Sunday, October 19, 2008
Investors willing to bet on the strong domestic and Middle-East’s IT (hardware and software) adoption story can consider buying the shares of Redington India, a hardware, software products and digital products distributor. At Rs 192, the stock trades at 10 times its likely 2008-09 earnings.
In the absence of listed peers and its strong positioning in the domestic IT market, the stock is attractive at these levels. The stock has come down from 27 times its historic earnings in January this year to the current levels.
Redington is the distributor for a range of IT products such as personal computers, laptops, servers, networking products and packaged software. It has vendor relationships with all the major names in this segment such as HP, HCL Infosystems, Acer, IBM, Intel and Cisco. This segment contributes over 85 per cent of its revenues.
The company has also started distributing products such as mobile handsets of Nokia, Microsoft X-Box, Apple iPods, Mac and consumer electronic products.
Redington’s revenues have grown at a compounded annual rate of 39 percent over the three years to Rs 10,883 crore in 2007-08, while net profits grew at a CAGR of 47.5 per cent to Rs 136 crore. The business is reliant on volumes and offers wafer-thin margins.
Though they remain narrow, Redington’s net profit margins have improved (from 0.69 per cent to 1.25 percent in the last five years) due to the reselling of better margin products such as networking products, lifestyle gadgets and contributions from improved after-sales and post-warranty service.
IT Products drive growth
Redington generates 53 per cent of its revenues domestically, and the rest from South East Asia, West Asia and Africa. The company’s customer base is now at 14,458 corporate clients, spread across as many as 44 brands and caters to a wide range of sectors.
Players such as HP and HCL Infosystems, and Wipro that dominate the domestic PC market, have continued to have strong relationship with Redington, thus assuring it of sustained volume growth.
According to a recent IDC report, the domestic IT hardware market is set to grow at an annual rate of 14.6 per cent to Rs 96,558 crore by 2012, while the packaged software segment is set to grow at a rate of 20.9 per cent to Rs 21,129 crore, representing a huge opportunity for players such as Redington. Increased Governmental spending on IT-enablement across the country is another important growth driver for the company.
The prospects are especially good for the better margin laptops, which have outpaced desktops in terms of sales growth in India and West Asia. The growth prospects for West Asia and the African region are equally impressive for IT hardware and software.
Redington, with its relationship with all the big names in the IT business, would be well placed to tap this opportunity.
In addition to hardware, the company has begun to resell packaged software as well and has tied up with players such as Adobe to distribute their products in India. This could usher in better margins, as does the expansion into networking and data storage products.
The company has also diversified into distribution of non-IT products such as mobile handsets of Nokia in Africa and other digital and consumer electronic products across India and West Asia. This segment contributes less than 10 per cent of the current revenues and may serve as a good diversification strategy over the long run.
Services business and other ventures
Redington has also added to its offerings, high-end repair, warranty and post-warranty services. These are aimed at capturing annuity-based revenues, in addition to hardware sales. This apart, Redington has leveraged on its existing distribution network to venture into third-party logistics and has acquired spaces in Chennai, Delhi and Kolkata and Dubai.
This division already has a few clients and hopes to target manufacturing companies for transporting their goods to retailers/other distributors. The company has already automated its distribution centres and additional clients may help the company optimise costs by better utilisation of space.
Both these ventures are at a nascent stage and do have the potential to scale up in the future.
Earlier this year, the company also started its NBFC operations to finance its channel partners. The division has already disbursed around Rs 477 crore and has reported profits for 2007-08. Given the long association with channel partners, Redington would be well aware of the credit quality of its borrowers, reducing the risk of default.
Competition from other bulk distributors such as Ingram Micro and Synnex Corporation is a threat. The company’s interest costs are going up. But the interest coverage has improved in 2007-08 compared to the previous fiscal (2.5 times compared to 2 times).
But in the light of the high interest rate scenario, maintaining effective working capital management could be a challenge.
Investors can consider accumulating the HDFC Bank stock with a two-year perspective, given the bank’s resilience in a challenging environment and scope for strong growth in earnings.
At the current price of Rs 1,026, HDFC Bank is trading at 19 times its estimated earnings per share for 2008-09 and 3.2 times historic book value. Best-in-industry Net Interest Margins (NIMs) which provide a cushion against rising costs, a high proportion of low-cost deposits and an extensive branch network that can drive advances growth, make the stock a preferred exposure in the banking space.
After including the effect of the Centurion Bank of Punjab (CBoP) merger, HDFC Bank posted a profit growth of 44 per cent, backed by net interest income growth of 66 per cent in the September quarter. NIMs at 4.2 per cent increased due to a hike in lending rates effected this quarter; the impact of this will be sustained over the next few quarters. Deposit growth was strong at 46.7 per cent, with the proportion of Current Account Savings Account at 44 per cent. The recent CRR cut will also release around Rs 3,300 crore to fund growth plans.
Over the past two quarters, strong topline growth for the bank has not translated into equivalent profit growth. The CBoP merger has increased operating costs and reduced asset quality, and added a higher proportion of retail loans. However, as the integration of CBoP takes shape over the next one year, the expansion in the branch network and asset portfolio may help ramp up the bank’s growth.
HDFC Bank’s successful integration of Times Bank in the past induces confidence on this score. The bank’s branch network has expanded 85 per cent post-merger, with a presence in 200 cities added over a year. With this, HDFC Bank’s branch network rivals its peer ICICI Bank, but its advances are less than half its rival’s levels, suggesting untapped potential.
A high proportion of retail advances (54.7 per cent) is a matter of concern, making the bank more vulnerable to asset quality slippages in a high interest rate scenario. However, macro indications suggesting a peaking of rates and the bank’s ability to limit slippages over the past two quarters are the positives. The net NPA to advances ratio remains at a comfortable 0.57 per cent, with the provision coverage on NPAs at 65 per cent. HDFC Bank’s capital adequacy ratio at 11.4 per cent is relatively low. But conversion of warrants issued to the promoter, which expire in December 2009, may infuse Rs 3,600 crore and may improve this ratio.
Even as late as June this year, investors in initial public offers (IPOs) continued to be better off than those who dabbled in the secondary market. Smaller IPOs continued to deliver good listing gains, even while selecting stocks in the secondary market became a much more difficult proposition.
But the vicious downswing in the market over the past three months has well and truly blown the froth off the IPO market. Not just the new ones, but even ones that were listed over the past year have all plunged below their offer price. Seventy-six of the 83 IPOs that listed between March 2007 and March 2008 are now available below their offer price.
Here are the lessons from those 83 IPOs (recent ones were excluded as the time window would be insufficient to draw conclusions).
Of the total 96 initial public offers in the period, 13 were withdrawn. The remaining 83 IPOs were considered for this analysis. For performance study, price movement from the listing date to October 15 was considered.
Should have sold on first day
One common lesson for investors from IPOs in this period is that, irrespective of the quality of the issuer, you would have fared better had you booked gains on the listing day. Holding these stocks in expectation of better gains in the secondary market would have resulted in sharp erosion in value. Fifty-two of the 83 stocks that debuted in the period closed in the green on listing day. Of these, 22 listed at a price which clocked a 50 per cent gain over their issue price.
However, of the 83 stocks only one (Allied Digital) currently trades at a price higher than its listing price; all others have fallen from their Day One prices. On the other hand, of those that had a bad listing, only three — Koutons Retail, Page Industries and Bang Overseas — made gains in the days following listing. The wait was not worth it for the others.
If stocks gave away much of the gains made on listing, a good number of them also plunged below their issue prices. As many as 76 IPO stocks are trading below their offer price now. When it comes to the extent of losses, the quality of the business didn’t matter much — IPOs from quality businesses, such as BGR Energy, Transformers and Rectifiers and Edelweiss Capital, were among the worst performers — their prices beaten down by over 70 per cent.
The extent of decline in stock prices shows that the pricing for IPOs in a bull market tends to factor in premium valuations and probably assume best scenarios for these businesses, resulting in high downside risk.
Better bet than listed peers
Would investors have been better off picking stocks from the secondary market as compared to the IPO? The answer is still ‘no’. Though IPOs have put up a dismal performance, they have still fared marginally better than peers from the same sector in the secondary market. A study of 30 prominent IPOs in this period suggests that newly listed stocks fared better than their listed peers since their offer date.
Of the 30 IPOs, 18 recorded a lower percentage fall than a listed peer from the same sector, from the time of their offer. In fact, select stocks such as Maytas Infra (up 22 per cent) and Religare Enterprises (up 76 per cent) actually delivered hefty gains from their offer price, even as listed companies from the sector fell sharply. Nagarjuna Construction (down 79 per cent) and Geojit Financial Services (down 47 per cent), loosely comparable to the above, declined sharply over the same period.
But do note that it is only the listing gains that have ensured better performance from the debutants.
Religare Enterprises, a financial services firm focussed on broking services, was sold at Rs 185 in its IPO. But on the day of listing, the stock closed at Rs 525.30, a straight 183 per cent gain. In one year from the month it listed (October 2007), the stock lost nearly 38 per cent, but the gains made on listing are still holding the stock above its issue price. This further supports the logic for selling stocks on the day of listing.
Maytas Infra, Power Grid Corporation, Everonn Systems, Allied Digital Services and ICRA are the other stocks that held on to gains over their offer price, thanks to strong listing performance.
So, if you were to make a decision on the day of the offer, the IPO would have been the better buy. But if you were to look for secondary market options, an older peer would have been a better buy than a newly listed stock.
The subscription figures delude
As in the preceding year, overwhelming response to an IPO was no guarantee of the stock’s performance. Of the IPOs in this period, Everonn Systems was in the top place, over-subscribed 145.5 times, followed by Future Capital (131.79 times), Mundra Port and SEZ (115.32 times) and BGR Energy (115.13 times).
However, from the date of listing to now (October 15), Everonn Systems has fallen by 55 per cent, Future Capital by 77 per cent, Mundra Port and SEZ by 60 per cent and BGR Energy by 81 per cent. The best performing IPO — Allied Digital Services — was subscribed by a little over 59 times and Indian Bank, another good performer, by 32 times.
No sector orientation
Last year’s IPO returns numbers showed a distinct trend, with those from financial services, software and infrastructure faring relatively well. But this year’s performance tally shows no sector-specific trend in the returns. In every sector an equal number of IPOs performed better than their listed peers as those that did worse.
The stocks that topped the listing gains list were Everonn Systems, Vishal Retail, Religare Enterprises, Nitin Fire and Mundra Port, hailing from diverse sectors. But the common thread that ran through them all was the time of their debut.
All these stocks were listed between June and December last year, a period when the Sensex rallied from 14K to 20K levels. And of all the IPOs, only seven are still holding above their issue price — Religare Enterprises, Maytas Infra, Koutons Retail, Everonn Systems, Time Technoplast, ICRA and Page Industries. Again, all of them listed between March and December 2007.
The performance of the IPOs was thus a function of market conditions at the time of the offer, more than company-specific or sector-specific factors. Of the 17 stocks that listed in the choppy markets between January and March this year only Bang Overseas is still in the green (up 54 per cent from the issue price). However, at current levels a few of them are really attractive ‘buys’ — Maytas Infra, Consolidated Construction Consortium, Mundra SEZ, Onmobile Global and MindTree Consultancy. Given the change in the earnings outlook, the ones in the financial sector are better avoided as concerns over the financial turmoil in broader markets persist.
Clearly this has been a bad year for greenhorns, whether they were investors or companies seeking to make a debut in the market!