THE STOCK IDEAS REPORT CARD FROM SHAREKHAN'S DESK Get choosy with stocks In our previous editorial we had observed that with most of the factors required to take the market higher already in place it remained to be seen if the rising crude prices would halt the market’s upward march. Well, the benchmark market indicator, the BSE Sensitive Index, has gained about 830 points in the past one month despite crude managing to stay above $65 levels. Obviously the boiling crude has failed to contain our market’s enthusiasm. What now? Is the market still a buy? STOCK IDEA International Combustion (India) Cluster: Cannonball Recommendation: Buy Price target: Rs450 Current market price: Rs350 Fire-power Key points * International Combustion (India) Ltd (ICIL), which makes heavy engineering equipment, and gear motors and gear boxes, is all set to benefit from the capacity expansion programme undertaken by India Inc as its products find application in various industries, such as steel, sugar, mining, chemicals etc. We expect its revenues to grow at a compounded annual growth rate (CAGR) of 35.7% over FY2005-07 on the back of a good order inflow. * The company has orders worth Rs30-32 crore to be executed over the next two quarters. What's more, the buoyancy in the country's economy shall ensure the visibility of its order book well beyond FY2007. The healthy order book shall translate into higher earnings, which are expected to grow at a CAGR of 104.4% between FY2005 and FY2007 (Rs42.5 per share in FY2007E). * In order to maintain the growth momentum the company proposes to raise its overall manufacturing capacity at a cost of Rs10 crore over the next two years and expand its product portfolio. It has joined hands with Ecutec (Spain) for selling microfine classifiers and with Danfoss Bauer (Germany) for selling the B-2000 series model (gearboxes and gear motors) in India. * The stock's valuations are compelling at a price/earnings ratio (PER) of 8.2x FY2007E earnings and enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 4.9x FY2007E. We initiate a Buy on ICIL with a price target of Rs450, expecting an upside of 28.6% from the current levels. Rico Auto Cluster: Emerging Star Recommendation: Buy Price target: Rs157 Current market price: Rs88 Rich cash flows Key points * Rico Auto Ltd (RAL) is one of the largest manufacturers of aluminium and ferrous components with integrated facilities and the largest supplier to Hero Honda Motors Ltd (HHML) and Maruti Udyog Ltd (MUL). * RAL has built relationships with global auto majors such as Ford, General Motors, Land Rover, Jaguar, Cummins, Matsuka and Delphi. We expect its export business to grow by 531.1% from 7.2% as a percentage of its net sales in FY2005 to 20.7% of its net sales in FY2008E. * RAL is increasing its capacity four-fold and is moving up in the value chain by emerging as a full service provider (FSP) to its clients; this will provide RAL high value addition, high capability and high margin business. * We estimate its revenue and profit after tax (PAT) to grow at a strong compounded annual growth rate (CAGR) of 30.1% and 28.5% over FY2005-08E on the back of a 531.1% increase in its exports, a 25.2% compounded annual growth in its domestic sales and a 110-basis-point expansion in its operating profit margin (OPM). * At the current market price of Rs88 the stock discounts its consolidated FY2007E earnings by 14.2 times, while its enterprise value (EV) discounts its consolidated FY2007E earnings before interest, depreciation, tax and amortisation (EBIDTA) by 6.7 times. Our discounted cash flow (DCF) valuation model estimates a fair value of Rs157 per share for RAL which indicates an upside of 78% from the current levels. TIL Cluster: Emerging Star Recommendation: Buy Price target: Rs224 Current market price: Rs160 Bell the cat Key points * Bright business prospects: there is a huge demand for TIL's material handling and construction equipment owing to (1) the government's initiatives to improve infrastructure (road, railways, ports, etc); (2) the government's policy initiatives (private sector investment permitted in captive mining and port development); (3) the manufacturing sector's efforts to improve efficiency by mechanising operations; and (4) the capacity expansion plans undertaken by India Inc. We expect this demand to cause TIL's stand-alone revenue to grow at a compounded annual growth rate (CAGR) of 15.1% over FY2005-07. * Caterpillar to drive its margins: TIL is the exclusive dealer for Caterpillar Inc, USA's (Caterpillar) equipment and spares, and also provides after-sales service to its Caterpillar customers. The margins are high in this business, as it requires minimal expenses and leverages the company's existing set-up and human assets. We expect a robust growth of 24.9% in the business which would result in a 230-basis-point improvement in its margins over FY2005-07. * De-risking of business to boost earnings: by increasingly focusing on the Caterpillar business the company is shifting its revenue model from manufacturing income to service and commission incomes. This de-risking of its business would broaden its revenue stream and boost its earnings. We expect TIL's stand-alone net profit to grow at a CAGR of 83.9% over FY2005-07. * Attractive valuations: TIL trades at a price/earnings ratio (PER) of 8.9x FY2007E and enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 5.0x FY2007E based on its stand-alone earnings and a PER of 7.4x FY2007E based on its consolidated earnings. We believe the stock's valuations are attractive and therefore initiate a Buy on TIL with a price target of Rs224, expecting an upside of 40% from the current levels. STOCK UPDATE Aban Loyd Chiles Offshore Cluster: Emerging Star Recommendation: Buy Price target: Rs740 Current market price: Rs612 To enter master’s league Given Aban's growth through the inorganic route, the firm drilling rates for its rigs and the possibility of a re-rating in its stock's valuation, we are revising our price target for the company to Rs740. Our price target is based on the valuations commanded by Aban's international peers, ie in the range of 10-15x CY2006 EBIDTA. We have valued Aban at 9x (excluding cash and liquid investment) FY2007 EBIDTA; at these valuations the stock is still at a discount to its international peers. Balmer Lawrie & Company Cluster: Cannonball Recommendation: Buy Price target: Rs481 Current market price: Rs410 Bright prospects We remain optimistic about the business outlook of Balmer Lawrie and there is no deviation from our earlier stance on the stock. Our investment arguments about the company remain intact and we have factored in all the possible downside in our estimates. The growth rate that we have assumed for each of the company's businesses is in line with the outlook shared by the company's management in the AGM. We reiterate our Buy recommendation on the stock with a price target of Rs481. Container Corporation of India Cluster: Apple Green Recommendation: Buy Price target: Rs1,450 Current market price: Rs1,289 Growth all the way We recently spoke to the management of Container Corporation of India (Concor) for an update on the company and here are the key takeaways from the same. DCM Shriram Consolidated Cluster: Ugly Duckling Recommendation: Buy Price target: Rs1,100 Current market price: Rs915 Room for more upside We had initiated coverage on DCM Shriram Consolidated Ltd (DSCL) in February 2005 at Rs460. The stock has given 95% return since then. We attended the analyst meet of the company recently and believe there is still some upside to the stock. We are therefore upgrading our price target for the stock to Rs1,100 per share. Emco Cluster: Apple Green Recommendation: Buy Price target: Rs450 Current market price: Rs421 Healthy order book At the current market price (CMP) of Rs421 Emco trades at 0.9x EV/order book. Going forward, we expect this trend to continue mainly on account of the huge investment lined up in upgrading the existing power infrastructure as well as in setting up new power facilities. We will review our recommendation and estimates at the time of Q2FY2006 results. Hyderabad Industries Cluster: Apple Green Recommendation: Buy Price target: Rs700 Current market price: Rs600 Upgrading target price In yet another interesting development, Hyderabad Industries Limited (HIL) has decided to amalgamate Malabar Building Products Limited (MBPL) with itself. HIL has a 48.11% stake in MBPL. We reckon this to be marginally EPS accretive for HIL. Infosys Technologies Cluster: Evergreen Recommendation: Buy Price target: RsRs2,750 Current market price: Rs2,386 Price target revised The margins in the initial period of the contract would be low, but they would not have any significant impact on the overall margins of Infosys in FY2006, as only a small part of the contract would be executed in FY2006. Though the margins in the initial period of contract would be low, the company expects the margins in the long-run to align with the average margins. In our last update dated August 18, 2005, we have mentioned that though on valuation basis our twelve-month target price should be revised to Rs2,750, but we kept our target price unchanged at Rs2,500 as our FY2006 earnings (of Rs92 EPS) were under risk (due to the subdued performance in Q1FY2006). The current ABN AMRO deal has increased the future growth visibility and therefore we are raising our twelve-month target price to Rs2,750 based on 22x our rolling twelve months' forward earnings estimates. Navneet Publications (India) Cluster: Emerging Star Recommendation: Buy Price target: Rs405 Current market price: Rs286 Don’t miss the bus Recently we met the management of Navneet Publications to get an update on the progress of the programme of changing the syllabus in Maharashtra and here are the key takeaways from our meeting. Sintex Industries Cluster: Apple Green Recommendation: Buy Price target: Under review Current market price: Rs690 Raising funds Sintex Industries, a dominant player in the textiles and plastic businesses, has raised USD50 million (approximately Rs220 crore) through a zero coupon unsecured and un-rated 5-year foreign currency convertible bond (FCCB) issue, with a yield to maturity set at 6.85%. Sterlite Industries Cluster: Emerging Star Recommendation: Book Profit Current market price:Rs841 Book profit We had initiated coverage on Sterlite Industries on April 28, 2004 at Rs506. The stock is trading near our price target of Rs850 and therefore we advise you to book profit at Rs841. Tata Iron & Steel Company Cluster: Apple Green Recommendation: Book Profit Current market price: Rs420 Book profit We had initiated coverage on Tata Iron & Steel Company on January 25, 2005 at Rs364. The stock has achieved our price target of Rs420 and therefore we advise you to book profit. Television Eighteen India Cluster: Emerging Star Recommendation: Buy Price target: Rs485 Current market price: Rs375 Target price revised While initiating the coverage on Television Eighteen India Ltd (TV18) we had set a price target of Rs350 on the stock. Four months have elapsed since we put a Buy on TV18 and the stock has already crossed our target-it is trading at Rs375. So where does the stock go from here? Further up. Yes, we are raising the price target for TV18 to Rs485. We continue to be bullish on the company for three reasons. The same are discussed in the report. Thermax Cluster: Emerging Star Recommendation: Buy Price target: Under review Current market price: Rs797 Strong order book We expect Thermax's earnings to grow at a compounded annual growth rate (CAGR) of 36.8% over FY2005-07, driven by a 20.5% CAGR in the revenues and a modest margin recovery. At the current market price the stock quotes at 1.0x EV/order book. We will review our recommendation and estimates upon receipt of Q2FY2006 results. MUTUAL GAINS Sharekhan's top equity fund picks Mutual funds are of various types, depending on what they invest in. For example, bond funds invest in bonds, equity funds invest in equities and balanced funds invest in equities and debt both. Then there are sector funds that invest in one particular sector of the economy. Index funds, on the other hand, invest in only indices. Thus in order to pick the right mutual funds you have to know what you are looking for. If your idea is to participate in the success story of a particular sector, for example, you should look for those sector funds that invest in the sector of your choice. Considering the ongoing bull run in our equities market, we have decided to look at the equity-oriented funds to begin with, so that you can also cash in on the buoyancy in the market. We present our recommendations in the equity oriented mutual fund category. Each mutual fund scheme is accompanied by its past performance, which is one of the key parameters for judging mutual funds. MUTUAL FUNDS: WHAT’S IN—WHAT’S OUT Fund Analysis: September 2005 An analysis has been undertaken on equity and mid-cap funds' portfolios, indicating the favourite picks of fund managers for the month of August 2005. Equity funds comprise of all diversified, index, sector and tax planning funds, whereas mid-cap funds inculde a universe of 13 funds such as Reliance Growth, Franklin India Prima Fund, HDFC Capital Builder, Birla Mid-cap Fund etc. SECTOR UPDATE Automobiles Reason to rejoice The FM P Chidambaram, on Thursday, hinted at a possible paring of taxes levied on small cars as he said that the government was fully aware that the companies intending to manufacture small cars are looking at India as a base for such manufacturing and hence the government would have to revisit the issue of taxation earlier than it thought. Automobiles come under the highest excise duty slab of 24%. Cement Good show continues Cement dispatches witnessed an exceptionally strong growth in August 2005, mainly due to the extremely low base of last year and a surge in the demand after the deluge in western India in the last week of July. The southern region also continues to see a robust demand growth driven by the rising demand for retail housing and infrastructure projects. As a corollary of the strong demand cement prices rose by 2.3% year on year (yoy) in August 2005 despite it being the peak of the monsoon season. We expect cement prices to gain momentum after a stable period during the monsoons. Considering the expectations of firm cement prices over the next 12 months and of a favourable demand-supply equation during the period we remain positive on cement stocks, with Associated Cement Company (ACC) and UltraTech Cement Ltd (UTCL) as our top picks from the sector. Sugar The party continues After two consecutive years of drought it's now excess rains that may keep the party on for the sugar industry. Prakash Naiknavre, the managing director of Maharashtra State Co-operative Sugar Factories Federation, estimates that nearly 15% of the standing crop of sugar-cane (or nearly 25 lakh tonne) in Maharashtra may have been washed away because of excessive rains and the consequent flood situation in the Kolhapur, Sangli and Satara regions of the state. As a result the sugar production could be lower by 2.75-3.0 lakh tonne in the country this year. SHAREKHAN SPECIAL Reliance Industries GRMs to surge post-Rita If further shut-downs happen and the supply of petroleum products remains under pressure, the gross refining margins (GRMs) shall shoot up. For the week ended September 2, 2005, after the crisis caused by Hurricane Katrina, the Singapore refining margins had moved up by nearly $4.5 to $10.95 over the week previous to that. A similar situation is likely to develop after the looming catastrophe. Reliance Industries Ltd (RIL), which runs a complex refinery that has the ability to process heavy/sour crude, will be the prime beneficiary of the spurt in the refining margins. RIL further commands a premium over the regional refining margins in Asia. Reliance Industries Vindicating our view We had mentioned in our earlier report "Hurricane Gains", dated August 31, 2005, that the rising petroleum product prices would be beneficial to companies like Reliance Industries. The recent movements in the Singaporean refining margins have just proved us right. We stand vindicated. Shipping Sector High tide again Hurricanes Katrina and Rita may have wreaked havoc only along the southern coastal areas of the USA, but their effects are being felt far and wide. The hurricanes have caused heavy damage to the USA's refineries. The need for more supplies of gasoline in the USA to compensate for the loss of the country's refining capacity has caused the oil tanker freight rates to almost double in the last three weeks. For example, the spot charter rates for a very large crude carrier (VLCC) that were about USD21,000 a day before Katrina made landfall in the USA have now jumped to USD36,000 per day. Wind energy: it is windy Wind energy has registered a robust year-on-year growth of 44% in FY2005. The current installations in the country are approximately 3,595 megawatt (MW). The ministry of non-conventional energy has estimated that by 2012, 10% of the projected 240,000MW of the new capacity will come from renewables-mainly wind power. We are very positive on the sector since the wind power industry is on a high growth trajectory. The beneficiaries will be major suppliers of wind turbines like Suzlon, Enercon and NEPC and auxiliary service providers like Sanghvi Movers and Kemrock Industries. VIEWPOINT Amtek Auto Value growing inorganically Amtek Auto, a leading domestic auto component manufacturer, is in an advanced stage of acquiring two companies abroad—a casting and machining company in the UK with a turnover of $35 million (Rs150 crore) and a machining company near Detroit in the USA with a turnover of $120-150 million (Rs500-650 crore). The UK deal is likely to be wrapped up in the short-term, while the US-based company’s buy-out may take some time. It is expected that through the proposed acquisitions, a large number of customers such as Ford, Jaguar, BMW, Renault, CNH and Honeywell will be added in the clients list of Amtek Auto. ANG Exports Unlocking value through merger ANGE, the flagship company of the ANG group, is one of the largest exporters of air brake components. The ANG group comprises of three companies, viz ANGE, ANG Auto Pvt Ltd (ANGA) and ANG Automotive Industries Pvt Ltd (ANGAI). Recently ANGE has announced its merger with ANGA. It further plans to acquire the business of ANGAI. Dr Reddy's Laboratories What a deal!!! Dr Reddy's Laboratories (DRL) has recently made four major announcements that may have a significant positive impact on not only its stock's valuations but also its own future. The announcements: * DRL to form a joint venture company, Perlecan Pharma, for the development of new drugs in association with ICICI Venture Fund and Citigroup Venture Capital. * DRL signs an agreement with Denmark-based company Rheoscience for the development and commercialisation of diabetes drug-Balaglitazole. * DRL signs a deal with ICICI Venture Fund for the commercialisation of generic products. * DRL to acquire a company in Europe to increase the sale of its generic products. Hindustan Sanitaryware India Don’t flush it The well-timed capacity expansion and the accelerating demand led by favourable macro conditions in the core business place Hindustan Sanitaryware India in a comfortable position. As a growth supplement, the company has adopted a smart strategy of exploiting its distribution channels to sell allied products, thereby capturing a much larger share of the market. With the other business of glassware containers also expected to do well, though lagging the growth in the sanitary ware business, we expect the overall revenues to grow at a much faster clip over the coming period (30% CAGR over FY2005-07). Hiran Orgochem Run Hiran run With the margins in the business increasing due to price escalation, backward integration and tax savings, and the capacity increasing fourfold, Hiran Orgochem appears all set to book good profits in the coming quarters. Lloyd Electrical Engineering Just chill Lloyd Electrical Engineering Ltd (LEEL) was promoted by the Punj Lloyd group, which is also the promoter of Fedder Lloyd. LEEL is in the business of manufacturing heat exchanger and condensing coils for air conditioning application. It also manufactures system tubing, and header line and sheet metal items for air conditioning equipment. The company imports state-of-the-art equipment from Burroak USA for the manufacture of condensing and evaporating coils. It has a sheet metal facility, which is equipped with CNC turret press, CNC press brake, CNC punch press and a shearing machine. LEEL also undertakes contract-manufacturing activity for assembling room air conditioners (ACs) on behalf of its original equipment manufacturer (OEM) clients. LEEL has a technical tie-up with LHB Gmbh, Germany for special ACs installed in trains. Narmada Gelatines Up for grabs Two strong contenders to acquire Narmada Gelatines are Bharti Healthcare and Sterling Biotech. If the deal with Bharti Healthcare takes place then Narmada's production advantage will be difficult to evaluate due to part captive usage. Although Bharti Healthcare has expertise in gelatine capsules manufacture, yet the gelatine manufacturing business will be a whole new ball game for it. Compared to this Sterling Biotech has over a decade's experience in the gelatine manufacturing industry and has been able to maintain a high operating margin of 47% against that of 10% for Narmada Gelatines. Pfizer Gradually back on track Result highlights Q3CY2005 * Pfizer’s net sales went up by 21% in the quarter ended August 2005 (Q3CY2005) to Rs162.7 crore from Rs134.2 crore in Q3CY2004 on the back of a 16% increase in the sales in the pharmaceutical division. * The other income saw an increase of 18.5% from Rs8.6 crore in Q3CY2004 to Rs10.2 crore in Q3CY2005 due to the inclusion of the service income of Rs6.8 crore from clinical trials conducted for the parent company. * The operating profit shot up by 112% during the quarter to Rs36 crore on account of operational efficiency while the profit after tax showed an increase of 84% from Rs16.3 crore in Q3CY2004 to Rs30 crore in Q3CY2005. * At the current market price of Rs803 the stock is trading at 26x CY2005 earnings estimate. Polar Pharma Moving towards pole position Polar Pharma is amongst the largest manufacturers of condoms in India. The pull-down in the profits was due to internal factors, as the market for condoms has been growing steadily. Realising this problem the company came up with the solution, which sought to realign its financial and operating structure. The company used a two-step approach to achieve this goal. Step1: Restructure and reduce the debt burden. Step2: Increase the sales and production, and thus improve the margins. Sterling Biotech Sterling prospects Key points * As Sterling Biotech is based in India, (India being the largest source of its raw material-bones) the company has a 30% cost advantage over its peers overseas. * As it is the leading manufacturer of gelatine, it benefits from the economies of scale. With expansion plans underway, the company shows a good growth potential. * New products like "Coenzyme Q-10" and "Archidonic acid" will complement the existing products and make for a diversified portfolio. * With the generics market booming in terms of volume and with drugs worth $80 billion coming off the patent list, the demand for gelatine will increase. * A high operating profit margin (49% in Q1CY2005) and a low cost of debt (2% in CY2004) provide an additional edge. COMPANY CORNER AGM: Bilcare Poised for growth Bilcare Ltd is a leading manufacturer of films and foils of blister packaging for pharmaceutical tablets and capsules in Asia with manufacturing and research facilities in Pune, India and Singapore. Recently, it has acquired ProClinical Inc, a Pennsylvania-based company in the USA offering packaging development and research services to pharmaceutical companies. Currently the company is in the process of raising $50 million through the foreign currency convertible bonds (FCCB)/global depository receipts (GDR) route for funding acquisitions of European pharmaceutical packaging facilities and capacity additions in the domestic and Singapore facilities. Bilcare's sales have grown at a compounded annual growth rate (CAGR) of 35% from Rs48.68 crore in FY2001 to Rs161.90 crore in FY2005. At the same time the profit after tax (PAT) has grown at a CAGR of 56% from Rs4.08 crore in FY2001 to Rs24.55 crore in FY2005. Bilcare aims to become a global leader in pharma packaging and research services by 2010. Analyst Meet: Kirloskar Pneumatic Company Don't write it off Key takeaways * Kirloskar Pneumatic Company Ltd (KPCL) manufactures high pressure compressors, air and gas compressors and refrigeration compressors. * The economic downturn in FY1999-2002 resulted in the slowdown in industrial investments, which coupled with huge employee cost and interest burden led to KPCL reporting losses. * The clean up exercise resulted in huge voluntary retirement scheme (VRS) expenditure and large bad debt write-offs during FY2002-2005, which in turn restricted KPCL’s bottom line growth. * With the exercise of extraordinary write-offs coming to an end in FY2006, KPCL’s financials would be a lot cleaner and its structure a lot leaner. * KPCL’s air compressor division is all set to reap the benefits of the huge investments being lined up in a number of infrastructure and mining projects. * With huge investments being lined up for its user industry, KPCL’s order book position, which stood at Rs173 crore on March 31, 2005, has grown to Rs230 crore as on September 1, 2005. * The management is targeting revenues of Rs600 crore by FY2008, an EBIDT of Rs72 crore and a net profit of close to Rs50 crore in FY2008. With these estimates, the company looks all set to roll.