Stocks you can pick up this week

Matrix Laboratories
Research: Merrill Lynch (April 18, ’07)
Ratings: Buy
CMP: Rs 192 (Face Value Rs 2)

Matrix’s significant 53% and 37% relative underperformance over the past year and six months respectively reflects the likely 55% earning de-growth in FY07E due to write-offs in the European generics business, revenue loss from certain contracts in European generics business (DocPharma), sharp increase in R&D spend, and rising interest cost.

Merrill Lynch estimate Q4 net profit of Rs 13 crore, a sharp 63% decline over the previous corresponding quarter largely due to high R&D spend and lower margin in the DocPharma business. Based on the refreshed estimates Matrix is trading at 20x FY08 and 14x FY09 earnings. This is in line with the pharmaceutical sector average on FY08E earnings and about 15% discount to the sector average on FY09E EPS.
On EV/EBITDA, Matrix trades at 15% discount to the sector average on FY08E estimates. The price target of Rs 229/share is based on 18x FY09E EPS, nearly in line with the stock’s six-month historical average, which reflects the period post announcement of acquisition by Mylan. Further, the stock’s current 40% discount to Mylan’s acquisition cost makes it an attractive candidate for a possible complete buyout by Mylan.

Cairn India
Research: Goldman Sachs
Ratings: Neutral
CMP: Rs 131 (Face Value Rs 10)

Cairn India was formed in August ’06 by the acquisition of Indian assets from Cairn Energy Plc. It is a pure E&P play, the assets of which could be bifurcated into a development block and 12 exploration blocks. Prior to the initial public offering in ’06, Cairn India acquired the Indian upstream assets from Cairn UK Holdings (100% subsidiary of Cairn Energy Plc.) with consideration of cash and shares amounting to $6 billion.

In the absence of information on the fair value of the assets acquired by Cairn India, Goldman Sachs have assigned book value to these assets based on consolidation of the statements of the three unlisted subsidiaries of Cairn Energy Plc which were holding them. The book value thus calculated works out to $213 million. This is low compared with $6 billion that Cairn India paid for these assets because the book value does not reflect the full reserve potential.

Notably, Petronas Malaysia has taken 10% stake in Cairn India at Rs 160/share — in line with the $6 billion valuation. Cairn India’s valuation multiples in the near term appear stretched as benefits from monetization of the Rajasthan block will impact earnings only ’09E onwards. However, the current share price has value built in for the Rajasthan asset, as the company has announced the reserve size and production targets.

UTI Bank
Research: Macquarie (April 17 ’07)
Ratings: Outperform
CMP: Rs 465 (Face Value Rs 10)

UTI Bank announced its 4QFY3/07 results. PAT was up 39% YoY to Rs 220 crore (20% ahead of the estimates) and NII was up 48% YoY to Rs460 crore. The key surprises were lower NPA provisions and lower tax rates. NPA provision was a major surprise and reduced 61% YoY to Rs 8.2 crore for the quarter (which was 40% below the estimates). According to the management, this reflects a dramatically improved performance on additional slippages in the current quarter.

Additional general provision of Rs 45 crore in the current quarter was marginally below the estimates of Rs 52 crore. Another surprise was the effective tax rate which, adjusted for general provision, stood at 29% for Q4 compared to our estimate of 33.5%. Finally, wage costs were 11% below Q4 estimates due to a 22% QoQ fall. There seems to have been one-offs in Q3 on which we have not received details.

Results for Q4 were a positive surprise to us. Over the long term, Macquarie continues to like the stock, as UTI Bank continues to ride deepening penetration to make rapid market share gains. As the branch network continues to expand rapidly, high growth is expected to be the key driver for the bank’s stock price performance and continue to retain the Outperform rating on the stock with a target price of Rs 621.

ACC
Research: Citigroup (April 19, ’07)
Ratings: Buy
CMP: Rs 791 (Face Value Rs 10)

ACC’S net sales grew 25% YoY to Rs 1,670 crore, in line with expectations. However, both EBITDA and PAT came in about 10% below expectations at Rs 510 crore (+55% YoY) and Rs 360 crore (+55% YoY) due to higher costs than anticipated. Sales volumes declined 2% YoY to 4.9 million tonnes.

ACC expects to add over 7 million tpa of capacity with 3.1 millio expected in CY07, 1.4 million in CY08 and the balance 3 million tpa in CY09. Around 130MW of captive power is also being added. ACC’s board has approved the transfer of its ready mix business (sales Rs 300 crore in CY06) to a new wholly owned subsidiary. On its own and along with its group company, Gujarat Ambuja Cements, it enjoys a strong market presence in several key markets.

Most of its capacity creation in ’06-08 is at a low capex. ACC has come a long way from its high debt equity of 1.64x in FY02. The combination of low-cost capex and strong cash flows in CY06 has resulted in ACC becoming a net cash company. Citigroup believe that EV/EBITDA is a better valuation parameter than P/E to get a proper perspective on valuation of Indian cement companies.

Additionally, P/E is not so useful in ACC’s case, because in the past 12 years, ACC has made minimal profits or even losses on three occasions. ACC’s average EV/EBITDA over the past 11 years, which encompasses three cement cycles, has been 13x. Using a shorter time frame (seven years) gives an average of 11x. At the target price of Rs ,260 EV/EBITDA would trade at 10x, a discount to its 10-year average EV/EBITDA, justified keeping in mind the historic high in valuations.

Ashok Leyland
Research: HSBC (April 19, ’07)
Ratings: Underweight
CMP: Rs 38 (Face Value Re 1)

Ashok Leyland is the second largest manufacturer of medium and commercial vehicles in India, with 28% market share in FY07. In addition, it also manufactures engines for industrial, generator sets and marine applications. Its products range from 18-seater to 82-seater double-decker buses, to 7.5 tonnes to 49 tonnes haulage vehicles, to special application vehicles.

Ashok Leyland’s earnings to remain flat in FY08e and decline by 15% in FY09e, following declines in volume and profit margin. The company is likely to benefit from reductions in tax paid on raw materials and components following the introduction of the value added tax regime and removal of turnover tax from January 2007 in the state of Tamil Nadu, where Ashok Leyland has its vehicle production units.

It would also get tax benefits once it starts production in Uttaranchal, in April 2008. However, rising fixed costs as a percentage of sales following our forecast decline in sales is likely to lead to a decline in net profit margin in FY08e and FY09e. The fair value of Rs 30 is below the share price of Rs 38 on April 16, hence HSBC initiate coverage on Ashok Leyland with an Underweight rating.


At the target price, the stock would trade at 5.8x FY08e EV/EBITDA, which is marginally lower than the last five year average of 6.0x one-year forward EV/EBITDA. Also, the FY08e price-to-book ratio of Ashok Leyland at the target price is likely to be 1.7x compared to the five-year average price to book ratio of 1.9x, based on actual book value per share of the last five years.