverage on Dishman with a ‘buy’ citing robust earnings growth prospects as the key trigger. The brokerage estimates Dishman’s EPS for 2006-07 at Rs 10.3 and for 2007-08 at Rs 15.5. In 2004-05, its EPS was at Rs 5.80. “
Dishman is likely to be one of the key beneficiaries of the increased outsourcing from India, resulting in 32% earnings CAGR (compounded annual growth rate) over FY07-FY09,” the brokerage said in a recent report to clients. “
Partnerships with large innovators like GSK, Merck, Astra Zeneca, J&J and Novartis imply good long-term potential for the CRAMS business, resulting in 25% revenue CAGR (excluding Carbogen-AMCIS ) for FY06-09,” it said.
CMP: Rs 688.85
Target price: Rs 900
CLSA Securities has retained ‘buy’ rating on Jet Airways with a 12-month price target of Rs 900 post the announcement of its buyout of Air Sahara.
“We believe the new deal helps Jet to get out of a sticky situation; an early dispute resolution will likely help in accelerating the fund raising program and staggered payment will ease potential stress on cash flows,” the French brokerage said in a note to clients. “
We also believe aircraft addition plans of some airlines have slowed down and the infrastructure constraints are currently at peak. Hence, additional slots, trained manpower and additional aircraft on order by Air Sahara will all come in handy for Jet,” it said.
CMP: Rs 465.05
Target price: NA
SSKI Securities has reiterated ‘outperformer’ rating on UTI Bank, post its fourth-quarter earnings. The brokerage has raised UTI Bank’s EPS estimates for 2007-08 by 3% to Rs 29.3 and by 3.8% to Rs 36.7 for 2008-09 on pre-dilution basis citing higher-than-expected increase in core earnings.
“Though the current adequacy numbers are comfortable, we expect the bank to raise equity capital in FY08. We believe that the bank has entered a successful chain of growth, enabling it to raise fresh equity capital at every stage at richer valuations to fund its strong loan expansion,” SSKI said in a recent research note.
CMP: Rs 335.20
Target price: Rs 358
Ask Raymond James has maintained a ‘buy’ on HCL, while downgrading its price target to Rs 358 from Rs 370 after the company’s January-March earnings announcement, citing “compelling valuations”.
“In view of the better-than-expected results, we have revised our FY07E (estimated) EPS to Rs 17.1 (+2.5%) and FY08E EPS to Rs 19.9 (+1.5%),” ASK said in a recent report to clients. “In-line with the recent downgrades that we had for the exit multiple for the top tier companies, we are reducing the target PE multiple for HCL Tech from 19x (times) to 18x,” it said.
We Indians are price-conscious; we know what value for money really means and we go out of our way to ensure that we get it. And we all love a good bargain. Case in point: The Big Bazaar Republic Day Sale. The first time Big Bazaar introduced it, there were so many people wanting to buy on sale that there was almost a stampede. The store had to be closed for some time and the sale was extended for another two days. The traffic jams were still there. Everyone throngs to the Big Bazaar stores to make the most of the incredible discounts.
Now contrast this to what happens in the stock market. You understand the importance of owning equities in your portfolio. You begin investing for your retirement which is some 10-15 years away — so you are essentially investing for the long term. You have probably even decided to invest a fixed amount every month. And, yet, when the Sensex falls 500 points, you wonder if you should sell your investments.
When to buy?
It falls another 200-300-500 points and you actually go ahead and sell your investments because you think it is going to fall further. But stop and think for a moment. If you actually want to buy something, which is the better time to make the purchase; when it is at full price or when it is on sale?
Let us look at an example: You have had your eye on the Infosys stock for a long time. You like the company and the reputation of its management. You have been reading in newspapers and magazines about how Indian IT companies are riding the offshore boom and are expected to do good business for the next three-four years at least. You are comfortable with the kind of revenue growth and profits Infosys is expected to make and you think in, say, five or 10 years, an Infosys share could be worth anywhere between Rs 5,000 and Rs 7,000. So, although the Infosys stock price has gone up from Rs 1,600 in July 2006 to almost Rs 2,300 in January 2007, you decide to buy the stock. You buy a few shares at Rs 2,300 and plan to buy more as soon as you have some savings to invest.
Stock on sale!
Fast-forward two months, the market has fallen and your Infosys stock is down to almost Rs 2,000, which is 13 per cent less than the price you initially bought the share at. So, how do you feel and what do you do? Will you get scared that the price will fall even further and, therefore, sell now and get out of the market while you still can? Or will you be happy that the Infosys stock is on `sale'! A 13 per cent sale! You can now buy more shares for the same investment amount!
Factors at play
This, of course, was a very simplistic example. At any given point, there are several factors at play that determine prices in the stock market.
How an investor responds to changes in stock prices is also a function of his overall financial situation, the money available to invest, and the asset allocation. But all said and done, the most important thing to remember is the difference between `stock price' and `company value'.
Regardless of which valuation tool you use to arrive at the `company value', the basic rule is:
when the `stock price', is higher than the `company value', the stock is expensive and although you have money to invest, you might want to keep that money in the bank instead of making an expensive purchase;
when the `stock price' is less than the `company value', the stock is on `sale' and it might be a good idea to consider buying the stock instead of putting money in the bank.
When things are `on sale', the discount that makes it attractive to you is purely a matter of personal preference. Some people think a 10 per cent discount is a good deal while others may think that a sale is really a good deal only when the discount is more than 40 per cent.
You decide what your preferred discount rate is. And the next time you read about a market crash do not forget to check and cheer because the companies you want to invest in may now be on sale!
And, congratulations! In addition to gaining a new interpretation of market crashes, you have also just learnt the philosophy behind a mutual fund category called `the value fund'. Simply put, `value funds' generally buy stocks when they are perceived to be on `sale' and sell them when they get expensive — when the stock market price exceeds their estimate of the company's value.
If you thought that the entry and exit loads that you pay on the purchase or sale of units are the only fees charged by a mutual fund for their market-beating performance, think again. There are other costs associated with your mutual fund investments. The costs charged by a mutual fund to operate and manage the portfolio is captured by a measure called the expense ratio. The net asset value, which determines the value of your holdings, is usually arrived at after adjusting the portfolio return for expenses incurred on marketing, administration and management fees.
Expense ratio is usually expressed as a percentage of assets managed by a fund. Expense ratios can be found in the half-yearly portfolio statements of funds and represent the amount charged to investors by the asset management company for recurring expenditure. In the Indian context, the expense ratio that can be charged by a fund house is capped by law. According to the Securities and Exchange Board of India (SEBI) rules, the expense ratio is capped at 2.5 per cent for an equity fund and 2.25 per cent for a debt fund. As a fund grows in asset size, the cap on expenses as a percentage of assets declines. This is one of the reasons why you find that funds with a larger asset base such as Franklin India Bluechip, HDFC Equity or Fidelity Equity have lower expense ratios.
Do expenses matter?
After a four-year rally when top-performing equity funds have delivered annualised returns of more than 40 per cent, you may believe that a 2.5 per cent charge on your NAV would have little impact on returns. But the same cannot be said of debt funds, which have struggled to deliver a return of 6-7 per cent.
In a debt fund, a 2.5 per cent expense ratio would shave off 25-30 per cent off your returns! Expenses are, thus, crucial in determining the performance of debt funds and should be a factor to consider when buying a fund. Typically, institutional options within debt funds deliver better returns because of the lower expenses required to services bigger customers.
Though they have not mattered much until now, expenses could assume greater importance for equity funds as well. In the developed markets, equity funds, which find it difficult to outperform the market by more than a per cent or two, are often evaluated on the basis of their expense ratios.
A low expense ratio is also a reason why investors in developed markets are advocated to buy passively managed index funds and exchange traded funds. These funds save on the steep management fee involved in active fund management.
In India, the strong outperformance of active equity funds have more than compensated for the higher expense ratio vis-à-vis index funds. But if the degree of outperformance begins to diminish, passive funds might begin to look more attractive as a low-cost, convenient alternative.
While it pays to monitor a fund's expenses, recent performance by equity funds reveal sharply divergent returns. This means that fund manager skills still play a big role in determining equity fund returns in the Indian context. Track record and investment strategy should therefore take precedence over expenses. Investors should check if expenses justify performances.
A fund with a low expense ratio may not necessarily be the best performer and vice-versa. Strangely, index funds too reveal differences in returns not only due to expenses but also because of tracking errors. Hence, focusing on expense ratios as a sole factor in choosing between equity funds is certainly not advisable.
Expense ratios can be useful in choosing between funds of comparable track record, size and investment strategy. The savings in expenses could compound into a sizeable difference in returns over a long holding period of five to ten years.
Choosing debt funds is a more difficult proposition, given the number of options available in the debt space, from deposits to small-savings to funds, and expense ratios may help you narrow down your choices. With heavier competition in this segment, funds do keep a tighter leash on expenses. Among debt funds, passive funds such as fixed maturity plans might be more attractive because of the lower expenses involved.
Transacting on the stock markets is a complex activity and leaves even the most hardened investor in a slightly muddled state. The juggling between trading accounts, demat accounts, dealing with the market intermediaries, making sure that you are not cheated out of your due entitlements of dividends, rights, bonuses etc. and to ensure that the various communiqués from the companies in your portfolios reach you is an onerous task.
A disciplined investor would have no difficulty in keeping track of all the above. But more often than not, we wake up to the fact that we have missed a bonus or a dividend only when it is too late. Fortunately, we do not live in a land of barbarians where naïve and absent-minded investors have no venue of redressal. There are several bodies that exist mainly to oversee the smooth functioning of the capital markets and to protect investor's interest.
The first such organisation is the Securities and Exchanges Board of India. The SEBI Web site has online investor grievance forms for a plethora of complaints that can be easily filled by the investors. The Internet link is http://investor.SEBI.gov.in/
Before filing a complaint with SEBI, the investor should make an attempt to clarify the matter with the company or the intermediary concerned. Only when the investor is unable to extract a satisfactory response from the erring person/company should he approach SEBI.
SEBI can take a company to task in issues relating to issue and transfer of stocks and debentures, non-payment of dividend, not delivering the letter of offer for rights etc. In addition to taking action against the companies listed on the exchanges, complaints pertaining to misconduct by market intermediaries such as brokers, sub-brokers, merchant bankers, banker to the issue, registrar and transfer agents, underwriters, credit rating agencies can also be registered on the Web site.
Investors in other instruments such as mutual funds, venture capital funds, portfolio management schemes can also bring their grievances to SEBI's notice through this mode.
Uncertainty and jitters. That probably best sums up the homestretch to the earnings announcements of software service majors this year. The prospect of a US slowdown, sharp rupee appreciation and possible turbulence in the financial services sector heightened fears of earnings growth skidding in 2007-08.
But, going by the management guidance and earnings conference calls of the top five software companies, most of the fears appear to have been assuaged, at least for the time being.
By toning down market expectations that were set much higher — at 25-30 per cent plus on revenues/earnings in the run-up to the results — Infosys Technologies managed to minimise the negative fallout to a large extent. And with Satyam Computers coming out with fairly strong guidance (apart from a good fourth quarter), most of the apprehensions have been set to rest.
While Tata Consultancy Services, Wipro (except for offering revenue guidance for the latest quarter) and HCL Technologies do not provide financial guidance, the senior management's comments on key trends in the marketplace are encouraging. Scanning the earnings radar throws up five key variables that are still working in favour of the software majors:
Almost every single frontline company has downplayed the impact of the probable US slowdown on software revenues. Except for the sub-prime mortgage woes that have hit a small segment of the financial services space, the overall business momentum appears quite robust.
In late March, Accenture, the multinational consulting-cum-services major, dwelt on its robust outsourcing pipeline, led by its management consulting practice. The company, which has 13,000 management consultants, is expected to nearly double its size over the next three years. Some part of this growth is likely come from low-cost, highly skilled locations such as India.
Similarly, SAP, the business management software company, has turned in weaker-than-expected earnings, though its software and software-related revenues have been fairly strong.
Similar views were echoed by the frontline domestic players. Take, for instance, the response of the top management of HCL Technologies in the latest conference call. Asked specifically about the slowdown, its President, Mr Vineet Nayar, said: "Am I concerned about the slowdown in America? The answer is no. Because we have polled our customers, especially the high-tech customers, and four of the deals we announced are in the high-tech area. So, as we speak, I do not see a slowdown trend."
Most other majors also responded in similar vein. A couple, however, witnessed sluggish revenue growth in the latest quarter from the financial services segment, one of the largest spend areas for the IT industry. Given the large-scale consolidation expected in the space, concerns had surfaced on whether the segment may witness an unexpected slowdown.
Dismissing such concerns, TCS' N. Chandrasekaran, Executive Vice-President and Head, Global Sales, said: "...the BFSI segment is not experiencing any slowdown at all.
On an annual basis if we really look at it, we have gone from 1.2 billion to 1.8 billion and all our clients are growing and it will continue to grow."
LARGE DEAL MOMENTUM
Pursuing large deals ($50-250 million) is fast becoming an integral part of the demand equation and overall corporate strategy of the top five domestic software companies. And by their very nature, these deals span multiple service offerings that range from application development/maintenance to infrastructure management, and engineering services to BPOs. At least four of the five frontline firms have talked extensively about the impact of large deals on their earnings call. For instance, TCS stated that it ended 2006-07 closing twelve $50-million plus deals across major markets and it is pursuing at least 10 deals which are more than $50 million plus.
Wipro also indicated that it has won 10 $50-million accounts and its pipeline remains strong in this area. Satyam stated that it bagged three large deals during the year, with its latest five-year $200-million Applied Materials contract being one of the largest deals it signed.
HCL Technologies, which announced six large deals over the past year or so, indicated that the EBIT (earnings before interest and tax) margins are higher than the company average for these big deals. The five majors have clocked revenues of $12-13 billion and if they have to maintain revenue growth of 25 per cent plus over the next year, they will have to clock incremental revenues of over $3 billion. Clearly, these large deals will play a crucial role in keeping the growth engine humming.
OTHER GROWTH LEVERS
For frontline players, the client pipeline across different revenue buckets — ranging from $1 million through $5 million and $10 million to $50 million — is still robust. Since mining the existing clients and repeat businesses have been key indicators of predictable growth, this metric has been tracked closely by analysts and observers alike. Take, for instance, Infosys. It has increased its million-dollar clients from 256 to 275. And at the upper end, the number of $50-million clients has increased to 12 from 11; $100-million clients from 2 to 3; and it has one client with revenues of $200 million.
The contribution of new service offerings, that was an insignificant proportion of revenues two years ago, today accounts for a fairly sizeable chunk. New service offerings such as engineering services, infrastructure management, testing and BPO account for over 20 per cent to a third of revenues for frontline companies. And this basket is only set to expand in the coming quarters.
Finally, the focus on the European geography has begun to pay handsome dividends for the top companies over the past year. This has helped broadbase the overall risks.
KEY POINTS TO WATCH
While IT companies have managed to tame expectations for 2007-08, a few key variables will influence their performance. These are:
Wage inflation and attrition: While frontline companies are budgeting yet another year of 12-15 per cent offshore salary increase, they hope to offset it through better utilisation and productivity increases. As supply challenges increase at the bottom of the employment pyramid in terms of recruitment of freshers, employee utilisation will be a metric that will be watched carefully in the coming quarters.
Billing rates: Though companies continue to maintain an upward bias to billing rates, it will be interesting to watch if this trend pans out as expected. This can offer some positive upside in some cases.
Client pipeline: While the top-ten clients have been firing on all cylinders for the frontline majors over the past year, the growth of non-top ten clients also needs to be monitored closely. In an unanticipated slowdown, they will hold greater scope for increased volumes and protect margin growth.
Investors with a long-term perspective can consider taking exposures in the stock of AIA Engineering (AIAEL), a manufacturer of impact, abrasion and corrosion-resistant high chrome parts. At current market price, the stock trades at about 23 times the expected per share earnings in FY2008. On the back of an estimated global market of Rs 12,500-crore for mill internals used in mining and cement sectors (growing at about 4-5 per cent per annum) we believe, AIAEL, the second largest player in the product category in the world, is well placed to capitalise on this increasing demand. This apart, the threefold expansion in capacities, and a strong clientele with the likes of Holcim, Lafarge and Cemex also lend more confidence to the company's business prospects.
AIAEL's decision to expand focus on global mining and utilities holds immense potential; given that currently only about 10-15 per cent of the mill internals in the mining industry are hi-chrome. However, the demand for these hi-chrome products is likely to be driven by substitution of conventional products. For the quarter ended December 2006, cement, utilities and mining contributed about 52 per cent, 34 per cent and 14 per cent respectively of the company's domestic revenues. However, in the overseas market, the entire revenues were contributed by the cement sector. Revenue contribution from the cement sector on the domestic front is likely to sustain given that cement companies, despite the price control imposed by the government, have not scaled down their expansion plans. In addition to this, since the cost of consumables as a percentage of cement production costs is only about 1.5 per cent, it is unlikely to affect the margins of AIAEL.
Since more than 70 per cent of the company's total revenues come from replacements, there is a low possibility of any significant drop in demand during a downturn in the capital spending cycle. Furthermore, the proposed backward integration (either by acquisitions or setting up a new plant) for sourcing Ferro chrome and the setting up of a captive power plant, could lead to improved operating margins. However, delay in expansion plans, lower than expected capacity utilisation and a sharp rise in raw material cost remain the principal risks to our recommendation.
Long-term investments can be considered in the stock of KSB Pumps, one of the leading players in the organised pumps and valves market.
At the current market price, the stock trades at about 12 times its expected calendar year 2008 per share earnings. Given the increase in capex across user industries such as power generation and refineries, we believe the revenue visibility of KSB is likely to remain buoyant.
In addition to this increased sourcing by its parent company, the tactical shift in product mix and an increase in capacity lend more confidence to its growth prospects over the long term.
KSB is among the leading manufacturers of pumps and valves in India. The pumps division, which caters to the agricultural, industrial and services segments, is likely to benefit from the favourable investment climate across user industries, besides the government's increased outlay towards irrigation and water resource management. For the year ended December 2006, the pumps division recorded 8 per cent growth in topline, contributing about 71 per cent of the total sales. In the absence of any negative growth triggers, this division is likely to sustain stable revenue growth. The valves division, on the other hand, with a perceptible increase in overall contribution, is likely to drive growth. Given the increasing demand for valves from industrial users, KSB's decision to dedicate its Coimbatore plant for making valves appears right. The division contributed about 23 per cent of the total sales and recorded a double-digit revenue growth of 30 per cent in CY-06.
KSB, given its established presence in the market, is likely to capitalise on any opportunity that might arise from the on-going capex across power generation and petrochemical industries. In addition, the high-wear condition in such industries is also likely to result in a good replacement market for its products. The competition in this segment is fairly low since pump manufacturers catering to the refineries and petrochemical industries are required to conform to the API (American Petroleum Institute) standards.
On the exports front, revenues are likely to improve, given the increased sourcing by KSB AG, its parent company. This has not only helped KSB diversify its target market, but also improve the overall realisation for its products. Also, the export of submersible pumps has helped decrease seasonal influences on its business, due to monsoons.
For the full-year ended December 2006, while the total revenues grew about 13 per cent compared to the corresponding previous period year, earnings rose 36 per cent. The operating profit margins improved by 230 basis points to 20.4 per cent, leading to a 27 per cent increase in operating profit.
Operating margins are likely to improve thanks to the plant automation programme undertaken by KSB. This would decrease engineering time, leading to an increase in the company's operational efficiency.
Any slowdown in the capex plans of user industries is likely to affect the growth of KSB negatively. Also, any unprecedented volatility in raw material prices could also affect the company's earnings. However, KSB's ability to pass on raw material price hikes to its customers offers some respite.
Investors with a high risk appetite may retain their exposure in the Tanla Solutions stock. At the current market price, the stock trades at a price earnings multiple of 20 times its 2006-07 per share earnings.
Our `Hold' recommendation on the stock is predicated on the fact that the company was only recently listed with a relatively short earnings history and its concentrated exposure to the non-voice mobile segment.
We had recommended investors to subscribe to the initial public offering made by Tanla Solutions in the price band of Rs 230-265 per share in mid-December and remain sanguine about its prospects. This is also evident from the strong financial performance of Tanla for the latest quarter and the year ended March 31, 2007. Investors can use any weakness in the broad markets to step up exposure in small lots.
The company's core strength lies in catering to a cross-section of the mobile messaging market, which has robust growth potential.
The company aims to capitalise on the multi-year growth potential of the non-voice mobile market that is broadly segmented into short messaging service (SMS) and multimedia messaging services.
Tanla offers telecom-signalling products to mobile operators; aggregation services (by acting as a single point interface between content developers and mobile network operators) and offshore services in the area of application hosting and infrastructure management. Its blue-chip clients include leading mobile operators in the UK such as 3G, Vodafone and Virgin Mobile.
Several research outfits have projected that messaging services will be a crucial experimental ground for mobile companies and Tanla's principal growth engine over the next few years. At the same time, the company has also indicated that it is conducting research in the area of telemetry and telematics. The company is likely to start marketing some of these technologies and products in the coming years.
The key risks, as we had spelt out in the IPO analysis, stem from high client concentration, slowdown in growth of 3G services if the price points for service prove to be too high, penetrating the new growth markets such as the US, and margin pressures arising from stiff competition in the aggregation services market in UK.
Of the Rs 420 crore raised through the IPO, the company has set aside a chunk for general corporate purposes, which include acquisitions that will provide it the beachhead in the US/Asia-Pacific markets.
Identifying the right acquisition target/s and integrating the acquisition with its offshore centre in India can prove a risky proposition.
In the latest quarter ended March 31, 2007, the company recorded consolidated revenues of Rs 78 crore and post-tax earnings of Rs 34 crore. On a sequential basis, the former have grown 37 per cent and the latter 47 per cent.
In the latest quarter, the operating profit margin dipped to 46.4 per cent from 52.2 per cent on a sequential basis. For the full year 2006-07, the operating profit margin was 49.8 per cent, down from 55.7 per cent.
Since the margin continues to be robust, there is no near-term concern, but over the next year maintaining the operating margin broadly in the 40 per cent range holds the key to sustaining post-tax earnings growth.
Investors with a long investment horizon can consider exposure to the Monsanto India stock at the current price levels of about Rs 1,400. Though the company's recent financial performance has been unimpressive, long-term prospects for the domestic seeds business, on which the company is now refocusing, are bright. Given that the business is research-driven and technology intensive, entry barriers to the business are high, translating into good growth prospects for entrenched players such as Monsanto India.
The recent listing of Advanta India, which has a global presence in the seeds business, is also likely to lend greater visibility to this business, on the bourses. The growth prospects for the conventional herbicide business, though modest in the near-term, also appear stable for players such as Monsanto, given the robust product pipeline and the focus on premium, less price-sensitive segments of the market. The Monsanto stock trades at about 14 times its trailing 12-month earnings per share.
Though crop protection, with a focus on herbicides, has traditionally been the key revenue driver for Monsanto India, the company has been increasing its focus on the hybrid seeds business over the past couple of years. The seeds business accounted for 53 per cent of Monsanto's sales in 2005-06, up from 21 per cent five years ago, while the contribution of the herbicides business fell from 65 per cent to 31 per cent. The increasing shortfall of key food and commercial crops, the rising pressure to step up farm productivity (Indian yields of most crops are far below global averages) and the economics of adopting high-yielding seed varieties for the farmer are the demand drivers for high-yielding seeds.
However, plant breeding (developing new seed varieties) is a specialised business that involves a fairly long gestation period and calls for considerable research strengths and access to proprietary germplasm. In this respect, the backing of Monsanto India's parent — Monsanto US, a global leader in the seeds and traits business, and the latter's strong product pipeline — is a strong positive for Monsanto India. Monsanto India currently markets seeds in India under the Dekalb brand name (a global brand) and focusses mainly on maize (corn).
The demand growth
The demand for maize in the Indian market has consistently raced ahead of available supplies. Going forward, the demand growth for corn is likely to be strong on the back of expansion in the organised poultry industry and the growth in corn-based snack foods and starch-based industries. Though adoption of hybrid maize seeds has sharply increased sharply in the Southern States, considerable potential for hybridisation exists in the Northern states, where about 70 per cent of the maize acreage is still under conventional varieties.
In the herbicides business, Monsanto has traditionally focussed on branded specialty products through well-recognised brands such as Leader, Roundup, Machete and Fastmix. However, price competition in this business is high, with several domestic players emerging as low-cost manufacturers of agrochemical formulations. Since the profitability of new products tends to wane quickly after the initial years, success in this business depends on a robust product pipeline and a steady stream of launches, apart from the company's brand equity.
Though Monsanto is well-placed on this front on account of its global product pipeline and focus on commercial crops and food grains, it is not immune to price competition. This appears to be the key reason for the company's recent sale of its Leader herbicide business to Sumitomo and its increasing focus on the seeds business.
These rationalisation efforts also explain the company's unimpressive financial performance in recent quarters, after a steady pace of earnings growth in earlier years.
However, only investors willing to wait for two-three years should invest in the Monsanto India stock now.
The final quarter of the financial year is usually a poor one for agrochemical companies such as Monsanto India, given the seasonality of the business. Moreover, though long-term prospects for its businesses are bright, the company's near-term financial performance could be modest on account of the ongoing shift in business focus and the restructuring efforts.
A well-diversified and relatively unique business in the engineering sector distinguishes Voltas from other listed companies. A strong position in the electro-mechanical products business, attractive margins from the engineering and agency segment and expected turnaround in the unitary cooling products division augur well for Voltas' earnings growth.
With a sound footing in West Asia, the company is well-poised to capitalise on the construction boom and the resultant cooling systems demand in the region. Voltas appears to be a good investment option in the engineering segment from a three-year perspective. At the current market price, the stock trades at about 18 times its likely earnings for FY-08, based on an expected 30 per cent annual growth in earnings from FY06-08. The marginal premium vis-à-vis other players appears justified, given the diversified nature of the business and the few listed players.
Voltas is an air-conditioning and engineering solutions provider. While the company's primary business is providing comfort air-conditioning requirements for homes and offices, malls, airports homes and multiplexes, it also operates in areas which require monitoring of temperature, humidity, or treatment of air. The users in this segment include steel and power plants, petrochemicals facilities and laboratories. The company is also into manufacturing of material handling equipment and provides agency services for selling textile machines and construction and mining equipment. This diversification should provide cushion for the company against any slowdown in any one segment.
Electro-mechanical segment, the driver
The Indian heating ventilation and air-conditioning (HVAC) market is dominated by Voltas, Blue Star and Carrier. The demand for office space, largely driven by the IT and IT-enabled service companies, has led to huge potential for the HVAC players. With few organised players in this sector, the above-mentioned companies should, among them, share the business opportunities. This apart, the increasing number of malls and multiplexes and the upcoming Special Economic Zones offer much scope for the HVAC business. Voltas has already executed projects in these segments. While Voltas appears evenly poised with competitors in making gains from the above-mentioned prospects, the company has an edge in the following areas of its business:
International strength: In the overseas market, Voltas is better known as a mechanical, electrical and public works contractor, including HVAC services. Of the total current order-book of Rs 2,400 crore, about Rs 1,300 crore is derived from international markets. Among its overseas markets, Voltas can be expected to benefit from the construction boom in West Asia. This region accounted for 27 per cent of the company's FY-06 revenues. The company's ability to compete with top players in the region such as the Emirates Trading Company has enabled it to become a sub-contractor for Bechtel.
Potential in airports: Voltas won projects of the value of Rs 160 crore in electro mechanical projects for the Hyderabad airport and appears keen to participate in the bidding for Mumbai and Delhi airports as well. With the upgradation and modernisation of airports in India gathering pace, Voltas may see increased bidding opportunities in this area. The company's earlier airport projects such as the Bahrain International airport and the new airport in Hong Kong, are likely to serve as reference points and give it the edge.
Key role in the retail story: India's success in the retail space may well depend on the availability of cold storage and warehousing solutions. Since a chunk of the investments in this area is in fresh food, this would require support in terms of cold chains, refrigerated transport and industrial refrigeration. Voltas, which is already an established player in this field, has further strengthened its position through a tie-up with Netherlands-based Besseling Group. The latter is a turnkey solutions provider for storage of horticulture. Voltas has secured an order from Adani Agri-Fresh for refrigeration systems. We expect Voltas to benefit from this segment, which may also offer slightly better margins than regular HVAC projects.
Improvements in other divisions
The engineering agency division of Voltas has over the last three quarters shown a propensity to make an increasing contribution to revenues. For the quarter ended December, 20 per cent of the revenue came from this division. Increased demand for construction and mining equipment and in-house manufactured forklifts are likely to drive revenues.
We view this as a positive, as the operating margins from this division are far superior to the 6-7 per cent OPM in the electro-mechanical segment. The company's unitary division, which consisted of room air-conditioners and refrigerators, was a drag on the company's margins.
Now, with the shutting down of this unit in Hyderabad and its relocation in tax-friendly Uttaranchal and the closing of the unprofitable refrigeration section, may see some improvement in margins. The company, among the top players in the room air-conditioning systems, has seen a 30 per cent growth over FY-07 in this area. We expect the increasing purchasing power of consumers to create robust demand for the product.
Voltas is a low-debt company with large cash coffers. Any growth through the inorganic route could be earnings accretive without much equity expansion. Further, any plan for liquidating real estate, after it shut down the Hyderabad unit, may unlock further value. We have not factored these positives in our valuation.
Risks: The OPM of Voltas, which is at less than 6 per cent, may take a hit if there is a hike in the price of raw material such as copper and aluminium, given that a number of its international contracts operate on a fixed price basis.
The company faces stiff competition in the room air-conditioning segment from Chinese products and the unorganised market. This may cause pressure in pricing and, consequently, margins. Any political unrest in West Asia or slowdown in construction in the region would affect revenue flow for Voltas.