ICRA

ICRA’s rich valuations don’t look expensive considering the high growth trajectory and robust fundamentals
CREDIT ratings agency ICRA has grown by leaps and bounds in the last three years. Though much smaller than the market leader, Crisil, the company is a prominent player in the rating industry. Since it is in the services industry, which does not require huge investment in fixed assets, its return on capital employed (RoCE) at 31% for FY 2009 is quite high.

BUSINESS:

Apart from credit rating, which accounts for a major part of the company’s revenues, ICRA is also into consulting and outsourcing services. There is great scope for growth in the ratings business in India for several reasons. Corporate bond market is highly underdeveloped in India. There are entry barriers in the form of brand name and expertise. And finally, there are just four big players in the industry—Crisil, ICRA, CARE and Fitch (India). The recent regulations of the Reserve Bank of India (RBI), according to which any company borrowing more than Rs 10 crore from a bank has to be rated, has given a fillip to ICRA.

Already its rating business is growing fast. ICRA’s rating revenues grew by 28% in June ’09 quarter. Indian companies require huge investments in projects and need to raise funds from various classes of investors to meet their needs. This will increase their dependence on the bond market. Through its subsidiary, ICRA Management Consulting Services (IMAcS), the company has also entered into consulting, wherein it provides services to companies in various industries such as banks, automotive, health and retail. Though last year the consulting business was affected by slowdown, it is set for a revival this year after the improvement in sentiment and increase in investments.

The company also has a presence in outsourcing services as well. In brief, the company has presence in a whole gamut of rating, consulting and BPO related businesses, which are the growth drivers of future.

FINANCIALS:

The company can grow its profits without substantial investments in fixed assets. For instance, its revenue has grown at a compounded annual growth rate (CAGR) of 40% in last three financial years. In the similar time frame the balance sheet grew at a CAGR of 25%. This is typical of companies, which are not asset heavy, wherein more returns can be earned from little investment. For this reason, RoCE has improved from 16% in FY 2006 to 31% in FY 2009. Moreover, the company has always been debt free, which results in better cash flows.

VALUATIONS:

The stock is trading at a price-to-earnings (P/E) multiple of 19.5 times.

Though, the valuations don’t look cheap, but factoring a high RoCE, it would look modest. The company is growing at a very fast rate — its profit jumped 73% in June ’09 quarter. Definitely, the valuation doesn’t look expensive in the context of growth trajectory. Historically, the stock has traded at very high valuations. For instance, in June 2007, the stock was trading at 45 P/E and then in December ’07, it was trading at a P/E of 40. This shows that the stock still has scope to catch up at current valuation.

Castrol India

A high dividend yield, stable business and sound financials make Castrol an attractive pick for long-term investors. It’s a must-have defensive bet during tough times

Beta: 0.41
Institutional Holding: 13.5%
Dividend Yield: 4.6%
P/E: 13.7
M-Cap: Rs 3,739.5 cr

AROBUST balance sheet, sound business model and strong brand equity of its products is enabling Castrol India to churn out good cash flows year after year. Even amidst a slump in the automobile sector, the company’s lubricants will still have a large potential market to tap.

In the past five years, there has been a dramatic increase in the number of cars and commercial vehicles on India’s roads. This aftermarket is likely to be a big growth driver for the lubricant industry in general and Castrol in particular, over the next few years. With a year-on-year outperformance of 10%, Castrol is a must-have defensive stock during difficult times.

BUSINESS:

Castrol India is the Indian subsidiary of UK-based Burma Castrol and is engaged in manufacturing and marketing of automotive and industrial lubricants and specialty products. It operates in the automotive as well as nonautomotive segments. The former includes oils for heavy-duty vehicles, cars, motorcycles and bikes, while the latter includes industrial lubricants, marine and energy lubricants and the services segment.

Public sector players like IndianOil, Bharat Petroleum (BPCL) and Castrol account for around 70% of the domestic lubricants market. Several other players, including global majors, account for the balance share, resulting in a highly competitive market. Besides having technologically superior products, Castrol also has strong distribution network and brand recall. The company is the market leader in the retail segment with a share of around 21% in the total automotive lubricants market.

GROWTH STRATEGY:

Castrol has gained market share in a declining lubricants market. The entry of new original equipment manufacturers (OEMs) offering new technology vehicles will provide additional opportunities for the company’s products. Lube consumption is projected to grow strongly in cars, fourstroke bikes, as well as building and construction equipment segments.

Gradual growth in personal mobility, as well as corresponding growth in demand for automotive services, are positive factors for the company in the long term. Castrol seeks revenue and value growth through higher dependence on superior technology products relevant to new generation of vehicles, as well as focus on volume growth in the key growth sectors which it has identified. Rather than a broad volume growth strategy, the company is looking at building on profitability.

FINANCIALS:

The company’s balance sheet size has only doubled in the past one-and-a-half decades, while its topline has quadrupled. This shows that the business is not capital-intensive and is earning high returns. The company’s return on capital employed (RoCE) for CY07 stood at 80%. Like a typical multinational company, Castrol adopts conservative financing by being debtfree and distributing the bulk of its profits in the form of dividends.

The company’s net sales have witnessed a compound annual growth rate (CAGR) of 10.8% over the fiveyear period ended December ’07 to Rs 1,966 crore. Its net profit has recorded a lower CAGR of 7.4% to Rs 218.4 crore. At an average payout of 85% of its profits, the company’s dividend payout has broadly grown in line with the corresponding growth in profit during the past five years.

Castrol posted a smart recovery in its operating and net profit margins in ’07. This was fuelled by certain factors like price hikes, exit from low-margin segments that have been commoditised, new product launches, and re-launch of old products with new identity, packaging and strong consumer propositions.

Rising crude oil prices have been a concern for the company since the past two years as oil is a critical raw material for lubricants. However, the company is expected to benefit from the recent crash in crude prices.

CONCERNS:

The growth in use of longer drain lubricants, especially in the commercial vehicle segment, is expected to significantly reduce consumption of lubricant per vehicle. This is expected to reduce volume growth significantly over the next 3-5 years.

Price undercutting by low-cost competitors in an attempt to gain volume share is another threat for this premium-category lubricant manufacturer. A long-drawn slump in the automobile segment may hamper future volume growth of the company’s products. Curtail in infrastructure spend due to the general economic slowdown is also likely to curb the market for lubricants. With an industrial slowdown, the company’s business in the non-automotive segment may also take a hit.

VALUATIONS:

Castrol’s current price-earnings (P/E) multiple is 13.7. This is fairly in line with the 12.8% growth in profit registered by the company over a period of 15 years. The stock is fairly valued at current multiples. Besides, a high dividend yield, stable business and sound financials make the stock an attractive pick for the long term.

Stock View on Raymond, GAIL, Puravankara Projects, Jaiprakash Associates

MERRILL LYNCH view on Raymond - RATING: UNDERPERFORM

MERRILL Lynch has maintained its ‘underperform’ rating on Raymond as the near-term earnings will remain subdued with denim continuing to be a huge drag on overall performance. The management has indicated that it may reduce its involvement in the denim business — this can be a time-consuming process. Raymond’s 50:50 denim joint venture with Belgian denim major UCO NV continues to pile losses (Q1 ’09 loss Rs 40 crore, FY08 loss Rs 120 crore). Losses are driven by suboptimal capacity utilisation in overseas facilities, continued poor denim market and rising cotton prices. Worsted capacity expansion by 7 million metres at Vapi is on track. This will take the total capacity to 38 million by March ’09 and can potentially help free up about 140 acres at Thane, where a part of its worsted capacity is currently located. Merrill Lynch estimates that this land may be worth over Rs 200 per share. However, the Thane closure is unlikely to be taken up before elections next year. Worsted fabric performance is likely to improve in the current fiscal. Merrill Lynch has assumed a 4% year-on-year (y-o-y) rise in realisations driven by price increases and a richer mix. This, together with slightly weaker wool prices, should drive EBIDTA margin expansion by 150 bps. FY09 will be a year of consolidation and streamlining of businesses. The management intends to entirely focus resources on 4-5 key brands. To this end, it aims to expand its retail network judiciously, with a larger proportion of stores through the franchise route in tier-III and IV towns. Raymond added 31 stores in Q1, to reach 518 stores.

INDIA INFOLINE view on GAIL - RATING : BUY

INDIA Infoline has maintained its long-term ‘buy’ rating on Gas Authority of India (Gail) with a target price of Rs 450. In its annual report, the company has emphasised on clean fuel industrialisation by creating green energy corridors. This is in line with its ongoing capacity expansion plan, which is focused on developing a countrywide gas grid and setting up city gas projects in 28 cities within the next five years. Gail registered net sales growth of 12.2% y-o-y to Rs 18,000 crore in FY08. This was driven by a robust growth of 52.6% y-o-y in LPG sales and 17.8% y-o-y growth in polymer sales. LPG volumes remained flat, but realisations were up by 52.2% y-o-y as sharing of under-recoveries declined 11.7% y-o-y. Petrochemicals volumes rose by 12.8% y-o-y, whereas realisations for the segment rose by 4.5% y-o-y. Gas trading volumes grew by 2.5% y-o-y to 23.3 billion scm and transmission volumes increased from 77.29 mmscmd in FY07 to 82.1 mmscmd in FY08. The profit and loss statement was a mixed bag with robust topline expansion and increase in operating margins being offset by a higher effective tax rate and one-time write-back of Rs 340 crore in the previous year. The balance sheet continues to remain strong with a fourth consecutive year of decline in the debt-equity ratio and a sharp improvement in return on capital employed (RoCE) in FY08.

DEUTSCHE BANK view on Puravankara Projects - RATING: SELL

DEUTSCHE Bank has initiated coverage on Puravankara Projects with a ‘sell’ rating. Its asset-light business model, strong balance sheet and good financial disclosures make Puravankara an excellent developer. However, high floor space index (FSI) on its landbank, coupled with over-concentration in the residential vertical and in Bangalore, are threats in the current environment of weakening demand and tight financial markets. Given its net worth, Puravankara has an asset-light model with a smaller land bank and at a lower cost (unlike peers). Furthermore, its land bank is largely paid for, implying less time and risk in securing clear land titles. The low gearing of 48% should enable it to replenish its land bank during cyclical slowdowns. Deutsche Bank believes that financials will be driven by scaling-up operations, coupled with moving up the value chain. The high FSI (~3.1x vis-à-vis ~1.2x for peers) on its land bank in the current environment of strong headwind can make marketing a challenge. Though Puravankara has been around for nearly two decades, its completions to date are lower than its peers in Bangalore. Concentration in residential (~80% of land bank) and Bangalore (63%), which is seeing significant oversupply, are other concerns. The trading price of Rs 165 is at a 30% discount to discounted cash flow (DCF)-based NAV of Rs 236. With a 19% downside potential to the target price, Deutsche Bank recommends a ‘sell’ rating.

EDELWEISS on Jaiprakash Associates - RATING : BUY

EDELWEISS Securities has maintained a ‘buy’ rating on Jaiprakash Associates (JPA) . Since November ’07, of the total 4.7 million sq ft that it owns, JPA has been able to sell 2.9 million sq ft in Greater Noida and 3.6 million sq ft in Noida, till date. Supported by its low land acquisition cost, the company is offering properties at various price points to ensure offtake. Accordingly, sales price varies from ~Rs 5,500-10,000/sq ft in Greater Noida and Rs 4,800-6,400/sq ft in Noida. The company has received Rs 900 crore in cash at Greater Noida and Rs 590 crore at Noida. JPA has completed sub-contracting for the project and has finalised 24 sub-contractors. The management has guided that the expressway will be available for commuting in time for the Commonwealth Games. JPA will retain project planning, equipment ordering and raw material procurement. Financial closure for the project is complete and land and forest clearances have been secured. The management has highlighted its intent to bring all the power entities under one fold. It indicated the need for infusing $500 million by September ’09, for which, it is considering various options like securitising operational power plants. The company reiterated its intent to convert first warrant issue (~Rs 1,985 crore at Rs 397/share; Rs 400 crore put in till date). To tackle concerns of the open offer, following the second warrant conversion (~10% dilution), it plans to defer shareholders meeting to extend conversion window till FY11E. After factoring in concerns over further cement price correction this year in the northern market, Edelweiss has lowered its EPS by 18.6% in FY09E and 23.3% in FY10E. While earnings growth is likely to remain moderate in the near term, long-term value remains in the stock.