Roundtable Conference 2007

Chetan Parikh: Good evening Ladies and Gentlemen,

On behalf of Capitalideasonline.com, I would like to thank all of you for taking time out to be with us this evening for the Annual CIO Investor and Fund Managers’ Roundtable.

Let me first tell you an anecdote:

“In the 1930s, out of power and financially strapped, Churchill taught a lecture course at Cambridge on human sociology. One afternoon standing at the lectern and, always prone to the dramatic, he turned to the large class and demanded, “What part of the human body expands to 12 times its normal size when subjected to external stimulation?”

The class gasped. Churchill, obviously relishing the moment, pointed at a young woman in the tenth row. “What’s the answer?” he demanded.

The woman flushed and replied, “Well, obviously it’s the male sexual organ.”

Wrong!” said Churchill. “Who knows the correct answer?”

Another woman raised her hand. “The right answer is that it’s the pupil of the human eye, which expands to twelve times its normal size when exposed to darkness.”

“Of course!” exclaimed Churchill, and he turned back to the unfortunate first woman. “Young lady,” he said, “I have three things to say to you. First, you didn’t do the homework. Second, you have a dirty mind, and third, you are doomed to a life of excessive expectations.”

The reason why I recounted that story is that the key to successful investing is expectations and you can make money and much more than 12 times when your expectations differ materially from those embedded in market prices and you are right.

And you increase your chances of being right when you have an edge.

Bill Miller, the market beating portfolio manager of Legg Mason, wrote that there are three sources of competitive advantages that an investor can develop: informational, analytical or behavioral.

Informational is when you know something material that others don’t. It is extremely difficult to get that edge in large, well researched stocks unless you act unethically on inside information. But small and midcap stocks, which are outside the radar of most brokerage houses, offer possibilities of developing that edge.

Take the second sort of edge: Analytical advantages come from taking publicly available information and processing and assessing it differently from others. And finally, there is the behavioral edge and there are ways to systematically exploit human behavior in the financial markets. I don’t want to go into prospect theory, support theory, cognitive psychology and neuroscience but behavioral finance and investor psychology are as important as understanding financial statements and valuation metrics.

Capital Ideas Online has promoted Capital Ideas Club. You may be seeing the banners and pamphlets of Capital Ideas Club and may well wonder why you need a CIC when you have CCI in Bombay.

Capital Ideas Club is an exclusive investment community where the best value investment ideas are presented and reviewed by other expert investors.

I urge you to apply for membership because this will be a great way to become a better investor and analyst as your ideas will be shared in an online forum with other expert value investors.

Membership is free, but will be limited to only a few sophisticated investors who will join based on the quality of their investment idea. Just 200 members will qualify for the Club.

The admission will be granted only after a careful screening of candidates.

Each person applying must submit an application at www.capitalideasclub.com that includes a current investment recommendation.

The quality of the applicant's investment analysis and research will be the main criteria for admission. Entrants submitting the best ideas will be accepted as members of the Capital Ideas Club and will be eligible for a quarterly cash prize. Let me emphasize that I suspect that for members the main motivation will be the thrill of playing the game and not the spoils.

There will be a 45 day delayed Access to ideas posted by members for non-members and only members will be eligible to post ideas.

With the investment community and your blessings and support, I would like to today formally launch the Capital Ideas Club.

We had released the book “India's Money Monarchs” last year. The book has done extremely well. There are a few copies available for those who wish to buy them at the stall at a special 40% discount.

Capitalideasonline.com would like to thank the Bombay Stock Exchange for allowing the use of this Convention Hall and the help and support they gave us for today’s evening. In particular, I would like to thank Mr. Kalyan Bose, Mr. Jeevan Sakpal, Ms. Saheli Chatterjee and Mr. Balasubramanian. Capitalideasonline.com would like to thank Reliance Mutual Fund for sponsoring the event and Emkay Shares and Stock Brokers Limited for being the associate sponsor and Business Standard for being the media partner. I would also like to thank Mr. Rakesh Jhunjhunwala for his support.

Capitalideasonline.com would like to thank the members of the today’s panel Mr. Ramdeo Agrawal, Mr. Anoop Bhaskar, Mr. Sanjoy Bhattacharyya, Mr. Prashant Jain, Mr. Rakesh Jhunjhunwala, Mr. Madhusudan Kela, and the moderator Mr. Ramesh Damani for taking time out to be with us today.

I would like thank Mr. Chetan Ahya of JM Morgan Stanley, who looks after India and South East Asia and who is the Indian economist most quoted in “The Economist” for his spontaneous agreement to giving the closing remarks and the vote of thanks.

I would like to thank all the members behind Capital Ideas Online – Mr. Navin Agrawal, Mr. R N Bhaskar, Mr. Manish Chokhani, Mr. Ramesh Damani, Mr. Jamshed Desai, Mr. Bharat Shah, Mr. Utpal Sheth and Mr. Avinash Wadhwa. Above all I would like to acknowledge the contribution made by Mr. Chandrakantbhai Sampat and his guiding values.

For making Capital Ideas Club possible I would like to thank Mr Bhavya Jain for his untiring effort and guidance. I would like to also thank Mr. Mayank Sharma.

I would like to thank Mr. Ramesh Wadhwa and Mr. Ravi Wadhwa for going well beyond the call of duty to make this evening a success. I would like to thank my wife, Sheila for all the work she put in behind the scenes. I would also like to thank Praveen Parola for the effort he has put in.

Value investors often refer to short-term price movements as noise. May I request you not to add to the noise by switching off your mobile phones.

It is a pleasant duty for me to hand over the remaining part of the evening to the wizard behind the wizards of Dalal Street, Mr. Ramesh Damani. He is a famous and familiar figure in India’s capital markets and his contribution to educating Indian investors is unparalleled.

Rameshji has been a member of the Bombay Stock Exchange for over a decade and a half. He is probably the most listened to financial commentator. He is one of the India’s savviest investors. Rameshji will be in charge of the rest of the evening. So join me in welcoming the magical money maestro, Mr. Ramesh Damani.

Ramesh Damani: To start the discussion we turn to the king of the panel first – so I’ll start with you, Rakesh, as always. Well, what do you think of the market?

Rakesh Jhunjhunwala: The bullish market is not the index, it is the bullishness of the Indian economy. And as long as I don’t come to a conclusion that India’s growth is not going to accelerate or we are not going to maintain 8-9 per cent economic growth constantly – this bull market is always going to remain alive whether the index is 12,000 or 20,000. The bull market is in the Indian economy and not in the stock market.

Although you could have the economy growing but you could have very high interest rates which is a big factor in the valuation of the market. That could temporarily disturb the market.

As long as India’s economy is doing well and I see no reason why it shouldn’t – the bull market is very much alive and kicking for me.

Ramesh Damani: Sometime they say stock prices are slave to corporate profits over the long term. What is your outlook for corporate profits or the Sensex in 2007?

Rakesh Jhunjhunwala: Well, to be very frank, I don’t do too much mathematical research. I don’t say that India is going to have consistent profit growth of 25-30 per cent y-o-y.

But I do believe that you have the biggest market and the biggest opportunity for all companies is the economy. Look at any sector, everything is at such an early stage of growth.

Ramesh Damani: I now have a question for you. We have had four years of solid gains in the Sensex. Do you make it five years in a row for 2007?

Rakesh Jhunjhunwala: Well, seeing the apprehensions that people have, I don’t see any reason why it shouldn’t be. Because if you have 15 to 18 per cent earnings growth, unless P/Es dip or those earnings dip, I don’t see any reason why there should not be a positive year.

Ramesh Damani: Sanjoy, in the 2006 roundtable, you had said that India will grow but it might be unprofitable growth. Were you here too early? Will margins shrink this year or inflation lead to unprofitable growth?

Sanjoy Bhattacharyya: I got it wrong the previous year. Clearly, I missed the way the economy would respond to a number of different stimuli – whether it was policy driven or liquidity driven – and many of those remain in place. To not have learned from that would be a tremendous sin.

Much of what has transpired in the past 12 months is indicative as Rakesh said of a turning point for this nation’s economy.

This market bears a burden of very high expectations. And the way people are pricing future earnings suggests that, the penalty for getting that wrong will actually be quite serious.

I don’t doubt that if you have an economy growing at 14-15 per cent in nominal terms and you have certain advantages which are there to stay and which are long term in nature, things are improving. That is a clear indication that things are getting better. That can only help productivity.

Ramesh Damani: And margins then?

Sanjoy Bhattacharyya: Margins are a function of where you are. I mean clearly in manufacturing margins are driven by factors which are not solely in the control of our economy.

Today we are much more open as an economy. There is much less tariff protection; much more global impact of commodity prices. So you are not able to insulate yourself from them and as we speak today, a lot of these things suggest that margins will be under pressure.

Ramesh Damani: If you were to say outlook for 2007 in terms of the Sensex, would you say it would be a negative year?

Sanjoy Bhattacharyya: I do think though that 2007 will not have the kind of returns we have seen in the last four years. We will not see 30-40 per cent plus type returns spread. The last four years actually have seen the index multiplying 4 1/2 times.

Ramesh Damani: Raamdeo, you started this great Bull Run with low interest rates as you said because previously capital was always crowded. In 2003 capital became easily available.

Now you’re seeing the tightening–prime rates are going up, housing rates are going up. Can that then stop all or even finish this bull market because interest rates are now swinging from low to extremely high?

Raamdeo Agarwal: This is the first globalised bull run in every asset class all over the world. The world economy is struggling to figure out all this noise about inflation, and only time will tell because there is no dearth of money.

The government is worried about the response to inflation and is saying the rate will fall in April. But the issue is that it is responding by closing down exports. So what happens is when sugar export was possible, you banned it. You got the inflation under control but what happened? It has shattered the entire sugar community.

Ramesh Damani: Raamdeo, what are your (Motilal Oswal’s) forecasts for 2007 Sensex earnings?

Raamdeo Agrawal: By the last count when this quarterly results got completed, our team had an EPS of Rs 710 for FY07 and more like Rs 840-845 for FY08 for the Sensex stocks.

Ramesh Damani: Madhu, Jim Rogers says that there is a 20-year bull market for commodities. But yet commodities sold off quite sharply recently. If you see, oils, zinc, copper have all sold off. What is your view on the commodities price going ahead?

Madhu Kela:

See, I am not a commodity expert. But however you see there are pockets of commodities which will do well. Soft commodities in the world would do well.

Things like food grains which have not seen any price – real rise in the world – will do well. But, I am truly scared when I look at let’s say something like zinc. You know on a five-year perspective is there a possibility that zinc prices can be stable at $3000-3500 a tonne while your cost of production is $500-600 for an efficient player? So these commodity prices which have really hit a significant high from their lows may not sustain. But that does not mean you will have bearishness across the board in commodities.

Ramesh Damani: Madhu, you have been one of the most successful stock pickers. Any particular themes that you think will work in 2007? In 2006, Madhu had come here and had said the thing to attract is real estate. What do you think of real estate now?

Madhu Kela: I am certainly not as gung-ho as I was last year. And in my wildest of imaginations, I also didn’t expect that stocks will go 100 times in a matter of a year. So, having said that, I don’t think you can completely ignore this sector because this is where 30-40 crore Indians are interested. Land and property would always be an interest to India. So you have to be far more stock specific and try and find value which will emerge in this sector.

Ramesh Damani: Tell us how the Sensex will end this year, plus or minus?

Madhu Kela: I am positive in a longer run. Making money is going to be tough if I take a 12-18 or even 24 months period. There are not companies which are available at 5 or 10 P/E multiples. However, we have had 50 years of under-valuation in India. What is the big deal about over-valuation for 12 or 18 months?

Ramesh Damani: Prashant, how seriously should investors view the threat of inflation and what do you tell your investors and how do you protect your portfolio in this case?

Prashant Jain: Real inflation is actually much more than probably what the numbers are suggesting. The largest component in any household expenditure is a house and houses are clearly unaffordable by whichever measure you see. If you look at the inflationary impact on the total consumption expenditure of the household, inflation is way in excess of what these numbers suggest.

Banks are offering 10-11 per cent on deposits, and as we go into March they may start offering 12 per cent. So over long periods of time, there is certainly a strong case to be made that exposure to equities in Indian households which is very low should increase significantly but I don’t know at what pace it will happen – given the fact that fixed maturity plans from mutual funds offer virtually safe 10 per cent return, which used to be 5-6 per cent two-three years back.

Economic growth will still accelerate, but profit growth will slow down. Profit growth will be lower in 2008 than the profit growth in 2007, and 2009 will be even lower.

Ramesh Damani: Does Raamdeo’s Sensex earnings target of Rs 840-845 seem too optimistic to you?

Prashant Jain: Yes. I don’t look at the Sensex as one composite.

In fact, Sensex has two parts to it–the secular growth companies which would be companies like telecom, IT, consumer goods and the cyclicals. If you split the Sensex into these two parts, you will get a more realistic picture of the valuations. And it is not very good. If you look at the secular growth companies they are all trading at close to 20 times FY09 earnings – two years forward, which is not cheap.

And there are risks – telecom will certainly slow down by then. You cannot have 100 crore mobiles in India in the next four-five years. So it has to slow down. You can only argue whether it will take three months or six months or one year.

Cyclical growth companies are trading significantly above replacement cost and we are somewhere close to a peak cycle. So how the sectors will pan out, how zinc, lead, aluminium and steel prices behave, how the margins behave is very hard to forecast. One thing is clear that these are economically unsustainable prices and these profits are not likely to sustain for long time.

Ramesh Damani: Anoop, what is your outlook for the market? Are you more cautious or optimistic?

Anoop Bhaskar: Last year has been quite camouflaged. If you look at the large-caps, there are only six or seven stocks which have contributed to the entire movement of the markets.

In terms of small-caps, we have been in a bear market for the last 15-18 months. So, it is only six stocks which have made this whole audience come out here and say that we are still in a bull market. The bull market has stopped around 12-15 months back, frankly.

People with only small-caps and mid-caps in their portfolios would have only gained about 8-12 per cent in the last eight months, which is not a bull market. I think we’re taking a breather.

With interest rates being where they are, a rational investor would take a three-month deposit paying about 9.5-10 per cent. So, people should invest in debt rather than equity with such returns from the markets.

In equity it is more like a marathon–you cannot run a sprint all the time. This is the point where you conserve your energy for the next 12-18 months and make sure that you conserve your capital for the next round. You cannot keep on running a 100-metre sprint for the next 20 years for sure. There are times when…

Ramesh Damani: …you got to move to debt or the like. Having said that, for the record, I think everyone knows the answer, but what would 2007 end for the Sensex, plus or minus?

Anoop Bhaskar: It will depend a lot on liquidity because what really matters today is not value, it’s only liquidity. I think the Sensex will be down between 7-10 per cent.

Ramesh Damani: In the first part, we surveyed the forest. Now we take a look at the trees. How do you turn the big picture view about the economy, interest rates, equity markets into winning stocks? There is, of course lies the essence of successful investing. The panelists have a vested interest in the recommendations they are making. Moreover the panelists may change their views on the stock recommendation at any point and therefore investors are requested to do their own homework before acting on this advice. I will start with my favourite stock-picker, Bhattacharyya… I would like to see three good stock ideas from you, for one year or three years…

Sanjoy Bhattacharyya: Tata Elxsi, Grindwell Norton and Rane (Madras). Tata Elxsi is in a focused business, it has gone away from doing things which it didn’t do well earlier. So, it has learnt from the past mistakes and is actually a rare company in information technology where the margins are becoming higher and higher progressively.

Second, the valuations still remain very attractive. This year it will earn Rs 16 per share. If you leave out the fact that it has had a difficult and troubled past, its earnings power relative to capital that it is employing is very impressive, a reasonably impressive management team and the growth is definitely sustainable.

Ramesh Damani: And a merger with TCS on cards?

Sanjoy Bhattacharyya: That would be a cherry on the top. I need not worry about that at all, even if it does not merge with TCS. Next one, Rane (Madras) is a play on the Indian automotive industry. It is in linkage products and manual steering gears.

Fortunately, in the Indian passenger vehicles, tractors, LCV business, a very large proportion of vehicles manufactured in these categories have manual steerings. So, growth is assured. Second, it has a very strong dominant competitive position with only two serious competitors – Sona Koyo and ZF Steering, and the record of all three suggests that the industry as a whole is doing very well. Third, it has been through a major financial restructuring. So, you will see a dramatic change in terms of the efficiency with which capital is utilised to prepare and grow for the future. And in exports, it has a link with TRW, a major global player.

Hopefully we will see Rs 100 crore exports in this to TRW by the year 2009 which will actually change the operating margin profile of Rane (Madras). Because right now the EBITDA margin is very low at 9.5-10 per cent which over time should improve and there should be benefits of scale.

It is cheap, it is going to earn about Rs 11.50 a share and it will continue to grow at 20-25 per cent for the next three years. Reasonably competent, trading at 8 times this year’s earnings, you should be all right.

Grindwell Norton is a quasi player at the middle of the abrasives market, with only two other big players: at the bottom is Orient Abrasives and Carborundum is the other one at the high end with coated abrasives.

With the industry growing at 9-10 per cent, an abrasive is like a consumable. To that extent, demand is assured, no hiccups.

The interesting thing is that Grindwell has managed to become far more efficient on the working capital front, sales growth has been 12-15 per cent and the company is now moving into higher and higher value added products as it has consolidated market share at the bottom end. So, there is a scope for increasing profitability with virtually no incremental capital employed.

Other names that I like are as follows: EIH Associated Hotels, which has gone through a major transformation. Another company called Steelcast and the third one is a company called Amara Raja Batteries.

All are on the same theme: cheap, sustainable earning power, volume growth, well managed. Oh, and one more company, ABC Bearings which has margins higher than the industry leaders. It is growing and it is very cheap at 8 times this year’s earnings.

Ramesh Damani: Raamdeo, what ideas do you bring for us?

Raamdeo Agrawal: I prefer business leaders – globally competitive and somewhat unpopular. One is Tata Steel. In 1994, it was struggling with half a million tonne and see the transformation of its balance sheet in the last 12 years. Although it is a cyclical business, this is one company that can execute, has competence, passion and trained people who understand steel like nobody else does.

The opportunity to make money in steel is going to be huge in the next five-ten years. I am not happy with the price it has paid for Corus, but one thing can happen. Corus’ average price is about $950 whereas that of Tata Steel is about $550.

The opportunity is that Tata Steel will borrow the technology and competence from Corus to bring up its entire 10-12 million tonne steel to fetch

$900 average. And Corus doesn’t know how to operate blast furnaces.

They pour hot metal at $450. These guys will supply them the technology to bring it down to $150. That is what should pan out. Whether it will or not, at this price you cannot lose much. If it happens, then this should give a very good return.

Second leader in its own category is Glaxo. It has underperformed the market in the past year. The reason is twofold: its earnings didn’t grow much and valuations were pretty stretched at the beginning of the year.

But in 2008 there are 3-4 patented products which are going to be launched globally from Glaxo’s portfolio and they will be launched simultaneously in India. I think at current valuation of 22-23 times CY07 earnings, you are not paying a very high price.

The patent law is in place, the products are being launched and it has a very good, transparent management. Of course, it is not a momentum driven stock, one cannot predict whether in six months one can make money or not.

Ramesh Damani: Any mid-cap, small-cap ideas?

Raamdeo Agrawal: One idea, a mid-cap called Dena Bank. A Rs 1,000-crore bank, it dominates half of Gujarat, about Rs 6-7 EPS this year, Rs 10-12 earning next year. The bank’s book value is going to be Rs 50 next year, and there is no bank stock today which you can get below price-to-book-value of 1.

Ramesh Damani: Madhu, last year you whispered ‘real estate’ in our ears. What are the themes or sectors and what are the magic words you would whisper today?

Madhu Kela: I would like to mention the contract research and manufacturing theme out of India. If you analyse this space, and as Raamdeo said, that now we’re discussing post-patent, so people are not scared to venture into whether it is outsourcing or contract manufacturing in this space.

Multinational companies annually spend something like $45 billion on research and another $45 billion is spent on manufacturing of pharmaceutical products. So, this is one very interesting opportunity which over the next three to five years will pan out very well for India.

Ramesh Damani: Madhu you’ve also been invested in media companies. Can you shed some light on the prospects for the media group?

Madhu Kela: In the media business the biggest thing that will work in its favour is the entry barrier, which is humongous across the board. Like in newspapers, you only have 80 per cent of the advertisements in the top newspaper, 15 per cent in the second one and the remaining 5 per cent in the next twenty. The second thing is, when convergence really happens, content will be the true king.

Ramesh Damani: … and the low advertisement rates in India have to go up over a period of time, so that represents the opportunity on the balance sheet side. Anoop, give us some ideas. Mid-cap space is something which the retail investor is always enthusiastic about.

Anoop Bhaskar: There are two broad ideas I would like to share. We produce roughly around 220-odd million tonne of food grain, which we have to take it to around 340-350 million tonne in the next five-seven years, because of our population.

Plus, if you have more income, you’re going to consume better than in the past. And in the last seven years there has been no greenfield project which has been set up for fertilisers because of government policies, constraints of finance etc.

India buys around 30 per cent of the world market of urea. And we are paying around $260 per tonne to buy it from the market. If we were to produce it in India at whatever cost of gas we get, it would cost us around $180-190.

Another idea is lubricants, a market in which the pricing is not controlled by the government and where the government companies are as ready as the private sector to raise prices. For the last 12 months, the prices of lubricants have moved up by almost 37 per cent. And this is one segment when over the next two-three years, lube oil refineries around Asia are going to double their capacities.

Therefore, the price of lube oil could actually move totally opposite to that of crude oil. Because there would be so much of supply and the pricing of the final product is not controlled by the government.

These are companies which have some brands. If they are able to keep a part of the fall in lube oil prices, then the jump in profits of these companies would be very high.

Ramesh Damani: Prashant, you won’t bet on stocks but tell us some themes at least.

Prashant Jain: I think auto components. If India is to become an automobile hub, look for companies in the auto-ancillary space which bring scale, the opportunity can be very large.

And there are signs that India is likely to emerge as auto ancillary hub. And these oil companies – I’ve been wrong last year, but they are available at a fraction of the replacement cost, and now government intention is that at least the oil bonds will…

Ramesh Damani: … make up for the losses.

Prashant Jain: Yes. So the downside becomes limited. They are available at book values, and the book values are fraction of the replacement costs. So, I think there’s some value. If oil prices fall, the upside could be very fast and very significant. But clearly there is no momentum and it is an out of favour sector, so one has to be patient. They also have good earnings yields.

Ramesh Damani: Let’s hear the stock picks from the best stock-picker in India. Rakesh, you’re going to share your picks, so please, we’re breathless.

Rakesh Jhunjhunwala: I agree with Raamdeo, that Tata Steel could be an extremely good long term investment over a three-five year horizon. The steel industry has changed.

The approach to the steel industry has changed from one of government approach to one of profit. Second, when people say that Tata Steel’s acquisition of Corus is a bull market excess, what bull market is Tata Steel in when it is valued at 6 times earnings, and pre-tax 5 times?

Tata Steel will make iron ore intensive products and sell it to Corus. Plus, Corus can add 4 million tonne finishing capacity without much investment, which can be utilised with the same labour force. Tata Steel itself is going from 10 million to 12 million tonne.

Mr Muthuraman has said that the combined EBITDA margin will be 25-30 per cent. If you look at Rs 100,000 crore of sales, at 25 per cent EBITDA margin, it’s Rs 25,000 crore. Tata Steel’s equity is not going to exceed Rs 750 crore, even after an issue. And then you look at it, they are financing it perfectly.

Tata Steel has $1 billion cash, $2 billion equity will come – they put that into an SPV. That SPV will borrow $1 billion which may have recourse to Tata Steel and that money will be invested in Corus. Corus will take debt, which will not have any recourse to Tata Steel. So, Tata Steel is not really risking anything except that $1 billion, which is 6-7 month cash flow for the company. And if they succeed at what they’re saying, a 750 crore equity can produce Rs 25,000 crore EBITDA.

My second investment is Titan. It’s a very expensive stock, but there are certain companies which will produce dominance, and when they will be in their youth, they will produce huge cash flows. So I believe Titan can be one such company. It’s for a patient investor and investing in it is fraught with risk.

The third stock is Bilcare, and again this is for a patient investor for three-five years. If Bilcare is successful in doing what it has set out to do, it will be among the top companies of the world in the pharmaceutical package. It will have a fully diluted equity of about Rs 21 crore and this year it will earn about 50 crore.

It’s not cheap at about 20 times its earnings. It has invested in facilities in Singapore, it has gone into the clinical trials business. Both will take time to mature. But if they do well, this stock will give mind-boggling returns. And with this, I will conclude by saying that I’m feeling very bullish after this discussion.

Ramesh Damani: There’s a very nice philosopher, who’s an existentialist – Albert Camus and he wrote a very nice thing, which is a great way to conclude this discussion.

He said you’re forgiven for your happiness and success only if you generously consent to share them. I want to thank my panelists by sharing the joy and wisdom of investing generously with all of us today.

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Mastek: Buy

Investors can consider taking exposures in small lots in the Mastek stock with a medium-term perspective. At the current market price, the stock is trading at a price earnings multiple of 11 times its likely per share earnings for 2006-07. We have a `buy' recommendation outstanding at Rs 360 made in mid-September 2006 and this is a reiteration of that call.

Investors can use any price weakness linked to the broad market to step up exposures. Considering that the stock has been locked in a narrow band for a few months, the returns from the stock will be sedate vis-à-vis other mid-sized software stocks of a similar genre. Investors may need to keep their return expectations to 12-15 per cent.

The two key levers that are working well for Mastek are the contribution from the European geography and steady build-up of revenues and clientele from Elixir.

Elixir, its enterprise platform addressing the life insurance, annuity and pension segment, has added four clients in the second quarter ended December 31, 2006.

The European geography, which accounted for 67 per cent of its revenues, grew by 8.2 per cent in the latest quarter. The improvement in order book to Rs 405 crore - after two sluggish quarters - and operating profit margin improvement in the latest quarter are added kickers to the overall growth.

The relatively upbeat revenue and post-tax earnings guidance at 8.5 per cent and 10 per cent for the third quarter lend confidence to the underlying fundamentals.

The slow traction in the US geography and high exposure to discretionary development spending represent downside risks to the stock. Application development revenues accounted for over 70 per cent of its total revenues in the latest quarter. The high client concentration (88 per cent from the top ten clients) linked to development spending and long lead-time in client acquisition also remain key risks to the business.

Punjab Tractors: Hold

he Punjab Tractors Ltd. (PTL) stock is in play. With more than half-a-dozen suitors lining up for the equity put on the block by two major shareholders, private equity firm Actis and the Burmans of Dabur, the stock has gained about 27 per cent since February 1. After touching a peak of Rs 342, the stock now trades at Rs 316. Shareholders can continue to hold the stock for reasons elucidated below. Fresh exposure, however, can be avoided as returns from current levels may not be significant enough to justify the risks assumed.

Up for grabs

Actis, which holds 29 per cent in PTL, has decided to exit the company and so have the Burmans, who hold 14.5 per cent. Bids are currently on and the biggest and the best companies of the vehicle manufacturing industry have been attracted to the sale. Tractor market leader, Mahindra and Mahindra, Ashok Leyland, Tractors and Farm Equipment Ltd (TAFE), International Tractors (Sonalika), and Escorts have confirmed that they are in the race.

Tata Motors, in association with Ford New Holland of the Fiat group, is also said to be interested though the company has not officially confirmed if it has put in a bid. Apart from these, a private equity combine headed by the former head of PTL, Mr Yash Mahajan, is also trying its luck at picking up the stake on offer.

What makes the sale significant is that the successful bidder will get management control over PTL. The stakes of Actis and Burmans together add up to 43.5 per cent and the acquirer will have to make an open offer, which, assuming it is for the minimum 20 per cent and successful, will take his stake to at least 63.5 per cent.

Why the rush?

PTL is an established and strong player in the tractor industry and its Swaraj brand commands big royalty in the major tractor markets of Punjab, Haryana, Rajasthan and Uttar Pradesh. Though in recent times its market share has whittled down to just 9 per cent from over 15 per cent a few years ago, it remains a formidable player in the industry.

But those are not the only reasons why PTL is in such demand. PTL owns 14 per cent of light commercial vehicle manufacturer, Swaraj Mazda's equity, and 33 per cent stake of engine manufacturer, Swaraj Engines. Swaraj Mazda is passing through a rough patch with sales growth in the negative terrain at a time when commercial vehicle sales are booming, but it is attractive nevertheless for a bidder such as Ashok Leyland.

Swaraj Mazda presents Leyland with a line of models where it has no presence in presently; in the long run, Leyland could also be eyeing the manufacturing facility of Swaraj Mazda, in combination with Swaraj Engines, as a foothold for itself in the North .

For M&M, acquisition of PTL will catapult it to unassailable No.1 in the tractor market with a wide and deep geographic presence. TAFE is keen because it will rise to be almost on a par with leader M&M if it is able to get control over PTL. Besides, TAFE can leverage PTL in terms of product and geographical diversity as well. The logic for Tata Motors is much the same as for Ashok Leyland with the additional motivation of enabling entry into the one segment of the automobile industry where it has no presence now.

Why hold on?

And that brings us to why shareholders should hold on to the PTL stock till the logical denouement — of the bid culminating in sale. Given the strong motivational factors driving each of the bidders, the price bids are likely to be extremely competitive reflecting their desire to gain control over PTL. There will also be a control premium to the bids because the successful bidder will gain management control over the company.

Besides, PTL is a well-run company with a strong goodwill in the market and there may not be other similar capacities coming up for grabs in the near future.

Finally, what also generates confidence is that the top four bidders have deep pockets and could be willing to go the extra mile given the boom time in the automobile industry.

Given that the stock was trading at around Rs 240 before the news of the two shareholders putting up their holdings for sale came out, and accounting for the above factors, including the control premium, it is likely that the share will be valued closer to the prevailing market price.

But is there no fall side at all? Yes, there is and that is the possibility of either one or both the sellers deciding to withdraw their offers. Such an unlikely prospect could lead to a precipitous fall in PTL's stock as the current market price cannot be justified by fundamental factors alone.

The fizz in the stock in recent times is due to the stake sale and it could dissipate in no time if the sale process runs into a snag.

It will be prudent for shareholders to watch the developments closely in the run up to the sale over the next couple of weeks and act accordingly.

Thermax: Hold

trong demand, burgeoning order-book and improved operating margins spell good times for Thermax, a leading player in energy and environment management. Further, an increase in capacity and the planned manufacturing foray into the Chinese market on the back of good demand from user industries are expected to add to earnings growth.

At the current market price, the stock trades at about 20 times its likely FY-08 per share earnings. Investors with a one/two-year perspective can hold on to the stock, while any price weakness linked to the broad market can be used to build fresh exposure.

Investment rationale

Increase in input costs due to the rise in crude oil price has forced many industries to go on an energy diet. This augurs well for Thermax, which specialises in energy conservation systems and captive power projects. Further, anticipating this rising demand scenario, Thermax has chalked out a capacity expansion plan. The new capacity is likely to become operational in two phases — the first by October 2007 and the second by January 2008. This would, however, effectively contribute to the earnings from late FY-08. Thermax also plans to set up a manufacturing base in China for which it has obtained licence.

This would cater to the demands of only the Chinese and the export markets, thus helping it contain the operating cost. The manufacturing foray is also likely to widen the reach of Thermax's products in the export market.

hermax's order-book has grown steadily, thanks to a favourable demand environment and increased industrial capex. For the quarter ended December 2006, the order-book was pegged at Rs 3,024 crore, up 94 per cent (year-on-year). Given the capex plans lined up by various user industries — steel, textiles, chemicals — we believe these growth rates are likely to be sustained. Backed by this strong demand, both the energy and environment segments of Thermax registered impressive revenue growth of about 50 per cent for the December quarter. The energy division continues to be the major contributor to the bottomline (about 80 per cent). The operating profit margin too has improved by about 1.07 percentage points on a year-on-year basis. Better realisation for its products, coupled with higher volumes, has helped Thermax enjoy higher margins.

Thermax is likely to gain significantly from the closure of the hitherto loss-making subsidiary, ME Engineering. That apart, it also stands to gain from the increased thrust on biomass cogeneration. However, the company's thrust on R&D and new product development is likely to be the growth driver.

Further, its focused foray into South-East Asian markets such as China and Hong Kong and the planned expansion of its product range also hold significant upside potential.

Concerns

Though the stable raw material cost in the recent past has helped Thermax improve its margins, any unprecedented rise in the input cost could pose a risk to the earnings. While Thermax has successfully managed to navigate through a rising input cost scenario, its ability to sustain the same could be of concern.

Nevertheless, the company's continuous efforts to prune costs by increasing its sourcing from China is a positive. Further, any unexpected slowdown in the industrial cap expenditure also poses a downside risk to our recommendation.

Pratibha Industries: Buy

Pratibha Industries is in the process of de-risking its business profile and moving to more lucrative segments. Better operating profit margin, the ability to forge joint-ventures to enable technical and financial qualification and the improved debt situation add to the company's earnings visibility.

We reiterate a buy after our `invest' recommendation on the company's public offer in February 2006.

At the current market price, the stock trades at 8 times its expected earnings for FY-08. We have not factored in revenues, if any, from the spiral-welded pipes business, capacities for which are expected to go on-stream from FY-08.

Moving up the value chain

Pratibha is a unique play among the small-cap infrastructure players as its revenue streams are markedly different from peers of similar size.

While a number of small players now ride on the huge spending in the road space, the company has traditionally derived a bulk of its income from water supply and distribution and waste management systems. Roads and mass housing and commercial projects contributed about 25 per cent.

The company has now moved up the value chain to more underground water tunnelling and storm water pumping stations independently and through joint-ventures.

Recent projects from the Rajasthan Government and the Airports Authority of India appear to be a way forward to becoming an integrated player in the infrastructure business.

Pratibha has already forged ties with an Austrian company for tunnelling and appears to be looking for avenues to enter the lucrative oil and gas pipeline project segment. This new segment will also be a natural extension of its existing business. As a backward integration strategy, the company is setting up a spiral-welded pipe division, which is likely to go on stream in FY-08. These pipes, typically used in water and oil and gas pipeline projects, are likely to bring better margins from the pipeline projects.

While the company had originally planned a joint venture for the spiral-welded pipes, it now intends to source the required knowhow from the equipment manufacturer itself and, therefore, proposes to retain the full profits from this unit.

Improving financials

The IPO proceeds have significantly ramped up the shareholders funds, thus financially qualifying it for bigger orders. The company's current order backlog of over Rs 1,200 crore is about seven times its revenues for FY-06. This is likely to be converted to revenues in about two-and-a-half years and lend visibility in the medium term. Operating margin, maintained at over 12 per cent, is superior to similar sized players.

Risks

Benefits from the pipe division are likely to be substantial only if the company forays into the oil and gas pipeline division. The company, however, can utilise the pipes for its water projects and to sell in the market, as the demand is high.

Further, we expect the company to benefit from its core business — water projects — on the back of water supply systems being implemented under the National Urban Renewal Mission.

Investment Nuggets

Challenging conventional thinking on investing has been Michael Mauboussin's leitmotif in an investment career spanning over one-and-a-half decades. Michael Mauboussin is currently the Chief Investment Strategist of Legg Mason Capital Management, joining them in 2004. Prior to that, he served as Managing Director and Chief US investment strategist at Credit Suisse First Boston. He has brought a multidisciplinary approach to investing that draws ideas from strategy, psychology, finance and complexity theory. Something that he has dwelt at length in his latest book, More Than You Know: Finding Financial Wisdom in Unconventional Places.

"Once we've established a belief — most of which come from people around us — we are loathe to change it. Social psychologist Robert Cialdini offers two deep-seated reasons for this. First, consistency allows us to stop thinking about the issue — it gives us a mental break. Second belief, consistency allows us to avoid the consequence of reason — namely, that we have to change. The first allows us to stop thinking; the second allows us to avoid acting."

"The logic of diversity requires that we constantly develop new tools if we hope to be successful in consistently solving complex problems. Constant learning and open-mindedness are the best ways to achieve this goal, but are cumbersome and generally not innate tendencies."

"I want to leave you with the notion that we humans are still not very good at dealing with risk or uncertainty. We are still linear thinkers; we have a nearly insatiable need to link cause and effect, and we assess probabilities poorly. However, we do now better understand some of the mechanisms that underlie complex systems, and that knowledge can be very helpful in preparation for future catastrophic events."

"When allocating capital, portfolio managers need to consider that unexpected events do occur."

"As networks increasingly dominate the business landscape, it is crucial for investors to understand network effects — how the value of a network increases with more users. Network effects can be classified along a spectrum, with stronger and weaker forms. As investors, we seek companies where network effects are strong and can be captured through superior financial performance."

"We spend a lot of time comparing. In many cases the stakes are not too high. But under some conditions, including investment decisions, good comparisons are essential. It's important to recognize when you add complexity to the problem of comparison — a temporal dimension, probabilities, and vast, often-ambiguous information — people make many more mistakes. Awareness of the pitfalls and taking some steps to mitigate them can go far in making you better at comparing — and investing."

Page Industries: Avoid

Page Industries, a licensed manufacturer of the popular `Jockey' brand of innerwear in the country, is entering the market with a public issue of equity shares. On offer is a fresh issue of capital by the company along with an offer of sale from the promoters. The company plans to raise between Rs 50 crore and Rs 55 crore depending on the eventual price fixed which would be used, among other purposes, for brand-building and for setting up additional manufacturing facility.

The company's sales have been growing at an annual rate of roughly 28 per cent in the last four years. The net profits have seen an even better rate of annual growth of nearly 60 per cent. There is, thus, little doubt that the company's brand of innerwear has gained market acceptance as evident in the growth of its sales and net profits. On the face of it, therefore, the company's claim to pricing its shares at an earnings multiple of between 22.5 and 25 (depending on the price within the band indicated by the company) based on the annualised profits of first half of fiscal 2006-07, appears reasonable.

A general rule of thumb in investment valuation is that an equity is considered an attractive candidate if the ratio of its P/E multiple to the annual growth rate in profits is below one. In the instant case, it is in the region of 0.5. On a comparison to its closest competitor, Maxwell Industries, manufacturer of the VIP range of innerwear whose current share price values its latest earnings by a multiple of around 22 too, the company's indicative price band for its share does not appear unreasonable.

Competitive parameters

But despite such attractive parameters of valuation, we are of the view that investors are better off avoiding the public offer for the following reasons. One, the market for innerwear is a highly fragmented one with a number of regional players in the branded segment, besides innumerable small players in the unbranded category.

While Page Industries' positioning as a premium product would limit the scope of competition, it must be admitted that the market is characterised by the existence of competing offerings at various price points and there is always the risk of `down trading' — customers settling for an offering at a lower price point — and this must exert some pressure on margins.

There are limits to premium pricing strategies to shore up profit margins, considering that innerwear by its very nature cannot command super luxury positioning that allows consumer to make a life-style statement.Two, the market is also seeing the entry of large apparel manufacturers with established brand equity entering the innerwear market. They are likely to pose a stiff competition to Page Industries, which has no presence in the traditional apparel market. It has a limited presence in the leisure wear segment.

Success at a price

Three, the entry of a number of players in the organised retail trade is likely to be marked by the advent of store brands both in the mass and premium segments across all consumer product categories. Innerwear cannot be an exception to this phenomenon. Even if the likes of Page Industries manage to hold their own amidst the clutter, the success will come at a price.

Historically, pricing power has tended to shift to the players in the organised retail trade with a chain of stores, given the volumes that they can muster. The company is trying to counter this with its own exclusive retail outlets besides a sharp hike in advertising outlays. The success of such a strategy is, however, fraught with uncertainty.

Offer details

The offer, lead managed by IL&FS Investsmart, opens on February 23 and closes on February 27. The net offer to the public is 27.89 lakh shares.

Emkay - Weekly Technicals

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Debuting scrips in the green

Both IPOs listed in the week were trading in the green compared to their IPO prices.

Two scrips were listed on the BSE during the week ended 23 February 2007. One was a BPO firm, Firstsource Solution, while the other to the power sector public financial institute, Power Finance Corporation. By 23 February 2007, both were trading higher than their IPO prices.

Of the two newly-listed companies, Power Finance Corporation surged the most, 30.76% to Rs 111.15, by 23 February 2007 compared with the IPO price of Rs 85. The stock clocked an average daily volume of 4.06 crore shares since the day of debut. The scrip was listed on the BSE at Rs 104.

Firstsource Solution rose 22.46% to Rs 80.05 by 23 February 2007, compared with the IPO price of Rs 65 on 22 February 2007. The stock clocked an average daily volume of 1.99 crore shares from the date of debut. The IPO was listed on the BSE at Rs 75.10.

During the period under consideration, the market declined amid high volatility. Factors like the CRR-hike, rising inflation, concern over rising domestic interest rates, unwinding in derivatives ahead of expiry of February 2007 contracts on 22 February 2007, and fear that short-term capital gains tax may be hiked in the Union Budget 2007-08, were the major triggers for the fall. Caution was also partly due to worries of a possible interest rate hike by the Bank of Japan (BoJ), which was raised to 0.50% on 22 February 2007.

The BSE Sensex shed 723.02 points for the week ended 23 February 2007, to settle at 13,632.53 compared with the previous week’s closing of 14,355.55 on 15 February 2007. The S&P CNX Nifty lost 207.30 points, to settle at 3,938.90 compared with the previous week’s closing at 4,146.20.

Firstsource Solutions has highest average daily volume for week

Firstsource Solution posted the highest average daily volume for the week ended 23 February 2007.

The average daily volume for the BPO firm, which debuted at Rs 75.10 on the BSE on Thursday (22 February 2007), stands at 1.99 crore shares for the week ended 23 February 2007. The IPO price of the scrip was Rs 64, and had settled at Rs 79.60 on the day of debut.

IFCI, Zee News, Redington India, Cinemax India, Reliance Natural Resources, Pochiraju Industries, Global Broadcast News, Himachal Futuristic Company, Bellary Steels, Sail, and Aptech were the other average daily volume topper for the week ended 23 February 2007.

IFCI was the volume topper on most of the days during the week under consideration. The scrip dropped 4.63% for the week ended 23 February 2007, to close at Rs 27.80. The scrip’s average daily volume for the week ended 23 February 2007, stands at 1.86 crore shares, compared to the average daily volume of 65.58 lakh shares in the past 1 year.

The scrip with the third biggest average daily volume for the week ended 23 February 2007 was Zee News. The scrip surged 15.34% during the week, to close at Rs 41.35, on an average daily volume of 1.06 crore shares, compared with the company’s average daily volume of 27.60 lakh shares in the past 1 year.

Redington India stood fourth in the average daily volume toppers for the week ended 23 February 2006. The scrip dropped 11.61% to close at Rs 144.30 on 23 February 2007, compared to the closing price last weekend. The scrip, however, was traded heavily in the market. Its average daily volume for the week ended 23 February 2007 stands at 45.33 lakh shares compared to the average daily volume of 81.89 lakh shares during the past 1 year.

The other high average daily volume gainers were Cinemax India at 43.71 lakh shares (86.71 lakh shares was its average daily volume in the past 1 year), Reliance Natural Resources at 39.90 lakhs shares (41.25 lakh shares), Pochiraju Industries at 36.20 lakh shares (70.20 lakhs shares), Global Broadcast News at 33.57 lakh shares (40.60 lakh shares), Himachal Futuristic Company at 31.52 lakh shares (26.41 lakh shares), Bellary Steels at 31.47 lakh shares (18.35 lakh shares), SAIL at 28.97 lakh shares (33.69 lakh shares), and Aptech at 28.48 lakh shares (4.30 lakh shares).

The market had declined through the week amidst high volatility. Factors like the CRR-hike, rising inflation, concern over rising domestic interest rates, unwinding in derivatives ahead of expiry of February 2007 contracts on 22 February 2007, and fear that short-term capital gains tax may be hiked in the Union Budget 2007-08, were the major triggers for the fall. Caution was also partly due to worries of a possible interest rate hike by the Bank of Japan (BoJ), which was raised to 0.50% on 22 February 2007.

The BSE Sensex shed 723.02 points for the week ended 23 February 2007, to settle at 13,632.53 compared with the previous week’s closing of 14,355.55 on 15 February 2007. The S&P CNX Nifty lost 207.30 points, to settle at 3,938.90 compared with the previous week’s closing at 4,146.20.