Investor's Eye - July 30 2007

Ceat
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs216
Current market price: Rs177

Price target revised to Rs216

Result highlights

• Ceat's Q1FY2008 results were in line with our expectations. The net sales have risen by 7.8% to Rs536.4 crore, mainly driven by strong realisation growth due to price hikes and product mix changes. In line with the industry slowdown, the original equipment manufacturer (OEM ) sales declined by 11% year on year (yoy), but the effect of the same was mitigated because of strong growth in the replacement and the export markets.
• The operating margins expanded 550 basis points to 9.2% during the quarter as a result of lower raw material cost, price hikes, improved product mix and other efficiencies. As a result, the operating profits grew by 166.3% to Rs49.4 crore.
• Adjusting for the impact of tax provisioning on the extraordinary gain, we estimate that the quarterly profits have grown to Rs20.4 crore against Rs0.2 crore same quarter last year. The quarter's results contain extraordinary items relating to refund from excise and income tax and reversal of export benefits granted in earlier years. Profit after tax (PAT) after extraordinary items have grown to Rs30.4 crore.
• Last few quarters have been pretty exciting for Ceat, as it has effected a smart turnaroud during the period and now its margins are comparable with the best in the industry. We expect this strong growth to continue, particularly driven by the replacement and the exports segment. We also expect the company to maintain its margins at these levels going forward. On the basis of strong performances by Ceat, we are raising our earnings estimate for Ceat by 6% to Rs16.9 for FY2008 and are introducing our FY2009 estimates of Rs21.1.
• The slowdown in the OEM segment is expected to continue for another couple of quarters. To counter the same, the company has already put in place strategies to concentrate more on the exports and the replacement markets.
• The land sale is expected to be finalised by the third quarter of the current fiscal, while the demerger process is expected to be completed by the end of this fiscal.
• At the current market price of Rs177, the stock is trading at 8.4x its FY2009E earnings and at an enterprise value (EV)/earnings before interest depreciation and amortisation (EBIDTA) of 3.9x. We maintain our Buy recommendation on the stock with a revised price target of Rs216.

State Bank of India
Cluster: Apple Green
Recommendation: Buy
Price target: Rs1,780
Current market price: Rs1,579

Strong operating performance

Result highlights

• State Bank of India's (SBI) results have been way above the market's and our expectations with the profit after tax (PAT) growing by 78.5% year on year (yoy) to Rs1,425.8 crore compared with our estimate of Rs1,147 crore. The results are significantly above estimates due to a higher than expected write-back in investment provisions and subdued operating expenses.
• The net interest income (NII) was up by 15% yoy to Rs4,497 crore. The reported net interest margin (NIM) remained more or less stable on a sequential basis but declined by six basis points yoy. Most of the public sector banks have reported a sequential decline in margins whereas SBI has maintained its NIM and grown its NII by 15.8% yoy which are commendable.
• The non-interest income grew by 18.7% yoy to Rs842.6 crore driven by good growth in the core fee income, which rose by 16.3% yoy, and a higher trading income, which increased by 30.5% yoy due to the gains recorded in the National Stock Exchange stake sale for around Rs150 crore. "Others" reflect a net negative figure due to amortisation expenses and one-time shifting losses booked through the non-interest income category as per new Reserve Bank of India (RBI) directives.
• The operating expenses grew by only 5.8% yoy to Rs2,978.5 crore mainly due to lower staff expenses, which grew by 5.3% yoy and remained almost unchanged on a sequential basis at Rs2,026.4 crore. A good net income growth of 15.6% yoy coupled with lower operating expenses helped the operating profit to increase by 30.8% to Rs2,361.5 crore. The core operating profit growth was at 15.8% yoy to Rs2,691.5 crore.
• Provisions declined by 36.4% yoy mainly due to a write-back in investments provisions for Rs376 crore. The bank made a Rs200-crore non-performing asset (NPA) provision during the quarter over and above the RBI's requirements, which helped it to improve the provision coverage by 140 basis points to 48.8% on a sequential basis.
• Business growth was strong with net advances up 29.3% yoy and deposits higher by 19% yoy. However, the asset quality showed deterioration with the gross NPA up by Rs760 crore in absolute terms and the net NPA up from 1.56% in Q4FY2007 to 1.62% in percentage terms.
• The operating performance has been strong with stable margins and robust business growth. However the margins are likely to be under pressure going forward as the bank has a net effective negative spread on the combined statutory liquidity ratio (SLR) and cash reserve ratio (CRR) book. On the other hand, it has reduced its interest rate risk significantly, with only 24% of its investment book under the marked-to-market category with a duration of 1.7 years. A lower provision coverage and the non-provision of transitional Accounting Standard (AS)-15 expenses (as it awaits the RBI's guidelines on this front) are the only concerns. Hence, we have not upgraded our numbers as we feel the AS-15 related provisions could restrict the earnings growth of the bank in FY2008 despite earnings being significantly above estimates. At the current market price of Rs1,579, the stock is quoting at 14.4x its FY2009E earnings, 5.9x pre-provision profits and, 1.9x stand-alone and 1.5x consolidated FY2009E book value. We maintain our Buy recommendation on the stock with a price target of Rs1,780.

Bank of Baroda
Cluster: Apple Green
Recommendation: Buy
Price target: Rs366
Current market price: Rs293

Price target revised to Rs366

Result highlights

• In Q1FY2008, Bank of Baroda's (BOB) net profit increased by 102.5% year on year (yoy) and 34.7% quarter on quarter (qoq) to Rs330.8 crore. The profits of the bank more than doubled on year-on-year (y-o-y) basis mainly because of a decline in provisions during the quarter on account of a write-back in the investment provisions on its marked-to-market investment portfolio.
• During the quarter the bank's net interest income (NII) increased by 15.5% yoy but declined by 8.9% on a sequential basis. The Q4FY2007 NII was adjusted for Rs30 crore for the cash reserve ratio (CRR) from the interest income and Rs22 crore interest income related to BOB Housing. The margins have remained stable on a y-o-y basis but have shown a six-basis-point decline at 3.2% on a quarter-on-quarter (q-o-q) basis.
• The non-interest income was up by 64.4% yoy mainly due to a higher treasury income component of Rs130 crore which included Rs90 crore from the National Stock Exchange (NSE) stake sale; the fee income was up by 13.5% yoy to Rs107.7 crore.
• The operating expenses were up 24% yoy to Rs684 crore as both the staff expenses and the other expenses increased by 17.6% yoy and 38.6% yoy respectively. The staff expenses were high because of higher retirement benefits while the other expenses increased due to higher depreciation on the assets (mainly technology). Although the operating profits improved by 28% yoy, the core operating profits (ie operating profits adjusted for treasury) declined by 6%.
• The bank's loan growth moderated to 27.5% yoy as in June 2007 from the high of 40% y-o-y growth in FY2007. The retail and foreign advances continued to be the main drivers of the growth with 38.5% and 44% y-o-y rise respectively. The deposit growth also moderated to 22.7% yoy from 33.4% registered in FY2007. The moderation in the overall business growth to a more comfortable level of 22-25% would help the bank conserve precious capital, maintain the margins and reduce the likeliness of higher defaults going forward.
• We have seen a marginal deterioration in the asset quality with the gross non-performing asset (NPA) level up 5.5% qoq and the net NPA level at 0.67% compared with 0.6% in March 2007.
• Although the margins were not under severe pressure, the core operating performance was dismal as the operating expenses remained high mainly due to technology implementation and providing retirement benefits for the staff. We expect higher operating expenses in FY2008 because of technology implementation and the Accounting Standard (AS)-15 provisions. We also expect the margins to remain under pressure as the bank plans to grow significantly its international operations (margins are comparatively lower in the international business). However the bank has comfortable capital adequacy and asset quality levels with a strong management focus to improve profitability. Due to its low return on equity (RoE) the bank trades at a much lower price to book value (BV) multiple than its peers. But with its RoE expected to improve to 15% plus going forward, we feel at the current valuations the bank is one of the most attractively valued among the public sector banks. We have introduced our FY2009 estimates in this report. At the current market price of Rs293, the stock is quoting at 6.8x its FY2009E earnings per share (EPS), 3.4x pre-provision profits (PPP) and 1x BV. We maintain a Buy recommendation on the stock with a revised price target of Rs366 at which it would trade at 1.25x FY2009E BV.

Grasim Industries
Cluster: Apple Green
Recommendation: Buy
Price target: Rs3,250
Current market price: Rs2,947

Price target revised to Rs3,250

Result highlights

• The Q1FY2008 net sales of Grasim Industries (Grasim) grew by 30.3% year on year (yoy) to Rs2,450 crore, mainly due to a pick-up in its viscose staple fibre (VSF) volumes as well as realisation and higher sponge iron prices. The VSF revenues grew by a robust 59% yoy to Rs700 crore on the back of a healthy 34% growth in the volumes and a 20% growth in the realisation yoy. The cement revenues improved by 25% yoy to Rs1,390 crore driven by a 12% growth in volumes and a 13% growth in realisations yoy.
• On the back of a higher top line growth, the operating profit grew by 54% yoy to Rs792 crore whereas the earnings before interest, tax, depreciation and amortisation (EBITDA) margin improved by 510 basis points to 32.4%.
• The interest expenses rose by 21.1% yoy to Rs28.5 crore on account of higher borrowings in the quarter whereas the depreciation provision increased by 14.7% yoy to Rs85 crore mainly due to part commissioning of the additional VSF capacity in FY2008.
• The other income jumped by 81% yoy to Rs67.7 crore on account of a high interest income from the profitable deployment of surplus cash from operations.
• Consequently, the net profit rose by 64% yoy to Rs512 crore, much ahead of expectations.
• The company has slightly modified its capital expenditure (capex) plans. As against expanding the capacities at Kotputli and Shambhpura by 4 million metric tonne (MMT) each as planned earlier, the company is now expanding the capacities at these two locations by 4.4MMT each. The Shambhupra capacity is expected to come up by Q4FY2008 whereas the Kotputli plant is expected to be commissioned by Q1FY2009.
• The company is also augmenting its VSF capacity at Kharach, Gujarat from 45,625 tonne to 63,725 tonne. The company is also in the process of getting regulatory clearance for expanding the capacity at Harihar by 31,000 tonne.
• Considering the optimistic outlook for the VSF business, the higher realisations from the sponge iron business and the higher earnings of UltraTech Cement, we are upgrading our earnings per share (EPS) estimate for FY2008 by 8.2% to Rs264 and for FY2009 by 12.6% to Rs234.

Tata Elxsi
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs370
Current market price: Rs288

Price target revised to Rs370

Result highlights

• For Q1FY2008, Tata Elxsi has reported a growth of 3.6% quarter on quarter (qoq) and of 45.7% year on year (yoy) in its revenues to Rs92.4 crore. The performance was ahead of expectations in view of the seasonal weakness in Q1 (especially in the system integration [SI] business) and the steep appreciation in the rupee during the quarter.
• However, the performance on the margin front was disappointing. The operating profit margin (OPM) plummeted by 670 basis points sequentially to 17.6%, which is among the lowest in any quarter during the past two years. The same can be attributed to the cumulative impact of the rupee's appreciation, wage hikes (given to a small part of its employee base; wage hikes are being effected since January for most of the employees), intake of fresh graduates (under training and not billable) and seasonal weakness in Q1 in case of the SI business. Consequently, the operating profit declined by 25.1% qoq to Rs16.2 crore
• In line with the operating profit, the earnings declined by 24.5% qoq and grew by 18.4% yoy to Rs12.1 crore, which was lower than our expectations of Rs12.6 crore.
• In terms of segmental performance, the sequential growth of 7.3% in the software development service (SDS) business was ahead of expectations. However, the profitability declined by 470 basis points sequentially to 17.5% during the quarter. On the other hand, the SI revenues declined by 13.8%. The segmental margins plummeted to 12.6% as compared with 29.4% in Q4FY2007 but were far better than 1.6% in Q1FY2007.
• To factor in the higher than expected pressure on the margins, we have revised downwards the earnings estimate for FY2008 and FY2009 by 4.5% and 3.4% respectively. At the current market price the stock trades at 14.2x FY2008 and 11.3x FY2009 estimated earnings. We maintain our Buy call on the stock with a revised price target of Rs370 (14.5x FY2009 earnings).

Apollo Tyres
Cluster: Apple Green
Recommendation: Buy
Price target: Rs425
Current market price: Rs375

On a fast track

Result highlights

• Apollo Tyres rendered a brilliant performance in Q1FY2008 on the back of a strong top line growth and an improvement in the operating profit margin (OPM).
• The top line grew by 15.4% to Rs874.1 crore, led by a volume growth of 5% and a realisation growth of about 9.9% during the quarter. Though the original equipment (OE) business witnessed a slowdown during the quarter, the replacement business remained strong.
• The OPM improved to 11.5% from 7.5% Q1FY2007 on the back of softer raw material prices, improvement in price realisations and increasing operating efficiencies. Consequently, the operating profit increased by 77% to Rs100.4 crore. The net profit for the quarter grew by 187.6% to Rs46.8 crore.
• On a consolidated basis, the net revenues rose by 22% to Rs1,150 crore while the net profit improved by 369% year on year (yoy) to Rs54.6 crore, indicating a sharp improvement in the performance of its subsidiary, Dunlop South Africa.
• Dunlop South Africa is performing very well as its earnings before interest, depreciation, tax and amortisation (EBIDTA) margin reached the level of 11% during the quarter. It recorded a growth of about 40% in its net sales to about Rs275 crore in the same period. However, the same was achieved on a low base due to a very low-key performance in the same quarter last year.
• Though the sales volumes of Apollo Tyres would be affected in the current fiscal as a result of the slowdown in the OE sales, we believe that the replacement sales for tyre makers would continue to remain strong, considering that the automobile industry, especially the commercial vehicle segment, has been recording a good growth for five straight years. Also, the fall in rubber prices augurs well for the tyre makers as it should help them maintain the high levels of margins.
• At the current market price of Rs375, the stock discounts its FY2009E earnings by 10.5x and quotes at an enterprise value (EV)/EBIDTA of 4.8x. We maintain our Buy recommendation on the stock with a price target of Rs425.

Mahindra & Mahindra
Cluster: Apple Green
Recommendation: Buy
Price target: Rs913
Current market price: Rs753

Q1FY2008 results: First-cut analysis

Result highlights

• The Q1FY2008 results of Mahindra & Mahindra are below our expectations. The stand-alone net sales of the company grew by 16.8% to Rs2,612.8 crore in the quarter. This growth was led by an overall volume growth of 13.6% in the same period. The automotive segment recorded a volume growth of 24%; the sales volume of the farm equipment (FE) segment was flat.
• On a segmental basis, the automotive revenues rose by 21% to Rs1,504.5 crore. The FE division reported a revenue growth of 9.7%. The profit before interest and tax (PBIT) margin in the automotive segment was affected by 110 basis points due to the strengthening of the rupee and the consequent lower export realisation that affected the profit during the quarter. The FE division was able to maintain the PBIT margin at 13.4%. Consequently, the overall operating profit margin (OPM) declined by 150 basis points to 10.6%, leading to an operating profit growth of only 2.5%.
• On account of an increase in the interest expenditure and higher depreciation the adjusted net profit grew by 6.8% to Rs192.75 crore. After taking into account the extraordinary items (voluntary retirement scheme expenses, special dividend income) the reported profit after tax (PAT) declined by 6.4% to Rs191.16 crore.
• On a consolidated basis, the gross revenues grew by 40.7% to Rs5,879.2 crore in Q1FY2008 while the profit before tax (PBT) and exceptional items grew by 11.7% to Rs535.7 crore.
• We expect FY2008 to be the year of consolidation for the company as new product launches would take place only in FY2009. We will present our full result update on the company after attending the post-result conference call of the company. At the current market price of Rs753, the stock discounts its consolidated FY2009 earnings estimate by 9.3x. We maintain our Buy recommendation on the stock with a sum-of-the-parts price target of Rs913.

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VIEWPOINT

Hindustan Zinc

High zinc price improves overall performance

Result highlights

• In Q1FY2008, the revenues of Hindustan Zinc (HZL) grew by 22% year on year (yoy) to Rs1,970 crore on the back of higher zinc prices and increased volumes. However in terms of sequential growth, the sales of the company dropped by 3% mainly because of the fall in the production of refined zinc refined metal by 4% quarter on quarter (qoq) to 92,631 tonnes. The company sold 54,835 tonnes of zinc concentrates and 13,651 tonnes of lead concentrates during the quarter. The concentrate sales revenue at $80 million during the quarter was higher than that of Q4FY2007 when the concentrate market was tight.
• The earnings operating profit soared by 15% yoy and 3% qoq to Rs1,436 crore mainly due to increased realisation and improved efficiency. The company is in the lowest decile of the cost curve across the globe. The operating margins contracted by 437 basis points yoy to 73% mainly because of a 92% increase in selling and other expenses due to the rising freight cost.
• The interest outgo declined by 74% yoy whereas the depreciation cost increased by 22% yoy, as the company commissioned a 38.4 megawatt (MW) wind energy plant in the last quarter.
• The profit of the company grew by 36% yoy because of the other income of Rs130.48 crore on account of one time reversal of earlier year liability relating to royalty payments to the government. The adjusted net profit grew by 21% yoy to Rs1,055 crore.

Great Eastern Shipping Company

Capex plan of $470 million in the next two years
We attended the conference call of Great Eastern Shipping company (GESCO) to discuss the Q1FY2008 results. We present the key takeaways from the call.