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Sunday, December 23, 2007

Market Index Outlook

The Indian markets suddenly caved in last Monday, catching most participants unawares. The disquieting aspect of last week’s trade was the weakness witnessed in the mid- and small-cap stocks. Both the BSE Mid-cap and Small-cap indices lost around 4 per cent as investors opted to take some money off the table prior to the year-end holiday season.

With just three days to go for the expiry of the December contracts in the derivative segment, volatility is expected to rule high. The large build-up in the open interest will exert downward pressure on stock prices. Liquidity too is far from robust; FIIs pulled out close to $1 billion in cash segment in the week gone by.

The near-term outlook for the Sensex is currently negative. The 14-day relative strength index at 45, and the 10-day rate of change oscillator slipping into negative territory imply that the down-move can continue in the near term. The weekly momentum indicators too corroborate this view. But short-term investors can take heart from the fact that the Sensex is yet to breach the support around 19000. An emphatic move below this level is needed to drag the index lower towards 18500 or 18182 in the near-term.

Our medium term outlook for the index stays positive. The Sensex is consolidating in a band between 18000 and 20500 since October 30. This sideways move is likely to be followed by a break-out to 20942 or 22627. This view will hold good even if the index were to fall to 17800. However, a close below this level will imply that a correction of a larger degree could be in progress.

The bulls are likely to marshal their resources and strike back early next week. The Sensex could move higher to 19500 or 19882. But a downward reversal is possible from either of these two levels. Failure to move above the first resistance would denote that the index would slide down 19067 or 18503. The support zone around 19000 would be effective this week as well.

Nifty (5766.5)

Nifty moved lower as indicated in this column last week. Though it breached the short-term support at 5834, the index was able to pull itself higher from the next support at 5700. The zone between 5650 and 5750 will be an important support level in the week ahead.

The index can attempt to move higher to 5871 or 5992 early next week. Fresh short positions can be initiated if the index fails to get past the first resistance. The downward targets would then to 5670 and then 5557. Our medium term outlook stays unaltered. The Nifty could move between 5400 and 6200 for a few weeks before the index moves higher to 6262 or 6795.

Global Cues

The Dow Jones Industrial Average gave everyone a scare towards the middle of last week when it dipped below the long-term 200-day moving average line. But the situation was salvaged to some extent by Friday’s rally. A move beyond 13500 by the index next week will ensure that equities enter the New Year with good cheer. The tech-heavy Nasdaq Composite Index spear-headed the surge last week with a 5 per cent recovery from the week’s lowest point. Asian equities remained steady, though the intermediate term trend continues to be down in most Asian markets.

Base metals such as aluminium and copper stayed in a weak mode. Comex gold is consolidating above the 50 day moving average. The outlook for this metal stays positive as long as it holds above $770

India Real Estate gets more funds

Amidst all the worries about a property bubble in the US, the Indian realty sector continues to witness a deluge of funds, not only from private equity investors but also from builders seeking a toehold in this market.

Twenty-one private equity deals worth $1,292 million were struck in the realty sector in the six months between April and September 2007. This is a substantial increase over eight deals worth $282 million inked in the same period last year, according to Real Estate Intelligence – a research and consulting firm.

From investment banking majors Morgan Stanley and Blackstone to UAE-based Khaleej Finance and Investment and Ras Al-Khaimah Investment Authority, Indian realty companies have been attracting a wide range of institutional investors. Institutional investors expect $5 billion to be pumped into Indian real estate over the next three years, says the recent FICCI-Ernst & Young India Real Estate Report 2007.
Direct-stake route

The size and number of such deals apart, the route now being taken by institutional investors to get an exposure to projects also reflects their bullish view on Indian realty. Investments which were initially routed through Special Purpose Vehicles (SPVs) are now beginning to come in through the direct portfolio route.

Portfolio level participation is a high-risk high-return proposition as investors take concentrated exposures to a few projects. Prominent private equity names such as ICICI Ventures, HDFC, IL&FS Investment Managers, Kotak, Morgan Stanley, and Citigroup had initially invested in real estate projects through SPVs which would, in turn, re-direct funds into 5-6 projects. In recent times, some of these investors have taken direct stakes in specific projects.

“Investors who were initially evaluating this market were using the SPV route. Now, with increased confidence and a more focused approach to the realty market, the portfolio route may be the way to go,” says Mr Anurag Mathur, Deputy Managing Director, Cushman & Wakefield India.

DLF recently offloaded a 49 per cent stake in seven of its residential projects across India to global financial major Merrill Lynch. According to Cushman & Wakefield, investments at the portfolio level are now the highest and account for 40 per cent of investments in Indian real estate.
Global builders

In another trend, entity-level partnerships have also emerged, with instances such as Morgan Stanley acquiring a stake in Mantri Developers, a Bangalore-based realty company. But it is not only institutional investors who are flocking to Indian realty, global builders are here too. Alliances announced by UAE-based Nakheel and Emaar, Amsterdam’s Plaza Centers NV and Israel’s Alony Hetz with Indian players indicate that overseas builders perceive a huge opportunity in this market.

“Their entry would help in improving quality and meeting timelines (on projects). Thanks to the deep pockets of the international players, the scale of projects will also increase,” predicts Mr Ramesh Nair, Managing Director, Jones Lang LaSalle Meghraj. As he puts it, “2005 was the year of the real estate investment tourists to India. 2006 was the year when they sought partners who have access to land. 2007 has been the year of searching for partners with good execution skills.”

Precision Pipes and Profiles Subscription Details

Qualified Institutional Buyers (QIBs) - 5.0343 times

Non Institutional Investors - 8.5824 times

Retail Individual Investors (RIIs) - 18.7003 times

OVERALL - 10.35 times

Mutual Fund Analysis

Mutual Fund Analysis

Welspun India

Welspun India

Weekly Watch - Dec 22 2007

Weekly Watch - Dec 22 2007

Analysts’ picks

Reco price: Rs 417
Target price: Rs 736
Current market price: Rs 420
Upside: 75.23%
Brokerage: IL&FS Investsmart
Pyramid Saimira Theatre (PSTL), a leading exhibitor based in South India is expected to emerge as India’s largest fully integrated media company with business interests in production, distribution and exhibition.
PSTL has successfully demonstrated its ability to enhance revenues and realise operating efficiencies while ramping up at a fast pace. The company’s revenues and net profit are expected to record a CAGR of 151 per cent and 254 per cent respectively through FY07-09E. IL&FS Investsmart has put a BUY recommendation with a target price of Rs 736.
The stock at the recommended price of Rs 417 is valued at PE multiple of 18 times FY08 and 9 times FY09E estimated earnings.
Reco price: Rs 235
Target price: Rs 358
Current market price: Rs 236
Upside: 51.7%
Brokerage: Emkay Share and Stock Brokers
GMR Infrastructure has recently announced the placement of 165.23 million shares at a price of Rs 240 to QIB's. The company has raised Rs 396.6 crore through the issue and would result in the equity base being expanded by 9.08 per cent post dilution.
The funds raised from this issue would be utilised for capital expenditure of its various projects. The fair value for GMR Infrastructure is based on the DCF value for each of the projects.
Though the equity dilution does not in any way change the fair value of the company, the per share value stands reduced on account of the increase in the equity capital. We revise our target price to Rs 358. The target price is based on the embedded value of each of the projects.
Reco price: Rs 87
Target price: Rs 106
Current market price: Rs 83
Upside: 27.7%
Brokerage: Angel Broking
Varun Shipping is one of the safest bets in the shipping industry, given higher stability in its revenues. Further, Varun Shipping has been consistently declaring dividends over the past many years.
The company is expanding its asset base and business operations in the offshore support services segment to explore newer opportunities in energy. Varun Shipping had allocated $400 million for expansion of fleet. Of this, it spent $320 million in the last one year with the addition of five vessels.
Most of the vessels acquired over the last 3-4 quarters are expected to contribute fully to the revenue 2HFY2008 onwards. At recommended price of Rs 87, Varun Shipping is trading at 5.8 times and 5.3 times FY2009 and FY2010 estimated earnings. The brokerage puts a buy recommendation with a 12-month target price of Rs 106.
Reco price: Rs 702
Target price: Rs 745
Current market price: Rs 693
Upside: 7.5%
Brokerage: Religare
According to the brokerage, Hero Honda is aggressively capturing market share in economy and premium segment. This is further expected to improve its market share to 18 per cent in the near term in the premium segment.
Also, on the back of attaining high degree of localisation of components and with the expectation that prices of nickel, aluminium will remain soft, EBIDTA margins are expected to improve.
Further, the company has indicated that it has lined up its new product and variant launches for motorcycle and scooters till FY10.
The brokerage house has increased its revenue and margin estimates on the back of recent developments in the company. With the revised estimates, the target has been raised to Rs 745. At the recommended price the stock is valued at 15.4 times FY08 and 13.7 times FY09 estimated earnings.
Reco price: 400
Target price: NA
Current market price: 412
Upside: NA
Brokerage: ICICIdirect
Core Projects and Technologies a pure IT company with interests in verticals such as education, logistics and healthcare, is set to capitalise on the education boom across the globe with its strong product portfolio.
The company has successfully acquired seven companies in the past two financial years across various verticals and products. This has helped the company triple its revenues in FY07 with the acquired companies contributing more than 65 per cent to revenues (Rs 194 crore) and net profit (Rs 33.37 crore).
The company’s inorganic growth strategy has helped it to penetrate newer geographies and cross-sell products and solutions to new clients. The company is expected to continue to grow inorganically and acquire companies having strong products in the US and UK.
Core Projects has signed an agreement with the CHL at NASA’s space centre for delivering educational content exclusively to the Asia-Pacific region.
The company has also signed a MOU with IL&FS and the Indira Gandhi National Open University (IGNOU) to create education content. At the recommended price of Rs 400, the stock trades at 55 times FY08 and 29.3 times FY09 estimated earnings.

Corporation Bank, Jindal Power and Steel

Corporation Bank, Jindal Power and Steel

Daily Technical Futures - Dec 24 2007

Daily Technical Futures - Dec 24 2007

Pantaloon Retail

Pantaloon Retail

India Equity Strategy

India Equity Strategy

Pullback likely

The markets witnessed a healthy correction last week mainly on account of sustained selling by the foreign institutional investors. The overseas investors net sold stock worth Rs 4,641 crore in the first three trading days of the week, as per data available on the Sebi website.

The Nifty plunged to an intra-week low of 5,677, down 363 points from the weekly high of 6,040, on account of unabated selling. It eventually ended with a loss of 4.7 per cent (281 points) at 5,767. The low of 5,677 was nearly R3 (resistance 3) on the quarterly charts. The index may pull back up to 5,900-6,000 provided it holds last week’s low. In case the index dips below 5,677, it may slip to 5550.

The Nifty has seen congestion around its 50-day daily moving average of 5,750. The Stochastic low at 20.6 is almost in oversold zone. This, coupled with the possibility of short-covering owing to the December series expiry, could aid the upmove. The index is likely to face resistance around 5,905-5,950-5,990 this week, whereas it may find support around 5,625-5,585-5,540.

After opening flat at 20,033 (up one point), the Sensex tumbled to a low of 18,886 - down 1,146 points from the week’s open. The index finally ended with a loss of 4.3 per cent (868 points) at 19,163.

In case of follow-up selling, the index may take support around 18,600 level. Resistance would emerge around the 19,800 level. The weekly support and resistance levels for the Sensex are placed at 18,725-18,590-18,450 and 19,600-19,735-19,875 respectively.

Weekly Report - Dec 24 2007

Weekly Report - Dec 24 2007

Rolta India: Hold

Investors can retain their holdings in Rolta India with a 12-18 month horizon, considering its fair growth prospects. At the current market price (Rs 677), the stock appears richly valued at 25 times and 20 times its estimated current year and 2008-09 earnings respectively.

This is close to the valuations enjoyed by KLG Systel and Infotech Enterprises (not strictly comparable), but at a significant premium to most Tier-II players in the IT space.

Investors can retain holdings and consider fresh exposures only on a substantial dip in stock prices. Amidst an uncertain environment for Tier-II IT companies, in general, the company has managed strong growth on the back of a domestic focus and niche areas of business. This has helped the stock deliver strong gains in recent months.

Rolta provides geo-spatial information systems (GIS) services such as digital mapping and photo-grammetry. Engineering design services is another area of operation.

Rolta also offers traditional IT services in partnership with Computer Associates and Enterprise Application Services with Oracle.
Business Drivers

Government orders and domestic theme: Rolta provides GIS services to a wide range of customers. This involves interpretation of satellite images, remote sensing and geo-spatial data modelling, which are delivered to agencies such as the Ministry of Defence, National Remote Sensing Agency, Survey of India, Airports Authority of India, as well as to a few non-government clients.

By the very nature of their operations, these organisations require constant upgrade and maintenance of imaging data. Rolta appears well-placed to tap potential repeat business, given its significant presence in this space and execution track record.

The telecom angle: Rolta also works with telecom companies in Europe and North America for enabling provision of geographic information/digital mapping services on mobile phones.

This is a feature that may help provide information about hotspots, traffic information, hotels and the like, which have high levels of usage in those countries. This constitutes another revenue stream.

This apart, as and when 3G services are commenced in India, Rolta, which works with BSNL as well, may be well-positioned to extend this service to Indian operators as well.

Engineering design and automation: This is another area where Rolta has been able to piggyback on India’s domestic infrastructure spend.

Its engineering design services cater to engineering, power, refinery and the shipping industries. Rolta’s services here cater to a good part of the engineering services value chain.

These are high growth sectors and Rolta has clients in such areas in India, West Asia and the US as well. Engineering services also commands higher billing rates than GIS services and has been growing at over 35 per cent for the company and may improve realisations.

The geographical spread and capabilities also means that it may be well-placed to latch on to the next wave of outsourcing, which is believed to have engineering services outsourcing as a chunk. The company has a joint-venture with Thales, a player in critical information systems working with aerospace, Defence and security market. This JV may help Rolta corner any outsourcing to the JV done by Thales’ clients.

Another JV has been forged with Stone & Webster in the engineering services space, enabling the company to work in areas such as nuclear power engineering.

The JV is revenue-accretive to Rolta, and is executing projects in Singapore. The two companies are also seeking to capitalise on any opportunity arising out of the Indo-US nuclear deal, when it is completed.

Rolta has a strong order-book of over Rs 950 crore for the current year. The strong domestic focus means that the company is well-placed to weather rupee appreciation risks. The company operates at a 40 per cent earnings before interest, tax, depreciation and amortisation (EBITDA) margin, placing it well above levels enjoyed by Tier-II players.

The company also has recurring revenues of about Rs 150 crore for this year, up 25 per cent over last year.

The company derives nearly 38 per cent of its revenues from government orders. This means that receivables cycles could be much longer than is the case with other software companies. There are certain projects where complete payment is received only after the warranty period.

These may place higher demands on working capital requirements.

This apart, in the traditional IT services business, the company has to contend with heavy competition from the top and Tier-II players.

Television Eighteen India: Hold

Through quick, successive moves in the print business, Television Eighteen India (TV 18) has added a missing link to its media value chain. With a presence that straddles television, Internet and soon print media, a demonstrated ability to strike the right partnerships to execute its plans, a leadership position in the electronic business news space and a clutch of Internet properties that hold potential for value unlocking, TV 18 remains the preferred stock in the media space.

Expensive valuations

But much of this is already captured in the stock’s current valuations, offering limited potential for strong upside in the near-term.

Adjusting for the valuation of its web properties (estimated at 15 times the likely FY-09 sales), the stock, at Rs 473, still trades at about 45 times its FY-09 earnings per share. This assumes significant growth rates for its existing businesses and success in new forays. But the company’s track record in execution inspires confidence, supporting our ‘hold’ recommendation.

However, TV 18 will remain in a heavy investment phase in the medium term. The print business has a longer gestation period than television and earnings could be impacted by losses from initial years; details are awaited on how the print business will be structured. Its flagship channel, CNBC TV 18, best known for its stock market focus, may suffer declines in viewership, should there be a change in investor sentiment.
Print plans in ink

TV 18’s long-expected foray into print has now been firmly inked. The Rs 178-crore acquisition of a 40 per cent stake in Infomedia India marked its entry into the segment. TV 18 intends to acquire a controlling stake in the company, by making an open offer to Infomedia’s shareholders for 20 per cent.

If the offer is not successful, TV 18 has the option to acquire an additional 13 per cent stake from existing promoters, ICICI Ventures.

The acquisition will provide the company access to the yellow pages directory business and, more interestingly, the special interest magazine segment, which includes magazines such as T3, Cricinfo, Overdrive and Better Interiors.

It will also provide it access to printing facilities. That would come in handy in publishing the English business magazine that TV 18 proposes to launch in 2008, in association with reputed business magazine Forbes Media.

This involves a content licensing arrangement and may extend to the introduction of other Forbes products, subject to regulatory approvals.

TV 18 also announced a simultaneous entry into the rapidly growing regional print market through a 50:50 joint venture with Jagran Prakashan, publishers of the leading regional newspaper — Dainik Jagran. Plans are on to launch a Hindi business newspaper in 2008, to be followed eventually by business newspapers in other regional languages.
Well-conceived strategy

The print business involves higher capex spends, requires an extensive distribution network, and a new player generally takes a longer period to penetrate the market and break-even compared with a new television channel, even if good content is taken as a given.

However, TV 18’s foray into the market appears, on first take, well conceived. The acquisition of Infomedia’s printing facilities, distribution network and a clutch of its brands may reduce time to market. TV18 also has strong partners in Forbes and Jagran Prakashan, which bring in their experience in print.

Secondly, it has entered the English business magazine segment, where there is less competition. In contrast, there are five-six players competing in the English business daily segment, some of them with considerable financial muscle. In the regional print segment, again, there is no existing business newspaper. TV 18 also has experience in Hindi business news, courtesy its Hindi business channel “Awaaz”.
Heavy investment phase

But TV 18’s recent forays are likely to require substantial investments over the medium term. Besides investing in the print business, it will have to continue to pump in money to improve the profitability of its recent acquisitions; Newswire 18 is still loss-making, while Infomedia’s earnings have been weighed down by declining margins.

Significant investments are also being made in Web 18, which operates web portals. This segment is not making money yet, although a series of acquisitions and new Web site launches has ensured a strong increase in revenues.
Value unlocking

Revenues from its Web operations in the first half of FY 08 were at Rs 21 crore, as against Rs 25 crore in the whole of FY 07. The portals attempt to get their revenues from not just advertising but also subscription, which brings some stability to the business model.

However, the losses from the Web business are a drag on profitability. TV 18’s operations on a stand-alone basis enjoyed margins of over 40 per cent in the first half compared to about 26 per cent on a consolidated basis. TV 18 intends to ultimately list the web business and unlock value; this is already captured in the current valuations for the stock.

But the timing of this event is uncertain and a significant delay in listing the subsidiary is a risk to the stock’s performance.

Greaves Cotton: Buy

Investors can buy the stock of Greaves Cotton with a two-three year holding perspective. Strong growth in the infrastructure equipment business, recent overseas acquisition and product launch, apart from its success in turning around operations, lend confidence to its growth prospects.

Though the stock has been weighed down by concerns about Piaggio setting up its own plant, the company has taken initiatives to improve contribution from the power engines segment and ensure that business does not suffer from the gradual withdrawal of its single largest customer — Piaggio.

The stock trades at 11 times its expected earnings for FY-09 at the current market price. This is at a discount to a few other players in the engines business.
No major threat from Piaggio exit

Greaves Cotton has been supplying 100 per cent of Piaggio’s engine requirements locally. The latter now plans to have its own plant, which is likely to take off by FY-10.

While it is true that Piaggio has been a major customer for Greaves’ single cylinder engine (auto engines accounted for about 57 per cent of its total revenues for FY-07), there are a number of other players in the three-wheeler segment whose relatively low volumes do not allow them to set up their own plant for engines.

While traditional players in the segment such as Bajaj Auto and Force Motors have achieved backward integration through engine manufacturing, newer players such as Atul Auto, Mahindra and Mahindra and Scooters India depend on outsourced engines. Greaves also supplies to a number of regional OEMs. The company’s efforts to broad-base customers may take off by the time Piaggio starts its production, which is two years away.

Greaves’ recent acquisition of a German engine-maker (single cylinder engine) may also provide better technology to the company apart from better access to a global distribution network.

This apart, the success of the one-tonne four-wheeler ‘Ace’ by Tata Motors has induced players such as Bajaj Auto and Atul Auto to enter this space. Piaggio has already launched its four-wheeler in India. Greaves, anticipating this demand, has launched twin cylinder engine for one-tonne four wheelers. Piaggio and Atul Auto are expected to source the same from Greaves. We expect this segment to make a visible contribution to revenues over the next few years.
Expanding non-auto segments

Greaves also makes air-cooled and water-cooled diesel industrial engines that find application in various quarters. The company has managed a 15 per cent share in a market dominated by unorganised players. It is now exploring sources of fuel for dual-fuel gensets on the back of escalating diesel prices. It is also simultaneously looking at introducing enhanced range of engines for industrial applications and gensets, improving its prospects for market penetration.

Similarly, in the agricultural engines segment (portable petrol/kerosene engines), the company has been successful in combating low-cost imports from China. While it makes its own engines, it exports them to China for conversion into power tillers, before importing them.
Not just engines

Greaves has also ramped up presence in road construction and concreting equipment. While there are quite a few players in the construction equipment segment, the concreting segment (consisting of transit mixer, batch mix plants and concrete pumps), is dominated now by Schwing Stetter (India), a subsidiary of a German company. With improved construction methods and stiffer execution time targets, concreting may offer a huge business opportunity.

While the construction segment contributes about 20 per cent to sales, we expect significant growth in the segment, which may also make up for any slowdown in the auto engines segment in the near term.

Greaves had a tepid September quarter on the back of slowdown in three-wheeler sales. Any policy move that further dampens the interest rate-sensitive auto sector may slow auto-engine sales. We however, expect the infrastructure equipment segment to provide some cushion through enhanced volumes from the recently commissioned facility in Tamil Nadu.

Cairn India: Buy

Investors can consider buying the Cairn India stock at the current price of Rs 224 with a medium-term investment perspective. The stock has appreciated 40 per cent in the last one year from its IPO price of Rs 160, undergoing a re-rating in the process. Appreciation from hereon could be slower though, and the stock price will be driven as much by positive news flowing in from the execution of the Rajasthan project as by sustained high oil prices.

Investors can consider acquiring the stock in tranches to exploit any price weakness caused by broad market factors.

Our recommendation is subject to three main risks. First, softer oil prices, which could erode the value of the company’s reserves in the Rajasthan field.

Second, the issue of who should bear the cess payable to the government — Cairn or ONGC — and in what proportion, is yet to be resolved. And, finally, a sustained appreciation in the value of the rupee versus the dollar could impact revenues as pricing is denominated in dollars.
On track

Cairn’s project in Rajasthan is on track to meet the deadline of mid-2009 for the first oil to flow out. The government’s approval for a pipeline to transport the oil to the Gujarat coast removes a major uncertainty surrounding the project –– the stock acquired momentum on news of the approval.

But one more hurdle remains to be crossed on this count as the government will have to approve the additional cost of laying the pipeline, estimated at $800 million (Rs 3,200 crore) including the storage tanks and single point mooring for evacuation of oil by sea.

Cairn has meanwhile gone ahead with the front-end engineering and design for the project and has also placed orders for equipment with long lead times.

The route of the specialised heated pipeline to transport the viscous Rajasthan crude has been planned in a manner that will give it access to existing pipeline infrastructure in the western region and to the refineries located there. Mangalore Refinery and Petrochemicals will be a prime customer for the oil which will be shipped from coastal Gujarat to the refinery.
Appreciating reserves

The sharp run-up in oil prices means that Cairn’s reserves have turned more valuable. Though the oil from Rajasthan will be priced closer to the commissioning of the project, the broad expectation is that it will be sold at a discount of between $5 and $7 per barrel to prevailing Brent crude price.

At current prices, that would mean Cairn will earn around $80-82 per barrel; at the time of its IPO a year ago, it was assumed that it will earn around $50-55 based on the then prevailing prices. Importantly, Cairn will not be weighed down by subsidies such as ONGC.

Cairn has conservatively estimated output from the field at 1,50,000 barrels per day at peak level, but this could increase by about 10-15 per cent with the company employing enhanced oil recovery techniques. The higher output and expected strong oil prices could buoy revenues and earnings in the initial period following commissioning of the project.
Risks to note

The biggest threat to Cairn’s valuation will be a retreat in oil prices. Given the rapidly rising global consumption and tight supply, the chances for a retreat appear small. But the travails of the US economy and the threat of a slowdown or even a recession there could cause oil demand to fall exerting pressure on prices. Subject to this caveat, the medium-term prediction is for oil to trade in the $80-90 band, which is beneficial to Cairn.

Second, the issue of who should bear the cess on the oil is in all probability headed for arbitration. Cairn is on strong ground as it is not liable, going by the production sharing contract.

However, chances are that eventually the company will be called upon to bear a part of the cess, thus affecting realisations. Cess payable ranges from Rs 927 to Rs 2,575 per tonne of oil depending on the classification of the field. An adverse decision could affect the stock sentiment.

The appreciating trend in the rupee is another cause for concern as Cairn’s output will be priced in dollars. Since the company’s IPO a year ago, the rupee has appreciated by 11.5 per cent against the dollar. Further appreciation could blunt the benefit flowing from higher oil prices.

Finally, the enhanced oil recovery techniques that Cairn will adopt such as chemical and polymer flooding in the wells are established ones but have not been tried out on the scale that the company plans to now do.

Incremental output over and above the planned 1,50,000 barrels per day may not materialise on the scale expected if the techniques fail.

ABG Shipyard: Buy

A burgeoning order book, continuing capacity shortage in the global shipbuilding sector and the company’s swift moves to capitalise on this scenario through capacity addition, make ABG Shipyard a good investment for those with a three-year perspective. At the current market price, the stock trades at 17 times its likely earnings for FY09. The stock may continue to trade at premium valuations, given the strong demand outlook for ships. This demand situation also suggests that new orders may be obtained at higher prices, which, in turn, may expand profit margins.

ABG Shipyard’s present order book of Rs 8,277 crore is about 12 times the company’s revenues for FY 07, lending earnings visibility for the next three to four years. The company has been ramping up its capacities to make sure that timelines on execution are maintained. For one, it has expanded its existing facility in Surat and also acquired a strategic stake in Vipul Shipyard located near the existing Surat unit. ABG is also setting up a new facility in Dahej, which is expected to commence operations from April 2008. Once this facility is fully operational, the company would be able to manufacture ships up to 1,20,000 DWT (dead weight tonnage), essentially implying ships with high profit margins.

ABG has also diversified its operations through the acquisition of the ailing Western Shipyard (WSI) – one of the largest private ship and rig repair companies. Apart from the strategic location of this acquired unit (in Goa), ABG is also likely to benefit from the highly lucrative repairs business. The ailing WSI, which has been troubled by mounting debt, has already received restructuring packages from banks and institutions. ABG’s infusion of cash would further help in the turnaround process. We have, however, not factored revenues from this company into our estimates at present.

ABG has bagged a good number of repeat orders as well as orders for small bulk carrier vessels with similar specifications. Repeat orders are likely to result in operational efficiencies as well as economies of scale. This trend, together with higher priced orders is likely to protect operating profit margins from erosion due to any hike in steel prices. The company’s operating margin for the September quarter rose to over 30 per cent, an increase of 160 basis points over the same period last year. A removal of the ship-building subsidy and slow execution are the key risks to earnings growth.