Dead Presidents! - India Equity Research

Monday, July 30, 2007

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.

Monetary Policy, ITC, Balaji Telefilms, Ranbaxy Labs, Wockhardt,

Monetary policy preview

RBI expected to maintain a status quo
We expect the Reserve Bank of India (RBI) to keep the policy rates unchanged during its first quarter review of the annual credit policy on July 31, 2007. With inflation down below 4.5% and the annual credit growth moderating to 24%, the RBI is much more comfortably placed than it was in the previous couple of quarters. Thus we feel the monetary policy's focus is likely to shift from inflation management to liquidity and exchange rate management, as the current high annual growth of above 21% in the money supply continues to be above the central bank's comfort zone. The market also seems to be unanimously agreeing that the status quo on policy rates (reverse repo and repo rates) would be preserved. However, market estimates suggest that there exists a 10% chance of the cash reserve ratio (CRR) being increased by 50 basis points in the upcoming policy review meet.

STOCK UPDATE

ITC
Cluster: Apple Green
Recommendation: Buy
Price target: Rs200
Current market price: Rs172

Better than expected results

Result highlights

The Q1FY2008 results of ITC were better than our expectations. In Q1FY2008 the net revenues of ITC grew by 16.7% year on year (yoy) as most of its businesses witnessed a strong growth: cigarettes (revenue up 9%), fast moving consumer goods (FMCG; revenue up 50.7%), hotels (revenue up 11.3%), paperboards (revenue up 5%) and agri-business (revenue up 27.6%).

The operating profit grew by 16% to Rs1,127 crore in Q1FY2008 as against Rs970.5 crore in Q1FY2007. The company's earnings before interest and tax (EBIT) margin dipped slightly by 26 basis points to 17.8% in Q1FY2008, primarily because of the ongoing expansion in most of its businesses that resulted in higher fixed and depreciation costs. We consider this to be a short-term phenomenon as the incremental capacity in these businesses will help the company to fuel growth and improve its positioning in the respective markets.

With a higher depreciation charge of Rs101 crore in Q1FY2008 as against Rs87.6 crore in Q1FY2007, the Q1FY2008 net profit grew by 20% yoy to Rs782 crore.

We believe despite the imposition of a 12.5% value-added tax (VAT), a 5% increase in the excise duty and a 33.5% trade tax in Uttar Pradesh, the net realisation in the cigarette segment improved in this quarter due to an average increase of 20% in the selling price of most of the brands. There had been a marginal decline in the volumes in this quarter due to a major price hike in the last week of April 2007. We believe the volumes in second quarter will also remain affected and from the third quarter the volumes will recover.

The non-cigarette FMCG business is the only business in ITC's portfolio that is not making a profit. However, its losses have come down in this quarter despite the roll-out of the Bingo brand of products throughout the country in March 2007. With the entry into new businesses and losses coming down, the improvement in the performance of the non-cigarette FMCG business is apparent.

In the hotel segment, with the current properties working at peak occupancies, the 11% growth in the top line was driven by improved revenue per available room (RevPAR) and the stellar performance of the food and beverage (F&B) segment.

The paperboard segment registered a slower growth of 5% due to the planned shutdown of a paperboard machine at Bhadrachalam in this quarter. With this machine getting fully operational again, the company expects the business to regain its growth trajectory going forward.

We have always maintained that the fear of VAT may have a dampening effect on the stock but the same is likely to be a short-term aberration and one should look at the stock with a long-term perspective. At the current market price of Rs172, the stock is attractively quoting at 21.6x its FY2008E EPS and 13.7x FY2008E EV/EBIDTA. We maintain our Buy recommendation on ITC with a price target of Rs200.

Balaji Telefilms
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs303
Current market price: Rs249

True on expectations

Result highlights

The Q1FY2008 results of Balaji Telefilms Ltd (BTL) are in line with our expectations. The company reported stand-alone numbers (our preview estimates were based on consolidated numbers) that do not include the results of its film business and subsidiary in the UAE.

The revenues for the quarter were almost flat year on year (yoy) at Rs74.5 crore, as was expected. The realisation from the commissioned programming business showed an impressive growth of 49.3% yoy to Rs33.5 lakh. However lower programming hours at 204.5 hours compared with 298 hours in Q1FY2007 led to a marginal increase in the revenues from this segment.

As per its strategy of finally exiting the sponsored programming business the company reduced its programming under this format from 220.5 hours to 142 hours, while the realisation improved by 39.3% yoy to Rs4.2 lakh per hour. This led to a drop in the revenue from this segment to Rs6 crore against Rs6.6 crore in Q1FY2007.

The operating profit margin (OPM) showed a good growth of 418 basis points yoy to 39.6% as the programming cost as a percentage of sales declined by 802 basis points on account of higher realisations. Thus the operating profit grew by 13.3% yoy to Rs29.5 crore.

Consequently, on account of a higher tax outgo the adjusted net profit grew by 6.1% yoy to Rs18.4 crore.

During the quarter BTL launched "Kasturi" on Star Plus and its overseas offering "Khwaish" on ARY channel while "Kesar" (Star Plus) and "KumKuma Bhagya" (Udaya TV) went off air. In July 2007 it also launched "Khwaish" on Sony. Considering that these new shows went on air and several other new launches have been planned in the coming quarters, we expect the commissioned programming volumes to pick up, especially on the launch of channels proposed under its joint venture with Star.

BTL's co-production "Shootout at Lokhandwala" (released on May 25, 2007) was a big hit and one of the top revenue grossers on the box office.

At the current market price of Rs249 the stock discounts its FY2009E earnings by 13.6x and quotes at an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 7.5x. We maintain our Buy recommendation on the stock with a price target of Rs303, based on our sum-of-the-parts (SOTP) valuation.

Ranbaxy Laboratories
Cluster: Apple Green
Recommendation: Buy
Price target: Rs558
Current market price: Rs375

Valtrex settlement improves earnings visibility

Key points

Ranbaxy Laboratories has reached an out of court settlement with GlaxoSmithKline (GSK) on Valtrex® (Valacyclovir Hydrochloride tablets), as per which Ranbaxy will enjoy the 180-day exclusivity for marketing the generic version Valtrex® in US market in late 2009 (after the expiry of the patent in June 2009). Valacyclovir Hydrochloride is used in the treatment of herpes virus infection

The total annual market sales of Valtrex were around $1. 3 billion, which the management expects to, touch $1.5 billion by late 2009 (we have considered $1.4 billion market size for our estimate). Anticipating Ranbaxy to garner at least 55% market share and 40% profit margin during the exclusivity period in late 2009, the product can generate $269 million in revenues and $107.8 million (Rs442 crore) in profits. This will translate into incremental EPS of Rs11.1 per share during the exclusivity.

At the current market price of Rs375, the stock trades at 18.0x its CY2007E earnings. Anticipating earnings surprises from its first-to-file product pipeline, we maintain our Buy recommendation on the stock with a price target of Rs558.

Wockhardt
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs552
Current market price: Rs383

Acquisition-led growth

Result highlights

Wockhardt's net sales increased by 52.7% to Rs630.3 crore in Q2CY2007. The growth was achieved on the back of a 16.2% growth in the domestic business and a 79.4% growth in the international business. On a like-to-like basis (excluding the impact of the acquisitions made during the year), the growth stood at about 9.2% during the quarter. The sales growth was in line with our estimates.

Wockhardt's European business almost doubled during the quarter to Rs361.2 crore, driven by a healthy performance across the existing markets of the UK and Germany, and the consolidation of Pinewood and the recently acquired Negma Laboratories (Negma).

The formulation sales in the US market grew by 50.7%, driven by five new product launches and strengthening of the existing product portfolio in the USA.

Wockhardt's operating profit margin (OPM) expanded by 240 basis points to 26.1% in Q2CY2007, driven by an improvement in the gross margin and a reduction in the research and development (R&D) cost. Adjusting for the capitalised R&D cost of Rs17 crore, the OPM remained flat at 21.5%. The company reported an operating profit (OP) of Rs152.2 crore, a growth of 69.7% year on year (yoy).

Wockhardt's net profit stood at Rs102.4 crore in the quarter, growing by 61.5% yoy. The profit growth was way ahead of our estimates, despite a 15-fold increase in the interest expense (on account of an increase in debt for funding acquisitions and foreign exchange [forex] loss), a 22.9% rise in the depreciation charge and a 180-basis-point increase in the tax incidence. On adjusting for the net forex gain recorded by the company during the quarter, the net profit stood at Rs96.4 crore, up 52.1% yoy.

During the quarter, Wockhardt completed the acquisition of France-based Negma, which has sales of $150 million and an earnings before interest, tax, depreciation and amortisation (EBITDA) margin of around 18%, in an all-cash deal worth $265 million. This acquisition is in line with the company's aim to achieve a turnover of $1 billion by 2009. With the company's successful track record of creating value post-integration, we believe the acquisition of Negma too will be value accretive for Wockhardt.

In order to account for the Negma acquisition and the appreciation in the rupee against all the other major currencies, we are revising our revenue and earnings estimates for Wockhardt. We have upgraded our revenue forecasts by 19.6% and 21.8% to Rs2,272.8 crore and Rs3,098.8 crore for CY2007 and CY2008 respectively. Our earnings per share (EPS) estimates have been upwardly revised by 2.6% and 2.9% to Rs31.0 and Rs35.8 for CY2007E and CY2008E respectively.

At the current market price of Rs383, the stock is available at 12.4x its CY2007E and 10.7x its CY2008E earnings, on a fully diluted basis. The valuations seem very attractive at these levels and should be viewed as a strong buying opportunity. We maintain our Buy recommendation on the stock with a price target of Rs552.

NIIT Technologies
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs690
Current market price: Rs495

Price target revised to Rs690

Result highlights

For Q1FY2008, NIIT Technologies Ltd's (NTL) consolidated revenues reported a decline of 5.8% quarter on quarter (qoq) and growth of 20.1% year on year (yoy) to Rs229.4 crore. The revenue growth in the quarter was dented by 4.8% due to the appreciation of the rupee and seasonal weakness in the domestic business (which declined by 26.7% qoq to Rs16.1 core).

The operating profit margins (OPM) plummeted by 340 basis points to 18.5% on a sequential basis. During the quarter, the OPM declined by 480 basis points due to the cumulative impact of the rupee appreciation (negative impact of 240 basis points), annual wage hikes (average hikes of 16% resulted in negative impact of 200 basis points) and increase in rentals (impact of 40 basis points). The same was partially mitigated by 100-basis-point improvement in the blended realisations and 40-basis- point gain from an increase in offshore component and better operational efficiencies.

The increase in the other income to Rs6.2 crore (up from Rs5.6 crore in Q4FY2007) was aided translation gains of Rs3.6 crore. The consolidated earnings declined by 23.5% qoq and grew by 60.3% yoy to Rs35.1 crore.

In terms of the outlook, the order backlog executable over the next 12 months grew to $105 million (up from $103 million in Q4FY2007) and the fresh order intake stood at $40 million. Apart from this, the joint venture (JV) with Adecco has become operational in the current month and would add to the company's overall growth in revenues. The management expects the margin to improve in the coming quarters and has guided for flat margins on a full year basis (as compared to its earlier guidance of improvement in the margins).

To factor in the effect of rupee appreciation, the earnings estimates is revised downwards by 3% and 4.3% in FY2008 and FY2009 respectively. At the current market price the stock trades at 12x FY2008 and 10.1x FY2009 estimated earnings. We reiterate our Buy call on the stock with a revised price target of Rs690 (14x FY2009 earnings).

Nicholas Piramal India
Cluster: Apple Green
Recommendation: Buy
Price target: Rs326
Current market price: Rs265

Price target revised to Rs326

Result highlights

The net sales of Nicholas Piramal India Ltd (NPIL) grew at a subdued rate of 15.5% year on year (yoy) to Rs603.5 crore in Q1FY2008. The same were much below our expectation of Rs660 crore.

The revenue growth was lower because the company lost about Rs25 crore worth of business from its largest brand Phensedyl, as Codeine, one the key raw materials, was in short supply. Further, the rise in the rupee and delay in revenue realisation also affected the top line growth.

NPIL's operating profit margin (OPM) contracted by 360 basis points to 13.2% during the quarter, largely due to the lost business and the rising rupee. The sharp increase in the staff cost also affected the margin, which was below our expectation of 15.3%. Consequently, the operating profit declined by 9.4% to Rs79.5 crore.

There was an incremental other income of Rs6.6 crore (including Rs4.6 crore of foreign exchange [forex] translation gain). But the interest cost jumped by 144.8% and the tax incidence shifted up from 11% in Q1FY2007 to 13%, resulting in a 19.4% fall in the consolidated net profit to Rs43.4 crore. The net profit too was below our estimate of Rs59.3 crore.

However, considering the rupee's appreciation and the lower than expected growth in the contract manufacturing operations (CMO), we have downgraded our estimates for the company. As per our revised estimates, NPIL's revenues and profit would grow at compounded annual growth rates (CAGRs) of 15.8% and 22.4% to Rs3,248.1 crore and Rs342.1 crore respectively in FY2009. Our revised EPS estimates for FY2008 and FY2009 stand at Rs13.4 (down by 5%) and Rs16.3 (down by 3.7%) respectively.

Based on our revised estimates, we have downgraded our price target to Rs326. In fact, we have valued the base business at Rs293 per share (ie 18x FY2009 EPS) and maintained the value of the research and development (R&D) deal with Eli Lilly at Rs33 per share.

At the current market price of Rs265, NPIL is discounting its FY2009 estimated earnings by 16.3x. In view of the traction in the operations of both the Indian businesses, the improvement in the operating leverage and the steady progress in the domestic business of formulations, we remain positive on the stock.

Analysts expecting another sharp drop in markets today

Taking a cue from the continued decline in US equities, the Indian equity market could witness another sharp decline on Monday, say analysts. The weakness could persist for the next two to three trading sessions, they add. The Dow Jones Industrial Average dipped 208 points, or 1.54%, to end at 13,265.47 on Friday.
Indices across the world had plunged on Friday after US markets crashed on Thursday. The Sensex—the benchmark index of the Bombay Stock Exchange (BSE)—shed 3.4% to close at 15,234.57 as foreign institutional investors (FIIs), the single most influential force in the markets, started selling.
FIIs were net sellers of equities worth Rs1,475 crore on Friday, while domestic institutional investors took this opportunity to buy shares (they were net buyers of equities worth Rs727 crore).
This was a sharp reversal of the trend witnessed so far this month. Until 26 July, the FIIs had made net investments of about $10 billion (Rs40,500 crore), while domestic institutions were net sellers of more than $2 billion worth of equities. Foreign portfolio fund managers, analysts say, are trying to cut short their exposure to riskier assets such as emerging markets equities.
Looking pensive: Investors standing outside the Bombay Stock Exchange react as the benchmark index shed 3.4% on Friday. Indices across the world fell after US markets declined the previous day.
Ketan Karani, head of research at Kotak Securities Ltd, says FII inflows could moderate in the next few weeks. “The ripple effect of problems in US financial markets will continue in our market. The liquidity in our market will dry up if the money flow from US investors slows down,” he adds.
But Lalit Thakkar, head of research at Angel Broking Ltd, says the correction period in the market will not last long. “There is no doubt that all the Asian markets will open weak on Monday morning. However, the fall will not be as steep as witnessed on Friday’s trade,” Thakkar adds. “FIIs currently own about 20% of the Indian equity market. India is still one of the strongest markets in terms of corporate earnings growth. It is very unlikely that this negative sentiment among FIIs will continue for long.”
Trading volumes on Friday’s session were very high, say technical analysts, pointing out that this signals an immediate risk. “When the market falls sharply on heavy volumes, it indicates severe weakness,” says Vinit Birla, a technical analyst at Mumbai-based Pranav Securities. Short positions built up by speculators will add to the downward trend.
“There is strong short build-up in many blue-chip counters and heavily on the index. This indicates fresh losses on Monday. The weakness will continue for three to four trading sessions. We see 14,700 as the downside for the Sensex. At that level, the index could start a positive rally to recover lost ground. In the case of Nifty, 4,310 is the downside,” he said.
Another Mumbai-based technical analyst who did not wish to be identified says a recovery rally could start in Asian markets after a few trading sessions. However, he expects plenty of volatility in the market. “I would advise taking a neutral position in a market such as this. The Nifty futures are trading at about 40 to 45 points discount. There is huge short build-up on the index. The Nifty could get support at 4,380 levels. If the Nifty breaks below 4,320, it could create panic leading to margin calls. This could accentuate the sell-off,” he adds

How long before a bounce back?

It took 33 trading sessions for the Bombay Stock Exchange’s benchmark Sensex index to recoup all the losses from its last big fall, a 4% or 540 point decline on 28 February.
Investors will be hoping that this time around, the recovery from Friday’s 3.4% or 542 point decline will be equally swift.
The February fall was triggered by the Shanghai stock market and spread to the Dow Jones Industrial Average (DJIA) amid fears that the fallout of US subprime mortgages would spread to the rest of the economy. This time, the DJIA started off the decline and has fallen some more since the Sensex closed on Friday.
There have been four major corrections, not counting the present one, in the bull run that began four years ago. The first occurred on 17 May 2004, when worries about a change of government and a global scare about rising interest rates led to an intra-day fall of 793 points in the Sensex. Although local factors exacerbated the situation, the fall occurred in emerging markets across the world, the MSCI Emerging Markets Free Index losing 8.7% in May that year. That time, the Sensex bounced back to its pre-17 May levels as early as 24 May, but it fell after that and it wasn’t till 23 July 2004 that it closed above the closing level of 14 May, some 50 trading sessions later.
The next panic attack was a more muted one, in March and April 2005, when fears about the high US current account deficit and the impact of rising oil prices took its toll on the Sensex. This time, the benchmark index fell a comparatively tame 220 points on 15 April, but this was a different sort of correction, with the markets grinding lower over an extended period. For instance, from its close of 6,746 on 16 March, the Sensex fell to a closing low of 6,118 on 18 April and it was only by 3 June that the index was able to regain all the ground lost since 16 March.
A year later, on 15 May 2006, the Sensex plummeted by 462 points, followed by a gut-wrenching 826 point drop on 18 May. It was only on 26 September that the Sensex closed above 12,285, the level at which it had closed on 12 May, some 90 trading sessions later. This time, the ostensible reason for the fall was the higher-than-expected inflation in the US, which would mean the US Federal Reserve would continue to raise interest rates.
Every one of these corrections came from a scare, either that global growth would falter, which explained the panic attacks of February-March this year and March 2005, or that interest rates will rise and liquidity diminish, which was the reason behind the May 2004 and May 2006 sell-offs.
On each one of these occasions, the trigger occurred ove-rseas, although it’s true that the May 2004 panic was made worse by the induction of a government at the Centre that was supported by Left parties. And finally, on each occasion, the markets bounced back and went on to make new highs.
The current global economy has often been described as a not-too-hot, not-too-cold Goldilocks economy and every time there’s a threat that growth may slow (the economy becomes too cold) or that interest rates may rise (it becomes too hot) the markets get nervous. Also, merely counting the days after a big crash to recover may not give the true picture. On several occasions, the market had started falling well before the big crash happened. For instance, in 2004, the Sensex had made a new high of 6,249 as early as January and it was able to reach that level only on 30 November. In effect, a bear market prevailed from January to November, punctuated by the crash in May.
Similarly, the Sensex reached a high of 12,671 on 11 May 2006, a peak it was able to regain only on 13 October. And this year, the index went up to 14,723 on 9 February and it was only on 2 July that it was able to cross that peak. Seen from that perspective, the question to really ask is how long it will take for the all-time high of 24 July to be surpassed.

Dead Presidents! - India Equity Research

Search Now

Recommendations

Monday, July 30, 2007

Results - Bharti Airtel, Maruti Udyog, IDFC, Federal Bank, Glaxo SmithKline Consumer

Infosys Technologies

Global Doom & Gloom

Monetary Policy, ITC, Balaji Telefilms, Ranbaxy Labs, Wockhardt,

Analysts expecting another sharp drop in markets today

How long before a bounce back?

Britannia Industries

Centurion Bank

Dr Reddy's Labs

HDFC

Infoedge Ltd

Central Bank Subscription Details

Technicals for the Week

ITC Ltd

IDEA Cellular