Tata Tea
Sunday, November 23, 2008
My Portfolio - Nov 23 2008
Not much of a change from the previous portfolio except few stocks went into deeper red and some recovered
Welspun Gujarat Stahl Rohren
Fresh investments with a two-three year perspective can be made in the stock of leading steel pipe manufacturer Welspun Gujarat Stahl Rohren .
The stock price has corrected significantly in the last couple of months following concerns that the fall in crude prices may possibly scale down the capex by global oil and gas companies.
This may be true of the incremental or fresh capex of these companies but it is unlikely that the plunge in oil price may affect the ongoing capex. To that extent, the company’s order book of over Rs 9,500 crore, executable over the next year and half, provides comfort.
At the current market price of Rs 91, the stock trades at about five times its likely FY-09 per share earnings, leaving ample scope for appreciation in the coming years.
Investors, nevertheless, should consider accumulating this mid-cap stock in lots since it may be subject to heightened volatility in price.
Demand scenario
To say that the global demand for pipes would continue to remain buoyant despite the global economic slowdown would be an exaggeration, as spends by oil and gas companies on E&P (exploration and production) activities may slow down.
However, it is unlikely to affect the expansion already undertaken by oil and gas majors.
Spends on pipelines happen only in the last leg of the entire capex and, thus, order flows from ongoing capex, may last a while. This does away with concerns that there may be any significant slowdown in demand for pipes in the foreseeable future.
Besides, demand may also get a lift from the need to replace some of the existing pipe networks in the US. That over 60 per cent of the existing line pipe network (over 1.5 million miles) in the US is over 30 years old and would soon be due for replacement, also lends ‘replacement’ market potential.
Strong presence in the export market and established relationships with many global oil and gas majors (in the US as well) reflect well on Welspun’s ability to grow its revenues, albeit at a slower pace.
The company’s order book, pegged at about Rs 9,500 crore (2.4 times FY-08 revenues), reinforces its stable prospects.
Financials
For the quarter ended September 2008, the company registered a 60 per cent growth in sales. Pipe volumes remained robust, witnessing a 34 per cent increase, while realisations grew by 12 per cent.
But the high sales volumes in Q2 were partly due to the deferment of shipments from first quarter when the government had imposed export tax on steel pipes. Blended pipe realisations that were up 4 per cent on a year-on-year basis registered a fall of over 7 per cent sequentially.
Operating margins, owing to higher raw material cost declined by 6 percentage points to 10.5 per cent.
Profits however declined by over 21 per cent due to forex losses (on account of realignment of net foreign currency exposure and ECB) of over Rs 88 crore during the quarter. If not for the forex loss, the company’s performance was commendable.
Concerns
The company’s steel plate facility, which was initially intended for both captive use and commercial purposes, however, may prove to be less of a money-spinner than expected.
After the recent fall in steel prices, which has made the commercial sale of steel plates less profitable, the management has reduced its plate production guidance to 340,000 tonnes (for this year) from 600,000 tonnes in the beginning of the year.
Instead, it plans to focus on using its plate facility for captive consumption and for upgrading it to manufacture pipes for critical applications such as the for the power sector.
While for now the company’s dependence on the US (45 per cent of its revenues) does not ring any alarm bell, given the possibility that the capex on pipeline network will continue, it may backfire if the US economy remains in recession for more than a couple of years.
In such a scenario, Welspun’s spiral pipe manufacturing facility (expected to be commissioned by Q3 FY-09) in the US may also prove counterproductive. The company may then need to increase its revenue share from countries in West Asia and South America and even India.
Till such time, trends in order inflows for the company over the next two-three quarters may bear a close watch.
Indraprastha Gas
Not too many stocks have held their ground in the meltdown of the last three months. Indraprastha Gas Ltd. (IGL) is one of them. Compared to the 43 per cent erosion in the Sensex since mid-August, the IGL stock has shed just 7 per cent with a low of Rs 98 and a high of Rs 121.
Though FIIs hold about 20 per cent of IGL’s equity, the stock has managed to stay afloat only because there are little concerns over its earnings prospects. Indeed, the stock is seen as a defensive bet during bad times such as these as its revenues and earnings are not directly linked to the economy.
The downside from the current price of Rs 104 appears minimal. Traditionally, the IGL stock has not been a fast mover during an uptrend and, as such, it will be fair to expect an upside of 15-20 per cent in the next one year, which is a reasonable return in the prevailing market. The dividend yield of about 4 per cent on the stock is a plus.
Recession-proof
IGL, which supplies compressed natural gas (CNG) for automobiles and piped natural gas (PNG) to homes and commercial units, is a monopoly in Delhi. Commercial vehicles in the National Capital Region are bound by law to use CNG as fuel. However, it is the private vehicles that are now driving IGL’s growth.
The number of CNG vehicles on Delhi roads rose 71 per cent to 1.21 lakh vehicles in 2007-08 with most of the increase coming from private vehicles and some from buses. CNG sales from its 163 stations accounts for 92 per cent of revenues with the rest coming from PNG.
The high prices of petrol and diesel are behind the rising conversion of private vehicles to CNG. There is a big benefit for vehicle owners even after accounting for costs of conversion, given the wide gulf between the prevailing prices of petrol/diesel and CNG.
IGL sells CNG at Rs 18.90 a kg while petrol costs Rs 50.62 a litre and diesel Rs 34.86 in Delhi. During the second quarter alone, about 15,000 cars and 300 buses were converted to CNG.
IGL has an allocation of 2.2 million standard cubic metres of gas a day (MMSCMD) from its parent Gail. Its average sales were 1.5 MMSCMD by end-March; given the increasing trend in conversion since, IGL must now be averaging about 1.7-1.8 MMSCMD of sales a day. There is still enough room in the allocated supply for IGL to expand its sales.
Growth drivers
IGL plans to build 50 more stations by 2010 in time for the Commonwealth Games which is expected to spur higher demand for CNG. The company is also planning to branch into adjoining territories such as Greater Noida, Ghaziabad and Panipat.
The company has jointly bid with a private player — Siti Energy — for marketing rights in Haryana. Approval from the regulator — Petroleum and Natural Gas Regulatory Board (PNGRB) — is awaited.
Meanwhile, a decision by the Delhi Government to stop registration of diesel-driven small cargo carriers is expected to benefit IGL. Combined with the rising conversion rate of private vehicles and buses, IGL appears to be well-placed in terms of volume growth. There is also tremendous scope in PNG where the penetration rate is estimated to be less than 1 per cent. Though it is a time-consuming process to network residential and commercial units, once done, the business can add significant incremental volumes for IGL.
Growth barriers
The two most formidable barriers that IGL could run into are access to gas and regulatory norms. The company will soon be using up its full allocation of gas. Though new gas from the KG Basin is expected to flow, the price may not be as low as the artificially set APM price that it now pays.
While ordinarily it should be able to pass on the higher price, it needs to also keep an eye on the price of competing fuels. This will be the case especially in the new markets that IGL intends to enter where there will not be any mandate, as in Delhi, for vehicles to use CNG only.
Second, there are regulatory uncertainties with the PNGRB and IGL yet to settle the question of licence for Delhi. While IGL claims that it was formed before the regulator came into existence and, hence, the latter’s norms are not applicable to it, the PNGRB insists that IGL has to secure a licence from it. Meanwhile, the regulator has set till 2010 for IGL’s Delhi monopoly status to end.
Zero-debt company
IGL is well-placed to raise funds for expansion, given its zero-debt status. The company plans to invest Rs 500 crore over the next two years in expanding its network in Delhi. Revenues and earnings have been growing steadily; in the latest quarter, revenues grew by 22 per cent to Rs 243 crore while earnings rose 17 per cent to Rs 50 crore.
NTPC
Investors looking for a defensive play in the current market can buy the stock of National Thermal Power Corporation (NTPC), trading at Rs 150 (price earnings multiple of 13). The stock has managed the market storm relatively better than many others. Compared to a fall of 43 per cent in the broad market (Sensex), it is down by 18 per cent only since mid-August. The market’s attraction for NTPC stems from three main factors — the large demand-supply gap for power, the company’s efficient operating profile and its emerging integrated business model with entries into coal mining and power trading.
The power major’s plant load factor (PLF) of 87.5 per cent in the first half of this fiscal, though marginally lower than the same period last year, is still way ahead of the industry average. PLF, despite the addition of fresh capacity of 1,000 MW since the same period last year, was affected due to maintenance shutdowns at some of its stations and also fuel scarcity.
While the company has addressed the fuel problem by ordering imports of 8.6 million tonnes of coal, gas remains a cause for worry. The imbroglio over gas supply for its current and expanded capacity at its gas-based stations in Kawas and Gandhar is pulling down the overall PLF of NTPC. The company has now switched to naphtha following the fall in price of the liquid fuel, but that may be a temporary solution.
It is steadily moving ahead in its backward integration into coal mining, the fruits of which will begin to be visible over the next few years. Meanwhile, of the 22,430 MW planned to be added in the Eleventh Plan (2007-12), NTPC has commissioned 2,490 MW while 16,180 MW are in various stages of construction. The company may yet fall short of the target given that about 2,600 MW of gas-based capacity is included in it.
The capital expenditure programme continues to be on track with an estimated Rs 12,670 crore to be spent this fiscal followed by Rs 18,700 crore in 2009-10. The company recently raised Rs 1,000 crore through bonds from the market at average rates of about 11 per cent even in the current tight liquidity scenario. Weighted average cost of the company’s total borrowings, at 7.2 per cent, is still on the low side.
Profits have grown at 15 per cent compounded annually in the last five years. In the first half of this fiscal, the unadjusted profit has fallen by 10.67 per cent year-on-year but the adjusted profit shows a growth of 8.64 per cent. In the same period, revenues have grown by 13 per cent, mainly owing to capacity addition, leading to higher generation.
Mindtree Ltd
Investments with a one-two year perspective can be considered in the shares of MindTree, considering its relatively strong business positioning among mid-tier IT companies and reasonable valuations.
Given the current difficult macro-environment where clients tighten IT spends and demand more value for money, MindTree may be one of the best-placed players in the mid-tier segment to weather the crisis. The company’s focus on applications delivery to the key areas of operations of the various verticals that it operates in, lends confidence in the current difficult macro-environment.
At Rs 234, the stock trades at seven times its likely 2008-09 earnings. This is at a slight premium to mid-tier players such as Hexaware Technologies and KPIT Cummins.
But MindTree’s blended offering of IT and R&D services, better revenue visibility on a wider vertical-mix, and an increasing domestic presence, may justify this premium. MindTree resembles any of the top-tier IT players in terms of service offering, but operates on a smaller scale. This apart, improvements in several key operating metrics and opportunities in areas such as testing, after the Aztecsoft acquisition, are positives for the company over the long run.
vertical-mix
MindTree offers both IT and R&D services, catering to a wide range of clientele. Traditional services such as application development and maintenance (ADM), package implementation, testing and the like are delivered to clients across four-five verticals. MindTree also works on product-realisation services with clients who produce storage and server systems, consumer appliances, communication systems and automotive systems.
This mix of IT-R&D services is around 80:20 in terms of revenue contributions to the company. Over the long run, R&D services have the potential to lead to IP-led revenues that are not linked to the manpower added and, therefore, may provide scope for margin expansion.
In terms of vertical-mix, MindTree is also favourably placed, given the current problems in the financial sector. Manufacturing contributes 27 per cent of the revenues, BFSI (26.4 per cent) and travel and transportation (20.4 per cent); clients are other important contributors. For instance, in the manufacturing segment, MindTree works in areas such as distribution planning and sales routing, business intelligence, and trade promotion data management to give feedback to product managers. In the BFSI, the company is quite selective in the way it operates.
ADM services contribute nearly 75 per cent of its revenues. Though these command lower billing rates, they are non-discretionary in nature.
Gains from acquisition
This means that IT-budget tightening of clients poses less of a threat to project flows. Together, these factors lend better revenue visibility over the medium term for the company.
MindTree has also looked to grow inorganically and has acquired a 79.9 per cent stake in Aztecsoft at an enterprise value of Rs 360 crore. MindTree is funding over 50 per cent of this deal through internal accruals.
Aztecsoft works with clients in niche areas such as transaction portals, intranet and extranet portals of enterprises, independent software vendors and mobile and wireless companies. It counts Microsoft and AOL as its clients.
Aztecsoft has enterprise software capabilities in these segments and has capabilities in key technology areas such as SaaS, Web 2.0 and cloud computing. MindTree’s R&D division together with Aztecsoft’s capabilities would now be able to address the entire value chain of product development business.
Aztecsoft has a strong independent testing service practice, which is slated to be a key growth area of outsourcing, according to Nasscom reports.
India Presence
HUL, ICICI Bank, ING Vysya and Titan Industries are some of MindTree’s major clients in India. Over the past year, MindTree has been pursuing deals in the government and Defence segments.
It has also participated in the e-governance initiative, with a large project for the Rajasthan Government for citizen services.
Other assignments include work done for the Chief of Army Staff and the Deputy Chief of Army Staff and a consulting assignment to manage the logistics of a war.
India contributes around five per cent of Mindtree’s overall revenues and the company hopes to enhance this. The company is eyeing more such deals and gain from government spends on IT enablement.
Improving operating metrics
Over the last few quarters, the company has enhanced several operating metrics to optimise costs and manage margins.
Utilisation, which was at 65 per cent levels, is now 70.5 per cent and MindTree hopes to increase this over the next year or so. In terms of revenue-mix, the offshore component is over 70 per cent.
This makes MindTree a player with one of the best mix among mid-tier IT players.
A better offshore component ensures better margins (but lower revenues) compared to onsite where revenues come at lower margins. Million dollar client additions are healthy.
Repeat business at 99 per cent is comparable to top-tier IT players and indicates that there is no significant reduction in engagement with existing clients.
Attrition has also come down significantly to 15 per cent from 16.3 per cent.
Risks
There is a possibility of clients coming back for price reductions for deals, which may hurt realisations.
With several large companies in the BFSI space filing for bankruptcy, and with automotive companies also facing the heat, the overall pie of newer deals may be reduced for MindTree.
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