Fw: Sharekhan Investor's Eye dated August 21, 2008

[Shiju Narayan]

 

Investor's Eye [August 21, 2008] Please see the attachment for details Sharekhan www.sharekhan.com

Summary of Contents STOCK UPDATE Tata Motors Cluster: Apple Green Recommendation: Hold Price target: Rs545 Current market price: Rs418 Rights issue trimmed down Key points Tata Motors has decided to prune the size of its rights issue from Rs7,200 crore announced earlier to Rs4,200 crore. It may be recalled that the company had proposed to raise Rs7,200 crore through three simultaneous but unlinked securities: an issue of ordinary shares amounting to Rs2,200 crore; an issue of “A” ordinary shares having differential voting rights amounting to Rs2,000 crore; and an issue of 0.5% five-year convertible preference shares amounting to Rs3,000 crore.

• Due to the prevailing capital market conditions and the decline in the share price of the company, the management has decided against issuing the convertible preference shares. 
• The amount of Rs3,000 crore that was to be mobilised through the convertible preference shares would now be raised through the divestment of the company’s investments (preferably as inter-group sales), at the prevailing market prices over the next six to eight months. 
• As a result of the pruning of the rights issue, the extent of dilution in the equity base will be lesser, of about 30-35% now, compared with the 40-45% dilution expected earlier. This is a marginally positive event for the stock.
• As per the latest annual report of the company, Tata Motors had quoted investments of Rs764 crore (current market value: Rs1,900 crore) and unquoted investments of Rs4,145 crore at the end of FY2008. Among the unquoted investments, Rs600 crore is invested in Fiat India Automobiles Pvt Ltd, which cannot be sold. The other major unquoted investments are in subsidiaries like Tata Motors Finance, Tata Technologies, Telco Construction Equipment Company, TAL Manufacturing Solutions, Tata Daewoo Commercial Vehicle Company, and associate companies like Tata Cummins and Tata Auto Components among others. 
• The divestment of the investments is going to be in the form of preferably inter-group sales. The company had earlier sold a 24% stake in Tata Auto Components Company to Tata Capital to raise Rs160 crore in Q1FY2009. To mop up Rs3,000 crore it would have to carry out a lot of inter-group sales. Whether Tata Motors would succeed in mobilising such a huge amount remains to be seen.
• Moreover, fresh divestment through inter-group sales would again give rise to concerns with regard to the valuation methodology and corporate governance adopted. This could affect sentiment towards the stock.
• Due to weakness in the commercial vehicle sector as well as the delay in the launch of new passenger vehicle models and huge capital expenditure plans of the company, we maintain a Hold on the stock with a price target of Rs545.

 

Larsen & Toubro 
Cluster: Evergreen
Recommendation: Buy
Price target: Rs4,044
Current market price: Rs2,628

Annual report review

Key points

• Larsen & Tourbro (L&T) had a brilliant FY2008, as the stand-alone revenues rose by 43.1% led by excellent performance of the stand-alone company as well as its key subsidiaries. The margins of the company improved despite rising costs due to itsexcellent execution capabilities and judicious choice of orders.
• L&T (stand-alone) incurred a capital expenditure (capex) of about Rs1,647 crore in FY2008, which is extremely significant considering its last year net block of Rs1,756 crore. Despite huge investments, the company has maintained its return ratios, as its return on capital employed (RoCE) stood at 29.1%, while the return on net worth (RoNW) was at 26.6%.
• To our positive surprise, the company further improved its working capital management. The net working capital cycle was reduced to 24.4 days in FY2008 as against 30.1 days in FY2007. The company also continued to generate strong cash flows during the year, with the cash flows from operations standing at Rs2,049 crore in FY2008. 
• The company has a strong cash and cash equivalent position of Rs6,131 crore on a consolidated level, which shall be used to fund its future projects. Furthermore, the debt-equity ratio remains comfortable at 1.14:1 on a consolidated basis. 
• The order book of Rs53,000 crore (as on March 31, 2008) provides excellent visibility. L&T also highlighted the tremendous opportunities from the Gulf region, which it is looking to capitalise considering its already-established presence in the region.
• Diversified business model (both across products as well as geographies), opportunities from international operations, strong order book, and huge possibilities from its new initiatives are likely to fuel L&T’s growth going forward. At the current market price, the stock is trading at 17.6x its FY2010E consolidated earnings. We recommend a Buy on the stock with our sum-of-the-parts based price target of Rs4,044.

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SECTOR UPDATE

Fertiliser

Subsidy dues to be paid in cash

• The government has announced that it will make cash payments to fertiliser companies as settlement against the fertiliser subsidies due to them for FY2009. The highlights of the plan are:
  • The government will immediately pay to the fertiliser companies a sum of Rs22,000 crore to be funded by loans to be raised from State Bank of India (SBI) and the other public sector banks (PSBs); 
  • The interest on the loans would be borne by the government;
  • The government will release additional Rs31,000 crore (actual budgetary allocation) within the next three months for the same purpose, the details about this payment have not been disclosed;
  • Collectively, this would result in a cash outflow of Rs53,000 crore from the government’s coffers in the next three months. 
• As a result of the rising demand for urea and complex fertilisers, and the spiralling prices of imported urea the total fertiliser subsidy bill is estimated to have reached a whopping Rs119,000 crore in FY2009. This implies an additional subsidy burden of Rs84,000 crore on the fiscal deficit.
• The government has not disclosed the payment mode (ie cash/bond) for the amount in excess of Rs22,000 crore that is to be paid in cash now.
• The decision to pay subsidy dues in cash (instead of bonds) augurs well for the cash-strapped fertiliser companies, as it would help them to meet their working capital requirements and reduce their capital costs. 
• We believe the decision to pay subsidy dues in cash is aimed at avoiding a shortage of urea by increasing the domestic production. Higher production of urea would help reduce the import of urea and the other complex fertilisers, thereby resulting in a lower fertiliser subsidy bill. Most of the fertiliser companies stand to benefit from this move. However, the payment method for the remaining subsidy portion would remain a key monitorable in the days to come. Tata Chemicals remains our top pick among the fertiliser companies.

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