Sunday, January 03, 2010
Investors in the stock of India Cements can consider booking profits at this point and entering the stock at a later date. Oversupply worries in the Southern region and the resultant pressure on prices in this region may curtail the stock's performance relative to the market.
Close to 16 million tonnes of additional cement capacity came up in South India in FY09, most of which has commenced complete commercial operations. A further 7 million tonnes have been added this fiscal which may gradually find its way into the markets.
This has imposed pressure on cement prices in the region, with prices correcting by around Rs 15-20 per bag from year ago levels to Rs 250 now. Andhra Pradesh, where most new capacities are concentrated, has seen higher pressure in recent months with prices cited at Rs 170/bag. Volume growth, though showing signs of improvement, may not be sufficient to completely offset the weakness in prices.
At Rs 123, the stock is trading at 8 times its trailing one year earnings. Other players in the South are trading at a valuation of six-seven times.
Pressure on prices
In 2008, when cement prices were flat in the entire northern region, the southern pocket saw an over Rs 20/bag increase to Rs 270/bag levels. This was at a significant premium to the rest of the country (all India average price being Rs 247/bag). New players moved into the region and existing players augmented their capacities based on the more remunerative prices and tight supply conditions.
As the new manufacturing facilities have slowly ramped up their output, it has imposed pressure on prices in this region, whittling down the regional premium. In the September month, prices dropped by more than Rs 20/bag and are since then hovering at Rs 250/bag levels. The surplus is also evident from the fact that capacity utilisation rates of cement units in the South had fallen from 80 per cent in the last year to around 65 per cent by November 2009. Prices are expected to be a little subdued in the south for some time to come.
In both the June and September quarters, India Cements reported a lower volume growth (4 per cent vs 4.6 per cent and 1.6 per cent vs 3.6 per cent) than the previous year. Demand offtake has been slower in Andhra Pradesh though growth in Tamil Nadu has been steady. This picked up to 30 per cent in the recent months of October and November, but is helped partly by the low base of last year (despatches fell by 8 per cent in the same months last year).
Given this backdrop, India Cements' sales were supported more by realisations than volumes in the past two quarters.
In the half-year ended September'09 the company reported an 8 per cent growth in sales when despatches were only 3 per cent higher. The outlook for the ongoing quarter is uncertain in the light of the disruption in offtake in Andhra Pradesh, where half of the company's capacity is located. Lower demand from this region may also aggravate surpluses in this region.
India Cements has made attempts to acquire a wider regional presence through new projects. With the commissioning of the 1.2-million-tonne grinding unit in Malkapur, AP, and the 1-million-tonne grinding unit in Parli, Maharashtra, the company's current capacity stands close to 14 million tonnes. While the company has deferred plans on a cement unit in Himachal Pradesh, a 1.5-million tonne plant in Rajasthan is in progress and is up for completion by June.
The unit at Rajasthan may give the company access to the markets in the West. However, this too may not remain a very lucrative market for long. Excess supplies from the South have already started moving to the West, curtailing the scope for higher prices in that region.
The September-ended half-year saw India Cement's net profit (before exceptional items) decline by 12.4 per cent to Rs 406.18 crore even as players such as Shree Cement (PAT doubled) and UltraTech (PAT up 56 per cent) reported a robust growth in profits. Higher depreciation, power and interest charges were a drag on the profit.
The company's depreciation costs have spiked by 16 per cent on new additions to capacity. Interest cost increased by close to 60 per cent to Rs 75.88 crore in this period. The company had recently raised Rs 140 crore through issue of commercial paper at 7.15 per cent.
Power shortage mainly in the state of AP resulted in the company buying power from alternate sources at higher costs. The power and fuel cost were higher by 15 per cent; savings on the fuel front on decline in coal prices didn't help much. India Cements is setting up power plants, one each in Tamil Nadu and Andhra Pradesh, at a cost of Rs 500 crore. It is also in the final stages of acquiring a coal mine in Indonesia.
Investors with a long-term perspective can buy the stock of small-cap textile player Bombay Rayon Fashions (BRFL), manufacturer of fabric and apparel. At Rs 189, the stock trades at 10.6 times its trailing 12-month per share earnings. Though not strictly comparable, this valuation is at a discount to other export and apparel textile players such as Gokaldas Exports and S Kumars.
In a year marked by sliding textile exports, BRFL has doubled its exports, added clients and increased business per client, boding well for its growth prospects. Healthy growth in revenues, an integrated manufacturing process leading to stronger margins and significant manufacturing capacities are other positives for this company. With consumer demand now on an upswing, domestic markets too hold good prospects.
BRFL makes fabric primarily for the domestic market, while garments are channelled almost entirely into exports. Higher-margin garments have contributed 64 per cent to sales in 2008-09, up from 43 per cent the year earlier. With design offices in India, New York, London, Amsterdam and Italy, among others, BRFL is able to provide a wider range of services. Besides creating its own designs according to seasons and trends, it works with clients to manufacture fabric and garments to suit their requirements.
Export revenues have more than doubled in FY-09, contributing 63 per cent to the year's revenues. This is a huge jump from the 40 per cent contribution in earlier years. The increase in exports amid the global slump, was the result of the trend of retailers turning to increased sourcing from low-cost suppliers. BRFL's clients are large-scale manufacturers and retailers such as Inditex, Carrefour, Walmart and so on.
As global players went in for cost controls, BRFL had scalability in terms of production capacity to meet a step-up in client requirement. The company has thus increased business per client and added new clients. Hitherto concentrated in the UK and the EU, BRFL is expanding geographical footprint, exploring tie-ups in Japan and China. It also has clients in West Asia.
The manufacturing process is integrated, from yarn dyeing to fabric processing to making garments. Such integration gives it the flexibility to alter production according to demand and helps cost control. Operating margins have held above 20 per cent for the past three years; margins in the first half of FY-10 are at 25 per cent.
The company had undertaken massive capacity expansions — fabric capacity is at 120 million meters per annum against 50 million in 2007. Garment manufacturing capacity increased from 19.2 million pieces per annum in 2007 to 73.8 million pieces currently. Its Maharashtra plant is expected to begin production from the next quarter.
Interest and debt
Sales, over the past three years, grew at a compounded annual rate of 88.7 per cent, while net profits doubled in the same period. Profit growth has been helped by reductions on the raw material front and manufacturing costs. For the first half of FY-10, sales have grown 28 per cent, though profit growth was at 9 per cent.
Interest costs, increasing almost five times between FY-07 and FY-09, have been the key cause for slower profit growth. Net margins dropped to 11 per cent in FY-09 from 13 per cent a year earlier. Similarly, net profit margins in the first two quarters of FY-10 have been lower than the margins in the same period in FY-09.
Debt has been taken on to fund capacity expansions. This debt comes under the Government's Technology Upgradation Fund Scheme that comes with an interest rate of 5 per cent and a long repayment period of 10 years. The company has further plumped up its funds base through equity — Rs 436 crore was raised through a GDR issue last quarter, Rs 322 crore came in earlier via an equity stake sale, another Rs 193 crore is in the pipeline post warrant conversions. With funds required now completely tied up, interest outgo is set to dwindle over the next few quarters.
Points of concern
In mid-2008, BRFL acquired high-end Italian brand; outlets span Portugal, Netherlands and Italy. It closed on a loss for FY-09, and BRFL hopes to break even this year. The first Indian store has also been opened in Mumbai, with no concrete roll-out plans on the cards. Higher-end retail is yet to return to it's hey days in the European markets. The retail venture is not likely to contribute significantly to revenues or profits in the near-term.
BRFL is also facing difficulties in sourcing yarn and grey fabric, which could lead to delays in production. On the forex front, the company has an average contract term of three months, mitigating risks of a steady decline in exchange rate, butexposes the company to short-term exchange rate fluctuations.
Shareholders can consider paring their exposure to the stock of Orchid Chemicals & Pharmaceuticals, which recently sold its antibiotic injectables business to the US-based Hospira Inc for $400 million (about Rs 1,870 crore).
Even though the deal valuations are attractive and would more than address Orchid's debt problems , it threatens to render the company's overall growth prospects unappealing. The generic injectables business enjoyed high-growth and high-margins and was the company's growth driver.
With the growth engine wedged out from its portfolio, Orchid's business would now primarily straddle across its low-margin API and oral dosage formulation businesses only. This is likely to reduce both revenues and margins, even as the company would enjoy significant savings on its interest outgo and depreciation charges.
At the current market price of Rs 184, the stock trades at about 14 times its likely FY-11 per share earnings. While this is at a discount to most peers, much of the premium that the company had earlier commanded was due to its presence in the niche antibiotic injectables area. With that gone, discounted valuations may be here to stay.
Parting with growth engine
As per the deal agreement, Orchid will transfer seven products (including two products in pipeline) in cephalosporins vertical and two products (including one in pipeline) in the penicillins vertical. It will also transfer its carbapenem line with key products such as meropenem and imipenem (with an estimated $1 billion market opportunity per product). In addition to the drugs, Orchid will transfer the manufacturing facilities of cephalosporin, penicillin, carbapenem and a R&D facility too. What's more, the sale also includes Orchid's key business of Tazo-Pip, for which it had acquired six-month exclusivity in September this year. Fortunately for it, the end of exclusivity for Tazo-Pip coincides with the transfer of business to Hospira.
This means by March 2010, when the businesses would effectively be transferred to Hospira, Orchid may have extracted peak sales from the Tazo-Pip opportunity.
On the whole, however, the company appears to have parted with its growth engine, for had it held on, it would have benefitted significantly from the opening up of business opportunities in carbapenem, where a handful of products were expected to go off-patent in the next couple of years.
Given the limited competition in these niche businesses and Orchid's low-risk and low-cost strategy of launching drugs with overseas partners, the divestment is certain to slice away a chunk of its future revenues.
The silver lining, however, comes from the 10-year agreement that Orchid has struck with Hospira.
As per the agreement, Orchid will supply active pharmaceutical ingredients (APIs) or bulk drugs required for producing the injectables. Not only will this help Orchid utilise its manufacturing capacities, export APIs that these would be, it may also help the company realise better margins. In addition to this, though it still may be early days, export API deals could also open up significant custom manufacturing opportunities for Orchid in the long run.
Deal money to help retire debt
On the valuations front, however, the company appears to have made the best of the deal. The antibiotic injectable business, which was expected to make up over $90 million in revenues this year, has been valued roughly at over four times, at $400 million.
For a company that was grappling with a debt of over Rs 2500 crore, including foreign currency convertible bonds worth $150 million redeemable in 2012, the deal money would provide the much-needed breath of fresh air, needed to sustain operations. The company had provided about Rs 109 crore as interest cost in the first half of the current year (about 18 per cent of its revenues) and Rs 76 crore as depreciation.
The influx of the deal money would help the company retire a chunk of its debt and improve cash positions. Orchid plans to retire its entire long-term debt of Rs 1200 crore and part of working-capital loan of Rs 550 crore. By doing this, the management expects to save around $40 million in interest cost alone.
And since the sale also involves transfer of assets (estimated fall in gross block of fixed assets at about Rs 600 crore and net block Rs 450 crore), it will help bring down depreciation charges too. Orchid expects the saving in interest cost and depreciation to help improve it's per share earnings by about Rs 7-8 next year.
Even though Orchid is likely to enjoy significant savings on the cost front, these near-term benefits are unlikely to supersede the lack of visibility on its revenue front. Post-deal, the management expects the company's revenues to be lower by $90 million and it's EBITDA to fall by over $30-40 million in FY11.
Operating margin too, as a result, is also likely to come under pressure as the share of the high-margin formulation business expected to go down from the likely 65 per cent level in FY10 to about 45 per cent in FY11. The management, however, is hopeful of improving the share of formulations to 50 per cent by FY-12. It expects the non-antibiotics segment to give it the next growth impetus, having filed 21 ANDAs with the USFDA.
Of those, seven are Para IV FTF (first-to-file) products, including the two FTFs that were recently settled with the US-based Schering-Plough. While the prospects do appear promising in the long run, given the inherent uncertainty and risks associated with FTF opportunities and drug application approvals, investors may be better off taking fresh exposure to the stock when such opportunities present themselves rather than remaining invested and wait them out
The year 2009 started off on a subdued note for equity investors but by year-end both the BSE Sensex and Nifty were trading 80 per cent higher. With the markets trading at a price-earning multiple of well over 21 times from 11 times at the start of year, the upside in the indices may be limited from here on. So equity investing in 2010 may require greater stock selection skills. Why not select actively managed diversified funds for your portfolio?
In emerging markets such as India there are several diversified funds that have managed to deliver better-than-index returns. However, these funds, even if they deliver better returns, may also, at times, take on higher risk.
While comparing the top performing equity schemes whose returns are identical, investors can look at additional factors such as beta and expense ratio to gauge the risk return profile. Investors planning to take exposure to equity funds should, of course, pick funds with a proven track record over an entire market cycle.
Here there are three funds from the large and mid-cap space that investors can consider for long-term wealth creation.
HDFC Top 200: This fund is among the few to consistently remain on the buy list due to its steady returns across market cycles. Its performance over the year has validated our recommendation.
HDFC Top 200, which invests in the top 200 companies by market capitalisation, despite its ever growing asset size (Rs 5,781 crore) continued to maintain its tempo and beat its benchmark BSE 200 by a wide margin.
For instance, over a three- and five-year period, the fund outpaced its benchmark by 10 percentage points. Even during the market meltdown in 2008 the fund contained the losses better.
In 2008 when most of the funds preferred to move in to cash to protect their portfolios, the fund had the grit to stay invested. This helped in a neat recovery from the market lows; the fund went on to generate returns of 96 per cent over a one-year period and was one among the top ten performers over this time frame. In its November portfolio, the fund's preferred sectors were banks, pharma and consumer non-durables. Despite its huge asset base the fund adopts a buy and hold strategy. To prop up its return, the fund invests 10-15 per cent of the assets in mid-cap stocks (with market capitalisation less than Rs 7,500 crore).
DSP BlackRock Equity: DSPBR Equity and DSPBR Top 100 more or less has similar investment strategy in selecting sectors. But the former invests sizable assets in mid- and small-cap stocks while the latter sticks to its mandate of investing in large caps. The advantage of DSPBR Equity is that the fund prefers to stay invested in equities irrespective of the market condition and despite the presence of the mid and small-cap stocks (this segment being more prone to volatility). This demonstrates the fund's conviction in its investment strategy. Even during 2008, with reasonable exposure to mid and small-cap stocks and lesser cash position it withstood the market correction and contained losses. Clearly, stock-picking strategy has held the key. Though the fund is benchmarked against Nifty, one-third of the assets are invested outside the Nifty basket.
For the risk it has assumed the fund compensated its investors and concurrently outpaced its benchmark by over 10 percentage points over three and five-year periods. Good stock selection strategy and a lower beta than its peer DSPBR Top 100 were key reasons for DSPBR Equity being a better choice for your portfolio. In its November portfolio the fund's top sectors were software, consumer non-durables and pharma.
Birla Sunlife Midcap: A consistent performer across the market cycles, this fund outpaced its benchmark over a three and five-year period by a good margin and can lend support to one's portfolio returns. It is therefore worthy of a place in your core portfolio.
Having said this, some large cap funds with lower risks generated returns as good as the top performing mid-cap funds over the past five years. Midcap funds such as Birla Midcap generated very good returns during the bull phase of the market compared with lesser “beta” stocks, implying that they have the ability to identify the winner ahead of market rallies.
The fund also dilutes its holding risky sectors once there are signs of over-heating and moves to defensive sectors to protect its portfolio.
The fund's one-year performance emphasises that it has timed its sector calls well during this ongoing rally. However, given the extraordinary gains that this fund generates during bull phases, investors would do well to occasionally book profits to cash in on such rallies. In its November portfolio the top three sectors were banks, power and finance which together accounted for less than 30 per cent of the assets. The fund has a well diversified sector allocation and its assets are spread across 22 sectors.
The year 2009 ended on a high note, with benchmark (BSE & NSE) indices registering best yearly gains in the last two decades and touching fresh 19-month peaks. The year, however, will be most remembered for the Sensex and the Nifty hitting the upper circuit for the first time.
In the week under review, the markets surprisingly moved in an extremely narrow band despite the two holidays and the derivatives expiry. The BSE benchmark index, the Sensex, moved in a narrow range of 200-odd points. The index touched a high of 17,531 and settled with a gain of 104 points at 17,465.
Among index stocks, Reliance Infrastructure surged over 4 per cent. NTPC, Grasim, Bharti Airtel, SBI, Hindalco and Jaiprakash Associates were the other major gainers. Sun Pharma dropped 3.6 per cent. DLF, Wipro and ITC were some of the other prominent losers.
Lack of momentum on the upside suggests the up move may halt temporarily. The Sensex needs to sustain above 17,550 for further gains, while on the downside, the index may seek support at 17,385-17,335, below which the bears are likely to have the upper hand.
The longer-term picture, since we are at the start of the New Year, looks quite promising. Chances are that we may re-test the 21,000-mark this calendar year, while there are multiple strong supports for the index on the downside. The bias will remain bullish as long as the index remains above 13,840 this year. There is a further deeper support around 11,590 in case of extreme bearishness. On the positive front, the Sensex is first likely to target 19,550, followed by 21,090, in 2010.
The Nifty moved in a range of 62 points and ended with a gain of 23 points at 5,201. Last week, I had mentioned that the Nifty needed to sustain above 5,210 for fresh bullishness. As we see, the index was unable to close above 5,210 on any single day. Currently, the chart suggests that the Nifty needs to close above 5,237 for fresh bullishness. The Nifty may face resistance around 5,225-5,240 and find support around 5,177-5,163. A dip below 5,163 could see the index fall to 5,100 and then further lower to 5,010.
Unlike the Sensex, the yearly Nifty chart reveals that it will be difficult for the index to attain its 2008 peak (6,357) this year. In fact, the index has strong resistance around 6,225. The first significant target for the index is 5,790. On the downside, the index is likely to find considerable support around 4,600 and further lower at 4,175.