Sunday, November 02, 2008
Punj Lloyd’s financial performance over the last two quarters amply demonstrates its ability to weather tough macro-economic conditions. The current trend of softening commodity prices and clear signals on interest rates softening from here on may further support the company’s earnings growth.
Investors with a 2-3-year investment perspective can consider adding the stock of Punj Lloyd. At the current market price, the stock trades at a modest valuation of about 9.5 times its estimated consolidated earnings for FY09. The current valuations provide a good entry point into the stock. The company’s earnings grew at 48 per cent compounded annually over the past three years.
The consolidated sales for the quarter ended September 2008 rose 53 per cent while net profit was higher by 61 per cent over a year ago. Net profit growth, excluding profit on sale of its ISP division (pending approval), was at 45 per cent. The company’s strong performance comes on the back of diversified business operations across several nations, a strategy that has enabled it to beat threats of a slowdown.
For instance, while revenue contribution from pipeline and process plant segment continues to remain significant in the latest quarter, its proportion to total sales has declined. Instead, the company’s infrastructure segment, further strengthened by its Singapore-based acquisition, has made a higher contribution. This segment’s increased contribution is visible in the order book as well.
Punj Lloyd has also made headway in geographic diversification, having significantly ramped up presence in South-East Asian and Asia-Pacific regions.
Over the past few quarters, infrastructure stocks have been beaten down on fears of higher raw material and borrowing costs hurting earnings. A mild slowdown in order book in the June quarter also sent the earnings estimates spiralling downwards for the company. Punj Lloyd has done well to cross these hurdles.
In the latest quarter, the proportion of raw material to sales witnessed a decline, improving operating profit margins by 50 basis points to 9.3 per cent. Interest cost too was comfortably covered by higher profits. Order inflows during the quarter, at Rs 5,600 crore, were more than double September 2007 levels.
The company’s current order book of Rs 21,700 crore (2.8 times FY08 sales) from cash-rich clients is likely to provide revenue visibility over the next 18 to 24 months. Beyond this period, new ventures such as defence equipment, onshore drilling and strategic stake in a shipyard are likely to expand the revenue stream. While a subsidiary has bagged its first onshore drilling contract, a further decline in crude oil prices may pose a threat to the rental income.
Investments with a two-three year perspective can be considered in Titagarh Wagons (TWL), a leading private sector wagon manufacturer.
Our investment argument stems from the relatively stable business opportunities available in the rail sector arising from setting up of dedicated freight corridors, sustained capex by leading container rail logistics companies and introduction of wagon leasing scheme.
All these factors hold considerable merit in today’s scenario as many mid and small-sized manufacturing companies are already facing a slowdown in demand. On that note, TWL’s revenues appear comparatively cushioned.
Not only is the demand for wagons stable, the fact that TWL has a long-standing relationship with both the Indian Railways (IR) and private players also lends considerable credence to its growth potential.
From a long-term perspective, the recent meltdown in the broad markets has rendered the company’s valuations quite attractive.
At the current market price of Rs 399, the stock now trades at about 10 times its likely FY09 per share earnings, down significantly from the PE multiple (of 17 times) it enjoyed at the time of its initial public offering in March this year. That there has been no significant mark down in capex, by either the IR or leading container rail logistics players such as Concor and Gateway Distriparks (GDL) in the interim period, suggests that there may be sufficient room for expansion in its price-earnings multiple from the current levels.
Wagon demand buoyant
The demand for wagons is largely driven by the capital expenditure incurred by the Indian Railways. That IR has moved to positive earnings territory over the last couple of years and given that railway spending has little linkage to the global economic slowdown (in recent times, the passenger traffic using railways has increased significantly) suggests that its budgetary spending on revamping its infrastructure and adding to its wagon fleet in the coming years may well continue.
This bodes well for TWL since IR had intended to procure an all-time high of about 20,000 wagons in the coming years. Another factor that adds up favourably for TWL is the high replacement demand from IR. To increase its share of the freight traffic, IR plans to substitute its older wagons with ones that have a higher axle load design and are made of stainless steel and aluminium.
The entry of new private players in container rail logistics is also a positive. While it may take a while for the demand from private players to ramp up, this space offers a huge business potential for wagon manufacturers (industry estimates peg it at about Rs 2000 crore).
The growing consensus that interest rates may have peaked and will begin to taper from hereon may also support demand. On that note, the wagon investment scheme, which seeks to provide 10 per cent rebate on normal freight charges to wagon owners and guaranteed supply of rakes every month, may also sustain demand.
Besides this, introduction of wagon-leasing scheme, which allows third-parties to invest in wagons and lease them, may also help.
In addition to all this, TWL has recently started the manufacture of Electric Multiple Units (EMUs), which are widely used for the passenger transport by the Railways. While only a nascent business presently, it holds the potential to become a significant revenue spinner for TWL in the coming years.
High barriers to entry
Given the high entry barrier in this business, private wagon manufacturers are likely to reap the benefits arising from near term opportunities. This is because IR’s procurement policy stipulates that three-fourth of its orders should be placed with players on the basis of their past five years’ track record. That straightway eliminates the threat of TWL losing any significant market share to newer players.
On the other hand, TWL may well procure incremental business from the Railways in the coming years since it is presently investing in doubling its wagon manufacturing capacity. That the capacity expansion will be funded through the IPO money raised by the company also does away with concerns regarding any high reliance on debt for expansion. The only bottleneck in this business is the limited availability of axle and wheel sets given the supply constraints of the domestic railways-approved wheel set manufacturers.
sThis, the company plans to circumvent by setting its own axle machining and wheel set assembling plant.
On a compounded annual basis, TWL has in the last four years grown its revenues and profits at 76 per cent and 97 per cent respectively.
Operating profit margins, during this period, have expanded by over 2.6 percentage points to 15.5 per cent.
Though TWL has presence in HEMM (heavy earth moving and mining equipment) and steel castings (captive consumption) businesses, we expect a bulk of its revenue growth to come from the wagon manufacturing division.
To that extent, it leaves little scope for expansion in margins and realisations as IR fixes the price of wagons on the basis of the lowest bid (L1) it receives.
Investors can consider accumulating the stock of Indian Bank, as the bank is backed by good fundamentals, robust advances and operating profit growth. The stock trades at a modest valuation, of about one time its September 30 book value and 5.3 times its trailing 12-month earnings.
Indian Bank, a small-sized public sector bank with more than 40 per cent of its total branches in Tamil Nadu, trades at a premium to peers such as Corporation Bank, Vijaya Bank, Dena Bank and Andhra Bank. The valuations are justified because of the high-quality diversified loan book, 100 per cent CBS-enabled operations, superior profitability ratios, strong net interest margin (NIM) and significant headroom to raise capital in future.
Indian Bank’s balance-sheet has grown at a 17 per cent compounded annual growth rate while its advances grew at 26.5 per cent over the past five years. Indian Bank, which faced a major crisis in the mid-1990s, was turned around through a re-capitalisation done by the government through the issue of bonds; consequently, the bank had more of its deposits parked in investments.
But the successive managements’ attempts to improve the bank’s profitability without compromising on the quality of assets, have helped it perform better than most of its peers.
Indian Bank has posted strong operating profit growth of 44 per cent in the half year ended September 30, but has reported muted net profit growth of 9 per cent. Operating profit growth did not translate into higher net profits due to higher provisions and tax outgo.
The bank is expected to maintain its momentum, given the advances growth it had managed to clock in tough economic conditions.
In the September quarter, the bank’s advances growth, combined with higher NIM (net interest margins) boosted net interest income by 44 per cent year-on-year. The NIM improved from 3.23 per cent to 3.86 per cent, on the back of increased yield on advances and lower cost of funds. Increased yield on advances was on expected lines as the bank has increased its PLR during the September quarter.
The bank saw its interest income component decline from Rs 232 crore to Rs 212 crore in the September quarter, mainly due to a decline in profit on sale of investments (down from Rs 66 crore to Rs 3 crore).
Non-recurring items such as recovery of bad debts also formed a major component of ‘other income’. Operating expenses were flat, with the bank already putting in place investments in technology; the cost-income ratio moderated to 40 per cent from 54 per cent last year. The net profits may grow at a higher rate from here on as there will be bond provision write-backs. Higher treasury income and growth in ‘other income’ will contribute to the bank’s growth but the AS-15 retirement benefits for the next four years will weigh on earnings.
Indian Bank’s loan book is focussed mainly on mid/large corporate (50 per cent), retail advances (18.5 per cent), SME advances (10.7 per cent) and agriculture advances (15 per cent).
The advances growth of the bank is contributed by the corporate credit (57 per cent) and SMEs (44 per cent). Retail credit, as a proportion of advances, has come down from 20 per cent to 18 per cent, Y-o-Y. That the incremental growth in advances was contributed by as many as 32 sectors, is a good sign and indicates a diversified loan book.
Deposit growth of 20 per cent was slower Y-o-Y, as the bank deliberately reduced bulk deposits during the first half of this fiscal, improving its CASA. The credit-deposit ratio rose substantially from 60 per cent to 73 per cent during the year.
The bank’s net NPA/advances of 0.18 per cent places it among the best banks based on asset quality. The provision coverage, which is as high as 81 per cent, will cushion the bank from adverse impacts. The bank’s capital adequacy ratio stands at 11.2 per cent with tier-1 capital 10.1 per cent (which is at comfortable levels). The government’s stake of 80 per cent may help the bank raise capital, once market conditions turn more favourable.
The bank’s performance till date is ahead of its FY-09 targets and the management is planning to go slow on advances from hereon, as a matter of caution. But with the expectation of interest rates coming down and with income from other avenues hard to come by, bank credit may be the key avenue to deliver reasonable growth.
The bank’s 100 per cent CBS will continue to help it contain operating costs and boost ‘other income’. Indian Bank’s ‘other income’ component at 28 per cent of the net revenue, is low and suggests scope for improvement.
The bank’s mark-to-market provision on its bond portfolio, taken in a rising interest rate environment, may be written back in coming quarters if interest rates fall, helping profits. Like other banks, Indian Bank too is a beneficiary of the farm debt waiver reimbursement and the CRR cut.
The recent RBI measures such as CRR cut of 350 basis points, repo rate cut of 150 basis points and SLR cut of 1 percentage point will help ease liquidity for the whole banking system. The bank will get around Rs 2,200 crore from the CRR cut. The transitional liability for AS-15 retirement provisions of Rs 92 crore every year for the next four years may, however, pressure profits.