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Stock Idea - Nicholas Piramal India

Recommendation: Buy

CMP = Rs 354

Price target: Rs 434

Key points:

• The Q4FY2008 and FY2008 results of Nicholas Piramal India Ltd (NPIL) are ahead of our expectations. The company's top line grew by 19.0% yoy to Rs 767.9 crore in Q4FY2008 and by 16.2% to Rs 2,872.8 crore in FY2008. The growth was driven by an impressive performance in the branded formulation business (up by 17.8% in FY2008, despite the temporary setback received in Q1FY2008 on account of lower phensydyl sales), strong traction in the Indian custom manufacturing (CMG) operations (up by 18.9% in FY2008) and the pathology laboratory (path lab) business (up by 71.8% in FY2008).
• The reported operating profit margin (OPM) expanded by 1,330 basis points to 26.5% in Q4FY2008 and by 340 basis points to 18.9% in FY2008. The margin improved on the back of rising operating leverage and savings arising out of the demerger of the new chemical entity (NCE) R&D unit into an independent company. Even on a like-to-like basis (without considering the impact of the savings from the NCE R&D demerger), the margin expanded by a robust 310 basis points in Q4FY2008 and by 100 basis points in FY2008.
• The company incurred a one-time restructuring charge in its international operations, on account of which the reported net profit (after extraordinary items) grew by 141.7% to Rs 132.8 crore in Q4FY2008 and by 53.1% to Rs 218.1 crore in FY2008. In FY2008 the company delivered earnings of Rs 17.5 per share, which were in line with its guidance and ahead of our estimate of Rs 17.2 per share.
• The management has guided towards a 16% like-to-like growth, with continued improvement in the OPM to 20.5%, resulting in earnings of Rs 21 per share in FY2009. Given the strong margin expansion, we believe that the earnings guidance provided by the management is conservative. The profits are expected to grow by 20.4% to Rs 533.3 crore, resulting in earnings of Rs 25.5 per share in FY2010E.
• At the current market price of Rs 354, NPIL is discounting its FY2009E earnings by 16.7x and its FY2009E earnings by 13.9x.
• I maintain Buy recommendation on the stock with a price target of Rs 434.

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Stock Idea - Andhra Bank

Recommendation: Buy
CMP = Rs 81
Price target: Under review
Key points:

• Andhra Bank reported a disappointing set of numbers for Q4FY2008. The profit after tax (PAT) declined by 10.5% yoy to Rs 124.3 crore. The net interest income (NII) was down 11.6% yoy to Rs 342.9 crore. The interest expenses growth of 42% yoy outpaced the 20.5% growth in the interest income, pointing towards pressure on the net interest margin.
• The non-interest income continued to be a major contributor to the bottom line with a 32.5% growth at Rs 183.3 crore. The operating expenses were down 7.6% yoy to Rs 213.1 crore, primarily driven by a substantially lower staff expenses (down 21.1% yoy).
• Meanwhile, the other operating expenses were up 8.1% yoy. Strong non-interest income coupled with a decline in the operating expenses helped the bank post a positive albeit a muted growth of 5.9% in the operating profit.
• The asset quality of the bank improved further as reflected by a 34 basis points y-o-y decline in % gross non-performing assets (GNPA) to 1.07%. On absolute terms as well, the GNPA declined by 6.2%. Meanwhile, the % net non-performing assets (NNPA) came in at 0.15%, down 2 basis points yoy.
• The capital adequacy ratio at end of the quarter stood at a comfortable 11.61%, largely in line with the year ago level of 11.33%. Advances registered a growth of 22.4% yoy to Rs 34,556 crore. Of the total advances, retail advances growth stood at 19.5% yoy, while small and medium enterprise advances were up by 22.7% yoy. The FY2008 PAT reached at Rs 575.6 crore indicating a growth of 7% yoy.
• At the current market price of Rs 80.6, is is trading at 5.5x FY2009E earnings per share, 2.9x FY2009E pre-provisioning profit and 1x FY2009E book value.
• I am currently reviewing the valuation of this stock and would shortly report my findings. Till then, I would advise my readers to include this stock in their portfolio.

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Stock Idea - Bharti Airtel

Recommendation: Buy

CMP = Rs 915

Price target: Rs 1,100

Key points:

• The net revenues of Bharti Airtel grew by 12.3% qoq and by 45% yoy to Rs 7,819.1 crore during Q4FY2008. The revenue growth was much ahead of the consensus estimate and driven by robust sequential growth of 14.4% and 9.3% in the mobile service business and the non-mobile service business respectively.
• The operating profit margin (OPM) declined by 100 basis points qoq to 41.6% during the quarter, largely due to an increase in the operating expenses resulting from the transfer of passive infrastructure (network towers) to its subsidiary, Bharti Infratel. Moreover, the downward revision in the tariffs to Rs1 a minute for all pre-paid schemes in January and higher sales & marketing expenses also dented the overall profitability. The operating profit grew by 9.7% qoq and by 45.1% yoy to Rs 3,251.8 crore.
• The interest expenses (net of interest income) jumped sharply to Rs 215.7 crore (up from Rs 81 crore in Q3) largely due to Rs 147.2 crore of losses related to forex fluctuations and mark-to-market losses on the company's derivative exposure. On the other hand, the depreciation charge declined by 6.5% qoq to Rs 970.2 crore (again due to the transfer of passive infrastructure to Bharti Infratel). Consequently, the earnings jumped by 7.6% qoq and by 36.9% yoy to Rs 1,852.9 crore.
• In terms of new developments, the company inducted $1.35 billion from private equity investors in Bharti Infratel, valuing the subsidiary at $10-12.5 billion. It has received additional spectrum in seven circles and is eligible in six more circles as per the new norms. In terms of regulations, the Telecommunication Regulatory Authority of India (TRAI) announced the phasing out of access deficit charges and introduced guidelines for sharing of active network infrastructure during the quarter.
• At the current market price the stock trades at 20.3x FY2009 and 16.7x FY2010 estimated earnings.
• I maintain Buy call on the stock with a price target of Rs 1,100.

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Stock Idea - Reliance Industries

Recommendation: Buy

CMP = Rs 2,577

Price target: Rs 3,025

Key points:

• Reliance Industries Ltd (RIL) has reported a growth of 35.8% yoy in its stand-alone revenues to Rs 37,286 crore for Q4FY2008 which is on the higher side of market expectations. In terms of segments:
• The refining division grew by 36.4% yoy to Rs 28,686 crore.
• The petrochemical division grew by 12.3% yoy to Rs 14,119 crore, driven largely by the growth in volumes. 
• The exploration and production (E&P) division grew by 51.1% to Rs 828 crore.
• The operating profit margin (OPM) during the quarter declined by 270 basis points yoy and by 80 basis points qoq to 16.1% in Q4FY2008. In terms of segments:
• The margin for the petrochemical division declined by 60 basis points to 10.4% due to higher crude oil prices.
• The gross refining margin (GRM) for the company increased marginally on a sequential basis from US$15.4 per barrel to US$15.5 per barrel in the quarter ended March 2008. The GRM was higher on account of sustained structural tightness in the global distillate market and sustained light-heavy differential.
• The margin for the E&P division declined by 110 basis points to 54%.
• The company's net profit increased by 24% yoy to Rs 3,912 crore during Q4FY2008 over the same quarter last year. Its interest expenses were lower during the quarter due to the rupee's appreciation vis-à-vis the US Dollar whereas the depreciation charge was marginally higher. For FY2008, the consolidated net sales grew by 19.5% to Rs 137,147 crore. The consolidated net profit (after excluding exceptional items) grew by 26.9% to Rs 15,326 crore. The exceptional item of Rs 4,733 crore represents gains primarily arising out of transactions concerning Reliance Petroleum Ltd (RPL) shares.
• During the year, RIL made nine new discoveries in its offshore E&P blocks. It also achieved 90% overall progress in the implementation of RPL's complex refinery. Reliance Retail today operates over 590 stores in 57 cities, spanning over 3.5 million square feet of trading space across 13 states.
• With nine oil and gas discoveries during the year and a portfolio of exploration blocks, the company holds a great promise in the exploration business. The refinery business would exhibit good performance on the back of superior margins and volume growth in future as RPL's new refinery becomes operational during FY2009. This along with the growing contribution from the retail business provides a well diversified growth opportunity.
• Currently the stock is trading at 14.5x FY2010E consolidated earnings and an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 11.1x.
• I maintain strong Buy recommendation on the stock with a price target of Rs 3,025.

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Stock Idea - UltraTech Cement

Recommendation: Buy (again!!)

CMP = Rs 824

Price target: Rs 1,100

Key points:

• UltraTech Cement (UltraTech) in their Q4FY2008 results reported a top line growth of 9.3% yoy at Rs 1,601.6 crore. Volumes for the quarter stood at 4.88 million metric tonne (MMT) against 4.81 MMT a year ago, implying an increase of 1.5% yoy.
• The operating profit margin (OPM) for the quarter improved by 260 basis points yoy to 30.5%. The OPM improved mainly on account of higher cement prices. The earnings before interest, depreciation, tax, and amortisation (EBIDTA) per tonne for the quarter stood at Rs 1,001, higher by 17.8% yoy. However, on a sequential basis EBIDTA per tonne was down 7.9%, as the increase in the cost of manufacturing cement was higher compared to the rise in the cement prices. For the quarter ended, the company reported a profit after tax (PAT) of Rs 282.8 crore, up 22.2% yoy.
• The cost of raw material per tonne of cement during the quarter ended shot up by 38.4% yoy to Rs 326. The cost of power and fuel per tonne of cement also was higher by 15.5% yoy to Rs 756.5. This was mainly on account of higher domestic and imported coal prices. Imported coal prices were up almost 100% yoy.
• For the quarter ended, the freight and handling expense per tonne of cement was lower by 10.6% yoy at Rs 578.7. However it was marginally up on a sequential basis. The increase in freight and handling cost sequentially can be attributed to the diesel price hike in February 2008.
• For the year ended FY2008, on a standalone basis the net sales stood at Rs 5,509.22 crore, up 12.2% yoy. The operating profit stood at Rs 1,720.06 crore, up 21.3% yoy and the PAT stood at Rs 1,007.61 crore, up 28.8% yoy. For the year ended FY2008, on a consolidated basis the net sales stood at Rs 5,623.82 crore, up 13.2% yoy and the PAT was reported at Rs 1,010.05 crore, up 28.7% yoy.
• The company has recently announced a dividend of Rs 5 per share. At the current market price of Rs 825, UltraTech is trading at 10.6x its FY2009E earnings per share (EPS) and at an enterprise value/tonne of $137.
• I maintain a Buy recommendation on the stock with a price target of Rs 1,100 over next 6 months.

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Stock Idea - Tata Consultancy Services (TCS)

Recommendation: Buy (very strong!!!)

CMP = Rs 887

Price target: Rs 1,079

Key points:

• Tata Consultancy Services (TCS) has reported a growth of 2.9% qoq and of 18.4% yoy in its consolidated revenues to Rs 6,094.7 crore for Q4FY2008. The sequential revenue growth was contributed by a volume growth of 4.8% and rupee depreciation of 1.1%. However, the revenues during the quarter were adversely affected by a 1.6% decline in the blended realisation and a 1.4% decline due to a change in the revenue mix (following a higher offshore proportion).
• The operating profit margin (OPM) declined by 118 basis points to 25.5% sequentially. The OPM was dented by lower blended realisation (a 1.6% sequential decline) and an increase in the overhead cost as a percentage of sales (up 70 basis points to 21.1% of the sales). On the other hand, a favourable offshore-onsite mix and a 320-basis-point improvement in the utilisation rate (including trainees) to 75.8% partially cushioned the pressure on the OPM. Consequently, the operating profit declined by 1.7% qoq to Rs 1,552.4 crore.
• The other income declined sharply by 25.4% qoq to Rs 78.1 crore. Moreover, the company's effective tax rate increased to 13.5% in Q4FY2008 from 12.7% in Q3FY2008. Consequently, the net income fell by 5.6% qoq to Rs 1,255.9 crore, which was below our expectation of Rs 1,377.7 crore. 
• The performance was largely dented by a slowdown in the business from two of its top clients (from the banking and financial services domain) and project delays in the other verticals in the last quarter. As a result, a 4.8% sequential volume growth didn't completely translate into higher revenues and improved margins. The stock is expected to under-perform in the near term.
• Given the sluggish demand in the BFSI vertical, the management is cautiously optimistic on the demand environment. The scenario is expected to improve, moving ahead.
• The company closed six large deals during the quarter. The deal pipeline is also healthy (25 deals with the run rate of over US$50 million) and the management expects the growth to improve in the coming quarters. TCS has set a target of 30,000-35,000 gross employee additions in FY2009.
• At the current market price, the stock is trading at 14.9x FY2009 earnings estimate and 14.0x FY2010 earnings estimate.
• I maintain very strong Buy recommendation on the stock with a price target of Rs 1,079 over next 6 months.

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Stock Idea - Esab India

Recommendation: Buy (again!!! J)

CMP = Rs 432

Price target: Rs 575

Key points:

• For CY2007 ESAB India has reported a healthy 19.4% growth in its sales and a 25.2% rise in its profits. The company continues to grow at a robust rate owing to the government's thrust on infrastructure development. ESAB India remains a leader in the welding products industry.
• The consumables business recorded a growth of 16.7% for the full year on account of a good volume growth with marginally better realisations except for the wire segment where price continues to be under pressure. The equipment business reported an increase of 26.8% in revenues while its earnings before interest and tax (EBIT) margin reported a healthy increase of 360 basis points on account of operating leverage.
• Overall, the company improved its operating profit margin by 70 basis points to 23.3%.
• During the year, Charter Plc, its parent company, increased its stake in ESAB India by acquiring shares from the open market at a price of Rs 505 per share, taking the total holding to 55.56% from 37.31% earlier. 
• The outlook on ESAB India remains positive. The hectic activity in India's core infrastructure sectors, like roads, ports, airports and construction, and the other industrial sectors are expected to drive the volumes for the welding industry.
• Being the market leader ESAB India is expected to make the most of this boom. I maintain strong Buy recommendation on the stock with a price target of Rs 575.

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Stock Idea - BASF India

Recommendation: Buy
CMP = Rs 210
Price target: Rs 330
Key points:

• The stand-alone Q4FY2008 results of BASF India (BASF) are in line with the expectations. The net sales of the company grew by 20.3% yoy to Rs 193.4 crore, mainly driven by a strong 29.6% growth in the sales of agricultural products and a 20.2% growth in the sales of performance products. The plastic division’s sales also grew by a healthy 18.1%.
• The operating profit margin (OPM) during the quarter remained flat at 5.1% yoy. The margin for the performance product and chemical divisions improved while the same for the agricultural product and nutrition division, and the plastic division declined during the quarter. Consequently, the operating profit grew by 18.5% to Rs9.8 crore in Q4FY2008.
• Despite increased interest and depreciation charges, the company’s net profit increased by 20.2% to Rs4.4 crore during the quarter. For FY2008, the consolidated net sales grew by 24.5% to Rs 1,053.6 crore and the PAT grew by 14.8% to Rs 57.5 crore on the back of the solid performance by the agricultural product and nutrition division during the year.
• The consumption boom in the company’s user industries (white goods, home furnishings, paper, construction and automobiles) is expected to continue and hence we should remain optimistic about the company’s growth prospects.
• In my opinion, the stock is trading at attractive valuations of 6.9x FY2009E consolidated earnings and an enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) of 3.9x.
• Hence I maintain Buy recommendation on the stock with a price target of Rs 330 over next 6 months.

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Stock Idea - HCL Technologies

Recommendation: Buy

CMP = Rs 261

Price target: Rs 318

Key points:

• HCL Technologies (HCL) has reported a revenue growth of 7.1% qoq and 23.3% yoy to Rs 1,944.8 crore for the third quarter ended March 2008. In dollar terms, it has reported a sequential growth of 5.2% in its consolidated revenues to US$484.9 million. The sequential growth in the revenues was driven by a volume growth of 6.6% (a 5.3% growth in software service business, an 8.5% growth in Infrastructure Management Services [IMS] and a 4.5% growth in the BPO business).
• The operating profit margin (OPM) improved by 88 basis points to 22.3% on a sequential basis. The margin improvement was aided by higher realisations (7 basis points), hedging gains (22 basis points), improved revenue mix (26 basis points) and efficiency gains (48 basis points). This positive affect was however partially offset by higher infrastructure expenses of around ten basis points. 
• In terms of segments, the EBITDA margin of all the three business lines improved on a sequential basis. The IMS and software service businesses reported a sequential margin improvement of 113 basis points and 93 basis points respectively. The BPO service business reported a 16 basis-point sequential improvement in its margin. However, the forex loss of Rs 27.1 crore as compared with a forex gain of Rs 5.8 crore in Q2FY2008 resulted in a relatively lower earnings growth of 2.9% qoq to Rs 342.5 crore.
• In terms of operational highlights, the company signed deals worth $500 million during the quarter. However, it has maintained its full year revenue growth guidance of around 35%, implying a relatively muted sequential growth in Q4FY2008. This is largely due to a slowdown in the business from two of its top ten clients as a fallout of the scenario in the USA. Moreover, the company added just 1,848 employees in Q3FY2008 and has scaled down the recruitment target to 9,000 employees in FY2008 from 12,000 employees targeted earlier.
• At the current market price, the stock is trading at 12.2x FY2009 earnings estimate and 10.9x FY2010 earnings estimate.
• I maintain Buy recommendation on the stock with revised price target of Rs 318 over next 3 months.

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Stock Idea - Ranbaxy Laboratories

Recommendation: Buy

CMP = Rs 482

Price target: Rs 625

Key points:

• Ranbaxy Laboratories (Ranbaxy) has entered into an out-of-court settlement relating to the launch of generic Nexium, Astra Zeneca's blockbuster drug for gastroesophageal reflux disease. Under the terms of the settlement, Ranbaxy can launch generic Nexium in the USA on May 27, 2014 with 180-days exclusivity. This is ahead of the drug's patent expiry in 2018. Further, Ranbaxy will also supply a significant portion of Astra Zeneca's requirement for Nexium in the USA from May 2010 onwards and supply esomeprazole magnesium (the active pharmaceutical ingredient for Nexium) from May 2009 onwards. 
• In a separate agreement, Ranbaxy has also been designated as the authorised generic player for two older Astra Zeneca products – the heart drug Plendil, or felodipine, and the 40mg version of ulcer pill Prilosec, or omeprazole. Ranbaxy will be compensated for its distribution services on standard commercial terms.
• Nexium clocked revenues of $5.2 billion in 2007 and is Astra Zeneca's biggest product. Using the discounted cash flow (DCF) approach, valuation of Ranbaxy's Nexium deal with Astra Zeneca comes to Rs 70 per share. 
• Clarity on the launch of generic Lipitor both in the USA as well as in the other world markets, along with news flow on further Para IV first-to-file (FTF) opportunities, would act as trigger for the stock. At the current market price of Rs 482, Ranbaxy is trading at 22.5x its base CY2008E and 19.7x its base CY2009E earnings (excluding exclusivity opportunities).
• I maintain Buy recommendation on the stock with a revised price target of Rs 625.

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Q4FY2008 earnings preview - Special Report

Key points:

• The earnings of the Sensex companies are likely to grow by 22.2% year on year (yoy) and 2.4% quarter on quarter (qoq) in Q4FY2008.
• Excluding ONGC and DLF, the earnings are expected to grow by 16.2% yoy and 3.6% qoq. The estimated earnings growth is expected to be relatively much slower than the growth witnessed in the previous few quarters and indicates moderation in the overall growth momentum.
• The report card of banking and capital goods companies will undergo extensive scrutiny following the series of negative developments recently.
  The expected 22.2% yoy growth would mainly be achieved on the back of the high growth in the oil & gas sector (76.2% yoy) and the telecom sector (34.9% yoy) while the automobile sector is expected to act as a drag on the Sensex' earnings.
• The Q4FY2008 performance gains all the more important against the backdrop of a deterioration in the macro environment, ie soaring headline inflation, a dip in the industrial production during January 2008, lower automobile sales and losses from foreign exchange (forex) derivatives.
• Some of the sectors have been facing tough challenges: Cement (high fuel cost), fast moving consumer goods (FMCG; higher raw material cost) and capital goods (capacity constraints).
• The Reserve Bank of India (RBI) and the finance minister have taken cognisance of the fears of a slowdown. However, the macro situation does not offer easy solution for stimulating growth because inflation (7.4% as on March 29th) is already well above the RBI's target rate of 5%.
• On the positive side, the Union Budget has spelled out multiple measures to stimulate consumption and investments. For instance, the loan waiver scheme and tax slab restructuring are likely to give a major boost to consumption, though in the medium to longer term.
• Overall, the scenario looks healthy, though I anticipate further moderation in earnings growth. I would suggest my readers to stay invested.

Stock Idea - Unity Infraprojects

Recommendation: Buy

CMP = Rs 581

Price target: Rs 970

Key points:

• Unity Infraprojects (Unity) has bagged two new orders worth Rs 222 crore. The first order totaling Rs 133.6 crore is for the construction of a mall and a hotel, whereas the second order worth Rs 88.3 crore is for the construction of five towers with basement and a podium.
• With these two orders, the company has bagged orders worth around Rs 450 crore in Q4FY2008. This implies its current order book stands at Rs 2,425 crore at the end of March 2008, which is a growth of 21.4% year on year (yoy).
• The prospects for Unity are very bright and I recommend Buy call on this scrip with a price target of Rs 970 over next 6 months.

Stock Idea - Madras Cements

Recommendation: Buy

CMP = Rs 3,202

Price target: Rs 4,800

Key points:

• Madras Cements has completed the process of buy back. As a result of the buy back the earnings per share (EPS) of the company will increase by 1.5%. Firm cement prices in south India will be the key driver for the company's earnings in Q4FY2008.
• The company had a capacity of 6 million tonne at the end of FY2007, which increased to 7 million tonne at the end of FY2008 and is expected to further increase to 10 million tonne by the end of FY2009. Capacity additions will drive the volumes growth of the company.
• At the current market price of Rs 3,202, the share trades at 8.7X and 6.7X its FY2008 and FY2009 earnings and an enterprise value (EV)/earnings before interest, depreciation, tax and amortisaion (EBIDTA) of 5.5X and 5X for FY2008 and FY2009 respectively.
• I maintain a strong Buy recommendation on the stock with a price target of Rs 4,800.

Stock Idea - Ashok Leyland

Recommendation: Hold

CMP = Rs 35

Price target: Rs 43

Key points:

• Ashok Leyland's total vehicle sales during March 2008 grew by 26.7% to 10,698 units from 8,444 units in the same month a year ago. The sales in the domestic market grew by 20%, whereas exports were up by 128% for the month. The surge in sales can be attributed to the year-end push in domestic sales and pending export orders. For FY2008 sales are at 83,309 vehicles, in line with our estimate of 83,200 units. For the same period, export sales have grown by 21% to 7,286 units whereas the domestic sales have declined by only 1.3% to 76,045 units leading to gain in the market share. 
• Ashok Leyland had announced a price hike of 2.5% in end February 2008 to offset the input price increase. Also, the management decided to pass on the benefit of a reduction in the excise duty on buses from 16% to 12% and of the cut in the cenvat on trucks from 16% to 14%. So, the effective price increase has been only to the extent of 1%.
• Ashok Leyland has recently concluded an external commercial borrowing program of US$200 million. This is the largest ever loan taken by the company in a single transaction till date. The loan will partly fund the requirements of the company to meet its expansion plans and overseas investments. 
• Ashok Leyland has a huge capital expenditure (capex) plan of ~Rs 2,000 crore for the next two to three years. It has planned capex to expand its existing capacity and to set up a new manufacturing facility at Uttarkhand. Further additional investment will be required for its light commercial vehicle joint venture with Nissan. 
• The stock price has corrected substantially, thereby providing decent upside to earlier price estimates of Rs 43. However, it would be reviewed again after the announcement of Q4FY2008 results, clarity on the investment in the joint venture with Nissan and impact of the higher raw material prices.
• Currently I recommend Hold call on this stock.

Stock Idea - Orchid Chemicals & Pharmaceuticals

Recommendation: Buy
CMP = Rs 207
Price target: Rs 375
Key points:

• According to a few media reports, Solrex Pharmaceuticals has acquired an 8.06% stake in Orchid Chemicals (Orchid) from the open market. The stake has been acquired at an average price of Rs 165-170 per share. As per media speculation, Solrex Pharmaceuticals belongs to the Ranbaxy group. If the media speculation is to be believed and the Ranbaxy group manages to take over Orchid at a cheap price of Rs 165-170 per share, it would come as a huge benefit for the group. The company will gain from acquiring a fundamentally strong business with a complementary product portfolio and that too at extremely cheap valuations.
• Pursuant to the ~40% plunge in the share price of Orchid on March 17, 2008 due to relentless selling by the troubled Bear Stearns and the subsequent margin call trigger for the promoters, the promoter holding in Orchid had reduced from 24% to 17%. The low promoter holding coupled with the sharp fall in the share price made Orchid an attractive takeover target.
• Tfair value of Orchid works out to Rs 375 per share, which means that the Ranbaxy group's purchase price would work out to a 120% discount to the fair value of the company and a 93% discount to the 52-week high price of Rs 328. In fact, the acquisition price would be at par with Orchid's estimated FY2008 book value of Rs 167.6 per share.
• Orchid's business model is fundamentally strong with a strong presence in the USA and expansion plans underway in Europe. However, the stock has been plagued by several concerns including a relatively low promoter holding and an over-leveraged balance sheet. I feel that the potential takeover of Orchid by the Ranbaxy group or even the holding of a minority stake by the Ranbaxy group in Orchid will ensure long-term growth for Orchid, as the latter would be in stronger and more credible hands.
• At the current market price of Rs 207, Orchid is discounting its FY2008E earnings by 11.9x and its FY2009E earnings by 8.8x. The valuations at these levels seem absolutely compelling when viewed in context of the strong growth potential that awaits the company.
• I retain strong positive stance on the stock and maintain Buy recommendation with a price target of Rs 375.

Stock Idea - ICI India

Recommendation: Hold

CMP = Rs 643

Price target: Rs 622

Key points:

• The board of directors of ICI India has approved divestment of its adhesives business for a total consideration of Rs 260 crore to an Indian affiliate of Henkel group, subject to adjustments for actual working capital and cash balances. This is in line with AKZO Nobel's (which has acquired 100% stake in ICI Plc, the parent company of ICI India) decision to divest ICI's global adhesives and electronic materials business to Henkel AG.
• While ICI's global business is transferred to Henkel AG at a valuation of 2.1X its sales, the Indian adhesive business has fetched 2.3X its expected sales for FY2008. The deal will include transfer of portion of Thane manufacturing facility and about 120 employees currently working with the business and the company's shareholding in its subsidiary Polyinks to Henkel.
• I remain positive on ICI India primarily on account of good prospects for paint industry going forward, synergies that would arise on concerted efforts of Akzo Nobel in growing ICI India's business and a huge pile of cash that opens up opportunities for organic and inorganic growth.
• Valuing the core business at 20X FY2009E EPS of Rs 17.8 (excluding other income) and adding the cash per share of Rs 266, I arrive at a fair value of Rs 622 for the stock.
• At the current market price of Rs 643, the stock trades at 21X its FY2009E EPS of Rs 30.9. I recommend a Hold call on this stock.