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Sunday, November 19, 2006

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Banking on banks

The bulls have taken a liking to the banks, with the Indian economy clocking an impressive GDP growth of more than 8% in the first quarter

The current rally has seen the BSE banking index outperform the main indices. The bulls have taken a liking to the banks, with the Indian economy clocking an impressive GDP growth of more than 8% in the first quarter.

Banks are seen as a proxy to the economy, and they generally tend to do better in good times. ICICI Bank, SBI, HFC Bank, OBC, PNB and Bank of India have been the biggest winners.

Banks seem to have regained pricing power after a lull of 3-4 years. Also, their treasury portfolio has done well on the back of the improvement in government bond prices this year. As a result, most banks have reported stellar results for the first two quarters of the current fiscal year, with aggregate profits rising by 19%.

Though private banks like ICICI Bank and HDFC Bank have done better due to higher net interest margins and increased fee-based income, the public sector banks are not too far.

Banks have witnessed a huge jump in credit growth, thanks to the rapid economic expansion across sectors and regions. This has been the main driver for the rally in bank stocks. All banks have seen their yields on advances move higher, resulting in expansion of net interest margins.

Shares of ICICI Bank and other banks surged this week, pushing the 18-member BSE Bankex to a record high, after Government bonds yields dropped to six-month lows. With the credit demand pegged at 30%, the bull run in bank stocks is likely to continue for a while. The only concern would be if the RBI hikes interest rates too a much higher level.

As given in the table above, in the last two weeks, the BSE Bankex has logged double-digit gains, to be precise around 10%, compared with the 1.84% increase in the BSE Sensex and 1.14% rise in the NSE Nifty.

Over last two weeks, ICICI Bank has gained smartly, hitting a life time high of Rs925 on 16th November. The stock has rallied almost 7%. In Q2 FY07, the private sector bank posted an increase of 30% in its net profit. It has also received approval from the RBI to open new branches and ATMs.

Others like HDFC Bank, SBI and Bank of India have gained by over 6% each during the same period.

Gulshan Sugars and Chemicals: Avoid

Investors can consider giving a go-by to this follow-on public offer by Gulshan Sugars and Chemicals. At an offer price of Rs 40, the price-earnings multiple works out to 15 times the trailing 12-month earnings on an expanded equity base. Though the offer, at 33 per cent discount to the secondary market prices, is attractive, valuations appear stretched for a chemical industry stock. A sustained surge in the prices of limestone, its primary raw material, and coal is likely to reduce margins.


Gulshan Sugars is among the larger manufacturers of calcium carbonate with a 24 per cent share of the domestic market. Though the company makes only one product, its risk profile gets diversified, as calcium carbonate is used in a range of industries, including paper, rubber and plastics, paints, pharmaceuticals, cosmetics and dentifrice. Gulshan Sugars manufactures a range of grades spanning both precipitated and activated calcium carbonate to cater to diverse sectors. Its customer list features large players in the dentifrice and paper sectors.

Though the company faces competition from large unorganised players on the pricing front, its leadership position vis-à-vis other players, scales down this threat. Gulshan Sugars plans to replace a substantial portion of imports by foraying into the ground calcium carbonate space, which caters mainly to the paper industry. With this entry, the company is poised to tap growth opportunities in the paper industry, which is expanding. The growing literate population in the country and the surge in operations in the print media space provide ground for this entry. However, the growth in the offtake from the plastics and dentifrice segments is likely to be modest.


Gulshan Sugars operates on comfortable margins. Power and fuel costs, along with selling and distribution costs, constitute a fair chunk of its operating cost. In FY-06, despite lower realisations, the company registered an improvement in margins by pruning its operating costs. Though limestone constitutes only 18 per cent of the operating cost, a surge in prices on the back of buoyant demand in the cement industry is a cause for concern.

Offer Details

Gulshan Sugars is offering 66 lakh shares (face value of Rs 8) valued at about Rs 26 crore. Gulshan Sugars plans to deploy a substantial part of the net proceeds to set up a ground calcium carbonate facility with a capacity of 20,000 tonnes and also set up a 3 MW captive generation plant. The offer will be open from November 22 to 28. SREI Capital Markets is the manager to the offer.

J K Lakshmi Cement : Despite heavy rains, bottom line almost triples

JK Lakshmi Cement reported a 30% growth to Rs 163.21 crore in revenue in the quarter ended September 2006 despite heavy rains affecting the company’s despatches and production.
Operating profit margin (OPM) improved 760 basis points (bps) to 24.2% due to high cement prices. Realisation was Rs 2900 per tonne as compared with Rs 2200 per tonne in the September 2005 quarter — up 32%. Net profit surged 174% to Rs 23.37 crore.
In the half-year ended September 2006, net sales jumped 41% Rs 351.95 crore, and net profit 205% to Rs 62.22 crore.
JK Lakshmi Cement produced 6.21 lakh tonnes in the September 2006 quarter compared with 6.59 lakh tonnes in the September 2005 quarter — down 6%. The company reported despatches of 6.4 lakh tonnes compared with 6.86 lakh tonnes in the September 2005 quarter — down 7%. Production and despatches were adversely affected due to heavy rains in Rajasthan in August 2006, which impacted inward and outward movement of material. The company estimated despatches of one lakh tonnes were affected.
However, normalcy has since been restored and, hence, the adverse fallout is not expected to go beyond the September 2006 quarter. In the December 2006 quarter, J K Lakshmi Cement expects to produce a minimum 7.5 lakh tonnes
J K Lakshmi Cement will invest Rs 152 crore for a petcoke-based power plant, of which Rs 45 crore will be funded by internal accruals and equity.
The tax rate will remain under MAT for another five to six years as J K Lakshmi Cement has huge accumulated losses and depreciation. Limestone reserves are likely to last for the next 30-35 years.
J K Lakshmi Cement is to set up a 0.5 million-tonne grinding unit in Gujarat near the fly ash source. The unit is likely to commence in August-September 2007. The company’s current capacity is about three million tonnes. By December 2008, it will be increased to four million tonnes.

LIC Housing Finance: Buy

Investors can consider an exposure to the LIC Housing Finance stock at its current price of about Rs 175 with a one/two-year perspective. Improvements in vital business parameters over the last few quarters coupled with strong positive outlook for the domestic housing finance market point to encouraging business prospects.

Improvement in margins

For LIC Housing Finance (LICHF), high cost of funds and, consequently, lower spreads had impacted profitability in FY 03-06. Intense competition from banks had put pressure on the company's ability to raise lending rates, thereby straining its margins.

However, this trend appears to be slowly changing now. For the quarter-ended September, margins rose from 1.8 per cent to 2.6 per cent on a year-on-year (Y-o-Y) basis, thanks to the rate hike of July. LICHF has close to 90 per cent of loans linked to floating interest rates while about 60 per cent of its own borrowings are also so contracted. What this essentially means is that, even if LICHF re-prices about 60-70 per cent of its outstanding loan portfolio, it is likely to have a positive impact on its margins. A chunk of LICHF's funds (over 35 per cent) comes through bank borrowings. Refinancing from the National Housing Bank and debentures account for about 40 per cent. Of late, its dependence on LIC has been reducing and it now forms about 17 per cent of the total borrowings.

As sourcing funds is becoming increasingly difficult amidst hardening interest rates, containing costs is likely to hold greater significance for the industry, in general, and LICHF, in particular. Though LICHF has brought down its funding costs over the last couple of years, the weighted average cost at close to 7 per cent remains high compared to the likes of Gruh Finance and HDFC.

The company intends raising public deposits to improve its cost structure. Being an NBFC, it has a leeway to raise deposits up to five times its net-owned funds.

However, with banks vying for retail deposits and short-term rates showing an upward bias, LICHF may find it tough to corner a share in the pie. Hence, its dependence on wholesale debt market is expected to remain fairly high.

Disbursals to pick up

LICHF's performance on business disbursements has not been very encouraging. On a five-year CAGR basis, sanctions have grown 25 per cent and disbursals 26 per cent. However, there has been some pressure over the last quarter. Total disbursements fell to Rs 1,172 crore in September 2006 from Rs 1,236 crore a year ago. This was primarily on account of the internal restructuring. In the last three-four quarters, the company was focussing on streamlining its processes and systems that impacted its business operations. With the exercise almost stabilised now, growth is likely to pick up.

The management expects a growth of 26-28 per cent in disbursements over the next year. For LICHF, 95 per cent of the new disbursements come from the retail sector, while loans to builders (projects) forms the balance. With the construction sector expected to remain buoyant, the projects business is likely to pick up faster. Some of the projects in the pipeline are expected to mature over the next few months. This is likely to be reflected in higher disbursements in the second half of FY-07.

The average size of the LICHF loan has also risen from Rs 5 lakh to about Rs 6 lakh, but is still below the industry average of Rs 7 lakh. The improvement has come on the back of a boom in real-estate market and increased exposure to builders. The disbursement-to-sanctions ratio has remained stable at 90 per cent. Any improvement on this front is likely to prove beneficial to the company. Through sharper focus on recoveries and adequate provisioning, LICHF has been able to bring down the level of net non-performing assets (NPAs) from over three per cent a year ago, to 2.1 per cent now.

The company has provisioning in excess of the mandatory requirement to the tune of 5 per cent. If it manages to sustain the pace of recoveries and prevent fresh non-performing assets, the provisioning levels could remain low, thereby boosting profitability. This would also help it attain the target of one per cent fixed for net NPAs by FY-08.


At its current price, the stock is valued at a price-to-book value of 1.1 and a price-to-earnings multiple of about 6.5 times its trailing 12-month earnings. This, in our view, is undervalued when compared to a P/BV of 1.5 for its peers. Further, the return on equity at 16 per cent is also healthy and is likely to remain around this level over the next couple of years. Assuming that disbursements rise by 20 per cent on a conservative basis, the company is likely to turn in an earnings growth of 15-18 per cent over the next year. This is likely to translate into an expansion of close to 20 per cent in per share earnings.

Andhra Bank: Buy

An investment may be considered in the stock of Andhra Bank with a one-year perspective. The bank's increasing focus on high-yielding loan segments, buoyancy in fee income and ability to mop up low-cost funds augur well for its growth over the medium term.

For the September quarter, the bank has turned in a good set of numbers. Its strategy of adopting a controlled credit growth without unduly stretching its balance sheet appears to have paid off. Unlike many other banks, which have grown their loan book by about 40 per cent, Andhra Bank has recorded a modest 23 per cent growth in advances.

By restricting its deposits growth to nine per cent against the industry average of 20 per cent, and staying away from bulk deposits to a large extent, the bank has managed to expand its net interest margins by about 10 basis points to 3.82 per cent on a sequential basis.

The growth in low-cost deposits has also helped the bank in containing costs. Low-cost deposits, which grew by 21 per cent YoY, now accounts for close to 40 per cent of its total deposits.

Non-fund based activities that remained relatively dull during FY 06 are now beginning to pick up sharply. The fee income has risen by 35 per cent in second quarter on the back of 12 per cent increase in first quarter. The momentum in the fee income is likely to remain high on the back of its initiatives in third-party distribution and credit cards business.

The deliberate change in loan-mix with higher focus on high-yielding segments such as retail, agriculture and SMEs also augur well. The growth in retail assets has been highest at 36 per cent.

Andhra Bank sports one of the cleanest balance sheets with bad loans constituting 0.1of net advances. Higher provisioning coverage (93.5 per cent) coupled with faster recoveries also offers a great deal of comfort on the asset quality.

The bank's ability to sustain its return on networth of 18 per cent post-equity expansion is a strong positive. Even with a modest profit growth of 10-12 per cent, the bank is likely to sustain its return on equity. The stock is quoting at a P/BV of 1.3 times its trailing 12 months earnings and appears attractively valued.

Blue Bird India: Avoid

Investors can avoid the initial public offer of Blue Bird India (BBIL). At the upper end of the price band, the offer values the company at about 12 times its annualised FY-07 per-share earnings, on a fully expanded equity base. This is in line with valuations commanded by Navneet Publications. The latter, while smaller than BBIL in terms of revenues, enjoys better margins due to its publication business and offers a superior exposure to this market segment.

BBIL manufactures notebooks and has a presence in western India. Close to 90 per cent of its Rs 400-crore revenue is derived from the sale of notebooks. The company also undertakes commercial printing and recently entered the publication business.

Performance and prospects

BBIL's performance in recent years has been encouraging. Revenues recorded an annualised growth rate of 65 per cent between FY-02 and FY-06. Profits have grown at a scorching pace, jumping fifty-fold during this period; this has been on a low base though. Technology improvements helped operating margins expand from about four per cent to about 13 per cent over this period. Growth in recent quarters appears to have been more sedate, with margins settling at about 13 per cent.

Growing literacy rates offers a steady market for BBIL, which has prompted it to expand its presence beyond Maharashtra. According to an AC Nielsen-ORG Marg study, the notebook market is likely to grow at a compound annual growth of 13 per cent through 2011. This is likely to ensure that BBIL sustains a double-digit revenue growth. A more aggressive push to increase the share of commercial printing and publication in overall revenues could prevent margins from stagnating at these levels. Concerns, however, stem from the long gestation period of the proposed project and the resource crunch that the company could face if the offer is subscribed only at the lower end of the price band.

Expansion plans

BBIL is to invest Rs 70 crore towards expanding its unit in Pune and setting up a new facility in South India. The project will expand its notebooks capacity by 50 per cent and double its printing capacity.

It also intends repaying long-term debt worth Rs 20 crore and augment working capital requirements of Rs 30 crore. With the help of its pre-IPO placement and the current offer, Blue Bird should be able to cover about Rs 100 crore of its requirements. The rest is likely to be met through internal accruals.

However, BBIL's cash flow situation has only now begun to show signs of improvement. The business is working capital intensive and operating cash flows turned positive only in FY-06. Using its internal accruals to meet the balance Rs 30 crore is likely to impose a strain on its resources.

Moreover, the new capacities will go on stream only in the fourth quarter of FY-08. In the medium term, therefore, there could be pressure on earnings growth.

Offer details: Eighty-seven lakh shares are on offer. The price band is Rs 90-105. At the upper end of the price band, Blue Bird will raise Rs 90 crore from the public. The promoter holding post-offer will be 52.6 per cent. The offer closes on November 22. The lead manager is DSP Merrill Lynch.

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Sobha Developers: Invest at cut-off

Investors with a high-risk appetite can consider investing at cut-off in the initial public offer of Sobha Developers (Sobha), a real-estate player. Strong growth in the residential and commercial space, steady contractual projects from IT giant Infosys, and a healthy land bank are the key positives for the company. Unlike the recent IPO by Parsvnath in the realty space, Sobha can at best be termed a South-based player, with Bangalore being its key revenue contributor. Thus the company carries the risk of geographical concentration. High dependence on a single client in the contract segment adds to the risk profile.

Sobha's present and prospective revenue segments, however, appear to offer relatively better visibility to earnings growth than its peers whose revenue streams are ridden with uncertainties from new ventures such as special economic zones. In the price band of Rs 550-640, the price earnings multiple is 19-22 times the company's likely FY-08 earnings on a diluted basis. As income from current projects is likely to bunch up only from FY-08, investors should be willing to hold with a time-horizon of two-three years.


Sobha is a real-estate developer with income from residential and contractual projects. The company has 2,747 acres reserves (close to 70 per cent of it in Bangalore) and additionally land arrangements, which are contractual, or on a joint development basis. Sobha plans to use the proceeds of the offer to finance land acquisitions, for construction and development of existing and proposed residential projects and repay some loans.

Changing business mix

Sobha Developers is a core player in the residential space and has completed over 25 projects in Bangalore. The current and future projects indicate that the company proposes to capitalise on this core strength. The company has 10 million square feet of ongoing and forthcoming projects in the residential segment, which is likely to add about Rs. 2000 crore to the top line in the next couple of years.

Revenue from this space has gone up from 40 per cent of total turnover in FY-04 to 63 per cent in FY-06. This has come about through a reduction in the proportion of contractual projects.

We consider this a healthy trend; for one, operating profit margins (OPM) are superior in real-estate development than contract to build.

Two, Infosys being the chief client contributing to the contractual segment, Sobha's risk profile is magnified by dependence on a single client for revenue. We view this change in mix as a move towards reducing risk and improving margins. The OPM, for instance, has jumped to close to 20 per cent in FY-06 from less than 10 per cent in FY-04.

The contract segment may see further diminution if the company is successful in its plans of building malls, multiplexes and integrated townships. An agreement with Reliance Energy for a consortium mooted by the Andhra Pradesh Industrial Infrastructure Corporation for development of a business district and trade towers appears to be a move towards diversifying its revenue stream.

Backward integration model

In the listed space, Sobha's backward integration model may be termed as unique, as it has in-house resources to deliver a project from conceptualisation to completion. This includes having its own concrete block making plant, woodwork and metal glazing factory. While it is true that a number of delays in projects in this industry can be attributed to sub-contracting, the latter may well turn out to be an economical proposition in some activities.

While Sobha is better equipped to finish projects on time, it may have to contend with price threats from competitors who can economise through sub-contracting. This issue may have appeared less significant so far, as most of its residential apartments belonged to the luxury category where quality and class often take precedence over price. The company has, however, ventured into its `dream series' of more affordable apartments, where pricing may prove the key variable.

Sobha's top line has grown at a compounded rate of 75 per cent over the past three years, with earnings surging by 320 per cent in the same period. While we are sanguine about the prospects of the company, we expect the future growth to be far more sedate.

In the contractual project space, Infosys still contributes 83 per cent to the segmental revenue. While the company's ability to retain this client is commendable, the skewed revenue nevertheless heightens risk. Land acquisition-related problems in Karnataka (where the company chiefly operates) is another risk factor to reckon with.

Offer details: The initial public offer is open from November 23-29. The company seeks to raise Rs 490-570 crore through this offer. Kotak Mahindra Capital and Enam Financial Consultants are the book-running lead managers. IL&FS Investsmart is the co-book running lead manager.

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Sobha Developers IPO Analysis

Premium price for a premium company

Promoted by NRIs P.N.C. Menon and Sobha Menon, Sobha Developers (SDL) is one of the leading south-based real estate development and construction companies with a strong presence in Bangalore’s premium real-estate market. The company has developed and constructed 21 residential projects in Bangalore covering approximately 2.98 million square feet, 75 contractual projects in eight Indian states comprising around 8.42 million square feet, and two commercial projects aggregating 0.11 million square feet.

SDL has executed projects such as convention centres, software development blocks, multiplex theatres, hostel facilities, guest houses, food courts, restaurants, educational and research centers and club houses for Infosys Technologies. The company signed an MoU with Reliance Energy (REL) in May 2006 to participate in a consortium in response to an expression of interest invited by Andhra Pradesh Industrial Infrastructure Corporation for the development of a business district and trade towers in Hyderabad. REL and SDL have agreed to form a special purpose vehicle (SPV) in future for this specific purpose and invest up to 26% of the share capital of the SPV.
SDL is coming out with an IPO to finance its existing projects, land acquisition, repayment of loans and meeting general corporate expenses.

As on 30 September 2006, SDL had land reserves of 2,747 acres and land arrangements of 3,373 acres. On 7 July 2006, Cushman & Wakefield had estimated the net present value of the land reserves to be about Rs 7035.6 crore - Rs 7776.2 crore. After deducting the developer’s margin, the value of the land reserves stand between Rs 3971.7 crore - Rs 4389.8 crore. The company plans to develop land in seven -10 years. The per share present value of land, based on Cushman & Wakefield valuation after deducting the developer’s margin, works out to about Rs 545 – Rs 602. After subtracting the amount to be paid in future, the value works out to Rs 360- Rs 418.
SDL has entered into land arrangements (contractual agreements) with third party to procure land located in and around Cochin, Pune and Chennai at or below certain prices on its behalf. The net present value of the land arrangements is estimated to be approximately Rs 4347.8 crore - Rs 4805.4 crore. After deducting the developer’s margin, the land value of the land arrangements is approximately Rs. 2306 crore - Rs 2548.7 crore. The per share present value of land arrangements, based on Cushman & Wakefield valuation after deducting the developer’s margin, works out to about and Rs 316- Rs 350. After subtracting the amount to be paid in future, the higher cap end is Rs 217-Rs 250 and lower end Rs 284-Rs 317.
SDL has backward integrated by venturing into activities such as concrete block making, metal and glazing, and interiors and woodwork. The company can deliver in-house a project from conceptualisation to completion. Being in the premium segment, backward integration enables the company to maintain the required quality of products and services required for the development and construction of a project, meet its quality standards, and deliver in a timely manner.

SDL is presently developing 15 residential projects in Bangalore aggregating about 4.97 million square feet of super built-up area comprising 26,820 apartments. In addition, the company has proposed to develop 13 residential projects in Bangalore, aggregating approximately 5.17 million square feet of super built-up area comprising 3,055 apartments. From the date of commencement, it ideally takes about two years for a company to complete residential projects. As per the management, the current average realisation in the segment in which the company operates is in the range of Rs 2500- Rs 2750 per square feet and the cost of construction is in the range of Rs 1300-1700 per square feet. Going ahead, real estate prices are likely to increase by 12-15% in Bangalore.
SDL is currently executing 23 contractual projects for various corporate and other entities such as a school, a hospital and software development blocks in various states amounting to about Rs 529.19 crore. Historically, the company’s EBITDA margin was about 17-18% in contractual projects.


Between FY 2004 to FY 2006, revenue shot up from Rs 195.09 crore to Rs 596.62 crore and net profit from 8.88 crore to Rs 89.23 crore Out of the total revenue, the share of contractual projects was 58%, 64% and 34%, respectively, for the past three years (from FY 2004 to FY 2006). The balance was contributed by residential and commercial projects.

Annualised EPS for the first half of current financial year works out to Rs 14.8. At the offer price band of Rs 550- Rs 640, the PE range is 37-43. Comparable but much smaller companies like D S Kulkarni Developers and Ansal Housing trade at PE of 18 and 15 times their first-half annualsied EPS.

Real-estate is currently the hottest industry in the stock market and likely to remain so till DLF completes its impending huge IPO. In such a scenario, its natural for premium companies like Shobha Developers to charge premium valuation.

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