Stocks to pick - March 31 2008

IVRCL Infrastructures
Research:LEHMAN BROTHERS
Rating:Overweight
CMP:Rs 406

Lehman Brothers initiates coverage of IVRCL Infrastructures & Projects with an ‘overweight’ rating and a March ’09 target price of Rs 593, implying 72% potential upside from current levels. Lehman’s March ’09 value for the base construction business is Rs 399, which is based on a P/E multiple of 17x FY09E earnings. IVRCL is likely to benefit from huge investments planned in the infrastructure sector. The total order inflows over FY08E-FY10E are expected to be around Rs 25,900 crore, compared with Rs 11,300 crore worth of orders received over the past three years. Lehman estimates a strong 40% earnings CAGR over FY07-FY10, on the back of expansion in core EBITDA margins from 10% in FY07 to 11.1% in FY10E. It expects that IVR Prime, which has around 85 million sq ft under development, will remain a key contributor to IVRCL’s value.

Reliance industries
RESEARCH:CLSA
RATING:Outperform
CMP:Rs 2,347.55

CLSA is upgrading FY08 EPS estimates for Reliance Industries (RIL) by 6% to build in stronger-than-expected refining margins in the fourth quarter. But it is downgrading estimates for FY09-10CL by 5% each. The downgrade in FY09 is led by lower KG-oil output assumptions and KGgas commencing in October ’08 (July ’08 earlier). Similarly, the downgrade in FY10 is led by lower peak oil output at 40 kbpd (50 kbpd earlier), lower associated gas production and lower savings for its refinery from natural gas substitution ($1.2/bbl from $1.5/bbl earlier). The target price continues to build in Rs 653/share ($22.5 billion) in E&P upside, implying that RIL will need to discover 6.8 billion barrels of oil equivalent (boe) of additional recoverable resources in the near term. So, CLSA values RIL on 10.4 billion boe of recoverable resources — similar to 10 billion boe target envisaged by chairman Mukesh Ambani in the previous shareholders’ communication. This remains a stiff task; CLSA continues to view new discoveries as justifying, rather than adding to this valuation estimate.

GAIL
RESEARCH:ABN AMRO
RATING:HOLD
CMP:Rs 442

ABN Amro retains its ‘hold’ rating on Gail with a target price of Rs 400. Thejump in valuation is due to a 50-63% upgrade in ABN Amro’s earningsforecast, following a revision in crude oil prices. Gail plans to raise itspipeline capacity from 150 mmscmd to 278 mmscmd by ’09 (capexRs 8,500 crore), and to 326 mmscmd by ’11 (additional capex Rs 10,300crore), which can lead to a jump in pipeline revenues.

But there is no visibilityon additional gas supplies to justify this expansion. In line with therecent experience of the Dahej-Uran and Dabhol-Panvel pipelines, ABNAmro has assumed the new pipelines will come in phases and the actualcapex over FY08-12 will be well below Gail’s current estimates. Absenceof significant earnings growth over FY08-10F and lack of visibility ongrowth thereafter from new pipelines may cap valuations. ABN Amrovalues Gail’s core business at 6x FY09F EV/EBITDA (Rs 306/share) andthe balance (Rs 94/share) will come from cash and investments.

GAMMON INDIA
RESEARCH:MORGAN STANLEY
RATING:OVERWEIGHT
CMP:Rs 398

Morgan Stanley retains ‘overweight’ rating on Gammon India and reducesits target price to Rs 461, implying 20% upside.

The target price isbased on sum of the parts and factors in the core construction business (Rs246/share) based on residual income model, Gammon InfrastructureProjects’ (GIPL’s) share value (Rs 202/share) based on IPO price, andGammon’s investment in Sadbhav Engineering (Rs 14/share). MorganStanley has reduced its PAT estimates for FY08E and FY09E by 27-30% asit takes into account the higher marginal tax rate of 34%, instead of the reducedtax rate that was used by Gammon.


While the GIPL issue closed atRs 167/share, the listing price of the stock may be an important driver.GIPL has a portfolio of 15 assets (six roads, six power plants and threeports), excluding one port in Gujarat where a GIPL-led consortium is thehighest bidder. With the majority of roads in its order book, Gammon willcontinue to lag its peers in terms of margins and net income growth,though it may continue to deliver 25% earnings CAGR over FY08-10E.But the impending listing of GIPL creates a value-unlocking opportunity.

HPCL
RESEARCH:Indiabulls Financials
RATING: BUY
CMP:Rs 263

Given the recent correction in HPCL’s share price, Indiabulls upgrades its rating on the stock to ‘buy’. For the quarter ended December ’07, HPCL’s net sales rose 22.4% y-o-y to Rs 27,120 crore led by sales volume of 6.43 mmt. The government’s issuance of oil bonds worth Rs 1,900 crore aided the increase in HPCL’s net sales. In February ’08, the government hiked prices of petrol and diesel by Rs 2 and Re 1 per litre, respectively.

Talks are on to raise the proportion of oil bonds issued to oil marketing companies from 42.7% of retail losses to 57%. If the new formula is approved, oil companies’ burden will reduce to only 10%, while 57% will be borne by the government, and 33% by upstream companies. HPCL’s outlook seems promising, but soaring global crude oil prices remain a risk. At the current price, the stock trades at a forward P/E of 6x for FY08E and 5.1x for FY09E. Historically, the company has traded at an average P/E of 6.5.

HINDALCO INDUSTRIES
RESEARCH:Standard chartered - STCI
RATING: BUY
CMP:Rs 175

Standard chartered - STCI recommends a ‘buy’ on Hindalco Industries with a target price of Rs 192 and 24% upside to its current level. Hindalco’s primary aluminium business is likely to be a cash-generator as the company expects to report a revenue CAGR of 13% over the next two years till FY10E on the back of higher London Metal Exchange (LME) prices. Transformation of China into a net importer of metal in ’10 will help to maintain high aluminium prices. Hindalco has lined up a capex of Rs 30,000 crore to be incurred over the next five years, which will triple its primary aluminium capacity to 1.5 million tonnes (mt), alumina capacity to 6 mt and power plant capacity to 3,437.2 mw.

This will help realign its upstream and downstream operations in the Asian market, as it will meet 30% of Novelis’ current production of 3.1 mt. Hindalco (standalone) currently trades at a P/E of 6.6x and 5.5x its FY09E EPS of Rs 23.4 per share and FY10E EPS of Rs 28.1 per share, respectively.