Stock Review: VLS Finance

 

VLS Finance is a flagship company of VLS Group. It operates through four of its subsidiaries and VLS Investment is another peer into the same subsidiary group. VLS Finance is a very interesting as the stock is terribly undervalued. The market cap of this company is just Rs 60 crore. The company had investments in Sunair Hotels, which is a Delhi metropolitan hotel, which is roughly worth Rs 800 crore. There is a pending litigation on the company with Gupta brothers.

If I see the entire litigation aspect I feel the case should be in favour of the VLS Finance Group and then this stock can be a multi-baggier because if I see the entire aspect—Rs 800 crore of worth where the company would be holding approximately 87% after the case hearing is closed—that will mean that the value of the stock itself would be around Rs 600 crore.

The current market cap is Rs 60 crore. Apart from this the company holds 14% in Relaxo Footwear along with its subsidiary, which again works out to be Rs 60 crore that means you are having a free stock available for you where there is unlimited upside—5-6 times even from here—and almost no downside for the stock.

The stock last time in 2007, just before the hearing, was approximately hovering around Rs 80-90 levels. With the case hearing coming near the stock could again go to those levels and if the case hearing is actually going to be in favour of the VLS Finance Group the market cap could be anywhere between Rs 400-500 crore also.

At Rs 600 crore marketcap where there is no downside risk because of Relaxo Footwear and other holdings like Gati etc, and there is unlimited upside potential we feel that this stock could be a multi baggier from current levels.

Stock Review: Empee Distilleries

 

Empee Distilleries is one of those stocks where I feel there is tremendous potential both in terms of their core business as well as because of their assets into the business. Empee Distilleries is a south-based group of Empee Group. The company, in 2007, actually came up with an IPO at Rs 400 and the current price is hovering around the Rs 150 levels, which roughly translates into marketcap of Rs 272 crore.

Going through their prospectus, I see there are tremendous hidden assets into the company best being the real estate part where we feel the company would be developing the real estate in the next three years that will generate cash flows over the current market cap of the company itself. That means in the next three years the company's cash flow from the real estate part itself will be much more than the current market cap.

What does this translates for common shareholder? A company that is paying a dividend of Rs 6 per annum, a company that has its core business some of the prestigious companies, which has a sale of above Rs 500 crore in to distilleries, these are restricted entry into the southern markets. We feel the market share is protected for the company plus you have a real estate story that will generate cash flows of more than the current market cap in the next three years.

You also have a power capacity of 10 megawatts into the company of which 75% is free salable and only 25% needs to be transferred to Tamil Nadu government that adds roughly about Rs 3-4 crore of free cash flow to the bottom-line. Apart from this also the company is holding 2.81 crore share of Empee Sugars and Chemicals.

At current market price it roughly translates to about Rs 130 crore. If I add up all these things I think there is tremendous value left into the company. What we feel is even if I give a heft discount of say 15-20-25% to its NAV it still works out to be at Rs 240 without discounted cash flow analysis. If I do that DFC analysis for the next 3-5 years the stock can easily touch its issue price of Rs 400.

Stock Review: Medi Caps

 

Medi Caps is the second largest gelatin capsule manufacturer. The interesting aspect about this company is a very small company with Rs 25 crore of marketcap but it has Rs 38 crore worth of debt mutual funds in the company's investment accounts. So you are getting the business of Rs 25 crore virtually free. Along with that you still have Rs 13 crore of mutual fund in addition.

Apart from this the company has recently entered into a joint venture (JV for a Pithampur SEZ spread over nine acres for manufacturing gelatin capsules. We feel that the potential for this particular SEZ on this nine acre land for the company is somewhere around Rs 70 to 80 crore. Given it is a 50% partner it adds Rs 40 crore or Rs 45 crore to the balance sheet in terms of the market share.

So, if I add Rs 45 crore plus Rs 38 crore of mutual fund, plus Rs 25 crore of actual value for the business—it roughly works out to be Rs 100-102 crore. Given it is a small company and it should trade at some discount we feel there is still tremendous juice left into the stock.

Stock Review: Wockhardt Pharmaceutical

Wockhardt Pharmaceutical is the fourth largest player in pharmaceutical industry. This company has gone through financial distress in financial year 2008-2009 due to forex losses. If I see the entire sales for last year, it was around Rs 1,800-1,900 crore. Looking at the pharma deals, it is happening around 8-9 times sales. This stock's enterprise value is less than Rs 7,000 crore.

The company has not been out of distress even as of now but we feel that the residual value that the company is trading at is definitely cheap. If we see the restructuring process that the company has undergone recently by selling their land for Rs 200 crore in Mumbai, along with that they have gone for hiving off their non strategic assets to other players to make sure that their financials are on backdrop.

There is only one catch over here is how much time this could take. The biggest challenge for the company is to come out of the woods because FCCB conversion has gone forward by five-years for QVT, a hedge funds based in US. The entire aspect if I see the stock is trading at least 50-60% discount to peers like Ranbaxy.

If you see the entire business—insulin business—it is one of the pioneer in that particular business. If I see the entire market cap, it is approximately Rs 1,600-1,800 crore, it is definitely a cheap buy given that we expect the value of the crore assets after reconstructing the debt would be around Rs 3,500 crore for the equity player and enterprise value would be around Rs 8,400 to Rs 9,000 crore. We are trading at 50% discount for Wockhardt.

Stock Review: Britannia

Competition eating into co's pricing power

BRITANNIA'S profitability suffered during the June 2010 quarter even though its topline continued to grow in double digits. This reflects the difficulty of the bakery and dairy products maker in passing on the impact of higher raw material costs to its consumers. Some other food companies such as Nestle and GSK Consumer Health Care have reported a similar trend earlier.

A stiff competition has forced food companies in the FMCG space to absorb majority of the impact of higher food inflation during the June quarter. In the case of Britannia, new players such as Unibic and McVitie's are competing at the premium end and ITC and Parle remain aggressive at the lower end. This has weakened Britannia's pricing power in its category. Its June quarter performance is reflective of this.

Britannia's revenue rose by 25% year-on-year during the June quarter. But the impressive growth is more a function of the low base a year ago. Furthermore, despite 20% volume growth, net profit was disappointingly down by 30% due to higher input costs, higher advertisement & promotion spend and much higher interest expense.

It has become tougher to protect and grow market share for the FMCG biggies such as Nestle, HUL and Britannia given the intensifying competition from the new domestic as well as international entrants. Most of these companies have chosen to keep product prices stable thereby taking a hit on their profit margins in the short term. Another strategy adopted by them is introducing new products to maintain their market share. These efforts have resulted into pushing up selling costs. For in-stance, selling and marketing expenses went up 50 basis points to 7.5% as a percentage of sales from the year-ago level. Britannia's stock has fallen by more than 11% during the two sessions post results. The question in front of investors is what could drive stock prices up if they are to stay invested in these FMCG scripts.

 

In case of Britannia, investors can look forward to two factors:

 

First, the trend in prices of raw materials including flour, sugar and milk. Of these, sugar and milk prices after inflating so much in last few quarters are easing out. This may take away some pressure on margins.

 

Another factor is the company's strategy to focus on new differentiated products that would attract premium pricing.

 

Stock Review: Motherson Sumi

 

But At Current Price Stock Looks Expensive Against Average P/E Of 26 For Auto Part Cos

 

AUTO ancillary firm Motherson Sumi System Limited's (MSSL) stock has performed in line with the ET Auto Ancillary index. During the past six months, the stock has gained 14%, outperforming the 4% return of the benchmark Sensex.

   MSSL's stock movement reflects its robust financial performance and going by its June quarter numbers, the stock may be able to outperform the broader market. MSSL posted robust consolidated net profit growth during the quarter ended June 2010 backed by strong performance of its overseas subsidiary, besides revenue growth from domestic market.

   The company's consolidated sales increased 32% to Rs 1,858 crore led by over 50% growth in domestic sales as automobile demand zoomed. Overseas business that supplies rear view mirrors to carmakers also saw double-digit growth in revenues, which is a positive factor despite developed economies still struggling to come out of slowdown.

   With latest sales figures for automobiles in the month of July showing high growth, there is reasonable visibility for strong revenues in the quarter ending September 30. However, what is of concern for its future topline growth is the tapering rate of growth on a sequential basis. MSSL reported 4% decline in the revenues compared to the previous quarter. This is in sharp contrast to 8% sequential rise in sales in the March 10 quarter.

   The company is yet to take a big hit in margins due to rising commodity prices. MSSL's operating margins improved 500 basis points (bps) over the year-ago period due to lower increase in raw material cost, besides control in other operating expenses.

   MSSL is a leader in wire harnessing products with over 50% share in domestic market. The acquisition of Visiocorp's rear-view mirror business in March 2009 has catapulted it to the position of the largest global player in that segment.
   MSSL has further chalked out plans to invest Rs 400-500 crore to expand production capacity for harnessing wire in passenger cars.

   A part of its earnings growth has already been captured in its valuations. The stock's last traded market price of Rs 169 is 29 times its trailing twelve months of earnings. This is expensive when compared with the average P/E of 26 for the auto ancillary sector.

   Given this background, the extent of earnings growth in coming quarter will depend on the volume growth for auto sales and trend in commodity prices.

 

Stock Views on PG Foils

PG Foils has got the third largest aluminum foil capacity in India. This company has a total capacity of about 5,000 tonne per annum. The major customers for the product are pharmaceuticals and food industry. Besides pharmaceutical and food industry, this company also gives its product to various other industry segments, though in smaller quantities, but the major customer is pharmaceuticals and food.

The company is currently undergoing an expansion programme wherein the capacity will increase about 6,000 tonne per annum. This expansion will go on-stream fully in the month of November-December 2010 and this will take the total capacity of the company to about 11,000 tonne per annum. If you look at the financials of the company closely for the last two financial years, for FY09, this company reported a loss of about Rs 1.5 crore. In this loss this company had provided for an exceptional item of close to Rs 13 crore, the company had about Rs 8.5 crore of loss on forex hedging and this company provided for about Rs 4.5 crore on account of payment of premium for Keyman Insurance Policy which means total exceptional items of close to Rs 13 crore.

Again for FY10, there are exceptional items for Rs 13 crore, which includes payment of Keyman Insurance Policy of Rs 4.5 crore and loss investment of close to Rs 8 crore after providing for these two items, this company reported a profit after tax of Rs 4 crore. Now if you compare the valuation of this company with the peer group namely Essdee Aluminum, you will find that even though the capacity of Essdee Aluminum is about 3.5 times that of PG Foils, the revenues of Essdee Aluminum are 3.5 times, operating margins are double that of PG Foils but the marketcap of Essdee Aluminum is roughly 38 times the marketcap of PG Foils. There I find a huge differential in valuation of these two companies.

Now coming to the valuation of PG Foils on an independent basis, if you look at the balance sheet of the company as on today, the marketcap of the company is just about 40 crore. As on March 31, 2009, this company had debt of Rs 50 crore, there is 50% decrease in the interest cost in FY10—assuming a debt of Rs 30 crore as on March 31, 2010 takes the enterprise value of this company to 70 crore. As against the enterprise value of Rs 70 crore, this company has cash and cash equivalents of roughly 42 crore.

 

This company has been paying premium towards Keyman Insurance Policy for the past six years and I believe that the cash flows—we don't have the details of the Keyman Insurance Policy—but talking to people in the insurance industry, the potential payback, which this Keyman Insurance Policy can bring in on maturity can be potentially more than the marketcap of the company.

Now you have a company where it is available at practically less than its cash value for a business, which does a turnover of about Rs 170 crore, makes the operating profit margin of 12% and the capacity going up in November- December to more than double—I think this is undervaluation. This undervaluation is primarily because of the fact that the market has failed to look beyond the numbers, which are understated for various reasons. Given the potential cash which the Keyman insurance policy can bring in, the cash and cash equivalents which are there in the company and the potential growth which can happen on the completion of ongoing capacity expansion, I think these things make this stock a growth stock with the deep value at good margin of safety.

 

 

Stock Review: POWER GRID

Profits may take a hit down the road

POWER GRID, a power transmission company, has managed to record a reasonable performance for June'10 quarter, after three quarters of nearly stagnant sales. The performance would provide the much needed boost to the company, which is expected to come up with its follow-on offer in the next few months. Though the performance in the June quarter has been good, the near term outlook for the company and the stock remains somewhat uncertain owing to the expected offer.

Lower inter-state power transmission has impacted Power Grid's growth in the previous quarters. In the June quarter, however, it witnessed a reasonable growth. Sales grew by 17%, against the average of less than 3% over last three quarters. Similarly, net profit growth is more than double the average at almost 30%, aided by cost control and lower fixed cost per unit of electricity.

The company has a very high proportion of fixed costs, with interest cost and depreciation accounting for more than half of total cost. While these two items recorded an increase, this was more than compensated by increase in sales, leading to better profitability. With high capital investment on the building of transmission grid, the cost is expected to remain high in the short to medium term for the company.

The company owns and operates power transmission network across the country and earns revenue in the form of user charges for its network. The business is highly capital intensive with over Rs 40,000 crore of capital employed generating revenue of about Rs 7,000 crore annually. Further, even though the business is regulated in nature, which caps its profits, the company plans to lay out the transmission network to meet the needs of power across regions. It is undertaking massive capex program totaling Rs 55,000 crore by 2012, about half of which has been completed. To meet the equity needs for this program, the company would be undertaking 10% equity dilution, which would increase its net wroth by nearly Rs 4,000 crore. The follow-on offer is also an important part of the government program of divestment, and would generate funds to the tune of Rs 4,000 crore for the government.

With the expected equity dilution and capex plans in the near term, the company may witness pressure on its profits in the next few months. The company may also witness the prospect of muted revenue growth in the medium term due to lower network utilisation in certain segments.

Stock views on Superhouse Ltd

 

 

 

This is a leather company based in Kanpur. This company is a leading exporter of leather and leather products from the country. This company has got 11 plants—all located in Uttar Pradesh. These plants are located in Unnao, which is very close to Kanpur. They have manufacturing operations in Kanpur, Agra and Noida. In all they have got 11 manufacturing plants making different products and besides these manufacturing plants, this company has got subsidiaries and overseas offices primarily for the purpose of sales of their products.

Now, the brands of the company are Allen Cooper and Double Duty. Allen Cooper has got good brand visibility also and it is used for the retailing of the company's products in the domestic market and also in select export markets. Double Duty is the company's brand for industrial safety shoes. Now if you look at the financials of the company, for FY10, this company reported sales of about Rs 355 crore, profit after tax was about Rs 13.5 crore. This company provided for a depreciation of close to Rs 18 crore which makes a cash profit of about Rs 21.5 crore. EPS on trailing 12 months basis is close to Rs 13.5. So at the current price of about Rs 56, this stock trades at a P/E multiple of just about 4.

So you have a stock where the cash profit is about Rs 21-22 crore and the marketcap is just about Rs 60-62 crore which means that the business is available at less than three years of cash flow. This company has been paying dividend on a consistent basis for the past few years. The latest dividend is about 12% and the most heartening fact is that the promoters for the past two years have been increasing their shareholding in the company.

The promoters holding has gone up from about 45% two years back to about 54%. So you have a company where the gross loss is about Rs 165 crore, sales are more than Rs 350 crore and the marketcap is just about Rs 62 crore. So at a P/E multiple of 4 and this kind of marketcap, the stock looks grossly undervalued.

 

Stock Review: Tulip Telecom

 

 

At Rs 182, Stock Trades At Nearly 10 Times Its Earnings For The Trailing 12 Months

 

THE stock of enterprise data connectivity provider Tulip Telecom has underperformed the broader market in the past six months. It earned 5% returns during the period against the 8% gain in the benchmark Sensex. The company's decent performance in the June 2010 quarter may support the stock going ahead.

   Tulip's consolidated revenue rose nearly 20% to Rs 525 crore in the June 2010 quarter. This was on account of the growth registered in high bandwidth fibre services and wireless business segment. Over the past 18 months, the company has extended its intra-city fibre network to over 6,000 kms to provide an end-toend data connectivity solution to its customers across cities. Also, with the fibre rollout, the company has enhanced its customer base to more than 600 and witnessed stronger engagements with the existing clients.

   Improved contribution from the fibre business and progressing wireless segment aided an expansion of 250 basis points (bps) in the operating margin at 27% on a year-on-year basis. The significant shrinkage in the other income was coupled with an extraordinary increase in the tax expense, which almost doubled to Rs 20 crore during the June 2010 quarter against the year ago. This led to a somewhat restrained increase of 9% in the bottomline to Rs 64 crore.

   Going ahead, the company plans to improve operating efficiency by focusing on revenue maximisation per customer, thereby improving on the net profit numbers. During the quarter, it has witnessed several order wins and licence grants. It has also entered into strategic tie-ups such as partnership with Qualcomm for Broadband Wireless Access (BWA) venture. This will enhance the company's service offerings and its reach in the enterprise data service market.

   At the current market price of Rs 182, the stock trades at nearly 10 times its earnings for the trailing 12 months. Given the extended fibre rollout, increased wireless demand and anticipated improvement in the margins, the company is expected to register an augmented performance in coming quarters.

 

Stock Views on RELIANCE INFRASTRUCTURE, TATA CHEMICALS, BANK OF INDIA

JP MORGAN on BANK OF INDIA

JP Morgan recommends `Underweight' rating on Bank of India. BOI reported Q1FY11 net profit at 730 crore, up 70% q-o-q, which was significantly higher than consensus estimates. A big surprise in margins and lower credit costs were the main reason for the profit beat. Asset quality has shown a smart improvement after three quarters of very high slippages. Asset quality held up much better than expected with gross and net NPAs (non-performing assets) contracting in Q1FY11. Net quarterly slippages were down to 50 bps from about 160 bps in FY10. As a result, credit costs fell by about 50% q-o-q in spite of increase in coverage. Provision coverage has now increased to 68%. Also, slippages from the restructured book were restricted to less than 100 crore in this quarter. Asset quality trend has been very positive in Q1FY11 and to some extent factored in the strong outperformance in the last one month. Also, the quantum in margin improvement was very surprising. JP Morgan's `Underweight' recommendation is based on bad asset quality trends over the last twothree quarters but Q1FY11 has been better than expectations on multiple parameters. They believe further stock performance would depend upon the sustainability of Q1FY11 asset quality trends.

BANK OF AMERICA on TATA CHEMICALS

Bank of America reiterates `Underperform' rating on Tata Chemicals on unfavourable risk reward. Tata Chemicals reported strong Q1 numbers helped by a jump in trading revenue and inventory gains. Adjusting for inventory gains, operating performance was flat. Higher margins reported in Q1 are not sustainable and we maintain annual estimates despite strong results. Stock trades at 11x FY12E PE for about 12% EPS CAGR. As per the company, while the urea plant operated below capacity at about 80% due to technical problems, utilisation is likely to be normal going ahead. The non-urea plant at Haldea worked at full capacity given the settled labour unrest. Trading revenue, up 4x y-o-y, was the main revenue driver in fertilisers. Also, the company reported the resignation of the head of the fertilisers division.

BNP PARIBAS on RELIANCE INFRASTRUCTURE

BNP Paribas maintains `Buy' rating on Reliance Infrastructure with a target price of 1,331. The major contributors to the valuation are the engineering, procurement and construction (or EPC) and Mumbai power distribution businesses and net cash on the balance sheet; the 45% stake in Reliance Power contributes 451 to the target price. Risks to the recommendation include poor execution, lower traffic, lower R-Power valuation and inability to recover cash advances. BNP assigns 621 per share to the standalone business (EPC + Mumbai energy + net cash). BNP derived R-Power's value using a 20% holding company discount to the utility team's target price of 140 for R-Power. BNP values all other assets (Delhi distribution, Kochi generation, highways, metros, transmission projects) at 259.

MAHINDRA and Mahindra Financial Services (MMFS)

 

 

Higher growth in disbursements and better asset quality may help M&M Financial Services outgrow its industry. Long term investors can buy this stock

 

MAHINDRA and Mahindra Financial Services (MMFS) is one of the leading non-banking financial companies (NBFC) in the country with a network of over 450 branches. Starting with loans for purchasing utility vehicles and tractors, the company now offers loans on heavy and used commercial vehicles with focus on rural and semi-urban markets.

   The company has recorded a robust performance in the June 2010 quarter on the back of higher growth in disbursements and better asset quality. This makes it an interesting bet for long-term investors.

BUSINESS:

MMFS is predominantly in the business of financing of utility vehicles, tractors and cars. These categories accounted for 90% of the disbursements in the June 2010 quarter. Of late, the company has ventured into other segments, such as heavy commercial vehicles (CV) and used CVs. The yield on used CV loans is higher as other financers shy away from these markets. This is because credit appraisal is extremely difficult in these markets.

   The share of newer categories in total disbursements stood at around 10% for the quarter ended June 2010. The management has indicated that the newer categories will be the growth drivers in the coming quarters. The company's presence in financing of various kinds of products helps it diversify the business risk.

FINANCIALS:

The company reported a 76% growth in disbursements in the June 2010 quarter year-on-year (y-o-y). Typically, the demand in the rural market picks up post monsoon. But this time around, the growth in disbursements was driven by an increase in demand from the auto/utility vehicles and heavy commercial vehicles segment on the back of the economic recovery.

   At the same time, the company has improved its asset quality too. Net non-performing assets formed just 1.3% of advances as against 3.1% in the same quarter last year. Investors can draw solace from the fact that the company has performed well both in the quality and the growth front.

   A high growth in disbursements has boosted the company's spreads, which jumped by 170 basis points in the June 2010 quarter compared to the year-ago period. Spreads are a measure of the difference between the cost of funds and yield on loans by the company. Spreads stood at 4.4% at the end of the June quarter.

   Moreover, the capital adequacy of the company stood at 18% at the end of the June quarter vis-à-vis 12% minimum required. This shows that the company has sufficient capital to expand without diluting its equity. Therefore, investors can expect a pro-rata growth in MMFS' profits and its earnings per share.

VALUATION:

At a price-to-book value (P/BV) of 2.1, it is trading at much lower valuations compared to its 2007 levels of 2.5. Therefore, it is cheaper compared to its
historical valuations. Moreover, the company's stock outperformed the Sensex with a return of 32% as against the benchmark's 4% in the past one month.

   This shows that investors' interest has increased recently in the company's stock. Higher growth in disbursements coupled with better asset quality will allow the company to outgrow its industry. Further, the segment it finances, primarily auto/utility vehicles and cars, tends to grow at a much higher rate than the industry in times of economic boom.

   And since the Indian economy is expected to grow its gross domestic product by 8-8.5% in the current financial year, the company can grow at a higher rate. Thus, the current valuations do not fully discount the company's growth potential. Investors can consider this stock for the long term.

 

Stock Views on PUNJ LLOYD, NMDC, GAIL

CREDIT SUISSE on GAIL

Credit Suisse maintains `outperform' rating on GAIL with a target price of 527. GAIL reported Q1FY11 EPS of 7, down 2.6% q-o-q. Revenue was up 9%, but higher costs meant EBITDA was up only 2.5%. Gas transmission tariffs returned to Q3FY10 levels. Though GAIL took a one-time revenue reversal on the provisional PNGRB (Petroleum and Natural Gas Regulatory Board) tariff cut, it does not seem to be applying the new tariffs on run rate. Transmission EBITDA was up 26% q-o-q. Petchem sales volumes disappointed and were significantly below production. Volatility in prices can prompt buyers to defer purchases and GAIL to build inventory, which can unwind as prices rise. The LPG segment was hit by higher subsidies, but these should fall beginning Q2, as the impact of the price hikes kicks in. GAIL has also been allowed to charge marketing margins on APM gas. The risk is GAIL may have to reverse more revenue, as tariffs are finalised. Credit Suisse builds in some of these upsides, and cuts the FY12E volumes. FY11E EPS increases 9% to 29.

UBS on NMDC

UBS maintains `Sell' rating on NMDC with a price target of 210. NMDC's Q1FY11 PAT of 1,500 crore was marginally lower than the estimate of 1,580 crore mainly due to lower revenue. This was partly offset by higher than estimated EBITDA margins. Revenue increased 97% y-o-y to 2,520 crore due to 20% increase in volumes. EBITDA margin improved to 81% from 76% in Q4FY11 largely due to: 1) 36% q-o-q increase in average net realisation 2) lower other expenses, primarily royalty costs. Total operating cost was 470 crore lower than the estimate of 670 crore, primarily because of lower other expenses. Royalty cost per tonne was 242 in Q1FY11. NMDC has raised prices by 22%/14% q-o-q for export/domestic customers for Q2FY11. NMDC now follows quarterly pricing and will pass on 2/3rd of the export price increase to domestic customers. UBS continues to value iron ore business using NPV (net present value) and steel business on book value of investments as at FY11E and remains cautious due to expensive valuations

CITIGROUP on PUNJ LLOYD

Citigroup maintains `Sell' rating on Punj Lloyd. Punj Lloyd reported Q1FY11 PAT loss of 30.6 crore, significantly below the estimate of 43.9 crore profit. PAT loss was driven by sharp decline in revenues. Q1FY11 revenue at 1,610 crore declined 46% y-o-y and was 36% below CIRA estimate of 2,500 crore. Continuing execution delays and operating leverage led to EBITDA margins falling to 0.4% in Q1FY11 from 9.7% in Q1FY10. Auditor qualification on profit of 119 crore on sale of investment has been removed in the quarter, but other auditor qualifications on 243 crore of project claims and 65.5 crore of liquidated damages related to the ONGC project continue. Work has started on civil projects in Libya, and the company expects to book revenue from Q2FY11. ONGC's Heera project has been completed, and all four offshore rigs are fully operational now. Punj Lloyd continues to face execution delays, cost overruns in projects and auditor qualifications. 38% order backlog consists of delayed Libyan orders where execution is slow.

Stock Review: VARUN Shipping

 

At Current Valuation, Stock Looks Attractive And Investors Could Play Long

 

VARUN Shipping, a leading player in the transportation of liquefied petroleum gas (LPG) to the country, took a hit in its June '10 quarter performance due to sluggish freight rates on a year-on-year basis. Varun also operates in the offshore segment via its fleet of anchor-handling towing supply vessels (AHTS). Analysts tracking this segment point at broadly weaker day rates earned by players in this segment compared with a year earlier.

   As a result, the company's operating margin plummeted to 12.9%, one-thirds of the year-ago margin. Its core freight & charter income also declined 24.8% to Rs 132.2 crore. However, the company had sold one LPG carrier in the first quarter, which resulted in a profit of Rs 108.36 crore. As a result, net profit jumped more than 10 times to Rs 23.5 crore in the quarter. Excluding this non-operating income, the company's net loss was nearly Rs 84.8 crore in the quarter.

   Investors, however, pushed up the stock 16.4% to Rs 47.6 on Thursday. According to analysts, the stock is available at attractive valuations, given its sharp fall in recent months. The stock had fallen to its 52-week low of Rs 39.8 at the end of July.

   The company has highlighted the possibility of higher domestic demand for LPG during the current financial year, helped by government schemes such as the Rajiv Gandhi Gramin LPG Vitrak scheme. This should give a boost to its freight earnings, going forward. In addition, day rates on a global basis have shown signs of moving up for the offshore segment over the past few weeks.

   Stocks of big players in the sector, including GE Shipping, have not seen much action in recent months, given the tough operating environment. The difficulty for Varun Shipping, in the quarter under review, is reflected in a 9% year-onyear fall in the average spot freight rates in the tanker segment related to LPG as per industry estimates. However, it needs to be noted that players like Varun Shipping have long-term contracts with key clients to minimise this impact.

   Clearly, investors looking to buy shipping stocks would need to have a long-term horizon, considering the extremely difficult operating environment over the past 15-months, and recovery signs that still appear tentative.

 

JSW Energy

 

 

The outlook for JSW Energy looks promising considering the status of its projects and balance sheet. Mid-term investors can bet on this stock

   JSW Energy has regained limelight after strong quarterly numbers, aided by commissioning of newer capacities. The company tapped the primary equity market last year. Its stock has gained nearly 30% since then. It currently trades at a P/E of 18 times on a consolidated basis. Compared to its peers, it is placed very favourably. Investors with a mediumterm time frame can take exposure in the stock.

BUSINESS:

The company is in the business of power generation. It started operations in a big way only over the past 3-4 years. However, it has moved much faster as compared to its peers, which started around the same time. The company currently has a total generation capacity of about 1,000 megawatt, most of which has been commissioned over the past one year. Apart from these, it is executing a lignite-based project of a total capacity of 1,080 mw, of which 135 mw has been commissioned. The other project, based on coal of 1,200 mw, is expected to be commissioned in FY12.

   These projects will increase its capacity by about 1,000 mw in FY11, and another 1,000 mw in FY12, providing an impressive improvement in its financials. With more than 70% of the cost already spent, the projects are not expected to see any major delay. Further, it has bought stake in a coal mine in South Africa, which will take care of about 25% of its imported coal needs.

   Other than that, it has placed boiler, turbine and generator (BTG) orders for another 270 mw projects to be based on mixed fuel of coal and lignite, which is expected to be commissioned in 2013. It is also undertaking a hydro project of 240 mw capacity. However, the hydel projects typically take longer time, and it would be completed by the end of 2015 as per the company.

   The interesting part of private power plant developers is that they are not having a prior power off-take arrangement for complete generation capacity. While this puts them at higher risk if they don't find a buyer in the spot market, it also enables them to get a better price, which could be 40-60% higher. Unlike other commodities, power cannot be stored leading to loss of production in case the company does not have a buyer at any particular time. While, the company has been so far selling more in the spot market, it plans to sell more through prior purchase agreement going forward. The strategy looks quite prudent as the market may see more uncertainties with the commissioning of more capacities to serve the spot market.

FINANCIALS:

The company has grown at a very strong pace over the past three quarters, aided by the commissioning of some of its capacities. For the quarter ended June 30, 2010, both sales and profits nearly tripled over the corresponding quarter last year, on a consolidated basis. While fuel cost/sales ratio has risen considerably from 36% to 46%, it is still significantly lower than that for other generation companies. With a marginal increase in other operating cost, operating profit also grew by an impressive 170%. While interest and depreciation have also more than doubled, it does not pose any threat to the profitability with strong growth in operating cash flows. 

   For the past three quarters since the commissioning of the projects, while sales have risen by 80%, profits have risen by more than 229%. The profitability has been aided by lower growth in fuel and other operating cost.

OUTLOOK:

The outlook for the company looks promising considering the status of its projects and its balance sheet position. However, there is a slight risk with its significant dependency on imported coal, which has seen high volatility over the past 3-4 years and can affect the margins. To mitigate this risk, the company has bought a stake in a coal mine abroad, and should be following it with more such stake buy. Investors with a medium-term time frame can take exposure in this stock with significant upside potential, with expectation of reasonable gains in the next 3-4 months.

 

Stock Review: DLF

IMPROVING asset realisations have helped DLF report a double-digit growth in revenue during the June 2010 quarter. But the company's margins have suffered due to higher debt burden. In the coming quarters, though topline is expected to see a healthy growth, higher leverage may eat into profitability.

The country's largest realty firm reported a 23% growth in sales, aided by higher asset prices and a onetime gain from sale of non-core assets. Net profit, on the other hand, rose at a slower rate of 9%.

Overall, the numbers for the first quarter were in line with analyst expectations though growth moderated compared with the past two quarters. This is because the financial results in the past two quarters were boosted partly due to lower base in the previous year. Lesser number of new project launches was another reason for tapering growth.

Demand recovery is reflected from the increase in the leasing space. DLF's office lease space increased 30% to 1.2 million square feet (msf) during the quarter. Further, leasing rental also improved 60% to Rs 48 psf per month for office building during the same period. This shows demand is slowly reviving in the commercial segment.

A cause for concern is higher debt on DLF's balance sheet. The company has piled up loan funds due to the acquisition of group firm DLF Assets. DLF's net debt increased 24.5% during the quarter to Rs 18,463 crore. This has pushed its debt-equity ratio to 0.7, higher than DLF's long-term target of 0.5.

One way the company can reduce its debt leverage is by selling off non-core assets. The firm has said it plans to raise up to Rs 2,500 crore from divestment of such non-core assets in the coming 15-18 months, besides diluting its stake in ongoing projects and cash generation from sale of new projects. If the improvement in the commercial leasing business is sustained, it could add further revenue for the company.

In the past six months, DLF's stock has been an underperformer. It lost 9% during the period against the 10% gain in the Nifty.

Going forward, growth in revenues would depend on the success of new launches. The company is awaiting approvals for some of its new projects. This, together with existing inventory, may keep its sales growth ticking, even though the impact of low base of the year ago quarters will be neutralised. Margins will largely be a function of how well the company can control the cost of servicing debt in the coming quarters.

Stock Review: GMR Infrastructure

The company can gain from monetising its assets in InterGen

GMR Infrastructure has managed to achieve closure for the acquisition of InterGen, one of the leading global power generation company. The closure for refinancing $737 million through a two-year loan at Libor plus 2.75 per cent, with afacility of a five-year Libor plus 4.24 per cent, is seen as apositive. It was in October 2008 that GMR had taken on a debt of $1.1 billion to fund the purchase of a 50 per cent stake in InterGen, which uses gas for 85 per cent of its power generation capacities.

While this is seen as a positive closure for the deal, concerns for GMR Infrastructure persist. According to analysts at Anand Rathi Securities, "Cash flows from InterGen should be able to cover the $55-60 million annual interest payment on the acquisition debt. Principal will be in the form of bullet repayment at the end of tenor. However, given InterGen's projected cashflow profile, it would need refinancing." Analysts also indicate that InterGen had $130 million distributable cash, of which it gave 50 per cent to shareholders. "Given aforementioned overhangs, we expect GMR management to focus on monetising InterGen stake," say analysts at Anand Rathi Securities.

One can expect some consistency from InterGen, as around 70 per cent of its revenues have been contracted till 2017-18, mention analysts. The company also enjoys a steady record of developing 16,000 Mw of power in 10 countries. Also, there are other aspects about GMR Infra that make the company's share price look to be a good prospect. One is that it has hit the floor at around Rs 55 per share and then there are triggers that could elevate the prospects. Sales to the merchant power trade from its barge-mounted plant from June and higher regulated revenues from the Delhi Airport business are also significant positives. A higher gas allocation from the ministerial group will also be extremely beneficial for the company.

The company can gain from monetising its assets in InterGen

GMR Infrastructure has managed to achieve closure for the acquisition of InterGen, one of the leading global power generation company. The closure for refinancing $737 million through a two-year loan at Libor plus 2.75 per cent, with afacility of a five-year Libor plus 4.24 per cent, is seen as apositive. It was in October 2008 that GMR had taken on a debt of $1.1 billion to fund the purchase of a 50 per cent stake in InterGen, which uses gas for 85 per cent of its power generation capacities.

While this is seen as a positive closure for the deal, concerns for GMR Infrastructure persist. According to analysts at Anand Rathi Securities, "Cash flows from InterGen should be able to cover the $55-60 million annual interest payment on the acquisition debt. Principal will be in the form of bullet repayment at the end of tenor. However, given InterGen's projected cashflow profile, it would need refinancing." Analysts also indicate that InterGen had $130 million distributable cash, of which it gave 50 per cent to shareholders. "Given aforementioned overhangs, we expect GMR management to focus on monetising InterGen stake," say analysts at Anand Rathi Securities.

One can expect some consistency from InterGen, as around 70 per cent of its revenues have been contracted till 2017-18, mention analysts. The company also enjoys a steady record of developing 16,000 Mw of power in 10 countries. Also, there are other aspects about GMR Infra that make the company's share price look to be a good prospect. One is that it has hit the floor at around Rs 55 per share and then there are triggers that could elevate the prospects. Sales to the merchant power trade from its barge-mounted plant from June and higher regulated revenues from the Delhi Airport business are also significant positives. A higher gas allocation from the ministerial group will also be extremely beneficial for the company.

Stock Review: Nestle India

The stock trades at a premium to the Sensex due to superior branding and innovative product strategies

The results of Nestle India were more or less in line with expectations.

However, the outlook on the share price is not the same, it's a tad low. According to analysts, the company's share price trades at a premium of around 120 per cent to the Sensex due to its superior branding and product strategies. Five-year average premium is also 80 per cent to the Sensex, hence, 120 per cent looks a tad expensive for this fast moving consumer goods (FMCG) major.

The company's revenues have grown 21 per cent yearon-year, while net earnings have also risen at a similar rate. Operations at Pantnagar (a 58-basis-point drop) and the tax cover helped on lower tax outflow, which helped in earnings to grow. But, operating profits remained muted due to to rising input costs.

The management has been proactive to beat competition in the noodles segment. It has launched two new variants in Maggi – tricky tomato and thrill in curry. Also, the introduction of hot and sweet Maggi Pichkoo is also expected to be positive.

Hindustan Unilever and Glaxo Smithkline have been penetrating the noodle market that Maggi rules. However, its distribution reach and cheaper units, which contribute 30 per cent to its sales, have been aiding strong double-digit growth in smaller towns, according to analysts. But there are concerns over the cost. The company gets affected by rise in prices of key inputs like sugar and milk. These would be watched by analysts as the monsoon unfolds.

As revenues in the milk food steady out, analysts expect the prepared foods business to grow more than 20 per cent in the current financial year and support revenue growth. If this happens, the premium valuations will be held.

Stock Review: Mundra port & SEZ

Positive news flow related to the development of an Australian port terminal and better-than-expected results have helped the Mundra Port & Special Economic Zone (MPSEZ) scrip climb seven per cent over the last one week to Rs 772. The Adani group, the promoter of MPSEZ, has also been in news after it snapped up a coal mine in Australia for $455 million plus a royalty payment based on production. The mined coal is likely to be shipped through the port terminal to be developed by MPSEZ.

Robust performance

MPSEZ reported 35 per cent yo-y growth in revenues for the June quarter on the back of a 27 per cent jump in cargo volumes to 12.6 million tonnes. Cargo-handling realisations grew 11 per cent y-o-y to Rs 320 atonne due to higher volumes from the new container terminal, CT-2. Lower cargo handling costs helped earnings before interest, tax, depreciation and amortisation (Ebitda) grow 31 per cent to Rs 290 crore. Adjusted for a forex loss of Rs 4.6 crore net interest charges fell 12 per cent to Rs 20 crore. High margins helped net profit register growth of 24 per cent to Rs 211 crore.

Operational gains

The company has scaled up operations in all three segments —dry bulk, liquid and container terminals. Higher cargo volumes in bulk (up 36 per cent due to rise in coal, iron and steel trade) and container cargo (up 28 per cent) have helped it post the jump in overall volumes.

Crude volumes, says an IDFC Securities report, recovered during the June quarter and grew 6.4 per cent to 2.2 million tonnes. Crude volumes had been impacted since the second half of FY10 due to lower offtake from Indian Oil Corporation. The oil major's depot near Jaipur was gutted in the December quarter last year.

Gaining share

The jump in cargo volumes implies that MPSEZ's share of the cargo pie in the country increased to 8.3 per cent from 6.7 per cent in the year-ago quarter. Its share of container volumes has increased by a percentage point to 12.8 per cent. The MPSEZ port is the eighth largest in the country in the cargo segment and the third largest in the container business.

Investment rationale

Given the growth in cargo volumes vis-a-vis other ports in the country, IDFC expects MPSEZ to be the leader in the ports business over the next five years. Further, the company has a strong balance sheet with leverage at less than 0.5 times and strong cash flows (Rs 1,000 crore annually) from the port business. This will help part-fund its expansions in Dahej, Mormugao and Hazira ports. IDFC believes leasing of the SEZ at Rs 70 lakh per acre has led to higher valuations than envisaged earlier. The recent jump in prices implies there is little upside for the stock in the near term.

Stock views on GRASIM, BANK OF INDIA

Enam Research on BANK OF INDIA

Bank of India reported a strong performance with 24 per cent increase in net profit y-o-y with an improvement in asset quality. Core income was up 34 per cent y-o-y led by 20 per cent loan growth and higher margins at 2.89 per cent.

Asset quality improved with absolute gross non performing asset (NPAs) declining 2 per cent sequentially led by lower slippages and strong recoveries/upgradations. Gross and net NPA ratio stood at 2.71 per cent and 1.18 per cent, respectively.

With the asset quality concerns of the bank receding, earnings estimates are revised upwards by 15 per cent and 4 per cent for FY11E and FY12E, respectively. The stock is trading at 1.4x FY12E ABV and 7.5x FY12E earnings with sector neutral rating.

Enam Research on GRASIM

Grasim's adjusted net profit dropped 22.5 per cent y-o-y during the quarter to Rs 575 crore.

The company's consolidated bottom-line fell on to poor performance by the cement division, which reported 27 per cent y-o-y decline in operating profit.

However, the VSF division continued its impressive show and registered 54 per cent y-o-y growth in operating profit. UltraTech will be the sole driver of its interests in the cement business post the UltraTech - Samruddhi merger, which comes into effect from August 1.

On a stand-alone basis, the company would primarily focus on its VSF business, which has recovered well over the past few quarters from the slump in FY09.

Stock Review: Hindalco

 

Co's Operating Margins May Take Some More Quarters To Recover

 

HAD it not been for higher aluminium prices and better by-product realisation in its copper business, Hindalco's first quarter results could have been worse.

   Lower realisation in the copper business and adverse rupee movement were the major headwinds for the country's top aluminium producer. These factors, together with rising energy costs, may continue to impact its performance in the next few quarters.

   The June quarter turned out to be a tough period for Hindalco on a standalone basis, since most of the macroeconomic factors that influence its business were negative. For example, copper realisation or treatment and refining charges (TcRc) are reduced by one-thirds during the quarter from the year-ago level. Since copper division contributes two-thirds of total standalone revenue (excluding Novelis), the sharp fall in its TcRc chopped the overall operating margin by as much as 437 basis points (bps).

   The rupee appreciation of 7% against the dollar on a year-on-year basis also weighed down on the company, which earns around 25% of revenue from exports.

   The company's copper business continues to face headwinds on account of low TcRc margins. Moreover, the mine supply continued to fall short of copper concentrate demand, which escalated pressure on copper margins. The company, however, is trying to mitigate the effect of low TcRc with the help of higher realisation on by-product and lower energy input costs.

 

   Going ahead, the woes of the copper division are likely to continue since the management does not foresee an immediate reversal in spot TcRc prices. Its aluminium business, on the other hand, continues to cushion its profitability. Though it contributes one-thirds of the revenue, its share in operating profit before depreciation is much higher at 62%.

   To leverage higher demand for its aluminium products, the company is focusing on high margin value-added products. It has also chalked out plans to reduce energy and input costs by increasing the share of captive coal mining and expanding production of aluminium, the key raw material for production of aluminium.

   However, these initiatives would take at least 12-18 months to commence. And until then, the company's performance would be closely linked to fluctuation in energy and input costs. Also, its operating margin can take some more quarters to recover, given the turbulence in its copper business.

 

Stock Review: GAIL

The increase in availability of gas in the country continues to benefit GAIL, which reported its highest ever quarterly revenues for the June 2010 quarter on Monday. Higher volumes and better realisation across business segments boosted its net profit during the quarter. Analysts are upbeat about GAILs prospects and estimate that volumes will increase further leading to an earnings growth of 10-25 per cent over two years. This should help the stock deliver good returns over the next one year.

Volume boost

Gas transmission volumes for GAIL have been on an uptrend -from the time RIL commissioned natural gas production from its KG-D6 basin around

March 2009 .The volumes gradually improved from 80-85 million standard cubic meters per day (mscmd) to 115 mscmd in March this year.

For the June quarter, transmission volumes stood at 116 mscmd, which reflects an increase of 20.2 per cent year-onyear. Although this business accounted for just 11 per cent of revenues, it contributes about 46 per cent to segment profits, and helped boost profit growth.

Analysts believe that GAIL may end the current year with transmission volumes of 116-118 mscmd against 107 mscmd in 2009-10. But, with GAIL's capacity expected to increase by 20 mmscmd from December 2010, they expect volumes to increase by 18-20 per cent in 2011-12.

In the gas trading business, too, volumes grew at a healthy pace which - along with the increase in administered gas prices (APM) and GAIL being allowed to charge marketing margins on APM gas sales - aided profit growth for the quarter. GAILs other businesses, especially LPG and liquid hydrocarbons, also did well, led by an increase in production and higher realisations.

On the flip side, consequent to higher crude oil prices, GAILs subsidy outgo nearly five-fold to Rs 445 crore, and restricted its profit growth during the quarter.

Investment rationale

Going ahead, while the expected rise in Indias gas production as well as higher liquefied natural gas imports by the likes of Petronet LNG and Shell will improve availability, the increasing urge towards this cleaner and cost efficient fuel (gas) will help sustain demand, ensuring higher volumes for GAIL.

On its part, the company is investing in augmenting its pipeline infrastructure (besides petrochemicals capacity), which should support the increase in volumes. While the overhang of subsidy sharing is likely to remain for some time (till the recommendations of Kirit Parekh committee of excluding GAIL from subsidy sharing gets accepted), GAILs medium-term growth prospects continue to look good.

Based on sum-of-the-part valuations, analysts have pegged a value of Rs 530 to the stock, which indicates good upside from the current levels.

Stock review: India Cements

Glut in the southern market has been a drag, but valuation of the IPL franchise could be a positive

The positive sentiment in the stock of India Cements emerges not from its cement business but from the fact that it owns the Indian Premier League (IPL) franchise of Chennai Super Kings. The franchise is expected to be valued around $1 billion.

The company's cement operations remained depressed in the June quarter due to the onset of monsoon. Moreover, poor demand and excess capacity in the southern markets put a lid on prices. India Cements sells around 90 per cent of its production in these markets, where prices have declined the most (by Rs 20-25 per bag over the past two months). Even though average realisations remained steady at around Rs 3,321 a tonne, they remained prohibitive, reckoned analysts. Revenues rose nine per cent year-on-year to Rs 880 crore, but net earnings were down 35 per cent to Rs 36.5 crore. The operating profit fell 21 per cent to Rs 100 crore.

The South India cement market will continue to face some pricing pressure, as it remains fragmented. Top five players account for less than 50 per cent market share in the region, as compared to 70-80 per cent in other parts of the country, point analysts. Almost 40 million tonnes a year capacity was added in FY10, half of which came from South India. To add to the woes, the region saw a drop in consumption by around three per cent on a year-todate basis in the current finanacial year.

Now, only the IPL franchise could save the day with decent valuations, but there is little clarity on these numbers. Analysts have been wary of making an estimate. If one just takes the cement business in consideration, the company is valued at around $70 per tonne, a 40 per cent discount to its replacement cost, say analysts at ICICI Direct. This does not leave much scope for any price appreciation. However, clarity on Chennai Super Kings numbers could provide an upside.

IPO Review: Prakash Steelage

Prakash Steelage, which is into manufacturing and trading stainless steel welded and seamless pipes, has come out with an initial public offer (IPO) of Rs 63-69 crore to fund expansion plans and working capital needs. The company manufactures several products of stainless steel pipes, which find application in major industries, including power, oil & gas, chemical, pharmaceuticals and automobile. It generates about 15 per cent of its revenue from exports, which it intends to increase after the expansion.

Improving prospects

The company is the secondlargest player in the organised stainless steel pipe industry, which is about half the total size of the industry. At present, the per capita consumption of stainless steel is low in India at about 1.2 kg compared to six kg in China. This figure is even higher in other developed countries. However, consumption is growing, led by the ongoing investments in user industries as well as new applications of stainless steel considering its qualities and resistance to corrosion.

Changing dynamics

On the back of opportunities, the company's sales turnover has grown more than four-fold in the last four years, supported by an increase in installed capacity from 4,000 tonnes in 2006-07 to 15,600 tonnes in 200910. The company is in the process of increasing capacity to 19,000 tonnes by end-2010. The company expects to produce 16,000 tonnes stainless steel products in 2010-11 and 17,500 tonnes in 2011-12 as compared to 10,699 tonnes in 200910. This will help it reduce dependence on the trading business, which currently accounts for half its total net sales and commands operating margins of just about three per cent as compared to 17 per cent in the manufacturing business.

As a result of this, while total sales will grow 10-15 per cent over the next two years, the net profit will see a significant jump as a result of higher margins. Currently, the company's operating margins hover around 10 per cent as compared to the industry average of 15 per cent.

Outlook

Overall, the company's profile — its market share, capacity, clients, financial performance and growth prospects — look good, which should ensure healthy pace going ahead. High leverage (debtequity ratio of 1.2 times post-IPO) and cyclical nature of the industry are the key risks. At the upper price band of Rs 100-110, the issue is priced seven times its preIPO capital (10 times post-IPO equity) based on 2009-10, which is largely on a par with its closest competitor and the largest player in the segment, Ratnamani Metals (quoting at 7.5 times its trailing earnings). Even after assuming growth rates and oneyear forward earnings of both these players, the IPO looks fairly valued.

 

Stock Review: Persistent Systems

 

 

Considering Persistent Systems' revenue and margin growth, the stock looks attractive for investors

 

INCORPORATED in 1990, Persistent Systems is a new entrant in the BSE mid-cap index. It is one of the leading players in outsourced software product development (OPD) services industry. The company provides services across all phases of the software product development cycle providing end-to-end solution. Currently, the company is present in the telecom, wireless, life sciences, healthcare, infrastructure and systems space.

FINANCIALS :

In the quarter ended June 2010, the company's topline grew considerably by 37% to Rs 181 crore over the year ago period. This was due to an almost 100% revenue growth in the I T infrastructure segment. While the company's telecom segment registered a single digit growth during the quarter year on year, the revenue growth of its life science segment stagnated.

   During the June quarter, Persistent's operating margin dropped significantly by 540 basis points (bps) against the year-ago period due to a 40% rise in staff costs. Also, a rise in selling, general and administrative expenses (SG&A), which increased by nearly 13% to Rs 34 crore, contributed to the falling margin. However, the company expects to restore its depleted operating margin on account of realizations from the fresh recruits next quarter.

   The company plans to maintain SG&A expenses at the current level of 19% of the net revenue for the coming quarters. The company has added 830 new employees last year. This substantiates for a demand upsurge in the OPD market, predominantly in the cloud computing and mobile handsets space.

GROWTH DRIVERS:

Due to the global meltdown, product companies had cut short their investment and research and development (R&D) activities. This led to a slowdown in the demand for OPD services. However, the economic stabilisation has augmented clients' R&D spends resulting in a growth of the market for OPD. As per analysts' forecasts, the compound annual growth rate for product engineering services is expected to be around 14% for the next five years.

   Persistent is planning to foray into the emerging growth areas such as cloud computing, analytics, collaboration and mobility which will benefit the company with an enhanced operational base. Also, it has recently made investments in the intellectual property (IP) based model resulting in value-added products and services to its existing client base as well as new clients. The recent initiatives taken up by the company would further add to its faster growth.

VALUATION:

OPD market is a niche area of operation with limited competition, which makes the company a leader in the space. At the current market price of Rs 456, the company's scrip is trading at nearly 16 times its earnings for the trailing 12 months. The current quarterly numbers substantiate for the company's annual EPS guidance of Rs 35 which discounts the current price by nearly 13 times. Considering a better revenue and volume growth in future, Persistent Systems looks an attractive bet for investors.

CONCERN:

Even though the company has a wide client spectrum and benefits from a large operational base, the revenue structure is geographically concentrated with more than 80% of the revenue coming from the US. This makes the company more vulnerable to currency fluctuations and economic cycles.

 

Stock Review: Adhunik Metalinks

 

Co Trades at 23.5 Times Its FY10 Earnings And High Growth Justifies Premium

 

THE stock of Kolkata-based steel maker Adhunik Metalinks has outperformed the Sensex over the past one year. It gained 23% compared with a 17% return of the Sensex during the period. In the past, the company recorded an impressive growth fuelled by the strong demand from the automobile sector, its key user segment.

   Adhunik Metaliks manufactures a wide range of products in carbon steel, alloy steel and stainless steel catering to the demand of automobile, power, engineering and oil industries. Currently, about 82% of the revenue comes from steel and the remaining from the merchant mining business.

   The company now intends to focus more on merchant mining of iron ore, manganese, and power business since margins are better in these segments. The company recently commissioned captive iron ore mine in Orissa. This can help the company to reduce its exposure to raw material prices and increase its operating margin. It is also expanding iron ore and manganese ore production facilities through its subsidiary Orissa Manganese and Minerals.

The expansion is expected to improve its iron ore mining by 50% in FY 11. The company also wants to foray into high margin merchant power business. It is currently setting up 1,080 MW merchant power plant at Jamshedpur. Both merchant power and merchant mining are profitable segments and are likely to help the company keep its growth momentum in the coming quarters.

   However, the company's expansion plans come at a cost. Its balance sheet is highly leveraged with debt: equity ratio of more than three. This leaves little room for Adhunik to raise further debt. The higher concentration of debt in its capital structure may prompt the company to look for strategic investors.

   In the March '10 quarter, the company clocked an impressive double-digit growth in sales whereas its net profit jumped more than 20 times. This was on account of investory stock adjustment and improvement in overall operational efficiency.

   The company is trading at 23.5 times its FY10 earnings. Though this seems to be higher than P/E of 14-16 for most of its peers, the premium can be attributed to Adhunik's high growth prospects.

STEELY SHOW

Adhunik Metaliks
manufactures a wide range of products in carbon steel, alloy steel and stainless steel

The expansion may improve its iron ore mining by 50% in FY 11. It also wants to foray into high margin merchant power business