Sunday, February 01, 2009
Investors with a 3-5 year perspective can consider adding the stock of Mundra Port & SEZ (MPSEZ), the only non-captive private sector port player in the listed space.
MPSEZ’s strong cargo volume growth, ability to handle a diversified range of cargo, long-term contracts that ensure some steady revenue flows and sufficient funds in hand (from the IPO) provide the company with an edge over most other infrastructure players. At the current market price, MPSEZ trades at about 17 times its estimated per share earnings for FY10. While this valuation may seem expensive in relation to the market, the port segment, especially in the private sector, is at a nascent stage and holds huge growth potential; perhaps why the market has continued to accord the stock premium valuations. To obtain better prices, investors may phase out their purchases of the stock, to capitalise on broad market declines.
MPSEZ registered a 29 per cent increase in cargo volume handled over the nine months to December, compared to a similar period a year ago. The cargo volume growth for major ports over this period was about 7.4 per cent. Growth for the last quarter too has been at a healthy 12 per cent for the company. The strong growth comes on the back of MPSEZ’s diversified cargo handling capacity which deals with commodities such as coal, oil and fertilisers. Further, Mundra has secured a number of long-term contracts that ensure steady stream of revenue. Further, dedicated coal terminals for massive coal-based (mostly imported) power projects in Gujarat are also likely to ensure steady import-traffic.
The robust volume clocked by the port enabled a 46 per cent revenue growth and 92 per cent profit growth for the December quarter on y-o-y basis. Operating profits too improved by 200 basis points to 63 per cent. Even as volumes have aided growth, MPSEZ can also derive comfort from the fact that it can set its tariffs in line with market rates as it is not governed by the Tariff Authority for Major Ports.
Over the long-term, MPSEZ’s cargo volume is likely to be driven by its captive SEZ which would house export and import-oriented industries. Lease income from the SEZ can also accelerate revenue growth. However, we have not considered any significant contribution from the company’s SEZ for now, given the slowing capex plans of many corporates. Over the next two quarters however, investors may have to be prepared for more sedate volume growth as the slowdown in exports in recent times may intensify.
At a time when corporate earnings have begun to mirror the slowdown felt by the economy, Crompton Greaves has managed to sustain sales and earnings growth, amidst stiff raw material costs and marginal slowdown in demand. In what could be termed as a tough quarter (December 2008), the company posted a 49-percent growth in net profits on a year-on-year basis.
That the company’s order inflows have been healthy and there have been no cancellations so far from slowing markets such as Europe and the US also suggests that the medium-term earnings visibility remains relatively strong.
Investors can consider accumulating the stock of Crompton given the sharp correction it has undergone, even as its prospects are relatively unaffected. At the current market price of Rs 130, the stock trades at 9.7 times its annualised consolidated per share earnings for FY-09 and 8.5 times its expected earnings for FY-10.
Investors should, however, note that companies such as Crompton that manage a handful of foreign subsidiaries would face a more challenging cost environment compared to those with domestic operations alone. Risks of demand slowdown are also higher in the countries in which these subsidiaries operate. Under these circumstances, pressure on profit margins to keep the volume robust may be a plausible response by corporates to tackle the slowdown.
Crompton appears to have come up with such a response, especially for its industrial segment and consumer products, two segments whose demand is under pressure.
Profit margin pressure would, therefore, remain a risk for the company especially its subsidiaries. However, we believe that Crompton, with a return on equity (40 per cent as of March 2008) that is superior to industry average, can afford to take a dent in profitability to counter a slowdown.
How it managed
Crompton’s consolidated revenues for the latest ended quarter grew 25 per cent even as net profits grew at twice this pace.
Crompton’s diversified presence across geographies as well as its wide product offerings have been the key reasons for the company sustaining growth during tough times.
The company’s foreign subsidiaries have largely enabled such a diversification; the acquisition of these companies over the last two years, therefore, appear well-timed in retrospect.
The performance over the quarter has, however, not been smooth. Crompton saw a 0.5 percentage point dip in its operating profit margins to 10.4 per cent as a result of muted performance in its industrial systems and consumer product segment.
The management has admitted that pricing has remained under pressure for these segments, on the back of an attempt to maintain growth. The consumer segment too, despite witnessing revenue growth, saw decline in profit margins.
We expect these two segments, especially industrial systems, to remain under pressure over the next few quarters on the back of reduced/postponed capex plans of industries locally and abroad.
The positive feature remains that the company has not had any order cancellations even in the industrial segment.
Power segment, the biggest contributor to revenues, however stole the limelight with a 2.7 percentage point increase in EBIT margin to 15.1 per cent. Here again, the demand for distribution transformers (DT) has been turbulent. Demand for DTs, which is the final link to supplying power to the consumer, has been affected by slowdown in housing.
However, the management has stated that growth in this segment has been made up by wind energy transformers. While volume from this segment may not have been significant, the emphasis on ‘green’ energy in Europe and the US (with the new Government) could translate into sizeable demand for wind transformers over the long-term.
The power segment growth is expected to be steady over the next nine-12 months as well, since over 90 per cent of the order backlog arises from this division.
The company’s overall consolidated order book at Rs 6,700 crore grew 28 per cent on a Y-o-Y basis. Order inflows for the quarter at 23 per cent over December 2007 also suggests healthy demand scenario.
The current orders combined with the fact that there have been no cancellations so far is likely to provide revenue visibility for the company over the next one year.
Investors may have to watch for order inflows from hereon to gauge the long-term revenue prospects of the company. For now, orders of over Rs 300 crore (in the line of Crompton’s business) are expected to be floated by Power Grid Corporation over the next couple of months.
On the net profit front, Crompton has received some relief from reduced depreciation rates as a result of switching from Belgian GAAP standards followed by its subsidiaries. Forex loss accounting in compliance with Accounting Standard 11 has, on the other hand, depressed earnings by Rs 35 crore for the quarter.
Crompton has been a steady investor in capital expenditure programmes with a 10-15 per cent expansion in its transformer capacity every year over the past few years, including the current one.
The company has planned a capex of Rs 250-300 crore over the next couple of years. Being comfortable on cash, Crompton may not face the nagging issue of fund availability, be it for capacity expansion or acquisitions, the latter being its more successful strategy in recent times.
The company has also been proactive in the development of large-sized transformers to suit new programmes of the Government for bulk transmission of power. For instance, the company is gearing itself to meet the 1200 kV ultra high voltage power transmission system envisaged by Power Grid Corporation.
Crompton recently announced the successful development of the 1,200kV capacitive voltage transformer towards meeting the new challenges.
Shareholders of India Cements can hold the stock. Continuing strong demand, healthy despatches and the moderation in input prices point to an improving earnings picture for the company in the coming quarters.
Also, as new capacities in the Southern region take time to flag off, the region (South) is unlikely to see a surplus supply situation in the near term. The company’s new plant in Rajasthan, which will commence operations in 2010, will also help the company tap the high-potential western market.
With the stock (Rs 102) trading at six times the trailing earnings per share, the market appears to have already factored in the possible negatives (of reduced demand and cost pressures). The enterprise value per tonne too is down significantly from Rs 6,423 per tonne in June 2008 to Rs 4063 per tonne now.
Demand still strong
India Cements caters predominantly to the southern markets and the demand growth in this region has been quite strong, even amid the slowdown over the past two quarters.
The last quarter saw an average 10 per cent growth in demand Y-o-Y in this region. New capacities coming up in the region are being postponed and cement offtake from the infrastructure-projects in Andhra Pradesh and Tamil Nadu continues to remain strong. This suggests that the demand outlook for the coming few quarters, at least, is positive.
India Cements, however, could not completely cash in on the growth in demand over the past quarter due to stoppage of work at two of its plants — Vishnupuram and Dalvoi — due to rains and maintenance work. India Cement’s despatches were lower by two lakh tonnes or 8.3 per cent for the quarter compared to the previous year.
With the plants likely to run at full capacity from the current quarter, volume growth will normalise from here on.
Prices hold high
The southern market is where cement prices have managed to hold up since last year. Even as prices in the South rule at Rs 260 per bag since January 2008, all other regions have seen over a Rs 5-10 per bag drop in prices.
Strong prices in the region have helped the company manage margins to some extent. In West (Gujarat), a one kg bag is sold at Rs 220.
In the last quarter, the company commenced operation of its new one-million tonne grinding capacity in Chennai. The capacity up-gradation in units at Malkapur, Andhra Pradesh (1.2 million tonne) and Parli, Maharashtra (1 million tonne) are in progress.
The company’s 1.5-million tonne capacity coming up in Rajasthan, also promises to widen India Cements’ addressable market. The proximity of this location to Gujarat, where several new infrastructure initiatives are taking shape, is an advantage. The West is set to emerge as a region of high demand potential for cement companies in the coming quarters.
As far as the capex plans are concerned, the company has spent Rs 350 crore of the budgeted Rs 500 crore in the Rajasthan facility.
With the remaining capex to be spent in the next two months (February-March 2009), the company expects the plant to commence production in March 2010. The two-million tonne capacity planned in Himachal Pradesh has been deferred for now due to economic slowdown. This decision may actually stand the company in good stead, given that the picture about the longevity of the current slowdown and the cement market remains clouded as of now.
If this project is pursued, the company will be spending Rs 400 crore on the project in FY-10 and Rs 200 crore each in FY-11 and FY-12 respectively.
Cost pressures to subside
India Cements saw its net sales rising by just 2 per cent in the last quarter on extended plant shutdowns. New additions to the capacity have seen depreciation too rising in the last quarter (depreciation cost higher by 65 per cent). Net profits dipped 51 per cent to Rs 61.91 crore in the last quarter. High power and fuel costs have been weighing on the company’s profit for the last few quarters and contributed to a sharp shrinkage in margins in the December quarter.
The December quarter saw the company’s power and fuel cost rising 33 per cent Y-o-Y. But these costs are set to subside with the correction in international coal and crude prices.
Imported coal prices have corrected from $195 in July last year to around $90 now. India Cements imports nearly 75 per cent of its coal requirements and the drop in coal prices can, thus, be expected to substantially ease margin pressures for the company.
Name of Co.
Invested at (Rs.)
|The India Cements||285.00||36.85||70.74|
|South Indian Bank||130.04||72.55||65.90|
West Coast Paper
|Bank of India||360.00||240.20||46.03|
Via HK Gupta
Sobha Developers, the Bangalore-based real estate developer, has reported a 88 per cent drop in net profit to Rs 7.5 crore for the third quarter ended December 31, 2008, as compared to Rs 61 crore in the corresponding period of last fiscal
The topline too declined 48 per cent to Rs 183 crore as against Rs 355 crore. The operating profit too fell 52 per cent as the company was caught in a grip of "most challenging environment."
J C Sharma, managing director, Sobha Developers said: "The present quarter in these trying times have seen demand shrinking resulting in liquidity crunch, which is further impacted by the banks taking a conservative approach in lending to the realty sector."
He added that in spite of many proactive measures taken by the government and RBI including rate cuts, stimulus packages for selective sectors it has not helped the realty sector so far.
"We have been taking exceptional steps in de-resking the company from slowdown, by introducing several measures like cost reduction, reduction of the prices of our products, aggresive marketing, introducing attractive payment terms ensuring that the customer gets the maximum value," Sharma detailed.
He noted that these measures have been positive and the present realty prices have come to a realistic level where potential customers can look for value buying.
Investors can give the initial public offering of Gemini Engi-Fab, which is engaged in manufacturing and salvaging of process equipment, a definite miss.
Besides the macro-economic concerns regarding the impact of the economic downturn on the revenue and profitability of both Gemini and its user industries, our recommendation is also driven by the ambitious pricing of this offer.
At the price band of Rs 75- 80, the company is valued at about 10-11 times its estimated (annualised) FY09 per share earnings on its post-offer equity base.
Not only is this at a premium to the market, it also compares poorly with pure-play capital goods and engineering companies, which are currently available at lower valuations in the secondary market.
Gemini Engi-Fab has been in the business of manufacturing and salvaging of process equipment for well over a decade now.
The company fabricates heat exchangers, tower and column internals, reactors and vessels for a fairly diversified user industry base.
It plans to use the proceeds of the public offer to expand its operation and set up a manufacturing workshop in Umbergaon, Gujarat.
As on September 30, 2008, the company had an order book of over Rs 17 crore (0.8 times its FY08 revenues).
The worsening economic situation may take a higher toll on Gemini Engi-Fab considering the small scale of its operations and dependence on few customers.
While the company did manage to grow its revenues (86 per cent CAGR) and profits (249 per cent) at enviable rates in the last four years, it is to be borne in mind that the growth was on a smaller base and during a period of rapid economic growth.
Replicating these growth rates in the present times when the economic outlook is anything but promising would be difficult.
To add to problems, companies that constitute its user industry are contemplating (some have already begun) scaling down their capex and expansion plans significantly, which may also tell on future revenues.
The company may also have to grapple with margin pressure with the shrinking revenue-pie and the highly competitive and unorganised nature of the fabrication industry.
However, the company’s presence in salvaging business may hold more promise in times such as these when companies are tightening belts.
Salvaging, which involves changing or reworking of the corroded portion of equipment instead of completely overhauling it, may certainly find more takers. But here again, Gemini may not be able to command a high pricing power since this business too is unorganised and has low entry barriers. That most large companies have in-house fabrication units may also act as a challenge.
But what argues strongly against investing in the IPO is the pricing. This Rs 21-crore company has been valued at about 10-11 times its annualised FY09 per share earnings (post-offer equity) in the given price band, failing to price in the many business risks.
Much larger companies today suffer lower multiples owing to uncertainties on order flows, higher debt incidence or increasing pressure on working capital; even the Sensex-30 or Nifty-50 basket of stocks are available at lower valuations.
The initial public offer is open during February 3-8. The company seeks to raise Rs 41-44 crore through this offer.
Almondz Global Securities is the book-running lead manager and Karvy Computershare Private Ltd is the registrar to the issue.