Sunday, November 05, 2006
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Market is likely to extend its rally in the coming week, on the back of high liquidity in the market. Strong buying support from FIIs and impressive Q2 results has boosted the market sentiment. Also stable crude oil prices will provide momentum. Nymex crude is hovering at $58 a barrel, off sharply from a record high of above $78 a barrel it had it in mid-July 2006.
FIIs have been the key drivers of the recent rally. FIIs inflow in October 2006 totaled Rs 8013 crore, compared to their inflow of Rs 5425 crore in September and Rs 4643 crore in August 2006.
However, high volatility may take place at a time when the Sensex at all time high.
Meanwhile, a large mop up from IPOs is expected in the next two months. Two large IPOs in the pipeline are Cairn India and DLF.
The rapid growth of the mortgage industry in India in the recent years has raised concerns about its sustainability and implications on the country's financial and macroeconomic stability. The IMF, in its World Economic Outlook, 2003 indicated that output losses after real estate crashes in developed countries have, on an average, been twice as large as those after stock market crashes, usually resulting in lasting recessions.
The fact that the surge in demand for mortgage credit has been trailed by an equally strong upturn in prices has led to apprehensions as to whether the boom is sustainable or is merely a financial bubble ready to burst. Further, the surge in housing prices globally has gone hand-in-hand with a much larger jump in household debt than in previous booms.
The magnitude of mortgage credit...
The pace of housing sector growth can be gauged from the fact that the total value of residential property in developed economies increased by an estimated US$ 20 trillion to over US$ 60 trillion in the last three years - which is higher than the increase in market capitalisation of global capital markets (Source: IMF). Housing market in India, as evidenced by the growth in bank exposures to the sector, took off mainly since FY01. Credit to the retail mortgage sector grew at a CAGR of 48% between FY01 to FY06 and comprised 12.3% of non-food credit against 3.5% in FY01. Also, as per the RBI's annual statement for FY07, the incremental growth in loans to commercial real estate and housing sectors clocked rates of 84% YoY and 29% YoY respectively in FY06.
Reasons for the surge...
The rapid growth in housing loan \nmarket has been jointly supported by the growth in middle class population, \nfavourable demographic structure, relatively lower real estate prices, and more \nimportantly, rise in disposable incomes. Furthermore, attractive fiscal \nincentives for housing loans make them ideal vehicles for tax planning for the \nsalaried class. For banks and housing finance institutions, the regulatory \nframework facilitated the higher exposure by prescribing risk weights for \nhousing loans and giving it the benefit of compliance with the targets mandated \nfor priority sector lending. Besides, the loans were backed by the relative \nsafety of such assets given the tangible nature of the primary security and the \ncomfort obtained from the SARFAESI Act, 2002.
Versus the US...
In the United States, which is at present \nexperiencing a strong cycle in the housing market, prices in certain regions \nhave risen sharply if measured against the yardstick of affordability - \ncalculated as the ratio of housing prices to annual income, reflecting a build \nup of the asset bubble. In fact, at present, the median price of new house in \nthe US is more than 5 times the median household income.
Contrasting this, the scenario is India is still comfortable. At present, \nthe median price of new house in India is 4 times the median household income as \nagainst 22 times in 1995. Also, thanks to fiscal incentives, the effective rate \nof home loan has come down to 4.5% in 2006 against 11.7% in 2000. \n\n
It\'s here to stay!
The mortgage to GDP ratio of 6% in India as \nagainst 54% in the US underscores the latent demand for the same. More so, with \nIndia being the second fastest growing economy in the world. Another interesting \npoint to note is that while the home loan demand in the developed economies is \nlargely for investment purposes (thus having a speculative component), 70% of \nthe demand in India is for habitation purpose (thus making it less risky). Thus, \nthe housing sector given its core importance in the developmental goals of the \neconomy and in sustaining financial stability - is set to remain on the \nregulator\'s radar. However, investors need to judge their stance on the sector \nbased on the fact that even if the current robust rate of growth may not be \nsustainable, the buoyancy in the sector may linger in the medium \nterm.
Reasons for the surge...
The rapid growth in housing loan market has been jointly supported by the growth in middle class population, favourable demographic structure, relatively lower real estate prices, and more importantly, rise in disposable incomes. Furthermore, attractive fiscal incentives for housing loans make them ideal vehicles for tax planning for the salaried class. For banks and housing finance institutions, the regulatory framework facilitated the higher exposure by prescribing risk weights for housing loans and giving it the benefit of compliance with the targets mandated for priority sector lending. Besides, the loans were backed by the relative safety of such assets given the tangible nature of the primary security and the comfort obtained from the SARFAESI Act, 2002.
Versus the US...
In the United States, which is at present experiencing a strong cycle in the housing market, prices in certain regions have risen sharply if measured against the yardstick of affordability - calculated as the ratio of housing prices to annual income, reflecting a build up of the asset bubble. In fact, at present, the median price of new house in the US is more than 5 times the median household income.
Contrasting this, the scenario is India is still comfortable. At present, the median price of new house in India is 4 times the median household income as against 22 times in 1995. Also, thanks to fiscal incentives, the effective rate of home loan has come down to 4.5% in 2006 against 11.7% in 2000.It's here to stay!
The mortgage to GDP ratio of 6% in India as against 54% in the US underscores the latent demand for the same. More so, with India being the second fastest growing economy in the world. Another interesting point to note is that while the home loan demand in the developed economies is largely for investment purposes (thus having a speculative component), 70% of the demand in India is for habitation purpose (thus making it less risky). Thus, the housing sector given its core importance in the developmental goals of the economy and in sustaining financial stability - is set to remain on the regulator's radar. However, investors need to judge their stance on the sector based on the fact that even if the current robust rate of growth may not be sustainable, the buoyancy in the sector may linger in the medium term.
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Once again, Dr. Y.V. Reddy, the Governor of the Reserve Bank of India (RBI) surprised the market by hiking only the repo rate, its key lending rate, and leaving the reverse repo rate, at which it borrows from banks, unchanged. The central bank increased the repo rate by 25 basis points to 7.25%, but kept the reverse repo rate at 6%. The bank rate and CRR were also left unchanged at 6% and 5%, respectively. The bond market had not anticipated any rate hike at all. Bond prices, which had been volatile prior to the policy announcement fell amid hawkish statements from the RBI Governor. Prices remained under pressure amid concerns that the RBI could go for another rate hike before its scheduled January meeting. Those fears got compounded with Friday's release of Government report on inflation, which accelerated to a new four-month high. Finance Minister P. Chidambaram said inflation control was the most important goal for the Government. He also said that the Centre would take necessary steps to check spiraling prices. Reacting to the latest inflation data, Dr. Reddy said that the central bank would not revisit its monetary stance. "This is included in the basic premises of the policy," he said.
Clearly, the RBI and the Government are worried about the run-away growth in credit amid a fast expanding economy. Of particular concern to them is the surging demand for loans from sectors such as real estate, housing loans and consumer loans. Non-food credit grew by 30.5% as at Oct 13, 2006 on top of an increase of 31.8% a year ago. Year on year growth in money supply (M3) was higher at 19% versus 16.8% a year ago. So, to arrest the soaring demand for credit, especially in sectors that are appearing to be showing signs of overheating, the central bank has made borrowing more costly for banks. What the RBI and the Government want is that banks should rebalance their portfolio by leaning less towards real estate and retail loans. The central bank is indicating that loans from it would be much more expensive compared to the market rate. Dr. Reddy has also hinted that if the loan growth continues at the current pace, there could even be some liquidity crunch as the economy enters the busy season. In a nutshell, the RBI is telling banks to pull up their socks and be more prudent in lending. Otherwise, they will have to resort to the central bank for borrowings, which will come at a higher rate.
Govt gets serious about infrastructure
The Government seems to be bent on removing the biggest bugbear of the Indian economy, the infrastructure. This week, it approved a slew of projects in the power and road sector that underlines its commitment to improving the tardy infrastructure. The Cabinet Committee on Economic Affairs (CCEA) approved the waiving of the Rs10bn ceiling for equity investment by NTPC Ltd. to establish Joint Ventures and wholly owned subsidiaries in India or abroad for participating in the ultra mega projects. This will be subject to the implementation of maximum two projects. However, the CCEA retained the ceiling of 15% of the net worth of NTPC in one project and the overall ceiling of 30% of the net worth of NTPC in all such projects put together. This will facilitate participation of Joint Venture of NTPC and BHEL in the bidding for ultra mega power projects and result in technically and commercially optimum bid as well as facilitate tying up with world class mining operators, Finance Minister P. Chidambaram told reporters after a CCEA meeting.
The Government also cleared the proposal by AES Corp. of USA to set up a coal-based power plant in Chhattisgarh at an investment of US$1.22bn. The CCEA gave its approval to AES OPGC Holding Mauritius for setting up a wholly owned subsidiary to undertake a green field coal based power generation plant and to undertake coal mining for captive consumption. AES expects to bring in US$ 370mn as FDI while the balance US$ 852mn would be raised through loan from domestic and/or International banks and Financial Institutions. The CCEA approved a plan to undertake construction of 1000 km of expressways under Phase VI of the National Highway Development Programme (NHDP). The projects would cost Rs166.8bn. While the private sector will contribute Rs90bn the balance Rs76.8bn will be provided by the Government as viability gap funding. The expressways would be built through Public Private Partnership (PPP) on Build, Operate and Transfer (BOT) basis. The projects are likely to be completed by December 2015.
"We would not like to comment on this at this point in time. The details of the offering are still being worked out," a Reliance spokesperson said.
Reliance Money is to offer a common platform for investors to invest in all equity products, commodities, forex, IPOs, insurance and other financial products.
While the company has not formally announced the launch of its operations, many traders said they have been approached by Reliance Money franchisees . Retail brokerage houses fear that Reliance Money may rewrite the rules of the broking business, distorting business dynamics in the short term, the way the Reliance group had done when it forayed into the telecom sector some four years ago.
"Broking has completely become a balance-sheet game as there is very little to distinguish between the services offered by various firms," said the head of a retail brokerage house. "A large player like Reliance has the capacity to absorb losses for a couple of years, making life difficult for rivals," he added.
In a Rs 500 card, an investor gets a maximum delivery limit of Rs 10 lakh; so, the initial fixed cost is 5 paise. The investor will be charged Rs 12 per trade if he purchases through a series of trades. If he buys shares worth Rs 10 lakh in 20 trades, at an average of Rs 50,000 per transaction, the total brokerage charge will be Rs 740 (500+240), which works out to 7.4 paise per Rs 100 worth of transaction
For non-delivery trades, an investor can take exposure up to Rs 90 lakh on a Rs 500 card. Suppose the investor uses up his limit in 90 trades of Rs 1 lakh each, at Rs 12 per trade, his total charge will be Rs 1,580 (1,080+500)
If you cannot afford to ignore the advice of the Oracle of Omaha, Warren Buffet, the man who taught the Sage the core investing tenets must obviously be someone very special. Meet the legendary Benjamin Graham, christened the "Father of Value Investing" and sometimes called the "Dean of Wall Street". He has also immortalised himself by penning two investment classics: Security Analysis (with David Dodd) and Intelligent Investor — must reads for anybody entering and staying wedded to the investment profession. Enjoy the wonderful wit and wisdom through these quotable quotes:
Short- vs long-term investing
"In the short term, the market is a `voting' machine whereon countless individuals register choices that are product partly of reason and partly of emotion. However, in the long term, the market is a `weighing' machine on which the value of each issue (business) is recorded by an exact and impersonal mechanism."
On market fluctuations
"Since common stocks, even if investment grade, are subject to recurrent and wide fluctuations in their prices, the intelligent investor should be interested in the possibilities of profiting from these pendulum swings. There are two possibilities of profiting from these pendulum swings: The way of timing and the way of pricing. By timing we mean the endeavour to anticipate the action of the stock market — to buy and hold when the future course is deemed to be upward, to sell or refrain from buying when the course is downward. By pricing we mean the endeavour to buy stocks when they are quoted below their fair value and to sell them when they rise above such."
The madness of `crowds'
A story that was passed down from Ben Graham illustrates the lemming-like behaviour of the crowd:
"Let me tell you the story of the oil prospector who met St. Peter at the Pearly Gates. When told his occupation, St. Peter said, "Oh, I'm really sorry. You seem to meet all the tests to get into heaven. But we've got a terrible problem. See that pen over there? That's where we keep the oil prospectors waiting to get into heaven. And it's filled, we haven't got room for even one more." The oil prospector thought for a minute and said, "Would you mind if I just said four words to those folks?" "I can't see any harm in that," said St. Peter. So the old-timer cupped his hands and yelled out, "Oil discovered in hell!" Immediately, the oil prospectors wrenched the lock off the door of the pen and out they flew, flapping their wings as hard as they could for the lower regions. "You know, that's a pretty good trick," St. Peter said. "Move in. The place is yours. You've got plenty of room." The old fellow scratched his head and said, "No. If you don't mind, I think I'll go along with the rest of 'em. There may be some truth to that rumour after all."
Warren Buffet, relating a story by Benjamin Graham
The company will benefit from large investments being made in improving the country's water infrastructure
In FY 2007, we expect the company to register sales and net profit 362.66 crore and Rs 18.96 crore respectively. On a tiny equity of Rs 4.84 crore (70% held by promoters) and face value of Rs 10 per share, EPS works out to Rs 39.2. Book Value will cross Rs 265. The share price trades at Rs 375. P/E works out to just 9.6.
A sound track record of profitability, geographical and business diversification, and strong demand scenario in the real-estate sector lend optimism to the earnings growth of Parsvnath Developers. An established player in residential projects, Parsvnath recently entered the integrated township segment and is ramping up activity in the malls and commercial space segment. The company is entering new business segments, such as hotels and special economic zones (SEZs), across the country. Uncertainties involved in entering new business segments do add to the risk profile of the company.
Investors willing to take the risk that come with an early entry in this fast emerging space may invest in Parsvnath with a three-four year perspective. With improved industry practices, the interest evinced by private equity funds and the clearance given for real-estate mutual funds, the stage is set for big unlisted players in the sector to make an entry.
At the price band of Rs 250-300 the price earnings multiple (P/E) will be 16-20 times the likely earnings for FY-08 (subject to projects being completed on schedule) on a diluted basis. The valuation is expected to become more attractive by 2009-10 as a number of the current projects are likely to be completed and sold/occupied by then.
At the offer price, the P/E multiple based on FY-06 earnings is at a discount to peers such as Unitech and Mahindra Gesco Developers but at a premium to smaller players such as Ansal Properties and Infrastructure, and D. S. Kulkarni Developers. The premium appears justified given the diversified business model and size.
Object of the issue
Parsvnath develops residential buildings, commercial complexes, including malls and multiplexes, and integrated townships. The company also plans to develop hotels, SEZs and information technology parks. It is seeking to raise Rs 830-1000 crore through this initial public offer and planning to use the funds towards development and construction of some of the projects on hand.
Healthy project mix
Parsvnath has completed 17 projects and acquired land or development rights for 72 projects spanning segments such as residential buildings, townships and commercial properties. The company has already deployed some funds in most of these projects, revenues from which are likely to start flowing from FY-08. The company has also got in-principle approval for the development of nine SEZs.
Further, the company is involved in ventures with the Delhi Metro Rail Corporation (DMRC) for the development of properties around railway stations and depots. The lease from DMRC for varying periods, of 12-30 years, allows Parsvnath to let out the premises for retail shops, offices and exhibitions. Of the 11 projects, two are complete and fully let-out. The initial earnings from this segments point to a high-margin business, providing regular revenue flows. This also differentiates the company's business model from its peers.
Parsvnath's FY-06 revenues came equally from residential projects and integrated townships. Going forward, we expect increasing activity of the company in the commercial space and lease with DMRC to contribute to revenues.
Early mover to non-metro cities
Parsvnath appear to have a planned strategy of entering early the smaller cities. Eighty eight per cent of the revenue for the quarter-ended June 2006 was derived from non-metro cities. This is reflected in its completed projects being spread over Greater Noida, Ghaziabad, Noida and Gurgaon among others. The current projects are also located in cities such as Chandigarh, Mysore, Pune and Indore.
In their search for more office space and their bid to save costs, a number of IT companies have been shifting work to Tier III cities. With a well-diversified geographical presence and relatively low-cost land in non-metro cities, Parsvnath appears well placed to capitalise on this expansion in office-space demand and consequent residential space requirement. Further, very few players in the listed category, except for Unitech, have projects with a pan-India presence. This gives Parsvanth the advantage of early brand recognition.
Parsvnath's revenue and profits have grown at a scorching 131 per cent and 141 per cent annually over the past five years, largely due to increased activity since 2003. The projects on hand are likely to keep the momentum going although the growth over the next one year may be subdued due to work-in-progress. The company's return on equity (ROE) at 53 per cent is superior to similar-size peers. This may, however, see a dent in the near term as a result of increased equity through the offer and lack of commensurate near-term earnings accretion. The ROE is, however, likely to remain at par with the listed peers. Although it operates in a working capital-intensive industry, the company's ability to comfortably cover interest costs lends confidence on its leveraging capability.
While Parsvnath's presence in non-metro cities is an advantage, the ability of Tier III cities to offer increased scalability in terms of physical infrastructure, intellectual capital and quality real- estate will determine the company's success in these cities. On this account, Parsvnath will remain a risky option to companies with presence only in Tier I cities.
Parsvnath's venture into SEZs may require dealing with a lot of policy related issues. The SEZ policy is evolving still. There have nevertheless been concerns raised on the revenue loss to the Government through tax exemptions and other concessions.
Further, SEZs have long gestation periods, with possible negative cash flows in the first couple of years. The funding process for these projects and the lag in earnings are risks that an investor should watch out for. Revenues from SEZs, hotels and forthcoming townships in Bangalore and Hyderabad have not been considered in our estimation.
The mounting number of projects adds to the risk of company's ability to execute them. The ramp-up in the asset base over the last couple of years, however, indicates that the company has been equipping itself to face the mounting number of projects.
Offer details: The offer is open from November 6 to 10. Enam, Financial, JM Morgan Stanley and DSP Merrill Lynch are book-running lead managers. At the lower end of the price band the market capitalisation on listing will be Rs 4600 crore.
Investors can consider subscribing to the initial public offering (IPO) of Lanco Infratech (LITL) at the cut-off price with a medium/-long-term holding perspective. LITL is in the growth phase and earnings from the investments being made now will begin to kick in gradually from 2008-09.
The various power projects that LITL is now investing in appear well sewn-up and the company's construction business is likely to bring in revenues till the power projects go on stream.
Our recommendation factors in the positives; the risks associated with this offer are elaborated in the accompanying box.
The challenge, however, arises from the lack of experience in simultaneously managing projects of such a scale based on different fuels, but the comforting factor is that the finances and power purchase agreements have been tied up for a major part of the expansion.
Simultaneously, LITL will also be investing in the business of property development where it has no experience. The positive here is that the company owns valuable land in Hyderabad, which has appreciated significantly and where it proposes to implement an integrated information technology park and residential campus.
LITL is a holding company that invests in the equity of subsidiaries created for specific projects. It owns 34 per cent of Lanco Kondapalli Power, which owns and operates the group's biggest power asset to date — the 360 MW gas-based combined cycle power plant in Andhra Pradesh.
LITL's stake in this company will rise to 59 per cent once it completes the acquisition of 25 per cent equity from one of the existing partners.
The company will also be buying 15 per cent equity from the Aban group, taking its total stake to 51 per cent in Aban Power Company, which operates a 120 MW gas-based plant in Tamil Nadu.
The planned investment for the two purchases accounts for a little more than 15 per cent of the IPO proceeds of Rs 1,067 crore at the upper end of the price band.
The rest of the funds will be invested in the various power projects being implemented by different subsidiary companies and in the property development project in Hyderabad.
The company is now implementing a 600 MW project based on coal at Amarkantak, Chattisgarh, the first phase of which (300 MW) is scheduled to go on stream 16 months from now, followed by the second phase in October 2008.
LITL recently tied up the finances for its 1,015 MW imported coal-based power plant in association with the Nagarjuna group in Mangalore where it plans to hold 74-per cent equity.
Apart from this, the company is on the verge of reaching financial closure for a 500 MW hydro power plant in Sikkim. It has also been shortlisted as the successful bidder for the 1,000 MW coal-based project in Anpara, Uttar Pradesh. In addition to these, LITL is investing in some small hydro power plants in Himachal Pradesh and Uttaranchal.
While these smaller hydro plants will go on stream by April 08, the Nagarjuna and Sikkim projects are scheduled to start operations only by December 09 with Anpara to follow after that.
In short, the full benefit of the investments planned now will not be felt in LITL's financials before 2010-11.
LITL's revenues will flow in from three streams — dividends from equity investment in the various subsidiaries implementing projects; engineering, procurement and construction (EPC) of these projects (power and property) and property development.
The construction business of the company now derives 90 per cent of its revenues from contracts with group outfits. While the use of its own construction division to implement group company projects helps in capturing value across the chain, it could also be a disadvantage if any of these projects land in distress.
The dividend income stream will depend on the policy of the various subsidiaries.
The property development income is probably subject to the highest risk among the three streams, given the company's lack of experience in this field and also the inherent volatile nature of the property market.
The key risks
The principal risk to our recommendation stems from the implementation aspect; LITL will grow from a company managing 509 MW of primarily gas-based power plants to one managing more than 3,700 MW of gas, coal, hydro and bio-mass based power plants in the next three years.
The two operating projects — Lanco Kondapalli and Aban Power — are supplied gas by Gail India. Gas supply in the Andhra Pradesh region is significantly short of demand.
While the Kondapalli project has a firm allocation, Gail's supplies in the last three years have shown a marginal declining trend.
A significant shortfall in gas supply could lead to some uncertainty as the company will have to decide between switching to liquid fuel, which is more expensive, or generating at lower capacities and take cover under the standby charges payable by the buyer.
Significantly, the gas supply agreement with Gail will come up for renewal in 2010 when some hard bargaining can be expected for both price and quantum of gas.
Any delay in the implementation of the various projects could set back the expected earnings stream of LITL; not only will the earnings and cash flows from the new projects be delayed, the revenues from construction activity would also be affected.
A steady generation of cash flows is crucial for LITL as it will be on the investment mode for the next three-four years.
The Anpara project has just been bagged by the company and the PPA is yet to be signed for offtake of power from the project.
Offer details: LITL is offering 4.44 crore shares in the price band of Rs 200-240.
The issue, which will open on November 6 and close on November 10, is lead-managed by JM Morgan Stanley, Enam Financial, ICICI Securties and Kotak Mahindra.