Investor's Eye - Aug 27 2007

NIIT Technologies
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs690
Current market price: Rs442

Stake sale to unlock value
According to media reports, the promoters of NIIT Group are looking to sell the 25% stake in NIIT Technologies (NIIT Tech) that is currently held by NIIT Limited. This much-awaited trigger in the stock is likely to unlock value for the shareholders, as the transaction is expected to be negotiated at a significant premium to the prevailing valuations.

State Bank of India
Cluster: Apple Green
Recommendation: Buy
Price target: Rs1,780
Current market price: Rs1,556

Taking steps in the right direction

Key points

SBI has decided to merge State Bank of Saurashtra: The State Bank of India (SBI), the country's largest commercial bank, has kicked off the consolidation process with its associate banks. It has decided to merge the State Bank of Saurashtra (SBS), an unlisted wholly owned associate bank, with itself. The boards of both the banks have given an in-principle approval to the merger proposal. The SBI will now have to get approvals from the Government (which holds 59.7% stake in SBI) and the Reserve Bank of India. We feel the SBI chose the SBS to begin the consolidation process, as the SBS is the smallest among the SBI's subsidiary banks and due to the ease of getting the regulatory approvals as the SBS is completely owned by the SBI.

First signs that SBI is serious in restructuring its subsidiaries: The SBI-SBS merger has been lingering around for many years without any concrete action on the ground. The merger process was slowed down mainly due to political hindrances and regulatory hurdles. However this time things are really looking bright as the formation of a holding company is in the pipeline and the merger process is already initiated.

Investor's Eye - Aug 27 2007

Investor's Eye dated August 10, 2007

Telecommunication

Record net adds
The GSM (global system for mobile communications) operators added 5.75 million subscribers in July 2007--that is higher than 5.38 million added in June 2007. This amounts to a growth of 4.2% (to 141.7 million subscribers) over the base of 136 million at the end of June 2007.

FMCG

Q1FY2008 earnings review
Companies from the fast moving consumer goods (FMCG) sector have reported an impressive performance for the first quarter of FY2008. On an average, the top line and bottom line of the FMCG industry grew by 17.5% and 20.6% respectively during the quarter. In spite of the rising pressure of high raw material prices, the industry was able to maintain its margins in Q1 and this was a positive surprise. The revenue growth was driven by higher volumes and improved pricing power. The strong growth in the revenues of companies like ITC (despite price hikes and declining volumes), Hindustan Unilever Ltd (HUL), Dabur India and Nestle indicates that the performance of the sector would be strong in the coming quarters.

Cement

Top three majors register a superlative dispatch growth
The top three cement majors registered a superlative dispatch growth in July. ACC's dispatches grew by 15.2% year on year (yoy) to 1.64MMT (million metric tonne) led by the higher capacities at its Lakheri and Kymore plants. Ambuja Cements recorded the highest dispatch growth of 19.5% yoy to 1.39MMT, whereas the AV Birla Group registered a dispatch growth of 13.1% yoy to 2.4MMT. We believe the growth looks inflated as most parts of India witnessed heavy monsoons in July last year. This is substantiated by the fact that the month-on-month decline in dispatches for July last year is very steep compared with that of the current year.

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MUTUAL GAINS

Sharekhan's top equity fund picks

We have identified the best equity-oriented schemes available in the market today based on the following 3 parameter : the past performance as indicated by the one and two year returns, the Sharpe ratio and Fama (net selectivity).

The past performance is measured by the one and two year returns generated by the scheme. Sharpe indicates risk-adjusted returns, giving the returns earned in excess of the risk-free rate for each unit of the risk taken. The Sharpe ratio is also indicative of the consistency of the returns as it takes into account the volatility in the returns as measured by the standard deviation.

FAMA measures the returns generated through selectivity, ie the returns generated because of the fund manager's ability to pick the right stocks. A higher value of net selectivity is always preferred as it reflects the stock picking ability of the fund manager

Investor's Eye dated August 10, 2007

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Investor's Eye dated August 09, 2007

Information Technology

Favourable policy changes

Key points

• The recent policy announcements by the government indicate its growing willingness to protect the rupee against any further appreciation. This is a positive move for the information technology (IT) service companies that have primarily an export-centric business model.
• The policy changes not only allay concerns related to further appreciation in the rupee but could also potentially result in earnings upgrades on the back of the possible weakening of the rupee. The positive impact of the same would be more pronounced in case of the mid-cap companies.
• Despite the distinct pick-up in revenues from the banking, financial services and insurance (BFSI) vertical in Q1 (after a lacklustre performance in Q4), the concerns related to a possible slowdown in demand from the BFSI vertical (in the wake of the subprime woes) would be an overhang on the tech stocks. Especially so, given the fact that the subprime crisis has affected large financial institutions from across the world.
• In terms of our top picks, we continue to prefer HCL Technologies (HCLT; given the company's strong results in the past three quarters, aggressive hedging strategy and reasonably attractive valuations) and Satyam Computer Services (Satyam; based on the distinct improvement in the company's operating metrics, its relatively lower exposure to the BFSI vertical and the strong growth momentum in its enterprise business). In the mid-cap space, we prefer 3i Infotech (purely on valuation basis and due to the company's limited exposure to the US geography).

Banking

RBI modifies ECB guidelines

The government has finally decided to curb the external commercial borrowing (ECB) route, which has been one of the main routes through which overseas money has been entering into India. We had expected a similar announcement during the first quarter monetary policy review. The modifications done to moderate the capital inflows through the ECB route are stated below:

• ECBs of more than US$20 million per borrower company per financial year would be allowed only if expenditure (for permissible end-uses) is in foreign currency; funds raised will need to be parked overseas and cannot be remitted into India.
• While ECBs of less than US$20 million can be raised for rupee expenditure as well, this will need prior approval from the Reserve Bank of India (RBI). Funds raised will need to be parked overseas until actual requirement in India.
• All other aspects of the policy such as the limit of US$500 million per company per year under the automatic route, definition of eligible borrower etc remain unchanged.
• The revised guidelines do not apply to borrowers who have already entered into loan agreements and obtained loan registration numbers from the RBI.

The move is aimed at controlling the dollar inflows via the ECB route as companies have been accessing this route purely to play the interest rate arbitrage mainly for domestic working capital purpose. Some of these borrowings are also getting converted into domestic deposits to exploit the arbitrage that exists between overseas borrowing rates and domestic deposit rates .

Investor's Eye dated August 09, 2007

Investor's Eye

KSB Pumps
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs625
Current market price: Rs520

Low-key performance

Result highlights

• KSB Pumps’ Q2CY2007 results were below expectations, both on the top line and the profitability front. The net sales for the quarter rose by just 1% to Rs112.4 crore. We believe that a lower contribution from the project business to the overall sales led to this slower growth. Also, the last years’ base was high considering that Q2CY2006 was one of the best quarters in the company’s history.
• The profitability took a substantial beating during this quarter as the overall margin declined by 1,090 basis points to 12%. On a segmental basis, the profit before interest and tax (PBIT) margin of the pump division fell to 9.5% (from 23.3% last year) while that of the valve division dropped to 15.9% (from 21.8% last year).
• We believe that the profitability of the company was affected in the quarter mainly because of the higher sales through dealers during the quarter and lesser contribution of the project business. We understand that the order book of the company in the project business is growing at about 40% year on year (yoy). Considering this, we expect higher revenue booking on account of the project business (which carries higher margins) in the subsequent quarters.
• The company continues to spend towards its capacity expansions. It spent about Rs50 crore in CY2006 towards capacity expansion and modernisation. It is expected to spend a similar amount this year.
• In view of the slower growth in the first half, we are downgrading our earnings estimates for CY2007 and CY2008 by 18.9% and 5% to Rs28.2 and Rs39.7 respectively. However, considering the buoyancy in its user segments (eg refineries and the power sector), we maintain our positive outlook on the company.
• At the current market price of Rs520, the stock is trading at 13.2x its CY2008E earnings and is available at an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 7.5x. We maintain our Buy recommendation on the stock with a price target of Rs625.

WS Industries India
Cluster: Vulture’s Pick
Recommendation: Buy
Price target: Rs108
Current market price: Rs75

Price target revised to Rs108

Result highlights

• In Q1FY2008 WS Industries' (WSI) top line grew by 21% to Rs.47.7 crore, which was slightly above our expectation.
• The operating profit increased by 52.5% to Rs7.1 crore, resulting in an expansion in the operating profit margin (OPM) by 310 basis points to 14.9% as against 11.8% in Q1FY2007. The margin improved mainly due to a change in the product mix and a reduction in the power and fuel cost on account of a higher utilisation rate and improved efficiency.
• The profit after tax (PAT) increased by 142.4% to Rs3.95 crore; the PAT growth was higher mainly due to a decrease in both the interest cost, which dropped by 9% year on year (yoy) to Rs1.72 crore, and the depreciation cost, which fell by 4.6% to Rs9 crore yoy.
• The order book of the company stood at Rs190 crore at the end of the quarter.
• A healthy order book of Rs190 crore, which is about 1.15x its FY2007 revenues, and increased production capacity indicate the high earnings capability of the company. Thus WSI is sure to benefit from the large investments lined up in the power sector, especially the transmission and distribution segments, during 2007-2012. We have valued WSI using the sum-of-the-parts (SOTP) method wherein we have valued its core insulator business at 9x its FY2009E earnings per share (EPS). This gives the fair value of Rs78.7 per share. Further, we have valued WSI's realty subsidiary at the current realisable value of Rs3,500 per square feet. Taking WSI's current 59% stake in the realty venture, we arrive at a value of Rs29 per share, which gives us a fair value of Rs108 per share of WSI. We remain positive on the stock and maintain our Buy recommendation with a revised price target of Rs108.

Wipro
Cluster: Apple Green
Recommendation: Buy
Price target: Rs648
Current market price: Rs462

Infocrossing acquisition earnings dilutive

Key points

• Wipro's acquisition of US-based Infocrossing in an all-cash deal of $600 million is important strategically as it would considerably boost the company's capabilities in the infrastructure management service business. The acquisition would enhance Wipro's positioning in terms of bagging large-sized total outsourcing deals.
• On the flip side, the deal appears to be expensive and would also dilute the earnings per share (EPS) over the next couple of years. Infocrossing has been valued at over 70x CY2006 reported net income and 52.2-55.6x CY2007 guided net income. Moreover, the incremental contribution to the consolidated earnings would be much lower than the yield on cash ($600 million outgo) and consequently result in a net negative impact of Rs22 crore and Rs81.5 crore in FY2008 and FY2009 respectively.
• To factor in the impact of the acquisition of Infocrossing, we have revised downward the earnings estimates for FY2008 and FY2009 by 0.6% and 2.1% respectively. At the current market price the stock trades at 20.1x and 16.7x FY2008 and FY2009 earnings estimates. We maintain our Buy recommendation on the stock with a price target of Rs648.

Investor's Eye

Investor's Eye - August 3 2007

ORG Informatics
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs184
Current market price: Rs109

In line with expectations

Result highlights

• ORG Informatics’ performance was in line with expectations during Q1FY2008. Its consolidated revenues grew by 76% to Rs84.3 crore largely driven by 89.3% increase in the revenues from the telecom segment.
• The operating profit margin (OPM) during the quarter stood at 9.5%, which is slightly higher than 9.4% in Q1FY2007 but significantly higher than 1.3% reported in Q4FY2007. The low OPM in Q4FY2007 was an aberration resulting from the cumulative impact of high contribution from the low-margin hardware supply part of the Mahanagar Telephone Nigam Ltd (MTNL) order, restructuring cost related to recent acquisitions and one-time write-off and provisions for debt. Consequently, the operating profit grew by 77.7% to Rs8 crore in Q1FY2008.
• The consolidated earnings of the company during the quarter grew at a relatively slower rate of 60.1% to Rs4.1 crore due to the increase in the interest outgo, higher depreciation charge and higher effective tax rate.
• In terms of the outlook, the management expects to maintain the growth momentum on the back of a healthy order pipeline and the margins in the 9-10% range. It has a pending order backlog of over Rs400 crore as in June 2007. Moreover, the company would continue to actively scout for inorganic opportunities and has given the mandate to Standard Chartered Bank for its proposed foreign currency convertible bond (FCCB) issue to raise $20 million to fund its inorganic initiatives.
• At the current market price the stock trades at 10.6x FY2007 and 7.7x FY2008 estimated earnings (on a diluted equity base of Rs17.1 crore). We maintain our Buy call on the stock with a price target of Rs184 (13x FY2008 earnings).

JK Cement
Cluster: Cannonball
Recommendation: Buy
Price target: Rs200
Current market price: Rs161

In line with expectations

Result highlights

• JK Cement’s top line in Q1FY2008 grew by 17% year on year (yoy) to Rs326 crore on the back of a 25% growth in realisations to Rs3,564 per tonne. The volumes , however, declined by 7% yoy to 915,820 tonne as the grey cement plant remained shut for 20 days for maintenance.
• On the costs front, the fixed costs increased by 33% yoy on the back of a 25% rise in employee costs and 38% yoy surge in the operating expenditure. The variable cost per tonne, which increased marginally by 3% yoy to Rs1,770 per tonne during the quarter, along with the drop in volumes resulted in the overall operating expenditure growing slower by 8% yoy to Rs229 crore.
• On the back of a higher realisation growth during the quarter, the operating profit jumped by 47% yoy to Rs96.5 crore whereas the operating profit margin (OPM) improved by 610 basis points to 29.6%. The higher realisations and flat variable cost structure caused earnings before interest, tax, depreciation and amortisation (EBITDA) per tonne expanding to Rs1,051 per tonne during the quarter from Rs280 per tonne in the corresponding quarter last year.
• The interest cost increased by 11% yoy to Rs9.1 crore due to the higher interest rates, whereas the depreciation provision increased by 11% yoy to Rs9.1 crore.
• Thanks to the excellent performance at the operating level, the net profit grew by 59% yoy to Rs52.5 crore.
• The company’s 20 mega watt (MW) pet coke power plant commenced its trial production in July 2007 and will be fully operational from August 2007. The 10MW turbine will get commissioned by August 2007, whereas the 13.5MW waste heat recovery plant will get commissioned in two phases from September to December 2007.
• The company expects a power savings of Rs150-200 per tonne once the captive power plants (CPP) get fully commissioned. In our calculations, we are assuming savings of Rs150 per tonne for the entire fiscal year FY2009.
• The company will be able to get the full benefit of the savings from the power plants in the fiscal FY2009, which will augur well for the company in the wake of a fall in the pricing power. We are maintaining our earnings per share (EPS) estimates of Rs30.2 per share for FY2008 and Rs25.8 per share for FY2009. At the current market price of Rs161, the stock is trading 5.3x its FY2008 earnings and 6.2x its FY2009E EPS. We maintain our Buy recommendation on the stock with a price target of Rs200.

Saregama India
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs375
Current market price: Rs281

Results not upto the mark

Result highlights

• Q1FY2008 results of Saregama India Ltd (SIL) are slightly below our expectations. Our preview estimates for the quarter were based on the expectation that the management of the company would include the film business in the stand-alone numbers post its amalgamation with the parent. However, SIL has indicated that it would possibly report such numbers from Q2FY2008.
• The revenues of the company were down 14.9% year on year (yoy) to Rs28.7crore due to a sharp 32.2% decline in the physical sales to Rs16.2 crore. The physical sales were down as there were no major audio, video or movie releases during the quarter and due to continuing trend of decline in the physical sales. On the positive side the non-physical sales (license fees) increased by 27.1% yoy to Rs12.5crore.
• Despite lower than expected costs the operating profit margin (OPM) of the company in Q1FY2008 stood at 13.5% as against 16.8% in Q1FY2007. Thus the operating profits were down 31.8% yoy to Rs3.9crore.
• A much higher tax rate of 14.7% during the quarter as against 2.2% in the corresponding quarter last year led the adjusted profit after tax (PAT) decline to Rs3crore compared with Rs5.4crore for the corresponding period last year.
• In Q1FY2007, SIL had written off Rs2.6crore worth of inventory and debts, thus the reported net profit stood at Rs3crore in Q1FY2008 as against Rs2.8 crore in Q1FY2007.
• We believe SIL stands in a sweet spot with its vast repertoire of music content experiencing strong growth in demand from radio and telecom industries and other opportunities available in the digital music space. However, the growth in demand is going to be counterbalanced by declining sales in the physical format. With margins being much better in the non-physical format, the profit growth will outpace growth in top line in the coming years.
• We realign our estimates for FY2008 taking into account a sharper than expected de-growth in physical sales and also introduce our FY2009 estimates through this update.
• At the current market price of Rs281, the stock is trading at 14.7x its FY2009E earnings per share (EPS) of Rs19.1 and an enterprise value (EV)/ earnings before interest, depreciation, tax and amortisation (EBIDTA) of 11.5x. We maintain our Buy recommendation on the stock with a price target of Rs375.

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VIEWPOINT

Gujarat NRE Coke

Realisation reflects strong coke market

We attended the analyst meet of Gujarat NRE Coke. Following are the key takeaways from the meet:

• The net sales of the company grew by a whopping 130% year on year (yoy) to Rs149 crore mainly driven by a strong rise in coke prices (FOB china), which rose to US$260 in the current quarter from US$150 in June 2006. However the volumes during the quarter were subdued due to increase in the inventory. The company currently has an inventory of ~ 25,000 tonne.
• The Earnings before interest, depreciation, tax and amortisation (EBIDTA) of the company during the quarter grew by 564% yoy to Rs59.2 crore on the back of the increased realisation (a 22% yoy) and the reduced cost of coal to the company. The average cost of coal to the company during the quarter was in the range of $100 per tonne as against landed cost of $170 per tonne, which rose by 14% in last ten months.
• The profit after tax (PAT) of the company during the quarter was Rs43 crore as against the loss of Rs9.7 crore in the corresponding last quarter. The loss was mainly due to the bad coke market and one time deferred tax of Rs10 crore.
• The current market value of the total investment of the company is close to Rs1,157 crore, which on expanded equity comes to Rs34 per share.

Investor's Eye - August 3 2007