EXCLUSIVE - Equibrain Report - July 30 2007
India Equity Analysis, Reports, Recommendations, Stock Tips and more!
Search Now
Recommendations
Monday, July 30, 2007
Ashok Leyland - Buy, ICICI Bank - Buy, Cipla - Sell, Garware Wall Ropes - Buy, Central Bank of India
Ashok Leyland - Buy, ICICI Bank - Buy, Cipla - Sell, Garware Wall Ropes - Buy, Central Bank of India
Trader's Corner
Humans are an optimistic bunch. They love sunshine, smiling faces, happy endings and soaring markets. Perhaps it is this natural trait that draws the investors to stock markets in the final stages of a bull market when things are extremely rosy with scarcely a cloud in sight.
It is again this tendency that accounts for the trader’s disillusionment since they invariably plough in all their capital near the market peaks only to see their accounts wiped out in a few sessions. Most of the pain can be avoided if traders stick to a trading plan.
Trading plans would have an entry point, the profit objective and a protective stop. Needless to say that enough deliberation should be done before deciding on the stock to trade on. If the trade goes against you and the stop is hit, it would mean that the entry signal was wrong and it would be time to move on to the next trade.
It never pays to keep reviewing a trade that has been stopped out. It will only cause unnecessary anguish as the stock would definitely have moved in the direction of your call after hitting the stop. Similarly, do not wage a battle with a stock that has made you book a loss. Many of us get in to this trap and keep visiting the stock every day to try and initiate a fresh trade in the stock that would wipe out the former loss. Apart from satisfying the ego, such an exercise is entirely meaningless.
The level at which stop losses ought to be placed and the amount of drawdown has been discussed in previous columns of the Trader’s Corner. It would however do to pay attention to the ratio between the stop loss and the profit target. For example, the profit target ought to be two to three times the amount risked in stop loss. If the stop loss is placed 1 per cent below the market price, the profit target ought to be at least 2 to 3 per cent above the price. This would ensure that the trading is rewarding in the long run.
SEL Manufacturing — IPO: Avoid
Investors can avoid the initial public offer of SEL Manufacturing, a producer of yarn, fabrics and knitted garments. At the upper end of the price band, the offer is valued at five-six times its FY-07 consolidated per-share earnings, on an expanded equity base. The valuation is in line with several mid- and small-cap textile stocks, which have undergone a severe de-rating over the past year. Larger players such as Nahar Spinning are available at comparable valuations. Given the uncertainty over the near-term prospects of textile stocks, investors may be better off sticking to the leaders in the space.
Background
SEL has a consolidated revenue base of about Rs 200 crore and derives its income from the export and domestic markets equally. About 40 per cent of its consolidated revenues are accounted for by the garment business. The company exports its garments mainly to Russia and the UAE. These are much smaller markets than the US or the UK, and imports by these countries are likely to be subject to fluctuation.
The company has over the past three years consolidated its outfits under its fold; it recently acquired a garmenting unit. Its previous financial performance is therefore not strictly comparable.
SEL is raising Rs 37 crore from the equity market, which will help fund only 20 per cent of its Rs 185-crore project. The rest will be funded mainly through loans under the technology upgradation fund scheme, which entitles it to an interest subsidy of 5 per cent. A substantial portion of the proceeds will be used to expand its spinning capacities by about 50 per cent. The project will add 1.5 million pieces to its garment capacity (now at six million). A part of the project has been implemented and commenced production. The rest of the capacities are expected to go on stream by August.
Prospects
While SEL has had a presence across segments, it has, so far, not capitalised on the advantages of integration and has, instead, outsourced most of its yarn and fabric requirements. Once the new capacities are installed, it will be able to captively source most of its requirements, which will lead to time and cost savings. SEL’s plans to discontinue its trading activities and polyester business also augurs well for profitability.
That the company’s capacities are set to go on stream shortly is also a positive. However, given the poor macro environment for textile exports, the ability to significantly ramp up utilisation levels will be a challenge. Its existing capacity utilisation of yarn and fabric do not also appear to be at optimum levels. With fresh supply coming in, realisations in the domestic market are likely to remain low. Its plan to further expand its spinning capacities in addition to the current project is also, therefore, a cause for concern, especially as it intends to fund the next phase of its expansion through additional debt.
With cotton prices showing signs of firming up and mounting interest costs, we expect profitability to come under further strain.
Offer details: About 41 lakh shares are on offer at the price band of Rs 80-90. The offer closes on July 31. The lead manager is UTI Bank.
Puravankara Projects — IPO: Invest at cut-off
Investors with at least a three-year perspective can consider subscribing to the initial public offer of Puravankara Projects. While the asking price of Rs 500-525 appears stiff now, the high earnings visibility from its current and planned projects may well provide an upside in the long term. Further, a strong track record of real-estate development, low-cost land bank, more transparent transactions and steady growth in revenue over the last five years are positives to this offer.
At the offer price, the price-earnings multiple is likely to be about 20 times the company’s expected earnings for FY-09. This is assuming there is no undue delay in its ongoing and planned projects. With a track record of having developed a sizeable area (without having to depend solely on the land bank to discover valuations), we believe the P/E multiple is an acceptable valuation metric in this case.
The company and offer
Puravankara is a real-estate developer with a majority of projects executed in Bangalore. The company’s core business lies in the residential segment with diversification into commercial projects. The company plans to raise about Rs 1,000 crore through this IPO. It plans to deploy the proceeds towards acquisition of land in Tamil Nadu and repayment of debt. Post-issue, Puravankara’s market capitalisation at the offer price would be over Rs 10,000 crore. While the company would be competing with bigger (in terms of turnover) players in this market-cap segment, there appears considerable scope for quickly ramping up revenue.
Comfortable past
Puravankara’s track record of executing 14 residential projects and a commercial one, spanning 3.93 million sq ft of developable area, is proof of its execution capability.
Further, it appears that the company has been benefiting from identifying low-cost land, ahead of the property market. That its land cost, as a proportion of total expenditure, has fallen from 24 per cent in 2004 to 6.4 per cent in 2007, reflects that the company has benefited from the boom in land prices over the last couple of years. Such a sharp decline in land cost also indicates that the company has been able to identify land at the right location and at the right time.
Going by its history and the current land holding, the company appears to prefer locations in cities and their peripheries. We believe that this strategy is relatively less risky as the demand for residential and commercial space is likely to remain robust in such areas. Corrections, if any, are also likely to be less sharp compared to smaller towns. Puravankara, therefore, appears to have a lower risk profile than similar-size peers which are aggressively moving to Tier-II and III cities.
Clean structure
Puravankara’s land holding appears to be structurally superior to a number of real-estate companies. The holding pattern also appears less complex and reflects better clarity in ownership. Of the developable area of 116 million sq ft, 14 million sq ft has ongoing projects in them.
Of the total land, 65 per cent is owned by the company; only 6 per cent of the land is on sole development rights where the title lies with the owner and the company gets only the development rights. The above proportion reduces the risk of any stalling of projects by landowners, who retain the title to the land. Even in the case of joint development projects, the company has stated that its economic interest in the same would be in the 60-77.5 per cent range. This percentage appears to be land owner-(who is typically the joint developer)friendly, striking mutual benefit.
The consideration for the above-mentioned land at Rs 795 crore is mostly paid, about 11 per cent remains outstanding.
Given that it has locked into land costs, the company may benefit from appreciation, as the land bank, going by its size, may last six-eight years.
Strength in joint venture
In 2005, Puravankara entered into a joint venture with a subsidiary of the Singapore-based Keppel Land, in which the Singapore Government’s investment arm, Temasek Holdings, has an indirect holding. Keppel Land has a presence across Singapore, China, Indonesia and Vietnam. While this joint venture is likely to improve the company’s execution capability, Puravankara has also been cautious in not exposing more than 7 per cent of its total developable area through this strategy. This venture may give Puravankara a presence in the overseas markets as well. Besides, the company has an ongoing project in Sri Lanka and an office in West Asia. Nevertheless, the venture has its risks, as the agreement does not preclude the venture partners from competing with each other.
The spread
With Bangalore being Puravankara’s strong point, the company continues to have 72 per cent of its developable area in this city. The company has also cautiously taken smaller exposure to land in Kochi and Chennai, Mysore and Hyderabad among other locations.
The demand from the middle- and upper middle-income group, to which Puravankara primarily caters to, is fairly robust in the above locations. Any correction in the now infrastructure constrained Bangalore is unlikely to dent the company’s profitability margins much, as the land is spread across the city and its outer limits. Further, the volume in the above income group segment is likely to provide some insulation to margins.
Strong financials
Puravankara’s revenue has grown at an annual rate of 75 per cent over the past three years, to Rs 417 crore in 2006-07. Operating profit margin at 32 per cent have remained stable over the past four years.
While there was scope for improvement in OPMs, with the land cost having reduced over the years, increasing construction costs appears to have prevented further growth. The margins are nevertheless above industry average.
The company is heavily geared and has a debt-equity ratio of over three. However, the proceeds of the issue are likely to bring this ratio to a comfortable level of less than 1.
DSP Merrill Lynch and Citigroup are the book running lead managers. The offer is open from July 31 to August 03.
Indraprastha Gas: Buy
There are few stocks in the oil and gas sector that come without the risk of a significant downside from rising global crude oil prices or government policy. Indraprastha Gas (IGL) is one. The stock is characterised by none of the traditional risks associated with an oil and gas sector investment.
For IGL, high global oil prices are not a threat; they are an opportunity. The Government policy on pricing of petroleum products do not affect IGL; they help the company. There are no subsidies that the company has to bear or share with other oil companies.
The company has a Supreme Court judgement, nothing less, to back its business. It is a monopoly player in the entire Delhi market and presents a huge entry barrier to competition. And, to top it all, the stock comes cheap at a multiple of just 10 times the annualised first quarter earnings.
The market appears to be ignoring the company’s prospects and its low-risk high-growth business model. Investors with a medium-term investment horizon can consider acquiring the stock at the current price of Rs 113.
Statutory backing
IGL supplies compressed natural gas (CNG) through a network of 154 gas stations across Delhi. Following a Supreme Court order, all commercial vehicles and public transport have to use CNG as fuel as it is clean and non-polluting. From last July, all new light commercial vehicles have also been brought under the CNG fold.
IGL now services 1.28 lakh vehicles in Delhi and this number will keep growing. Growth will also come from private vehicles that are increasingly beginning to convert to CNG as the economics are in its favour with petrol prices ruling at Rs 43.52/litre there. IGL sells CNG at Rs 19.20/kg in comparison.
The company also plans to spread out to areas in the National Capital Region (NCR) such as Noida/Greater Noida, Ghaziabad, Ferozabad and Panipat. The Commonwealth Games, scheduled to be hosted by Delhi in 2010, is expected to add significantly to the vehicle population, including public transport and all these vehicles will have to use CNG as fuel.
IGL also sells piped natural gas to domestic households in Delhi; this segment is also growing rapidly with the only limitation being the ability to extend the pipeline network to the residential areas in and around the city.
The company sources natural gas from GAIL (India) at administered prices that are substantially cheaper than the market rates. Given the Supreme Court order, GAIL is obliged to supply the entire natural gas demand of IGL on a preferential basis; gas availability for IGL to grow its business is, therefore, not an issue.
Robust financials
IGL had a very good first quarter 2007-08 immediately following its excellent performance in the fourth quarter of 2006-07 ended March 31. Earnings were up 39 per cent at Rs 3.84 crore while net sales were up 19 per cent at Rs 16.18 crore. CNG sales volume at 89 million kg grew 13 per cent compared to the same quarter last year, while piped natural gas sales grew 16 per cent to 9.6 million standard cubic metres.
IGL also improved its operating margins to 44.9 per cent from 41.5 per cent in the same period last year mainly by controlling costs. The company passes on any increase in natural gas prices to its customers. That it has practically no debt on its balance-sheet helps margins because interest charges are nil.
Rising oil prices and consequent increase in retail prices of transportation fuels will actually help IGL by pushing the conversion rate of private vehicle owners to the considerably cheaper CNG.
The company is also not part of the subsidy-sharing mechanism that is causing so much uncertainty in the oil sector, leading to poor discounting for its stocks.
IGL’s rapid expansion of the CNG/PNG network across Delhi and surrounding areas leaves limited scope for a second player to enter the market.
There are other virgin markets opening up for CNG networks in hinterland cities and towns where other players might be interested.
Given these, IGLs prospects appear bright. Investors can acquire the stock at the current price levels with a medium-term holding perspective.
McNally Bharat Engineering: Buy
Investments with a two/three-year horizon can be considered in the stock of McNally Bharat Engineering (MBE), a turnkey material handling company.
An expanding order book, possible expansion in operating margins, shift in product mix in favour of high-margin businesses such as steel sector applications and equipment point to strong earnings growth in future.
This apart, given MBE’s established market presence, it may be one of the leading beneficiaries of the increased focus on infrastructure and the ongoing capex boom across industries.
At the current market price, the stock trades at about 23 times its expected FY-08 earnings per share on a fully diluted basis.
Investment argument
Buoyant trends in infrastructure and capacity expansions across MBE’s user industries such as power, steel, minerals and coal, to name a few, are likely to translate into improved business prospects for the company. Apart from providing turnkey solutions, MBE also manufactures equipment used in construction, mines and metal production.
Anticipating a rise in demand for such equipment, McNally has embarked on an expansion and modernisation drive for its plants in Kumardhubi and Bangalore.
This apart, it plans to set up a greenfield plant in West Bengal for heavy fabrications at a cost of Rs 22-25 crore. While it could take about a year or two for contributions from these expansions to kick in, they could deliver a potential boost to earnings.
Another significant pointer towards McNally improving prospects is its bulging order book. Pegged at Rs 1,125 crore (as on May 2007), its order book is about 2.2 times its FY-07 revenues.
In addition, McNally has bid for orders worth Rs 7,500 crore. Notably, it has emerged the L1 bidder in Rs 2,000 crore worth orders. The order book, which comprises mainly orders from steel sector applications (about 50 per cent), also points at a shift in revenue-mix towards segments that enjoy higher margins.
While this shift will help better its margins, it will also help MBE tap a considerable portion of the capex boom across such sectors.
In this context, the capex plans of SAIL (MBE’s main customer) of about Rs 42,000 crore for its various steel plants over the next five years offer MBE a potential market to scale operations.
Markedly, all these steel plants are located near MBE’s factories, giving it a logistic advantage over its peers. This apart, the strict pre-qualification norms in the steel sector, which are currently met by only MBE and L&T, are also likely to give MBE an edge.
Financials
For the year ended March 2007, MBE’s revenues grew 51 per cent while its earnings more than doubled on a sustainable basis; both the product and project businesses grew by more than 60 per cent each.
On an operational front, margins declined marginally to about 5.0 per cent. This could be attributed to the losses incurred after MBE withdrew from the highway construction business on facing disputes relating to land acquisition.
This apart, margins also were dented as the company had executed earlier orders at low margins.
Given that the loss from the road construction business was a one-time affair and with the change in the composition of the order book in favour of higher contribution segments, one can expect the pressure on margins to eventually ease.
In this regard, the management’s guidance for a double-digit margin for FY-09E also provides confidence.
Concerns
The long gestation period of McNally’s projects tend to reduce flexibility on pricing; as contracts may be locked in for a period of the contract.
Moreover, since its projects are completely dependent on the capex cycles of its user industries, any delay in execution from the user industries’ side could also affect earnings
Thermax: Buy
Investments with a one-two year perspective can be considered in the stock of Thermax, a leading energy and environment engineering solutions provider. A strong business outlook on the back of capex across user industries, a robust order book, and good growth across segments underscore our recommendation.
At current market price, the stock trades at about 23 times it FY09 expected per share earnings. Though the stock has appreciated considerably over the last two months, fresh exposures can be considered in light of strong medium-term earnings prospects.
Specialising in energy conservation systems and captive power projects, Thermax is likely to profit from the growing importance for energy management among its user industries. This apart, given the nationwide shortage of power, it is also likely to benefit from the increasing demand for captive power solutions.
Revenues could get a further fillip with the addition of the two new manufacturing facilities, being put up in Gujarat and China. These facilities are expected to become fully operational by March 2008. The company has recorded impressive earnings growth for the quarter-ended June 2007, with a twofold expansion in profits and revenues.
On a consolidated basis, revenues doubled to about Rs 724 crore, driven by 115 per cent growth in revenues of the energy segment (about 86 per cent of total revenues). The environment segment, on the other hand, grew by about 56 per cent.
On the operational front, rise in raw material cost, rupee appreciation and intake of small orders led to a marginal decline in margins. However, the management has guided that margins could stabilise.
The group's current order backlog of Rs 3,057 crore adds further visibility to its revenues. In this context, the management's expectations of a 40 per cent growth in revenues and an expected ramp up in the momentum for order inflows appear achievable.
However, a dramatic change in the oil price outlook, further appreciation of the rupee, and any unexpected slowdown in the economy remain primary risks to our recommendation.
Will markets be able to shake off the blues?
Where are Indian equities headed in the short term? Going by the severity of Friday’s fall and the continued weakness in global markets, chances of a recovery appear slim. The Dow Jones Industrial Average fell by 208 points, or 1.5%, on Friday to close at 13,265.47, while the Nasdaq Composite Index shed 37 points, or 1.4%, to end the day at 2,562.24.
Back home, the futures segment on the National Stock Exchange could hold some clues about the short-term trend. On Friday, foreign institutional investors were net sellers of Rs 4,985 crore ($1.24 billion) of Nifty August futures, which closed at 4,402.20, a discount of nearly 43 points to the spot. Dealers said the quantum of sales was unusually large, even after accepting the fact that the derivative market is much more liquid than it was about a year ago.
Market players haven’t a clue as to who could have absorbed this huge chunk of sales. While FIIs account for roughly 38% of the outstanding positions in the market, derivative traders say the top five players among them account for nearly 70% of the market share. Individual investors are unlikely to have been the major buyers.
For one, most of them have been long on the market and would have been trying to unwind their positions rather than building fresh ones. Also, brokers would have been cautious in allowing them to take up long positions in a falling market. Many of the key market operators too are reported to have taken a bearish view for the time being and are unlikely to buy in a big way.
As the figures speak for themselves, foreign funds have been net sellers. While activities by domestic mutual funds have been on the rise, they too are unlikely to have gone long on the Nifty, given the fragile sentiment in world markets.
“Nifty futures were being unloaded (by foreign funds) at a 40-50 point discount to the spot; a clear indication of panic selling, and it needed real guts for somebody to stand up to them,” said a derivatives trader. So who absorbed the avalanche of Nifty futures unloaded by foreign funds on Friday?
Market watchers say a cartel of highly influential domestic investors were behind the purchases. This group is betting there is likely to be a short-term rebound which will allow them to exit their positions at a neat profit. Over the past couple of weeks, Indian indices had managed to gain ground despite the correction in world markets.
Strong foreign fund flows apart, this cartel too is said to have contributed significantly to the trend. Still, some of the seasoned players say the cartel’s act of taking up huge long positions in the market is no assurance of a recovery in the short-term. After all, these players had taken up huge long positions in Nifty futures in February just ahead of the Budget in a falling market. Despite the purchases, the market continued to fall over the next couple of weeks.
Coming back to present correction, foreign fund flows will be a deciding factor for a near-term recovery. And the global liquidity scenario does not look too promising at the moment. Apart from the crisis in the sub-prime loan segment, markets’ reluctance to finance a couple of high-profile leveraged buyouts (Chrysler in the US and Boots in the UK) has required banks to step in and subscribe to these offerings.
In effect, that could mean cash, which could have found its way to risky assets such as emerging market equities, will no longer be available. In addition, the emerging sub-prime losses would require many banks and hedge funds to liquidate their positions elsewhere and shore up their capital at home.
Global Doom & Gloom
This week was quite memorable. The markets were volatile, with the Sensex scaling a new high on Monday to fall on Wednesday. The F&O expiry witnessed a record turnover on Thursday. Quarterly results continued to be declared. The rupee continued its upward descent against the dollar.
On Friday, the Indian market closed in the red. But it was not just in India that mood was subdued. Global markets too felt the tremors of rising interest rate concerns caused by high inflation, rising oil prices which will further aggravate inflation.
World markets plunged on Thursday, hit by concerns that higher interest rates will hit profits and takeover deals. Rising interest rates have indicated that the days of easy money are over. According to observers, the tightening of credit is causing a lot of uncertainty. When looked in the light of the rising share prices been largely driven by takeovers - corporate or private equity, this does take on some amount of significance.
The fall was initiated by US markets. The Dow plunged 311.50 points to 13,473.57. The close was its worst since a 416.02 point loss on February 27, 2007. T he concern was that not only would higher corporate borrowing costs curb the rapid pace of takeovers but also aggravate the sluggish environment for home sales and the continued defaults in sub-prime loans.
But in London, the FTSE 100 rebounded into positive territory, easing fears that the share slump would be extended.
Let's wait and see.
Subscribe to:
Posts (Atom)