Sunday, June 21, 2009
Trading at just 10 times its trailing earnings, the stock of Ambuja Cements, at Rs 91, promises upside backed by savings on coal cost, clinker capacity expansion and ramp-up in power generation. The company is enhancing its clinker capacity by 4.4 million tonnes and raising its power generation capacity by 75 mega watts (MW) before end of this year.
Ambuja Cements’ enterprise value per tonne is Rs 7,040 per tonne, nearly half of what it was in end-December 2007 (a little higher compared to ACC). Investors can hold the stock and look to accumulating it on broad market declines.
Ambuja Cements has five cement plants, six grinding stations and three bulk cement terminals across the country. The Holcim group (Swiss cement major) has a 45.67 per stake in the company. The same group has a significant stake in ACC too, suggesting scope for consolidation of capacity within the group.
Ambuja Cements is a pan-India player with major shares in the North and Western markets. The West, which has seen a 5 per cent growth in demand in the January-April period of 2009, looks promising with the pace of new investments in Gujarat set to accelerate. This region is also likely to see the lowest new capacity additions this year, suggesting a lower supply overhang.
The company has also seen good growth in the Northern market where despatches have posted a strong 15 per cent growth in the period January-April 2009, following higher infrastructure spending by the government.
To cater to the domestic demand, which has been gathering speed in the coastal markets of Gujarat and Maharashtra, through the sea route, the company is adding three ships to its existing fleet of seven this year. Ambuja Cements’ cumulative despatches for the year-to-date were at 66.38 lakh tonnes, higher by 6.5 per cent over the previous year. Despatches in May were at 16.38 lakh tonnes, higher over the previous year by 8 per cent.
Ambuja Cements’ current capacity is 20 million tpa. The company is commissioning two new grinding units of capacity 1.5 million tonne each at Dadri, Uttar Pradesh and Nalgarh, Himachal Pradesh before end of the first quarter of 2010. Further, to stop relying on clinker imports (as also to curtail costs), Ambuja Cements is expanding its clinker production capacity. At Bhatapara, Chattisgarh and Rauri in Himachal Pradesh the company is setting up two new clinker units of 2.2 million tonne capacity each. These units are expected to commission production by end 2009.
With cash and cash equivalents standing at Rs 643 crore as of end-December 2008, a modest debt:equity ratio and the core business growing strongly, funding of the capex may not pose a major challenge for the company.
Expensive imported coal and high-cost power sourced from the grid have been eating into the company’s margins until the March quarter. But now it appears that there will be respite for the company, with coal prices cooling off in the international markets and the company also enhancing is its captive power capacity.
Though coal prices had corrected way back in January, cost savings for the company did not materialise in the March’09 quarter as the company still held high-cost inventory of coal. Cost-savings on coal can thus be expected to reflect from the current quarter.
The company is also expanding its captive power capacity. With the addition of an 18.7 MW plant at Rabriyawas plant in Rajasthan, the company’s total captive power capacity rose to 300 MW in 2008. In the March’09 quarter the company added another 15 MW power unit at Bhatapara plant. With this the company has already set work to raise its power capacity to 390 MW by end this year.
Margins can rise again
Ambuja Cements, which reported an operating margin of 53 per cent in 2007, has seen its margins slide significantly in 2008 not withstanding the rise in raw material prices and of fuel and power. Sales grew 10 per cent in 2008 while expenses expanded 24 per cent, pushing margins down to 36 per cent, on a par with the larger players in India. There have been some conscious efforts to curtail expenses and improve efficiency in recent months.
The company’s clinker capacity expansion will moderate the cost of importing clinker. The impact of the clinker import on the company’s operating margins in 2008 was approximately two percentage points according to the company.
The company is looking at options of acquiring coal blocks for captive mining and also considering alternative fuels to fire its plants. Efforts to lower power consumption and the dependence on grid may also help reduce costs.
Small and mid-sized infrastructure companies could benefit from higher spending on roads and possible changes in norms that gives more room for smaller players to participate.
Sadbhav Engineering, with its primary business of road contracting, may be one of the key beneficiaries. A strong order-book, the ability to tide over a period of liquidity crunch with reasonable leveraging and strong earnings growth during a difficult year also augur well for the stock’s prospects.
Investors with a two-year perspective can consider buying the stock of Sadbhav Engineering.
At the current market price of Rs 683, the stock trades at 12 times its expected per share earnings for FY-10 on an expanded equity base (taking into account a possibly successful rights issue).
Risk-averse investors can consider buying the stock on declines linked to broad markets, what with signs of volatility once again creeping in.
The recent rally, together with heightened expectations of a renewed thrust on the infrastructure segment in the upcoming budget, has led to such stocks returning 100-300 per cent since March; with valuations, especially of large-sized companies, soaring to levels that have set challenges to the earnings growth of these companies. Smaller companies too witnessed strong rallies, albeit with valuations still at a big discount to their larger peers.
While stiff qualification/bidding norms and stringent rules under the model concession agreement was perceived to be less beneficial to smaller infrastructure players, the recent statements of the new Minister of Road Transport and Highways appears to suggest that the National Highways Authority of India (NHAI) could be drawing a more viable and inclusive plan for highway projects. Such a move in which BOT (Build Operate Transfer) models may be removed if found unviable in certain cases could prove beneficial for contractors such as Sadbhav, which have relatively less financial muscle and scale.
Apart from roads, Sadbhav has also increased its presence in irrigation and mining projects.
The last two segments account for 16 per cent each of the total order-book of Rs 4,500 crore (4.5 times FY-09 revenues), thus providing a diversified revenue-mix for the company. It is perhaps these segments that ensured that the company clocked reasonable growth rate in FY-09, a year fraught with delays, specifically for road projects.
Sadbhav Engineering closed FY-09 with a 19 per cent growth in sales to Rs 1,062 crore and 31 per cent growth in net profits to Rs 63 crore.
The earnings growth was superior to most peers which witnessed sluggish growth on the back of slower execution of projects (as a result of fund crunch or delay in land acquisition).
Operating profit margins too held on to the 10 per cent levels during the year. Interest costs appeared higher only on account of interest income not being netted with interest charges any more (and instead shown as other income).
With the latest numbers, Sadbhav’s sales growth over a three-year compounded annual basis was 53 per cent, while earnings grew 31 per cent annually over the above period.
Except for a BOT project that was delayed due to land acquisition issues, the rest of the projects under execution are stated to be on track. Given the company’s ability to tide over tough times, the growth on the back of an economic revival can be expected to be superior.
From bagging its first BOT project in FY-06, Sadbhav has come a long way in now holding a portfolio of six BOT road projects (of which one is operational, three have achieved financial closure). Interestingly, five of the six are toll projects with only one mandating revenue-sharing with the Government.
Going forward, with revenue-sharing clauses likely to be attached to most projects, the portfolio appears lucrative. Besides, if the Highways Ministry opts to be more discreet with awarding BOT toll projects (going by the hints given by the Minister) then the toll portfolio of Sadbhav may well look attractive in terms of profitability compared to players which bag similar projects hereon.
Delays in BOT projects remain a key risk if land acquisitions continue to spell trouble.
Signals to look for before deciding when to enter, lie low or get out of stock markets.
Cautious Bull, Optimistic Bull, Fearful Bear are some of the terms thrown at equity investors in the past several weeks. Most investors are waiting on the sidelines, mulling whether to enter the market or not. Some question if this rally is sustainable. Remember two things. One, there is no way for anyone to predict what the markets can do in the next few days. Two, and a key point:equity markets recover much before the actual economy does. There are no easy answers but, yes, there are certain signals one should look at.
Let's start with this, an easy one for most people. India is a very shallow equity market and in global market parlance, is like a village when compared to developed equity markets where there is a lot of participation, not just from institutional investors but also from retail investors, through retirement and education plans. The point is that Indian markets are highly dependent on flows from foreign institutional investors (FIIs).A few billion dollars have the propensity to take the market in either direction. Hence, FII inflows and outflows must be tracked carefully to see if delivery-based buying has been taking place consistently. If markets move up consistently on rising volumes and increasing FII flows, it's a signal that buying interest has come back and its time to scale up equity exposure. Of course, it is important to take stock of valuations but these can remain stretched for an extended period of time.
Then there is credit, the lifeline of any economy. It's important that companies and individuals have access to credit at reasonable rates. High inflation is followed by higher interest rates and this often has a dent on corporate and consumer balance sheets. At the same time, if banks are unwilling to lend, the short-term outcome will not be rosy. On the other hand, low inflation, low interest rates and easy credit flow are good signs for corporations and individuals. When this happens, take a look at the loans disbursed by banks and financial institutions. The question to ask is, have banks started to lend and are corporations and individuals borrowing? A healthy credit situation and easy liquidity situation, beside good future corporate performance, also means equity markets could see decent inflows and less outflows.
GENERAL SENTIMENT/ CONSUMER SPENDING
This is, again, an important signal a lay person can see if around him. Are people buying homes , cars, taking vacations , buying electronic items, queuing at restaurants and so on? If you see most of these things happening around you, it means people have disposable income and access to credit. If this is so, corporate profits are likely to improve or increase in the future. Also ask yourself: "Are people more optimistic about the future now than they were six months before? What about businesses? Have they started hiring again?" Recruitment activity picking up is again a very important signal and one to be watched closely. Though there is no employment or unemployment data that is released in India every month, talking to people from different sectors and companies could give you a good indication. Look within your own firm or business. Has the business scenario changed for the better or worse?
IMPROVEMENT IN MACRO NUMBERS
That means corporate earnings, inflation, GDP growth, agriculture output, IIP numbers, export numbers, oil prices -- being some of the macro numbers one should look at. Their interpretation should be viewed in the context of what has happened in the immediate past and whether there are any improvements in these numbers. Most analysts were expecting a GDP growth of below 5 per cent last year, but this prediction was short-lived, as the numbers were a strong 6.3 per cent. If in one of the worst years the economy has the potential to grow at 6.3, does it mean we could grow at much higher rates if the economic and investment environment were favourable?. There are several such questions to review on every parameter. At the same time , do not overanalyse, as it may lead to inaction.
EQUITY MARKET MOVES
Then again, are equity market moves more broad-based across sectors or restricted to one or a few sectors? During the technology boom of 1999 and the power sector boom of 2007, any company that had technology and power written on it would go up by leaps and bounds, defying logic and common sense. At the same time, there are times when the market moves are broader-based, like the ones we saw during a substantial part of the bull run. If the market moves are broad in nature and mid-caps also start to catch up, then there is a strong likelihood that a much stronger upward move will happen in the future.
Finally, remember two cardinal rules. Do not put any short-term money, required in the next one to two years, in equity. Second, the best time to invest is when the markets stink, so ignore the noise around you and invest if you get to do so between PEs of 8 to 12 of the market. Rational and courageous investors who did buy between October 2008 and March 2009 are now laughing all their way to the bank.
by Amar Pandit, BS
Investors who hold shares of Satyam Computer Services can reject the open offer made by Tech Mahindra. The offer price appears unattractive in the light of Satyam’s future prospects, with the recent financial disclosures showing the company’s financial position to be much better than expected.
The open offer price of Rs 58 is at a discount of 27 per cent over the current market prices of Rs 80 per share. The short-term capital gains tax that investors would incur while tendering their shares (as opposed to open market sales) also makes the offer unattractive.
At the offer price of Rs 58, the stock discounts its likely per share 2008-09 earnings by 8-9 times. This is at a steep discount to all other top tier IT companies (which trade at 14-16 times), which may have been justified if, as Mr Ramalinga Raju had claimed, Satyam were a company with an operating margin of just 3 per cent. But the financials declared for the December 2008 quarter and for January and February, which may not be final given that it is yet to be audited, show a margin of 12 per cent. The revenue size and the fact that the company is profitable at the net level in the December quarter as well as the months of January and February may necessitate a better valuation.
The provisional financials disclosed to the exchanges show that, contrary to expectations, Satyam Computer’s revenues for 2008-09, taking its monthly collections run-rate, could be $1.9 billion. That is only slightly less than HCL Technologies’ revenues.
These disclosures show that average monthly collections starting from April 2008 leading up to February 2009 have been Rs 811 crore. After Mr Raju’s confession early in January, the monthly run-rate of receivables has come down to Rs 670 crore levels. Even taking this to be a representative figure, Satyam would still be a $1.3-1.4 billion company.
The operating margin for the December quarter was 12.5 per cent, it dipped in January, but came back to that level in February. The net profit margins too, at around 8 per cent, though below the industry standards of 15-27 per cent, are better than expected. This could be partly ascribed to the fact that there may have been a large number of un-billed employees. To address this problem, Tech Mahindra has initiated a ‘virtual pool’ of employees who are unbilled.
Under this process, 7,000-10,000 employees will not work for the company but will be on its payrolls, with only their basic salaries (plus provident fund and medical insurance) being given for up to six months.
This move has the potential to bring down employee expenses drastically and take the net profit margin to over 11-12 per cent levels over the next year or so. That would make it again comparable to HCL Technologies in terms of its margin profile, especially after its acquisition of Axon. Incidentally, HCL Technologies trades at 15 times its trailing earnings.
Being an off-market transaction, the shares, if tendered, would suffer higher than usual short term capital gains (at 30 per cent), if the shares were held for less than a year or a long-term capital gain if held for over a year.
Over the next couple of years, Satyam investors can also look forward to reaping the synergy benefits from Tech Mahindra and revenue and margin improvements from a restructured organisation. The disclosed financials give a value of Rs 1,085 crore for the entire fixed assets owned by the company as of December 2008. This gives a value of Rs 11 per share for Satyam. The market value though may be much higher (Rs 1,700 crore levels) for the 125 acres of land that Satyam owns, as indicated by one of the Government appointed directors in April. One may have to factor in a loan of Rs 300 crore taken against this, though.
The lawsuits, including that of the Upaid case and claims from several companies (37 of them), together, have the potential to necessitate an outflow for Satyam to the tune of over $1.5 billion.
If this is taken out of Satyam’s cash flows, this may be the key downside for the company. The challenging outlook for the IT sector as a whole also presents a key risk. Given these uncertainties, risk-averse investors not willing to take a long-term view may consider selling the shares in the open market.
Usually a diehard optimist, Mr Sandip Sabharwal, CEO - PMS, Prabhudas Lilladher Markets, sounds a note of caution about the stock markets after their breathless rally over the past three months. Markets have not been so overbought technically for a very long time and such a state will not last too long, he says. Even while expecting a 10-20 per cent correction from the peak, he feels that India’s valuations will continue to remain at elevated levels, given the improved growth prospects for the economy.
Excerpts from the interview:
Have the Indian markets run up way ahead of companies’ fundamentals, especially in sectors such as realty, cement and infrastructure? The pace and ferocity of the recent rally in the stock markets is unprecedented. If one looks at a market like India, the key indices have all nearly doubled in a period of just around 13 weeks.
This run-up has come on the back of beaten down valuations, extreme pessimism and short positions in the markets, huge cash on the sidelines, improving liquidity, reducing interest rates and a bottoming of economic performance globally. The weakness in the US Dollar combined with low short-term interest rates has made the “Dollar Carry Trade” gain momentum.
If we go back to the year 2003 when the last rally started, it took the markets nearly one year to double from the bottom. The same thing has happened in just three months this time. However as a counterpoint, markets also never sold off the way they did in the year 2008. Since the fall was so sudden and sharp, the initial rally had to be sudden and sharp.
The key is that the speed of the rally has made everyone too complacent and has led to a phenomenon of panic buying in the markets.
Lot of the stocks in the above mentioned sectors have clearly run ahead of fundamentals although the prospects for cement still look positive. Valuations have moved up due to improving growth prospects and growth in the economy is likely to be strong at least for the next five years. Under the circumstances valuations will continue to remain at elevated levels over the next few quarters.
Should investors wait for a correction now to start buying?
Markets look overbought in the short run and should see some correction. I believe it is important today to stick to fundamentals and not to be carried away with the market momentum.
As we sit to evaluate what should be the course of action going forward it is important to recollect a number of data points that have come out over the last few days:
- Global trade continues to be in doldrums and both exports and imports of most countries are still in a severe downturn.
- Most large economies continue to contract and there are no signs of economic revival anywhere in the West. It is just that the pace of fall has slowed down.
- The valuations of most markets have clearly run ahead of fundamentals with most emerging markets now trading in the range of 15-17 times 2010 earnings, up from 7-10 times in the beginning of March 2009.
- The fiscal deficit projections of most governments worldwide are continuously moving up with slowing tax collections and higher spending.
- Cash on the sidelines has come down very sharply over the last two to three weeks as most institutions, especially mutual funds and FIIs whose portfolios are declared at the end of every month rushed to deploy a large part of their cash holdings so that their month end portfolio does not show huge cash throughout the rally .
- Inflows into emerging market funds which were running at over a billion dollars a week have now slowed down drastically over the last two weeks. As such a combination of low cash and low inflows should be a near-term negative.
- Markets have not been so overbought technically for a very long time and such overbought conditions will not last too long and will ultimately lead to a big sell off. The overbought nature of the markets at this point in time is similar to the markets prior to the fall in May 2006 when the markets fell off sharply before recovering in the latter part of the year. It is also similar to February 2008 when emerging markets were most oversold than ever in history.
- Government bond yields have firmed up globally over the last few weeks, driven by fears of huge borrowings and high fiscal deficits. The rise in these bond yields will make interest rate declines more difficult and may lead to interest rates stabilising at levels higher than what they should have given the global economic outlook and low inflation prevailing currently. Reducing Libor and corporate bond spreads have hidden this phenomenon in the near term, however this is something that need to be watched out
- If one includes the QIP issuances announced till date combined with the IPO pipeline, nearly $10 billion is proposed to be raised from the markets over the next one year. This is a huge supply of paper which can not only reduce the pace of market up move but also stop it at its heel.
Markets, as they start their correction, can fall by 10-20 per cent from the peak.
Mid-caps have once again caught the fancy of investors. Have the concerns about the companies abated?
The fear of insolvency or defaults in mid-cap companies has significantly reduced today. Moreover prior to the elections, most investors were unwilling to invest into mid-caps as they were not sure whether they could move out if things turned adverse. Subsequently, as investors became convinced over the long term direction of the markets, mid-caps have come back into the investment radar. Improved liquidity and reducing interest rates will now benefit mid-caps more than large caps. A vast majority of mid-caps fell by nearly 70-80 per cent in the bear market and have now bounced back to 30-50 per cent of their peak values on a broad basis. I believe that given the growth prospects of the Indian economy there are lot of quality mid-cap companies which will not only go back to their earlier highs but also move higher up. As such, any corrective moves in the market will provide a good opportunity to build up positions in high quality mid-cap companies.
Growth-oriented stocks will continue to get a greater premium over the next few weeks and months as investors become more convinced that the economy is clearly on the path of recovery. As such, long-term investors should prefer growth over value.
There have been contradicting signals on the commodity recovery story. What is your view on commodities?
More than 50 per cent of the global economy is unlikely to see much growth over the next five years and as such demand pressures will be low. This will result in commodity prices remaining suppressed (not withstanding the current rally backed by dollar weakness and expectations of economic recovery). Moreover the capacity expansion over the last few years have led to an overcapacity in lot of commodity industries which is unlikely to correct in the near term. Under the circumstances, I do not expect commodity prices to rally significantly over the next two to three years and would be more or less range bound.
Investors with a long-term perspective can subscribe to the initial public offer of Mahindra Holidays & Resorts. The company’s position as the dominant player in the business of vacation ownership, its early-mover advantage in a business with little competition and its strong growth record suggest good potential.
The company’s revenue model, which involves upfront payment of the ownership fee and recurring annual maintenance fee thereafter, also provides for higher visibility and a more stable stream of revenues than for pure hospitality players. Stiff pricing of the offer, however, may curtail scope for near-term gains on the stock, post listing.
Mahindra Holidays’ overall growth, to a great extent, hinges on its ability to expand its member base.
While it has been able to grow its member base exponentially in the past, this was on a lower base and during an economic boom. Sustaining similar growth rates over the next couple of years may not be as easy.
While signs of revival in economic activity do lend comfort, Mahindra Holidays relies heavily on discretionary spending by consumers, which may be the most vulnerable to economic cycles. It is in this context that the offer price of Rs 275-325 appears a tad stiff. The offer price discounts the company’s likely FY10 per share earnings by about 23-27 times on post offer equity base.
The fact that the company has no strict comparables and is the market leader in its segment does offer room for premium valuations. The offer, nevertheless, would leave more room for upside over the next year, if priced at the lower end of the price band.
Mahindra Holidays & Resorts has, over the years, grown to become a popular name in the business of providing leisure hospitality services through vacation ownerships in India.
A relatively nascent concept in India, Mahindra Holidays’ service offering is based on the model of time shares in which multiple owners (its vacation ownership members) hold the rights to use its various properties and are allotted specific time slots (depending on member choice) in which they may use the property.
The company has a total of 27 resorts across India and Thailand with a capacity of 1,261 apartments and cottages. Club Mahindra Holidays, its flagship service offering, currently entitles its members the choice of holidaying at any of its 23 resorts, for seven days each year, in a season and apartment type of their choice, for 25 years. Members can also choose to access a range of resorts globally through its RCI affiliation.
That apart, it also features other vacation ownership packages aimed at specific user segment such as Zest (young urban families), Club Mahindra Fundays (corporate houses) and Mahindra Homestays (overseas and Indian travellers). In order to further widen its network, it also launched clubmahindra.travel in April 2007.
Despite the odds of venturing into new territory, the company has done well in growing its membership enrolments at a compounded annual growth rate of 33 per cent over the last three years. As of May 31, 2009, it had about 92,825 vacation owners.
Broader economic travails had, however, led to a dip in the pace of new member acquisitions last year, especially in the third quarter, with a 26 per cent addition to its member base last year.
While the company says that it managed to get back to its historical levels of member acquisitions in the fourth quarter by increasing focus on Tier II cities, replicating similar growth levels over the next couple of years will hinge mainly on a revival in the economy.
While there’s no doubt that the its existing member base will continue to vacation at its properties, contributing to annual resort revenues (its room nights booked have only increased year on year), member additions from hereon at historical growth rates may not come by as easily.
The recent phase of salary cuts and job losses, especially in the services sector, if it persists, may moderate discretionary spending, impeding growth for this company.
It is in this context that Mahindra Holiday’s increasing marketing presence and brand recognition may help.
The company has a total of 19 branches and 61 retail outlets across India, of which 45 are owned and 16 franchised. In addition, it also has direct to home operations and on-site operations at a few of its resorts.
While it plans to further add to its market presence over the years, the significantly high share of member referral sales lends confidence on its ability to add members, macro challenges remaining the same. For the last fiscal year, over 35 per cent of its sales were through member referrals. The high share of referrals does away with the company’s member acquisition expenses.
Despite worries about new member additions, the recurring revenue stream that the company enjoys by way of annual subscription fees and resort revenues lend immense strength to its revenue model.
Mahindra recognises a portion (60 per cent) of the total fee as admission fee in a given fiscal, the balance entitlement fee is booked over the period of membership. That ensures a committed stream of annuities from existing members, even if new member contributions taper down.
While the default on annual subscription fee is also a risk, the company hasn’t seen significantly high numbers on that front so far.
Results and IPO proceeds
Over the last four years, Mahindra Holidays has grown its revenues and profits at a compounded annual growth rate of about 43 per cent and 76 per cent, respectively. In the same period, both its operating and profit margins have expanded significantly to about 34 per cent and 18 per cent, respectively.
Through this issue, which also involves an offer for sale by the promoter company M&M, Mahindra Holidays intends to finance the expansion of its resorts in Coorg, Ooty and Ashtamudi and setting up of new ones in Tungi and Theog.
The initial public offer is open between June 23-26. The company seeks to raise Rs 162-192 crore through the fresh issue of shares. Kotak Investment Banking and HSBC Securities and Capital Markets are the book-running lead managers. Karvy Computershare is the registrar to the issue.