JMC Projects

Investors with a penchant for risk can consider buying the stock of JMC Projects, a diversified construction contractor. At Rs 186, the stock trades at 11 times its trailing 12-month per share earnings, on a par with peers in the construction space. Given its small-cap status, investors are advised to buy the stock in phases based on price dips linked to broad markets.

JMC has expertise in varied segments such as roads, bridges, power, industrial construction and housing and commercial construction. A healthy order-book, tie-ups with bigger companies for better projects, repeat orders from clients, kick-off into build-own-operate projects are other factors that boost the prospects of this company. Increased infrastructure spending by the Government will also benefit order inflows.

JMC undertakes construction contracts in a variety of segments. It constructs plants for industries such as automobiles, textiles, pharmaceuticals, and so on. Real-estate projects constitute commercial, office and residential complexes, hospitals and hotels. Infrastructure contracts take the form of road projects, bridges, bus terminals besides contracts in the power segment.

Order book

It enjoys healthy relationships with its clients, the likes of which include BHEL, Larsen & Toubro, besides government bodies such as Bangalore Development Authority, Maharashtra State Road Development Corporation and so on. It also partners companies such as Sadbhav Engineering, which could help it secure bigger contracts besides enhancing own track record and expertise. Increased outlay on the part of the Government to develop urban infrastructure will help order inflow. The company plans to move into the rather less competitive north-east regions, which may help it secure more orders at perhaps superior profit margins.

Fresh order inflow slowed in 2008-09, with the outstanding order book 15 per cent lower at Rs 1,810 crore as of March 09 against the value in March 2008.

Since then, however, order inflow has picked up, currently valued at about Rs 2,955 crore. At about 60 per cent, industrial and real estate projects take up the majority of the order book.

Power projects account for a further 24 per cent, with the balance taken up by infrastructure projects. The order book is a tad more than twice the revenues clocked in 2008-09, and with an execution period of 24 to 30 months, provide medium-term earnings visibility.

In its bid to increase focus on infrastructure, JMC, in consortium with SREI Infrastructure, has won a road construction contract from NHAI on a build-own-operate basis. With a cost of Rs 1,000 crore and an execution period of 36 months, the project is located in Haryana. However, given its long execution period, revenues flowing from this contract have not been factored.

Financials

JMC more than doubled revenues between 2006-07 and 2008-09. In the period of slowdown in 2008-09, the company still clocked net profit growth of 20 per cent in the year. On the margins front, operating margins for 2008-09 have been maintained at 8 per cent.

But as a result of high depreciation and interest costs, margins slipped to 3 per cent at the net level. Increase in investments in plant and machinery, and higher rates charged on some machinery accounted for the spike in depreciation costs. Such investments would however ensure timely availability of equipment. Interest costs doubled in 2008-09 over the previous year, following an increase in debt.

On the funding side, the company concluded a rights issue in the September 09 quarter, raising about Rs 39 crore which funded working capital. Inventory and working capital turnover also remain quite robust at 14 times and 7 times respectively, boding well for the company's execution abilities.

Having recorded impressive revenue growth in 2008-09, JMC suffered a delayed effect of the slowdown. With order inflow slipping, the half-year period ending September 2009 saw a dip in sales by about 6 per cent. This, coupled with higher interest and depreciation outgo, made a dent of 17 per cent in net profits.

Improvement came about in the December 2009 quarter, which saw a 9 per cent increase in sales and a 43 per cent increase in profits on the backs of sustained reduction in interest costs.

With a higher interest rate cycle in the offing, increase in interest costs is quite likely. The debt-equity ratio is on the high side at 0.8 times. Interest and debt, therefore, remain key concern areas.

However, interest cover is rather comfortable at about four times. As a percentage of sales too, interest costs are at about 2 per cent.

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Jubilant Organosys

Investors with a long-term perspective can consider investing in the stock of Jubilant Organosys, among thelargest custom research and manufacturing services company in the country. Besides improving trends in global pharma outsourcing, Jubilant's presence across the pharmaceutical value chain, likely expansion in capacities and a strong order pipeline underscore our optimism.

At the current market price of Rs 328, the stock trades at a reasonable valuation of about 11 times its likely FY11 per share earnings. This is at a discount to pure play CRAMs players, mainly due to its high debt burden and presence in non-core businesses of agri products and performance polymers.

However, with Jubilant planning to demerge its Agri and Performance Polymer (APP) business into a separate listed company and taking steps to address its debt burden, it may only be a matter of time before valuations catch up.

Business segments

The company's business can be broadly divided under two segments — Pharmaceutical Life Sciences Products and Services (PLSPS) segment, which makes up more than 80 per cent of its revenue pie and the APP segment that accounts for the rest.

With the APP segment now slated to be demerged, it is the PLSPS business that holds the key to future growth. This segment is further divided into CRAMS (50 per cent of revenues), pharmaceutical products (9 per cent), life sciences chemicals (17 per cent), and nutrition ingredients (5 per cent). Jubilant also has nascent presence in healthcare – hospitals.

Multi-pronged growth

CRAMs, which makes up more than half of the company's revenues and has grown at a compounded rate of over 45 per cent in the last five years, is likely to remain Jubilant's main growth driver in future too. Its stronghold in the manufacture of pyridines and its derivatives (used as solvents and intermediaries in many pharmaceutical applications) — makes up more than half of CRAMS revenues — is likely to sustain, led largely by capacity expansion.

The company is planning to increase Pyridine and Picolines capacities by over 20 per cent in the next few months. The management has indicated improving demand and is negotiating for more than three new contracts with large innovator companies. Confirmation of orders could therefore be potential triggers. Besides that, it has signed contracts worth $77 million for this year and has a pipeline of 11 products (three in Phase II and eight in Phase III).

Improving trends in global pharma outsourcing also augur well for Jubilant given its niche in sterile injectables space. It has a strong customer base — services six of the world's top ten pharma companies — and has a capacity of over 180 million vials (including that of Draxis and Hollister).

With capacity utilisation at about 65 per cent, there is scope for the company to take on more orders. The management has indicated at improving prospects in this business too. The company recently signed four new contracts for the division in the December 2009 quarter; these orders are expected to drive the segment's revenue growth this fiscal. Overall, the division has an order pipeline worth $102 million (almost equal to the segment's FY09 revenues).

Jubilant also has plans to invest in its manufacturing facility of APIs. It expects the new capacities to be operational by the second quarter of current fiscal. It is also planning to commission a high-potency API facility (for oncology) by January 2011. While procuring orders will hold the key, the hipo facility is likely to enjoy higher margins. That said, considering Jubilant's healthy regulatory track record — it has so far filed 37 DMFs in USA, 19 in Canada and 17 in Europe — procuring orders may not be very challenging. Besides, its focus on therapeutic segments — CVS, CNS, Gastro-intestinal, and anti-infectives — and global leadership in Carbamazepine, Oxcarba-mazepine, and Lamotrigines also lend confidence. It plans to file 8-10 DMFs every year.

Its presence in Drug Discovery & Development Services business holds the potential to emerge as an independent growth engine. Operating with three subsidiaries — Chemsys, Biosys, and Clinsys — the division operates as a full service research organisation. The division has signed contracts worth $43 million for FY11 so far.

Potential triggers

These apart, Jubilant has a string of potential revenue drivers lined up. For one, the likely launch of Sestamibi (pharmaceutical agent used in nuclear medicine imaging).

The US FDA had approved the product a year ago, but owing to shortage of nuclear isotopes, its sales did not take off as expected. The management, however, expects better availability of nuclear isotopes from this quarter onwards. Jubilant has a distribution tie-up with GE Heathcare in the US and Guerbet for Europe.

As of December 31, 2009 the company had a net debt of Rs 2,866 crore on its books (consolidated). This amounts to interest coverage of about 4.8 times. In an effort to address its high leverage, Jubilant recently raised $85 million (about Rs 380 crore) through QIPs at Rs 344.5 per share.

While this would result in an equity dilution of about 8 per cent, it may not affect profits as much given the interest cost savings it is expected to make (a portion of debt enjoys a high average rate of 9.7 per cent). The management expects its improving cash flows to help meet its debt obligations. Note that the company had exercised the option of AS 11 and to that extent, restatement of foreign currency borrowings including FCCBs were taken to its balance sheet.

Demerger of APP business

The demerger of its APP business, which is expected to be completed by the third quarter of this fiscal, would also help reduce the volatility in earnings. While there will be a one-time impact on the revenues, it wouldn't be much as performance polymers and fertilisers business contributes to just about 10 per cent and 4 per cent of Jubilant's total sales and net profits.

Besides, shares of the new company would be issued to the existing shareholders of Jubilant Organosys; the de-merged entity will have a mirror-shareholding pattern to that of Jubilant. The bulk of the debt (about 96 per cent) however will remain with Jubilant Organosys.

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HEG

Investments can be considered in the stock of graphite electrode producer HEG. With a clear sign of bounce back in steel production, besides expansion plans in the sector, increased demand from the steel industry for graphite electrodes can only follow.

Among the two graphite electrode players in India, HEG's superior profit margins and timely expansion plans are likely to ensure that it is a key beneficiary of the demand revival.

At the current market price of Rs 354, the stock trades at seven times its estimated per share earnings for the financial year 2012. Any significant fund raising through issue of equity can weigh on the stock in the near term until the expanded capacities come on stream by mid-2012. Investors with a two-year perspective can consider limited exposure to the stock.

Demand driver

Graphite electrodes are consumed while producing steel through the electric arc furnace route (EAF). According to industry data, steel produced through the EAF route accounts for 31 per cent of the total production globally.

Steel produced through this route has been growing globally, especially in North and South America and West Asia, as a result of higher availability of steel scrap (key input in EAF process), higher productivity and flexible product mix.

Demand for steel, availability and price of key raw material needle coke, managing cost efficiencies and price contracts with customers are the key factors that determine the fortunes of the seven or eight graphite players globally. Among these factors, India players score on the manpower and power cost front.

Steel production

HEG's improving prospects are visible from its capacity utilisation over the three quarters ending December 2009. From a 57 per cent utilisation level in the June quarter, the company operated at a 75 per cent rate by December. It can be expected to reach its pre-downturn operating levels of over 80-90 per cent as steel producers bring their idled capacities back on stream.

Besides, the World Steel Association has forecast an 11 per cent increase in steel production in 2010 (world crude steel production was 1.22 billion tonnes in 2009).

HEG plans to increase its capacity from the current 66,000 million tonnes (mt) to 80,000 mt to cater to anticipated demand. While HEG had put on hold these plans last year, the current surge in activity in steel has revived the expansion.

Secure supplies

Needle coke, a key and scarce raw material used to produce graphite electrode, plays a significant role in determining profit margins for graphite players.

HEG has stated that it has booked its needle coke requirement for the current year at prices similar to the financial year 2010. The prices of needle coke rose by 35-40 per cent last year and are currently at $1,650-$1,800 a tonne.

The freezing of supply and price of the raw material is expected to provide stability to margins.

Besides, given an anticipated supply-demand mismatch on the back of graphite production not keeping up with increase in steel produced, the company is likely to ensure that the electrode realisations make up for input cost hikes.

Realisation of electrodes increased by 11 per cent year-on-year for the quarter ended December, reinforce the above.

HEG scores over its Indian peer Graphite India on account of managing its power needs captively with 77MW of generation capability.

The company has also managed to sell its surplus power at Rs 2.95 a unit in the December quarter. This has led to the company enjoying operating profit margins of 32 per cent compared with its peer which on an average operates at 20-25 per cent.

Superior profitability has ensured better return on equity of about 32 per cent (FY-09) compared with about 22 per cent for Graphite India.

Sales for the nine-months ending the financial year 2010 stood at Rs 811 crore and net profits at Rs 131 crore. Exports accounted for 75 per cent of revenues.

Earnings for the last three years grew annually at 40 per cent. HEG's superior operating metrics has traditionally helped it command a premium over Graphite India.

Risks

The graphite electrode industry is fraught with risk due to volatility in demand (as a result of cyclicality of user industry- steel) and raw material cost and energy costs.

While Indian players have done well on the cost front, limited pricing power with steel majors such as Arcelor Mittal and POSCO and the availability of needle coke supplies, remains a sector risk.

It is for this reason that the Indian players in the graphite sector trade at a discount to global peers.

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Hindustan Zinc

Thanks to stimuli rolled out by the Government in 2008-09, industrial output statistics are improving every month. This augurs well for the steel and, in turn, zinc manufacturers. The growth in vehicles sales witnessed last year has helped the automobile battery-makers regain volumes, translating into increased demand for lead, a critical raw material for batteries.

Hindustan Zinc is a key beneficiary of the strong demand for zinc and lead. At Rs 1,216 and trailing 12 months earnings by 15 times, investors can consider buying this stock.

Business operations

Hindustan Zinc is a part of the Sterlite Group. After the recent capacity expansion, the company has zinc smelting capacity of 9,64,000 tonnes per annum (tpa) and lead smelting capacity of 85,000 tpa.

Hindustan Zinc is the second-largest integrated zinc and lead producer in the world and is the only integrated zinc manufacturer in India.

Due it its large scale of operations, Hindustan Zinc is also among the low-cost zinc and lead producers. While domestic sales contribute 65 per cent of the company's revenues, exports, mainly to China, account for the rest.

Zinc and lead

Zinc and lead contribute over 95 per cent of the company's revenues. Zinc is anti-corrosive and hence finds application in construction activities, infrastructure facilities, household appliances, automobiles, steel furniture, and so on.

Galvanisation (a metallurgical process where zinc is coated on steel or iron to prevent corrosion) accounts for 50 per cent of its usage. Over 80 per cent of India's demand for zinc is met by Hindustan Zinc.

Lead is the primary ingredient for automobile and industrial batteries. Over 88 per cent of the demand for lead comes from the batteries industry.

Since most battery-makers have their lead-extraction facilities, Hindustan Zinc's share in the domestic market is about 18 per cent. In addition to its principal products, the company also recovers silver, cadmium and sulphuric acid as by-products.

Demand outlook

Global steel consumption for 2010 is expected to increase by 12 per cent. In line with this, the International Lead and Zinc Study Group (ILZSG) also forecasts 12 per cent increase in zinc demand.

While global steel production between April 09 and February 10 was up by 24 per cent, domestic production is yet to catch up, mainly due to capacity constraints. Steel production in India during this period was up by 8.5 per cent. The demand forecast for lead is equally positive, and ILZSG has predicted an 8 per cent demand growth in 2010.

With a revival in infrastructure, construction and automobile sales, demand for both the metals may remain strong. Though Hindustan Zinc did not take much of production cuts during the commodity meltdown, many global zinc and lead miners suspended their operations during this period.

Therefore, unlike in the case of aluminium, which faced the problem of stock overhangs for a long time, zinc and lead saw a relatively quicker correction in their warehouse stocks in the London Metal Exchange (LME).

Decline in warehouse stocks at LME, coupled with the positive demand outlook, have helped the LME prices of zinc and lead move up by 35 per cent and 13 per cent respectively since October 2009.

Financially strong

Like most commodity players, Hindustan Zinc also saw its sales and net profits shrink by 28 and 38 per cent respectively during the downturn period of FY-09. However, the company's financials have seen quick rebound.

In the nine months between April 09 and December 2009, it posted a sales growth of 25 per cent while its profits expanded by 29 per cent.

Though these growth numbers are on relatively depressed earnings, given that the period between October 08 and March 09 was one of the worst phases for commodity players, demand for zinc and lead have started picking up since November 2009. Hindustan Zinc registered a 24 per cent quarter-on-quarter sales growth, and its profits went up by 23 per cent in this period.

It is also one of the few base metals players that maintains a high operating profit margin of 67 per cent and a net profit margin of 50 per cent.

The company has taken on quite a few exploration projects and has sufficient internal funding. Hindustan Zinc, a cash-rich company with a debt burden of just about Rs 8.69 crore as on March 31 2009.

As on December 31, 2009, the company was left with a cash balance of Rs 10,700 crore and this translates into Rs 253 per share.

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Rolta India

Investors with a two-year horizon can buy the shares of Rolta India, a software solutions provider, considering its strong order book position, favourable geographic mix and a strong focus on areas such as Defence where spends are increasing.

At Rs 183, the stock trades at 10 times its likely FY11 per share earnings. Given its differentiated focus, there are no strict peers, but valuations are at a discount to most mid-tier IT companies of similar size.

In the nine months of FY10, the company has seen revenues grow by 7.7 per cent to Rs 1,120.6 crore, while operating profits improved 14.9 per cent to Rs 440.8 crore.

Rolta provides geospatial information to the armed forces, the DRDO, the Survey of India, the Airports Authority of India and a host of other governmental nodal agencies. This segment contributes to half its revenues, while engineering services (25 per cent) and enterprise IT solutions (about 25 per cent) are its other divisions.

The company derives 55 per cent of its revenues from Indian clients, with a strong concentration towards government customers, where spends are being enhanced. With a 45 per cent overseas currency exposure, across the dollar, euro and the pound, the impact of rupee appreciation on revenues has largely been muted (2.5-3 per cent).

Its client base is resilient in India. With Defence spends increased by four per cent in the 2010-11 Union Budget to Rs 1,47,344 crore, companies such as Rolta with existing relationships can look to a increased share of the pie.

The nuclear reactor segment, another key area where the company recently won a deal, is also set to improve contribution as India signs deals with various members of the nuclear suppliers group.

The company has an order book of Rs 1,770 crore (more than its expected current year revenues) executable over the next four-five quarters. The order book comprises healthy contribution from all three of its segments of operations, with geospatial services and engineering services accounting for nearly 79 per cent. This gives a fair degree of revenue visibility for the company across divisions.

Also, the billing rates have stabilised across all three segments and in cases, even marginally increased. IP services, which ensure strong margin-led growth, account for 8-9 per cent of Rolta's revenues currently. The company expects this proportion to go up to 20-25 per cent over the next three years.

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ULIPs - the way forward

The dispute between regulators over unit linked insurance plans (ULIPs) marketed by insurance companies has left many investors confused. Here's an FAQ to address some of the doubts that investors may have:

What is the status of my existing ULIP after the SEBI ban? Should I continue to pay my renewal premium? Will it be accepted?

With both the regulators agreeing to jointly seek a binding legal mandate from a Court in this matter, there is as of now no change in the status of your ULIP.

If you have taken the ULIP to meet any of your financial goals, you should not stop paying the annual premium. The insurance companies will continue to accept the renewal premium.

SEBI's clarification this week also exempts ULIPs existing as on April 9, 2010, from the earlier ban.

Should I surrender my ULIP as there seems to be some regulatory problem?

The current issue is not about ULIPs, but about who will regulate them. Hence, you need not surrender the policy, especially if it is less than five years old.

ULIPs typically collect high surrender charges in the first five years. The surrender charges could be as high as 25 per cent if you have paid premium only for two years.

Apart from that, due to high initial upfront charges you may not even get what you have invested.

So don't make a hasty decision.

Will my money be safe if there is change in the regulator?

You need not worry about that. The issue of safety will arise only if the insurance company is going bankrupt.

In ULIPs, the money collected is mainly invested in equity and debt instruments based on the mandate of the policy. Your investments do carry market risk and can suffer if the portfolio of the fund does not perform. But as long as the equity and debt markets are functioning smoothly, a change in the regulator will not impact you.

I have paid premium for three years. Will I continue to get risk cover on my life if I stop paying premium?

Policyholders will be covered for life risk as long as your fund value is above the regular premium payable. If your fund value falls below this threshold due to adverse market conditions, then your policy will be closed and the proceeds will be paid to you, after deduction of surrender and other charges.

I have paid premium for two years. Is it possible for me to surrender the policy?

If you stop regular premium payments before three years have passed, your funds will be held in suspense, after deduction of surrender charges. The amount in the policy will be paid out to you only at the end of the third year.

Is it possible for me to convert my ULIP to a pure term insurance products?

It is not possible to convert your ULIP into another product. If you have decided to close the ULIP, with that proceeds you can buy a new term insurance policy.

Is investing in a ULIP a bad investment decision? If I pay premium for three years for a 10-year term, will it affect the overall return?

ULIPs are not a bad product per se. Insurance is a long-term product and the cost structures are designed in such a way that only investors who with the fund for 8-10 years will reap the benefits of the investment. Early exit is penalised through high charges.

If you bought a ULIP believing it to be a three-year product, then it will fail to reward you for the risk of blocking your money.

In a ULIP, more of your money goes to build your fund value only from the third year onwards. Therefore, only someone who keeps investing for 8-10 years may get an equity market return.

The major problem with an ULIP is that if the product underperforms the market for the initial years and if you try to exit, investors suffer a double whammy – low returns and high charges.

Should I invest in a ULIP today, given all this controversy?

First and foremost, it is to be understood that insurance are long- term product intended for, say, 10-15 years. We do not know how the current dispute on regulations will end. But it may alter the structure, costs and other features of products. Some changes may also be beneficial for investors.

Under the uncertain situation, it may be better to postpone the investment in new ULIPs and wait for clarity.

Tomorrow if the life insurance agent's commission is reduced, like mutual funds, and if he stops collecting the premium cheque and stops advising me, how should I handle the situation?

If that does happen, based on the service you require and the service rendered by the agent, you can negotiate and fix an advisory fee for him. You should also note that payments and reminders about renewal premium have become easier to deal with as several options are available.

To pay premia, you can opt for electronic clearance mode, credit card payment option, online payment or use the cheque-drop facility.

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