Weekly Track - Jan 28 2008
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Sunday, January 27, 2008
RBI meet, IPO refunds may decide the market course
Stock market will pin its hopes next week on two central banks -- India`s RBI and Federal Reserve of the US -- in its bid to recoup close to Rs 10,00,000 crore lost in the recent turmoil on the bourses.
In addition, the market would also look forward to refunds from two major initial public offers, one by Kishore Biyani-led Future Capital and another from Anil Ambani Group`s Reliance Power.
The two public issues had seen demand worth over Rs 8,00,000 crore collectively, a large portion of which was diverted from the secondary market.
While post-allotment future capital shares, close to Rs 16,000 crore is estimated to find its way to the secondary market, the allotment of shares in Reliance Power IPO would release more than Rs 1,00,000 crore.
The refunds for unalloted shares of Future Capital, to list on February 1, would start on January 29, while that for Reliance Power would follow soon after.
The refunds to qualified institutional investors alone are estimated at about Rs 40,000 crore in Reliance Power IPO.
But, all the eyes in the market would be on the monetary policy review by Reserve Bank of India on January 29 for future direction to the Indian bourses. The possibility of a 25 basis points Repo rate cut by the central bank has increased, especially after a sharp cut in the US rates.
After cutting the rate by 75 basis points in an emergency meeting last week, Fed`s rate-setting committee is holding its scheduled meeting on January 30, where it could provide further insights on the future outlook.
Art investment picking up
India’s economic boom has fuelled demand for condos, cars and company stocks but some of the new wealth created in Asia’s third-biggest economy is finding its way into art.
Entrepreneurs and young professionals, the biggest beneficiaries of India’s financial prosperity, are buying works of art both to signal they have arrived in life and as a safe-haven investment, auctioneers and gallery owners say.
The trend was on show last week at a Bangalore sale to snap up works by modern Indian artists such as Maqbool Fida Husain, Jamini Roy, Vasudeo Gaitonde and FN Souza.
“The interest in art is part of the lifestyle change we are witnessing,” said Maher Dadha, 54, chairman of Bid and Hammer Auctioneers, who estimated the minimum value of the combined collection at Rs100 million.
“Wealth has percolated down and people are buying art just like they are buying penthouses,” he said.
The hammer went down on a 1971 Husain watercolour on paper, entitled Shiva, at Rs3.4 million, the top price paid at the auction. At the start of this decade, Husain’s works fetched less than Rs600,000.
Auctions of modern and contemporary Indian art have raised millions of dollars overseas in recent years, with Christie’s selling a Tyeb Mehta painting for $1.6 million in 2005.
“Now it’s an internal trend, where Indian art is getting recognition in India itself,” said Dadha, adding that India’s rich “don’t blink for a moment over cost.”
Economic growth running at an annual 9%, a stock market that rose a record 47% last year and surging salaries for finance and technology professionals have created a middle class clientele for art.
Collecting Indian art has been traditionally a pursuit of former maharajahs, industrial houses, overseas collectors and rich expatriates.
The local art market -- both gallery sales and auctions -- is worth between $400 and 450 million and expanding as prices jump, said Arun Vadehra, owner of Vadehra Art Gallery in New Delhi and a consultant to Christie’s.
Gallery sales have jumped from barely $2 million in 2000 to $150 million, said Vadehra.
“The art market is very hot,” said prominent Indian art critic Ella Datta. “The collector base is growing with lots of of people like doctors, lawyers and IT professionals who can afford art coming into the market,” she said.
According to Bid and Hammer, the most renowned Indian art currently delivers solid annual returns of 35%. “Eight years ago, I bought a Jaya Jhaveri for a small throwaway price and today it is worth at least Rs100,000,” said Bangalore entrepreneur Sudhir Udayakanth, 34. “Today art has become an investment,” he said.
In 2006, auction house Osian’s raised Rs1.02 billion for a fund dedicated to art, luring investors with the promise of converting the country’s cultural wealth into capital assets.
The fund was open to those capable of depositing at least Rs1 million for three years. Osian’s paid a dividend last year, becoming the world’s first art fund to share income with investors before the lock-in period ends.
Indians also have access to purchasing art online, with Internet auction sites such as Saffronart opening up. The online market is worth between $30 and 40 million a year, said Dinesh Vazirani, a co-founder of Mumbai-based Saffronart.
Via Mint
India most bullish in Asia Pacific
Investors in India continue to remain the most optimistic across the Asia-Pacific, according to the ING Investor Sentiment Index launched today. An overwhelming 93% of investors in India said that they expect the overall investment sentiment will be better in 2008 compared to 2007.
Despite a drop in confidence level among Asian investors in the fourth quarter of 2007 due mainly to subprime concerns, and political and governmental policy changes in some markets, investor sentiment remained the highest in India with a score of 167 (wave one: 168). The overall sentiment going into 2008 was robust with investors in India, Hong Kong, and Philippines among the most optimistic, while those in Japan, Australia, New Zealand and Taiwan were the least optimistic. Notably, the previous quarter’s enthusiasm by Chinese investors has been dampened.
"Although the ING Investor Sentiment Index reveals that the subprime-led credit crunch and political uncertainties have made investors more cautious, core sentiment remained positive in the region as 2007 came to a close," commented Eddy Belmans, Regional General Manager, North Asia, ING Investment Management Asia/Pacific.
The ING Investor Sentiment Index is based on the analysis of a quarterly survey commissioned by ING and carried out by international and independent research firm, TNS. First launched in October 2007, the tracking study surveys changes in investment sentiment and behaviour across 13 Asian markets, namely Australia, China, Hong Kong, India, Japan, Indonesia, Malaysia, New Zealand, Philippines, Singapore, South Korea, Taiwan and Thailand. For wave two of the survey, which was conducted in late November 2007, a total of 1,311 mass affluent investors were interviewed through either face-to-face or online interviews. The survey does not capture more recent events that have seen some markets drop on growing concern about the global economy.
Markets watch RBI move as inflation rises
India's inflation, based on the Wholesale Price Index (WPI), increased marginally in the week ended January 12 due to higher edible oil prices, even as the Government failed to make up its mind on fuel price hike. The annual point-to-point inflation rose at a 3.83% rate in the second week of January as against the previous week's rise of 3.79%, the Commerce & Industry Ministry said. The rate matched average forecast of analysts and is the last reading before the Reserve Bank of India (RBI) reviews interest rates on Tuesday. The annual inflation rate was 6.15% during the year-ago period. Speculation has been rife in the bond market recently that with inflation under control and some moderation in economic growth, the RBI may be tempted to trim its short-term rates from a five-and-a-half-year high.
The Federal Reserve's surprise rate cut may also put some more pressure on the central bank to reduce borrowing costs. The RBI may also prune rates to discourage greater foreign inflows amid rising interest rate differential between local and US rates. The rising interest rate arbitrage between Indian and US rates could once again boost foreign capital flows, which could make it tough for the central bank to formulate monetary policy and manage money flows. Higher overseas inflows could also increase money supply and fuel inflation in Asia's third-largest economy. Some economists expect the RBI to maintain status quo on interest rates at its Jan. 29 meeting. The Fed rate cut may push capital inflows and the RBI may reduce rates after March depending on inflation and outlook on economic growth.
KNR Constructions IPO Review
Investors with a two-year perspective can consider applying to the initial public offer of infrastructure company KNR Constructions. A strong order book, reasonable track record in the industry and ability to forge joint ventures to foray into larger projects are the key positives that provide earnings visibility over the medium term.
At the offer price band of Rs 170-180, the company is valued at 8-9 times its expected per share earnings for FY 2009 on the expanded equity base. The stock’s market capitalisation at the issue price would be about Rs 500 crore. The small market-cap could expose the stock to steep declines if there are any broad market corrections. Investors should, therefore, be willing to hold the stock over a longer time horizon.
Offer details
KNR Constructions is a Hyderabad-based infrastructure company with operations predominantly in the road and highways sector. The company is also present in irrigation and urban water infrastructure segments. It plans to raise Rs 142 crore through this offer. The proceeds will be utilised to invest in capital equipment and finance build-operate-transfer (BOT) projects secured through joint ventures.
Strong order book
The unexecuted portion of the orders in hand is Rs 1,734 crore. This is about 5.4 times the company’s sales for FY 2007.
That a good number of these orders are slotted for completion by FY 2009 provides strong earnings visibility for the next two years.
KNR is also geographically well diversified with state/NHAI projects in Andhra Pradesh, Uttar Pradesh, New Delhi, Assam and Gujarat. While the South accounts for 70 per cent of the order book (as a result of the large size of BOT orders bagged in the region), the rest of the orders are from the East, North-East and the Northern regions.
With the National Highway Development Programme moving to the next phases (Phase IIIA and later IIIB) of road development, KNR’s qualification in projects across the country lends confidence as to its ability to bag bigger orders in the new phases.
While roads remain KNR’s area of focus, it has diversified into irrigation as well as urban water solutions. Although business prospects for these segments remain bright, the company may have to compete with larger/established regional players.
Deriving strength through joint ventures
KNR has steadily moved to implementing larger-sized orders, thus improving its operating profit margins. Its OPMs have grown from 8.3 per cent in 2006 to 15.5 per cent for the half-year ended September 2007. The company’s ability to forge successful joint ventures may have been the key to ramp up the size of orders.
Notable among them is KNR’s association with Patel Engineering for the past seven years. Joint ventures and special purpose vehicle (SPV) projects with Patel Engineering have enabled KNR to not only diversify to other locations but also move to big-ticket orders. Its recent venture into BOT projects in the road space is through SPVs of Patel-KNR. These SPVs, in turn, secure KNR the Engineering Procurement and Construction (EPC) contract for such projects.
Interestingly, in order to forge a cautious entry into this new segment, the company has decided to go in for annuity-based BOT projects, which provide assured payments from the Government. The company plans to bid for toll-based projects too in future. Its well-timed move into the BOT space and the prospects arising from Phase IIIA (which awards only BOT projects) augur well for future orders in this segment.
KNR being a mid-sized company, its cautious approach to new segments through joint ventures with reputed players and annuity-based models minimises the risks typically associated with small companies aiming to qualify for bigger/high-end projects.
KNR’s net profit grew at a compounded annual rate of 42 per cent over the three years ended FY 2007. The company witnessed some slowdown in orders in 2005 before they picked up pace. While the prospects for the next two years, based on orders in hand, appear bright, investors with a longer perspective may have to look out for the company’s ability to scale up the order book beyond this time frame.
Although KNR has comfortably managed its debt obligations, its debt-equity ratio has been high. Post offer, however, the ratio would come to 1.6. An adverse interest rate scenario, though not an immediate risk, could affect the bottom line. At the operating profit level though, the increasing contribution from irrigation and urban water infrastructure projects may bolster earnings.
The offer is open during January 24-29. Axis Bank is the book running lead manager.
Bang Overseas IPO Review
Investors can avoid the initial public offer of Bang Overseas Ltd (BOL). At the upper end of the price band of Rs 200-Rs 207, the offer is valued at close to 20 times the company’s annualised FY 08 per-share earnings, on a fully expanded equity base. The company is in its infancy, and with an insufficient track record in the branded retail business, there could be execution risks to its expansion plans. If it manages to execute its capacity addition and retail expansion plans successfully, the valuation is likely to be at more attractive levels on a forward basis. Given the turbulence in the markets, however, staying invested with better-established players may be a more appropriate strategy.
Focus on garments
BOL has a domestic market bias and is, therefore, relatively less exposed to rupee fluctuations and export slowdown, problems that are plaguing most other textile companies.
The company started its garments business in 2002. Till then, it was predominantly a trader in imported fabric. The company sells men’s clothing under the brand “Thomas Scott” through a network of multi-brand outlets, departmental stores such as Shoppers’ Stop and Globus and 12 exclusive outlets.
A growing share of garments in the revenue mix has significantly improved profitability. Revenues and profits have grown at a stupendous pace since 2005. The company ended fiscal 2007 with revenues of close to Rs 100 crore. Garments currently account for about 40 per cent of revenues.
Through the proceeds of the offer, the company will expand its garments capacity six-fold to more than 7 million pieces a year and expand its retail chain to 100 stores. The fresh capacity is expected to come on stream by September 2008. The company expects to add an additional 88 stores by June 2009; 41 will be company-operated and the remaining franchisee-run.
The additional garment capacity will likely feed its expanding retail operations. and will also help it cater to increasing demand from apparel retailers. BOL is also to foray into women’s wear with a line of clothing — Miss Scott.
Execution risks
While these moves can help boost margins and profits in the long-term, there are execution risks, especially when it comes to the retail business.
BOL has identified locations across different regions in the country, with focus on tier-two and tier-three cities. However, there has not been much progress in finalising properties for its retail operations. Agreements have been signed for only nine of the planned 41 stores. The company has not entered into further franchisee-agreements for running the remaining stores.
The offer document does not state whether the stores will be stand-alone or in malls, nor does it mention the size of these stores. Less than Rs 10 crore of this Rs 70 crore issue has been earmarked for retail expansion. Cost over-runs are likely, considering increasing real-estate rentals and higher competition from established retailers and other garment exporters in tier-two towns. There could also be considerable delays in store openings. The company’s lack of experience in the retail business also does not inspire confidence in its execution. At the same time, retail operations may be crucial to making a mark in the branded apparel business, considering that the company lacks the financial wherewithal to commit huge sums to brand-building. Several large garment exporters are also turning to the domestic market to combat the slowdown on in the export front, which is likely to heighten competition in this segment.
Considering the low visibility of prospects at this stage, investors may be better off following a wait-and-watch approach and revisit the stock once the company gains a firmer foothold in the domestic apparel market.
The offer opens on January 28 and closes on January 31, 2008.
Onmobile Global IPO Review
Investments can be considered in the initial public offering of OnMobile Global, a telecom value-added services (VAS) provider, in the light of its track record in the Indian market and good growth prospects. The offer price, though, appears to be stiff given current market conditions and the valuation accorded to frontline telecom service and software players.
At the upper end of the price band (Rs 450) the stock would be valued at 44 times its estimated current year earnings, on the post-offer equity base. But the niche nature of OnMobile’s business, sustainable growth prospects, strong operating margins (45 per cent) and the absence of peers in the listed space make a strong case for investment. Value-added services (such as music downloads and gaming) augment the voice revenues of telecom players. The market for value-added services has strong growth potential in India where telecom players are grappling with falling realisations (ARPUs) and looking to generate higher revenues from subscribers.
OnMobile Global offers content aggregation and application development, which is software-packaged, to telecom service providers. The company retains the intellectual property rights to the platform and applications. OnMobile, with its established relationships with most of the dominant players — Bharti Airtel, Reliance Communications, and BSNL — appears well-placed to capitalise on this potential.
An expanding client profile to include media companies and handset manufacturers and an expanding South-East Asian footprint are positives for the company.
Integrated VAS Play
Among value-added services, short messaging service (SMS) continues to be the top non-voice revenue generator for telecom companies. But increasingly, services such as ringtone downloads, voice SMS, gaming and information services are also catching up and providing alternative revenue streams to operators. Other VAS include MMS (multimedia messaging service), USSD (unstructured supplementary service data) and WAP (wireless application protocol). OnMobile, with its positioning and experience, appears well placed to establish its presence in this space. Mobile Commerce, service that facilitates payment for movie tickets, utility bills, pre-paid recharge and shopping, is an area where OnMobile is expanding its offerings.
With players such as Reliance Communications and Bharti Airtel already having launched this service, the company could benefit from increased spending in this segment. Together, these give OnMobile a healthy service base.
Broadening client profile
Moving beyond telecom clients, OnMobile is broadbasing its customer base by offering interactive services to newspapers, magazines, television and radio broadcasters. Clients in this segment include ESPN, Star, AOL and Buena Vista. With mobile contests, polling, voting, song downloads and other interactive services on the increase from media companies, OnMobile may see this segment contribute significantly to revenues. The revenue sharing arrangement is three-way between OnMobile, media clients and the telecom company. The company also works with handset manufacturers such as Nokia to market its products, creating a holistic business model.
Expanding Geographical footprint
In addition to domestic presence, OnMobile has expanded its offerings to clients in the fast-growing South East Asian markets. The relationship here is with strong telecom players in this region such as Maxis, Optus, Bakrie Telecom and Banglalink. Some of these countries have higher ARPUs than India and also a high propensity to use value-added services. OnMobile stands to gain with any increased spend on VAS by these players.
In addition, OnMobile has acquired two companies — Vox mobili in France and ITFINITY in India — both VAS players. While the former is said to have 21 customers worldwide, the latter has good software products. These moves help in widening OnMobile’s offerings and client base.
Technology independence and 3G policy:
OnMobile’s applications are claimed to be network-neutral. This means that services can be delivered to a 2, 2.5 or 3G phone or network.
In the Indian context, this becomes relevant as a vast number of users still have low-end phones. As operators upgrade the technology of their network, OnMobile’s products may not require substantial reworking to be commissioned in the network. The imminent announcement of the 3G policy, with many operators betting on increased offtake of high-end voice, data and video services, could provide a trigger to this business. OnMobile, with its offerings and operator relationships, may be able to tap into this high-margin market.
Risks
Most of the revenues that OnMobile generates is outcome-based — a revenue share arrangement with the operator, based on offtake of services by mobile subscribers. The success or failure of an offering thus directly affects realisations.
This apart, a substantial number of new subscribers may have come in because of offers such as ‘life-time recharge’, ‘chota recharge’ and so on. These are typically low ARPU subscribers and may not use value-added services in a significant way. This has adverse implications for OnMobile. Competition from other (unlisted) players in the same segment such as Bharti Telesoft, IMI Mobile and Servion Global may create pricing pressures on OnMobile. Vendor rationalisation from players such as BSNL may force OnMobile to work with a smaller pie.
Issue details
The company proposes to issue 1.09 crore shares at a price band of Rs 425-450, for purchase of office equipment, repayment of loans and working capital requirements. The offer is open during January 24-29. Deutsche Bank and ICICI Securities are book running lead managers to the issue.
Gateway Distriparks: Buy
Investment with a two-three year perspective can be considered in the stock of Gateway Distriparks (GDL), a leading provider of logistics solutions. Expansion in container handling capacities, setting up inland container depots at strategic locations and foray into container rail operations are likely to help GDL capture a significant share of the growing logistics market.
At the current market price of Rs 115, the stock trades at a reasonable valuation of about 12 times its likely FY-09 per share earnings. This appears attractive, given the strong earnings prospects of the company over the long term. Investors may, however, buy the stock in lots considering the broad market volatility.
Growth in volumes
The container volumes of the company appear set to increase given GDL’s presence in key Indian ports such as JNPT (Mumbai), Chennai, and Visakhapatnam. Jawaharlal Nehru Port Trust (JNPT) in Mumbai, which has traditionally been GDL’s forte, may see a further rise in volumes with the acquisition of operational stake in Punjab Conware facility (January 2007). GDL has paid a one-time upfront fee of Rs 35 crore and will pay an annual fee of Rs 1 crore for the next 15 years to Punjab Conware to operate the latter’s facility. As a result, effective earnings contribution from this facility may begin only by FY09.
Nonetheless, increase in container handling capacities and addition of new inland container depots and container freight stations (ICDs/CFSs) at Kochi, Ludhiana (40 acres) and Faridabad (66 acres) may drive GDL’s overall growth in container traffic (from FY09).
GDL’s backward integration into rail container business may also offer a significant earnings upside over the long term. It has, through its subsidiary Gateway Rail Freight Pvt Ltd (GRFPL), formed a joint venture with Container Corporation (51:49) to construct and operate the rail-linked inland container depot (ICD) at Garhi, Gurgaon. This will help GDL consolidate its double-stack container business on the high-traffic exim route between National Capital Region (NCR) and western ports such as JNPT, Mundra and Pipavav.
Improving hinterland connectivity and the proposed addition of 30 trains in the next two-three years are likely to help GRFPL gain a significant share of the rail container business. However, given Concor’s extensive network and competitive pricing strategy, GRFPL may have to settle for lower margins in the near-term. GRFPL already owns six trains and expects to get delivery of six more before March 2008. While funding of capex so far has been through a mixture of debt and internal accruals of GDL, GRFPL may raise about Rs 250-300 crore through private equity for future expansions.
Fall in margins
For the quarter ended September 2007, GDL reported a 68 per cent rise in revenues. Commencement of operations at the Punjab Conware CFS and deployment of two rakes by GRFPL inflated costs and triggered an 18-percentage point dip in operating margins to about 39.9 per cent. Earnings, as a result, declined by 10 per cent to Rs 18.8 crore. This pressure on margins may remain over the near term, given the increasing competition and pricing pressure for freight operators in JNPT and higher gestation period for rail container business. Earnings growth, as a result, may remain sedate in this period.
However, changing revenue-mix and increasing contributions from CFSs across other ports may help abate margin pressure in the long-term.
On a segmental basis, while the revenues from container freight business grew by about 25 per cent, container rail logistics grew by about 116 per cent. The company’s cold chain initiative, through its 51 per cent subsidiary, Snowman Foods, put up a 10 per cent increase in revenues. Nonetheless, the business is yet to turn around (the management expects it this fiscal).
Increasing competition, delay in expansion plans and cost overruns pose downside risks to our recommendation.
Reliance Communications: Buy
An investment with a 1-2 year perspective can be considered in the stock of Reliance Communications (RCom), considering the recent correction in its valuations and strong growth prospects for the company. With an end-to-end telecom services model spanning voice, data and international connectivity and its recent foray into IPTV, RCom appears well placed to deliver strong earnings growth over the medium term. At Rs 667, the stock trades at 28 times its FY08 earnings and 22 times its FY09 estimated earnings. RCom’s licence win, which enables it to become a national GSM operator, strong growth in the data segment and increased revenue contribution from Yipes Communications provide scope for strong earnings growth over the next 18 months.
RCom adds about one million subscribers a month in its existing operations. The company’s recent licence win to offer GSM services in 14 additional circles will give it a nationwide footprint. Contracts for setting up the network have already been awarded to Huawei Technologies. Over time, this could provide RCom with dual revenue streams from the GSM and CDMA businesses, with a presence in high revenue metros. The revenue realisation per minute, at 74 paise, has remained stable over the past year, despite the industry-wide trend of falling realisations and tariffs.
RCom’s non-voice business is also fairly substantial. The broadband business generates an average revenue per line of Rs 1,948, among the highest in the country, and is registering growth on the back of strong enterprise offtake. The buyout of US-based Yipes Communication through FLAG Telecom signals its intent to become an international player in data communications. FLAG gives the company global connectivity through its huge undersea cable network.
Yipes connects 14 key cities in the US, a very data intensive market, providing substantial high margin revenue opportunity. Yipes also has top stock exchanges and traders in its client roster. The company has also sold a 5 per cent stake in Reliance Telecom Infrastructure (the tower business) for Rs 1,400 crore.
Any further stake sale may unlock more value for investors in the stock. RCom has also joined the IPTV (Internet protocol television) bandwagon with the announcement of a $500 million deal with Microsoft for launching this service. Pressure on tariffs, penetrating new circles where there are established players, and any regulatory pressure on offering dual technology are risks to this recommendation.
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