Valueline March 2008

Under the shadow of concerns

Continued flow of negative news pertaining to global economy has kept the market depressed and volatile. The developments on the domestic front have only added to the prevailing weak sentiments. The first jolt came in the form of the disappointing listing of Reliance Power followed by the failure of high profile initial public offerings by Emaar MGF and Wockhardt Hospitals. As if this were not enough, the higher than expected write-off by some of the leading companies such as ICICI Bank and Suzlon Energy negatively surprised the markets. To top it all, the tinkering of the short-term capital gains tax and huge debt waivers announced in the Union Budget 2008 pushed the markets to below the lows seen in January 2008 on a closing basis. The point is that not only have the existing global worries intensified but some concerns have also surfaced at the home front in the past month. Will the market be able to come out of the shadow of these concerns?

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Sharekhan top picks

In the February 2008 issue, we had recommended the best 12 of our Stock Ideas as Sharekhan Top Picks. As on February 29, 2008 the basket of stocks has given a negative return of 0.9%. The basket’s performance has been in line with the market’s, as the Sensex has declined by 0.4% and the S&P CNX Nifty has risen by only 1.7% during the same month.

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SHAREKHAN BUDGET SPECIAL

Budget 2008-09: Populist yet growth oriented

Given the election year, the finance minister (FM) tabled a populist budget aimed at pleasing a large section of rural population and also the salaried middle class. Apart from the substantial increase in budgetary allocation for rural and social infrastructure, the budget has proposed huge debt waiver and relief worth Rs60,000 crore to farmers. But in spite of the increased expenditure, the fiscal prudence has been maintained with fiscal deficit target set at 2.5% for 2008-09.

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RAILWAY BUDGET SPECIAL

Railway Budget 2008-09

With general elections due next year, the Railway Minister Mr Lalu Prasad tabled a people friendly Railway budget in the Lok Sabha on Tuesday. This budget was marked by good performance on both the freight and the passenger traffic fronts and a continued improvement in the operating ratio. The Railway Minister has attributed this performance to reduced fares/tariffs driving volumes and profits. The Railways continue on its profitable growth path and the accent continues to be on capital expenditure (capex) to make it more competitive.

Other highlights of this budget are reduction in passenger fares by 5% for second-class sleeper trains and reduction of 3-7% in fares for AC classes. The freight rates on petrol and diesel is reduced by 5% (by reducing its classification), whereas the freight on fly ash is cut by 14%. To further gain market share in the freight segment, the minister has taken initiatives like introduction of new wagon leasing policy and bulk and non-bulk goods terminal scheme. The budget also spells out the aim of using the public private partnership (PPP) model to offer door-to-door solutions including value-added services like modern material handling facilities, warehouses and multi-modal logistic parks.

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STOCK IDEA

Larsen & Toubro
Cluster: Evergreen
Recommendation: Buy
Price target: Rs4,428
Current market price: Rs3,536

Numero uno!

Key points

• Proxy play on country's infrastructure story: Larsen & Toubro (L&T), being the largest engineering and construction (E&C) company in India, is a direct beneficiary of the strong domestic infrastructure boom and industrial capital expenditure (capex). Strong infrastructure spend is set to ensure strong growth momentum in the company's order inflows. We estimate the overall order inflows for the company to grow at a CAGR of 20.7% between FY2007-10.

• International business driving growth: The contribution of international revenues has grown from 4% to 17.5% in the last five years and is expected to reach 25% by FY2010. Gulf Corporation Council (GCC) nations offer immense business opportunity ($1.25 trillion) over the next six years, which augurs well for company like L&T.

• New initiatives to drive growth beyond FY2010: We believe there lies an immense opportunity in the new verticals in which the company is entering namely ship building, defense, railways, thermal and nuclear power. Given the company's excellent track record, we are quite confident of its success in these initiatives and are also encouraged by higher returns on investments in these segments.

• Margin expansion: We believe there is a scope for further improvement in the margins on the back of rising operational efficiencies, larger ticket-size and more complex nature of orders, better raw material sourcing and integration, and higher contribution of its new businesses that carry higher margins.

• Subsidiaries picking up in size: We believe some of the subsidiaries of L&T, particularly L&T Infotech, L&T Finance and LT FZE have reached critical size and importance, making L&T a true conglomerate and a diversified play.

• Valuations: Sound execution track record, bulging order book, and strong performance of subsidiaries reinforces our faith in L&T. We value the core business of L&T at 28x FY2010E earnings, or Rs3,403 per share, while we value the subsidiaries at Rs1,025 per share of L&T. At the current market price of Rs3,536, the stock is trading at 21.9x its FY2010E consolidated earnings. We recommend a Buy on the stock with our sum-of-the-parts based price target of Rs4,428.

Unity Infraprojects
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs970
Current market price: Rs692

Riding on realty and infrastructure boom

Key points

• Real estate sector growth supports strong order inflows: Unity Infraprojects (Unity) is a leading construction company with well-diversified expertise across the projects. We believe the strong growth in real estate sector will trickle down to construction companies, which would lead to strong order inflows for these companies. The growth in real estate sector coupled with government thrust on infrastructure spending would lead to over 20% compounded annual growth rate (CAGR) growth in Unity's order inflows during the period FY2007-2010.

• Strong order book provides growth visibility: Unity has strong order book of approximately Rs2,450 crore, which is 4.8x its FY2007 revenues. We believe the robust order book coupled with growth in order inflows would lead to a strong financial performance. Consequently, we expect Unity's revenues and earnings to grow at a CAGR of 37.1% and 31.8% respectively during the period FY2007-2010.

• Real estate subsidiary to unlock value: Unity has forayed into real estate sector through a wholly owned subsidiary, Unity Realty and Developers Limited (URDL). The real estate projects include those at Nagpur, Pune, and Goa, which are on the build-operate-transfer (BOT) basis. Beside this, the company plans to develop 15 million square feet (mn sq ft) in Kolkata. In line with this, the company has acquired 150 acre of land for Rs100 crore in Kolkata. To fund these projects, the company plans to dilute its stake in URDL, which will unlock value for Unity's shareholders.

• Attractive valuation: We value the stock using sum-of-parts-valuation (SOTP) method. We value Unity’s core construction business at Rs757 per share ie 10x at its FY2010 estimated earnings. To value Nagpur and Goa projects in the real estate sector and Ulhasnagar water supply project, we have used net present value (NPV) method. These projects contribute Rs192 per share to our valuation. We value the company's Pune project at Rs21 per share based on the recent stake sale to Clear Hotel Capital. We have not factored in Kolkata project since there are no development plans as of date. We initiate Buy recommendation on Unity with a price target of Rs970.

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STOCK UPDATE

Aban Offshore
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs5,420
Current market price: Rs3,812

Riding high on offshoring upcycle

Key points

• With the oil crossing the $100 barrier and the limited scope for increasing the output from the existing assets, the global E&P expenditure is on a rise and the upcycle is likely to continue.

• The day rates for jackup rigs have remained firm, and looking at the tight demand-supply scenario and high utilisation levels (which is expected to be 95%+ for the next two years), the rates are expected to remain strong inspite of new additions in the next couple of years.

• Transocean Inc the world's largest offshore oil and gas driller has reported
  excellent Q4 numbers (December-ending) and has also indicated continual buoyancy in the deep-water and jackup rigs market. The demand and rates for jackup rigs have positively surprised the company and is likely to remain strong through the first half of this year.

• Factoring in the impact of the recent deployment of the company's drillship Aban Ice at higher rates, we are raising our earnings estimates for FY2009E by 1.9% to Rs398.9 and FY2010E by 1.5% to Rs513.8. We are also reducing our estimates for the current fiscal by 11.8% on the back of lower number of operating days for one of its rig Aban VI and no announcement on the deployment of the recently acquired rig Bulford Dolphin.

• At the current market price of Rs3,812, the stock is discounting its FY2009E earnings by 9.6x and FY2010E earnings by 7.4x. We believe that the valuations are extremely attractive and maintain our Buy recommendation on the stock with a price target of Rs5,420.

Ahmednagar Forgings
Cluster: Ugly Duckling
Recommendation: Book Out
Current market price: Rs203

Book out

Result highlights

• The Q2FY2008 results of Ahmednagar Forgings Ltd (AFL) are below our estimates.

• The company's sales for the quarter grew by only 8.8% to Rs165.8 crore. The domestic sales remained flat at Rs111 crore and the export sales grew by 30% to Rs54 crore. The export revenues were flat on a quarter-on-quarter (q-o-q) basis.

• The operating profit margin (OPM) has been maintained at 20.6%. As a result, the operating profit grew by 8.5% to Rs34.2 crore. Higher interest and depreciation costs led the profit after tax (PAT) to remain flat at Rs17.7 crore.

• The ramp up in exports is not happening, as expected. There has been a delay in product approvals for exports. The domestic revenues are also not growing due to a slowdown in the domestic market.

• AFL is making preferential allotment of 17 lakh shares and 38 lakh warrants to its promoters at a price of Rs240, thereby raising Rs132 crore. The funds will be used in buying assets such as forging lines. The preferential allotment would lead to an equity dilution of 16%. The resolution to raise money through debt of Rs2,000 crore has also been cleared.

• Slow ramp up in exports, slow down in domestic market and 16% equity dilution would be a dampener on AFL's performance. We downgrade our earning estimates for FY2008 and FY2009 by 25% to Rs16.3 and Rs20.6 respectively. At the current market price of Rs203, the stock is trading at 9.9x its FY2009E earnings and is available at an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 6.0x. We advise investors to Book out of the stock.

Andhra Bank
Cluster: Cannonball
Recommendation: Buy
Price target: Rs117
Current market price: Rs91

Showing signs of improvement

Result highlights

• Andhra Bank reported its Q3FY2008 results with the net profit going up by 16.7% year on year (yoy) and 5.2% quarter on quarter (qoq). The year-on-year (y-o-y) growth was driven by higher other income (up 29.3%) and lower staff expenses (down by 17.8%). The core performance was better than that of last quarter (Q2FY2008) with the net interest margin (NIM) improving slightly due to a slim reduction in the cost of deposits.

• The bank's advances grew 22.7% yoy and 2.7% qoq with the net interest income (NII) going up by 1.8% yoy and 7.4% qoq. Our calculations suggest that the bank's NIM improved by 10 basis points qoq mainly due to the increase in the yield on advances (7 basis points) and a reduction in the cost of deposits (10 basis points). An increase of 290 basis points qoq in the low-cost savings account and current account (CASA) deposit base helped matters.

• The non-interest income grew by 11.1% yoy to Rs147.7 crore due to a 258.7% jump in the treasury income, while the core fee income showed a decline of 3.7% yoy. The fall in the core fee income is a cause for concern though the management expects this to improve going forward with an increase in the income from distribution of third party products.

• The operating expenses fell by a moderate 2.6% yoy helped by a 17.8% fall in employee costs, which is in contrast to other public sector unit (PSU) banks. The main reason for the fall in the employee costs is the bank's decision to adjust the transitional liability on account of AS-15 (amounting to about Rs375 crore) against the reserves. Upto Q2FY2008 the bank used to make an adhoc provision for this liability.

• This coupled with a 4.3% y-o-y growth in the net total income resulted in a moderate growth of 10.5% yoy in pre-provisioning profits. Provisions were lower at Rs 27.8 crore due largely to a write back of investment depreciation (Rs15 crore) and lower standard asset provision.

• Andhra Bank's business grew quite strongly with the advances up by 22.4% yoy. The deposits mirrored the advances growth going up by 21.6% yoy. The deposits were down 1.2% qoq, which is an indication of the bank giving up some of the high-cost deposits.

• Despite the strong growth in the advances, the asset quality continued to remain among the best in the industry with the gross non-performing assets (GNPA) at 1.35% and the net non-performing assets (NNPA) at 0.16%.

• As these quarterly results indicate, the pressure on margins is easing and the situation should improve going forward. The capital adequacy levels are comfortable at 12.03% with the Tier-I capital adequacy ratio (CAR) at around 8-9%, which is not a constraint on growth. The asset quality continues to remain among the best in the industry. At the current market price of Rs91, the stock is quoting at 6.3x its FY2009E earnings per share (EPS), 3.4x pre-provision profits (PPP) and 1.1x book value (BV). The stock is available at attractive valuations given its low price to book multiple compared with its peers. We maintain our Buy call on the stock with a price target of Rs117.

Bank of India
Cluster: Apple Green
Recommendation: Buy
Price target: Rs458
Current market price: Rs364

Price target revised to Rs458

Result highlights

• Bank of India (BoI) reported a profit after tax (PAT) of Rs511.9 crore for Q3FY2008, which was up by a whopping 101.0% year on year (yoy) and 20.4% quarter on quarter (qoq). The PAT beat our and consensus estimates by a significant margin. The strong PAT growth was on the back of robust interest income growth, spike in the non-interest income led by treasury gains and contained operating expenses.

• The net interest income (NII) during the quarter grew by 25.7% yoy to Rs1,079.5 crore. The NII growth was mainly due to a continued strong growth in the advances and an improvement in the net interest margin (NIM).

• The reported NIM of 3.14% during the quarter reflects an improvement of 10 basis points yoy from 3.04% for the year-ago period. The NIM improvement was mainly due to improvement in the yields on advances (115 basis points) and the investments (105 basis points), which outweighed the 83 basis points year-on-year (y-o-y) increase in the cost of funds.

• During the quarter, the advances grew by a strong 30% yoy to Rs 103,657 crore indicating an uptick in the credit off take compared with that of H1FY2008. The growth in the advances was led by a strong growth in the foreign advances (up 32.7%). Meanwhile the deposits grew by 27.4% yoy to Rs135,835 crore on the back of a 36% y-o-y growth in the term deposits and a 32.5% y-o-y growth in the current account deposits. However, due to a higher growth in term deposits, the current account and saving account (CASA) ratio declined to 37% from 40.7% a year ago.

• The non-interest income witnessed a huge growth of 72% yoy to Rs554.1 crore. The growth in the non-interest income was primarily due to the spike in the treasury gains, which were up 109% yoy. Meanwhile the fee income grew by a strong 46% yoy and 40.7% qoq.

• Notably, the operating expenses were up by only 5.5% yoy, whereas it declined by ~2% qoq to Rs662.2 crore, partly because of a higher base for the year ago period. The lower operating expenses growth can be traced to the decline in the other operating expenses (down 13% yoy), while the staff expenses were up 17% yoy. As a result of the lower operating expenses and the strong income growth, the cost-income ratio improved significantly to 40.5% compared with 50.6% for the year-ago period.

• Asset quality during the quarter continued to improve yoy, with a 10% y-o-y decline in the gross non-performing assets (GNPA) to Rs1,969.3 crore and a 29.5% decline in the net non-performing assets (NNPA) to Rs633.5 crore.

• Capital adequacy remains healthy with capital adequacy ratio (CAR) at 12.5% at the end of December 2007, compared with 11.7% at the end of December 2006.

• At the current market price of Rs364, the stock trades at 8.8x its 2009E earnings per share (EPS), 4.4x its 2009E pre-provisioning profit (PPP) and 1.9x its 2009E book value (BV). We maintain our Buy recommendation on the stock with a revised twelve-month price target of Rs458.

Bharat Bijlee
Cluster: Apple Green
Recommendation: Buy
Price target: Rs3,792
Current market price: Rs2,848

Price target revised to Rs3,792

We met the management of Bharat Bijlee Ltd (BBL) and bring to you the key highlights of our discussion.

Key highlights

• Q3FY2008 results of Bharat Bijlee Ltd (BBL) were below our and street expectations, as the production during the quarter was disrupted due to capacity expansion being undertaken by the company.

• BBL is expanding its transformer manufacturing capacity to 11,000 Mega Volt Ampere (MVA) from 8,000MVA. The enhanced capacity is expected to come on stream by April 2008.

• We expect the revenues to pick up in Q4FY2008 as the inventory build-up during the quarter should be cleared by then and hence we maintain our full year's revenue estimates.

• We are also incorporating our FY2010 earning estimates and expect the revenues and profits to grow at a compounded annual growth rate (CAGR) of 27.9% and 33.4% respectively over FY2007-10E.

• The current order book stands at Rs400 crore and is executable over the next 10-12 months period.

BL Kashyap & Sons
Cluster: Emerging Star
Recommendation: Hold
Price target: Rs1,827
Current market price: Rs1,801

Price target revised to Rs1,827

Result highlights

• The reported revenues of BL Kashyap & Sons (BLK) during Q3FY2008 grew by 71.8% year on year (yoy) to Rs405.8 crore.

• The operating profit margin (OPM) improved by 111 basis points to 11.7% during the quarter under review. Consequently, the company's operating profit grew by 89.8% yoy to Rs47.4 crore during the quarter.

• Higher interest and tax expenses restricted the bottom line growth. The interest expenses increased as the debt rose to Rs91 crore in Q3FY2008 from Rs60 crore in the previous quarter. Furthermore, the company's effective tax rate also increased to 40.1% in Q3FY2008 from 34.3% in the corresponding period last year (Q3FY2007). Consequently, the company's bottom line grew by 63.9% yoy to Rs25.2 crore, which was below our expectation of Rs30 crore.

• The order backlog stood at around Rs1,850 crore in the third quarter. Commercial projects contributed around 78% to the total order book followed by industrial projects (15%) and residential projects (7%). These projects are expected to be executed over the next 15-18 month period.

• At the current market price, the stock trades at 19.0x FY2009 and 14.8x FY2010 estimated earnings after adjusting for the real estate subsidiary value. We are rolling over our target multiple to FY2010 estimated earning and value the stock at Rs1,827 based on the sum-of-the-parts (SOTP) valuation. Although the stock appears to be fairly valued at the current market price, we recommend Hold on the stock, as BLK's negotiation to dilute its stake in the real estate subsidiary could bring surprise and provide more upside than our estimates.

Cadila Healthcare
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs368
Current market price: Rs255

Price target revised to Rs368

Result highlights

• Cadila Healthcare (Cadila)'s total operating income (consolidated) grew by a 22.7% year on year (yoy) to Rs579.4 crore in Q3FY2008. The sales were in line with our estimate and were driven by a 14.9% growth in the domestic business and a 40.4% growth in the exports.

• While the domestic formulation business continued to remain sluggish during the quarter, the improved performance of the French business (a growth of 14.9% yoy) and the US business (a growth of 47.4% yoy) contributed largely to the robust growth in the exports. The company has already garnered ~$45 million in revenues from the US generic business in M9FY2008 and is well placed to exceed its guidance of $50 million for FY2008. We have modeled $55 million in US generic sales in FY2008 and $70 million in FY2009.

• The prospects of Cadila's joint venture (JV) with Altana have been uncertain, with generic companies entering the market. This is already evident in Q3FY2008 as the revenues and profits of this JV dropped by 32% sequentially in Q2FY2008 and by 43% sequentially in Q3FY2008. The management has indicated that the expected loss of profits due to the generic entry in Pantoprazole would be to the tune of Rs17-18 crore in FY2009. On the other hand, Wyeth's (Altana's partner in the USA) appointment of an authorised generic player increases the JV's prospects, as the JV would be supplying the Pantoprazole active pharmaceutical ingredient (API) to the authorised generic player. We have conservatively modeled revenues of only $28 million in FY2008 and of $20 million in FY2009 for the JV. Any positive outcome from the ongoing talks between Cadila and Altana would be an upside to our estimates.

• Cadila's operating profit margin (OPM) expanded by 50 basis points to 17.9% in Q3FY2008. The expansion in the margin was largely due to a 170-basis-point improvement in the raw material cost. Consequently, the operating profit grew by 25.8% to Rs103.5 crore in Q3FY2008.

• The pre-exceptional net profit grew by 13.2% to Rs52.4 crore due to a 27.4% rise in the depreciation (on account of acquisitions) and a 780-basis-point increase in the tax incidence. The net profit was below our estimate of Rs62 crore. The earnings for the quarter stood at Rs4.2 per share.

• Cadila's JV with Hospira for oncology injectables seems to be on track to start contributing from FY2009 onwards. The management has indicated that the JV will generate Rs150 crore in revenues in FY2009. However, we have built in only Rs100 crore into our estimate (of which Cadila's share will be Rs50 crore).

• In view of the slower than expected ramp-up in the domestic formulation business and the reduced revenue and profit potential of the Altana JV (due to generic entry), we are downgrading our numbers for Cadila. Further, we are also incorporating the revised guidance provided by the management on the revenue potential of the Cadila-Hospira JV from FY2009 onwards. We have revised downwards our FY2008 and FY2009 earnings estimates by 12.0% and 12.5% respectively to Rs19.7 per share in FY2008 and Rs23.0 per share in FY2009.

• Cadila's stock price has seen a significant correction over the past two weeks. We believe the current price more than factors in the genericisation of Pantoprazole. At the current market price of Rs255, the stock is available at attractive valuations of 12.9x our FY2008 and at 11.1x our FY2009 estimated earnings. We reiterate our Buy recommendation on Cadila with a revised price target of Rs368 (16x FY2009E earnings).

Ceat
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs250
Current market price: Rs181

Results in line with expectations

Result highlights

• Ceat's Q3FY2008 performance was in line with our expectations.

• The net sales grew by 5.1% to Rs564.1 crore due to lower production owing to festive holidays during the quarter and a slowdown in original equipment manufacturer (OEM) sales, which declined by 26.6% year on year (yoy). Replacement sales continue to be strong and rose by 21.9% during the quarter.

• The operating profit margin (OPM) remained stable at 7.4% against 7.3% in the same quarter of the last year but declined significantly on a sequential basis from 9.4% in Q2FY2008 due to lower production and rising raw material prices, particularly rubber prices. Consequently, the operating profit grew by 7.1% to Rs41.8 crore.

• A higher other income for the quarter at Rs8.3 crore, lower interest cost and stable depreciation charge led to a 63.2% rise in the net profit to Rs19.2 crore.

• The land sale at its Bhandup plant is expected to be complete by Q4FY2008 and the company would gradually sell the whole plant and shift the operations to Patalganga.

• Considering the continued buoyancy in the replacement market and strong opportunities in the specialty tyre segment, we maintain our positive outlook on Ceat. On back of very strong performance in the first nine months, strong margins and higher other income, we upgrade our FY2008 earnings estimate by 16.9% to Rs24.3 and expect the company to record a 10.4% top line growth in FY2009.

• At the current market price of Rs181, the stock is trading at 6.9x its FY2009E earnings and an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 3.1x. We maintain our Buy recommendation on Ceat with a price target of Rs250.

Corporation Bank
Cluster: Apple Green
Recommendation: Buy
Price target: Rs542
Current market price: Rs312

Lower provisions boost PAT

Result highlights

• Corporation Bank reported a lacklustre set of numbers for Q3FY2008, though the profit after tax (PAT) indicates a strong growth of 30.4% year on year (yoy) and 18.3% quarter on quarter (qoq) to Rs191 crore.

• The net interest income (NII) stood at Rs334 crore, up 6% yoy was down 6% qoq. The disappointing NII was mainly due to the contraction in the net interest margin (NIM).

• During Q3FY2008 the calculated NIM witnessed a 31 basis points decline yoy, mainly due to higher cost of funds, which outweighed improvement in yield on investment and advances.

• The non-interest income registered a subdued growth of 4.8% yoy, while declining 8.8% qoq to Rs167 crore. During the quarter, the fee income registered a strong growth of 24.5% yoy, which was outweighed by a passive performance in treasury gains and recoveries.

• Further, the operating expenses grew by 11.8% yoy to Rs223 crore. The higher operating expenses can be traced to a 23% year-on-year (y-o-y) increase in the staff expenses, while other operating expenses were up marginally by 2% yoy to Rs108 crore.

• Disappointing NII growth, subdued non-interest income and higher operating expenses led to a lacklustre growth of 1.1% yoy in the operating profit, while on a quarter-on-quarter (q-o-q) basis it declined by 5.8%.

• Notably, provisions of Rs9.7 crore for the quarter were down significantly by 88.3% yoy and 82% qoq, which surprised us. The lower provisioning helped the bank report a healthy PAT growth.

• Asset quality continued to improve as reflected by a 4.2% decline in the gross non-performing assets (GNPA) to Rs598.5 crore and a 17.7% decline in the net non-performing assets (NNPA) to Rs112.3 crore.

• At the current market price of Rs312, the stock is quoting at 5.8x FY2009E earnings per share (EPS), 3.0x FY2009E pre-provision profits (PPP), and 0.9x FY2009E book value (BV). We maintain our Buy recommendation on the stock with price target of Rs542.

Crompton Greaves
Cluster: Apple Green
Recommendation: Buy
Price target: Rs423
Current market price: Rs313

Price target revised to Rs423

Key points

• The M9FY2008 performance of Crompton Greaves Ltd (CGL) has been below our expectations. The power system business of the company displayed sluggish growth in its revenues. While in Q2 the revenue growth saw a set back due to a fire in a transformer plant, the Q3 revenues grew by only 13.1% due to logistical problem and delay in the delivery of orders.

• In the recent conference call, the management of the company has guided for a revenue growth of 19% in the power business, 20% in the industrial business and 15% in the consumer business in FY2008. The guidance was below our earlier estimates, leading us to the downgrade our estimates.

• In this report, we are also introducing our FY2010 earning estimates and expect CGL revenues and profits to grow at a compounded annual growth rate (CAGR) of 21.6% and 33.7% respectively over FY2007-10E.

• The standalone order book of the company remained flat at Rs2,175 crore, while the consolidated order book of the group stood at USD1.3 billion. We expect the order inflow to pickup from Q4FY2008 onwards.

• On a consolidated basis, the company reported net sales of Rs1,713.5 crore, while the net profit was at Rs82.7crore. The consolidated operating profit margin (OPM) increased by 80 basis points quarter on quarter (qoq) to 10.9%. An year-on-year (y-o-y) comparison could not be made, as the quarterly consolidated numbers were not reported earlier.

• We have downgraded our earnings estimates by 8.8% and 4% respectively for FY2008 and FY2009. Our revised earning per share (EPS) estimates now stands at Rs10.6 and Rs14.4 for FY2008 and FY2009 respectively.

• We remain bullish on the stock and reiterate Buy recommendation with a revised price target of Rs423. We have valued CGL based on 23x FY2010E EPS, which is based at 15% premium to our target multiple of Thermax.

• CGL is one of the largest players in the power sector and with the acquisition of Pauwel, Ganz, and Microsol has plugged the gaps in its products and services offerings. We believe these valuations are attractive because of (a) Robust operating performance of the company on a standalone basis; (b) Higher geographical width and product depth of the company due to its subsidiaries and (c) Management's expertise in turning around the operations of the subsidiaries. At the current market price, the stock trades at 21.7x and 17x its FY2009E and FY2010E consolidated earnings.

Deepak Fertilisers & Petrochemicals Corporation
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs169
Current market price: Rs118

Price target revised to Rs169

Result highlights

• The net sales of Deepak Fertilisers & Petrochemicals Corporation (DFPCL) for Q3FY2008 increased by 12.6% year on year (yoy) to Rs274 crore. The chemical division and the fertiliser division contributed 76% and 24% respectively to the net sales. The revenues from the chemical division increased by 27.6% yoy to Rs211.6 crore on the back of a strong contribution from isopropyl alcohol (IPA), while the sales of the fertiliser division dropped by 19% yoy to Rs68.3 crore due to the reduced availability of phosphoric acid in the international market and the lower availability of the same for trading.

• The operating profit during the quarter grew by 11% yoy to Rs45.1 crore. Lower sales realisation for methanol offset the strong performance of IPA, thereby declining the overall operating profit margin (OPM) by 20 basis points to 16.5%. The segmental profit before interest and tax (PBIT) for the chemical division reduced by 1.4% to Rs52.4 crore with the margin declining from 32.1% to 24.8%. The loss in the fertiliser division dropped to Rs5.5 crore from Rs13.5 crore. Increased raw material cost including that of outsourced ammonia and propylene decreased the segmental PBIT margin for the chemical division, while the higher price realisation for fertilisers reduced the segmental loss.

• The interest expenses were higher by 55% yoy due to increased outstanding debt issued for new projects and capacity expansions. The depreciation charge also increased by 3% yoy during the quarter.

• The adjusted profit after tax (PAT) declined by 1.1% yoy to Rs24.6 crore with the margin reducing by 120 basis points to 9.0%. The effective tax rate increased during the quarter as the company has no carry-forward losses this year.

• The company has already increased its ammonia capacity to 130,000 tonne per annum (TPA) from 90,000TPA during the second quarter. This along with increased natural gas availability and additional ammonia storage tank would help the company in reducing the raw material cost and enhancing its nitric acid capacity.

• Dahej-Uran pipeline is complete and tested. The company is in the process of negotiating a long-term gas supply contract and is expected to finalise the same by Q1FY2009. Improved supply of natural gas to Taloja plant would help in replacing naphtha for steam generation. Spot liquid natural gas at around $12-14 per Million British Thermal Units (MMBTU) would cost almost half the price of naphtha ($22 per MMBTU).

• The company has started setting up the ammonium nitrate plant at Paradeep (Orissa). The civil and construction work of the plant is complete and orders for various equipment have been placed. The set-up cost of the plant has increased to Rs500 crore from Rs400 crore estimated earlier. The 300,000TPA plant is expected to be operational in H2FY2008.

• The company's specialty mall Ishanya (for interiors and exteriors) commenced its operations during the quarter, ahead of the festive season. The company has already leased out nearly 80% of the 550,000 square feet leasable area at an average rental price of Rs46 per square foot.

• At the current market price of Rs118, the stock is trading at 7.6x its FY2009E earnings and at an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 5.7x. The improved supply of natural gas would benefit the fertiliser division in the coming years, while its ammonium nitrate project would also start contributing from H2FY2010. In view of future earnings visibility, Ishanya, the company's specialty mall for interiors and exteriors is valued at Rs28.7 per share. Due to the delay in the gas supply, we are downgrading our FY2009 profit estimates to Rs137.8 crore from Rs150 crore earlier. We maintain our Buy recommendation on the stock with a revised price target of Rs169.

Grasim Industries
Cluster: Apple Green
Recommendation: Buy
Price target: Rs3,853
Current market price: Rs2,736

Price target revised to Rs3,853

Result highlights

• Grasim Industries' (Grasim) Q3FY2008 net sales increased by 15.4% year on year (yoy) to Rs2,630 crore, mainly on the back of higher realisations from Viscose Staple Fibre (VSF) and sponge iron businesses.

• The operating profit margin (OPM) improved by 340 basis points to 32.6%, mainly on account of higher realisations from VSF and sponge iron businesses. Consequently the operating profit was up 29% yoy to Rs856.3 crore.

• The reported profit after tax (PAT) was up by a robust 34.6% yoy to Rs553.79 crore because of a healthy growth reported across all the segments namely cement, VSF, sponge iron and caustic soda.

• The company's expansion plans are on track for both cement and VSF businesses. The company is adding about 9 million tonne per annum (MTPA) of cement capacity by Q2FY2009 and about 95,000 tonne of VSF capacity, of which 64,000 tonne is expected to come by March 2008. The company has also announced a Rs840-crore greenfield plant with 88,000 tonne VSF capacity.

• The management has hinted at a possible buyback, which will be a positive trigger for the stock.

• Considering the better-than-expected nine month consolidated performance, we are upgrading our profit estimate by 9.4% and 8.0% for FY2008 and FY2009 respectively. At the current market price of Rs2,736 the stock is trading at 9.4x its estimated FY2008 earnings per share (EPS) and 10.8x its estimated FY2009 EPS. We maintain our Buy recommendation on the stock with a revised price target of Rs3,853 based on our sum-of-the-parts valuation.

HDFC Bank
Cluster: Evergreen
Recommendation: Buy
Price target: to Rs1,747
Current market price: Rs1,548

Price target revised to Rs1,747

Result highlights

• HDFC Bank's Q3FY2008 results have been better than expectations. The profit after tax (PAT) grew by 45.2% to Rs429.4 crore compared with our estimate of Rs406.6 crore. The PAT growth, of 45.2% year on year (yoy), for the quarter was also much higher than the steady 30-31% growth in the PAT the bank has been delivering quarter after quarter (Q2FY2008 growth was 40.2% and Q1FY2008 growth was 34.2%).

• The net interest income (NII) grew by 65.6% yoy and 23.6% quarter on quarter (qoq) to Rs1,437.6 crore. The year-on-year (y-o-y) growth in the NII was due to an average asset growth of 43.9% yoy and a 55-basis-point improvement in the calculated net interest margins (NIM) to 4.5%.

• The non-interest income growth was 81.9% yoy and 40.7% qoq mainly due to a spike in the treasury gains coupled with a robust growth in the fee income. The treasury income reached Rs132 crore compared with a loss of Rs21 crore for the year ago period, while the fee income grew by 38.8% yoy and 17.4% qoq.

• The operating profit grew by 67.5% yoy and 29% qoq to Rs1,066.4 crore, while the core operating profit (operating profit excluding the treasury income) was up 42.2% yoy to Rs934.9 crore.

• Provisions and contingencies were up sharply to 105.4% yoy and 46.2% qoq to Rs423.1 crore, in line with the bank's focus on unsecured retail portfolio such as personal loans, credit cards etc, which offer higher yields.

• The bank's advances grew by 48.7% yoy and 14.6% qoq to Rs71,387 crore and the deposits grew by 48.9% yoy and 9.1% qoq to Rs99,387 crore. The bank displayed a strong business growth despite the difficult environment during the last five-six month period.

• The bank reported a 45.2% PAT growth for the quarter, which is much higher than the steady 30-31% growth in the PAT the bank has been delivering quarter after quarter. The business growth continued to remain robust with superior asset quality and margins compared with that of the industry. The bank has delivered a strong set of numbers and maintained or improved on most parameters amidst a difficult environment.

• We therefore continue to like HDFC Bank as a true evergreen stock under most circumstances. At the current market price of Rs1,548 the stock is quoting at 27.6x FY2009E earnings per share (EPS), 10.4x FY2009E pre-provision profit (PPP), and 4.1x FY2009E book value (BV). We maintain our Buy recommendation on the stock with an increased 12-month price target of Rs1,747 (earlier price target was Rs1,694). We have raised the price target after factoring in the higher growth momentum, which the bank is experiencing this year. Our net profit forecast has increased by 1.5% for FY2008E and 1.7% for FY2009E.

Hindustan Unilever
Cluster: Apple Green
Recommendation: Buy
Price target: Rs280
Current market price: Rs203

Back with a bang!

Result highlights

• Hindustan Unilever Ltd's (HUL) Q4CY2007 results are in line with our estimates. The net sales grew by 16.8% year on year (yoy) to Rs3,687.4 crore. The sales growth was driven by strong performance of both the home & personal care (HPC) and food segments, which grew by 18.6% and 17.4% respectively on a year-on-year (y-o-y) basis.

• The soaps & detergents business put up a strong show with sales growth of 18.3% yoy to Rs1,689 crore and the profit before interest and tax (PBIT) margin of 17.2% (up by 165 basis points yoy). The personal care products business that had been a laggard for the last four quarters reported a strong growth of 19.1% yoy on account of a low base effect. The PBIT margin for the segment stood at a hefty 33.4% (up by 153 basis points yoy).

• The operating profit margin (OPM) as a whole declined by 54 basis points to 15.3% yoy, mainly due to the increase in employee expenses by 46% yoy to Rs194.5 crore and the rise in advertising and selling cost by 32.3% yoy to Rs375.9 crore. The raw material cost as a percentage to sales showed a substantial decline of 270 basis points to 51.5%. Hence the operating profit increased by 12.8%yoy to Rs564.2 crore.

• Other income increased by 49.3% yoy to Rs159.7 crore leading the earnings before interest, depreciation, tax and amortisation (EBIDTA) to increase by 19.3% to Rs723.9 crore.

• Consequent to the higher tax rate of 19.1% during the quarter as against 15.3% in Q4CY2006, the adjusted net profit was up by 14.6% to Rs554 crore, which is in line with our estimate of Rs569.8 crore.

• While competitive pressures to maintain the market share in its flagship HPC segment are on the rise coupled with input cost inflation, we are pleased that HUL is exploring ways by expanding its presence into premium personal care products to maintain the growth in HPC segment. At the current market price of Rs203, the stock trades at 21.8x its CY2008E earnings per share (EPS) of Rs9.30. We maintain our Buy recommendation with price target of Rs280.

ICI India
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs581
Current market price: Rs495

Lower other income dampens profit growth

Result highlights

• ICI India's sales growth of 14.5% year on year (yoy) to Rs256.7 crore is as per our expectations. The paints segment registered a like-to-like growth (excluding Q3FY2007 sales of Advanced 2K refinish paints that was hived off in March 2007) of 22% yoy. The chemicals segment continued the impressive growth with a 24.8% year-on-year (y-o-y) growth in the sales for the quarter.

• The operating profit margin (OPM) for the quarter under review stood at 14.9% against 15.6% in Q3FY2007. The operating profit thereby increased by 9.3% yoy to Rs38.3 crore on account of a good top line growth.

• The other income was lower at Rs0.6 crore against Rs7.7 crore in Q3FY2007, as the company has invested its huge pile of cash (~Rs650 crore) mostly in fixed maturity plans, wherein the returns are accounted on cash basis (on receipt basis) leading to an erratic quarter-on-quarter (q-o-q) other income. The adjusted net profit therefore grew only by 7.2% yoy to Rs25.2 crore.

• As against the expectation that the takeover of ICI Plc by Akzo Nobel (completed on January 2, 2008) would trigger an open offer to the shareholders of ICI India, the Securities and Exchange Board of India (SEBI) has made it clear that Akzo Nobel is not under an obligation to make an open offer, as this is an indirect acquisition under a scheme of arrangement.

• In light of the nine-month performance of ICI India, we have revised our estimates for FY2008. This is primarily on account of much lower other income, as the company accounts for income from fixed-maturity plans on receipt basis that leads to a big variance in the yearly other income due to maturity of these investments bunching up in a few years.

• We remain positive on ICI India primarily on account of good prospects for paints industry, synergies that would arise on concerted efforts of Akzo Nobel in growing ICI India's business and a huge pile of cash (~Rs650 crore) that opens up opportunities for organic and inorganic growth.

• At the current market price of Rs495, the stock trades at 20.8 x its FY2008E earnings per share (EPS) of Rs23.8 and 15.7x FY2009E EPS of Rs31.6. We maintain our Buy recommendation on the stock with a price target of Rs581.

Jindal Saw
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs1,302
Current market price: Rs904

Entering new territories

Result highlights

• Jindal Saw Ltd's (JSL) Q5FY2007 numbers were ahead of our expectations on the back of higher topline and improved margins. The net revenues marked a growth of 35.1% year on year (yoy) to Rs1,611.7 crore due to high growth witnessed in the submerged arc welded (SAW) pipe and the ductile iron (DI) pipe segments.
• The US division, which contributed Rs535 crore to the topline during the quarter, has been hived off. Since the US division was operating at lesser margins of about 8-9%, its hiving off would result into an expansion in the company's profit margins.
• On the back of a favourable product mix, lesser contribution of the US division, and greater efficiencies, the operating profit margin (OPM) expanded by 100 basis points yoy and 50 basis points sequentially to 12.4%. Consequently, the operating profits surged by 46.3% to Rs199.8 crore. Lower taxes led the profit before extraordinaries to grow by 83.1% to Rs110.1 crore.
• JSL's order book at the end of the quarter stood at $1 billion executable by January 2009, with more than 65% contribution coming from international markets. Of this, $775 million orders were for SAW pipes, while the remaining orders were for DI and seamless pipes.
• The company has announced new initiatives and has identified opportunities in new areas of infrastructure, transportation and fabrication industry, all through wholly owned subsidiary Jindal ITF. In all, the capital expenditure (capex) of Rs1,800 crore is planned to be spent on these businesses with 25% equity contribution.
• To fund these plans, the company would also be issuing 26 lakh warrants and 27.3 lakh convertible debentures to the promoters, convertible at Rs819 per share.
• We are not taking into account the impact of these new initiatives into our numbers currently and would await more clarity on the same. However, we do believe that there lies immense potential in these businesses, and the same would also offer higher return on capital than that of the core business.
• We maintain our positive outlook on the company considering strong scope for its core business and margin expansion. We believe the stock is trading at attractive valuations at 9.9x its CY2008E earnings and 5.4x its CY2009E earnings. We maintain our Buy recommendation on the stock with a price target of Rs1,302.

Mahindra Lifespace Developers
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs1,096
Current market price: Rs629

Q3FY2008 results—in line with expectation

Result highlights

• Please note that Q3FY2008 numbers are standalone numbers, which does not give a complete picture, as the company's major SEZ projects (Chennai and Jaipur SEZ projects) are executed through its subsidiaries. The consolidated numbers are eported on an annual basis.

• Mahindra Lifespace Developer's (MLD) revenues grew by 3.8% year on year (yoy) to Rs43.4 crore in Q3FY2008. During the quarter, the revenues were booked from Mahindra Eminente in Goregaon, Mahindra Royale in Pune and Sylvan County in Chennai. In M9FY2008, MLD's revenues declined by 7.4% yoy to Rs112.5 crore, due to delay in the projects launches for the standalone properties in the previous quarters.

• The operating profit margin (OPM) contracted by 329 basis points yoy to 19.1%. Consequently, the company's operating profit declined by 11.5% yoy to Rs8.3 crore.

• MLD's net income grew by 17.6% yoy to Rs11.2 crore primarily due to the increase in the other income to Rs5.2 crore in Q3FY2008 from Rs3.1 crore in Q3FY2007. The other income rose on account of higher interest income generated on cash surplus. In M9FY2008, MLD's net income grew 175.8% yoy to Rs10.6 crore primarily due to higher other income on account of dividend income received from its subsidiary, Mahindra World City Developers.

Mold-Tek Technologies
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs197
Current market price: Rs103

Price target revised to Rs197

Result highlights

• Mold-Tek Technologies' (MTT) Q3FY2008 results were in line with our expectations. The net sales increased by 15.3% year on year (yoy) to Rs24.1 crore. The contribution of the KPO (Knowledge Process Outsourcing) division to the total revenues of the company increased to 20.5% from 14.3% during the same quarter last year. The revenues from the plastics division increased by 6.6% yoy to Rs19.1 crore, while the sales from the KPO division increased by 67.9% yoy to Rs5 crore.

• The operating profit margin (OPM) increased to 18.4% from 16.5% during the same quarter last year on account of an increased contribution from the KPO division. Consequently, the operating profit rose by 28.3% to Rs4.4 crore. The segmental profit before interest and tax (PBIT) for the plastics division increased by 28.2% to Rs1.4 crore with the margin expanding by 110 basis points to 7.2%. The PBIT for the KPO division increased by 55.4% to Rs2.6 crore.

• The interest costs increased by 8.2% to Rs53 lakh, while the depreciation rose by 12.7% to Rs80 lakh. Modest increases in interest and depreciation costs resulted in a 52.6% growth in the net profit to Rs3.5 crore.

• Pursuant to the order of high court of Andhra Pradesh, the de-merger scheme has been approved by the shareholders. The de-merger of the company into two separate entities is expected to unlock value in the KPO business, as it is currently valued in line with the plastics business, where the margins are quite low compared to the KPO business.

• MTT has gained size and expertise required to carve its niche within structural engineering KPO business. The company has also taken inorganic growth path to increase its presence in the key overseas markets. Consequently, we estimate the KPO business to grow at a compounded annual growth rate (CAGR) of over 150% till FY2010 including growth through acquisitions.

• At the current market price of Rs103, the stock is trading at 5.5x its FY2009E earnings. We maintain our Buy recommendation on the stock with a revised price target of Rs197.

Navneet Publications (India)
Cluster: Emerging Star
Recommendation: Hold
Price target: Rs120
Current market price: Rs115

Results ahead of expectations

Result highlights

• Navneet Publication Ltd's (NPL) Q3FY2008 results are ahead of expectations. The net sales grew by a robust 29.2% year on year (yoy) to Rs59.1 crore on account of healthy growth in the stationery business, which grew by 38.6% yoy to Rs22.7 crore.

• Though the turnover of the stationery business increased, the profits from the business did not increase proportionately on account of additional sales promotion cost of Rs1.1 crore. However, the company expects to benefit from these sale promotion activities going forward.

• The operating profit margin (OPM) declined marginally by 39 basis points to 13.3%. This was mainly because of the increase in the other expenditure, which grew by 33.6% to Rs12.61 crore. The operating profit increased by 25.5% to Rs7.87 crore in Q3FY2008 from Rs6.27 crore in Q3FY2007.

• The increase in depreciation by Rs99 lakh was mainly on account of windmills, which started operating from September 2007. Higher depreciation and interest expenses led to a much lower growth of 7.7% yoy in the profit after tax (PAT) to Rs3.64 crore.

• Going forward the publication segment, which is one of the major contributors (63% of the total revenue) to the topline of the company, will achieve a flat growth, as syllabi is no more being revised in the schools of Gujarat and Maharashtra. The flat growth of the publication segment would however be offset by some of its new initiatives such as non-paper stationery products, introduction of Urdu publication and e-learning business, which would drive the growth for NPL in near future. Grafalco, its Spanish subsidiary, has performed as per expectation showing a growth of 81% in its revenues to Rs11.6 crore.

• The company's foray into e-learning business is being well recognised among schools in Gujarat and Maharashtra. At the current market price of Rs114.8, the stock is trading at 18.4x its 2009E earnings per share (EPS) and at an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 11.9x. Though the valuation appears to be stretched, we believe that the e-learning business could throw up positive surprises. Consequently, we maintain our Hold recommendation on the stock with a revised price target of Rs120.

Punj Lloyd
Cluster: Apple Green
Recommendation: Buy
Price target: Rs620
Current market price: Rs395

Other income boost profit growth

Result highlights

• Punj Lloyd Ltd (PLL) has reported a revenue growth of 47.7% to Rs2,117 crore for Q3FY2008. The same is marginally below our expectations. Its subsidiary, Sembawang E&C (SEC), reported revenues of Rs832.4 crore for the same quarter.

• The pipeline business reported revenues of Rs631.3 crore, ie 28.7% of the total revenues. The process plants contributed the highest revenues at Rs881.5 crore, ie 40.1% of the total revenues of the company.

• In the current quarter the company has provided for losses of Rs67.9 crore on SEC legacy orders. PLL is in negotiations with clients in order to recover these losses. Adjusting for the one-off expenditure of Rs67.9 crore, the operating profit grew by 107.5% year on year (yoy) to Rs172.4 crore. Subsequently, the operating profit margin (OPM) stood at 8.1%, up 230 basis points yoy.

• The interest expense remained flat—it was up 1.8% to Rs28.4 crore. The depreciation charge, however, reported a growth of 23.4% to Rs36.5 crore.

• In the current quarter the company reported a one-time income of Rs37.1 crore on account of the write-back of the provisions for doubtful loans and contingencies.

• The adjusted net profit after tax reported a growth of 145.1% to Rs116.9 crore in Q3FY2008. The growth was higher than expected mainly on account of a higher than expected other income. The reported profit grew by 92.1% yoy to Rs91.7 crore.

• The order book of the company remains robust at Rs16,012.9 crore, which is 3.1x its FY2007 reported revenues. However, in the current quarter major orders came in for SEC, its subsidiary.

Ranbaxy Laboratories
Cluster: Apple Green
Recommendation: Buy
Price target: Rs558
Current market price: Rs412

Board clears proposal for hiving off discovery R&D

Key points

• The board of Ranbaxy Laboratories (Ranbaxy) has cleared a scheme of demerger of the company's New Drug Discovery Research (NDDR) unit into a subsidiary, Ranbaxy Life Science Research Ltd (RLSRL). The demerger scheme is subject to requisite approvals.

• Under the scheme of demerger, all assets, liabilities, research personnel and pipeline related to the NDDR unit will be transferred to RLSRL. In consideration, each shareholder of Ranbaxy will receive one equity share of Re1 each of RLSRL for every four equity shares of Rs5 each held in Ranbaxy.

• The demerged company will be an independent company, the equity shares of which will be listed on the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE), while global depositary receipts (GDR) will be listed at the Luxembourg Stock Exchange. All approvals required for the scheme to come into effect are expected in the 2nd half of 2008.

• The demerger will enable the company to explore various funding options for the NDDR projects as well as allow for enhanced focus and dedicated resources for long-term value creation.

• The demerger will also improve the profitability of the core manufacturing business. The management has indicated that the demerger will result in savings of approximately $25 million in CY2008. The savings have already been factored into our estimates.

• At the current market price of Rs412, Ranbaxy is trading at 19.3x its base CY2008E earnings and 16.8x its base CY2009E earnings. We maintain our Buy recommendation on the stock with the sum-of-the-parts price target of Rs558 (20x CY2009E earnings of base business plus Rs68 for exclusivity opportunities).

Ratnamani Metals and Tubes
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs1,440
Current market price: Rs1,070

Steady growth momentum

Result highlights

• For Q3FY2008, Ratnamani Metals and Tubes Ltd (RMTL) reported a growth of 14.3% year on year (yoy) in the net sales to Rs214.4 crore. The net sales were however marginally below our expectation.

• The operating profit grew by 13.9% to Rs48.1 crore and the operating profit margin (OPM) remained flat at 22.5%. The OPM remained flat on the back of stable raw material prices and improved operational efficiency.

• The other income showed a steep increase on a year-on-year (y-o-y) basis and came in at Rs3.3 crore. The increase in other income is attributed to the foreign exchange (forex) gain.

• The interest cost was up 28.1% to Rs4.4 crore, while the depreciation charge jumped by 85.9% to Rs6.2 crore.

• The net profit increased by 25.7% to Rs27.3 crore inline with our expectation of Rs28.5 crore.

• The order book stood at Rs532 crore executable over the next six-month period. Orders worth Rs132 crore came in from direct exports.

Sanghvi Movers
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs298
Current market price: Rs250

Price target revised to Rs298

Key points

• Large investments in core sectors like refineries, windmills, petrochemicals, cement and power will create huge demand for cranes. Sanghvi Movers Ltd (SML) which is the largest player in crane hiring business in the country is likely to corner a large share of the opportunity

• In the first nine months of FY2008, SML added 16 cranes to its fleet and is expected to add another 22 cranes in the Q4FY2008. By the end of FY2008, SML would have a fleet size of 283 cranes with capacity ranging from 20 to 800 tonne. The fleet would be the biggest in the country and the wide tonnage range would enable SML to provide unmatched service.

• In FY2010, we expect SML to clock revenues of Rs407.1 crore though yields are likely to be lower. We expect the revenues to grow at a compounded annual growth rate (CAGR) of 31.6% over FY2007-10E. Stable operating performance should help the bottom line to grow at a CAGR of 31.8% over FY2007-10E.

• SML plans to spend Rs200 crore in FY2008, Rs390 crore in FY2009 and Rs100 crore in FY2010 to acquire more cranes.

• The Q3FY2008 results were above our expectation. The robust top line growth and stable operating performance resulted in a strong profit growth during the quarter. We have fine-tuned our earnings for FY2008 in wake of better than expected Q3FY2008. On increased capital expenditure (capex) guidance, we have revised our FY2009 estimates by 3.1% to Rs18.90 per share.

SEAMEC
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs273
Current market price: Rs165

Price target revised to Rs273

Result highlights

• Q4CY2007 results of SEAMEC have been quite disappointing. The revenues during the quarter declined by 64% year on year (yoy) to Rs22.3 crore from Rs61.6 crore due to lesser deployment of vessels. During the quarter, SEAMEC III was the only vessel that was fully deployed, while SEAMEC II and SEAMEC IV were not operational due to up-gradation or repair work for longer duration than expected. SEAMEC I was also under-utilised due to premature termination of contract.

• The company registered an operating loss of Rs11.6 crore as against the operating profit of Rs30.4 crore during the corresponding quarter last year (Q4CY2006). The company incurred dry docking expense of Rs10.3 crore during the quarter.

• The company suffered a net loss of Rs15.9 crore during the quarter as against the net profit of Rs25.9 crore during Q4CY2006 on account of lower revenue generation and higher dry docking expenses.

• On yearly basis, the revenues registered a modest growth of 7.1% to Rs170.4 crore, while the operating profit declined by 28.2% to Rs50.8 crore.

• With SEAMEC II to be out of operations for a minimum of six-month duration and delay in up-gradation of SEAMEC IV, we expect the company's performance to suffer during H1CY2008. Consequently, we are downgrading our CY2008 estimates to Rs23.1 per share from the earlier estimate of Rs33.5 per share.

• At the current market price, the stock trades at 7.2x CY2008 and 5.2x CY2009 estimated earnings. We maintain our Buy recommendation on the stock with a revised price target of Rs273 (8.5x CY2009 earnings).

Selan Exploration Technology
Cluster: Ugly Duckling
Recommendation: Hold
Price target: Rs160
Current market price: Rs158

Volume growth below expectations

Result highlights

• For Q3FY2008, Selan Exploration Technology (Selan) has reported a growth of 44.4% in its revenues to Rs7.8 crore. However, the revenues declined by 12.5% sequentially. The sequential growth was dented by a 21.9% drop in the volumes (barrel of crude oil) sold, which is lower than our expectations. This was partially mitigated by a 12.6% sequential improvement in the average realisation (per barrel) during the quarter.

• In Q3, the production volume was dented by seasonality factor. The third quarter has lower number of working days due to festive season. Moreover, some of the wells were partially shut down for testing and maintenance.

• The operating profit margin (OPM) at 62% in Q3FY2008 was lower than 64.1% reported in Q2FY2008. The OPM declined largely due to additional cost incurred on maintenance and higher overhead cost as percentage of sales. The operating profit grew by 77.9% year on year (yoy) and declined 15.3% quarter on quarter to Rs4.8 crore.

• However, the earnings grew at a healthy rate of 14.7% sequentially and 109.7% yoy to Rs3.9 crore. The earning growth was boosted by the lower effective tax rate during the quarter.

• For the nine-month period ended December 2007, the revenues and the earnings have grown by 37.9% and 44.6% respectively. The OPM at 64% is higher than 61.4% reported in the corresponding period last fiscal.

• To factor in the lower than expected production volumes in Q3FY2008, we are revising downwards our earnings estimates by 2.6% for FY2008 and 4.5% for FY2009 respectively. We are factoring a volume growth of 25.3% compounded annual growth rate (CAGR) over FY2007-09 (lower than the management guidance of 30-40% CAGR over the two-year period). At the current market price, the stock trades at 16.1x FY2008 and 11.8x FY2009 estimated earnings. We maintain our Hold recommendation on the stock with a revised price target of Rs160 (12x FY2009 earnings; 2.2x enterprise value (EV)/oil reserves [2P]).

SKF India
Cluster: Apple Green
Recommendation: Buy
Price target: Rs475
Current market price: Rs355

Price target revised to Rs475

Result highlights

• SKF India's Q4CY2007 results are in line with our estimates. The net revenues for the quarter grew by 10.8% year on year (yoy) to Rs420 crore. The revenue growth has been impacted due to slowdown in the automobile segment, mainly two-wheelers.

• The operating profit margin (OPM) improved by 100 basis points to 14.5%, leading to a 18.6% growth in the operating profit to Rs61 crore. A higher other income and interest income led the profit after tax (PAT) grow by 26.7% to Rs40.2 crore.

• For CY2007, the sales grew by 16.8% to Rs1,568.3 crore. The OPM for the year improved by 380 basis points from 12.4% to 16.2% in CY2007. The PAT for CY2007 is at Rs160.7 crore, a growth of 62%.

• SKF, AB plans to invest Rs420 crore in its new manufacturing facilities in India. Of this, Rs150 crore is invested by SKF India and Rs270 crore is through SKF's 100% subsidiary in India—SKF Technologies India Private Ltd.

• We maintain our positive outlook on SKF India in view of the growing demand for bearings and allied services. We introduce our estimates for CY2009. At the current market price of Rs355 the stock is discounting its CY2009 earnings estimate by 9.1x and its earnings before interest, depreciation, tax and amortisation (EBIDTA) estimate by 4.2x. We maintain our Buy recommendation on the stock with a reduced price target of Rs475.

Tata Chemicals
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs535
Current market price: Rs291

Disappointing overseas performance

Result highlights

• Q3FY2008 results of Tata Chemicals Ltd (TCL) have been quite disappointing. The consolidated revenues during the quarter registered a de-growth of 4.5% year on year (yoy) to Rs1,700.1 crore on account of a lower contribution from the fertiliser segment. The revenues from the fertiliser segment decreased by 13.1% to Rs860 crore, while the same for the chemical division increased by 6.2% to Rs840 crore.

• The consolidated operating profit during the quarter decreased by 14.5% from Rs292.2 crore to Rs249.8 crore, with the operating profit margin (OPM) declining by 170 basis points to 14.7%. The inability to pass on the increased input costs in overseas operations (due to long-term yearly contracts) led to an overall margin reduction. The segmental profit before interest and tax (PBIT) for the chemical division fell by 27.5% to Rs103 crore with the margins declining from 18% to 12.3%. While the PBIT for the fertiliser division increased by 29% to Rs99 crore with the margins improving by 380 basis points to 11.6%.

• The consolidated profit after tax (PAT) decreased by 31.9% to Rs106.1 crore with the margins reducing by 260 basis points to 6.2%. A pre-payment penalty of Rs15 crore imposed on the early payment of high-cost debt and higher depreciation costs affected the subsidiaries' as well as the overall performance of the company.

• On a stand alone basis, the net sales decreased by 6.4% due to lower volume of fertilisers traded, while PAT increased by 7.4% to Rs125 crore. The stand alone performance was little subdued also due to lower foreign exchange gains.

• After the initial teething troubles, the new plant at Magadi facility is functioning smoothly and is expected to reach around 75% capacity utilisation by the next quarter. As soda ash prices in spot market remain firm at $280-300 per tonne, new long-term contract prices are expected to be much above the last year price of $200 per tonne. This would help the company regain its lost margin in the next two quarters.

• De-bottlenecking of urea capacity to expand its Babrala capacity to 1.3 million metric tonne per annum (mmtpa) is progressing well and would be operational by September 2008. The company's new business initiatives like Fresh Produce and Biofuel are also shaping well.

• TCL has recently entered into definitive agreements to acquire US-based General Chemical Industrial Products Inc (GCIP) for US$1,005 million, subject to stockholder and other regulatory approvals. GCIP is among the top five global producers with 2.5mmtpa of natural soda ash capacity, and its estimated recoverable trona ore reserves is approximately 600 million tonne. Prima Facie, this is a positive development in view of the soda ash upcycle remaining firm for the next two years. As the details of the acquisition are not disclosed, we have not updated financials of the company for the development. The company plans to finance this acquisition with a mix of debt-equity funding, which would lead to equity dilution. However it is earnings per share (EPS) accretive.

• At the current market price of Rs291, the stock is trading at 9.8x its FY2009E diluted earnings and at an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 5.0x. We maintain our Buy recommendation on the stock with a price target of Rs535.

Tata Consultancy Services
Cluster: Evergreen
Recommendation: Buy
Price target: Rs1,250
Current market price: Rs869

May witness short-term growth pressure
TCS has planned to reorganise its global operations that would be effective from April 2008. Under the old structure the company was split under groups like geography, industry verticals, services and delivery. Such a structure worked well when TCS had less number of employees and had not so-scalable business. But the things have changed now and TCS has become a $4.2 billion company (revenues in M9FY2008) with an employee base of over one lakh compared to a $900-million revenue generating company in FY2002. It now handles more complex assignments than just being an application development and maintenance (ADM) player.

Television Eighteen India
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs571
Current market price: Rs388

Going strong

Result highlights

• TV18 pulled out a robust performance for Q3FY2008. The operating revenues for the quarter grew by a healthy 73.8% to Rs112.6 crore. All the segments—news, internet and newswire—registered high growth numbers.

• The news business revenues grew by 57.5% year on year (yoy) to Rs91.4 crore reflecting niche positioning of its channels CNBC TV18 and Awaaz. The operating profit margin (OPM) for the segment was up 100 basis points quarter on quarter (qoq) to 44%.

• Web18 continues in investment mode. Thus despite a stupendous 161.6% year-on-year (y-o-y) growth in the revenues to Rs17.6 crore, the operating loss stood at Rs7.2 crore, as the company wrote off all the costs incurred (rather than capitalising on it). Thus Web18 is spending heavily after its growth, the results of which we believe would be seen over the longer term.

• Newswire18 posted a 44% quarter-on-quarter (q-o-q) growth in its revenues to Rs3.6 crore. The operating loss in Q3FY2008 was down at Rs1.7 crore against Rs2.2 crore in Q2FY2008. The business is witnessing rapid subscriber addition and we expect the business to break even in FY2009.

• The consolidated OPM of the company during the quarter stood at 28.1% against 45.3% in the corresponding quarter last year Q3FY2007 (and 26.7% in the previous quarter Q2FY2008). The overall OPM continues to be impacted by the heavy spend on augmenting the internet and the newswire businesses. Thereby the operating profit growth was restricted to 7.6% yoy to Rs31.6 crore.

• A higher depreciation, interest and tax rate led the adjusted profit after tax (PAT) pre-ESOP charge during the quarter to be at Rs10.8 crore against Rs19.2 crore in the same period last year (Q3FY2007).

• TV18 forayed into print media by acquiring 40% stake in Infomedia India (Infomedia). The company has made an open offer to the shareholders of Infomedia for a further 20% stake in the company at Rs237 a share, as TV18 intends to increase its stake in Infomedia to atleast 53%.

• Close on the heels of acquisition of Infomedia India, TV18 forged an alliance with Forbes Media. While the alliance would begin with the launch of a business magazine soon, other publications would follow suit. The company also entered into a 50:50 joint venture with Jagran Prakashan for launching a Hindi business newspaper. The duo would also launch business dailies in other Indian languages. Thus TV18's foray in print media completes an integrated media model for Network18 group.

• We maintain our positive stance on the stock and maintain our Buy recommendation with our sum-of-the-parts price target of Rs571.

Torrent Pharmaceuticals
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs260
Current market price: Rs160

Strong margin expansion

Result highlights

• Torrent Pharmaceuticals (Torrent) reported a revenue growth of 3.1% to Rs347.8 crore in Q3FY2008. The revenues were in line with our estimate of Rs348 crore. The subdued growth in the top line was mainly due to lower sales of the German acquisition, Heumann and low growth in the branded domestic formulation business in India.

• The branded formulation business in India remained sluggish, growing by only 4.3% (vis-à-vis the market growth of 12.3%), mainly due to the higher-than-expected attrition of the sales force during Q2FY2008. The Heumann business also continued to bleed with the sales declining by 4% year on year (yoy) due to market-led restructuring of its operations.

• On the other hand, the contract manufacturing business performed well, growing by 43.6% during the quarter to Rs40.9 crore. Also, the international business (excluding Heumann) grew by 29% to Rs111.4 crore, driven by robust sales growth in Europe and Commonwealth of Independent States (CIS).

• The operating profit margin (OPM) expanded by 570 basis points to 17.5% (against our estimate of 14.4%), on the back of a 300-basis-point improvement in the gross margins and a 170-basis-point reduction in the employee costs. Consequently, the operating profit grew by 52.5% to Rs60.9 crore.

• The robust operating performance caused Torrent's net profit after tax (PAT) to grow by 45.3% to Rs37.3 crore. The net profit reported by the company was above our estimates of Rs30.8 crore. The earnings for the quarter stood at Rs4.4 per share.

• At the current market price of Rs160, Torrent is discounting its FY2008E earnings by 11.3x and FY2009E earnings by 8.6x. We maintain our Buy recommendation with a price target of Rs260 (14x FY2009E diluted earnings).

UltraTech Cement
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs1,100
Current market price: Rs864

Price target revised to Rs1,100

Result highlights

• Net sales of UltraTech Cement Ltd (UCL) for Q3FY2008 was up 9.7% year on year (yoy) at Rs1,382 crore. The net sales growth was on the back of higher realisation, which grew by 13.7% yoy. However dispatches reported a drop of 3.6% yoy as volumes were down in domestic sales due to slow pick up post-monsoon and decline in exports.

• Net realisation for the quarter was up 13.7% yoy to Rs3,207 per tonne, as cement prices during the current year were firm due to higher demand mainly from southern India. However on a quarter-on-quarter (q-o-q) basis, the realisation fell by about Rs50 per tonne mainly because of higher clinker sales.

• Reported profit after tax (PAT) was up 31.6% yoy to Rs279.5 crore on account of higher realisation.

• Operating profit margin (OPM) improved by 370 basis points and was at 33.9% for the quarter, mainly because of better realisation. Consequently the operating profit was up 23.2% yoy to Rs468.5 crore.

• Going ahead the brownfield expansion of 4.9 million metric tonne (MMT) at Andhra Pradesh, which is scheduled to be commissioned by the end of Q1FY2009, will drive the volumes of the company, whereas the captive power plant will aid in controlling power costs.

• We believe as capacities start coming up, we could see some ease in prices. As UCL is highly leveraged to prices, we have downgraded our FY2009 earnings per share (EPS) by 15%. Consequently, we have reduced our price target to Rs1,100.

• At the current market price of Rs864, UCL trades at 10.7x its FY2008E EPS, 11x its FY2009E EPS and at an enterprise value (EV) of $142.5 per tonne. We maintain a Buy on the stock with a revised price target of Rs1,100.

WS Industries India
Cluster: Vulture’s Pick
Recommendation: Buy
Price target: Rs127
Current market price: Rs108

Price target revised to Rs127

Result highlights

• For Q3FY2008, WS Industries (WSI) has reported net sales of Rs56.3 crore after a growth of 40.4% year on year (yoy). The net sales figure is marginally above our estimate.

• The operating profit of the company grew by 78.1% yoy to Rs8.7 crore, resulting in an operating profit margin (OPM) of 15.5%. The OPM improved by 330 basis points mainly on account of better operating efficiency. Due to improved operating efficiency the power & fuel cost as a percentage of sales declined by 430 basis points to 15% from 19.3% in Q3FY2007.

• The interest cost was up 11.3% yoy to Rs1.8 crore while the depreciation cost increased by 3.4% to Rs1.0 crore.

• During the quarter under review, the company made provision at a higher tax rate of 40.3% as against 13.6% in the corresponding quarter of the previous year.

• Consequently, the net profit reported an increase of 66.2% to Rs3.6 crore, which was in line with our estimate of Rs3.5 crore.

• The current order book of the company stands at Rs150 crore.

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SHAREKHAN SPECIAL

Economic Survey 2007-08

The Economic Survey 2007-08 mentions that the economy has moved to a higher growth phase with growth exceeding 8% every year since 2003-04. The survey further states that maintaining the growth rate at 9% will be a challenge and raising it to double digits will be an even greater challenge.

Q3FY2008 Banking earnings review

Most of the banks under our coverage reported higher-than-expected earnings for Q3FY2008 driven by higher-than-expected treasury gains in most of the cases, while lower-than-expected provisions also contributed in some cases to higher earnings.

Q3FY2008 Capital Goods earnings review

After the conclusion of Q3FY2008 earnings season, we bring to you a review of the companies under our capital goods and engineering and construction (E&C) universe.

• Revenue growth during Q3FY2008 for the coverage universe was marginally lower than our expectations. The growth in frontline stocks like Bharat Heavy Electrical Ltd (BHEL) and Crompton Greaves Ltd (CGL) was also sedate. While BHEL growth was low due to slower execution, CGL faced certain logistical issues.

• In mid-caps, Bharat Bijlee reported a flat growth in its sales on account of disruption in production due to ongoing expansion. While the sales growth in IndoTech Transformers Ltd (ITTL) was in line due to better-than-expected realisations, the volume growth was flat.

• The operating profit margin (OPM) for the coverage universe came in as a positive surprise with majority of the companies under our coverage reporting improvement in their margins. CGL in spite of a decline in its sales reported an improvement of 260 basis points in its OPM, but ITTL stood out of the lot with a 770-basis-point improvement in its OPM, which is one of the best in its peer group.

• While companies like Thermax and CGL reported slowdown in their order booking, order inflows continued to be robust for BHEL, Larsen & Toubro (L&T), Punj Lloyd Ltd (PLL) and Ratnamani Metals and Tubes Ltd (RMTL). Going forward, we expect inflows to gain further momentum.

• We expect the performance of all the companies to pick up in Q4FY2008, as the last quarter is historically the best quarter in terms of revenue booking and operating performance. The orders should also gain momentum again and we expect to see further inflows for the companies.

• Against the backdrop of strong emphasis by the government to develop the country's infrastructure, we believe the companies in the capital goods and E&C space would have lot to rejoice, and therefore we maintain our positive outlook on the sector.

Q3FY2008 FMCG earnings review

Performance of most of the companies in the Sharekhan FMCG universe was robust due to festive sales combined with good demand dynamics driving volume growth for most of the companies. The topline growth was also aided by price increase across categories, which was the result of companies passing on the input cost inflation to consumers, depicting healthy pricing power with the industry. Thus, the net sales of fast moving consumer goods (FMCG) companies in the Sharekhan Universe increased by 13.4% to Rs8,836.5 crore in Q3FY2008. The operating profit margin (OPM) declined marginally by 41 basis points year on year (yoy) to 23.2% primarily on account of increased ad spends by the companies on account of festive season, new product promotions and to maintain/increase their market share. The adjusted profit increased by 18.6% to Rs1,568.3 crore.

Q3FY2008 Pharma earnings review

The overall Q3FY2008 performance of the Sharekhan Pharmaceutical Universe has been above our expectations, with a topline growth of 20% (as against our expectation of a 16.1% growth) and a net profit growth of 45.3% (as against our expectation of a 28.4% growth). The companies under our coverage reported a mixed performance: Ranbaxy Laboratories (Ranbaxy), Sun Pharmaceuticals (Sun Pharma), Orchid Chemicals (Orchid) and Lupin gave positive surprises, while Aurobindo Pharma, Cadila Healthcare and Unichem Laboratories (Unichem) delivered a disappointing performance.

Q3FY2008 Auto earnings review

The volume growth in the automobile sector was flat in Q3FY2008. This slow down in the growth was due to higher interest rates, non-availability of funding due to credit control and high base of last year in some segments. With the interest rates expected to decline in FY2009, revival should be in the offing. The sector is expecting excise cuts in the Budget for FY2008-09, which should further help the revival process. Also in some segments like Commercial Vehicle (CV) segment, revival should come due to the low base in FY2008.

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MUTUAL GAINS

Sharekhan's top equity fund picks

We have identified the best equity-oriented schemes available in the market today based on the following 3 parameters: the past performance as indicated by the one and two year returns, the Sharpe ratio and Fama (net selectivity).

The past performance is measured by the one and two year returns generated by the scheme. Sharpe indicates risk-adjusted returns, giving the returns earned in excess of the risk-free rate for each unit of the risk taken. The Sharpe ratio is also indicative of the consistency of the returns as it takes into account the volatility in the returns as measured by the standard deviation.

FAMA measures the returns generated through selectivity, ie the returns generated because of the fund manager's ability to pick the right stocks. A higher value of net selectivity is always preferred as it reflects the stock picking ability of the fund manager.

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SECTOR UPDATE

Banking

Major PSBs cut PLR

Highlights

• Major public sector banks lowered their prime lending rates that is likely to contract their net interest margins (NIMs) by 10-20 basis points

• However, the adverse impact would be substantially mitigated by reduction in deposit rates expected post-March 2008

• Maintaining our earnings estimates; will revisit estimates post clarity on deposit rates

Information Technology

Cognizant boosts confidence
Cognizant, one of the leading offshore information technology (IT) service vendors, has given a robust revenue growth guidance for CY2008. Moreover, the management appears quite confident and its comments on market scenario are quite encouraging. This has boosted the overall sentiments towards tech stocks.