Sunday, September 20, 2009
A sustained revival in passenger vehicle sales, signs of recovery in commercial vehicles production, healthy replacement demand and cost controls paint a good picture for tyre manufacturer, CEAT. At Rs 163, the stock trades at a valuation multiple of 10.2 times its trailing 12-month earnings, cheaper than most peers. CEAT’s tyre-client portfolio is far-reaching, covering passenger cars, two-wheelers, trucks and buses, light commercial vehicles, earth-moving equipment and so on, with a 13 per cent market share. However, concerns linger over effects of exchange rate fluctuations, vulnerability to rubber prices and sustenance of demand from commercial vehicles. Investors can retain the stock, but can use price falls linked to broader market declines to accumulate it.
Supply to auto manufacturers has been on the wane in the past year but CEAT has made up for the fall through its strength in the replacement market. This segment grew overall by 10 per cent in June ’09 with the trucks and buses (T&B) segment and light commercial vehicles (LCV) segment accounting for a lion’s share.
About 79 per cent of the June 2009 quarter sales for CEAT can be attributed to the replacement market, up from the 70 per cent for 2008-09. Even with a good part of sales stemming from trucks and buses, given that tyres for such vehicles are generally replaced in 12-18 months, there remains a substantial demand for replacement tyres. To reach its wide customer base, CEAT has a national store network of 3,500 dealers, including 100 exclusive outlets called CEAT Shoppe for passenger cars, up from the 75 that it had the year before. Besides, the company has around 96 CEAT ‘HUBs’ for trucks and buses.
On the OEM front, production is showing signs of recovery in the key commercial vehicle segment. Tyre production in the T&B segment showed a growth of 6.2 per cent in June ’09 over the same period last year. OEMs account for just about 8 per cent of CEAT’s sales, but cater to a broad range of manufacturers such as Hero Honda, TVS, Piaggio, Maruti, Ashok Leyland, Eicher, John Deere and others.
Radialisation is a technological development that reduces tyre friction and improves fuel economy. The domestic passenger car segment is almost fully radialised, but the T&B segment is at 10-12 per cent levels only against the global average of 60 per cent. It is this segment that holds promise for CEAT, with very few players in the segment currently.
Towards this end, the company is setting up a 140 tonnes per day (tpd) radial tyre plant in Gujarat with an investment of Rs 500 crore, funded by debt and internal accruals.
The plant will be operational from mid-2010 and is expected to contribute to revenues from the second half of FY-10. Besides this, capacity expansion for its plant at Nashik by about 35 tpd is on the cards, which will aid volume growth. CEAT is aiming at improving its passenger vehicle offtake though it will remain focused on the T&B segment.
Role of raw material
The primary raw material for making tyres is rubber, accounting for 42 per cent of raw material consumption. This cost played a significant role in the 77 per cent operating profit fall in FY-09 over the preceding year. As a percentage of sales, raw material costs moved from 66 per cent in FY-08 to 72 per cent in FY-09.
During the year, rubber prices touched a high of Rs 135 per kg, only to crash to Rs 65 per kg in early 2009. Consequently, the company pulled out of losses, posting a net profit of Rs 60 crore in the June ’09 quarter over a loss of Rs 10 crore in the corresponding previous period.
But in response to the upswing that rubber prices are now riding, the company will hike tyre prices by 3-5 per cent, and which may ensure that tabs are kept on cost overruns. On another positive note, CEAT managed to marginally improve turnover of inventory in FY-09 to 9.8 times from the 9.3 times the year before.
Sales grew at a CAGR of 13 per cent in a three-year period, due largely to the poor performance of FY-09. Though the company sustained losses at the net level in FY-09, it still maintained operational profitability.
Operating profit margins for FY-09 stood at 3 per cent, improving to 16.3 per cent in the June quarter. Net profits margins are at 8.9 per cent. Debt-equity ratio stands at 1.14 times, on a par with most peers, but interest costs could cut into gross profit margins with additions to debt likely to fund its new plant.
Investors must, however, note that the company faces quite a few risks. For one, it is vulnerable to fluctuations in raw material prices. Exports contribute 17 per cent of sales numbers and CEAT imports raw materials as well; the company has hitherto suffered sustained forex losses. Though radial tyres hold promise, the segment is still in its infancy and will begin to contributing to revenues from the next financial year.
Investors with a medium-term perspective can consider selling at least a part of their holdings in the stock of Sanghvi Movers, a leading player in the crane hiring business, to lock into profits. The stock has almost trebled in value since our last ‘buy’ recommendation. While we continue to be positive on the long-term growth prospects of the company, given its strong market position, large fleet size and business with leading corporates, the stock price gains provide very little margin of safety for the risks to the earnings outlook for the next one year. At the current market price of Rs 185, the stock trades at about 9 times its likely FY10 per share earnings.
For the current fiscal, revenue growth for Sanghvi may remain subdued given lower demand. Though opportunities in power sector are expanding, the company may still go on to report a dip in overall sales for the year as other sectors continue to see sluggish offtake. The company’s high reliance on power projects for revenue growth also makes revenues susceptible to execution delays in power projects.
Investors can avoid the initial public offering of Thinksoft Global Services, a software testing company, given the concerns that surround its performance and global trends in the IT deal landscape. Its niche offerings may also force it to rely on a smaller universe of clients.
At the upper end of the price band of Rs 130, the offer discounts its 2008-09 per share earnings by about nine times on an expanded equity base. Most mid-tier IT companies, even those of much larger scale than Thinksoft, trade at about the same valuation, suggesting that the offer is not cheap compared to peers.
Thinksoft is a niche player, in the sense that the company offers software testing services to clients only in the banking financial services and insurance (BFSI). This limited offering of relatively lower value services, and to a single vertical, could stunt scalability.
To achieve the scale of even existing mid-tier IT companies, a blended offering of application development and maintenance, software testing, BPO and a small portion of high-end services catering to two-four verticals may be necessary. Reinforcing this is the fact that despite 11 years of operation, Thinksoft continues to have relatively small revenues of Rs 95.7 crore in FY09. Over the last four financial years (2004-09), revenues and profits grew by 44.1 per cent and 74.6 per cent, respectively, on a compounded annual basis. The company derives over 80 per cent of its revenues from clients based in Europe, West Asia and other Asian countries.
Business and macro concerns
Thinksoft derives nearly 93 per cent of its revenues from its top 10 clients making for very high client concentration levels. This is accentuated by the fact that its largest clients contributed 26 per cent to its 2008-09 earnings.
Any cancellation or reduction in volumes of projects from its top clients can thus significantly dent revenues. The company derives nearly 62 per cent of its revenues from services delivered onsite making for a sub-optimal cost structure. Mid-tier IT companies typically derive 60-80 per cent of their revenues from offshore locations and are thus able to maintain wage and cost structures to manageable levels.
Nearly 88 per cent of the company’s revenues come from projects that are billed on a time & material basis. This means that the company is all the more susceptible to cuts in pricing affecting most IT players.
Then there are the industry concerns. Testing as a service has seen a decline in contribution in revenues for top tier IT players over the last one year, which should serve as a lead indicator on the demand environment for such services. Mid-tier IT players such as Hexaware and MindTree have strong presence in the testing practice and are more integrated in terms of offerings, thus adding to the competition.
Recent deals, at least larger ones, have been awarded after considerable vendor consolidation by clients. This means that a number of small and medium-sized vendors who were taken for their ‘niche’ offering are done away with as large vendors can anyway offer all those services. Recent deals won by Indian majors suggest that lower-end services such as application development and maintenance could be the ones to increase volumes. Any software testing component in these deals could be catered to by existing large or mid sized IT players, what with ‘more for less’ being the fiat from clients.
Finally, being present in one service and one vertical seriously limits future growth prospects, both in terms of scalability of business or climbing up the value chain of service offering.
At the upper end of the price band (Rs 120-130), the company hopes to raise Rs 47.4 crore. Of the 3,646,000 shares on offer, nearly 63 per cent of it is an offer for sale by an existing shareholder — Euro Indo Investments.
Of the Rs 17-odd crore that would remain with Thinksoft, the company is looking to build a new software testing centre with an additional seating capacity of 400. The company has 360 employees offshore in its existing facility in Chennai.
Investors can book profits selling a part of their holdings in HCL Technologies, in light of the expensive valuations that the stock currently trades at. At Rs 339, the stock discounts its likely 2009-10 per share earnings by nearly 18 times. Not only has this narrowed the gap with peers such as Infosys, TCS and Wipro, it is also at the upper end of historic valuations for the stock. The company has had some reasonable deal wins in the last couple of quarters and may benefit from vendor consolidation which could prove beneficial to large IT players.
But the markets may have read too much into the June quarter numbers, apart from overlooking other concerns. HCL’s June quarter performance, especially on the net profits front has been made possible due to a combination of containing employee costs, selling and marketing expenses as well as a significant forex gain component. In the upcoming quarters, fluctuation in forex losses and employee costs could increaseOn a trailing 12-month basis, the contribution from its top 20 clients has declined significantly, as has the repeat business percentage. This suggests sluggishness in client ramp-ups.
Investors can refrain from subscribing to the Initial Public Offering of Euro Multivision (Euro). Lack of track record in the photovoltaic business, competition from larger players in this business and the delays in commissioning the project, suggest that it may be better for investors to adopt a ‘wait and watch’ approach before taking exposure in the company. The company’s current operations are centred around manufacturing compact disk recordables (CDR) and digital versatile disk recordables (DVDR) . At the upper end of its price band of Rs 75, the company is expecting to raise Rs 62 crore.
Euro Multivision hopes to bridge the funding gap for its Rs 178-crore photovoltaic or PV (solar) cell manufacturing with a capacity of 40MW in Gujarat through the IPO proceeds. The company has also tied up with banks to raise about Rs 100 crore to part-fund this project. The company expects to start commercial operations by January 2010.
CD and DVDR business
During the period 2006-08, sales grew 47 per cent compounded annually but has seen some moderation in 2008-09. Eurovision’s sales depend completely on CD/DVD (digital versatile disc recordables) business. It is the second largest manufacturer of CD/DVD in India (after Moser Baer) with a production capacity of 18 crore CD and DVD units. The operating margin in 2007-08 was as high as 34 per cent. Its strong distribution network, coupled with some revival in PC sales, may boost DVD and CD sales for the company.
Euo’s business carries substantial uncertainties, with falling realisations and a high risk of obsolescence, with superior technologies such as BlueRay, HD-DVDs, USBs threatening its market share. There is also an increasing threat in the form of the grey market and inexpensive storage devices.
The high levels of technology innovation are also leading to shrinking product life-cycle of the current products. This business may also call for periodic investments in upgrading manufacturing facilities, which would involve more capex.
While there is a huge demand for renewable energy on the back of the Kyoto Protocol, investments in this stock can be postponed till the company commissions its capacities and acquires clients for its photovoltaic cells.
Developed counties such as Germany, Spain and other European nations have taken major steps towards reducing emissions by incentivising non-renewable energy, which has led to the entry of large industry houses, including Reliance, Tata, Videocon and Moser Baer into this business. The company’s proposed project size at 40 MW appears small in scale compared to rivals such as Moser Baer,
Tata BP Solar and Webel-SL Energy have scaled up and have a cell manufacturing capacity of 80 MW, 52 MW and 10 MW respectively, with further plans to augment their respective capacities to 240 MW, 180 MW and 100 MW respectively. In this situation, acquisition of clients is a challenge and may pressure the company’s margins.
The SEZ status which the company enjoys for this project is also not a unique advantage as some of the other semi-conductor makers enjoy it too. Euro Multivision has already faced a delay in the setting up of its project, with the original deadline of January 2009 pushed forward by nearly a year.
Any further delay beyond January 2010 — as the company is waiting for various regulatory approvals and is yet to place orders worth Rs 40 crore (forms 22 per cent of the total project cost) for commissioning of the plant — may affect the payback of the company.
The company is issuing 8.8 crore shares at a price band of Rs 70-75; the issue opens on September 22 and closes on September 24.
Aggressive plans for expanding cement capacities by entering new markets, newly commissioned capacity which is set to contribute to revenues this year and good prospects for the sugar business argue for investing in the stock of Dalmia Cement (Bharat), which trades at 10 times its trailing one-year earnings. About 74 per cent of the company’s revenues are derived from cement, 20 per cent from sugar and the rest from refractories (material used for lining inner surface of furnaces). The company’s cement business is strongly placed in its home market of South India, with a sizeable addition (five million tonnes per annum) to capacity in the last six months. The current installed capacity is nine mtpa, which DCBL plans to enhance by another 18-20 million tonnes over the next 10 years
Demand in the South
The company’s current capacities are all centred in the South — a 4 mtpa unit in Dalmiapuram and a 2.5 mtpa unit in Ariyalur, both in Tamil Nadu; and a 2.5 mtpa unit in Kadapa, Andhra Pradesh.
Of this, both Kadapa and Ariyalur are recently commissioned units which will begin contributing to revenues and earnings only from this fiscal.
The Southern region, which reported sluggish growth in cement demand in May and June, caught up in July with a 10 per cent growth in despatches against the all-India average of 11 per cent. One near-term worry for players in the region is the recent capacity additions — of the total 20 million tonnes of cement capacity added during FY-09, 16 million tonnes were in the South. This has brought down average utilisation rates for cement units in the region to 82 per cent now from the 92 per cent of last year.
In the long term, however, the South looks a promising region with State governments according priority to infrastructure and urban development projects. The metro rail projects, higher spending on road development for rural connectivity and housing for the poor may, for instance, ensure good demand in the home State of Tamil Nadu.
Diversification to help
Dalmia Cement also has ambitious plans to expand its geographic presence outside of the South. It aims at becoming an all-India player with a total capacity of 35 mtpa at the end of ten years. Including the 5.3 mtpa of OCL India, in which the company has a 21.7 per cent stake, the company controls capacity of 14.3 mtpa currrently.
With two units of capacity totalling 6 mtpa at Belgaum and Gulbarga, the company is planning an entry into Karnataka.
Also on the cards are units in Himachal Pradesh (4 mtpa), Meghalaya (2 mtpa), Rajasthan (4 mtpa) and Madhya Pradesh (2 mtpa). In Rajasthan and MP, the company has procured land and preliminary activities are on. Limestone belts have been identified in all these regions.
While this expansion bid will no doubt add scale and diversify revenues, the Northern and Western markets are already intensely competitive with several established brands.
The mode of financing for this massive Rs 7,200-crore expansion is also as yet uncertain, with the company evaluating the options of private-equity funding and a follow-on public offer, both of which will entail equity dilution.
As the company’s current debt-equity ratio stands at 1.8:1, further room to increase borrowings is limited. Net debt outstanding, as of March ’09, was Rs 2,338 crore (higher over the previous year by 48 per cent).
Apart from cement, Dalmia Cement controls sizeable crushing capacities for sugarcane at 22,500 tonnes per day. The company has seen a steady increase in its sugar output and realisations over the past five years, with the company marketing 1,62,000 tonnes of sugar in 2008-09 (75,000 in 2004-05).
Prospects for the sugar business (21 per cent of revenues in 2008-09) are bright over the medium term, given the big domestic shortfall in sugarcane output and tight demand-supply equation.
With sugar prices doubling from their lows, realisations for producers can be expected to expand sharply this year. Already, as a result of buoyant sugar prices in 2008-09, DCBL’s EBIDTA margin (of the sugar division) improved from 9 per cent in FY-08 to 17 per cent in FY-09. With the sugar operations just turning profitable at the net level in 2008-09, one can expect a sharp improvement in sugar contributions to the profitability this fiscal.
While there may be price-driven improvement in profits for sugar, the cement operations may see margin expansion as result of falling coal prices. Substitutes have been used for high-cost inputs used in the raw mill and fuels deployed in the kiln.
DCBL’s operating margins have shrunk significantly (from 41 per cent in FY-07 to 28 per cent in FY-09) in the last two-year period mainly due to the rise in coal and other input costs (fly ash and gypsum).
The company will, however, see some relief in costs as inventory is replenished this quarter. New captive power plants (of 300 MW) which the company intends to put up at Kadapa and Ariyalur will also drive savings in cost.
“I have a full year’s savings with me and equity investments look attractive at this stage. Tell me, what stocks to buy?” I was surprised when my friend shot this question at me. But my friend isn’t the only one eyeing the equity plunge.
With markets beginning to look up again, such enquiries are on the rise. So, how do you decide which stocks to buy, that too in a market that has already run up considerably?
Granted, picking stocks is not as easy as shopping for a pair of jeans. But then, certain basic aspects of making a choice hold good for both. For instance, the value-for-money proposition or the “would-it-fit-me” question still remains the same.
Broadly, there are two ways of selecting a stock — top-down approach and bottom-up approach. The top-down style involves identifying sectors first and then getting down to stock specifics — akin to getting the ‘big picture’ first.
The bottom-up approach, on the other hand, entails a stock-specific approach to investments, giving higher weightage to a thorough analysis of the company, while remaining relatively uninfluenced by macro-economic trends or concerns relating to that sector. Whichever of the two you opt for, note that there are some basic tests that the stock you eye should clear before it becomes a part of your portfolio.
The compounded annual growth rate (CAGR) in sales and profits of a company would give you a picture of the historic performance of that company over a longer time frame.
This becomes more relevant as the CAGR also irons out the lumpiness in the growth numbers of a company during that time.
For instance, while the year-on-year sales or profit growth would tell you how the company has performed in that particular fiscal year, the yearly performance, however, may be prone to seasonality.
So, to that extent, it could be misleading. CAGR, on the other hand, may help give a perspective on the average sustainable growth rates.
For instance, take the case of Hindustan Unilever and Marico. While for the last fiscal year, Marico grew its sales by 25 per cent, HUL reported a sales growth of about 46 per cent.
This growth picture, however, would change considerably if we consider the compounded growth rates over the last five years. While HUL reported a sales growth of 14.11 per cent, Marico expand its sales by 21.87 per cent during the period.
Operating profit margin
Operating profit margin denotes the sales margin left with a company after meeting all its operating expenses. This is different from operating profit.
For example, Hero Honda posted an operating profit of Rs 692.60 crore for the quarter ended June 2009 while Bajaj Auto, for the same period, posted an operating profit of Rs 454.54 crore. While on the face of it, it may seem that Hero Honda made more money from its operations, the story changes if you consider operating margins for comparison. Despite a lower operating profit, Bajaj Auto has a higher OPM (21.12 per cent), while that of Hero Honda stood lower at 18.17 per cent.
Price earnings ratio
Price to earnings multiple of a company indicates the price the stock market is willing to pay for every rupee of earnings generated by a share of the company.
Typically, stocks with high PE ratios indicate that their stock price is at a premium to their earnings, whereas ones with lower multiples are believed to be a discount.
On the whole, the general perception is that stocks with low PE offer better growth potential. For example, between Maruti Suzuki and Mahindra and Mahindra, while Maruti Suzuki trades its trailing four quarters earnings at a PE ratio of 33 times its peer M&M trades lower at about 24 times.
But even as the general idea is to spot stocks that are trading at a discount to their intrinsic value, note that a lower PE doesn’t necessarily mean that the stock has a potential to appreciate. In some cases, the market accords a lower multiple to certain stocks in keeping with the overall business dynamics of those companies. On a similar line, a higher PE also doesn’t necessarily mean premium valuations.
More to go
While these filters will help you line up a list of suitable stock candidates, know that these tools by themselves aren’t enough to spot the right stock.
You may need to employ other filters and take a closer look at the company-specific financials, its balance sheet strength, cash flows and management bandwidth before making an investment.
via Business Line
Markets gained for the second week in a row, backed by positive sentiments on hopes of a speedy global economic recovery, higher advance tax numbers and fund buying. The Sensex ended the week with a gain of 2.93 per cent at 16,741.
The index began the week on a subdued note, but later picked momentum and rallied to a 16-month high of 16,820. The index has gained over 1,000 points in the last two weeks.
Among the index stocks — Jaiprakash Associates soared 12.6 per cent to Rs 257. Maruti, SBI, Hindalco, Tata Steel, ACC, Tata Motors and Mahindra & Mahindra surged 8-12 per cent each.
The Sensex hit resistance at 16,800 and consolidated later. Going forward, its strength above 16,800 could see the index rally up to 18,000. At the same time, one should keep an eye at the 16,480 level for any sign of a trend reversal. On breaching 16,480, the index may slip to 16,170. There could be significant unwinding afterwards.
The NSE Nifty crossed the 5,000-mark in intra-day trades after a long gap of 16 months. The index, however, could not sustain above this mark for long owing to some profit booking. The index finally closed the week with a gain of 3.03 per cent (147 points) at 4,976.
Next week, the Nifty may target 5,110 on the upside, with some resistance around 5,060. On the downside, the index is likely to find support around 4,895 and further down at 4,840.
The upmove for the Nifty from current levels seems limited to around 5,100-5,360 levels. Although, quite a few key technical indicators — Moving Average Convergence/ Divergence (MACD), Relative Strength Index (RSI) and Stochastic Oscillator Slow are in overbought zones, there are no sell signals. Hence, the market may move sideways at higher levels till there comes a clear directional move.
Significant correction in the Nifty, could see the index drop to 4,760 (20-day daily moving average) and 4,525 (50-day daily moving average).