Sunday, June 10, 2007
|Four years after delisting its shares from the Delhi Stock Exchange, real estate behemoth DLF is knocking at the capital market again selling shares at - hold your breath - 837 times the valuation at which it exited the stock market. Should you buy?|
|If the country's largest real estate developer DLF had been listed on the bourses over the past four years, it would have delivered a return unparalleled in the history of Indian stock markets.|
|Promoter K P Singh opted to delist the company in its earlier avatar as DLF Universal from the Delhi Stock Exchange in September 2003 by buying back the public holding, valuing the company at Rs 112 crore. Over the past 45 months, DLF has seen an annualised appreciation of over 500 per cent going by the valuation it is commanding for its latest initial public offer.|
|The 10-odd per cent public shareholders would have potentially amassed wealth of over Rs 8,500 crore by now had the company remained listed. In a dramatic reversal though, the ace builder is now offering to dilute 10.26 per cent stake earlier bought back by the promoters dirt cheap -- for less than Rs 50 crore, for a minimum of Rs 8750 crore.|
|"The market would not have forgiven a smaller company for this act but here we are talking about one of India's largest private enterprises and that too at a time when global investors are queuing up to get a share of booming real estate market," says a leading fund manager on the condition of anonymity.|
|After controversies relating to a small group of minority shareholders who had remained invested in the stock even after the delisting, DLF was forced to withdraw its application for public offer from the capital market regulator last year.|
|Even as the book building for the IPO constituting 17.5 crore equity shares of Rs 2 each priced in the band of Rs 500-550 begins today, it appears that the delay has ironically played out in favour of DLF with market sentiment much better than a year ago.|
|The company has utilised the additional time fruitfully by changing its corporate structure and strategy that has helped it inflate profits for the past year over ten times and make it less difficult to justify its aggressive projections.|
|Valued at the higher end of the price band, the company would be the eighth largest by market capitalisation, post-listing. With negative cash flows and current earnings abysmally low compared with future projections, the company is demanding its price relying solely on its vast land holdings, the value of which is not clear.|
|Here is the promise. Armed with 10,000-odd acres, DLF plans to build over the next 10 years more than double the area it has developed over the past 60 years. In the next three years, DLF has a target of developing over 70 million square feet or triple the area it has developed till the last calendar.|
|As a result, investment bankers are forecasting the company's sales at Rs 20,000 crore in fiscal 2009, up from Rs 2600 crore achieved in the last fiscal, and net profit in excess of Rs 11,000 crore, roughly six times that for the year gone-by.|
|The grand plan|
DLF has outlined a three-pronged growth strategy, which includes strengthening its pan-India presence, building up land reserves at strategic locations, and leveraging its real estate capabilities in related areas be it special economic zones or hospitality.
|The company will primarily be a developer and sell its properties retaining limited assets to be leased out. The money raised through the IPO would go towards buying more land (Rs 3500 crore), developing existing projects (Rs 3500 crore) and repayment of loans.|
|Going by the scale of development done so far, DLF is the largest real estate player in the country with land reserves of 10,255 acres or about 574 million square feet (msf) of developmental area. Of this, 171 msf is located in or near developed urban areas while 404 msf is urbanisable.|
|"About 90 per cent of the total land bank is available as large contiguous plots enabling large integrated development", says, chief executive officer Rajiv Singh.|
|After being centered around Delhi for many years, the company now has a nation-wide presence across 31cities and towns. It has developed 29 msf of residential, commercial and retail projects and integrated townships spread over 3000 acres in Gurgaon so far. Currently, some 44 msf of development is under progress and projects involving 524 acres is planned over the next few years.|
|The company intends to focus on its core competence while partnering with leading global players such as Nakheel (SEZs), Laing O'Rourke (construction), ESP (engineering and design), Feedback Ventures (project management) for better execution.|
|Right from acquiring low cost land to creating a full fledged township to realise the true potential of the land, DLF has amply demonstrated its success in Gurgaon. One key advantage is that DLF's average cost of acquisition of land is fairly low at around Rs 274 per sf which will enable it sit out the cycles and not indulge in distress sale ever.|
|Some key determinants of profitability for real estate companies apart from the land cost, is the developer's land acquisition and aggregation skills, relationship with the state authorities and reputation – on all these DLF scores highly.|
|And with its unquestionable capabilities as a successful developer, DLF seems best placed to capitalise on the booming real estate market, which is expected to grow at 20 per cent-plus annually from the current size of $40-45 billion.|
|Even more, the national capital region, where the company has over 50 per cent of its land holdings, is among the fastest growing markets in the country. Apart from the boom in retail malls and residentials owning to rising disposable income, there are several new vistas opening up for developers which DLF is planning to tap -- for instance, SEZs which offer opportunities to create integrated townships, hotels and serviced apartments, multiplexes, airports and the list goes on.|
A look at DLF's financial performance is hardly inspiring. Last year, the company sold its asset to a group company to get its revenues and profits to a respectable level. Sales to fully owned promoter company DLF Assets Limited (DAL) constituted almost 55 per cent of total revenues and 77 per cent of profits.
|According to a newly devised strategy, the company would, instead of leasing out commercial projects, indulge in outright sale to potential buyers including DAL. This model rests on the ground that DAL would be able to garner low cost capital by tapping the alternative investment market overseas and pay a higher capitalisation rate for DLF's properties resulting in faster growth in revenues and better margins too.|
|Though swift disposal of assets can favourably alter DLF's return ratios, DAL's ability to raise cheap funds is still unclear and poses a threat to DLF's cash flows.|
|Even otherwise, earnings of developers tend to be less predictable with lumpy revenues and cash flows. And after the phenomenal rise in property prices over the past three to five years and the rise in interest rates, analysts expect a property price correction because of the double whammy.|
|Though demand for retail malls and commercial estates is currently buoyant, huge supplies are yet to hit the market with most builders planning an aggressive ramp-up, again, increasing the risk of weaker property prices.|
|On the residential side too currently, investors (or the secondary market) are selling residentials at a price lower than the builder's price in most parts of the country and the demand from investors could dry up if cost of funds continue to be high and properties do not turnaround around quickly. Roughly, a 1 per cent fall in sales realisation cuts DLF's earnings by 2 per cent. If prices were to correct about 10 per cent, a fifth of its earnings could be shaved off meaning stock prices could take a considerable beating.|
|Is it fair?|
So what is a fair price to pay for DLF? Since there is little strength in either its P&L or balancesheet, an investor is essentially betting on the ability of the management to create another Gurgaon and realise the best price for their cheap land. To put a number to this, analysts are looking at the net asset value of the company which is essentially a measure of cash flows of the firm from its entire land bank discounted by its cost of capital (CoC) less the debt in its books.
|Various analysts peg the net asset value in the range of Rs 70,000 crore to 95,000 crore. Edelweiss estimates NAV at approximately Rs 88000 crore based on a CoC of 12 per cent primarily assuming that the company would develop the entire land bank only over the next 15 years as against the management projection of 10 years.|
|This results in fair value of Rs 512-517. First Global estimates NPV at Rs 70,000 crore or Rs 413 per share based on its base case assumptions and says that a majority of global real estate companies in Singapore and Hong Kong trade at a discount of 10-30 per cent discount to NAV.|
|DLF's investment bankers too estimate NAV to be in the range of around Rs 80,000 crore to Rs 1 lakh crore but they argue that the company deserves to be traded at a premium to its NAV, an argument most domestic fund managers refuse to buy. Property stocks in Hong Kong, China, Singapore, Japan and Australia have traded at earnings multiples upwards of 20 in their early cycle but on this metric again DLF looks grossly expensive.|
|Apart from property prices, another risk for DLF is that of delays in execution. Edelweiss estimates that for every one year delay in execution would drag down the net asset value by six per cent.|
|Says Ramdeo Agrawal, managing director, Motilal Oswal, "Although the future seems quite rosy, the stock will face several challenges going forward trying to meet the tall projections that form the basis of current valuations." He adds that there is little margin of safety in buying the stock at current valuations.|
|Besides, with nearly 112 related entities and the promoter's past track record concerns on corporate governance remain. Although Rajiv Singh reassured investors of good governance standards during the IPO launch, on paper (prospectus) the company has gone out of the way to state that "we cannot assure that our promoters will act to resolve any conflicts of interest (with certain other promoter-owned companies) in our favour or in the best interest of our minority shareholders," signalling that investors better be prepared for negative surprises.|
|Having said that, the issue looks poised to deliver good returns in the short term. Flush with liquidity from global investors, investment bankers are confident of a huge over-subscription. For the common investor on the Street it is time to make a quick buck. For in the longer term, India's largest builder appears to be on a shaky ground.|
Vishal Retail’s IPO appears reasonably priced considering the growth potential and its unique strategy.
The great Indian middle class has demonstrated its purchasing power time and again, the proof of which could be found in markets ranging from telecom to the burgeoning retail sector. To capitalise on the spending spree, and benefit from the rising disposable incomes across the country, Vishal Retail has adopted a strategy to focus on mid and smaller cities.
The company has 51 retail hypermarkets across 39 cities so far, of which only seven are located in large (Tier-I) cities. It now plans to expand its reach even more in order to create a pan-India presence with 82 stores by FY08. To fulfil this objective, it is coming up with an initial public offering (IPO) to aggregate Rs 110 crore, to part fund its expansion.
Bottom of the pyramid
Vishal Retail targets consumers mainly in the second and third tier cities of India, where its larger competitors have not yet set foot. Apart from tapping the aspirational consumers early on, its proposition of value retailing tends to work better due to low rentals for retail spaces in these cities.
"Our average cost of rent across all the shops is Rs 31.50 per sq ft, while our retail price of goods remains the same as it would be in the metros," claims Ram Chandra Agarwal, the company's chairman and managing director.
Vishal's rentals are considerably low compared to the average rentals in Tier-I cities which range anywhere between Rs 50- Rs 100 per sq ft. In addition to lower costs, the company has also managed to set up an efficient supply chain, and is now confident of entering even the larger cities with a similar value retailing proposition.
Starting with a topline of Rs 50 crore in fiscal 2003, Vishal Retail has managed to grow to Rs 603 crore last year (See table: Solid growth). Its topline grew at a compounded rate of over 86 per cent annually, over FY03-FY07.
For the same period, its compounded growth in net profit was a whopping 160 per cent. On the operating profitability front, the company has consistently improved its operating profit margins from a meagre four per cent in FY03 to over 11 per cent in FY07.
"Going further, we expect to maintain similar levels of profitability by integrating backward," says Ritesh Rathi, chief operating officer.
The company already has a 5,000 pieces per day apparel manufacturing unit in Gurgaon, and plans to set up another unit in Dehradun. Its existing shareholders include HDFC, a Delhi-based private equity firm Gaja Capital, the Burman (of Dabur) and Munjal (of the Hero group) families, among others.
Given that the organised retail has penetrated the Indian markets just 6 per cent, and is expected to grow by 25 per cent annually to become a Rs 12,180 crore industry by 2010, the potential is vast.
Vishal Retail, with its strategy to spread out to the smaller cities, is creating a strong base to compete with its larger counterparts. The company has over 1.2 million sq ft of retail space currently, and has another 4 lakh sq ft tied up for 13 stores as part of its expansion plans for FY08.
At 13-15 times FY08 estimated earnings, Vishal Retail appears reasonably priced compared to larger established organised retailers like Pantaloon Retail (67), Shoppers' Stop (77) and Trent (22). When compared on other parameters, such as return on equity and return on capital employed, the ratios are favourable for the company (See table: Returns).
Vishal Retail is expected to earn a RoE of about 13 per cent on its expected FY08 earnings, as compared to Pantaloon's 9 per cent, Shoppers' Stop's and Trent's estimated 7 per cent. The RoCE is expected to be about 27 per cent on its estimated FY08 earnings, as compared to Pantaloon's 7 per cent, Shopper's Stop's 8 per cent and Trent's 6 per cent. To sum it up, the issue appears worth subscribing both for short and long term investors.
The Indian rupee's wave impulse on the down seems incomplete, making a case for further appreciation.
The INR touched our anticipated level close to 40. In the Smart Investor dated December 4, 2006, we said, "The currency is headed down to 43 and lower, despite what the RBI does, despite macroeconomic conditions and despite the seasoned trader."
When we hit 43, we carried the next rupee update on April 2 saying, "The long term trend remains near 40 vs. the dollar". Well, the wait was not too long, as in barely two months the INR managed to touch 40.14, missing 40 by a whisker.
And where do we go from here? There are several ways to get an answer to this. We can try interpreting the story and see the correlation between the Rupee and the Sensex, or the talk about the wave of capital flows, or the drivers behind the Indian economic story, which never tires and knows no cycles.
Not to forget, we can try comprehending the Reserve Bank endeavours to curb volatility in the local currency, which saw a free fall of 15 per cent in less than a year. Other reasons might lie in the forex reserve settling at a new high.
Some might even look out of the box. What is the rupee strengthening against? It's the Dollar. So if the Dollar Index continues to weaken, the INR will strengthen against its counterpart. So may be, the stories should be pegged around Dow and not the Sensex.
So as you see, there can be more reasons, innocuous and silly. For us at Orpheus, it's not over yet. And markets, like Keynes said, can remain irrational longer than you can remain solvent.
So just that 40 seems a good psychological level, and good enough for a pause, can't be a reason for INR to pause. The psychological or wave impulse down seems incomplete.
We will be surprised if any bounce back takes the INR beyond the 42 level. We see this as a coiling continuing action. The main trend still seems down to near 38 or lower. Above 42 we review.
AMTEK AUTO: The company continues to pick up assets and clients and could soon end up being India’s biggest auto parts maker.
Striking when the iron’s hot. That’s something Amtek Auto, India’s second largest auto components maker, has been doing quite well.
Over the past seven years, the Delhi-based firm, which is expected to post revenues of Rs 4,000 crore plus in FY07, has made six overseas acquistions, giving it 10 manufacturing bases overseas. It’s no surprise that Amtek’s stock price has appreciated ten-fold over the last five years from just Rs 40 to Rs 420 today.
Amtek Auto’s latest buy is an aluminium foundry in the UK, with a capacity of about 20,000 tonnes per annum. At $35 million, the deal is valued at around 0.6 times sales.
That doesn’t seem too high a price even if JL French (Witham) – the seller – is in deep trouble, and its plant running at just over half the capacity. It posted revenues of around $60 million last year and barely managed to stay out of the red.
What’s more, as Ramnath S, who tracks the automobile space at SSKI Securities, points out, “JL French has capabilities in product design, high pressure die casting and precision machining. Also, Amtek gets some brand new customers like PSA Peugeot, a top of the line name.”
Like it has done with assets that it bought out earlier, this time too Amtek will shift JL French’s 18 production lines back to its Pune plant over the next three to four years. The idea is to make cheaper aluminum castings which are used extensively by the automotive industry.
Says Santosh Singhi, CFO,“ Once we shift the entire capacity back home, we will have a total of 40,000 tpa and that should give us better economies of scale. In any case, we should save at least 30-35 per cent on labour costs by manuafcturing in India rather than in the UK.”
Adds Ramnath, “It should be possible to scale up the operations of the JL French facility with minimum capital expenditure.” Indeed, Singhi believes that once production is ramped up to match the capacity, profits from the JL French unit should be close to $10 million compared with less than $ 1 million currently.
In fact, that’s precisely why Ford Motor, one of JL French’s bigger customers, recommended that Witham sell off the assets. Ford even agreed to up prices by about 3-4 per cent so that the unit could become more profitable.
Explains Arvind Dham, chairman, Amtek “In such deals, it’s important to have the approval of key customers. Besides, customers realise there has to be some solution to the problem, so they’re willing to look at price hikes.”
So while Ford can surely hope to source cheaper components from Amtek, the Indian firm’s client list, which already boasts of marquee names such as BMW, Hyundai, CNH Global, Scania, Delco Machining, Land Rover and Renault, should also gain from the company’s more efficient operations. Umesh Karne of Emkay Securities expects Amtek’s operating margins to expand by at least 200 basis points in the next two years.
Currently, over 70 per cent of Amtek’s consolidated revenues come from sale of components to passenger car makers. With a new set of customers, this share could go up further.
Meanwhile, Dham talks about a merger between Amtek Auto, in which the promoters have 33 per cent and Amtek India, also an auto ancillary firm, in which they have 38 per cent. “We have been doing some re-organising because we have so many companies and a merger is on the cards,”he explains.
So, will Amtek overtake Bharat Forge to become India’s biggest component maker? Dham asserts that he doesn’t want to make comparisons but says Amtek is hoping to achieve a turnover of Rs 7,000 crore in three years, using both the organic and inorganic routes.
For perspective, market leader Bharat Forge posted consolidated revenues of Rs 4,178 crore in FY07. While Amtek Auto should register sales of around Rs 4,000 crore for the year ending June 2007, the numbers are not comparable because Amtek’s revenues include several inter-segment transfers.
Says Karne, “Amtek may not become bigger than Bharat Forge, unless it does more acquistions than the latter, but it should remain a very close second.” No mean achievement this.
TATA TEA: The company's water initiative, though insignificant today, could pay off in the long run given the huge potential for growth.
It tested the waters by picking up a 30 per cent stake in vitamin water player Glaceau for $670 million last year.But in less than a year Tata Tea decided to sell out because it didn’t want to play second fiddle to a new multinational owner.
That doesn’t mean it’s mothballing ambitions to become a global player in the water segment. On the contrary, last week, the Rs 4,045 crore tea and coffee maker picked up a 45.7 per cent stake in Mount Everest Mineral Water, which owns the Himalayan natural mineral water brand.
At an enterprise value of Rs 470 crore, the deal appeared to be a trifle expensive because Mount Everest’s sales are just about Rs 25 crore. However, the value of the company, according to Percy Siganporia, managing direcor, Tata Tea, lies in an aquifer in the Himalayas, which is one of the largest, purest and perennial sources of spring water.
“The aquifer is on a 99 year old lease from the government and barely one per cent of its potential which could be about a billion litres, has yet been tapped,” says Siganporia.
Neither has the potential in the Indian market. Despite growing at 25 per cent annually for the past decade, sales of bottled water today are estimated at just about Rs 1,100 crore.
The space is fragmented with nearly 200 brands, most of them regional. But experts say that with investments coming in, there is bound to be some consolidation. Even if the market doubled, however, it would not account for more than 8-9 per cent of the world market which consumed 154 billion litres in 2004. Its share of value would be even less.
That’s because prices haven’t risen too much over the years, as Unmesh Sharma, FMCG analyst with Macquarie Securities, points out.“It’s not a bad idea to have a presence in the space because penetration is extremely low,”he says.
At 0.6 litre per person perannum, consumption is way behind that in countires like Italy where it is 183.6 litres.While the Parle group, which hawks the Bisleri brand, is understood to command a value share of of 16 per cent, multinationals Pepsi which owns the Aqua Fina brand and Coca Cola which sells the Kinley brand are estimated to have a share of 13 per cent each. Himalayan’ s share is believed to be about 10 per cent.
And that’s what Tata Tea will be looking to grow. The strategy, according to Pradeep Poddar, CEO, will be to start off with the institutional market, where Himalayan already has a presence.
As Yasmin Shah, who researches the FMCG space at Alchemy Securities, points out, “The firm can use its own distribution network and also tap group companies such as Indian Hotels.” For the retail foray too,which will happen soon,Tata Tea will bank on its distribution strengths.
But that alone will not boost volumes. In a price sensitive market, even those that have priced their products lower than Himalayan, are not finding the going easy. Nestle has reportedlywithdrawn its product, taking a Rs 50 crore hit. Himalayan is priced at a premium—a one litre bottle retails for Rs 25 compared with Rs 14 for other brands. Foreign brands such as Evian and Perrier are, of course, priced far higher at between Rs 80 and Rs 110 a litre.
But, Poddar’s confident customers will upgrade. “Aspirations are growing and we believe that customers will be willing to pay a premium for spring water,”he says.
At a later stage, Poddar’s looking to broaden the product range to include vitamin water, so as to straddle the entire segment.
And it’s not just the home market that Tata Tea’s setting its sights on; Siganporia believes there’s tremendous potential overseas. That’s true. Sales of bottled water in the US market alone were about $1 billion in 2006 and the market is growing. Mount Everest,may be a small brand,but for Tata Tea it’s a good start
Via Business Standard
Mid-cap stocks are in the news. Here's why you should jump on to the bandwagon. Benefits of diversification between different asset classes are well known. Putting all your eggs in one basket, be it stock market, real estate or fixed income is risky. It may lead to high volatility as well as under-performance of the portfolio in long run.
In the same vein, once it’s decided what portion of your portfolio needs to be invested in equities, you should further diversify within this asset class. A good diversification would include investing in different stocks based on sectors, type (growth vs value) and market capitalisation.
Similarly, it’s important to balance between growth and value stocks (simply put, high price-earnings (P/E) multiple vs low P/E multiple high dividend stocks).
Companies are differentiated on the basis of their size into large, mid and small-cap stocks. Some of the examples are Reliance, HDFC and SBI (large-caps), SKF India, Arvind Mills and Mphasis BFL (mid-caps) and Natural Capsules, Indian Toners etc (small-caps).
After the market correction in May 2006, the subsequent market recovery was restricted to large-caps alone till January 2007. Most of the mid-caps remained at the depressed May 2006 levels and had hardly moved.
Over the last couple of years, mid and large-caps have rallied one after the other with only a couple of months at maximum separating one from the other. If, large-caps rally from May to July, mid-caps would follow by August or September.
This time, the gap between rallies in the large and mid-cap classes has been of around eight-nine months and probably the longest in recent times. This year, the mid-cap index has rallied for the past few months. For example SKF India, after spending nearly 12 months hovering around the price of Rs 300, suddenly moved to Rs 480 from April beginning to May end—a 60 per cent return in just two months.
If we look at the recent past at the stock market in general, the large-cap CNX Nifty as of June 1, 2007 has given a three-year annualised return of 42 per cent.
This performance gets slightly better, if we consider last one year returns at 45 per cent. Compare this with CNX Midcap returns of three years and one gets a similar figure of 43 per cent. And in the last one year, the return has been to the tune of 33 per cent.
Sure, if someone invested with a one-year horizon, he would have been better off in large-caps. But over three years, the returns are more comparable. Over a longer period, the difference could be far larger. But since in India, we do not have very long period data on mid-cap indices, let’s visit a study done in the US.
In 2005, US research firm Morningstar released a report on returns generated by mid-caps vs large-caps in the US over a period of 30 years from (1975 to 2005). According to the report, Every dollar invested in large-cap stocks in 1975 would be worth $32.7 in 2005 vs $65.3 in mid-cap stocks! That’s more than double. The CAGR stands at 14.9 per cent.
If we look around us in India, common stock market millionaires are those who invested in HLL in the seventies, Reliance in the eighties, Infosys in the nineties and Bharti in 2000s and held them. Dr Reddy’s, Cipla, Asian Paints and most of today’s large-caps too fall in that category. These were mid-caps not too long ago. These stocks are unlikely to make you millionaires if you were to enter now.
Consider the following points before you make a judgment call on mid-caps: In any time frame of investments, both categories will have some losers and some winners. Large-cap HLL has lost 15 per cent over the past year.
Given the fact that large-caps have rallied during the same time by 45 per cent, the opportunity cost for the HLL investor is 60 per cent (45 per cent lost in not buying the index and 15 per cent lost on account of holding HLL.
Stocks of sunrise industries will mostly be mid-cap stocks in their early phases. For example, the information technology industry, the mainstay of our services industry as well as exports today, was a sunrise sector in early nineties.
The mobile telephone industry was similar in early 2000s. Big money making opportunities were available to investors through only mid-cap companies in these sectors.
Only later, companies in these industries, after passing through volatile and testing times prove their worth and move up the next level–the world of large-caps.
Today, we could possibly classify media and healthcare sectors in this category. Healthcare need is rising in the country. Rising population and stressful lives are fuelling this demand.
Besides, most of the Indian pharmaceuticals companies have a robust export business. In media, there is strong demand for both print and television as penetration increases.
However, like Infosys in IT or Bharti in telecom, it’s difficult to name a single company that would represent healthcare or media in the future. Some companies are taking small steps to get there – are they large-caps in the making? We do not know. But surely one can say that there will be some companies which will emerge as market leaders in the next decade. Picking that winner is the challenge.
But then there are drawbacks to investing in mid-caps we well.
# Expect volatility in the initial years
# Unknown management
# Cost of borrowing is higher so their balance sheets take bigger hits in terms of interest payout etc
# Low liquidity, especially if markets turn negative
The two most important factors that will determine your financial health in the mid-cap universe are good research and lots of patience. If your investment time horizon is long, this segment of the equity markets is definitely a must have in your portfolio for keeps.
Via Business Standard
Indian stocks are at a crucial support level. If the indices break crucial support levels, the upper side resistance will become stronger.
The Sensex crossing its all-time high level seemed imminent at the beginning of last week but global cues and events changed the course. In fact, June may maintain the current market volatility.
On the back of the turbulence in the Chinese market, came the bad news from Europe last week. The European Central Bank had raised the interest rates to a six-year high.
As bond yields were rising sharply in the US, international investors assumed that America may actually raise the rates in the near future. This triggered selling that let the markets down.
After a long gap, Indian markets saw dampening effects in the last hour of trading as cues started coming from the European markets. If Asian markets follow the US performance on Friday and open with some optimism on Monday, India will find some short-term support.
On Friday, the US stock market rebounded, ending a three-day slump, after bond yields retreated from the highest level in five years and oil prices fell.
Domestic cues will be available from the industrial production data, which might be announced on Tuesday. It will give signals about the effectiveness of the RBI measures to control overheating in the economy.
Even the weather will play its part. Markets will find a reason to fall if the monsoon gets delayed. Early rains could help the fertiliser and agro-chemical sectors and companies such as Mahindra & Mahindra will see a surge in tractor demand.
Cement stocks can expect a dull season. With low demand and saturated prices, some fall is expected. The auto stocks are also not doing well as automobile majors are on a production mode and the market will continue to discount this as seen from the selling.
The recent fall of the rupee could help export-dependent companies, especially IT firms and boost the realisation.
Some expectations on the sugar and textile fronts on the incentive package being announced had also helped the market to withstand the selling pressure.
Such sector-specific developments should be watched. Markets would also look at factors, which would help find support at lower levels. The market would be favouring DLF and ICICI Bank issues in the primary market.
Foreign investors interest is intact. Said a Singapore-based fund manager, “Many FIIs want to enter Indian markets . Even if the market does not fall for a few days, they are willing to enter at the current levels.” If FIIs do this, it will provide the required boost to the bulls.
The markets corrected last week as participants booked profit ahead of the mega DLF IPO. Moreover, weak cues from global markets also pulled the market down.
On each falling day, the markets attempted to recover, but every rise was met with greater selling pressure at higher levels. However, the main indices have so far not breached their key support levels.
As long as these levels hold, the strategy of buy-on-decline should continue. But once these levels are breached, the market sentiment will become bearish in short- to medium-term.
Last week, we said if the Sensex crossed the weekly high, it could rally to a new all-time high. However, the index could barely manage to move higher than the previous week’s high at 14,683.
Considerable selling saw the index tumbling to a low of 14,011 — an intra-week fall of 673 points. The Sensex finally ended with a loss of 507 points (3.5 per cent) at 14,064.
It was also predicted last week that the 14,000-mark for the Sensex would be a key support level for June. This week can very well determine the future market trend for the month. One needs to closely watch the 13,900-14,000 level for buying support.
The Nifty spurted to a fresh all-time high of 4,363 at the beginning of the week, but thereafter, the gains fizzled out and the index slumped to a low of 4126 — a drop of 237 points. The index finally finished with a significant loss of 152 points (3.5 per cent) at 4145. The key support level for the Nifty this week will be 4085.
Among stocks, Infosys continued to find support around the Rs 1,900-mark. A sharp depreciation in the rupee helped the stock gain some strength in an otherwise weak market. With strong support existing at Rs 1,900-level, the stock may now attempt to cross its resistance level of Rs 2,000.
The ITC shares, true to our prediction, dropped to a low of Rs 150 last week. It will be interesting to see if the support holds, and the stock bounces back from the current levels. If not, the stock may slide to Rs 135-level.
The second tenet of technical analysis is that `price discounts everything'. To accept this tenet, one needs to spend at least a few years poring over the industries and companies' performance data, trying to correlate the stock price moves to such numbers. The frustration that this exercise leads to, will lead to dawning of the ultimate truth — price is determined by not just fundamental but political, psychological, economic and even manipulative factors.
That is the reason why most technical analysts believe that study of the market price is sufficient in forecasting the future trend in prices. If the stock is in an up trend, it means that the factors affecting the price are bullish — so demand is greater than supply. The reverse is true in a downtrend i.e. the factors affecting the price are bearish — so supply is greater than demand.
One of the reasons for the superiority of the study of market action is the inefficient nature of our stock markets where information is not disseminated evenly to all. Insiders who buy and sell based on news and information that is known to a select few cause sharp and unaccountable fluctuations in price.
The technical analyst can accept the sharp spike in price as a breakout and trade on it, whereas a fundamental analyst would have qualms about buying a stock without understanding why the price is moving in such a fashion. A sizeable portion of the move might be missed before such an understanding is achieved.
But this tenet is not infallible. Market action is at times entirely manipulative and undertaken by unscrupulous entities with the sole intention of luring naïve investors in to the counter. Technical indicators give false signals in such phases. They can also fail to give advance notice of an impending crash.
There are two ways in which such stocks can be dealt with. The easier recourse would be to avoid trading in such stocks. The second way out would be to move in and out of such stocks quickly, i.e. keep booking profits at every ascent.
A circuit filter is an upper/lower limit imposed on the price movement of a stock during a trading day. This is done to limit the erosion or appreciation in value that an investor is likely to experience on a particular day. Once the circuit limit is reached, trading in that stock stands frozen for the day.
The filters called `price bands' on the NSE are applied only to specified stocks. A filter can be a 2 per cent band as in the case of Tanla Solutions or a 5-10 per cent limit. As per the last update available, 3i InfoTech, Inox Leisure and Texmaco are some of the stocks in the 10 per cent band. Assuming that Texmaco is trading at Rs 950, the upper circuit limit will be reached if the price touches Rs 1,045. Likewise, Rs 855 will be the lower limit. CRISIL, Rajashree Sugars and Godrej industries are among those in the 5 per cent bracket.
Scrips such as Bharti Airtel, Unitech and Reliance Industries on which derivative products are available have no circuit filters imposed on them. The over 20 per cent rise in the price of Deccan Aviation on May 17 is a case in point. This upward movement was possible because the NSE had removed the circuit limit on the stock and added it to the Futures and Options (F&O) segment (derivatives segment) on May 14.
A price band of 20 per cent is applicable on all remaining instruments, including debentures, warrants, preference shares. The BSE also has similar filters on its stocks. The list of stocks under the respective circuit filters are reviewed by the both the exchanges from time to time.
If circuit filters are applied to movement in individual stock prices, circuit breakers are applicable to movements in the broad market as captured by the indices. The circuit breaker system applies at three stages of the index movement — at 10 per cent, 15 per cent and 20 per cent. When the Sensex or the Nifty breaches this mark, a nation-wide halt in trading is brought about. The duration of this stoppage varies from half an hour to an entire day depending on the percentage of rise or fall and the part of the day when it happens. For example, in case of a 15 per cent movement of either index, there would be a two-hour halt if the movement takes place before 1 p.m. On May 17, 2004, the circuit breaker was triggered when the market nose-dived following the defeat of the BJP in the general elections. Index-based circuit breakers were activated for the second time on May 22, 2006, halting trading for an hour. The Sensex crashed over 1100 points in intra-day trade amidst fears of a liquidity crisis.
Circuit Filters on IPOs
The recent proposal by the Securities and Exchange Board of India (SEBI) to introduce circuit filters on IPOs is to prevent the artificial jacking up of prices on the day of listing caused by speculative trades in a stock. There are several instances of stocks that have seen wild swings in price on Day One.
For example, ICRA, when it listed earlier this year, opened at a 64 per cent premium to its offer price and ended the day, with a whopping 151 per cent gain. In many cases, buy orders on listing day are not delivery-based and the initial listing gains may be unsustainable. So, circuit filters on the listing day are to shield retail investors from such sharp volatility (though they will not impact the extent of premium or discount at which stocks actually open on listing day).
Circuit filters are not expected to affect the price discovery mechanism, as the market will discover the true value of a stock over a period, if not immediately. The only flip side is that investors looking to cashing-in on listing gains will now have to be content with limited profits as filters might freeze trading, once the stock has zoomed by a certain percentage.
Investors with a medium-term perspective can consider booking profits on at least a part of their holdings in the stock of Everest Kanto Cylinders (EKC), a leading player in the manufacture of seamless steel gas cylinders. At current market price, the stock trades about 24 times its likely FY08 earnings per share. While we remain optimistic on the growth prospects given the company's market presence and increasing capacities, the positives already appear to be factored into the current stock price. Besides, given EKC's recent announcement of a Rs 240-crore expenditure for further expansion (likely to be funded through equity-linked instruments), equity dilution also remains a risk to immediate earnings.
Given the robust demand scenario for CNG cylinders, EKC is set to benefit from the increase in capacities through both greenfield and brownfield expansion. Contribution from exports is also slated to increase given EKC's presence in Dubai and China. While the Dubai plant is expected to commence production from the current quarter itself, the China plant is likely to start production from the third quarter of FY08 only. However, since the full impact of the expansion is likely to be derived from FY09 only, earnings expansion in the current fiscal year may not be at levels impounded by the stock's valuation.
For the financial year 2007, EKC registered an 80 per cent growth in net sales and 114 per cent increase in earnings on a consolidated basis. While margins improved on the back of higher realisations and utilisation, the latest quarter saw a decline in margins in the Indian operations due to a change in the sales mix. Any domestic acquisition for capacity expansion, rise in oil prices or a change in regulations by the Union Government expediting the roll-out of CNG-run vehicles are likely to remain the primary risks to our recommendation.
An investment can be considered in the Initial Public Offer of Vishal Retail with a medium-term perspective. Vishal Retail operates 50 hypermarkets (large stores that offer a wide variety of goods ranging from apparel to household goods) predominantly in North India under the name of "Vishal Megamart". The retail chain targets lower-middle and middle- income groups in the Tier-II and Tier-III cities. The offer proceeds will help fund the addition of 32 stores in cities such as Ajmer, Bareilly, Bhopal, Faridabad and Sholapur, to name a few. About 22 of them are slated to open in FY-08.
This value retailer has a revenue base of Rs 600 crore and recorded profits of Rs 25 crore in FY-07. A significant amount of its growth has been attained in the last two years on the back of new store openings.
At the upper end of the price band, the offer price values the company at about 16 times its likely FY-08 per share earnings. The company does not really have a comparable player in the listed space; it might not be appropriate to compare its valuations with more premium players such as Pantaloon Retail, which is seen as a front-runner of the retail industry and operates a mix of formats. The valuation might, however, be justified considering the strong growth potential for organised retail in Tier-II and Tier-III cities; the market in such cities is projected to grow at 50-60 per cent a year, compared with 35-40 per cent in large cities. The offer presents another alternative for investors to play the retail story at a time when its competitors, mostly focussed on the top 10 cities, are dealing with stiff competition and margin pressures. Over a one-year period, assuming the company opens its proposed 22 stores on time, the fundamental picture looks positive.
However, investors can consider taking profits in the event of strong gains upon listing. Several retailers with more financial resources are increasingly targeting small towns, having sensed the opportunities in these cities. Small towns might well be the main focus of the Bharti Retail, given that its partner Wal-Mart pioneered the small-town retail format. As these players are well-placed to achieve higher sourcing efficiencies, they are likely to deliver higher quality and branded products to these markets at more competitive prices. Second, we expect more quality players — Subhiksha being one in the near future — to tap the market over the next year to 18 months. Such offers might make for more compelling investment options for those with a long-term perspective.
Small town, big opportunity
In the medium term, however, Vishal stands to benefit from its focus on small towns, where real estate is cheaper as are staff costs. The low brand penetration in small towns makes it possible for retailers to sell more of their private labels. A large proportion of unbranded products and private labels and a high share of apparels in its sales mix explains its superior gross margin of 42 per cent as against Pantaloon Retail's 35 per cent. In the last fiscal, Vishal managed to add 27 stores, which suggests that it is capable of executing its projects on time. Revenue growth is, therefore, likely to be strong in the medium term and would drive profit growth.
However, investors would have to watch out for trends in operational parameters such as sales per square feet, footfall conversion rate and same store sales growth, where its performance has been patchy in the last couple of years. The company's same store sales growth slowed down to 11 per cent in FY-07. While footfalls (number of customers who visit the store) have risen, the conversion rate has dropped. If this trend sustains, it means that revenue growth will depend more upon its store additions and therefore, its execution capabilities, rather than the strength of its own operations.
Given the nascent stage of its operations, it might also take a while for scale efficiencies to kick in.
Offer details: Vishal Retail is promoted by Mr Ram Chandra Agarwal. The offer will raise Rs 110 crore from the public. The price band is at Rs 230-270 and the lead manager is Enam Financial Consultants.
Investors with a risk appetite can consider an exposure in the Initial Public Offer (IPO) of DLF, one of the largest real-estate developers in India.
DLF's well-rounded businesses in the residential, commercial and retail space; the superior location of its land bank; and, more important, its management bandwidth and track record place the company among the top real-estate players in India.
In the offer price-band of Rs 500-550, the company is valued at a price-earnings multiple of 39-43 times the consolidated earnings for FY-07 on the current equity base.
Given the stiff pricing, the offer calls for at least a three-year investment perspective and an appetite for risk beyond what is traditionally associated with equity investments.
The aggressive growth plans outlined by the company pose a number of risks. One, the company does not own all the land on which it has planned its projects.
Two, there are doubts about whether the market can absorb high-end luxury residential projects on the massive scale planned by the company (particularly in Gurgaon).
Three, while the company has settled the discord with the minority shareholders on the debenture conversion issue, the imbroglio has dented somewhat its image in the eyes of shareholders on its crisis management skills.
Based on the net asset value of its existing land bank (another valuation method usually applied to realty companies), the offer appears fully priced. The net asset value calculates the discounted value per share net of liabilities, based on the income the company is likely to derive by converting its land bank into projects.
This method does not factor in the company's ability to replenish its land bank and the income potential from the same.
This does not also take into account potential revenue from the company's plans in the hotel, infrastructure and Special Economic Zone segments or agreements it entered into recently to acquire other landparcels .
On DLF and the offer
DLF enjoys a strong brand positioning across residential, commercial and retail segments. It plans to venture into infrastructure projects, hotels and SEZs and has entered into joint ventures with international players for the same.
The company has developed 224 million square feet of land and has 574 million sq ft of developable area, slightly higher than its peer Unitech's 472 million sq ft.
DLF plans to raise Rs 8,750-9,600 crore through this IPO. It plans to use Rs 3,500 crore for acquisition of land and development rights and a similar amount on on-going projects.
The rest would be used to repay a part of its debt. Post-issue, the company's market capitalisation is likely to be about Rs 90,000 crore at the offer price.
DLF has stated in its offer document that its land bank of 10,255 acres is likely to last 10 years.
If the company is able to settle the balance due on its land bank (Rs 4,395 crore as of April 30), this would effectively help the company lock into land costs for projects over the next 10 years, thus cushioning against any price inflation.
This also implies that the company has a good 10-year window to replenish its land bank; it can time its acquisitions over different market phases. We consider this as a major positive for DLF, as it is important for developers to demonstrate the sustainability of their business by replenishing the raw material — land — at a good price and time.
Operations: A comparison
Going by DLF's size and scale of operations, Unitech may be the only comparable player in the listed space. A comparison between the two is interesting:
DLF's land bank diversification across 31 cities is a positive. It has land in Tier-I and Tier-II cities, providing better visibility and realisation to its projects.
As much as 51 per cent of DLF's land bank is in the National Capital Region against Unitech's 19 per cent.
Further, it has higher visibility in metro cities, than Unitech. DLF's presence in prime locations in New Delhi and Mumbai (NTC mill land) also suggests the high quality of its land bank.
We believe that this would aid the company command higher realisations than competitors.
Further, DLF's strategy of taking an aggressive stance in familiar territory, while being cautious in moving to new regions, appears a less risky way of foraying into new regions. Unitech, which has land in 16 cities, is more aggressive in less familiar territories.
DLF has aggressive plans for residential projects, especially in Gurgaon. While we do see risks from the company's exposure to that market, some of the ongoing projects give comfort.
About 85 per cent of the projects under construction is in the commercial and retail space. Industry reports suggest that demand in these segments is likely to remain strong in the medium-term, especially in the NCR.
In the light of the above, the prospects for the ongoing projects appear encouraging. It has also managed to rent out 97 per cent of the commercial space it has built so far. As for the residential segment, the company undertakes massive projects but in phases.
This allows the company to modify its plans, depending on market condition. We believe this could give the company leeway to move to the middle and upper-middle consumer group, were it to see saturation in the high-end residential business. A shift from plotted developments to townships and high-end apartments could provide acceleration to the operating profit margin over the long-term.
DLF has realised the need to augment its resources and execution capabilities for its ambitious plans, and has been striking joint ventures with strategic partners. For instance, the tie-up with international players such as WSP and Laing O'Rourke would enable DLF outsource a chunk of the design and construction activity. Similarly, partnering with players such as Nakheel Developers is likely to provide superior know-how. These may provide a cushion against execution risks.
DLF has also tied up with the Hilton group for managing hotels in India and identified 22 locations for the same. Further, in-principle approvals for 26,100 acres of SEZs and tenders for infrastructure projects are businesses in the offing.
Though the revenue streams have not been factored into our calculations, success in these areas could make DLF one of the most diversified plays in real-estate and infrastructure.
Further, the sheer size of operations should give the company the advantage of economies of scale, right from raw material sourcing to higher utilisation of assets.
This is evidenced by DLF's OPM growing from 27 per cent in 2005 to 57 per cent in 2007 (on sustainable earnings).
The contentious areas
Both sales and profit numbers for FY-07 have benefited from the sale of certain commercial property to DLF Assets Private Ltd, a promoter-owned company.
Two debatable issues arise from this transaction.
One, whether such income would be one-time and, two, if the sale to DLF Assets was done on competitive basis.
On the first issue, DLF's offer document states that it follows a build and sale/lease model and would execute such transactions in future too.
We believe that cashing in on some of the assets built, when the company sees value in such unlocking of cash, is an acceptable strategy to generate operational cash flows.
On the issue of the transaction involving a group company, DLF has stated that it has followed a competitive bidding process and would do so in future too.
DLF Assets had paid 65 per cent of the consideration to DLF as on the date of the red herring prospectus and this has, subsequently, been fully settled.
DLF does not own all of its 10,255-acre land bank. While it has title to 11.3 per cent of the bank, a good 35 per cent is still under `agreement to purchase'. The more important aspect is that the company has sole development rights to about 45 per cent of the land.
This entitles it to develop the land and enjoy substantial revenuesfrom such development for a fixed consideration.
While this agreement lacks clarity, such transactions owe their origin to the various urban land ceiling laws that were/ are in force in many regions.
DLF's history of success in dealing with such arrangements, however, inspires some confidence.
DLF has traditionally been a highly geared company. Post-issue and after utilising a part of the issue proceeds to repay loans, the debt-equity ratio should be about 1.5:1.
The company may, however, go back to the high gearing levels, given its major plans. This may not be a major concern as long as the company maintains its now comfortable interest coverage ratio.
We are, however, concerned about the high proportion of floating rate interest loans (75 per cent now), which could pose serious concerns in a scenario of hardening interest rates.
Macro factors such as a softening of real-estate prices (given the correction seen in certain markets) and the possible drying up of demand as a result of higher borrowing costs are factors that may pose a threat to the absorption of DLF's residential projects.
The offer is open from June 11 to 14.