Weekly Scrip Watch - June 1 2008

INDIAN OIL

RESEARCH: MERRILL LYNCH

RATING: BUY

CMP:Rs 425

Merrill Lynch retains its ‘buy’ rating on IndianOil (IOC) with a price target of Rs 507. The target price is based on a P/E multiple of 7x on FY09E consolidated EPS of Rs 57. The target prices include the market value of IOC’s investments in ONGC, Petronet LNG and Gail of Rs 142 per share.

IOC’s FY09E earnings forecast is higher than its FY07 earnings (Rs 50.2/share), but lower than the forecast for FY08E (Rs 95/share). The P/E used by Merrill Lynch to value IOC is lower than Asian refiners’ average FY09E/08E P/E. IOC’s consolidated EPS for FY08 jumped by 37% y-o-y to Rs 69 per share. It was mainly driven by a 115% y-o-y rise in refining margins ($9/bbl versus $4.2/bbl in FY07) and inventory gains in FY08 vis-à-vis a loss in FY07.

Other income also surged 84% y-o-y to Rs 5,100 crore. IOC trades at attractive valuations of 6.1-7.4x on FY08-09E EPS. The downside risks for IOC include: (1) Government fails to issue enough oil bonds to keep IOC in the black; (2) Government reverts to a cost-plus based regulated pricing mechanism; (3) Steep decline in regional refining margins, and hence, IOC’s refining margins to levels below those assumed by Merrill Lynch; and 4) Steep decline in the market price of ONGC, Petronet LNG and Gail.

TATA MOTORS

RESEARCH:MACQUARIE

RATING:OUTPERFORM

CMP:Rs 577

Following Tata Motors’ financing plan, Macquarie expects the company’s fully diluted equity base to rise by 44-48%, depending on the price. In FY03-09, the basic number of shares can increase by 30-35%, while the remainder will be converted in 3-5 years.

The rights issue is set to be priced at around Rs 350/share; while the subsequent convertible preference shares should be at a conversion price of Rs 450-500/share. In addition, Jaguar Land Rover (JLR) will raise debt on its balance sheet.

The management has cautioned against extrapolating Q1 CY08 profit ($421 million) of JLR into the full year. Further details on the profitability of JLR are expected in June. Operating environment for the core automotive business remains tough. Profitability remains under pressure due to strong raw material costs.

The standalone pre-exceptional profit at Rs 480 crore was well below estimates. The operating margins were disappointing at 9.1% (down 196 bps y-o-y).

MAHINDRA & MAHINDRA

RESEARCH:CITIGROUP

RATING:BUY

CMP:Rs 593

Mahindra and Mahindra (M&M)’s reported PAT of Rs 221 crore was buoyed by an exceptional gain following the restructuring of the holdings among group subsidiaries. The management has indicated that pricing in both key segments — utility vehicles (UV) and tractors — remains fairly buoyant and rising cost pressures will be passed on, but margins can decline further, given the harsh commodity price environment.

The sharp uptick in capital costs is disconcerting. There are downside risks to the estimates on account of escalating capital costs, given the company’s aggressive capital expenditure programme of Rs 9,000 crore over the next three years.

Citigroup forecasts 12-13% growth in the UV business, in line with the management’s outlook and sees some downside risks to the forecast for the tractor business (currently 7% CAGR over FY09/10E), given issues with regard to availability of credit, and also the growing moral hazard within the banking sector that can further starve the sector of credit over the long term.

EVEREST KANTO CYLINDER

RESEARCH:CLSA

RATING:BUY

CMP:Rs 315

CLSA reiterates its ‘buy’ recommendation on Everest Kanto Cylinder and indicates a 17% upside on a 12-month basis. Everest Kanto, the high-pressure cylinder manufacturer of CNG and industrial cylinders, reported 45% PAT growth for FY08, in line with expectations. Net sales for FY08 stood at Rs 530 crore, up 24.4% y-o-y (up 31% y-o-y on a like-for-like basis, excluding trading revenues from FY07).

The company sold ~6,53,000 cylinders in FY08, of which, 3,98,000 were for CNG applications, while the balance was for industrial purposes. CNG cylinders account for 60% of the mix by unit volume, but 72% of sales by value. Total debt on the balance sheet is $75 million, of which, $45 million is on account of the company’s bank-guaranteed debt for the acquisition of the jumbo cylinder manufacturing unit of CP Industries.

The annual cost of debt is about 7%. Everest Kanto has spent $66.3 million for the large pressure vessel plant of CP Industries, incorporating step-down subsidiaries in Hungary and the US. This division complements the product portfolio of Everest Kanto, which already has CNG and industrial cylinders in its fold, with high-value jumbo cylinders.

The company expects to produce 3,500 jumbo cylinders in FY09 and expects realisations of about $15,000 per unit. There is an 11% translation loss on consolidation of Dubai accounts in Indian rupees due to the depreciation of the US dollar.

SIEMENS INDIA

RESEARCH:INDIABULLS FINANCIALS

RATING:HOLD

CMP:Rs 560

Indiabulls Financials reiterates its ‘hold’ rating on Siemens India. Siemens’ lacklustre performance of Q1 FY08 continued in Q2 FY08, as revenues grew by a meagre 0.6% y-o-y. Lower revenue, coupled with a tepid order inflow, translates into lower visibility on earnings potential.

But considering the conducive demand for power, automation, industrial services and healthcare products, Indiabulls believes Siemens can win base orders to ensure an RoE of 27-30% over the next two years.

The management is confident of doubling revenues by ’10. To meet this target, it plans to expand its transformer manufacturing capacity, start manufacturing turbines and optimise its existing processes. At CMP, the stock trades at a forward P/E of 29.4x its FY08E and 21.8x its FY09E earnings. Siemens believes its nearterm EPS may face the impact of disposal of value-accretive businesses and higher costs during Q2 FY08.

Indiabulls has cut the company’s earnings forecast for FY08E and FY09E by 13.5% and 11.1%, respectively, to factor in cost escalation. So, Siemens may report a CAGR of 22.2% in revenues and 21.5% in earnings over FY07-09E. Based on Indiabulls’ DCF valuation, the stock is fairly valued and no major upside from current levels is foreseen.

ING VYSYA BANK

RESEARCH:HSBC

RATING:UNDERWEIGHT

CMP:Rs 291

After lagging its peers in loan and deposit growth, ING Vysya Bank has been showing signs of recovery. Growth in advances improved to 22% in FY08 from 17% in the previous year. Growth in total deposits accelerated to 33% from 16%. This helped the bank to improve its market share to 0.6% from 0.5%.

High cost ratios vis-à-vis its peers have been a stress point for ING Vysya Bank. While the bank’s cost-income ratio has fallen marginally y-o-y, it continues to be higher than for most peers. The main reason for this is employee productivity, which has shown little improvement over the past year, despite continued investment in branches and employees.

The focus on opening new branches in urban areas can help alleviate stress in the long term, though near-term respite looks unlikely. HSBC raises its net profit forecasts for FY10 and initiates forecasts for FY11. The revised target price of Rs 270 is 8% higher than the previous target price.

HSBC benchmarks the returns of ING Vysya Bank against select state-owned and private sector banks under its coverage. The bank continues to lag its peers in key profitability metrics due to low margins and high cost ratios.