Stock Review: COAL INDIA

Higher e-auction sales and other income powered a 64% growth in Coal India's earnings in the first quarter of FY11. Though demand for coal will remain strong across sectors, especially power, India's largest company by market capitalisation will have to manage its operational side to benefit from this.

In the first quarter of FY12, Coal India's net sales rose 27% to . 14,499 crore and its operating margins improved 630 basis points due to higher average realisation per unit of coal sold due to price increases in February and higher sales through e-auction.

Sales through e-auction accounted for 12.7% of total revenues against 11.1%, with average realisation being 2,245 per tonne, almost two times the price notified by the company earlier. Its other income was also up by almost 50% to . 1,572 crore, taking the net profit to . 4,144 crore. For the current fiscal, Coal India has set a coal production target of 452 million tonnes, 4.8% higher than previous year's and to avoid the piling up of the already huge inventory, it has set a year-on-year 7% higher dispatch target of 458 million tonne. Though the yearon-year numbers are good for the first quarter, it needs to be noted that the company missed the production and dispatch target by 16% and 2%,

respectively. The growth has been primarily because of a higher selling price. Coal production in the first quarter was 96.3 million tonne, or 21.3%, of the target set for the year and it dispatched 23.2% of the yearly target in the first quarter. Higher dispatch was possible, primarily because of the higher availability of the rail rakes, 168 per day against 154 per day in the June quarter previous year.

But in the second quarter, the company's production will be impacted due to heavy rainfall, which was not very severe last year. Also, the company's performance is strongly linked to the rakes being available to dispatch coal from the mines. To achieve the remaining target, it will need around 175 rakes per day, which will not be so easy. Rake availability in the first quarter was 168 per day. Given this, the company's future performance will be highly dependent on average coal selling price and other income. Another price increase this year looks less likely because of inflationary pressure. The huge cash pile of close to . 50,000 crore on its books will help the company boost its other income in a high interest rate scenario. At the current market price of . 394, the company is trading at a price-to-book value of 7.5 and any upside looks limited.

ULIP Review: ING Market Shield

Product Details

ING Market Shield is a Type I unit-liked insurance plan that offers highest net asset value (NAV) guarantee on a daily basis over seven years. However, unlike other guaranteed schemes Market Shield guarantees only 80% of the highest NAV. So, if the net asset value of the plan increases from 10 to 20, the guaranteed NAV will only be 16. ING Life offers just one investment option to investors under the scheme, the guaranteed NAV fund.

Unique Feature

Market Shield offers guaranteed NAV on surrender or demise of the policyholder. Others pay just the accumulated fund value in these situations. It is an open ended scheme which allows investors to invest in it any time. They do not need to wait for the series to recommence. The scheme has a tenure of 15-20 years compared to a maximum of 10 years for its peers.

For Existing Customers

Those already invested in the plan should remain invested. The fund is likely do well in the long term due to its higher exposure to equities. However, considering the capital market cycle one should shorten the policy tenure to 7-10 years. You may add term insurance if your life cover is not adequate.

For Those Looking to Invest

For those interested in ING Market Shield, it's a good time to invest in the plan as you will get a unit at 9.72with 8.1 as the guaranteed return. However, one should bear in mind that the cost structure of the scheme is high. Investors with a high risk-return appetite may skip this scheme as most of the investment is in debt.

Our View

ING Market Shield is unique in the D category of guaranteed NAV plans. Its offer of benefit of guarantee on death, surrender and partial withdrawal makes the product beat most other scheme as they offer guarantee only on maturity. However, a volatile market has impacted the fund's performance. The returns have fallen by 2.3% taking the NAV to 9.77, below the base NAV of 10. Currently, the guaranteed return stands at 8.1 per unit only due to its 80% cap. At 100% guarantee, the return would have been 10.13 per unit.

 

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Also, know how to buy mutual funds online:

 

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Invest in L&T Mutual Funds Online

 

Invest in Edelweiss Mutual Funds Online

 

Stock Review: Colgate-Palmolive

 

Colgate-Palmolive (India) is close to celebrating its platinum jubilee in India, and yet the brand remains as fresh in consumers' minds as when it first entered this market. Its toothpaste brands have captured slightly more than half of the Indian oral care segment. The company no longer relies on toothpaste alone: it now straddles the toothbrush and toothpowder segments as well and comes out tops in both.

So far Colgate has had a successful run. At the national level, it has had to contend only with HUL (Pepsodent) and Dabur (Lal Dantmanjan and Babool). Its other competitors are smaller regional brands. More players though are now seeing serious money in your cavities and are going all out for a piece of the action.

 

Sources of moat

Imagine reaching out to 1.2 crore school-going children (read, prospective customers) every year. Imagine stocking your flagship product in over 45 lakh stores and being present in 1,000 towns all over India.

Finally, imagine engaging 36,000 doctors to recommend your products.
That's what Colgate does every year. Colgate's success, apart from the usual branding story, is one of building an elaborate distribution network — one which few competitors can duplicate easily. As a result, Colgate has captured 53.1 per cent of the Indian toothpaste market — twice more than its closest competitor.

Colgate's moat also comes from the high stickiness of its products. Like the daily newspaper, consumers don't change their preferred brand of toothpaste in a jiffy. That is the nature of this product. Hence, companies enjoying a dominant position in this category have a comfortable advantage over their competitors. In fact, Colgate has created such an effective machine that its average ROE for the last three year stands at nearly 140 per cent (though this figure will moderate in future).

Fortifying its hold. Colgate has extended its stranglehold to other oral care categories as well. In toothbrushes, it has a 40.3 per cent market share — way ahead of its nearest competitor (which has an 18.4 per cent share). In the toothpowder category, it has a 46.4 per cent market share (its closest competitor holds 30.1 per cent).

Colgate's high-decibel advertising, coupled with its unmatched distribution, has kept it ahead of the comcompetition. Within the toothpaste category, Colgate reported annualised volume growth of 14.7 per cent during the last three years — ahead of the industry's 10 per cent. Its toothbrushes saw higher volume growth of 26.6 per cent (annualised) compared to the industry's growth rate of 22.8 per cent.

Colgate's distribution strength. Colgate's market leadership is also owing to the strength of its distribution network. By 2010 its network had reached 94 per cent of rural areas and 97 per cent of urban areas. This depth of coverage is expected to help Colgate be present wherever the opportunity of uptrading comes up.

Rural focus. Colgate's focus on rural areas is now producing results. A full 40 per cent of the company's FY10 revenues came from rural areas. This is up from 35 per cent about five years ago.

 

Growth drivers

Low penetration. Toothpaste has a penetration of only 64 per cent in India. In rural India that number falls even lower to 40 per cent. Look at it another way - about 435 million Indians still do not use toothpaste (though some use toothpowder). For companies like Colgate that is a huge market that remains to be tapped.

Low per capita consumption. Further, at 127 grams, the per capita consumption in India per year is still lower than in many other markets. The Chinese, for instance, use twice as much toothpaste as Indians do, while Americans use four times as much. Simply encouraging people to increase usage by, say, brushing twice a day regularly will set the cash registers ringing for toothpaste companies.

New categories. Tooth-care companies are now chasing new categories like mouthwash. This Rs 100 crore market is dominated by Johnson & Johnson's Listerine with a 70 per cent share. Colgate has increased its volume share in this category from 7.5 per cent in FY10 to 22 per cent in FY11.

New launches. Colgate recently launched its Sensitive Pro-Relief toothpaste which addresses the sensitive-tooth segment. So far only GSK Consumer's Sensodyne was present in this segment. It has also introduced Colgate 360 Sensitive Pro-Relief Toothbrush.

 

What could cause moat to be breached

Toothpaste, as we said, is a product that has high connect with users, and something that they don't change easily. Those competing against Colgate have the option to address new users (like children), non users (persuade the rural population to migrate to toothpowder/toothpaste) or focus on niches (herbal toothpastes like Meswak). Regional players like Neem could maintain their hold through effective marketing.

The P&G threat. Procter & Gamble (P&G) is expected to launch either its Oral B or Crest brand of toothpaste in India. That will likely be the biggest threat to Colgate's predominance in the country. P&G is world's no. two oral care company just behind Colgate. Globally Colgate has managed to beat P&G in the toothpaste segment. It will be interesting to see how market shares change once P&G's toothpaste enters this market.

Current competitors looking for cavities. Domestic competitors like HUL's Pepsodent, Dabur's Babool, Red toothpaste and Meswak have upped the ante. Both are giving Colgate a run for its money in rural areas with their low priced variants. All are now spending more than ever on their brands. The stress is beginning to show. Volume growth for Colgate came in at 10 per cent during Q4FY11 — the lowest in the last 12 quarters. In future, strong rural reach by both HUL and Dabur could possibly slow down Colgate's volume growth.
So far Colgate has managed to fend off all its competitors successfully. Pumped up by higher ad spends, the company has managed not only to maintain its market share but has even increased it steadily. It is advantage Colgate so far.

 

Concerns

Higher advertising costs. Colgate spent 13.4 per cent of its revenues on ad spends during Q4FY11 (20.9 per cent in Q3FY11). That is among the highest in the category. Look at it another way: Colgate currently spends around 70 per cent more on ad spends today than it did five years earlier. Ad spends are expected to remain in the range of 15-16 per cent for Colgate in the immediate term.

Lower margins. High ad spends along with higher packaging costs due to rise in crude prices and other input prices (mint and menthol) impacted EBITDA margin by 287 basis points (bps) y-o-y in Q4FY11; it declined to 24 per cent. On a full-year basis, EBITDA margin for FY11 declined by 138 bps to 20.3 per cent. Margin expansion could continue to be muted on account of higher ad spends.

 

Financials

Over the last five years, the company's revenue has grown at a compounded annual growth rate (CAGR) of 16 per cent while its profit after tax has grown at 30 per cent. It is a debt-free company. Over the last five years, it has clocked a very high average return on equity of 105 per cent.

In Q4FY11, Colgate reported revenue growth of 12.6 per cent y-o-y to Rs 581 crore, largely driven by volume growth in the toothpaste category. Overall volume growth came in at 12 per cent for the quarter. Only toothpowders registered a marginal decline in volumes. All of Colgate's core brands, i.e., Colgate Dental Cream, Active Salt, Max Fresh and Cibaca did well. Earnings took a hit of 0.3 per cent (in Q4FY11) to Rs 114.1 crore on account of a 150 per cent jump in tax rates as the Baddi plant lost its tax benefits. In future, tax benefits will decline from 100 per cent to 30 per cent.

 

Valuation

Currently the stock is trading at a 12-month trailing PE of 32.77, which is higher than its five-year median PE of 26.1. Thus the company is trading at a level that is higher than its own historical levels.

This is not the best of times to accumulate this stock. The annualised earnings growth of the company over the last five years stands at 23.95 per cent. This gives it a price-earnings to growth (PEG) ratio of 1.37, which is rather high. Wait for a market correction before accumulating the stock.

 

 

Stock Review: India Cements

 

Chennai-based India Cements benefited from curtailed output among players in the South in the June 11 quarter. In addition, there was a strong improvement in realisations on a per-tonne basis. As a result, the company's operating profit margin doubled compared to a year earlier to 23.2% in the first quarter of FY12 while net sales improved 20.2% year-on-year (YoY) in the quarter under review.

In the company's key cement division, its realisations improved an estimated 29% YoY to . 4,172 per tonne in the first quarter of FY12, while dispatches declined nearly 12.8 %. Other leading players in the South, like Madras Cement, also improved their realisations by nearly 20.7% YoY on a per-tonne basis in the first quarter of FY12.

According to analysts' estimates, total cement despatches in the South declined nearly 5.4% YoY in the first quarter of FY12. India Cements' smaller divisions include its presence in the cricket series IPL, coupled with vessels involved in coastal shipping. However, the turnover of these two smaller activities is less than 10% of its net sales. Strong cement realisations helped India Cements' net profit rise 308% YoY to . 102 crore in the June 11 quarter. South-based players had also maintained production discipline in the March 11 quarter and it had also helped them report an improved performance in that quarter.

The India Cements stock ended Monday's trade 1.75% higher at . 70. And despite the improved performance in the June quarter, investors are skeptical of the broader sector, with the India Cements' stock hovering above its recent 52-week low. And that's because rising home finance rates have cast a shadow on demand from key users.

Going forward, the September quarter is the monsoon quarter and there is curtailed construction activity across the country. Also, the cement companies' ability to manage rising operational costs would remain key.

India Cements trades at a P/E of 14.8 times on a trailing four-quarter basis. Rival, Madras Cements trades at 9.5 times.

Stock Review: M&M

Even as its peer index, the BSE Auto, and the broader markets have registered losses of eight to 10 per cent over the past three months, Mahindra & Mahindra (M&M) has posted a four per cent gain and recently become the country's most valuable automobile company.

While macro headwinds and slowing demand have led to muted volume growth for most of its peers, M&M's leadership position in the fastgrowing utility vehicles (UVs) and farm equipment segments has held it in good stead. Vineet Hetamasaria, head of research at Pioneer Intermediaries, says its outperformance is because the company gets nearly all its sales from the diesel segment and a little over 65 per cent of its sales are to the rural/semi-urban segment. In addition, the introduction of new products in the pick-up segment has helped.

While others are finding the going tough, M&M is expected to maintain its margins and market share, due to its superior product positioning. At the macro level, with rural incomes likely to get a boost from the autumn harvest and higher crop prices, analysts expect the demand for tractors to remain robust. Likewise, the price advantage of diesel over petrol would ensure strong demand for its UVs. Analysts have pegged targets in the range of `800815, which indicates an upside of 15 per cent from the current levels.

The auto sector is likely to put up a muted volume show, with the Society of Indian Automobile Manufacturers cutting its industry growth outlook for the current financial year to 11-13 per cent from the earlier 12-15 per cent, on the back of higher costs of vehicle, fuel and credit. While the M&M management believes industry volumes are likely to moderate, it has maintained its tractor sector growth outlook at 11-13 per cent. Jinesh Gandhi of Motilal Oswal Securities believes the company will post 13 per cent growth in tractors and 18 per cent in UVs in 2011-12.

MARKET SHARE GAINS

Even as the key companies in the passenger vehicle segment are struggling with lower demand, M&M has posted steady growth. For the June quarter, its domestic passenger UV volumes grew 14 per cent, while that of the segment was at five per cent, helping it post market share gains of 450 basis points, to 56.2 per cent. In tractors, sales grew afifth as compared to the industry's 13.7 per cent, helping it to gain 230 basis points in market share to 43 per cent. Analysts say consolidation in the sector such as TAFE's acquisition of Eicher and M&M taking over Punjab Tractors, has helped lower the competitive intensity, giving pricing power to leaders such as M&M. "More often than not, the company has been able to pass on the rise in costs to customers," says Hetamasaria.

COST SAVINGS

On a standalone basis, higher raw material costs dented Ebitda (earnings before interest, taxes, depreciation and amortisation) margins, which declined 170 basis points yearon-year to 13.3 per cent, as input costs jumped 220 basis points in the June quarter.

However, on a sequential basis, the company was able to improve margins by 60 basis points, due to savings on other expenses, as well as price rises to the tune of three per cent taken in April across its portfolio. The gains would have been higher but for the margin hit on its tractor portfolio, due to the higher proportion of costly steel, rubber and castings. The farm equipment (tractor) portfolio fetches higher margins to the tune of 16-17 per cent as compared to the auto segment's 10-12 per cent. Given its leadership position in the two key categories, expect the company to report healthy margins in 2011-12.

SSANGYONG WORRY

M&M's Korean subsidiary is likely to post a small loss on revenue of $3 billion in this calendar year. While analysts expect it to meet the management's expectation of a 50 per cent jump in volume growth for the current year to 120,000 units, its task for the next year, calendar 2012, is cut out. Exports to Europe form a significant part of revenue and given the situation, it will be tough going, says an analyst. Though a small contributor, the company hasn't been able to achieve any significant success in the two-wheeler space, something the Street will keep an eye on.

On the flip side, other subsidiaries like M&M Financial Services, Mahindra Holidays and Tech Mahindra are expected to sustain healthy growth in the coming quarters, thereby adding value to the consolidated entity.

Stock Review: Linc Pen

Linc Pen is exact proxy to Camlin . Now what happened in Camlin is that the foreign players actually entered into the stock and has given a market cap to sales ratio multiple of almost 1.6 times which triggered an open offer. They were ready to pay Rs 110 a share for the 20% mandatory open offer.

From that perspective, the market cap to sales ratio for this particular company Linc is 0.25-0.3 times approximately. That means there is a chance of rerating in terms of market cap to sales ratio going forward.

Their Q1 performance was dismal and the stock currently in a battered shape. I think the worst case scenario would be around at Rs 56-58, from where people who are serious investors can definitely look into this particular stock. The main reason for the de-growth in terms of net profit is because of aggressive expansion plan and advertisement. They have actually hired Shahrukh Khan as their brand ambassador and that's talking a toll on their profits.

Going forward, looking at the way the company is foraying into the retail space, I think this will be a good proxy in the longer term to Camlin. They also have a joint venture with Mitsubishi so there is again a chance that a foreign promoter can come in this particular company which will raise the stocks significantly. Going through the same mathematics, I think the stock can easily touch Rs 95-100 in the next 15 months.

 

Stock Review: Rashtriya Chemicals and Fertilisers (RCF)

Thal plant coming on-stream and growing demand for complex fertilisers will help co post stable results

 

 

The shares of state-owned fertiliser manufacturer Rashtriya Chemicals and Fertilisers (RCF) plunged over 6% since Wednesday's opening price to . 73.7 after the company announced disappointing results for the June 2011 quarter. Costly natural gas and raw material prices have hit the company's profitability during the quarter, pulling down the shares. Still the company has additional capacities coming up in the second half of the year, which could help it expand its bottom line sustainably.

During the June 2011 quarter, while the company's top line rose nearly 10% to . 868.4 crore, the bottom line plunged almost 80% to . 4 crore.

This can be attributed to the increasing prices of inputs such as rock phosphate and muriate of potash, which led to a 400-basis point jump in raw material prices in relation to sales during the quarter against the corresponding period last year. This led to a 268-basis point contraction in the company's operating profit margin, which stood at 2.7% during the quarter. Besides, the company's Trombay unit, which accounts for around 45% of the company's overall business, remained shut for a short period during the quarter following some technical issue.

However, despite the dismal results, capacity-expansion plans coming on stream are a positive for the company. RCF is increasing the existing urea capacity at Thal in Maharashtra through de-bottlenecking at a capex of . 500 crore, which is expected to commission by the second half of the current fiscal, thereby adding considerably to the company's top line for FY13.

Also, the state-run company has plans to spend . 12,000 crore towards expansion of its urea manufacturing capacity at Thal plant as well as Talcher in Orissa. Gail India and Coal India will be the joint venture partners for the company's Talcher expansion unit. These plants, which could each add 1.15 million-tonne urea capacity, can commence operations over next 3-5 years.

Given the revamping of the Thal plant coming on-stream and growing demand for complex fertilisers, the company is expected to post stable results in the coming quarters. Also, any positive announcement from the new urea NBS policy should be beneficial for the company, going ahead.

 

Stock Reivew: NMDC

Natural resource stocks have been in the news over a period now. We have seen Coal India retain its position as most valued company (in competition with Reliance ), we are seeing GMDC moving up quite swiftly on the hope that they will be doubling their production of lignite and other minerals….In lieu with industry trend, NMDC too looks quite interesting at the current price of Rs 220.

The ban on iron ore mining is not applicable to this company as they have their major presence in Chattisgarh. Considering the demand and the layoff which have been happening in Karnataka, probably, this company will stand to gain.

Going by the financials, the networth of the company is Rs 19000 crore and this entire amount is held as cash and bank balances. In Q1, Rs 2800 crore was topline and Rs 1800 crore came in as bottomline, which translates into an EPS of Rs 4.50 on an equity base of Rs 400 crore with face value of Re 1. Therefore, it is likely that the company should be able to post about Rs 20 earnings per share for FY12.

Knocking off the cash held by the company, which works out to about Rs 50 per share, it gives a value of about Rs 170-175 per share that is eight times price to earnings( PE). Coal India is now ruling close to 15-16 times, and Sesa Goa at six to seven.

Coal India and this company have similar shareholding pattern with low public float; 90% is government and about 8-9% is held by the institutions.

So, the moment you see renewed buying interest coming into the stock, this can easily move to about Rs 255-260 in the next couple of months. This stock is capable of giving annualized return of 20% because from hereon, the risk is very low. If I consider from the FPO price perspective, and peer comparison too, the stock is quite attractive at the current levels.

Stock Review: Wendt India

Wendt India is an exact proxy to Alfa Laval , where promoters were paying to acquire new companies at an annualized equivalent value of 11.5-12%. Now this is one stock which we have been tracking as a delisting candidate for the past year. However, we have now changed our view because we feel that this is a portfolio bet, not just a delisting candidate when it was hovering around at Rs 1000 mark. What interests me is that its parent Winterthur technology has been taken over by 3M India.

Now the company is promoted by two groups, an Indian promoter from the Murugappa group - Carborundum Universal and now 3M India which controls almost 78% share. I don't think any of these two promoters would like to reduce their holdings to that 75% mark. On the contrary, the company law board Carborundum Universal has actually been able to get a sanction for the open offer trigger. Therefore, even though there is no open offer for the company right now, I get the impression that the open offer will come soon. If that mandatory trigger happens, then there will hardly be any float left in the market.

Looking at it from a fundamental perspective, 3M India trades at 30 odd PE multiple, while its same group company is trading far below this range. Taking a call based on the annualized equivalent value which was paid to Winterthur technology, I think the fair value works out to Rs 1860 to be precise. Thus, there is good scope in terms of upside from current levels.

What will happen if the company does not get that clearance of open offer? The stock might correct by 8-10%, but that is the maximum downside for this particular stock. In terms of dividends, Wendt India paid Rs 25 last year. Therefore, this is one stock that should warrant portfolio weight from longer term perspective. Thus, we are very aggressive in suggesting that one should definitely go for a portfolio bet for this stock.

Stock Review: Pidilite Industries

 

Pidilite Industries is a leading manufacturer of speciality chemicals in India. It produces adhesives, sealants, construction and paint chemicals, automotive chemicals, art materials, industrial adhesives, industrial and textile resins, and organic pigments and preparations. The company's major brands include Fevicol, Fevikwik, and Dr. Fixit. It currently exports to more than 80 countries and has 14 overseas subsidiaries. Moreover, it has significant manufacturing and sales operations in USA, Brazil, Thailand, Singapore, Bangladesh, Egypt and Dubai.

 

Sources of moat

Focus on brand creation. The company focuses on creating brands even in low-involvement categories where end-customer engagement is low or nil. All over the world there is very little branding in products such as adhesives and sealants. But Pidilite has increased brand awareness through advertising and also by educating users like carpenters, plumbers, and civil contractors. It promotes Fevicol among carpenters, and M-Seal and Dr. Fixit among plumbers. It educates construction workers about the benefits of using its Roff tile-fixing solutions. It also conducts training classes for carpenters and water-proofing workers at its in-house Dr. Fixit Institute.

Strong sub-segmentation strategy. The company has developed a large suite of products to cater to different sub-segments. For instance, it has different adhesives for product categories such as furniture, paper, marine products and crockery. Each adhesive has different characteristics and targets different categories of customers. Strong distribution network. Pidilite has developed a strong and diversified distribution network for its wide-ranging product suite. It sells its products through stationery, hardware, kirana, medical and furniture stores. It also sells some of its products directly to end consumers. Operating through such varied distribution channels has helped it augment its sales.

Targeting niches. The company has avoided launching products in highly competitive or well-penetrated segments. Instead it has targeted niche sub-segments like adhesives and sealants where competition is limited. In these sub-segments, it has developed strong market-leading brands such as Fevicol, Dr. Fixit, and M-Seal. Its products enjoy as high as 80 per cent market share in these niche segments. In adhesives, a mature product category, Fevicol commands more than 50 per cent market share in all regions.

No major competitor in sub-segments. In these niche sub-segments the company's competition is comprised of mostly local players who lack the managerial acumen and financial strength to build major brands. These players also lack the resources to invest in research and development. Hence, they have conceded market leadership to Pidilite.

3M (previously Minnesota Mining & Manufacturing Company), Henkel and AkzoNobel are the major global producers of adhesives. However, they cater to institutions and do not have branded products for retail.

Innovative products for niches. The company has developed products for new sub-segments that were non-existent earlier. It has created brands such as M-Seal to stop leakages in pipes (whereas earlier pipes were replaced when they began to leak). Also, it has created adhesives to fix broken tiles, whereas earlier such tiles were discarded altogether. Its products for mending crockery and utensils have also created new sub-segments.

Strong pricing power. The company has strong pricing power in all the sub-segments that it operates in. Hence it is able to pass on higher raw material costs to end customers. At the national level, Pidilite is the price-setter in roughly 65-70 per cent of its revenue pie.

 

What could cause moat to be breached

As mentioned above, the company is the market leader in adhesives and sealants. Its strong brands, pricing power and the absence of any major competitor in these segments make it unlikely that its moat will be breached in the near future.

However, construction speciality chemicals are generally not do-it yourself products and require end-to-end integrated services. The key to leadership in this category is to acquire new technologies that address the needs of Indian consumers (water-proofing, damp-proofing, etc.). Only by doing so continuously will Pidilite be able to maintain its economic moat.

 

Growth drivers

Changing revenue mix. The company's revenue mix is shifting in favour of consumer products, whose share had increased to 79 per cent of sales in FY10 compared to 70 per cent in FY01. With the revenue mix changing towards higher-margin sub-segments, the company's overall margins are expected to expand in future.

Growing demand. The demand for fast moving consumer goods is growing rapidly in semi-urban and rural centres on account of rising income levels. The company is well-placed to tap this opportunity owing to its elaborate countrywide distribution network.

 

Concerns

Uncertainty around Elastomer project. In June 2007, the company acquired the plant and machinery, patents and technology of a synthetic Elastomer (polycholoroprene rubber) facility. It was earlier expected to commence commercial production in March 2010, and its production capacity was estimated at 25,000 TPA. Due to slowdown in global industrial demand, the company went slow on the project. It had earlier indicated that once it chose to commence work in full swing, time to commissioning would be around 18 months. It had also indicated that the project would entail a further capex of Rs 250 crore (Rs 260 crore has already been spent).

Now the date for commissioning of the Elastomer project has been pushed forward to FY12 with an incremental capex of Rs 150 crore (a reduction of Rs 100 crore) plus working-capital deployments.

With Rs 260 crore invested, no visibility yet on commissioning, and further investment requirement of Rs 150 crore billion, this project poses a risk to the company's future earnings.

Ongoing business risks. The industrial pigments business is cyclical in nature and could pass through periods of unprofitability if inventories or capacities run high. In adhesives, margins are likely to erode over time as it is now a mature market. In art products, competition is strong. In construction chemicals, managing the quality of services and solutions as it scales up rapidly will be a challenge.

Raw-material price risk. The company has done backward integration for its key raw material VAM (vinyl acetate monomer) and now has a hedging mechanism in place for the raw materials that it imports. But in case of sharp fluctuations in foreign-exchange rates, similar to that in FY09, some impact on profitability cannot be ruled out.

 

Financials

The company has notched up strong return numbers. Over the last five years it has registered a compounded annual growth rate (CAGR) of 23.62 per cent in total income and 29.07 per cent in profit after tax. Moreover, the five-year average of its profitability ratios such as return on capital employed and return on net worth is 25.34 per cent and 27.83 per cent respectively.
The company also has a low debt-equity ratio, currently at 0.31 times (FY11). In FY11, its free cash flow stood at Rs 339 crore.

Its operating profit margin decreased by 0.2 percentage points in FY11 compared to FY10 while net profit margin down by 0.7 percentage points over the same period.

 

Valuation

The stock is trading at a price to earnings (P/E) ratio of 27.11(as on September 2, 2011). This is higher than its five-year median P/E of 21.96. The company has registered a five-year CAGR in earnings per share (EPS) of 29.25 per cent which translates into a price-earnings to growth (PEG) ratio of 0.92 times.

Investors may invest in this stock on declines with at least a three-year investment horizon.

 

Stock Review: Dr Reddy’s Laboratories (DRL)

Dr Reddy's Laboratories (DRL) June quarter results were not too different from its results in the preceding quarter. The company's business in the US and Russia continued to be growth drivers while its European and Indian businesses did not show sign of improvement.

Though the results were in line with expectations, no recovery in its Indian and German businesses disappointed the markets and the company's stock has since slid by over 3.4%.

Growth in the US was driven by improved sales of DRL's key products with limited competition. The quarter also includes the initial sales of generic fexofenadine.
The company launched four products from its newly-acquired Bristol penicillin facility during the quarter and expects to scale up its production by the third quarter this year. European business posted the lowest growth among all the regions of DRL, thanks to the sluggish performance of the company's German operations. The German business continues to witness price erosion after the switch to tender-based model. Despite the company winning few high-volume tenders, the margins are expected to remain low.

The company's performance in the domestic market remained poor and below expectations. Most of its top brands have been under pressure from competition. Expansion of field force has not had the desired result in terms of improvement in sales. The company's management has held that the pressure from competition has been less than that seen in the preceding March quarter.

It seems to be confident of improved performance in the second half of this fiscal. Continued under-performance in the home market is a cause of concern for the company.

USFDA recently imposed an import ban on certain products made at DRL's facility in Mexico. The company's pharma services business suffered significantly due to this ban which is likely to lead to an annual revenue loss of $30 million.
Though 50% of its business continues to drive growth for the company, there are enough sore points in its remaining businesses for the investors to worry.

DRL has not given any growth guidance for the current fiscal. However, given the concerns, the management's contention of a better performance in the second half of this fiscal is to be taken with more than a pinch of salt.

Stock Review: Castrol India Ltd

Castrol India Ltd (CIL) is the second-largest player in the Indian lubrication industry. From just 6 per cent market share in 1993, the company now commands approximately 20 per cent of the lubrication market. It was the first to advertise and promote engine oils. CIL's innovative and attention-grabbing advertisements have over the years strengthened its brand image. Its business can be classified into three categories — automotive, industrial, and marine.

 

History

 

CIL commenced operation in India in 1919 as a trading unit of C C Wakefield. In 1983 it went public, with 60 per cent of its equity being held by retail investors. In 1994 Burmah Castrol increased its shareholding in the company to 51 per cent. Following the takeover of Burmah Castrol by BP in 2000, the latter took control of the company with 71 per cent shareholding. After the amalgamation of Tata BP Lubricants India Limited with CIL in May 2003, BP now holds 71.3 per cent stake in the company.

 

Industry dynamics

The Indian lubricant industry is around Rs 17,000 crore in size and is growing at approximately 5 per cent per annum. It is the fifth-largest lubricant market in the world. The top four players — Indian Oil Corporation Limited (IOCL), CIL, Bharat Petroleum Corporation Limited (BPCL) and Hindustan Petroleum Corporation Limited (HPCL) — control 70 per cent of the market. The rest is shared by both regional and global players. CIL commands approximately 20 per cent market share, which it has gained at the expense of the market leader, Servo of IOCL (which has 40 per cent share).

 

Sources of moat

Brand. The credit for transforming lubricants into a fast moving consumer good, where branding holds the key, goes to CIL. With its tagline, "It's more than just oil; it's liquid engineering", the company has been able to establish an unprompted brand awareness of 92 per cent (according to AC Nielsen Brand Tracker).

Despite as many as 27 brands vying for the same set of customers, CIL has been able to hold its own. Customers in this industry look at the value proposition (price to performance ratio) of different brands and then make an informed decision. Customer awareness of brands is high in this industry. In such a market, CIL has been able to demonstrate to its customers that its engine oil is more effective and also results in cost savings for them.

Around 2002, CIL found that sales of CRB Plus, its tractor engine oil (its flagship brand which in 2007 completed 75 years), were dropping. To re-establish its position, it offered live demos to people to visually demonstrate the heatproof technology of CRB Plus.

Moreover, CIL has strong tie-ups with original equipment manufacturers (OEMs) like Tata, Maruti Suzuki, Ford, BMW, Volvo, Volkswagen and Audi in the automobile segment; Mahindra & Mahindra and John Deere in the tractor segment; and JCB, L&T Komatsu, and Telcon among commercial equipment manufacturers. It was the first to bring out an engine oil for Maruti 800. This engine oil was endorsed by the company, Maruti Suzuki.

Product differentiation. A lubricant is not just a commodity but a blend of base oil and chemical additives. Its functions are to reduce friction among mechanical parts, protect them from wear and tear, keep them clean, control the heat generated, and reduce energy consumption and emissions. Hence a perfect blend is essential to enhance the performance of engines. Over the years, CIL has been able to demonstrate to its customers that using its products enhances engine life.

The company has a full-fledged R&D centre in Mumbai. With its in-depth understanding of the Indian market, it has been able to launch products that satisfy customer needs. It has about 100 automotive lubricants and 300 industrial lubricants in its arsenal. In addition, it has access to BP's 5,000 products.

Pricing power. After the decontrol of the industry in 1993, CIL concentrated on cost effectiveness rather than on volume growth. Its superior technology has enabled the company to maintain an edge over its competitors. Its 12-month trailing (till March 2011) operating margin stands at 17.10 per cent. Over the last five years CIL's margins have improved consistently. It has been able to leverage its brand to pass on increases in the prices of raw material to its customers. Moreover, its focus on the premium segment has also aided CIL in maintaining a healthy margin.

Distribution. In India petrol pumps are still the fiefdom of PSU oil marketing companies like IOCL, HPCL and BPCL which have their own lubricant brands. Hence, early on CIL understood that trying to push its products through petrol pumps wouldn't go a long way, Instead it adopted the "bazaar route", wherein it employed distributors who would directly cater to shops selling lubricants. It has around 270 distributors who service 70,000 plus outlets. Servo, on the other hand, has access to about 40,000 outlets.
In 2007, the company set up Castrol Authorised Service Associates (CASA) who service independent workshops. Till date with 400 CASAs CIL has been able to reach 12,000 workshops.

 

Could the moat be breached?

Competition. As we mentioned earlier, this is a very competitive industry, with strong domestic and international players. Domestically there is competition from IOCL's Servo (the market leader), BPCL's MAK, and HPCL's HP Lube. Among international players there is Royal Dutch Shell, the global market leader. Therefore, there is no shortage of contenders wanting to usurp CIL's position. However, till date nobody has been able to match CIL on strategy. In terms of brand recall or products so far no one has come close to CIL. In distribution only Servo comes close.

Undercutting. In spite of the cut-throat competition that prevails in the lubricant sector, no rival has resorted to undercutting so far. Even though the public sector oil marketing companies have the distribution muscle to undercut CIL, their existing losses from selling petrol and diesel have kept them from posing a serious threat to it. Moreover, as long as customers are prepared to pay a premium for quality, CIL will be able to retain its moat.

 

Financials

CIL has shown remarkable financial performance in the past five years. Between CY05-10, its sales grew from Rs 1,430 crore to Rs 2,735 crore at a compounded annual growth rate (CAGR) of 14 per cent. Its profits grew at a much faster rate of 27 per cent over the same period, which demonstrates the company's ability to manage its expenditures. Efficient capital management has enabled the company to post an impressive five-year average return on capital employed (RoCE) of 98.23 per cent. Over the past five years, the company has grown at a faster rate than the entire industry. If it continues to do so in future, CIL could well snatch the market leader's crown from Servo. Currently the diesel engine oil business contributes 80-85 per cent of sales. However, its share of overall sales has been declining over the years. As more new generation trucks get launched, which require less frequent refills, sales of diesel engine oil are expected to fall, while the share of premium engine oils is expected to rise.

 

 

 

Valuations

The stock has earned the reputation of being a good downside protector even in the most trying times. It fell just 4.55 per cent in 2008 compared to the 52 per cent fall of the Sensex.

Despite the high returns of recent years, the stock can still be called a value pick: it is still trading at a price-earnings to growth ratio (PEG) of 0.92 (in addition, it also offers investors an attractive dividend yield of 3 per cent.) But compared to its five-year median price to earnings ratio of 18.59, it is trading at 25.10, a premium of 35 per cent. In order to enhance your margin of safety, buy this stock on dips and hold it for at least three years.

Stock Review: NALCO

The recent news about National Aluminium Company (Nalco) receiving approval to mine coal in its Orissa block saw the stock rise almost 16 per cent from a 52-week low on Friday (August 19). Though it has given up some ground thereafter, the development is positive and improves the company's coal security for future expansion projects, besides cost savings.

Since early 2011, Coal India had raised prices by a little over 30 per cent, which had led analysts to significantly downgrade Nalco's earnings for 2011-12, as well as 2012-13. The move was logical, as the company procures almost 90 per cent of its requirement (used in generating power, for producing aluminium) from entities like Coal India. The approval to mine coal, hence, signals that things should change for the better.

The company's management expects to mine about two million tonnes of coal every year from the Orissa block, which has about 70 mt of reserves. "The approval for the coal mine is positive, given that this will provide the company integration for its future capacity," says Ravindra Deshpande, who tracks the metals sector at research firm Elara Capital.

At `63.90, the stock is trading near its fair value of about 73-75. Hence, analysts do not see much downside, unless aluminium prices fall significantly from current levels.

VOLUMES TO SUPPORT GROWTH

Nalco is the second largest company in the domestic aluminium industry. It has been akey beneficiary of the rising international aluminium and alumina prices. However, most of its growth in recent quarters has come due to the increase in realisation, whereas volumes have been stagnant. The pressure on Nalco's margins, though, has remained, largely due to higher cost of production and employee expenses. Going forward as well, although there would not be much change in aluminium volumes (almost 80 per cent of the revenue) in the absence of the new capacities and utilisation at over 80 per cent, overall revenue growth will be mainly led by higher volumes in the alumina business.

In the current and next financial years, the completion of alumina capacity expansion (alumina accounts for about a fifth of Nalco's revenue) from 1.5 mt to 2.1 mt in the first quarter of 2011-12 would drive overall growth in revenues. By analysts' estimates, a 50 per cent growth in alumina volumes and 10 per cent increase in alumina prices at about `420-450 per tonne in 2011-12 would help the company grow its alumina business by 60-70 per cent. This will lead to overall revenue growth of a little over 20 per cent and help improve margins over the next two years.

REALISATIONS, KEY TO PROFITS

However, since aluminium still accounts for about 80 per cent of revenues, investors will need to keep a close eye on international aluminium prices. In fact, these have already corrected to $2,320 per tonne, as against the average price of $2,600 per tonne in the June quarter and about $2,4502,500 per tonne estimated by analysts in 2011-12. A further correction in international prices could impact the company's earnings, given the high sensitivity.

Also, the pressure on the margins needs to be monitored,as the company's cost of producing aluminium has gone up from $1,572 per tonne in 2009-10 to $1,829 per tonne in 2010-11 and further to $1,975 per tonne in the June quarter. So far, the company has been able to absorb input cost pressures because of increasing realisations. For the quarter ended June, the company reported a 50 per cent jump in alumina prices and about 28 per cent increase in aluminium realisations.

Stock Review: Tata Steel

AMONG the world's top seven steel makers, it has a consolidated annual capacity of 25.6 million tonnes. Given that the company has a global footprint, demand factors in both India and Europe impact profits. The Indian operations are largely integrated, as the company owns 100 per cent of its domestic iron ore requirement and 60 per cent of its coking coal requirement. This helped the company maintain margins in the current quarter.

So, the Street is rather surprised with higher-than-expected numbers of Tata Steel. The major reason for this is the performance of Tata Steel Europe. Tata Steel's consolidated Ebitda came in at `4,400 crore, compared to the consensus estimates of `3,800 crore. The company's Indian operations posted Ebitda per tonne of $440 (up 10 per cent sequentially), while European operations came in at $78 a tonne (a 48 per cent sequential growth). While sales were mostly in line with the Street's estimates at 3.5 million tonnes, adjusted margins were much ahead of expectation at $78 a tonne. This was primarily on account of higher-than-expected realisation of $1,313 a tonne. Analysts claim the main reason for this outperformance in margins is the temporary mismatch between raw material prices and market prices. Indian operations benefited from low-cost coking coal during the first quarter, but this will change in the second quarter.

Analysts expect European operations to come under pressure after the June quarter, due to weaker prices and lagged impact of higher costs. While European hotrolled coil (HRC) prices have fallen seven per cent in the past three months, HSBC Global projects that European steel prices will increase from September, as price premiums to China have dropped below $100 a tonne (hence lower imports). According to Bank of America Merrill Lynch, domestic margins are likely to have peaked and should trend lower, as steel prices fall and the cost base remains stable due to integration. The management expects slower demand over the next three-six months in Europe, as uncertainty has increased significantly. In India, however, the demand remains stable, but prices are expected to drift slightly downward.

Stock Review: Coal India

 

TOsay Coal India is sitting on agold mine would be an understatement. The company is not only the world's largest coal reserve holder and producer but also controls 80 per cent of the Indian coal market. But, soon after becoming India's most valuable company, Coal India's stock fell 5 per cent on Wednesday, as news of potential wage hikes and closure of its 22 mines in Jharkhand came in. Coal India's subsidiary, Bharat Coking Coal (BCCL) is said to be facing environmental issues over 22 mines. If there is a closure, then daily production, to the tune of 50,000 tonnes, would be affected. What makes it worse is the fact that BCCL is a nontax paying entity and the mines produce coking coal have a 50 per cent profit margin. The impact would add up to `1,500 crore for FY12 if the shut-down is for real. However, analysts maintain the government cannot afford such a closure at this point. The other issue the company has been facing pertains to impact of impending wage rises on earnings per share. Wage revisions are due from July and employees are demanding a 100 per cent rise. However, analysts expect no more than a 30 per cent increase. Earlier in the year, the company had increased prices of coal, factoring in wage hikes due in July. The company may have to undertake another round of price hikes to compensate for the higher than estimated wage cost, if any. According to Nomura, a one per cent swing in total employee cost would lower CIL's earnings per share by one per cent. The stock also fell on news of closure notices to select mines in Jharkhand. However, the company denies this. Apart from these issues, the company continues to be plagued by operational issues. Analysts say an analysis of the company's FY11 annual report points to sluggish progress in sanctioning new mining projects, delays in commissioning of new mines and decline in incremental volumes from newly-commissioned mines. According to IndiaInfoline, incremental volume from XIth Plan projects was 23 million tonnes (mt) in FY11. The company expects only 8.6 mt additional volume from these projects in FY12. In FY11, only three projects totalling 11 million tonnes per annum were sanctioned. Inventory pile-up will ensure FY12 sales targets can be achieved even if production slips, but IIFL sees a few upsides to its estimate of 4.4 per cent sales volume compound annual growth rate in the medium term.

 

Stock Review: Punjab National Bank (PNB)

A sudden spike in the provisioning of bad loans tarnished an otherwise good show by Punjab National Bank (PNB) in the first quarter of the current financial year. Asset quality remains a concern, but investors can draw solace from the fact that the bank has sustained its interest margins and also witnessed a sharp uptick in core fee income.
PNB, the second-largest PSU bank in the country, has grown its loan book by almost 26% over FY07-11. This quarter, too, despite a challenging macro environment, the bank maintained its loan growth at 23%, much above the industry average.

Furthermore, PNB has one of the best liability franchises with its low-cost current and saving account forming almost 37% of the total deposits. This has helped the bank maintain its interest margin in a rising interest rate regime. At a 3.84% net interest margin (NIM), PNB has a relatively high NIM among public sector banks.

Another positive for the bank was the strong 33% growth in its core fee income. This, along with a 20% growth in its net interest income (NII), which is the difference between interest earned and interest expense, helped PNB post a 3.8% growth in net profits despite a sharp rise in its provisioning (other than tax and employee cost), primarily because of current year's liabilities related to employee benefits. One major concern for the bank is its asset quality which is deteriorating due to increasing slippages. The quarter witnessed a growth in the gross nonperforming asset (NPA) by 20 basis points as incremental delinquencies remained high at 2% due to . 1,177 crore of fresh slippages. System-based NPAs are the main reason for the sharp rise in slippages. Theses slippages are expected to remain high in FY12 as per street experts.

The June 2011 quarter may not be as good for PNB as the previous ones. However, PNB has shown resilience. This is a good sign for investors. PNB is also buying a 30% stake in insurance provider MetLife India which may boost its third-party income (fee income), going forward. Still, investors are advised to keep a sharp eye on its asset quality for the next few quarters.

Stock Review: Bajaj Finance

The valuations have become quite attractive. If I take the PE multiple based on FY12 expected earning, I am expecting an EPS of close to Rs 86-90. That means, the share is ruling at a PE multiple of seven times.

Bajaj Finserv holds 56% stake in the company and they have recently subscribed 60 lakh warrants which will get converted at Rs 651. Q1 results have been quite robust for Bajaj Finance with a topline of Rs 450 crore and PAT of Rs 91 crore, translating to an EPS of Rs 25.

Upon peer comparison with companies of same size such as Mahindra and Mahindra Finance and Shriram Tranport , I think this stock looks quite attractive. In fact, a positive view is maintained on all the three stocks I mentioned in spite of them looking expensive.

Nonetheless, Bajaj Finance is looking like it should be able to move to Rs 800 in the next 8-10 months.

Stock Review: Arvind

The immediate trigger for the stock to move higher is the monetization of the land. They have 12 million sq ft of which, they have already inked agreement for that about 9 million. Tata Housing got a deal for 134 acres of land and 3 million sq ft is with other developers. Over the next couple of years, the company should be able to generate about Rs 1500 crore from this.

Arvind is currently sitting on close to one-third the land bank. If they knock off the about Rs 1800 crore debt, that will make the position of the company quite healthy.

The interest burden of the company is more than Rs 200 crore on an annualized basis.

However, Q1 is giving quite some comfort recording a topline of Rs 1200 crore with EPS of close to Rs 2.50. FY12 EPS could easily be a double digit, close to about Rs 10 from core operations.

Arvind is the largest denim maker in the world with 110 million sq ft capacity and integrated textile plant. Their shirting division has been doing quite well and fall in the cotton prices bodes well for them. These factors and the foray of the company into retail are going to be a big kicker for revenue. This replicates the trend of Raymond , which also is monetizing land, and has strong brand equity.

Taking all this into consideration, I am quite convinced and attracted to the stock and expect that, maybe in the near-term, in the next 2-3 months, Arvind's shares should move to about Rs 90. It has the capability to breach three digit mark in the next 8-10 months time.

Stock Review: Bombay Burmah

Bombay Burmah has a very strong balace sheet. he stock could however be a bit boring over extreme long-term considering the price is likely to hover betwen Rs 400 and Rs 500. An 8-12 month view is ideal for this stock that trades at nearly Rs 410 now.

Bombay Burmah is a good pick on account of its clever holding in other companies such as a 51% stake in Britannia and 14% in Bombay Dyeing. As those businesses flourish, Bombay Burmah is set to reap the benefits.

Stock Review: Cummins India

 

Cummins India is the country's largest engine manufacturer with a 40 per cent market share. It produces engines ranging from 31 horsepower (hp) to 3,500 hp, which can operate on diesel, gas, and dual fuel. Being a 51 per cent subsidiary of Cummins USA, its competitive advantage lies in the fact that it enjoys access to its parent's technology.

Cummins India manufactures engines that are used in sectors like power generation, automobile, construction, mining, marine, locomotive and fire-fighting. The company sells its engines to original equipment manufacturers (OEMs) that manufacture generators and vehicles. This enables it to focus entirely on the technology and manufacturing of engines. One division of the company provides service-based solutions.

While 70 per cent of Cummins India's revenue comes from the domestic market, 30 per cent comes from exports.

 

 

Sources of economic moat

As said earlier, Cummins India's competitive advantage comes from its access to its parent's technologies. Cummins USA is the world's largest designer and manufacturer of diesel engines. It possesses the best technology for manufacturing engines that find application across segments. It also possesses the technology to address the growing demand for gas and dual-fuel engines.
Cummins USA is among the few MNCs that are investing in their listed subsidiary in India. The parent company wants that Cummins India's contribution to global revenue should increase from the current 10 per cent to 15 per cent.

 

What could cause moat to be breached

The competition that Cummins India faces is mostly in the lower horsepower segment. In mid- and higher horsepower engines, where technological superiority counts, the company is the clear leader. Analysts do not expect its leadership position to be challenged anytime soon, given the company's technological strength, scale of operation, its parent's technological strengths and deep pockets.

 

Growth drivers

Domestic outlook improving. After the global financial crisis, demand for engines was sluggish till the first half of FY10. Since then demand has recovered. According to analysts at Motilal Oswal, revenue from the domestic market is expected to grow at a compounded annual growth rate (CAGR) of 26 per cent between FY10 and FY12.

Strong demand from power sector. Power is Cummins India's most important segment, accounting for 45 per cent of its revenue. The company offers power generation solutions to industry, services, and the real estate sector. About 25 to 30 per cent of the country's industrial power needs are met through captive power plants. India's continuing power deficit situation will ensure that the demand for diesel-powered generators and inverters remains high.

Industry. This segment accounts for 15 per cent of total sales. Some of the key sectors to which Cummins India supplies engines include construction, mining, compressors, oilfields, marine, defence, and railways. India is set to invest a huge amount of money on expanding infrastructure. Hence, demand from sectors such as construction and mining is expected to be particularly strong.

In the first half of 2011, India is likely to adopt India Stage-III emission norms. This will provide additional growth opportunities to the company as it already has engines that meet these norms.

Automotive sector. This sector accounts for 10 per cent of the company's sales. The company supplies 300 hp engines to Tata Motors for its heavy trucks. The demand for heavy trucks being strong, this segment is likely to put up strong growth in future.

Many Indian cities will adopt CNG buses in times to come. The engines for these buses will be supplied to their manufacturers by Cummins India.
Gas. With new gas discoveries, in future many power plants around the country are likely to be fuelled by gas. According to estimates, around 200 MW of capacity for gas-fuelled power plants could be set up each year. The key reason for preferring gas as fuel is that the cost of generating electricity using gas is much lower than using coal. Cummins India has a strong lean burn natural gas product line and stands to benefit from this opportunity.

Sales and services. This division offers after-sales services to the engines sold by the company. It replaces and re-conditions old engines. In recent years revenue from this segment has grown at the rate of 15 per cent annually. As the count of engines sold by the company increases, the after-sales division's revenues will also grow.

Meanwhile, the company's margins are likely to expand due to the following three reasons:

Cost-cutting programmes. In 2005 Cummins India initiated the accelerated cost-cutting exercise, which aimed to cut spending on raw materials by 30 per cent in three years. Thereafter, the company initiated another cost-cutting program called Trims, which aimed at bringing down spending on materials and services by another 30 per cent in three years. Thus the company has been able to cut down its raw material costs substantially.

Favourable pricing environment. In mid- and high horsepower engines, the company faces less competition and hence enjoys better margins.

Sale of higher-value engines to grow. For engines to meet higher emission norms, more high-value components have to be added to them. With India set to adopt higher emission norms, Cummins India will be able to sell more value-added engines, which will in turn improve its margins.

Another factor that will drive the compa ny's growth is capacity expansion:
Capacity expansion. Cummins USA plans to triple its investment in India from the current $150 million to $500 million by 2015.

Cummins India plans to spend Rs 140 crore in FY12 and Rs 90 crore in FY13 on capacity expansion.

The company is setting up a greenfield manufacturing facility at Phaltan near Pune in Maharashtra for manufacturing more engines and generators. By FY13 this facility will have a capacity of 40,000 units. This manufacturing unit will be developed within a Special Economic Zone (SEZ) and will be meant entirely for export.

Strong export growth. The export business will benefit from Cummins USA's commitment to source medium and high horsepower engines (of up to 50L) and small generators of less than 200 KVA from India. About
75 per cent of its exports are engines in the high horsepower category, and 25 per cent are generators of up to 200 KVA.

Growth in exports will be driven both by the existing portfolio and by the addition of new products. New products that the company could supply to its parent include engines for industrial applications.

In recent times, Cummins USA has been raising its sales guidance. From $10.8 billion in 2009, its sales are expected to increase to $20 billion by 2014, a CAGR of 13 per cent. This augurs well for Cummins India, which the parent intends to use as a manufacturing hub.

In FY10 Cummins India's exports amounted to Rs 480 crore. In that year demand shrank in the US and European markets. But with demand in overseas markets improving (albeit slowly) now, Cummins India's exports are expected to rise to Rs 1,500 crore by FY12.

 

Concerns

The key risk to the company arises from the fear of an impending economic slowdown. According to analysts at Edelweiss, Cummins belongs to the capital goods industry. This, they say, is the first sector to be affected by a slowdown and the last to benefit from an upturn. The ongoing slowdown in industrial capex has the potential to affect the company's sales.

With markets like US and Europe slowing down once again, Cummins India's exports too could get affected.

 

Valuation
The stock is currently trading at a price-to-earnings ratio of 18.93. This is slightly higher than its historic (five-year) median PE of 22.7. It is trading at a five-year trailing price-earnings to growth (PEG) ratio of 0.68. Buy this stock.