When debt is not a burden

Do not invest in companies merely because they have lots of cash. Instead select those that use the cash better

An economic a slowdown leads to falling demand. Rising interest cost to service the debt taken earlier either for capacity expansion or inorganic growth is the last thing that a company and an investor would want. So while many debt-heavy companies see their profitability erode during a downturn due to the high interest cost component on loans taken to fund capital-intensive grassroots projects or to finance acquisitions, companies with little or no debt have no such worry.

Low debt (or leverage) not only keeps a company's interest cost down, but also gives it flexibility to invest its cash back into the business to expand or develop new products. As debt-free companies are mostly cash-rich, they also do not need to raise large funds from the market to run their operations.

There are many other advantages that debt-free companies enjoy. For instance, debt-free company need not keep aside a portion of the profit to meet the cost of capital. They get interest on their cash deposited with banks, adding to their reserves. They have low interest-rate risk.

However, debtless companies have their share of disadvantages, too. It shows that the company is not proactive on expansion and, thus, would be left out on growth rates when the environment turns bullish. There would be lower chances of debt-free companies getting long-term debt at short notice during an emergency as the company will not have a sufficient debt history to boast.

A zero- or low-debt company, therefore, is not always worthy of investment. Investors have to look at many other factors. "Apart from debt, investors should look into the earning per share, financial history, prospects of the company in the coming years, the sector in which it is operating and last, but not the least, the price earning multiple of the share," says Alex Mathew Head of Research, Geojit Financial Services.

For instance, large IT companies like Infosys Technologies and TCS may not have interest-rate concerns. But their prospects would always be subject to other important factors including exchange rate fluctuations and economic conditions in the US and other major export markets. Not surprisingly, despite being zero-debt companies, IT companies are out of favour of the market at present.

Similarly, it is not always unwise to invest in companies with large amount of debt. Proper use of debt to build new capacities, purchase inventories and make strategic acquisitions in favourable market conditions bring better returns on equity. In most capital-intentive industries, not taking debt is not practical. Equity investors will not like to fund big projects entirely as this will bloat equity capital and reduce return. "Debt is a very small component in the valuation of a company," says Avinash Gupta, Assistant Vice President, Research-Equity, Bonanza Portfolio. "Valuation is largely based on the free cash generated over a period of time, which is the resultant of business potential and capital structure,"

Debt-laden companies can enjoy the benefits of expansion and have better chances of getting more debt as they have a debt history to show. Heavy debt companies, whose operational risk is not high, (i.e., continuity of revenue and profitability is visible) get higher return on equity capital invested.

Debt is good as long as the combined financial and operational risks tend to give right return. "It is wrong to paint debt-free and debt-laden companies with the same brush without looking at the specific business of the company," says Pankaj Chopra, CEO, Iden Investment Advisors. "In the current environment, it may appear that low debt is a good thing. But if the company maintains low debt even when interest rates are low and there is strong business visibility, then its competitive advantage would be lower than others who use low-cost debt more fruitfully."

Debt-laden companies, however, have the disadvantages of keeping some portion of the profit for payment of cost of capital. "The key is to have optimum debt-equity ratio to enhance return to equity shareholders and at the same time reduce balance sheet risk," says Manish Sonthalia, Senior Vice President, Research and Strategy, Motilal Oswal Financial Services. "Hence, it is not true that debt-free companies are always good for investment or debt-laden companies are bad investment choices."

Capital Market decided to study the stock performance of debt-free companies in relation to the BSE Sensex. A list of companies with zero debt was compiled. A further filter was applied to restrict the list to companies with a minimum market cap of Rs 1000 crore.

The list of debt-free companies were dominated by MNC associates, IT companies and PSU companies. They accounted for 71% of the sample. While 12 MNC companies featured in the list, there were seven PSUs and eight IT companies of the total 38 companies that met the criteria of zero debt/equity ratio companies with a minimum of Rs 1000-crore market cap.

Zero-debt MNC companies in the list included ABB, Siemens, GlaxoSmithkline Consumer Healthcare, Crisil, ICI (India), Gillette India, P&G Hygiene, Aventis Pharma, Pfizer, GlaxoSmithkline Pharma, Astrazeneca Pharma and 3M India.

Debt-free IT companies (including MNCs) comprised Infosys Technologies, TCS, Satyam Computer, Oracle Financial, MphasiS, Patni Computer, Info Edge (India) and Sterling Intl.

There were also quite a few debtless PSU companies. They were NMDC, National Aluminium, Container Corporation, Bharat Electron, MTNL, Engineers India and PTC India.

But not all debt-free companies in the list fared well on return. Some lost more, some lost less. But, on an average, debtless companies with Rs 1000 crore and more market cap performed exactly in line with the BSE Sensex, losing on an average 57% of the market cap as against 56% lost by the BSE Sensex between 1 January 2008 and 27 November 2008.

MNC and IT companies outperformed the market fall. The 13 MNC companies lost 55% of their market cap on an average. Market capitalisation of IT stocks shrank by 39% on an average. However, eight debt-free PSUs lost 68% of their value on an average.

Debt-free pharmaceutical companies (which were all MNCs) with a market cap of Rs 1000 crore and more lost 10% on an average. On the other hand, debt-free FMCG companies (which were incidentally all MNCs) shed 32%.

In comparison with the BSE's sectoral indices, the BSE FMCG sector lost just 21%, the Healthcare index 36%, and the BSE IT index 45%. On the other hand, the BSE PSU index shed 57%.

While debt-free MNC pharmaceutical and IT stocks with market cap of more than Rs 1000 crore outperformed both their sectoral indices and the BSE Sensex, debt-free PSU stocks with market cap of more than Rs 1000 crore underperformed both the BSE Sensex and BSE PSU index. MNC FMCG companies also underperformed. But that was due to the unprecedented rise in commodity prices, which have fallen massively of late.

The fact that debt-free PSUs with a market cap more than Rs 1000 crore lost on an average 68% compared with the 56% market-cap loss of the BSE Sensex means investors are not comfortable with PSUs in spite of being debt-free. "This implies that PSU managements do not have the drive/incentive to generate high return on equity (ROE)," says Pankaj Chopra, CEO, Iden Investment Advisors. "Remember, debt means risk and the managers of these companies just do not want to take on risk. There is no incentive for them to do so."

There is no rationale, however, for utility companies not to return shareholders' money and take on some debt. The key is management vision. The problem is lack of continuity of management in PSUs. So even if there are some who give it a vision, they tend to be replaced in a couple of years. So the vision is lost.

IT and MNC FMCG companies have low debt because of low requirement of capital, and high profit margin. They are also mostly in secular businesses, where growth is sustained out of the retained earning. Increased profitability and low capital lead to higher ROE/ return on capital employed (ROCE), resulting in higher P/E.

MNCs in India are funded by their parent companies. The MNC parent is likely to have taken debt to offer higher return to its own shareholders. Hence, there is no intention to leverage the Indian associate/subsidiary.

Non-pharmaceutical and non-FMCG MNCs (excluding MNC IT companies) such as ABB, Siemens, Crisil, ICI (India) and 3M India as a group lost a massive 68%. Individually, ABB lost 71% of its market capitalisation, Siemens 71%, while 3M India, Crisil and ICI (India) 57%, 34% and 30%, respectively. In comparison, the 38 debt-free companies with a minimum market cap of Rs 1000 crore cap lost 57% on an average.

Once market darlings ABB and Siemens have fallen much more than the market due to their relatively high valuation. Even their debt-free status could not help them. These companies cater to industrial demand. There are doubts whether their business growth will be as robust as the market was earlier expecting it to be. The market likes visibility in earning and stock prices are nothing but a reflection of future earning potential of a company. Stock prices start discounting two-three years of earning in advance. This is the reason that Siemens and ABB were quoting at very high P/Es earlier. When the visibility in earning reduces, as is happening now to both these companies (margin compression, low fresh order intake, low revenue growth), prices correct to reflect that change. This is regardless of the fact whether the company has high debt or no debt and has more to do with the changing business dynamics.

Though debt-free companies, on an average, have been market performers, the market seems to have taken the zero- or low-debt status positively when compared with highly leveraged companies. The market cap of the top 50 highly leveraged companies, i.e., the ones with high debt-equity ratio, fell 75% on an average, the market cap of the top 100 highly leveraged companies dropped 83%. The market cap of 322 companies with debt-equity ratio of 2 or more declined 76% on an average.

In the current scenario of high interest rates and slowdown in economy, debt-free companies offer a good avenue for investment. However, fund managers do not make investment decisions solely on the debt status of a company. Investment can be avoided in debt-free companies where growth conditions remain weak and despite net cash/low debt would not lead to any worthwhile appreciation in the stock price.

On the other hand, debt-laden high growth companies, with quality management and where prospects of earning are positive, should be assessed for investment.

Investment in these companies ought to be evaluated regularly as, in a period of downturn, these companies may incur lower earning/losses due to higher interest outgo. In certain cases, the company may also find the going difficult. This is reflected in lower share prices of these companies. 

Debt-free stocks that have outperformed the current bear phase are likely to be underperformers when the uptrend resumes. Majority of debt-free companies fall under the tags of Old Economy and defensive sectors. These stocks have lower betas (volatility), which are very close to 0.75 as against a bet of 1 taken for the broad market. In a falling market, the rate of fall will be substantially lower compared with other stocks. But in a bullish market, these stocks will rise only marginally.

Whether a debt-free or debt-laden company is a good investment bet depends on case-to-case basis. Investors need to see if the business environment of the company is good and warrants the debt it has taken, and if it will be able to refinance that debt. It is very much possible that a company that has debt is more attractive than another which does not have debt. But as the economy is slowing down, debt-free companies — MNC FMCG companies in particular —are good bets to keep volatility of the portfolio at bay.

India Cements - Value in the gloom

We have a negative view on the cement sector's earnings and pricing outlook, but we believe ICEM at its current valuation has priced in all the gloom. The stock is trading at 0.7x FY10F P/B and US$50 EV/mt (half replacement cost), which we see as cheap. We cut our earnings by 20-28% and our target price to Rs103.93. Buy. 

ICEM is exposed to the best cement market in India 
Demand growth ytd is 6.5% on an all-India basis, but 12% in the south. This has meant better pricing for ICEM, which achieved an EBITDA/mt of Rs1,227 in 1HFY09, vs Rs902 for Associated Cement. While capacity additions of 32mmt in the south through FY11F will outstrip our incremental demand forecast of 18mmt and cause pricing pressure, we expect the south to remain one of India's better markets. 

ICEM's expansions are fully funded 
In 2007, ICEM began investing Rs8.4bn to raise capacity in the south from 9.1mmt to 14.2mmt, a move now near completion. This was funded in part by a Rs3.2bn FCCB (May 2011 redemption). The company also began spending Rs14.5bn on two greenfield cement plants in the north, which would raise overall capacity to 18mmt. In December, it raised Rs5.9bn via an equity raising to fund this programme. ICEM has since put one of the greenfield plants (costing Rs6.5bn) on hold, so we believe it should be able to meet all its planned capex to raise capacity now to 16mmt without incremental leverage. We forecast its current debt/equity ratio of 70% will fall to 27% by FY11. 

We see an industry surplus for the next two years 
We downgrade our demand expectation to 6.5% for FY09 and 8% for the FY10-11, due to the slowdown we have already seen on the back of the global credit crisis and reduced activity levels in real estate and construction. While the commissioning of a few cement plants has been delayed, we reckon more than 90% of the announced projects will still be commissioned causing a surplus for the next two years at least. 

We cut our earnings sharply, but maintain Buy 
We lower our FY09-10F volumes by a total of 1.5mmt to 10mmt and 11.5mmt and cut our FY09-10F EPS 20-28% to account for lower cement and coal prices. We value ICEM at a 10% discount to the end-2009 EV/EBITDA valuations of ACC and Ambuja Cement given its focus on the south and higher leverage, giving us a fair value and target price of Rs103.9. Even so, we see ICEM as cheap at current valuations. Buy. 

Associated Cement - A long winter ahead?

ACC seems financially well placed with moderate expansion plans, but we believe its earnings outlook has weakened, given the industry is likely to see excess supply for at least two years, which would lower cement prices. We cut our EPS estimates and downgrade to Sell. 

We see higher earnings risk for the next two years 
FY09F cement demand growth ytd (6.6%) is below our expectations, due, we believe, to the stress in credit markets and delays in capex in many sectors. Hence, we lower our demand estimate for FY10 and FY11 by 200bp each to 8%, which exposes the industry much longer to larger surplus supply. The commissioning of a few cement projects has been delayed, but, with rapid progress at most projects, we expect capacity addition of around 89mmt until FY11, with incremental demand in this period being just 46.3mmt. We believe this will put pressure on prices. 

We expect the current cement downcycle to be shorter than the last 
In the 10 years after ACC's earnings peak in FY96, there were eight difficult years and two good ones. We expect the current earnings downcycle to last until FY11, given better consolidation in the sector (the top five groups now control more than 60% of the market), a large share of capacity is being added by existing players and that we see scope for more consolidation. 

ACC seems financially better positioned to handle this downturn 
Restructuring over the last five years has seen ACC exit many non-core businesses (refractory). The company, which had high gearing in the last business cycle (1997-2003), now seems in a much stronger financial position. We estimate it would have a debt-equity ratio of just 7% even after financing its entire planned capex of Rs37bn over the next three years. This capex would raise it capacity by 9.6%, just slightly ahead of the expected demand growth. 

We cut earnings sharply, and downgrade Sell 
We lower our FY09-11F cement volumes due to macro factors, and also adjust EBITDA to factor in lower cement and coal prices. We cut our EPS estimate by 11-12%, and lower our DCF-based target price to Rs369.9. ACC looks cheap, trading at a cement EV/mmt of US$61 (vs replacement cost of US$110), but we see more downside to earnings, given the overhang of excess supply. 

For all Warren Buffet Fans

A version of this article appeared in print on October 17, 2008, on page A33 of the New York edition.

Buy American. I Am By Warren E. Buffett

The financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be
scary.

So ... I've been buying American stocks. This is my personal account I'm talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.

Why?

A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation's many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.

Let me be clear on one point: I can't predict the short-term movements of the stock market. I haven't the faintest idea as to whether stocks will be higher or lower a month - or a year - from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.

A little history here: During the Depression, the Dow hit its low, 41, on July 8, 1932 . Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor's best friend. It lets you buy a slice of America's future at a marked-down price.

Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.

You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy.

Today people who hold cash equivalents feel comfortable. They shouldn't. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.

Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky's advice: "I skate to where the puck is going to be, not to where it has been."

I don't like to opine on the stock market, and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I'll follow the lead of a restaurant that opened in an empty bank building and then advertised: "Put your mouth where your money was."

Today my money and my mouth both say equities.

Grasim Industries - Earnings outlook deteriorates

Grasim's ongoing capex should raise its cement capacity by 59%, but the underlying demand outlook has weakened. We expect just 75-80% utilisation in both its VSF and cement businesses, as well as margin pressure. We cut our FY09-11F earnings by 6-37%, and downgrade to Sell.

Grasim to capitalise Rs110bn of assets in the next few months
Grasim says it plans to raise its cement capacity by 18.1mmt to 48.8mmt in the next few months by commissioning capacity in three greenfield locations. However, this comes as the outlook for industry demand growth has weakened due to the ongoing global financial crisis and consequent capex slowdown in many sectors. The slowing of textile exports has weakened the volume outlook even at Grasim's viscose staple fibre (VSF) business, where the company recently raised capacity to 334,000mt per year (from 270,000mt). We expect Grasim's capital-related costs to rise, straining profits.

We see cement oversupply persisting for more than two years
We have lowered our FY09-10 demand growth expectation from 9-10% to 7-8%. FY09 trends, so far, indicate growth of just 6.5%. We expect incremental cement capacity addition of 89mmt till FY11 vs incremental demand growth of just 46.3mmt, which, we believe, will put pressure on prices in FY10 and FY11.

VSF earnings could stabilise after the sharp fall in FY09F
The VSF business, which competes with polyester staple fibre and cotton, has faced slowing volumes due to weak global textile demand. Prices of sulphur, a key raw material, have fallen from US$850 in June 2008 to US$85 currently, reducing overall VSF costs by 12%. However, the recent weakness in both cotton and PSF prices will force Grasim to reduce VSF prices as well. We expect VSF EBITDA to fall 49% in FY09, although they should recover gradually from there on.

We cut earnings sharply, downgrade to Sell
We have reduced our FY09-11 cement volume forecast due to macro factors, and adjusted EBITDA to factor in lower cement and coal prices. We have cut our FY09-11F EPS by 6-37% and lowered our DCF-based target price to Rs919. Trading at 0.8x FY09F book and at an EV/mmt of US$66 (vs replacement cost of US$110) on cement, Grasim looks cheap, but we see more downside risk to earnings in next two years, given the large capacity creations.

Jyoti Structures Limited - 2QFY09 update

JSL’s 2QFY09 numbers were inline with our estimates. Top line grew by 32% yoy to Rs4.2bn & bottom line growth of 18.5% yoy to Rs201mn. EBITDA margin stood at 11.9% down 61bps yoy. The recent correction in the stock price has brought the stock in to value zone where it trades at less then 4.4x its FY10F consolidated EPS. We are revising our target price downward by cutting the target PE multiple from 12x to 7x on account of challenging macroeconomic environment. We maintain BUY.

.. JSL’s 1QFY09 sales were in line with expectation, Sales at Rs4.21bn up 32.3% yoy (expected Rs4.26bn). EBITDA margins stood at 11.9% down by 61bps yoy (11.8%) on account of raw material cost up 40% yoy at 67% vs 63.3% in 2QFY08 & staff cost up 39.6% yoy at 3% vs 2.8% in 2QFY08. However other expense was up only by 12.1% yoy at 18.1% vs 21.3% in 2QFY08. Interest expense stood at Rs174.3mn up 64% yoy (Rs160.6mn). However PAT was marginally above our expectation at Rs201.1mn up 18.5% yoy (Rs197.8mn) due to lower tax provisioning at 35.6% (39.1%).

.. Order book stood at Rs36bn. The order book consists of 60% from transmission line, 20% from substation & remaining 20% from rural electrification. Domestic orders were worth 85% of the total order book while the remaining 15% consist of exports & deemed exports. Management expects ~Rs58bn (Rs30bn in transmission line, Rs6bn in rural electrification & another Rs21bn in substation) domestic jobs to be put for tendering in next couple of months. They also indicated to bid for Rs7-8bn worth of international orders.

.. We keep our forecast intact however revise downward our target price on account of challenging macroeconomic environment. We cut our target PE multiple from 12x to 7x. Planned expenditure on T&D in the 11th five year plan & current order book provides visibility on account of revenue going forward. We retain our positive outlook on the company & maintain BUY. At CMP of Rs63, JSL is trading at 5.5x FY09F consolidated EPS of Rs11.3 & 4.4x FY10E consolidated EPS of Rs14.1. Higher order winning could likely see a re-rating in the stock. The key risk for the stock would be further margin pressure due to higher raw material price, higher interest cost and high institutional holding.

Maruti Suzuki India - Small car for the long haul

Maruti looks well placed to recover from its weak Sep 08 quarter results with the help of product launches amid easing commodity and fuel prices. We trim our EPS estimates, factoring in a gradual recovery in the demand, but maintain our Buy rating.

September 2008 results: EBITDA margins hit a new low
Maruti's Sep 2008 results disappointed us, with EBITDA margin 8% lower than we expected due to higher manufacturing and other expenses. Still, an improving product mix extended the sharp rise in realisation per vehicle. The discrepancies between our expectations and the results include the impact of currency fluctuations on imports and higher power and promotion expenses.

New product launches to limit the impact of weak demand
Maruti's new product launches in the coming quarters should help limit the impact of weak demand. We expect any recovery in car demand to be gradual, especially in an environment of job insecurity, pay cuts in the private sector and limited vehicle finance availability. Maruti's focused efforts to convert government employees' sixth-pay-commission benefits into car purchases should offer some relief. We trim our domestic sales volume estimates 3-6% for FY09-10F to reflect a 7% CAGR in domestic volume. We maintain our export targets, however.

Easing commodity prices to boost profitability in the coming quarters
We expect EBITDA margins to bottom near Sep 2008 levels as new product launches in the compact segment help reduce promotion expenses, and easing commodity prices support profitability. However, factoring in our concerns about domestic volumes, we trim EPS 5% for FY09-11F. We expect a higher yield on the company's Rs52bn investment book to help limit the impact of margin pressure.

We maintain our Buy rating
Maruti looks well placed to weather these turbulent times given its cash-rich balance sheet, and new expanded capacity to support new products and engine series for both the domestic and export markets. We expect competition from international car majors to ease, especially in capacity build and new product launches. On our revised EPS estimates, Maruti trades at the low end of its historical forward PE band, at 10.5x FY09F. We lower our target price to Rs750 to reflect our EPS changes. It remains our top pick in the Indian auto sector.

Dabur India

A diversified product portfolio with known brands will keep it on steady growth path

Dabur India is the fourth largest fast moving consumer goods (FMCG) company in India, with presence in health care, personal care and food products in various categories such as hair oils, shampoos, toothpaste, health supplements (glucose, chyawanprash), baby and skin care, insect repellants, fruit juices, and ayurvedic tonics. It has powerful brands like Dabur Amla, Dabur Chyawanprash, Dabur Honey, Vatika, Hajmola and Real. Manufacturing locations are across India and abroad. The company also has an international business division.

Consolidated net sales grew 16% to Rs 2361.07 crore in the year ended March 2008 (FY 2008) compared with Rs 2043.14 crore in FY 2007. In the haircare category, hair oils sales rose 13%, led by Dabur Amla, which grew 18% in FY 2008. The shampoo category, too, continued its strong performance, with sales increasing 25%. Dabur has now expanded its haircare offering with the introduction of a new Vatika Black Shine shampoo variant besides entering the conditioner market with two variants under the Vatika brand.

Dabur’s toothpaste sales, led by Babool, Dabur Red and Meswak, spurted 27% in FY 2008 and FY 2007 — much ahead of the industry growth of 14%. The company has also expanded its oralcare portfolio with the introduction of the Babool Neem variant in the fiscal.

Revenue of the health supplement business moved up, while the foods business grew 19% in FY 2008. Dabur India has revamped and relaunched 60% of the consumercare division product portfolio, laying the foundation for a stronger future growth. The consumerhealth division also marked a turnaround, with sales spurting 12% in the second half of FY 2008 and 5% in the entire financial year.

Overseas sales also recorded significant gains, surging 26% in FY 2008, with strong performances across most focus markets. Sales in the Gulf Co-operation Council (GCC) region increased 33%, led by new product launches, while Dabur Egypt’s sales soared a robust 49%.

Operating profit margin (OPM) increased 20 basis points (bps) to 17.3%. Strong growth in key categories coupled with stringent cost-saving initiatives helped Dabur India to mitigate the impact of escalating costs. Operating profit grew 17% to Rs 409.33 crore, profit before tax 20% to Rs 384.44 crore, and net profit after minority interest 18% to Rs 332.94 crore.

Dabur India is seeing high growth in the fruit-drink segment in addition to the fruit-juice segment as consumers are shifting from aerated waters to fruit drinks. The company plans to emphasise fruit drinks, going forward, after giving its current product Twist a new identity. The integration of foods into the consumercare division will help in the next big emphasis on fruit drinks.

Besides rolling out the Gulabari skin-care range across India and launching ayurvedskin care, Dabur India will unveil juice variants at different price points, and re-launch Meswak.

The other key development in FY 2008 will be Dabur India’s foray into retail through its subsidiary company H&B Stores. The subsidiary plans to grow rapidly and mark its presence across India by opening around 30 new stores by end FY 2009. Initially, the business will be in an investment phase, but will start generating returns as it attains a certain size and increases its footprint. Investments in retail resulted in a minor negative impact on consolidated net profit in FY 2008, and will continue to have such an impact over the next couple of years.

We expect Dabur India to register consolidated sales and net profit after minority interest of Rs 2720.29 crore and Rs 380.48 crore, respectively, in FY 2009. On an equity of Rs 86.50 crore and face value of Re 1 per share, EPS works out to Rs 4.5. The share price trades at Rs 72. P/E is 16.

Wyeth

Continues to expand in line with the steady growth in the domestic pharmaceutical industry

Wyeth is a 51.12% subsidiary of the US$ 22.4-billion Wyeth, US, a leading player in the pharmaceutical, consumer healthcare and animal health products. Three companies — Wyeth Laboratories, John Wyeth (India) and Wyeth (India) Pvt Ltd — were amalgamated with Cyanamid India and the combined entity was named Wyeth Lederle on 1 January 1998. Effective 1 April 2003, Geoffrey Manners & Company was merged with Wyeth Lederle and the name of the company was changed to Wyeth.

In India, Wyeth is a market leader in oral contraceptives, folic acid and depilatory cream. The company has many established brand names in the formulations segments of anti-infectives, gynaecologicals, corticosteroids and tranquilisers. Some of the prominent brand names include Wymox (antibiotic), Wysolone (corticosteroid), Ultragin (analgesic) and Ovaral (contraceptive).

Pioneering several new therapies in India, Wyeth was the first to launch hormone therapy and vaccines against HIB and invasive pneumococcal disease. Enbrel, a breakthrough treatment for rheumatoid arthritis; Rapamune, an immuno suppressant for prevention of rejection after renal transplant; Prevenar, a pneumococcal conjugate vaccine; and Tygacil, the world’s first glycilcycline antibiotic, are among the internationally known products launched by Wyeth in India.

One new product has been unveiled every year since FY 2007 and plans are on to launch one new product in the financial year ended March 2009 (FY 2009), too. Tygacil, a hospital injectable antibiotic for life threatening infections such as complicated intra-abdominal infections and complicated skin and skin structure infections, was launched in 2008. The products launched in the last couple of years have achieved good growth. Enbrel, a breakthrough treatment for rheumatoid arthritis and psoriasis, grew 65% FY 2008. Revenue from Prevenar, a vaccine for invasive pneumococcal disease, rose 222% in FY 2008.

Wyeth’s consumer healthcare division recently introduced an extension of its product Anne French in the form of 25-gm tube pack. This initiative has been well received by consumers and the trade. To enhance the brand image of Anne French, leading film star Kareena Kapoor has been signed on as brand ambassador.

As with demands made on many other pharmaceutical companies, the government of India asked from Wyeth Rs 59.08 crore (inclusive of total interest of Rs 42.06 crore) up to 31 March, 2008 under the Drugs Prices Control Order (DPCO), 1979. The company feels the ultimate liability would not exceed the amount already provided in the accounts.

Wyeth’s sales grew 15% to Rs 331.32 crore in FY 2008 in line with market growth of 14.84%. The Indian retail pharmaceutical market, valued at Rs 32095.75 crore, expanded 14.84% in FY 2008 (source: IMS MAT, March, 2008), and is expected to advance 12%-14% in the coming years on growth in rural areas and health insurance.

Sales grew 21% to Rs 105.83 crore in the quarter ended September 2008. Operating profit margin (OPM) was steady at 41.1% as against 41.6% in the quarter ended September 2007, taking the operating profit (OP) up 20% to Rs 43.46 crore. Profit before tax (PBT) spurted 20% to Rs 46.69 crore, and net profit 25% to Rs 33.83 crore.

Sales were up 15% to Rs 200.843 crore in the six months ended September 2008 over the same period of the previous year. OPM jumped 39.4% (39%), pushing up OP 17% to Rs 79.12 crore. PBT increased 14% to Rs 85.29 crore, and net profit 17% to Rs 60.38 crore.

Wyeth continues to invest in all the key brands to increase sales and also takes initiatives to reduce cost to improve profitability. Currently, its top 10 products contribute 50%-55% of the total revenue. Around 8% of the products come under the DPCO.

In the last few years, Wyeth’s growth was hurt as it rationalised major products and discontinued some that did not have a future. The company has no major pending discontinuation now.

We expect Wyeth to register sales and net profit of Rs 386.48 crore and Rs 94.99 crore, respectively, in FY 2009. EPS works out to Rs 41.8. The company has paid dividend of Rs 30 per share since the last two years. The share price trades at Rs 370. P/E works out to just 8.8 and dividend yield an attractive 8.2%

Axis Bank

Axis Bank's performance in 2Q09 has laid to rest concerns about whether the bank can pursue growth without sacrificing NIMs, asset quality and profitability. The disclosure of SME loan rating and growth in fee income is particularly pleasing, in our view. Buy, with a new target price of Rs769.10. 

NIMs and profitability improve; asset quality holds up 

Axis Bank’s 2Q09 net interest margins increased both yoy and qoq. We believe asset quality remains good, with GNPLs at 0.9% and NNPLs at 0.4%. Loans grew 54% yoy. About 84% of corporate loans have a rating of 'A' and above. Further, about 78% of SME loans have a rating of 'SME3' (equivalent to an 'A' rating) and above. In addition, profitability in terms of return on average assets improved to 1.34% in 2Q09, from 1.10% in 2Q08. 

Fee income growth continues to surprise positively 

Fee income jumped 91% yoy in 2Q09. Fees from retail banking, corporate and SME loans, capital markets and treasury grew strongly. Cash management throughput increased 350% yoy and placements and syndications grew 52% yoy. Fees from the cards business and from the distribution of third-party products showed robust traction. 

We raise FY09 and FY10 estimates and introduce FY11 numbers 

The bank’s reported NIMs were largely in line with our estimates, and the momentum on fee income should be sustained. We now expect non-interest income to grow about 53% in FY09 (+76% yoy in 1H09), compared to our earlier estimate of 20%. However, we increase provision charges for loan losses, offsetting the impact of higher non-interest income growth. We raise our net profit estimates by 11.7% for FY09 and 7.8% for FY10. We expect profits to moderate in FY11 and grow 16.5% yoy. 

We reiterate Buy with a new EVA-based target price of Rs769.10 

We reiterate Buy, as we believe Axis Bank will be able to maintain profitability and sustain aboveindustry average growth. Our assumptions for cost of equity and terminal spread remain unchanged. However, we have reduced our terminal growth assumption to 3%, from 5%. Accordingly, we cut our target price to Rs769.10 (from Rs791.90). At our target, the stock would trade at 2.5x FY10F BVPS, adjusted for 100% of pre-tax net NPLs.

Tata Consultancy - TCS acquires Citigroup's BPO arm

TCS has announced the acquisition of Citigroup Global Services (CGS), the captive BPO arm of Citigroup, for US$505m in an all-cash deal. As part of the deal, TCS gets assured process outsourcing business of US$2.5bn over 9.5 years. This is in addition to TCS's existing relationship with Citigroup for application development and maintenance, and infrastructure support services, currently at an annual run-rate of US$150m. We estimate the acquired business makes Citigroup TCS's top account. We view the transaction to be near-term EPS neutral. We estimate the transaction values CGS at 8.6x FY09F EBITDA, ahead of the current valuation of Genpact, the closest comparable (7x CY08F EBITDA, as per IBES consensus) and in line with 9x FY09F EBITDA for TCS at current levels. 

TCS acquires Citigroup Global Services for US$505m 

We estimate the transaction values CGS at 1.9x FY09F revenues or 8.6x FY09F EBITDA. According to management, CGS is projected to have revenues of US$278m for CY08 with about a 30% CAGR over the last three years. As part of the deal, TCS get assured “take-orpay” business at the current run-rate – translating to US$2.5bn – over 9.5 years. It also becomes the preferred vendor for incremental process outsourcing work from Citigroup. 

We rate the transaction as EPS neutral in near term… 

TCS aims to fund the transaction with internal cash reserves. We estimate the return on purchase consideration at 8.7% (assuming EBIT margins at 20%, 0 other income and effective tax rate at 18% for CGS for FY09), in line with the current effective post-tax yield on cash balance of about 8%. The transaction should thus be EPS neutral in the near term. Management expects it to turn EPS accretive over the next three years. We believe this would depend on incremental revenue flow; we see limited margin expansion potential, given CGS’s current margins (23.5%) are comparable to TCS’s (25.5% for FY08). Note, about 30% of revenues for CGS are from Citi’s India operations. 

HCL Infosystems - Opportunity in scepticism

A lull in consumer demand and a 17% fall in the rupee in the last six months pose near-term challenges. However, SI order booking is ahead of our expectations and the recent stock price correction provides an attractive entry point, in our view. 

Near-term pain in the core PC business 

Recent industry data shows PC shipments slowed to single-digit yoy growth in the June 08 quarter, as rising inflation and high interest rates hit consumer demand. Rupee depreciation also put a significant burden on margins, while competition in the commercial PC segment has weakened pricing power. However, some of this impact could be mitigated by down-trading from notebooks to desktops, given HCLI's traditional strength in the latter segment. We reduce our EBITDA margin estimate for the segment by 136bp for FY09 to factor in the rupee depreciation. 

SI order wins are a bright spot, execution is now the key 

HCLI announced cumulative System Integration (SI) order booking of Rs1.2bn for April-August 08. These order wins replenished the current order book, which was substantially executable over FY09. Execution is still the key, given the lumpiness of project revenues. We expect new orders to drive 27% growth in SI revenues in FY09, though we expect revenues to remain volatile on a quarterly basis. 

Reselling business stable, rupee depreciation could mitigate ASP decline 

GSM subscriber additions trended up in the past 12 months, taking account of monthly volatility. We expect current momentum in subscriber additions to be sustained in the medium term, with the likely entry of 4-6 new/crossover players in several circles. The depreciation of the rupee over the last three months could help mitigate the decline in ASPs in the near term. However, we could see some near-term pressure on the segment's margins, given the high margin office automation business depends on corporate capital expenditure levels. 

Valuations look attractive, we expect dividends to be sustained 

We cut our FY09-11F EPS by 20-24% on the back of the slowdown in the PC business and rupee depreciation. We expect near-term financial performance to be slowed by these headwinds. Nevertheless, at 5.6x FY09F EPS, valuations appear attractive both historically and relative to peer group. Our base and stress cases indicate adequate room to sustain the present dividend payout in FY09, implying a 7.7% yield. Buy with a DCF-based target price of Rs157 (down from Rs266). 

Bharati Shipyard - Too much pessimism

Bharati Shipyard has a current order book of US$975m, tied up funding for two new yards and procured 90% of its steel requirement. Therefore, execution will generate profits. We estimate 20% order book growth for FY09. Maintaining Buy. 

Execution of order will lead to profit growth 

Bharati is setting up two greenfield yards for US$250m, which it hopes to complete by December 2010, to execute its US$975m order book, which is also due to be largely executed by December 2010. Yard funding has been tied up at 0.8x debt:equity, with about 80% of debt having been drawn already. We believe the balance debt will not be required for another 12 months. Assuming execution completes by FY11, we estimate a 25% FY08-11 earnings CAGR. 

But what about order book growth, steel prices and subsidy 

Ytd, Bharati has received new orders of US$68m, which is lower than our expectation. That said, order flow can be lumpy and we expect additional new orders of US$125m in FY09 (20% order book growth). Further, 68% of order book is from the offshore oilfield sector, which is unlikely to face cancellation risk. Bharati has also procured 90% of its steel requirement, which should protect margins from steel price volatility. But we cut EBITDA margins from 20.4% in FY08 to 17% by FY10F. About 65% of the order book is eligible for subsidy as orders were received before August 2007. Thus, Bharati is entitled to subsidy on execution of orders through FY11. That said, the stock is trading ex-subsidy, in our view. We estimate ex-subsidy EPS of Rs32.6 for FY09, Rs42.5 for FY10 and Rs66.1 for FY11. The stock has recently seen a sell-off on concerns of a change in the MD's commission from 0.5% of profit to the lower of 0.15% of revenue or 1.5% of profit. This should have only 1% impact on FY09F PAT. 

Going very cheap, in our view 

We cut FY09-11F EPS by 15-45%, but estimate a 25% earnings CAGR over FY08-11. The earnings revisions reflect cut in revenue and margin estimates. Based on three-year forward RoE of 22% and CoE of 15.5%, we get a target FY11F P/B of 1.4x (vs 1.7x earlier), which we discount (8.5%) back to FY09F, resulting in a target price of Rs455 (Rs700 previously). On Bloomberg consensus estimates, global shipyards are trading on 4.4x EV/EBITDA and 5.4x PE on three-year forward earnings, while Bharati Shipyard is trading at a deep discount of 2.6x EV/EBITDA and 2.4x PE. We maintain our Buy rating.

Hikal

Ideally poised to capitalise on the increasing opportunities in global outsourcing of key crop protection chemicals and pharma intermediates by MNCs

Established in 1988, Hikal collaborates with innovator companies and offer solutions in contract research, custom synthesis and custom manufacturing. Broadly, the company manufactures bulk agro technicals (crop protection), active pharmaceutical ingredients (APIs) and intermediates.

In 2008, there were many measures taken by Hikal to remove low-margin agrochemicals from its portfolio. As a result, the crop protection business grew only 9% as against the 56% growth of the pharmaceutical division. Pharma sales, therefore, overtook sales of agrochemicals. The share of the pharma division in total sales stood at 50.2% as against 49.8% of the crop protection business in the year ending March 2008 (FY 2008).

In the crop protection business, sales of Thiabendazole to Syngenta, Switzerland, constitutes around 40% of the total agrochemical division sales. Syngenta is expanding and Hikal expects the sales of Thiabendazole to remain at least steady, if not buoyant, going forward. Many products in the crop-protection market are becoming offpatent in the coming years and Hikal has taken necessary steps including expansion of production capabilities to cater to the demand. It is in talks with two such players and will make an announcement. Contribution from the Syngenta group to the agrochemical division is expected to reduce to 25% in 2010-11 because of new products and new clients.

Hikal to bag outsourcing orders for won a big order of manufacturing (outsourcing) patented products from Bayer Corporation. This is a big achievement because it is the only company that will manufacture a patented product whose intellectual property (IP) is still with Bayer. This opens up opportunity to bag outsourcing orders for patented products, where margin is high and competition is very low. The production of the product will start from Q4 of FY 2009.

The shortage of capacities facing western agrochemical companies due to the increase in demand across the entire product chain, particularly active ingredients and select intermediates, has created the necessity for outsourcing. Hikal, with its expanded facilities, is poised to capitalise on these opportunities. The drive towards ethanol for fuel has farmers planting more corn making the farm land more valuable, increasing the value of crops and creating a wider use for crop protection products.

China, the main supplier of crop protection intermediates and actives, has been witnessing changes in export subsidies and strengthening of its currency, the renminbi (RMB), leading to product prices going up significantly. This is an advantage for Indian companies like Hikal to supply crop protection products.

The pharmaceutical division had a rough ride in 2005-2007, when the generic market collapsed and price erosion was severe. It is at this moment that Hikal decided to secure orders to manufacture patented products and rationalise its product stream. The pharma division is now expecting stupendous growth and is very optimistic about contract research and manufacturing services (CRAMS). The company wants to establish itself as among the top companies in the would in the CRAMS business.

Hikal has signed long-term supply agreements with Pfizer and Alpharma to supply API and intermediates. It invested to enhance the capacities of its existing facilities in FY 2008, and is further increasing these capacities substantially. Supplies of products to Pfizer has already commenced. The company is now looking to expand its customer base in the US., Europe, South America and the Far East. The manufacture of two new products is currently under validation by its prospective customers and is ready for commercial production at its US Food and Drug Administration (FDA)-approved facility.

Hikal plans to allot 13,60,000 equity shares to International Finance Corporation at Rs 474 a share, raising Rs 64.46 crore. After this allotment, the equity capital will rise to Rs 16.44 crore. The company still has foreign currency convertible bonds (FCCBs) pending conversion at Rs 745 by October 2010, which will dilute equity by a further Rs 0.72 crore if all FCCBs are converted.

We expect Hikal to register EPS of Rs 36.2 on equity of Rs 16.44 in FY 2009. The share price trades at Rs 459. P/E works out to 12.7.

Thermax

To regain growth from next year after consolidation in the current year

Thermax is a global solutions provider in energy and environment engineering. It offers products and services in heating, cooling, waste heat recovery, captive power, water treatment and recycling, waste management and performance chemicals. The company exports across the globe and recently opened manufacturing operations in China.

The order backlog of the Thermax group stood at Rs 2637 crore end March 2008 compared with Rs 3100 crore in the corresponding period of the previous year. Order intake in the first three quarters of the year ending March 2008 (FY 2008) slowed down, especially in the captive power segment, which was affected by combination of factors such as higher global coal prices, restriction on captive coal linkages for captive power plants with capacity less than 25 MW, and lower grid prices. However, order intake in the fourth quarter of FY 2008 picked up momentum. The order intake of the Thermax group was up by 12% to 731 crore in Q4 FY 2008 and that of Thermax standalone 9.2% to Rs 710 crore compared with the corresponding period a year ago.

The order intake picked up further in the first quarter of FY 2009. Order intake was higher by 46% in the quarter compared with Q1 of FY 2008. Order booking for Thermax standalone was Rs 914 crore in the first quarter. The share of energy was Rs 740 crore and that of environment Rs 117 crore. The consolidated order intake was Rs 964.4 crore, of which the share of energy was Rs 791 crore and that of environment Rs 174 crore. The company’s orders on hand were Rs 2649 crore end June 2008 compared with Rs 2435 crore at the beginning of the financial year.

Hikal received two major orders in the quarter ending September 2008. Its orders in the current quarter included an order of Rs 410 crore from a leading steel maker for setting up a captive power plant for its upcoming blast furnace complex on an engineering, procurement and contract (EPC) basis. It received another huge order from a major refinery to supply pulverised coal fired boilers for their captive cogeneration plant. This order is worth Rs 820 crore and is the single largest order ever for the company. On inclusion of the above two orders, the second quarter will show a strong sequential growth in order inflow and order backlog.

Soaring prices of conventional fuels used for running Diesel Generator (DG) sets, high cost of power supplied by state electricity boards and a favorable policy environment have prompted power-intensive industries to opt for captive generation. Huge shortage in the power industry and capacity expansion across industries will also drive demand for captive power plants, which are more economical and a reliable source of power. Thermax is well placed to leverage on the strong growth in the industry considering its proven technology to generate power from nearly 60 different kinds of fuels (like agri-waste and coal). It is a leading player in the captive power generation systems and undertakes EPC contracts for up to 135 MW power plants.

In the services segment, Thermax provides facility energy management services (FEMS), which basically conducts energy audits for process industries as mandated by the Bureau of Energy Efficiency. In addition to this, Thermax is also targeting the operations and maintenance (O&M) services for its captive and cogen plants. This segment is a recent addition to the portfolio. There is a huge potential for O&M services of power plants as the strategy enables clients to focus on their core business.

Thermax has entered into a 15-year agreement with Babcock & Wilcox Power Generation Group to manufacture and supply utility boilers up to 800 MW. Currently, Bhel is the only major utility power generating equipment maker in the country with a 65% market share. However, in the next few years, there would emerge three-four players including Thermax in the power generating equipment sector in India.

We expect Thermax to register EPS of Rs 26.5 in FY 2009. This is likely to rise to Rs 35.4 in FY 2010. The share price trades at Rs 416. P/E works out to just 11.7.

Automobiles - Advantage passenger cars

Our industry checks suggest that passenger cars have an advantage over twowheelers in terms of demand revival, given the Sixth Pay Commission benefits, new model launches and availability of vehicle finance. Maruti Suzuki and Mahindra & Mahindra remain our top picks. Sell Hero Honda and Tata Motors.

We visited dealers around Mumbai city to get a sense of vehicle demand ahead of the peaksales festival season. Below we outline our key takeaways.

Passenger cars: long waiting period for new models

Maruti Suzuki

.. The company has initiated targeted marketing to gain from the Sixth Pay Commission payout for central government employees. It has asked dealers to recruit four-member teams to restart the ‘Wheels of India’ promotion and target government employees. Dealers expect special schemes to be launched, and hope to get a better market share given limited direct competition in this user segment.

.. The waiting period for Maruti diesel cars has risen to 4-6 months. The recent launch of the Tata Indica Vista has had no impact.

.. The impact of Hyundai’s i10 kappa engine and General Motors’ Spark is limited, as these models also have a waiting period.

.. The effective interest rate for consumers has increased from 12% before the Sixth Pay Commission payouts to 13.5%. ICICI Bank is pushing for floating interest rates for car loans, but customers have been trying to avoid these.

.. Finance availability is tough due to the strict implementation of SIBAL, wherein poor credit history leads to delays in approvals as either the consumer has to get it rectified or senior bank officials have to clear it as an exception with an appropriate explanation.

.. The Zen Estilo seems to be the weakest in Maruti’s portfolio, as its discounts have been higher than for the Wagon R and volumes lower.

.. Inventories are 1.5-1.8x above normal, which may be used up during the festival period. But if demand fails to revive, it may create problems in November-December 2008.

NTPC Ltd - Coal stock shortage

NTPC has delivered lower-than-targeted power generation so far in FY09. Management has indicated a shortfall in 1Q09 mainly due to maintenance shutdowns. There has been little improvement in 2Q09, but the company's coal stocks at its thermal power stations have not increased either. Management had indicated that coal stocks would improve once the monsoon season is over. We take account of the coal stock position at all of its power stations and the generation shortfall (vs set targets). We maintain our Buy rating on NTPC with a target price of Rs202.21 but would turn more cautious on any earnings shortfall from continued shortages in coal supplies.

Coal stock and generation
NTPC has been suffering coal-supply shortages from its linkage mines with Coal India. The three ministries dealing with power, coal and railways have been blaming each other for the increased shortages. While the Power Ministry has been asking for increased coal supplies, the Coal Ministry has said that NTPC produces much more than the rated plant load factors (PLF), thereby causing the shortage in coal stock.

.. Despite our expectation that the coal stock position at NTPC’s thermal stations would improve on seasonality, it has not (see Table 1). NTPC management indicated last month that the lower coal-stock position and implied shortage of supply was due to the monsoon and that the situation would improve once the monsoon rains pass.

.. Although NTPC normally maintains a lower-than-required average coal stock position, an increasing concern is that some plants have “zero” days, or less than one day of stock

Cairn India - Management roadshow highlights

We hosted Cairn India (CIL) on a non-deal roadshow in Singapore last week. While the timelines on oil production from Rajasthan remain unchanged, there is likely to be more news flow on exploration in the short term. In the next six months, seven exploration wells are set to be drilled - six by CIL in its own blocks and one by ENI. Since our DCF valuation does not assume any new exploration success, any positive news on this could add to our valuation.

CIL was represented by 1) Santosh Chandra - Director, Drilling and Petroleum Engineer, and 2) Anurag Chandra - Group Treasurer.

Details

Rajasthan project on track
CIL reiterated it is on track to start producing oil from the Rajasthan block by 2H09, and expects plateau production from the Mangala-Bhagyam-Aishwariya (MBA) fields to be 175kbd. Management said the pipeline from Mangala to Viramgam would be ready in 1H09 and from Viramgam to Salaya in 2H09. All major contracts have already been awarded and pricing for most has been locked in fully.

It sees the greatest reserves potential in the Rajasthan block, in terms of reserves addition from the 1.7bn boe of in-place oil in the small field and tight reservoirs within the block. This would be implemented through the use of enhanced oil recovery (EOR) techniques, which could raise the production plateau and/or extend the plateau period.

Exploration news likely
CIL had ordered two rigs for its Rajasthan oil development, which have arrived. Since the development process will start only next year, management said the rigs would be used for further exploration. The first rig has reached Kolkata and would be used to drill one exploration well in Bihar (block GV-ONN-2002/1, CIL stake 50%), followed by two exploration wells in onshore KG basin (block KG-ONN-2003/1, CIL stake 49%). The second rig would drill three exploration wells in the Rajasthan block.

Ranbaxy Laboratories - Uncertainty prevails

The FDA's moves against Ranbaxy may mean physicians and patients opt for other, 'non-controversial' generics in a highly commoditised market. Though we cut our estimates, the risks may not be fully priced in and more pain cannot be ruled out. Sell.

FDA ban - cascading effect possible
The US FDA first issued a warning to Ranbaxy, regarding its Paonta Sahib plant, in June 2006. In July 2008, the US Justice Department (independent of the FDA) filed a motion alleging fraudulent conduct and improper record-keeping by Ranbaxy. So while the FDA has stated it doesn't believe Ranbaxy's products are harmful, patients and physicians may still move to 'less controversial' generics in what is a highly commoditised market, affecting the sales of Ranbaxy's other products in the US.

Estimates cut, but risks may not be fully priced in; more pain possible
With existing inventories and the weak rupee limiting damage to the top line in 2008, we expect the full impact of the FDA measures will be felt from 2009. We have cut our operating margin estimate (SGA expenses unlikely to fall as much as sales), which knocks 40% off our 2009F EPS. Our estimates do not capture all the risks - there could be more pain if the FDA places more of Ranbaxy's drugs or plants on its banned list or raises safety issues (currently only manufacturing issues) or if more countries place similar curbs on Ranbaxy's products.

FTF accounts for a third of target price; we downgrade to Sell from Hold
Our revised estimates and target price are based on the scenario post the completion of the Daiichi open offer. Due to the uncertain environment, the worst may not be over for Ranbaxy. We believe Ranbaxy may be a victim of political pressure on the FDA to be 'proactive', and a resolution may take some time, especially as the Paonta Sahib issue has not been resolved for over two years. The FTF one-off pipeline represents 33% of our target price, which is also fraught with uncertainties. For instance, valcyclovir HCL (generic Valtrex), one of the agreements Ranbaxy has had with GSK and which is due to launch in 2009, is also on the list of banned drugs. Similarly, patients could prefer Dr Reddy's version of generic Imitrex to Ranbaxy's (both to be launched at end-2008; Dr Reddy's is the AG of GSK, while Ranbaxy is the FTF holder). The stock trades at 25.4x core 2009F EPS and seems expensive, especially in the current environment

NIIT Technologies - Management meeting highlights

NTL remains cautious about the impact of global macro issues on its clients. However, most clients, which were in a 'wait-and-watch' mode earlier in the year, have now assessed spending priorities, with increased preference for offshore-led engagements. Management believes none of its clients are in bankruptcy or takeover situations. The new ROOM solutions version looks on track for an early October launch; order intake should pick up in the March 2009 quarter after one or two implementations are completed. The BPO practice has been fully restructured and is now aligned to IT Services. Management expects to hold margins in FY09 through operational efficiency and scale-up of the non-linear business, mitigating the impact of potential revenue loss from its US$222m hedge position. Overall, we retain our view of NTL reporting a top-line recovery in 2H09 and holding margins in FY09. The stock appears to be pricing in perpetually negative earnings growth, which we believe is pessimistic. The stock offers 7% trailing dividend yield at current prices. 

Key highlights 

.. Overall, NTL remains cautious about the macro challenges facing clients, but is confident about growing in line with the IT services sector. None of its clients are facing bankruptcy/consolidation situations, so far. Management believes that clients have now re-assessed their spending priorities, with several travel and transportation clients looking to invest in offshore-led engagements. 

.. NTL expects to maintain FY09 operating margins around FY08 levels though improved operational efficiency, building in potential hedging losses to be accounted in revenues in FY09 (hedge position of US$222m at end-1Q09, at Rs40.11/US$). Management expects to achieve this by raising utilisation to 80%+ levels by end-FY09 (78% in 1Q09), raising the share of non-linear service revenues and improving offshore effort mix by 1% per quarter in FY09. 

.. The next version of the ROOM solutions platform looks on track for an early October launch. While initial uptake in 3Q08 will likely be limited to one to two clients,management expects order intake to start gathering pace in 4Q09, once a successful implementation is completed. 

ICICI Bank - Mark-to-market vs default risk

ICICI Bank's exposure to global financial risk through its international subsidiaries does not appear material. A scenario analysis indicates that potential losses in the international assets portfolio (largely comprising global banks and financial institutions) are less than 2% of the bank's FY09F net worth, even in a worst-case scenario. In the past, the cumulative default rate of banks globally over a five-year period has been less than 1%, according to Fitch. We see value in ICICI Bank's stock and reiterate our Buy rating. 

International subsidiaries - exposure to global financial risk exists, but does not appear material 

We believe the market’s reaction to ICICI Bank’s exposure to global financial risk is overdone. In our base case scenario of a 2% default rate, we estimate that the risk is 1.2% of FY09F net worth. Even in our worst case scenario of a 3.0% default rate, losses in the international asset portfolio (largely comprising exposure to global banks and financial instituions) would not exceed 1.8% of FY09F net worth. However, the risk is that near-term earnings could surprise negatively due to mark-to-market losses arising from the decline in value of securities held. 

Note that our scenario analysis is based on cumulative failure rates of all banks as per Fitch ratings (1990-2006). According to Fitch, the probability of a bank failing is significantly greater than it defaulting. For instance, the cumulative default rate for all banks over a fiveyear period is less than 1.0%, compared with a failure rate of 5.94%. 

ICICI Bank has investment paper that is generally rated ‘A’ and above in the international subsidiaries. According to Fitch, the failure rate is lower for banks with higher ratings. For instance, for banks rated A, the failure rate is 0.0%. 

We believe ICICI Bank offers value at this price and we reiterate our Buy rating. The stock trades at 14.2x FY09F earnings and at 1.4x FY09F adjusted book value after writing off 100% pre-tax net NPLs.