Punj Lloyd Limited
Sunday, August 09, 2009
Investors with a risk appetite for commodity stocks can buy the stock of plastic products maker Supreme Industries (Rs.295). The company’s diversified product profile — consisting of pipes, packaging and industrial products — makes it a beneficiary of spending in segments such as irrigation, housing and infrastructure.
A relatively stable outlook for raw material costs and demand, after several challenges last year, make this a reasonable time to pick up the stock. The company’s current market price discounts the trailing four quarter earnings by eight times, at a par with players such as Sintex Industries.
Supreme Industries operates across four segments — plastic pipes, which contribute to 40 per cent of total turnover, packaging (27 per cent), industrial (21 per cent) and consumer products (12 per cent).
Pipes made by the company find extensive use in irrigation, bore-wells, portable water supply, plumbing, drainage, underground sewerage, rainwater harvesting and water management. A derived demand could come from the increase in rural irrigation as well infrastructure outlays. Replacement of metal pipes with plastic is also a positive factor for the company.
The packaging division caters to a wide spectrum of user industries, such as sports goods, electronics, food items, textiles, healthcare, toys, insulation and construction. Offerings in this segment range from packaging film to protective packaging material. The company also makes cross laminated films or tarpaulin sheets which have agricultural and industrial applications.
In the industrial products segment, Supreme Industries manufactures dashboards and other components for automobile companies (Tata Motors and Mahindra and Mahindra being some of the important customers) and equipments for consumer electronic goods such as LCD TVs and air-conditioners.
That apart, it also manufactures industrial craters for storage of textiles, fisheries, food items and soft-drinks. PepsiCo India and Coca Cola India are major customers. In the consumer products division, the company is a market leader in the moulded furniture segment, which offers scope for better margins.
Recently, the company expanded its production capacity of cross-laminated film and products, at its Halol, Silvassa, Gadegaon and Pondicherry plants, from 9000 TPA to 13000 TPA. It has also increased the capacity of injection moulding machines and ancillary equipments and has started a new factory at Jamshedpur for the ‘World Truck’ project of Tata Motors. Similarly, it has expanded plant capacities in Gadegaon and Jalgaon to launch varieties of plastics piping systems.
While operating profit margins from segments such as pipes and packaging are vulnerable to raw material cost increases, Supreme Industries has managed to hold its margins at a steady 11-12 per cent in recent years. Volume driven growth in the pipes segment has been complemented by reasonable pricing power in the industrial and consumer segments.
It has managed a compounded annual sales growth of 9 per cent and operating profits growth of 13 per cent in the last three years. However, performance in 2008-09 did take a brief knock from the ups and downs of the commodity cycle. The company ended 2008-09 with a sales growth of 26 per cent and net profits growth of 82 per cent, but slipped briefly into losses in the December 2008 quarter mainly due to unusual fluctuations in raw material prices — polypropylene prices fell steeply from $1800 a tonne in July 2008 to $625 by end of the year. (Major raw materials consumed are PVC resin, polyethylene and polypropylene and they account for nearly 80 per cent of the total raw materials cost.) That prompted order cancellations, as the company’s customers expected a further fall in the prices of plastic products and opted to wait before making fresh purchases.
With commodity prices improving along with the crude oil cycle, polypropylene prices have since moved back to $940 levels. Net sales and margins started improving from the March quarter as material prices began to stabilise and customers resumed their orders. The expansion in the past year, pick-up in demand and a tilt in product mix towards high margin products, point to stability in margins in the coming quarters.
Unlike its peers, such as Time Technoplast and Sintex Industries, Supreme Industries has negligible exposure to foreign currency fluctuations. More than 60 per cent of the raw materials are domestically procured and less than 10 per cent of its total turnover is through exports to countries such as the UK Australia and New Zealand.
However, another bout of volatility in crude oil and thus polymer prices could destabilise margins.
Investors with medium-term perspective can consider selling Exide Industries stock. Though it has been on an intermediate-term up trend from March low of Rs 34, it encountered resistance at Rs 90 and began to decline.
The stock’s trend reversal is backed by prolonged negative divergence, added with bearish engulfing candlestick pattern displayed in the weekly chart.
Moreover, we observe that volumes are dropping over the past two weeks.
The daily momentum indicator is losing its strength and weekly indicator has reached over-bought territory signalling weakness.
We believe that the stock has the potential to decline to the support level at Rs 55 in the medium-term.
We don’t rule out minor consolidation around Rs 65 while declining. Medium-term investor can sell with stop at Rs 92.
Short-term traders can sell with a target of Rs 73 and stop at Rs 85
The NHPC initial public offer (IPO) is ideally suited for long-term investors. Hydroelectric projects, by their nature, have long gestation periods of 5-7 years. On the existing generation capacity and financial profile, the offer appears to be fully priced. Valuations could, however, undergo a change as the company gradually commissions the different projects that are under implementation over the next four years and as the return on equity improves.
There are a number of positives to recommend an investment in this IPO not the least of which is the 12 per cent gap between demand and supply of electricity in the country. NHPC’s established record in implementing hydropower projects, its good operating performance and the fact that all of its capacity has been tied up with different customers through power purchase agreements are pluses.
Existing capacity of 5,175 megawatt (MW) will almost double in the next four years as new projects totalling 4,292 MW are commissioned. With a further 4,565 MW of projects awaiting government clearances, NHPC is expanding rapidly in an industry that is set to undergo a lot of changes, mostly favourable to the generators.
For instance, some of NHPC’s future projects, either in whole or in part, will sell power on a ‘merchant basis’. Given the large deficit in availability of power and the active part played by traders such as PTC India, generators such as NHPC can hope for higher realisations.
Given that its fuel cost is next to nil, NHPC sold its power last year at an average price of Rs 2.03 per unit. Though this is an advantage in the merit-order despatch system where the cheapest power is picked up first, it also means that the company is not able to capitalise on the supply shortfall.
NHPC has the advantage of its projects being located on perennial rivers and it has managed a capacity index of 95 per cent on an average. This is a major plus given that the northern grid, where NHPC sells most of its generation, is extremely starved for power.
Not surprisingly, some of its projects such as Chamera II in Himachal Pradesh have managed to earn a handsome sum as fees for meeting excess demand over that projected by the consuming State electricity board.
That said, NHPC also suffers from some blemishes that could, if not managed well, scar its financial performance and balance-sheet. Thanks to a historical reliance on equity funding through government grants, NHPC carries a huge equity base of Rs 11,182 crore that will increase to Rs 12,300 crore after the public offer now. A large quantum of equity funds is locked up at any given time in ongoing projects and this does not earn any return till the projects are commissioned.
The result is that the company’s return on equity is a poor 7 per cent despite it earning an assured return of 14 per cent on its equity till last year (15.5 per cent from this fiscal for the next five years) as per regulatory norms. Peers such as NTPC boast of a return on equity that is double that of NHPC’s.
The picture could change for the better in the next few years due to two reasons. First, NHPC has been off government grants since the last two years and its projects are now funded on 70:30 debt:equity with the equity coming from internal accruals. Second, as the projects under construction now start generating returns, the return on equity will gradually improve.
Cost and time overruns
NHPC’s projects are implemented in difficult physical terrain that are also often environmentally sensitive and hence require numerous government clearances. Given this, delays in commissioning projects are not uncommon, leading to big cost and time overruns.
For instance, the 2,000 MW Subansiri Lower project in Arunachal Pradesh was originally scheduled to be completed in September 2010 but the company now expects to commission it only by December 2012. The 240 MW Uri II and 160 MW Teesta Low Dam IV projects are also on a delayed schedule. Incidentally, these are among the projects that are proposed to be part-funded from the IPO now.
The increased costs have to be approved by the regulator, failing which the company will have to bear the burden.
The central electricity regulator issues a five-year tariff policy that governs NHPC’s tariffs. The 2009-2014 policy, while increasing the return on equity to 15.5 per cent from 14 per cent earlier, has changed the method of computation of annual fixed cost recovery in a manner that is adverse to NHPC. Incentives for generation beyond the design energy level have also been capped at Rs 0.80 per unit. Given the large public interest involved in the sector and also the huge demand-supply gap, it is likely that the regulator will play an active role which may not always work to NHPC’s interests.
The offer price band of Rs 30-36 does not leave much on the table for investors in the near-term. The price-earning multiple of 30 at the lower end of the price band is almost the same as that of Jai Prakash Hydro and higher than NTPC’s PEM of 21 based on historical earnings.
In price-to-book-value (P/BV) terms though, NHPC’s offer price compares favourably with the rest. At the offer price band, NHPC has a P/BV of 1.8-2.2 times; JP Hydro’s, in comparison, stands at close to four times while NTPC has a P/BV of three.
Given the high institutional interest in the power sector and the company’s fundamentals, it is likely that the stock will attract much attention in the market. Investors with a long-term holding strategy can subscribe to this offer.
Investors with a two-year horizon can buy the shares of Cinemax India, considering that the worst may be over for the company and the multiplex industry, with a string of releases charted for the next few months, steep increases in footfalls, and occupancies and increases in food and beverage revenues.
At Rs 50.50, the stock trades at about 14 times its expected 2009-10 earnings and 11 times its next year's estimates; on very conservative assumptions. This is at a discount to Fame India, despite the company's larger scale of operation.
The past two-three quarters were exceptionally challenging for multiplexes with the Mumbai terror attacks reducing footfalls and occupancies, the IPL-2 keeping audience glued to the small screen and the standoff with distributors over quantum of revenue sharing, delaying fresh releases.
For the June quarter, the company's revenues fell by over 18 per cent over June 2008 to Rs 25.3 crore, while EBITDA fell by 88 per cent to Rs 0.53 crore.
Many other multiplex operators incurred losses even at the EBITDA-level.
But with these one-off challenges behind it, the prospects of improvements over the next few months are bright. Recent reports suggest that in July, after the multiplex-distributor tussle ended, there has been a doubling of monthly box-office earnings.
Cinemax, which has 74 screens across 24 locations and many in the lucrative Mumbai market, has benefited from recent releases. Multiplex players have benefited from the large draw such movies as New York, Kambakt Ishq and Love Aaj Kal have had. Over 50 movie releases are expected over the next two quarters (that were held back due to the tussle), starring some big names in Bollywood.
Some big-ticket ones such as Kaminey, 3 Idiots, London Dreams, and Kites are expected to set the box-office ringing. Surprisingly, even English movies such as Terminator Salvation and The Hangover are reportedly running at 60-70 per cent occupancy.
Cinemax has seen its average ticket price decline to Rs 114 in the June quarter from the Rs 125 levels earlier. But the average spends on food and beverages have witnessed an increase to Rs 31 from Rs 29. As occupancies increase to 25 per cent plus levels on the back of higher footfalls and hit movies, the ticket price is set to increase.
The company, despite the slump in the June quarter, hopes to achieve an EBITDA margin of 25 per cent for the full year and an occupancy level of 25-27 per cent.
The stock market witnessed some profit-taking last week as monsoon worries resurfaced. The BSE benchmark index, the Sensex, crossed the 16,000-mark briefly to touch a high of 16,002. However, it slipped to a low of 15,104 towards the end of the week. The Sensex finally ended the week with a loss of 510 points, or 3.26 per cent, at 15,160.
Among index stocks — Jaiprakash Associates and Maruti with losses of around 9 per cent each were the biggest losers. ITC, Hero Honda, Reliance Communications, Hindustan Unilever, HDFC Bank, DLF, Bharti Airtel, HDFC and Tata Power were down 6-8 per cent each. On the other hand, Sun Pharma, Reliance and Wipro declined only around 2 per cent each.
Going forward, the monsoon factor is likely to remain a major dampener. Any negative cues from world markets could also have a spillover effect on our markets.
This week, the Sensex is likely to exhibit a rangebound movement with the upside seemingly capped around 15,700, and the downside support around 14,700. The Nifty came down by 155 points, or 3.34 per cent, to 4,481, after moving in a range of 4,731-4,464.
The index is currently below its short-term (15-days) simple moving average, which is a negative indicator. However, the short-term moving average, currently at 4,565, is above the mid-term (45-days) simple moving average of 4,391, which is a positive indicator. The bollinger bands have also narrowed down to 4,735-4,391, hence, in the coming week one could see movement in a narrow range.
On the downside, the mid-term moving average at 4,391 should act as a good support. In case, the index drops below 4,391, than it may slide up to 3,943 — its long-term (200-days) simple moving average.
Before we discuss about the dreary spell of the monsoons, let us first comment on the excellent grades given by our fellow analysts to the June Quarter results.
We find nothing exciting in these results, as the sales have dipped and the profits too have followed suit. Whatever profits were reported were efforts of vigorous cost cutting, treasury and other income. Some of the sectors did see generous margin expansions on the back of cheaper raw material costs.
Our contention is neither the cost cutting nor lower cost of raw materials are sustainable going forward. Unless the increased margins comes through higher price or volumes, we would not be enthused by these results.
Contrary to what the Agriculture Minister and the ‘Mausam Bhavan’ mandarins have been telling the media, the monsoons have played truant.
While we fully understand the fact that weather prediction is not a refined science as of now, but where is the need to give false and misleading assurances. Why do ruling parties have to err on the side of optimism? Why can’t they be realistic. No one is going to hang any minister simply because the precipitation was low. If the rains don’t come, it is neither the met department’s or the minister’s fault. They are merely messengers. But if the messenger unnecessarily gives a pink hue to the message, then it is unpardonable.
A drought is considered if the precipitation is less than 10% of the long term average and 20% of the total land area has a deficiency of more than 20% of the long term average. These two conditions have to be simultaneously met. We already have a deficiency of 25% nationwide and 25 of the 36 met divisions (70%) have a deficiency of more than 20%.
Also consider the fact that till August 5, we usually receive 58% of the season’s precipitation. So even if we were to assume that rain gods have a change of heart and become benevolent for the remaining season, then also, the end result will be a drought by the Governments own definition.
Then why isn’t the Government announcing one? May be they are waiting for the ‘Sharad’ ritu. Pun intended.
While a weak monsoon has been priced in by the markets, a drought is not. The Government will need to spend more on water harvesting measures, provide for fodder, seed inputs, drinking water, food for work programmes, etc.
All this will mean more spending and a larger deficit.
While the markets this week will open higher on better than expected US non-farm pay rolls data, the gains are unlikely to sustain for long.