Stock Views on ACC, Power Grid, Bank of Baroda, Steel Authority of India, Hindustan Construction, Reliance Industries

ABN Amro on ACC

ABN Amro has cut ACC’s earnings and downgraded it to ‘sell’. ACC seems financially well-placed with moderate expansion plans, but its earnings outlook has weakened, since the industry may see excess supply for at least two years, which will lower cement prices. FY09 cement demand growth YTD, at 6.6%, is below expectations, due to the stress in credit markets and delays in capex. So, demand estimates for FY10 and FY11 fell by 200 bps each to 8%, which exposes the industry much longer to surplus supply. Restructuring over the past five years has seen ACC exiting non-core businesses. The company, which had high gearing in the last business cycle (1997-03), now seems in a stronger financial position. ABN estimates it will have a debt-equity ratio of just 7% even after financing its entire planned capex of Rs 3,700 crore over the next three years. This will raise its capacity by 9.6%, slightly ahead of the expected demand growth. ACC looks cheap, trading at a cement enterprise value/mmt of $61 (vs replacement cost of $110), but ABN sees more downside to its earnings, given the overhang of excess supply.

HSBC on Hindustan Construction

HSBC Global has reiterated its ‘underweight’ rating on Hindustan Construction Company (HCC). It has factored in a dividend payment of Re 1 per share, implying a dividend yield of 2.2%. Thus, the total potential return on investment in shares over the next year is -1.8%. HSBC considers the share price to be volatile. For Indian stocks, HSBC considers the average cost of equity to be 11%. A volatile Indian stock with a potential total one-year return of 10 percentage points on either side of 11%, i.e. 1-21%, merits a ‘neutral’ rating. As the potential total one-year return on HCC is less than 1%, HSBC reiterates its ‘underweight’ rating on the stock. A key upside catalyst for the stock is sharp increase in order inflows and reduction in leverage, resulting in lower interest costs. A sharp drop in execution volumes along with demand slowdown remain key downside risks to HSBC’s valuation

CITIGROUP on Power Grid Corporation

CITIGROUP has maintained its ‘sell’ rating on Power Grid Corp (PGCIL) with a target price of Rs 69. PGCIL’s shares have outperformed the Sensex, post its IPO. Despite correcting more than 55% from its peak, it is not in the value zone yet. They are trading on par with NTPC, which appears unjustified. The key upside risks are: 1) Favourable CERC regulations for FY10-14E; 2) Faster-than-expected project execution; and 3) Higher non-core business profits. PGCIL has the potential to generate 14-17% returns on its regulatory equity base, compared with NTPC’s 14-22%. NTPC under-reports its profit/net worth. PGCIL matches depreciation under the tariff with reported depreciation, whereas NTPC’s depreciation under the Company Law is higher than under the tariff. PGCIL’s target price of Rs 69 is set at 1.8x FY10E P/BV from 2.2x earlier — a 10% discount to the target P/BV multiple for NTPC. PGCIL’s H1 FY09 reported PAT, at Rs 700 crore, was down 15% y-o-y. But this is largely due to forex fluctuations and a pass-through in tariffs.

Indiabulls Securities on Bank of Baroda

INDIABULLS Securities has reiterated its ‘hold’ rating on BoB. The bank reported an average performance in Q209, even as its asset quality improved. It expects interest income to grow by 16% in FY09, against 31% in FY08, as the growth rate of advances is likely to fall to 23% in FY09 vis-à-vis 28% in FY08. In addition, the expected fall in yield on investments will affect interest income. Advances may be under pressure due to the global financial crisis and slowdown in the domestic economy. Over 20% of the loan book is accounted for by real estate and SMEs, which are prone to default in the current domestic scenario. BoB’s net interest margin (NIM) increased by a mere 4 bps sequentially to 2.8%. NIM is likely to be under pressure in the coming quarters due to increased cost of deposits, though RBI has lowered its key policy rates. With increased risk-aversion, BoB may shift the mix of interestearning assets from high-yield, risky advances to safer, low-return investments. This is likely to reduce the average yield, further pressurising NIM.

MERRILL Lynch on Reliance Industries
MERRILL Lynch has retained it ‘buy’ rating on Reliance Industries (RIL). Its refining margin has consistently been higher than the benchmark Singapore complex refining margin. Analyses suggests RIL’s superior refining margin is due to its ability to refine heavier crude than Dubai. Compared to the last refining downturn, RIL is set to benefit more in FY10-FY11E from its ability to refine heavier crude. Reliance Petroleum’s (RPL) refinery, which is expected to start operations soon, can process even heavier crude than RIL and has a superior product slate. The average discount of Arab heavy to Dubai since FY01 is $2.4/bbl. The discount has sustained at over $5/bbl even in the past six weeks, despite the slump in oil prices. Merrill Lynch estimates RPL’s refining margin at $12.9/bbl if it were to operate in Q3 FY09, vis-à-vis Singapore margin of $7.3/bbl. It will produce more gasoline than RIL. Gasoline cracks have always been at a premium to naphtha and LPG cracks. Merrill Lynch feels that a weakening in diesel and gasoline cracks is the main risk to RPL attaining such high margins when it begins operations.

EDELWEISS on Steel Authority of India

SAIL has a saleable steel capacity of 13 mt. But with no major capacity expansion over the next two years and moderate demand scenario, incremental volume growth is seen at 0.6 mtpa in FY09E and may decline by 0.4 mtpa in FY10E on production cuts. SAIL’s average volume-based growth till FY10 will be more muted than that of Tata Steel and JSW Steel. The company is targeting completion of modernisation-cum-expansion by end-FY11, which is set to hike its saleable steel capacity to 23.1 mtpa, up 78% from FY08 levels. It will also improve the company’s productivity and refine its product mix. While the project will put SAIL in the global league, its timely completion looks daunting. Due to its scale and operational vastness, SAIL is best-positioned among its peers to gain from Indian steel consumption growth in the next two years. But in the absence of tangible volume growth, slow demand growth for steel, exposure to tight coking coal market, highest susceptibility to government norms on prices, and potential delay in expansion plan, Edelweiss expects SAIL’s margins to be under pressure in the next two years.

Investment tips on HDFC BANK, ITC, UNITED SPIRITS, HINDUSTAN CONSTRUCTION, ADHUNIK METALIKS

GOLDMAN SACHS on HDFC BANK RATING: NEUTRAL

GOLDMAN Sachs maintains its ‘neutral’ rating on HDFC Bank with a target price of Rs 1,260. The bank reported 44% growth in net profit to Rs 460 crore in Q1 FY09, which was ahead of the consensus expectation of Rs 440 crore. Strong revenue growth, mainly NII growth, and a modest rise in credit costs are the key drivers of this positive surprise in consensus expectations. Sluggish growth in non-interest income will surprise expectations negatively. CASA deposits declined to 44.9% from 51.5% in Q1 FY08. But efficiency improvements in CBoP franchise should help HDFC Bank improve this ratio during the current financial year. The key metrics for asset quality have held steady, even after the merger of CBoP’s balance sheet with HDFC Bank, but the management continues to maintain a cautious stance. An upside to NII growth is likely, based on the reported performance, but non-interest income growth may remain sluggish. Goldman Sachs believes the upside to NII growth expectations may be offset by sluggish fee income growth. Realisation of benefit ahead of expectations presents the upside risk to the stock, while downside risks arise from delays in realising the merger synergies.

CLSA on ITC RATING: BUY

CLSA continues to remain positive on ITC and a potential weakness in the stock on the back of lower-than-expected earnings will present a ‘buy’ opportunity. For the first time, ITC reported a y-o-y decline of 4.4% in earnings during Q1 FY09. This 15% lower-than-expected profit was due to higher losses in the company’s new FMCG business, which is a cause for worry. Moreover, the company booked one-time expenses related to certain write offs, due to discontinuation of its non-filter cigarettes business, as well as additional point-of-purchase expenditure incurred in upgrading consumers to the filter category. On the positive side, ITC’s overall volume drop in the cigarette business was only 3%, driven by 20% volume growth in filter cigarette volumes, which was much better than expected. After a negative surprise in Q4 FY08, the losses recorded by ITC’s new FMCG business further increased to Rs 122 crore during Q1, against expectations of Rs 50 crore. This is attributable to a sharp rise in input costs and higher ad spend to support new product launches. The company will hike prices in Q2, but the impact of this will be felt only from Q3. The impact of higher losses in ITC’s FMCG business gets neutralised with its lower cigarette volume drop assumption. CLSA maintains its earnings forecast and positive view on the stock.

MERRILL LYNCH on UNITED SPIRITS RATING: BUY

UNITED Spirits’ standalone profit grew 34% in the June quarter to Rs 110 crore, led by stronger sales. Merrill Lynch maintains its full-year estimates on the stock, but acknowledges that there is upside risk if retail price hikes begin to come through. At P/E of 18x FY09E and 15x FY10E, the company’s valuations are attractive. Domestic sales grew 25-26% in Q1, led by volume growth of 19%. The company’s key premium brands grew 17%. The management expects key premium brands to grow 12-13% in FY09, but tactical moves to tap low price brands may lead to stronger volume growth. Some evidence of this was witnessed in Q1 as well. June quarter EBITDA grew 27%, while margins fell 90 bps, led by a 55% jump in ad spend. For the full year, the management expects to offset rising molasses and glass prices through price hikes, mix gains, buying power, light weighting of glass bottles and increased share of tetra-packs. Input costs are likely to be higher in the September quarter, but these may be offset by lower advertising costs relative to the June quarter. The company’s Q1 sales grew 40% and EBITDA grew 70%. The management reiterated its full-year EBITDA guidance of 15-20% growth and highlighted that scotch prices will remain strong.

RELIGARE on HINDUSTAN CONSTRUCTION RATING: BUY

RELIGARE retain its ‘buy’ rating on HCC with a target price of Rs 230. The company’s net sales increased by 18.8% y-o-y in Q1 FY09. About 37% of its revenue came from the power segment, 36% from the transport segment, 25% from the water segment and 2% from other segments. EBITDA increased by 15.6% y-o-y. HCC’s interest cost increased by 21% y-o-y, while depreciation rose by 11% y-o-y. Interest cost increased due to higher working capital requirements, capex and investments in real estate. Adjusted PAT rose by 37% y-o-y, mainly due to higher other income and lower tax rate. The company reported forex losses worth Rs 50.6 crore on account of overseas borrowings and a gain of Rs 61.9 crore from the transfer of land to its group company. At its CMP, the stock trades at a P/E of 24x FY09E diluted earnings. Religare is revising its target price downwards to Rs 230 from Rs 280, due to a downward revision in the valuation of Lavasa because of higher discounting rates. It had earlier valued Lavasa based on the discounted rate of 13%, which has now increased to 14.5%. The company is in advanced stages of finalising a stake sale of 5-10% in Lavasa to PE investors. This will set the benchmark for valuing Lavasa, which is the key trigger for the stock.

INDIA INFOLINE on ADHUNIK METALIKS RATING: BUY

INDIA Infoline recommends a ‘buy’ rating on Adhunik Metaliks (AML) with a target price of Rs 244 per share, implying an upside of 121.4%. In Q1 FY09, AML reported strong results. Its trading income fell 8.2% y-oy to Rs 56.3 crore from Rs 65.8 crore in Q1 FY08. The share of trading income to total sales in Q1 FY09 reduced to 15% from 29% in the corresponding quarter last year. The rise in PAT growth was curtailed by a jump in interest and depreciation costs. In the second half of FY08, the company had raised debt to fund its expansion plans. This pushed up its interest cost 77.4% y-o-y to Rs 22.5 crore. With the new steel melting shop operational in Q3 FY08, depreciation for the company increased 49.3% y-oy to Rs 7.4 crore. PAT stood at Rs 23.5 crore in Q1 FY09, compared to Rs 17.8 crore in Q1 FY08, and was a mere 7.5% higher than Rs 21.9 crore in Q4 FY08. During the past two years, AML has been in a major expansion phase. It is not only increasing its steel-making capacity, but is also going up the value chain. AML is doubling its sponge-iron and billet-making capacity. The expansion is being done in two phases. In the first phase, it is increasing its billet-making capacity to 0.45 mtpa, and setting up a rolling mill of 0.1 mtpa and a ferro-chrome plant of 37,760 tpa. India Infoline has valued AML based on the sum-of-parts method, which is primarily based on the EV/EBITDA multiple for its steel and mining business and discounted cash flow for its power business. Based on 4.5x FY10E EV/EBITDA for the Rs 680-crore steel and mining business, India Infoline has arrived at a fair value of Rs 209 per share.