Sectors surviving the odds

A 5% appreciation in the rupee during the quarter brings further bad news for the export-oriented sector.

The petroleum companies are expected to report a y-o-y fall in sales and profits due to the economic blues. The oil marketing companies have been selling the auto fuels below cost for most part of the quarter, which would impact their profits. The refining business too is facing a pressure on margins; with the fuel consumption reducing globally while additional refining capacities commissioning operations.

In the cement sector, realisations in the June quarter are likely to be 8-9% higher on year-on-year basis for all-India players like ACC given strong demand from rural housing and government infrastructure. While ACC and Ambuja Cements are expected to post double digit growth in sales, revenue growth for Grasim is likely to be lower as the latter hived off its sponge iron business in May.

The June’ 09 quarter is likely to see a marginal improvement in the year-on-year performance of India Inc relative to the previous quarter’s performance. It needs to be seen if the ensuing budget provides it the much needed cushion for the coming quarters.

Current uptrend in markets sluggish

The market ended the previous week with modest gains, with the BSE Sensitive Index finishing 1.01% or 148.41 points higher, and the Nifty 1.11% up. The CNX Midcap Index gained 0.48%. Tata Steel was the biggest winner among the index stocks with a 13.0% gain.

The other index stocks to go up included ONGC, HDFC, Mahindra & Mahindra, and NTPC with gains falling between 9.0% and 4.8%.

Tata Motors was the biggest loser among the index stocks with an 11.7% loss. The other index stocks to go down included Reliance Communications, ACC, Hindalco, and Jaiprakash Associates, with losses falling between 6.4% and 3.1%. Educomp Solutions was the biggest winner among the more heavily traded non-index stocks with a 25.6% gain. The other non-index stocks to go up included Tulip Telecom, NIIT, BEML, IRB Infrastructure Developers, Torrent Power, Gail India and Aptech with gains falling between 22.0% and 10.8%.

Gujarat NRE Coke was the biggest loser among the more heavily traded non-index stocks with a 15.2% loss. The other non-index stocks to go down included Suzlon Energy, Idea Cellular, Firstsource Solutions, Petronet LNG, India Cements, KS Oils and Gateway Distriparks with losses falling between 13.4% and 5.2%.

INTERMEDIATE TREND

The market is in an intermediate uptrend which started on June 23 at the sensitive index’s intraday low of 14,017. The uptrend has thus already lasted two weeks, but is moving at a snail’s pace when compared to the one from March 6 to June 12. The intermediate uptrend would end if the sensitive index were to fall below 14,356, the Nifty below 4,250 and the CNX Midcap under 5,361.

These levels are the indices’ previous minor bottoms, and are also last week’s intraday lows. The intermediate downtrend that preceded the current uptrend saw the sensitive index retrace just 20% of the previous uptrend’s 7,553-point gain. This may be considered to be a “healthy” correction, as most bull market retracements tend to fall between 33% and 50%. The implication here is that the long-term demand for stocks can be seen as good, even though the market has been stagnant during this intermediate uptrend.

LONG-TERM TREND

The market’s long-term (i.e. major) trend is up, which means this is a bull market. Over 90 percent of the more heavily traded stocks have entered long-term uptrends and gone above their 200-day moving averages. The bull market can be said to have started with the sensitive index’s October 27, 2008 low of 7,697.

TRADING & INVESTING STRATEGIES

Additional longer-term investing should have been carried out during the last intermediate downtrend, as suggested earlier. Portfolio additions – if not fully invested already – should be now attempted only after the next intermediate downtrend. Current long-term portfolios should be held on to.

GLOBAL PERSPECTIVE

A majority of global markets are still in intermediate downtrends. The Hang Seng and the sensitive index are among the few which have recently started uptrends. Shanghai did not enter a downtrend at all.

The US and European indices do not look like they are on the verge of starting new intermediate uptrends. The Dow would even fall to a two-month low if it drops and stays below 8,150. A strong downtrend in the Dow could eventually hit markets which are doing reasonably well as of now.

The BSE Sensitive Index had gained 12.0% in the twelve months that ended on Thursday, keeping it at the 3rd place among 35 well-known global indices considered for the study.

Shanghai heads the list with a 13.2% gain. Chile, the sensitive index, Turkey and Sri Lanka follow. The Dow Jones Industrial Average has lost 26.6% and the NASDAQ Composite lost 20.0% over the same period. (These rankings do not take exchange rate effects into consideration).

Indian shares post biggest weekly fall in 8 mths

Indian shares fell 1.8 per cent on Friday and posted their biggest weekly fall in more than eight months as concern about the economy kept investors jittery, but Infosys bucked the trend and rallied on strong quarterly result.

Infosys Technologies, the country's No. 2 outsourcer, reported a better-than-expected 17 per cent rise in June quarter profit and marginally raised full-year forecast but warned the business environment was still challenging.

However, a poor start to monsoon rains, crucial for India's domestic demand-led economy, and lingering concern about a world recovery weighed.

The 30-share BSE index fell 1.84 per cent, or 253.24 points, to 13,504.22, its lowest close after the ruling coalition won re-election in mid-May and triggered a strong rally.

"I have been expecting a fall but not to this extent," said Ambareesh Baliga, vice president, Karvy Stock Broking. "Some foreign funds were selling."

Twenty-four index components ended down in choppy trade as a pullback of more than 1 per cent at one stage triggered heavy profit-taking in the last half hour.

"The immediate reason for the fall is a sell-off by some hedge funds due to redemption pressures from their investors. The biggest worry for the market, apart from the monsoons, is the global economic crisis," said R.K. Gupta, managing director, Taurus Mutual Fund.

The benchmark index lost 9.4 per cent on the week in its sharpest fall since last Oct. 26, with Monday's annual budget setting the trend as big government borrowing plans and few expected reforms disappointed investors.

"Now that the budget is over the market will come back to basics," said Gaurav Dua, head of research at Sharekhan, adding traders and investors would be looking more closely at valuations.

The BSE index is still up 40 per cent in 2009 after an almost 50 per cent rally in the June quarter.

"Markets are going to be tentative next week on account of monsoons, quarterly earnings, global cues and most important foreign fund flows," said Arun Kejriwal, director of research firm KRIS.

Farm Minister Sharad Pawar told parliament on Friday the poor monsoon rains in northern parts of India were a serious problem.

Rains have been 8 per cent below normal in early July, reviving after the driest June in 83 years, but water in the main reservoirs has more than halved, putting at risk even winter-sown oilseeds and wheat.

Higher than expected industrial output in May also failed to move the market, with traders shrugging it off as historical data. Output rose 2.7 per cent in May, above a Reuters poll forecast of 1.4 per cent.

Energy giant Reliance Industries, which led the index losers, fell nearly 4 per cent to 1,778.40 rupees. The stock has fallen 12.3 per cent this week, the second steepest weekly slide this year.

Infosys firmed 3 per cent to 1,726.50 rupees and spurred other outsourcers. Bigger rival Tata Consultancy Services rose 1.6 per cent to 394.65 rupees, while No. 3 outsourcer Wipro Ltd gained 3.4 per cent to 384.70 rupees.

In the broader market, losers outnumbered more than 2:1 on moderate volume of 333 million shares
.

The 50-share NSE index, or Nifty, closed down 1.9 per cent at 4,003.90 points.

"The market will be volatile next week, and the Nifty can fall below 3,800," Gupta said.

Stocks that moved

Mahindra Satyam, formerly Satyam Computer Services, rose 2.05 per cent to 74.50 rupees after it said late on Thursday it had signed a 5-year multi-million dollar support contract with GlaxoSmithKline Plc.

Punj Lloyd rose as much as 7 per cent after its Singapore unit won projects worth $1.2 billion in Libya, but closed down 0.7 per cent at 185 rupees on profit-taking.

Sterlite Industries rose 3.3 per cent to 575.70rupees after its parent Vedanta Resources said it would begin bauxite mining for its alumina plant in eastern India in October and would invest $1.2 billion to expand its capacity sixfold by 2011.

Main Top 3 by volume

Unitech Ltd on 23.3 million shares

Suzlon Energy on 21.1 million shares

Mahindra Satyam on 20 million shares

Frontline stocks overvalued? Investors should wait and watch

There's no stopping the Indian equity markets right now, it appears. Last week, stocks further extended their winning streak and the benchmark

BSE Sensex gained nearly 500 points or 4.2% in five trading sessions ending May 8.

The rally continues to be broadbased as in the previous few weeks. In the past five trading sessions, the Nifty jumped 4.2%, the Nifty Junior went up by 5.2% while the BSE Midcap and BSE Small cap

indices continue to outperform the benchmarks.

Obviously, the sentiment is extremely positive on Dalal Street right now. While the bulls are rearing to go, opportunities are shrinking for retail investors with each passing day. Value is evaporating fast. If in early March, most frontline stocks were dirt cheap by historical measures, a majority of them are currently over-valued.


This puts retail investors in a tight spot, especially those looking to use the economic downturn to build an equity portfolio for retirement. ET Intelligence Group looks through the fog at the historical valuations of Nifty-50 stocks and gauge the sustainability of the current rally.

On Dalal Street, the fair value of a stock is typically measured by three variables: dividend yield (in percentage), price-to-book value (P/BV) ratio and price-to-earnings multiple (P/E ratio). Everything being equal, a stock with higher dividend yields and a lower price-to-book ratio is preferable. Similarly, a long-term investor would prefer a company with a lower price-to-earning multiple. The absolute value of the parameter doesn't matter much though. The key is to compare the current valuations with historical averages.

We have used the three ratios to run a value check on 50 stocks that comprise the NSE Nifty index. For historical averages, we have taken the median value of parameters in the past 36 quarters beginning January-March 2001. This way, we capture both the bear phase (during 2001-03) when stocks were dirt cheap as well as the subsequent Bull Run when valuations scaled new highs. We have omitted Nifty stocks for which the comparable data was not available for a long-enough period, and were left with 41 stocks.

In our framework, 33 out of 41 stocks look expensive. These account for nearly 75% of the combined market capitalisation of all 50 Nifty companies. That's not a recipe for a sustainable rally unless you are a trader and like to play the momentum game. (The data on all 41 companies is available on www.etintelligence.com)

Many of the stocks are now more expensive than their valuations in financial year 2002-03, the previous economic downturn. Take BHEL, for
Buy Or Sell instance. Right now, it is trading at nearly 29 times its net profit in the past 12 months, an over 40% premium to its long-term average P/E multiple.

The stock is now priced seven times the book value (of its assets), which is more than twice the historical average of 3.2. An investment of Rs 10,000 in the stock will currently earn you a dividend of Rs 90. In the December 2002 quarter, the same investment would have yielded a dividend of Rs 230. At the other end of the valuation spectrum is Tata Steel.

With a dividend yield of around 5.5%, the stock looks inviting at its current price. The euphoria, however, dies down soon enough, when you consider that the stock offered a better yield in 2002-03. Moreover, in 2003, the company had no Corus to worry about. With a higher risk, investors
deserve a lower, not higher valuation.

There's nothing wrong in higher valuations per se. What matters is the corresponding growth in earnings. For instance, a price-earning multiple of 22 is fine for NTPC as long as the company can grow its earnings at 22-25 % per annum on a sustainable basis.

But this is difficult, given its historical performance and nature of the industry. In the past 15 years, the company's net profit has grown at a compounded annual rate of 15%, which is close to its historical average P/E multiple of around 17.

The analogy applies to most leading stocks right now. In a majority of cases, valuations are running ahead of fundamentals. Given the state of the economy and the demand conditions at home and overseas, it will be an uphill task for India Inc to meet market expectations in the forthcoming quarters. And everyone knows what happens to stock prices when companies fail to meet the Street's expectations. So to those of you who have missed the bus, it's advisable to stay out for the moment. The current momentum may take the market to a new high, but the reversal could be equally sharp.

Infosys cautious about short-term growth

Infosys Technologies Ltd, the second largest Indian IT exporter, came out with a positive surprise on Friday when it reported 17% year-on-year rise in its quarterly net profit at Rs 1527 crore. Its topline, reported at Rs 5472 crore, beats the ET Intelligence Group’s revenue estimate of Rs 5245 crore. The stock market took this news positively and the Infosys stock surged by 2.5% to a flat Sensex during morning trade.

Infosys’ European business, which accounts for around one-fourth of total revenue, seems to have performed badly compared to business from US. Its US business declined by 2.7% following 6% appreciation in the rupee against the dollar. Revenue from the European market was expected to see some buoyancy given 8.5% depreciation in the rupee against the pound. However, it fell by 1.3% sequentially. The management has hinted at increased spending in sales & marketing activities. Given its poor show in Europe, a significant pie of this expenditure may go towards strengthening its sales & marketing activities in this region.

The operating margin for the June ’09 quarter expanded by around 50 basis points compared to previous quarter. However, this is not expected to continue for the rest of the year. The management expects the operating margin for the financial year 2009-10 to decline by around 150 basis points on account of increased spending on sales & marketing and lower utilization rates, among others.

Though June quarter is relatively better, the management has lowered the guidance for the full year keeping most of the negative factors in mind. It would be interesting to see whether other large Indian IT companies are also going to report a similar set of good numbers for the quarter ended June ’09.

Green shoots in investment in agriculture

In a bid to improve farm yield, the investment in agriculture has been on a steady rise globally reviving the fortunes offarm-input companies. "Agriculture is the best, enterprise is acceptable, but being on a fixed wage is a strict no-no," thus goes an old Indian proverb. Modern India has turned that adage on its head, and in an economy that's set to overtake China as the world's fastest growing, a high fixed wage is acceptable, enterprise is preferred, and agriculture, well, seems eminently avoidable. However, a grain crisis that erupted in the last few years has reinforced how central food security is to an economy, developed or emerging. The reality has dawned on policy makers that high food prices will cripple every other sectors of the economy, as consumers, struggling to put food on the table, tighten their purse strings on every other non-essential product. The world is today consuming more than what it makes, and massive farm-to-fuel programmes are limiting the available farmland for foodgrains. This practice is now under review in many countries ranging from the corn belt of the US to the sugar cane farms of Brazil. Back home, the government's investment in agriculture has grown steadily over the years and a boom in agri-commodity prices in the last couple of years means that the farmers are in a better position today to make long-term investments. For a long-term investor this is a good sign to invest in companies that supply key inputs to the agriculture industry. In view of this, ET Intelligence Group has cherry picked firms that could benefit from the rising demand for farm inputs and agricultural infrastructure. While the valuation of these stocks provides scope for appreciation, they could prove defensive bets in times of turmoil due to strong demand from agriculture segment. Food, after all, is a recession-proof business. Growing government investment The direct government expenditure in agriculture has seen a sharp rise over last five years enabling better farm credit and creation of support infrastructure like irrigation (See chart). As a result, over last few years India has seen a spurt in the capital formation in the agriculture sector including initiatives such as irrigation projects, rural roads and communication infrastructure, sales and marketing infrastructure, production of fertilizers and pesticides, agricultural education, research and development of agricultural technology. Schemes like National Rural Employment Guarantee Scheme (NREGS) are also instrumental in improving the infrastructure in the rural areas. The global scenario is changing Under the Renewable Energy Directive (RED) passed by the EU Parliament in January 2009, bio-fuel blending of 5.75% is envisaged by 2010 to be scaled up to 10% by 2020. In the US the ethanol consumption is set to quadruple to 36 billion gallons by 2022. In India also, the government has mandated a 5% ethanol blending to be raised to 10% next year. All this is necessitating the world to invest more in improving farm yields. This needs optimum usage of pesticides, farm nutrients including fertilizers, creation of infrastructure such as irrigation, warehousing and transportation and usage of automated processes from tilling to harvesting. Over the last few years, consumption of food grains has risen faster than the growth in supply. Although the higher foodgrain production in 2009 has assuaged the fears about immediate food scarcity, long-term worries remain. Most of the agrocommodities witnessed a sustained rise in prices in the last couple of years, which are currently at nearly double their 2001 prices. These factors reinforce a sustained rise in the demand for the farm inputs in the years to come. In fact, after a sluggish spell of five years, for the first time in FY09 the agrochemicals industry worldwide witnessed a robust double-digit growth. Similarly, India's fertilizer industry, which was stagnating till FY04, has picked up growth in the last five years. India's fertilizer consumption, which rose at a CAGR of just 0.6% from FY98 till FY04, jumped to a CAGR of 5.6% subsequently. For FY08, the country consumed over 20.9 million tonne of three major farm nutrients viz. nitrogen, phosphorous and potassium. Five years back, the corresponding figure was 17 million tonnes.

Cadila Healthcare looks to be an attractive long-term bet

Cadila Pharmaceuticals Limited

Beta 0.3

Institutional holding 17.5%

Dividend Yield 1.2%

P/E 14.9

M-Cap Rs 4,578cr

CMP Rs 359.7

One of the top ten pharma companies (by sales) in the country, Cadila Healthcare’s stock went up by 56% in the last four months, outperforming the ET Pharma Index that rose by 43% during the period. At twice its revenues, the company looks fairly valued for its size and business. However, considering Cadila’s growth potential, it looks to be an attractive long-term bet. Nevertheless, any short-term rally in the stock does not look sustainable, as the market seems to have discounted most of the current good news.

Business:

Ahmedabad-based Cadila Healthcare is the flagship company of the Zydus Cadila group. It is engaged in manufacturing of formulations, active pharmaceutical ingredie-nts and consumer products. A lit-tle over half of its revenues are contri-buted by its operations in India, 30% from regulated mark-ets like US, EU and Japan and the rest from emerging markets. In the domestic market, it manufactures drugs related to cardiology, gastro-intestinal, women’s healthcare and respiratory illnesses. It is also involved in contract manufacturing space thro-ugh joint ventures with Switzerlandbased Nyco-med and USbased Hospira.

Growth Strategy:

Cadila’s growth comes primarily from its exports. In FY09, the company acquired Spainish generic player Laboratories Combix, and followed it up by acquiring South Africabased Simalya Pharmaceuticals. The company is now actively strengthening its regulatory drug pipeline to enter new territories. The company has filed a total of 92 ANDAs and 76 DMFs. Cadila invests 6% of its revenues in R&D.

The company which plans to be a research driven pharmaceutical firm is currently working on 6 New Molecular Entities (NME). The company expects to have at least 10 active R&D programs in clinical research by 2011. It has entered into a new drug discovery and development agreement with Eli Lilly in the area of cardiovascular segment. The company may receive milestone payments of up to US$ 300 million and royalties on sales if a molecule is commercialized by Eli Lilly. Cadila has also integrated its restructured con-sumer business into its subsidiary Zydus Wellness.

Financials:

The Rs 2800 crore company logged a better than expected performance in FY09. And it has set itself an ambitious target of doubling its revenues to $1 billion (Rs 5000 crore) by FY2011. To achieve its target, the company is betting on the ramp up of its operations in its joint venture contract manufacturing business and export formulations. The company’s earnings would be further boosted as its joint venture with Hospira has started commercial operations from May this year.Amajor concern, however, is the slow rate of growth registered by its domestic business, the highest contributor to its revenues currently. During FY09, its Indian business operations grew only by 10%, lagging behind the average industry growth of 12%.

Valuations:

Given the multipronged business and the significant scale up in its operations, the company’s stock, unlike its peers, had been under valued till recently. With most large pharma companies having taken a beating due to poor performance or clamp-down by US FDA, the market turned to stocks having untap-ped value. Cadila Healthcare was one such stock with a lot of value intact. However, with most of the value having been realised , the stock looks fairly valued in the near term. For long term investors, it is good buy, while the investors with very short term horizons can probably give it a miss.

Not all's lost for market

While there was little in the Budget to cheer equity investors, sub-brokers have something to thank the finance minister for.

The proposal to exclude sub-broking services from the ambit of service tax will benefit over 41,000 equity sub brokers (as per Dun & Bradstreet estimates), empanelled with various brokerages across the country. “The definition of a stock broker is being amended to exclude the sub broker from its ambit.

As a consequence, sub-brokers will be outside the purview of service tax,” Memorandum 3 of the Budget document clarified. The main brokers are still required to remit service tax to the government.

The move will increase the earnings of sub brokers who have been paying 10.3% service tax on the sub brokerage earned (from the main broker), according to tax experts. “The exemption will help sub brokers to earn a bit more, as they will no longer have to remit service tax on sub brokerage,” said Rohit Jain of Economic Laws Practice, a consulting firm specialising in corporate law and taxation.

The move to exclude sub brokers from the service tax net comes at a time when high-profile brokers are partnering with individuals to increase reach and cut (business) start-up costs. According to industry sources, brokers, in their bid to cut infrastructure cost, are shutting down branches in smaller towns and designating sub brokers on profit- (or loss) sharing basis to carry out business.

According to a highly-placed official of a listed brokerage, sub-brokers usually get a raw deal. “During the bull run, brokers were not interested in sharing profits with sub brokers. Now when times are bad and the probability for incurring losses is more, brokers are looking for tie-ups on a revenue-sharing model. The exclusion of service tax levy will help them earn a bigger portion of the brokerage,” said a senior official of a listed brokerage firm.

In times of buoyant markets, brokers call the shots, forcing sub brokers for 60-40 revenue-sharing agreement, favouring brokers. However, with markets entering a bear phase, profit-sharing ratios have turned in favour of sub brokers. There have been instances where brokers have agreed for even a 50-50 arrangement with the sub broker.

BULL'S EYE: Rolta India, Tata Steel, Max, Cairn India, Aditya Birla Nuvo, Nestle

Rolta India

RESEARCH: BNP PARIBAS

RATING: BUY

CMP: Rs 127 BNP Paribas upgrades Rolta India to `Buy’ with a target price Rs 160. Management indicates that order inflow continues to improve and that the company is on track to meet its FY09 guidance. Rolta is in advanced stages of signing several new domestic infrastructure and defence-related orders, but these are unlikely to make the order book immediately with client go ahead still pending.

The international business will likely remain subdued, however, until oil capex and enterprise IT spending improves. BNP Paribas’ earlier margin assumptions were conservative - management expects flattish wage costs in FY10, while pricing could be better than the expectation on sales of newly launched solutions. Also note the current order book provides 65% revenue visibility for FY10E.

The target price rises on higher FY10/11E and medium-term projections, and implies FY10/FY11E P/Es of 11.4/10.0x. The latter is in line with the historical average and higher than the trough cycle of 6.8x P/E earlier. While the company may have missed the opportunity to buy back the FCCBs earlier in the year when the prices were much lower, any buyback at a discount is still positive as it reduces debt in the books and hence a likely heavy payback in 2012.

TATA STEEL

RESEARCH: JP MORGAN

RATING: NEUTRAL

CMP: Rs 438.30 JP Morgan recommends `Neutral’ rating on Tata Steel, but raises the price target to Rs. 415. While June and September 09 quarters should be weak, JP Morgan believes the worst is likely behind in terms of operational environment for Corus.

JP Morgan European steel analyst Jeffrey Largey expects European steel prices and demand to recover as inventory de-stocking comes to a close and believes European steel earnings are likely to improve from Q4CY09E with the real benefits flowing through in CY10E. While current capacity utilization at Corus remains at 50%, utilisation levels will gradually increase from here.

As the recent cancellation of the agreement by the buyers of slabs at the Teeside plant shows, FY08-level sales volumes are unlikely to come back for Corus any time soon. Indian operations should continue to do well and provide strong cash flow support over the next 12-18 months as Corus restructures. While deleveraging is expected to be limited over the next 18 months, it should pick up pace once Corus’ earnings normalise. JP Morgan does not rule out capital-raising to accelerate deleveraging, as net debt remains high.

MAX

RESEARCH: CLSA

RATING: BUY

CMP: Rs 206 CLSA maintains `Buy’ rating on Max India by raising the price target to Rs. 240. Max’s healthy growth in new business premiums of the insurance segment moderated towards Q4FY09, in line with the sector. But the high persistency rate of 82%, healthy margins on new policies and the cash breakeven of the healthcare business were encouraging. During FY10, Max New York Life (MNYL) will focus on expansion and targets to achieve breakeven by FY12.

MNYL's new business sales in Q4FY09 declined 13% y-o-y, compared to a 38% growth in the first nine months, reflecting industry-wide slowdown in sales, as weak equity markets led to a sharp fall in demand for unit-linked products. Revenue growth of 13% y-o-y was driven by sharp growth in outpatient revenues (32% y-o-y).

Average revenue per occupied bed day improved 3% y-o-y while utilisation remained flat at 65%. Max intends to expand total bed capacity from the current 770 to about 1,800 by FY12. CLSA values the healthcare segment at Rs27/share by ascribing 12x FY11CL EBITDA on current operational beds and adds net present value of replacement cost for rest of the beds.

CAIRN INDIA

RESEARCH: CITIGROUP

RATING: HOLD

CMP: Rs 230 Citigroup downgrades Cairn India to `Hold’ from `Buy’ with a revised target price of Rs 237. Citigroup’s long-term crude assumption (2012E onwards) remains unchanged at $65/bbl. For $65 long-term crude assumption, the stock is pricing in most of the quantitative and qualitative upsides.

Creation of surplus capacity (205k bpd plateau against Citi’s assumption of 185k bpd) exhibits confidence in terms of exploration potential and higher recovery. In addition, Citigroup now ascribes 5% premium to NAV to build in the exploration potential in other blocks as well as to factor in the potential for a positive surprise in project development targets.

In addition, Cairn’s positioning as the only hedge against crude for the “India-dedicated” money

ADITYA BIRLA NUVO

RESEARCH: UBS INVESTMENT

RATING: BUY

CMP: Rs 886 UBS Investment maintains ‘Buy’ rating on Aditya Birla Nuvo and raises price target to Rs 1,050 as UBS incorporates Idea’s revised valuation and lower holding company discount (10% from 30% earlier). ABNL has significantly appreciated (+126%) since 20 March ‘09 compared with a 59% rise in Sensex. UBS believes that Idea’s management’s strategy of investing in 1800 Mhz circles is sensible. Idea has gained excellent traction in revenue market share in the past few quarters due to its brand strength as well as excellent management. Idea’s 900 Mhz circles provide the company with a significant opportunity to create shareholder value. ABNL is likely to benefit from any increase in FDI/FII limits in insurance. Further triggers could be: 1) Any unlocking of value in insurance business, 2) Any stake sale in Idea or divestment of any non-core standalone businesses.

NESTLE

RESEARCH: HSBC

RATING: OVERWEIGHT

CMP: Rs 1975 The F&B industry in India is characterised by low penetration and low per capita consumption. The per capita consumption for some F&B categories in India is just 1-2 % of that in developed economies and is low even by emerging market standards. India’s income distribution pattern is changing, with the ‘deprived’ population set to decline from 50% of households in 2005 to 18% in 2025, resulting in a whole new consuming class. India has one of the youngest populations in the world, as well as a growing urban population, both of which are conducive to F&B growth.

With sales of Rs 4,320 crore in CY08, Nestlé is the largest processed food company in India and is poised for aggressive and sustainable growth. It has a robust milk supply chain enabling regular supply at an economical cost. The company drives new user recruitment through affordable priced packs and drives revenue and margins through brandsvariants/extensions; 76% of its sales growth is volume-led.

The company has excellent financials, marked by a net margin of 13%, a CY08-11 E EPS CAGR of 18.3%, negative working capital, and RoE of 125%-plus . HSBC values Nestlé at Rs 2,210 per share - 26x FY11E PE - as it deserves an about 8% premium to Hindustan Unilever (HUL), given its higher and better-quality growth in some categories and less competition in others. should support valuations. In addition, management’s track record in project execution adds a defensive shade to the stock despite the high leverage to crude prices. Cairn has adhered to its timelines, and readiness to start producing crude this month provides comfort on further milestones. Pricing seems to be settled with discount to Brent ranging between 10-15 %. The cess issue is likely to get resolved only in 2010, until which time Cairn is likely to pay at the present rate.

Disinvestment of public sector units in India: EY

The public sector contributes about a quarter of India’s domestic output and employs about 19 million people, both in the centre and the states. Bulk of this output, mostly in industry and services, is contributed by close to 250 public sector enterprises, owned and managed by the Central Government. Besides, there are 1,100 state level public enterprises that are relatively small in size, largely intended to meet social welfare objectives and to secure resources from public sector banks and develop financial institutions. While, the contribution of these publicly owned and managed enterprises, to national development has been widely acknowledged, their poor financial return has been a matter of concern.

The process of privatisation was initiated in 1991-92 with the sale of minority stakes in some PSUs, primarily to raise resources to bridge the fiscal deficit. In order to raise resources and encourage wider public participation, a part of the Government’s shareholding in the public sector was offered to public investment institutions, financial institutions, general public and workers.

The disinvestment policy of 1991 aimed to focus public sector investment on strategic, high-tech and essential infrastructure. Boards of public sector companies were made more professional and performance improvement was sought, by providing greater autonomy and accountability. PSUs, which were chronically sick and unlikely to be turned around were referred to the Board for Industrial and Financial Reconstruction (BIFR) and social security mechanisms were created to protect the interests of workers. The disinvestment process of the early 1990s came to an abrupt halt following the collapse of the stock markets. Since, the stock markets remained subdued for much of the 1990s, the disinvestment targets were largely unmet. After a change in the Government in 1996, although there was a rethink on the disinvestment policy, there was no reversal in policy. The Disinvestment Commission constituted during this period recommended: Restructuring and reorganising of PSUs before disinvestment, Strengthening of PSUs, which were performing well and Utilisation of disinvestment proceeds for restructuring of PSUs.

The Disinvestment Commission’s recommendations led to some prominent profit making PSUs being declared as “Navratnas” or jewels. These PSUs were granted greater managerial and financial autonomy. However, the process of disinvestment did not pick up as share prices remained largely subdued due to a series of irregularities in the financial markets.

After the NDA government came to power in 1998, the disinvestment process took a new turn with substantial portions of equity in select PSUs sold to strategic partners – marking a transfer of managerial control to private enterprises. The primary focus was on improving efficiency and productivity of PSUs, although much of the disinvestment proceeds were eventually used to bridge the fiscal deficit.

A separate ministry was created and sales were organised through auctions and bids to avoid interference of respective ministries and bypass the stock markets, which continued to be sluggish. Every effort was made to ensure transparency at all stages of the disinvestment process, to avoid controversy and allegations of corruption, usually associated with such sales.

Disinvestment in public sector undertakings:

Year	Target (Rs. Crore)	Proceeds (Rs. Crore)
1991-92	2,500	3,038
1992-93	2,500	1,913
1993-94	3,500	-
1994-95	4,000	4,843
1995-96	7,000	362
1996-97	5,000	380
1997-98	4,800	902
1998-99	5,000	5,371
1999-00	10,000	1,860
2000-01	10,000	1,871
2001-02	12,000	5,632#
2002-03	12,000	3,348
2003-04	14,500	15,547
# Figures inclusive of amount realised by way of control premium, dividend/ dividend tax and transfer of surplus cash reserves prior to disinvestment etc. Source: Ministry of Disinvestment

In the context of corporate governance and efficiency of use of resources in a socialist economy, PSUs are unlikely to be efficient because of soft budget constraints whereby firms do not go bankrupt for their poor performance, primarily because they can restructure their contracts to hide their inefficiency. Managers’ efficiency objectives may also come in conflict with political interference in operational matters, to meet narrow political goals. Even in market economies, large firms of strategic importance may well be protected, to avoid significant systemic risks.

In principle, natural public monopolies such as railways, highways, water, sewage etc. where competition is weak or absent and payback periods are longer – increasing risk and uncertainty for contracting parties – public ownership should prevail. On the other hand, industries driven by rapid changes in technology such as telecom and consumer goods industries should be privatized to meet the twin objectives of financing the fiscal deficit and achieve efficiency and productivity gains. Financially unviable and loss making PSUs should be substantially restructured or closed down with a fair share of the proceeds being offered as compensation to workers.

One of the possible reform measures, practiced in countries like Japan, involves reduction of government holding in PSUs to less than 50 per cent by transferring shares to mutually complementary firms, tied around a public sector bank or financial institution. For example, interlocking of equity holding among steel, coal and electricity firms or petroleum exploration, refining and petrochemical complexes. Such a measure would eliminate both procedural audit as well as regular political interference.

To ensure public accountability, managers may be asked to demonstrate efficiency of resource use. In addition, there could be a specified timeline for budgetary support or government guarantee for loans. Banks would have the incentive to monitor the performance of PSUs because they would have substantial equity and loans at stake.

Share pricing may complicate PSU divestment

The price discovery of the shares of public sector companies are not very efficient in view of the low floating stock. Just a few buy orders can skyrocket their share prices and vice versa.

If wishes were horses, the Indian government could raise up to Rs1.24 trillion by divesting stakes (with the government retaining about 75%) in listed public sector companies with a very low floating stock in the stock bourses. That is, if one only refers to the prevailing share prices as the benchmark for pricing the shares for divestment of government companies.

But this is a simplistic calculation, because the price discovery of the shares of these public sector companies are not very efficient in view of the low floating stock. Just a few buy orders can skyrocket their share prices and vice versa.

For instance on Wednesday, till 1pm just one trade was reported in the BSE at the MMTC counter, a company which trades in metal commodities. The MMTC share price gyrated in a range of Rs25,900 to Rs28,700. The 52-week high-low price band for the MMTC scrip was even more disparate, swinging from a low of Rs9125 to Rs39,090.55.

The market capitalization for the PSU company that reported a net profit of Rs200 crore in financial year 2007-08, was Rs1,40,848 crore with the government owning more than 99.93% of the equity. If 25 % is offered to the public as per the new budget proposal, the government can pocket Rs34,268.32 crore from just one divestment proposal in a metal trading company.

Ditto with NMDC Ltd and NTPC Ltd, where the government owns 98.38% and 89.5%.

Nestle India Multi Bagger

Company Profile:
Nestle India is a subsidiary of Nestle S.A., world's biggest food company and a leading Swiss giant. With seven factories and a large number of co-packers, Nestlé India is a vibrant company that provides consumers in India with products of global standards. Nestle manufactures a wide variety of processed food products - milk products and nutrition, coffee, chocolates & confectioneries and prepared dishes & cooking aids .Company has a wide presence across India with its portfolio of strong brands (Nescafe, Maggi,Milkybar,Milo,KitKat,Bar-one,Milkmade,Nestea,Nestle Milk,Nestle Fresh 'n' Natural Dahi and NESTLE Jeera Raita.). The company is focused on growing its market share through renovation and innovation of its existing brands in India.

Nestle has reported topline growth of 26.4% with its net sales for the Q1CY08 at Rs 1090.9 crores as compared to Rs 863.08 crores in Q1CY07 on the back of continuous brand innovation strategy. The net profit stood at Rs 160.15 crores showing a strong growth of 47.7%. Company has improved over operating and PAT margins. Company also gets tax benefits in the quarter due to greater Maggi production at Pantnagar, Uttaranchal.

Investment Positives:

Nestle has the right set of product portfolio, strong brand image and excellent distribution network to sustain its growth momentum on the back of favorable demographics, growing urbanization and the transition to organized retail sector.

Nestle enjoys a big share in the growing Indian processed foods sector. Nestle can reap benefits from investments in organized retail and distribution infrastructure in India. With the continuous brand innovation and aggressive business strategy Nestle is on the way to get more market share in India to encash the coming opportunities in the space.

Multibagger stocks| Dhampur Sugar Mills Ltd. (DSML)

CMP: Rs 65.75 Target: Rs 110.00

DSML is holding sugar inventory of 2.3 lakh tonnes (97.0% of sugar production in 1HFY09) costing INR 18.9 per kg as of March 2009. We believe the company is expected to benefit materially due to low cost inventory and recent surge in sugar prices. We expect the company to make gross margin (sugar price - cane cost) of INR 5.5 per kg and INR 8.0 per kg of sugar sold in FY09E and FY10E respectively. We also expect EBITDA margins for the company to improve by 170 bps and 210 bps YoY in FY09E and FY10E respectively. Our understanding of sugar situation (global and domestic scenario) concludes that average sugar realisation for the company will increase to INR 21.6 per kg and INR 26.0 per kg in FY09E and FY10E respectively. We believe better sugar realisations together with high inventory will provide strong traction to the topline. We expect Net sales to grow at healthy 41.0 % in FY09E and 13.7 % in FY10E.

We expect shortage in sugar cane production to persist through SY10 even after accounting for 25.0 % increase in acreage, resulting in import of raw sugar to cover the shortfall. DSML has refining capacity of 1700 TPD and has contracted to import 1 lakh tonnes of raw sugar. We believe that the company will able to refine only 25000 tonnes of raw sugar in 2HFY09 and rest will be refined in FY10. As per our calculation, the company will add INR 53.8 million in FY09E and INR 217.9 million in FY10E to EBITDA through processing raw sugar.
DSML has increased its exportable power capacity by 33.0% YoY to 80 MW at the end of FY08. We expect gross power sales to increase by 3.2% and 4.7% to INR 535.8 million and INR 560.8 million in FY09E and FY10E respectively. The company plans to start power generation from coal in FY10 and is in negotiation with government for open power sale. We believe that concerns on highly leveraged balance sheet will subside by FY10 as debt will come to a more manageable level. The company doesn’t have any additional capex plan in FY10 and will generate substantial free cash flow for repayment of debt. We expect debt-equity ratio to decline from 2.0x in FY08 to 1.8x in FY09E and 1.3x in FY10E.

Valuations At CMP, DSML is trading at 3.7x FY10E earnings and 3.4x FY10E EV/EBITDA. Historically,
sugar companies have mostly traded in one year forward EV/EBITDA band of 4.0-7.0x. Our target EV/EBITDA multiple of 4.5x values DSML at INR 110. We rate the stock as BUY with potential upside of 58.0%. Our reasoning for using low valuation multiple to arrive at price target is due to our belief that sugar cycle will reverse post FY10.