Nitco Tiles IPO

Look behind the shine

Sourcing from China is not a sustainable USP

Nitco Tiles provides flooring solutions. Its range of tiles is at various price points. The company’s products include mosaic tiles, ceramic floor tiles, vitrified tiles, paving tiles and imported marbles. It currently has an installed capacity of 0.8 million sq meters of mosaic tiles and 4.03 million sq meters of ceramic tiles.

Even while other manufacturers of vitrified tiles were fighting to block imports from China, Nitco went ahead and tied up for sourcing 15 lakh sq meters of vitrified tiles from a Chinese manufacturer. In fact, this is the main USP of the company. Imports of vitrified tiles from China attract a preferential import rate of 6.45%, without anti-dumping duty. As a result, Nitco derives an EBIDTA margin of 18% compared to 13% for tiles manufactured by the company in India.

Nitco has a distribution network of 550 direct dealers and about 5,000 outlets across India for retail sales. Its ratio of institutional to retail sales is 1:1.

The proceeds from the current issue are to be utilised to (a) expand the existing ceramic floor tiles capacity by 2.28 million sq. meters. to 6.31 million sq. meters by June 2006, (b) acquire/ set up a wall-tile capacity of 1.75 million sq. meters by April 2007, (c) install six wind mills to be completed by March 2006. The assessed funds requirement is Rs 95 crore, but the company is raising Rs 140 to Rs 168 crore.

Strengths

Increased thrust on housing and retailing augurs well for the tiles sector.

Weaknesses

1. The sector is dominated by the unorganised sector due to the easy availability of raw materials and low capex.
2. Nitco Tiles’s sourcing advantage is not a sustainable advantage and other players are likely to catch up in some way or the other. Or the government may plug the loophole, which is helping the company avoid the anti-dumping duty.
3. With additional capacities planned by industry players, prices of tiles are expected to decline. Increased imports from China are directly or indirectly affecting prices.
4. Nitco Tiles is not as strong as competitors in the retail segment.
5. There was a negative cash flow from operating activities in FY 2005 on increased inventory due to the build-up of imported tiles from China.

Valuation

Unlike other players, Nitco Tiles’s manufacturing sales is very small. Traded (mainly sourced form China) sales accounted for 65% of total sales in the first-half of FY 2006.

In FY 2005, manufactured sales fell 3% to Rs 97.22 crore and traded sales shot up 63% to Rs 105.13 crore. These traded sales are driving the company’s financials.

With a price band of Rs 140 – 168, Nitco Tiles’s PE on FY 2005 EPS ( post-issue equity) works out to 41.4 – 49.7 times and 16.7 – 20.1 times H1 FY 2006 annualised earning on the post-issue equity.. Comparable players like Kajaria Ceramics trade at a TTM PE of 11: Murudeshwar gets a multiple of 8.

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B.L. Kashyap and Sons

Steep price

Focusing on commercial and residential construction

B L Kashyap & Sons (BLK) constructs hospitals, hotels, industrial plants, IT/ITES campuses, malls and multiplexes. It is also undertakes turnkey residential and corporate projects including external finishing and fittings. The company provides furnishing and fittings fit outs through its subsidiary BLK Furnishers.

In the corporate sector, BLK has constructed projects for Escorts, Great Eastern, IBM, Hughes Software, Microsoft, Oberoi Hotels, Taj Hotels and other blue-chip companies. In the residential sector, the company’s projects for developers encompass multi-storeyed complexes, mainly in the northern and southern states.

Residential projects form about 32% of BLK’s order book, while corporate projects about 14%. Other projects (malls and multiplexes) comprise about 54% of the order book. The order book on 30 September 2005 stood at Rs 579 crore. Another Rs 300-crore orders were added till 31 December 2005, translating into orders worth 2.8x FY05 total sales.

Vinod, Vineet and Vikram Kashyap are the promoters of BLK. They have also promoted brokerage houses BLK Financial Services and BLK Securities.

BLK proposes to use the proceeds of the current issue for (a) investment in plant and machinery, (b) setting up a factory under its subsidiary BLK Furnishers, (c) acquiring land for storage of equipment used for construction work; and (d) financing long-term working capital.

Strengths

1. The up-trend in housing, retailing & ITES sectors augurs well.
2. As the private sector is the major clientele, default or delay in payment is not likely to be a problem.

Weaknesses

1. BLK is at the lower end of the construction value chain, thereby susceptible to competition from the unorganised sector.
2. The investment of Rs 20 crore to set up a factory for the manufacture of kitchen cabinets, doors, door frames, wooden flooring and other furnishings, through subsidiary BLK Furnishers, looks unconvincing. Furnishings form only a small part of total contract and can be outsourced in a construction project.

Valuation

With a price band of Rs 625 – 700, BLK’s PE for FY 2005 works out to be 62.7 – 70.2 times FY 2005 earnings and 26.1 – 29.3 times H1 FY 2006 annualised earning on the post-diluted equity (with greenshoe option).

TTM PE for the construction sector is 32.3. However, BLK cannot be compared with civil construction companies like Gammon, Hindustan Construction, Nagarjuna Construction, Patel Engineering, and IVRCL, which enjoying PE of 30 and above. Ansal Housing, which is a developer, is trading at a TTM PE of 16.8 times. However, BLK is not a developer but only takes up construction activities for residents and companies. Still, the price band looks steep.

BLK made a preferential allotment of 80,000 equity shares to a group company of the merchant banker at a price of Rs 400 on 14 October 2005.

Mahindra and Mahindra Financial Services

Asking too much for the rural reach

Paying five times the adjusted book value for the rural reach it commands is very costly

Mahindra & Mahindra Financial Services (MMFS) is one of India’s leading non-banking finance companies focused on the rural and semi-urban sector providing finance for utility vehicles (UVs), tractors and cars. It is a subsidiary of Mahindra & Mahindra (M&M), a leading tractor and UV manufacturer.

The objects of the issue are to achieve the benefits of listing, providing liquidity to present shareholders and augmenting Tier I capital base for further asset growth. The two crore equity-share public issue of face value Rs 10 each comprises a fresh issue and an offer for sale for one crore equity shares by M&M. The pre-issue promoter (M&M) holding, which stands at 89.8%, will come down to 67.7% post issue. The issue will constitute 23.26% of the fully diluted post-issue paid-up capital of the company.

MMFS aims to become the preferred provider of retail financing services in the rural and semi-urban areas of India by leveraging its nationwide distribution network. It seeks to position itself between the organised banking sector and local moneylenders. The company predominantly finances M&M UVs and tractors for commercial and personal purposes and plans to expand its lending for M&M vehicles.

Strengths

* Enjoys the brand equity and a ready market provided by M&M.

* MMFS has a superior nationwide network (295 branches end December 2005) compared to its peers, which it can leverage to its advantage. It will also benefit from the government’s focus on agriculture and rural development as tractors and UVs play a significant role in rural activities.

Weaknesses

*NPAs as a percentage of total assets (at 3.7% of net advances end December 20’05) are on the higher side compared to its peer group.

* MMFS’s credit rating at AA+ is not in the highest slab. Bajaj Auto Finance and Sundaram Finance enjoy higher ratings.

*Tractor & UV sales tend to be cyclical and affected by monsoon.

*MMFS faces severe competition from banks, adversely affecting its margin. The gross spread has come down continuously, from 12.9% in FY 2003 to 8.7% in the latest nine months. The return on average assets has also come down from 3.5% to 2% in this period.

Valuation

Among its peer group comprising Bajaj Auto Finance, Cholamandalam Investment & Finance and Sundaram Finance, MMFS has the best nationwide network. At the price band of Rs 170 to Rs 200, the scrip is at (18.2 to 21.4) x its FY 2005 EPS of Rs 9.3 (on post- issue equity and after deducting the preference dividend) and (3.4 to 3.9) x its FY 2005 book value(BV) of Rs 51 (on pre-issue BV end March 2005) and (4.7 to 5.5) x its FY 2005 adjusted BV of Rs 36 (on pre-issue book value end March 2005).

The valuations are high compared to the net profit growth of 26% in FY 2005 and just 15% in the latest nine months. The peer group gets a PE of 14.6 to 25.3 and P/BV of 1.4 to 3.3. However, the peer group valuations also factor in stakes of these companies in mutual fund and insurance business. MMFSL does not have any such stakes.

Besides, banks are better placed compared to NBFCs in the financing business and PSU banks are better placed in rural finance. Compared to the valuations of banks, NBFCs are getting very high valuations, which may not be sustained in the long run.

Sharekhan Investor's Eye

Aban Loyd Chiles Offshore
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs1,200
Current market price: Rs800

Price target revised to Rs1,200

At the current market price (CMP) of Rs800 the stock is discounting its FY2008 earnings by 13.4x and its earnings before interest, depreciation, tax and amortisation (EBIDTA) by 6.1x. However, as the rig day rates are expected to continue the uptrend and the favourable outlook for the re-pricing of all of Aban's rigs by FY2009, we believe FY2009 earnings are the correct earnings to value Aban. As mentioned earlier, we expect its earnings to register a CAGR of 80% with a net profit of Rs513.4 crore and an EPS of Rs135 in FY2009. Hence the stock is discounting its FY2009 earnings by only 5.9x and its cash earnings per share (CEPS) by 3.9x. Also the valuations are extremely attractive on EV/EBIDTA basis with a value of only 3.3x its FY2009 EBIDTA.

Given the favourable outlook for the re-pricing of Aban's rigs in FY2009, its strong cash generation and its continued appetite for growth through organic or inorganic routes, we see an increasing amount of earnings visibility for the company at least till FY2009. We are revising our price target to Rs1,200. We have arrived at our price target by discounting Aban's FY2009 earnings of Rs135.5 by 10x and bringing it to its present value by discounting it by the company's cost of capital of 12.8%.

Wockhardt
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs552
Current market price: Rs480

Price target revised to Rs552

Result highlights

• Wockhardt's net sales for Q4CY2005 were up 5.4% year on year (yoy) on a consolidated basis to Rs365.9 crore as against Rs347.1 crore in Q4CY2004.
• The earnings before interest, depreciation, tax and research (EBIDTR) margins were maintained at 27.7% during the quarter. A decrease in the research and development (R&D) expense by Rs4.8 crore helped in bumping the operating margins which rose by close to 200 basis points.
• A decrease in the other income contributed to the fall in the earnings before interest, depreciation, tax and amortisation (EBIDTA) that stood at Rs87.8 crore. The profit after tax stood at Rs62.9 crore, showing a rise of 9.4% yoy on an adjusted basis. The net profit margin increased by 116 basis points yoy.
• At the current market of Rs480, the stock is trading at 17.4x its CY2007 earnings estimate. We reiterate our Buy recommendation on Wockhardt with the revised price target of Rs552.

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Sharekhan Investor's Eye

Orchid Chemicals & Pharmaceuticals
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs355
Current market price: Rs315

Growing strongly

• Orchid Chemicals & Pharmaceuticals (Orchid) is planning to file 25 abbreviated new drug applications (ANDAs) in the next 12 months that will form the product portfolio of the company from FY2008 onwards.
• We expect these filings to be in the lifestyle drug segments apart from one filing in the high revenue molecule tazobactum+piperacilllin.
• These filings indicate the commitment of the company towards generating a long-term revenue stream for the future. It also speaks volumes of the strong thrust that the company has towards making a big entry in the lifestyle drug segments of the regulated markets in FY2008.

Hindustan Lever
Cluster: Apple Green
Recommendation: Buy
Price target: Rs270
Current market price: Rs236

Price target revised to Rs270

Result highlights

• Hindustan Lever Ltd's (HLL) revenues grew by 14.4% year on year (yoy) for Q4CY2005, the strongest ever growth in the last eight years, on the back of the strong traction in soap and detergents and personal products businesses. The growth was also strong quarter on quarter (qoq) at 8.9%.
• The home and personal care business reported a growth of 17.3% in its revenues on the back of the re-launch of key brands whereas, the food division reported a growth of 9.1%.
• HLL's operating profit grew by 14.7% with a marginal five-basis-point expansion in the operating margins. The margins expansion could have been higher but for the advertising and promotion (A&P) expenses, which went up by 49.7% yoy. The management has guided that the spending on A&P is likely to continue at that level in an effort to strengthen the brands of the company.
• A better supply chain management and aggressive cost cutting has helped HLL reduce its losses in the food processing and ice-cream businesses substantially, which helped it to sustain the margins despite the A&P spend going up.
• We have upgraded our earnings per share (EPS) estimates for CY2006 and CY2007 by 9% and 16% respectively.
• At the current market price of Rs236, the stock is quoting at 27.1x its CY2007E EPS and 23.3x CY2007E enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA). We reiterate our Buy recommendation on the stock with a revised price target of Rs270 per share.

Gitanajali Gems IPO

Gitanjali Gems

Going aggressively retail

Polishing a well-established presence in retail

Gitanjali Gems (GGL) is an integrated diamond and jewellery manufacturer and its operations include sourcing, cutting and polishing roughs into diamonds and the crafting of diamond and other jewellery. The company derives nearly 85% of its revenue from sale of cut and polished diamonds, which are mainly exported. The remaining 15% of the revenue come from the sale of branded jewellery in the domestic market and export of jewellery in the international markets. Exports account for around 70% of total sales.

The company sells jewellery in India under four major brands: Gili, Nakshatra, Asmi and D’Damas. These brands are well established in the market and feature in top 10 best-known jewellery brands in India. Gili and Nakshatra are acknowledged as super brands.

Group company Gili India, in which GGL holds a 40% stake, owns the brand Gili. Nakshatra and Asmi are brands of de Beers. The D’Damas brand is owned by GGL’s 50:50 joint venture (JV) with Damas Jewellery LLC of the UAE.

For branded jewellery, GGL has established a large retail setup, which includes 26 exclusive distributors across India, around 620 outlets including those in host stores, five standalone stores and 17 franchisee stores in 30 cities and towns in India.

Recently, GGL entered into an agreement with the government of Andhra Pradesh to develop a special economic zone, spread across 200 acres in Hyderabad, exclusively for the gems and jewellery industry. The company has bagged 75 acres. A wholly owned subsidiary, Hyderabad Gems SEZ, was incorporated to oversee this project. GGL will invest Rs. 50 crore in the company.

GGL plans to utilise the proceeds of the IPO to invest in its subsidiaries / associate companies, expand its manufacturing capacities, and penetrate the retail market besides the development of SEZ near Hyderabad. The company will invest Rs. 75 crore in Fantasy Diamond Cuts, a 99.04% subsidiary, to establish retail outlets in medium and small cities in India. GGL will invest Rs 50 crore in the 50:50 JV with Damas Jewellery LLC to expand its retail operations.

Further, GGL plans to invest Rs. 10.2 crore in Brightest Circle Jewellery, in which the company holds a 33.34% stake along with two other Indian players, to expand its retail operations. Brightest Circle owns the Nakshatra brand of diamond studded jewellery.

Strengths:

1. India is the largest market for gold jewellery. Around 800 tonnes of gold are consumed in India annually. Besides, the diamonds processed in India amount to approximately 60% of the global consumption in value terms, 85% by weight and 92% by numbers
2. The branded jewellery segment in India, in which GGL operates, is reportedly growing at more than 20% per annum.
3. Retail jewellery sales offer around 15% net profit margin as against less than 3% in the polished diamonds business. Thus, a shift to jewellery business and retail expansion will strengthen the bottom line of GGL.
4. With established brands and integrated nature of business, GGL has strong prospects for topline growth and healthy profit margin.
5. Presently, GGL is the only company in India manufacturing the Asmi brand of jewellery, which is owned by the DTC.

Weaknesses:

1. One of the group companies, Digico Holdings, has a ‘sight-holder’ status with DTC. However, around 50% of the rough diamonds procured from DTC are used by other promoter group companies (controlled by Chetan Choksi, brother of GGL’s promoter Mehul Choksi) engaged in the same business. Also, GGL or its promoter does not control the operations of Digico, which is managed by Chetan Choksi. As a result, GGL has to purchase over 75% of its rough diamond requirement from the open market, which is costlier compared to the rough diamonds procured directly from DTC. There is also possibility of conflict of interest between the two brothers.
2. Diamonds and jewellery are luxury products, forming discretionary purchases by consumers. Thus, rising gold and diamond prices, inflationary pressures or adverse economic conditions may affect sales adversely.
3. GGL amalgamated three of the promoter group companies – Gemplus Jewellery, Prism Jewellery and Giantti Jewels – with itself from 1 April 2005. As such, its results for the half-year ended September 2005 are not comparable with any of its previous financial results. It is, therefore, impossible to determine the growth rate or change in the operating profit margin of the company over the years. The comparable results available from FY 2003 to FY 2005 are disappointing with a continuous fall in OPM as well as the profit after tax (PAT).
4. In the current year, GGL will have to provide for doubtful debts of Rs 21.18 crore accumulated since 2001 as extraordinary item.
5. GGL’s business is highly working capital intensive and has been showing negative cash flow from operating activities.

Valuation:

GGL has set a price band of Rs 170 to Rs 195, which translates into a PE of 19.4x to 22.2x annualised EPS in the half-year ended September 2005 on post-issue equity. This business was once perceived as risky and non-transparent and was getting P/E of less than 10. However, retail initiatives by this sector have changed investor perception towards it. Now the sector gets average PE of around 20 on a TTM basis. Due to GGL’s established presence and aggressive plans, it can enjoy higher P/E than the sector’s.

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Union Bank of India

An aggressive PSU

Union Bank of India (UBI) made its maiden public issue in 2002. The government of India (GoI) currently holds 60.9% of the pre-issue paid-up equity share capital (Rs 460.12 crore), which will come down to 55.4% after the issue.

As on December 2005, UBI had 2,064 branches and 146 extension counters serving more than 1.5 crore customers. The bank mainly focuses on and will continue to focus on rural and semi-urban regions of India.

The main objects of the follow-on offer include augmenting the capital base. In September 2005, UBI’s capital adequacy ratio (CAR) stood at 10.5% as against the Reserve Bank of India (RBI)-stipulated 9%. The bank intends to take advantage of the domestic economic boom and to venture out internationally. . It plans to expand geographically in India by increasing the volume of retail business and by cross-selling various fee-based financial products and services.

Strengths

• NPAs are reasonable at 4.22% and 1.37% of gross and net advances respectively as on 30 September 2005.
• UBI is perceived as very aggressive in its peer group.
• Good progress has been made towards de-risking the investment portfolio from future interest rate rise.

Weaknesses

Like any PSU bank, fall in treasury gains will continue to limit the rise in profit for UBI also.

Valuation

In the nine months ended December 2005, UBI recorded a growth of 18% to Rs 1776 crore in the net interest income (NII). However, the other income (OI) decreased by 30% to Rs 413 crore. The fall in OI was mainly due to the fall in treasury profit. The operating profit grew 4% to Rs 1138 crore, and provisions declined 20% to Rs 464 crore in the first nine months of FY 2006 compared to Rs 581 crore in the corresponding period of FY 2005. Thus, the net profit increased by 11% to Rs 531 crore.

The scrip currently trades around Rs 120. The last one-year, six- and three-month average price of the scrip stood at Rs 121, Rs 123 and Rs 119, respectively.

At the offer price band of Rs 100-110, P/E works out to be 7x to 7.9x nine-month FY 2006 annualised EPS of Rs 14 on post-issue equity. At Rs 110, September 2005 post-issue book value (BV) of Rs 78 is discounted 1.4 times and adjusted BV of Rs 65 is discounted 1.7 times. The valuation ratios are more or less in line with the peers. However, its aggressiveness will help it outperform the banking sector going forward.

Sharekhan Investor's Eye

Saregama India
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs375
Current market price: Rs330

Price target revised to Rs375

Key highlights

• Saregama India Limited (SIL) reported sales of Rs31 crore in Q3FY2006, up 12.5% quarter on quarter (qoq) and up 15.2% year on year (yoy). The sales from music cassettes and CDs/VCDs increased by 6.8% yoy to Rs26.2 crore. However, the revenue from publishing increased by 101% yoy to Rs4.7 crore.
• In spite of a growth in sales, the operating profit declined by 6.4% qoq to Rs2.9 crore. An increase in the royalty expenses was the prime reason for the decline in the operating profit. The company acquired music rights of “Bluffmaster”, “Kalyug” and “Holiday” during the quarter that led to an increase in the royalty expense.
• The interest cost was down by 71% yoy to Rs0.19 crore as the proceeds of the rights issue were used for debt repayment.
• SIL's net profit grew by 41.7% yoy, but declined by 6.8% qoq to Rs2.77 crore.

Union Bank of India
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs150
Current market price: Rs125

IPO note

Key highlights

• Union Bank of India (UBI) will be coming out with a follow on public issue of 4.5 crore equity shares in the price range of Rs100-110, which we believe is attractively priced.
• With its pan-India presence, UBI has recorded a strong compounded annual growth rate (CAGR) of 24% in its advances over FY2001-05. We expect the loan book to grow at a CAGR of 22% over FY2005-07E.
• UBI’s net profit is likely to grow at a CAGR of 24% over FY2005-07E and the diluted earnings per share (EPS) are likely to grow at 19%.
• We expect the follow on issue to add Rs9-10 to UBI’s book value based on the issue price.
• At the current market price of Rs125, the stock is quoting at 1.0x its FY2007E book value and 5.3x its FY2007E EPS. We believe that the follow on offer of the bank with a price band of Rs100-110 is attractively priced looking at the fact that its fair price/book value works out to 1.3x based on its strong return on equity. We reiterate our Buy recommendation on the stock with a price target of Rs150.