Sharekhan Valueline - July 2007

FROM SHAREKHAN'S DESK

The moment of truth is nigh
Q1 results to decide if markets will stay on a high

The recent spate of monsoon showers may have brought down temperatures across the country but the climate in the country's stock market remains hot. After having visited the peak of 15k for a brief period once, the benchmark index is perched on 14,900 levels and investors' mood is upbeat. Besides the fact that the south-west monsoon, so critical for the agricultural sector of the economy, has been above normal so far and covered most parts of the country, the market has several other reasons to rejoice.

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SHAREKHAN TOP PICKS

Sharekhan top picks

In the June 2007 issue, we had recommended the best 12 of our Stock Ideas as Sharekhan Top Picks. As on July 2, 2007, the basket of stocks has given an absolute return of 2.1% as compared with a 0.6% appreciation in the Sensex and a 0.4% rise in the S&P CNX Nifty in the same period.

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STOCK IDEA

Network 18 Fincap
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs651
Current market price: Rs476

Striking the right(s) note

Key points

• News businesses to flourish: Network 18 Fincap (Network 18) controls the front-line business channels CNBC-TV18 and Awaaz, and the fast growing general news channels CNN-IBN and IBN 7. With the digitalisation of cable and advent of DTH platform, the subscription revenues would substantially boost the profitability of the group. Also, Awaaz, CNN-IBN and IBN 7 have shown good viewership gains and should drive the growth as they mature over the coming years.
• Web properties to add tremendous value: Network 18 through its associate companies Television Eighteen India (TV18) and Global Broadcast News (GBN; together the two hold 100% in Web18) owns several web properties like moneycontrol.com, poweryourtrade.com and yatra.com among others, covering the news, e-transaction, travel, recruitment, shopping and e-ticketing genres. It has added many new web properties over the last year and started spending heavily on enhancing these sites and popularising them.
• Taking big steps in entertainment: Through GBN it has entered into an alliance with Viacom Inc to launch a Hindi general entertainment channel. The alliance also gives it part ownership of MTV India, VH1 and Nickelodeon. The group's movie business would derive synergies from Viacom Inc's world-famous studios.
• Group builds war chest for growth: Sensing the opportunities provided by the booming Indian media & entertainment industry and allied sectors, the TV18 group is building a war chest for exponential growth. While TV18 has raised Rs200 crore through a QIP, Network 18 proposes to raise a similar amount through a rights issue of partly convertible preferential shares. GBN aims to raise $200 million through an overseas offering while its board members have approved a plan to raise a debt of Rs1,500 crore. We believe with all these funds the TV18 group aims to become one of the big wigs of the Indian media and entertainment business.
• Rights issue adds Rs133.6 per share to value: The company proposes to raise Rs200 crore via a rights issue of 5% partly convertible cumulative preference shares (PCCPS). It will offer one PCCPS for every five equity shares held. Our calculations suggest that the rights add Rs133.6 to the value of each existing equity share and make the Network 18 stock even more attractive.
• Valuations suggest a 37% upside: Our valuation of the Network 18 scrip based on its holdings gives us a value of Rs517.8 per share before the rights issue. The rights issue adds Rs133.6 to the price of the existing float, giving us a fair value of Rs651 for the scrip and indicating a good 37% upside from the current market price of Rs475.5. We initiate a Buy recommendation on the stock with price target of Rs651.

Tourism Finance Corporation of India
Cluster: Cannonball
Recommendation: Buy
Price target: Rs30
Current market price: Rs17.1

Riding on improved prospects for tourism sector

Key points

• To benefit from the positive outlook on tourism sector: Tourism Finance Corporation of India's (TFCI) deteriorating financial performance and increasing NPAs were a direct consequence of the downturn in the tourism sector in the late 1990s. However, the positive outlook for the tourism sector going forward would significantly benefit TFCI in terms of higher loan growth.
• Substantial improvement in asset quality: TFCI has significantly improved its asset quality. Its net NPAs, which were high at 11% in FY2004, were at 2.6% in FY2006 and are expected to fall further in FY2007. Higher recoveries and lower incremental NPAs have helped reduce the level of its NPAs.
• Possible foray into private equity space to boost future earnings: TFCI is also reported to be in talks with major private hotel chains, real estate funds and private equity players to raise private equity to finance large hotel projects. This will enable TFCI to generate a fee income, and increase its ability to co-invest and lend.
• Dividend payment now possible: Due to its high NPAs, TFCI was not permitted by the RBI to pay dividends in FY2005 and FY2006. TFCI had paid a dividend of Rs0.7 per share in FY2004 If it resumes dividend payment at the earlier historical rate, the dividend yield would work out to 4%, which could provide a margin of safety for the stock.
• Stock could trade at Rs30: TFCI had a reported book value of Rs27 per share in FY2006. The stock is trading at 0.6x trailing book and is cheaper than most other financial stocks. At our target price/book value of 0.8x for FY2009, the price target for the stock works out to Rs30 per share. We believe that the valuation at 0.8x is reasonable given that the company has never made losses, its NPAs have turned around and its loan growth is expected to be strong with the improving prospects of the hotel and tourism industry. We therefore recommend a Buy on TFCI with a price target of Rs30.

Zensar Technologies
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs484
Current market price: Rs342

Zen(sar) and the art of growing

Key points

• Strengthening its portfolio of service offerings: Zensar Technologies (Zensar) has effectively utilised the inorganic route to gain the required critical mass in the fast growing enterprise solutions segment (through the acquisition of OBT Global and ThoughtDigital), to strengthen its footprint in under-penetrated geographies such as Japan (through joint venture with Eza, Japan), and to gain access to marquee clients.
• Maintaining the growth momentum: Zensar is well poised to report a healthy growth of over 40% in FY2008. It is witnessing a strong traction in its organic business and the incremental revenues of Rs110 crore from the recent inorganic initiatives would only add to the overall growth momentum in its revenues Consequently, even after factoring in the adverse impact of the rupee appreciation, the company is expected to achieve its stated revenue guidance of Rs850 crore in FY2008.
• Margins are sustainable: Zensar is also expected to buck the general declining trend in margins in FY2008. That's because some of its relatively new businesses of ITS and BPO that have been in the investment mode are expected to show a substantial improvement in their margins. It also has other margin levers like a favourable revenue mix and lower overhead costs to cushion against the adverse impact of wage hikes, the appreciation in the rupee and the consolidation of the relatively lower-margin revenues of ThoughtDigital.
• Key concern of stake sale by Fujitsu has been dispelled: The acquisition of the entire stake of Fujitsu in Zensar by the RPG group has eliminated a key concern that was a drag on the stock's valuations.
• Attractive valuations: At the current market price the stock trades at 10.6x FY2008 and 8.2x FY2009 estimated earnings; the valuations are extremely attractive considering the estimated earnings growth of 33% CAGR over FY2007-09. We recommend Buy on the stock with a price target of Rs484.

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STOCK UPDATE

Aban Offshore
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs3,110
Current market price: Rs2,750

Price target revised to Rs3,110

Key points

• Aban Offshore Ltd's (AOL) earnings estimate for FY2009 has been revised upwards by 15.8% to factor in the higher than our assumption of day rates for the six existing assets that are scheduled for renewal over the next three quarters. The revised estimate also factors in the steep appreciation of the rupee and the exchange rate assumption has been revised to Rs41 against the US Dollar (USD) for FY2008 and FY2009.
• In addition to the net positive impact of the re-pricing of its assets at higher day rates and the change in the foreign exchange (forex) rate assumption, the sentiment towards the stock would be boosted by the flow of positive news related to the delivery of two newly built jack-up rigs and the contracts for the same. Moreover, the delivery of its drill ship, Aban Abraham, is also scheduled in August 2007.
• At the current market price the stock trades at 21.8x FY2008 and 7.5x FY2009 estimated earnings. We maintain our Buy call on the stock with a revised price target of Rs3,110 (8.5x FY2009E earnings).

Alphageo India
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs395
Current market price: Rs370

Price target revised to Rs395

Result highlights

• Alphageo India has reported a 56.7% growth in its revenues to Rs29.5 crore for the fourth quarter ended March 2007. This is in line with our estimate of Rs29 crore.
• The operating profit margin declined by 5.3% to 44.5% during the quarter, largely due to the incremental cost related to the third 3D crew. The crew became operational only in the latter part of Q4FY2007 but the staff cost for the same was reflected in the entire quarter.
• The net profit grew by 41% to Rs6 crore which is marginally higher than our estimate of Rs5.9 crore.
• On the full year basis, the revenue and earnings have grown by 127.5% to Rs54.3 crore and 80.2% to Rs7.5 crore respectively.
• Along with the results, the board has approved a dividend of 15% (or Rs1.5 per share) for the existing shareholders.
• The company had a pending order book of Rs110 crore as of end March 2007. The order book is executable over the next five quarters and provides a strong visibility for the revenue growth in FY2008. Accordingly, we have revised upwards our estimates for FY2008. At the current market price the stock trades at 11.2x FY2008 estimated earnings. We maintain our Buy recommendation on the stock with a revised price target of Rs395 (12x FY2008 estimated earnings).

Ashok Leyland
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs42
Current market price: Rs38

Annual report review

We went through the recently released annual report of Ashok Leyland. We present the highlights below.

Key points

• Ashok Leyland had a splendid FY2007 as the commercial vehicle (CV) sales were driven by the strong availability of freight and the Supreme Court's ban on the overloading of trucks.
• The company made substantial improvement in its operating efficiencies during the year with the success of its "Mission Gemba". The operating profit margin for the year declined by 80 basis points to 9.2% even though the raw material cost as a percentage of sales rose to 74.4% from 71.9% last year. The company also made substantial improvement in its working capital management during the year.
• The return ratios also improved smartly as the return on capital employed rose from 21.7% to 25.8% while the return on net worth rose from 20.2% to 21.5% during the year.
• The company expects FY2008 to be moderate for the industry, as the demand would be affected by the increase in the interest rates. However, increased investments by the government in the infrastructure sector could encourage growth.
• The company maintains its target of making over 100,000 vehicles in FY2008, and has drawn up aggressive plans to increase its annual capacity and sales to over 180,000 vehicles each in the next four to five years. It would also look to increase the share of the non-cyclical business to de-risk its business model.
• At the current market price of Rs38 the stock discounts its FY2009E earnings by 9x and quotes at an enterprise value/earnings before interest, depreciation, tax and amortisation of 6.2x. We maintain our Buy call on the stock with a price target of Rs42.

Aurobindo Pharma
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs914
Current market price: Rs725

USFDA approvals enrich earnings visibility

Result highlights

• Aurobindo Pharma has received the approval from the US Food and Drug Administration (USFDA) for oral suspensions of its antibiotic Cefpodoxime proxetil in 50mg/5ml and 100mg/5ml strengths.
• Cefpodoxime proxetil is the generic version of Pharmacia Upjohn's brand Vantin. It is an oral third generation Cephalosporin antibiotic.
• The size of the branded market for Cefpodoxime proxetil suspension is about $20 million and the patent of the product expired a few years ago. This is a critical product and just two competitors, including the innovator and Ranbaxy Laboratories, are there in the market.
• Aurobindo Pharma is the proven leader in this segment in several markets in the world. So anticipating a 20% market share and a 20% price erosion, the product can add annual revenue of $3.2 million and profit of $0.64million. That would translate into incremental earnings per share (EPS) of Rs0.43.
• Aurobindo Pharma with 82 abbreviated new drug applications (ANDAs), 110 drug master files (DMFs) and 11 USFDA-approved facilities is well positioned to exploit the generic opportunity going forward. Further, its expansion into Europe and emerging markets, and the likely incremental revenue flow from its largest approved anti-retroviral product basket would fuel its revenue growth and margin expansion in future.
• At the current market price of Rs725, the stock is trading at 15.8x its FY2008E and 12.6x its FY2009E earnings. In anticipation of the ramp-up in the formulation exports (particularly to the USA) we maintain our Buy recommendation, with a one-year price target of Rs914.

BASF India
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs300
Current market price: Rs273

Q4FY2007 results: First-cut analysis

Result highlights

• BASF reported decent results for the fourth quarter of FY2007. Its top line grew by 10.7% to Rs160.7 crore. There was an extraordinary item pertaining to a voluntary retirement scheme (VRS) expenditure of Rs3.92 crore during the quarter. Adjusting for the same, the operating profit margin (OPM) grew by 40 basis points to 7.6% and the profits grew by 52.4% to Rs7.6 crore.
• Since BASF's business is seasonal in nature, it is more prudent to look at the yearly numbers of the company. Further, since the company transferred its plastic business to a subsidiary called BASF Polyurethanes India, it makes more sense to look at the consolidated numbers reported by the company. Its consolidated sales rose by 24% to Rs846.6 crore in FY2007. The OPM after adjusting for the VRS expenditures stood at 11.5% against 13.4% in FY2006. The margins were under pressure due to a high raw material cost, which rose from 50.5% in FY2006 to 53.5% in FY2007 as a percentage of sales. The net profit grew by 20.8% to Rs57.1 crore. For the current year, the exports rose by a strong 27% to Rs32 crore.
• All the segments of the company showed considerable improvement, with the agricultural product division reporting a growth of 16.1% mainly due to higher realisations and rationalisation measures undertaken during the year. The margins appear to be down because of the extraordinary item of the VRS expenditure, which was related to this segment. Adjusting for the same, the profit before interest and tax margin stood at 19.4% as against 17.5% in FY2006. The performance product division grew by 19.3% as the capacity utilisation in all the segments of the division improved during the year. The plastic division's top line grew by 44.9% during the year; its margin however declined to 6.6% from 9.6% in the previous year.
• The company has declared a dividend of 70% for the current fiscal. We are pretty positive on the prospects of the company considering the ongoing consumption boom in its user sectors, eg white goods, home furnishings, paper, construction and automobiles. We believe that this strong growth momentum in the user segments is sustainable, making the prospects very bright for a company like BASF. To cater to the resulting demand, BASF is also expanding its capacities in key products like expandable polystyrene and polymer dispersion, which are used in user segments like white goods and paper. Further, it also has access to the wide product portfolio of its parent company in various segments. Considering its growth prospects, we believe the company is trading at attractive valuations of 13.3x FY2007 earnings and 9.5x FY2008E earnings. We maintain our Buy recommendation on the stock with a price target of Rs300.

Bajaj Auto
Cluster: Apple Green
Recommendation: Buy
Price target: Rs2,271
Current market price: Rs2,094

Annual report review

Key points

• FY2007 was an interesting year for BAL as the company rendered a strong performance in the first nine months of FY2007, even though the performance faltered in the last quarter of the fiscal due to the rising interest rates and certain actions taken by the Reserve Bank of India (RBI) to control the growth in non-food credit.
• A number of variants in the motorcycle segment in all sub-segments, good export performance, a launch of new ungeared scooter Kristal led the growth during the year.
• The company continued its productivity improvements during the year as the turnover per employee increased from 132 in FY2004 to 266 in FY2007. BAL also continues to enjoy negative working capital. The high capital expenditure (capex) of the company during the year affected the return ratios as the return on capital employed reduced from 25.5% to 22.3% and the return on net worth reduced from 20.9% to 18%.
• The company expects this slowdown to be an aberration and is hopeful the situation would improve going forward. However, hardening raw material prices, the competitive scenario and possible lower demand in the first half of FY2008 would restrict the margins and the same are expected to remain in the region of 13-15%. The company has plans to launch a new bike in the second quarter of FY2008 and the management believes that the bike will be a blockbuster.
• At the current market price of Rs2,094, the stock trades at 16.1x its FY2009E and at an enterprise value/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 9.2x. We maintain our Buy call on the stock with a price target of Rs2,271.

Bharat Bijlee
Cluster: Apple Green
Recommendation: Buy
Price target: Rs2,425
Current market price: Rs1,936

Price target revised to Rs2,425

Key points

• Bharat Bijlee Ltd (BBL) continued its robust performance, in terms of both sales and profitability, in FY2007. Its net sales increased by 56% to Rs470 crore and net profit grew by a superb 62% to Rs55.1 crore in FY2007.
• The profit grew mainly because of good volume growth, operational efficiency, higher productivity, good product mix and higher price realisations.
• During the year, the sales of the motor business grew by 29% against the industry growth of 20%. The sales of the transformer business rose by 95% led by higher realisations and increased production from the expanded capacity.
• The company increased its transformer manufacturing capacity from 5,000MVA to 8,000MVA and considering the robust demand for power generation, transmission and distribution, it plans to increase the transformer manufacturing capacity further to 11,000MVA.
• The outlook for the motor business also appears healthy. The industry has shifted towards larger motors. BBL has already made investments to expand the facilities for larger motors. It also has plans to invest in plant and machinery to increase the maximum rating of motors from 200KW to 400KW.
• The order inflows for motors, transformers and projects increased by 77% from Rs325.3 crore in FY2006 to Rs574.8 crore in FY2007.
• Given the huge investments lined up in India's power generation, transmission and distribution sectors, and the future expansion plans of BBL that provide good revenue visibility, we maintain our positive view on the stock. We retain our Buy recommendation on BBL with a revised price target of Rs2,425.

Crompton Greaves
Cluster: Apple Green
Recommendation: Buy
Price target: Rs280
Current market price: Rs250

Price target revised to Rs280

Result highlights

• Crompton Greaves Ltd's (CGL) revenues grew by 25% year on year (yoy) in Q4FY2007 to Rs990.0 crore. The revenues were slightly below our expectations. The top line of the power system division grew by 37.1% to Rs560.1 crore. The revenues of the consumer product division grew by 9.3% to Rs276.7 crore while that of the industrial system division rose by 22.2% to Rs240.8 crore.
• The operating profit margin (OPM) of CGL improved by 80 basis points to 11.5% from 10.7% in Q4FY2006. The raw material cost/sales ratio rose by 40 basis points to 71.4 % in Q4FY2007 from 71.0% in Q4FY2006. However, lower employee and other expenses helped in the overall improvement in the OPM. The operating profit grew by 34.2% to Rs114.3 crore.
• The profit before interest and tax (PBIT) margin of the power system division improved by 450 basis points to 13.9%. The consumer product division's PBIT margin improved by 50 basis points and the industrial system division's PBIT margin improved by 450 basis points on a year-on-year (y-o-y) basis.
• Consequently, the profit before tax (PBT) increased by a strong 36.5% to Rs106.3 crore.
• CGL provided for full tax rate in Q4FY2007 as against the minimum alternate tax (MAT) rate in Q4FY2006. The increased tax provisioning led to a lower bottom line growth of 24.7% to Rs69.9 crore.
• The stand-alone order book grew by 40% to Rs2,300 crore. The consolidated order book stood at Rs4,400 crore out of which Rs2,100 crore came from Pauwels and Ganz Transelektro Villamossagi Zrt (GTV).
• In view of the robust top line growth, expansion in margins, continued good performance of Pauwels and the expected stabilisation in the operations of GTV in FY2008, we are maintaining our FY2008 estimates. At the current market price, the stock is trading at 23.9x its FY2008E consolidated earnings and 13.6x its FY2008 EV/earnings before interest, depreciation, tax and amortisation (EBIDTA). We believe that these valuations are attractive because of (a) the robust operating performance of the stand-alone company; (b) higher geographical reach and product depth of its subsidiaries; and (c) its management's expertise in turning around loss-making subsidiaries. We maintain our Buy recommendation on the stock with a revised price target of Rs280.

HDFC Bank
Cluster: Evergreen
Recommendation: Buy
Price target: Rs1,355
Current market price: Rs1,127

Price target revised to Rs1,355

HDFC Bank has announced it plan to raise additional equity capital of Rs4,200 crore or $1 billion, whichever is higher. The additional capital is required to strengthen its capital base under the new Basel II guidelines and also fund the future growth plans. We had earlier factored in our valuations a minor equity dilution of 5% during FY2008, based on the historical trend of capital raising programmes of the bank. However the bank's recently announced capital raising plan is expected to lead to a dilution of 13.3% of the existing equity base and the same is much above our estimate. After the capital raising exercise the Tier-I ratio of the bank is expected to be at 11.6%.

Key points

• The present promoter's (ie the HDFC group) stake stands at 21.6%. With a view to maintaining the stake of the promoter group at or about 23% of the enhanced capital base, the bank would make a preferential offer of 13,582,000 equity shares of Rs10 each to the promoter group at a price of Rs1,023.49 per share determined by the SEBI formula. Thus the promoters would infuse Rs1,390 crore to maintain their stake at 22.8% of the enhanced equity base. The balance amount of the proposed equity capital may be raised either as a domestic public offering or as public or private offerings in one or more international markets. The bank already has 18.9% of its existing capital as American depository shares (ADS).
• We have assumed a follow-on offer price (FOP) of Rs1,000 per share for HDFC Bank which would result in a fresh issue of 2.81 crore equity shares to raise the remaining amount of Rs2,810 crore. The FOP is significantly higher than the bank's FY2007 year-end book value of Rs201 per share. Hence the issue would significantly add to the book value of the bank. The book value is expected to go up by 62% to Rs327 per share by March 2008 if we factor in a stable 31% earnings growth in FY2008.
• We have revised our FY2008 earnings estimate upwards by 1.8% to Rs1,503 crore from Rs1,475 crore. But after factoring in the higher dilution, the earnings per share (EPS) estimate has reported a decline of 7.3% to Rs41.6 from Rs44.9. We have also introduced our FY2009 estimates and at the current market price of Rs1,127 the stock is quoting at 20.7x FY2009E EPS, 8.0x FY2009E pre-provision profits and 3.1x FY2009E book value. The historical one-year forward price-to-book value chart indicates that the HDFC Bank stock consistently trades around the 3.7x price-to-book value band. So maintaining the same price-to-book multiple of 3.7x for HDFC Bank we uphold our Buy recommendation on the stock with a revised price target of Rs1,355.

ICI India
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs581
Current market price: Rs520

Price target revised to Rs581

Result highlights

• The net revenues grew by 5.7% year on year (yoy) to Rs201 crore despite the discontinuation of the surfactant businesses (Uniqema).
• The sales from the continuing businesses (ie paints and chemicals) have shown a growth of 23%. The paint business grew by 26% yoy to Rs170 crore. The continued chemical business grew by 13% yoy to Rs31 crore.
• The profit before interest and tax (PBIT) from the continued businesses grew by 51% in the quarter under review on the back of improved PBIT margin of both the businesses. The PBIT in the paint business grew by 67% yoy with a 170-basis-point expansion in the margin. The PBIT in the residual chemical business grew by 11.5% yoy with an 20-basis-point expansion in the margin.
• The overall operating profit (including all businesses) dropped by 10% yoy with a 150-basis-point contraction in the operating profit margin (OPM).
• With a higher other income (due to a dividend income of Rs31 crore) and stable depreciation, the net profit grew by 20% yoy to Rs12.7 crore.
• ICI India's Q4FY2007 net profit (adjusted for extraordinary items and taxes) at Rs12.7 crore was slightly below our expectations. The net profit grew by 20% yoy.
• The company has announced that it would be utilising Rs210 crore to buy back its own shares from the minority shareholders at a price not exceeding Rs575 per share through market operations.
• Taking into account the sell-off of Quest International and the auto refinish business, we are also introducing our FY2009 numbers. At the current market price of Rs520, the stock trades at 18x its FY2008E EPS of Rs29 and 15.7x its FY2009E EPS of Rs33. In view of the cash per share of Rs202 and 21x FY2008 core earnings per share (EPS) of Rs18, we have revised upward our price target to Rs581. We maintain our Buy recommendation on the stock.

ICICI Bank
Cluster: Apple Green
Recommendation: Buy
Price target: Rs1,173
Current market price: Rs918

Preferred play on insurance boom

Key points

• India's largest private sector lender ICICI Bank plans to raise Rs20,125 crore ($5 billion) through a follow-on public offer (FPO). The FPO is to be equally distributed in the domestic and foreign markets. The FPO would remain open from June 19- 22, 2007 and the offer price band is at Rs885-950 with a Rs50 discount offered to retail bidders. Further issue details are provided on next page.
• The bank's management has indicated that the pace of growth in the economy as well as the bank's business in the past few years is unprecedented and the FPO tries to address the increased capital requirements of the bank for the next three years.
• The life insurance sector has been growing at a scorching pace for the past few years and ICICI Prudential Life Insurance is the private sector leader with a 30% market share among the private players and a 10% market share in the overall insurance market. The insurance sector is considered to be a sunrise sector and currently there are no listed insurance companies to play on the boom in the insurance sector. Hence, ICICI Bank, which has a 74% stake in ICICI Prudential Life Insurance, remains our preferred choice to play on the insurance story.
• In the past the bank has had to divert a significant amount of the capital raised through its earlier issues to fund its insurance subsidiaries. However this time we feel the difference is that ICICI Bank has already made arrangements for continuous funding of its insurance businesses. Thus with the funding of the insurance businesses taken care of, we feel, there will be more capital available to the bank to grow its core banking business without frequent dilutions in future. However, the huge FPO would take its toll on the return on equity (RoE), which is expected to come down to 10.3% and 10.5% in FY2008 and FY2009 respectively from 13.3% in FY2007.
• We feel one of the concerns pertaining to the bank revolves around its subsidiary ICICI Financial Services (IFS). The formation of the subsidiary is still in the conceptual stage and the bank has only received a firm commitment of Rs2,650 crore for a 5.9% stake sale. To fully materialise and be executed in black and white from the conceptual stage the deal would require regulatory clearance from the Reserve Bank of India (RBI), Insurance Regulatory and Development Authority (IRDA) and Foreign Investment Promotion Board (FIPB).
• We feel the stock will continue to consolidate around the current levels, as has been the case in the past after the announcement of any equity issuance. This provides a good opportunity to buy the stock. At the current market price of Rs918, the stock is quoting at 20.1x its FY2009E earnings per share (EPS), 8.9x its pre-provision profits (PPP) and 2.0x FY2009E book value (BV). We maintain our Buy recommendation on the stock with the price target of Rs1,173.

Indian Hotels Company
Cluster: Apple Green
Recommendation: Buy
Price target: Rs180
Current market price: Rs144

Price target revised to Rs180

Result highlights

• The FY2007 results of Indian Hotels Company Ltd (IHCL) are above our expectations. However, on a stand-alone basis the FY2007 results are not comparable with the results of FY2006 as the former take into account the effect of the merger of five companies into IHCL with effect from April 1, 2006.
• The company reported a consolidated total income of Rs2,665.8 crore for FY2007 as against Rs1,914.1 crore for FY006. That implies a growth of 39%. Operating profit showed a growht of 39.5% from Rs512 crore to Rs715 crore in FY2007. The interest and depreciation charges were higher in FY2007 due to the merger of the five companies in the year. IHCL posted a consolidated profit after tax (PAT) of Rs369.9 crore in FY2007 as against Rs248.7 crore in FY2006. This resulted in earnings per share (EPS) of Rs6.1.
• The healthy trend in the top line is due to the rise in the number of foreign tourist arrivals in India, which has pushed up the average room rate (ARR) and the occupancy rate (OR). The hotel industry has witnessed continued buoyancy in the arrival of foreign tourists. The number of foreign tourist arrivals increased to 40 lakh from 44 lakh in FY2007, representing a 15% growth year on year (yoy).
• In FY2007 the ARR grew by 28.4% to Rs9,234 from Rs7,186 in FY2006; the OR increased from 70% in FY2006 to 73% in FY2007.
• IHCL has issued 16,219,670 equity shares to the members of Indian Resort Hotels, and Gateway Hotels and Getaway Resorts which has led to equity dilution of 2.76%. The new equity capital is 60.3 crore.

Q4FY2007 results (stand-alone)

• On a stand-alone basis, for the fourth quarter of FY2007 IHCL reported a top line growth of 42% at Rs505.2 crore against Rs355 crore in Q4FY2006. The operating profit margin (OPM) improved by 640 basis points from 35.5% in Q4FY2006 to 42.0%. The operating profit grew by 67.6% to Rs212.1 crore. The bottom line of the company grew by a healthy 71% to Rs134.5 crore from Rs78.7 crore in Q4FY2006, resulting in earnings of Rs2.23 per share.
• The company has merged Asia Pacific Hotels, Indian Resort Hotels, Gateway Hotels and Getaway Resorts, Taj Lands End and Kuteeram Resorts Pvt Ltd with itself with effect from April 1, 2006. This has led to an addition of around 400 rooms to the existing inventory. The results for the year ended March 31, 2007 are therefore not comparable with the results of the previous year.
• We have introduced our FY2009 estimates for the company with a consolidated PAT of Rs547.8 crore. At the current market price of Rs144 the stock is quoting at a price/earnings ratio (PER) of 20x FY2008E consolidated EPS of Rs7.4 and 16X FY2009E consolidated EPS of Rs9.1. We maintain our Buy recommendation on the stock with a revised price target of Rs180.

International Combustion (India)
Cluster: Cannonball
Recommendation: Buy
Price target: Rs519
Current market price: Rs320

Results meet expectations

Result highlights

• The revenues of International Combustion India Ltd (ICIL) grew by 15.6% year on year (yoy) to Rs24.1 crore in Q4FY2007, in line with our estimates.
• The revenues of the heavy engineering division (HED) grew by 24.8% yoy to Rs18.4 crore while that of the geared motor and geared box division (GMGBD) declined by 5.1% yoy to Rs5.9 crore. However, on a sequential basis the GMGBD's top line grew by 61.2%.
• The operating profit margin (OPM) of the company improved by 280 basis points yoy to 20.3% in Q4FY2007, in line with our estimates. The margin expansion was driven by a lower raw material cost as the raw material cost as a percentage of sales ratio declined to 51% from 56.3% yoy. Consequently, the operating profit grew by 34.6% to Rs4.9 crore.
• The margin of the HED improved by a whopping 1,340 basis points yoy to 32.6% while that of the GMGBD declined by 1,800 basis points to 14.7%. The GMGBD's margin declined largely because the company started manufacturing the B2000 series of geared motors and gear boxes in this year. It has made huge investments in the B2000 series project the results of which will get reflected in its FY2008 numbers.
• The interest cost declined by 7.7% yoy to Rs0.1 crore as the company repaid its entire debt and became a debt-free company in this year. Consequently, the net profit grew by a strong 47.4% yoy to Rs2.8 crore.
• The outstanding order book stood at Rs56 crore out of which the HED's order book stood at Rs48 crore with the GMGBD accounting for the balance Rs8 crore.
• ICIL is currently trading at a price/earnings ratio (PER) of 6.8x its FY2008E earnings and 4.2x its FY2008E enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA). Considering the strong order backlog and the expansion plans of its key user industries such as steel, sugar and cement, we maintain our Buy recommendation on the stock with a price target of Rs519.

Madras Cement
Cluster: Cannonball
Recommendation: Buy
Price target: Rs3,500
Current market price: Rs2,746

Price target revised to Rs3,500

Result highlights

• Cement volumes of Madras Cement Ltd (MCL) grew at a slower rate of 10.1% in Q4FY2007 compared the previous quarters to 1.48MMT as the plant at Alathiyur witnessed a maintenance shutdown for 15 days. The realisation growth was strong at 27% year on year (yoy) to Rs2,923 per tonne which resulted in a robust top line growth of 45.1% yoy to Rs435 crore.
• The operating expenditure increased by 29.4% yoy to Rs301.8 crore as the power and fuel cost increased by 25% yoy to Rs85 crore on the back of higher international coal prices and freight cost, which increased by 35% yoy to Rs72.8 crore. The employee cost too jumped substantially to Rs18 crore as against Rs12 crore in the previous quarter on account of the bonuses given to employees.
• The operating profit doubled yoy to Rs133 crore whereas the operating profit margin (OPM) improved by 800 basis points yoy to 30%; though on a sequential basis, the OPM dropped by 270 basis points.
• The interest cost reduced by Rs3 crore yoy to Rs6 crore, thanks to the repayment of debt in the quarter. The depreciation provision remained more or less flat sequentially at Rs18.2 crore.
• With the tax provision growing at a marginal rate, the net profit jumped by 117% yoy to Rs71 crore.
• Thanks to the additional capacity of 4MMT that kicked in during the fourth quarter, we expect the company to clock a healthy volume growth of 12% in FY2008 and 26% in FY2009 yoy. The accompanying captive power plants (CPPs) will help the company to keep its power cost under control.
• We are reducing our FY2008 earnings per share (EPS) estimate by 6.6% to Rs313 from Rs334 earlier as we expect the cement prices to remain firm for the next one year. We are also introducing our FY2009 estimate of Rs359.
• We expect the company to clock a 40% compounded annual growth in its earnings over FY2007-09. At the current market price of Rs2,746, the stock trades at 7.7x its FY2009 estimates and an enterprise value (EV) per tonne of USD77. Considering the positive outlook, we maintain our Buy recommendation on the stock with a reduced price target of Rs3,500 per share.

Orchid Chemicals & Pharmaceuticals
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs390
Current market price: Rs253

Cefepime--a huge opportunity!

Key points

• Orchid Chemicals & Pharmaceuticals (Orchid) has received approval from the US Food and Drug Administration (USFDA) for its abbreviated new drug application (ANDA) for Cefepime injection.
• Cefepime injection is a life-saving Cephalosporin antibiotic drug used in hospitals. The brand product had recorded sales of $190 million in December 2006. The patent for the product has already expired.
• Since there will be only two players in the market including the innovator, Orchid will enjoy a near-exclusivity situation with this product and Apotex, through its strong marketing prowess, will be able to capture a healthy market share to the tune of 50-60%. Besides, with the entry of just one player, the market is also unlikely to get eroded beyond 20-30%.
• We believe that Cefepime injections will generate $18.3 million in revenues for six months of FY2008 (from July 2007-March 2008) and $36.6 million in revenues in FY2009. This will translate into incremental earnings of Rs2.6 per share and Rs5.3 per share in FY2008 and FY2009 respectively, on a fully diluted basis.
• At the current market price of Rs253, the stock is trading at 10.1x its estimated FY2008 earnings, on a fully diluted basis. Based on the FY2007 performance of the company, the outlook provided by the management and the recent news flow relating to the company, we are reviewing our estimates for Orchid and will come out with an update shortly. In view of the bright prospects for the company, we retain our positive stance on the stock and maintain our Buy call with a price target of Rs390.

ORG Informatics
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs184
Current market price: Rs105

Price target revised to Rs184

Result highlights

• ORG Informatics' performance was below expectations in Q4FY2007. Its revenues grew by 17% to Rs70.4 crore, below our expectations. The revenue growth was dented partly by the slippage of some revenues to Q1FY2008.
• The operating profit margin (OPM) declined sharply to 1.3% (as against 9.5% in the nine months ended December 2006) due to the cumulative impact of the higher contribution from low-margin hardware supply part of the MTNL order, expenses related to integration and restructuring of the recently acquired entities (United Technologies and DGIT) and a one-time write-off (around Rs1.3 crore related to provision for bad debts and stock adjustments).
• However, the steep jump in the other income and the write-back of tax provisions enabled the company to post a relatively higher growth of 24.7% in its consolidated earnings to Rs5.3 crore.
• On the full year basis, the consolidated revenues and earnings grew by 97.6% to Rs306.6 crore and 113.7% to Rs17.3 crore. The OPM declined by 110 basis points to 7.6% in FY2007.
• In terms of the outlook, the management expects to maintain the growth momentum on the back of a healthy order pipeline and the expected improvement in its margins as the high-margin maintenance revenues kick in from the MTNL contract. Moreover, the company would continue to actively scout for inorganic opportunities and has got the board approval to raise up to $30 million for the same.
• We have revised downwards the earnings estimate of FY2008 by 2.6% to factor in a higher tax rate. We maintain our Buy call on the stock with a price target of Rs184.

Ratnamani Metals and Tubes
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs1,215
Current market price: Rs917

Price target revised to Rs1,215

Result highlights

• The Q4FY2007 results of Ratnamani Metals & Tubes Ltd (RMTL) are above our expectations.
• The company reported strong quarterly results. Its revenues for the quarter grew by 95.3% to Rs172.6 crore.
• The operating profit for the quarter grew by 78.3% to Rs34 crore. The operating profit margin (OPM) for the quarter declined by 240 basis points to 22.3% from 24.7% in Q4FY2006. The OPM declined due to a higher raw material cost as a percentage of sales. The raw material cost went up by 310 basis points to 62.9% from 59.8% in Q4FY2006. Other expenses as a percentage of sales also went up by 110 basis points to 12.4%.
• The interest expense for the quarter increased by 111.4% to Rs4.9 crore, while the depreciation cost for the quarter increased by 309.6% to Rs6.2 crore.
• The profit before tax grew by 80% to Rs27.7 crore. The net profit for the quarter grew by 39.4% to Rs17.6 crore due to a higher tax rate of 36.7% in this quarter compared with 17.8% in Q4FY2006.
• For the full year, the net sales grew by 79% to Rs571 crore and the net profit grew by 91% to Rs64.2 crore.
• The order book at the end of the quarter stood at Rs500 crore.

Shree Cement
Cluster: Cannonball
Recommendation: Buy
Price target: Rs1,500
Current market price: Rs1,187

Price target revised to Rs1,500

Result highlights

• Shree Cement's top line grew by a robust 68% year on year (yoy) to Rs378 crore in Q4FY2007. The growth was achieved on the back of a robust 36% growth in volumes and a 24% rise in realisations over last year.
• The operating expenditure grew by 67% yoy to Rs226.97 crore on account of higher power& fuel expenditure and employee cost.
• Consequently, the operating profit grew by 69% yoy to Rs151 crore whereas the operating profit margin (OPM) stood flat at 40% yoy.
• The company claimed an additional depreciation of Rs114 crore on its new unit (the fourth one) at Ras in the fourth quarter. This resulted in an overall depreciation cost of Rs134 crore. The interest cost reduced from Rs2.3 crore in Q4FY2006 to Rs1.64 crore in the quarter.
• The tax provision remained very low at Rs0.3 crore, thanks to a higher depreciation provision. On the back of high depreciation provision, the net profit remained low at Rs24 crore.
• With additional capacity of 4MMT coming up over the next two years, Shree Cement will witness a robust year-on-year (y-o-y) volume growth of 19% in FY2008 and of 26% in FY2009.
• In view of the high volume growth and strict control measures, we expect the company's profits to grow by 22% yoy in FY2008 and by 9% in FY2009, resulting in a compounded annual growth of 15% over FY2007-09.
• At the current market price of Rs1,187, the stock is trading at 9.4x its FY2008 earnings per share (EPS) and 8.7x its FY2009 EPS. On an enterprise value (EV)/per tonne basis the stock trades at USD84. Keeping our bullish view on the stock, we maintain our Buy recommendation with a price target of Rs1,500 per share.

State Bank of India
Cluster: Apple Green
Recommendation: Buy
Price target: Rs1,780
Current market price: Rs1,525

Price target revised to Rs1,780

Key points

• The Reserve Bank of India (RBI) has announced that it is going to transfer its 59.7% holding in State Bank of India (SBI) to the government for Rs35,530 crore on June 29, 2007. The transaction is revenue neutral for the government, as the RBI would declare a special dividend of a similar amount to replace the amount paid by the government for the stake sale.
• The SBI management has said that the bank will require to raise Rs15,000 crore of capital in FY2008; of this Rs6,000 crore is likely to be in the form of equity and the balance as debt.
• The current guidelines restrict SBI from diluting the promoter's stake below 55% and this would hinder the bank's capital raising plans. Hence the management is of the view that the follow-on offer would take place after the amendment to the SBI Act, most probably in December 2007.
• SBI has plans to consolidate its insurance and asset management businesses into a separate non-banking financial company (NBFC). It also plans to sell a 10% stake in the NBFC to three to four investors and intends to list the arm in FY2009 All these would be significant value drivers going forward. The chairman of the bank has stated that he expects the valuation of the life insurance business to be around Rs28,700 crore ($7 billion) while we have valued the same business at Rs23,800 crore ($5.8 billion). Our valuation is lower considering the roadblocks that the bank is likely to face while unlocking the value in these investments, just as ICICI Bank is facing now.
• After providing for the AS-15 impact (Rs900 crore of extra provision per year from FY2008-12) our earnings estimates for FY2008 and FY2009 have reduced by 4% each. We have also introduced our FY2009 estimates. Based on the current market price of Rs1,525 the stock is currently trading at 13.9x FY2009E earnings per share (EPS), 1.9x FY2009E stand-alone book value of Rs813 and 1.4x FY2009E consolidated book value of Rs1,061. The stock has run up 54% in a span of the past three months. Hence in the near term there could be some profit booking and consolidation. However, we believe the bank has entered a sweet spot as a host of policy changes in the banking sector and for SBI could unlock significant value in the stock in the medium term. We maintain our Buy recommendation on the stock with a revised twelve-month price target of Rs1,780.

Tata Motors
Cluster: Apple Green
Recommendation: Buy
Price target: Rs792
Current market price: Rs685

Annual report review

We have analysed the recently released annual report of Tata Motors (TAMO) and present the highlights below.

Key points

• TAMO had a good FY2007, registering a 32.3% growth in its top line and a 37.5% growth in its bottom line. The medium and heavy commercial vehicle (M&HCV) sales volumes picked up splendidly during the year, led by a strong growth in the freight availability and the Supreme Court's ban on the overloading of trucks. The light commercial vehicle (LCV) volumes sustained their growth momentum as Ace continued to do well while passenger car volumes remained strong on the back of good Indica sales.
• The company continued to make progress towards improving its operational efficiencies as its turnover per employee rose to Rs73 lakh against Rs68 lakh in FY2006. The return ratios remained stable with the return on capital employed (RoCE) at 29.9% and return on net worth (RoNW) at 27.1%. The debtor days reduced to 10.5 days while the inventory days too reduced to 33.7 days from 35.8 days.
• The company has a capital expenditure (capex) plan of Rs12,000 crore for the next four years. The funds shall be spent towards new product development and capacity expansion. To part finance the activities, the company has recently announced the issue of five-year foreign currency convertible alternative reference securities (CARS) aggregating to $490 million, including a green-shoe option of $40 million. The same will be convertible at the option of the company into depository receipts or ordinary shares at a price of Rs960.96 per share. At that price, it would lead to a dilution of 5% over its current diluted equity.
• The company maintains its optimism towards the automobile sector, considering the strong macro factors. However the growth during the current year is expected to be lower in comparison to that in the previous year as the same shall be affected due to the higher interest rates and tightening liquidity. As a strategy going forward, the company plans to focus on new product launches and has lined up a number of launches in the next couple of years.
• We maintain our cautious view on the commercial vehicle (CV) industry and believe that the lacklustre trend in sales would continue in the coming months. We expect a revival at the end of the monsoons and with the commencement of the festive season. At the current market price of Rs685, the stock quotes at 10.4x its consolidated FY2009E earnings and at 5.2x its earnings before interest, depreciation, tax and amortisation (EBIDTA). We maintain our Buy recommendation with a price target of Rs792.

Television Eighteen India
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs967
Current market price: Rs813

Price target revised to Rs967

Result Highlights

• TV18 India (TV-18) reported good results for Q4FY2007 with revenues of Rs80.4 crore and adjusted net profit (pre-ESOP amortisation and extraordinary items) of Rs22.8 crore.
• During the quarter its top line grew by 50.2% and bottom line increased by 23.7% on a year-on-year (y-o-y) basis. Sequentially, its revenues increased by 24.1% whereas its net profit grew by 19.7%. However, the results are not strictly comparable with those of Q4FY2006, as the numbers of "Awaaz" were included (post-restructuring) in the reported results from Q2FY2007 onwards.
• The operating profit grew by a meagre 10.8% year on year (yoy) to Rs31.7 crore. The growth in the bottom line was lower than that in the top line on account of a drop in the operating profit margin (OPM). The OPM dropped by 1,400 basis points yoy and 590 basis points quarter on quarter (qoq). It declined because of the lower profitability of "Awaaz", which is still at a nascent stage, and the operating loss of Web-18, which is building up new growth avenues and investing in enhancing its existing offerings.
• With the depreciation charge increasing by 53% to Rs5.5 crore, the interest cost more than doubling to Rs2.0 crore and the tax outgo decreasing, the net profit (pre-ESOP charge) grew by 23.7% yoy in Q4FY2007.
• After acquiring CRISIL Market Wire and announcing its foray in the booming stock broking business with Ambit Capital and Centurion Bank of Punjab in Q3FY2007, TV18 acquired a majority stake in Bigtree Entertainment, a movie and entertainment ticketing company, in Q4FY2007. It also entered into a 50:50 joint venture with the business process outsourcing (BPO) division of Infosys Technologies to provide media process outsourcing services under the brand "Source 18".
• TV-18 raised Rs200 crore during the quarter through a qualified institutional placement (QIP) to fund its organic and inorganic growth plans in the media, television and Internet space.
• At the current market price of Rs813, the stock quotes at 36.4x its FY2009E earnings per share (EPS) of Rs22.3 and 20.9x FY2009 enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA). We maintain our Buy recommendation on the stock with our some-of-the-parts (SOTP) price target of Rs967 per share.

Tourism Finance Corporation of India
Cluster: Cannonball
Recommendation: Buy
Price target: Rs30
Current market price: Rs20.65

Q4FY2007 results: First-cut analysis

Result highlights

• For Q4FY2007 Tourism Finance Corporation of India (TFCI) has reported a 331% year-on-year (y-o-y) growth in its profit after tax (PAT) to Rs9.6 crore, which is ahead of our estimate of Rs8.6 crore. The quarter-on-quarter (q-o-q) PAT growth stood at 281.3% but since the earnings are back-ended (the fourth quarter earnings comprise 60-65% of the total annual earnings) the q-o-q PAT growth figure is not relevant.
• In FY2007 TFCI's PAT stood at Rs14.3 crore, up 20% year on year and ahead of our estimate of Rs13.3 crore.
• The net interest income was up by 8.2% to Rs15.4 crore for Q4FY2007 and by 1.2% to Rs28.9 crore for FY2007.
• The operating profit was up by 6.3% to Rs13.7 crore for Q4FY2007 but down 3% to Rs24.9 crore for FY2007.
• Provisions and contingencies declined by 43.4% for Q4FY2007 and by 27.5% for FY2007, reflecting the lower provisioning requirement due to lower incremental non-performing assets (NPAs). We expect TFCI's net NPAs as percentage of loans to have improved from 2.5% in FY2006 to 1.8% in FY2007.
• As per our expectations the company has resumed dividend payment and declared a 5% dividend, which gives a 2.5% dividend yield. At the current market price of Rs20.65, the stock is quoting at 5.8x its FY2009E earnings and 0.6x FY2009E book value. We maintain our Buy recommendation on the stock with the price target of Rs30.

Transport Corporation of India
Cluster: Cannonball
Recommendation: Buy
Price target: Rs100
Current market price: Rs88

Price target revised to Rs100

Result highlights

• In Q4FY2007 the overall revenues of Transport Corporation of India (TCI) grew by 18.9% year on year (yoy) to Rs292.6 crore on the back of the better performance of both the XPS and the SCM division.
• The earnings before interest and tax (EBIT) of the company grew by 61% to Rs15.7 crore yoy whereas the margin improved by 300 basis points to 10% in the quarter, driven by the SCM division's margin of 12%.
• The interest cost doubled to Rs3.12 crore from Rs1.7 crore last year whereas the depreciation provision stood flat on a sequential basis at Rs5.45 crore but increased by 41% yoy, as the company added assets in the form of warehouses and trucks.
• On the back of a better performance at the operating level, the net profit more than doubled to Rs9.42 crore.
• As we have mentioned in our earlier update, TCI has drawn up a capital expenditure (capex) plan of Rs440 crore for the next two to three years. The funds would be utilised for buying ships, expanding the warehouses and augmenting its truck fleet.
• The company is also in the process of forming a 50:50 joint venture with Scan Trans Holding, Denmark to conduct shipping business. It is in the initial stages of forming the joint venture and we will update you on the same once we get more information.
• The company has identified four properties covering a total area of 12.5 acre for development. The value of these properties taken together translates into Rs26 per share on diluted equity. We believe this provides significant cushion to the company's stock price.
• At the current price of Rs88 per share, the stock is trading at 14.7x its FY2009 earnings estimate. Considering the bullish outlook for the company, we are upgrading our target price to Rs100 per share.

UTI Bank
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs638
Current market price: Rs588

Price target revised to Rs638

UTI Bank has announced its plan to come out with a follow-on public offer (FOP) for 7.43 crore equity shares to raise around $1 billion at the assumed FOP price of Rs550. Among the private sector banks that are raising capital (ICICI Bank and HDFC Bank) we feel UTI Bank needs to raise capital more than the others with its Tier-I ratio at 6.4% and overall capital adequacy ratio (CAR) at 11.6% as on March 2007. The additional capital is required to strengthen its capital base under the new Basel II guidelines and also fund its future growth plans. We had earlier estimated that the bank would raise $400 million worth of capital which would dilute its equity base by 13% in FY2008. However the bank has announced its plan to raise capital of around $1 billion. That works out to 26.3% of its existing equity base and is much above our estimate. After the capital raising exercise the Tier-I ratio is expected to be at 10.8%. The details of the issue as well as our revised estimates are stated below.

• UTI Bank has decided to increase its authorised share capital from Rs300 crore to Rs500 crore in its latest annual general meeting to facilitate its FOP, as post-issue its equity capital base would increase to Rs355 crore.
• UTI Bank is looking to raise around $1 billion through a combination of overseas equity issue and a preferential issue to the promoters. The bank plans to issue 4.24 crore equity shares to non-promoters through global depository receipts. It had earlier raised $257 million through a global depository receipt (GDR) issue in March 2005.
• The stake of the present promoters (ie Specified Undertaking of the Unit Trust of India [SUUTI], Life Insurance Corporation [LIC], General Insurance Corporation and four other public sector insurance companies) is at 43.3%. The preferential offer to the promoters is for 3.19 crore equity shares, which would help the promoters to maintain their stake at 43%.
• The recent preferential allotment to the promoters doesn't indicate that the promoters may be willing to lower their stake. The chances of the bank becoming one of the preferred acquisition targets for foreign banks post-FY2009 seem to have reduced to some extent. UTI Bank has grown exceedingly well under the chairmanship of PJ Nayak who is likely to remain as the chairman of the bank. But the issue of leadership succession would resurface once Mr Nayak retires in a couple of years. Hence the restoration of the return on equity (RoE; which would fall to 13.7% post-FPO from above 20% levels currently) would be a tall task going forward in the absence of Mr Nayak. However, the growth prospects of the bank remain sound and if the second tier of the management manages to fill up the void that Mr Nayak's exit would create, the same would augur well for the bank's performance.
• We have revised our FY2008 earnings estimate upwards by 3% to Rs875 crore from Rs851 crore but our earnings per share (EPS) estimate has declined by 9% to Rs24.6 from Rs26.8 earlier after factoring in the higher dilution to be caused by the capital raising exercise. We have also introduced our FY2009 estimate and at the current market price of Rs588 the stock is quoting at 18.2x FY2009E EPS, 8.3x FY2009E pre-provision profits and 2.3x FY2009E book value (BV). We maintain our Buy recommendation on the stock with an upgraded twelve-month price target of Rs638. At the target price UTI Bank would trade at 2.5x its FY2009E BV, within its historical average one-year forward price/BV band. We feel the bank's earnings quality has improved a lot, asset quality is good and growth prospects remain strong. All this should allow it to trade at historical valuations despite a fall in its RoE, which too would get restored in the next three to four years.

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SHAREKHAN SPECIAL

Q1FY2008 Auto earnings preview

The first quarter of the current fiscal has started on a weak note for the automobile industry, as the sales volumes were affected by the rising interest rates, tightening of liquidity by the financiers and the seasonal effect of the monsoon. The two-wheeler segment was the worst affected as the sales in the 100cc segment were hit by price wars that led to stringent checks and lower loan sanctions by financiers. The commercial vehicle (CV) sales too slowed down during the quarter due to lower availability of finance as well as freight (the latter due to the monsoon). The surprise in the pack was the passenger car segment, which saw a good growth led by a number of new launches in the recent times.

The operating profit margins are expected to remain under pressure for the whole sector considering the high raw material prices and increasing competition (particularly in the two-wheeler segment). We expect MUL, Ceat, Apollo Tyres and Ahmednagar Forgings to be among the lead performers in the sector in Q1FY2008.

Q1FY2008 Banking earnings preview

We expect the first quarter numbers from the banking industry to be mixed as the net interest margins (NIMs) and provisions are expected to vary across banks. With liquidity not being a concern for the major part of this quarter, we expect most of the banks to have had a sound operational quarter.

With inflation having moderated to 4% levels and less pressure on deposit rates, we feel that interest rates are likely to remain stable in the medium term, thereby providing a good operational environment for banks going forward. Our top picks in the private bank space remain HDFC Bank and UTI Bank while in the public sector we like State Bank of India and Bank of Baroda.

Q1FY2008 Cement earnings preview

• The growth in cement volumes is expected to have been subdued in Q1FY2008 with capacity utilisations touching 100% and no major capacity having come up in the period. Amongst the front-line stocks, ACC is expected to report a volume growth of 14% year on year (yoy) and of 9% quarter on quarter (qoq) for Q1FY2008, thanks to the incremental volumes from the addition of 0.9 million metric tonne (MMT) capacity at its Lakheri unit. Grasim Industries is expected to report an 8.2% growth yoy for the quarter. Amongst our mid-cap companies, Shree Cement is likely to report a huge volume growth of 23% on account of its capacity expansion at Ras. We expect the Sharekhan cement universe to report a combined volume growth of 7.1%.
• Cement prices across the country remained more or less stable throughout the quarter under review except in the south. In the south, Andhra Pradesh witnessed a hike of Rs5-9 per bag in the first week of June whereas Tamil Nadu saw price hikes of Rs6-7 per bag in May and of Rs7-8 per bag in June. Thus except for the south-based companies, the cement realisation of the cement industry is expected to be more or less flat on a sequential basis for Q1FY2008.
• Amongst our front-line cement stocks, we expect ACC to report a top line growth of 24% yoy to Rs1,820 crore on the back of a higher volume growth. We expect Grasim Industries to report a top line growth of 28.6% to Rs2,414 crore backed by firm viscose staple fibre (VSF) prices. We expect Shree Cement to report a top line growth of 34% yoy to Rs413 crore.
• On the earnings front, we expect our cement universe to clock a growth of 39% yoy backed by an 85% growth in Orient Paper and Industries and a 48% growth in Grasim Industries on account of higher cement realisations and firm VSF prices. On account of the merger of Visaka Cement and India Cements, we expect India Cements' profit to touch Rs200 crore.
• Contrary to the industry's expectations, the cement price freeze will no longer be applicable as clarified by the finance minister recently. We thus expect the demand-supply economics to govern the cement pricing and any cost increase to be passed on to the consumer, as witnessed in Andhra Pradesh recently. We have already seen that prices have increased by Rs3-5 per bag across the country in first week of July. Prices in Andhra Pradesh and Tamil Nadu have already risen by Rs5-15 per bag. With the industry utilisation levels reaching 100%, we believe the higher realisations augur well for the cement players, as the same would result in better than expected profitability even though the volume growth will remain subdued going ahead. We rate Grasim Industries and Jaiprakash Associates as our top picks in the sector as their non-cement businesses are expected to do extremely well going ahead. Amongst our mid-cap universe, we like Orient Paper and Industries, as it trades at a cheap valuation of USD23 on its expanded capacity.

Q1FY2008 IT earnings preview

Against all possible odds
It couldn't have been worse for the information technology (IT) service companies. During the first quarter, the margins of the front-line IT companies are generally dented by the cumulative impact of the incremental cost of visa charges (the visa window opens only during Q1 every year), the inflow of fresh engineers (they are put under training and are non-billable) and the annual salary hikes. (The annual salary hikes are fully reflected in Q1 in case of Infosys Technologies [Infosys] and Tata Consultancy Services [TCS]; the other front-line IT companies provide for the same in either Q2 or spread it out over a number of quarters.) In addition to all this, the steep appreciation in the rupee against all major currencies in Q1 added to the pressure on the margins.

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MUTUAL GAINS

Sharekhan's top equity fund picks

We have identified the best equity-oriented schemes available in the market today based on the following 3 parameter : the past performance as indicated by the one and two year returns, the Sharpe ratio and Fama (net selectivity).

The past performance is measured by the one and two year returns generated by the scheme. Sharpe indicates risk-adjusted returns, giving the returns earned in excess of the risk-free rate for each unit of the risk taken. The Sharpe ratio is also indicative of the consistency of the returns as it takes into account the volatility in the returns as measured by the standard deviation.

FAMA measures the returns generated through selectivity, ie the returns generated because of the fund manager's ability to pick the right stocks. A higher value of net selectivity is always preferred as it reflects the stock picking ability of the fund manager.

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SECTOR UPDATE

Automobiles

Thrown out of gear for a while

• The automobile sector has been on a dream run since 2004. A strong economy, easy and cheap availability of finance, rising income levels, lifestyle changes and low penetration levels led to this phenomenal performance. While all the other macro factors remain intact, the rising interest rates and liquidity crunch are severely affecting the sector's growth, forcing it to take a breather.
• Overall, the sector's sales are expected to pick up with the beginning of the busy season, ie October onwards. Sales for June are also expected to be affected due to the presence of Adhik mahina, an inauspicious period for buying any new product, in this month The slowdown in the automobile industry will surely affect the earnings of all the major players.
• Considering this we are downgrading our estimates for all the stocks under our coverage. At the current prices, most of the stocks are trading at a discount to the valuations of the Sensex. We expect stocks from this sector to continue to trade at a discount to the index in the medium term and hence continue to underperform the market. However, considering the long-term potential of individual stocks, we maintain our Buy recommendation on the stocks, save for Bajaj Auto, which is being downgraded to a Hold. Our preferred bets are Maruti Udyog, and Mahindra and Mahindra.

Cement

Impact of hike in coal royalty
Last week the government increased the royalty on the coal produced and consumed domestically. The royalty, which is charged at a specific rate, will now be charged at an ad-valorem rate of 14%. This will affect the coal consuming industries like power, cement and steel. We have assessed the implications of the same for the cement industry.

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VIEWPOINT

Lakshmi Machine Works

Growing at a rapid pace
Lakshmi Machine Works (LMW) is a leading textile machinery manufacturer in India with presence in machine tools and foundry businesses. The company is a major player in the textile machinery space and has about 50% of the domestic market share. The machine tools division makes the CNC machine tools and is a brand leader for customised products while the foundry division makes precision casting.

Though the company has presence in three sectors but the revenues from its textile machinery segment, which contributed 89% of the total revenues in FY2007, dominate its top line. LMW is known for its quality and all its divisions are ISO 9000 certified.

SREI Infrastructure Finance

SREI, BNP Paribas arm in 50:50 JV
SREI Infrastructure Finance (SREI) and BNP Paribas Lease Group (BPLG), the leasing arm of BNP Paribas, have reached an agreement regarding a strategic partnership in equipment finance in India.