Everest Kanto: Book profits

Investors with a medium-term perspective can consider booking profits on at least a part of their holdings in the stock of Everest Kanto Cylinders (EKC), a leading player in the manufacture of seamless steel gas cylinders. At current market price, the stock trades about 24 times its likely FY08 earnings per share. While we remain optimistic on the growth prospects given the company's market presence and increasing capacities, the positives already appear to be factored into the current stock price. Besides, given EKC's recent announcement of a Rs 240-crore expenditure for further expansion (likely to be funded through equity-linked instruments), equity dilution also remains a risk to immediate earnings.

Given the robust demand scenario for CNG cylinders, EKC is set to benefit from the increase in capacities through both greenfield and brownfield expansion. Contribution from exports is also slated to increase given EKC's presence in Dubai and China. While the Dubai plant is expected to commence production from the current quarter itself, the China plant is likely to start production from the third quarter of FY08 only. However, since the full impact of the expansion is likely to be derived from FY09 only, earnings expansion in the current fiscal year may not be at levels impounded by the stock's valuation.

For the financial year 2007, EKC registered an 80 per cent growth in net sales and 114 per cent increase in earnings on a consolidated basis. While margins improved on the back of higher realisations and utilisation, the latest quarter saw a decline in margins in the Indian operations due to a change in the sales mix. Any domestic acquisition for capacity expansion, rise in oil prices or a change in regulations by the Union Government expediting the roll-out of CNG-run vehicles are likely to remain the primary risks to our recommendation.

Punj Lloyd: Buy

Punj Lloyd's inspiring financial performance for FY07, a strong order book buoyed by newly acquired subsidiaries and renewed focus on its core areas of oil and gas infrastructure solutions, are indicative of strong prospects for earnings growth. We recommend investors to buy the stock with a 2-3 year perspective to derive the full benefits of earnings arising from the present group order backlog of about Rs 16,000 crore. At the current market price, the stock trades at 13 times its expected consolidated earnings for FY09. Punj Lloyd's present order backlog is skewed towards oil and gas and petrochemicals (through subsidiary Sembawang). Civil and infrastructure works, as a source of orders, now receives less prominence. This changing revenue mix is likely to help the company's operating profit margins as the former yields relatively better margins.

The company's entry into the offshore platform segment (awarded by ONGC), which was earlier considered an exclusive domain of Larsen & Toubro, provides qualification to bid for lucrative marine oil and gas projects. This project has been bagged in alliance with its offshore engineering arm, which was part of the Sembawang acquisition.

The company has also won an order for construction of a wheat-based bio-ethanol plant in the UK, through its other subsidiary Simon Carves. If the European Union's mandate of at least a 10 per cent ethanol blending for transport fuels receives good response from its members, then this segment would translate into good business potential for Punj Lloyd. On the oil and gas side, spending by upstream and downstream oil companies is likely to remain robust, considering that firm trends in oil prices may continue. Punj Lloyd would be among the biggest beneficiaries of this trend in India, given that the area forms the nucleus of its operations.

Punj Lloyd's sales and net profits saw a three-fold expansion on a consolidated basis for FY07. Operating profit margins (OPMs), which remained healthy on a standalone basis, declined to about 9 per cent for the group. The company has stated that new orders booked by the ailing subsidiaries are likely to generate OPM of about 7.5 per cent. On the flip side, Punj Lloyd's increased focus on overseas projects can lead to currency fluctuation risks. Further, any increase in raw material costs can mute margins. However, price escalation clauses in road projects, supply of pipes by clients in some projects and planned procurement in anticipation of requirement may mitigate input cost increases. Increased working capital requirements for the huge order backlog may lead to higher interest costs

Crompton Greaves: Integrating rapidly

With the acquisition of the Ireland-based Microsol Holding, through its subsidiary, Crompton Greaves (CG) has made further strides in its objective to expand globally in the power systems and solutions business. This leaves the company with three foreign acquisitions between 2005-07. While the first two companies, Pauwell and Ganz, helped CG move to higher-end transformers, the current acquisition may well aid the company move up the value chain in the power business. Microsol Group provides high-end automation services for new sub-stations and retrofitting services With this, CG has primary transformer solutions under one roof to compete with global majors such as ABB and Siemens in their respective product spaces.

The trend in Crompton Greaves' acquisitions is quite evident. Similar to the earlier two acquisitions, Microsol has also had operating losses in FY-2006 (reported to have made profits in FY 2007), badly in need of cash infusion but with strong expertise in its area of operations. CG has demonstrated its ability to turnaround the operations of Pauwel, its acquisition in 2005, wherein profits before interest and tax more than tripled and return on capital employed grew from 4 per cent to 20 per cent within a year. CG also expects the operating profit margins of the other acquisition — Ganz to move from negative territory to 8 per cent by the end of CY-07. Crompton Greaves had a healthy Rs 250-crore cash flows from operations in FY-06 and managed its earlier acquisitions through internal accruals. While it is not clear as to how it will fund the recent one at the enterprise value of euro 10.5 million (Rs 55 crore), there is not much concern on this front, given the company's low debt-equity ratio.

CG's acquisitions would equip the company with a competitive product portfolio, superior technology and ready manufacturing units that are likely to provide the company a smooth foray into the markets of Europe and North America. This would also enable de-risk the company from any slowdown in the Indian business.

NIIT Technologies: Strong wicket

For NIIT Technologies, FY-07 has been a good year with revenues growing by 46 per cent and profits almost doubling since last year. The operating profit margin has risen steadily to 20 per cent this year from 15 per cent in 2003- 04. Concentration on select verticals, inorganic growth, a turnaround in the BPO Solutions segment and increased utilisation rates have all contributed to the good financial performance.

The successful integration of Room Solutions, a UK-based insurance solutions provider, acquired in May 2006 has strengthened the BFSI vertical. Contribution to revenues from this segment has grown to 42 per cent from 33 per cent. The acquisition has also been EPS accretive. The company's geographically-diversified revenue model has seen Europe bringing in 50 per cent of the revenues in FY-07; this augurs well in an environment where a rising rupee-dollar exchange rate is seen as a risk to IT earnings. The company has also had a strong order intake of $72 million in Q4. The joint venture with Addeco SA, a Fortune 500 company to deliver application software development and maintenance solutions to its clients, will be operational by July 1, 2007. Increased offshoring arising from this JV and improved billing rates are expected to improve margins in the coming year.

Idea Cellular: Hold

Listed in March at Rs 85, the Idea Cellular stock has since appreciated 47 per cent, and now trades at around Rs 125. The sharp appreciation in the stock's price since listing has significantly narrowed the valuation gap between Idea Cellular and the telecom market leader, Bharti Airtel.

The stock now trades at an enterprise value to EBIDTA multiple that is quite close to that of Bharti, despite a less broad-based business profile. Investors can retain the stock, given the continuing strong subscriber additions and Idea's growing footprint.

However, given the relatively high valuations, the stock may offer opportunities for fresh entry at lower price levels.

Operations

Idea Cellular, which started out in 1997, is a pure-play GSM cellular services provider. It has over the last decade ramped up revenues both through organic growth as well as circle-level acquisitions of companies such as Escotel, RPG Cellular and the Andhra Pradesh operations of Tata Cellular.

These moves have helped Idea Cellular ramp up its geographic presence and acquire a national footprint, with operations now in 11 circles (geographic zones) and a subscriber base of 14.5 million. Idea appears well set in its eight established circles, where it is adding over 4.5 lakh subscribers a month and is the biggest or the No 2 player (based on total GSM subscribers).

In the 11 circles it operates in, eight are profitable, while in three where it started operations recently — Himachal Pradesh, Rajasthan and Uttar Pradesh (East) — the company has reported operating losses.

Operating profits in the eight established circles were at Rs 1,595 crore in the latest financial year, while losses in the three new circles were at Rs 85.7 crore. Idea has also been able to tap the Universal Service Obligation (USO) Fund and has won 27 clusters in the auction process.

This is likely to expand Idea's footprint and also result in savings on operational expenses such as rentals and cell-site maintenance.

Idea Cellular has managed its subscriber base well through such innovative schemes such as two-minute outgoing free, reduced tariff rates for loyal pre-paid subscribers, life-time recharge and so on.

The company has also been among the early movers in offering value added services (VAS) such as ringtone downloads, caller ring-back tone, services catering to more youthful audience .

As for the infrastructure, Idea was the first in India to launch GPRS and EDGE technology-ready mobile networks. These moves have resulted in a rising contribution of VAS to Idea's revenues.

The contribution stood at 9.2 per cent for Idea compared to 10.1 per cent for Bharti Airtel. Idea may be better placed to take advantage of any opportunity arising from third generation mobile services (3G) spectrum policy, which is expected in the next few months.

Taking a cue from Bharti Airtel, Idea has also taken the managed outsourcing route. It recently signed a $700-million agreement with IBM for all its IT infrastructure requirements and inked a $500-million deal with Nokia and Siemens for supply of network equipment.

As a rapidly growing mobile services provider, this move can help Idea reduce overheads and bring greater focus to its core functions. As these deals are recent, and benefits will begin to flow in from the current financial year.

Financials

On the operational metrics, Idea Cellular fares better than the national average for GSM telecom players on metrics such as ARPU (average revenue per user) and churn rate, and compares reasonably with Bharti Airtel on most.

Both Idea and Bharti have similar pre-paid subscriber percentages. Idea's churn rate (customers lost) is lower than the national average of 7 per cent.

Idea has a higher ARPU, of Rs.332, than the national average of about Rs 300, though this pales in comparison with Bharti's Rs 406.

Idea, however, realises more per minute usage revenue at Rs 0.91 compared to Bharti's Rs 0.85.

This is a reflection of Idea's current operations in relatively higher ARPU circles. Going forward, the ARPU is likely to continue to soften across players, but the impact on margins is expected to be made up by a better service mix (with higher VAS and initiatives such as 3G).

Idea's EBITDA (earnings before interest, tax, depreciation and amortisation) margin is relatively high at 34.2 per cent, though this may come down in the near term, in the event of pricing pressure, major network expansion and related operational expenditure.

While margins are on a par with industry average in the established eight circles, it is clear that the three new circles have been a drag on profitability.

But the healthy subscriber additions over the last quarter suggest scope for higher revenues and improved EBITDA in the new circles. This could result in an improvement in the overall profitability for Idea the next fiscal.

Apart from this, the foray into Mumbai could offer Idea the potential for an improvement in margins.

Mumbai is a high ARPU circle and is expected to generate higher revenues and lead to quicker recovery of the capex cost. Idea has indicated a Rs 647-crore spend on initial network building, from its IPO proceeds, for the Mumbai circle.

With increased ARPU in Metro and A category circles, and strong subscriber additions and consolidation elsewhere, Idea could emerge as a leading player in the mobile telephony space.

Possible risks

Though the company boasts of strong growth prospects, investors in the stock have to factor certain risks.

Given that the company is still in the process of ramping up its regional presence, execution risks to its operations are higher than those for Bharti.

Recent cuts in Access Deficit Charge (ADC) on outgoing international calls and roaming charges may also pressure realisations for Idea, if it reduces tariffs. While Bharti and Reliance immediately announced tariff cuts, Idea is yet to do so.

There is speculation on a possible acquisition of Spice Telecom by Idea. Spice has operations in Haryana and Karnataka and has about 2.8 million subscribers.

Though the outcome would depend on the pricing, such a deal can further expand Idea's geographic presence and subscriber base.

Another event that can prove a trigger to the stock price is the possible takeover of Idea Cellular by global telecom majors keen to strengthen their India presence. However, this remains in the realms of speculation.

Sanghvi Movers: Buy

Investors with a one to two-year perspective can consider taking an exposure in Sanghvi Movers, one of the largest crane-hiring companies in India. At current market price, the stock trades at about 12 times its likely FY08 earnings per share.

With a market share of more than 50 per cent in the crane-hiring market in India, Sanghvi Movers is likely to be a leading beneficiary of the robust demand environment for such services.

This apart, an expansion in capacities and market presence also point to strong earnings growth. Sanghvi derives a significant portion of its revenues from windmill manufacturers, mainly Suzlon Energy. A robust order-book for Suzlon and the increase in sops and tax rebates for wind power generation could translate into strong order flow for Sanghvi. Though the company's recent earnings performance has been unimpressive, this is unlikely to be the trend over the next few quarters. For the quarter ended December 2006, revenues dipped by about 12 per cent in comparison to the corresponding quarter last year and profits declined by about 31 per cent.

The blip in sales can be explained by a base effect caused by the shutdown of Reliance's Jamnagar refinery in the third quarter of last year.

This generated additional sales for Sanghvi. Apart from lower revenues, earnings were impacted by a change in depreciation method and higher interest costs. Though these charges could continue to expand costs, we expect this to be offset by strong volume growth.

In an effort to increase it market presence, Sanghvi has lined up a capex of Rs 330 crore for FY08. Margins are also likely to get a boost from the proposed merger of its group company, Sanghvi Projects with itself. This apart, the recent acquisition of land in Mumbai-Pune highway could also contribute to savings on transportation cost for equipment.

The risks to business arise from the capital-intensive nature of this business; Sanghvi's ability to manage the overall utilization of its cranes is crucial. This apart, high dependence on the wind power segments for earnings, is also a risk as any slowdown in this segment could pressure performance.

Britannia Industries: Book profits

Influenced by factors such as excise duty exemptions and an improving earnings outlook, the Britannia Industries stock saw a 17 per cent appreciation in price over the past month. Investors can use the recent price appreciation to book profits on part of their holdings.

Though the earnings over the next two years are likely to improve on the back of recent excise duty exemptions, price hikes and new launches, the current valuations for the stock seem to capture improved earnings prospects.

At 21-22 times its expected earnings for FY08, Britannia Industries trades at a significant premium to its historical valuations.

What is more, this valuation places Britannia on a par with FMCG companies such as Marico Industries and Hindustan Lever though the company has a lower margin profile and a narrower product portfolio.

Persistent pressures on raw material costs and competition also continue to pose risks to the earnings growth.

Lower margin profile

Britannia Industries is the leading player with roughly a 30 per cent share of the domestic biscuits market. Dairy and bakery products account for a small proportion of its overall revenues. The narrow product portfolio makes Britannia's profit margins more sensitive to fluctuations in raw material costs and competitive pressures, than is the case with many of its FMCG peers.

Over the past year, Britannia's profit margins have been under pressure from rising raw material costs (due to spiralling wheat and milk prices) accompanied by considerable competitive pressures (from ITC through its Sunfeast range and several local brands).

In the 12 months ended December 2006, Britannia's net profits fell 25 per cent, even as sales growth accelerated by a strong 21 per cent. Operating profit margins dropped to 6.7 per cent from 13.2 per cent, as rising material costs were unmatched by price increases on products.

Improving outlook

The earnings picture is likely to improve on the back of company initiatives as well as some external factors. Britannia's recent move to rationalise pack sizes and raise prices on select brands should improve unit realisations in the coming quarters. The recent amendment to the Budget proposals to exempt certain categories of biscuits from excise (biscuits costing Rs 100 a kg, instead of the earlier Rs 50, will now be exempt from excise duty) will also deliver a one-time boost to margins over the next year.

After sluggish new launch activity over the preceding years, Britannia also stepped up new launches in recent months — rolling out products, Treat Fruit Rollz and NutriChoice Sugarout. Efforts are also on to broadbase the product portfolio through the acquisition of a 50 per cent stake in Daily Bread, a specialty bread manufacturer.

Acquisition of a bakery business in West Asia may help the company broadbase its geographical footprint.

Input Price Pressures

Though these factors point to strong revenue growth for Britannia Industries and a recovery in earnings over the next fiscal, certain risks to the earnings picture remain.

For one, though Britannia has already taken a few price increases on its products to offset input cost pressures, input prices are likely to continue on their uptrend.

Firm trends in prices of wheat and milk, key inputs for Britannia, appear likely to persist over the next few quarters. The significant domestic supply deficit for wheat in the face of growing demand and possible legal hurdles to imports, suggest that wheat prices will remain firm.

Milk process similarly are likely to remain upward bound on global influences as well as domestic shortages. Second, competitive pressures from ITC and other local brands in the core biscuits business are unlikely to abate to any significant extent.

Despite VAT issues pressuring ITC's core cigarette business, thanks to its diversified profile, the company's cash coffers may remain healthy enough to fund its investments in its FMCG businesses.

Keeping these factors in mind, current valuations for the Britannia Industries stock already appear to capture much of the likely improvement in earnings. Institutional buying related to the stock's inclusion in the MSCI index also drove some of the recent appreciation in the company's stock price. With these influences waning, the stock price could cool off in the near term. Investors could wait for future opportunities to re-enter the stock, if there is a significant decline in valuations.

Hindustan Construction: Sell

Hindustan Construction's revenue and profit numbers continued to disappoint on the back of start-up and execution delays and mounting losses from the Bandra-Worli project.

The company's balance-sheet also faces the pressure of fresh capital for the various projects in its core business and real-estate ventures. HCC's strong order backlog therefore does not provide much visibility in the near term.

Investors can consider switching to other infrastructure stocks to prevent any opportunity loss given the bright prospects for the sector. Hindustan Construction's performance over the next couple of years may provide direction for fresh investments

At the current market price, the stock trades at about 32 times its expected earnings for FY-08 on a diluted basis. This valuation is at a premium to a number of peers and also appears to have captured earnings the potential of its real-estate ventures. But we believe this to be a bit premature, given the long-term nature of real-estate projects, and HCC's ventures being at a preliminary stage. We would be comfortable valuing the real-estate projects once the realisations trickle in.

Huge orders, less comfort

While Hindustan Construction's order backlog of Rs 9,300 crore provides optimism, the execution has not been smooth to provide the much-needed visibility to earnings growth. Apart from natural hazards, such as heavy rain and snowfall that have delayed projects, the company has been facing delays due to non-completion of land acquisition by clients.

This apart, the above order backlog includes Rs 1940-crore worth of HCC's share of the Sawalkote hydel project, which is subject to the decision of High Court. The company has also decided to remove Rs 151 crore of the Icha Dam project, as there is no development on that front though the order award stands. Our concern on the delays stems from the fact that apart from delaying revenue flows, such projects may become unviable or less profitable by the time the execution begins.

Power projects account for 48 per cent of the current order backlog. While this is a positive (as the segment provides relatively lucrative margins), hydel power projects typically have a long gestation period and require fresh capital investments.

Profitability

The company continued to book losses from the Bandra-Worli Sea Link project and expects to book another Rs 110 crore of losses. The losses arose, as the Maharashtra State Road Development Corporation did not accept some price variations apart from new additions to the project work not bargained for initially.

While there is some optimism in receiving claim for the latter issue, the rest is subject to arbitration. Any positive ruling in HCC's favour may well see improvement in margins. For now, the losses are expected to be booked up to 2008 and would continue to drag the margins over the next few quarters.

There was a steep rise in HCC's staff and interest costs. The interest coverage ratio for FY-07, though comfortable at 2.9 times the profits, has nevertheless declined from over four in FY-06. We do not expect the interest cost to ease as the debt component can only go up, with the company tying up with banks for partly funding the real-estate projects.

A positive feature is that the company has managed to maintain its OPM in the 9 per cent range as raw material and construction costs remained under control. As power projects now form a larger chunk of the order book, the OPM may improve once these projects start yielding returns.

On the removal of Section 80 IA benefits, the company had to effect only accounting treatment and did not have any cash outflows as it had either paid taxes and made claims or created provisions for the same. Hence, the net profits have not been affected as much as other peers on account of this issue.

Real-estate Investments

The company has so far invested Rs 550 crore in the Lavasa Project and would require additional investments of Rs 300 crore over the next couple of years. While the company plans to launch the first phase in the market in October 2007, the 12,500-acre project is a long-drawn one and may see revenue flows in a phased manner.

Investors need to watch the development in this project before factoring any income from the company's real-estate venture. Further, that the company has shelved plans for a township in Navi Mumbai and decided to convert its Vikhroli (a Mumbai suburb) project into a corporate park instead of an IT Park planned earlier appears to reflect lack of clear strategy and foresight for these projects.

While real-estate is a natural extension for an infrastructure player and a number of companies have ventured into this space, our caution stems from the following: HCC's project portfolio have traditionally been long-term in nature. Its foray into real-estate has been made with the over 10-year-old Lavasa project. A long-term pay-back period, possible dilution in earnings as a result of huge capital necessitated by the nature of projects and execution risks do not augur well for this otherwise established company's earnings visibility in the medium term.

If the pace of execution of the company's core and real-estate business improves and arbitration issues get sorted quickly, the medium-term picture may turn positive. This possibility remains the principal risk to our recommendation.

Alfa Laval: Reject

Shareholders in Alfa Laval India need not tender to the open offer by its Swedish parent, Alfa Laval AB. Given the Indian arm's bright prospects on the back of a robust demand environment and increased exports to group companies, there appears to be a significant scope for earnings growth over the long term.

Following a lukewarm response to the previous offer price of Rs 875, the parent company recently revised the offer price to Rs 1,300. This price discounts Alfa Laval India's likely FY-08 earnings per share by about 24 times. There may be some scope for appreciation from this price in the light of the growth expectations. Furthermore, as the parent company is only looking at upping its stake to about 89.99 per cent, with no immediate intention of delisting from the bourses, shareholders could stand to gain by remaining invested.

Investment Rationale

Alfa Laval India is likely to see healthy growth given the robust demand environment across its user industries such as marine and shipbuilding, power, pharma, general engineering and automotive components. While at home the resurgence of interest in breweries, vegetable oil and ethanol businesses could spell good times for the company, export revenues could get a leg-up on increased sourcing by group companies. The company is also likely to benefit from the parent's shift in focus towards establishing a presence in emerging markets such as India.

Notwithstanding the muted revenue growth for the fiscal ended December 2006, the outlook for the current year appears positive. A 28 per cent rise in opening order backlog of about Rs 314 crore over the corresponding period last year, coupled with a proposed capex of Rs 30-35 crore towards increasing capacities and expanding the product range lend more confidence to the company's growth prospects.

For the calendar year ended December 2006, while the segment profits of the equipment division witnessed a 39 per cent growth, the process technology division, on the contrary, witnessed a 20 per cent drop in earnings. This de-growth in this segment can be attributed to project overruns and product recalls. As it was a one-time occurrence, the contribution from the process technology division can be expected to rise.

This is a conditional offer, with a minimum acceptance ratio of about 72 per cent. In this context, it needs to be noted that as a significant chunk of the company's shareholding (about 19 per cent) rests with foreign and institutional clients, their response to the offer could be crucial. Though the business prospects for the company appear sound, investors who hold on to the stock should factor the liquidity risk into their calculations if they opt not to tender to the offer.

Offer details

The offer is to acquire 4,702,500 equity shares at Rs 1300 per share representing 25.89 per cent of the paid-up equity capital of Alfa Laval India. The offer, that opened on May 7, will close on May 26. HSBC Securities and Capital Markets (India) Private Limited is the manager to the offer.

Trader's Corner

The first tenet of technical analysis is that price patterns repeat themselves. The reason why stock price movements display recurring patterns is because stock markets worldwide are driven by men.

The basic needs and emotions of men have not changed from primitive times. There is no way we can do without food or sleep. Similarly, human emotions like love, greed, exuberance, depression, contentment, etc., will stay no matter how rapidly technology changes. Human behaviour, exposed to certain set of circumstances can be fairly constant and predictable.

Many of the tools of technical analysis are based on this psychological basis. The twin tools of supports and resistances are one such example. Supports are nothing but troughs (reaction lows) from where a downward movement can reverse. The sellers turn tentative at these levels and the buyers have the chance to wrest the advantage here. The reverse is true with resistance, which are previous peaks. The buyers get edgy at these levels and sellers gain more power.

How do these support and resistance levels work? Well, these are important points of reversal in the past. Every time the price nears these levels, the memories of investors go clickety-clack. They say to themselves, "hey, the price turned from here once so it can very well do so again". That is how these levels prove to be so effective. The human element!

The supports and resistances discussed above pertain to the highest price on a day when a major peak is formed or the lowest price on a day when a significant trough is formed. Other ways in which supports and resistances are derived are with the aid of trend lines, trend channels, Fibonacci retracement levels, moving average lines etc.

If a stock has reversed from a certain price more than once in the past such supports and resistances gain greater credibility. Once a support level has been effectively breached, it turns in to a resistance level for future upward movements. Similarly resistance levels, once crossed emphatically turn in to supports for future downward movements.

Sadbhav Engineering: Buy

Investors looking to diversify their exposure in the infrastructure sector can consider the Sadbhav Engineering stock. The company's ability to diversify its portfolio and forge ties through the joint venture route were key uncertainties when we recommended the IPO (initial public offering) a year ago. The company has made significant progress in both these respects. It has also managed robust financials and renewed bidding strength as a result of a ramp-up in net worth after the IPO. At the current market price, Sadbhav trades at 12 times its expected earnings for FY-08. Investments can be considered with a two-year perspective. Any weakness in the broad market can be used to buy the stock.

Diversification

While Sadbhav continues to remain focussed on road projects, it has managed to increase its order book in mining operations. A 10-year mining operations contract from Gujarat Heavy Chemicals (GHCL) has taken the company's orders-in-hand from mining operations to Rs 265 crore or 11 per cent of the order book. This will see the company deriving an increased contribution from the sector. In FY-06 and FY-07 the segment accounted for barely 2-3 per cent of the total revenue. Further, the payment for mining contracts with GHCL are based on the total excavation work made and not just on the mineral extracted.

The company plans to concentrate only on similar projects. This segment holds potential on the back of plans of Gujarat Mineral Development Corporation (GMDC) to set up new projects to aid power generation. While we do not expect the mining operations to be the key growth driver, this segment can help maintain operating margins, as returns are relatively lucrative compared with the road segment.

Forging ties

Sadbhav ramped up its net worth from Rs 60 crore in FY-05 to about Rs 125 crore, post-IPO. While this has strengthened its qualification to bid for projects, BOT (build-operate-transfer) schemes, which are typically large in size, often require a higher net worth that can be achieved through tie-ups with bigger players. Sadbhav has managed to forge ties with players such as Patel Infrastructure and Gammon India. Such joint ventures lend optimism to the company's prospects in bidding for big projects.

Comfortable order book

Sadbhav's order book as on March 2007 stood at Rs 2393 crore. This is close to five times the FY-07 turnover. The company has stated that about 80 per cent of the orders on hand are likely to be completed in 30 months. This lends considerable visibility to the earnings growth provided the company is able to complete the projects on time. Roads account for 72 per cent of the current works on hand. A majority of these are BOT based with a mix of annuity- and toll-based models. While the latter is considered slightly risky, the company has two of the three toll-based projects with a grant component, which lends more viability to the model.

Sadbhav's turnover grew 68 per cent in FY-07 and net profits more than doubled. The Operating Profit Margin, which is in the 11-12 per cent range, is superior to a number of industry peers. If the company focuses on BOT projects in the road space instead of pure contracts, the OPM is likely to stay at this level.

Any jump in the price of raw materials such as steel and cement is a major risk. The company depends on a few clients for orders in irrigation and mining sector though there is enough scope to broad-base operations in the irrigation space. Any miscalculation in the toll potential in its toll-based projects would leave limited returns on the table from such projects.

Short Takes

Retail margins pressured?

Expansion costs and competitive pressures are beginning to weigh on the financial performance of leading retailers such as Pantaloon Retail, and Shoppers' Stop. In the quarter ended March, both companies reported a strong revenue growth, but profit expansion was subdued. While Pantaloon reported an 89 per cent growth in revenues, net profits rose by 15 per cent. Margins of Shoppers' Stop also dipped by 80 basis points with the departmental store recording a loss in the fourth quarter. Depreciation costs jumped after the company revalued the useful life of its assets. While some of the margin pressure can be explained by aggressive new store openings during the quarter, burgeoning staff costs and increasing interest burden also appear to be straining profit growth. If the trend continues, the stocks' valuations might get tempered.

One-time drag on earnings

Tech Mahindra reported a net loss in the fourth quarter of FY-07 attributable to an exceptional charge. It has, however, recorded a strong growth in revenues and operating profits. In December, Tech Mahindra had signed a $1-billion, five-year outsourcing deal with British Telecom, which encompassed IT services and business process management. Since deals of this size require upfront savings to be shared with the client, Tech Mahindra has made an upfront payment towards `contract concession' amounting to Rs 525 crore ($118 million) to BT. Tech Mahindra claimed that after consultations with its auditors, it has decided to fully expense this amount in its books during the quarter, instead of amortising it over a specified period. Though a sharp escalation in SG &A (selling, general and administrative) expenses impacted the operating profit margin, the company is likely to be less vulnerable to rupee-dollar appreciation, given its focus on the European geography. Revenue from the BT contract are expected to materialise from the second half of FY-08.

Tiles to realty

Nitco Tiles witnessed a 51 per cent revenue growth and a 90 per cent increase in net profits in FY-07. While the company continues to enjoy robust volumes in its ceramic and vitrified tiles business, investors need to track certain developments, which may have significant earnings implications. Nitco recently entered into a joint venture with a Chinese company for sourcing vitrified tiles over the next three years. With increased demand for vitrified tiles (a low-cost substitute for natural granite), higher Chinese sourcing could boost revenues. With exemption from anti-dumping duties on such imports, Nitco may have an edge in the pricing of such products compared to local players. While the core business remains robust, we are cautious about the company's plans to enter real-estate through its 100 per cent subsidiary, Nitco Realties. The company has plans for six projects mostly in Mumbai and Thana, including an IT park at its mosaic tile factory premises. While success in this foray may improve consolidated earnings over the long term, we prefer to now value the company for its tiles business alone. The company lacks experience in the real-estate business and may have to compete with bigger players to establish itself.

Mudra Lifestyle: Buy

An investment can be considered in the stock of Mudra Lifestyle. This recently listed textile company continues to trade well below its offer price of Rs 90. The stock, on Friday, reacted sharply to the strong earnings reported by the company; Mudra reported a 57-per-cent increase in revenues and a 90-per-cent growth in profits for FY07.

With significant capacities likely to come on stream in the first half of FY08, revenue and earnings growth is likely to be robust for the current year as well. At the current market price, the stock trades at less than 10 times its likely FY08 per-share earnings, assuming its expansion plans are commissioned as per schedule.

Textile stocks have been under pressure as a competitive export market, scaling-up challenges, and an appreciating rupee continue to weigh on performance. In this context, we favour companies such as Mudra Lifestyle that have a domestic market focus. The stock could serve as an indirect play on the domestic consumption theme.

Mudra has been a supplier of finished fabrics to garment manufacturers. It recently forayed into garments with the aim of supplying to local branded garment outfits. It appears to have garnered some orders from leading garment manufacturers, judging by the early traction in the garments business.

Mudra, with the help of offer proceeds, is tripling its garment capacities to more than 10 million pieces a year. It is simultaneously ramping up its weaving and processing capacities as well. Its garments division is likely to be operational in June. The long-term prospects for this business model appear bright.

Local branded players such as Madura Garments (Aditya Birla Nuvo) and Raymond are focusing on expanding their retail presence and are likely to look to outsourcing production to players such as Mudra. The bigger story is the demand from retailers such as Reliance and Bharti Wal-Mart as they look to stock stores with private labels.

It might take a year or two for the company to ramp up utilisations, with the new entrants yet to foray into garment retailing. Competition from exporters looking to diversify into the domestic market is also a risk. Any cooling off in prices following the sharp movement on Friday could be used as an entry point. Buy with a two-year perspective.

Colgate-Palmolive: Hold

In an exaggerated reaction to good earnings numbers and a one-time dividend announcement, the Colgate-Palmolive India stock rose by 12 per cent in a single day (May 4).

Shareholders can retain the stock, given the relatively sound long-term prospects arising from traction in the company's growth numbers and its improving product mix.

However, after the recent sharp move the stock trades at about 32 times its trailing earnings, at a valuation premium to the rest of the FMCG space. The stock price could cool in the short term.

Healthy numbers

After an inconsistent performance in the preceding quarters, Colgate Palmolive India reported strong profit growth of 37 per cent in the March quarter of 2006-07.

The profit growth appears to be driven by an improving product mix, lower tax incidence on account of newly-commissioned facilities at Baddi, HP, and a slower growth in adspend. Sales growth also improved sequentially, from 12.8 per cent in the preceding quarter to 13.3 per cent in the latest quarter. Domestic sales of oral-care products such as toothpaste and tooth brush picked up pace recently on the back of increasing offtake from the rural and semi-urban areas. Colgate, as the dominant player in the mass-market segment (HLL does not have a presence), has been a key beneficiary of this trend.

The company's efforts at broad-basing its portfolio also appear to be bearing fruit, with the company garnering significant market shares in liquid soap and body wash segments.

The improving growth trajectory has helped Colgate close FY-07 with a healthy 15 per cent growth in sales and a 17 per cent growth in net profit.

One-time dividend

Along with its earnings numbers for the March quarter, the company unveiled a proposal to declare a one-time "deemed dividend" of Rs 9 per share.

This move, intended to return excess capital to shareholders, has been structured as a capital-reduction proposal that will reduce the face value of each Colgate share.

This is likely to take time to implement, as it requires shareholder and court approvals.

Investors need to note that though it will eventually result in an inflow of about Rs 9 per share, this move has no direct wealth implications for them:

The capital reduction proposal will have no impact on the company's per share earnings , as the number of outstanding shares will remain unchanged. Though the proposal will reduce the face value of each share, the absolute stock price will not fall after the dividend payout.

Investors need to note that this move to return capital is different from a stock split. In a stock-split proposal, the number of outstanding shares available for trading in the stock market expands while the face value of each share shrinks.

In this case, only the face value shrinks from Rs.10 to Re 1, with Rs 9 per share being returned to shareholders. The per-share earnings and the number of outstanding shares remain the same.

The move will, therefore, not improve liquidity in the stock or reduce the absolute stock price.

However, the proposal may have an indirect impact on valuations, as it will improve Colgate's returns metrics — its Return on Equity, Return on Net Worth and Return on Capital Employed numbers.

This is because Colgate will be liquidating Rs 122 crore worth of low-return yielding investments (now part of its net worth) and carried by its treasury operations, to fund the deemed dividend.

Though investors who buy the stock now will be entitled to dividends of Rs 18.5 per share over the next year (Rs 9.5 annual dividend plus Rs 9 special dividend), the sustainable dividend per share amounts to only Rs 9.5 (this amounts to a sustained dividend yield of less than 3 per cent on current stock price).

Praj Industries: Hold

Long-term investors can retain their exposure to the stock of Praj Industries, a leading solutions provider for ethanol plants, worldwide. The enhanced interest in bio-fuels the world over, thanks to a firm price outlook for crude oil over the medium term, and the mandatory ethanol blending in petrol in countries such as the US offer a robust demand scenario for Praj Industries.

Back home, Praj is also likely to benefit from the Government's proposal to enhance the ethanol-blended petrol programme to 10 per cent from the current 5 per cent. However, despite such a healthy growth environment, the valuation appears stiff.

At the current market price, the stock trades at about 31 times its FY-08 expected per share earnings on a fully diluted basis. Short-term investors can consider booking partial profits and re-entering the stock at lower levels. Medium/long-term investors, however, can hold on to the stock.

Scaling up globalLY

Revenue contribution from the export market is likely to scale up, given the increasing business opportunities in Europe and the UK, the US and Brazil. World ethanol production, as per industry estimates, is expected to surpass 90 billion litres by 2010. Globally, over 300-400 ethanol plants are likely to be installed over the next three-four years.

Given that Praj figures among the top five global companies involved in supplying equipment for distillery projects over the past two years, its ability to benefit from such a healthy demand scenario appears promising. It is also likely to capitalise on any opportunity that could arise from the ramp-up in corn ethanol capacities in the US.

The acquisition of the US-based CJ Schneider, an equipment provider, is also likely to expand the client base of American operations. However, it could well be two-three years before the investment in this acquisition starts to pay back.

In the European market, the EU member-states' proposal to reduce carbon emission by 8 per cent by 2012 also offers a substantial growth potential. Envisaging the upcoming demand, Praj has entered into a joint venture with the Netherlands-based Aker Kvaerner. Praj could leverage Aker's execution capabilities and the extensive European market knowledge, while using its own technology to cater to the European market.

Encouraged by the ethanol production scenario in Brazil (estimated to double production by 2010), Praj is scouting for acquisitions to set up an operational base in the country. This, when it happens, is likely to help Praj tap the huge ethanol production market in Brazil. Praj's ability to break into new markets also lends more visibility to its earnings. However, it could face stiff competition from established players in the respective markets.

Domestic ethanol scenario

Keeping in mind the current sugar glut, the Government's decision to blend ethanol with petrol is a welcome move. With sugar prices in a downturn, sugar companies could rely to a greater extent on by-products such as ethanol for revenues and profits; capex in this segment is, therefore, likely to continue. The introduction of ethanol blending is likely to prompt sugar mills to invest additionally in improving technology and infrastructure and in setting up appropriate processes. This would be a positive for Praj.

Additionally, any policy move allowing sugar companies to directly process sugarcane juice into ethanol, would improve the economics of ethanol production and generate additional orders for Praj.

However, given that the sugar industry is subject to various policy controls ranging from the Sugarcane Control Order to the Essential Commodities Act, the ethanol-blending programme is likely to remain heavily reliant on government policies. Furthermore, licensing and procedural requirements, levy of a plethora of taxes and restriction of inter-State movement of industrial alcohol also remain challenges for the smooth implementation of this programme.

The R&D wing of Praj, dedicated to ethanol technology, offers it a competitive advantage over other players. Its foray into biofuels technology could also offer a sizeable potential growth, given that most countries are major diesel consumers and nearly 60 per cent of the incremental growth in world transport fuel is diesel-based.

Additionally, the strategic setting up the Kandla SEZ, for the manufacture of large equipment is also encouraging.

Financials

For the quarter ended March 2007, Praj reported a 111 per cent increase in revenue on year-on-year basis, whereas the overall FY-07 revenues grew by about 127 per cent.

Operating profit margin stabilised on a year-on-year basis with a marginal 40 basis points jump to 13.7 per cent. However, the operating margins witnessed a decline of 10 per cent on a sequential basis, on account of a differing product mix.

This can be attributed to the realisation of a higher proportion of equipment technology revenues (during the third quarter), which yield better profitability for the company. The overall FY-07 earnings expanded more than doubled, aided by a higher volume growth and lower tax incidence.

Concerns

Since the European and American markets are likely to drive Praj's growth, any slowdown in the capacity expansion plans in these countries could affect the earnings for Praj.

This apart, any steep decline in crude oil prices could temper the interest in ethanol, which is mainly owed to its favourable cost economics. This could, in turn, discourage companies from setting up newer capacities for ethanol.

Global technology advances in biofuels could undermine Praj's competitive edge, if it does not keep up; this remains a key risk.

On the domestic front, any adverse changes in the government policy relating to export, import or pricing of sugar could have a negative impact on the company's earnings.

Trader's Corner

It would not be news to those associated with the stock markets that stock prices are sensitive to news. Memories of May 2004 when Sensex plummeted more than 15 per cent on a single day as the tidings of the BJP debacle in the Lok Sabha elections hit the markets would be indelible in the minds of most of us.

It is not always that news has this dire an impact on the stock prices. But research in this area shows that stock prices do react to news and the volatility in stock prices does increase in periods of high news flow and volatility subsides when news flow is lesser.

Trading on news is one of the forms of trading that is followed by the agile and active traders. There are two ways to do it. The first is to ferret out any potential news that can cause a major move in the stock price. We are not talking about listening at keyholes or any other under hand activity. All it would involve is simple research that would put you ahead of the rest of the pack.

The idea is to exploit the time lag that exists between the news being disseminated to the majority. One example is to keep track of international commodity prices such as sugar, copper, steel etc. These prices percolate down to the domestic commodity markets and then the relevant stocks start moving up.

The other way to trade on news is to take position as soon as the news breaks out in the media with the hope of having the first-mover advantage. As a greater number of people come to know about the development, the stock price would move higher/lower and the subsequent move should be utilised to exit the position. Needless to say this style of trading is fraught with risks.

Exaggerated moves made by markets in response to news often get corrected in the next trading session as was witnessed after the World Trade Centre bombing. The US market and the rest of the global markets bid adieu to a long-term bear phase the day after the event occurred. It would be prudent to wait for a period of consolidation after the news-driven breakout in which to enter in to a position.

Zensar Technologies: Hold

Investors can retain their exposure in the Zensar Technologies (Zensar) stock. At the current market price, the stock trades at a price-earnings multiple of 13 times its consolidated 2006-07 per share earnings.

It may be advisable for investors to consider an entry into the stock only on weakness linked to the broad market. We have a `buy' call outstanding on the stock at Rs 213 made in end- September 2006.

The company's strengths stem from its broad-based portfolio of service offerings, robust client additions, scope for acquisition-led growth and reasonable growth potential from these levels. However, as a mid-cap stock, Zensar's valuation may be influenced by its high client concentration, prospects of slowdown in IT spending in the US later this year and slower-than-expected shift in offshoring by its new clients (both organic and inorganic).

Key variables

Zensar's performance in 2007-08 is likely to be dictated by the following variables:

Broad-based portfolio: Zensar operates five business segments — Application portfolio management (APM), enterprise application services (EAS), innovative technology solutions (ITS), business process outsourcing and optimisation (BPO) and consulting services. APM has been the company's key contributor, accounting for 53 per cent of its revenues and 83 per cent of its profit before interest and tax (PBIT) for 2006-07 announced recently.

However, over the past year, the contribution from EAS has risen significantly to 28 per cent of revenues (from 21 per cent in the previous year), while PBIT share has more than doubled to 26 per cent (from 21 per cent in the previous year).

This trend is also reflected in the PBIT margin, which improved for EAS to 13.5 per cent in 2006-07 from 6.7 per cent in the previous year. The PBIT margin from APM also improved by two percentage points to 22 per cent for 2006-07. While the company has staged a turnaround in its contribution from BPO, its share from consulting services, the new segment added this year, has been fairly healthy.

The only disappointment has been the contribution from the ITS segment, whose revenues have also dipped from the previous year, and it has also incurred operating losses. This segment offers services that range from application modernisation, embedded systems, product engineering services and legacy migration.

Client mining: While the top ten clients of Zensar account for 69 per cent of revenues for the year ended March 31, 2007 (up from 60 per cent in the previous year), the company is well-placed to mine its existing clients in different areas.

For instance, it has increased the number of clients in the $1 million-$5 million bracket to five in 2006-07 from three in the previous year. This also reflects its long-standing client relationships with the Mark and Spencer, National Grid, Credit Suisse, Cisco, among others.

In addition, of the 236 active clients, 222 are below $0.5 million, and this offers ample opportunity for scale-up of select clients in the coming quarters.

Inorganic growth: Over the past quarter, the company has put through two key growth initiatives. One, it has acquired the US-based ThoughtDigital Inc. through its US subsidiary for an all-cash consideration of $24.9 million.

ThoughtDigital specialises in Oracle implementation, with clients in the communication, financial services and media space. It had reported revenues of $27 million for the year-ended December 2006.

It is expected to strengthen Zensar's presence in the enterprise applications space. Two, it recently entered into a 60:40 joint venture with the Tokyo-based software company, EZA.

This is likely to help Zensar get a foothold in the niche areas of media and entertainment in the Japanese market.

Texmaco: Buy

Investors with a two/three-year investment horizon can consider exposure to the stock of Texmaco, a leading supplier of wagons to the Indian Railways.

At the current market price, the stock trades at about 22 times its expected FY-08 per share earnings. Given the increase in capacity by the Railways, Texmaco's wagon division is likely to witness a significant growth in demand.

This apart, privatisation of container freight movement and entry of private logistics players into the railway freight business may also contribute to higher demand for wagons, leading to further growth potential. The proposed doubling of capacity of the steel foundry division and a robust demand environment for Texmaco's hydro-mechanical equipment and structurals division also lend optimism to earnings prospects.

Investment argument

Driven by increasing demand from the Indian Railways and the private sector, Texmaco's rail wagons division may be set to witness robust growth.

The government's proposal to expand the railway network, increase capacity of existing wagons and introduce higher capacity wagons are likely to scale up its revenues over the next two/three years.

The proposed setting up of dedicated freight corridors on Delhi-Mumbai and Delhi-Howrah sections could also contribute to topline growth. The introduction of wagon investment scheme, entry of wagon leasing companies and allowing private participation in inland container transport could also create a healthy demand scenario for Texmaco.

On the back of an on-going power shortage scenario, the government's planned capacity-addition in various hydropower projects is encouraging.

It is likely to open up newer markets and revenue outlets for the hydro-mechanical equipment division of Texmaco, which makes gates, penstocks, electromechanical and hydraulic hoists for dams, barrages and power stations. Also, given the untapped hydropower potential in the North-East India and Texmaco's proximity to it, it is likely to have an edge over other companies in procuring such orders.

The process equipment division, which caters mainly to sugar, industrial gas and space industry, on the contrary, could be a drag, given the slowdown in orders from the sugar industry.

The steel foundry division, apart from meeting the captive requirement of the wagon division, is a major supplier of bogies and couplers to other wagon builders. It is also the largest supplier of bogies and couplers to the Indian Railways with a market share of about 32 per cent and 42 per cent respectively.

A healthy demand scenario, doubling of capacity and the thrust on export lend confidence in the revenue visibility of this division. Consequently, the foundry division is likely to emerge as a growth driver in the future.

For the quarter-ended December 2006, Texmaco recorded a 61 per cent rise in revenues compared to the corresponding previous quarter. The operating profits margin, however, remained stable at about 13 per cent despite a rising cost scenario.

Concerns

Since a significant portion of the overall revenues is contributed by the Indian Railways, any slowdown or delay in orders could affect the earnings negatively.

Texmaco also faces the risk of under-utilisation of capacity, given the dependence of its wagon division arising from erratic planning and off-take of Indian Railways. Hence, when there are no orders from the Railways, margins could come under pressure.

This apart, an unprecedented rise in raw material cost, increase in competition and any unfavourable change in government policies also pose a downside risk to our recommendation.

Shree Renuka Sugars: Hold

Investors with a two/three-year perspective can retain their exposure in the Shree Renuka Sugars stock at the current price. This recommendation follows an earlier "book profits" recommendation on the stock at the Rs 1,030 levels. The revision in outlook is based on the stock's much cheaper valuations at the current price levels and the possible upside to stock price arising from the recent completion of the company's expansion projects.

Though the earnings outlook for the sugar sector, in general, appears bleak in the light of the weak trends in the domestic and global prices, Renuka Sugars may remain an out-performer on account of a recent scaling up of capacities and new revenue streams from the sale of ethanol and other by-products. The stock trades at about eight times its estimated FY-07 earnings (year-ending September 2007).

Scaling up production

Renuka Sugars raised funds through an IPO in October 2005 to substantially scale up its production, refining, ethanol and power cogeneration capacities that were spread across Karnataka and Maharashtra. The capex plans, which included cane crushing capacity of 12,500 tcd and cogeneration facility of 23.5 MW, were revised upwards after the IPO, to 20,000 tcd and 50 MW respectively. The company also flagged off a new 2,000 tcd sugar refining unit at Haldia to enable trading operations. The expansion plans envisaged in the IPO have been completed only recently, with the commissioning of crushing and distillery capacities in Munoli of 7,500 tcd and 120 klpd respectively, commissioning of the greenfield 4,000 tcd unit at Havalga and the setting up of the 6000 tcd unit at Athani. Given that each of these expansion projects have been completed in phases between December 2006 and March 2007, they can be expected to contribute to revenues and earnings only from the current quarter.

No doubt, the substantial ramp-up in the company's production capacity has been timed, rather unfortunately, to a downturn in the domestic sugar cycle. Domestic sugar prices have declined nearly 30 per cent over the past year after a series of upward revisions in domestic sugar output estimates. These revisions have left the latest production estimate for the 2006-07 season (ending September) at over 260 lakh tonnes, doubling sugar inventories to about 100 lakh tonnes at the end of season — a full six months' consumption.

Margins under pressure

With inventories at a comfortable level, and next year's sugar output forecast to grow further to 280 lakh tonnes, prices may remain in the depressed mode for some time to come. Even the recent lifting of the export ban and the incentives announced by the government may not provide significant succour from surplus stocks in the domestic markets. Global sugar prices have corrected significantly on the back of excess supply in the current crop year and expectations of a higher Indian output.

These factors suggest that the company's margins may be under pressure in the coming quarters. Declining sugar prices have already contributed to a sedate financial performance from the company in the quarter-ended March 2007, with consolidated net profits declining by almost half to Rs 22.9 crore in this quarter, despite an expansion in revenues.

Moderate growth

However, Renuka Sugars still appears well placed (compared to peers in the sector) to deliver moderate earnings growth over a one/two-year time-frame. For one, going forward, lower realisations on sugar may be offset partially by the substantial volume growth from the recently expanded capacities.

Second, with the company successfully bidding for contracts to supply ethanol to the oil marketing companies, it is set to scale-up its ethanol supplies to these companies from about six million litres a quarter to about 12 million litres over the few quarters. Though this is a fixed price contract (realisations at Rs 21.50 per litre), the higher ethanol sales would add directly to the bottomline. The company is among the largest ethanol suppliers in the domestic market. Third, with its factories located mainly in Karnataka and Maharashtra in surplus cane areas, the company faces relatively low competition for procurement of cane and low-cost pressures on this score. Fourth, the recent lifting of the export ban on sugar could enable the company to scale up its trading operations, which would contribute additional revenues. Export opportunities for ethanol and any realisations from carbon credit would be an added bonus.

In any case, locational advantages associated with the company's mills, its integrated processes and the ability to process raw sugar, all contribute to an extended crushing season and high operational efficiency and productivity for the company's operations. In light of these factors, shareholders can retain the stock in the hope of some upside to the price.

Tata Power: Hold

Shareholders can stay invested in the Tata Power stock, which has appreciated 10 per cent in the last seven trading days. The long-term prospects for the company appear bright as the ambitious capacity expansion programme will begin delivering results by 2010.

Fresh buying, with a medium-term perspective, can be contemplated at declines from the current levels linked to broad market trends.

Expansion-driven growth

Tata Power will be adding more than four times its current capacity of 2,300 MW in the next five years taking its total generation capacity to about 15,000 MW.

This includes the 4,000-MW Mundra Ultra Mega Power Project that formally came into the company's fold following the acquisition last week of the special purpose vehicle created for the purpose by the government.

This apart, Tata Power is also planning a 3,000-MW project in coastal Maharashtra that will be fuelled by imported coal, just like the Mundra plant, and a 1,000-MW plant in Chattisgarh based on domestic coal.

The smooth completion of all formalities for the Mundra Ultra Mega Power Project and the acquisition of two coal mining companies in Indonesia that will supply fuel to the project appear to be driving the present positive sentiment in the stock.

The acquisition of the Indonesian companies will secure 50 per cent of Tata Power's requirement of imported coal with the assurance of further supplies on production increases. Coal supplies at preferential prices and long-term fuel security are two obvious advantages for the company flowing from the Indonesian acquisitions.

Low-voltage growth

The expansion projects are critical to Tata Power's revenue and earnings that have remained stagnant over the last five years showing almost flat growth.

While revenues are hostage to fuel prices — low fuel cost means lower prices for electricity supplied — profits are largely a factor of the company's ability to rein-in costs and maintain a high plant load factor, which it has managed to do well ensuring that there is no dip in the bottomline.

Though revenues remained flat, Tata Power continued to increase generation and sale of electricity in unit terms. For instance, in the third quarter of 2006-07, electricity generation was higher by 12 per cent while electricity supplied grew 9 per cent to 3,655 million units.

The third quarter was financially a good one for the company, thanks to a Rs 159-crore tax write-back of provision made in earlier years. The final quarter's profits are likely to be affected by this, as the company is obliged to pass on the tax write-back benefit to its customers.

There is also a worry over the operating margin in the third quarter which, at 17.55 per cent, was the lowest in the first three quarters of 2006-07.

Meanwhile, North Delhi Power Ltd., the distribution subsidiary in Delhi, has been performing exceptionally well in curtailing aggregate technical and commercial losses and the experience in the tough Delhi circle should stand the company in good stead as it bids for other distribution privatisations in future.

Tata Power's stated intent to bid for other ultra mega power projects that are likely to be put up for competitive bidding, and its plans for the transmission line business, augur well for its growth prospects.

Shareholders should note that the company's revenue and earnings buoyancy may not be significant till the new capacities come on stream. As such, the stock is for those with a medium-term perspective.

KEC International: Buy

KEC International's strong financial performance, superior execution skills in power transmission projects and diverse client base provides high visibility to its earnings growth. Investors can consider investing in small lots. Any weakness related to the broad markets can be used to increase exposure.

At the current market price, KEC International trades at about 14 times its expected FY08 earnings. Investments can be considered with a two to three year perspective.

KEC is an integrated player in the power transmission business. The company's current order book at Rs 3,000 crore is about 1.4 times its FY07 revenue. KEC has reported a decline in its project execution cycle from 24 months a couple of years ago to 18 months now. This is likely to lead to quicker translation of revenue to earnings thus lending higher visibility to earnings in the near term. KEC has chosen to focus on project management and outsource the low-margin tower manufacturing business, unlike a few other players in this space who manufacture in-house. We view KEC's focus on the high margin project management segment as a positive to maintain margins and prevent any disruption in execution, arising out of capacity constraints.

KEC has a diversified client base with a firm footing in West Asia and Africa. It has recently entered into a joint venture with US-based Power Engineers, a power transmission distribution consulting sector. With this the company has bagged an order in the country. Over 70 per cent of KEC's present order book comes from overseas projects. While the strengthening of the rupee against the dollar may pose concerns on foreign exchange, the company operates in different currencies as the projects are spread across the globe. This may provide some against any particular currency risk. KEC is also looking to enter the Build Own Operate (BOO) model in power transmission through a joint venture. While the company will see strong competition from bigger players, success in this space could improve the margins for the company. A good number of KEC's overseas projects are fixed price contracts. Any steep hike in raw material costs can affect margins and remains a principal risk.