Special Report

Eight For 2007

Even if you are the perennially optimistic investor who does not believe that the Indian growth story is anywhere near its conclusion, you have to admit that the bulls are running out of steam.

Even if you are the perennially optimistic investor who does not believe that the Indian growth story is anywhere near its conclusion, you have to admit that the bulls are running out of steam. Face it. We have already witnessed the demise of a broad-based rally when any and every stock moved up. The market has got much more discerning and volatile. And if you don't agree, just look at the numbers. In 2004, just over 400 stocks (out of the 2,000 odd traded on the BSE) ended the year in the red. That is just 20 per cent of the entire universe. The very next year, the number rose to 25 per cent as around 550 stocks (out of 2,200) closed with losses. In 2006, this jumped to 50 per cent. As many as 1,200 stocks out of the 2,400 traded on the BSE ended in the red. And this was despite the Sensex gaining over 40 per cent. Prune the list down to include only the stocks with a market cap of Rs 100 crore or more, and you will find that a significant 368 (out of 951) ended 2006 in the negative territory. We are not for a moment saying that the rally has ended. But what we are very clearly advocating is that to make money in the market, one will have to pinpoint the right themes and stocks. In this month's cover story, we present you with eight recommendations made by ICICI Direct. These stocks have not been picked with a top-down approach where first a sector is examined and then good buys within it are picked. Instead, these stocks have been selected by taking a bottom-up route which identifies good value picks. The stocks recommended by ICICI Direct are done so only after the company fulfils the strict internal benchmarks of value and growth. A quantitative model throws up investment opportunities, which is re-verified by company via management interaction followed by extensive business modelling factoring macro and company specific variables. You will notice a clear bias towards mid-caps in the recommendations. Because we believe that's where the value lies.

Banswara Syntex
Rajasthan-based Banswara Syntex (BSL) is among the integrated textile players manufacturing man-made, synthetic, blended, cotton yarn and garments. The company's products are exported to over 50 countries. Among the domestic brands, the company supplies to Provogue, Park Avenue, Arrow, Lifestyle, Westside and Pantaloon.

As part of its Rs 250-crore expansion drive, the company plans to increase its capacity from 92,032 spindles to 1,60,000 while increasing the number of looms from 143 to 207. The company is also looking forward to add capacities in value-added products. BSL, which was until now known only as a yarn manufacturer, is forward integrating into high-margin garment manufacturing. The garment manufacturing business is likely to drive the top line of the company. The company is increasing its garmenting capacity to 28,60,000 pieces per annum. The garment business is expected to grow at a CAGR of 147 per cent over FY06-FY08.

So far the company's profitability had been restrained due to the high cost of power. In an attempt to reduce the expenditure, the company is setting up its own power plant. The 18-mw thermal power plant is expected to be operational by February. The company's current power cost per unit is Rs 4.2. Post-commissioning, the cost is expected to come down significantly to Rs 2.8. The benefits of the lower power cost would start showing up in FY '08. The power cost is expected to decline to 6.8 per cent of net sales in FY 08. On its expanded capacity, the company expects to save around Rs 16.7 crore, thereby boosting bottom line significantly.

BSL has entered into a joint venture with France-based Carremen Michel Therry Group. The unit will manufacture high-value lycra-based designer fabrics. The joint venture will produce four million metres of fabric annually and the yarn for the project would be sourced from BSL. Being a preferred supplier, the deal will add to BSL's revenues and profitability. The company would also stand to gain on account of the technical expertise of Carreman. The joint venture will be using BSL's processing house thereby improving the revenue of the processing division. BSL's raw materials are based on the prices of crude. The recent decline in crude prices may also stand in good stead for the company. BSL faces tough competition from low-cost manufacturing Pakistan and Bangladesh.

Birla Power Solution
Birla Power Solution Ltd, formerly Birla Yamaha Ltd, is one of the leading manufacturers of gensets and inverters in India. It was incorporated in April 1984 as a joint venture between Tungabhadra Industries (Yash Birla Group) and Yamaha Motors of Japan. In 2002, the joint venture agreement came to an end and the Indian promoters acquired the entire holding of Yamaha Motors. Subsequently, the name of the company was changed to Birla Power Solutions Ltd. The company incurred losses continuously for a period of five years from 1989-1990 to 1993-1994 and it was referred to the BIFR. After a rehabilitation program, it came out of the purview of the BIFR in 1997-98.

It was the first company to manufacture portable generators in India in 1986. Currently, it manufactures wide range of generators catering to the power requirements of 500 w to 5.5 kw, and has a 32 per cent share of the domestic market. It is taking a series of steps which are expected to give a boost to its revenues and profits. Its foray into higher range engines and gensets, along with initiatives to expand capacity for inverters and lower the debt burden are expected to improve its financial performance. Entry into higher range KVA gensets would enable it to cater to high-value institutional customers as well as export demand. As a part of the restructuring initiatives, the company had raised Rs 50.4 crore through a follow-on public issue in March 2006 to augment capacities in key product segments such as portable gensets, inverters, multipurpose engines, alternators and fuel tanks. Apart from that, it is also introducing LPG and CNG-based gensets, which are fast gaining acceptance.

Moreover, the new facility at Dehra Dun would have excise and other tax benefits and would help the company price its product more competitively. The company is also expected to repay around Rs 27 crore of its Rs 70 crore debt by FY 2008, which will help it to reduce costs by Rs 3.44 crore per annum. The company is also taking other initiatives to increase its revenues. It has entered into a marketing and distribution tie-up with Kipor, a leading Chinese engine and genset manufacturer, to distribute its products in India. It also has a co-branding agreement with HPCL to sell gensets and irrigation pumps. As a result of these initiatives, the company's sales and operating profits are expected to grow at a CAGR of 34 per cent and 51 per cent, respectively through FY 2005-2008.

Granules India
Granules India started operations in April 1991 as an exporter of bulk drugs. Today, it manufactures several active pharmaceutical ingredients (APIs) and pharmaceutical formulations intermediates (PFIs).

For the uninitiated, API is the main ingredient in a formulation which cures the disease, and PFIs are pre-processed blends of APIs, ready to be compressed into tablets or to be filled in capsules. In the pharma value chain, APIs are processed to form PFIs, which are further processed to make the tablets/ capsules (also referred to as formulations) ready to be consumed by the patients.

Granules presently operates at the first two stages of this value chain, manufacturing APIs and PFIs. It is the world's third largest player in its business segment and the only one in the world to manufacture a number of multi product PFIs and combination PFIs. It has three manufacturing units located around Hyderabad, which have got approvals from US FDA, Australian TGA and German Health Authority. The company is set to become an integrated player with the commissioning of its tablet making plant in early 2007. Post expansion, Granules would move up the value chain (the plant is expected to become operational from May 2007), which will translate into higher revenues and margins.

The company is on an expansion path and has entered into an arrangement with PharmaMatch of Netherlands, to jointly develop, manufacture and market formulations in the European market. Under the arrangement PharmaMatch would transfer the existing marketing authorisations for products such as Paracetamol to Granules. Its strategy for the US market is also on course and it has already received its first ANDA approval for the anti diabetic- Metformin. ANDA (Abbre-viated New Drug Applications) is the copy of the original molecule in all respects, and does not require any clinical trials before its launch. Moreover, the company plans to shift its focus from OTC (over-the-counter) paracetamol to prescription drugs in the US. It currently generates around 40 per cent of its revenue from prescription drug-related PFIs, but post its forward integration, it would enter long-term agreements for 70 per cent of its PFI capacity. As realisations for PFIs related to prescription drug are at least 50 per cent higher than that in the OTC markets, this would give a further boost to its profits.

JK Cement
JK Cement is one of the leading grey cement manufacturers in northern region. It is also a major manufacturer of white cement in the country. It was formed following the de-merger of JK Synthetics in November 2004. JK Synthetics was involved in manufacturing man-made fibres and cement. However, it incurred heavy losses and subsequently, the cement division was de-merged. JK Cement has plants at two locations in Rajasthan- Nimbahera with three kilns and 2.8 million tonnes per annum (mtpa) capacity, and Mangrol with a capacity of 0.75 mtpa. Recently, the company expanded its grey cement capacity by 0.5 mtpa, increasing its installed capacity for grey cement to 4.05 mtpa.

Cement stocks are currently among the favourites of investment managers, since this sector has been the prime beneficiary of ongoing infrastructure boom in the economy. Moreover, the demand-supply mismatch has also landed cement manufacturers in a sweet spot. The sector outlook continues to be buoyant as demand from rising housing & construction activities will outstrip the supply. But apart from the macro variables, there are a few distinct advantages that make the case for JK Cement ahead of other cement companies. Firstly, the company is set to record a significant decline in operating costs, once its captive power plant is complete in April 2007. This is likely to translate into savings of Rs 76 crore during FY 2008, leading to a significant increase in operating margins. Secondly, white cement business accounts for 17 per cent of its revenues. This provides the company a lot more stability, because white cement demand is non-cyclical in nature and it sells at 2.5 times the price of grey cement.

Moreover, high barriers to entry in the white cement business, due to scarcity of quality limestone, are also in the company's interest. The company is attractively priced on the valuations front as well. On EV/tonne basis, JK Cement is quoting at $87.41 per tonne, which is quite low vis-à-vis its peers. In fact, some of the recent deals in this sector have happened at valuations as high as $150-$200 per tonne. The P/E multiple approach values JK Cement at Rs 293 per share, at an industry average P/E of 13.5x FY08E EPS. At the target price, the stock would be valued at an EV/tonne of $117, which is still at a considerable discount to the market.

PTC India
Alongside the shortage of power, Indian economy is also marked by periods of seasonal surplus in one region coinciding with periods of deficit in another. This presents opportunities to improve the efficiencies and better utilisation of resources by having a proper mechanism of power trading across regions. It is with objective that PTC India (formerly Power Trading Corporation of India Limited) was incorporated in 1999. The company is credited with pioneering the concept of power trading in India. It is a leading provider of power trading solutions. These include intermediation for the supply of power from identified domestic and cross-border power projects, providing equity support to select power projects, advisory services and foray into providing fuel linkages to power plants of various utilities/generators participating in the power market. Currently, it has a 72 per cent share of the power trading market. It started off as a short-term power trader (short-term contracts still account for 80 per cent of its traded volume), but it is diversifying into more stable long-term contracts with power producers and buyers. The company is aiming for a 50:50 ratio of short-term and long-term trades. This would add to the stability of revenues, mitigating volatility risk in short-term trading.

Moreover, it is expanding by trading in the excess power generated by many industries from their captive power plants. Out of the 20,000 MW of power generated through captive generation, around 50 per cent is unutilized.

PTC has also been identified as the nodal agency by the government for power trading with Bhutan and Nepal. Both countries have immense potential for hydro power and export surplus power to India. An increasing focus on high-growth, high-margin long-term trading should help it sustain growth and also improve margins. Using a discounted cash flow valuation methodology, ICICI Direct puts an intrinsic value of Rs 95 per share to the company.

The major concern here is any change in policy. The Central Electricity Regulation Commission, through its regulation, has capped trading margin to Rs 0.04 per unit for short-term trading. Any change in long-term margin could reduce the company's operating profit. Additionally, PTC may face increasing competition. There are 19 players with trading licenses, though only five are active, like NTPC Vidyut Nigam, Reliance Energy Trading and Tata Power Trading.

Shree Cements
The Indian cement industry is poised to grow at a compound annual growth rate of 10 per cent on the current boom in the housing and real estate and the thrust on infrastructure development and industrial projects.

Shree Cements (SCL) is the largest cement producer in Rajasthan with plants located at Beawar. The most cost-efficient cement company in north India has a installed capacity of 3.8 million tonnes. SCL plants enjoy huge locational advantage as they are in a position to cater to entire Rajasthan as well as Delhi and Haryana. SCL sells 90 per cent of its produce under Shree Ultra Cement brand in north India with Rajasthan accounting for 30 per cent market share, followed by Haryana (25 per cent), Delhi (19.5 per cent) and Punjab (11.5 per cent). SCL may witness strong growth in turnover due to the commissioning of new plants and firm trend in cement prices.

SCL has embarked on a huge capital expenditure programme for the next three years. The company recently commissioned a plant for additional capacity of 1.2 mtpa at a cost of Rs 450 crore. Another planned expansion will further enhance capacity by 1.2 mtpa, scheduled for commissioning by the second quarter of 2008. The company has also launched its new brand, Bangur Cement.

Cement demand in north India is projected to increase to 34.62 million tonnes in 2007-08. With no fresh capacity coming up until 2008, the northern region will remain cement deficient, as incremental demand will exceed incremental supply. Shree Cements can leverage its position given the supply-demand mismatch. As there has been no substantial capacity addition in the northern region for the past five years, most cement companies based in the north are already operating at over 95 per cent capacity. Net sales turnover of the company is likely to touch Rs 1,042.9 crore in FY07E and Rs 1,345 crore in FY08E. At present, Shree Cements has the highest EBIDTA margin in the industry, which is expected to show strong growth on account of favourable pricing environment in the northern region. As cement prices are likely to firm up by 10.71 per cent in 2007-08, a strong earnings growth will give further boost to the valuation of the company. Operating profits should rise to Rs 303 crore in 2006-07E and Rs 467 crore in 2007-08E. Tighter cost management and improved realisations will help the company boost operating margin levels.

Reliance Capital
Reliance Capital is India's leading financial services companies. With huge unrealised gains on its equity book, the company is sitting on a gold mine. The unrealised gains on quoted equity portfolio comes to around Rs 2,600 crore, which equals Rs 106 per share of Reliance Capital. There is also a significant value accretion from its subsidiaries. Its asset management business is second largest in India in terms of asset under management. The general and life insurance business is also expected to grow at a fast pace. The company is expected to foray into stock broking soon under Reliance Money brand.

Moreover, the company has agreed to acquire 100 per cent equity of Travelmate Services, which will mark its entry into the exciting growth area of money changing and money transfer.

Sangam India
Sangam is a Rajasthan-based textile conglomerate. It has one of the largest dyed yarn units in the country and is a leading manufacturer and expo-rter of suiting, flock fabrics and yarn from India.

The company is shoring up capacities and had recently ann-ounced to further increase its on-going expansions plans by Rs 167.40 crore, aggregating to Rs 707.40 crore. It has targeted December 2007 for the completion of this expansion plan. With the capacity expansion of PV yarn and PV fabrics, and its entry in cotton yarn, sales are ex-pected to record a CAGR of 46 per cent over FY06-FY08E. Profits are expected to surge at a CAGR of 54 per cent over the same period.

Moreover, in the post-quota scenario, it has increased its focus on the export market and its products are gaining global acceptance.

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