Sunday, January 04, 2009
Investors can consider fresh investments in the stock of Punjab National Bank (PNB).
A likely beneficiary of the recent stimulus measures, PNB’s cost of funds may ease on the back of recent CRR cuts totalling 400 basis points. The bank has strong advances and earnings growth, higher margins (3.78 per cent), a large proportion of low-cost deposits and a diversified advances book.
Earnings growth may be driven by advances and backed by low-cost deposits, though margins and asset quality may take a slight dip in the coming quarters. At the current market price of Rs 531, the stock trades at an attractive valuation of 7.2 times its trailing earnings and 1.4 times its September book value.
PNB’s advances have grown at 26 per cent annually for the last five years, with the momentum sustained this fiscal (28 per cent growth). A high proportion of corporate advances (32.6 per cent) and low slippages here, helps the quality of the loan book. PNB may be well placed to expand its balance sheet on the back of strong credit growth. The bank has acted ahead of its peers to pass on rate cuts to its customers and has the lowest PLR among banks. This move may weigh on profitability in the short term , but can help gain market share.
The net profit increased by 26 per cent in the first half due to higher advances growth and better Net Interest Margins (3.78 per cent). Non-Interest income of Rs 1,119 crore also aided profits. Moderate operating costs (8 per cent growth); improved cost-income ratio (45 per cent) helped the operating profit, even as provisions weighed on net profits. The bank’s provision coverage of 82 per cent brought down the Net NPA/Advances to 0.42 per cent. Going forward, as interest rates fall further, the bank’s profits may be shored up by treasury gains and write backs of provisions. Though margins may be under pressure for a few quarters, as high cost deposits were raised until December, this may be offset by treasury gains.
New provisioning norms may slow down asset quality deterioration, while capital adequacy may improve on the back of the Government’s re-capitalisation plan for PSU banks. However, PNB’s capital adequacy is at present comfortable at 13.64 per cent.
In terms of risks, PNB does have a higher proportion of bulk deposits, which tends to add to cost of funds. Any delinquencies from priority sector lending and non-fund exposures to exports may expose the bank to risks.
Investments with a two-three-year perspective can be considered in the stock of Everest Kanto Cylinders, a leading manufacturer of high-pressure CNG (compressed natural gas) and industrial cylinders. Our optimism stems from the relatively strong demand for EKC’s products when compared to that of other mid-tier capital goods and manufacturing companies, besides the abating pressure on input costs, and the company’s highly diversified geographical presence.
At current market price of Rs 184, the stock trades at about nine times its likely FY10 per share earnings. While this may appear at a premium to that of the market, it is supported by the company’s fairly steady growth prospects. That said, investors may be better off accumulating this stock in small lots, given the heightened volatility in the broad markets.
In the last two years, the company has grown its consolidated revenues at a compounded rate of over 50 per cent, while profits soared by over 78 per cent.
Even in recent times, despite the all the mayhem caused by the unprecedented rise in input price and the slowdown in global economies, the company has done well to maintain its growth rates.
In the quarter ended September-08, EKC put up a 73 per cent growth in sales, driven mainly by its recent acquisition of US-based CP Industries (17 per cent of revenues) and the commencement of production in its China plant.
Profit growth, however, remained a little curtailed at 52 per cent, attributable to the increased interest cost (as the acquisition of CP Industries was funded primarily through debt) and high depreciation.
It is, however, the company’s performance on the margin front that inspires more confidence. Despite the spurt in raw material prices, EKC managed to up its EBITDA margins by over 1.1 percentage points to 31.8 per cent.
This was made possible due to the company’s sufficiently large build-up in inventory that insulated its margins. Besides, the present softening trends in input prices may only help it maintain its margins from here on.
While a high crude oil price would have substantially catalysed the demand for CNG-based energy options considering that they would then have been more cheap and viable in comparison, their demand may well continue to remain robust despite the substantial fall in oil price. This is because regardless of the oil price, most countries in the long run are likely to be on the constant look-out for ensuring their energy security. So, while blips in oil price may impact the near-term demand dynamics for CNG-based applications, their long-term picture continues to look promising.
On that note, considering that EKC’s expanded capacities (capacity to manufacture over one million cylinders per year), which compares with some of the global names in cylinder makers such as Beijing Tianhai Industry Company (China) and Faber Cylinders (Italy), puts its future growth prospects in better light. That EKC only recently (in July-08) hiked the price of its cylinders also underscores the strong demand for its products.
Another key point that strengthens the investment argument in EKC’s favour is its strong foothold in the domestic market. With an 80 per cent market share in India, EKC appears best placed to benefit from the Supreme Court injunction mandating the use of CNG as auto fuel for heavy vehicles in New Delhi and the city gas distribution initiatives of the government.
While these factors, plus the fact that some of the leading car makers in the country have announced CNG variants of cars, may go a long way in paving the company’s future growth story, it needs to be understood that the CNG, as a concept, is still in its nascent stage in India.
So, while that leaves a lot of room for future growth, it also leaves quite a few issues for the government to put in place, including improving CNG infrastructure, before CNG applications take off in a big way in India.
And it is this dependence on government spending and policy initiatives that can limit or postpone the company’s domestic growth avenues. On the export front, while demand continues to remain stable, the company’s earnings may be susceptible to the highly dynamic forex market.
That in the last quarter, the company suffered a Rs 12-crore translation loss on its FCCB may help put this earnings risk in perspective. These apart, delays in the production ramp-up of new plants also pose a downside risk.
If the Cenvat concession and interest rate cuts of the first stimulus aimed at trimming costs for India Inc as a whole, the second one singles out select sectors for its munificence.
It promises lower borrowing costs for large infrastructure companies through the ECB route and paves the way for financial closure of stalled projects. It also offers incentives for commercial vehicle makers and the logistics sector, while raising the barriers of protection for cement makers. Here is a listing of possible beneficiaries.
Freeing up funds
For the infrastructure sector, moves such as the removal of the ECB ceiling, aggressive rate cuts and greater borrowing powers to IIFCL may infuse liquidity and temper the cost to borrowing. It may also speed up financial closure for infrastructure projects that are struggling to achieve financial closure. Players such as Larsen & Toubro, Hindustan Construction and Maytas Infrastructures, key bidders in road projects, may be the possible beneficiaries.
While the CRR cut will lower the cost of funds for banks, the package also takes care to open up additional avenues for fund-raising by NBFCs. NBFCs engaged in infrastructure funding such as IDFC, REC and Power Finance Corporation, as also those that lend to the transport sector, may be able to obtain easier access to funds.
On the real estate front, the most significant incentive is the green signal given to realty developers to raise ECBs for developing integrated townships; a ban on raising funds for such townships was imposed in May 2007. DLF, Ansal Properties & Infrastructure and Parsvnath Developers that have plans in this direction may reap the benefits of this move.
Spillover for logistics
The focus on funding for road and port projects may also have spillover gains for the logistics sector, which has been grappling with dwindling volumes at the ports. Potential beneficiaries would be companies in the container rail space such as Container Corporation of India and Gateway Distriparks, besides players such as Allcargo Global, Sical Logistics and Mundra Port and SEZ. The sector may benefit from the easing of pre-shipment and post-shipment credit norms. The EXIM Bank has obtained a Rs 5000-crore line of credit from the RBI to provide credit to domestic exporters at competitive rates.
Inventory relief for CVs
Commercial vehicle makers have been dogged by steadily sliding sales and an inventory pile-up in recent months. The latest stimulus package tries to address this by offering an accelerated depreciation of 50 per cent for commercial vehicles purchased up to March 31, 2009. While availability of financing for purchases will hold the key to actually reviving vehicle demand, the accelerated depreciation benefits may push buyers to expedite purchase decisions.
This could help clear inventories for CV makers such as Ashok Leyland, Tata Motors and Escorts. The financing problem has been addressed by asking PSU banks to provide a line of credit to NBFCs (such as Sundaram Finance and Shriram Finance) for the purchase of commercial vehicles.
The Government has raised the barriers of protection for the domestic cement industry and allowed greater pricing power, by re-imposing countervailing duty (CVD) and Special CVD on cement imports.
Though the volume of imports has not been very large after the scrapping of import duty last year, cement players in the surplus northern region have been threatened by the shipments from Pakistan. Ambuja Cements, ACC, Shree Cement and JK Lakshmi Cement may be possible beneficiaries from this move.
Rumors of a broad workforce reduction at the world's largest software maker have been swirling since a blog post last week purported to show that Microsoft was preparing to lay off as many as 15,000 employees, or 17 percent of its workforce. A Microsoft source tells Goldman that the speculation is "grossly exaggerated," but added that "any company not paying careful attention to headcount in a climate like this is nuts." Calls and emails to Microsoft Saturday morning were not immediately returned.
“Ponzi scheme” is a term that has been used to describe many scams and financial frauds — ranging from the failure of large NBFCs in India in the nineties to the recent scam perpetrated by Bernard Madoff on Wall Street.
The scheme is named after Charles Ponzi, who duped people by promising quick returns from trading in discounted postal stamps. In a typical Ponzi scheme, as long as new entrants keep coming-in, earlier investors get good returns. But once that stops, the scheme collapses.
Charles Ponzi promised to double investors’ money in 90 days. The returns, he claimed were from exploiting the exchange rate difference on international postal reply coupons. He convinced people on the kind of extraordinary returns the arbitrage trade could give and amassed money. He then started his own company, employed agents to propagate the scheme and made millions in a short span. But Charles Ponzi kept it in the dark that investor “returns” actually came, not from profits, but from the capital brought in by new investors. The recent Madoff scam has been likened to a Ponzi scheme. Madoff, ex-chairman NASDAQ, founder of Bernard L Madoff Securities LLC was caught in the scam this December.
Madoff was alleged to be running a $50-billion Ponzi scheme through his securities firm. Not just lay investors but many big investment firms are said to have exposure to Madoff’s firms. Bernard L Maoff owned a securities firm (started in 1960) and an asset management firm (launched in 1990s).
His funds were delivering consistent returns every year, even as conventional mutual funds faced declining returns. Madoff claimed that his strategy was investing in blue-chip stocks and buying options simultaneously to limit downsides. Things went on smoothly till money kept pouring in.
The first sign of problem was visible in December last year when some of Madoff’s hedge fund clients wanted their money back. Appeals for withdrawal totalled $7 billion.
Madoff couldn’t arrange for redemption and admitted to a scam. Madoff told the senior employees of his firm on Wednesday, December 10 when he was arrested, “it’s all just one big lie…..basically, a giant Ponzi scheme”.
Investors with a two-year horizon can buy the shares of Rolta India, a niche software provider offering geo-spatial information and engineering design services.
At Rs 120, the stock trades at a historic low of six times its likely 2008-09 earnings. This is the valuation that most mid-tier IT companies enjoy currently.
But given Rolta’s superior net profit margin (greater than 21 per cent) vis-À-vis most mid-tier IT companies and its business prospects over the next few years in areas such as power, oil and gas, and geographic mapping for the defence forces, the stock appears attractive.
The current difficult business environment means that only select mid-tier IT companies with differentiated offerings and those with strong domestic focus would be reasonably placed to stem the tide.
Rolta, with a strong domestic revenue base and catering to clients which are mostly government institutions and large core engineering industries, might fit this criterion.
Key domestic presence
Rolta derives 55 per cent of its revenues from services rendered in India. The US contributes 31 per cent of its revenues, while BFSI as a whole less than 4 per cent. The domestic exposure is the highest among IT companies in India.
The company provides geospatial information to clients such as the armed forces, DRDO, Survey of India, Airports Authority of India and a host of other governmental nodal agencies.
This segment contributed 50 per cent of its revenues in FY-08. With spends on internal security and defence capabilities enhancement, this segment provides Rolta with a fair degree of revenue visibility over the long term.
The nature of services that the company delivers are also such that there would be constant upgrades and maintenance required, thus providing a steady stream of revenues.
The company has managed to create software products by using its own and third-party software such as Intergraph to cater to segments such as government, Defence, infrastructure and utilities.
The company has a joint-venture with Thales, a player in critical information systems working with aerospace, Defence and security market. This JV may help Rolta bag any outsourcing deals to the JV done by Thales’ clients.
Engineering services strength
Rolta derives over 30 per cent of its revenues from delivering high-margin engineering services to clients. Its design services cater to engineering, power, refinery and the shipping industries and cover a good part of the value chain.
Domestically, with refining capacities and power generation set to improve manifold over the next few years, the company may be well-placed to tap such opportunities for delivering its services.
Here too, JV has been forged with Stone & Webster in the engineering services space, enabling the company to work in areas such as nuclear power engineering.
The JV is revenue-accretive to Rolta, and is executing projects in Singapore. The two companies are also seeking to capitalise on opportunities arising out of the Indo-US nuclear deal.
Other services and order-book position
The company delivers traditional IT services in partnership with players such as Oracle and Computer Associates.
This is a low-margin service, but has been growing in triple digits over the last couple of years.
Its presence here results in an end-to-end offering to engineering clients. But this business segment has to withstand competition from a host of Tier-1 and mid-Tier IT players.
The company has a current order-book position of over Rs 1,500 crore to be executed over the next 12-18 months across all segments of operation. This is about 1.5 times its FY-08 revenues, and lends visibility.
For Rolta, high dependence on governmental clientele means that receivables cycles could be much longer than is the case with other software companies.
There are certain projects where complete payment is received only after the warranty period. These may place higher demands on working-capital requirements.
This apart, the company derives 34 per cent of its revenues from new clients, which means lower annuity-based revenues.
However, the company’s focus on products-driven business may improve this situation.
IVRCL’s sustained growth in order book, strong financial performance despite some pressure from higher cost of borrowings and leadership in the irrigation space shore up its growth prospects. Investors can consider accumulating the stock of IVRCL Infrastructures and Projects with a three-year perspective. Consider buying the stock in small lots on declines linked to the broad market.
The company’s price-earnings multiple of about 6.5 times its expected stand-alone earnings for FY-10, makes it one of the most attractive candidates in the listed infrastructure space.
IVRCL is among the few construction companies that has shown resilience in the current economic slowdown. The company’s dominating presence in the irrigation segment is one of the key reasons for this hardiness.
The company has, therefore, remained one among the few players that has not witnessed any slowdown in the order book. The irrigation spends by States have not seen any significant slowdown until now, thanks to the political sensitivity in lowering the spending in this sector. IVRCL has, in recent times, bagged one of its biggest lift irrigation projects in Andhra Pradesh valued close to Rs 900 crore. With this, its total order-book stands at about Rs 15,000 crore — four times its revenue for FY-08.
The stream of order flows has also resulted in other companies such as Patel Engineering and Hindustan Construction increasing their focus on the sector.
Andhra Pradesh, one of key States with high irrigation spends, is said to have utilised over Rs 38,000 crore on irrigation projects over the last four years, that too without resorting to market borrowings so far. However, the State appears to be facing some fund constraints in recent times; there are reports of the State government’s plans to raise Rs 14,000 crore of debt for spending in irrigation projects.
The government, however, plans to continue with its new projects, what with the Cabinet recently approving Rs 38,500 crore worth of irrigation projects in the State. This being the case, the irrigation sector may witness steady order flows but with limited funds to utilise, thus bearing a risk of slowdown in execution. A similar limitation could also affect the Centre’s irrigation spending under the Eleventh Plan (2007-12).
This said, the slowly easing liquidity situation could well bring back the much-needed cash into the coffers of the spenders. Hence, while there could be some short-term slowdown in the execution of irrigation projects, this is unlikely to affect the plans over the long term.
IVRCL, for its part, has managed to so far execute its projects as per schedule, albeit at the expense of a steep increase in borrowing costs. The execution of projects and translation into revenues has also kept pace.
IVRCL’s financial performance for the half-year ended September 2008 — a 52 per cent growth in sales and 36 per cent growth in net profits — places the company among the top growing large infrastructure companies in the first half of 2008. The company has also recently issued redeemable non-convertible debentures worth Rs 200 crore to LIC to meet capex and working-capital requirements.
Aside of irrigation, IVRCL’s integrated business in water supply and sanitation and its continued presence in building contracts has ensured bagging of small, but regular, orders in other areas as well.
Of its total order-book, 65 per cent come from water projects, 17 per cent from buildings, 10 per cent from power and the balance from road and other projects.
IVRCL’s 51 per cent subsidiary, Hindustan Dorr Oliver (which has also witnessed strong growth in 2008), has enabled IVRCL to broaden its presence in other integrated water-related projects. Similarly, IVRCL has not lost focus on construction contracts.
It has recently procured orders worth Rs 750 crore for construction of various housing and commercial buildings.
This segment of contract work, although not necessarily superior in terms of profit margins, certainly reduces the risk profile associated with the role of a ‘developer’ and provides support on the volume front.
IVRCL has also moved to new fields such as oil and gas exploration. To grow in this business, the company, in late 2007, acquired Alkor Petroo, a local company that shares five exploration blocks with Gujarat State Petroleum Corporation and others in Yemen and Egypt.
The acquisition, for a consideration of Rs 6 crore, can be viewed as a small investment rather than a primary business integration strategy.
The company’s interest in another line of business, marine mining works, that includes micro tunnelling, could, however, hold much promise as the field is still at a nascent stage in the country.
IVRCL’s operating profit margins for the quarter ended September 2008 (at 7.8 per cent) has withstood testing times arising from commodity price hikes.
A good 90 per cent of contracts protected by price variation clauses helped sail the rough tide.
The company was not, however, as lucky on the net profit margin front with NPMs showing a mild decline to less than 5 per cent in the above quarter. The margin dip does not appear bad for a company whose interest cost increased five-fold.
On the debt front, IVRCL has managed to keep its gearing ratio comfortable at less than one.
While the recent debenture issue would lever up the ratio, IVRCL’s capital requirement for BOT projects is relatively low compared to peers such as Nagarjuna Construction or Hindustan Construction. As a result, the debt is likely to aid revenue growth sooner than later.