Separating Winners from Losers using Financial Statement Analysis

Separating Winners from Losers using Financial Statement Analysis

Another week, another big issue to test market

Technically, this week the market looks good. On the rising side, the Sensex has a resistance band in the region of 14,330-14,360 points. A conclusive closing above this level would mean more gains as the next key resistance level would only come at 14,613 points. However, if this level is also broken, then the all-time high of 14,723.88 would be the next target, which would be relatively easy to breach.

On the down side, there is good support at 14,010, following which there is another close support at 13,962 points. However, if the Sensex falls below this level, then there would be a strong support only at 13,736.

This week, on our technical radar, are stocks including Century Textiles Ltd, IVRCL Infrastructure Ltd and Punjab National Bank.

Century Textiles, at a current rate of Rs604, has the potential to move up to Rs639, with a stop-loss of Rs575. IVRCL, at current close of Rs335, has the short-term potential to move up to Rs356 with a longer target of Rs379, and a stop-loss of Rs318. PNB is in consolidation phase, and from the current price of Rs488, it can see a spurt to Rs506 with a stop-loss of Rs471. From last week’s recommendations, HDFC Bank Ltd hit a high of Rs1,128 on Monday, which was close to our target of Rs1,135. Reliance Communication Ltd touched a high of Rs524.05. GMR Infrastructure Ltd had a great run on bourses. The stock recommended at Rs508, hit a high of Rs572.95 during the same week, which was way above its target.

Markets recap

Last week was like a rollercoaster on the global exchanges as all major bourses danced to the tune of US economic data, which saw bond yields swinging in both directions. The week started on a positive note as bourses across Asia, including India, resumed with an upward gap buoyed by gains on US bourses. However, concerns over the DLF IPO restricted gains on Indian bourses. As the issue progressed, confidence returned, but then fresh concerns over higher US bond yields and rising global interest rates took their toll and drove the market lower. But a strong showing by the US economy later in the week led to a sharp recovery. The mood on the US bourses turned positive after Thursday’s report on core producer prices, which were in line with expectations. It got a further boost on Friday, when the core consumer price index rose 0.1% in May, below Wall Street’s expectations of a 0.2% gain. The analysis of both these key numbers reinforced the view that the US Federal Reserve is likely to hold benchmark US interest rates steady.

Indian scenario

Back home, the market struggled, in the absence of any fresh trigger. However, oversubscription of the DLF IPO eased concerns over liquidity on bourses, leading to a recovery in the later part of the week. Another mega public issue of ICICI Bank Ltd hits the market on Tuesday. But this week, the focus will be on the rupee, which is likely to appreciate due to increased capital inflows. This may have a detrimental effect on export-oriented companies, especially IT companies.

Also, now the guessing game on Q1 earnings will begin as the quarter heads to a close. This could mean some consolidation in the market. Going by primary indicators such as advance tax collections, industrial growth rate and monthly sales, the performance of Indian firms in the first quarter looks promising, which is contrary to analysts’ assumptions that monetary tightening could take a toll on the earnings.

Week ahead

The market is likely to resume on a positive note with an upward gap as strong US data will push equities higher across Asian markets. But later in the week, the trend will depend on a lot of domestic and international factors.

There are fresh concerns on China’s stock markets after Premier Wen Jiabao warned that the government would tighten policy further to prevent the economy from overheating. Even though global markets have developed resilience to the swings in China’s markets, this may have cascading effect on global bourses. The US economy will also be tested on the grounds of housing starts. On Tuesday, the commerce department will issue data on home construction and building permits for May. It is expected that the housing starts may fall to an annual pace of 1.480 million units from 1.528 million in April. But the building permits are expected to pick up a bit to an annual pace of 1.471 million units from a revised 1.457 million for April. Though fall in housing starts has already been factored in, any significant negative surprises on this count may give market a jolt. Broadly speaking, sentiments on the US bourses would remain strong ahead of first quarter earnings announcement. On Thursday, a report on leading economic indicators and another on regional manufacturing activity, as well as

If Rupee rises to 35...

The recent management of the rupee-dollar exchange rates by the Reserve Bank of India (RBI) has attracted enormous comment in the media. The common theme of all the commentators is that there is a disjoint in monetary policy and that both the finance ministry and RBI appear to be tackling the issues somewhat half-heartedly.

At the core is the issue of considerable inward capital flows, likely to be exacerbated by the interest being shown by funds and investors overseas in initial public offers (IPO), investments in venture capital, and the like. If one adds the corporate external commercial borrowings (ECB), there is a flood of inflows. As RBI sterilizes, the resultant additional liquidity is bringing overnight call rates to near zero. If RBI does not sterilize the inflows, the resultant appreciation of the rupee is seriously affecting exporters, increasing imports, making manufacturers choose imported inputs over local, affecting domestic production, and leading to growing current account deficits.

In these troubled waters there are several fishermen. Two types are visible. The academics and the economists are arguing vehemently over the validity or otherwise of the actions, in this juicy debate on monetary policy. Allow the rupee to appreciate, import goods to relieve supply-side constraints and thus control inflation, argue some. Why is RBI sterilizing at such a cost, and how long can it do so, argue others.

The other fishermen are those that expect this volatility to lead to some commercial gains. There are those who argue for early capital account convertibility, others who think currency futures would be a great idea provided that it is regulated according to their wishes, and yet others who think that this is an opportunity to encourage industry to invest overseas.

Apart from these interested comments, there is little analysis on how this would affect the overall growth rate, the economy and in short, the people.

First, there is sufficient anecdotal evidence that exports are hurting. Several textile exporters are refusing winter orders, and even the IT industry has reported that margins are getting squeezed. Tata Consultancy Services has announced recruitment of 5,000 people in Mexico, employment that could have been provided here. Every day one reads of industry investment choosing China, Vietnam and even Romania over an alternative in India. To believe that all is well, would be quite foolish. Employment in the manufacturing sector is essential, as the service sectors are absorbing only a minuscule number of the workforce, those with special skills. It is only recently that manufacturing in several sectors has become internationally competitive, and that exports have been growing at a very healthy pace. This should not be lost. The first concern is the impact on growth in employment.

Second, to those who argue that supply-side constraints are being tackled by greater imports and thus helping to control inflation, the real worry is about prices of those items that are not imported—the prices of foodstuff, for example, and oils and pulses and vegetables. Land prices are over the top, and the recent IPOs in real estate will make it even more so, as overseas money fuels the high prices.

Flat prices are in millions, and are no longer for the middle class. There are worries that, in the absence of attention to agriculture, availability of foodgrains per capita is set to decline, and India will be a great importer of food in years to come. The cheaper dollar will not address these concerns, and several people have pointed out that inflation at a fairly high level will remain.

The third concern is about current account deficits. The capital flows are masking the real impact of the trade deficits. If, in the long run, we are to be an energy importing country, a foodgrain importing country as well as an importer of manufactured goods, the only way we can pay for these is by exporting manpower. Interestingly, the policies are actively encouraging industry to locate overseas by allowing over-the-top ECB, and even announcing that foreign exchange reserves can be used for overseas acquisitions. How does all this improve my GDP per capita? An analysis of the Tata-Corus deal indicates that the liabilities, risks as well as the benefits are all offshored. So how do we gain?

If there are so many concerns to my unintelligent mind, why are these actions persisting? First, perhaps those who benefit from these policies, the second kind of fishermen, would like these to continue. No cap on ECBs, easy inflow of capital (with little trace of whether it is used productively or not), and let RBI/government bear the costs. Second, because this suits the politics of the day, it is important to keep up a buoyant image, not to express concern over capital inflows, current account deficits and excess liquidity, at least for another year and a half until the elections. The third, most worrying, is that those in charge of actions, do not know what to do, as this is the kind of crisis that they have not encountered before. One notices the tiredness of RBI, and the lack of reaction in North Block. I think we are juggling too many balls, and if the rupee rises to around Rs35 by this time next year, with low foodgrain stocks and high inflation, we would have fallen flat on our faces.

I hope this will not happen.

Mukesh Ambani v Anil Ambani - Two Years of Separation

Mukesh Ambani v Anil Ambani - Two Years of Separation

KP Singh - DLF will always be family-owned but professionally run

A visitor to DLF Chairman Kushal Pal Singh’s office on the 9th floor of the company’s Parliament Street building in the capital gets a glimpse of some rare maps, among the earliest ever drawn, of “Hindoostan” or the “East Indies”, depending on whether the cartographer was Portuguese or British.

Singh’s desk is also littered with old navigation equipment and in the backdrop is a flag of the tiny, yet super-rich principality of Monaco, of which he is consul general.

Flush with the success of having overseen the country’s largest-ever public issue (over Rs 9,000 crore), the 75-year-old builder of modern Gurgaon tells Nayantara Rai and Siddharth Zarabi that he isn’t tired at the end of it all. “It’s all a part of the game. After all, it is the beginning for DLF.” Excerpts from the interview:

So, are you pleasantly surprised with the response?

It would be unfair for me to say I never expected it. I expected it to be subscribed fully. Renowned foreign investors have put in millions and that too in these adverse times. If you ask how much I was expecting to raise, I could never answer. But, just see the high quality and magnitude of the investment.

You said “adverse times”. Are you referring to the run-up to the issue and to those who said the stock is overpriced?

No, not at all. Real estate is a sunrise sector. People do not understand how to evaluate these stocks. Incorrectly, people talk about land banks.

The other day I saw an analyst on TV say that one of the negatives of DLF is that it is too highly concentrated in Gurgaon. What is he talking about? It is common sense that Gurgaon will continue to flourish. Connectivity with the expressway and the Delhi Metro is only going to help Gurgaon. We are sitting on gold and platinum.

Will KP Singh and DLF make another Gurgaon ever?

In my lifetime, that is not possible, but I hope my son and grandchildren would. And I know my son (the 48-year-old Rajiv Singh) has plans for it.

You aren’t telling us about the next Gurgaon…

I cannot share that with you…people will then start buying land there! You have no idea how difficult it was for me to make DLF City successful. Nobody except I had faith in the project.

Whoever thought people would live 20 km outside of Delhi? It was initially called DLF Qutab Enclave. Why did I call it that? It was just a marketing gimmick…making the township sound as if it was an enclave of Qutab Minar, even though it was 15 km away. I had a vision and convinced people (to buy it).

So will Rajiv do it then?

I know he is my son, but if I divorce myself from that relationship, I have to say that he is one of the greatest visionaries. Just imagine what he has done. Anybody can be a builder, but only visionaries can be developers.

My son is an alumnus of MIT. When he joined the business 15-20 years ago, he told me, “Dad, this is not the way to do it. We need to shift from plotted development to high-rise buildings.” Outside of Bombay, where had you seen group housing? DLF pioneered high-rises and today everyone is following us.

Two years ago, Rajiv got McKinsey to restructure the company. They did a great job and we paid them a lot of money! Then Rajiv gave a $13 million order to IBM for our systems.

Today, we have over 200 subsidiaries across India and we are one of the most automated companies. We prepare audited results of all subsidiaries here within 10 days of the financial year ending—it is a different thing that now they will be prepared in five days.

Will DLF always be controlled by the family?

What is wrong with family control? We have done very well. DLF will always be family-owned but will be a professionally run company.

In hindsight, could the issue size have been larger?

No. That was not required. If we had done that you people would have criticised it….We can always come back for a fresh round.

India Strategy - June 2007

India Strategy - June 2007

Idea-Spice deal fails on pricing

Talks between Idea Cellular, India’s sixth-largest wireless operator, and the BK Modi-owned Spice Telecom on a merger have broken down due to differences in price, a person close to the negotiations said. The two sides had held preliminary discussions on the possibility of a merger or an acquisition by Idea three-four weeks ago. Idea, which is present in 11 out of the country’s 23 circles, was keen on expanding its subscriber base. But it baulked at the price being demanded by Spice Telecom.

“Expectations of the Spice management were unrealistic. They were quoting almost twice the value of the company. The merger was called off around a fortnight ago. There is no question of it even after the Spice IPO,” said the person who did not wish to be quoted as he is not authorised to speak. Idea Cellular MD Sanjeev Aga refused to comment. Spice Telecom CMD Dilip Modi could not be reached for comment.

Spice, which offers cellular services in Punjab and Karnataka, had revenues of around Rs 553 crore in 2006. It was looking at a valuation of about $1.3 billion (over Rs 4,300 crore). Idea found it excessive, as Spice does not have a nation-wide presence and continues to make losses.

Analysts say that if Bharti Airtel’s valuation is taken as the benchmark, Spice would command a price of about $1 billion. But Spice is only present in two circles and is a pure-play mobile company compared with Bharti, an all-India integrated operator. Therefore, Spice’s valuation would be at a discount of 30%-35% to Airtel, or about $650 million-$700 million.

Idea officials are also believed to have cited Spice’s weak presence in Karnataka as a dampener. It ranks sixth in the southern state with a share of around 7% despite having made an early start. While most operators have expanded footprint across India after starting with a few circles in the 1990s, Spice has confined to just two circles. It applied for pan-India licences only in September last year.

Idea is present in 11 out of 23 circles and has licences to operate in Mumbai and Bihar where is expects to roll out services as soon as spectrum is allocated. While a merger with Spice would have given it ready presence in two more circles, the price demanded was almost four times Idea would need for rolling out greenfield operations in these two circles. Idea shares gained 0.79% to close at Rs 115.50 on Friday.

The BK Modi group has a 51% stake in Spice, while Telekom Malaysia holds the rest. After the IPO, Telekom Malaysia will hold 39% and the Modis 41%. Another person close to the Modi group said the group had been keen on exiting Spice at a good valuation. “They have been looking for a buyer and while Telekom Malaysia has shown some interest, it will also not pay too high for buying out Modis,” the person, who did not wish to be identified said.

India Equity Strategy

India Equity Strategy

Citigroup - Weekly Technicals

Citigroup in their weekly technical report,

Nifty — The index traded flat on the opening session of the week; it dipped down toward 4100 levels and saw a rise toward the latter part of the week's trading. It
ended the week up 26 points.

Daily Simple Moving Averages — The index is trading around the averages, witnessing support and resistance around the averages. The 10 dma = 4183; 20 dma = 4223; 50 dma = 4112. The 10 & 20 dma crossover is negative, suggesting pullback will face resistance at higher levels. [dma = daily simple moving averages; negative crossover – 10 dma has crossed the 20 dma from above.]

Momentum Oscillators — The RSI (14) - Relative Strength Index on the daily chart is exhibiting a reading of 49.79 (reading of 30 signifies oversold). MACD on the daily chart is in sell mode. Stochastic Daily (5,3) is in buy mode. Momentum study suggests Nifty can see intra-week volatility.

Fibonacci Retracement — The retracement levels of the decline from high of 4363 (4 June 07) to the low of 4100 (12 June 07) are: 50% = 4232 (approx.) and 62% = 4263 (approx.). Index can see test of retracement levels during the current week.

Support — The index has support around 4112 (50 dma) – 4100 & 4052. Intraweek dips should find support around 4100 levels.

Resistance — The index has resistance in the 4223 (20 dma)-4232 band.

Conclusion — We expect range-bound movement with rise toward 4232; intra-week
volatility can be expected.

Weekly Technicals

The pattern of three successive lower tops since June 4 suggests that the market has entered an intermediate downtrend.

The market eased through several sessions of consolidation at lower levels followed by an abortive breakout on Friday. The Nifty closed at 4171 points for a nominal gain of 0.64 per cent. The Sensex was up 0.7 per cent at 14063 points. The Defty moved up by 0.8 per cent as the rupee continued to strengthen.

Breadth was almost balanced by the weekend while volumes were low through the week. FIIs and Mutual funds showed divergent trading patterns through the first four sessions of the week. The FIIs were net buyers while the mutual funds were net sellers. The Broad BSE 500 did gain 0.83 per cent.

Outlook: The Nifty found support several times at around the 4100 mark. It failed to beat resistance at 4175. Next week could see range-trading inside this same zone. Or, there may be a dip till the next support at 4050.

The signals don't suggest an upside breakout. In fact, the pattern of three successive lower tops since June 4 suggests that the market has entered an intermediate downtrend.

Rationale: ifty 4100 appears to be a pretty good support. But the market will need to generate much higher volumes to burst through the selling pressure at 4170-plus.

This didn't happen this week due to liquidity being sucked off by DLF's IPO and it's unlikely to happen next week if only because of ICICI's FPO. On the downside, the secondary support at 4050 seems strong. But if that is broken, a dip till 3850 is on the cards.

Counter-view: Sentiment may just improve given the qualified success of the DLF IPO. If it does, the requisite volumes could be generated to create an upside breakout. Even then, the market will face continuous selling pressure above 4200.

Bulls & Bears: At the stock-specific level, the bearish impression is reinforced. Most stocks across the F&O universe are in range-trading mode. A few are bearish. However there are some lower-weighted stocks that seem capable of moving up despite the generally indecisive or bearish mood. Our picks for the week are all chosen from these non-correlated scrips.

In terms of sectors, some smaller banks such as Corporation Bank, Syndicate Bank, UTI Bank Union and Vijaya Bank are mildly bullish. There's also a little bullish action in Bhel, Suzlon Energy and Tata Power.

Apart from these sector-specific moves, isolated gainers such as Divis Lab, GMR Infrastructure, Maruti, Reliance Capital, Titan, Nicholas and TVS are visible. This is not enough to pull the market up given the number of range-trading pivotal stocks.

MICRO TECHNICALS

UTI Bank Current Price: 599.75 Target Price: NA

The stock has made a breakout but this hasn't been backed by a volume expansion. The chart formation suggests that a target of 640 is possible and a projection made off weekly charts would lead to a target of 700 in the timeframe of 3 months. However the lack of volumes should be a danger signal. Keep a stop at 595 and go long.

Educomp Current Price: 1896.55 Target Price: 1940

The stock surged on Friday with a sharp volume expansion. It is going to test resistance at 1940 so that is a minimum upside target. If it managesto close above 1940, there will be a target projection of 2150. Keep a stop at 1885 and go long.

GMR Infrastructure Current Price: 564.15 Target Price: 540

The stock continues to rise with support on a 45 degree trendline which it has managed to maintain since early April when it came off a low of 327. It's impossible to project a target with this formation except by trendline extension. Keep a trailing stop at 540, go long. Move the stop up 10 points for every 10 point advance.

Nicholas Current Price: 301.5 Target Price: 325

The stock jumped on Thursday, closing at 306.5 with a volume expansion. There was a lot of profit booking on Friday but that caused only a minor pullback. There is an upside till 325. Keep a stop at 290 and go long. It may be worth holding a reduced position even above 325 because the major trend has changed.

Suzlon Energy Current Price: 1387 Target Price: 1475

The stock is testing resistance at current closing levels and slightly above. If it closes above 1405, it will complete a formation with a likely target of 1475-80 and a potential target of 1515.

Bull’s Eye

Reliance Industries
Research: UBS Investment (June 14, ’07)
Rating: Buy
CMP: Rs 1,680 (Face Value Rs 10)

Based on an improved outlook for gas price realisation from KG D6 gas, UBS Investment has raised the FY09 EPS estimate by 3.6% from Rs 96.4 to Rs 99.8, while FY08 estimate remains unchanged. Media reports indicate that Reliance Industries (RIL) has received bids in the region of $4.3-4.7/mmbtu (excluding transportation charges, marketing margins and sales tax) for 25 mmscmd of gas. The contracts are likely to be for three years. UBS is upgrading its estimate for average KG D6 gas realisation from $3.55/mmbtu to $4.2/mmbtu. Recent disclosures by RIL’s partner, Hardy Oil (HOGP), indicate additional upside in new blocks D3, D9 and GS-01. HOGP has estimated gross prospective resources of 33.6 tcf of gas in D9 and 4.2 tcf of gas in D3. RIL has 90% interest in these blocks.

Dabur
Research: Macquarie (June 13, ’07)
Rating: Outperform
CMP: Rs 101 (Face Value Rs 1)

Dabur’s competitive advantage lies in its niche position as the premium player in ‘herbal’ personal care products. The company owns some of India’s most trusted brands in hair care, oral care and health supplements on an Ayurvedic platform. These factors support Dabur’s margins due to sustainable pricing power. The trend of margin expansion is unlikely to reverse. The strength of Dabur’s core business and brands, combined with the positive impact of its recent forays on the bottomline, should protect against any margin erosion due to investment in new businesses such as retail. Macquarie expects Dabur to remain among the fastest-growing FMCG players in India and report a three-year earnings CAGR of 18%. The company’s core business strength has enabled it to consistently deliver 20-50% earnings growth over the past five years. Importantly, earnings have outpaced revenues in each of these years. Dabur trades at a P/E ratio of 17x FY08E earnings, which is at a ~20% discount to its domestic consumer sector peers.

Gujarat State Petronet
Research: Citigroup (June 13, ’07)
Rating: Buy
CMP: Rs 55 (Face Value Rs 10)

Citigroup has raised the target price of Gujarat State Petronet as higher volumes of gas are likely to flow from Reliance Industries through GSPL’s network, as indicated by the management of both companies. The gas volumes transported through GSPL’s pipeline network are likely to increase ~2.5-fold to 38 mmscmd by FY12E. Recent speculation on the adverse impact of regulatory intervention in setting pipeline tariffs is premature and overdone. Based on the analysis, introducing regulated tariffs on the cost of service methodology may result in a net positive impact of 7-11% to Citigroup’s steady state (FY10-12E) earnings estimates. GSPL is Citigroup’s top pick in the domestic gas utilities space. A pure play gas transmission company, GSPL is highly levered to increasing consumption of gas in Gujarat, without being exposed to the vagaries of gas pricing. The stock trades at 8.8x FY09E P/CEPS, marginally higher than other gas utilities, but this is justified by its 30% EPS CAGR over FY07-10E (significantly higher than peers) and highest leverage to KG gas

Jaiprakash Associates
Research: CLSA (June 14, ’07)
Rating: Buy
CMP: Rs 690 (Face Value Rs 10)

Jaiprakash is well-positioned for growth in the construction, cement, hydropower and real estate sectors. Cement capacity is set to triple by FY10 and construction revenue should improve by H2 FY08 as the Taj Expressway project takes off. Jaiprakash will triple its cement capacity to 21.7 million tonnes by FY10CL. Its average cost of capacity expansion is 30-40% below benchmark replacement cost, and it will receive excise duty and sales tax exemptions at some of its new plants. The government’s strategic interest in hydropower will boost the company’s construction order flow (hydro-projects comprise 70% of the order book) and provide opportunities for investment in new projects. The company’s two existing projects earn a 22-24% return on equity. Jaiprakash’s construction business will also see a rebound in construction segment revenue in FY09CL, with a pick-up in progress of the Rs 6,000-crore Taj Expressway project. The addition of 650 acres to its existing land bank of 600 acres in Noida, over the next few months, will deliver visibility on the value-creation potential in the Taj Expressway project.

Indraprastha Gas
Research: Enam Securities (June 11, ’07)
Rating: Buy
CMP: Rs 120 (Face Value Rs 10)

Indraprastha Gas (IGL) is the only distributor of compressed natural gas (CNG) and piped natural gas (PNG) in the national capital territory of Delhi (NCTD). IGL offers a leveraged play on the increasing penetration of natural gas in India. During Q4 FY07, IGL continued to benefit from its aggressive marketing strategy in CNG and PNG. As a result, it experienced a 12% YoY and 2% QoQ growth in CNG, primarily driven by conversion towards CNG by private car owners. PNG sales grew 44% YoY and 14% QoQ in Q4 FY07. Overall, IGL posted a 13% volume growth in Q4 FY07. Enam expects IGL to sustain a long-term volume growth of over 10% given: (1) economic benefits of CNG (2) regulatory directives and (3) a relatively under-penetrated market. Although competition remains inevitable in the near future, Enam expects IGL’s leadership position to be maintained, given its access to gas supplies and its first mover advantage. Given IGL’s strong business franchise, superior profitability and inexpensive valuations, it’s attractively valued at 9.8x FY08E EPS.

Gateway Distriparks
Research: ASK Securities (June 13, ’07)
Rating: Buy
CMP: Rs 178 (Face Value Rs 10)

Gateway Distriparks (GDL) is the largest private sector logistics service provider in the container freight station (CFS/ICD) business with a market share of 18%. With India’s containerised traffic set to double to 10 million TEU over the next five years, GDL is well-positioned to capitalise on the same. Unbridled competition in the traditional CFS business has led to a price war, which is most likely to play out for a few more quarters. Hence, margins may remain range-bound at 50%. Landside infrastructure development, particularly with regard to the upcoming dedicated freight corridor, may not lock step with growth in container traffic and therefore, the shift in time lines will impact the overall throughput. GDL is in the right business at the right time. While opportunities are compelling, the near-term prospect for GDL is lukewarm. Hence, GDL is an investment proposition only for the long term. Based on ASK Securities’ DCF analysis, the fair value is Rs 251. GDL discounts its FY08 and FY09 earnings of Rs 9.8 and Rs 11.6 by 18.2x and 15.5x, respectively.

Max India
Research: Merrill Lynch (June 8, ’07)
Rating: Sell
CMP: Rs 250 (Face Value Rs 2)

Merrill Lynch has downgraded Max India to a ‘sell’ as the company continues to lose market share and its first-year premia growth (though up 72% YoY) was 17% below estimates and 30% below the sector growth of 104%. Healthcare revenues were also 16% below estimates. Merrill Lynch has assigned higher NBAP multiples of 20x FY09E NBAP (v/s 16x earlier) due to its strong growth trajectory and higher margins that Max New York Life is likely to have on higher share of traditional policies and lower costs.

Analysts' corner

Tayo Rolls
Current Price: Rs 186
Target: Rs 300

Antique Stock Broking has given a strong buy for this Tata group company which is the largest integrated (makes its own pig iron) manufacturer of rolls in India. With steel industry estimated to grow at 10% till 2012, TRL's revenues are expected to grow at a CAGR of 25- 30% till FY10.

The company has been regularly increasing its capacities and plans to take it up to 18,000 TPA by 2010 from the current 13500 TPA. Exports will get a further boost post TISCO's acquisition of Corus as it plans to supply rolls to all nine plants of Corus across Europe.

BASF India
Current price: Rs 269
Target: Rs 300

Sharekhan has put a buy on BASF India with a price target of Rs 300 from the current price of Rs 273. On the back of decent numbers in Q4, 2007, the company is expanding its capacities in key products like expandable polystyrene and polymer dispersion to cater to the consumption boom in its user sectors of white goods, home furnishings, paper and construction.

Further, it also has access to the wide product portfolio of its parent company to add to its existing line up in its three divisions—agriculture, performance products and plastics. Considering its growth prospects, the research firm believes that the company is trading at attractive valuations of 13.3x FY2007 earnings and 9.5x FY2008E earnings.

JK Lakshmi Cement
Current Price: Rs 107
Target: Rs 129

SBICAP Securities is bullish on JK Lakshmi Cement (JKL) and believes that at current levels there is an upside of 20%. The recommendation is based on the robust growth in the earnings driven by savings in power cost and various other initiatives, cheaper valuations and an improved balance sheet.

The stock, research firm believes, is trading at hefty discount to its peers and deserves a rerating. The company is expanding cement production capacity by 1.2mn tonnes by the Oct'08 including split grinding unit of 1.1mn tonnes capacity which will result in savings of Rs 24mn on PAT level or addition of Rs 0.4 in the EPS for FY09E.

Dabur India
Current Price: Rs 100.85
Target: Rs 120

Macquarie Research recommends a “buy” on Dabur India, at a price of Rs 99.60, with a 12-month target of Rs 120, denoting an upside of 20 per cent. Dabur India has achieved a niche positioning of being a premium player in herbal personal care products. Its brand portfolio includes ayurvedic hair care, oral care, and health supplement products, which deliver high margins to the company.

The company has delivered a consistent earnings growth of 20-50 per cent over the past five years. Macquarie expects Dabur India to maintain its sales momentum at a compounded rate of 17 per cent annually over the next three years. The stock is valued at 17 times its estimated FY08 earnings, which is at a 20 per cent discount to its Indian consumer goods sector peers.

Marico
Price Rs 56
Target Price Rs 69

Emkay Share and Stock Brokers has recommended a buy on stock of Marico on the the back of growth in its well established core business, increasing presence in the broader “wellness and beauty” platform, rising international business and continued pursuit of newer avenues for growth-both organic and inorganic.

Emkay expects revenue growth to be at a CAGR of 17.5 per cent in FY2007-09E period and earnings growth at CAGR of 26.5 per cent, which is higher than industry earnings growth. At a recommonded price Marico is trading at PER of 18.9 times FY2009E earnings and EV/ EBIDTA of 11.7X FY2009E.

Dishman Pharma
Current Price: Rs 291
Target: Rs 360

Karvy Stock Broking puts a “buy” recommendation on Dishman Pharma at the price of Rs 288, with a target price of Rs 360. The company had acquired Carbogen Amcis of Switzerland in August 2006, for $74.5 million.

Further, it has set up a QUATs facility in China. Add to this, its diverse customer base, the technology transfer model, and strengthening international presence is expected to boost the company’s performance with greater revenue and earnings momentum. The stock is valued at 15 times its expected FY09 earnings.

Taking stock of market valuations

Is the stock market overheated? Should I brace myself for a correction? Such investor concerns are often addressed by drawing attention to the "market" valuations, as reflected in the current price-earnings multiple (PE) of the Sensex or the Nifty.

The current Sensex PE of about 20.5 times, may, for instance, appear quite reasonable if one considers that India Inc.'s earnings grew over 40 per cent for the just-concluded quarter.

But investors may need to treat such numbers with caution. For one, the published PE multiples of the Sensex and the Nifty indices tend to be understated, because of the method adopted for their calculation.

Second, given that so much of the market action in the Indian context, takes place outside of the index stocks, PE multiples for broader market indices such as the BSE-500 may be a better gauge of "market" valuations.

An analysis of "market valuations" after accounting for these two factors clearly shows that the price-earnings multiples have expanded sharply over the past year.

This suggests that last year's stock price gains have been driven as much by a "re-rating" of company earnings (that is, the markets' willingness to pay more for every rupee of current earnings), as by the scorching pace of earnings growth.

Restating the Sensex PE

Published PE numbers for market indices such as the Sensex or the Nifty may be understating the actual multiples enjoyed by India's frontline companies.

This is because the published PE numbers are calculated by dividing the total market capitalisation of the index by the total profits of the index constituents.

But using the aggregate numbers bestows select companies with a large earnings base, such as ONGC or Tata Steel, with a huge influence on the index valuations.

Loss-making companies in the basket (though there were none in 2006-07) may further distort the picture, as they would not have any meaningful PE, but would drag down the aggregate profits for the Sensex basket.

A re-computation of the Sensex PE multiple based on the average multiples actually enjoyed by individual stocks (using market cap to "weight" these numbers) places the Sensex PE at about 23 times trailing 12-month earnings.

A similar computation for the Nifty places its valuation at about 24 times earnings. Neither is a modest valuation.

In fact, current market valuations require the earnings of the index constituents to grow at 23-25 per cent compounded over the next five years.

PEs expand

Trends in the PE multiple over the past year also raise flags of caution. Between June 2006 and now, the Sensex PE multiple has widened from about 16 times historical earnings to over 23 times.

While stock prices of the Sensex companies appreciated by an average 48 per cent over this period, per share earnings of the companies in it expanded at an average 33 per cent.

Clearly, if stock prices gained so sharply over the past year, this is not only because companies delivered strong earnings growth, but also because investors are now willing to pay a higher price for each rupee of earnings delivered by the company. Such a "re-rating" suggests that investors are now factoring in a significant acceleration in earnings growth for companies from current levels.

A disappointment, in the form of slower earnings growth or fewer companies that are able deliver on expectations, could lead to a de-rating of valuations and a significant downside to stock prices.

Investors should also note that, apart from the average multiple moving up, over the past year, more Sensex companies have moved into the "expensive" zone.

While 21 of the 30 Sensex companies traded at a PE multiple of less than 20 times in June 2006, more than half the Sensex stocks are currently traded at a multiple of over 20 times their historical earnings.

Mid-cap stocks

Granted, the PE multiples for the bellwether indices have widened significantly over the past year. But would the stocks in the investment portfolios of individual investors have witnessed similar trends? Maybe not.

Individual investors, as well as mutual fund managers, tend to liberally pepper their portfolios with mid-cap stocks; but the PE multiples for the Sensex or the Nifty capture trends only for the highly visible frontline companies in India Inc.

But if you expected the PE multiple for the broader market to be much lower than that for the Sensex, you might be in for disappointment.

The PE computation for a broad market index, such as the BSE-500 (which captures a wide cross-section of mid-cap as well as large cap stocks), shows that the PE for this index is actually higher than that for the Sensex or the Nifty, at this juncture.

The weighted average PE for the BSE-500 is currently at a lofty 26 times trailing earnings, up from about 19 times a year ago.

If this is taken as a more accurate gauge of broad market valuations than the Sensex or Nifty, investors may have to tread cautiously indeed, as the earnings expectations factored into these multiples are quite high.

But when it comes to mid-cap companies, investors have greater leeway to reduce the overall risk to their portfolio through stock selection.

For one, unlike Sensex companies, earnings growth for the BSE-500 companies has largely outpaced stock price growth.

This suggests that the higher valuations of mid-cap stocks have been underpinned by better earnings growth.

Second, given the considerable divergence in earnings performance across companies, there continue to be opportunities for stock selection.

Companies such as Jagran Prakashan, UTV Software and Shree Cement have, for instance, witnessed a manifold expansion in earnings over the past year, reducing their historic price-earnings multiples. On the other hand, earnings growth for companies such as Apollo Hospitals or IndiaBulls Financial Services has significantly lagged the extent of stock price appreciation.

Third, mid-cap companies show greater divergence in valuations than frontline companies.

While the companies at the top end (Max India Financial Technologies, Reliance Natural Resources) enjoy three-digit PE multiples based on trailing earnings, the other end of the spectrum features companies such as Graphite India and Gujarat Gas, which trade at a multiple of less than 10.

Therefore, despite an average multiple of 26 times for the BSE-500 stocks, a good number of stocks in this basket continue to be available at a single-digit PE.

About 103 stocks, or roughly one in five in the BSE-500, are currently at PE multiples of less than 10 times their historic earnings.

This suggests that investors wary of current market valuations are more likely to locate winners while sifting through the mid-cap universe, rather than chasing frontline stocks.

SSKI - Nicholas Piramal

Nicholas Piramal India's (NPIL) growth strategy involves partnering with global Innovators for providing Contract Research and Manufacturing (CRAMS) services. NPIL has built unique capabilities across the formulations development value chain with manufacturing assets in UK and India. After the initial hiccups, we believe the CMS business is on track with CMS revenues exceeding US $200m in FY07. We see accelerated growth ahead, well supported by steady domestic sales and strong discovery R&D capabilities. We estimate 17% CAGR in NPIL's consolidated revenues and 26% CAGR in earnings over FY07-09. Reiterate Outperformer with a price target of Rs353 (24.1x FY08E and 20x FY09E earnings).

FII interest in DLF outsmarts net inflow

The initial public offer of realty major DLF Ltd may have failed to hit the right cord with the Indian retail investors, but the interest shown by overseas investors has exceeded the total net inflow into the country's equity market so far in 2007.

The country's largest real estate player, which has raised Rs 9,187.5 crore from the IPO, received bids worth about Rs 25,500 crore from the foreign institutional investors alone, which is higher than about Rs 17,000 crore net FII inflow into Indian equities this year.

According to data available with market regulator SEBI, total FII inflow into equities since the beginning of 2007 stands at Rs 17,432 crore.

The FII demand for DLF public offer was nearly 80 per cent of the total demand of about Rs 32,000 crore recorded by the issue, which is the largest ever IPO so far in India.

However, the total demand for the DLF issue pales in comparison to other major IPOs that have hit the Indian equity market in the recent past.

The demand is, in fact, less than issues which were much less in size, including those from peer firms in the real estate space such as Parsvnath and Sobha Developers.

Public offerings of Mukesh Ambani group company Reliance Petroleum Ltd (RPL), Birla Group telecom firm Idea Cellular, and Mahindra Group company Tech Mahindra have also witnessed higher demand in value terms than DLF.

Incidentally, the capital raised by all these IPOs was less than DLF.

Parsvnath and Sobha Developers issues, which raised between Rs 500-1,000 crore, saw demand worth over Rs 60,000 crore -- nearly double of that for DLF IPO.

Parsvnath IPO was subscribed over 60 times, while that of Sobha received bids for about 114 times of the total issue size.

Besides, Idea Cellular recorded demand for shares worth about Rs 1,42,500 crore against issue size of about Rs 2,500 crore, an oversubscription of about 57 times.

RPL saw demand worth about Rs 1,38,500 crore for its Rs 2,700 crore issue with an oversubscription of about 52 times.

Telecom technology services provider Tech Mahindra also recorded demand worth about Rs 33,500 crore, which was higher than DLF, even though its issue size was less than Rs 500 crore.

However, DLF has garnered higher demand than a number of recent issues such as Maran family promoted Sun TV, hypermarket chain Vishal Retail and the Indian subsidiary of British energy giant Cairn Plc and credit rating agency ICRA.

Sun TV got bids worth about Rs 28,300 crore as against its issue size of about Rs 600 crore, while demand for Vishal, ICRA and Cairn India were below Rs 10,000 crore.

Among other major issues, those of GMR Infrastructure and Global Broadcasting Network (GBN) also received bids worth between Rs 5,000-6000 crore.

Like DLF, the public issue of Cairn India, which gained immense popularity before it hit the capital market, could garner only 1.1 times oversubscription for the Rs 5,260 crore offer.

DLF IPO was subscribed 3.47 times of the size, while the company offered to sell 17.5 crore shares representing a 10.27 per cent of its post-issue capital.

The company has fixed its issue price at Rs 525 a share, at the middle of its price band of Rs 500-550 per share, based on which it would outsmart Unitech Ltd as the country's most valued real estate firm