Sunday, July 06, 2008
The markets ended with losses for the seventh week in a row as they continued to be haunted by global market cues, record crude oil prices, rising inflation and political worries.
The Sensex crashed to a low of 12,822 during the week - down almost 1,000 points from its previous close. However, some bargain hunting in beaten-down financial and realty stocks helped the index cut losses towards the end of the week. The index finally ended with a loss of 348 points at 13,454. It has shed a whopping 22.8 per cent (3,981 points) in the last seven weeks.
Among the index stocks, ACC, Maruti, Grasim and Reliance Infrastructure dropped 13-17 per cent last week. Tata Steel, Tata Motors, Ambuja Cements, ICICI Bank, Reliance Communications, ITC and Mahindra & Mahindra shed 7-12 per cent each.
On the other hand, BHEL surged nearly 9 per cent. Jaiprakash Associates, ONGC, Satyam and L&T gained 5-7 per cent each.
Political concerns, inflation worries and possible action by the RBI would continue to affect the markets in the short term. The market sentiment will also be driven by the earnings season.
Technically, the Sensex may drift towards its yearly support of 12,100. However, if the index manages to sustain above the 12,750-12,800 range in the short-term, there may be a pull-back rally upto 13,900 and 15,200. The index is likely to find support around 13,050-12,930-12,800 and resistance at 13,855-13,980-14,100.
The Nifty moved in a range of 315 points during the week. From a high of 4,163, the index dropped to a low of 3,848 and finally settled with a loss of 121 points at 4,016. The index tumbled over 22 per cent (1,142 points) in the last seven weeks. The Nifty shall seek support in the broad range of 3,750-3,850, below which it is likely to fall to 3,500.
via Business Standard
Contract Research and Manufacturing Services (CRAMS) is expected to grow faster than other sub-sectors in the pharmaceutical industry. This is due to the expected ramp up in revenues as global pharma majors look to cut costs through outsourcing and strong operating margins for players which usually work on a ‘cost-plus’ base.
Early players, which are at the last leg of their capex cycle and have put together acquisitions that stretch from early stage to late-stage commercialisation of medicines, may stand to reap greater benefits from this trend. Dishman Pharmaceuticals and Chemical, a leading CRAMS player catering exclusively to innovator companies, appears a good bet, in this context.
Initially constrained by small size, low capacities and a business skewed towards fine chemicals, the company today has manufacturing capabilities focussed on patented molecules, key medicine intermediates and special chemicals.
CRAMS accounted for 75 per cent of net sales in 2007-08. Acquisition of Carbogen Amcis has given it the much-needed strength to carry out full-fledged CRAMS, with the subsidiary now contributing more than half of CRAMS’ revenues.
Our earlier recommendation on Dishman was a ‘buy’ at Rs 275 in February. The stock has held its ground even as the broader markets have fallen by 33 per cent in the period that followed. The company’s annual results strengthen conviction in the company’s growth prospects. Dishman managed to register strong growth on both sales (39 per cent) and profit terms (32.5 per cent) against an appreciating rupee (around 8 per cent).
Quite a few new contracts are lined up for execution in the next 12-18 months even as Dishman is engaged in advanced talks with major MNC clients for new orders.
Post-commissioning, its new units are expected to generate over Rs 500 crore each year at optimum utilisation (expected in two-three years). On a consolidated basis, taking into account losses in some subsidiaries and a poor performance from the marketable molecules segment (19 per cent of sales), Dishman’s net profit margins came down to 15 per cent from 16 per cent last year.
Higher realisations from CRAMS business (with new contracts), good client management history and rupee depreciation are set to play out well for Dishman, which draws 90 per cent of its sales from exports. At the current market price of Rs 286, the stock trades at around 14 times its estimated per share earnings for 2008-09. This is at a fair discount to sector leader Divi’s Labs. The valuation is comparable to Piramal Healthcare (formerly Nicholas Piramal), which is a much larger player (but less exposed to CRAMS).
Dishman’s client dependence has been de-risked further with Solvay accounting for less than 14 per cent, against 20 per cent in the December quarter. Cumulatively, top five clients now account for around 35 per cent of the business compared to more than 45 per cent even a year ago.
Dishman’s FY-08 EBITDA margin was muted at 19 per cent. Several extraordinary and one-off costs took their toll. Plus, the marketable molecules business was hampered with unexpected price hike in raw materials. Going forward, coupled with 5-10 per cent price increases (management expectations) for that business and absence of the non-recurring expenditure, Dishman’s core margins are expected to be back to 22 per cent levels.
CRAMS is also expected to profit from higher capacity utilisation. Profit margins will also be aided by the fact that most of Dishman’s subsidiaries are expected to break-even this year.
There are several opportunities and challenges for Dishman over the next two years. The company is looking at new areas such as manufacturing high potency (hipo) products. Unit 9, which is expected to be operational from March 2009, would cater to these typically high-cost and low-volume products such as anti-cancer drugs, steroids, hormonal drugs etc.
Indian CRAMS players are involved in initial stages of these ‘hipo’ products whereas Dishman (benefiting from Carbogen’s specialisation) will target class 3 and 4 substances.
Margins of Dishman’s Vitamin D business (4 per cent of turnover) are expected to normalise at 18 per cent over the next two years.
Business from marketable molecules segment is expected to remain under pressure for the next two quarters (the China unit starting soon may provide some relief). Dishman’s bulk drugs JV in Saudi Arabia is unlikely to pay off before 2010 and much will depend on the speed of execution.
Lastly, the company could book forex losses (as against forex gains in last one year) on its $100-million forex loans as the rupee begins to depreciate, affecting near-term earnings.
Inflation, rising interest rates and a slowing economy — if any set of companies is well-placed to weather this turbulent environment — it is a select set of FMCG makers. The FMCG business is not capital-intensive and generates high levels of cash; FMCG spends also make up a small, “core” portion of the consumer’s portfolio that is not immediately vulnerable to a cyclical economic slowdown.
Marico Industries, with a strong clutch of brands in personal products, hair care and edible oils, appears a good investment in this backdrop. Amidst spiralling input prices, strong brand equity in its traditional hair oil business has allowed the company to take periodic price increases without impacting volume growth or market share.
The company is also firmly ensconced in high potential FMCGs such as hair care, branded foods and male grooming, targeted at the affluent urban consumer. A healthy pipeline of new products and a successful retail services foray (Kaya Skin Care & Kaya Life) also have the potential to add significantly to earnings over the medium term.
The stock, trading at Rs 53 (16 times estimated FY-09 earnings), is at a valuation discount to the FMCG space (20 times forward earnings), not having participated in the recent up-move in the sector. The stock offers potential for a 15-20 per cent return, with relatively low downside risk.
Improving product mix
From relying mainly on coconut oil and edible oils for revenues, Marico Industries has in recent years expanded its portfolio through brand extensions and forays into lucrative niches such as post-wash conditioners, male grooming, skin care services and functional foods.
The hair oil portfolio, where Marico continues to be the national market leader, has been extended well beyond Parachute coconut oil, into value-added offerings such as Shanthi Amla, Hair & Care, Parachute Advansed and Parachute Jasmine.
With a 13 per cent growth in 2007-08, hair oil has been among the fastest growing segments within FMCGs over the past year, driven by consumer uptrading from plain to value-added oils and from unbranded to branded offerings.
Marico’s entry into the niche post-wash care market with Parachute After-Shower cream for men (42 per cent market share) and Silk N Shine for women (32 per cent) has resulted in strong market shares for Marico in both these markets.
The company has a strong new product pipeline in hair care, with nascent forays into cooling oils (Maha Thanda), hair care (Night repair cream) and kids shampoos and oil (Parachute Starz).
In edible oils, Marico has gradually exited the price-sensitive sunflower segment (Sweekar) and has focused on its premium Saffola franchise, which is strongly positioned on the health platform. Marico’s offerings of blended oils have delivered a 22 per cent volume growth in 2007-08 amidst rising edible oil prices, heavy competition and consumer down-trading to low-priced brands. Marico’s plans for Saffola include an expansion in blended edible oils and a foray into functional foods such as Saffola atta — targeted at diabetes and cholesterol management.
Changes in the product mix, with a higher proportion of premium products, have contributed to a sharp expansion in Marico’s operating profit margins from 9 to 14 per cent over the past five years.
A higher proportion of premium brands ensures that Marico retains strong pricing power to pass on input cost increases to consumers. Marico’s foray into the retail skin care services through Kaya Skin Clinics has showed good traction, growing 45 per cent over three years and attaining breakeven in 2007-08.
Apart from nurturing a healthy pipeline of new products, Marico has also embraced inorganic growth through a string of domestic and overseas brand acquisitions. Domestic acquisitions have brought in strong regional brands such as Nihar and Oil of Malabar coconut oil and Manjal soap, which extend the company’s distribution reach. Marico’s overseas buys have focussed on building a brand and marketing presence in countries such as Bangladesh and the West Asian and African regions, which offer a large consumer market with good growth potential. This overseas presence entails some currency risks, but allows Marico to build brands in new geographies, with lower competitive pressures than in the Indian market.
Though some of these acquisitions (Sundari LLC, Enaleni Pharmaceuticals) are yet make a significant contribution to numbers, the international business has managed a sharp 50 per cent growth in 2007-08 (21 per cent organic).
The string of acquisitions, costing Rs 550 crore in all, has been funded by a QIP offer (Rs 151 crore) and pegged up debt on Marico’s balance-sheet. However, both the debt:equity and interest cover remain well within comfort zone.
The company closed 2007-08 with a 22 per cent growth in revenues (17 per cent organic) and a 27 per cent growth in sustainable net profits on a consolidated basis. Compounded sales and profit growth rates for the past five years, stand at 21 per cent and 30 per cent respectively.
With a strong presence in the niche area of post-production services for films, a unique cross-border business model and a good pipeline of film projects, Prime Focus is a preferred pick within the media sector. A substantial correction in recent months has the stock trading at about 15 times its likely FY ’09 consolidated earnings per share, which is reasonable given the high visibility in earnings growth. An investment can be considered in the stock with a three-year perspective.
Prime Focus has an estimated 60 per cent market share in India. With six facilities across Mumbai, Hyderabad and Chennai, its domestic business continues to grow at a fast pace, as the use of visual and special effects in Indian films is on the rise. The business is highly profitable with operating margins at 50-60 per cent, although higher employee costs have moderated margins in recent quarters. A large pipeline of 8-10 film projects in FY 09 should ensure a steady stream of revenues for the domestic operations.
Prime Focus has built an international presence with facilities spanning the UK, US and Canada. Its first acquisition in the UK (VTR) has paid off, with Prime Focus successfully turning around the company and the facility has begun to outsource work to India. As the London operation works more on advertising film projects, it has been affected by the advertising slowdown witnessed in these markets in recent times.
Prime Focus acquired Frantic Films and Post Logic Studios for $43 million in late 2007, which gave it access to facilities and talent pools in key markets of Los Angeles, New York, Vancouver and Winnipeg. The targets have combined revenue of $25 million (Rs 107 crore) and have been associated with films such as Spiderman 3, Fantastic Four and Superman Returns. These businesses are yet to be consolidated with Prime Focus and may not contribute to profits in the next one year. However, the presence of cross border facilities have helped create a unique business model, where a significantly higher amount of work can be carried out by facilities across time zones in a cost efficient manner. Prime Focus’s tie up with Warner Bros’ Motion Picture Imaging appears to be recognition of the merits of this international operation. The benefits of the strategy are likely to pay off from FY ’10. An unexpected slowdown in domestic operations is a key risk to earnings estimates. The stock’s small-cap status may call for careful timing of investments.
We had expected the four-year long bull-phase to terminate in the first quarter of 2008 in our long-term outlook at the beginning of this year.
Our outermost target for the Sensex for 2008 was at 13700. Now that this level has been conclusively breached, a review of the long-term counts is called for.
The signs of a significant bull-market top were littered all over in the last quarter of 2007 – irrational price movement, excessive speculation, unjustifiable valuations, bottom-rung stocks coming out of wilderness to enjoy their days in the sun, surfeit of exorbitantly priced IPOs and so on. The party had to come to an end and it did at the peak at 21206 on January 11.
As explained in our yearly outlook, it is possible to anticipate a correction but difficult to judge the nature of the correction. We had taken the more optimistic view at the beginning of this year and anticipated the corrective move to halt at the first long-term support at 13700.
A halt here would have implied a sideways move between 13700 and 21000 for a couple of years before the up-trend resumed to take the Sensex beyond 30K.
But the decline below 13700 brings the next long-term supports for the Sensex at 11900 (50 per cent retracement of the up-move from 2001) and then 9703 (61.8 per cent retracement) in to focus.
We stay with our long-term count that the current down-move is the fourth part of the long-term cycle that began in 1980.
The fifth leg (upward) would then take the index beyond 25000 again. Caveat - decline below 9703 would need recasting of the counts.
The more difficult question is, how long would this down-trend last? As per Elliott Wave theory, corrections can extend from anywhere between 0.33 to 1.618 times the time consumed by the previous up-move.
The previous up-move lasted four years. That gives us the range between 16 to 77 months. Since the previous long-term correction from 1994 to 2003 was a long-drawn one, applying rules of alteration, the correction this time can be a sharp and swift one that ends in one to one- and- a- half years.
Second half of 2008
Though the Sensex appears to be hurtling lower in to an abyss right now, a three wave A-B-C movement downwards is drawing close to termination. A 1:1 relation between the A wave and the C wave gives us the target at 11206. Fifty per cent retracement of the bull market from 2001 gives us the support at 11900. The decline from January can halt somewhere between these two levels.
However, it needs to be borne in mind that the down-move from 21206 could be the first leg of the long-term correction. But once this leg ends, we would have an intermediate term up-trend that would provide some respite to the battered stocks.
The preferred view is that the index would halt in the zone between 11000 and 12000 and spend the rest of 2008 in a range between 12000 and 16500. Our outer targets for the year would be 18000 and 9700. We await clues from subsequent rallies to tell us how the rest of this correction will shape-up.