Sunday, April 05, 2009
A steeper-than-expected downward revision in sugar output estimates has made the outlook for domestic prices quite bullish over the medium term.
Despite policy intervention to curb prices, sugar prices, over the next few quarters, are likely to respond to the extremely tight demand-supply situation.
Higher realisations on sugar are likely to reflect in improving profit margins and expanding earnings for select sugar producers which have access to adequate cane supplies over the next two years.
Bannari Amman Sugars, an integrated sugar producer with cane crushing capacities of 14,000 tcd spread over Tamil Nadu and Karnataka, appears a good investment bet in this scenario.
Lower cane prices in the southern markets, the company’s ability to weather deficit situations in the past and its integrated operations, suggest that it may be among the sugar players better placed to capitalise on the favourable turn in the sugar cycle.
At the current price of Rs 661, the stock trades at just six times its estimated earnings for 2008-09, at a discount to peers such as Balrampur Chini Mills and Bajaj Hindusthan.
Buoyant price outlook
Following three downward revisions in output in March alone, the current sugar season (October 2008 to September 2009) is expected to close with a domestic sugar output of 145 lakh tonnes, a 45 per decline from the 264 lakh tonnes produced last year.
After considering imports of 15 lakh tonnes, that is likely to leave closing inventories at just 12 lakh tonnes, a precariously low stock of just one month’s consumption. Even a higher output of 200 lakh tonnes for next year may just about balance supplies with demand.
These trends suggest that domestic sugar prices may remain upward bound over the next few quarters, even after the 30 per cent jump in prices since July 2008.
Given the political sensitivity of the issue, spiralling sugar prices have attracted policy curbs in the form of permission for duty-free raw sugar imports (under advance licences), stock holding limits on the sugar trade and higher free sale releases of sugar for this quarter.
But moves such as the imposition of stock holding limits and higher free sale releases may only give a short-term boost to supplies and are unlikely to have any lasting impact on prices.
Yes, duty-free raw sugar imports have the potential to impose a cap on any significant price rise in the domestic markets. However, imports are not an attractive proposition at current global price levels and prices will have to weaken substantially to make imports viable.
Even if raw sugar imports do become attractive later this year, players such as Bannari Amman Sugars are positioned to turn this into a revenue opportunity, given their sugar refining capacities (800 tcd post-expansion) that enable processing of raw sugar into white sugar for domestic sales.
Having steadily increased its crushing capacities over the past three years, Bannari Amman Sugars has also invested in forward integration projects, by adding to power cogeneration (currently 56 MW) and alcohol capacities. These have ramped up their contribution and helped the company remain profitable during the recent downturn in the sugar cycle.
Plans are on the anvil to expand the acquired (and relocated) 2,500 tcd Modhali sugar unit to 6,000 tcd, while setting up a 28.3 MW cogeneration plant. Regulatory approvals have also been obtained for a new 5,000 tcd integrated unit at Tiruvannamalai in Tamil Nadu.
Revenue contributions from these expansion projects may not flow in the near term, given the severe constraints in cane availability and higher competition for its procurement this year.
However, over a two-three year time-frame, as the company invests in cane development in the new command areas, these expansion projects may contribute not only to better volumes but also to a more diversified profile.
Escalation in cane prices and shortfalls in cane availability pose the key risks to the company’s earnings over this year and the next. However, cane prices in the southern states are still well below SAPs in States such as Uttar Pradesh.
Raw sugar imports and by-products such as power, alcohol and ethanol allow mills such as Bannari Amman to improve overall realisations. That may allow sufficient room for the company to earn a reasonable margin, even after shelling out higher cane prices this year.
Though crushing volumes are likely to be sharply lower than last year, it may be compensated by a sharp improvement in sugar realisations.
The first nine months of 2008-09 saw a sharp expansion in the company’s net sales (up 38 per cent to Rs 638 crore) and net profit (Rs 8.5 crore to Rs 84.6 crore), helped by liquidation of inventories and the sugar business’ return to profitability. The per share earnings stood at Rs 101 for the trailing 12-month period.
Investors with a high-risk appetite can consider accumulating the stock of Welspun Gujarat Stahl Rohren, a leading manufacturer of steel pipes. At the current market price of Rs 80, the stock trades at about five times its estimated FY10 per-share earnings. Besides attractive valuations, the company’s buoyant order book and well-entrenched relationship with global oil and gas players also makes it a good investment.
New business opportunities, in terms of setting up of pipe infrastructure network, driven by the commencement of the KG Basin gas supply by Reliance Industries and city gas distribution initiatives of the Government, also brighten prospects. Given the recent surge in the markets, phased accumulation is recommended for the stock.
Over the last few months, falling crude oil prices had sent the stock price of Welspun Gujarat into a downward spiral on concerns that this would eventually lead to a drastic decline in oil and gas capital expenditure. But despite the downturn, the company has managed to add significantly to its order book, which currently stands at about Rs 9,300 crore (2.4 times FY08 revenues). Not only does that reflect well on the company’s ability to procure business during tough times, it also provides revenue visibility that is higher than that enjoyed by peers.
As the bulk of these orders are with established global players, the risk of cancellations and postponements for its orders are lower. The company has also completed the commissioning of its helical pipe manufacturing facility in the US. Endowed with a capacity to produce 3 lakh tonnes of HSAW pipes, this facility has also received API accreditation.
News of order wins by both the domestic and the new site in the US may be the key triggers for the stock price in future.
For the quarter ended December 2008, even as the company managed to grow its revenues by over 40 per cent, it disappointed on both the margin and profits front. Led by writedown of inventories (Rs 38.5 crore) and forex losses (Rs 41.9 crore) due to re-alignment of creditors and ECBs, Welspun suffered a contraction in both operating and net profit margins.
While operating profit margins dropped seven percentage points to 10.2 per cent, its earnings nearly halved as compared with the corresponding quarter last year. Had it not been for these provisions, the company would have seen a mild increase in profits. In this context, the recent relaxation of mark-to-market norms may boost the reported numbers. The risk to realisations and to the outstanding loan amounts due to rupee fluctuations, however, remain.
The increased order flow to the power transmission sector is another signal that select sectors of the economy may be in the revival mode. Kalpataru Power Transmission, a turnkey solutions provider in transmission lines and substation structures, is among the key beneficiaries of order flows from Power Grid Corporation (PGCIL).
Aside of domestic projects, Kalpataru Power has also been successful in keeping the overseas order book in expansion mode.
Now, at beaten down valuations, the Kalpataru stock could receive a boost from the T&D revival. In the current economic scenario, the company’s diversified business profile and potential earnings accretion (on a consolidated basis) from infrastructure subsidiary — JMC Projects — makes it a superior option to other transmission and distribution contractors. Investors can consider the Kalpataru stock with a two-year perspective.
At the current market price of Rs 347, the stock trades at six times its standalone earnings for FY10. On a consolidated basis the valuation appears more attractive at about 4.5 times its estimated per share earnings for FY-10.
Beneficiary of Eleventh Plan
Since the beginning of January 2009, there has been a spurt in order flows, especially from public sector major, Power Grid Corporation.
This momentum is expected to prolong given that a good two-third of the planned capacity additions of power under the Eleventh Plan (2007-12) are expected to be commissioned over the remaining years of the Plan period.
Further, public power utilities are also looking at reviving Build-Operate-Transfer projects in T&D. Power Finance Corporation and Rural Electrification Corporation have floated tenders worth Rs 6,000 crore over the last several months.
There are already signs of Kalpataru benefiting from these initiatives — the company received Rs 770 crore of orders from PGCIL in March alone.
Besides domestic orders, Kalpataru has been actively pursuing its international business despite the global slowdown.
In this regard, it scores over its nearest peers, KEC International and Jyoti Structures. It has tapped the key markets in Africa and West Asia which are expanding their regional transmission network.
The company has won about Rs 1,650 crore worth of orders in Kuwait and Algeria in the quarter ended March 2009 alone, suggestive of the size of order flows.
Kalpataru’s revenue segments can be classified into T&D, biomass energy and infrastructure. While the first two have witnessed healthy revenue growth in the December quarter, the last segment saw a dip.
Laying of pipelines, which account for a good part of the infrastructure segment, has, however, once again seen a revival.
With the recently-won order for a crude oil pipeline for the HPCL-Mittal Energy joint venture, this segment would now have about Rs 650 crore or 13 per cent of the total orders in hand. Going forward, with increasing oil and gas finds that are required to be transported, this segment could see heightened activity.
While the company’s biomass division is not significant in terms of total revenue, its contribution to revenue has been increasing. As a result, this tax-free division has helped in reducing the company’s tax burden. Besides, this division has a high operating profit margin (OPM) of 45 per cent. Any increase in this segment’s contribution towards revenue is likely to aid the overall OPMs.
Kalpataru’s geographical diversification is also likely to come to its aid, especially in reviving the now lower OPMs. About 44 per cent of its current order book of over Rs 5,000 crore is from overseas projects.
These projects, mostly in the T&D space, have typically offered higher margins to Kalpataru in the past, giving it backward integration, apart from more lucrative deals available in export projects in this space.
Kalpataru’s subsidiary, JMC Projects, with an order basket of Rs 1,700 crore is also well-poised to tap civil work opportunities in power projects. This subsidiary too lends diversification and may aid backward integration in some large projects.
Financial concerns may ease
On a standalone basis, Kalpataru’s revenues grew a healthy 20 per cent to Rs 1,331 crore for the nine months ended December 2008 over the corresponding previous period.
However, net profits fell 28 per cent for the above period, dragged by raw material costs, interest costs and notional forex losses. But risks from the above factors may stand mitigated for the following reasons: Price of steel billets in Mumbai have plunged from Rs 40,000/tonne a year ago to less than Rs 19,500/tonne now.
Steel, which accounts for as much as 80 per cent of the material cost in a tower, however continued to hurt as a result of high inventory.
Now, with fresh inventory of steel procured at lower cost and with about 40 per cent of Kalpataru’s orders having fixed price contracts, the company will be able to retain the benefits of reduced steel prices.
This could provide some respite to profits and declining OPMs (currently at 10 per cent). Falling interest rates too can provide substantial relief on interest costs and improve profits. A shuffle in top management in early 2009 remains a point of concern.
US stocks ended higher on Friday as investors` confidence overweighed bleak economic data.
The Dow rose 39.51 points, or 0.5%, to 8,017.59, Standard & Poor`s 500 index climbed 8.12 points, or 1%, to 842.50, while the NASDAQ composite index increased 19.24 points, or 1.2%, to 1,621.87.
Indian ADRs ended in positive.
Investments with a two-year horizon can be considered in the shares of CMC, in the light of the stock’s reasonable valuations. The company is an integrated IT systems player and has managed a fruitful margin expansion drive through a change of its business mix.
A roster of domestic and international clients, especially government clientele where large deals continue to be won, and improving prospects for its education and training divisions promise broad-based growth for CMC.
The synergies that accrue from its association with TCS (of which it is a subsidiary) have also resulted in domestic as well as overseas deal wins for CMC.
At Rs 352, the share trades at five-six times its likely 2009-10 earnings. This is at a slight premium to HCL Infosystems. But CMC enjoys a much higher EBITDA margin of close to 15 per cent and a net profit margin of over 11 per cent, which justifies this premium.
The stock has fallen over 55 per cent in the past year, largely on concerns about a global slowdown in hardware demand and currency fluctuations impacting profitability.
But the decline in revenues in the last couple of quarters appears attributable to a conscious decision to reduce focus on its low-margin hardware-equipment, sales-intensive customer services business. From 60 per cent of overall revenues, this proportion has, over the last three quarters, declined to less than 40 per cent.
The company is looking at tapping deals that involve a higher service component which it hopes to deliver through its high-margin system-integration offering. CMC derives 60 per cent of its revenues from India and the rest mainly from US . This mix in a way nullifies the effect of dollar fluctuation against the rupee and acts as a natural hedge, lowering the forex risks to the company’s earnings.
Changing business mix
Equipment sales will still remain a key offering for CMC, but pursuing a strategy wherein equipment sales is followed up with a meaty services component may help improve margins over the long term. But it may be a few years’ time before equipment sales decline to a small part of the revenue and CMC becomes a complete IT solutions company.
The change in focus has meant that its ITES (IT Enabled Services) division which manages IT applications and is also involved in digitisation services has grown 20 per cent this fiscal. Also, system integration, that contributes 45 per cent of overall revenues, is now the main contributor to overall revenues. This is significant as systems integration is a high margin service (30 per cent PBIT margins).
This change in business alignment means that the company is now well-positioned to win deals overseas, especially from the US, where requirements go beyond mere equipment sales and implementation. The company has won two deals with local governments in two counties in the US for providing various citizen services.
The synergy from TCS is also quite pronounced as CMC is now able to participate and benefit from large infrastructure management deals that TCS wins and also expand margins by services delivery of its own.
TCS’ deal with the Ministry of External Affairs for passport issuance to citizens of India is one such example. The deal size is around Rs 1,000 crore, spread over six years. This deal follows an earlier one that TCS had won with the Department of Company Affairs in 2006, which was worth around Rs 345 crore.
CMC was also a beneficiary of the deal. The present deal would entail TCS digitising and enabling online filing of applications for passports. In most of these areas it is CMC that is expected to play a key role in the service delivery.
This apart, the company has been expanding client relationships in areas such as defence, e-governance, ports and transportation, all key drivers of domestic IT spend. CMC’s education and training division has grown 20 per cent in the December 2008 quarter over December 2007.
Apart from vocational and IT (Hardware, networking and software) training, the company also trains users at client’s location. For example, CMC would handle the IT infrastructure and management and provide education and training services to the client company’s personnel at these outlets. This means additional revenues for CMC.
For the nine months of FY09, the company has seen a decline of 16 per cent in its revenues, but net profits have grown by 10 per cent.
In terms of risks, competition from entrenched players such as HCL Infosystems and Wipro Infotech may create pricing pressure for CMC.