Search Now


Sunday, October 28, 2007

Opto Circuits, UBI, Binani Cement, Shringar Cinema, Dishman Pharma - BUY; Cipla - SELL

Opto Circuits, UBI, Binani Cement, Shringar Cinema, Dishman Pharma - BUY; Cipla - SELL

Precious metals shine as crude soars

Gold prices at highest level in past twenty-seven years as dollar plunges

It was a shining time for the bullion metals at Comex on Friday, 26 October, 2007 with gold prices and silver prices rising. A new all-time-low dollar against the euro and all time high crude prices sent precious metals to their new high levels.

Gold has traditionally been used as a safe-haven asset against rising inflation. Investor sentiments are boosted by the fact that gold and silver are alternate sources of good investment in the face of declining dollar and rising energy prices. Rising crude increases inflationary pressures. On the other hand strong dollar reduces the appeal of the metal as alternate source of investment.

Comex Gold for December delivery rose $16.5.5 (2.1%) to close at $787.5 an ounce on the New York Mercantile Exchange today. Earlier in the day, it rose to a high of $789/ounce. It was the highest price after a record $873 on 21 January, 1980. Before today, prices reached a 27-year high of $776.90 last Friday (19 October).

Comex Silver futures for December delivery rose 37.5 cents (2.7%) to $14.28 an ounce. The metal has climbed 10% this year.

In the currency market today, the dollar was lower against most major currencies except for the yen. Dollar was dragged down by surging oil prices today. The euro traded at $1.4383 after earlier rising to $1.4392. Crude oil closed at $92/barrel today after trading on fresh Middle East tensions between Iran and Iraq.

The dollar index, which tracks the performance of the greenback against a basket of other major currencies, fell 0.3% at 77.04.

As usual, dollar also dropped on speculation that Federal Reserve might be going for another interest rate cut in this year.

In recent times, the weakening of dollar have continued to affect the price of the metal. Dollar had been witnessing a free fall since Federal Reserve cut interest rates by half percentage point. The U.S. currency has lost almost 8.3% against the euro this year.

Gold prices have jumped 15% during the third quarter and it is the most since 1999. The yellow metal has climbed 23% this year. Since the last rate cut, prices have gone up by almost 7%.

At the MCX, gold prices for December delivery closed at Rs 9978 per 10 grams. The closing price is Rs 150 (1.5%) higher as against previous closing price. Prices rose to a high of Rs 9987 per 10 grams and fell to a low of Rs 9834 per 10 grams during the day’s trading.

At the MCX, silver prices for December delivery closed Rs 317 (1.7%) higher at Rs 18,684/Kg. Prices opened at Rs 18,390/kg and rose to a high of Rs 18,698/Kg during the day’s trading.

Religare Enterprises IPO Analysis

Promoted by promoters of Ranbaxy Laboratories, financial services and products company Religare Enterprises (REL) has 11 subsidiaries. The principal subsidiaries are Religare Securities.(RSL), Religare Finvest., Religare Commodities and Religare Insurance Broking. The financial services offered range from equities, commodities, insurance broking, to wealth advisory, portfolio management services, personal finance services, investment banking and institutional broking services. It has also promoted subsidiaries to enter venture capital, private equity, arts and real-estate infrastructure management of group companies.

REL has a majority stake in the special purpose vehicle (SPV) Religare Insurance Holding Company (RIHCL). The 50:50 joint venture (JV) with leading global life insurance and pension company Aegon International NV is to foray into mutual funds. REL has infused about Rs 18.96 crore in RIHCL for a 75.39% stake in this start-up subsidiary.

A JV with Macquarie Bank to expand its wealth management business is set to start subject to necessary approvals. Macquarie will be a 50% shareholder of Religare Wealth Management Services (RWMSL), expected to be renamed Religare Macquarie Wealth. Both the partners have committed to contribute their pro-rata share of the equity capital: 20 lakh shares worth of Rs 20 million. Also, they have agreed not to transfer their shares or any right, title or interest in it for five years.

The objective of the issue is to fuel future growth including expansion of branches of two of its subsidiaries: Religare Securities and Religare Insurance Broking. REL plans to fund the retail finance business as well as expand its financing business through its subsidiaries Religare Finvest and Religare Finance.


  • A wide geographic reach, growing clients, and a diversified portfolio of products and services. End September 2007, had six regional offices and 40 sub-regional offices across 392 cities and towns controlling 1,217 business locations (managed with business associates) all over India as well as a representative office in London. Also, has a region-focused entrepreneurial management team leading 6,500 employees.
  • Products and service offered under three broad client-interface categories: Retail Spectrum, Wealth Spectrum and Institutional Spectrum. Retail Spectrum offers equity and commodity brokerage, personal financial services, internet trading and personal loans. Wealth Spectrum offers portfolio services (PMS), wealth advisory services and private client services. Institutional Spectrum offers institutional distribution and investment banking services.
  • Increasing clients in both equity and commodity trading. Equity clients (including institutional clients) increased from 1,49,000 clients end March 2007 to 2,37,000 clients end September 2007, an increase of 59% over the six months. Also, clients in the commodity service jumped 54%, from 14,955 to 23,000. Online investment accounts surged 189%, from 11,600 to 33,500. Also, market share of trading volume on NSE imoved up from 4.76% to 8.67%.


  • The Securities and Exchange Board of India (Sebi) has taken actions (subject to final orders) against Religare Securities for price manipulation in certain scrips.
  • The track record of listed group companies Fortis Financial Services and Fortis Healthcare has been far from encouraging.
  • Proper execution and supportive economic environment will be necessary to implement the aggressive growth plans across the financial spectrum..


At the offer price band of Rs 160-Rs 185, P/E based on the year ending March 2007 (FY 2007) EPS of Rs 3.3 works to 48.7 (on lower band) to 56.4 (on upper price band) times. P/E of other comparable listed players is: India Bulls Financial Services (27.4 times), Emkay Shares (47 times), India Infoline Financial Services (66.8 times), IL&FS Investsmart (31.2 times) and Geojit Financial Services (35.8 times).

While valuations appear steep based on FY 2007 numbers, they appear cheaper based on the performance for the six months ended September 2007. During this period, the company reported net profit of Rs 36.19 crore on a consolidated basis, which was 46% higher than the profit reported in FY 2007. The annualised EPS on post-IPO equity works out to Rs 9.6. This is discounted 19.4 times by the upper band of issue price of Rs 185 and 16.7 times by the lower band of Rs 160.

Bank of India

Bank of India

Satyam Computers

Satyam Computers



India shining

In the early 1990s, just post-liberalisation, investors often remarked on the disconnection between the corporate sector and the macro-economy. At that time, private capital and management contributed a very small share of manufacturing and services.

Earnings trends were often out-of-synch with the gross domestic product (GDP) trend. The private contribution is much larger now. As the ratio of private contribution has arisen, corporate performance has aligned with GDP. If it's a good year for macro-economic growth, it's a good year for India Inc.

There is a handsome premium. In the past five years, GDP has grown at somewhere between 6-8 per cent per annum with inflation at about 6-7 per cent. The Nifty's averaged earnings have grown at an annualised rate of 27 per cent and the major market index has offered a price-return of about 40 per cent per annum. So there's been an earnings premium of about 10 per cent over the sum of GDP plus inflation and of course, a further premium of 13 per cent in price-returns over earnings.

Can this happy state of affairs continue? Well, there does seem to be a premium for corporate performance in every healthy market. US GDP has moved at somewhere between 2-3 per cent since 2002, with inflation in the 2-3 per cent region. Corporate earnings have grown at nearer 10 per cent and the Dow Jones Industrial Average has returned over 13 per cent compounded annual growth rate (CAGR) in the past five years.

The next five years will see enormous investments. The Planning Commission hopes that during 2007-12 (the period of the XI Plan), over $500 billion will be pumped into new infrastructure projects. It assumes that at least 30 per cent of this will come from private sources. That means both FDI and FII and also Indian household savings channelled through IPOs and vehicles like mutual funds and insurance units.

It isn't farfetched. The rupee IPO market can easily raise Rs 100,000 crore per annum. That means eight DLF or ICICI-sized issues or perhaps 4 mega-issues and another 10-15 smaller ones. Good infrastructure IPOs will be lapped up, going by examples like NTPC, PowerGrid, PFC, GMR, Idea, RComm, Reliance Petro, etc.

Consider FDI and again, the money's surely there. China picks up over $50 billion FDI per annum India can surely absorb $20-30 billion without too much effort. If that money is gainfully employed, capacities would double across most bottleneck areas and perhaps for the first time since Sher Shah built the Grand Trunk Road in the 1550s, growth would not be hobbled by infrastructure constraints.

It should be possible to maintain 9 per cent GDP growth or even aspire to double-digits. The premium on corporate earnings may drop somewhat. But the Nifty's Earnings should still grow at 20 per cent or more. If the premium of price-returns to EPS growth holds, the indices should return better than 20 per cent per annum. Obviously infrastructure-sensitive sectors should return more.

It all seems very convincing in theory. In practice, the next 18 months will be fraught and the resolve of long-term investors will be tested. There will be a general election followed by another coalition government. Eventually some version of this broad vision will come through but there will be intervening uncertainty.

In September 2005, a technical analyst named Milind Karandikar made a bold prediction in this publication that caused some shock. He said that the Sensex (which was then at above 8,000) could be somewhere "between18,000-40,000 within the next five years." Also, that he expected a major rally to last till mid-2010 and then be followed by a five-year consolidation.

In the event, Karandikar's lower limit has been crossed within two years! From here to Sensex 40,000 (about Nifty 11,500) by mid-2010 implies an index return of 16 per cent per annum. That falls well within the bounds of rational probability since the long-term market return is higher than 16 per cent.

People often sneer at technical analysts. But Karandikar's predictions can be validated by broad macro-economic logic tied to GDP and earnings projections. Remember this and invest heavily if the market drops like a stone during the next general elections or during the lead-up. That is perfectly possible - remember May 17, 2004? For a long-term investor, every dip from now onwards should really be viewed as an opportunity.

India Strategy - P-Note proposals: less participation in the near term

India Strategy - P-Note proposals: less participation in the near term

Corporate Action Tracker October 26th, 2007

Corporate Action Tracker October 26th, 2007

GTL Buyback

GTL Buyback

Interest rate expectations from credit policy

The next review of the credit policy for 2007-08 is expected on October 30. With moderate inflation, the expectations of a decrease in interest rates are high. Interest rates hikes for the past couple of years have put pressure borrowers. Recently, the Finance Minister had asked banks to take a soft line on interest rates. The wholesale price index inflation has come down significantly.

The growth in loans has moderated, and there is a slight rolling over in the economic activity. These are the desired outcomes of the tight monetary policy that the RBI has followed. As of now, the prime lending rate (PLR) of banks varies between 12.75 and 13.5 percent. Inflation is hovering around five percent. Other countries have substantially lower interest rates. China has a negative real interest of 2.64 percent. South Korea's real interest rate is three percent.

Thailand's is 1.45 percent and Malaysia's is 1.72 percent. The rupee's continuing upward march is throwing up problems for exporters. Despite billions of dollar of buying, the central bank is unable to stop the rise of the rupee against the dollar. The RBI's forex reserves are now more than $12 billion. The liquidity arising from forex intervention is being mopped up immediately with MSS bonds. However, the fiscal cost of this is becoming unbearable. Servicing these bonds will add well over Rs 10,000 crores to Government expenditure. The fund flows through the foreign institutional investor (FII) route has continued unabated.

The recent reigning in of the participatory note (PN) route may slow down the funds flow through this route. The surge in capital inflows has prompted the RBI to accelerate the pace of intervention in the foreign exchange market and the consequent scaling up of sterilisation through the market stabilisation scheme (MSS), restrictions on capital inflows through external commercial borrowing (ECB), the restricted use of PNs and liberalisation of capital outflows. Despite aggressive intervention, the rupee has kept appreciating. The issue of liquidity overhang continues to pose a challenge for the RBI in containing inflationary pressures.

All-time high global crude oil prices, global food shortages and the escalating domestic consumer price indices indicate a build-up in inflationary expectations. The enhanced MSS programme is also proving to be inadequate in absorbing excess liquidity meaningfully. The reverse repo auctions continue to attract large amounts of over Rs 300 billion.

The equity markets are demonstrating fair signs of resilience. FII inflows' share in accretion to forex reserves has averaged only 40 percent. So, a hike in the cash reserve ratio (CRR) appears inevitable. The CRR is a blunt and a direct instrument to impound liquidity to contain inflationary pressures largely emanating from higher than desired M3 growth. One alternative is to open the reverse repo window. This will come at a cost for borrowers. The other option is to increase the CRR.

While this could be the preferred solution, it could force up lending rates as banks try to recover the loss of interest on the CRR. While taking a decision on whether to reduce interest rates or not, the RBI will be guided by the inflation situation and expectations. Global crude oil price hikes are going on. Crude has touched nearly $80. It is to be noted that high interest rates are taking a toll on the economy. The corporate sector is already feeling the pinch. There is a strong demand and visible case for reduction in interest rates.

The hard work done to control inflation has started yielding results. The RBI cannot afford to undo these efforts. The primary instrument which may be used to control liquidity in the system would be the CRR. This would draw out excess liquidity from the system. Also, with reduced funds, interest rates may not be brought down by the banks. On the contrary, they may have to stay at the present levels. An increase in interest rates is unlikely.

Grey Market - Religare, Allied Computer, Varun, SVPCL

Reliance Power 50 to 51

Mundra Port & Sez 400 to 440 320 to 330

Circuit Systems (India) Ltd. 35 3 to 4

Rathi Bars 35 3 to 4

Allied Computers 12 15 to 16

Varun Ind. 60 39 to 40

SVPCL 40 to 45 5 to 7

Religare Enterprises 170 to 190 260 to 270

Barak Valley Cement 37 to 42 12 to 13

Empee Distilleries 350 to 400 30 to 35

Mega Power IPOs coming soon

So you thought the real estate sector mopped up the lion's share of the capital market this year? Just check these stats — blazing the trail this year is the power sector with an impressive IPO line-up of more than Rs 20,000 crore. This is around 35% more than the Rs 13,000- crore worth of IPOs mobilised in the real estate sector this year, including the mega DLF offering.

In fact, as many as seven companies, including Anil Dhirubhai Ambani's Reliance Power, have filed draft papers for IPOs with market regulator SEBI in the last couple of months. Already, funds worth Rs 3,900 crore from the capital market has come to the power sector this year. In addition, the sector is expected to raise over Rs 16,000 crore as companies such as Reliance Power, REC and NHPC line up to float their IPOs in the next couple of months.

Says Sanjeev Zarbage, assistant vice-president, research, Kotak Securities: "The power sector needs huge funds and that's why we are seeing a slew of companies wanting to tap the capital market. Since the economy is doing well, capital expansion is a natural way of catering to the services of the population.

Infrastructure has remained a major bottleneck in development for a long time. The power sector is expected to raise a lot of money from the markets in the next couple of years too. Apart from that, banking is another sector that will raise money through public issues to keep the credit growth going."

The action in the power sector is currently being fuelled by the growth in the services sector. "We are in the capacity building stage. The huge amount of money raised in the power sector will eventually support the other sectors to grow and, in turn, help the overall growth in the country.

Infrastructure is the other sector where we will see a lot of activity happening. Housing companies, commercial malls, airports and ports are the core infrastructure segments that will raise big amount of money from the markets. Power and infrastructure are the base of growth for any country," says Religare Enterprises COO Shachindra Nath.

The companies that have entered the capital market this year include Power Finance Corporation and PowerGrid Corp. Besides, there have been smaller issues from Suryachakra Power and Indowind Energy, which mopped up nearly Rs 135 crore collectively from their IPOs. The fund flow through capital market into the power sector was nearly Rs 1,300 crore in 2006 through IPOs of firms such as Lanco Infratech and GMR Infra

The mega offering from the sector will be Reliance Power's issue, tipped to be the biggest-ever IPO in the Indian market at nearly Rs 12,000 cr. The company, a 51% subsidiary of Reliance Energy, has identified 12 power projects with a total installed capacity of 24,200 mw. The proceeds through sale of 130 cr equity shares would be utilised to develop the projects, which are at various stages of development.

State-run Rural Electrification Corp (REC) and National Hydroelectric Power Corp (NHPC) also seek to mop up Rs 1,200 cr and Rs 1,700 cr, respectively, through their public offers. The REC IPO would consist of a fresh issue of 10% or up to 7.8 cr shares and an offer for sale of an equal number of shares by the government.

The government's holding will come down by up to 18.18% after the public issue. NHPC would offload around 24% stake through the issue of 111 cr fresh equity shares and offer for sale of more than 55 cr shares by the government.

Again, Chennai-based BGR Energy, equipment supplier to power and process industries, expects to garner Rs 700 cr by floating an IPO of close to 134 lakh shares. Another Chennai-based firm Shriram EPC, part of the Shriram group, is likely to fund its investment plans in the renewable energy market through issue of 5 mn equity shares, representing 11.66% of post-issue paid-up capital.

Kolkata-based Ramsarup Lohh Udyog also proposes to enter the capital market with a public issue of 3 lakh equity shares of Rs 10 each to consolidate its position in power and infrastructure sectors.

Similarly, Transformers and Rectifiers India has filed papers with the market regulator for its nearly 3 lakh shares public offering. The company plans to raise over Rs 96 cr in the primary market to set up a transformer manufacturing facility in Ahmedabad.

Resistance around 20,550

The markets ended last week on a high note as the major indices gained by over 9 per cent. The Sensex began the week on a weak note, as was expected, but the bulls came back strongly and took the index to a new high. It rallied to a fresh all-time intra-day high of 19,276, gaining by 2,105 points from the weekly low of 17,171.

The Sensex finally ended the week at a record 19,243, registering a hefty gain of 9.6 per cent or 1,683 points.

The low of 17,171 was significantly higher then the support level of 17,000 mentioned last week. Now that the markets are back into unchartered territory, it will be difficult to set upside targets.

The positive trend should continue this week. The Sensex is likely to target 20,000 to 21,000 by the year-end. On the downside, the index has a near support at 19,000 and below this, it may drop to 17,870.

The NSE Nifty came quite close to its peak of 5737 as it touched a high of 5717, up 646 points from the week’s low of 5071.

The index settled with a gain of 9.3 per cent (487 points) at 5702. The Nifty could face resistance around 5970 before crossing the 6000 mark. It is likely to find significant support around 5400 in case of a downmove.

The Sensex may face resistance around 20,045-20,295-20,550 this week. Support, on the downside, should emerge around 18,440-18,190-17,940. The Nifty, on the other hand, may face resistance around 5950-6025-6100, while on the downside, it is likely to find support around 5455-5380-5300 in the coming week.

Colgate, GSPL, HT Media, NIIT

Colgate, GSPL, HT Media, NIIT

Religare Enterprises: Invest at cut-off

Investors with a high risk appetite may subscribe to the Initial Public Offer from Religare Enterprises, a financial services firm which derives the bulk of its revenues from equity broking and financing services. A recent entrant to the financial services space, the company has managed an impressive ramp-up in its client base and transaction volumes. However, the company conducts its business through a web of subsidiaries. Relevant financials for Religare’s consolidated operations are available only for a year and a half.

The offer price band of Rs 160-185 values the company at about 20-23 times its earnings for 2007-08 on the fully diluted equity base. The earnings for the full year have been estimated using first half performance, after factoring in operating profit margins managed by the company’s peer group. Most brokerage firms of comparable size trade in the price-earnings band of 30-40 times their current earnings at this juncture.


Religare’s businesses, routed through subsidiaries in which it holds 75-100 per cent stakes, span stock broking, loans against shares, commodities broking, personal lending, depository services, wealth management, venture capital, insurance broking, real-estate investing, insurance and arts advisory services. These are offered to retail and institutional clients.

Equity broking: Pluses and pitfalls

Most of these businesses are in a nascent stage, and equity broking and financing services currently contribute the lion’s share of the company’s consolidated revenues and earnings. For the first half of 2007-08, Religare reported a total income of Rs 307 crore on a consolidated basis; with EBIDTA (earning before interest, depreciation, tax and amortisation) margins of about 41 per cent and net profits of Rs 36.7 crore.

Broking operations (mainly equity), contributed 52 per cent of this income; interest on loans against shares/delayed payments from clients brought in about 30 per cent; while transaction charges/fees from clients and investment income chipped in with the rest. Though the company has a presence in the institutional segment, it is the retail business on which revenues and earnings rely heavily.

The focus on retail broking may deliver strong growth under the secular bull market conditions prevailing now. However, this may result in high volatility in Religare’s earnings over the medium-to-long term.

This pegs up the company’s risk profile in relation to others who have a more broad-based revenue stream. Regulatory and systemic risks would also be higher with retail-focused firms.

The equity broking business is a volume-driven one. Transaction volumes, which have reached new highs recently, could dry up quickly if stock markets move from a buoyant to a prolonged choppy or range-bound phase. This could have a direct impact on Religare’s revenues and, thus, profits.

Falling fee structures also heighten these risks. The growing retail pie in the domestic stock market has intensified competition, with private banks, finance companies and new global players entering the business. The possible rise of discount brokerages and popularity of online trading, also point to pressure on fees earned by full service broking firms such as Religare, making volumes crucial.

Strong growth so far

Religare has, however, displayed an ability to grow quite aggressively in its key businesses in the relatively short period of its existence. The number of clients registered for Religare’s equity/derivative broking services grew from just 12,000 in March 2005 to 2.37 lakh by September 2007. An expansion in the number of trades executed from 49,517 to 4.70 lakh over the same period; gave the company a rough 3.8 per cent share on the combined turnover on the NSE and the BSE.

These compare well with established players such as Motilal Oswal Securities. Religare’s investments in acquiring a pan-India presence (392 cities reaching out to 1200 locations) and a strong research backing for each of its businesses, appear to have aided asset expansion.

The company has been a relatively late entrant to the online platform, starting trading in August 2006 and investments in May 2007. The wealth advisory services and portfolio management services, advised/managed assets of Rs.185 crore and Rs.255 crore respectively in September, most of it garnered since 2006.

The company’s ability to deliver sustainable earnings growth may hinge on its success in driving growth in its non-broking businesses.

Several of the nascent businesses into which Religare is charting a foray (insurance broking, insurance, wealth management, asset management) hold immense potential for growth. This apart, these businesses are also quite scalable and may require lower incremental investments, given Religare’s wide geographic reach and its existing resources in terms of research and marketing personnel.

Having acquired a good client base in equity broking, there are also significant cross-selling opportunities that each new business can tap into.

However, with a slew of Indian and foreign players making a beeline for each of these businesses, none of this will offer Religare any protection against competition.

Overall, investors with a high risk appetite may consider subscribing to this offer in the light of the lower pricing relative to listed firms in this space and the sector’s growth potential.

Offer details: Religare Enterprises is offering 75.7 lakh shares in the price band of Rs160-185 to raise Rs121-140 crore. Offer proceeds will be deployed mainly in funding the lending and retail finance businesses and in expanding the branch network

P-note regulations and after

The Securities and Exchanges Board of India (SEBI) caused a furore in the stock market by imposing restrictions on money flowing in through participatory notes or P-notes, as they are more commonly called.

It is not news to anybody that the SEBI, the Reserve Bank of India and the Finance Ministry have been concerned about the opaqueness of these instruments and the quality of money that was flowing into the country through this route. Here is an assessm ent of the likely impact of these measures on liquidity flows into the country.

Ceiling on P-note issue

SEBI has ruled that FIIs holding P-notes that account for less than 40 per cent of their assets under custody (AUC) can issue further P-notes to increase the outstanding proportion to 40 per cent, but at an incremental rate of 5 per cent of AUC per year. However, FIIs with outstanding P-notes exceeding 40 per cent of AUC on September 30, can issue fresh P-notes only on a cancellation or redemption of existing instruments.

This clause effectively seeks to cap the money coming in through the P-note route. As per a recent report by securities firm CLSA, FII holdings in Indian equities were at $220 billion in August 2007. That suggests that the value of P-notes issued (not counting derivatives) by FIIs and their sub-accounts is currently at roughly 26 per cent of the assets managed by them in India. There could, thus, be room for a further 50 per cent increase in the value of these instruments over the next few years, but this increase would be gradual, as P-notes issuance can only be pegged up by 5 per cent every year.

This move appears welcome, given the heightened volatility that accompanied the deluge of funds hitting Indian stocks in August and September 2007.

Given the overall cap on P-notes, there are a couple of ways in which the gross number of P-notes issued can increase from current levels. If a large number of FIIs possessing the intent to issue P-notes enter the Indian equity market, then the P-notes issued each year may see a dramatic increase. However, given that, of the 1,125 FIIs and 3,450 sub-accounts registered with SEBI, only 34 FIIs/sub-accounts issue participatory notes, it is unlikely that there will be a large increase in FIIs that issue P-notes registering with SEBI in the near future.

Unwinding P-notes on derivatives

A sharp increase in the AUC of existing FIIs can also create room for increases in P-note issues, on a calibrated basis each year. However, SEBI has not clarified whether the date for determining the AUC will be frozen at September 30 this year or if it will be reviewed periodically and the limits modified accordingly.

The logic behind this enforcement is understandable since derivative positions held through P-notes could be partially responsible for the uncontrolled spiral in key pivotals in the stock market in recent weeks. P-notes on derivatives are also likely to be held with a more short-term perspective than the P-notes held on cash transactions. Another reason for banning the P-notes on derivatives could be to bar short-only funds that revel in downward-moving markets.

But one limitation of this move is that P-note holders in cash markets can no longer hedge their positions through futures and options. Speculative short positions will also become difficult to initiate since the mechanism for short-selling by FIIs is not yet in place.

Even if this is implemented, it is not clear if P-note holders will be allowed to use this facility. Forcing P-note holders to take only a long (optimistic) view of the market and preventing them from thinking or acting otherwise could be seen as setting limits on the natural functioning of the stock market. One consequence of this could be that some of these external investors may be forced to hedge Indian securities through overseas exchanges. This may cause loss to the exchequer and result in reduced liquidity in the market.

The unwinding of P-notes with derivatives as the underlying is not expected to cause any market upheavals in near term, given the 18-month window allowed for unwinding of such positions.

But extinguishing the $29 billion worth of ODIs on derivatives over the next 18 months, could more than offset any increase that can take place in P-notes by way of cash market purchases. The unwinding of derivatives-backed P-notes may thus balance out increases in further P-note issuances with cash markets as the underlying.

Hedge Fund Angle

The regulator’s stress on ‘regulated’ versus ‘registered’ entities has caused qualms in many quarters regarding the ebbing of hedge fund money from the market. The fears are justified since hedge funds have been using the participatory notes route for the convenience it provided in gaining exposure to the Indian market.

However, contrary to general perception, many hedge funds are regulated in the countries of incorporation and they have large institutional investors such as pension funds, university funds, charitable institutions, and so on, investing through them. There are more than a dozen hedge funds registered with SEBI and operating in India.

However, since these funds seek high returns through innovative strategies, not all the hedge funds investing through P-notes would want to disclose their strategies that regulation in a country such as India would entail. Their investment horizon would also be relatively short-term.

So, it is highly unlikely that they would go through the long-winded process of first getting themselves regulated in a country with which India has a double taxation agreement (such as Mauritius) and then registering as an FII in India, just to participate in the India growth story. It appears likely that a large chunk of the hedge fund money could turn away from Indian shores.

A wholly unsympathetic stance towards hedge funds may not be warranted. If a market was entirely devoid of short-term investors, there would be no one to sell the stock to long-term investors looking to buy, and vice-versa when they intend to sell.

In other words, short-term investors are essential for imparting liquidity to markets. Though pockets of disequilibrium occur from time to time, markets have a way of getting back to normalcy.

To sum up, it does appear as if liquidity flows into Indian stocks will be affected, with the flows through P-notes on cash transactions capped and P-notes with derivatives as underlying banned altogether.

One section of the investing community, hedge funds, might reduce its presence in the Indian market. However, the strong growth in the Indian economy could attract investors with a longer-term commitment that can make up for the temporary thinning-down of flows.

Amara Raja: Hold

Shareholders can retain their investments in Amara Raja Batteries (ARBL), a player in the industrial and automotive storage batteries business. At the current market price of Rs 159 (post-split), the stock trades at a P-E of 14 times the trailing 12 months earnings. This is a discount to Exide Industries, the market leader. The potential for high growth in the telecom and UPS battery segments and higher replacement demand for automotive batteries due to the buoyant automobile sales in the last few years are positives for the company. But firm trends in the prices of lead, the key raw material, and competition from bigger players such as Exide remain a concern. The stock has appreciated considerably in the past one year giving over 80 per cent returns. Investors with a long-term view, however, can consider exposure on weaknesses relating to the broader markets.

Under the brands ‘Power Stack’ and ‘Quanta’ in the industrial segment, the company manufactures batteries for the telecom, railways and the IT and ITES industry.

It provides automotive batteries branded ‘Amaron’ to Ashok Leyland, Mahindra and Mahindra, Tata Motors, Maruti and Hyundai, among others. Both segments contribute equally to revenues.


As telecom service providers expand their networks and get into sharing infrastructure, the company will benefit from the increased demand for batteries, which support their tower and exchange infrastructure. UPS battery sales will be propelled by growth in the IT and ITES industry, which requires back-up power, and the demand from households and offices due to the continued power shortage situation.

In the automotive segment, the existence of a de-risked sales mix catering to passenger cars, tractors and commercial vehicles will help the company tide over a slowdown better. Besides, the rollout of new models by the OEMs may bring the opportunity to become sole suppliers for that model ensuring a steady revenue stream. Fuelled by the rising demand, the company had embarked on capacity expansion last year. Besides, it is also setting up a greenfield plant with a capacity to manufacture one million units of two-wheeler batteries by Q3 FY-08 and five million by FY-09.

In a bid to boost volumes and improve their market share in the higher margin replacement market, the company has conceptualised retail outlets called ‘Power Zones’ to be set up in rural and semi-urban areas. A network of 500 stores is to be set up in FY-08.


Raw material costs account for about two-thirds of sales and lead constitutes 70 per cent of the raw material used. India is a net importer of the metal; international lead prices have seen a huge rise since the beginning of this year. Operating margins have declined from around 18 per cent to 15.6 per cent in the latest quarter, mainly due to raw material costs which have shown over a 100 per cent increase for the same period. Part of this rise was offset by passing it on to the customers.

Although the battery-makers increased prices earlier this year, the company may face resistance to future price increases as automakers themselves are faced with a slowdown and OEMs are looking at cost-cutting.

Exide has announced plans to increase prices by a further 7.5 per cent this month, but Amara Raja is yet to follow suit. Exide has also announced plans to buy out a smelter to recycle used lead-acid batteries which will help them reduce input costs.

While the capacity expansion for industrial batteries was completed in FY-07, the automotive and two-wheeler battery divisions are expected to start contributing to revenues by FY-09. Until then, net margins could be impacted by way of higher interest and depreciation costs. Given the slowdown in the two-wheeler segment, there are uncertainties surrounding the contributions from the company’s foray into the making of two-wheeler batteries.

Shanthi Gears: Buy

Fresh investments with a one to two-year perspective can be considered in the stock of Shanthi Gears, a leading manufacturer of industrial gears. Buoyant demand trends from user industries, improving product and revenue mix combined with a significant expansion in margins suggest strong growth prospects for the company.

At current market price, the stock trades at about 11 times estimated FY09 per share earnings, assuming full conversion of its foreign currency convertible bonds into equity.

The positive demand environment for industrial gears is driven by rising capital spending across Shanthi’s user industries such as steel, compressors and cement. In this context, Shanthi’s timely expansion in capacity and upgradation of technology lend confidence on its ability to meet the rising demand.

The management’s guidance towards a capital expenditure of about Rs 20-25 crore over each of the next two years also appears favourable. Revenues could also get a lift from the company’s increased focus on exports.

Shanthi, apart from being the global supplier to Atlas Copco’s Belgium unit, may also soon start supplying to Atlas’ branches in China and Thailand. For the quarter ended September 2007, the company recorded a 52 per cent increase in earnings on the back of a 26 per cent growth in revenues.

Operating margins expanded by a significant 2 percentage points to about 40 per cent.

While the company has traditionally enjoyed higher margins owing to its fully integrated facility (notably all processes are done in-house), this 2-percentage points expansion could be credited to the change in product mix during the quarter.

Given Shanthi’s evolving product mix, which favours custom-built products over the low-margin standard ones (60:40), margins are likely to sustain at higher levels.

Any unprecedented rise in raw material prices could impact the company’s earnings negatively.

However, given the shorter delivery schedule of orders (3-4 months), Shanthi appears better positioned to build volatility in input prices, into its contracts while pricing them.

Besides, the price escalation clause in most of its contracts also offer insulation in this regard. Slowdown in the capex across user industries remains the primary risk.

Sasken: Hold

Shareholders can hold on to the shares of Sasken Communications with a two-year perspective. The stock, at its current price of Rs 301, trades at 20 times its trailing 12-month earnings.

At this valuation, the stock price appears to capture Sasken’s near-term growth prospects. The share trades at a discount to other telecom software companies such as Subex Azure or Tanla Solutions but at a premium to Tier-2 software companies such as Hexaware Technologies and iGate Global Solutions.

The margin growth for the company has been steady, but slow. EBITDA (earnings before interest, tax, depreciation and amortisation) margin at 17 per cent is lower than Subex Azure, Tanla Solutions and Hexaware Technologies.

Sasken has hedged $46.6 million, around 40 per cent of its revenues, at Rs 43.02 to the dollar. This and the fact that Sasken’s US exposure is restricted to 35 per cent of its revenues, the lowest among Tier-2 players, may provide some cushion against margin erosion due to rupee appreciation.

When Sasken’s product business, a high-margin one, starts making higher contributions to revenues over the next 12-18 months, there would be scope for a higher profit margin profile. The volume growth and the highest contributor to revenues will continue to be the services business for the next few years.


Sasken is a pure-play telecom software vendor. The company caters to requirements across the telecom business span — network equipment vendors, mobile handset vendors, semiconductor companies, telecom services companies and test and measurement companies.

However, the prime mover at this point in time appears to be the handsets business which provides services, develops protocols and multimedia applications for a variety of vendors. This is accomplished through a strong working relationship with Texas Instruments and Symbian for smart-phones chipset and operating systems. These help Sasken leverage on the middleware and application development capabilities.

Prime Movers

Sasken derives 44 per cent and 19 per cent of its revenues respectively from the EMEA (Europe and Middle-East Asia) region and India.

This is significant for a few reasons. Europe is the largest market for high-end telecom services and Sasken has strong relationship with clients such as Nokia which are looking to expand market share there. This may help Sasken tap a potentially sound market in the next few years.

In West Asia, some countries such as Qatar are inviting applications for second or third telecom player licence, thus opening a vista of opportunity for telecom players. Sasken works with Nokia, Nortel, Motorola, Lenovo and Samsung which are potential suppliers of network equipment and other infrastructure to players who may win the licences.

This again presents a potential opportunity for Sasken to deliver on its R&D capabilities and services business as well.

This geographical diversification also means that Sasken’s exposure to the US markets and any potential slowdown is lower.

The company’s revenue model with respect to its handsets business is based on a royalty/licensing component and a services component. This gives Sasken a sustainable revenue stream linked to the sale of handsets.

This model is working reasonably with NTT DoCoMo. The shipment of Motorola phones is to start from the third quarter and is expected to contribute to revenues in the medium term.

The shipment of Lenovo mobile phones has been delayed but is expected to contribute significantly to revenues, as Lenovo phones are targeted at the Chinese market, which is the second fastest growing telecom market.

In the handsets business, the company works across technologies such as 2G, 2.5G and 3G. This diversity is important for a market such as India that has requirements across the low- and high-end phones.

Working with clients which have India and China as their top priority markets is a good augury for the company.


The mobile handset products business and royalty model depend on offtake for these handsets in the various target markets of clients.

The top five customers contribute over 74 per cent of Sasken’s revenues, representing concentration risk. The semi-conductor and network equipment segments of the company are witnessing relatively slower growth and may not contribute significantly to the margins.

Attrition, at over 23 per cent, among the highest in the IT industry, poses execution risks.

Lupin: Buy

Investors with a two-three year perspective can buy the stock of drug maker Lupin, now trading at Rs 623. A healthy and visible earnings picture geared to profit from higher super-generics and formulation exports and the company’s strengths in the contract research and manufacture model of business, form the foundation of our investment recommendation.

Lupin is well-positioned to deliver strong growth rates over the next two-three years in the domestic and international markets backed by an aggressive acquisitions strategy and a strong pipeline in drug filings.

A good pipeline of new drug assets across four therapy areas and new acquisitions (Kyowa-Japan and pharmaceutical business of Rubamin India), can help scale up earnings over the next few years. At the current market price, the stock trades at about 15 times its estimated earnings for 2007-08, which is a discount to peers.

Business profile

From being a prominent player in low-margin anti-TB market Lupin has, over the years, acquired strength in therapeutic areas such as cardiovascular, cephalosporins and non-steroidal anti-inflammatory drugs (NSAIDs).

The company continues to focus on niche opportunities and new drug delivery platforms in the export market, enabling it to shift to generics, super generics and branded segments. As opposed to simple generics, super generics differs from the original product in formulation or method of delivery.

Lupin has more than seven patent applications pending for novel drug delivery platforms in major areas, which can bolster the super generics business.

About one in five of the company’s filings in the US are patent challenges and a third are “super generics” or finished medicines that are hard to formulate. The company has a roster of over 50 drug filings in the US and is gearing up for more in the next six-seven months.

Clearance for these filings will enable Lupin to increase its product portfolio in the US. However, Lupin is also looking to expand further in markets such as Europe, South Africa and Australia, effectively addressing the risk attached to the dollar-rupee volatility.

Lupin has a strong position in antibiotics in the advanced markets and this should start translating into sales and profits from the next two quarters.

This, along with further expansion in high-growth segments such as CNS (brain and spinal cord) and oncology in India, suggest good prospects for domestic sales. .

Products: Lupin’s antibiotic Cefdinir, launched in May, has been able to ward off competition and maintain a 14 per cent share in the US market.

Lisinopril tablets, used to treat hypertension, maintained the US market leadership with 34 per cent market share while another antibiotic, Suprax’s sales in the US grew 55 per cent over September quarter last year.

Lupin has also launched oral third-generation cephalosporin, Cefpodoxime Proxetil tabs, in France which is expected to do well.

Lupin has a strong innovative pipeline, pursuing a dual approach using customary chemical synthesis and herbal leads to identify drug candidates.

Once some of these new chemical entities reach the proof of concept stage (end of Phase II), they can be out licensed. It has recently received a second tranche of Euro 20 million for sale of additional patents for hypertension drug Perindopril to Laboratoires Servier.

In April, Lupin had received a similar amount for patents of same drug in multiple countries to Servier.

On acquisitions

Lupin’s acquisitions may not deliver immediate benefits to earnings, but have the potential to scale up revenues over the next few years.

The recent acquisition of generic company, Kyowa Pharmaceutical, has provided Lupin a foothold in the Japanese market where the Government is encouraging greater use of generics.

Though the current generic market size is around 6 per cent of the total $60 billion market, methodical integration with Kyowa helps it leverage hard-to-acquire skills such as product development and manufacturing, while acquiring access to marketing channels in Japan.

That Lupin is already into a two-year relationship with Kyowa, one of top eight companies in Japan, as a marketing partner will help expedite this process.

The acquisition of Rubamin Laboratories, with multiple manufacturing units in Vadodara, will help Lupin focus on advanced intermediates for active pharmaceutical ingredients under the CRAMS model.

This model can help Lupin position itself as a high-end, complex manufacturing services provider with its front-end marketing presence and thus enable better realisations over the long term.

India Strategy - Oct 26 2007

India Strategy - Oct 26 2007