Sharekhan Investor's Eye dated October 30, 2006

[Sunil]

 

Investor's Eye [October 30, 2006] Please see the attachment for details Share khan www.sharekhan.com

Summary of Contents STOCK UPDATE Bharat Heavy Electricals Cluster: Apple Green Recommendation: Buy  Price target: Rs2,650 Current market price: Rs2,440 Unexciting performance Result highlight At Rs360 crore the Q2FY2007 net profit of Bharat Heavy Electricals Ltd (BHEL) is marginally below our expectations, primarily because of higher-than-expected staff and other expenses.  BHEL's revenues for the quarter grew by a smart 35% year on year (yoy) to Rs3,341 crore driven by the order backlog of Rs45,700 crore. The power division registered a 29% growth in its revenues whereas the industry division recorded a revenue growth of 35%.  However the operating profit margin (OPM) for the quarter declined by 100 basis points to 13.7%, as its staff cost increased by 21% and the other expenditure rose by 38.6%. The staff cost increased on two counts. One, the company made an additional outlay of Rs45 crore during the quarter for gratuity provision on an actuarial basis, according to the new AS 15 norms. Two, the company also paid additional performance incentive of Rs15 crore during the quarter.  The other income increased by 61% to Rs170 crore mainly on account of the rising yields on the huge cash reserves of the company. Also as BHEL's export revenue was higher during the quarter, the export incentive (which BHEL shows in the other income) boosted the other income. The net profit for the quarter grew by 38% yoy to Rs360 crore.  The order backlog during the quarter maintained its momentum and grew by a very impressive 42% yoy to Rs45,700 crore, resulting in an order inflow of Rs10,035 crore.  Bharat Electronics Cluster: Apple Green Recommendation: Buy  Price target: Rs1,525 Current market price: Rs1,120 Better performance in H2 Result highlight Bharat Electronics Ltd (BEL) has reported a lacklustre performance for the second quarter. On a stand-alone basis, its net revenues grew marginally by 0.7% to Rs834.3 crore. The operating profit margin (OPM) declined by 240 basis points to 22.4% from 24.8% in Q2FY2006. The OPM was dented by an increase in the employee cost as a percentage of sales (up from 12.1% in Q2FY2006 to 13.9% in Q2FY2007) and a jump of 38.8% in the other expenses. On the other hand, the raw material cost as a percentage of sales declined by 50 basis points and supported the margins. The other income more than doubled to Rs50.8 crore, which enabled the company to report a marginal growth (1.1% year on year [yoy]) in the net profit to Rs148.3 crore. On a half-yearly basis, the net revenues grew marginally by 0.7% to Rs1,317.4 crore. The OPM declined by 180 basis points to 19.6% during the period. The earnings grew by 2.6% to Rs208.6 crore aided by a 65.8% jump in the other income to Rs89.2 crore. Notwithstanding the lower-than-expected performance, the company is likely to achieve the stated gross revenue target of Rs4,200 crore during the current fiscal. The fresh order intake of over Rs800 crore during H1FY2007 was much better than that of Rs285 crore in H1FY2006. Moreover, the company generally accrues the bulk of its revenues (especially from the government segment) in the second half of the fiscal. In terms of valuations, the company trades at attractive valuations of 13.3x FY2007 and 11.8x FY2008 estimated earnings (without adjusting for the free cash of Rs229 per share on its books at the end of FY2006). We maintain our Buy call with a price target of Rs1,525.   Omax Autos Cluster: Apple Green Recommendation: Buy  Price target: Rs134 Current market price: Rs100 Price target revised to Rs134 Result highlight Omax Auto's Q2FY2007 results are in line with our expectations with the sales reporting a growth of 12.1% to Rs168.6 crore. However, due to the delay in the export orders from Arvin Meritor and Tenneco, the company witnessed a slower-than-expected ramp-up in its exports.  The operating profit margin (OPM) improved by 220 basis points to 9.9% on the back of lower power costs and other expenses. Consequently, the operating profit grew by 44.7% to Rs16.7 crore.  However, higher interest and depreciation charges as a result of the capital expenditure incurred by the company led the profit before prior period expenses to grow by 22.2% to Rs5.8 crore. The net profit after the prior period expenses grew by 18.7% to Rs5.7 crore. Due to the delay in the export revenues and a muted performance in the domestic business (Hero Honda contributes 60% of the company's sales), higher interest and depreciation charges, we are downgrading our FY2007 and FY2008E earnings by 23% and 32% respectively. At the current market price of Rs100, the stock quotes at 6.8x its FY2008E earnings and enterprise value/earnings before interest, depreciation, tax and amortisation of 3.9x. Considering the cheap valuations we maintain our BUY recommendation on the stock with a revised price target of Rs134.   ITC Cluster: Apple Green Recommendation: Buy  Price target: Rs220 Current market price: Rs188 All-round performance Result highlight ITC's Q2FY2007 net profit grew by 18.7% year on year (yoy) to Rs680.0 crore, in line with our expectations. The net revenues for the quarter grew by 32.3% yoy as most of its businesses grew strongly: cigarettes (14%), fast moving consumer goods (FMCG; 66%), hotels (30.5%), paperboards (11.3%) and agri-business (86.6%). The profit before interest and tax (PBIT) grew by 19.4% yoy as the PBIT margin contracted by 100 basis points, as per our expectations.  The contraction in the margin was on account of a higher contribution from the low-margin agri-business. Except the agri-business all the other businesses witnessed a healthy expansion in their PBIT margin. The non-cigarette FMCG business is the only business in ITC's portfolio that is making losses. However, with a strong growth in the revenues, the magnitude of losses, ie the loss margin, have come down considerably. We have always liked the way ITC has channelised the strong cash flows generated from the cigarette business into the other businesses without affecting its return on capital employed (RoCE). At the current market price of Rs188, the stock is attractively quoting at 21.3x its FY2008E earnings per share (EPS) and 13.6x FY2008E enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA). We maintain our Buy recommendation on ITC with a price target of Rs220.  Godrej Consumer Products Cluster: Apple Green Recommendation: Buy  Price target: Rs205 Current market price: Rs182 First-cut analysis Result highlight The stand-alone revenues of Godrej Consumer Products Ltd (GCPL) grew by 16.2% year on year (yoy) to Rs182.5 crore in Q2FY2007. The revenue growth was below our expectations. The soap business grew by 16.5% yoy to Rs127.2 crore whereas the personal care business grew by 15.4% yoy to Rs55.3 crore. GCPL's operating profit (OP) grew by a meagre 3.8% yoy to Rs33.8 crore in Q2FY2007, also below our expectations. The operating profit margin contracted by 220 basis points to 18.5%. The mediocre growth in the OP was a result of a sharp increase in the material cost, which jumped by 27.8% to Rs92.2 crore during the quarter. This increase was a result of the hardening prices of vegetable oil, which is a key raw material for the fast moving consumer goods companies. The profit before interest and tax (PBIT) margin of the soap division reduced by 400 basis points yoy to 10.8% whereas that of the personal care division increased by 60 basis points yoy to 42.7% during the quarter. The interest cost zoomed by 87.1% to Rs1.6 crore. The effective tax rate also increased from 5.8% in Q2FY2006 to 12.7% Q2FY2007. The higher-than-expected interest cost and tax expenses coupled with the lower-than-expected operating performance led to a 6% decline in the profit after tax to Rs26.1 crore. The same was below our expectations. GCPL's consolidated revenues for Q2FY2007 stood at Rs231.8 crore. Its consolidated OP and net profit stood at Rs39.7 crore and Rs31.0 crore respectively. The company's consolidated numbers reflect the stand-alone numbers of Keyline, UK and Rapidol, South Africa (the latter is the subsidiary company GCPL acquired this quarter). The stock trades at a price/earnings ratio of 22.4x FY2008E consolidated earnings. In view of the lower-than-expected results in the second quarter we are revising our earnings estimates for the company. We shall update our estimates after attending the company's earnings conference call for the Q2FY2007 results.  Universal Cables Cluster: Ugly Duckling Recommendation: Buy  Price target: Rs179 Current market price: Rs118 Performance in line with expectations Result highlight Universal Cables' Q2FY2007 net profit at Rs5.64 crore is in line with our expectations. The net revenues have grown by 20.4% year on year (yoy) to Rs91 crore driven by a 19.6% growth in the cable sales. The sales of capacitators grew by 45.3% yoy. The operating profit margin (OPM) contracted by 49 basis points yoy, resulting in a slower operating profit growth of 15.5% yoy. The margin at the profit before interest and tax (PBIT) level in the cable business contracted by 48 basis points yoy. This resulted in a slower growth of 14.8% yoy in the PBIT to Rs9.85 crore. The PBIT margin in the capacitator business contracted by 77 basis points, leading to a slower PBIT growth of 40.3% yoy to Rs0.87 crore. The net profit growth too was lower at 14.4% due to higher depreciation during the quarter. At the current market price of Rs118, the stock is quoting at 5.5x its FY2008E earnings per share (EPS) and 3.2x FY2008E enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA). We reiterate our Buy recommendation on the stock with price target of Rs179.  Allahabad Bank Cluster: Cannonball Recommendation: Buy  Price target: Rs106 Current market price: Rs93 Core performance remains weak  Result highlight Allahabad Bank's net profit grew by 24.8% year on year (yoy) to Rs210.2 crore in Q2FY2007. The net profit grew at a rate higher than our expectations of 13.2% mainly due to a write-back in provisions, as at the operating level the profit growth was below our expectations at just 0.8% yoy. During the quarter, the bank's net interest income (NII) grew by 6.1% yoy to Rs389.9 crore, much below our expectations of a 16.9% year-on-year (y-o-y) growth. The NII growth was lower since the net interest margin (NIM) slipped by 47 basis points yoy and by 41 basis points quarter on quarter (qoq) to 2.6%. The yield on advances improved by 25 basis points yoy and by 11 basis points quarter on quarter (qoq) to 8.88%. However, the same and a 47.4% growth in the advances couldn't restrict the fall in the NIM. That is because the deposit cost increased by 56 basis points yoy and by 31 basis points qoq, and the deposits grew by 23.6% yoy during the quarter.  The other income decreased by 24.6% yoy to Rs122.2 crore mainly due to a fall in the trading and other non-fee incomes. The other income excluding the treasury income also reported a fall of 15.5%. The core fee income, however, grew by 8% yoy. The operating expenses reported a fall of 6.8% yoy on account of a 12% fall in the staff expenses. As a result, the operating profit grew marginally by 0.8% yoy to Rs243.3 crore. The operating profit excluding the treasury income grew by 12.4% yoy, much below our expectations of a 21.5% growth. However, despite a marginal rise at the operating level, the bank reported a 41.8% rise in its profit before tax (PBT). This was mainly on account of a Rs19.7-crore write-back in the total provisions arising due to a Rs38.4-crore write-back in depreciation on investments.  Even though the operating performance was below expectations and the write-back in the provisions higher than expected, the net profit at Rs210.2 crore was much above our expectations. We have revised our earnings per share (EPS) estimates for FY2007 from Rs14.6 to Rs15.7 mainly on account of the lower provisioning requirements and operating expenses of the bank. Our FY2008 EPS estimates however remain unchanged at Rs21.8.  At the current market price of Rs93, the stock is quoting at 4.3x its FY2008E EPS, 3x pre-provision profit (PPP) and 0.8x book value. The bank is available at attractive valuations, considering its strong average return on equity (RoE) of 20.2% over FY2006-08E. We maintain our Buy call on the stock with a price target of Rs106.   Andhra Bank Cluster: Cannonball Recommendation: Buy  Price target: Rs109 Current market price: Rs92 In line with expectations Result highlight In Q2FY2007 Andhra Bank's net profit grew by 10.2% year on year (yoy) to Rs146.4 crore, in line with our expectations. During the quarter the bank's net interest income (NII) grew by 14.7% yoy to Rs330.9 crore, below our expectations of a 23.8% year-on-year (y-o-y) growth. The growth in the NII was lower because of an 8.7-basis-point fall in the net interest margin (NIM) due to a lower yield on investments and a higher cost of deposits. The other income increased by 9.1% yoy to Rs128.7 crore. The growth was in single digits mainly due to a fall of 39.7% in the trading income. However, the other income excluding the treasury income reported a strong growth of 25% with the core fee income growing by 22.3% yoy to Rs47.7 crore.  The operating expenses reported a rise of 14.8% yoy and the operating profit grew by 11.3% yoy to Rs223.1 crore. The operating profit excluding the treasury income grew by 19.9% yoy, below our expectations. With the provisioning lower than expected, the net profit grew by 10.2% yoy to Rs146.4 crore, in line with our estimates. We have revised our earnings per share (EPS) estimates for FY2007 from Rs10.7 to Rs11.3 mainly on account of the improving core banking performance and the stable other income growth. Our FY2008 EPS estimates however remain at Rs13.3.  At the current market price of Rs92, the stock is quoting at 6.9x its FY2008E EPS, 4.1x pre-provision profits (PPP) and 1.2x book value. The bank is available at attractive valuations given its improving operating performance, the adequate capital available in its books to meet the Basel II requirements and asset quality that is one of the best in the industry. We maintain our Buy call on the stock with a price target of Rs109.   Bank of India Cluster: Apple Green Recommendation: Buy  Price target: Rs185 Current market price: Rs167 Exceptional results Result highlight Bank of India's net profit grew by 60.5% year on year (yoy) to Rs212.1 crore, which is above our expectations of a 52.5% growth. The excellent numbers were driven by an improvement in all the key parameters of the bank's business. During the quarter the bank's adjusted net interest income (NII) grew by a robust 39.6% yoy to Rs908.5 crore compared to our expectations of a 27% year-on-year (y-o-y) growth. The improvement in the NII was due to the expansion in the net interest margins (NIMs) coupled with the growth in the advances.  The domestic NIMs improved by 45 basis points yoy while the global NIMs improved by 43 basis points yoy. The expansion was also robust on a quarter-on-quarter (q-o-q) basis as the domestic NIMs improved by 21 basis points while the global NIMs improved by 15 basis points. The other income showed a good growth of 16.5%, with the fee-based income showing a strong 30.7% growth.  The operating expenses were up 31.2% mainly due to the expenses incurred on the implementation of the core banking solution (CBS) that the bank charges to the profit and loss account unlike the other banks that prefer to capitalise and claim depreciation on the same. Some promotional expenses for the centenary year celebration also kept the operating expenses on the higher side. As a result, the operating profit grew by 33.9% yoy to Rs538.2 crore. The operating profit excluding the treasury income grew by 37.6% yoy. We have revised our earnings per share (EPS) estimates for FY2007 and FY2008 from Rs15.5 and Rs18 to Rs18.8 and Rs22.2 respectively to take into account the improved expected operating performance of the bank going forward. The improved performance of the bank is based on the improving margins, which should stabilise going forward coupled with the stable other income and the operating expenses growth.  The capital adequacy ratio (CAR) of the bank stood at 11.85% with the Tier-I ratio at 6.19%. This leaves very little room for the bank to grow its assets without diluting its equity in the medium term. However, the bank has shown no intent of raising its equity capital, unless absolutely necessary. Hence, we feel that the bank would initially use all the options available like innovative Tier-I capital. A plain equity issue may follow in H1FY2008, which would enhance the bank's book value and be value accretive going forward for the investors.  At the current market price of Rs167, the stock is quoting at 7.5x its FY2008E EPS, 3.3x pre-provision profits (PPP) and 1.2x its book value. The bank is available at attractive valuations looking at the strong visibility in its earnings and is less prone to interest rate risk shocks unlike some leading PSU banks. We reiterate our Buy call on the stock with a revised price target of Rs185.   State Bank of India Cluster: Apple Green Recommendation: Buy  Price target: Rs1,116 Current market price: Rs1,095 Strong growth in core operating profits Result highlight State Bank of India's (SBI) Q2FY2007 stand-alone net profit at Rs1,184.5 crore was down 2.5% year on year (yoy), but above our expectations of a fall of 11.4% largely due to the lower-than-expected operating expenses reported by the bank and on account of lower provisions.  The net interest income (NII) grew by 8.1% yoy to Rs3,898.7 crore, above our expectations of a 6.9% growth. The improved yield on the advances (up by 67 basis points) to 8.48% over a 21.2% advances growth coupled with the lower cost of deposits (down 15 basis points) to 4.64% mainly resulted in a better NII growth. The reported core net interest margin (NIM; adjusted for a one-time interest income) for H1FY2007 has improved by 40 basis points to 3.32%. Most other PSU banks have reported an increase in the cost of deposits, while SBI has reported a fall mainly due to the improvement in its CASA ratio to 42.6% from 39.5% and the lowering of the bulk deposit rates to discourage high-cost deposits in its books.  The other income increased by 10.7% yoy to Rs1,433.8 crore, restricted mainly due to a drop of 96.9% in the trading income during Q2FY2007 to Rs7.7 crore from Rs246.7 crore in Q2FY2006. The other income excluding the treasury income reported a very strong growth of 36.1%. With the net income up by 8.8% yoy and a decrease of 2% in the operating expenses, the operating profit increased by a healthy 24.7% yoy. The operating profit excluding the treasury income was up 42% yoy. The provisions were down 16.7% yoy mainly on account of the absence of investment depreciation during the quarter. However the tax outflow at Rs606 crore with an effective tax rate of 33.9% was much above our expectations.  At the current market price of Rs1,095, the stock is quoting at 9.6x its FY2008E earnings per share (EPS), 4.5x its pre-provision profits (PPP), 1.6x its stand-alone book value and 1.3x its consolidated book value. The bank is definitely a proxy investment for the Indian economy and the improved operating performance post the redemption of India Millennium Deposits (IMDs) could still provide some upside from the current levels. We maintain our Buy call on the stock with a price target of Rs1,116.   Orient Paper and Industries Cluster: Vulture's Pick Recommendation: Buy  Price target: Rs800 Current market price: Rs590 Performance below expectations Result highlight Orient Paper & Industries Ltd's (OPIL) Q2FY2007 net profit at Rs20.4 crore is below our expectations primarily because of a 33-day maintenance shutdown at the company's Amlai paper unit for a major overhaul. This plant shutdown resulted in a 21% decline in the paper division's revenues, leading to a loss of Rs8.5 crore. However the performance of the cement business (earnings before interest, depreciation, tax and amortisation [EBIDTA] per tonne of Rs929 as against Rs111 per tonne) is above our expectations.  The revenues for the quarter grew by 34.6% to Rs229 crore entirely driven by its cement division, which almost doubled its revenues to Rs141 crore. The paper division registered a decline of 21% in its revenue due to a shutdown and the fans division showed a decent performance registering a 22.6% growth in its revenues. The operating profit for the quarter grew by a whopping 288% to Rs43.8 crore as the cement division's earnings before interest and tax (EBIT) reported a significant jump to Rs49 crore signifying the effect of the cement prices on the company's profitability. The paper division reported an overall loss of Rs8.5 crore out of which Rs5.6 crore is the loss because of a 33-day plant shutdown and the balance is on the already non-operational Brijrajnagar unit. The other two units together reported a loss of Rs1 crore. Hence the overall profitability was significantly affected.  The operating profit margins (OPMs) for the quarter jumped three-fold to 19.1%, driven by the stellar performance of the cement division. The performance at the operating level was strengthened by a 26% decline in the interest cost and a 25% increase in the other income to Rs2.44 core and consequently the pre-exceptional net profit for the quarter stood at Rs20.4 crore as against a loss of Rs3.36 crore a year ago. Q2FY2006 included a profit of Rs6.6 crore on the sale of investments which we have treated as an extraordinary income. Hence OPIL's reported net profit jumped by 526%.   VIEWPOINT Moser Baer Strong reversal in fortune Incorporated in 1983, Moser Baer has emerged as one of the top three optical storage media manufacturers in the world. It has a wide range of products ranging from floppy disks, compact discs (CDs) to digital versatile discs (DVDs). It has relationship with all the top 12 global technology brands and has steadily gained market share over the past few years. Recently, the company has diversified into manufacturing of photovoltaic cells to tap the growing demand for solar power generation globally. The company is likely to commission the first phase of its photovoltaic cell manufacturing facility in the fourth quarter of this fiscal. Dr Reddy's Laboratories Results above expectations Result highlight Dr Reddy's Laboratories (DRL) reported revenues of Rs2,003.9 crore in Q2FY2007, as against Rs580.4 crore in Q2FY2006, representing an increase of 245% year on year (yoy). The revenues from the international markets increased by 391% yoy at Rs1,760 crore largely because of the contributions from the authorised generics and acquisitions. The revenues from its core businesses (excluding the contributions from the authorised generics and acquisitions) increased by an impressive 42% to Rs820 crore during the quarter. The overall gross margin declined to 41.3% from 51.6% in the corresponding quarter of the previous year, largely because of the pricing pressures in the USA and Europe and due to the integration of the Betapharma acquisition. However, with the impressive reduction in the selling, general and administrative (SG&A) cost to 18.3% of sales from 30% in Q2FY2006, the operating profit margin (OPM) expanded to 19.0% from 11.9% in Q2FY2006. The net profit increased by over two times (up by 214%) at Rs279.8 crore. At the current market price of Rs752, the stock trades at 18.2x and 22.0x of FY2007 and FY2008 consensus earnings. Currently, the management plans to focus strategically on enhancing the earnings by leveraging its Day-1 launches (as 55 ANDAs are in the pipeline) and authorised generic deals. On the cost front, DRL plans to curtail its litigation costs by out of court settlements and has already started tightening its SG&A expenses. On the R&D front, the company has already de-risked its model by partnering with financial partners. With all these developments we are positive about the stock.

Regards, The Sharekhan Research Team myac...@sharekhan.com