Monetary policy preview
RBI expected to maintain a status quo
We expect the Reserve Bank of India (RBI) to keep the policy rates unchanged during its first quarter review of the annual credit policy on July 31, 2007. With inflation down below 4.5% and the annual credit growth moderating to 24%, the RBI is much more comfortably placed than it was in the previous couple of quarters. Thus we feel the monetary policy's focus is likely to shift from inflation management to liquidity and exchange rate management, as the current high annual growth of above 21% in the money supply continues to be above the central bank's comfort zone. The market also seems to be unanimously agreeing that the status quo on policy rates (reverse repo and repo rates) would be preserved. However, market estimates suggest that there exists a 10% chance of the cash reserve ratio (CRR) being increased by 50 basis points in the upcoming policy review meet.
STOCK UPDATE
ITC
Cluster: Apple Green
Recommendation: Buy
Price target: Rs200
Current market price: Rs172
Better than expected results
Result highlights
- The Q1FY2008 results of ITC were better than our expectations. In Q1FY2008 the net revenues of ITC grew by 16.7% year on year (yoy) as most of its businesses witnessed a strong growth: cigarettes (revenue up 9%), fast moving consumer goods (FMCG; revenue up 50.7%), hotels (revenue up 11.3%), paperboards (revenue up 5%) and agri-business (revenue up 27.6%).
- The operating profit grew by 16% to Rs1,127 crore in Q1FY2008 as against Rs970.5 crore in Q1FY2007. The company's earnings before interest and tax (EBIT) margin dipped slightly by 26 basis points to 17.8% in Q1FY2008, primarily because of the ongoing expansion in most of its businesses that resulted in higher fixed and depreciation costs. We consider this to be a short-term phenomenon as the incremental capacity in these businesses will help the company to fuel growth and improve its positioning in the respective markets.
- With a higher depreciation charge of Rs101 crore in Q1FY2008 as against Rs87.6 crore in Q1FY2007, the Q1FY2008 net profit grew by 20% yoy to Rs782 crore.
- We believe despite the imposition of a 12.5% value-added tax (VAT), a 5% increase in the excise duty and a 33.5% trade tax in Uttar Pradesh, the net realisation in the cigarette segment improved in this quarter due to an average increase of 20% in the selling price of most of the brands. There had been a marginal decline in the volumes in this quarter due to a major price hike in the last week of April 2007. We believe the volumes in second quarter will also remain affected and from the third quarter the volumes will recover.
- The non-cigarette FMCG business is the only business in ITC's portfolio that is not making a profit. However, its losses have come down in this quarter despite the roll-out of the Bingo brand of products throughout the country in March 2007. With the entry into new businesses and losses coming down, the improvement in the performance of the non-cigarette FMCG business is apparent.
- In the hotel segment, with the current properties working at peak occupancies, the 11% growth in the top line was driven by improved revenue per available room (RevPAR) and the stellar performance of the food and beverage (F&B) segment.
- The paperboard segment registered a slower growth of 5% due to the planned shutdown of a paperboard machine at Bhadrachalam in this quarter. With this machine getting fully operational again, the company expects the business to regain its growth trajectory going forward.
- We have always maintained that the fear of VAT may have a dampening effect on the stock but the same is likely to be a short-term aberration and one should look at the stock with a long-term perspective. At the current market price of Rs172, the stock is attractively quoting at 21.6x its FY2008E EPS and 13.7x FY2008E EV/EBIDTA. We maintain our Buy recommendation on ITC with a price target of Rs200.
Balaji Telefilms
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs303
Current market price: Rs249
True on expectations
Result highlights
- The Q1FY2008 results of Balaji Telefilms Ltd (BTL) are in line with our expectations. The company reported stand-alone numbers (our preview estimates were based on consolidated numbers) that do not include the results of its film business and subsidiary in the UAE.
- The revenues for the quarter were almost flat year on year (yoy) at Rs74.5 crore, as was expected. The realisation from the commissioned programming business showed an impressive growth of 49.3% yoy to Rs33.5 lakh. However lower programming hours at 204.5 hours compared with 298 hours in Q1FY2007 led to a marginal increase in the revenues from this segment.
- As per its strategy of finally exiting the sponsored programming business the company reduced its programming under this format from 220.5 hours to 142 hours, while the realisation improved by 39.3% yoy to Rs4.2 lakh per hour. This led to a drop in the revenue from this segment to Rs6 crore against Rs6.6 crore in Q1FY2007.
- The operating profit margin (OPM) showed a good growth of 418 basis points yoy to 39.6% as the programming cost as a percentage of sales declined by 802 basis points on account of higher realisations. Thus the operating profit grew by 13.3% yoy to Rs29.5 crore.
- Consequently, on account of a higher tax outgo the adjusted net profit grew by 6.1% yoy to Rs18.4 crore.
- During the quarter BTL launched "Kasturi" on Star Plus and its overseas offering "Khwaish" on ARY channel while "Kesar" (Star Plus) and "KumKuma Bhagya" (Udaya TV) went off air. In July 2007 it also launched "Khwaish" on Sony. Considering that these new shows went on air and several other new launches have been planned in the coming quarters, we expect the commissioned programming volumes to pick up, especially on the launch of channels proposed under its joint venture with Star.
- BTL's co-production "Shootout at Lokhandwala" (released on May 25, 2007) was a big hit and one of the top revenue grossers on the box office.
- At the current market price of Rs249 the stock discounts its FY2009E earnings by 13.6x and quotes at an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 7.5x. We maintain our Buy recommendation on the stock with a price target of Rs303, based on our sum-of-the-parts (SOTP) valuation.
Ranbaxy Laboratories
Cluster: Apple Green
Recommendation: Buy
Price target: Rs558
Current market price: Rs375
Valtrex settlement improves earnings visibility
Key points
- Ranbaxy Laboratories has reached an out of court settlement with GlaxoSmithKline (GSK) on Valtrex® (Valacyclovir Hydrochloride tablets), as per which Ranbaxy will enjoy the 180-day exclusivity for marketing the generic version Valtrex® in US market in late 2009 (after the expiry of the patent in June 2009). Valacyclovir Hydrochloride is used in the treatment of herpes virus infection
- The total annual market sales of Valtrex were around $1. 3 billion, which the management expects to, touch $1.5 billion by late 2009 (we have considered $1.4 billion market size for our estimate). Anticipating Ranbaxy to garner at least 55% market share and 40% profit margin during the exclusivity period in late 2009, the product can generate $269 million in revenues and $107.8 million (Rs442 crore) in profits. This will translate into incremental EPS of Rs11.1 per share during the exclusivity.
- At the current market price of Rs375, the stock trades at 18.0x its CY2007E earnings. Anticipating earnings surprises from its first-to-file product pipeline, we maintain our Buy recommendation on the stock with a price target of Rs558.
Wockhardt
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs552
Current market price: Rs383
Acquisition-led growth
Result highlights
- Wockhardt's net sales increased by 52.7% to Rs630.3 crore in Q2CY2007. The growth was achieved on the back of a 16.2% growth in the domestic business and a 79.4% growth in the international business. On a like-to-like basis (excluding the impact of the acquisitions made during the year), the growth stood at about 9.2% during the quarter. The sales growth was in line with our estimates.
- Wockhardt's European business almost doubled during the quarter to Rs361.2 crore, driven by a healthy performance across the existing markets of the UK and Germany, and the consolidation of Pinewood and the recently acquired Negma Laboratories (Negma).
- The formulation sales in the US market grew by 50.7%, driven by five new product launches and strengthening of the existing product portfolio in the USA.
- Wockhardt's operating profit margin (OPM) expanded by 240 basis points to 26.1% in Q2CY2007, driven by an improvement in the gross margin and a reduction in the research and development (R&D) cost. Adjusting for the capitalised R&D cost of Rs17 crore, the OPM remained flat at 21.5%. The company reported an operating profit (OP) of Rs152.2 crore, a growth of 69.7% year on year (yoy).
- Wockhardt's net profit stood at Rs102.4 crore in the quarter, growing by 61.5% yoy. The profit growth was way ahead of our estimates, despite a 15-fold increase in the interest expense (on account of an increase in debt for funding acquisitions and foreign exchange [forex] loss), a 22.9% rise in the depreciation charge and a 180-basis-point increase in the tax incidence. On adjusting for the net forex gain recorded by the company during the quarter, the net profit stood at Rs96.4 crore, up 52.1% yoy.
- During the quarter, Wockhardt completed the acquisition of France-based Negma, which has sales of $150 million and an earnings before interest, tax, depreciation and amortisation (EBITDA) margin of around 18%, in an all-cash deal worth $265 million. This acquisition is in line with the company's aim to achieve a turnover of $1 billion by 2009. With the company's successful track record of creating value post-integration, we believe the acquisition of Negma too will be value accretive for Wockhardt.
- In order to account for the Negma acquisition and the appreciation in the rupee against all the other major currencies, we are revising our revenue and earnings estimates for Wockhardt. We have upgraded our revenue forecasts by 19.6% and 21.8% to Rs2,272.8 crore and Rs3,098.8 crore for CY2007 and CY2008 respectively. Our earnings per share (EPS) estimates have been upwardly revised by 2.6% and 2.9% to Rs31.0 and Rs35.8 for CY2007E and CY2008E respectively.
- At the current market price of Rs383, the stock is available at 12.4x its CY2007E and 10.7x its CY2008E earnings, on a fully diluted basis. The valuations seem very attractive at these levels and should be viewed as a strong buying opportunity. We maintain our Buy recommendation on the stock with a price target of Rs552.
NIIT Technologies
Cluster: Ugly Duckling
Recommendation: Buy
Price target: Rs690
Current market price: Rs495
Price target revised to Rs690
Result highlights
- For Q1FY2008, NIIT Technologies Ltd's (NTL) consolidated revenues reported a decline of 5.8% quarter on quarter (qoq) and growth of 20.1% year on year (yoy) to Rs229.4 crore. The revenue growth in the quarter was dented by 4.8% due to the appreciation of the rupee and seasonal weakness in the domestic business (which declined by 26.7% qoq to Rs16.1 core).
- The operating profit margins (OPM) plummeted by 340 basis points to 18.5% on a sequential basis. During the quarter, the OPM declined by 480 basis points due to the cumulative impact of the rupee appreciation (negative impact of 240 basis points), annual wage hikes (average hikes of 16% resulted in negative impact of 200 basis points) and increase in rentals (impact of 40 basis points). The same was partially mitigated by 100-basis-point improvement in the blended realisations and 40-basis- point gain from an increase in offshore component and better operational efficiencies.
- The increase in the other income to Rs6.2 crore (up from Rs5.6 crore in Q4FY2007) was aided translation gains of Rs3.6 crore. The consolidated earnings declined by 23.5% qoq and grew by 60.3% yoy to Rs35.1 crore.
- In terms of the outlook, the order backlog executable over the next 12 months grew to $105 million (up from $103 million in Q4FY2007) and the fresh order intake stood at $40 million. Apart from this, the joint venture (JV) with Adecco has become operational in the current month and would add to the company's overall growth in revenues. The management expects the margin to improve in the coming quarters and has guided for flat margins on a full year basis (as compared to its earlier guidance of improvement in the margins).
- To factor in the effect of rupee appreciation, the earnings estimates is revised downwards by 3% and 4.3% in FY2008 and FY2009 respectively. At the current market price the stock trades at 12x FY2008 and 10.1x FY2009 estimated earnings. We reiterate our Buy call on the stock with a revised price target of Rs690 (14x FY2009 earnings).
Nicholas Piramal India
Cluster: Apple Green
Recommendation: Buy
Price target: Rs326
Current market price: Rs265
Price target revised to Rs326
Result highlights
- The net sales of Nicholas Piramal India Ltd (NPIL) grew at a subdued rate of 15.5% year on year (yoy) to Rs603.5 crore in Q1FY2008. The same were much below our expectation of Rs660 crore.
- The revenue growth was lower because the company lost about Rs25 crore worth of business from its largest brand Phensedyl, as Codeine, one the key raw materials, was in short supply. Further, the rise in the rupee and delay in revenue realisation also affected the top line growth.
- NPIL's operating profit margin (OPM) contracted by 360 basis points to 13.2% during the quarter, largely due to the lost business and the rising rupee. The sharp increase in the staff cost also affected the margin, which was below our expectation of 15.3%. Consequently, the operating profit declined by 9.4% to Rs79.5 crore.
- There was an incremental other income of Rs6.6 crore (including Rs4.6 crore of foreign exchange [forex] translation gain). But the interest cost jumped by 144.8% and the tax incidence shifted up from 11% in Q1FY2007 to 13%, resulting in a 19.4% fall in the consolidated net profit to Rs43.4 crore. The net profit too was below our estimate of Rs59.3 crore.
- However, considering the rupee's appreciation and the lower than expected growth in the contract manufacturing operations (CMO), we have downgraded our estimates for the company. As per our revised estimates, NPIL's revenues and profit would grow at compounded annual growth rates (CAGRs) of 15.8% and 22.4% to Rs3,248.1 crore and Rs342.1 crore respectively in FY2009. Our revised EPS estimates for FY2008 and FY2009 stand at Rs13.4 (down by 5%) and Rs16.3 (down by 3.7%) respectively.
- Based on our revised estimates, we have downgraded our price target to Rs326. In fact, we have valued the base business at Rs293 per share (ie 18x FY2009 EPS) and maintained the value of the research and development (R&D) deal with Eli Lilly at Rs33 per share.
- At the current market price of Rs265, NPIL is discounting its FY2009 estimated earnings by 16.3x. In view of the traction in the operations of both the Indian businesses, the improvement in the operating leverage and the steady progress in the domestic business of formulations, we remain positive on the stock.