Valueline - October 2007

Market gets propelled to fast track

Till recently most market experts had pegged the Indian stock market's fair value at around 15,500-16,000 levels. But the latest policy initiative of the US Federal Reserve (Fed) has changed that perception and much more. On September 18, the Fed cut the key short-term interest rate by 50 basis points instead of 25 basis points as was widely expected. The effect of the surprise Fed action on our market was such that despite the re-emergence of concerns of a slowdown in the domestic economy, the market rallied by over 653 points the very next day, comfortably conquering the peak of 16,000 in the process. In another six days the market sprinted past the milestone of 17,000 as well, recording its fastest 1,000 ever. Incredibly, the euphoric rally triggered by the Fed's rate cut continues till day and the Sensex is now within kissing distance of--hold your breath--18,000! We had always said that a rate cut in the USA would be an enormous positive for our markets, well, the recent performance of the market bears us out. Now, no target seems too lofty or far-fetched for the market anymore and there are even talks of it reaching as high as 20,000 by the year-end. We believe the market has got propelled to the fast track and is likely to scale newer heights in the days to come.

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MARKET OUTLOOK

Global liquidity to dictate markets

We have seen a sustained one-way rise in our stock market after the US Federal Reserve (Fed) cut the key short-term rate on September 18, 2007. The Fed cut has boosted not just our market but the other emerging markets (EMs) as well. It seems that the US sub-prime concerns are a thing of the past. So what has suddenly changed that the EMs look more attractive than ever before? We feel there has been no change in the fundamentals. What has changed is the liquidity condition and the increased liquidity globally is expected to drive the EMs to a higher valuation orbit.

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Sharekhan top picks

In the September 2007 issue, we had recommended the best 12 of our Stock Ideas as Sharekhan Top Picks. As on October 1, 2007, the basket of stocks has given an absolute return of 13% as compared with a 12.4% appreciation in the Sensex and a 13.2% rise in the S&P CNX Nifty.

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STOCK IDEA

BL Kashyap & Sons
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs2,850
Current market price: Rs2,189

On a concrete footing

Key points

• Poised to ride construction boom: With its proven execution skills, reasonably large-scale of operations and an established customer base, BL Kashyap & Sons (BLK) is well poised to ride the construction boom in the fast-growing industrial, residential, commercial and retail segments.
• Relatively low risk strategy: Unlike most of its peers, BLK's strategy revolves around providing contractual construction services to private sector clients and it has consciously avoided exposure to long duration infrastructure projects that are prone to delays and are much more capital intensive. Thus, it does not require regular infusion of funds through debt or equity dilution.
• To sustain growth momentum: Despite its strategy to stay away from the big-ticket infrastructure projects, BLK has shown a healthy CAGR of 72.6% in its stand-alone revenues to Rs808 crore over the past three years. What's more, the strong order backlog of Rs2,100 crore (2.6x FY2007 revenues) provides a robust revenue growth outlook for the coming years. We expect the stand-alone revenues to grow at a CAGR of 48.8% over FY2007-10.
• Value in real estate subsidiary: BLK has forayed into real estate development through its subsidiary SSP, which undertakes joint development projects with the existing owners of land. Currently, it is executing six projects with saleable area of 13.2lsf (SSP's share of around 8.5lsf) and also has rights for around 150-acre land in Bikaner, Rajasthan. We have valued SSP at Rs580 crore.
• Upside of 30% from current levels: BLK's stand-alone earnings are estimated to grow at a CAGR of over 48% over FY2007-10. More importantly, given the company's limited exposure to highly capital intensive infrastructure projects, there is limited risk of equity dilution. At the current market price the stock trades at attractive valuations of 12.8x FY2009E and 9.3x FY2010E earnings (after adjusting for the value of its subsidiary: Rs554 per share). We recommend a Buy call on BLK with a price target of Rs2,850.

Jindal Saw
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs830
Current market price: Rs635

Opportunities in the pipeline

Key points

• De-risked business model: Jindal Saw Ltd (JSL), the largest pipe manufacturer in the country, is expected to make the most of a huge opportunity in the pipe sector due a global surge in E&P activities and a strong domestic demand. JSL is present in almost all pipe segments, which makes it a de-risked and strong play on the booming Indian pipe sector.
• Strong order book: It enjoys a strong order book of $700 million, ie almost 1.1x its FY2006 sales from Indian operations. Executable by May 2008 this strong order book and the buoyancy in the pipe industry provide good visibility to its future earnings.
• Margin expansion: We expect a sharp improvement in the margins of JSL going forward due to the sell-off of its US business (which was less profitable), better product mix in favour of seamless and ductile iron pipes, and greater operating efficiencies. The OPM of the company is expected to improve from 10.6% in FY2006 to 15.2% in FY2009.
• US sell-off positive: We regard the sell-off of the US operations as a positive for the company, since its lower margin was dragging the company's overall profitability. Moreover, JSL has been able to get a good price from the stake sale and the transaction would lead to a post-tax inflow of $275 million. The company would utilise part of this to repay some amount of debt and expand its capacity.
• Attractive valuations: Considering its strong growth potential, strong improvement in its margin and the buoyancy in the pipe segment, we believe the stock is trading at very attractive valuations. We expect the profits of the company to grow at a CAGR of 40% over FY2006-09. At the current market price of Rs635, the stock is discounting its FY2009E earnings by 7.6x and is available at an EV/EBIDTA of 3.6x, which is lower than that of its peers. We, therefore, recommend a Buy on JSL with a price target of Rs830.

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STOCK UPDATE

Aban Offshore
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs3,765
Current market price: Rs3,165

Price target revised to Rs3,765
Aban Offshore has announced a contract for three of its jack-up rigs (Aban III, Aban IV and Aban V) with Oil & Natural Gas Corporation (ONGC) for a period of three years. At the renewed day rate of US$156,600 the total value of the contract works out to around Rs2,000 crore.

Alphageo India
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs517
Current market price: Rs416

Annual report review

Key points

• In FY2007, Alphageo India's (Alphageo) revenues increased by around 128% year on year (yoy) to Rs54.3 crore. The operating profit rose by 128% yoy to Rs25.5 crore as compared with Rs11.2 crore in FY2006. However, the operating profit margin (OPM) remained almost flat at 46.9% in FY2007. The net profit grew at 78.3% yoy to Rs7.5 crore.
• The company witnessed a significant improvement in its project mix in FY2007, where the 3D projects made up around 77% of the total revenues as compared with around 44% in FY2006.
• The company's order book as on April 30, 2007 stood at Rs117.1 crore, which is around 70% higher than that of Rs68.8 crore on April 30, 2006. Around 85% of the company's current order book comprises of 3D projects.
• During the year, the company received a Rs58.4 crore contract from ONGC in the operational blocks of the Cauvery basin, Tamil Nadu. The contract will reduce company's excessive dependence on non-monsoon assignments.
• The Company added one more 3D crew in FY2007. The crew strength of the company now stands at five of which three are 3D crew and two are 2D crew.
• Alphageo is the largest private sector player with five crew (three 3D crew and two 2D crew) in operation for 2D and 3D seismic services. The company is well versed with almost all the terrains in the country, which makes the company one of the most experienced (private sector) players in the country to take the advantage of the ongoing boom in oil and gas exploration in the country. At the current market price of Rs416, the stock discounts its FY2009E earnings by 8.0x and is available at enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 4.0x. We maintain our Buy recommendation on the stock with a price target of Rs517.

Ashok Leyland
Cluster: Ugly Duckling
Recommendation: Hold
Price target: Rs42
Current market price: Rs39

Decline continues

Key points

• Ashok Leyland's total vehicle sales during August 2007 declined by 6.6% to 6,055 units as against 6,483 units in the same month a year ago. The sales in the domestic market declined by 3.2%, whereas the export sales were substantially down by 31% for the month. On a month-on-month basis the total sales grew by 8.6%, which can be attributed to higher sales of passenger and light commercial vehicles.
• The passenger/bus segment grew by 61% to 2,220 vehicles. The domestic passenger vehicle sales rose by 81% to 1,832 units on the back of orders from various State Transport Corporations, mainly the Tamil Nadu State Transport Corporation. These orders are expected to continue for one more month.
• The truck sales declined by 25% to 3,794 vehicles. The domestic truck sales declined by 22% year on year (yoy) to 3,656 vehicles, while the truck exports declined by 67% to 138 vehicles.
• The company under performed the industry during the month as its sales declined higher than that of the industry.
• For the full year, the company expects the commercial vehicle industry to grow by 5-6%. We estimate that the overall volumes for the company will decline by 4.7% in the current year but to grow by 13% the next year.
• The capital expenditure for FY2008 has been doubled to Rs1,000 crore and is expected to restrict the profit after tax (PAT) growth. We remain very cautious on industry's prospects considering weak freight rates, low freight availability due to seasonal factors, reduced auto loan disbursals by financiers and increase in the instances of delinquencies. Consequently, we are maintaining Hold on the stock.

Bajaj Auto
Cluster: Apple Green
Recommendation: Buy
Price target: Rs2,550
Current market price: Rs2,393

XCD launch to improve margins
Bajaj Auto Ltd (BAL) expects its overall margin to rise in the second quarter of FY2008 on the back of sales of XCD, the recently launched 125cc motorcycle, and the closure of the Akurdi plant.

Bank of India
Cluster: Apple Green
Recommendation: Buy
Price target: Rs325
Current market price: Rs260

Price target revised to Rs325

Key points

• Bank of India (BoI) is considering diluting 5% of the government's stake in it. At present, the government holds 69.5% stake in the bank.
• A 5% reduction in the government's stake would result in an issue of 3.8 crore shares equivalent to 7.8% of the existing equity base of 48.8 crore shares which would help the bank to raise around Rs1,000 crore.
• The bank is weighing the option of raising resources through both the follow-on public offer (FPO) option and the qualified institutional placement (QIP) route but prefers the latter since it could be faster and cost effective.
• If the bank goes ahead with the QIP offering, it will be the first public sector bank (PSB) to do so. We feel the QIP route would make more sense, considering the small dilution plans of the bank. It would also help the bank to fetch much better pricing than it would normally get if it adopts the FPO route.

Bharat Electronics
Cluster: Apple Green
Recommendation: Buy
Price target: Rs1,975
Current market price: Rs1,775

Annual report review

Key points

• Gross sales of Bharat Electronics Ltd (BEL) grew by 11.8% in FY2007 on the back of a healthy growth in the civilian segment whereas the defence business remained stagnant during the year. The earnings growth of 23.2% was aided by a jump of 65.6% in the other income component and a decline in the interest outgo. In terms of balance sheet, the huge jump in the sundry debtors resulted in a lower than expected growth in the free cash on its books.
• The order backlog at the beginning of the year stood at a record level of Rs9,130 crore of which Rs3,969 crore is executable in the current fiscal. The company has agreed to a revenue target of Rs4,725 crore for FY2008.
• BEL is gearing itself to meet the increasing competition through the roll-out of new products (leveraging its research capabilities) and tie-ups with suitable partners (domestic and foreign vendors). During the year, the company signed agreements with leading global defence vendors including Lockheed Martin, Boeing, Northrop Grumman and CASA.
• At the current market price the stock trades at 13.7x FY2008 and 11.2x FY2009 earnings estimates (adjusted for the estimated free cash on its books). We maintain our Buy call on the stock with a price target of Rs1,975.

Bharat Heavy Electricals
Cluster: Apple Green
Recommendation: Buy
Price target: Rs1,954
Current market price: Rs1,910

Annual report review

Key points

• Bharat Heavy Electricals Ltd (BHEL) had a splendid FY2007, registering a 29% growth in its revenues to Rs18,739 crore and a 44% increase in its net earnings to Rs2,414.7 crore. The operating profit margin (OPM) expanded marginally (by 60 basis points) to 19.1%.
• The power business registered a healthy growth of 28% in its revenues while the industrial business recorded a rise of 32% in its revenues during the year.
• It was a remarkable year for BHEL in terms of order inflow, which grew at 88.2% year on year (yoy) to Rs35,643 crore. Consequently, the order backlog at the end of the year stood at Rs55,000 crore.
• BHEL's cash pile stood at a huge Rs5,808 crore at the end of FY2007, thanks to reduced working capital requirement and lower capital expenditure during the year.
• The company has crafted a "Strategic plan 2012" targeting a turnover of $10 billion by 2012 vs $4 billion at present.
• In our view, the government's focus on increasing power generation in order to meet its mission of providing "power for all by 2012" would be one of the key catalysts for BHEL's order inflows, providing clear visibility to the company's earnings.
• We believe in future, the execution capability is going to be a key differentiating factor in this business and BHEL, which is a large player, will be better placed to secure the best orders in the industry. Hence, we remain bullish on the stock and reiterate our Buy recommendation with a price target of Rs1,954. At the current market price Rs1,910 the stock is trading at 30.4x its FY2008E earnings and 24.4x its FY2009E earnings.

Elder Pharmaceuticals
Cluster: Apple Green
Recommendation: Buy
Price target: Rs508
Current market price: Rs399

Biomeda acquisition to be earnings accretive from FY2009

Key points

• Elder Pharmaceuticals (Elder) has acquired a 51% stake in Biomeda Group in Bulgaria for 5 million euros (around Rs28 crore) in an all-cash deal.
• Biomeda is among Bulgaria's top ten oral dosage formulation manufacturer and distributor. The manufacturing division of the company includes a manufacturing facility to produce oral formulations and hard gelatin capsules. The company imports products from the global players and distributes them to clients all across the European Union through its warehouses.
• In line with its strategy to expand its global footprint, Elder's acquisition of a 51% stake in Bulgaria's Biomeda group is expected to provide it with an entry point into the European markets. With Biomeda's stable of nine products and its strong relationships with global pharmaceutical companies, Elder hopes to grow the existing business of Biomeda at an annual rate of 15-20% in the next two-three years. Further, Elder is also planning to introduce products from its own portfolio into Bulgaria and the other European countries through Biomeda.
• We believe that through the introduction of Elder's products into the Bulgarian and other key European markets, Biomeda's sales will grow by 20% to 12 million euros in CY2008/FY2009 and by 50% to 18 million euros in CY2009/FY2010. Further, cheaper sourcing of the raw materials and rationalisation of operating costs will improve Biomeda's margins from the current level of 8-10% to 12% in the next three years. Our back-of-the-envelope calculations indicate that after minority interest, the Biomeda acquisition will dilute Elder's earnings by Rs0.06 per share in FY2008, but add Rs0.8 per share in FY2009 and Rs2.3 per share in FY2010.
• At the current market price of Rs399, Elder is quoting at 9.9x its estimated FY2008 earnings and at 8.8x its estimated FY2009 earnings. We maintain our Buy recommendation on the stock with a price target of Rs508.

Esab India
Cluster: Vulture's Pick
Recommendation: Buy
Price target: Rs575
Current market price: Rs470

Subdued response to open offer

Key points

• ESAB India's parent company had made an open offer to the shareholders of ESAB India for acquiring 58.01 lakh equity shares, which amounted to 37.69% of the equity share capital, at the rate of Rs505 per share.
• The shareholder response to the offer was lukewarm as only 28.09 lakh equity shares were tendered during the offer period. This shows high confidence in the company by its existing shareholders.
• Post offer, the shareholding of the parent company increased to 55.56% as against 37.31% prior to the offer. Consequently, public shareholding decreased from 62.69% to 44.44%.
• After conclusion of the offer, the parent company wanted to hold 75% of the equity capital however, a subdued response to the offer is a testimony to the growing confidence of the existing shareholders in the company. ESAB India has recently expanded its product range and capacities indicating the management's confidence in the increasing demand for the company's products. The company has also reported a spectacular growth in both its revenues and earnings in the first half of CY2007.
• We expect order inflows and robust product demand to continue for the company owing to planned investment in core infrastructure sectors like roads, ports, airports and construction in India.

Genus Power Infrastructures
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Under review
Current market price: Rs599

Issue of warrants to meet working capital needs

Key points

• Genus Power Infrastructures (Genus) has issued 1,500,000 equity shares of Rs10 each on a preferential basis at a price of Rs560, aggregating to Rs84 crore.
• The company had earlier issued 1,000,000 convertible warrants, convertible into an equivalent number of equity shares of Rs10 each at Rs409 each and another 600,000 convertible warrants convertible at Rs342.50 each.
• According to our estimates, the issue of warrants would dilute the equity base to the extent of 12.13% from the current levels.
• The company would use the proceeds from the issue to fund its working capital requirements.
• The company recently also launched RFID-based contact-less smart card pre-paid meters. The pilot project for the technology has already started in India and the product has already been approved by the Brazilian utilities.

Hindustan Unilever
Cluster: Apple Green
Recommendation: Buy
Price target: Rs280
Current market price: Rs218

Regaining pricing power

Key points

• Rising input prices have been a concern for the fast moving consumer goods (FMCG) industry for quite some time now. In the past quarters the FMCG companies were able to combat this issue with price hikes, innovative products with higher realisations and prudent advertising spend. Hindustan Unilever Ltd (HUL) was also able to pass on the pressure of the rising raw material prices to consumers by effecting a price hike in the soap, shampoo, skin and oral care product categories.
• According to industry data, the market share of most of the segments has improved except for the personal wash segment, which is showing a declining trend. Though the premium segment in soaps continues to garner market share, it is the lower-end segment that is losing market share, which we believe is positive for the margins. The segments that have shown an improvement in the market share compared with the June quarter of CY2007 are laundry (+50 basis points), shampoo (+20 basis points), skin care (+10 basis points), tea (90 basis points) and coffee (+110 basis points).
• On a sequential basis, we expect HUL's advertising spend to go up with aggressive spending in categories like skin care products and shampoos where the company is facing fierce competition from Proctor and Gamble (P&G; P&G's Olay launched against HUL's Pond's Age Miracle recently). In the shampoo segment, the entry of ITC has further intensified the competition. Moreover, our channel checks reveal that P&G is planning to launch skin care products for the mass segment which could further add to the competition.
• Buy back of shares at Rs230 per share and below will act as a support for the stock price. The buy back is commencing from October 03, 2007.
• This is not the first time in the year that HUL has increased the prices of its products. The price increase vindicates our view that the company is regaining its pricing power, which coupled with the strong volume growth, should help it report a good growth in its earnings. At the current market price of Rs218, the stock is quoting at 25.6x its CY2007E earnings per share (EPS) of Rs8.5 and 22.8x its CY2008E EPS of Rs9.6. We maintain our Buy recommendation on the stock with a price target of Rs280.

India Cements
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs300
Current market price: Rs263

Price target revised to Rs300

Key points

• With a revised capital expenditure (capex) plan of 14 million metric tonne (MMT) by the end of FY2009, India Cements will emerge as one of the top five cement players in India in terms of capacity. The company will witness a robust volume growth of 23% over FY2007-09.
• South India is expected to witness a strong cement demand in the next couple of years due to heightened industrial activity and upcoming government projects.
• The company received the Madras High Court's approval for merger of Visaka Cements in Q1FY2008.
• For Q1FY2008, the combined turnover of the company stood at Rs701 crore. The turnover was much in line with our expectations. Backed by higher realisations, the operating profit margin (OPM) improved by 400 basis points year on year (yoy) to 38%, whereas the earnings before interest, tax, depreciation and amortisation (EBITDA) per tonne stood at Rs1,150. Consequently, the profit before tax (PBT) stood higher at Rs215 crore beating our expectation of Rs200 crore for the same.
• In the last couple of months, the cement retail price have touched Rs280 per bag in certain regions and the dealers expect it to touch Rs300 per bag in the coming months. Considering the rise in prices, we are upgrading our estimates by 33.9% for FY2008 and 32.5% for FY2009.
• The company's strategy of augmenting its capacity through the brownfield route at a lower capital cost will enhance the company's return on capital employed (RoCE) going forward. The Lower capital cost coupled with higher profitability will put the company's financials in an enviable position.
• Healthy financials, a leadership position in the South and a lower promoter stake make the company a potential target for acquisition. Whether the promoters will sell their stake is a question that time will answer but in case that happens we believe the acquirer will have to pay a hefty premium to the company as it will directly make them the market leader in the South.
• We expect the earnings of the company to grow at a compounded annual growth rate (CAGR) of 27% over FY2007-09 on an enhanced equity capital of Rs260 crore. At the current market price of Rs263, the stock is currently trading at 9.5x its FY2009E earnings per share (EPS) and at an enterprise value (EV)/EBITDA of 5.1x. Considering all these aspects, we maintain our positive outlook on the stock with a revised price target of Rs300.

International Combustion (India)
Cluster: Cannonball
Recommendation: Buy
Price target: Rs519
Current market price: Rs391

Sharp increase in margins

Result highlights

• The revenues of International Combustion India Ltd (ICIL) grew by 27.2% year on year (yoy) to Rs20.2 crore in Q1FY2008. The revenue growth was in line with our estimates.
• The revenues of the Heavy Engineering Division (HED) of the company grew by 18.9% yoy to Rs16.5 crore. The Geared Motor and Geared Box Division's (GMGBD) revenues rose by an impressive 78.9% yoy to Rs3.8 crore.
• The operating profit margin (OPM) expanded by 560 basis point yoy to 24%. The OPM rise was due to a reduced raw material cost to sales ratio, which declined by 380 basis points to 46.8% in Q1FY2008. The staff cost to sales ratio and the other expenses to sales ratio both saw a decline of 90 basis points yoy.
• The HED reported a profit before interest and tax (PBIT) margin of 38.4%, which was up 670 basis points yoy. The GMGBD, which incurred a loss in the corresponding quarter last year reported a PBIT margin of 1.3% for this quarter.
• The net profit jumped by a whopping 104.4% yoy to Rs2.8 crore led by a higher other income and robust expansion of margins. The profit after tax (PAT) margin for the quarter was 13.9%.
• The outstanding order book of the company at the end of July 2007 was Rs64 crore. The HED has an order backlog of Rs52 crore while the GMGBD has pending orders worth Rs12 crore.
• The company plans a capital expenditure (capex) of Rs8 crore in FY2008 towards capacity addition in the HED and the GMGBD to meet the rising demand for its products.

ITC
Cluster: Apple Green
Recommendation: Buy
Price target: Rs200
Current market price: Rs184

Breaking new grounds

Key points

• Despite the imposition of a 12.5% value-added tax (VAT), an increase of 5% in the excise duty and a levy of 32.5% trade tax in Uttar Pradesh, there had been only a marginal decline in the cigarette volumes of ITC in the first quarter. Our channel checks reveal that the second quarter is expected to witness a trailing effect of the same since this quarter would also bear the full effect of the 32.5% sales tax levied by the Uttar Pradesh state government.
• ITC launched Fiama Di Wills, a premium range of shampoos, in three variants. The product has been priced between Hindustan Unilever's Sunsilk and Procter and Gamble's Pantene. Looking at the success rate of its newly launched products, we believe the company would be able to establish itself in the soaps & skincare segment also.
• The salted snacks business Bingo is also doing well. The product has been rolled out in all the 10-lakh-plus population markets and by leveraging on the company's vast distribution network it has been able to capture 10-12% share in these markets.
• Biscuits category, which is growing at a scorching pace of 40-50% year on year, though at a lower base, against the industry growth of 10-12%. In a very short span, the company had been able to garner a market share of 11%, which speaks volumes about its potential to create market positions in new segments.
• At the current market price of Rs184, the stock is attractively quoting at 23.2x its FY2008E earnings per share and 14.8x FY2008E enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA). We maintain our Buy recommendation on ITC with a price target of Rs200.

Madras Cement
Cluster: Cannonball
Recommendation: Buy
Price target: Under review
Current market price: Rs4,082

A buyback in the offing
Madras Cement has announced at its extraordinary general meeting held on September 14 that subject to provisions of the Companies Act 1956, the company may buy back its own shares. The details of the buy-back proposal have not been disclosed yet.

Marico
Cluster: Apple Green
Recommendation: Buy
Price target: Rs70
Current market price: Rs61

Growth momentum continues
The copra prices have strengthened in the last two months but Marico has taken a price hike of 3% in Parachute, which will offset the increase in its raw material cost and help it to safeguard its margin. The company has been able to maintain its market share at 48%. The launch of Fortune (agro tech foods) has been a non-event for Marico since the same has not been able to erode its market share.

Marksans Pharma
Cluster: Emerging Star
Recommendation: Book Out
Current market price: Rs98

Book out

Key points

• Marksans Pharma's (Marksans) performance in FY2007 has been extremely disappointing. The company's revenues declined by 17% whereas its profits plunged by a massive 56% to Rs9.9 crore. The company has reported poor revenues in all segments of its business. Sales of bulk drugs have decreased by 35.8% year on year (yoy), led by the decline in bulk drug sales in domestic and export markets, whereas the sales of formulations remained flat at Rs136 crore in FY2007.
• Ciprofloxacin and Ranitidine form the mainstay of Marksans' bulk business. With increasing commoditisation and competition from Chinese players, the prices for Ciprofloxacin bulk and Ranitidine bulk have fallen by approximately 28% each in the last one year, leading to a decline in the realisations. Due to this, the company's bulk business has plunged by almost 36% in FY2007 and 42% in Q1FY2008. The uncertainty over the future prices of these bulk drugs is a cause for concern and makes Marksans' bulk business unpredictable.
• Against Rs100 crore worth of orders for the CRAMS business for FY2007, Marksans has only executed Rs52 crore. This was primarily due to a delay in obtaining regulatory approvals for its filings and site variation applications. Marksans has made four certificate of suitability (COS) filings so far for Ciprofloxacin, Ranitidine, Metformin and Losartan. Our growth assumptions for the export business were based on the company receiving these COS approvals and launching these products in FY2007. However, the company has not yet received any of the COS approvals and there seems to be no clarity on the timeline of these approvals. We do not expect a major ramp-up in the company's CRAMS business until the regulatory approvals come through.
• Marksans had raised $50 million in November 2005 through a foreign currency convertible bond (FCCB) issue, primarily to fund acquisitions. Even though the redemption date for the FCCBs is distant--in November 2010--yet the conversion price of each bond into an equity share stands at Rs336.92, which is almost three times the current market price of Rs98 per share. Further, if the bonds are not converted into equity shares by November 2010, Marksans will have to redeem the bonds at 145.2% of their principal amount. We believe the risk of non-conversion and the resultant burden of the redemption premium are causing Marksans to retain the FCCB money as cash instead of deploying it for acquisitions.
• Despite giving repeated promises and timelines, the management has not been able to deliver on several counts, ranging from growth in the domestic market, to execution of the CRAMS orders and approval of regulatory filings. The company seems to be in an investment phase, planning for its future growth in the domestic market and its foray into newer markets such as South Africa, Europe and the USA. At the current price of Rs98.0, the stock is trading at 52x its FY2007 consolidated earnings. In view of the disappointing performance in FY2007 and the uncertain outlook on the future prospects of the company, we advise investors to book out of the stock.

Navneet Publications (India)
Cluster: Emerging Star
Recommendation: Hold
Price target: Under review
Current market price: Rs77

e-learning: new initiative
Navneet Publications has ventured into a new stream of business, e-learning. The company has launched a new product called "Navneet e-Book", a system of e-learning which is an animated content of the textbooks for effective understanding of concepts. It has already started receiving enquiries from schools of Gujarat and Maharashtra.

The company is initially planning to target private schools in the states of Maharashtra and Gujarat. For the other states the company has started mapping their curriculum. It has already introduced products at the distributor level to be supplied to schools. After establishing the efficacy of its products in the schools, it intends to target the students.

Nicholas Piramal India
Cluster: Apple Green
Recommendation: Buy
Price target: Rs326
Current market price: Rs288

Demerger of discovery R&D to unlock value

Key points

• Nicholas Piramal India Ltd (NPIL) has announced the demerger of its new chemical entity (NCE) research into a separate company called Nicholas Piramal Research Company (NPRC). The proposed demerger would be effective from April 1, 2007 and the new company will be listed on the bourses by June 2008.
• With a focus on the therapeutic segments of oncology, diabetes, inflammation and infectious diseases, NPIL has a pipeline of 13 molecules, including one molecule in-licensed from Eli Lilly for clinical development. Of the 13 molecules, nine molecules (including the one in-licensed from Eli Lilly) are in pre-clinical development stage, whereas the remaining four molecules are in Phase II clinical trials. Further, four more molecules are scheduled to enter the clinics by the end of FY2008, which would make NPIL one of the largest clinical development pipelines among the Indian players.
• As a part of the demerger plan, NPIL will initially invest Rs4.55 crore as equity capital in the new company (NPRC). It will also transfer Rs90 crore worth of fixed assets (as per book value) and Rs95 crore of cash to the new company. In consideration, NPIL will issue one new share of face value Rs10 each in the new company to all its shareholders for every ten shares of face value Rs2 each held in NPIL (ie in the ratio of 1:10).
• With the proposed demerger, the managament has revised its guidance for FY2008. Even though the top line growth guidance has been maintained at 25%, the operating profit margin (OPM) is expected to expand to 17.7% (as against the earlier guidance of 15.5%) on the back of a Rs70 crore savings in the research and development (R&D) expenses. The capital expenditure (capex) is also expected to come down to Rs150 crore versus the earlier guidance of Rs210 crore. As a result, the earnings per share (EPS) is expected to improve by Rs3 to Rs17.0 (as compared with the earlier guidance of Rs14).
• We have attempted to value NPRC in line with Sun Pharma Advanced Research Company (SPARC, which is the demerged innovative R&D unit of Sun Pharmaceuticals). SPARC is currently trading at an estimated 5.7x its planned R&D spend of around $70 million (Rs287 crore) over the next three years. On assigning a similar multiple to NPRC's projected discovery R&D spend of Rs310 crore, we arrive at a value of Rs1,755.2 crore for NPRC. This translates into a per share value of Rs688.3 (2.545 crore shares of face value Rs10 each). However, for NPIL, whose shares have a face value of Rs2 each, this would imply a per share value of Rs137.6.
• With the demerger of the R&D division, the earnings of the company are expected to improve by Rs3 per share (as per management guidance), implying a price appreciation of Rs54 (if we assign a multiple of 18x to the incremental EPS). We will be revising our estimates for NPIL in order to incorporate the impact of the proposed demerger at a later date. At the current market price of Rs288, the stock is trading at 21.5x its estimated FY2008E earnings and at 17.7x its estimated FY2009E earnings. We maintain our Buy recommendation on the stock with a price target of Rs326.

Ranbaxy Laboratories
Cluster: Apple Green
Recommendation: Buy
Price target: Rs500
Current market price: Rs417

Lipitor launch in Canada delayed; Ranbaxy to appeal

Key points

• Pfizer Inc has succeeded in winning patent protection in Canada for its blockbuster drug, Lipitor, thereby prohibiting its rival, Ranbaxy Laboratories (Ranbaxy), from launching a generic version of the cholesterol-reducing drug until the expiry of the patent in July 2016.
• The Canadian Federal Court in Toronto has ruled that Ranbaxy's proposed generic drug would infringe Pfizer Inc's patent that covers a crystalline form of atorvastatin (patent # 2,220,018) which is due to expire in July 2016. On the other hand, the Canadian court has granted a favourable ruling to Ranbaxy in the case of the patent # 2,220,455, which covers the process for making an amorphous form of atorvastatin and is also due to expire in July 2016.
• Despite handing out a mixed ruling wherein the validity of the patent for crystalline atorvastatin has been upheld and the patent for the amorphous form of the compound has been invalidated, the court has ordered the Canadian health ministry not to issue a notice of compliance (approval) to Ranbaxy for marketing the generic version of Lipitor until the expiry of the patent covering the crystalline form of atorvastatin in July 2016, thereby preventing the company from entering the market until July 2016.
• Ranbaxy has confirmed its intention to appeal against the ruling of the Canadian Federal Court to the Federal Court of Appeal in Canada and is confident of reversing the current ruling, thereby enabling it to launch the product in Canada before July 2016. Thus, Ranbaxy would be barred from launching the product until July 2016, unless it succeeds in reversing the court's current ruling in its appeal.
• The unfavourable ruling received in Canada would come as a major setback to Ranbaxy in its battle for launching generic Lipitor in various markets across the world. However, we remain optimistic on the company's ability to receive a favourable ruling on all the four patents in its appeal in Canada. At the current market price of Rs417, the stock is trading at 23.6x its CY2008E earnings. We maintain our Buy recommendation on the stock with a price target of Rs500.

Satyam Computer Services
Cluster: Apple Green
Recommendation: Buy
Price target: Rs538
Current market price: Rs430

On a transformational path

Key points

• Satyam Computer Services' (Satyam Computer) management articulated its business strategy to identifying new markets and new opportunities for its growth in the coming years. The key ingredient to the overall strategy is to prepare itself for the next wave of opportunity—transformational outsourcing.
• Infrastructure management services (IMS) is an important part of the overall growth strategy. The company is targeting managed services and remote management services part of the opportunity rather than the traditional business of taking over the hardware assets. This segment contributes around 35% of the total IMS market estimated at $234 billion by 2010, up from about 29.5% in 2006.
• The management re-iterated that it has not witnessed any change in the overall environment due to the subprime issue. It has been in regular interaction with its clients and the overall confidence level continues to be high. However, the management added a word of caution stating that it is premature to assess the possible impact if the fallout of subprime issue spills over to other sectors and results in a marked slowdown or recession in the USA.
• At the current market price the stock trades at 17.2x FY2008 and 14.4x FY2009 earning estimates. We maintain Buy call on the stock with a target price of Rs538.

Seamec
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs300
Current market price: Rs208

Unexpected damage
Seamec has announced that its vessel Seamec II has been damaged in its front portion due to a fire while the vessel was undergoing statutory dry-docking in a shipyard at Netherlands. The extent of damage is not certain as of now. However, it is clear that the dry-docking days for the vessel would get extended now, resulting in lower revenue and earnings for the company in CY2007.

Surya Pharmaceuticals
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs205
Current market price: Rs83

Strong growth at cheap valuations

Key points

• During FY2007, Surya Pharmaceuticals (Surya) has enhanced its production capacities and has improved efficiencies of its production processes through de-bottlenecking exercise. >From a collective capacity of manufacturing 4,152 metric ton (MT) per annum, the company's current capacity stands at 5,423MT per annum marking an increase of 30%. The resultant capacity increase is expected to translate into higher revenues for the company's existing business of active pharmaceutical ingredients (APIs) and intermediates from FY2008 onwards.
• Surya has also initiated construction of a new plant in the tax-haven state of Jammu. The Jammu plant will be constructed in line with the US Food and Drug Administration (US FDA) standards primarily to manufacture new APIs and sterile cephalosporins. With the commissioning of this facility, Surya will enter the high-margin injectable business. We expect the Jammu facility to contribute an incremental Rs100 crore to Surya's revenues in FY2009E.
• Surya has recently entered the business of manufacturing menthol and its derivatives. The company primarily intends to sell these products to its overseas clients, and the company has started exporting these products in August 2007. We expect the menthol business to add Rs50 crore to Surya's turnover in H2FY2008E and Rs100 crore in FY2009E.
• Having made a foray into the contract manufacturing space, Surya is now increasing its focus on the contract research area. The company is in advanced stage of negotiation with a British company for the development of a cost-effective process for a new molecule. Surya expects that partnering with the British company at this early stage of development will open up huge contract manufacturing orders for it, once the molecule gets commercialised. However, as the deal has not yet been finalised, we have not factored the upsides from this development into our estimates.
• We have introduced our FY2009E revenue and earning estimates for Surya. We expect Surya's profit to grow at a compounded annual growth rate (CAGR) of 55.3% over FY2007-09E on the back of a 46.2% CAGR in the revenues and a 100 basis point expansion in the operating profit margin. Based on this, we have projected fully diluted earnings of Rs28.8 per share in FY2008E and Rs32.1 per share in FY2009E.
• At the current market price of Rs83, Surya is trading at 3.6x its FY2008E diluted earnings of Rs23.2 and at 2.6x its FY2009E diluted earnings of Rs32.1. The stock is highly undervalued when compared with its peers like Ankur Drugs, Sharon Bio-Medicine and Granules India, which are trading at an average FY2009E price earning (P/E) multiple of 7x. At current prices, Surya offers a remarkable combination of strong growth at cheap valuations. We view this as a strong buying opportunity and hence maintain our Buy call on the stock with a price target of Rs205.

Tata Motors
Cluster: Apple Green
Recommendation: Buy
Price target: Rs792
Current market price: Rs691

Continued decline in key M&HCV segment

Key points

• Tata Motors' overall sales for the month stood at 45,144 vehicles. The overall sales declined slightly by 0.4% on year-on-year basis.
• The commercial vehicle sales grew by 1.6% to 23,431 vehicles. The sales growth was driven by strong sales of light commercial vehicles (LCVs), which grew by 23% year on year on the back of its new launches Magic and Winger. The medium and heavy commercial vehicles (M&HCV) sales declined by 13.6% to 11,625 vehicles as the low demand continued in the segment. Our channel checks also reveal that the lower demand for M&HCV vehicles (particularly in the 12-16-tonne segment) led to a greater inventory creation in the system. Consequently, to fuel the growth the company has been offering attractive discounts of almost 4-6%.
• Lower cargo availability during the monsoons caused the truck rentals to fall by about 1.5-2% on an average during the month. The lower cargo availability also led to a sharp decline in the round trips for truck operators, which is affecting their profitability slightly. The situation is expected to improve from the next month with the start of the festive season.
• The passenger vehicle sales remained weak and declined by 5% in August to 16,620 vehicles. Indica sales dropped by 4% while Sumo and Safari sales dropped by 12% during the month. The lack of new product offerings has been the prime reason for the decline in the sales. The company has been offering discounts on most of its products and the discounts are likely to continue in September as well.
• The exports remained stable and grew by 8% in August to 5,093 vehicles.
• At the current market price of Rs691, the stock discounts its FY2009E consolidated earnings by 10.6x and is available at an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 5.3x. We maintain our Buy recommendation on the stock with a price target of Rs792.

Tata Tea
Cluster: Apple Green
Recommendation: Buy
Price target: Rs970
Current market price: Rs762

Getting branded

Key points

• In FY2007 the consolidated net sales of Tata Tea Ltd (TTL) grew by 29.6% year on year (yoy) to Rs4,024.9 crore. The growth was mainly driven by higher branded sales across the business and the inclusion of revenue of Rs558 crore from new acquisitions. The organic growth in FY2007 was 11.5%. Branded sales now constitute around 89% of the total sales compared with 85% in FY2006.
• TTL reported a 24.6% year-on-year (y-o-y) jump in its consolidated net profit (adjusted for extraordinary items) to Rs366.2 crore.
• In the domestic market, the company reported a top line growth of 9% to Rs1,054 crore in FY2007. The branded business (which constitutes 80% of the sales) continued with its impressive performance during the year, registering a 9% growth in volume and a 12% rise in value compared with that in the last year.
• For the same period, the turnover of the Tetley group (a 77.7% British subsidiary of TTL) was Rs2,298 crore, which was 13% higher than that in the previous year. The organic growth was 8.5% which includes the benefits of exchange transactions. For FY2007 the profit after tax (PAT) of Tetley was lower by 12% at Rs130 crore as against Rs147 crore in FY2006. The PAT was lower mainly on account of an interest charge incurred due to the acquisition of Energy Brands Inc., USA (EBI).
• During the year the company acquired a 25% shareholding in EBI, commonly known as Glaceau®, for US$677 million (enterprise value of EBI was estimated at US$2.2 billion). Subsequently, TTL has agreed to sell its stake in EBI for an approximate consideration of $1 billion to the Coca Cola Company. This transaction is expected to result in a pre-tax profit of approximately $415 million.
• TTL also acquired a 15% stake in Mount Everest Mineral Water (MEMW), the owner of the Himalayan brand, by subscribing to a preferential issue at a price of Rs140 per share. It will purchase another 9.15% stake in MEMW from the latter's current promoters at the same price. The company would also make an open offer to acquire an additional stake of up to 20% in MEMW at Rs140 per share This acquisition makes TTL a complete beverage company, having presence in all the verticals, ie tea, coffee and water.
• TTL is selling North Indian Plantation Operations (NIPO), which includes 24 tea estates in northern India, to a new company called Amalgamated Plantation Pvt Ltd (APPL). The sale would be effective from April 1, 2007. We believe that this move is in line with TTL's overall strategy to focus on packaged and specialty tea.
• We believe the company is poised to become a strong player in the beverage market by penetrating new geographies through the inorganic route as well as by gaining presence in every segment of the beverage industry. On the valuation front, the TTL stock looks attractive at 11x its FY2009E diluted consolidated earnings per share (EPS) when compared with its peers in the fast moving consumer goods (FMCG) sector, especially when with the sale of NIPO, TTL has become a pure branded FMCG play. We maintain our Buy recommendation on the stock with a price target of Rs970.

Television Eighteen India
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs967
Current market price: Rs838

Revising estimates

Result highlights

• TV18 India (TV 18) reported a top line growth of 50.1% for Q1FY2008 with revenues of Rs68.1 crore on the back of a strong growth in both news and Internet segments.
• The operating profit margin (OPM) dropped to 15.2% as against 31.3% in Q1FY2007 as web18 and Newswire 18 are in high investment phase.
• The adjusted net profit (pre-ESOP amortisation and extraordinary items) stood at Rs0.6crore primarily on account of lower consolidated margins.
• Web18 expanded its portfolio of offerings through the launch of bookmyshow.com and buzz.com. We expect Web18 to get listed by Q1FY2009.
• After raising Rs200 crore through qualified institutional placement (QIP), TV18 board has approved a preferential allotment of 50 lakh warrants at Rs796 per share to the holding company Network18. This will increase holding of the parent company from 49.18% to 53.3%. We believe these funds will be utilised for the organic and inorganic growth plans in media and allied space.
• TV18 has acquired a 35% stake in Mobile NXT a Bangalore based mobile retail chain. Mobile NXT has 25 retail outlets and has plans to open 150 stores by March 2008.
• We have revised our estimates for FY2008 and FY2009 to factor in the higher revenue growth and the increased spend on account of ramping up new businesses that are in investment phase.
• We maintain a price target of Rs967 for the stock derived from our sum-of-the-parts methodology of valuation of stock.

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SHAREKHAN SPECIAL

Q2FY2008 earnings preview

Earnings of Sensex companies to grow by 20% yoy

Key points

• The earnings of the Sensex' companies excluding oil companies and adjusted for one-time items are likely to grow by 20% year on year (yoy) and remain stable quarter on quarter in Q2FY2008.
• In Q1FY2008 we had seen that around 10% of the reported earnings had come from foreign exchange (forex) gains. Keeping the current strong uptrend of the rupee in mind, we may see companies reporting another 3-5% of one-time forex gains during the quarter. This would be in contrast to the initial expectations of forex losses in Q2FY2008, as the rupee had started to decline when our markets were facing the threat of large-scal e withdrawal from foreign institutional investors (FIIs). After the political turmoil and global subprime saga unfolded in end July and most part of August 2007 there were fears that the FIIs would pull out serious money from the market.
• The Q2FY2008 earnings of the Sensex are going to be driven by companies from the telecom, information technology (IT) and banking sectors.
• The backdrop of Q2FY2008 performance is not very encouraging with a lower export growth in rupee terms, a decline in the industrial output, deceleration in manufacturing revenues and a drop in automobile sales. All these leading indicators have been discussed in detail later.
• Latest corporate tax collection growth rate for the period April to September 15, 2007 has slowed down to 25% from 49% reported for the period April to August 2007 (the first five months in FY2008). This translates into a 11% yoy growth in corporate tax collections for the first fortnight of September which includes the second installment of advance tax payments for corporates. We need to look at full tax collections for the month as the collections could have been influenced by the banking holiday falling on September 15, 2007 and the period of advance tax payment being extended to September 17, 2007.
• Considering that all the leading indicators are pointing towards a slowdown, would the Reserve Bank of India (RBI) take cognisance of the matter and make the interest rate environment more conducive for growth? We feel the RBI is more likely to adopt a neutral stance in its next quarterly policy review meet (October end) before it starts easing its monetary stance. However the interest rates may start to come down slowly if the credit growth doesn't pick up and deposits continue to grow ahead of advances. This should set the stage for a recovery in key sectors like housing and automobiles with the onset of the festive season in the second half of the current fiscal.

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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

Banking

Banking sector poised for a re-rating
In this report we have discussed our views on the various macro aspects that have been a concern for the banking sector in the recent past. We have also delved into the various positive and negative factors that are likely to affect the banking sector in the medium term. Keeping in mind the strong interest of the investors in the financial sector, we feel the unfolding of the various positive triggers could lead to a re-rating of the banking sector in the medium term. Hence, we have revised our price targets for most leading banks (explained in detail later).

Banks	CMP* (Rs)	Old price target (Rs)	New price target (Rs)	Upside (%)
Bank of Baroda	322.0	366.0	400.0	24.1
Bank of India	260.0	280.0	325.0	25.0
SBI	1886.0	1780.0	2282.0	21.0
HDFC Bank	1433.0	1355.0	1694.0	18.2
Axis (UTI) Bank	768.0	725.0	960.0	25.0
*CMP as on September 27, 2007

Information Technology

Two-pronged impact of Fed cut
The recent rate cut by the US Federal Reserve has affected the Indian technology stocks in two ways. First, it is a positive development in terms of the remedial steps taken to avoid a possible slowdown in the US economy. On the other hand, the move has weakened the US Dollar against all the other currencies including the Indian Rupee.

In fact, the rupee has breached the psychologically important benchmark of Rs40/US Dollars. This has dented the sentiments towards the tech stocks. Moreover, with the appreciation coming at the fag end of the quarter, it would also severely affect the performance in the second quarter.

Media

TRAI's notification on interconnection issues in DTH
To facilitate the smooth expansion of direct to home (DTH) services in India, the Telecommunications Regulatory Authority of India (TRAI) has been addressing the key issues that have emerged in the initial stages of the DTH takeoff in the country. TRAI has recently issued regulations mandating the broadcasters to issue Reference Interconnect Offer (RIO) to DTH service providers.

Steel

Sustained upturn in steel prices
The average international hot rolled coil prices has increased by approximately 6% in the last one month to $570 per tonne. Following the global buoyancy in the international market and the increase in feedstock prices, international companies such as POSCO and Hyundai steel have raised the prices for the second time in the last two months. We believe cost-push factors will keep the steel price firm for the medium term and increasing consolidation will ensure reduced volatility over the longer term.

Telecommunication

Healthy growth in subscribers continues
The mobile service providers reported a healthy month-on-month growth of 4.2% in net subscriber additions during August. This is similar to the growth rate of 4.1-4.25% reported in the previous two months.

Of the total net subscriber addition of 7.94 million in August, GSM operators added 5.95 million additional users. This amounts to a growth of 4.2% over the base at the end of July 2007, thereby taking the GSM subscriber base to 147.7 million. On the other hand, the CDMA operators added 1.99 million subscribers in August (a growth of 4.2% over last month), taking the user base to 49.24 million users.

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VIEWPOINT

Great Offshore

Fleet expansion boosts FY2007 revenues
We attended the Annual General Meeting (AGM) of Great Offshore (GOL) and the key takeaways from the same are mentioned.

Gujarat NRE Coke

Merger of subsidiaries and growing investment value
India NRE Minerals Ltd (INR) proposes to acquire Gujarat NRE resources NL (GUJ) by way of an off market take over bid with the merged operations creating a major Australian coal company with coking coal reserves of ~456 million tonne.