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Sunday, April 29, 2007
Wkly Technical Analysis: Get set to reap profits
The NSE Nifty ended unchanged at 4,084 after coming in the striking distance of its all-time high at 4,245 by hitting the weekly peak of 4,218.
The NSE index may face stiff resistance for its short-term target of 4,250. A break of 4,035 this week could see the index dropping to a low of 3,955.
The weekly support and the resistance levels for the Nifty are as follows: the index is likely to face resistance around 4,145-4,165-4,180, while it may find support around 4,020-4,000-3,985.
The Sensex moved with a positive bias for most of the trading week until the Friday selloff, which saw the index shedding the entire gains in a single day. The index from a low of 13,850 rallied to a high of 14,384 -- an intra-week gain of 534 points. However, in Friday’s selloff, it ended almost flat at 13,909.
Last week, we had reported the possible short-term targets for the Sensex at 13,990-14,275-14,565 against which the index touched a high of 14,384.
While the possibility of the index attempting to scale 14,565 still remains intact, it may counter stiff resistance around 14,240 on its way up.
While there is no clear direction available on the Sensex chart, the broader range of the idex next week could be from 13,580 to 14,240.
The index may find support around 13,705-13,640-13,580, and may face resistance around 14110-14175-14240. Get set for a profitable week.
The march of the rupee
If you offer to exchange US dollars for Indian rupees, a person who is aware of market trends would probably decline the offer. The rupee is showing its mettle in the foreign exchange markets. It has appreciated to an eight-year high of Rs 42.90 against the dollar. Since January 2006 till date, it has appreciated by almost 4.8 per cent. During calendar year 2006, it went up more than 3 per cent.
Improving economic fundamentals and stronger growth prospects have led to a global interest in the Indian economy. Foreign money is pouring in to ride the economic boom and take advantage of the rising interest rates and stock and real estate prices.
The net FII inflow (debt and equity) since January 2006 was close to $10 billion. Non-Resident Indians also remitted home a considerable amount of dollars. The higher interest rates in the domestic market compelled companies to borrow in dollars in foreign markets (external commercial borrowings) to fund their expansions plans. Naturally, when the supply of dollars exceeded the demand, the rupee soared.
What implications does an appreciating rupee have on the economy and the common man?
Indian exports are denominated in dollars. If the rupee appreciates and the dollar depreciates (other currencies remaining stable), Indian exports will become expensive and uncompetitive, leading to lower volumes. The appreciating rupee could also adversely impact the employment generating software and outsourcing (BPOs and KPOs) sectors' income, which is also denominated in dollars.
Thankfully, the Indian economy is less export-dependent than some of its Asian peers, where falling exports slows growth and brings in higher unemployment. Exports constitute less than 20 per cent of India's GDP, yet they are an important part of the economy.
Higher imports may add to the trade deficit (imports minus exports), which is not always in the interest of the economy.
NRI deposits and remittances would fetch less rupees for their dollars if the rupee continues appreciating. With the trade deficit deteriorating sharply, these remittances have helped India remain in a surplus situation on the balance of payments.
FIIs usually get money in India in dollars to invest in stocks and other assets. A stronger rupee will mean that they get a lower amount to invest. A rising rupee will add to the dollar returns of FIIs that don't hedge the currency risk.In order to prevent a rapid appreciation of the rupee, the RBI buys dollars from banks and sells rupees, which enhances the liquidity in the banking system.
If this liquidity is not sterilised (absorbed) out of the banking system by the RBI, interest rates are likely to fall. These excess dollars usually find their way to the country's foreign exchange reserves. The RBI and the government incur costs on account of the sterilisation measures and maintenance of reserves.
Higher reserves can be helpful in the event of an external financial crisis, such as the foreign exchange crisis in India in 1991.
The long-term intrinsic value of a currency is a function of various other factors, such as interest rate differentials, trade equations, and so on. It should be kept in mind that the rupee has appreciated primarily on account of the excess dollars chasing the economic boom in India.
Any reversal of such flows due to a change in the global perception of India could put the rupee under pressure.
Trader's Corner
It would not be news to those associated with the stock markets that stock prices are sensitive to news. Memories of May 2004 when Sensex plummeted more than 15 per cent on a single day as the tidings of the BJP debacle in the Lok Sabha elections hit the markets would be indelible in the minds of most of us.
It is not always that news has this dire an impact on the stock prices. But research in this area shows that stock prices do react to news and the volatility in stock prices does increase in periods of high news flow and volatility subsides when news flow is lesser.
Trading on news is one of the forms of trading that is followed by the agile and active traders. There are two ways to do it. The first is to ferret out any potential news that can cause a major move in the stock price. We are not talking about listening at keyholes or any other under hand activity. All it would involve is simple research that would put you ahead of the rest of the pack.
The idea is to exploit the time lag that exists between the news being disseminated to the majority. One example is to keep track of international commodity prices such as sugar, copper, steel etc. These prices percolate down to the domestic commodity markets and then the relevant stocks start moving up.
The other way to trade on news is to take position as soon as the news breaks out in the media with the hope of having the first-mover advantage. As a greater number of people come to know about the development, the stock price would move higher/lower and the subsequent move should be utilised to exit the position. Needless to say this style of trading is fraught with risks.
Exaggerated moves made by markets in response to news often get corrected in the next trading session as was witnessed after the World Trade Centre bombing. The US market and the rest of the global markets bid adieu to a long-term bear phase the day after the event occurred. It would be prudent to wait for a period of consolidation after the news-driven breakout in which to enter in to a position.
Zensar Technologies: Hold
Investors can retain their exposure in the Zensar Technologies (Zensar) stock. At the current market price, the stock trades at a price-earnings multiple of 13 times its consolidated 2006-07 per share earnings.
It may be advisable for investors to consider an entry into the stock only on weakness linked to the broad market. We have a `buy' call outstanding on the stock at Rs 213 made in end- September 2006.
The company's strengths stem from its broad-based portfolio of service offerings, robust client additions, scope for acquisition-led growth and reasonable growth potential from these levels. However, as a mid-cap stock, Zensar's valuation may be influenced by its high client concentration, prospects of slowdown in IT spending in the US later this year and slower-than-expected shift in offshoring by its new clients (both organic and inorganic).
Key variables
Zensar's performance in 2007-08 is likely to be dictated by the following variables:
Broad-based portfolio: Zensar operates five business segments — Application portfolio management (APM), enterprise application services (EAS), innovative technology solutions (ITS), business process outsourcing and optimisation (BPO) and consulting services. APM has been the company's key contributor, accounting for 53 per cent of its revenues and 83 per cent of its profit before interest and tax (PBIT) for 2006-07 announced recently.
However, over the past year, the contribution from EAS has risen significantly to 28 per cent of revenues (from 21 per cent in the previous year), while PBIT share has more than doubled to 26 per cent (from 21 per cent in the previous year).
This trend is also reflected in the PBIT margin, which improved for EAS to 13.5 per cent in 2006-07 from 6.7 per cent in the previous year. The PBIT margin from APM also improved by two percentage points to 22 per cent for 2006-07. While the company has staged a turnaround in its contribution from BPO, its share from consulting services, the new segment added this year, has been fairly healthy.
The only disappointment has been the contribution from the ITS segment, whose revenues have also dipped from the previous year, and it has also incurred operating losses. This segment offers services that range from application modernisation, embedded systems, product engineering services and legacy migration.
Client mining: While the top ten clients of Zensar account for 69 per cent of revenues for the year ended March 31, 2007 (up from 60 per cent in the previous year), the company is well-placed to mine its existing clients in different areas.
For instance, it has increased the number of clients in the $1 million-$5 million bracket to five in 2006-07 from three in the previous year. This also reflects its long-standing client relationships with the Mark and Spencer, National Grid, Credit Suisse, Cisco, among others.
In addition, of the 236 active clients, 222 are below $0.5 million, and this offers ample opportunity for scale-up of select clients in the coming quarters.
Inorganic growth: Over the past quarter, the company has put through two key growth initiatives. One, it has acquired the US-based ThoughtDigital Inc. through its US subsidiary for an all-cash consideration of $24.9 million.
ThoughtDigital specialises in Oracle implementation, with clients in the communication, financial services and media space. It had reported revenues of $27 million for the year-ended December 2006.
It is expected to strengthen Zensar's presence in the enterprise applications space. Two, it recently entered into a 60:40 joint venture with the Tokyo-based software company, EZA.
This is likely to help Zensar get a foothold in the niche areas of media and entertainment in the Japanese market.
Texmaco: Buy
Investors with a two/three-year investment horizon can consider exposure to the stock of Texmaco, a leading supplier of wagons to the Indian Railways.
At the current market price, the stock trades at about 22 times its expected FY-08 per share earnings. Given the increase in capacity by the Railways, Texmaco's wagon division is likely to witness a significant growth in demand.
This apart, privatisation of container freight movement and entry of private logistics players into the railway freight business may also contribute to higher demand for wagons, leading to further growth potential. The proposed doubling of capacity of the steel foundry division and a robust demand environment for Texmaco's hydro-mechanical equipment and structurals division also lend optimism to earnings prospects.
Investment argument
Driven by increasing demand from the Indian Railways and the private sector, Texmaco's rail wagons division may be set to witness robust growth.
The government's proposal to expand the railway network, increase capacity of existing wagons and introduce higher capacity wagons are likely to scale up its revenues over the next two/three years.
The proposed setting up of dedicated freight corridors on Delhi-Mumbai and Delhi-Howrah sections could also contribute to topline growth. The introduction of wagon investment scheme, entry of wagon leasing companies and allowing private participation in inland container transport could also create a healthy demand scenario for Texmaco.
On the back of an on-going power shortage scenario, the government's planned capacity-addition in various hydropower projects is encouraging.
It is likely to open up newer markets and revenue outlets for the hydro-mechanical equipment division of Texmaco, which makes gates, penstocks, electromechanical and hydraulic hoists for dams, barrages and power stations. Also, given the untapped hydropower potential in the North-East India and Texmaco's proximity to it, it is likely to have an edge over other companies in procuring such orders.
The process equipment division, which caters mainly to sugar, industrial gas and space industry, on the contrary, could be a drag, given the slowdown in orders from the sugar industry.
The steel foundry division, apart from meeting the captive requirement of the wagon division, is a major supplier of bogies and couplers to other wagon builders. It is also the largest supplier of bogies and couplers to the Indian Railways with a market share of about 32 per cent and 42 per cent respectively.
A healthy demand scenario, doubling of capacity and the thrust on export lend confidence in the revenue visibility of this division. Consequently, the foundry division is likely to emerge as a growth driver in the future.
For the quarter-ended December 2006, Texmaco recorded a 61 per cent rise in revenues compared to the corresponding previous quarter. The operating profits margin, however, remained stable at about 13 per cent despite a rising cost scenario.
Concerns
Since a significant portion of the overall revenues is contributed by the Indian Railways, any slowdown or delay in orders could affect the earnings negatively.
Texmaco also faces the risk of under-utilisation of capacity, given the dependence of its wagon division arising from erratic planning and off-take of Indian Railways. Hence, when there are no orders from the Railways, margins could come under pressure.
This apart, an unprecedented rise in raw material cost, increase in competition and any unfavourable change in government policies also pose a downside risk to our recommendation.
Shree Renuka Sugars: Hold
Investors with a two/three-year perspective can retain their exposure in the Shree Renuka Sugars stock at the current price. This recommendation follows an earlier "book profits" recommendation on the stock at the Rs 1,030 levels. The revision in outlook is based on the stock's much cheaper valuations at the current price levels and the possible upside to stock price arising from the recent completion of the company's expansion projects.
Though the earnings outlook for the sugar sector, in general, appears bleak in the light of the weak trends in the domestic and global prices, Renuka Sugars may remain an out-performer on account of a recent scaling up of capacities and new revenue streams from the sale of ethanol and other by-products. The stock trades at about eight times its estimated FY-07 earnings (year-ending September 2007).
Scaling up production
Renuka Sugars raised funds through an IPO in October 2005 to substantially scale up its production, refining, ethanol and power cogeneration capacities that were spread across Karnataka and Maharashtra. The capex plans, which included cane crushing capacity of 12,500 tcd and cogeneration facility of 23.5 MW, were revised upwards after the IPO, to 20,000 tcd and 50 MW respectively. The company also flagged off a new 2,000 tcd sugar refining unit at Haldia to enable trading operations. The expansion plans envisaged in the IPO have been completed only recently, with the commissioning of crushing and distillery capacities in Munoli of 7,500 tcd and 120 klpd respectively, commissioning of the greenfield 4,000 tcd unit at Havalga and the setting up of the 6000 tcd unit at Athani. Given that each of these expansion projects have been completed in phases between December 2006 and March 2007, they can be expected to contribute to revenues and earnings only from the current quarter.
No doubt, the substantial ramp-up in the company's production capacity has been timed, rather unfortunately, to a downturn in the domestic sugar cycle. Domestic sugar prices have declined nearly 30 per cent over the past year after a series of upward revisions in domestic sugar output estimates. These revisions have left the latest production estimate for the 2006-07 season (ending September) at over 260 lakh tonnes, doubling sugar inventories to about 100 lakh tonnes at the end of season — a full six months' consumption.
Margins under pressure
With inventories at a comfortable level, and next year's sugar output forecast to grow further to 280 lakh tonnes, prices may remain in the depressed mode for some time to come. Even the recent lifting of the export ban and the incentives announced by the government may not provide significant succour from surplus stocks in the domestic markets. Global sugar prices have corrected significantly on the back of excess supply in the current crop year and expectations of a higher Indian output.
These factors suggest that the company's margins may be under pressure in the coming quarters. Declining sugar prices have already contributed to a sedate financial performance from the company in the quarter-ended March 2007, with consolidated net profits declining by almost half to Rs 22.9 crore in this quarter, despite an expansion in revenues.
Moderate growth
However, Renuka Sugars still appears well placed (compared to peers in the sector) to deliver moderate earnings growth over a one/two-year time-frame. For one, going forward, lower realisations on sugar may be offset partially by the substantial volume growth from the recently expanded capacities.
Second, with the company successfully bidding for contracts to supply ethanol to the oil marketing companies, it is set to scale-up its ethanol supplies to these companies from about six million litres a quarter to about 12 million litres over the few quarters. Though this is a fixed price contract (realisations at Rs 21.50 per litre), the higher ethanol sales would add directly to the bottomline. The company is among the largest ethanol suppliers in the domestic market. Third, with its factories located mainly in Karnataka and Maharashtra in surplus cane areas, the company faces relatively low competition for procurement of cane and low-cost pressures on this score. Fourth, the recent lifting of the export ban on sugar could enable the company to scale up its trading operations, which would contribute additional revenues. Export opportunities for ethanol and any realisations from carbon credit would be an added bonus.
In any case, locational advantages associated with the company's mills, its integrated processes and the ability to process raw sugar, all contribute to an extended crushing season and high operational efficiency and productivity for the company's operations. In light of these factors, shareholders can retain the stock in the hope of some upside to the price.
Tata Power: Hold
Shareholders can stay invested in the Tata Power stock, which has appreciated 10 per cent in the last seven trading days. The long-term prospects for the company appear bright as the ambitious capacity expansion programme will begin delivering results by 2010.
Fresh buying, with a medium-term perspective, can be contemplated at declines from the current levels linked to broad market trends.
Expansion-driven growth
Tata Power will be adding more than four times its current capacity of 2,300 MW in the next five years taking its total generation capacity to about 15,000 MW.
This includes the 4,000-MW Mundra Ultra Mega Power Project that formally came into the company's fold following the acquisition last week of the special purpose vehicle created for the purpose by the government.
This apart, Tata Power is also planning a 3,000-MW project in coastal Maharashtra that will be fuelled by imported coal, just like the Mundra plant, and a 1,000-MW plant in Chattisgarh based on domestic coal.
The smooth completion of all formalities for the Mundra Ultra Mega Power Project and the acquisition of two coal mining companies in Indonesia that will supply fuel to the project appear to be driving the present positive sentiment in the stock.
The acquisition of the Indonesian companies will secure 50 per cent of Tata Power's requirement of imported coal with the assurance of further supplies on production increases. Coal supplies at preferential prices and long-term fuel security are two obvious advantages for the company flowing from the Indonesian acquisitions.
Low-voltage growth
The expansion projects are critical to Tata Power's revenue and earnings that have remained stagnant over the last five years showing almost flat growth.
While revenues are hostage to fuel prices — low fuel cost means lower prices for electricity supplied — profits are largely a factor of the company's ability to rein-in costs and maintain a high plant load factor, which it has managed to do well ensuring that there is no dip in the bottomline.
Though revenues remained flat, Tata Power continued to increase generation and sale of electricity in unit terms. For instance, in the third quarter of 2006-07, electricity generation was higher by 12 per cent while electricity supplied grew 9 per cent to 3,655 million units.
The third quarter was financially a good one for the company, thanks to a Rs 159-crore tax write-back of provision made in earlier years. The final quarter's profits are likely to be affected by this, as the company is obliged to pass on the tax write-back benefit to its customers.
There is also a worry over the operating margin in the third quarter which, at 17.55 per cent, was the lowest in the first three quarters of 2006-07.
Meanwhile, North Delhi Power Ltd., the distribution subsidiary in Delhi, has been performing exceptionally well in curtailing aggregate technical and commercial losses and the experience in the tough Delhi circle should stand the company in good stead as it bids for other distribution privatisations in future.
Tata Power's stated intent to bid for other ultra mega power projects that are likely to be put up for competitive bidding, and its plans for the transmission line business, augur well for its growth prospects.
Shareholders should note that the company's revenue and earnings buoyancy may not be significant till the new capacities come on stream. As such, the stock is for those with a medium-term perspective.
KEC International: Buy
KEC International's strong financial performance, superior execution skills in power transmission projects and diverse client base provides high visibility to its earnings growth. Investors can consider investing in small lots. Any weakness related to the broad markets can be used to increase exposure.
At the current market price, KEC International trades at about 14 times its expected FY08 earnings. Investments can be considered with a two to three year perspective.
KEC is an integrated player in the power transmission business. The company's current order book at Rs 3,000 crore is about 1.4 times its FY07 revenue. KEC has reported a decline in its project execution cycle from 24 months a couple of years ago to 18 months now. This is likely to lead to quicker translation of revenue to earnings thus lending higher visibility to earnings in the near term. KEC has chosen to focus on project management and outsource the low-margin tower manufacturing business, unlike a few other players in this space who manufacture in-house. We view KEC's focus on the high margin project management segment as a positive to maintain margins and prevent any disruption in execution, arising out of capacity constraints.
KEC has a diversified client base with a firm footing in West Asia and Africa. It has recently entered into a joint venture with US-based Power Engineers, a power transmission distribution consulting sector. With this the company has bagged an order in the country. Over 70 per cent of KEC's present order book comes from overseas projects. While the strengthening of the rupee against the dollar may pose concerns on foreign exchange, the company operates in different currencies as the projects are spread across the globe. This may provide some against any particular currency risk. KEC is also looking to enter the Build Own Operate (BOO) model in power transmission through a joint venture. While the company will see strong competition from bigger players, success in this space could improve the margins for the company. A good number of KEC's overseas projects are fixed price contracts. Any steep hike in raw material costs can affect margins and remains a principal risk.
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