Weekly Track Report - Jan 7 2008
Sunday, January 06, 2008
After the loss of the United States, Britain needed a new penal colony for the relocation of convicts in its overcrowded prisons. (The prisons were full mainly due to the unemployment created by the Industrial Revolution). In 1787 the First Fleet of 11 ships and about 1350 people under the command of Captain Arthur Phillip set sail for Australia. On 26 January 1788—(a date now celebrated as Australia Day, but regarded as "Invasion Day" by some Aboriginal people and supporters)—a landing was made at Sydney Cove. The new colony was formally proclaimed as the Colony of New South Wales on 7 February. Thus European settlement began with a troupe of petty criminals, second-rate soldiers, and a crew of sailors.
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The total investors wealth surged by more than Rs35 trillion during 2007, while it has already grown by more than Rs2.66 trillion so far in 2008.
The total market cap stood at Rs71,69,983 crore on 31 December 2008, as against Rs36,24,357 crore at 2006-end. The market capitalisation has grown to a record high of Rs74,36,689 crore, as on 4 January 2008.
The gain of Rs35,45,626 crore in the investors’ wealth results into an average gain of Rs14,182.5 crore in one trading session or Rs42 crore every minute. However, the gain of Rs2,66,706 crore so far in 2008 gives an average of Rs66,676 per trading session or Rs199 crore per minute.
Even though SEBI has removed entry load for direct investors, you need to do your homework before exercising that option.
Mutual funds are subject to market risks. Please read the offer document carefully before investing…A footnote that follows every mutual fund advertisement. With the Securities and Exchange Board of India's (SEBI) new guidelines that the applications received directly by the asset management companies (AMCs) and over the internet will get complete entry load waiver, a direct investor will have to follow the above mentioned footnote more seriously.
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Where will the Sensex end 2008? Coming up with the right answer to that question is as difficult as predicting the quantum of rainfall in an Indian monsoon. In any case, what the Sensex does is often of little relevance to those of us who hold a portfolio made up largely of stocks outside the index basket. So instead of where the Sensex will be a year from now, we crystal gaze to identify some trends for 2008, which could decide how a retail investor should build her portf olio for the year ahead.
Index juggernaut may slow: Indian markets have repeatedly rubbished the notion that investors should expect only a 15-20 per cent return from their stocks. But 2008 may be the year in which Indian stocks, specifically index heavyweights and large-caps, struggle to come up with an encore. Until the end of 2006, profit growth for Indian companies was sprinting comfortably ahead of stock valuations.
Even in end 2006, the PE multiple for the BSE-500 index (22 times trailing earnings) was comfortably ahead of profit growth managed by these companies(31 per cent annually in the preceding five years). Growth expectations built into stock prices, thus appeared attainable.
But the recent stock rally has taken the BSE 500’s PE multiple to a demanding 27 times, though profit growth has actually slackened to 26 per cent in the September quarter.
With stock valuations factoring in high growth expectations, price gains from here on may be moderate, at least for front-line stocks.
Liquidity, unlimited: FII interest in Indian stocks may continue unabated, amidst a turbulent environment for stocks in the US and moderating interest rates in key developed markets. But hurdles, such as the unwinding of PN-routed FII investments ahead of April 2009 and the elections mid-year, suggest a bumpy road ahead. On the positive side, corrective phases may not be allowed to last.
With domestic investors (insurance companies, mutual funds, retail) finally acquiring an avid appetite for equities, the leading names of India Inc may continue to receive buying support on every significant dip. Buying interest from domestic investors has reduced the Indian markets’ vulnerability to global corrective phases recently and this trend may continue into 2008. Should global investors turn more risk-averse, stocks and sectors that play on purely India-specific themes may deliver.
Sunny prognosis for mid-caps: While the Sensex and the Nifty may merely coast along, mid-cap stocks may continue to sizzle in 2008, for three reasons. One, with interest rates set to peak, if not eventually decline this year, mid-sized and smaller companies could receive an earnings boost.
Second, as last year’s rally has already stretched PE multiple for frontline companies, the price-value equation is now more favourable for mid-caps. The search for “value” may take investors — both domestic and foreign — deeper into the basket of mid- and small-cap stocks this year.
Third, recent months have seen a surge in corporate actions by smaller companies. Institutions have made significant purchases in select sectors through the block deals route. Undervalued mid-caps have seen takeover bids, stake hikes by promoters and buyback announcements. Events such as these may top up strong earnings growth from the mid-cap basket.
The bright prognosis for mid-caps, however, will not apply either to small-caps with shaky fundamentals or to penny stocks. This segment of the market has seen indiscriminate buying on a deluge of retail money in recent months, and seems set for a cool-off.
Stock ideas from new sectors: Of the two pillars of the ‘India’ story, ‘consumption’-related sectors have lagged capex-driven ones in the past couple of years.
Strong resurgence in urban income is now a proven fact and better agricultural growth this year will likely drive rural spending. This may trigger new investor interest in domestic and “consumption”-related themes this year. But playing this theme through the usual routes — FMCGs, MNC pharmaceuticals or retail — may not be the best way to go.
Equity broking firms, financial services companies and banks may be a good proxy to piggyback on the swelling appetite for consumer goods and all forms of investment. The long line-up of foreign players waiting to enter insurance/asset management will continue to drive deal-making and thus, better valuations for recently listed financial services firms. Media stocks, which are catching up recently, remain good picks for investors who seek growth, albeit at a high price. Realty companies, both national and regional, may witness further re-rating as interest rates cool off, and new investment vehicles such as REITs redirect funds into this sector.
For investors looking for value picks that will contain downside risk, pockets of ‘value’ remain in PSU banks, smaller housing finance companies, automobile components (companies with a diversified product profile and those focussed on passenger car OEMs) and select capital-goods makers.
Robust rural growth and spiralling farm goods prices may throw up ‘dark horse’ opportunities from sectors that have been moribund: fertilisers, crop protection and seeds.
he Nifty made a ‘strong white candle’ on the last day of the week in daily and weekly charts. According to Asit C Mehta Investment, a technical analysis firm, both the stochastics are in the highly over-bought zone.
The 14,3,3 stochastic is still in the buy mode, while the 5,3,3 stochastic may generate a fresh buy signal with a further rise. The relative strength index (RSI) is in the positive mode. However, it is nearing the over-bought zone.
The five-day simple moving average (SMA) is providing good support during the last 10 days on a closing basis. Any daily close below the 6,183 level may be an earlier indication of the short-term weakness. The ten-day SMA has breached the 20-day SMA and is moving upwards. All these show that the undertone is bullish.
The weekly charts display early signals for a further rally. Both the stochastic and RSI generated a fresh buy signal during the last week.
The Nifty is expected to show some early weakness, which may be a short-lived one. However, the undertone is still bullish. The index is nearing the retracement resistance levels and it may act as strong resistance on the upmove.
The Nifty sees resistance at 6,305 (strong for the short term). Any decisive trade above this level will lead the Nifty to 6,351, 6,450 and 6,499.
A close below 6,153 will delay the upmove to these levels. On the other hand, the Nifty has support at 6,222, 6,153 (on a closing basis), 6,114-6,130 (strong for the short term), 6,038 and 5,946 (strong for the medium term).
The Nestle India stock is an attractive investment option for investors with a two-three year perspective. With a brand portfolio that straddles high-growth FMCG segments such as infant foods, dairy, beverages and processed foods, Nestle India enjoys strong pricing power and faces relatively low competition in the categories where it operates. At the current market price, the stock trades at a PE multiple of about 23 times expected earnings for 2009. While this is at a premium to the market, it appears justified in light of Nestle’s superior growth prospects and similar valuations enjoyed by peers such as Hindustan Unilever and Dabur India.
Nestle India’s brand portfolio appears best positioned among listed FMCG companies to capture the rising urban spends on health products and convenience foods. ; this appears to have reached an inflexion point. Dairy, infant foods and prepared dishes contribute about two-thirds of the sales, while beverages and confectionery account for the rest. Each of these categories carry significant room for market expansion and given the breadth of Nestle’s brand portfolio, offers scope for sustained double-digit growth in sales over the next few years.
Nestle India appears to be capitalising on this opportunity by expanding its brand portfolio through new launches in dairy products (probiotic and low fat dahi, milkshake and fruit yoghurt), prepared foods (Maggi Healthy Soups, Rice Noodles) and beverages (Nescafe Mild and an expanding chain of vending machines). The topline growth climbed to 25 per cent in the first nine months of 2007, from the low double digits managed for several years. The wide repertoire of brands and presence in the under-penetrated segments also shield it from the bruising competition being witnessed in mature FMCG segments such as personal care or shampoos. The company’s low adspend-to-sales ratio (less than 5 per cent, compared with 8-12 per cent for peers) reflects low competitive intensity.
An inflationary environment for inputs such as milk, wheat and coffee over the near to medium-term does pose a risk to margins. However, considerable room for price increases in the product categories, declining tax incidence and accelerated topline growth may still help drive a healthy pace of profit growth over the next three-four years.
Investors can continue to hold the shares of Firstsource Solutions. The stock offers potential for moderate capital appreciation due to reasonable business prospects and its valuations. At Rs 80, the stock trades at 19 times current year earnings and about 14 times its estimated 2008-09 earnings. This is at a premium to other business process outsourcing players in the Indian listed space, such as Allsec Technologies and Cambridge Solutions.
But Firstsource’s revenues and margins are higher, and it appears well-placed for significant scalability compared to its peers; this provides justification for valuations that are close to tier-two IT players. EXL Services and WNS, Firstsource’s peers listed in the US, are trading at 25 and 50 times their trailing earnings, respectively, despite their lower operating profit margins.
Firstsource is a pure-play BPO services provider, catering to clients in the banking, financial services & insurance, healthcare and telecom/media sectors. Voice and transaction processing services contribute almost all of its revenues. Forecasts from Nasscom suggest that business and knowledge process outsourcing services may manage stronger growth rates in the coming years than traditional application development IT services. A player such as Firstsource may be well-placed to gain from any heightened outsourcing wave from the US and Europe.
MedAssist acquisition holds promise: Firstsource completed the acquisition of MedAssist, a revenue cycle management company in the healthcare sector, recently. This acquisition is strategic as MedAssist is estimated to have over 800 hospitals as its clients in the US and would give Firstsource an expanded client base.
Also, Firstsource, which has a significant client base in the Insurance segment, will now be able to be on the payer as well as the claim management space, thus offering a complete chain of integrated services. MedAssist is already EBITDA accretive to Firstsource and may be expected to increase its contribution to realisations over time. Payoffs from this have not been factored into our earnings estimates.
Domestic and telecom exposure
The revenues from back office operations for Hutch, now Vodafone, have started to flow in for the company. With the hurdles to the Vodafone-Essar deal now cleared, Vodafone has embarked on customer acquisition ramp-up; this suggests that revenues for the company from Hutch may pick up in volume.
Considering that India also is the fastest growing telecom market, Firstsource appears well-placed to capture fresh market share from deals with other operators, for instance, any vendor rationalisation exercise by the likes of Bharti Airtel.
Global delivery model
The company has 24 delivery centres, which is a high number for BPO players. This spread allows Firstsource to deliver a mix of offshore, onsite and near shore services, thus optimising costs and margins. Some of these centres are in strategic low-cost destinations such as Argentina and the Philippines (a preferred outsourcing destination for many players) with sufficient manpower availability.
This may also help cater to clients who may be more comfortable with these destinations because of data-security fears or sensitivities expressed in outsourcing to India.
Firstsource’s partnership with Metavante, an IT player catering to banking clients, to tap North American markets seems to have worked in its favour. This partnership has helped the company to win several deals from top-tier banking and financial services clients. In view of the sub-prime crisis and fears of slowdown, this partnership may bring in expertise for targeted client-mining.
The company has a repeat business proportion of over 94 per cent. This compares favourably even with mostIT players and may be indicative of reasonable service quality levels. An increase here may also, over time, help Firstsource to reduce selling and marketing expenses. An improving revenue mix — both in terms of geography and verticals — is a healthy indication.
Although telecom and media and BFSI contribute 79 per cent of revenues at present, healthcare is also showing increasing contribution. The company hopes each of these verticals to contribute to one-third of its revenues, thus reducing concentration. The increasing domestic contribution (13.2 per cent) to revenues may also provide relief against any further depreciation of the dollar against the rupee.
Attrition, at 54 per cent, is higher than the sector norm and constitutes a very significant execution risk. With more captive units becoming third party BPOs to broadbase their offerings, they could pose a threat to the company’s market share.
Given the high growth prospects, pricing and competitive pressures from existing players in this segment such as Office Tiger, WNS, Genpact, and EXL Services looking to capture markets is a distinct possibility.
Last, top tier/second-rung players in IT services are making a significant foray into BPO/KPO services by way of outsourcing deals that have such a component. This may cut into the overall pie for players such as Firstsource.
Investors with a high-risk appetite and a three-four year perspective can consider exposure in the stock of Gremach Infrastructure Equipments and Projects (GIEPL).
While we had recommended that investors refrain from investing in the initial public offer, GIEPL’s recent expansion in product portfolio and the subsequent entry into new business segments presents the case for a relook.
Addition of four onshore drilling rigs with plans to add36 more in three-four years, acquisition of controlling stake in coal mines in Mozambique and the booming market for equipment rentals suggest good earnings prospects.
At current market price of Rs 436, the stock is valued at 25 times its likely FY-09 per share earnings, assuming partial dilution of equity and deployment of a minimum of six rigs in FY-09.
This valuation is expensive; but Gremach’s foray into the oil rig business and the robust demand prospects suggest strong growth.
Investors, however, can accumulate the stock in lots, given the volatility in the broad markets.
GIEPL’s foray into oil rigs holds immense potential. For one, it offers Gremach a share of the fast-growing onshore oil rig business, where there is a demand-supply mismatch, resulting in rising oil rig rentals. Rising rentals and better utilisation levels have shrunk the average payback period for oil rigs.
Second, the increasing number of onshore blocks in each phase of the NELP (New Exploration Licence Program) points to strong demand prospects. Drilling costs account for 20-25 per cent of the cost of developing an oil well and are showing an increasing trend.
Third, Gremach may also benefit due to the fewer players in the domestic market (Shiv Vani Oil — listed and John Energy — unlisted). Besides, unfavourable cost economics for overseas oil companies to set up onshore rigs in India is also a factor in favour.
Gremach has signed a MoU (memorandum of understanding) with Baoji Oilfield Machinery (BOMCO), subsidiary of China National Petroleum Corp for the delivery of 40 rigs, which includes 36 onshore and four offshore rigs.
The management expects to take delivery of the first rig in the first quarter of 2008 and another three within the current year.
However, effective contributions from the rigs may accrue by FY-09 only. Delivery of the remaining 36 rigs would be spread across the next three-four years. For this purpose, Gremach has floated a Singapore-based special purpose vehicle, Petrogrema Energy Pte, which would be a rental company for supply of rigs.
The company proposes to provide rigs to both Indian oil companies and global players in West Asia and US. This holds significance given the buoyant demand trends in overseas markets.
In this context, Petrogrema Energy’s initial breakthrough in terms of obtaining a firm commitment from the state-owned oil company of Saudi Arabia, Saudi Aramco, and a few other oil majors in the Gulf, lends confidence.
The management proposes to invest about $1 billion towards its oil rigs business. In this regard, it has already raised FCCB (foreign currency convertible bonds) worth about $50 million from overseas investors and proposes to compensate for the rest from a mixture of debt, internal accruals and the proposed listing of its Singapore arm.
Despite the highly-leveraged nature of this business, it holds the potential to generate an IRR (internal rate of return) of about 36 per cent with a payback period of over 3-4 years.
Equipment business on a roll
With demand drivers in place, Gremach’s equipment rental business has recorded sharp growth.
The change in revenue mix, skewed more towards owned-equipment than re-hired ones, on the back of a firm demand scenario have helped Gremach expand profit margins. Its margins for the half-year ended September 2007 expanded by 14.5 percentage points to about 27.4 per cent.
Entering coal business
Gremach has taken a 75 per cent controlling stake in 11 coal mines in Mozambique. This region falls in the Karoo basin, which is recognised as a prime hard coking coal area in Africa.
Given the global shortage in hard coking coal, these mines, expected to be rich in prime hard coking coal (about 200 million tonnes) could contribute significantly to Gremach’s coffers in the long-term. Prospecting of these mines is expected to be complete by mid-2008.
The management proposes to use this acquisition to provide feedstock security to its group firm, Austral Coke & Projects (unlisted), which makes met coke. Our valuation, however, has not factored any contributions from this division.
Any positive results in prospecting in Mozambique, listing of Austral Coke & Projects and the likely setting up of SEZs (special economic zones) by Gremach could also be triggers for taking exposure in the stock.
On the flip side, delays in delivery of rigs or drilling projects and decline in rig rentals during this gestation period pose a downside risk to our recommendation.