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Sunday, December 10, 2006
SBI Magnum Contra: Invest
Investment can be considered in SBI Magnum Contra. The fund's track record over three- and five-year periods has been impressive. With its contrarian approach, the fund seeks to invest in stocks or sectors that hold potential for appreciation but are currently undervalued or out of favour.
Contrarian funds are normally suitable for patient investors willing to wait for a market cycle to reap good returns. Magnum Contra's three- and five-year returns of 70 per cent and 62 per cent place it among the top three among diversified funds. It outpaced the benchmark BSE-100 by a huge margin over this period. However, its strong performance reflects that it has not been strictly contrarian; its performance has got a lift from its overweight position in engineering and construction stocks that have been in market fancy.
Performance: The fund's tilt towards mid-caps during 2003 and 2005 helped it to generate fairly good returns. It made a timely shift to large-cap stocks last year; and stocks with a market cap less than Rs 2,500 crore now account for 15 per cent of the portfolio and the rest are invested in large-cap.
In the past year Magnum Contra generated a return of 56 per cent. This fund has a buy-and-hold strategy and book profits marginally. And stocks such as Arvind Mills and Welspun Gujarat Stahl Rohren, despite losing close to 50 per cent of the value since the start of the year, still enjoy the fund's confidence with only a marginal drop in holdings. Hindustan Zinc, ACC and IVRCL Infrastructure delivered handsome gains.
Portfolio Overview: The fund has 47 stocks in its portfolio and the top 10 accounted for 38 per cent. It has well-diversified sectors and the top three corner 32 per cent of the asset allocation. Capital goods still get the highest allocation, followed by the auto sector. In the banking space Oriental Bank of Commerce and Union Bank of India found fancy ahead of State Bank of India.
Fund Facts: Magnum Contra was launched in July 1999 and Mr Sanjay Sinha manages the fund. The fund has an asset base of Rs 1,335 crore. Minimum investment is Rs 2,000 and the entry load is 2.25 per cent.
Tanla Solutions: Invest at cut-off
Investors with a high-risk appetite can consider taking an exposure in the public offer by Tanla Solutions. The company has a good business model in place to capitalise on the burgeoning growth opportunity in the non-voice mobile market.
The price band for the offer is Rs 230-Rs 265 per share. The price-earnings multiple works out to 16-18.5 times the annualised per share earnings for 2006-07 (aided by an exceptionally strong first half of 2006-07) on an expanded equity base. Bidding at the cut-off price is recommended, as investors will remain eligible to participate in the offer even if the price gets fixed at a lower level.
The company's strength stems from its business segments straddling a wide cross-section of the mobile messaging market with strong growth potential. It provides telecom-signalling products to mobile operators; aggregation services (by acting as a single point interface between content developers and mobile network operators) and offshore services in the area of application hosting and infrastructure management. Servicing some of the established mobile operators in the UK such as 3G, Vodafone, Virgin Mobile and O{-2} for its aggregation services, also puts the company in a good position to scale-up its service offerings.
The principal risks to our recommendation are the high client concentration, margin pressures arising from intense competition in a fragmented UK market for aggregation services and slowdown in uptake of high value-added services, as 3G rollout takes place over the next few years. Besides, the risk associated with identifying the right acquisition targets to jump-start growth in the US/Asia-Pacific market will be fairly high.
Business contours
The current promoters got their entire stake through an acquisition in 2000 when the company was known as Prism Foods; this was later renamed to Tanla Solutions. The stock is now listed on the Hyderabad, Madras and Ahmedabad stock exchanges and, following this offer, on the BSE and the NSE. The offer proceeds of Rs 360-420 crore (based on the price band) are to be used to set up infrastructure facilities for the development centre at Hyderabad (Rs 77 crore), upgradation of existing R&D centre (Rs 22 crore), back-up/disaster recovery centre at Bangalore (Rs 13 crore), overseas marketing offices in the US and Asia-Pacific (Rs 5 crore) and working capital (Rs 28 crore). A chunk of the offer proceeds is also to be made available for general corporate purposes, including acquisitions and investments in strategic businesses.
The company is seeking to ride on the huge growth potential of the non-voice mobile market that is categorised into short messaging service (SMS) and multimedia messaging services. Most research and marketing outfits, such as Mobile Messaging, Strategy Analytics and Informa Telecoms and Media, have projected a substantial growth in the total messaging market over the next few years.
Of the three business segments of Telecom Signalling solutions, messaging applications and billing services (aggregator) and offshore services, Tanla Solutions derives almost two-thirds of its revenues from aggregation services, with the balance split between the other two. In the aggregation market, it has entered into agreements with several UK-based players such as 3G, Vodafone, T-Mobile and O2 among others. It plans to extend these relationships and replicate the success in the new markets that it plans to enter.
Riding on the strength of the two acquisitions, of Techserv Teleservices (now Tanla Solutions-UK) and Smartnet Communication Systems, and the agreements forged in the UK, the company has recorded a substantial improvement in its financial performance in 2005-06 and the first half of 2006-07 compared to 2004-05.
On a consolidated basis, the company has reported revenues of Rs 63 crores in 2005-06, up from Rs 22.3 crore in the previous year, with post-tax earnings also rising five-fold to Rs 30.24 crore during this period.
The first half of 2006-07 has turned out to be even better, with revenues at Rs 87 crore and post-tax earnings at Rs 35.7 crore being higher than that for the full year 2005-06. Since the company is operating on a small revenue base, sustaining a strong pace of growth may not pose a challenge. However, maintaining the operating profit margins will be a key to sustaining the growth in post-tax earnings.
Offer details: The offer opens on December 11 and closes on December 14. The lead managers to the offer are SBI Capital Markets, IL&FS Investsmart and ICICI Securities.
Cairns IPO: On a sticky field
The biggest risk an investor will be assuming is that Cairn is unable to produce the peak quantum of oil projected from the Rajasthan field due to technical reasons. Oil reserve estimation and projection is a specialised activity and the best of methods employed could fail to provide the exact picture.
If the plateau production, which refers to the peak production that is sustainable over a period without causing irreversible damage to the field itself, turns out to be lower than the 1,50,000 barrels projected, the revenue and earnings picture could change adversely.
The infrastructure for transportation, ideally to be developed along with the field itself, is lagging and there is a disagreement between Cairn and the government nominee for the oil, MRPL, on who should set up the infrastructure. There is no clarity on the subject as yet; if anything, it is getting murkier and, ultimately, Cairn may be forced to set up the pipeline on its balance-sheet.
Though Cairn may well prefer it as a more secure option, given that the field is likely to have a 40-year life, it could lead to an increase in project costs by Rs 1,800-3,000 crore ($400-700 million).
Cairn is now in the midst of negotiations to get the best possible deal on this issue but a further delay in beginning work on the transport infrastructure could lead to either a delay or low production from the field. There could be other cascading effects as well, as disbursement of the syndicated loan is also linked to the transportation infrastructure being finalised.
The Rajasthan crude is thick, heavy and waxy which solidifies at lower temperatures. This calls for specialised production techniques such as hot water injection into the wells. While the technology is not new and has been employed elsewhere in the world, it has not been tried out on a scale that is envisaged by Cairn. A likely fallout of this technology not working satisfactorily is lower production from the field as the well pores could get blocked by the wax in the oil. Access to non-stop water supply and energy for heating the water is also critical here.
Cairn plans to use the associated gas production from its smaller fields in the South to produce power for heating the water, which will come from a saline ground aquifer in the vicinity of the project.
The price at which the crude will be sold will be decided closer to the production date. The price will be based upon a basket of crude oils similar in quality to the Rajasthan crude and has to be agreed upon by Cairn and the main buyer, ONGC/MRPL.
Given the quality of the crude, it is likely to sell at a discount of 5-10 per cent to Brent, an industry benchmark. A disagreement on pricing could lead to litigation with implications for revenue and earnings.
Cairn and the government have not been able to come to an understanding on the issue of cess on the oil produced. Cairn, relying on the production-sharing contract terms, disputes the government contention that it is liable to pay cess. The present cess is Rs 2,500 per tonne ($8.14 per barrel) and, according to the existing practice in other fields, can be recovered as cost by Cairn. But it will still mean lower earnings for the company.
Cash flows from the project will begin only in 2009/10; in the interim, Cairn is likely to suffer negative cash flows due to its being in the investment phase. This risk gets accentuated if one factors in the fact that the Ravva oil and Gauri gas production are projected to decline from 2007; gas production from the Lakshmi field has entered the decline phase.
This could have cash flow implications as about Rs 1,890 crore ($420 million) of the total Rajasthan project cost is expected to be funded by cash flows from the existing assets.
Cairn India: Invest at cut-off
Cairn India's Initial Public Offer is for investors with an appetite for high risk and the stamina to stay invested in the stock for the long term. First oil from the Rajasthan field, the development of which will be partly financed by this IPO, will not begin to flow until mid-2009, assuming the project is on schedule. Capital appreciation in the interim may not be adequate to justify the investment risk assumed.
Our recommendation to invest is subject to some significant risks(see article alongside), but Cairn's track record as an explorer and producer of oil in India and its ability to access the latest technology and resources for exploiting the Rajasthan field lend confidence.
Cairn is the operator of the prolific Ravva offshore oilfield on the east coast where it produces about 50,000 barrels of oil per day. It took over the project in the mid-1990s when the field was producing around 3,500 barrels and developed it in phases to the present level.
Cairn also operates two gas fields — Lakshmi and Gauri — offshore Gujarat that yielded 35.4 billion cubic feet of natural gas in 2005. Apart from these, the company has an interest in 10 exploration blocks that are under various stages of exploration.
The Rajasthan project
The Rajasthan project consists of three major fields — Mangala, Bhagyam and Aishwarya — and two smaller ones — Raageshwari and Saraswati. Together, these fields are projected to produce 1.5 lakh barrels of oil per day at the peak level in 2011 beginning in phases from mid-2009. To put this in perspective, ONGC produces approximately 5.75 lakh barrels of oil per day .
The Mangala field is the biggest and is projected to produce more than 1,00,000 barrels at the peak level. DeGolyer and MacNaughton, a well-known independent petroleum engineering consultant, has certified the reserves in the Rajasthan Block at 568 million barrels of oil against Cairn's own estimate of 632 million barrels.
Assuming that the block development happens according to schedule, peak production will be reached by 2010-11 and be sustained for three years before the field goes into the decline phase.
The production-sharing contract for the Rajasthan block lasts till 2019 but the field's life can be extended up to 2041 through further development and by adopting enhanced oil recovery techniques.
Cairn has estimated the cost of developing the Rajasthan fields at $1.5 billion; $600 million of that will be financed through the IPO and another $850 million through a syndicated loan facility. The Rajasthan fields are shallow, which means that reservoir pressure will be lower than in deeper fields and Cairn will have to adopt artificial methods to increase pressure for the oil to flow out by itself.
The bigger problem in the Rajasthan field, of course, is that the oil is heavy and has a thick, waxy residue with a propensity to solidify at low temperatures.
Cairn will be adopting methods to maintain reservoir temperature at a high level through injection of hot water and steam into the wells to help move the oil and to prevent it from solidifying.
Transportation of this oil would also require specialised heated pipelines for to enable the oil to flow. This is one of the downsides of this IPO as the transportation aspect has not been tied up yet.
There is a disagreement between Cairn and the officially-nominated buyer of the crude, Mangalore Refinery and Petrochemicals (MRPL), over whose responsibility it would be to install the pipeline infrastructure. Cairn could end up installing the pipeline in which case its project cost could go up.
Issue details
Cairn hopes to raise between Rs 8,600 crore and Rs 10,200 crore ($1.9-2.2 billion) from this IPO, depending on the price band and without accounting for the greenshoe option. Of this, Rs 5,934-7,265 crore ($1.4-1.7 billion) will be paid to Cairn Energy Plc, the parent company, in part consideration for acquisition of shares in Cairn India Holdings, which owns the producing assets of Cairn in India as also the Rajasthan block.
Apart from cash, the parent company will also be allotted 86.17 crore shares at the same price as the IPO to fulfil the balance consideration payable taking its stake to 69.5 per cent of the post-issue equity. The net offer to the public without the greenshoe option is 32.88 lakh shares. The offer, which is open between December 11 and 15.
Pyramid Saimira Theatre: Invest at cut-off
Pyramid Saimira Theatre's (PSTL) proposal to upgrade and digitalise theatres across the country makes the stock an interesting exposure in the film exhibition space. At the upper end of the price band, the offer values the company at 29 times its annualised FY-07 earnings, on a fully expanded equity base. The valuation is at a discount to peers such as PVR and Inox Leisure, and it is likely to improve as the company adds more theatres to its fold. However, challenges in execution, relative lack of experience of promoters in the theatre business and an untested concept make it suitable for investors with a high-risk appetite and those looking to diversify their portfolio with an offbeat stock.
PSTL was engaged in the production of films. It discontinued that business to concentrate on its "mega digital theatre chain" project, which it launched in November 2005. With 148 screens under its fold, PSTL has built a strong presence in the Southin a short period.
It has achieved this by entering into lease agreements with traditional stand-alone theatres that have been suffering the onslaught of multiplex chains. The company is focusing on the Tier-II cities , where films are typically released several weeks after their launch in top rung cities. By that time, the quality of the print deteriorates, resulting in a poor viewing experience. Moreover, pirated copies hit the market before the originals make it to the theatres and eat into the revenues. Stand-alone theatres in these towns tend to suffer from low occupancy rates as well as low admission prices.
Going digital
PSTL hopes to overcome these problems by setting up digital theatres. Essentially, this does away with the celluloid film, which costs about Rs 60,000-70,000 to print. Because of the stiff costs involved, production houses order 300-400 prints that are played in theatres in A category cities alone; the real requirement is about 12,000 as there are as many screens in the country. However, a digital print is not as expensive. Through satellite as many as 12 films can be launched simultaneously across different theatre locations, even as print costs are contained.
The upfront cost of setting up a digital theatre is steep and this has prevented traditional theatres from upgrading. However, with these theatres finding it difficult to compete with the modern organised multiplexes, they appear amenable to agreements with outfits such as PSTL, where the latter takes over operation of the theatre, refurbishes them and converts them into digital theatres. PSTL pays theatre owners a rent, and retain the box-office collections.
PSTL hopes to lease out 120 theatres in A category towns and 235 theatres in B and C ones by March 2007. It hopes to increase utilisation levels and admission rates with latest film releases, strong content and better theatre experience. The model, however, will remain low cost, with its average ticket priced at around Rs 30, against Rs 80-90 charged by most multiplexes.
Technological tie-ups
But PSTL will save on capex through its tie-ups with other players with experience in the digital cinema space. It has tied up with Valuable Media (which runs its digital initiative under the name UFO Moviez) for the installation of comprehensive digital cinema systems in 1,000 theatres. These services will be provided on a "pay-per-view" basis.
It has also tied up with the Chennai-based Prasad Labs for the conversion of films to high definition format; with Real Image for sound systems; with Tatanet for bandwidth and has arranged with Delta Electronics, Taiwan, to import projectors. The tie-ups lend confidence.
Territorial dominance
The other interesting aspect of the PSTL business model is establishing dominance in a distribution territory. While there are players operating at the national level, the distributor continues to exert greater negotiating power. The recently-released mega-starrer Dhoom-2, for instance, saw distributors asking for a higher share of revenues. Large multiplexes such as PVR Cinemas failed to reach an agreement on the terms of revenue sharing and did not screen the movie; this resulted in lost revenue potential.
PSTL's model focuses on gaining critical mass in territories so that they will be too large for distributors to ignore. This could help it secure strong content, which will attract audiences.
Risks
While the business model appears to be well conceived, the following risks will have to be considered.
One, because it operates on a low-cost format and seeks territorial dominance, the success of its venture rests almost completely on execution. PSTL hopes to have 2,000 screens in its fold by 2010. That is the number of theatres that should be willing to hand over their operations to the company. Theatre owners may prefer to sell their properties to real estate developers, rather than lease them out.
Two, in the immediate term, the focus will be on gaining scale. Upgradations and digitalisation will happen once PSTL has about 400-500 theatres under its fold. Profit growth could be moderate until revenues from the new initiatives kick in.
Three, its fortunes remain vulnerable to the success of films at the box office, just as for multiplexes. It will have to ensure capacity utilisation at 25-30 per cent for it to break even.
The risks are more because PSTL assumes all the risks of the business as it takes over from theatre owners.
Finally, the success of the technology at such a scale is yet to be proven.
Offer details: About 85 lakh shares are on offer. The price band is Rs 88-100. At the upper end, the offer will raise Rs 85 crore.
About Rs 35 crore of the proceeds will go towards upgradation of theatres, Rs 25 crore towards digitisation and the balance towards rental/security deposits and working capital. The offer opens on December 11 and closes December 18. The lead manager is Keynote Corporate Services.
Everest Kanto Cylinders: Hold
Investors with a long-term perspective can hold on to the stock of Everest Kanto Cylinders (EKC), a major player in the manufacture of seamless steel gas cylinders. Despite the fact that the stock has appreciated considerably after its debut listing last year, we believe there is room for growth in the long term. The market for compressed natural gas (CNG) vehicles is set to expand, and EKC will be among the front-runners to benefit from this trend. Its presence in Dubai and China and capacity additions give fillip to the company's growth prospects. The stock trades at about at about 15 times the expected per-share earnings for FY-2008. Corrections, if any, may be used as good entry opportunities for fresh exposures.
Investment Rationale
The demand for CNG vehicles is expected to grow given the firm oil prices, lower running cost and rising environmental concerns. The Supreme Court's decision mandating the use of CNG as auto fuel for heavy vehicles in New Delhi has created a demand for such cylinders by both OEMs (original equipment manufacturers) and retrofitters (conversion agents). The court has also mandated that vehicles in 28 highly polluted cities switch to CNG. With a market share of more than 80 per cent, EKC stands to benefit the most from this shift. The CNG segment, thus, would prove to be a major revenue driver. However, non-availability of proper CNG infrastructure in cities may prove a major drawback.
EKC also manufactures industrial, medical and beverage cylinders. The industrial segment is likely to witness steady growth driven by an upsurge in industrial capex.
The use of piped gas in the residential and industrial segments, if and when it takes off, could contain the growth in these segments. However, this is unlikely to be of concern in the medium term.
Export initiatives
The CNG segment is the fastest growing market both in India and abroad. EKC's manufacturing plant in Dubai caters to demand from Malaysia, Thailand, several Gulf countries and CIS (Commonwealth of Independent States) nations, besides Pakistan (EKC has a market share of about 65 per cent in Pakistan). It has also set up a manufacturing plant in China through a 100 per cent subsidiary. The Chinese market is likely to be the growth driver, given that the country is witnessing a boom in CNG vehicles.
Further, EKC's effort to consciously target gas-rich nations is likely pay off, as the number of players in the export market is limited.
Financials
For the quarter ended September, EKC recorded a 74 per cent increase in net sales on a year-on-year basis. Its net profit grew 46 per cent despite an increase in expenditure. This was mainly due to better realisations for its products, reflecting the pricing power that EKC enjoys over its peers. Moreover, a rising demand vis-Ã -vis limited supply scenario also augurs well for the company.
Concerns
Specialised seamless tubes, a major raw material for EKC, is difficult to source as only a few suppliers in the world produce it in large volumes. Cylinder manufacturers, in comparison to the oil-rig applications, do not enjoy much bargaining power with the suppliers. Thus any rise in steel prices is likely to be passed on to them. Hence, EKC's capability in sourcing raw materials appears crucial.
In addition to this, any fade out in the market appeal for CNG will pose a risk to the revenue stream of the company. Delays in expansion plans, slowdown in the growth of economy or a fall in oil prices are other risks to our recommendation.
Bharat Electronics: Buy
Investments in Bharat Electronics can be considered with a two-three year perspective. Healthy order book, robust cash flows and moves to reduce dependence on revenues from defence sector augur well for the earnings growth of Bharat Electronics (BEL).
The company also holds a track record of paying liberal dividends. The stock trades at 14 times its expected earnings for FY07, assuming a 19 per cent growth in earnings.
BEL is one of the largest manufacturers and suppliers of wireless and satellite communication equipment, electronic surveillance systems and simulators for the defence sector and electronic systems in the civilian segment. At present, the company maintains its forte in the defence business and has collaboration with Defence Research and Development Organisation. It has a number of system developments to launch new products are at an advanced stage through this collaboration. Development of newer products and initiatives in research are likely to help the company maintain its dominant position in the electronic defence sector despite opening up of the defence market to private sector.
While defence has so far accounted for over 80 per cent of its revenues, the company is working towards changing the revenue mix through increased activity in the civilian segment. Initiatives in areas such as end-to-end solutions for FM transmitters, opportunities in expansion of CDMA and GSM networks and solar lighting systems have started yielding results. We expect a more balanced business mix by 2008 that may well mitigate risk of dependence on a single sector. While order book as of March 2006 stood at over Rs 6,600 crore (about two times FY06 revenues), the company booked about Rs 800 crore of new orders in the first half of FY07. We expect this order book to comfortably sustain growth for the next couple of years.
The earnings scorecard for the half-year ended September 2006 remained flat for BEL owing to delayed revenue booking, especially from the defence sector. The company has in earlier years shown a weak trend in the first half of the year with a majority of revenues catching up in the latter half. Though operating profit margins have been muted in the latest quarter, it is expected to bounce back as revenue flow increases in the second half.
Prabhudas Lilladher : Fundamental Check
Prabhudas Lilladher remain positive on sectors such as Auto, Banking, Cement and Engineering.Their top large-cap picks are Maruti, M&M, ICICI Bank, Larsen & Toubro, Relaince Communications and Grasim.
According to the brokerage house, the markets have moved up and are now trading at 18.8x for the Sensex and 17.7x for the Nifty on FY07 estimates. "Despite seemingly rich valuations, we believe sustaining liquidity (on the back of steady interest rates) and strong earnings growth (29.6% in the previous quarter) will keep the positive momentum in India going over the medium to long-term."
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Prabhudas Lilladher- Cairn IPO
Prabhudas Lilladher has recommend investors to subscribe to the public issue of Cairn India.
According to the brokerage house, in a pre-IPO private placement, Cairn India had placed about 11.88% (of the post-issue capital) or 209.7m shares at Rs 176.5 each.
The report added that, at the middle of the price band (Rs 160-190), the stock trades at an EV/Boe of $12.7, which seems to be on the higher side compared to the global peer $11.5 average. Moreover, it is almost at an 80% premium to ONGC’s current EV/Boe of $6. However, ONGC’s valuations are impacted by subsidies, lack of clarity regarding policies and no substantial recoveries over the past decade.
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