Sharekhan Valueline - August 2007

FROM SHAREKHAN'S DESK

Dark clouds gather from the West

For those who were caught in the market this week and the week before it was no less than a roller-coaster ride with breathtaking climbs, stomach-churning drops et al. Not content with conquering the lofty levels of 15k, the market rapidly gained another 800 points in less than a fortnight to close at an all-time high of 15,869 on July 24. Just when expectations were building up that the market would comfortably cross even the magic figure of 16k before the month got over, the market did a complete volte-face. It plummeted by over 541 points on July 27, in reaction to the weakness in global markets.

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MARKET OUTLOOK

Time to turn cautious—it's not only global

"When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing." - Citigroup CEO Charles Prince

We feel it is time to turn cautious on the equity market (and stop dancing!). There is too much complacency about India/Asia being immune to the sub-prime lending crisis as well as the continued strong growth in the domestic economy and corporate earnings. We feel this complacency is not warranted given (a) the market's high dependence on foreign fund flows; (b) the mounting evidence that the economic growth is slowing down; and (c) the signs that the earnings growth momentum has peaked. The complacency is not restricted to investors or TV commentators but, more worryingly, is also present among the policy makers and central bankers who feel that strong domestic growth is a given and are only fighting mythical inflation battles.

We are worried about:

• High dependence on foreign institutional investor (FII) inflows
• Slowdown in all economic growth indicators
• Sharp deceleration in exports
• Likely worsening of the current account deficit
• Slowdown in earnings: For the first time in several quarters the earnings of the Sensex companies were below expectation after stripping out the foreign exchange (forex) gain. This slowdown in the earnings momentum would become more visible from the second quarter onwards when the forex gains will not be there. A slowdown in the earnings growth would itself lead to a derating of the market's price/earnings (PE) multiple—investors would be OK paying 17-18x for a market growing at 30% but would they do the same if the growth were 15%? We discuss these factors in more detail.

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Sharekhan top picks

In the July 2007 issue, we had recommended the best 12 of our Stock Ideas as Sharekhan Top Picks. As on August 3, 2007, the basket of stocks has given absolute return of 4.2% as compared with a 3.2% appreciation in the Sensex and a 2.0% rise in the S&P CNX Nifty.

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STOCK IDEA

Balaji Telefilms
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs303
Current market price: Rs231

Viewer’s choice, investor’s delight

Key points

• Content in demand: The Indian general entertainment space is witnessing a lot of action. Supported by the rise in ad spending and the changing landscape for subscription revenues, broadcasting has become an attractive business and resulted in a flurry of announcements of new channel launches. While this creates tremendous growth opportunities for content providers, the rising competition for quality content also augurs well for their realisation growth.
• Excellent track record: Balaji Telefilms Ltd (BTL) has revolutionised the Indian small screen with its family dramas. Over several years its "Saas Bahu" soaps have been the mainstay of Star Plus and have consistently hit the top slots on the rating charts. About eight of the most watched Top 10 shows in the C&S households are produced by BTL. BTL produced an unmatched volume of 1,820 hours of content (in FY2007) in Hindi and all major south Indian languages, and the quality of the content is no doubt the most admirable factor. But what differentiates BTL from competition are its creative force and infrastructure which make scaleability appear a lesser issue when compared to the others.
• Broadcasting JV—a key value creator: BTL has entered into a JV with Star to launch regional GECs. While Star brings to the JV its already running Tamil channel Star Vijay, the JV within a couple of years plans to launch similar channels in Telugu, Kannada, Malayalam, Bengali, Marathi and Gujarati. We believe the JV has the potential to drive the volume growth of BTL's core content business. The stake in the JV promises to be big value creator going forward.
• Attractive valuation: At the current market price of Rs231 the stock quotes at 12.6x its FY2009E EPS of Rs18.3. We believe the valuations are attractive considering the overtly bullish scenario for BTL and the new steps it has taken into broadcasting. We recommend a Buy on the stock with a price target of Rs303.

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STOCK UPDATE

3i Infotech
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs400
Current market price: Rs307

Impressive performance

Result highlights

• 3i Infotech has reported an impressive performance for the first quarter of FY2008. The company’s consolidated revenues grew by 23.8% quarter on quarter (qoq) and by 102.6% year on year (yoy) to Rs260.3 crore in Q1FY2008. Even after adjusting for the incremental revenues of Rs23 crore (or a 10.9% sequential growth) from the recent inorganic initiatives (Professional Access, aok in-house BPO Services, oak in-house Factoring and KNM Services), the organic revenues grew at a healthy rate of 12.9% sequentially.
• The operating profit margin (OPM) declined by 100 basis points sequentially to 24% during the quarter, largely due to the adverse impact of the annual wage hikes (an average of around 10%) and unfavourable revenue mix (relatively higher contribution from the low-margin services business) during the quarter. The impact of the rupee’s appreciation on margins was minimal as the company earns only around 20-25% of its revenues in US Dollar and has a natural hedge in terms of a similar kind of expenditure in foreign exchange. The operating profit grew by 19.1% qoq and by 113% yoy to Rs62.5 crore.
• The consolidated earnings grew by 21.6% qoq and by 83.6% yoy to Rs39.2 crore. The jump in the interest outgo was mitigated by the increase in the other income component (a 406% jump qoq to Rs3.9 crore) and lower depreciation charges.
• The order backlog grew at a healthy rate of 15.1% qoq and 123.3% yoy to Rs654 crore. The order backlog of the services business grew by 25.1% sequentially to Rs364 crore. The growth was aided by the consolidation of the pending order book of the recently acquired European company, Professional Access. On the other hand, the product business showed a sequential growth of 4.7% in the order backlog to Rs291 crore.
• To factor in the impact of the recent acquisitions and the further dilution of the equity (a foreign currency convertible bond [FCCB] issue of $100 million was closed recently), the estimates for the earnings per share (EPS) have been revised upwards by 2.7% and 0.5% for FY2008 and FY2009 respectively. At the current market price the stock trades at 14.1x FY2008 and 11.4x FY2009 estimated earnings (on the fully diluted equity base of 84 million shares). We maintain our Buy call on the stock with a price target of Rs400.

Aban Offshore
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs3,295
Current market price: Rs2,988

Price target revised to Rs3,295

Result highlights

• For Q1FY2008, Aban Offshore has reported a marginal growth of 7.5% quarter on quarter (qoq) and of 3.1% year on year (yoy) in its stand-alone revenues to Rs127.6 crore. The revenues were expected to be flat as there was no re-pricing or addition of asset in the parent company over the period.
• The operating profit margin declined marginally to 53.3% as compared with 55% in Q1FY2007. On a sequential basis, the massive margin improvement of 13.1% was largely due to the lower base of Q4FY2007. The company had accounted for Rs7.5 core of extraordinary expenses in Q4FY2007. Consequently, the operating profit was flat sequentially but higher by 42.8% yoy to Rs68.1 crore.
• The jump of 374% in the other income component to Rs15.4 crore enabled the company to report a 48.4% increase in its earnings to Rs28.3 crore. Sequentially, the earnings declined by 4.1% as the positive impact of the higher margin was more than nullified by a 55% drop in the other income component.
• It should be noted that the stand-alone results do not provide the complete picture as the valuations are based on the consolidated earnings estimates of FY2009.
• In terms of key events, the contract with Hardy Oil for the floating production unit Tahara was extended for a two-year period and is estimated to generate $63.9 million, which translates into a day rate of around $88,000 (up from $27,000 earlier). This would add to the growth in the revenues and earnings in the parent company with effect from July 28, 2007. In addition to this, the company has recently announced contracts for two assets under its subsidiaries: Deep Driller 5 (a newly built jack-up offshore rig) and Drillship Valentine (under a 50:50 joint venture between Sinvest and Petrolia Drilling). The contract for Deep Driller 5 would generate $36.3 million over the six-month period, translating into a day rate of $200,000, in line with our expectations. On the other hand, the drillship is contracted to Exxon-Mobil for a two-year period and is estimated to generate $220 million (amounting to a day rate of $410,000).
• At the current market price the stock trades at 24.6x FY2008 and 8.5x FY2009 estimated earnings. We maintain our Buy call on the stock with a revised price target of Rs3,295 (9x FY2009E consolidated earnings).

ACC
Cluster: Apple Green
Recommendation: Buy
Price target: Rs1,210
Current market price: Rs1,117

Price target revised to Rs1,210

Result highlights

• In Q1FY2008 ACC's volumes grew by 14% year on year (yoy) to 5.3 million metric tonne (MMT) on account of the incremental volumes from the Lakheri unit. Its cement realisations grew by 10% yoy to Rs3,390 per tonne. The blended realisations (including those from ready-mix concrete [RMC] and excluding the inter-segmental revenue) grew by 12% yoy to Rs3,524 per tonne. Consequently, the top line grew by a smart 28% yoy to Rs1,867 crore.
• The operating expenditure grew by a sharp 32% yoy to Rs1,323.5 crore on the back of a 22% year-on-year (y-o-y) growth in the raw material (RM) cost and a 38% y-o-y growth in the other operating expenditure on account of higher packing and consultancy expenditure. The employee cost too jumped by 15% yoy to Rs93 crore.
• Consequently, the operating profit growth was lower at 20% yoy to Rs544 crore whereas the operating profit margin contracted by 200 basis points to 29.1%.
• Thanks to a higher interest income earned on surplus cash, the net interest component was positive at Rs2.27 crore. The depreciation provision was higher by 9% on a y-o-y basis at Rs63 crore on account of the expansion work at Lakheri and Kymore.
• Backed by a higher other income component of Rs28 crore the net profit grew by a healthy 36% yoy to Rs351 crore.
• As mentioned in our earlier reports, ACC's expansion programme is progressing as per schedule. An additional capacity of 0.90MMT as well as a 25-megawatt (MW) captive power plant (CPP) at Lakheri got operational in the current quarter. The company also augmented its grinding capacity at Kymore. Work on the 1.18MMT expanded capacity at Bargah and a 30MW power plant is in progress. The company is also setting up a greenfield project at Wadi. Thus at the end of CY2008, the company's capacity will increase to 24MMT.
• Considering the price rise in the south, savings from higher blending as well as the removal of the government's price freeze, we are upgrading our CY2007 earnings per share (EPS) estimate by 16.6% to Rs82.8 and our CY2008 EPS estimate by 20.8% to Rs79.5 (assuming a drop of Rs5 in per bag of cement).
• We believe that the free pricing scenario will augur well for the company on account of the latter's leverage to cement prices. The incremental capacity (achieved partly through higher blending) will not only provide the much needed volume growth but also result in cost savings. These coupled with the increased focus of the cement industry on cost efficiency (with the advent of Holcim) will drive the earnings of the company going forward. At the current market price of Rs1,117, the stock trades at 14x its CY2008 EPS. We are maintaining our Buy recommendation on the stock with an upgraded price target of Rs1,210 per share.

Allahabad Bank
Cluster: Cannonball
Recommendation: Buy
Price target: Rs125
Current market price: Rs102

Price target revised to Rs125

Result highlights

• Allahabad Bank's net profit increased by 56.3% year on year (yoy) to Rs200.4 crore in Q1FY2008. The growth was driven by an improvement in the net total income and a lower base of Q1FY2007. The core income growth showed an improvement as the bank has once again decided to focus on maintaining margins rather than chasing business growth at any cost.
• During the quarter the bank's net interest income (NII) increased by 15.4% yoy and remained stable on a sequential basis. The net interest margin (NIM) of the bank was down four basis points on a year-on-year (y-o-y) basis but stable on a sequential basis at 2.97%.
• The bank's NIM has been declining for the past few quarters as it has decided to grow its business aggressively. Its loan growth had stood at 41% in FY2007. However the bank slowed down its business growth in Q1FY2008 and the loan growth moderated to 23.5% yoy in the quarter.
• The non-interest income was up 68.5% yoy mainly due to a higher growth in the treasury and fee incomes.
• The operating performance improved by 39.3% on a y-o-y basis with the core operating profit up by 26.4% yoy.
• Provisions and contingencies declined by 84.9% yoy mainly due to a provision write-back of Rs31 crore in Q1FY2008 compared with an investment depreciation of Rs142 crore in Q1FY2007. However the savings in provisions was negated due to higher tax provisions.
• Going forward, we expect the bank's operating performance to improve as the bank has again shifted its focus to moderate growth with stable margins. We have introduced our FY2009E numbers in this report. At the current market price of Rs102, the stock is quoting at 4.7x its FY2009E earnings per share (EPS), 3x pre-provision profits (PPP) and 0.8x book value (BV). The bank is available at attractive valuations given its low price-to-book multiple compared with its peers and return on equity of 18%. We maintain our Buy call on the stock with a revised 12-month price target of Rs125.

Alphageo India
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs517
Current market price: Rs386

Price target revised to Rs517

Result highlights

• Alphageo India's (Alphageo) Q1FY2008 results are in line with expectations. The company reported a healthy growth of 84.7% in its revenues to Rs20.7 crore during the quarter.
• The operating profit margin (OPM) declined from 51.6% in Q1FY2007 to 38.5% in Q1FY2008. The steep decline in the OPM was disappointing and below expectations. The margin contracted because of the under utilisation of the company's resources and unfavourable business mix (a higher contribution from the low-margin 2D work). The operating profit grew by 37.6% to Rs7.9 crore.
• The savings in the interest expenses (lower by 14% to Rs0.9 crore compared with that in Q1FY2007) and a lower depreciation charge as a percentage of the sales (down to 1.6% as compared with 2.2% of the sales in Q1FY2007) enabled the company to report a 48.5% growth in its earnings to Rs2.4 crore. The same was in line with our estimate of Rs2.3 crore.
• Generally, the second quarter is a lean season for the company. Especially since most of its contracts are concentrated in the tough terrains of the north east region where it is difficult to do any work during the monsoons. However, the situation is likely to be much better this fiscal. Work is expected to commence on the recently bagged contract from Oil & Natural Gas Corporation (ONGC) in the Cauvery Basin (in south India) in August this year and the project would contribute to the company's revenues from Q2FY2008.
• To factor in the higher than expected pressure on the margins in Q1, the earnings estimate for FY2008 has been revised downwards by 7%. We are also introducing our FY2009 estimates for the company in this note. We maintain our Buy call on the stock and are rolling over the price target to Rs517 (which is 10x FY2009E earnings).

Apollo Tyres
Cluster: Apple Green
Recommendation: Buy
Price target: Rs425
Current market price: Rs375

On a fast track

Result highlights

• Apollo Tyres rendered a brilliant performance in Q1FY2008 on the back of a strong top line growth and an improvement in the operating profit margin (OPM).
• The top line grew by 15.4% to Rs874.1 crore, led by a volume growth of 5% and a realisation growth of about 9.9% during the quarter. Though the original equipment (OE) business witnessed a slowdown during the quarter, the replacement business remained strong.
• The OPM improved to 11.5% from 7.5% Q1FY2007 on the back of softer raw material prices, improvement in price realisations and increasing operating efficiencies. Consequently, the operating profit increased by 77% to Rs100.4 crore. The net profit for the quarter grew by 187.6% to Rs46.8 crore.
• On a consolidated basis, the net revenues rose by 22% to Rs1,150 crore while the net profit improved by 369% year on year (yoy) to Rs54.6 crore, indicating a sharp improvement in the performance of its subsidiary, Dunlop South Africa.
• Dunlop South Africa is performing very well as its earnings before interest, depreciation, tax and amortisation (EBIDTA) margin reached the level of 11% during the quarter. It recorded a growth of about 40% in its net sales to about Rs275 crore in the same period. However, the same was achieved on a low base due to a very low-key performance in the same quarter last year.
• Though the sales volumes of Apollo Tyres would be affected in the current fiscal as a result of the slowdown in the OE sales, we believe that the replacement sales for tyre makers would continue to remain strong, considering that the automobile industry, especially the commercial vehicle segment, has been recording a good growth for five straight years. Also, the fall in rubber prices augurs well for the tyre makers as it should help them maintain the high levels of margins.
• At the current market price of Rs375, the stock discounts its FY2009E earnings by 10.5x and quotes at an enterprise value (EV)/EBIDTA of 4.8x. We maintain our Buy recommendation on the stock with a price target of Rs425.

Ashok Leyland
Cluster: Ugly Duckling
Recommendation: Hold
Price target: Rs42
Current market price: Rs38.5

Put on Hold

Result highlights

• Ashok Leyland's Q2 results are in line with our expectations. The top line has marked a growth of 13.9% to Rs1,621.1 crore due to a volume growth of 6.6% and a realisation growth of 6.8%, mainly due to higher bus sales.
• The margins marked a 100-basis-point improvement to 9.5%, due to higher contribution of buses during the quarter, which usually enjoy higher margins. Consequently, the operating profits (excluding the foreign exchange [forex] gain) for the quarter grew by 27.4% to Rs154.5 crore.
• The company maintains that the higher interest rates have affected the sales as it caused the prospective customers to defer their buying decisions. The company expects a revival in the second half of the year. For the full year, the company expects the truck industry to register a growth of about 5-6%, while it has set a target of selling 90,000+ vehicles for itself (earlier 100,000). We estimate an overall volume growth of 5% for the current year and a 13.8% growth for the next year.
• Though the company's capacity expansions plans, better product mix, improving operating efficiencies and increasing presence in the overseas markets are some of the positives for the stock, we remain very cautious on industry's prospects considering weak freight rates, lesser availability of freight due to seasonal factors, reduction in auto loan disbursals by financiers and increasing instances of delinquencies. Consequently, we are downgrading our rating on the stock to a Hold.
• A lower other income (due to dividend income received in Q4FY2007, higher interest costs due to additional working capital requirements and higher taxes led to a 5% drop in the net profits for the quarter to Rs71.9 crore. Taking into account the extraordinary items of Rs19.8 crore forex gain and a Rs3.5 crore voluntary retirement scheme expenses write-off, the profits after extraordinary items have marked a growth of 27.5% to Rs88.2 crore.
• At the current market price of Rs38.5, the stock quotes at FY2009E price/earnings ratio of 9.4x and at an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 6.0x.

Aurobindo Pharma
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs914
Current market price: Rs769

FY2007 results in line with expectations

Result highlights

• For FY2007 Aurobindo Pharma has reported an impressive growth of 349.8% in its consolidated profit to Rs203.2 crore against our expectations of a profit of Rs202.7 crore.
• In FY2007 the company's consolidated revenue grew by 32.7% to Rs2,250.2 crore. The revenue growth was driven by a 64% increase in the international business during the year. The exports from the domestic base increased by 34% to Rs1,147.6 crore in the same period.
• The operating profit margin (OPM) expanded by 230 basis points to 13.4%, which was lower than our expectations. However, the operating profit grew by 70% to Rs302.0 crore during the year. The net profit jumped by 349.8% to Rs203.2 crore on the back of a 25% fall in the interest cost and a substantial decline in the tax incidence brought about by the minimum alternate tax (MAT) credit entitlement of Rs14.54 crore.
• At the current market price of Rs769, the stock trades at 13.4x of its FY2009E earnings. We maintain our Buy recommendation on the stock with a price target of Rs914 per share.

Bajaj Auto
Cluster: Apple Green
Recommendation: Hold
Price target: Rs2,470
Current market price: Rs2,423

Price target revised to Rs2,470
Bajaj Auto Ltd (BAL) has recently disclosed its new business achieved profits (NBAP) in a presentation. The company has stated the NBAP at Rs703.6 crore for FY2007. The NBAP has been calculated by ascertaining the present value of all future profits (net of tax) arising from the sale of new contracts during the reporting period, on best estimate assumptions, after allowing for the cost of capital.

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.

Bank of Baroda
Cluster: Apple Green
Recommendation: Buy
Price target: Rs366
Current market price: Rs293

Price target revised to Rs366

Result highlights

• In Q1FY2008, Bank of Baroda's (BOB) net profit increased by 102.5% year on year (yoy) and 34.7% quarter on quarter (qoq) to Rs330.8 crore. The profits of the bank more than doubled on year-on-year (y-o-y) basis mainly because of a decline in provisions during the quarter on account of a write-back in the investment provisions on its marked-to-market investment portfolio.
• During the quarter the bank's net interest income (NII) increased by 15.5% yoy but declined by 8.9% on a sequential basis. The Q4FY2007 NII was adjusted for Rs30 crore for the cash reserve ratio (CRR) from the interest income and Rs22 crore interest income related to BOB Housing. The margins have remained stable on a y-o-y basis but have shown a six-basis-point decline at 3.2% on a quarter-on-quarter (q-o-q) basis.
• The non-interest income was up by 64.4% yoy mainly due to a higher treasury income component of Rs130 crore which included Rs90 crore from the National Stock Exchange (NSE) stake sale; the fee income was up by 13.5% yoy to Rs107.7 crore.
• The operating expenses were up 24% yoy to Rs684 crore as both the staff expenses and the other expenses increased by 17.6% yoy and 38.6% yoy respectively. The staff expenses were high because of higher retirement benefits while the other expenses increased due to higher depreciation on the assets (mainly technology). Although the operating profits improved by 28% yoy, the core operating profits (ie operating profits adjusted for treasury) declined by 6%.
• The bank's loan growth moderated to 27.5% yoy as in June 2007 from the high of 40% y-o-y growth in FY2007. The retail and foreign advances continued to be the main drivers of the growth with 38.5% and 44% y-o-y rise respectively. The deposit growth also moderated to 22.7% yoy from 33.4% registered in FY2007. The moderation in the overall business growth to a more comfortable level of 22-25% would help the bank conserve precious capital, maintain the margins and reduce the likeliness of higher defaults going forward.
• We have seen a marginal deterioration in the asset quality with the gross non-performing asset (NPA) level up 5.5% qoq and the net NPA level at 0.67% compared with 0.6% in March 2007.
• Although the margins were not under severe pressure, the core operating performance was dismal as the operating expenses remained high mainly due to technology implementation and providing retirement benefits for the staff. We expect higher operating expenses in FY2008 because of technology implementation and the Accounting Standard (AS)-15 provisions. We also expect the margins to remain under pressure as the bank plans to grow significantly its international operations (margins are comparatively lower in the international business). However the bank has comfortable capital adequacy and asset quality levels with a strong management focus to improve profitability. Due to its low return on equity (RoE) the bank trades at a much lower price to book value (BV) multiple than its peers. But with its RoE expected to improve to 15% plus going forward, we feel at the current valuations the bank is one of the most attractively valued among the public sector banks. We have introduced our FY2009 estimates in this report. At the current market price of Rs293, the stock is quoting at 6.8x its FY2009E earnings per share (EPS), 3.4x pre-provision profits (PPP) and 1x BV. We maintain a Buy recommendation on the stock with a revised price target of Rs366 at which it would trade at 1.25x FY2009E BV.

Bank of India
Cluster: Apple Green
Recommendation: Buy
Price target: Rs280
Current market price: Rs257

Price target revised to Rs280

Result highlights

• Bank of India's (BOI) Q1FY2008 profit after tax (PAT) grew by 51% year on year (yoy) to Rs315.2 crore. The growth was driven by a strong operating performance on both the interest income and the non-interest income front.
• The net interest income (NII; adjusted for amortisation expenses as BOI treats the same as an interest expense) grew by 22.6% yoy and by 2% quarter on quarter (qoq) to Rs1,011 crore. The reported domestic net interest margin (NIM) showed an improvement of 11 basis points yoy to 3.06%. Our calculations suggest that global (domestic and international) NIM declined by five basis points yoy and by six basis points sequentially.
• The non-interest income grew by 26.6% yoy but declined by 38% qoq to Rs317 crore. The details of the non-interest income composition are awaited, however the bank had booked one time gains in Q4FY2007of Rs52 crore on the sale of some Nigerian oil bonds and profit of Rs14 crore on sale of fixed assets excluding which the fall would be lower.
• The operating expenses grew by a modest 7.1% yoy, which helped the operating profit to improve by 45% yoy to Rs677.8 crore.
• Provisions and contingencies increased by 18.3% yoy on account of higher other provisions as the non-performing asset (NPA) provisions declined by 20.1% yoy. Tax provisions also increased by 80.7% yoy.
• The bank's asset quality has showed consistent improvement with the net NPA and the gross NPA both showing a decline in percentage and absolute terms. The net NPA stood at 0.69% as in June 2007 compared with 0.74% reported in March 2007. The provision coverage has also improved from 61% in Q1FY2007 to 70% in Q1FY2008 yoy.
• We feel BOI continues to remain one of the best performing public sector banks in terms of earnings growth, return on equity and asset quality. However the bank's current Tier-I capital adequacy ratio (CAR) is around 6.5-7%, which is a cause for concern going forward. Despite exploring hybrid options, we feel the bank would need to come out with a follow-on issue in FY2009. Hence, we have factored in a capital dilution in FY2009 of 9.7 crore equity shares equal to 20% of the pre-issue equity at an assumed follow-on offer price of Rs230, which will help the bank to raise around Rs2,200 crore and increase its Tier-I ratio CAR to 8%.
• We have increased our FY2008 earning estimates by 3.2% to Rs1,394.2 crore and introduced our FY2009 estimates in this note. At the current market price of Rs257, the stock is quoting at 8.7x its FY2009E earnings per share (EPS), 4.2x pre-provisioning profit (PPP) and 1.4x FY2009E book value (BV). We maintain our Buy recommendation on the stock with a revised price target of Rs280.

BASF India
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs300
Current market price: Rs272

Agriculture segment spurs overall growth

Result highlights

• BASF reported decent results for Q1FY2008. Its top line grew by 14.1% to Rs236.0 crore in Q1FY2008. Looking at the segmental results, sales of agricultural products rose by 38.5% while that of performance products increased by 15.4%.
• However, it is important to mention that the results are not strictly comparable with those of last year as the indenting and trading activities related to the polyurethane system were transferred to a subsidiary, and the same would be reflected in its consolidated accounts. Further, the agricultural products are seasonal in nature.
• The operating profit margin (OPM) grew by 30 basis points to 14.2%, mainly as a result of a strong margin growth in the agricultural products division. Consequently, the operating profit grew by 16.2% to Rs33.4 crore.
• Stable interest charge and tax outgo aided the company to grow its net profit by 15.4% to Rs19.9 crore in the quarter.
• We remain optimistic on the prospects of the company, considering the ongoing consumption boom in the company's user sectors, such as white goods, home furnishings, paper, construction and automobiles. To cater to the resulting demand, BASF has already expanded its polymer dispersion capacity at Mangalore from 20,000 tonne per annum (tpa) to 65,000tpa in March 2007.
• Considering its growth prospects, we believe the company is trading at an attractive valuation of 9.5x FY2008E earnings. We maintain our Buy recommendation on the stock with a price target of Rs300.
  

Bharti Airtel
Cluster: Apple Green
Recommendation: Buy
Price target: Rs1,100
Current market price: Rs925

Price target revised to Rs1,100

Result highlights

• Bharti Airtel (BAL) has shown a robust revenue growth of 9.5% quarter on quarter (qoq) and 53.1% year on year (yoy) to Rs5,905 crore during Q1FY2008. The sequential revenue growth was driven by a 10.7% rise in the mobile revenues whereas the non-mobile businesses declined by 1.4% sequentially to Rs1,845 crore.
• The operating profit margin (OPM) at 41.4% for the quarter was marginally lower than 41.5% reported in Q4FY2007. This is a commendable performance given the fact that the OPM in the quarter was dented by the change in the accounting policy for the revenues generated from the lifetime pre-paid scheme. The company used to book the initial rental payment over the period of 18 months period earlier, which was increased to 24 month from the current fiscal. This has resulted in the revenue loss of Rs70 crore during the quarter. The operating profit grew by 9.2% qoq and 64.3% yoy to Rs2,447 crore.
• The consolidated earnings grew at a relatively higher rate of 11.7% qoq and 100.2% yoy to Rs1,512 crore, ahead of our expectations of Rs1,480 crore. The earning growth was aided by exchange rate fluctuations of Rs239 crore (included in net interest outgo) and write-back of provisions (around Rs40-50 crore included in the other income component), which more than made up for the sharp increase in the effective tax rate.
• In terms of operational metrics for the mobile business, BAL reported a record net addition of 5.56 million subscribers during the quarter, taking its subscriber base to 42.7 million as on June 30, 2007. The average revenue per unit (ARPU) declined by 4% qoq to Rs390 and minutes of usage increased 16% qoq to 57.1 billion minutes, amounting to average revenue per minute of Rs0.82 (down from Rs0.86 in Q4FY2007). The spread per minute stood at Rs0.33 (slightly lower than Rs0.34 in Q4FY2007). The company has increased its overall market share to 23.5%, up from 22.9% in Q4FY2007.
• In terms of key highlights, the company has crystallised its plans to form a separate wholly owned subsidiary, Bharti Infratel. The passive network infrastructure (such as towers) would be transferred to this tower company. We have valued the tower company at Rs173 per share based on the estimated addition of towers over the next three years and the valuation of US$ 6.75 billion attracted by the tower company formed by Reliance Communication (which is much smaller in terms of asset base).
• To factor in the better than expected performance, we have revised upwards our earnings estimates by 4.8% and 3.4% for FY2008 and FY2009 respectively. At the current market price the stock trades at 27.6x FY2008 and 21.9x FY2009 estimated earnings. We maintain our Buy call on the stock with a revised price target of Rs1,100.

Ceat
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs216
Current market price: Rs177

Price target revised to Rs216

Result highlights

• Ceat's Q1FY2008 results were in line with our expectations. The net sales have risen by 7.8% to Rs536.4 crore, mainly driven by strong realisation growth due to price hikes and product mix changes. In line with the industry slowdown, the original equipment manufacturer (OEM ) sales declined by 11% year on year (yoy), but the effect of the same was mitigated because of strong growth in the replacement and the export markets.
• The operating margins expanded 550 basis points to 9.2% during the quarter as a result of lower raw material cost, price hikes, improved product mix and other efficiencies. As a result, the operating profits grew by 166.3% to Rs49.4 crore.
• Adjusting for the impact of tax provisioning on the extraordinary gain, we estimate that the quarterly profits have grown to Rs20.4 crore against Rs0.2 crore same quarter last year. The quarter's results contain extraordinary items relating to refund from excise and income tax and reversal of export benefits granted in earlier years. Profit after tax (PAT) after extraordinary items have grown to Rs30.4 crore.
• Last few quarters have been pretty exciting for Ceat, as it has effected a smart turnaroud during the period and now its margins are comparable with the best in the industry. We expect this strong growth to continue, particularly driven by the replacement and the exports segment. We also expect the company to maintain its margins at these levels going forward. On the basis of strong performances by Ceat, we are raising our earnings estimate for Ceat by 6% to Rs16.9 for FY2008 and are introducing our FY2009 estimates of Rs21.1.
• The slowdown in the OEM segment is expected to continue for another couple of quarters. To counter the same, the company has already put in place strategies to concentrate more on the exports and the replacement markets.
• The land sale is expected to be finalised by the third quarter of the current fiscal, while the demerger process is expected to be completed by the end of this fiscal.
• At the current market price of Rs177, the stock is trading at 8.4x its FY2009E earnings and at an enterprise value (EV)/earnings before interest depreciation and amortisation (EBIDTA) of 3.9x. We maintain our Buy recommendation on the stock with a revised price target of Rs216.

Cipla
Cluster: Cannonball
Recommendation: Book Profit
Current market price: Rs191

Book profit

Result highlights

• Cipla reported much lower than expected results for Q1FY2008 with a net profit of Rs119.8 crore against the expectation of Rs176.8 crore. The earnings have been lower due to the disappointing performance of the export business and a significant contraction in the operating profit margin (OPM).
• The revenues were marginally higher by 4.4% to Rs901.8 crore. The sales growth was lower basically due to the lower-than-expected performance of the export business, which grew by a marginal 2.1%. The disappointing exports could partly be justified by the decline in the export realisations caused by the rupee appreciation. The low growth in the exports was also partly attributed to the high base in Q1FY2007 when the company had gained hugely from the Finasteride exclusivity in the USA. Going forward, the high growth rate seen in the previous quarters seems even more difficult to sustain on the high base of the previous year. Thus, in order to factor in the above, we are moderating our formulation export growth estimates for FY2008 and FY2009 to 20% each from the earlier estimates of 30% and 25% respectively.
• Cipla’s domestic business grew by just 6.9% during the quarter, which was way below the industry growth of 10-12%. This was mainly on account of lower stocking of certain older brands of products at the primary level.
• The OPM witnessed a sharp 870-basis-point decline to 17.8% in the quarter due to the higher contribution of low-margin anti-retrovirals (ARVs) and the decline in the export realisation due to rupee appreciation. Further, rising staff and manufacturing expenses also affected the margin. Consequently, the operating profit stood at Rs160.7 crore, down by 29.8%. Going forward also, Cipla’s margin will continue to be affected by the increased contribution from the low-margin ARV sales. Hence, we are revising down our OPM estimates for FY2008 and FY2009 to 19% (from 21.5%) and 20.5% (from 22%) respectively.
• With the 15.5% fall in the other income and a 16.3% rise in the depreciation cost, the net profit declined by 29.7% to Rs119.8 crore in Q1FY2008.
• Cipla’s performance continued to be disappointing in Q1FY2008, largely due to the lower than expected performance of the export business and the decline in the OPM. Hence, we are revising down our FY2008 and FY2009 earnings estimates by 18.1% and 15.7% respectively.
• At the current price of Rs191, the stock trades at 21.4x and 17.7x its FY2008E and FY2009E earnings respectively. At this level, we feel the stock is richly valued, considering the limited scalability of formulation exports and the company’s inability to effect margin improvements, which leaves limited room for upside for the investors. The stock has yielded a return of 88.7% since our recommendation and we advise investors to book profits on Cipla.

Corporation Bank
Cluster: Apple Green
Recommendation: Buy
Price target: Rs422
Current market price: Rs382

Price target revised to Rs422

Result highlights

• Corporation Bank's net profit increased by 22.8% year on year (yoy) and 49.5% quarter on quarter (qoq) to Rs177.1 crore in Q1FY2008. The growth was driven mainly by lower provisions as the bank reported a decline of 16% year-on-year (y-o-y) and 22.6% quarter-on-quarter (q-o-q) in the operating profit.
• During the quarter the bank's net interest income (NII) increased by 7.8% yoy but declined by 9.6% on a sequential basis. Our numbers are adjusted for a one-time prior period item of Rs22 crore (for the claim receivable from the government in respect of relief measures provided for debt-stressed farmers) included in the interest income for Q1FY2008 and around Rs16 crore of one-time cash reserve ratio (CRR) interest income received in Q4FY2007.
• The reported net interest margin (NIM) of the bank at 3.01% (2.82% adjusted) was down 59 basis points on a y-o-y basis and lower by 28 basis points on a sequential basis after adjusting for the one-time items. The bank's NIM has been under pressure as it funded its asset growth largely through high cost term deposits. The bank's low cost deposit base of current and saving account (CASA) decreased by almost 400 basis points on a y-o-y basis and by 500 basis points on a sequential basis to 29% as in June 2007.
• The non-interest income declined by 28.1% yoy and 26.7% qoq mainly due to a lower treasury income; the fee income growth was in single digits at 8.2% yoy.
• The operating performance was dismal due to a 4% y-o-y decline in the net income and a 14.4% y-o-y increase in the operating expenses, which resulted in a 16% y-o-y decline in the operating profit. The staff expenses were higher on a y-o-y basis because the bank provided for Rs27 crore as AS-15 related expenses in Q1FY2008 which was absent in Q1FY2007 and excluding which the operating profit declined by 7% yoy.
• Some positive news on the core operating profit performance front where we witnessed a 5.3% y-o-y growth. Adjusting for the AS-15 related expenses the growth improves to 17.5% yoy.
• The profit after tax (PAT) increased by 22.8% yoy mainly due to the fall in the provisions and contingencies. Provisions declined by 76.2% yoy on account of a write-back of Rs18 crore in Q1FY2008 compared with an investment depreciation of Rs48 crore in Q1FY2007 as bond yields have receded sequentially.
• We feel with interest rates peaking out and bulk deposit rates falling by 200 basis points already, the going would be easier for the bank in the coming quarters. The worst on the margin front looks to be over and with its high capital adequacy and superior asset quality, we expect the bank to report improved performance going forward. The valuation of the bank is not expensive considering its return on equity of around 17%. We have introduced our FY2009 estimates. At the current market price of Rs382, the stock is quoting at 7.3x its FY2009E earnings per share (EPS), 3.8x pre-provision profits (PPP) and 1.2x book value (BV). We maintain a Buy on the stock with a revised price target of Rs422.

Deepak Fertilisers & Petrochemicals Corporation
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs126
Current market price: Rs100

Rise in raw material cost hampers profitability

Result highlights

• Deepak Fertiliser & Petrochemicals Ltd's (DFPL's) Q1FY2008 results were a mixed bag compared to the corresponding period last year, as the sales showed a healthy growth while the profits slipped.
• The net sales grew by a healthy 32% year on year (yoy) to Rs219.8 crore, positively affected by a 38.3% growth in the chemicals segment to Rs152.02 crore and a contribution from Isopropyl alcohol (IPA), which stood at Rs63.68 crore for Q1FY2008.
• The raw material cost increased by around 120% yoy to Rs61.7 crore. The raw material cost as a percentage of the net sales shot up by 1,130 basis points yoy to 28.1%. The major reason behind this huge jump in the raw material cost was the shutdown of the ammonia plant for around 41 days. The shutdown was carried out to augment the plant's capacity to 390 metric tonne (MT) per day from 272MT per day and it led to outsourcing, resulting in a higher input cost. Overall, the operating expenses increased by 40% yoy to Rs181.12 crore. The resultant operating profit grew only by 4.3% yoy to Rs38.7 crore. However, the operating profit margin (OPM) declined by 470 basis points yoy to 17.6%.
• The interest expenses growth was strong at 99% yoy to Rs5.0 crore whereas the depreciation provision increased by 36% yoy to Rs10.6 crore.
• The net profit declined by 8.9% yoy to Rs22.6 crore due to higher raw material cost and interest expenditure.
• The IPA plant, which commenced its operations in August 2006, has stabilised. In FY2008, the company expects this plant to run with a production capacity of 50,000 tonne, though the total production capacity of the plant is 70,000 tonne. Since the company is the only producer of IPA in India, we feel that IPA would be a strong factor to drive the top line and bottom line of the company in future.
• DFPL has also set up a specialty mall known as "Ishanya". With this project, the company will be focusing and try to capitalise on the emerging opportunity in the interiors and exteriors segment. The construction of this mall is already complete and the company has already leased out around 76% of the total leaseable area (around 220,000 square feet).
• The status of the ammonium nitrate project in Orissa is on schedule and the plant is expected to commence operations in July 2009.
• The profit fell in the first quarter due to the extraordinary situation of the plant shutdown, which increased the raw material cost, thereby negatively affecting the profitability in Q1FY2008. However, we feel that this is a temporary fluctuation due to unforeseen circumstances and will not continue in the coming quarters. We estimate the net sales of the company would increase by 33.8% and 11.6% in FY2008 and FY2009 respectively. We also estimate the earnings would increase by 21.7% and 23.3% to Rs114.9 and Rs141.7 crore in FY2008 and FY2009 respectively.
• At the current market price, the stock is trading at 6.2x its FY2009 earnings and at an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 5.0x. We maintain our Buy recommendation on the stock with a price target of Rs126.

Elder Pharmaceuticals
Cluster: Apple Green
Recommendation: Buy
Price target: Rs508
Current market price: Rs422

Growth momentum continues

Result highlights

• Elder Pharmaceuticals (Elder) maintained its growth momentum in Q1FY2008. The company’s net sales rose by 20.0% to Rs125.3 crore in Q1FY2008. The sales growth was in line with our expectations and was driven by the continued momentum in the company's star brands, the new products and line extensions launched over the past one year, and an increased offtake of antibiotics.
• Elder reported a marginal drop of 30 basis points in its operating profit margin (OPM), which stood at 18.5% during the quarter. The contraction in the margin was largely on account of a 32.1% rise in the other expenditure incurred by the company. The increase in the other expenditure was mainly due to an increase in the marketing spend for the launch and ramp-up of the newly launched osteoporosis drug called Bonviva, which was in-licenced from Swiss drug maker, Roche.
• Consequently, the company’s operating profit rose by 17.6% to Rs23.1 crore in Q1FY2008.
• Elder’s net profit rose by 15.4% to Rs15.1 crore in Q1FY2008. The growth in the profit was marginally ahead of our estimate of Rs13 crore, despite an increase of 32% in the interest cost and a rise of 43% in the depreciation charge during the quarter. The net profit growth was aided by the substantially lower tax provision made during the quarter.
• Elder’s performance has been consistent quarter after quarter. With strong brand building capability, a continuous spate of new in-licencing deals, launch of new products, and scale-up of business in the lifestyle, skin-care and paediatric areas, Elder’s growth prospects continue to remain bright for the years to come. The company has been aggressive in striking in-licencing deals and as the products from the deals signed over the past few quarters get launched, the growth momentum will accelerate.
• At the current market price of Rs422, the stock is quoting at 10.5x its estimated FY2008 earnings. We maintain our Buy recommendation on the stock with a price target of Rs508.

Fem Care Pharma
Cluster: Ugly Duckling
Recommendation: Book Profit
Current market price: Rs503

Book profit

Result highlights

• Fem Care Pharma Ltd (FCPL) has reported an encouraging performance for FY2007. On a full year basis, the consolidated performance of the company was quite encouraging. The consolidated revenues grew by 14.7% to Rs80.7 crore. The operating profit margin (OPM) improved by 330 basis points to 19.9%. The profit after tax (PAT) showed a robust growth of 53% to Rs10.7 crore.
• The company has reported lower profitability at the consolidated level due to the piling of stocks in its marketing arm Mirasu to meet the robust demand in the April-May period, which is the marriage season. These stocks were shown as stand-alone sales of the company.
• The company is expected to show lower top line growth in the first half of FY2008 due to the shifting of the Q1FY2008 stand-alone revenues to Q4FY2007 and a tough second quarter on account of the high base effect. Moreover, the expected delay in the installation of its speciality chemical plant is another negative trigger for the company.
• Given the concern that its performance is likely to be lacklustre in the coming two quarters, we advise investors to book profit in the stock. We had put a Buy on the stock on December 13, 2006. The stock has appreciated by 41% and achieved our target of Rs500.

Genus Power Infrastructures
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs450
Current market price: Rs370

Price target revised to Rs450

Result highlights

• Genus Power Infrastructures has announced its Q1FY2008 results. The net sales for the quarter grew by 63.7% to Rs83.5 crore with revenues kicking in from the new facility in Uttranchal. The net earnings grew by 86.5% to Rs6.9 crore.
• The operating profit for the quarter grew by 67.1% to Rs13.2 crore, the operating profit margin (OPM) for the quarter improved by 30 basis points to 15.8% as against 15.5% in Q1FY2007.
• The interest expense for the quarter increased by 57.7% to Rs4.1 crore
• The order book of the company stood at around Rs370 crore at the end of the first quarter.
• With effect from March 31, 2007 the company's name has been changed to Genus Power Infrastructures Ltd (GPIL).
• GPIL, a leading manufacturer of tamper proof electronic energy meters (EEMs), has been growing at a robust pace. The healthy growth is expected to continue on the back of the large investments being made in the transmission and distribution sector, and the replacement of old meters with new EEMs by various state electricity boards (SEBs).
• At the current market price of Rs370 the company is discounting its FY2008E earnings by 9.8x. We maintain our Buy recommendation on the stock with a revised price target of Rs450, keeping the target multiple of 12x FY2008E earnings.

Grasim Industries
Cluster: Apple Green
Recommendation: Buy
Price target: Rs3,250
Current market price: Rs2,947

Price target revised to Rs3,250

Result highlights

• The Q1FY2008 net sales of Grasim Industries (Grasim) grew by 30.3% year on year (yoy) to Rs2,450 crore, mainly due to a pick-up in its viscose staple fibre (VSF) volumes as well as realisation and higher sponge iron prices. The VSF revenues grew by a robust 59% yoy to Rs700 crore on the back of a healthy 34% growth in the volumes and a 20% growth in the realisation yoy. The cement revenues improved by 25% yoy to Rs1,390 crore driven by a 12% growth in volumes and a 13% growth in realisations yoy.
• On the back of a higher top line growth, the operating profit grew by 54% yoy to Rs792 crore whereas the earnings before interest, tax, depreciation and amortisation (EBITDA) margin improved by 510 basis points to 32.4%.
• The interest expenses rose by 21.1% yoy to Rs28.5 crore on account of higher borrowings in the quarter whereas the depreciation provision increased by 14.7% yoy to Rs85 crore mainly due to part commissioning of the additional VSF capacity in FY2008.
• The other income jumped by 81% yoy to Rs67.7 crore on account of a high interest income from the profitable deployment of surplus cash from operations.
• Consequently, the net profit rose by 64% yoy to Rs512 crore, much ahead of expectations.
• The company has slightly modified its capital expenditure (capex) plans. As against expanding the capacities at Kotputli and Shambhpura by 4 million metric tonne (MMT) each as planned earlier, the company is now expanding the capacities at these two locations by 4.4MMT each. The Shambhupra capacity is expected to come up by Q4FY2008 whereas the Kotputli plant is expected to be commissioned by Q1FY2009.
• The company is also augmenting its VSF capacity at Kharach, Gujarat from 45,625 tonne to 63,725 tonne. The company is also in the process of getting regulatory clearance for expanding the capacity at Harihar by 31,000 tonne.
• Considering the optimistic outlook for the VSF business, the higher realisations from the sponge iron business and the higher earnings of UltraTech Cement, we are upgrading our earnings per share (EPS) estimate for FY2008 by 8.2% to Rs264 and for FY2009 by 12.6% to Rs234.

HDFC Bank
Cluster: Evergreen
Recommendation: Buy
Price target: Rs1,355
Current market price: Rs1,148

Other income compensates for lower core income

Result highlights

• HDFC Bank's results have been in line with expectations with the profit after tax (PAT) reporting a growth of 34.2% to Rs321.2 crore compared with our estimate of Rs313.5 crore. Even though the numbers are in line with estimates, the core income growth is below expectations. The non-interest income has, however, compensated for the lower than expected core income growth.
• The net interest income (NII) grew by 27.5% year on year (yoy) but declined by 4% quarter on quarter (qoq) to Rs1,042.2 crore, below our expectations of Rs1,153 crore. The growth in the NII was primarily driven by the asset growth, as our calculations suggest that the net interest margin (NIM) declined by three basis points yoy and by 56 basis points qoq to 4.2%.
• The bank had witnessed a significant improvement of 35 basis points in its NIM during Q4FY2007 mainly due to a higher current and savings account (CASA) balance at 57.7% compared with an average of 50% during FY2007 and of 51.5% during Q1FY2008. Some decline in the NIM on a sequential basis was expected as such high CASA is unsustainable and was only an aberration.
• The bank had almost stopped expanding its business during Q4FY2007; very high deposit rates had prompted HDFC Bank to go slow on mobilisation of deposits, especially term deposits, which had resulted in the significant increase in the CASA balance in Q4FY2007. However, we feel that with the deposit rates moderating, the bank has again grown its deposit book. Since, the deposit growth is higher in the current quarter and the credit offtake is generally lower during the first quarter, we feel the bank may have parked the excess in short-term investments (only to utilise the same when the credit growth picks up in the second and the third quarter) and this could have lowered the overall investments yield. However, going forward we expect the core income to improve as the credit growth improves leading to better yields.
• The non-interest income growth was much higher at 77.3% yoy and 56% qoq mainly due to lower treasury losses during the current quarter and a higher fee income from the foreign exchange (forex) and derivatives segment.
• The operating profit grew by 41% yoy and 7% qoq to Rs783.7 crore while the core operating profit (operating profit excluding treasury) was up only 27.5% yoy and down by 8% qoq to Rs787.8 crore.
• Provisions & contingencies were up 50.5% yoy and 15% qoq to Rs307 crore mainly due to higher provisioning requirements on certain categories of standard assets as personal loans grew by 46% yoy and 23% qoq.
• The sequential decline in the NIM was expected but the lower growth in the NII is mainly due to higher deposit costs and lower investment income. We expect the NIM to stabilise at the current 4.2% levels and the core income growth to pick up going forward. At the current market price of Rs1,148 the stock is quoting at 21.1x FY2009E earnings per share (EPS), 8.1x FY2009E pre-provision profits (PPP) and 3.1x FY2009E book value (BV). We maintain our Buy recommendation on the stock with a price target of Rs1,355.

Hexaware Technologies
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs184
Current market price: Rs139

Price target revised to Rs184

Result highlights

• For Q2CY2007 Hexaware Technologies has reported lower than expected consolidated revenues of Rs261.6 crore, which marks a marginal decline of 1% quarter on quarter (qoq) but a growth of 26.5% year on year (yoy). The revenues in dollar terms grew by 6.6% qoq but the appreciation in the rupee by 7.1% resulted in a sequential decline in rupee terms.
• The operating profit margin (OPM) declined 280 basis points qoq to 12.2%, in line with our estimates. The company witnessed an adverse impact of 700 basis points on its margins due to the rupee appreciation (an impact of 320 basis points) and aggressive salary hikes (a 17.5% salary hike for the offshore employees and a 5% increase for the onsite employees resulted in a negative impact of 380 basis points). The effect of the stronger rupee and aggressive salary hikes was partially mitigated by the improvement in the utilisation rate (a positive impact of 1.1%), an increase in the billing rates (up 0.6%) and efficiency gains of 2.5% on a sequential basis.
• The effective tax rate also increased from 13.5% to 16.6%, resulting in a 25.8% quarter-on-quarter (q-o-q) and 12.2% year-on-year (y-o-y) decline in the company's consolidated earnings to Rs26.1 crore. The same is below our and the market's expectations.
• In terms of outlook, the company has temporarily suspended the practice of providing growth guidance for the coming quarter due to the growing uncertainty related to the exchange rate. However, the management reiterated that the demand environment is quite robust and it would be able to make up for the slowdown in the ramp-up from two of its clients (Citibank NA and Hewitt) from the list of its top ten customers.
• In operational highlights, the second consecutive quarter of a decline in the employee headcount is quite worrying and was possibly done to shore up the employee utilisation rate. The company has guided for gross addition of 650 employees in Q2CY2007. The fresh order intake of $40.5 million (as against $61 million in Q1) was also lower than expected and implies that the pending order backlog would have declined to around $240 million as on June 2007 (down from $260 in March 2007).
• To factor in the lower appreciation in the rupee (CY2007 exchange rate assumption changed to Rs41.2/USD based on assumption of Rs40 in Q3 and Rs40 in Q4) and the higher than expected pressure on the margins (due to aggressive wage hikes and higher overhead cost), we have revised the FY2008 and FY2009 earnings estimates downward by 16.8% and 15.8% respectively. At the current market price the stock trades at 14.3x FY2008 and 11.4x FY2009 earnings estimates. We maintain our Buy call on the stock with a price target of Rs184.

ICI India
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs581
Current market price: Rs488

Continued business grows by 15.3%

Result highlights

• The net revenues of ICI India declined by 1.5% year on year (yoy) to Rs226.7 crore in Q1FY2008 due to the discontinuation of its surfactant business (Uniqema).
• The paint business grew by 15% yoy to Rs191 crore in the same quarter. The continued chemical business grew by 16% yoy to Rs35.4 crore. The discontinued business had contributed Rs34 crore to the company's total revenues in Q1FY2007.
• The profit before interest and tax (PBIT) in the paint business grew by 24.8% yoy with a 58-basis-point expansion in the margin. The PBIT in the residual chemical business grew 43% yoy with a 250-basis-point expansion in the margin. After the sale of the Uniqema business, the continuing chemical business now contributes 15.6% to the top line as against 13.3% in Q1FY2007.
• The PBIT from the continued businesses for the quarter under review grew by 29% on the back of an 88-basis-point expansion in the PBIT margin to 8.4% from 7.5% in Q1FY2007.
• The other income for this quarter was Rs13.1 crore as against Rs6.6 crore in Q1FY2007. With a higher other income and lower tax provisioning, the net profit grew by 26% yoy to Rs22.8 crore.
• On July 12, 2007 through postal ballot the shareholders approved a proposal of the company to buy back its own shares from the minority shareholders through market operations, in accordance with the applicable regulations, at a price not exceeding Rs575 per share.
• The outlook for the full year seems to be positive with the company's increased focus on the premium products (the Dulux portfolio). Further with cash pile of Rs877 crore growth through the inorganic route would be another big opportunity for the company. At the current market price of Rs488, the stock trades at 16.7x its FY2008E earnings per share (EPS) of Rs29 and 14.8x FY2009E EPS of Rs33. We maintain our Buy recommendation on the stock with a price target of Rs581.

ICICI Bank
Cluster: Apple Green
Recommendation: Buy
Price target: Rs1,173
Current market price: Rs970

Higher non-interest income drives profits

Result highlights

• ICICI Bank’s Q1FY2008 results have been higher than expectations with its profit after tax (PAT) growing by 25.1% year on year (yoy) to Rs774.8 crore compared with our estimate of Rs704 crore. The numbers are higher mainly on account of a very high growth of 69.7% yoy in the non-interest income category. The core operating performance in terms of the net interest income (NII) has been lower than expectations though.
• During the quarter under review the bank’s NII grew by 16.2% to Rs1,714.3 crore compared with our estimate of Rs1,854.2 crore. The bank's reported net interest margin (NIM) declined by 20 basis points yoy and by 36 basis points quarter on quarter (qoq). The absence of interest on the cash reserve ratio (CRR) balances coupled with a higher increase in the cost of funds compared with the yield on the assets led to the decline in the NIM.
• The non-interest income was up 69.7% yoy to Rs1,715 crore, much above our expectations of Rs1,405 crore, mainly driven by a higher treasury gain of Rs195 crore compared with Rs18 crore in Q4FY2007, a fee income of Rs1,428 crore (up 35.4% yoy), and a lease and dividend income of Rs327 crore (up 59.8% yoy).
• Although the bank’s total advances grew by 34.7% yoy, yet the growth in the retail advances moderated to 29% yoy from 39% in Q4FY2007 as the bank sold off Rs3,850 crore of loans during the quarter adjusted for which the retail growth would remain at 32.9% yoy. The deposit growth also moderated to 26% yoy from 39.6% in Q4FY2007. The total assets of the bank grew by 34.1% yoy and 3.6% qoq.
• The operating profit was up 58% yoy; but the core operating profit growth was lower at 28.9% yoy.
• The asset quality deteriorated with the gross non-performing asset (GNPA) going up by Rs1,193 crore on a sequential basis and the net NPA (NNPA) rising to 1.38% compared with 0.98% in Q4FY2007. The increase in the NPAs was mainly a result of higher defaults witnessed in the non-collateralised segments, which include credit cards and personal loans.
• We feel the core operating performance should improve with the NIM likely to stabilise or show marginal improvement going forward. The non-interest income growth is expected to remain steady. The only concern is the uptick in the NPAs which need to be watched going forward. At the current market price of Rs970, the stock is quoting at 21.2x its FY2009E earnings per share (EPS), 10.4x its pre-provision profit (PPP) and 2.2x FY2009E book value (BV). We maintain our Buy recommendation on the stock with the price target of Rs1,173.

Infosys Technologies
Cluster: Evergreen
Recommendation: Buy
Price target: Rs2,440
Current market price: Rs1,937

Improved growth outlook

Result highlights

• Infosys Technologies (Infosys) reported a flat growth in its consolidated revenues and adjusted earnings for Q1FY2008. The highlight of the quarterly performance was the higher than expected growth of 0.8% quarter on quarter (qoq) and 29.5% year on year (yoy) in its consolidated earnings to Rs1,028 crore (after adjusting for the write-back of tax provisions). The same was achieved on the back of an unexpected jump of 112.6% qoq in the other income to Rs253 crore during the quarter.
• The consolidated revenues in dollar terms grew by 7.5% sequentially aided by a healthy volume growth of 6.9% and an improvement of 1% in the average blended billing rates. However, the consolidated revenues in rupee terms were largely flat due to the adverse impact of 7% on account of the appreciation in the average exchange rate realisation to Rs40.66 in Q1 as compared with Rs43.75 realised in the previous quarter.
• The operating profit margin (OPM) declined by 300 basis points to 28.7% during Q1FY2008. There was an adverse impact of 700 basis points on the OPM due to the cumulative impact of wage hikes (an impact of 250 basis points), visa charges (an impact of 100 basis points) and appreciation in the rupee (an impact of 350 basis points). On the other hand, there was a positive impact of 400 basis points from the improvement in employee utilisation (a 3% improvement in the net utilisation resulted in an increase of 150 basis points in the OPM), higher realisation (1% improvement in blended billing rates), improved performance of its subsidiaries and benefits of scale (a positive impact of 150 basis points). The sequential decline of 9.4% in its operating profit to Rs1,084 crore was largely in line with market expectations.
• The other income component was boosted by a Rs68-crore gain on the foreign exchange (forex) cover and a higher than expected yield of 11% on the free cash and cash equivalents on its books.
• The revised guidance for FY2008 is in line with expectations. The revenue growth guidance in dollar terms has been revised upwards marginally to a range of 29-31% (up from 28-30% guided in April) and the earnings guidance has been upgraded by 2.5-3% to $1.92-1.94 per share. On the other hand, in rupee terms, the revenue guidance has been reduced by around 5% to Rs16,238-16,433 crore and the earnings guidance has been cut by 2.6-3.2% to a range of Rs78.2-79 per share (including the non-recurring income of Rs51 crore from the write-back of tax provisions). The guidance appears to be conservative as it does not factor in the possible upside from the pipeline of large deals and expected improvement in its blended realisations in the coming quarters.
• For Q2, the management has guided to a 4.7-5.8% sequential growth in revenues and around a 5% jump in the earnings per share (EPS) to Rs18.9 as compared with the adjusted earnings of Rs18 per share in Q4FY2008. The second quarter guidance is also in line with expectations.
• The overall business environment continues to be robust and is reflected in the increased recruitment target of 26,000 gross additions of employees (up from 24,500 given earlier) in FY2008. Another encouraging sign is the company's confidence in limiting the decline in the OPM to 100-150 basis points after factoring in a 10% appreciation in the rupee and no further improvement in its blended realisations over the next three quarters. This clearly shows the flexibility of its business model and the kind of cushion available to exceed its own growth guidance for the year.
• We have marginally revised upwards our earnings estimates for FY2008 (up 0.2%) and FY2009 (up by 1.7%) despite revising the exchange rate assumption to Rs40 for FY2008 and FY2009 (from Rs41 in FY2008 and Rs40.5 in FY2009). At the current market price the stock trades at 23.6x FY2008 and 18.8x its FY2009 earnings estimates, which is close to the lower end of its trading range. We maintain our Buy recommendation on the stock with the price target of Rs2,440.

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.

Jaiprakash Associates
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs1,061
Current market price: Rs825

Price target revised to Rs1,061

Result highlights

• Jaiprakash Associates (JP Associates) is augmenting its cement capacity by 23.5 million metric tonne (MMT) over the next three years, taking its total cement capacity to 30.5MMT. At end of this exercise, JP Associates will have a diversified presence in the cement industry spanning the northern, western and central regions.
• The company's construction order book at Rs11,750 crore (7.8x its engineering, procurement and construction [EPC] revenues) provides the much needed visibility to its EPC revenue.
• As mentioned in our earlier reports, the company has been awarded the Taj Expressway project, which entails the construction of a 160km expressway between Noida and Agra. As an incentive the government will be awarding the company a land bank of 6,250 acre, which will be used by the company for developing residential as well as commercial complexes. We expect the project to be a tremendous value driver for the company and translate into a value of Rs456 per share. We expect the Jaypee Greens project to contribute Rs88 per share to the company's stock price.
• Apart from the three projects currently in the hydropower space, the company has signed a memrandum of understanding for two projects in Arunachal Pradesh —1,600 megawatt (MW) Lower Siang project and 500MW Hirong project. It enjoys higher returns on equity (RoEs) of 20-24% on these projects (as against the normal power RoE of 16%), thanks to the incentives in the form of higher secondary energy and higher plant availability. Hence we expect the hydropower projects to provide stability to the company's earnings.
• For the first quarter ended FY2008, the overall revenues of JP Associates grew by 9% year on year (yoy) to Rs926 crore whereas the net profit grew higher by 52% yoy to Rs139.8 crore. The growth was achieved on the back of the robust growth in the cement profits and a higher other income component.
• Over the years JP Associates has emerged as the most diversified infrastructure conglomerate in the country with businesses spanning all the major industries, eg cement, power, hotels and real estate. We believe it is a proxy play on the Indian infrastructure theme.
• On account of its diversified business portfolio, we believe the company is one of the most comfortably placed companies in the cement industry. We expect its consolidated earnings to grow at a compounded annual growth rate (CAGR) of 16% over the next two years to Rs767 crore. At the current market price of Rs824 per share, the stock is trading at 23.4x its FY2009 earnings. Taking cognisance of the company's higher cement capacity as well as the higher value of its realty projects, we are upgrading our price target to Rs1,061, expecting an upside of 29% from the current levels.

JM Financial
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs1,352
Current market price: Rs1,080

Price target revised to Rs1,352

Key points

• Morgan Stanley (MS), the world's second largest securities broker and investment bank, has decided to set up its own shop in India and hence it has decided to end its current joint venture with the JM Financial (JMF).
• MS and JMF operated in all the spheres of the capital market through two unlisted private companies named JM Morgan Stanley Pvt Ltd (JMMP) and JM Morgan Stanley Securities Pvt Ltd (JMMSP).
• JMF will sell its 49% holding in JMMSP (engaged in institutional broking, largely foreign institutional investor [FII] business) to MS for $445 million (Rs1,970 crore). Simultaneously, MS will also sell its 49% holding in JMMP (engaged in investment banking [IB] business) for $20 million (Rs90 crore) to JMF. This will make MS the 100% owner of the securities business and JMF the 100% owner of the IB business.
• Some regulatory approvals have been pending and the finalisation of the deal is expected by mid-July 2007. The beauty of this deal lies in the fact that Nimesh Kampani has been able to sell the institutional broking business at a cost far higher than what he had paid for the IB business. However the profit contributions from both the businesses were roughly similar in the previous fiscal. The securities business contributed about 48% while the IB and retail brokerage businesses together contributed 51% of JMF's consolidated earnings in FY2007.
• JMF has adopted the strategy of growing both organically and inorganically to expand its current businesses. The same, we feel, is a well thoughtout policy that would compensate for the loss in the revenues (after the split with MS) and make proper utilisation of the huge cash pool that would be available at JMF's disposal post-sale.
• JMF has already acquired a 60% stake in ASK Securities, which is engaged in institutional equity broking business, for Rs58 crore and is looking at buying a stake in a global boutique investment bank, which will offer advisory services for global mergers and acquisitions (M&As).
• We feel JMF would need some time to restructure its operations; hence we have not based our valuation on FY2008E earnings but looked at FY2009E earnings, which we feel would reflect the earnings potential of the company in a much better way as the exit of MS is bound to have its implications on the FY2008E revenues.
• We feel tie-ups with investment banks having global reach would help to bridge the gap created after MS' exit. The retail broking and distribution business should continue to grow with its thrust on expanding the retail branch network. The margin funding and IPO funding business is expected to double with its huge pool of cash and increased reach. Other nascent businesses like the commodities, private equity and mutual funds businesses are expected to contribute to the consolidated PAT going forward. Considering the above developments our 12-month price target—based on the FY2009E earnings using the sum-of-the-parts (SOTP) model—works out to Rs1,352. At its current market price the stock is trading at 25.2x FY2009E earnings per share (EPS) and 1.2x FY2009E consolidated book value (BV) which provide a decent 25% upside from the current price of Rs1,080. At our target price the company would trade at 32x FY2009E EPS and 1.5x FY2009E consolidated BV. The price/earnings (P/E) multiple looks a bit on the higher side mainly due to the negative contribution from some of the nascent businesses. The valuations are attractive from the BV perspective.

Lupin
Cluster: Apple Green
Recommendation: Buy
Price target: Rs840
Current market price: Rs692

Results in line with estimates

Result highlights

• Lupin's net sales increased by 26.2% year on year (yoy) to Rs601.8 crore in Q1FY2008. The growth in the top line was marginally above our expectations and was driven by a 22% growth in the domestic formulation business and an appreciable 233% jump in the export of formulations to advanced markets of the USA and Europe.
• Lupin's growth in the advanced markets was driven by the launch of four new products in the USA, including the entire range of Cefdinir. During the quarter its branded generic, Suprax, clocked sales of $5 million, up by 45% yoy.
• In Q1FY2008 Lupin's operating profit margin (OPM) expanded by 190 basis points yoy to 17.3%, which was lower than our expectation of 18.4%. The OPM was below expectations on account of a foreign exchange (forex) loss of Rs19.24 crore, despite an appreciable 740-basis-point drop in the raw material cost. The forex loss affected the OPM by almost 320 basis points. Consequently, the company's operating profit grew by 59.6% yoy to Rs104.1 crore in Q1FY2008.
• Despite a 42% reduction in the other income, Lupin's net profit grew by a handsome 33.2% to Rs78.4 crore in Q1FY2008. The strong profit growth was largely driven by the robust performance on the operating front and was in line with our estimates. The earnings for the quarter stood at Rs9.6 per share.
• Lupin's performance on a consolidated level was affected by the increased scale of its operations and four new product launches in the USA for which significant inventory had to be built up at its US subsidiary, Lupin Pharmaceuticals Inc. Consequently, the net sales rose by only 16% to Rs575.7 crore and profits grew by only 4.4% to Rs55.9 crore. The consolidated sales and profits were lower by almost Rs25 crore and Rs22 crore respectively as compared with their stand-alone counterparts on this account.
• At the current market price of Rs692, Lupin is quoting at 14.9x its FY2009 earnings estimate, on a fully diluted basis. Keeping in mind the strong business fundamentals and growth potential of the company, we reiterate our Buy recommendation on Lupin with a price target of Rs840.

Madras Cement
Cluster: Cannonball
Recommendation: Buy
Price target: Rs3,700
Current market price: Rs3,328

Price target revised to Rs3,700

Result highlights

• In Q1FY2008, Madras Cements' top line grew by 37.7% year on year (yoy) to Rs469 crore on the back of a 5.8% growth in volumes and a 30% rise in realisations. The rise in realisation was because of a Rs10-15 increase in the price per bag of cement in May and June in the south.
• The operating expenditure rose sharply by 40% yoy to Rs286.6 crore on account of higher freight cost and higher employee expenditure. The costs per tonne grew by 32% yoy to Rs1,976 because of a 26% increase in the variable costs.
• The operating profit margin on a year-on-year (y-o-y) basis was lower by 100 basis points at 39.5% whereas on a sequential basis, it was higher by 830 basis points on account of a higher realisation growth. The higher realisations also helped the earnings before interest, tax, depreciation and amortisation (EBITDA) per tonne to grow by 26% yoy to Rs1,260.
• During the quarter, the interest cost doubled to Rs8 crore, thanks to higher borrowings, whereas the depreciation provision grew by 37.4% yoy to Rs23.9 crore.
• Consequently, the profit after tax (PAT) grew by 27.5% yoy to Rs100.5 crore, which was in line with our expectations.
• The company is incurring a capital expenditure (capex) of Rs1,474 crore to expand its capacity by 4 million metric tonne (MMT) in the next one year. The 2MMT expansion at Jayantipuram (including a 1MMT grinding unit at Kolkata) will be commissioned by the third quarter of FY2008, whereas the remaining 2MMT capacity at Ariyalur including an additional 56 megawatt (MW) wind power plant will be commissioned by the second quarter of FY2009.
• Taking cognisance of the higher volume growth and the improved pricing scenario after the price freeze, we are upgrading our FY2008 earnings per share (EPS) estimate by 18% to Rs368 per share and FY2009 EPS estimate by 23% to Rs443.
• The higher capacities will drive the volume growth of the company going forward whereas the improved pricing scenario will improve its profits. The captive power plants (CPPs) will help lower the power & fuel cost. The company will be able to save income tax in FY2009 to the extent of the accelerated depreciation available on wind power plants, which will positively increase the cash flows of the company. At the current market price (CMP) of Rs3,328,the stock is trading at a valuation of 7.5x its FY2009 earnings which almost captures the near-term opportunity. Thus we maintain our Buy recommendation with a revised price target of Rs3,700.

Mahindra & Mahindra
Cluster: Apple Green
Recommendation: Buy
Price target: Rs913
Current market price: Rs753

Q1FY2008 results: First-cut analysis

Result highlights

• The Q1FY2008 results of Mahindra & Mahindra are below our expectations. The stand-alone net sales of the company grew by 16.8% to Rs2,612.8 crore in the quarter. This growth was led by an overall volume growth of 13.6% in the same period. The automotive segment recorded a volume growth of 24%; the sales volume of the farm equipment (FE) segment was flat.
• On a segmental basis, the automotive revenues rose by 21% to Rs1,504.5 crore. The FE division reported a revenue growth of 9.7%. The profit before interest and tax (PBIT) margin in the automotive segment was affected by 110 basis points due to the strengthening of the rupee and the consequent lower export realisation that affected the profit during the quarter. The FE division was able to maintain the PBIT margin at 13.4%. Consequently, the overall operating profit margin (OPM) declined by 150 basis points to 10.6%, leading to an operating profit growth of only 2.5%.
• On account of an increase in the interest expenditure and higher depreciation the adjusted net profit grew by 6.8% to Rs192.75 crore. After taking into account the extraordinary items (voluntary retirement scheme expenses, special dividend income) the reported profit after tax (PAT) declined by 6.4% to Rs191.16 crore.
• On a consolidated basis, the gross revenues grew by 40.7% to Rs5,879.2 crore in Q1FY2008 while the profit before tax (PBT) and exceptional items grew by 11.7% to Rs535.7 crore.
• We expect FY2008 to be the year of consolidation for the company as new product launches would take place only in FY2009. We will present our full result update on the company after attending the post-result conference call of the company. At the current market price of Rs753, the stock discounts its consolidated FY2009 earnings estimate by 9.3x. We maintain our Buy recommendation on the stock with a sum-of-the-parts price target of Rs913.

Marico
Cluster: Apple Green
Recommendation: Buy
Price target: Rs70
Current market price: Rs55

Results in line with expectations

Result highlights

• The Q1FY2008 results of Marico were as per our expectations. In Q1FY2008 the net revenues of the company grew by 25.8% year on year (yoy) to Rs469.1 crore. The growth was driven by a strong growth of 20% in the focused brand portfolio (organic growth) accompanied by a 6% inorganic growth.
• The operating profit margin (OPM) declined by 100 basis points to 14.1% on account of an increase in the employee expenses as well as a higher raw material cost. Consequently, the operating profit grew by 17.3% yoy to Rs66.01 crore.
• The raw material cost as a percentage of sales went up from 51.3% in Q1FY2007 to 52.1% in Q1FY2008. This rise was primarily due to an increase in the prices of some of the edible oils. Employee expenses were higher on account of annual increments, increase in the headcount and the provision made for the likely performance-linked-pay.
• The interest cost for Q1FY2008 grew from Rs4.8 crore in Q1FY2007 to Rs7.1 crore, which was more than our expectations. The depreciation and amortisation cost was lower by 48% as the intangibles were written off in FY2007.
• The net profit after the extraordinary items grew by 33% yoy to Rs40.1 crore, resulting in earnings per share (EPS) of Rs0.66. Further, the company declared the first interim dividend of 13.5% on equity shares of Re1 each for the financial year 2007-08.
• The domestic Kaya business grew by an impressive 31% yoy to Rs17 crore, whereas Kaya Middle East contributed Rs4 crore in the quarter. Marico plans to open roughly 15 new Kaya clinics in FY2008.
• We maintain our positive outlook on the company and expect its turnover to grow by 21% in the current financial year. The stock is trading at attractive valuations of a price/earnings ratio (PER) of 16.5x FY2009E earnings and enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 11x FY2009E. We maintain our Buy recommendation on the stock with a price target of Rs70.

Maruti Udyog
Cluster: Apple Green
Recommendation: Buy
Price target: Rs921
Current market price: Rs840

Sharp margin recovery

Result highlights

• The Q1FY2008 results of Maruti Udyog Ltd (MUL) are much ahead of our estimates on account of stronger than expected margins and higher than expected other income.
• The net sales for the quarter grew by 25.7% to Rs3,913.7 crore, backed by a volume growth of 17.1% and a realisation improvement of 7.4%. This growth has been primarily due to successful new launches by the company in recent times and a better product mix towards B and C segment cars.
• The sharp recovery in the operating profit margin (OPM) in the quarter was higher than our expectations. The OPM improved by 220 basis points (bps) quarter on quarter (qoq) at 14.62% and remained stable year on year (yoy). The rise in the OPM was due to a better product mix, raw materials contracted at last year's lower prices and depreciation in the yen as compared with the rupee. Consequently, the operating profit grew by 26% to Rs574.8 crore.
• A higher other income of Rs223.2 crore in the quarter, arising mainly from the deployment of surplus cash that led to a higher non-operational income, aided the profit to grow by 48% yoy to Rs499.6 crore.
• We maintain our bullish outlook on the company, which happens to one of our top picks in the sector. The company now has a very strong product basket with products in every segment of the passenger car market. The company has further strengthened its presence with the recent entry into the diesel and premium segments.
• In view of the improvement in the profit margins and higher non-operation income, we upgrade our estimates for MUL by 4.3% each to Rs62.7 for FY2008 and to Rs73.9 for FY2009.
• At the current market price of Rs840, the stock is quoting at 11.4x its FY2009E earnings and at an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 6.7x. We maintain our Buy recommendation on the stock with a price target of Rs921.

New Delhi Television
Cluster: Emerging Star
Recommendation: Book Profit
Current market price: Rs390

Book profit

Key points

• New Delhi Television's (NDTV) Q1FY2008 results are below our expectations. The top line recorded a subdued growth of 10.2% year on year (yoy) to Rs70.2 crore against our expectation of Rs74 crore. On the bottom line front, NDTV posted a loss of Rs11.4 crore (pre-employee stock option [ESOP] cost) against our expectation of a lesser loss of Rs5.2 crore.
• The higher than expected loss was on account of a special joining bonus of Rs7.87 crore doled out to fill up the top management slots for its new ventures. This led the staff cost to shoot up by 68.2% yoy. We believe that this is not a continuously recurring cost. But considering that NDTV's newer ventures are in the process of building their teams, the possibility of its recurrence in the coming quarters cannot be ruled out, though the magnitude of the cost may not be as high as in Q1FY2008.
• To fight competition and to maintain and expand the reach of its channels NDTV continues to increase the spend on marketing and distribution. For the quarter this spend increased by 32% yoy. This cost head has relentlessly grown quarter on quarter and we believe it is far from stabilising.
• Thus the company posted an operating loss of Rs7.4 crore against an operating profit of Rs7.8 crore in the corresponding quarter of FY2007 and the reported loss stood at a staggering Rs14.8 crore against Rs8.7 crore a year earlier.
• We like the expansion plans of NDTV but the same come with a lot of execution risk. Further, the manner of funding the new ventures brings a potential risk for the existing news business; also competitive pressure on the news business raises concerns on its growth. Thus, we recommend investors to Book profits as the stock price discounts the value of the existing businesses and the embedded value of the new ventures. At the current market price of Rs390 the stock has appreciated by 116% since our recommendation given on February 10, 2005 and is above our price target of Rs375.

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.

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).

Nucleus Software Exports
Cluster: Emerging Star
Recommendation: Hold
Price target: Rs920
Current market price: Rs915

Continues to be on Hold

Result highlights

• For Q1FY2008 Nucleus Software Exports (Nucleus) has reported a growth of 10.8% quarter on quarter (qoq) and of 33.9% year on year (yoy) to Rs66.7 crore. The product revenues of the company grew by a robust 23.7% sequentially, however a sequential decline of 8.2% in the project and service businesses dragged down the company's overall growth during the quarter.
• The operating profit margin (OPM) declined sharply by 630 basis points sequentially to 22.3% due to the adverse impact of aggressive wage hikes (an average hike of 24.5% to offshore employees resulted in a negative impact of 390 basis points) and the appreciation of the rupee (a negative impact of 240 basis points). Consequently, the operating profit declined by 13.5% to Rs14.8 crore.
• However, the increase in the other income component (to Rs2.7 crore) and the lower effective tax rate enabled the company to report earnings growth of 0.5% qoq and 4.7% yoy to Rs14 crore.
• The quarter's order backlog of Rs289 crore was lower than Rs330 crore reported at the end of March 2007, largely on account of the steep appreciation in the rupee. The company added six new clients and eight product orders (for 23 modules) during the quarter. The management has indicated that the order pipeline is robust.
• To factor in the higher than expected pressure on the margins, resulting largely from the steep appreciation in the rupee, we have revised downwards the earnings estimates for FY2008 and FY2009 by 10.8% and 10.5% respectively. We continue to maintain the Hold recommendation on the stock as the same is fairly valued at 14.9x FY2009 estimated earnings. Moreover, the stock is expected to underperform in the near term due to a lacklustre performance for the third consecutive quarter. However, the long-term outlook remains positive as the company is witnessing robust traction in its product business globally.

Omax Autos
Cluster: Apple Green
Recommendation: Book Out
Current market price: Rs71.5

Book out

Result highlights

• Omax Auto's Q1FY2008 results were better than our expectations due to a higher than estimated top line and stable margins during the quarter.
• The net sales of the company grew by a good 7.5% to Rs172.3 crore in the quarter, led by an 8.3% growth in the domestic sales to Rs165 crore. The exports for the quarter were disappointing at Rs7.3 crore against Rs8 crore in the same quarter last year.
• The operating profit margin (OPM) for the quarter declined by 80 basis points year on year (yoy) and was flat sequentially at 9%. Consequently, the operating profit declined by a marginal 0.7% to Rs15.6 crore.
• A higher capital expenditure (capex) led to an increase in both the interest and the depreciation cost. This led to a 29.3% decline in the profit to Rs4 crore.
• Omax Auto has rendered a mixed performance in the past few quarters. Though its margins have improved a bit, the company has fallen short of meeting its export targets. The entry into the business of components for commercial vehicles would de-risk its business model a little. However, we expect the company to face the heat in the domestic market due to a slowdown in the two-wheeler industry. Moreover, the cut-throat competition in the ancillary industry might restrict the margin growth for Omax Auto. We thus expect FY2008 to be weak for Omax Auto, both in terms of top line and bottom line growth.
• We expect the company to report a 27.6% decline in its earnings in FY2008 but recover in FY2009, with better two-wheeler volumes as well as the commencement of supplies to Tata Motors. We expect its earnings per share to reach Rs11.3 in FY2009. At the current market price, the stock is trading at 6.3x its FY2009E earnings and is available at an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 4x. Considering the slowdown in domestic market in FY2008, slower offtake in its exports and restricted margins, we are closing our recommendation on the stock. We recommend investors to book out.

Orchid Chemicals & Pharmaceuticals
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs375
Current market price: Rs234

Core earnings exceed expectations

Result highlights

• Orchid’s top line grew by 18.1% year on year (yoy) to Rs238.2 crore in Q1FY2008. The top line growth was above our estimates of Rs223.2 crore and was driven by new launches including the launch of Cefepime injections in the USA.
• The company maintained its performance in its major market, the USA. Its key products—Ceftriaoxne and Cefproxil—continued to enjoy a healthy market share in excess of 20-25%. Further, being the sole generic supplier of Cefoxitin and Cefazolin in the USA, Orchid maintains its high market share for these products.
• Driven by the improvement in the raw material costs, Orchid’s operating profit margins (OPM) expanded by 110 basis points to 29.9% in Q1FY2008. On the other hand, the rising R&D costs (due to FTF filings) and increasing staff costs adversely impacted the margins. On a like-to-like basis (excluding the Rs10 crore incremental cost incurred on FTF filings, the margin expansion would have been even more robust at 530 basis points to 34.1%. Consequently, the operating profit grew by 22.8% to Rs71.2 crore in Q1FY2008.
• The reported net profit jumped up by 251.7% to Rs51.3 crore, largely due to the foreign exchange (forex) gains recorded during the quarter and the reduction in the interest expense. On the other hand, the net profit was adversely impacted by the increased tax outgo due to the imposition of minimum alternative tax (MAT). On adjusting for the forex gains, losses and the associated tax implications, the adjusted net profit rose by 81.8% to Rs26.5 crore.
• On a consolidated basis, Orchid’s revenues grew by 18.4% yoy to Rs251.8 crore in Q1FY2008. The company’s OPM shrank by 190 basis points to 24.1% in the quarter, causing the operating profit to rise by only 9.8% to Rs60.7 crore. The net profit rose by a robust 348.6% to Rs48.6 crore due to a large marked-to-market gain recorded on the outstanding foreign currency convertible bond (FCCB) loans of the company and a 25.1% lower interest expense.
• Orchid has just received approval for Cefdinir tablets and suspension from the US Food and Drug Administration (FDA). The product, with a market size of $850 million in the USA, will be launched immediately by Orchid. We estimate Orchid to generate approximately $19 million and $25.5 million in revenues in FY2008 and FY2009 respectively.
• At the current market price of Rs234, Orchid trades at 9.9x its estimated FY2009 earnings, on a fully diluted basis. In view of the company’s strong growth prospects ahead, we retain our positive outlook on the stock and maintain our Buy call with a price target of Rs375.

Orient Paper and Industries
Cluster: Vulture’s Pick
Recommendation: Buy
Price target: Rs680
Current market price: Rs455

Stellar cement performance drives earnings

Result highlights

• In Q1FY2008 the overall revenues of Orient Paper Industries (Orient Paper) grew by 13.4% year on year (yoy) to Rs293 crore. The revenue growth was achieved on the back of a robust 21% year-on-year (y-o-y) growth in the revenues from the cement business to Rs170 crore. The paper business witnessed a decline of 8% yoy as the plant was shut for eight days for maintenance.
• Thanks to the higher realisations and cost savings on account of higher blending, the cement profits grew by 55% yoy to Rs73 crore, whereas the earnings before interest and tax (EBIT) per tonne jumped by 38% yoy to Rs1,130. The paper division witnessed a profit decline of 61% yoy to Rs3.4 crore. The overall EBIT grew by 41% yoy to Rs79 crore.
• The overall EBIT margin improved by 530 basis points (bps) to 26.9% mainly on account of 1,000-bps jump in the cement margins.
• The interest cost declined from Rs9.2 crore last year to Rs5.56 crore in the quarter because of repayment of the debt and the depreciation provision, which stood flat at Rs6.4 crore as the company did not invest in any assets in the quarter. Boosted by the other income component of Rs2.03 crore, the company's net profit registered a robust 71% y-o-y growth to Rs44.6 crore.
• As mentioned in our recent update of July 2, 2007, the company's capital expenditure (capex) plans are on track. The cement capacity of the company will increase by 1 million metric tonne (MMT) by the end of the current fiscal and further by 1.6MMT by the first quarter FY2010. At the end of 2010, the company will have a capacity of 5 MMT. The coal-based 50 megawatt (MW) captive power plant (CPP) of the company will also be commissioned by the first quarter of FY2010 which will lead to cost savings for the company.
• At the current market price of Rs455 the stock trades at 4.8x its FY2009 earnings per share (EPS), whereas the cement business trades at a valuation of USD27 at the expanded capacity of 5MMT. Taking cognisance of the positive outlook and the stock's attractive valuations, we maintain our Buy recommendation on the stock with a price target of Rs680.

Punjab National Bank
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs636
Current market price: Rs525

Price target revised to Rs636

Result highlights

• Punjab National Bank's (PNB) Q1FY2008 profit after tax (PAT) grew by 15.7% year on year (yoy) to Rs425.1 crore. The PAT figure was slightly higher than our expectations of Rs401.5 crore.
• The net interest income (NII) grew by only 7.4% yoy to Rs1,378.2 crore as the net interest margin (NIM) declined by 27 basis points (bps) to 3.83%. The margin declined mainly because of a sharp increase in the cost of funds as a result of high cost deposits raised during Q4FY2007.
• The non-interest income grew by whopping 47.5% yoy to Rs431.9 crore mainly driven by a higher treasury income that grew by 147.7% yoy to Rs132 crore and fee income that grew by a modest 13.1% yoy to Rs275 crore.
• The operating expenses grew by 25.9% yoy to Rs877 crore mainly driven by a 33.8% year-on-year (y-o-y) increase in the staff expenses to Rs641.1 crore. We believe the sharp increase in the staff expenses is on account of the additional provisions made by the bank to meet its shortfall in pension liabilities. The management has stated that the shortfall is likely to be of around Rs1,000 crore to be written over the next five years. Thus, the operating profit grew by only 6.2% yoy, however the core operating profit was down by 3% yoy.
• Provisions and contingencies declined by 15.9% yoy to Rs307.2 crore despite the bank making higher non performing asset (NPA) provisions of Rs137.9 crore compared with Rs28.4 crore in Q1FY2007 as there was a write-back in investment depreciation during the quarter discussed later
• The bank's asset quality has deteriorated with the net NPA at 0.98% as in June 2007 compared with 0.76% reported in March 2007. The gross NPA also increased by Rs317 crore to Rs3,708 crore in absolute terms.
• We have revised our FY2008 earnings estimate downwards by 5% to Rs1,874 crore to factor in the net effect of the shifting loss and release in provisions, and increased AS-15 related expenses. We have also introduced our FY2009 numbers in this report.
• Despite the dismal performance on the core operating side, PNB still continues to enjoy a high level of current account and savings account (CASA) at 46% and superior margins of over 3.8%. The deposit rates have cooled off from the March 2007 highs and the margins for the bank should stabilise around the current levels. The bank's Tier-I capital adequacy ratio (CAR) at 8.5-9% provides it enough headroom to maintain a healthy growth going forward. With its high return on equity of around 17.8%, we feel the valuations are attractive after the correction post-Q1FY2008 results. At the current market price of Rs525, the stock is quoting at 7.5x its FY2009E earnings per share (EPS), 3.8x pre-provisioning profit (PPP) and 1.2x FY2009E book value (BV). We maintain our Buy recommendation on the stock with a revised price target of Rs636.

Ranbaxy Laboratories
Cluster: Apple Green
Recommendation: Buy
Price target: Rs558
Current market price: Rs352

Core earnings remained under pressure

Result highlights

• Ranbaxy Laboratories' (Ranbaxy) revenue grew by 12.4% to Rs1,611 crore in Q2CY2007 against our expectation of Rs1,586.6 crore. The revenue growth was moderated due the declining realisation from the international sales. The company's average rupee realisation against the dollar declined by 10% year on year (yoy) during the quarter. However the global sales in dollar terms grew by 25% in Q2CY2007.
• The operating profit margin (OPM) of the company remained under pressure during the quarter and declined by 750 basis points yoy and by 100 basis points sequentially to 9.4% during the quarter. The margin declined partly because of the higher base of Q2CY2006, when Ranbaxy had earned a higher margin from the launch of Simvastatin in the USA under 180-day exclusivity. Further, the appreciation in the value of the rupee against the US Dollar also took its toll on the OPM. With the decline in the revenue realisation and the consequent fall in the OPM, the operating profit stood at Rs152.2 crore, down 37.2%.
• Due to a substantial foreign exchange (forex) gain of Rs201.40 crore during Q2CY2007 (against a forex loss of Rs50.6 crore in Q2CY2006), the net profit jumped up by 117.6% yoy to Rs263.50 crore, which was ahead of our expectation of Rs189.6 crore.
• At the current market price of Rs352 the stock trades at 17.8x its CY2007E earnings. We remain optimistic about the stock's prospects and maintain our Buy recommendation on the stock with a price target of Rs558.

Satyam Computer Services
Cluster: Apple Green
Recommendation: Buy
Price target: Rs538
Current market price: Rs480

Ahead of the pack

Result highlights

• For Q1FY2008 Satyam Computer Services (Satyam) has reported a growth of 2.9% quarter on quarter (qoq) and of 26.8% year on year (yoy) in its consolidated revenues to Rs1,830 crore, which is ahead of market expectations. In dollar terms, the consolidated revenues have grown by 10% sequentially, primarily driven by the robust growth of 9.5% in the volumes.
• The sequential decline in the operating profit margin (OPM) was limited to 65 basis points to 22.4% in Q1FY2008. The margins were adversely affected by 400 basis points owing to the visa charges (an impact of 100 basis points), appreciation in the rupee (an impact of 230 basis points), increased charges on restricted stock units (an impact of 40 basis points) and increased losses in its subsidiaries (an impact of 30 basis points). The adverse impact was partially mitigated by the cumulative positive impact of 335 basis points from (1) the sharp improvement in the employee utilisation rate (up 45 basis points; a 150-basis-point improvement in the net utilisation to 79.9%), (2) higher billing rates (up 85 basis points; a sequential improvement of 1.3% in the onsite rate and of 1.5% in the offshore rate resulting in a positive impact of 110 basis points), (3) favourable revenue mix (a 60-basis-point improvement due to a 140-basis-point increase in the offshore contribution to 52%), and (4) other operational efficiency and productivity gains (up 145 basis points).
• In fact, the gross margin actually improved by five basis points sequentially and the adverse impact of rupee appreciation was more than fully absorbed at the gross level during the quarter. However, the higher overhead cost (at 17.1% of the sales in Q1 as compared with 16.5% in Q4) dented the profitability at the operating level, resulting in a flat sequential growth in the operating profit to Rs410 crore.
• Surprisingly, the other income declined by 10% sequentially to Rs63 crore, largely due to a net foreign exchange (forex) loss of Rs6 crore (a translation loss of Rs96 crore as against marked-to-market gains of Rs90 crore on the forward cover). This coupled with higher effective tax rate resulted in a decline of 3.9% sequentially and a growth of 6.9% yoy in its consolidated earnings to Rs378.3 crore.
• In terms of outlook, the guidance for Q2 is a bit muted. The revenues are guided to grow by 4.7-5.2% sequentially. But the consolidated earnings are guided to decline by around 5% sequentially due to a 350-basis-point negative impact of the aggressive annual salary hikes on its margins. On the brighter side, the revenue guidance for the full year of FY2008 has been revised upwards both in dollar and rupee terms, which is quite encouraging. In dollar terms, the revenue guidance has increased by close to 4.5% to $1.96-1.98 billion (a revenue growth of 34-35.5%) and the earnings per share (EPS) guidance has been upgraded marginally by around 1% to $1.17-1.19 (an EPS growth of 28.3-29.7%). In rupee terms, the revenue guidance has been revised upwards by 0.5% to Rs7,853-7,942 crore (a revenue growth of 21.1-22.5%) in spite of the rupee appreciation and unlike the downward revision carried out by Infosys Technologies. The average EPS guidance has been downgraded by 4.8% to Rs24.14-24.46 per share (a 12.5-14% growth in EPS), largely to factor in the change in the exchange rate assumption to Rs40.5 (as against Rs42.3/USD taken in April 2007).
• In terms of margins, the company has guided for a decline of 125 basis points in the OPM for FY2008. The expected improvement in the billing rates, a favourable revenue mix, leverage in overhead cost and improved performance of subsidiaries are the key margin levers available to partially mitigate the adverse impact of the salary hikes and the rupee appreciation.
• Satyam's overall performance in Q1 was superior to that of its other listed peers in terms of higher growth in volumes and growing confidence to maintain the growth momentum. The same was reflected in the marginal upward revision in the full year revenue guidance in rupee terms. The healthy net addition of 2,795 employees (at the consolidated level; amounting to a growth of 7.1% over the base in March 2007) is also an encouraging indication. The improvement in the billing rate is also healthy and the management indicated that it is able to extract premium pricing in some of the differentiated services such as consulting and enterprise solutions.
• To factor in the change in the exchange rate assumption to Rs40/USD (compared to Rs41 in FY2008 earlier), the FY2008 earnings estimate has been revised downwards by 1.5% whereas the FY2009 estimate has been left unchanged. At the current market price the stock trades at 19.2x FY2008 and 16.1x FY2009 earnings estimates. We maintain our Buy call on the stock with a price target of Rs538 (18x FY2009E earnings).

Shree Cement
Cluster: Cannonball
Recommendation: Buy
Price target: Rs1,625
Current market price: Rs1,440

Price target revised to Rs1,625

Result highlights

• In Q1FY2008 Shree Cement’s revenue grew by a healthy 37.6% year on year (yoy) to Rs425 crore on the back of a 25% growth in volumes and a 10% increase in realisations.
• The company’s operating expenditure increased by 41.7% yoy to Rs243.5 crore, thanks to higher power & fuel and freight costs. On a per tonne basis, the total cost increased by 13% yoy to Rs1,726 which translated into a sequential decline of 4%.
• On the back of a higher growth in the operating expenditure, the operating profit grew at a slower rate of 32.6% yoy to Rs182 crore whereas the operating profit margin (OPM) dropped by 160 basis points to 42.8%.
• On account of a higher volume growth, the earnings before interest, tax, depreciation and amortisation (EBITDA) per tonne improved by 6% yoy and by 8% quarter on quarter (qoq) to Rs1,294.
• The interest cost declined by 27.5% yoy to Rs3.9 crore on account of the repayment of debt whereas the depreciation provision increased by 35.8% yoy to Rs35.7 crore as a fall-out of the increase in the gross block.
• Thanks to the higher other income component of Rs12.6 crore as well as the lower interest cost, the net profit grew by a healthy 29.5% yoy to Rs117 crore, in line with our expectations.
• Shree Cement is augmenting its cement capacity by 4 million metric tonne (MMT) over the next couple of years. Unit V, which is a 1.5MMT clinkerisation unit, is expected to come up by September 2007 whereas the integrated unit VI is expected to come up by September 2008. The 3.5MMT grinding unit at Khushkera is expected to come up in two phases, ie 2MMT by September 2007 and 1.5MMT by December 2007. Considering the timely implementation of the capital expenditure (capex) plan, we are assuming the volumes would grow by 33% yoy in FY2008 and by 20% yoy in FY2009.
• Taking cognisance of the change in the pricing scenario, we are also assuming the prices would increase by Rs5 per bag in the second half of the year but keeping our assumption of a Rs5 drop per bag in FY2009 unchanged.
• Keeping in view the change in the price and volume assumptions and the higher income earned by the company on surplus cash, we are upgrading our earnings per share (EPS) estimates for FY2008 and FY2009 by 26% to Rs156 and by 20% to Rs162 respectively. At the current market price, the stock is trading at a price/earnings ratio (PER) of 8.9x FY2009E EPS and 4.7x FY2009E enterprise value (EV)/EBITDA. Considering the attractive valuations of the stock, we are maintaining our Buy recommendation on Shree Cement with an upgraded price target of Rs1,625 per share.

SKF India
Cluster: Apple Green
Recommendation: Buy
Price target: Rs500
Current market price: Rs450

Price target revised to Rs500

Result highlights

• SKF India's Q2CY2007 results are way ahead of our estimates, on the back of a very strong top line growth and healthy margin improvement. The strong growth is attributed mainly to the strong growth in the industrial bearing segment. The net sales for the quarter rose by 22.4% to Rs401.5 crore.
• The margin improvement during the quarter was a positive surprise. We believe the margins improved mainly as a result of a higher contribution from the industrial bearing business, where the margins are higher, to the overall sales and better utilisation of the new capacities.
• The operating profit margin (OPM) jumped up by 320 basis points to 16.2% during the quarter. Consequently, the operating profit grew by 52.2% to Rs64.8 crore.
• A higher interest income, a slightly higher other income and a stable depreciation charge helped the company to grow its profit by 60.8% to Rs40.7 crore.
• The company is consistently supported by its parent SKF AG in terms of new technology. A number of new products including the Conment bearings and power transmission products were launched by SKF India in the last few months. We believe that the company would continue to develop new and innovative products to maintain its leadership position in the domestic market.
• In view of the very strong performance of the company in the first two quarters, a buoyant outlook on its prospects (considering the strong growth forecast in both industrial and automotive bearing segments) and its capacity expansion plans, we are upgrading our earnings estimates for SKF India by 14% for CY2007 to Rs27.6 and by 7.4% for CY2008 to Rs33.4.
• At the current market price of Rs450 the stock is discounting its CY2008 earnings estimate by 13.5x and its earnings before interest, depreciation, tax and amortisation estimate by 7.5x. We maintain our Buy recommendation on the stock with a revised price target of Rs500.

State Bank of India
Cluster: Apple Green
Recommendation: Buy
Price target: Rs1,780
Current market price: Rs1,579

Strong operating performance

Result highlights

• State Bank of India’s (SBI) results have been way above the market’s and our expectations with the profit after tax (PAT) growing by 78.5% year on year (yoy) to Rs1,425.8 crore compared with our estimate of Rs1,147 crore. The results are significantly above estimates due to a higher than expected write-back in investment provisions and subdued operating expenses.
• The net interest income (NII) was up by 15% yoy to Rs4,497 crore. The reported net interest margin (NIM) remained more or less stable on a sequential basis but declined by six basis points yoy. Most of the public sector banks have reported a sequential decline in margins whereas SBI has maintained its NIM and grown its NII by 15.8% yoy which are commendable.
• The non-interest income grew by 18.7% yoy to Rs842.6 crore driven by good growth in the core fee income, which rose by 16.3% yoy, and a higher trading income, which increased by 30.5% yoy due to the gains recorded in the National Stock Exchange stake sale for around Rs150 crore. “Others” reflect a net negative figure due to amortisation expenses and one-time shifting losses booked through the non-interest income category as per new Reserve Bank of India (RBI) directives.
• The operating expenses grew by only 5.8% yoy to Rs2,978.5 crore mainly due to lower staff expenses, which grew by 5.3% yoy and remained almost unchanged on a sequential basis at Rs2,026.4 crore. A good net income growth of 15.6% yoy coupled with lower operating expenses helped the operating profit to increase by 30.8% to Rs2,361.5 crore. The core operating profit growth was at 15.8% yoy to Rs2,691.5 crore.
• Provisions declined by 36.4% yoy mainly due to a write-back in investments provisions for Rs376 crore. The bank made a Rs200-crore non-performing asset (NPA) provision during the quarter over and above the RBI’s requirements, which helped it to improve the provision coverage by 140 basis points to 48.8% on a sequential basis.
• Business growth was strong with net advances up 29.3% yoy and deposits higher by 19% yoy. However, the asset quality showed deterioration with the gross NPA up by Rs760 crore in absolute terms and the net NPA up from 1.56% in Q4FY2007 to 1.62% in percentage terms.
• The operating performance has been strong with stable margins and robust business growth. However the margins are likely to be under pressure going forward as the bank has a net effective negative spread on the combined statutory liquidity ratio (SLR) and cash reserve ratio (CRR) book. On the other hand, it has reduced its interest rate risk significantly, with only 24% of its investment book under the marked-to-market category with a duration of 1.7 years. A lower provision coverage and the non-provision of transitional Accounting Standard (AS)-15 expenses (as it awaits the RBI’s guidelines on this front) are the only concerns. Hence, we have not upgraded our numbers as we feel the AS-15 related provisions could restrict the earnings growth of the bank in FY2008 despite earnings being significantly above estimates. At the current market price of Rs1,579, the stock is quoting at 14.4x its FY2009E earnings, 5.9x pre-provision profits and, 1.9x stand-alone and 1.5x consolidated FY2009E book value. We maintain our Buy recommendation on the stock with a price target of Rs1,780.

Subros
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs340
Current market price: Rs238

Strong performance

Result highlights

• Subros' Q1FY2008 results are above our expectations, thanks to a strong improvement in its profitability. The net sales of the company grew by 11.4% to Rs157.7 crore in the quarter led by a volume growth of 17%. The strong performance of one of its key customers, Maruti Suzuki India, particularly contributed to Subros' impressive performance.
• The operating profit margin (OPM) improved by a good 150 basis points to 12.2% during the quarter due to rising efficiencies and savings in logistic cost as a result of better operations from its newly commissioned Gurgaon plant. Consequently, the operating profit for the quarter grew by 26.1% to Rs19.2 crore.
• Both interest and depreciation charges were higher due to the capital expenditure (capex) incurred by the company for the new plant and efforts to raise its capacity further. Consequently, the company reported a 10.1% growth in its net profit to Rs6.6 crore.
• We maintain our positive outlook on Subros. We also understand that the company has recently bagged a huge order from Suzuki for the export vehicle that shall be manufactured from the Japanese company's Manesar plant. Also, the company shall be supplying to Mahindra and Mahindra for the latter's yet to be launched Ingenio range.
• At the current levels, the stock is available at attractive valuations of 5.3x FY2009E earnings and an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 2.5x. We maintain our Buy recommendation on the stock with a price target of Rs340.

Sun Pharmaceutical Industries
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs1,287
Current market price: Rs965

Q1FY2008 results in line with expectations

Result highlights

• In Q1FY2008 the consolidated net sales of Sun Pharmaceuticals (Sun Pharma) grew by 22.8% year on year (yoy) to Rs627.5 crore. The same were significantly higher than our estimate of Rs587.9 crore. The strong growth was driven by an increase of 25.7% in its domestic business and an 18% growth in its exports.
• Its US subsidiary, Caraco Pharma, continued its growth momentum. Caraco Pharma's sales grew by 43% yoy to $25 million with the net income rising by 70% to $8.5 million in Q1FY2008.
• The operating profit margin (OPM) declined by 120 basis points to 34.2%, which was still 300 basis points better than our expectations. As a result, the operating profit grew by 18.6% to Rs214.8 crore. This margin performance is very encouraging, given the 47.8% growth in the company's research and development (R&D) expenses as well as the negative impact of the rupee's appreciation.
• In the quarter the other income was higher by 121.1% to Rs60.6 crore, largely supported by the translation gain coming from outstanding foreign currency convertible bonds (FCCBs). Subsequently, the depreciation charge rose by 12% and the tax incidence moved up to 3.9% (from 0.1% in the corresponding previous quarter), resulting in a 29.1% growth in the profit after tax (PAT) to Rs243.0 crore. Finally, the minority interest increased by 38.1% to Rs15.8 crore, consequent to which the bottom line stood at Rs227.2 crore (against our estimate of Rs227.8 crore).
• In order to factor in the rupee's appreciation, the new product approvals, the transfer of assets to Sun Pharma Advance Research Company (SPARC) and the money outflow for the Taro Pharma (Taro) acquisition, we are revising our FY2008 estimates and introducing our FY2009 estimates in this note. Our revised EPS estimates stand at Rs44.8 (which is 6.5% lower than our earlier estimate of Rs47.9) and Rs53.1 for FY2008 and FY2009 respectively.
• At the current market price of Rs965, Sun Pharma is valued at 21.6x FY2008E and 18.1x FY2009E fully diluted earnings. We maintain our Buy recommendation on the stock with a price target of Rs1,287 (after adjusting the estimated value of SPARC, ie Rs54, from our earlier target of Rs1,341).

Sundaram Clayton
Cluster: Apple Green
Recommendation: Buy
Price target: Rs1,350
Current market price: Rs835

A subdued quarter

Result highlights

• Sundaram Clayton Ltd's (SCL) Q1FY2008 results were below expectations because of a slower than expected growth in the top line. The net sales grew by just 6.1% year on year (yoy) to Rs201.4 crore, mainly due to a slower growth in its domestic brake business.
• The company was able to maintain its operating profit margin (OPM) despite cost pressures, primarily because of its excellent cost management and continuous efforts to save costs. Consequently, the OPM rose by 60 basis points yoy to 15.2% as the operating profit rose by 10.1% to Rs30.6 crore.
• Higher interest and depreciation charges due to the capital expenditure (capex) incurred by the company during the quarter led to a marginal 1.4% growth in the profit to Rs18.2 crore.
• The company had also recently announced its de-merger and would be spinning off its brake division into a subsidiary. The new entity will be called WABCO-TVS and will be listed on stock exchanges. We believe that the demerger would help both the companies to focus on their core areas and benefit SCL in the long run.
• The performance of SCL is largely dependent on the performance of its key clients in the commercial vehicle (CV) sector. Considering the buoyancy in the economy, the long-term outlook for the CV industry remains positive. We view the current slowdown as just an aberration and expect the demand to pick up in the second half of the fiscal, with the start of the festive season. Consequently, we expect the next quarter to be subdued but growth should pick up from the third quarter of the fiscal.
• However, due to the current slowdown and the lacklustre performance of the first quarter, we are downgrading our sales estimates for FY2008 and FY2009 by 7.8% and 1.8% respectively. Consequently, we are reducing our earnings estimate for FY2008 by 9.8% to Rs53.3 and that for FY2009 by 1.2% to Rs73.6.
• At the current market price, the stock is trading at 11.4x its FY2009 earnings and an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 8.7x. We maintain our Buy recommendation with a price target of Rs1,350.

Tata Consultancy Services
Cluster: Evergreen
Recommendation: Buy
Price target: Rs1,425
Current market price: Rs1,128

Price target revised to Rs1,425

Result highlights

• Tata Consultancy Services (TCS) has reported a growth of 1.1% quarter on quarter (qoq) and 25.5% year on year (yoy) in its consolidated revenues to Rs5,202.8 crore during Q1FY2008. The sequential revenue growth was largely driven by a 7.6% volume growth in the international business and a 2.2% improvement in the billing rates and employee productivity. On the other hand, the appreciation in the rupee adversely affected the revenue growth by 6.4% on a sequential basis.
• The earnings before interest and tax (EBIT) margin declined by 250 basis points to 23.1% sequentially, largely due to the adverse impact of the rupee's appreciation (an impact of 258 basis points) and wage hikes (an impact of 208 basis points). On the other hand, the improvement of 220 basis points in the billing rates and productivity gains limited the decline in the margins. The operating profit declined by 9% qoq to Rs1,199.9 crore.
• The other income jumped by 68.9% qoq and 129.8% yoy to Rs151.6 crore. If the one-time income of Rs66.3 crore from the stake sale in SITEL is excluded from the other income of Q4FY2007, the other income has leapfrogged by 545.5% on a sequential basis. The jump in the other income component was aided by the gain of Rs107 crore on the foreign exchange (forex) cover during the quarter.
• The high other income and lower tax rate (due to a write-back of Rs29.3 crore of provision made earlier) enabled the company to report a 3.5% quarter-on-quarter (q-o-q) and a 34% year-on-year (y-o-y) growth in its consolidated earnings (adjusted for one-time items) to Rs1,156.2 crore.
• In terms of the outlook, the company doesn't give any specific growth guidance. However, it re-iterated that the demand environment continues to be robust and the gross employee addition would be higher than 32,462 reported in FY2007 (11,000 gross additions in Q2). The TCS management also expects to maintain the net margins on a full year basis, in spite of the steep appreciation in the rupee and the aggressive salary hikes in FY2008 (12-15% for the offshore employees and around 3% for the onsite employees). The loss at the operating level due to the pressure on the margins is expected to be offset by a higher other income resulting from the gains on the forex cover.
• The key operational highlights of Q1 are: (1) an addition of 54 clients; (2) a healthy mining of the existing client base in terms of a robust jump in the number of clients in all categories over the annual revenue run rate of $1 million; (3) a sequential growth of 4.3% in the revenues from the Top 10 clients (in spite of the adverse impact of the rupee appreciation); (4) the attrition rate in the information technology (IT) service business at a comfortable level of 11%; and (5) the closure of one large deal worth over $100 million and three deals of over $20 million each. On the flip side, there has been a slowdown in the sequential growth of revenues from the manufacturing industry vertical and global consulting practice.
• To factor in the exchange rate assumption of Rs40 for FY2008 and FY2009, we have revised down the FY2008 and FY2009 earnings estimates by 2.5% and 3% respectively. We maintain the Buy call on the stock with a revised price target of Rs1,425 (around 23x FY2009 earning per share [EPS]).

Tata Elxsi
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs370
Current market price: Rs288

Price target revised to Rs370

Result highlights

• For Q1FY2008, Tata Elxsi has reported a growth of 3.6% quarter on quarter (qoq) and of 45.7% year on year (yoy) in its revenues to Rs92.4 crore. The performance was ahead of expectations in view of the seasonal weakness in Q1 (especially in the system integration [SI] business) and the steep appreciation in the rupee during the quarter.
• However, the performance on the margin front was disappointing. The operating profit margin (OPM) plummeted by 670 basis points sequentially to 17.6%, which is among the lowest in any quarter during the past two years. The same can be attributed to the cumulative impact of the rupee's appreciation, wage hikes (given to a small part of its employee base; wage hikes are being effected since January for most of the employees), intake of fresh graduates (under training and not billable) and seasonal weakness in Q1 in case of the SI business. Consequently, the operating profit declined by 25.1% qoq to Rs16.2 crore
• In line with the operating profit, the earnings declined by 24.5% qoq and grew by 18.4% yoy to Rs12.1 crore, which was lower than our expectations of Rs12.6 crore.
• In terms of segmental performance, the sequential growth of 7.3% in the software development service (SDS) business was ahead of expectations. However, the profitability declined by 470 basis points sequentially to 17.5% during the quarter. On the other hand, the SI revenues declined by 13.8%. The segmental margins plummeted to 12.6% as compared with 29.4% in Q4FY2007 but were far better than 1.6% in Q1FY2007.
• To factor in the higher than expected pressure on the margins, we have revised downwards the earnings estimate for FY2008 and FY2009 by 4.5% and 3.4% respectively. At the current market price the stock trades at 14.2x FY2008 and 11.3x FY2009 estimated earnings. We maintain our Buy call on the stock with a revised price target of Rs370 (14.5x FY2009 earnings).

Tata Motors
Cluster: Apple Green
Recommendation: Buy
Price target: Rs792
Current market price: Rs699

Q1FY2008 results: First-cut analysis

Result highlights

• Tata Motors Q1FY2008 results were below our expectations due to lower than expected margins during the quarter. However, the bottom line was buttressed by a higher foreign exchange (forex) gain on account of the appreciation in the rupee during the quarter.
• The net sales for the quarter grew by 5.3% to Rs6,056.8 crore on the back of a 1.3% volume growth and a 3.9% realisation growth during the quarter.
• However, high raw material cost and lower volumes, particularly in the commercial vehicle segment, adversely affected the margin (excluding the forex gain/loss). The margin declined to 9% from 11.9% in the same quarter of the last year. Hence, the operating profit dropped by 19.9% to Rs546.3 crore.
• A little higher interest and depreciation charges led to a drop of 39.4% in the adjusted net profit to Rs259 crore. After accounting for the forex gain of Rs205.9 crore during the quarter, the net profit grew by 22.4% to Rs466.76 crore.
• On consolidated basis, the company's sales grew by 13.3% to Rs7,631.3 crore while the net profit excluding the forex gain declined by 27.7% to Rs308.2 crore. The profit after extraordinaries and forex adjustments increased by 35.7% to Rs516.1 crore.
• At the current levels, the stock trades at 10.6x its FY2009E consolidated earnings and is available at an enterprise value/earnings before interest, depreciation, tax and amortisation of 5.3x. We maintain our Buy recommendation on the stock with a price target of Rs792.

UltraTech Cement
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs1,100
Current market price: Rs929

Price target revised to Rs1,100

Result highlights

• In Q1FY2008, the net sales of UltraTech Cement (UltraTech) grew by 16% year on year (yoy) to Rs1,365 crore. The growth was achieved due to a 15% growth in realisations to Rs3,054 per tonne on account of the price increase of Rs10-15 per bag in the south in the last two months of the quarter. The volumes were flat at 4.5 metric million tonne (MMT), as the company did not add any capacities in the last one year.
• The raw material cost of the company witnessed a steep rise of 29% yoy to Rs117.5 crore, whereas the freight cost grew by 12% yoy to Rs275 crore. The other operating expenditure grew by a strong 26% yoy to Rs177 crore. Consequently, the overall expenditure witnessed a 16% year-on-year (y-o-y) growth to Rs931 crore.
• The operating profit for the quarter grew in line with the top line by 15.7% yoy to Rs433 crore, whereas the operating profit margin (OPM) remained flat at 31.7%. The earnings before interest, tax, depreciation and amortisation (EBITDA) per tonne grew by 15% yoy to Rs969 per tonne and by Rs159 per tonne on a sequential basis on the back of a robust realisation growth.
• The interest cost reduced by 10.8% yoy to Rs20 crore on account of repayment of debt, whereas the depreciation remained more or less flat at Rs55.86 crore.
• The net profit increased by 23% yoy to Rs259 crore boosted by a higher other income component of Rs26.9 crore. The increase in the net profit was higher than our expectations on account of better than expected realisations and higher other income.
• The company, which is expanding its capacity by 4MMT at Tadipatri, has decided to enhance the capacity further by 0.9MMT. The company has also decided to put up a 33-megawatt (MW) captive power plant (CPP) at Awarpur in Maharashtra. It is further enhancing its grinding capacity by 2MMT at Gujarat to cater to the western markets.
• Going ahead, the incremental blending as well as higher capacities will drive the volume growth of the company. The company will also enjoy higher margins because of the savings in the power cost once the CPPs are in place. We are upgrading our earnings estimate for FY2009 by 12% to Rs80.4 per share and for FY2009 by 19% to Rs91.5 per share.
• At the current market price of Rs929, the stock is trading at 11.5x FY2008 and 10.1x its FY2009 estimated earnings. Looking at the positive triggers for the stock, we maintain our Buy call on the same with a revised price target of Rs1,100.

Unichem Laboratories
Cluster: Apple Green
Recommendation: Buy
Price target: Rs360
Current market price: Rs245

Exports take a hit, core earnings in line

Result highlights

• For Q1FY2008 Unichem Laboratories (Unichem) has reported a sales growth of 12.1% to Rs153.5 crore, which is lower than our expectation of Rs165 crore. The growth was subdued largely due to a sharp 18.8% decline in the company's exports on account of the appreciation of the rupee.
• On account of the rising rupee, the management did not push its exports during the quarter. Instead, it chose to re-negotiate the pricing terms with its key clients. The negotiation process is currently on and the management is hopeful of improving its export realisations in the future quarters.
• Unichem's strong brand building efforts, the continued momentum in its power brands and therapy focused marketing initiatives have caused the domestic formulation business to perform in the quarter. The revenues from this segment grew by an impressive 20.9% to Rs126.8 crore—way above the industry growth rate of 11-12% witnessed during the quarter. However, the management has also indicated that such a high growth rate for this business might not be sustainable going forward. The company expects the growth to moderate in Q2FY2008, due to the Drug Price Control Order (DPCO) related price cuts imposed on its largest brand, Ampoxin, towards the end of Q1FY2008.
• Within its domestic formulation business it has recently launched a new marketing division by the name of "Unikare". This division will focus on marketing dermatology products. With the launch of this division, the company is hopeful of participating in this fast growing Rs1,500-crore dermatology market in India.
• Unichem's operating profit margin (OPM) expanded by 80 basis points to 22.4% in the quarter. The margin expansion was driven by a decline in the raw material cost, despite the decline in export realisations. On the other hand, the rising research and development (R&D) cost (on account of product development expenses incurred for abbreviated new drug application [ANDA] filings) and an increase in the staff cost adversely affected the margin. The operating profit grew by 16.3% to Rs34.4 crore in the quarter.
• Unichem's reported net profit declined by 7.3% to Rs22.2 crore in Q1FY2008. The decline was largely due to a foreign exchange (forex) loss of Rs3 crore incurred on the receivables due to the appreciating rupee and an increase in deferred taxes (due to a large capital expenditure [capex] plan in FY2008E). On excluding the impact of the forex fluctuations, the net profit showed an improvement of 9.8% to Rs25.2 crore.
• At the current market price of Rs245, Unichem is trading at 8.6x its estimated FY2008 earnings. In view of the positive outlook for the company, we maintain our Buy recommendation on Unichem with a price target of Rs360.

Union Bank of India
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs192
Current market price: Rs154

Price target revised to Rs192

Result highlights

• Union Bank of India (UBI) recorded a 34.9% year-on-year (y-o-y) growth in its profit after tax (PAT) to Rs225.1 crore in Q1FY2008. The growth was driven by an improvement in the overall operating performance.
• The net interest income (NII) was up by 21.6% year on year (yoy) to Rs771.3 crore in the same quarter. The net interest margin (NIM) of the bank improved by 17 basis points on a y-o-y basis to 3.11% and remained stable on a sequential basis, as the bank did not raise any significant high-cost bulk deposits and shifted its portfolio towards high-yielding assets during the quarter.
• The non-interest income increased by 40.2% yoy to Rs178 crore with the core fee income up 13.3% yoy and treasury income higher by 17.9% yoy.
• Due to the revised AS-15 guidelines the bank had to provide Rs25 crore as provisions during Q1FY2008 and intends to provide Rs100 crore of the same for FY2008. The shortfall in provisions due to the new AS-15 guidelines is estimated at Rs350 crore which the bank intends to write off over the next five years.
• The operating profit grew by 35.7% yoy and the core operating profit increased by 34.6% yoy, driven by a good net income growth and controlled operating expenses.
• Provisions and contingencies rose by 31% yoy mainly due to higher non-performing asset (NPA) provisions and investment depreciation on IFCI bonds, which needed to be shifted from the "held to maturity" category to the "available for sale" category by June 2007, as per the directives of the Reserve Bank of India.
• As a result of the higher provisioning and write-offs, the bank's NPA level improved to 0.78% from 0.98% in Q4FY2007 and the provision coverage rose to 72% from 68% in Q4FY2007. The management is confident of maintaining the improved asset quality going forward.
• The bank intends to focus on high-yielding loans funded primarily by core deposits, unlike in the past when the bulk deposits funded a major part of its loan portfolio. This strategy should augur well for the bank's margins going forward. UBI's asset quality improved in Q1FY2008 and the management is confident of maintaining the same. We have introduced our FY2009 estimates and expect a 24.2% compounded annual growth in the bank's profits for the period FY2006-09. At the current market price of Rs154, the stock is quoting at 6x its FY2009E earnings per share (EPS), 2.9x pre-provision profits (PPP) and 1.2x book value (BV). We maintain a Buy on the stock with a revised price target of Rs192.

UTI Bank
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs725
Current market price: Rs645

Price target revised to Rs725

Result highlights

• UTI Bank's Q1FY2008 profit after tax (PAT) was slightly lower than our expectations of Rs188 crore at Rs175 crore, up 45.2% year on year (yoy). The PAT was lower than expected due to higher than expected operating expenses during the quarter.
• The net interest income (NII) was up by 38.8% to Rs446.8 crore compared with our estimate of Rs471 crore. UTI Bank's reported net interest margin (NIM) expanded by four basis points yoy but declined by 34 basis points quarter on quarter (qoq). A sequential fall in the NIM was expected as the bank had invested in low yielding priority sector securities. However, the sequential increase in the cost of funds has been sharp which has resulted in a lower than expected NII.
• The bank has again reported a robust growth, with assets up by 49% yoy and 8% qoq, driven by a strong advances growth of 60% yoy and 12% qoq. The deposits have grown by 45% yoy and 3.9% qoq with an improvement in the current and savings account (CASA) ratio on a year-on-year (y-o-y) basis.
• The non-interest income was up 70.8% yoy and 13.7% qoq to Rs342.3 crore, much above the expectations of Rs273 crore mainly driven by a higher trading income of Rs70 crore, which grew by 346% yoy and 64% qoq. The core fee income was up 67.6% yoy.
• The operating expenses were up by 76% yoy to Rs421.2 crore mainly driven by higher staff expenses, which reported an 85.6% y-o-y and 66.3% sequential growth.
• Although UTI Bank has grown at a robust pace in the last couple of years, yet there are no alarming signs of any deterioration in its asset quality. The net non-performing asset (NPA) level (as a percentage of its net customer assets) improved to 0.59% from 0.61% in Q4FY2007.
• UTI Bank has announced its plan to come out with a follow-on public offer (FPO) for 7.43 crore equity shares (26.3% of its existing equity base) to raise around $1 billion. We have assumed the FPO price to be Rs600 per share, up from Rs550 assumed earlier (as the minimum or floor price for the FPO has been decided at Rs575 per share). This would help the bank to raise around Rs4,459 crore.
• The NIM normally dips for the bank in the first quarter and then gradually picks up. The fee income, business growth and asset quality remain healthy, hence there is no major concern for the bank on the operational side. The capital raising would allow the bank to grow for the next three years without any further dilution. We feel UTI Bank has excellent growth potential which coupled with its strong management and earnings quality should allow it to trade at a slightly higher than its historical book value (BV) valuation band of 2.5-2.7x, as all the parameters that decide the valuations have improved considerably. At the current market price of Rs645 the stock is quoting at 20x its FY2009E earnings per share (EPS), 8.9x its FY2009E pre-provisioning profits (PPP) and 2.4x its FY2009E BV. We maintain our Buy recommendation on the stock with a revised price target of Rs725 at which level it will trade at 2.74x FY2009E BV.

Wipro
Cluster: Apple Green
Recommendation: Buy
Price target: Rs648
Current market price: Rs505

Price target revised to Rs648

Result highlights

• Wipro's global information technology (IT) service business reported a decline in revenues of 1.1% quarter on quarter (qoq) and a growth of 22.5% year on year (yoy) to Rs3,003 crore (under US GAAP) for Q1FY2008. The numbers are largely in line with our expectations. In dollar terms, the revenues grew at a reasonably healthy rate of 5.1% sequentially to $726 million (ahead of its guidance of $711 million). The revenue growth was achieved on the back of a 4.9% growth in the IT service business and a 7% growth in the business process outsourcing (BPO) business. The sequential growth in the IT service business was driven by a volume growth of 6.5%, despite a 1.5% sequential decline in the average realisations. On the other hand, the sequential growth in the BPO business was driven by a 3.9% growth in the volumes and a 3.1% improvement in the average realisations.
• The operating profit margin (OPM) declined by 280 basis points sequentially to 20.7%. The decline can be attributed to the wage hike effected by the company in the first quarter (the company usually does not provide annual wage hikes in Q1) and a steep appreciation in the rupee (a negative impact of 240 basis points). It was partially mitigated by a steep improvement of 400 basis points in its employee utilisation rate (a positive impact of 150 basis points), which limited the decline in the gross margins to 90 basis points. However, the higher sales & marketing spend added to the pressure on the margins at the operating level. During the quarter, the overhead cost of the global IT services business jumped to 12.9% from 11% in Q4FY2007.
• In terms of outlook, the company has given a healthy revenue guidance of $777 million for the global IT service business in Q2, which amounts to a growth of 7% sequentially. It has also considerably increased the foreign exchange (forex) forward cover to $400 million (up from around $195 million as in March 2007). However, the annual wage hike of 12-13% given to its offshore employees with effect from August (as against the general practice of giving a hike in September) is likely to have an adverse impact of 140-150 basis points on its OPM in Q2. The management expects to mitigate the same through better operational efficiencies and possibly show some improvement in the margins on a sequential basis.
• In addition to the lacklustre performance of the global IT service business, the Indian IT service business reported a sequential decline of 15.7% in revenues to Rs657.4 crore due to the seasonal weakness. Consequently, Wipro's consolidated revenues declined by 3.5% qoq to Rs4,183.2 crore (as per the US GAAP). The OPM declined by 250 basis points to 16.4% largely due to higher sales, general and administrative (SG&A) expenses and a forex loss of Rs85.2 crore. This resulted in a higher than expected decline of 17.5% qoq in its consolidated earnings, bringing the same down to Rs710.5 crore. After adjusting the tax write-back of Rs70 crore in Q4FY2007, the decline in the consolidated earnings stood at 10.2% on a sequential basis.
• We have revised down the FY2008 and FY2009 earnings estimates by a marginal 4.5% to factor in the lower exchange rate (assumption of Rs40/USD factored in the revised estimates) and the company's inability to show any uptick in average blended realisations in the IT service business. We have also factored in the recent acquisition of the Singapore-based Unza in the consumer care business. At the current market price the scrip trades at 21.6x FY2008 and 17.7x FY2009 estimated earnings. We maintain our Buy call on the stock with a revised price target of Rs648 (23x FY2009E earnings).

Zensar Technologies
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs442
Current market price: Rs300

Price target revised to Rs442

Result highlights

• Zensar Technologies has announced that its consolidated revenue grew by 9.7% quarter on quarter (qoq) and by 36.4% year on year (yoy) to Rs187.9 crore in Q1FY2008. The sequential growth in the consolidated revenue was driven by the incremental revenue of Rs18 crore from the recently acquired entities. The organic revenue declined marginally by 0.8% sequentially.
• The performance was quite disappointing on the margin front. The operating profit margin (OPM) plummeted by over 450 basis points to 9.7% on a sequential basis. The OPM was dented by the cumulative impact of the appreciation in the rupee (an impact of by 150 basis points or Rs2.9 crore), an increase in the selling, general and administration expenses (SG&A; 17.6% of the sales as compared with 16.8% in Q4FY2007) and an additional cost of Rs1 crore due to the intake of around 200 fresh graduates during the quarter. The expenses related to the integration of ThoughtDigital and the setting up of a development centre in Poland (a cumulative impact of around Rs1.6 crore) as well as the unexpected jump in the bench strength (due to a delay in the commencement of work by one of the large clients and completion of a testing project in Holland) dented the margin by Rs1.4 crore. Consequently, the operating profit declined by 25.3% qoq and 8.9% yoy to Rs18.2 crore.
• In line with the operating profit, the consolidated earnings also declined by 22% qoq and 8.6% yoy to Rs13.4 crore, which is much lower than our expectation of Rs15.8 crore for the quarter.
• The management has maintained its guidance of Rs850 crore of consolidated revenue and Rs85 crore of earnings for FY2008, despite the steep appreciation in the rupee. However, we continue to remain sceptical about the management's ability to achieve the stated guidance and the same was highlighted as a key concern in our research note dated June 18, 2007. Consequently, we maintain the earnings estimate for FY2008 at Rs77.9 crore, which is around 9.1% lower than the guidance.
• At the current market price the stock trades at 9.2x FY2008 and 7.2x FY2009 earnings estimates. We maintain our Buy call on the stock with a revised price target of Rs442.

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SHAREKHAN SPECIAL

Monetary policy review

CRR hike a surprise, but market takes it in its stride
In the first quarter review of the annual monetary policy, the Reserve Bank of India (RBI) has kept the policy rates unchanged as per expectations but hiked the cash reserve ratio (CRR) by another 50 basis points to 7%, which has come as a surprise. Higher money supply and reserve money growth coupled with risks from higher commodity and oil prices to price stability and inflation are likely to have forced the RBI to take the rather pre-emptive step. In addition to price stability the RBI has added maintenance of financial stability in the policy stance.

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MUTUAL GAINS

Sharekhan's top equity fund picks

We have identified the best equity-oriented schemes available in the market today based on the following 3 parameter : the past performance as indicated by the one and two year returns, the Sharpe ratio and Fama (net selectivity).

The past performance is measured by the one and two year returns generated by the scheme. Sharpe indicates risk-adjusted returns, giving the returns earned in excess of the risk-free rate for each unit of the risk taken. The Sharpe ratio is also indicative of the consistency of the returns as it takes into account the volatility in the returns as measured by the standard deviation.

FAMA measures the returns generated through selectivity, ie the returns generated because of the fund manager's ability to pick the right stocks. A higher value of net selectivity is always preferred as it reflects the stock picking ability of the fund manager.

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VIEWPOINT

Great Eastern Shipping Company

Capex plan of $470 million in the next two years
We attended the conference call of Great Eastern Shipping company (GESCO) to discuss the Q1FY2008 results. We present the key takeaways from the call.

Hindustan Zinc

High zinc price improves overall performance

Result highlights

• In Q1FY2008, the revenues of Hindustan Zinc (HZL) grew by 22% year on year (yoy) to Rs1,970 crore on the back of higher zinc prices and increased volumes. However in terms of sequential growth, the sales of the company dropped by 3% mainly because of the fall in the production of refined zinc refined metal by 4% quarter on quarter (qoq) to 92,631 tonnes. The company sold 54,835 tonnes of zinc concentrates and 13,651 tonnes of lead concentrates during the quarter. The concentrate sales revenue at $80 million during the quarter was higher than that of Q4FY2007 when the concentrate market was tight.
• The earnings operating profit soared by 15% yoy and 3% qoq to Rs1,436 crore mainly due to increased realisation and improved efficiency. The company is in the lowest decile of the cost curve across the globe. The operating margins contracted by 437 basis points yoy to 73% mainly because of a 92% increase in selling and other expenses due to the rising freight cost.
• The interest outgo declined by 74% yoy whereas the depreciation cost increased by 22% yoy, as the company commissioned a 38.4 megawatt (MW) wind energy plant in the last quarter.
• The profit of the company grew by 36% yoy because of the other income of Rs130.48 crore on account of one time reversal of earlier year liability relating to royalty payments to the government. The adjusted net profit grew by 21% yoy to Rs1,055 crore.

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