Stocks you can pick this week

Bharat Forge
Research: Man Financial (May 24, ’07)
Rating: Downgrade from buy to outperformer
CMP: Rs 329.35 (Face value Rs 2)

Bharat Forge disappointed in Q407 since its operating margins fell 190 bps to 24.1%. This was largely on account of higher material and manufacturing expenses. At Rs 64.3 crore, its standalone net profit was also below expectations. The company’s standalone sales grew by 17.7% YoY to Rs 516 crore.

Consolidated net sales rose by 16.6% to Rs 1,110 crore, while net profit grew by 16.4% to Rs 80 crore. Domestic buoyancy aided growth, while export ramp-up remained lacklustre. Falling margins and rising capacity utilisation indicate the company has not been able to capitalise on the operating leverage and is facing pricing pressures in India and abroad.

Man Financial believes the revenue growth visibility is fading in the automotive space. Any material upside from the high-margin non-automotive space is possible only after FY10. It hints at a correction in the valuation premium that the company has been enjoying vis-à-vis industry peers in view of falling earnings visibility.

Cairn India
Research: Merrill Lynch (May 23, ’07)
Rating: Buy
CMP: Rs 150.1 (Face value Rs 10)

Merrill Lynch is bullish on Cairn India following potential upside in peak output from the Rajasthan oil field and likelihood of higher reserves. Cairn India expects peak oil output of 150,000 barrels per day (bpd) from the Mangla and Bhagyam oil fields. Another 10,000-15,000 bpd of peak output is expected from the Aishwarya field. Thus, peak output at 160-165k bpd could be 7-10% higher than 150k bpd expected earlier.

The potential upside to ’10-11E earnings will be 6-15%. A commensurate increase in reserves is also likely. Hence, proven plus probable (2P) oil reserves from the three oil fields could be 7-10% higher at 466-481 mmboe. An addendum to the Mangala development plan is likely to be filed with the regulator in end ’07. Clarity on upside is likely when the addendum is approved, which is expected by Q108E.

This does not include additional upside from a proposed enhanced oil recovery (EOR) programme or from tight oil in the Balmer Hill formation, which could be substantial. An EOR implementation plan is expected by end ’07. Merrill Lynch believes the stock offers compelling value, exceptional growth, sector-leading returns, strong management, combined with exploration and M&A appeal.

GMR Infrastructure
Research: Macquarie Research (May 23, ’07)
Rating: Outperformer
CMP: Rs 496.4 (Face value Rs 10)

GMR Infrastructure is the only pure-play infrastructure company listed on the domestic stock exchanges. It has a number of projects, both operational and under implementation, in sectors like airports, roads and power. Indian aviation is in a high-growth phase with 23% CAGR in passenger traffic in the past three years.

Macquarie is positive about continued traffic growth due to the hugely under-penetrated air travel market, continued strong growth in the overall economy and increasing affordability, driven by declining air fares and increasing per capita incomes. GMR’s airport portfolio consists of Delhi airport — the country’s second-largest airport — and Hyderabad airport — the sixth-largest and the fastest-growing among major airports. GMR has development rights over 250 acres of land near Delhi airport, located in the middle of a fast-growing metropolis.

Macquarie has valued this land at Rs 43.8 crore per acre and the 700-acre site near Hyderabad airport at Rs 8.4 crore per acre. The net present value (NPV) of its existing asset portfolio is Rs 18,600 crore, representing 18% upside from current levels. Macquarie believes there is significant upside potential to these valuations, as real estate near airports attracts a premium, and given the management’s indication of higher valuations. GMR raised Rs 1,336 crore during FY07, compared to its total funding commitment of Rs 1,170 crore. The current portfolio will start to generate significant cash flows from FY11 onwards, enabling it to fund future projects without further dilution.

ICICI Bank
Research: Morgan Stanley (May 23, ’07)
Rating: Equal-weight
CMP: Rs 913.1 (Face value Rs 10)

ONE of the key factors driving ICICI Bank’s stock in the past few months has been the proposed spin-off of ICICI Bank’s stake in life insurance, general insurance and asset management subsidiaries into a separate holding company, ICICI Holdings, and its plans to issue shares in this new entity — thereby monetising its stake in these businesses.

The bank is looking at conducting a private placement of its stake in ICICI Holdings. This places the value of the business at Rs 2,200 crore ($527 million) or Rs 19 per share of ICICI Bank. Morgan Stanley values ICICI Holdings at about $7.5 billion. However, since ICICI is conducting a private placement of a small part of this business, significant value may be attributed to this business.

This is because the private equity firm may take a very long-term view to value this firm. On the base case assumptions, to arrive at a value of $10 billion, the private equity player will have to value the business at value due in three years in the DCF analysis. Hence, the base case value for ICICI Holdings will translate into a contribution of Rs 260 per share of ICICI Bank.

The bull case scenario will value the business at Rs 346 per share of ICICI Bank. The bear case scenario will be a 20% holding company discount on the base case scenario to arrive at a value of Rs 208 per share of ICICI Bank. On the banking business, Morgan Stanley expects returns to remain muted as the bank’s net interest margins remain lukewarm and credit costs continue to escalate due to continued weakness in retail asset quality.

Thermax
Research: Citigroup
Rating: Initiate with buy
CMP: Rs 440.1 (Face value Rs 10)

Thermax is the market leader in the small and mid-sized boilers market, with a share of 21%. Bharat Heavy Electricals (Bhel), which is the market leader in the big-boiler segment, has a share of 69%. Bhel is concentrating on higher capacity boilers, leaving the lower capacity market for Thermax. The company is expected to do well due to an expected increase of 63% in captive power generation and strong growth in industrial tariffs. Products and solutions aimed at environment protection will also be important revenue-drivers for the company, going forward.

Ultratech Cement
Research: Edelweiss
Rating: Reduce
CMP: Rs 824.2 (Face value Rs 10)

The cement cycle can reverse over the next few years as 60 million tonnes of new capacity will come up between FY07 and FY09 and another 32 million tonnes is expected to be added in FY10. Ultratech Cement has traded at one-year forward EV/EBITDA multiples of 6.5-10 during the current cycle upturn. The company is currently in the last leg of the upturn and a middle of the range valuation multiple of 7.5 may be more appropriate.

Earnings estimates for FY08 and FY09 have been revised upwards due to the increase in cement prices. The company will also save Rs 140 crore per annum due to 142 mw of captive power capacity, which is likely to be commissioned in FY09.