Ceat

Ceat

Ceat

Ceat

CEAT

We recommend a buy in the stock of CEAT from a short-term perspective. It is seen from the charts of the stock that it had been on an intermediate-term downtrend from its October 2009 peak of Rs 190 until it found support at around Rs 125 in May 2010. However, after hovering between Rs 125 and Rs 130 , the stock started to trend up and has since been on a medium term uptrend. On August 17, the sock jumped 12 per cent accompanied with good volumes, conclusively penetrating its 50 and 200-day moving averages. Thereafter, the stock decisively breached its intermediate-term downtrend line, signalling resumption of uptrend. Moreover, on Wednesday, the stock bounced up 6.6 per cent reinforcing the bullish momentum. The stock is trading well above its 50 and 200-day moving averages. The daily relative strength index has re-entered into the bullish zone from the neutral region and weekly RSI is on the brink of entering into this zone. Further, the weekly moving average convergence divergence oscillator is likely to enter into the positive territory implying upward momentum.

Ceat

Ceat

CEAT

With tyre makers riding on the back of a convincing revival in the automobiles industry, including the medium and heavy commercial vehicles (or the trucks and buses segment), investors can consider buying the stock of CEAT.

A strong brand presence in the aftermarket and high exposure to the trucks and buses (T&B) segment makes the scenario favourable for CEAT. Since both the segments are still in the early phase of recovery, investors can be confident of a robust sales and profits growth in the quarters to come.

Given the presence in the higher margin replacement market, CEAT may be able to pass on cost pressures such as the increasing rubber prices and the recent hike in excise duty, without having to take a deep cut in its operating margins.

Priced at Rs 146 and discounting its trailing four quarter earnings by just three times, CEAT is among the less expensive tyre manufactures.

Market presence

CEAT is a part of the RPG Group, with an annual production capacity of 7 million tyres every year. It commands 13 per cent market share in the entire tyre market and caters to a wide range of automotive segments.

The company derives over 84 per cent of its revenues from T&B, a key segment for all the tyre makers since it offers better margins. The passenger cars and OTR currently contribute to 14 per cent and 2 per cent respectively, to CEAT's revenues.

Thanks to a strong network of 34 regional offices and over 3,500 dealers, CEAT is among the leading brands in the replacement market and enjoys high brand recall in aftermarket space.

This apart, the company has approximately 100 exclusive CEAT Shoppe outlets for passenger cars and 96 exclusive CEAT HUBs for T& B. About 88 per cent of total revenues flow from the aftermarket sales.

Nascent recovery

CEAT's business revolves round high-revenue and high-margin pockets. While OEM tyre sales in the T&B segment have grown by 3 per cent in April-November 2009, demand in the replacement market has grown by 15.6 per cent in the same period. The T&B segment and aftermarket sales are still in the early recovery stages.

A stepped up allocation to state-run projects such as Jawaharlal Nehru National Urban Renewal Mission, may further boost the OEM and replacement demand in the T&B segment. Apart from domestic sales, exports contribute to 16 per cent of CEAT's total revenues.

Capacity expansion

To ease out capacity constraints and keep pace with the rapid growth in the automobiles industry, CEAT has taken up expansion plans in its existing facilities in Maharashtra (Bhandup and Nashik). But what may give the real fillip to CEAT's earnings is the ongoing Greenfield project in Halol (Gujarat).

With an investment size of Rs 700 crore and a production capacity of 145 tonnes per day, this plant will cater to the trucks, buses, LCV and passenger cars radial tyres market. The first phase of investment for Rs 500 crore has already been implemented, partly through internal accruals and debt; and Rs 200 crore will be invested in 2011- 12. The plant will become operational by October ‘10.

Financial comeback

CEAT managed 13 per cent CAGR sales growth until FY-08. This took a beating in FY-09, when the company expanded its sales by just 5 per cent and posted a net loss of Rs 16.1 crore that year.

Like other tyre makers, CEAT has also been swift to return to profits since the beginning of the current fiscal. For the nine months ended December ‘09, it registered a healthy 9 per cent growth in sales, while profits have expanded by over three-fold, when compared with the same period last year.

CEAT may be able to sustain top-line growth at the current pace, though it may see some near term moderation in the operating margins, due to sharp increase in raw material costs and partial roll-back of excise duty benefits.

Raw materials account for over 60 per cent of the total costs and its prices have risen by over 35 per cent since October ‘09.

However, its foothold in the replacement market may permit it to partially pass on the cost pressures to its customers. A positive demand situation, ramp up in production and a increase in sales volume, may be help CEAT make up for cost increases.

Cairn India, Carborundum Universal, CESC, Ceat, Colgate Palmolive, Crompton Greaves, Cummins India

Cairn India, Carborundum Universal, CESC, Ceat, Colgate Palmolive, Crompton Greaves, Cummins India

CEAT

A sustained revival in passenger vehicle sales, signs of recovery in commercial vehicles production, healthy replacement demand and cost controls paint a good picture for tyre manufacturer, CEAT. At Rs 163, the stock trades at a valuation multiple of 10.2 times its trailing 12-month earnings, cheaper than most peers. CEAT’s tyre-client portfolio is far-reaching, covering passenger cars, two-wheelers, trucks and buses, light commercial vehicles, earth-moving equipment and so on, with a 13 per cent market share. However, concerns linger over effects of exchange rate fluctuations, vulnerability to rubber prices and sustenance of demand from commercial vehicles. Investors can retain the stock, but can use price falls linked to broader market declines to accumulate it.
Demand revival

Supply to auto manufacturers has been on the wane in the past year but CEAT has made up for the fall through its strength in the replacement market. This segment grew overall by 10 per cent in June ’09 with the trucks and buses (T&B) segment and light commercial vehicles (LCV) segment accounting for a lion’s share.

About 79 per cent of the June 2009 quarter sales for CEAT can be attributed to the replacement market, up from the 70 per cent for 2008-09. Even with a good part of sales stemming from trucks and buses, given that tyres for such vehicles are generally replaced in 12-18 months, there remains a substantial demand for replacement tyres. To reach its wide customer base, CEAT has a national store network of 3,500 dealers, including 100 exclusive outlets called CEAT Shoppe for passenger cars, up from the 75 that it had the year before. Besides, the company has around 96 CEAT ‘HUBs’ for trucks and buses.

On the OEM front, production is showing signs of recovery in the key commercial vehicle segment. Tyre production in the T&B segment showed a growth of 6.2 per cent in June ’09 over the same period last year. OEMs account for just about 8 per cent of CEAT’s sales, but cater to a broad range of manufacturers such as Hero Honda, TVS, Piaggio, Maruti, Ashok Leyland, Eicher, John Deere and others.
Radial tyres

Radialisation is a technological development that reduces tyre friction and improves fuel economy. The domestic passenger car segment is almost fully radialised, but the T&B segment is at 10-12 per cent levels only against the global average of 60 per cent. It is this segment that holds promise for CEAT, with very few players in the segment currently.

Towards this end, the company is setting up a 140 tonnes per day (tpd) radial tyre plant in Gujarat with an investment of Rs 500 crore, funded by debt and internal accruals.

The plant will be operational from mid-2010 and is expected to contribute to revenues from the second half of FY-10. Besides this, capacity expansion for its plant at Nashik by about 35 tpd is on the cards, which will aid volume growth. CEAT is aiming at improving its passenger vehicle offtake though it will remain focused on the T&B segment.
Role of raw material

The primary raw material for making tyres is rubber, accounting for 42 per cent of raw material consumption. This cost played a significant role in the 77 per cent operating profit fall in FY-09 over the preceding year. As a percentage of sales, raw material costs moved from 66 per cent in FY-08 to 72 per cent in FY-09.

During the year, rubber prices touched a high of Rs 135 per kg, only to crash to Rs 65 per kg in early 2009. Consequently, the company pulled out of losses, posting a net profit of Rs 60 crore in the June ’09 quarter over a loss of Rs 10 crore in the corresponding previous period.

But in response to the upswing that rubber prices are now riding, the company will hike tyre prices by 3-5 per cent, and which may ensure that tabs are kept on cost overruns. On another positive note, CEAT managed to marginally improve turnover of inventory in FY-09 to 9.8 times from the 9.3 times the year before.
Financials

Sales grew at a CAGR of 13 per cent in a three-year period, due largely to the poor performance of FY-09. Though the company sustained losses at the net level in FY-09, it still maintained operational profitability.

Operating profit margins for FY-09 stood at 3 per cent, improving to 16.3 per cent in the June quarter. Net profits margins are at 8.9 per cent. Debt-equity ratio stands at 1.14 times, on a par with most peers, but interest costs could cut into gross profit margins with additions to debt likely to fund its new plant.
Risks

Investors must, however, note that the company faces quite a few risks. For one, it is vulnerable to fluctuations in raw material prices. Exports contribute 17 per cent of sales numbers and CEAT imports raw materials as well; the company has hitherto suffered sustained forex losses. Though radial tyres hold promise, the segment is still in its infancy and will begin to contributing to revenues from the next financial year.

Ceat, ABB, Neyveli Lignite, Unitech

ABB
Research: Merrill Lynch
Rating: Buy
CMP: Rs 1,103

Merrill lynch has maintained a ‘buy’ rating on ABB. The company has stated that its strategy of expanding products, capacities and markets should continue to deliver strong growth, despite volatile commodity markets. The management has said that India’s plan to add 78 gigawatts (gw) of new generation capacity, related investment in transmission and distribution (T&D) and industrial capital expenditure (capex), especially in the metals & mining and infrastructure space, are picking up. ABB’s order book, at Rs 5,000 crore — up 49% year-on-year (YoY) — support its growth strategy.

The company has won key orders such as robotics from Tata Motors, Karnataka Power Transmission Corporation’s (KPTCL) supervisory control and data acquisition (SCADA) order and transformer/traction motor order from Bombardier for the Delhi Metro. ABB is spending $100 million over ’08-09 on capex (factories) and launching new products — wind generators for exports. The structural drivers of ABB are India’s plans to expand its national power transmission grid, with inter-regional grid capacity of ~37.2 gw (14.1 gw in FY07) and industrial capex focused on higher automation.

The adoption of ultra high voltage direct current (HVDC) lines by FY09E is a significant opportunity for a world leader like ABB. Further, the downstream opportunity lies in medium voltage and engaging in cross-selling across businesses to focused verticals such as metal, water and special economic zone (SEZ), which comprise around 10% of its sales.

Neyveli Lignite
Research: Indiabulls Financials
Rating: Hold
CMP: Rs 110

Indiabulls has reiterated its ‘hold’ rating on Neyveli Lignite Corporation (NLC). However, any decline in the share price from the current level will be a good buying opportunity. As on March 14, ’08, NLC inked a memorandum of understanding (MoU) with Northern Coalfields to set up a 1,000-mw pit-head power station worth Rs 5,200 crore at Gorbi mines in the Singrauli coal fields. Moving ahead with regard to its capacity expansion plans, NLC is also holding talks with Mahanadi Coalfields (MCL) to set up a 2,000-mw pit-head power unit at Vasundhara mines in the IB Valley coalfields.

With the increased energy deficit in NCL’s customer states, demand risks for the company are minimal. Moreover, NCL draws sustainable competitive advantage from its competitive capital cost, low variable cost of generation, and easily available lignite. However, lignite being a low-grade coal suffers from the disadvantage of lower plant load factor (PLF), thus resulting in reduced generation. To overcome these disadvantages and to improve PLF, the company is foraying into coal-based power plants, with the first one in Tuticorin of 1,000 mw, expected to be commissioned by FY10-12.


Unitech
Research: CLSA
Rating: Outperform
CMP: Rs 267

Unitech’s plans to raise $1bn+ have been delayed due to adverse market conditions. Hence, CLSA has cut the company’s FY10 consolidated volume estimates by 15% as Unitech will have moderate growth plans. A potential private equity for Mumbai business expansion can be a positive trigger in the near term.

Taking into account the potential demand-supply issues and aggressive pricing strategy adopted by certain industry players, CLSA has reduced base residential price assumptions by 5-10% and has assumed a 10% correction in office/retail rentals over FY08-FY10. In the residential segment, 79% of projects are valued at Rs 3,000/square foot or less. CLSA has also raised the cap rate assumptions by 100-200 bps, driven by the rise in Singapore real estate investment trust (REIT) yields. With this, CLSA has set a 9% cap rate for office and 10% for retail.

Based on the above changes in assumptions and cap rate, Unitech’s forward net asset value (NAV) comes off by 15% to Rs 365/share. Sensitivity analysis shows that if rentals and price assumptions are lowered by another 10%, the NAV will come down to Rs 304/share — 10% higher than the current stock price.

Opto Circuits India
Research: Networth Stock Broking
Rating: Buy
CMP: Rs 326

Networth Stock Broking has recommended a ‘buy’ rating on the stock with one-year price target of Rs 429 — an appreciation of 30% from the current level. Opto Circuits operates in a niche area of manufacturing healthcare equipment in India.

It is engaged in the design, development, manufacturing, marketing and distribution of medical electronic devices and monitoring products that employ sensing and detection techniques. Its product portfolio comprises sensors, probes, pulse oxymeters, patient monitoring systems and digital thermometers.

Following the acquisition of Eurocor in FY06, Opto has successfully launched its bare-metal and drug eluding stents with focus on the Asian and European markets. It recently launched Dior, a unique drug eluding catheter, which can be used in the treatment of coronary in-stent restenosis and small diameter coronary artery lesions.

Eurocor is the only company in the world to have obtained a CE certification for its drug eluting balloon catheters. Opto’s net sales and profits are expected to witness a compound annual growth rate (CAGR) of 42% and 41% from FY08E to FY10E. At the current market price of Rs 330, the stock trades at 23.6x and 16.9x its FY08E and FY09E diluted earnings, respectively.


Ceat
Research: Edelweiss
Rating: Buy
CMP: Rs 97

Edelweiss maintains a ‘buy’ recommendation on Ceat. The company sold 6.92 acres of the 31-acre land at its Bhandup plant for Rs 130 crore, valuing the property at Rs ~18.8 crore/acre. Of the total consideration, Rs 120 crore will be received by the company in Q4 FY08E and the balance in FY09E. The current sale will not impact the company’s production.

Over the next 24-30 months, the company intends to shift capacity from Bhandup to a new facility at Ambernath or Patalganga, after which, the balance 24 acres will be sold. Great plans to increase capacity by 40 tonnes per day (tpd) at the new facility from the existing 240 tpd at the Bhandup plant. It also plans to set up a radial tyre facility at a cost of Rs 500 crore over the next 36 months. The company plans to incur a capex of Rs 200 crore each for FY09E and FY10E, which will be funded through land sale and internal accruals.

With increased focus on outsourcing, original equipment manufacturer (OEM) volumes are set to increase. Given strong demand from the replacement market, Edelweiss has a positive outlook on Ceat. At current market price of Rs 115, the stock is trading at 5x FY08E (core) EPS of Rs 22.9 and 3.5x FY09E EPS of Rs 32.6

Navneet Publications, CEAT, Real Estate

Navneet Publications (India)
Cluster: Emerging Star
Recommendation: Hold
Price target: Under review
Current market price: Rs108

e-learning: Key to growth

Results highlights

• Navneet publications Ltd's (NPL) sales for Q2FY2008 grew by a robust 35.5% year on year (yoy) to Rs82 crore. The sales were primarily driven by the hefty sales growth of the publication segment.
• Sales of the publication segment grew by 47.7% yoy to Rs61.7 crore as the sales in Q1FY2008 got deferred to Q2FY2008. The sales were deferred to Q2 as the publishing of supplementary books by NPL got delayed due to late arrival of government books. The profit before interest and tax (PBIT) margin for the segment improved by 540 basis points to 26.4% due to higher volumes.
• The stationery division had a subdued growth of 8.8% for the quarter primarily on account of decline in exports and strong sales growth witnessed in Q1FY2008. The segment witnessed a PBIT loss of Rs91 lakh in the quarter on account of a one-time write-off of bad debts worth Rs2.57 crore and increase in the advertising expenses. The advertising expense rose on account of aggressive brand building exercise undertaken by the company for the paper stationery and the new non-paper stationery businesses.
• The operating profit margin (OPM) improved by 211 basis points to 16.5% despite a 45.2% year-on-year (y-o-y) increase in other expenditure, which was on account of aggressive advertising by the company. The operating profit thereby increased by 55.3% to Rs13.5 crore. Further, aided by higher other income and a lower tax rate at 24.9% in Q2FY2008 as against 32.9% in Q2FY2007, the adjusted net profit grew by a hefty 98.3% yoy to Rs9.4 crore.
• The company launched e-learning modules in Gujarat in August 2007 and aims at launching the same in Maharashtra by January 2008. To ensure that the product gains acceptability, the company targets installing the product in 500 private schools in each of the states. Post this, it would release the product for retail sales (to students) from March-April 2008.
• We believe, with curriculum changes in Maharashtra and Gujarat being over, NPL's growth prospects depend to a great extent on the success of its new initiatives specifically that of e-learning. However, this venture being in a nascent stage, we would like to monitor the company's progress towards making it an acceptable product for the students. We believe that the current market price of Rs107.6 captures the fair value of the existing business and that of the company's new initiatives (considering the existing visibility). We thereby maintain our Hold recommendation on the stock.

Ceat
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs250
Current market price: Rs198

Price target revised to Rs250

• The production has been lower in Q3FY2008 due to festive season holidays and capacity expansion undertaken by the company. To offset the production loss, the company is trying to push its replacement sales and exports and is realigning its strategies. The demand from the Original Equipment Manufacturers (OEM) of commercial vehicles is picking up and is expected to improve further from Q4FY2008. For FY2008, the company expects a volume growth of ~10%.
• Rubber prices have started rising from October 2007 onwards after continuously falling for the last ten months. In view of this rise in the cost of rubber (the main raw material) and rising crude oil prices, the company is expected to announce a price increase of 1-1.5% in the first week of December 2007. Prices have been increased in the export markets also.
• Profit margins in Q3FY2008 may get affected to some extent on a quarter-on-quarter basis due to lower production and higher input costs. However the profit margins are expected to improve in Q4FY2008 on the back of increase in prices, higher production and commencement of additional capacities for off-the-road (OTR) tyres at Bhandup and passenger car tyres at Nasik.
• Relocation of the Bhandup facility to Patalganga is expected to start from FY2009 onwards and will lead to cost savings of ~Rs 30 crore per year.
• The management is planning to outsource low value-added products such as two-wheeler, jeep and tractor tyres, but will continue in-house manufacture of all value-added tyres such as OTR and those for trucks and cars. This should further improve the profit margins in FY2009.
• The high court has recently approved the de-merger of its investments to a separate company named CHI Investments Ltd, with the core tyre business remaining with Ceat. The financial restructuring entails conversion of every 100 shares of Ceat to 75 shares of the existing company and 25 shares of CHI Investments. Thus, the equity capital of Ceat (core tyre business) will reduce by 25% enhancing its earnings per share (EPS).
• The currently listed entity Ceat is expected to get delisted in December 2007 and the relisting of both the new entities is expected in January 2008.
• We maintain our positive outlook on the company, given its smart turnaround and brilliant performance improvement. At current levels, the stock trades at 7.5x its FY2009E and at an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 3.3. We maintain our Buy recommendation with a revised price target of Rs250.

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SECTOR UPDATE

Real estate

ULCRA repeal to unlesh acres of land
The Maharashtra assembly today passed the motion to repeal the three-decade-old Urban Land Ceiling and Regulation Act (ULCRA) that imposed ceiling on the amount of vacant land that an individual could poses in a particular urban area. The ceiling was fixed based on the classification of cities. And with Mumbai being 'A' class city the limit was set at 500 square meters.

Ceat India

Ceat has brought in cost efficiencies in operations and its investment arm demerger and land sale will bring in a cash pile.

After reeling under rising cost of raw materials and attendant competitive cost pressures which had whittled margins, tyre majors are reaping benefits of cost optimisation and dipping natural rubber prices.

One such tyre company that has seen its operating margins move from under 4 per cent five quarters ago to a healthy 9.2 per cent in the current quarter is Ceat. With short-term triggers coming from non-core areas such as sale of land and demerger of its investment arm, the stock could see a rerating.

Unlocking value

Ceat wants to shift its 31-acre manufacturing facility located in Bhandup, Mumbai to a new location and sell the land to real estate developers. As a first step, the company has identified 6.5 acres which will be sold by the third quarter of the current fiscal. At Rs 14 crore an acre, the land is expected to fetch Rs 91 crore.

By FY09 when the entire facility will be shifted out to Patalganga and the entire land is sold, the company is expected to pocket nearly Rs 400 crore. The company is also demerging its investment arm, CHI Investments into a separate listed entity and this too is expected to boost the stock price.

Investment gains

CHI Investments has exposure to stocks of RPG group companies and has an investment value of Rs 127 crore. The current market value of these investments is put at nearly Rs 400 crore. According to the financial restructuring, existing shareholders will get one share in CHI Investments and three shares in the new Ceat for every four shares held in Ceat holding in the new entity.

In addition to these, the company is also expected to make an octroi saving of Rs 28 crore (in the event octroi is abolished), and has received refunds from income tax and Sicom to the tune of Rs 15 crore and Rs 8 crore respectively.

These are all windfall gains, and are mostly of a one-time nature. But besides these, the company has put in place plans to move into higher value-added products and improve realisations.

Value-added portfolio

To tackle increasing cost pressures and cut-throat competition, Ceat adopted a three-pronged strategy to improve margins. Ceat’s vice president Amit Kumar says that the company changed its product mix, went up the product value chain and outsourced low-end manufacturing activities.

Of Ceat’s three segments, OEM, replacement and exports, realisations from supplies to auto manufacturers historically were 15-20 per cent lower than Ceat’s largest revenue earning segment - the replacement market which accounts for 62 per cent of sales. High demand and lack of supply has put Ceat at an advantage and the difference is now only 5-10 per cent, which has boosted margins in the past quarter.

The company is aggressively scouting for more opportunities in the export markets which account for 20 per cent of sales and come with higher realisations of Rs 18 per kg. The company’s focus on exports and replacement could not have come at a better time, according to Kumar as Ceat’s OEM sales are expected to dip by 20 per cent because of the slowdown.

The company is also trying to shake off the tag that it caters primarily to the economy segment by including high-end products in its portfolio. Says Kumar, “Ceat is looking at speciality tyres -- be it radials which have realisations of Rs 100 per kg or off-the-road tyres where it has doubled its capacity with a investment of Rs 47 crore in the last fiscal and saved on costs with in-house mixing.”

In line with its aim of moving up the value chain, the company is outsourcing low-end tyre manufacturing activity for scooter, motorcycle, auto rickshaw and agricultural application tyres. This has freed up capacity to focus on high margin products and at the same time reduce costs.

The company is planning to relocate its 240-tonne Bhandup plant to Patalganga which will have an enhanced capacity of 300 tonne of which 100 tonne would be for manufacturing specialty tyres. The capacity at its Nashik facility has been enhanced to 180 tonne from 140 tonne.

The cost of the Patalganga facility is expected to be Rs 300 crore which is to be funded by internal accruals and debt in a 1:1 ratio. To make deeper in-roads in the radials business, the company plans to set up a greenfield facility to manufacture passenger car radial facility along with truck and bus radials. The production facility, the location for which has not been finalised, is expected to come on stream by FY11.

Efficiency gains

The company’s focus on cost cutting is paying off. Interest, depreciation and manpower costs are down from nearly 20 per cent of sales to half that number over the last seven years even though the top line has nearly doubled during this period.

Says Kumar, “Costs are down thanks to value engineering which involved the use of low weight tyres and material substitution based on natural and synthetic rubber prices.”

The key raw material for the company is natural rubber which accounts for 46 per cent of its raw material cost while crude oil by-products synthetic rubber (8-12 per cent), carbon black (20 per cent) and nylon cord fabric (15 per cent) account for the rest.

The company changes this mixture and uses arbitrage opportunities between domestic and international prices to bring down its raw material costs. This helps balance the cost differential as natural rubber is seeing a declining trend while crude prices are going up.

Valuations

Since most holding companies trade at a 50-70 per cent discount to their investment value, Ceat’s holding arm, which has investments of Rs 400 crore, would work out to Rs 26 per share. After deducting Rs 12 per share of the land value as well, Ceat’s core business trades at a P/E of about 9.8 times estimated FY08 earnings.

With a 40 per cent net profit growth, analysts say the P/E of the core business could get re-rated up to 12 times, thus valuing the share at Rs 170. If its invested companies like KEC International, CESC and Phillips Carbon Black rise further or if the holding company discount is not as low as 70 per cent, there could be further upsides.

Investor's Eye - July 30 2007

Ceat
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs216
Current market price: Rs177

Price target revised to Rs216

Result highlights

• Ceat's Q1FY2008 results were in line with our expectations. The net sales have risen by 7.8% to Rs536.4 crore, mainly driven by strong realisation growth due to price hikes and product mix changes. In line with the industry slowdown, the original equipment manufacturer (OEM ) sales declined by 11% year on year (yoy), but the effect of the same was mitigated because of strong growth in the replacement and the export markets.
• The operating margins expanded 550 basis points to 9.2% during the quarter as a result of lower raw material cost, price hikes, improved product mix and other efficiencies. As a result, the operating profits grew by 166.3% to Rs49.4 crore.
• Adjusting for the impact of tax provisioning on the extraordinary gain, we estimate that the quarterly profits have grown to Rs20.4 crore against Rs0.2 crore same quarter last year. The quarter's results contain extraordinary items relating to refund from excise and income tax and reversal of export benefits granted in earlier years. Profit after tax (PAT) after extraordinary items have grown to Rs30.4 crore.
• Last few quarters have been pretty exciting for Ceat, as it has effected a smart turnaroud during the period and now its margins are comparable with the best in the industry. We expect this strong growth to continue, particularly driven by the replacement and the exports segment. We also expect the company to maintain its margins at these levels going forward. On the basis of strong performances by Ceat, we are raising our earnings estimate for Ceat by 6% to Rs16.9 for FY2008 and are introducing our FY2009 estimates of Rs21.1.
• The slowdown in the OEM segment is expected to continue for another couple of quarters. To counter the same, the company has already put in place strategies to concentrate more on the exports and the replacement markets.
• The land sale is expected to be finalised by the third quarter of the current fiscal, while the demerger process is expected to be completed by the end of this fiscal.
• At the current market price of Rs177, the stock is trading at 8.4x its FY2009E earnings and at an enterprise value (EV)/earnings before interest depreciation and amortisation (EBIDTA) of 3.9x. We maintain our Buy recommendation on the stock with a revised price target of Rs216.

State Bank of India
Cluster: Apple Green
Recommendation: Buy
Price target: Rs1,780
Current market price: Rs1,579

Strong operating performance

Result highlights

• State Bank of India’s (SBI) results have been way above the market’s and our expectations with the profit after tax (PAT) growing by 78.5% year on year (yoy) to Rs1,425.8 crore compared with our estimate of Rs1,147 crore. The results are significantly above estimates due to a higher than expected write-back in investment provisions and subdued operating expenses.
• The net interest income (NII) was up by 15% yoy to Rs4,497 crore. The reported net interest margin (NIM) remained more or less stable on a sequential basis but declined by six basis points yoy. Most of the public sector banks have reported a sequential decline in margins whereas SBI has maintained its NIM and grown its NII by 15.8% yoy which are commendable.
• The non-interest income grew by 18.7% yoy to Rs842.6 crore driven by good growth in the core fee income, which rose by 16.3% yoy, and a higher trading income, which increased by 30.5% yoy due to the gains recorded in the National Stock Exchange stake sale for around Rs150 crore. “Others” reflect a net negative figure due to amortisation expenses and one-time shifting losses booked through the non-interest income category as per new Reserve Bank of India (RBI) directives.
• The operating expenses grew by only 5.8% yoy to Rs2,978.5 crore mainly due to lower staff expenses, which grew by 5.3% yoy and remained almost unchanged on a sequential basis at Rs2,026.4 crore. A good net income growth of 15.6% yoy coupled with lower operating expenses helped the operating profit to increase by 30.8% to Rs2,361.5 crore. The core operating profit growth was at 15.8% yoy to Rs2,691.5 crore.
• Provisions declined by 36.4% yoy mainly due to a write-back in investments provisions for Rs376 crore. The bank made a Rs200-crore non-performing asset (NPA) provision during the quarter over and above the RBI’s requirements, which helped it to improve the provision coverage by 140 basis points to 48.8% on a sequential basis.
• Business growth was strong with net advances up 29.3% yoy and deposits higher by 19% yoy. However, the asset quality showed deterioration with the gross NPA up by Rs760 crore in absolute terms and the net NPA up from 1.56% in Q4FY2007 to 1.62% in percentage terms.
• The operating performance has been strong with stable margins and robust business growth. However the margins are likely to be under pressure going forward as the bank has a net effective negative spread on the combined statutory liquidity ratio (SLR) and cash reserve ratio (CRR) book. On the other hand, it has reduced its interest rate risk significantly, with only 24% of its investment book under the marked-to-market category with a duration of 1.7 years. A lower provision coverage and the non-provision of transitional Accounting Standard (AS)-15 expenses (as it awaits the RBI’s guidelines on this front) are the only concerns. Hence, we have not upgraded our numbers as we feel the AS-15 related provisions could restrict the earnings growth of the bank in FY2008 despite earnings being significantly above estimates. At the current market price of Rs1,579, the stock is quoting at 14.4x its FY2009E earnings, 5.9x pre-provision profits and, 1.9x stand-alone and 1.5x consolidated FY2009E book value. We maintain our Buy recommendation on the stock with a price target of Rs1,780.

Bank of Baroda
Cluster: Apple Green
Recommendation: Buy
Price target: Rs366
Current market price: Rs293

Price target revised to Rs366

Result highlights

• In Q1FY2008, Bank of Baroda's (BOB) net profit increased by 102.5% year on year (yoy) and 34.7% quarter on quarter (qoq) to Rs330.8 crore. The profits of the bank more than doubled on year-on-year (y-o-y) basis mainly because of a decline in provisions during the quarter on account of a write-back in the investment provisions on its marked-to-market investment portfolio.
• During the quarter the bank's net interest income (NII) increased by 15.5% yoy but declined by 8.9% on a sequential basis. The Q4FY2007 NII was adjusted for Rs30 crore for the cash reserve ratio (CRR) from the interest income and Rs22 crore interest income related to BOB Housing. The margins have remained stable on a y-o-y basis but have shown a six-basis-point decline at 3.2% on a quarter-on-quarter (q-o-q) basis.
• The non-interest income was up by 64.4% yoy mainly due to a higher treasury income component of Rs130 crore which included Rs90 crore from the National Stock Exchange (NSE) stake sale; the fee income was up by 13.5% yoy to Rs107.7 crore.
• The operating expenses were up 24% yoy to Rs684 crore as both the staff expenses and the other expenses increased by 17.6% yoy and 38.6% yoy respectively. The staff expenses were high because of higher retirement benefits while the other expenses increased due to higher depreciation on the assets (mainly technology). Although the operating profits improved by 28% yoy, the core operating profits (ie operating profits adjusted for treasury) declined by 6%.
• The bank's loan growth moderated to 27.5% yoy as in June 2007 from the high of 40% y-o-y growth in FY2007. The retail and foreign advances continued to be the main drivers of the growth with 38.5% and 44% y-o-y rise respectively. The deposit growth also moderated to 22.7% yoy from 33.4% registered in FY2007. The moderation in the overall business growth to a more comfortable level of 22-25% would help the bank conserve precious capital, maintain the margins and reduce the likeliness of higher defaults going forward.
• We have seen a marginal deterioration in the asset quality with the gross non-performing asset (NPA) level up 5.5% qoq and the net NPA level at 0.67% compared with 0.6% in March 2007.
• Although the margins were not under severe pressure, the core operating performance was dismal as the operating expenses remained high mainly due to technology implementation and providing retirement benefits for the staff. We expect higher operating expenses in FY2008 because of technology implementation and the Accounting Standard (AS)-15 provisions. We also expect the margins to remain under pressure as the bank plans to grow significantly its international operations (margins are comparatively lower in the international business). However the bank has comfortable capital adequacy and asset quality levels with a strong management focus to improve profitability. Due to its low return on equity (RoE) the bank trades at a much lower price to book value (BV) multiple than its peers. But with its RoE expected to improve to 15% plus going forward, we feel at the current valuations the bank is one of the most attractively valued among the public sector banks. We have introduced our FY2009 estimates in this report. At the current market price of Rs293, the stock is quoting at 6.8x its FY2009E earnings per share (EPS), 3.4x pre-provision profits (PPP) and 1x BV. We maintain a Buy recommendation on the stock with a revised price target of Rs366 at which it would trade at 1.25x FY2009E BV.

Grasim Industries
Cluster: Apple Green
Recommendation: Buy
Price target: Rs3,250
Current market price: Rs2,947

Price target revised to Rs3,250

Result highlights

• The Q1FY2008 net sales of Grasim Industries (Grasim) grew by 30.3% year on year (yoy) to Rs2,450 crore, mainly due to a pick-up in its viscose staple fibre (VSF) volumes as well as realisation and higher sponge iron prices. The VSF revenues grew by a robust 59% yoy to Rs700 crore on the back of a healthy 34% growth in the volumes and a 20% growth in the realisation yoy. The cement revenues improved by 25% yoy to Rs1,390 crore driven by a 12% growth in volumes and a 13% growth in realisations yoy.
• On the back of a higher top line growth, the operating profit grew by 54% yoy to Rs792 crore whereas the earnings before interest, tax, depreciation and amortisation (EBITDA) margin improved by 510 basis points to 32.4%.
• The interest expenses rose by 21.1% yoy to Rs28.5 crore on account of higher borrowings in the quarter whereas the depreciation provision increased by 14.7% yoy to Rs85 crore mainly due to part commissioning of the additional VSF capacity in FY2008.
• The other income jumped by 81% yoy to Rs67.7 crore on account of a high interest income from the profitable deployment of surplus cash from operations.
• Consequently, the net profit rose by 64% yoy to Rs512 crore, much ahead of expectations.
• The company has slightly modified its capital expenditure (capex) plans. As against expanding the capacities at Kotputli and Shambhpura by 4 million metric tonne (MMT) each as planned earlier, the company is now expanding the capacities at these two locations by 4.4MMT each. The Shambhupra capacity is expected to come up by Q4FY2008 whereas the Kotputli plant is expected to be commissioned by Q1FY2009.
• The company is also augmenting its VSF capacity at Kharach, Gujarat from 45,625 tonne to 63,725 tonne. The company is also in the process of getting regulatory clearance for expanding the capacity at Harihar by 31,000 tonne.
• Considering the optimistic outlook for the VSF business, the higher realisations from the sponge iron business and the higher earnings of UltraTech Cement, we are upgrading our earnings per share (EPS) estimate for FY2008 by 8.2% to Rs264 and for FY2009 by 12.6% to Rs234.

Tata Elxsi
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs370
Current market price: Rs288

Price target revised to Rs370

Result highlights

• For Q1FY2008, Tata Elxsi has reported a growth of 3.6% quarter on quarter (qoq) and of 45.7% year on year (yoy) in its revenues to Rs92.4 crore. The performance was ahead of expectations in view of the seasonal weakness in Q1 (especially in the system integration [SI] business) and the steep appreciation in the rupee during the quarter.
• However, the performance on the margin front was disappointing. The operating profit margin (OPM) plummeted by 670 basis points sequentially to 17.6%, which is among the lowest in any quarter during the past two years. The same can be attributed to the cumulative impact of the rupee's appreciation, wage hikes (given to a small part of its employee base; wage hikes are being effected since January for most of the employees), intake of fresh graduates (under training and not billable) and seasonal weakness in Q1 in case of the SI business. Consequently, the operating profit declined by 25.1% qoq to Rs16.2 crore
• In line with the operating profit, the earnings declined by 24.5% qoq and grew by 18.4% yoy to Rs12.1 crore, which was lower than our expectations of Rs12.6 crore.
• In terms of segmental performance, the sequential growth of 7.3% in the software development service (SDS) business was ahead of expectations. However, the profitability declined by 470 basis points sequentially to 17.5% during the quarter. On the other hand, the SI revenues declined by 13.8%. The segmental margins plummeted to 12.6% as compared with 29.4% in Q4FY2007 but were far better than 1.6% in Q1FY2007.
• To factor in the higher than expected pressure on the margins, we have revised downwards the earnings estimate for FY2008 and FY2009 by 4.5% and 3.4% respectively. At the current market price the stock trades at 14.2x FY2008 and 11.3x FY2009 estimated earnings. We maintain our Buy call on the stock with a revised price target of Rs370 (14.5x FY2009 earnings).

Apollo Tyres
Cluster: Apple Green
Recommendation: Buy
Price target: Rs425
Current market price: Rs375

On a fast track

Result highlights

• Apollo Tyres rendered a brilliant performance in Q1FY2008 on the back of a strong top line growth and an improvement in the operating profit margin (OPM).
• The top line grew by 15.4% to Rs874.1 crore, led by a volume growth of 5% and a realisation growth of about 9.9% during the quarter. Though the original equipment (OE) business witnessed a slowdown during the quarter, the replacement business remained strong.
• The OPM improved to 11.5% from 7.5% Q1FY2007 on the back of softer raw material prices, improvement in price realisations and increasing operating efficiencies. Consequently, the operating profit increased by 77% to Rs100.4 crore. The net profit for the quarter grew by 187.6% to Rs46.8 crore.
• On a consolidated basis, the net revenues rose by 22% to Rs1,150 crore while the net profit improved by 369% year on year (yoy) to Rs54.6 crore, indicating a sharp improvement in the performance of its subsidiary, Dunlop South Africa.
• Dunlop South Africa is performing very well as its earnings before interest, depreciation, tax and amortisation (EBIDTA) margin reached the level of 11% during the quarter. It recorded a growth of about 40% in its net sales to about Rs275 crore in the same period. However, the same was achieved on a low base due to a very low-key performance in the same quarter last year.
• Though the sales volumes of Apollo Tyres would be affected in the current fiscal as a result of the slowdown in the OE sales, we believe that the replacement sales for tyre makers would continue to remain strong, considering that the automobile industry, especially the commercial vehicle segment, has been recording a good growth for five straight years. Also, the fall in rubber prices augurs well for the tyre makers as it should help them maintain the high levels of margins.
• At the current market price of Rs375, the stock discounts its FY2009E earnings by 10.5x and quotes at an enterprise value (EV)/EBIDTA of 4.8x. We maintain our Buy recommendation on the stock with a price target of Rs425.

Mahindra & Mahindra
Cluster: Apple Green
Recommendation: Buy
Price target: Rs913
Current market price: Rs753

Q1FY2008 results: First-cut analysis

Result highlights

• The Q1FY2008 results of Mahindra & Mahindra are below our expectations. The stand-alone net sales of the company grew by 16.8% to Rs2,612.8 crore in the quarter. This growth was led by an overall volume growth of 13.6% in the same period. The automotive segment recorded a volume growth of 24%; the sales volume of the farm equipment (FE) segment was flat.
• On a segmental basis, the automotive revenues rose by 21% to Rs1,504.5 crore. The FE division reported a revenue growth of 9.7%. The profit before interest and tax (PBIT) margin in the automotive segment was affected by 110 basis points due to the strengthening of the rupee and the consequent lower export realisation that affected the profit during the quarter. The FE division was able to maintain the PBIT margin at 13.4%. Consequently, the overall operating profit margin (OPM) declined by 150 basis points to 10.6%, leading to an operating profit growth of only 2.5%.
• On account of an increase in the interest expenditure and higher depreciation the adjusted net profit grew by 6.8% to Rs192.75 crore. After taking into account the extraordinary items (voluntary retirement scheme expenses, special dividend income) the reported profit after tax (PAT) declined by 6.4% to Rs191.16 crore.
• On a consolidated basis, the gross revenues grew by 40.7% to Rs5,879.2 crore in Q1FY2008 while the profit before tax (PBT) and exceptional items grew by 11.7% to Rs535.7 crore.
• We expect FY2008 to be the year of consolidation for the company as new product launches would take place only in FY2009. We will present our full result update on the company after attending the post-result conference call of the company. At the current market price of Rs753, the stock discounts its consolidated FY2009 earnings estimate by 9.3x. We maintain our Buy recommendation on the stock with a sum-of-the-parts price target of Rs913.

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VIEWPOINT

Hindustan Zinc

High zinc price improves overall performance

Result highlights

• In Q1FY2008, the revenues of Hindustan Zinc (HZL) grew by 22% year on year (yoy) to Rs1,970 crore on the back of higher zinc prices and increased volumes. However in terms of sequential growth, the sales of the company dropped by 3% mainly because of the fall in the production of refined zinc refined metal by 4% quarter on quarter (qoq) to 92,631 tonnes. The company sold 54,835 tonnes of zinc concentrates and 13,651 tonnes of lead concentrates during the quarter. The concentrate sales revenue at $80 million during the quarter was higher than that of Q4FY2007 when the concentrate market was tight.
• The earnings operating profit soared by 15% yoy and 3% qoq to Rs1,436 crore mainly due to increased realisation and improved efficiency. The company is in the lowest decile of the cost curve across the globe. The operating margins contracted by 437 basis points yoy to 73% mainly because of a 92% increase in selling and other expenses due to the rising freight cost.
• The interest outgo declined by 74% yoy whereas the depreciation cost increased by 22% yoy, as the company commissioned a 38.4 megawatt (MW) wind energy plant in the last quarter.
• The profit of the company grew by 36% yoy because of the other income of Rs130.48 crore on account of one time reversal of earlier year liability relating to royalty payments to the government. The adjusted net profit grew by 21% yoy to Rs1,055 crore.

Great Eastern Shipping Company

Capex plan of $470 million in the next two years
We attended the conference call of Great Eastern Shipping company (GESCO) to discuss the Q1FY2008 results. We present the key takeaways from the call.

Investor's Eye - July 30 2007