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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.

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Sharekhan Investor's Eye

Cipla
Cluster: Cannonball
Recommendation: Buy
Price target: R600
Current market price: Rs560

Price target revised to Rs600

Proscar provides a key upside to our estimates. The sales of Sertraline in the regulated markets and that of ARVs in Africa along with the supply agreements with partners like Watson are also expected to substantially increase the revenues. For Cipla we estimate a net profit of Rs667 crore for FY2007. At the current market price of Rs560, the stock is trading at 22.3x its FY2007 earnings estimate. Considering the company's strong growth prospects and the de-risked business model, we are basing our price target on our FY2008 estimates. We believe that due to the partnership model that Cipla uses, it can benefit from the future generic approvals of its partners and this is the hidden potential for the company. Hence we believe that Cipla should command a FY2008 multiple of 21x. Keeping in mind the huge growth potential of the company we reiterate our Buy recommendation on Cipla with the revised price target of Rs600.

Hindustan Lever
Cluster: Apple Green
Recommendation: Buy
Price target: Rs227
Current market price: Rs208

Precursor to HLL's results

Unilever has declared its results today. Mentioned below are the major highlights of its CY2005 results. Further, we shall discuss the impact of the results on Hindustan Lever (HLL), which is scheduled to announce its results on February 14, 2005.

Tata Motors
Cluster: Apple Green
Recommendation: Buy
Price target: Rs844
Current market price: Rs754

Price target revised to Rs844

Result highlights

• Tata Motors' net sales for Q3FY2006 were better than expectations at Rs5,074.55 crore, marking an increase of 16.3%.
• The sales volumes for the quarter at 111,228 units, grew by 12.74%. The domestic sales volumes registered a growth of 11%. The export volumes registered a growth of 35% to 11,782 vehicles.
• Excluding the foreign exchange loss, the operating profit is up by 27% and consequently the earnings before interest, depreciation, tax and amortisation (EBIDTA) margins have improved from 11.8% in Q3FY2005 to 13% in Q3FY2006. The profit before tax (PBT) includes a gain of Rs164.30 crore from the sale of 20% equity in its subsidiary Telco Construction Equipment Company Limited (Telcon), to Hitachi.
• The reported net profit has increased by 45.6% to Rs460.2 crore as compared to Rs316.2 crore for the corresponding quarter of the previous year, while the adjusted net profit was down by 2% to Rs312.8 crore.
• We are upgrading the earnings for FY2006 from Rs37.6 to Rs38, to account for the one-time income from the sale of the stake in Telcon. We are maintaining our unconsolidated EPS of Rs42 for FY2007. We are introducing our consolidated earnings for FY2006 at Rs43 and for FY2007 at Rs53.6.
• Doing the sum-of-parts valuation of Tata Motors and taking into account the value of its investments, we have arrived at a target price of Rs844 and maintain our Buy recommendation.

Prathibha Industries IPO

But unexciting diversification and undisclosed incomes are disconcerting

Pratibha Industries (PIL), promoted by Ajit Kulkarni and his relatives, has developed expertise in building and developing infrastructure projects in core areas of water supply and distribution system, environmental engineering, pre-cast design & construction. It also undertakes projects in road construction, housing (mass and real estate development).

PIL proposes to enter the lucrative engineering, procurement and construction (EPC) business for executing oil and gas transmission contracts. The company, through its subsidiary Pratibha Infrastructure, plans to diversify through backward integration by installing a manufacturing and coating facility to produce spirally-welded steel pipes used in the transmission of water, oil and gas.

The proceeds from the current issue are to be invested in: (a) BOT/BOOT projects; (b) the capex for the spiral pipes project through investment in Pratibha Infrastructure, which does not carry on any business at the moment; (c) the long- term working capital; and (d) repaying part of existing high-cost debt.

Strengths

1. The thrust by the Central and state governments on infrastructure development including water, environmental engineering, roads and other infrastructure sectors augurs well for PIL.
2. Consolidated sales have grown at a CAGR of 51% between FY 2002 to FY 2005 to Rs 121.39 crore and the net profit at a CAGR of 88% to Rs 8.09 crore.
3. PIL has been awarded more than 50 projects in last seven years by various government and semi-government authorities. Its order book on 31 December 2005 was Rs 516 crore, with a backlog of Rs 316 crore (75% water-based and environmental engineering projects), i.e., 2.6x FY 2005 consolidated revenue.

Weaknesses

1. Income-tax searches resulted in the promoters and group companies to admit undisclosed income of Rs 3 crore. Thus, the returns for the past many years will have to be re-filed and penalty may be levied.
2. The logic behind investing Rs 14 crore to diversify into spirally welded pipes is not convincing.
3. The cash flows at the operating levels were negative Rs 10.19 crore, Rs 8.19 crore and Rs 10.35 crore in FY 2004, FY 2005 and nine months ended December 2005. This indicates very high working capital requirement due to government projects.

Valuation

In the nine months ended December 2005, PIL reported consolidated sales of Rs 105.19 crore, a net profit of Rs 6.99 crore. The annualised EPS is Rs 6.5 on post-issue equity. The offer price band of Rs 100 to Rs 120 gives a PE range of 15.4 to 18.5. Due to the mad frenzy for construction scrips, the sector TTM P/E stands at 32.3. However companies engaged in making pipes and related projects trade at TTM P/E of 20.

PIL’s financial track record and reasonably large order book in this scenario are comforting.

South Indian Bank

Marching northwards

The South Indian Bank (SIB), by its name, reveals its strong presence in south India. Of its 432 branches in 17 states, 220 are in Kerala and 93 in Tamilnadu. As of December 2005, nearly 87% of its business was networked under the core banking solution.

SIB has started its network in north Indian cities like Amritsar, Ludhiana and Bhopal. Approvals for more than 20 other branches are pending with the Reserve Bank of India (RBI).

An old private sector bank with no identifiable promoters. ICICI Bank, which holds 10.73% of SIB’s pre-issue equity capital, has to bring its shareholding down to 5%, as per RBI guidelines.

SIB had come out with a rights issue (1:3 at Rs 40) in July 2004. The main objectives of the current offer include augmenting the capital base to meet the future capital requirement arising out of the implementation of the Basel II standards. On September 2005, SIB’s capital adequacy ratio (CAR) stood at 10.28% as against the RBI-stipulated 9%.

Strengths

• Good progress has been made in de-risking the investment portfolio from future rise in interest rate.

• SIB has signed a memorandum of undertaking with Hadi Express Exchange Company to provide management services to its NRI clients in Gulf countries. It is a pure fee-based revenue mechanism to provide a single-window facility to NRIs.

Weaknesses

• The net NPA ratio of 2.4% as on December 2005 leaves scope for improvement. Moreover, SIB has a high concentration of its loan and NPA portfolio among certain customers and sectors. As per prospectus, the single largest borrower accounted for approximately 14.32% of its capital funds, while the largest borrower group accounted for 13.09% on September 2005,

Valuation

In nine months ended FY 2006, SIB’s net interest income witnessed a growth of 18% to Rs 230.37 crore. The other income fell by 38% to Rs 43.13 crore. The provisions and contingencies were down by 48% to Rs 58 crore. After providing for tax, at Rs 11.60 crore, the profit after tax was Rs 34.59 crore, up by 243%.

The last two years were extremely bad for SIB’s profit. Hence, this year’s recovery is on low base.

The last one-year, six- and three-month average price of the stock was around Rs 68.

The offer price band is Rs 60-66. At Rs 60, PE on nine-month annualised EPS of Rs 6.3 (on post-issue equity capital of Rs 72.68 crore) works out to 9.5. At Rs 66, PE on its nine-month annualised EPS of Rs 6.5 (on post-issue equity capital of Rs 70.41 crore) works out to 10.1.

Considering the price of Rs 66, post-IPO book value (BV) is Rs 86.0 and adjusted book value (ABV) Rs 61.0. P/BV is around 0.8 and P/ABV around 1.1. In a normal market, SIB will trade around a P/ABV of 1.

The banking sector needs consolidation and small regional banks without strong promoters, such as SIB, will have to ultimately merge with stronger and larger players once the government policy supports such moves. Till then they will have to survive and try hard to keep their presence felt in a highly competitive scenario.

Indo Tech Transformers

Indo Tech Transformers (ITT) manufactures distribution transformers and power transformers. The company currently has three plants. Two are located in Chennai, Tamil Nadu, and one in Palakkad, Kerala. These three plants manufacture 500 –600 transformers of assorted sizes every month. They have an overall annual capacity of 2,450 MVA.

The key customers of ITT include state electricity boards (SEBs), engineering, procurement and construction (EPC) contractors, and the corporate sector. The company has also exported transformers to Nigeria, Srilanka, UK, US, Ghana, and Canada.

The net proceeds from the issue, after meeting issue expenses, will be utilised to:

*Relocate and modernise the Saidapet plant into a new distribution transformer plant of 750 MVA / annum at Thirumazhisai.

*Set up a new power transformer plant with a capacity of 2,400 MVA per annum including 220 KV class of transformers.

*Put up a 120-unit per annum dry-type transformer plant at Thirumazhisai.

*Meet the working capital requirements of the company.

The expected date of commencement of production of the distribution transformer plant, power transformer plant and dry-type transformer plant are 15 August 2006, 1 April 2007 and 20 June 2006, respectively.

Strengths

• The Union government’s emphasis on providing power for all by 2012 and reform initiatives including the accelerated power development and reforms programme (APDRP) is likely to benefit all organised electrical equipment manufacturers as there will be a thrust on quality products. About 1,00,000 MW of power generation capacity is likely to be added by 2012. For every 1MW of new capacity that comes up, 7-MVA transformers are used across generation, transmission and distribution segments. This implies a demand of 700,000 MVA of transformers unfolding over the next five years. This will result in an annual demand of about 1,40,000 MVA.
• Transformers usually have a life of 20-30 years. Hence, transformers installed in the 1970s and 1980s are likely to be replaced in the next few years. On an average, about 67,517-MVA transformer capacity has been added annually in the sixth five-year plan(1980-85). Since the life of these transformers exceeds 20 years, they are likely to be replaced.

• The commissioning of the proposed 2,400-MVA transformer plant will enable ITT to manufacture power transformers of higher range: 132 KV and 220 KV class of transformers. The margin in the higher end of transformers is better and competition is less as more technical knowledge is required.

Weaknesses

• ITT will lose the benefits it enjoys as a small-scale unit when the proposed projects are implemented. Once it loses this status, the company will not be entitled to the price preference that is available to small-scale manufacturing units for supply of equipment to the Tamil Nadu Electricity Board (TNEB). This is likely to shave off 100 basis points from its margin.
• TNEB accounts for almost half of its revenues, making it over-dependant on it.

Valuation

EPS for the FY 2005 is Rs 7.3 on post-issue equity. At an offer price of Rs 130, PE works out to 17.8. Annualised half-year EPS is Rs 9.2 and PE 14.1. TTM PE for the power sector is around 20.

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