Citigroup - Tata Consultancy Services

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Sharekhan Investor's Eye dated January 15, 2007

PULSE TRACK

• November 2006 IIP zooms to 14.4%

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STOCK UPDATE

Marico
Cluster: Apple Green
Recommendation: Buy
Price target: Rs634
Current market price: Rs580

Intangible gains

Key points

• The board of directors of Marico has approved a proposal to split the stock in the ratio of 1:10.
• The board has also proposed financial restructuring to write off the intangibles against the reserves.
• The restructuring will lead to a leaner balance sheet and better return ratios.
• Due to the restructuring our earnings estimate would be higher by 17.1% for FY2008. We are not changing our earnings estimates and price target but will be revisiting the same after the Q3FY2007 results.
• The stock is trading at a price/earnings ratio of 24.1x FY2008E and enterprise value/earnings before interest, depreciation, tax and amortisation of 13.7x FY2008E. We continue to remain bullish on Marico and reiterate a Buy on the stock with a price target of Rs634.

Elder Pharmaceuticals
Cluster: Apple Green
Recommendation: Buy
Price target: Rs508
Current market price: Rs397

Price target revised to Rs508

Key points

• The revenues of Elder Pharmaceuticals (Elder) grew by 28.6% in H1FY2007 and by over 30% in Q2FY2007. We expect this 30% + growth trend to continue into H2FY2007 on the back of the sustained momentum in the company’s core brands, pick-up in the revenues from the in-licenced products and the growing contribution from the Fairone brand.
• Elder has been spending aggressively on advertising and promoting its existing products. With the increased penetration of its existing brands, rapid pace of new product launches and new in-licencing deals, we believe the growth momentum will continue in FY2008 as well.
• A lower raw material cost on account of backward integration into active pharmaceutical ingredients (APIs), an improving product mix, and substantial excise and tax savings arising out of the shift of manufacturing to the plants in the fiscal havens of Uttaranchal and Himachal are expected to improve the margins of the company. The increased selling and marketing expenses, on the other hand, are likely to put pressure on the margins. We expect Elder’s margins to expand by 180 basis points to 19% in FY2008E.
• To account for the above, we have revised our revenue and earnings estimates for Elder. We have revised Elder’s revenue estimates upward by 9.2% and 12.9% to Rs457.5 crore and Rs562.1 crore for FY2007 and FY2008 respectively. We have also upgraded Elder’s net profit estimate by 10.4% to Rs55.7 crore and Rs74.8 crore for FY2007 and FY2008 respectively.
• In view of its strong growth potential, we remain positive on Elder’s future growth prospects. At the current market price of Rs397, Elder is quoting at 9.9x our revised FY2008 earnings estimate. Based on our revised earnings, we are upgrading our price target for the stock to Rs508.

Aban Offshore
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs2,090
Current market price: Rs1,670

Results in line with expectations

Result highlights

• Aban Offshore Ltd (AOL) reported a 4.5% growth in its stand-alone revenues to Rs126.1 crore for the third quarter ended December 2006.
• The operating profit margin (OPM) declined by 310 basis points to 54.8% largely due to higher insurance charges (up 260 basis points) and an increase in the other expenses (up 660 basis points due to the amortisation of the expenses related to the foreign currency convertible bond issue done earlier). On the other hand, the savings in the staff cost and repairs as a percentage of sales limited the decline in the OPM.
• The net profit grew at a relatively higher rate of 13% to Rs20.8 crore in line with expectations. The growth in the bottom line was aided by an 87% jump in the other income to Rs5.6 crore. However, it should be noted that the company does not declare consolidated quarterly results and the stand-alone results do not reflect the robust growth in the earnings on a consolidated basis. We expect the performance to improve significantly in FY2008 and FY2009 due to the huge incremental gains from the additional assets and the scheduled re-pricing of its assets at relatively much higher day rates going forward.
• Along with the results, the company has announced the signing of a joint venture with the state government of Gujarat to offer offshore drilling services. The memorandum of understanding (MoU) has been signed between Gujarat State Petroleum Corporation (nominee of the Gujarat state government) and AOL’s subsidiary, Aban 8 Pte Ltd. The joint venture would function through a special purpose vehicle. The company is expected to spell out the specific details about the scope and scale of the operations of the new venture over the next couple of months.
• At the current market price the stock trades at 14x FY2008 and 6.8x FY2009 consolidated earning estimates. We maintain our Buy call on the stock with a price target of Rs2,090 (based on the derived value of its subsidiaries combined with the calculated value of its stand-alone earning estimates).

UTI Bank
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs580
Current market price: Rs535

Performance above expectations

Result highlights

• UTI Bank's Q3FY2007 profit after tax (PAT) reported a 40% year on year (yoy) growth to Rs184.6 crore which is 6.4% higher than our estimate of Rs173.5 crore, mainly due to a higher trading income reported during the quarter.
• The net interest income (NII) was up by 44.7% to Rs415.8 crore compared with our estimate of Rs407 crore. The reported net interest margin (NIM) expanded by six basis points yoy and by eight basis points quarter on quarter (qoq).
• The other income zoomed by 61.3% to Rs279.7 crore due mainly to a higher trading income while the core fee income growth remained robust at 58.9% yoy.
• The operating expenses continue to remain high due to a significant increase in the employee expenses and network expansion.
• The bank currently has a network of 481 branches with 2,126 automated teller machines (ATMs). This has helped the bank to grow its savings and current account deposits by 58.8% and 61.3% respectively compared with the overall deposit growth rate of 49.7% and improve its current and savings account (CASA) ratio to 37.1% from 34.7% yoy. However on a sequential basis, the CASA ratio has declined to 37.1% from 40% in Q2FY2007 mainly due to a 14.2% quarter on quarter (q-o-q) decline in the current account balance.
• The capital adequacy ratio (CAR) for the bank as on December 2006 stood at 11.8% with the tier-I capital at 6.96%. The bank has already raised Rs420 crore of hybrid tier-I capital and exhausted the headroom to raise more funds using the same route. Hence, considering the growth potential of the bank, we feel the bank needs to come out with a plain equity issue in FY2008. We have factored in an equity dilution of 3.6 crore shares (12.8% of pre-issue equity capital) at an issue price of Rs500 per share. This would help the bank to raise Rs1,800 crore and improve the tier-I ratio to above 8%. The book value (BV) per share would increase by almost Rs40 per share post-dilution from our previous pre-issue estimates.
• Based on the improved performance of the bank we have also increased our FY2007 and FY2008 PAT estimates by 7.3% to Rs645 crore and Rs829 crore respectively. Thus the revised FY2007 earnings per share (EPS) estimate stands at Rs23.2, up from Rs21.6. The equity dilution assumed by us has reduced the FY2008 EPS estimate rom Rs27.8 to Rs26.4. At the current market price of Rs535 the stock is quoting at 20.3x its FY2008E EPS, 10.3x its FY2008E pre-provisional profit (PPP) and 2.9x its FY2008E BV. We feel the dilution would be BV accretive and hence maintain our Buy recommendation on the stock with a revised price target of Rs580.

Nicholas Piramal India
Cluster: Apple Green
Recommendation: Buy
Price target: Rs393
Current market price: Rs262

Earnings upgraded

Key points

• Nicholas Piramal India Ltd (NPIL) and Eli Lilly and Co have signed a landmark new drug development agreement to develop and, in certain regions, commercialise a select group of Lilly's pre-clinical drug candidates that span multiple therapeutic areas. This agreement indicates the world-class research and development (R&D) capabilities of Nicholas Piramal.
• While NPIL's landmark deal with one of the leading innovative drug researchers like Eli Lilly has infused confidence among the investors the domestic formulations business has reported a more than expected growth. Alongside, the increased momentum in its CRAMS business and the successful integration and improvement in the capacity utilisation of the recently acquired facilities at Morpeth, UK (from Pfizer) enhances the earning visibility of the company. Hence, we are revising our estimates upward for FY2007 and FY2008.
• With the better than expected growth in the domestic formulation business, particularly in respiratory, anti-diabetics, gastrointestinal, dermatology, NSAIDs etc and the strong bounce back in the cough and cold brand--Phensedyl--we are revising the compounded annual growth rate (CAGR) of the formulation business from 12% to 14% during FY2006-08. On the other hand, the exports, largely supported by the successful integration and improvement in the capacity utilisation at Morpeth and the steady growth in the CRAMS business, would grow at a CAGR of 88% during FY2006-08. Hence, we are revising our revenue estimates to Rs2,347.8 crore and Rs2,770.1 crore for FY2007 and FY2008, respectively.
• On the margin front, we estimate a 480-basis-point expansion to 17.3% during FY2006-08, which would largely be driven by the increasing high-margin revenue flow from CRAMS, progressive shifting of manufacturing to excise-exempt facility at Baddi (Uttaranchal) and improved operating leverage at the Morpeth facility.
• With the improving revenues and margin coupled with the lower tax burden due to the commissioning of the manufacturing facility at Baddi,  we estimate the net earnings at Rs232.8 crore (87% growth) and Rs345 crore (48% growth) for FY2007 and FY2008, respectively. Our revised earnings estimates stand at Rs11.0 per share for FY2007 and Rs16.4 per share for FY2008. At the current market price of Rs262, NPIL is discounting its FY2008 estimated earnings by 16.0x.
• As per our revised estimates, we have valued NIPL's continuing business at Rs360 and have valued the drug development deal at Rs33 (ie 10x of the risk-adjusted EPS of Rs3.3). While valuing the drug development deal, we have just valued the potential milestone earning and ignored the potential royalties from the sale of the product by Eli Lilly in the USA, the EU & Japan and the revenue potential from the sale of the product by NPIL in other selected markets. Hence, we are fixing a revised target price of Rs393.

HCL Technologies
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs720
Current market price: Rs630

Firing on all cylinders

Result highlights

• HCL Technologies has reported a revenue growth of 6.2% quarter on quarter (qoq) and 39% year on year (yoy) to Rs1,465.1 crore for the second quarter ended December 2006, which is slightly below expectations. The sequential growth was largely driven by a 12.5% increase in the revenues of the infrastructure management service (IMS) business. On the other hand, the business process outsourcing (BPO) and software services businesses grew at a relatively lower rate of 5.4% and 5.2% respectively, on a sequential basis.
• The earnings before interest, tax, depreciation and amortisation (EBITDA) margins improved by 40 basis points to 22.1% on a sequential basis, despite the annual salary hikes given to 15% (senior and middle management level) of its work force with effect from October, the adverse impact of the steep appreciation in the rupee (3.6% appreciation in the average realised exchange rate against the US dollar) and the relatively higher selling, general and administration (SG&A) cost as a percentage of sales. The margin expansion was primarily driven by the higher employee utilisation (positive impact of 120 basis points) and better realisations (positive impact of 140 basis points).
• In terms of segments, the EBITDA margins of the software service and BPO businesses improved by 60 basis points and 40 basis points respectively. On the other hand, the IMS business reported a marginal decline in the margins to 17.5%, down 10 basis points sequentially.
• The earnings grew a a robust rate of 14.4% qoq and 57.8% yoy to Rs286.2 crore (ahead of our expectations of Rs258.8 crore and the consensus estimates of a flat growth sequentially). The growth in the earnings was also aided by the huge foreign exchange [forex] gains of Rs34.7 crore on the open forward contracts.
• In terms of operational highlights, the management indicated that the ramp-up in the large deals is beginning to make a material impact on the overall performance. The revenues from the six multi-million multi-year deals contributed to around 10% of the total turnover and is reflected in the third consecutive quarter of over 8% quarter-on-quarter (q-o-q) growth in the software services business in the dollar terms. What's more, the EBITDA margin on the revenues from the large deals is indicated to be higher than the average margins of the company.
• At the current market price the stock trades at 18.8x FY2007 and 15.2x FY2008 estimated earnings. We maintain our Buy recommendation on the stock with a price target of Rs720.

Tata Consultancy Services
Cluster: Evergreen
Recommendation: Buy
Price target: Under review
Current market price: Rs1,328

Q3FY2007—fist cut analysis

Result highlights

• Tata Consultancy Services (TCS) has reported a growth of 8.4% quarter on quarter (qoq) and of 40.8% year on year (yoy) in its consolidated revenues to Rs4,860.5 crore. The sequential revenue growth was largely driven by a 7.87% growth in volumes, a 2% improvement in the billing rates and productivity gains of 2.6% on the fixed price projects. On the other hand, the revenue growth was dented by 2.46% due to the appreciation of the rupee and by 1.56% from the shift towards offshore business.
• The earnings before interest and tax (EBIT) margins improved by 79 basis points to 26.1% on a sequential basis. The steep appreciation of the rupee dented the margins by 1.37% that was more than made up by the positive impact of 1.74% from the higher billing rates, 0.28% from the shift towards offshore business and 0.14% from the cost efficiencies. The company maintained its broad guidance of maintaining the full year margins close to 25.8% reported in FY2006.
• The other income stood at Rs30 crore (includes foreign exchange fluctuation gain of around Rs5 crore), up from Rs7.7 crore in Q2FY2007. Consequently, the earnings grew at a relatively higher rate of 11.4% qoq and 47.2% yoy to Rs1,104.7 crore.
• In terms of operational highlights, the company added 5,562 employees and 5 new clients during the quarter. It also bagged five large deals; two deals of over $100 million and three deals of over $50 million.
• Given the higher-than-expected performance, we would be revising upward the earnings estimates and the price target in the detailed result update. We maintain the Buy call on the stock.

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Merrill Lynch, Citigroup - TCS, Divi's Lab

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Merrill Lynch - TCS

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Motilal Oswal - TCS

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Kotak - TCS

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Sharekhan Investor's Eye - Oct 16

KEI Industries
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs500
Current market price: Rs361

Power packed performance

Result highlight

• In Q2FY2007 KEI Industries (KEI) recorded a robust growth of 96% year on year (yoy) in its net profit to Rs10.1 crore. The growth was in line with our expectations.
• KEI's net sales for the quarter rose to Rs136.8 crore, up 108.6% yoy and by 37.7% quarter on quarter (qoq). The revenues from the cable segment grew by 105.3% yoy and by 35.6% qoq on the back of expanded capacities.
• The operating profit grew by 142.5% yoy and by 45.2% qoq as the operating profit margin (OPM) expanded by 225 basis points yoy and by 83 basis points qoq.
• However, the pressure on the raw material cost continued as the raw material consumed (RMC)/sales ratio increased by 100 basis points to 70.1% during the quarter.
• The profit before tax (PBT) increased by 137% yoy and by 39.5% qoq. However, the net profit grew by a lower 95.8% yoy and by 33.2% qoq because of a higher effective tax rate.
• KEI is planning a foreign currency convertible bond (FCCB) issue of $35 million (Rs150 crore) to fund its expansion at Uttaranchal. The funds would be raised over the next three to four weeks. The promoters are ready to dilute their stake up to 10% which means the issue may be priced at Rs440-450 per share.
• At the current market price of Rs361, the stock quotes at 7.4x its FY2008E earnings per share (EPS) and 4.5x its enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA). We maintain our Buy recommendation on KEI with a price target of Rs500.
  

Crompton Greaves
Cluster: Apple Green
Recommendation: Buy
Price target: Under review
Current market price: Rs240

Margins under pressure

Result highlight

• Crompton Greaves' revenues grew by 48.6% year on year (yoy) in Q2FY2007 to Rs824.0 crore, beating our expectations. Although all its three divisions reported a strong performance, the power system division led the pack with a revenue growth of 68.7% yoy to Rs449.7 crore. The revenue of the consumer product division grew by 33.3% yoy to Rs225.3 crore and that of the industrial system division grew by 36.8% yoy to Rs226.1 crore.
• The raw material cost/sales ratio spiked to 75.6% in Q2FY2007 from 69.5% in Q2FY2006 largely due to an increase in the prices of the base metals like copper and steel, and the inability of the company to pass on the same to its customers. However, lower employee and other expenses muted the impact of the same. Consequently, the operating profit margin (OPM) reduced by 60 basis points yoy to 8.9% and the operating profit for the quarter grew by 39.1% to Rs73.6 crore.
• The profit before interest and tax margin of the power system division declined by 50 basis points to 8.0% during the period. The high-margin businesses maintained their margins (the consumer product division's margin was up 10 basis points to 9.7% and the industrial system division's margin was up 20 basis points to 13.6%).
• Crompton Greaves moved out of the ambit of the minimum alternate tax (MAT) in Q3FY2006 and hence paid tax at the full tax rate in Q2FY2007 as against at the MAT rate in Q2FY2006. Also, it provided for deferred tax to the tune of Rs7.5 crore. The increased tax provisioning led to a slower growth of 25.0% yoy to Rs40.7 crore in the profit after tax. But the growth was still in line with our expectations.
• The top line and PBT of its Belgium subsidiary, Pauwels, stood at Rs595.38 crore and Rs21.3. crore respectively during the quarter.
• The stand-alone order book grew by 0.6% sequentially and by 20.0% yoy to Rs1,800.0 crore in Q2FY2007. The consolidated order book stood at Rs3,739.0 crore.
• The board has announced a bonus of two shares for every five shares held.
• The stock is currently hovering around our price target of Rs239. Although the top line performance of Crompton Greaves in H12007 has beaten our estimates, yet there is a severe threat to the OPM going forward and the same poses a risk to our call. We are in the process of revising our estimates and may revise our price target as well.
• At the current market price of Rs240, Crompton Greaves is trading at 28.4x its FY2008E stand-alone earnings and 19.1x it's FY2008E consolidated earnings.
  

UltraTech Cement
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs1,000
Current market price: Rs886

Results below expectations

Result highlight

• UltraTech Cement Ltd (UCL) has announced a net profit of Rs127.4 crore for Q2FY2007 and the same is below our expectations, primarily because of higher-than-expected power & fuel cost and other expenditure.
• The company's revenue for the quarter grew by a healthy 58.3% to Rs1,004 crore driven by a 17% rise in its cement volume and a 35.2% increase in its cement realisation.
• The operating profit for the quarter grew by 291.8% to Rs254.5 crore as the operating profit margin (OPM) expanded by 15.1 percentage points to 25.3%. The same was however below our expectations primarily because of higher-than-expected power & fuel cost and other expenditure.
• During the quarter UCL�s jetty situated at its Gujarat plant was non-operational for about 15 days. Hence the company not only lost some export volumes but also had to incur an additional expense of Rs15-20 crore on its repairs. Also the packing cost has gone up by Rs10 crore. This in turn increased the other expenditure per tonne by 30% yoy. Had these costs not been there, the company would have easily met our estimates.
• During the quarter UCL's cost per tonne of cement increased by 12.5% against a 35% rise in realisation per tonne. Hence its earnings before interest, tax, depreciation and amortisation (EBITDA) per tonne in the quarter stood at Rs691 against Rs206 per tonne in Q2FY2006.
• On the back of flat interest cost and depreciation charge, the net profit for the quarter registered a quantum jump to Rs127.4 crore during the quarter.
  

Tata Consultancy Services
Cluster: Evergreen
Recommendation: Buy
Price target: Rs1,325
Current market price: Rs1,130

Margins firm up

Result highlight

• For Q2FY2007 Tata Consultancy Services (TCS) has reported a growth of 8.2% quarter on quarter (qoq) and of 42% year on year (yoy) in its consolidated revenues to Rs4,482.2 crore. The sequential revenue growth was largely driven by a 10.8% quarter-on-quarter (q-o-q) growth in the international business with the domestic revenues declining by 14.3% on a sequential basis. The international business witnessed a strong volume growth of 11.33% sequentially.
• The earnings before interest and tax (EBIT) margins improved sharply by 294 basis points to 25.3% on a sequential basis. Apart from the impact of lower visa cost, the margins were boosted by an offshore shift (67 basis points), gains from foreign exchange (forex) movement (50 basis points) and an overall improvement in the employee productivity (driven by better realisations and operational efficiencies). The EBIT margins were also positively impacted by the write back of Rs46.8 crore worth of provisions (made for the provident fund earlier) and lower provisioning for bad debts during the last quarter. The operating profit grew by 21.4% qoq to Rs1,229.4 crore.
• Consequently, despite the sharp decline in the other income to Rs7.7 crore (down from Rs66.8 crore reported in Q1), the consolidated earnings grew by 15% qoq and by 43.7% yoy to Rs991.5 crore (higher than the consensus estimate of around Rs835 crore).
  w In terms of outlook, the company does not provide any specific growth guidance. However, the management reiterated that the demand environment is quite favourable. It is also confident of maintaining the EBIT margins at around the 25.8% level (on the full year basis) in line with FY2006. This implies a significant improvement in the EBIT margins in the second half as the margins stood at 23.9% during the first half ended September 2006.
• The company has announced an interim dividend of Rs3 per share.
• At the current market price the stock trades at 27.8x FY2007 and 22.1x FY2008 revised earning estimates. We maintain our Buy call on the stock with a price target of Rs1,325.

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