Sunday, July 13, 2008
The Tata Power stock has declined sharply in the ongoing market correction. The stock has shed 40 per cent from the peak registered in early January which is in tune with the erosion suffered by the benchmark Sensex over the same period. At the current price of Rs 975, the stock appears attractive for investments with a long-term perspective. The current price represents a 22 per cent fall since our recommendation to book profits in the stock in mid-November 2007.
Of all the power generation companies now implementing projects, Tata Power is placed best in terms of revenue visibility over the medium-term. Financing and fuel have been tied up already for over half the projected capacity addition in the next five years while its subsidiaries in transmission and distribution are beginning to contribute handsomely to the consolidated financial picture.
Financial returns from the investment in two Indonesian coal mining companies has started flowing in even as implementation of the 4,000 MW Mundra ultra mega power project is on schedule. Investors would do well to acquire the stock in small lots taking advantage of price weaknesses caused by broad market factors.
Expansion on schedule
The next five years will see Tata Power adding more than 10,000 MW to its existing capacity of a little under 2,500 MW. While the Mundra ultra mega project will contribute 4,000 MW, there are other big capacity projects such as the 1,050 MW Maithon and the 2,400 MW Coastal Maharashtra projects.
The company is well on track to commission the Mundra project by 2012, two years ahead of the committed date in 2014. While financing was tied up in April, orders for boilers, turbines and other equipment that have a long lead time have already been placed and civil construction has commenced at the project site.
While fuel will come from the Indonesian acquisitions, Tata Power has also tied up the logistics by setting up a shipping subsidiary in Singapore which will take care of the transportation of coal from Indonesia to Mundra.
Meanwhile, funding for the Maithon project, which is a 74:26 joint venture with Damodar Valley Corporation, has been tied up as also the coal supply. The project is on schedule for a 2011 commissioning. In the current fiscal, Tata Power will be adding about 600 MW of fresh capacity mainly at Jamshedpur (120 MW, 74:26 joint venture with Tata Steel), Trombay (Unit 8, 250 MW) and Haldia (120 MW). The full impact of the cash flows from these projects will be felt from 2009-10. Projects adding up to another 5,670 MW are at advanced stages of finalisation.
With funding, fuel and customers tied up for more than 5,000 MW of projects under implementation, visibility in revenues and earnings is high.
Two of Tata Power’s subsidiaries — Powerlinks Transmission, the 51:49 joint venture with Power Grid Corporation that operates the transmission line from the Tala hydroelectric project in Bhutan and North Delhi Power Ltd., the 51:49 joint venture with Delhi Vidyut Praday Nigam which is a distribution licensee in Delhi — have begun to contribute significantly to the consolidated financials.
In 2007-08, North Delhi Power’s post-tax earnings rose by 52 per cent to Rs 282 crore while revenues increased by 11 per cent to Rs 2,287 crore.
The company earned a hefty Rs 53 crore incentive by reducing aggregate technical and commercial losses in its licence area to 18.4 per cent, which is considerably lower than what was mandated. Similarly, Powerlinks turned in a net profit of Rs 58 crore on revenues of Rs 245 crore in 2007-08.
The two Indonesian coal companies chipped in with a handy dividend of more than Rs 300 crore ($75 million); they contributed about 17 per cent to the consolidated post-tax earnings.
The dividends will be useful to service the large debt incurred for the acquisition. Given the rising prices of thermal coal, Tata Power stands to gain significantly from its investment in the Indonesian companies financially.
The downside to our recommendation stems from possible delays in commissioning the projects that are under implementation and on the drawing board. Project schedules could go haywire if there is a delay in delivery of critical equipment, which is something not in the control of the company.
There is also the risk that given the rising interest cost regime worldwide, Tata Power will have to service costlier loans. About Rs 18,000 crore of the total capital requirement of Rs 24,000 crore over the next five years will be funded by debt, domestic and overseas.
The company may be forced to contract loans at a higher rate than what it had bargained for, leading to pressure on cash flows, especially in projects that will operate on a merchant basis.
Industry body CII has asked the government to remove hurdles in investments, improve access to capital, fast-track fiscal reforms and boost infrastructure building in the wake of slowing industrial production as indicated by IIP figures for May.
CII has expressed its concern over fall in industrial production to 3.8 percent, as this is for the first time IIP growth has fallen to such a low rate since March-2002, CII said in a release.
"It seems that the period of robust 8 percent plus growth of the last four years is coming to an end," the chamber said.
Rising interest rates continued to hit industry as its growth plummeted to 3.8 percent in may against 10.6 percent a year-ago and manufacturing and electricity generation rose by a decelerated rate.
This is the second month in a row this fiscal that the industry performed poorly with industrial growth, as reflected by the index of industrial production (IIP), dipping to 5 percent in April-May against 10.9 percent a year-ago.
"The distinct possibility has arisen that growth will be below potential in the near term," CII said and added that average growth in April-May 2008 was 5 percent down from 10.9 percent in the previous year.
"The slowdown in capital goods is especially worrisome as it indicates slower growth in investment demand. While the other sectors have been slowing down through last year, growth in the capital goods sector had remained strong," it said.
"CII appreciates the dilemma that this causes in the minds of the government and the Reserve Bank of India regarding how to balance the objectives of robust growth and low inflation," it added.
Investors with a low-risk appetite can avoid taking fresh exposures in the stock of Glenmark Pharmaceuticals at the current levels (Rs 630), given its rich valuations. Glenmark, an integrated pharma major with capabilities in drug discovery and manufacture of finished medicine dosages, has grown its revenues by over 40 per cent and profits by over 70 per cent compounded annually in the last five years.
Partly due to this robust performance and the fancy for ‘drug discovery plays’, a lot of interest has been built into the stock — it trades at around 21 times its estimated 2008-09 earnings per share — making it highly valued, when seen in comparison with other large-cap pharma companies as well as the benchmark Sensex.
Though the outlook on the company is positive, there are two concerns. First, on how the distribution of benefits from the reorganisation of Glenmark’s businesses, are going to take shape. The company plans to have two separate companies focussing on speciality and generics. The specialty business will include the discovery and branded business (under Glenmark) while the generics business (housed under Glenmark Generics) will comprise bulk drugs, generic business in the EU and the US, Argentina oncology business as well as a research-based division focused on API and formulation development. Glenmark has already got approval to transfer these businesses for not less than Rs 698 crore to its subsidiary Glenmark Generics, where Glenmark holds 90 per cent and the balance is held by another wholly owned subsidiary. It remains to be seen how Glenmark will utilise the money, as and when it receives the full consideration. Shareholders may benefit from the proposed IPO (of Glenmark Generics), likely to occur later this year, as Glenmark dilutes its holding.
However, they are unlikely to receive any shares as witnessed in de-mergers of companies in the pharma space. While this reorganisation may give both the companies better valuations, on a standalone basis Glenmark will have to make up for the 30 per cent revenue, which are going into Glenmark Generics.
Secondly, even though Glenmark has broadened its drug discovery portfolio (13 in discovery pipeline) and its base business has witnessed major traction in the US and Latin America, Glenmark currently is not a straight-forward investment decision. The sheer presence of the element of drug discovery adds a threat, as does the failure of any molecule, affecting future milestone payments (over $700 million). Plus, compared to generic players of similar size, Glenmark’s front-ended presence is weak and efforts to build its own (Glenmark Generics will have to build capabilities also) could weigh on earnings. Execution will remain a key, especially in regulated markets.
Glenmark’s business does present quite a few positives. Its businesses — specialty/proprietary as well as generics — makes it an end-to-end specialty company and integrated generic formulation maker.
Glenmark has also delivered strongly on earnings as well as guidance. Its 2007-08 core revenues grew by 62 per cent, driving profits by over 100 per cent on a year-on-year basis. The US generic business was a key driver (enjoying exclusive products and limited competition). Operating margins expanded by 7.5 per cent to 40 per cent. The outlook is strong with management now guiding sales growth of over 35 per cent for both 2008-09 and 2009-10.
In the 12-15 month horizon, the Glenmark stock could see potential triggers from out-licensing deals, ‘value unlocking’ from Glenmark Generics listing and acquisitions in the EU and the US. However, there continue to be certain areas that may pose challenges.
Glenmark’s US business, which focusses on niche segments, may not find ramping up drug filings that easy over the next two years (currently has 61 approvals). Drug filings translate to approvals needed for selling drugs in the US.
The company’s target to file 25 filings this year, if achieved, would swell the R&D spend, thereby putting pressure on margins. As stated earlier, Glenmark’s R&D capabilities appear to be its key attraction. Having forged four deals, plans to bring eight molecules to the lab by next fiscal and targeting different therapeutic areas — every molecule, including the ones already under work — look promising.
This said, world over most molecules fail to make it to commercialisation in the later stages and in this context, uncertainties associated with research should be assessed.
While early-stage development-linked milestone payments (around $110 million till now) will be retained in an event of a failure, a few more instances reputation could however take a beating.
American health regulator USFDA has filed a motion in a US court seeking 'certain' documents from Ranbaxy, amid reports of systematic fraudulent conduct, which the company denied.
"No legal proceeding has been initiated against us and we continue to co-operate with the department of justice," a company spokesperson told a news agency.
The spokesperson, however, admitted that USFDA had filed a motion in a US court seeking certain documents.
The spokesperson refused to disclose as to what the USFDA was seeking clarifications on from the company.
A section of the media has reported that USFDA has taken Ranbaxy to the court for systematic fraudulent conduct and has asked the court to force Ranbaxy to internally review the manufacturing operations.
The spokesperson said Ranbaxy will remain committed to supply high quality generic medicine at affordable prices the to US customers , the spokesperson added.
Mid- and small-cap stocks often bear the brunt of a steep market correction such as the present one. These stocks also face higher challenges in terms of making a comeback. Stocks (in this segment) with strong business prospects, sustainable growth and minimal risks of blip in earnings are the ones that would hold renewed return potential for investors.
The triple-digit growth experienced by Bartronics in revenues and profits over the last couple of years has come on the back of a rapid scale-up of operations and expanding geographic presence.
Its automatic information and data capture (AIDC) business and, more recently, its smart-card business which has seen an increasing pipeline of orders from government initiatives provide a sustainable revenue stream for the company. Importantly, many of these deals may provide scope for improving margins over the next couple of years.
In this light, investors with a one-two year perspective can buy the shares of Bartronics, considering its strong business prospects and reasonable valuations. At the current share price of Rs 157, the stock trades at about 10 times its trailing earnings and 6-7 times its likely earnings for FY 2009.
Bartronics primarily sells products and solutions for data capture in the areas of logistics and inventory management, time and attendance management and asset tracking operations. It has now broad-based its AIDC offering to services such as bar coding, biometrics, radio frequency identification and radio frequency data communications and electronic article surveillance. This has not only signalled a move up the value chain but also enabled the company to have a stronger client penetration in India, South-East Asian countries and the US. The company derives 50 per cent of its revenues from India, 30 per cent from the US and the rest from countries such as Singapore and Malaysia, providing reasonable geographic diversification.
Smart Cards drive growth
The smart card business, for which the company has its own manufacturing facility, holds considerable promise with opportunities in areas such as SIM cards, identity cards, credit cards and social security. Bartronics appears well-placed to capture a reasonable slice of the SIM cards market. It is also doing pilot studies in this field with a few banks and is eyeing the opportunity of the government rolling out national social security cards. With a production capacity of 80 million smart cards, the company has ramped up utilisation levels to 90 per cent from a production of 40 million cards in March 2008. Bartronics has subsidiaries in Singapore and the US to cater to the local markets in South-East Asia. The Singapore facility has already started to contribute to profits. This segment is expected to contribute to over 50 per cent of total revenues in the next couple of years.
Strong Deal Pipeline
Bartronics continues to benefit from government technology initiatives. For example, the Bhamashah Financial Empowerment Scheme of the Government of Rajasthan intends to cover about 50 lakh families through biometrically identifiable smart cards. The project, valued at about Rs 150 crores, commenced operations earlier this month. A similar project involving issuance of 39 lakh smartcards envisaged by the Bihar Government has also commenced last month. There is also a national identification card project on the anvil to be introduced across the country and Bartronics would look at tapping this opportunity.
Promise in AIDC
In AIDC, the company is well-placed to capture a significant share of manufacturing clients, both in India and abroad. The boom in organised retail in the country also offers opportunities for scaling up revenues. With strong client base in the manufacturing space — in the areas of inventory control and material tracking — this segment continues to be the main contributor to revenues (over 50 per cent) as of now.
With the Railways also looking at RFID (radio frequency identification) enablement across trains in the country and increased spends therein, Bartronics with its prominent presence in this segment appears well-qualified to capitalise on investments made by the Railways in IT enhancement.
Competition from players such as CMC in the RFID space is a risk. Direct entry by the company’s overseas principals (from which Bartronics sources some products), into the Indian market, is also a risk if there is an absence of non-compete agreements.
This stock recorded a sharp reversal on Friday forming a bearish engulfing candle in the daily chart. This move has also made the stock close below both the 200 and 50-day moving averages and also below the key medium-term support at Rs 1,700.
Both the daily and the weekly momentum oscillators are in the sell mode now implying the reversal in both the short and the medium-term trend.
However, the medium term view will turn overtly negative only on a close below Rs 1,528. Subsequent target is Rs 1,300.
The stock could move lower towards Rs 1564 in the near-term. A reversal from here would mean that a move towards Rs 2,000 is again possible. Resistances would be at Rs 1,876 and then Rs 1,937.