ET - Hot Picks for the week

Reliance Industries
Research: Motilal Oswal
Recommendation: Buy
CMP: Rs 957 (Face Value Rs 10)

RIL has outperformed the market over the last six months by 26%, on the back of robust financial performance, E&P related announcements (Mahanadhi and CBM reserves) and value unlocking through the RPL public issue.

The current stock price fairly reflects our SOTP valuation of Rs 934/share, which is based on the company's core business earnings, the value of its E&P reserves declared till date and the value of its stake in RPL and IPCL. These are discovered reserves whose size is yet to be announced.

Media reports indicate, potential reserves of 7 TCF gas and 1bn barrels of oil. Phase III exploration is in progress and could lead to materialisation of 8.2 TCF of potential upside indicated during the announcement of the first 2.35 TCF in-place reserves.

Potential reserves are estimated at about 9 TCF. Expected announcement – Sonhat: 3-6 months, Barmer 1 & 2: 18-24 months. Motilal Oswal assigns a very high probability to the materialisation of the KG Basin reserves (valued at Rs189/share).

Also, RIL is making forays into the retailing and SEZ development businesses. These businesses, which command higher valuations than its core commodity business, would be the next big growth drivers. Given RIL's strong execution skills, the company should achieve its aggressive targets for these ventures.

Motilal Oswal's basic SOTP value is Rs934/share and they estimate upside potential of Rs424/share over the next 12-24 months from the E&P business.

Core business fundamentals could only improve from current levels. Investments in new businesses – retailing and SEZ development – would be the next growth drivers. The stock trades at a P/E of 14.4 times FY08E and EV/EBITDA of 8.8x FY08E.

Merck
Research: Networth Stock Broking
Recommendation: Buy
CMP: Rs 520 (Face Value Rs 10)
12-Month Price Target: Rs 814

Merck is the 51% subsidiary of Merck KGaA – Germany, popularly known for vitamins (particularly vitamin E). The pharma business has been contributing around 56% to the topline (with sustained segmental margin of 30%) and the rest by the chemicals division.

Recently, with the disposal of the life science and analytics business (which was 30% of total sales) from the chemical division, the pharma business becomes even major, contributing over 70% of total revenue. Merck's priority brands have reported appreciable double-digit growth in last 12-month period ending March '06.

Going forward, with steady performance by the existing brands with relatively larger market share and fresh revenues coming in from new product launches, we expect Merck to deliver over 10% growth in the pharma business during '06 and '07.

In Q1 CY06, Merck sold out it's highly uncompetitive and low margin business of lifs science and analytics (LS&A) (which was part of its chemical division), which would strengthen the margin and profitability of the remaining chemical business as well as the overall business of the company. This deal brings in a one-time profit of R.66 crore (about Rs 40 per share).

Such exceptional items as a result of this sale may enrich the bottom-line in '06. With the likely launch of new products, improving operating margin (consequent to the sell of LS&A division and rising share of high margin pharma business), scaling up exports and efficiencies, Merck would generate PAT of Rs.66.204 crore and Rs.73.6.5 crore in '06 and '07, respectively.

At the current market price of Rs.565, the stock is available at a PE of 14.4 times and 12.9 times its CY06 (E) EPS of Rs.39.3 and CY07 (E) EPS of Rs.43.7 respectively.

In addition, the company currently holds cash amounting to Rs.310.crore, i.e. almost Rs 184 per share, which may trigger couple of acquisitions (both brand/business) shortly (in line with Merck's strategy to expand pharma business). Considering the growth potential and stout cash position, we recommend buy with 12-month price target of Rs 814.

Indraprastha Gas
Research: Angel Broking
Recommendation: Buy
CMP: Rs 118 (Face Value Rs 10)
12-Month Price Target: Rs 160

In Q4FY2006, Indraprastha Gas (IGL) clocked a 16.3% growth in net sales on the back of growth in gas supplies and price increase.

Net profit remained flat at Rs 29.5 crore due to higher tax provisioning, which increased from 27% to 34.6% and high base effect (in Q4FY2005) on account of one-time gain of Rs 4.5 crore due to write-back of excess provision for transportation. CNG volumes for the quarter witnessed a 6% growth while PNG volumes grew by 54%.

IGL commenced supply of LNG in February '06 and sold 25,000 scm of LNG. VAT levied on PNG has not been passed on to the customers and thus margins in PNG have reduced. Staff cost increased 44% on account of wage revision.

Due to the delay in regulation mandating conversion of LCVs to CNG, IGL initiated measures to get LCVs to voluntarily convert to CNG.

This effort has yet to reap the desired results and hence we reduce our FY2007 estimates. Angel Broking have reduced FY2007E EPS from Rs 10.6 to Rs 8.9.

The earnings downgrade is just a postponement of earnings from LCV conversion by a year or so. In view of the continued belief on LCV conversion and rapid expansion in the NCR region, Angel Broking maintains a `Buy' on the stock with a target price of Rs 160 despite the earnings downgrade.

ITC
Research: India Infoline
Recommendation: Buy
CMP: Rs 164 (Face Value Re 1)

All-round business segment performance drove topline growth of 28% yoy. While the profit growth on the face of it looks subdued at 2%, normalising it for the one-off luxury tax write-back, growth stood at 24%.

This could have been higher but for the margin squeeze on account of rising raw material cost, which pulled down margins by 260 bps. The strong growth in the cigarette business indicates continuing strong volume growth as well as impact of price increases undertaken in the early part of the year.

Outlook for the non-cigarette businesses such as hotels and paper also remains positive with continued demand buoyancy. The other FMCG businesses are also rapidly expanding, while losses are being gradually curtailed.

ITC's hotels business has continued its strong growth momentum aided by acquisition of Ansal Hotels, addition of Grand Central, Mumbai (recorded net profit in FY06 - the first full year of operations) and improving occupancies. As per the company's strategy of maximizing presence in the key business locations, it is constructing a luxury hotel in Bangalore and has finalised architectural plan for the proposed hotel at Chennai.

ITC is planning to enter the HPC (home and personal care) market by launching its soaps and shampoos under a brand name - Superia. The products are likely to be priced competitively to take on competition from HLL and P&G. HLL is the market leader in the shampoos and detergents segment (market share of ~56%) despite the competition from P&G and other players.

However, ITC can become a tough competitor for HLL, given its strong distribution network in the rural (6,000 e-choupals and seven choupal saagars) and urban markets. Also, strong cash flows from the cigarette business can be invested in advertising heavily to build the personal care portfolio in the initial stage.