Banking Q2FY2007 earnings review
- After two relatively dull quarters, the latest quarterly results truly justified the run-up in the banking stock prices. The exuberance in the banking sector is based on the core fundamentals and improved visibility in the earnings of the sector, a glimpse of which we have seen during Q2FY2007.
- The net interest income (NII) witnessed a handsome growth, backed by a strong advances growth and the relatively stable net interest margins (NIMs). Higher growth in the fee income helped a commendable growth in the core operating profits.
- With the benchmark yields down almost 50 basis points from the quarter ended June 30, 2006, instead of a mark-to-market provisions charge that was seen in the previous couple of quarters, we saw most banks writing back excess provisions. This kept the overall provisions down and helped the robust growth in profits.
- Based on the improved visibility in the earnings for the banking sector, we have revised the earnings for certain banks. We feel that with the busy season ahead the banking sector is poised to see better times. Our top picks among the public sector banks remain Bank of India, Canara Bank and Punjab National Bank while in the private banking space UTI Bank is our preferred choice.
STOCK UPDATE
Solectron Centum Electronics
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs315
Current market price: Rs227
Unlocking value
Result highlights
- Solectron Centum Electronics (SCEL) has reported a robust growth of 146.3% in its net revenues to Rs41.3 crore during the second quarter ended September 2006. The growth was largely driven by a 264.5% jump in the electronic manufacturing services (EMS) business to Rs32.4 crore. The component business grew by 12.7% to Rs8.9 crore.
- The operating profit margin (OPM) declined by 840 basis points to 11.5% due to the continued increase in the proportion of the low-margin EMS revenues in the total turnover. Moreover, the margins in the EMS business itself have been declining gradually (in line with the global benchmark decline of 5-6%).
- The robust jump of 363% in the other income component to Rs1.3 crore mitigated the impact of higher interest and depreciation charges. Consequently, the company posted a net profit growth of 51.2% to Rs3.6 crore. This is after including the provisions of Rs0.7 crore made for the proposed restructuring of the organisation.
- On the half yearly basis, the net revenues grew by 181.3% to Rs77.7 crore. However, the 810-basis-point decline in its OPM has limited the earnings growth to 31.5% (Rs6.8 crore).
- Along with the results, the company announced that its board has approved the scheme to de-merge the EMS business into a separate new company, Solectron EMS India Ltd (SEIL), which would be controlled directly by Solectron Corporation. On the other hand, the current management (the Indian promoter) would manage the component manufacturing business. The move is aimed at enhancing the focus on the two diverse business lines and is likely to be beneficial to the existing shareholders over the long term.
- At the current price the stock trades at 22.3x FY2007 and 20.5x FY2008 estimated earnings. We are upgrading the stock to a Buy recommendation with a revised price target of Rs315.
Hyderabad Industries
Cluster: Apple Green
Recommendation: Buy
Price target: Rs700
Current market price: Rs250
Disappointing performance
Result highlights
- Hyderabad Industries Ltd's (HIL) Q2FY2007 results are below our expectations. Lower-than-expected sales and higher raw material costs primarily affected the company's performance during the quarter.
- The net sales for the quarter rose by 15.4% to Rs101 crore. The sales were lower than estimates as the company faced rejection of products from its new Satharia plant due to certain quality issues.
- The operating margins have come down drastically from 17.6% to 3.2% due to the production problems faced at the new plant, and high ruling prices of cement, which is the key raw material. Consequently, the operating profits for the quarter declined by 79.2% to Rs3.2 crore. The raw material cost as a percentage of sales increased significantly from 45.1% to 56.3% in Q2FY2007.
- Higher depreciation costs due to the commissioning of its new plant at Satharia further impacted the profits as the net profit after extraordinary items for the quarter declined by 90.4% to Rs0.7 crore.
- At the current market price of Rs250, the stock is trading at very attractive valuations of 3.9x FY2008 earnings and 2.6x its FY2008 earnings before interest, depreciation, tax and amortisation (EBIDTA). We maintain our Buy recommendation on the stock with a price target of Rs700.