Stock Idea - Esab India

Recommendation: Buy (again! J)

CMP = Rs 385 (at the time of this recommendation)

Price target: Rs 575

Key points:

• The revenues of Esab India for the quarter grew by 31% to Rs 114.4 crore led by the magnificent performance of the consumable division (revenues grew by 39.8% to Rs 86.6 crore) during the quarter. The equipment division's revenues grew by 9.6% to Rs 27.8 crore in the same quarter. The operating performance of the company remained stable with the operating profit margin at 24.6% in Q2CY2008. Consequently, the operating profit of the company grew by 29.8% to Rs 28.1 crore in the same period.
• The PBIT of the consumable division increased by 45.4% to Rs 25.2 crore in the quarter. This resulted in a 120-basis-point increase in the division's PBIT margin. The earnings before interest and tax margin of the equipment division, however, declined sharply by 320 basis points, leading to an 8% decline in the PBIT of the business to Rs 4.7 crore. Esab’s interest cost increased by 26.1% to Rs 0.3 crore whereas its depreciation charge rose by 21.8% to Rs 1.6 crore during the quarter. Consequently, its net profit grew by 30.9% to Rs 18.5 crore.
• For H1CY2008, Esab reported growth of 27.9% and 28.4% in its revenues and profits respectively. It also declared a 130% (= Rs 13 per share) dividend for its shareholders during the second quarter of CY2008. Esab would remain one of the major beneficiaries of the continued buoyancy in its user industries, such as pipes, shipbuilding and steel. Furthermore, a greater level of component indigenisation is likely to protect its margins against any adverse impact of the rising steel prices.
• At the current market price the stock discounts our CY2008 and CY2009 earnings estimates by 9.1x and 7.7x respectively.
• I maintain Buy recommendation on the stock with a price target of Rs 575 over next 5-6 months.

Stock Idea - Gateway Distriparks

Recommendation: Buy (again!!! J)

CMP = Rs 85 (at the time of this recommendation)

Price target: Rs 236

Key points:

• On a consolidated basis, the net sales of Gateway Distriparks Ltd grew by almost 99% yoy to Rs 96.2 crore particularly due to the continued strong volumes at the Jawaharlal Neheru Port Trust (JNPT) and a ramp-up of the rail business. It’s Q1FY2009 results of are quite positive, owing to a strong top line growth and lower than anticipated losses in the rail business during the quarter.
• The operating profit margin declined by 1,050 basis points yoy because of a change in the company's sales mix but improved by 230 basis points sequentially to 35.1%. The sequential improvement in the margin was achieved on the back of improved profitability of the rail and cold storage businesses. Better utilisation, increased efficiency and commencement of operations on the export-import routes improved the profitability of the rail business.
• The cold storage business too broke even at the net level in Q1FY2009. Consequently, the operating profit of GDL grew by 53% to Rs 33.7 crore in Q1FY2009. Both depreciation and interest charges rose considerably due to high capital expenditure incurred by the company to expand its container and rail businesses. Consequently, the net profit grew by 12% to Rs 21 crore in Q1FY2009.
• The company, in its board meeting, has also approved a proposal to buy back its shares from the open market through stock exchanges at a price not exceeding Rs 110 per share, payable in cash, for an aggregate amount not exceeding Rs 64 crore.
• At the current levels, the stock is trading at 9x FY2010E earnings.
• I maintain a very strong Buy recommendation on the stock with a price target of Rs 236 over next 6-7 months.

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Stock Idea - 3i Infotech

Recommendation: Buy (again!! J)

CMP = Rs 107 (at the time of this recommendation)

Price target: Rs 180

Key points:

• 3i Infotech's top line grew by 33.9% qoq to a whopping Rs 468.5 crore in Q1FY2009. While, the acquisitions contributed 19.9% to the sequential growth, the organic growth contributed 14.1% to the same. The operating profit margin declined by 299 basis points to 21.8% during the quarter on account of unfavorable sales mix (higher revenues contribution from the low-margin business). Consequently, the company's operating profit grew by 17.7% qoq to Rs 102 crore during the quarter.
• The net income grew by 20.1% qoq to Rs 58.7 crore. In terms of operational highlights, the company's order book grew by 6.1% qoq to Rs 917.8 crore driven by healthy sequential growth of 9.7% in the product order book. The revenues from the top five clients and top 10 clients (excluding ICICI group) grew by 148.7% and 78.5% respectively on a sequential basis.
• I have revised the FY2009 earning estimates upwards by 1.8% because of higher-than-expected contribution from the acquisitions.
• At the current market price, the stock is trading at attractive valuation of 7.3x FY2009 earning estimates and 6.0x FY2010 earning estimates.
• I maintain Buy recommendation with price target of Rs 180 over next 3-4 months.

Stock Idea - Allahabad Bank

Recommendation: Buy

CMP = Rs 58

Price target: Rs 95

Key points:

• Allahabad Bank reported PAT of Rs 93.4 crore for Q1FY2009, indicating a decline of 53.4% yoy. This decline was mainly because of a substantial increase in the provisions and contingencies which increased to Rs 202.2 crore as at the end of Q1FY2009 compared with Rs 24.5 crore during the same period last year. The sharp rise in the provisions was primarily due to higher investment depreciation to the tune of Rs 264.1 crore. The reported net interest income for the quarter stood at Rs 495.5 crore, up by 9.8% on a yoy basis, mainly driven by a around 24% increase in the advances during the quarter. 
• On the margin front, while the margins remained largely stable sequentially, the net interest margin declined by 22 basis points yoy to 2.75% from 2.97%. The growth in advances was slightly below the industry growth during the quarter. However, it still remains healthy at 24% yoy, due to higher demand from the oil marketing companies. Meanwhile, the deposits registered a growth of 16.5% yoy.
• The non-interest income for Q1FY2009 stood at Rs 117 crore, up 23.6% yoy on the back of higher treasury gains. The core fee income increased 6% yoy to Rs 107.3 crore. The gross non-performing assets in percent terms improved by 59 basis points to 1.87%. However, the net non-performing assets in percent terms remained flat at 0.75%. The capital adequacy ratio of the bank stood at 11.68% in Q1FY2009 compared with 12.71% a year ago.
• At the current market price of Rs 58, the stock trades at 3x 2009E EPS, 1.8x 2009E pre-provisioning profit/share and 0.5x 2009E book value/share.
• I maintain a Buy recommendation on this stock with a price target of Rs 95 over next 4-5 months.

Stock Idea - Satyam Computer Services

Recommendation: Buy (My personal favourite!)

CMP = Rs 383 (at the time of this recommendation)

Price target: Rs 521

Key points:

• The consolidated revenues of Satyam Computer Services grew by 8.5% qoq and 43.2% yoy to Rs 2,620.18 crore in Q1FY2009. In dollar terms, the revenues grew by 3.9% qoq to $637 million. The revenues in dollar terms were inflated by $13.5 million due to accounting difference in the US GAAP and the Indian GAAP. Adjusting for this, the company's revenues grew 1.7% qoq to $624 million, which were below its guidance range of $631.7-634.8 million. This was primarily due to loss of the animation business in Satyam's BPO subsidiary, aggregating to $6.7 million. 
• The operating profit margin improved by 134 basis points qoq to 24.1%, despite the negative impact of the rise in the visa cost (80 basis points). This improvement was mainly due to the positive impact of the rupee depreciation and operational efficiency. Consequently, the company's operating profit grew 14.8% qoq to Rs 632.3 crore. The net income grew by 17.3% qoq to Rs 547.7 crore. Despite forex loss of around Rs 36 crore in Q1FY2009, the other income stood at Rs 33 crore in Q1FY2009 as compared to Rs 23 crore during same period last year.
• In terms of guidance for Q2FY2009, the revenues in dollar terms are guided to grow at a muted sequential rate of 2.3% (unadjusted for accounting difference). The earnings in dollar terms for the next quarter are guided to decline by 7.9% sequentially due to the wage hike (effective July). The management is cautious on the demand environment in the retail and the banking, financial services and insurance (BFSI) verticals and maintains its stable outlook on pricing.
• At the current market price, the stock is trading at attractive valuation of 11.9x FY2009 earning estimates and 10.3x FY2010 earning estimates.
• I continue to maintain a strong Buy recommendation on Satyam with a price target of Rs 521.

Stock Idea - Thermax

Recommendation: Buy (again!!)

CMP = Rs 375 (at the time of this recommendation)

Price target: Rs 602

Key points:

• Thermax has announced its largest order win valued at Rs 820 crore (that is 31% of its current backlog) for the supply of a coal fired boiler to a captive cogeneration plant of a refinery. The boiler is expected to generate 390 megawatt of electricity. It would manufacture the coal fired boiler under the technology license with Babcock & Wilcox. The current order may be executed jointly by Thermax and Babcock in order to enable the indigenisation of the technology.
• Of late, the biggest area of concern for Thermax has been the slowdown in its order inflow, as is evident from the Q4FY2008 order backlog of Rs 2,637 crore vis-à-vis the order book of Rs 3,100 crore in Q4FY2007. The latest order may provide some respite as far as the concerns over a slowdown in the order inflow are concerned. We expect a gradual pick-up in the company's order inflow in future as clients are expected to finalize the pending orders.
• Though the visibility of the company's revenues has increased with the latest order win, the rising input cost continues to pose a risk to its operating profit margin and to its earnings as a result. The concerns are valid. However, Thermax carries 70-75% of its order backlog on a fixed price basis for which it ties up raw material supplies as soon as a contract is won. The stock price of Thermax has been under pressure lately because of concerns over its slowing order inflow and rising raw material cost that could adversely affect its earnings.
• At the current market price, this stock is valued at 12.2x and 10x FY2009E and FY2010E earnings.
• I continue to recommend a Buy call on this stock with a price target of Rs 602.

Stock Idea - Glenmark Pharmaceuticals

Recommendation: Buy

CMP = Rs 599 (at the time of this recommendation)

Price target: Rs 754

Key points:

• Glenmark Pharmaceuticals has proved itself as India's best play on research-led innovation. Of its pipeline of 13 molecules, five molecules are undergoing clinical trials. The company has managed to clinch four out-licensing deals for its developmental molecules collectively worth $734 million and has already received $117 million in initial milestone payments for the same. It has recently decided to restructure its business into two separate entities: GPL and GGL. GGL would be a 100% subsidiary of GPL and would be listed on the Indian bourses.
• Its core business comprising generics in the USA and branded formulations in Latin America, the other semi-regulated markets and in India has seen stupendous success, due to its focus on niche specialties and brand building. I expect the core business to grow at a 34% CAGR over FY2008-10, driven by a CAGR of 40% in the generic segment and a 29% CAGR in the branded formulation business.
• I expect Glenmark's consolidated revenues to grow at a 31% CAGR over FY2008-10 to Rs 3,377.7 crore, driven by a 34% CAGR in the core business and a $60-million milestone income in each of the two years. A robust growth in the top line would lead to a 26% CAGR in the consolidated profits over FY2008-10 to Rs 994.8 crore.
• Assigning a PE multiple of 18x to its fully diluted core earnings of Rs 30.6 per share in FY2010E, I value Glenmark's core business at Rs 550 per share.
• I recommend a Buy option on this stock with a price target of Rs 754.

Stock Idea - HDFC

Recommendation: Buy (must buy!!!)

CMP = Rs 1,721

Price target: Rs 2,912

Key points:

• HDFC reported a bottom line of Rs 468.1 crore in Q1FY2009, indicating a growth of 25.6% on yoy basis and a decline of 23.4% on qoq basis. The PAT was just Rs 529 crore, below earlier estimates.
• The net interest income for the quarter was Rs 651.6 crore, up 36% yoy buoyed by a 27.6% growth in loan disbursals and a healthy improvement in the net interest margin. The healthy top line growth could not trickle down fully to the net total income due to the moderate growth (16.4% yoy) in the other operating income. Besides this the company did not report any capital gains during the quarter. The net total income stood at Rs750.3 crore, up 28.2% yoy.
• The operating expenses were up by 26.6% yoy to Rs 86.7 crore, primarily driven by a significant increase in the other expenses (up 44.8% yoy) and the staff expenses (up 35.8% yoy). 
• Loan approvals during the quarter stood at Rs 9,996 crore, up 29.6% yoy in the same period last year. The disbursements during the quarter rose by almost 28% to Rs 7,204 crore from Rs 5,645 crore in the same period last year.
• At the current market price of Rs 1,721, the stock trades at 19.8x FY2009E EPS and 3.6x FY2009E book value/share.
• I maintain a strong Buy recommendation with a revised price target of Rs 2,912 over next 7-8 months.

Stock Idea - Marico

Recommendation: Buy (again!! J)

CMP = Rs 50 (at the time of this recommendation)

Price target: Rs 77

Key points:

• Marico's net sales increased by 22.5% to Rs 1,906.7 crore in FY2008 from Rs 1,556.9 crore in the same period last year. The sales growth was mainly achieved because of a strong volume growth of 13%, a price hike of 5% and an inorganic growth of 4.5% during the year.
• Marico's focus portfolio delivered a strong performance in FY2008. Its flagship brand Parachute, premium edible oil brand Saffola and hair oil basket achieved a healthy volume growth of 11%, 22% and 16% respectively during the fiscal. During FY2008, despite a rise in the number of creditor days to 57.6 from 54.8 in FY2007, the working capital cycle increased from 27.5 days to 33.5 days on account of an increase in both the inventory and the loans & advances.
• Marico’s ROCE increased by almost 7% in FY2007 – it was possible on account of the restructuring of the balance sheet undertaken by the company in FY2007 (including an adjustment of the intangible assets against the special reserves to the extent of Rs 309 crore). It is now aiming at rationalising its portfolio to focus on its beauty and wellness business. It divested its processed food business operated under the brand Sil to Scandic Food India Pvt Ltd, the Indian subsidiary of Good Food A/S, for a profit of Rs 10.6 crore in FY2008.
• The growing urbanisation of the Indian population and the increasing acceptance of specialised products and services provide a good opportunity for Marico to strengthen its roots in the country's lowly-penetrated beauty and wellness segment. To become a major player in this segment the company is continuously looking to expand its focus portfolio in both organic and inorganic ways. 
• At the current market price of Rs 50, the stock trades at 16.2x and 12.7x its FY2009E and FY2010E EPS of Rs 3.1 and Rs 3.9 respectively.
• I maintain Buy recommendation on Marico with a price target of Rs 77 over next 6 months.

Stock Idea - Orbit Corporation

Recommendation: Buy (again!)

CMP = Rs 249 (at the time of this recommendation)

Price target: Rs 808

Key points:

• The top line of Orbit Corporation grew by 28.8% yoy to Rs 81.8 crore in Q1FY2009. The bulk of the revenues (almost Rs 56 crore) were booked from Orbit WTC and around Rs 11 crore from Orbit Arya. Orbit had pre-sales revenues worth Rs 578.3 crore at the end of Q1FY2009 compared with Rs 644.8 crore at the end of Q4FY2008.
• The operating profit margin of Orbit declined to 40.5% during the quarter due to an increase in both its corporate expenses and its raw material cost. Consequently, the company's operating profit grew by 18.6% yoy to Rs 33.1 crore during the quarter. The company's effective tax rate stood at 32.2% in Q1FY2009 vs 23.6% in Q1FY2008, as none of its projects qualified for tax benefits under the section 80 IB during the quarter. The company has indicated that none of its projects is going to qualify for tax benefits in the future as well. Hence, going forward, the company is likely to pay tax at full rate.
• During Q1FY2009, the company's interest expenses grew at a lower rate than expected, as it capitalised the interest expenses on compulsorily convertible debentures worth Rs 200 crore raised for the Orbit Highcity project. The interest expenses on the project stood at Rs 8.27 crore during the quarter. Orbit's net income remained flat at Rs 18.2 crore during the quarter.
• In Q1FY2009, the company acquired an 85% stake in Ahinsa Buildtech Pvt Ltd at a cost of Rs 130 crore. The acquisition will give Orbit the right to develop the Orkay Mills project at Andheri in Mumbai. The average cost of land for this project works out to Rs 4,725 per sq ft. The company plans to develop the saleable area of 275,000 sq ft for mixed use.
• However, the capitalisation of the interest expenses for the Orbit Highcity project would also lead to a reduction in the interest expenses of Orbit because the project is not likely to start in the near term.
• At the current market price, valuation of this stock stood at 4.3x FY2009 earnings estimate and 3.1x FY2010 earnings estimates.
• I continue to maintain Buy recommendation on this stocj with a price target of Rs 808.

Stock Idea - Ranbaxy Laboratories

Recommendation: Buy (again!!)

CMP = Rs 476 (at the time of this recommendation)

Price target: Rs 575

Key points:

• The US government has levied against Ranbaxy Laboratories the allegations of violation of federal law, fraud, concealment of data and introduction of adulterated and misbranded products in the US. The US FDA has filed a motion in a US court seeking access to relevant documents to review Ranbaxy's manufacturing operations at its Paonta Sahib plant in Himachal Pradesh.
• Ranbaxy has denied the charges made by the US FDA, stating that there is no evidence of using unapproved active pharmaceutical ingredient sources or fabricating data, and intends to file a response on July 14, 2008. Its US formulations accounted for 26% of its revenues and ~35% of its earnings before interest, tax, depreciation and amortisation in CY2007. The legal implications of the allegations made by the US FDA could range from recalling some of Ranbaxy's products from the US to a complete ban on the company from supplying products in the US market.
• Further, legal damages in the form of penalties could follow and the management's role in the current developments could raise credibility issues. Despite the US government taking Ranbaxy to court, Japanese drug maker, Daiichi Sankyo, has decided to pursue its acquisition of Ranbaxy at the previously agreed price of Rs 737 per share. 
• The above development could depress sentiment and remain as a negative overhang on the stock until the issue is fully resolved. On the other hand, Daiichi Sankyo's continued interest in Ranbaxy, despite the criticality of the above issues, lends some comfort to the stock.
• At the current market price of Rs 476, Ranbaxy is discounting its CY2008 base business by 34.0x and its CY2009 base business earnings by 20.2x.
• I maintain a strong Buy recommendation on the stock with a price target of Rs 575.

Industry Update - Cement industry forecast for Q1FY2009

Key points:

• It looks that severe cost pressures will continue to impact profitability of companies in the Cement sector. Overall, select cement companies have registered a 6% growth in the volumes in Q1FY2009. Companies like Shree Cement, Madras Cements and Orient Paper and Industries have reported an impressive volume growth of around 26%, 12% and 10% respectively. This was mainly due capacity enhancements carried out by them.
• In terms of realisation, India Cement is expected to show a strong growth of 16.3% in its realisation due to a change in its market mix. Apart from this, the average realisation for Orient Paper and Industries is expected to increase by 13.2%, as the average realisation in the corresponding quarter of the last year was depressed due to clinker sales.
• Despite this, the cement industry as such looks quite promising. I estimate an average growth of 11.6% in the revenues and a almost 17% decline in the earnings for the select companies.

Industry Update - Pharma industry forecast for Q1FY2009

Key points:

• Companies which I am considering here would report almost a 30.9% increase in their revenues for Q1FY2009. Major driver for this mammoth growth would be a steady growth in the domestic market, the new product launches in the regulated markets, strong growth in the contract research and manufacturing services businesses, and the consolidation of the acquisitions made in the previous year. As exports command over 50% share of the pharma industry's revenues, the weaker rupee would also aid the top line.
• The operating profit margin of companies (that are covered here) is expected to expand by 330 basis points, largely driven by exclusivity revenues (Sun Pharmaceuticals), savings arising out of the de-merger of R & D units (Piramal Healthcare) and the effect of operating leverage for companies with a strong top line growth (Lupin and Ranbaxy). On the other hand, rising input, power and fuel costs would negatively affect the margins of companies like Orchid Chemicals and Surya Pharmaceuticals. Wockhardt and Opto Circuits may reel under margin pressure on account of the consolidation of low-margin acquisitions.
• Despite a strong top line growth and a robust operating performance, the reported net profit of companies would grow just by 1.6%. This would be on account of the mark-to-market losses recorded by companies like Ranbaxy Laboratories, Orchid, Wockhardt and IPCA Laboratories (because they have outstanding forex liabilities). Higher interest and depreciation costs (due to acquisitions) would also affect the reported profits in the case of Wockhardt, Cadila and Opto. On excluding the forex impact, the adjusted net profits of these companies might grow by 50.5%.
• My personal top picks include Sun Pharma (which surprised positively with higher than expected exclusivity revenues), and Lupin (which is expected to deliver strong top line and bottom line growth). On the other hand, companies like Ranbaxy, Wockhardt and Orchid could surprise negatively due to higher than anticipated forex losses.
• The key risk to the above estimates is companies reporting mark-to-market losses on hedging instruments or on foreign currency derivatives. I believe Ranbaxy & Wockhardt would have outstanding foreign currency hedges, on which they could incur certain losses.

Stock Idea - Cadila Healthcare

Recommendation: Buy

CMP = Rs 314 (at the time of this recommendation)

Price target: Rs 372

Key points:

• Cadila Healthcare (Cadila) has decided to hive-off its consumer product business and merge the same with its listed subsidiary, Carnation Nutra Analogue. In consideration, Carnation Nutra will allot to shareholders of Cadila four fully-paid-up equity shares of Rs 10 each for 15 equity shares of Rs 5 each held in Cadila. Consequently, Cadila's stake in Carnation Nutra would increase from 61.56% currently to 70.2% post the restructuring.
• Cadila would also amalgamate Zydus Hospital and Medical Research Private Ltd with itself by canceling the existing nine crore shares held by Zydus Hospital in Cadila and issuing 10.08 crore fresh equity shares to Zydus Hospital. The move would result in equity dilution of 8.7% in Cadila and add no value for the minority shareholders. The restructuring is intended to consolidate the group's consumer product business under one entity and aims to unlock value in its consumer product business. 
• In consideration for the consumer product business, Cadila shareholders would get additional shares of Carnation Nutra (4:15 – 4 shares of Carnation Nutra for every 15 shares of Cadila). I would value Carnation Nutra stock at Rs 87 per share.
• I maintain Buy call with a price target of Rs 372.

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Stock Idea - ICICI Bank

Recommendation: Buy

CMP = Rs 601 (at the time of this recommendation)

Price target: Rs 1,204

Key points:

• Margins and not volumes is what ICICI Bank seems to be focusing on now. The current account and savings account growth will be the key driver for margin expansion going forward. A deceleration in the advances book growth and a near 100% growth in the incremental growth proves the point.
• With seasoning of credit portfolio, the bank has seen an up tick in delinquencies. Rapid growth in unsecured lending (CAGR of 82%) as compared to total advances (CAGR of 24%) over the past three years is likely to put further strain on the asset quality. The rising interest rate scenario may further worsen things for the bank.
• ICICI Bank's contingent liability increased by 105% in FY2008. 90% of this constitutes exposure in currency & interest rate swaps and other derivative instruments. In view of the Reserve Bank of India's latest provisioning guidelines related to these instruments, the bank may have to make additional provisions. Unfavorable market conditions raises concern over the bank's higher exposure to sensitive sectors like real estate and capital markets. The management, however, believes that the road ahead will be challenging considering the worsening global and domestic economic scenario. Despite this, the management is bullish on India's long-term growth prospects and foresees robust growth outlook for the Indian financial sector. 
• At the current market price of Rs 601, the stock trades at 13.7x 2009E earnings per share.
• I maintain a strong Buy recommendation on the stock with a price target of Rs 1,204.

Stock Idea - Navneet Publications (India)

Recommendation: Buy

CMP = Rs 66.5 (at the time of this recommendation)

Price target: Rs 80

Key points:

• The net sales of Navneet Publications Ltd (NPL) for Q4FY08 grew by a robust 29.5% yoy to Rs 59.1 crore. The sales growth was on account of hefty growth in publication and stationery businesses. The publication business witnessed a robust growth of 28.5% yoy to Rs 21.8 crore. The stationery business achieved a healthy growth of 33.8% yoy to Rs 38.0 crore, mainly on account of good domestic demand and introduction of non-paper stationery products.
• The operating profit margin declined by 102 basis points to 9.0%, mainly on account of a higher other expenditure. An additional promotional expenditure of Rs 1.5 crore towards the stationery business led to a steep hike of 47% in the other expenditure to Rs 15.9 crore. The other income for Q4FY08 stood at Rs 1.0 crore as compared to Rs 0.5 crore during Q4FY07. A higher other income coupled with a lower incidence of tax led to a 57.1% growth in the reported net profit to Rs 2.1 crore.
• Going forward the publication segment, one of the major revenue contributors for NPL, will achieve a moderate growth, as in FY2009 revision of syllabus is due only for a few standards in the states of Gujarat and Maharashtra. However, the growth in near future will be driven by some of the new initiatives undertaken by the company such as introduction of non-paper stationery products, foray into Urdu publication and e-learning business. 
• At the current market price of Rs 66.5, the stock is trading at 8.8X its 2010 estimated EPS and at an enterprise value /earnings before interest, depreciation, tax and amortisation of 5.7X.
• I maintain a strong Buy recommendation with a price target of Rs 80 over next 6 months.

Monetary squeeze & high Inflation expected to continue...

The Reserve Bank of India (RBI) stepped up its efforts to tame inflation by increasing both the repo rate and the Cash Reserve Ratio (CRR) rate by 50 basis points each (100 basis points = 1 percentage point). This latest move reflects the reversal in interest rate expectations in 2008. With domestic inflation under control and a slowdown in industrial production, markets were expecting monetary easing at the start of the year. However, a sharp rise in headline inflation numbers changed the interest rate environment dramatically.

The economy had witnessed a period of sustained high growth rate for the past few years and relatively lower inflation, helped by pre-emptive actions taken by RBI. It had withstood the rise in oil and commodity prices relatively well, helped by strong growth and the absence of a full passthrough of global energy prices. However, sustained domestic demand and rising imported inflation have led to a sharp rise in headline inflation numbers since March, leading to a slew of fiscal and monetary measures. This culminated in the multiyear high inflation numbers released two weeks ago, and RBI’s 50 basis-point hike in CRR and repo rates last week. Thus yields have moved up sharply across the curve.

On the other hand, strong capital outflows and concerns about the widening trade deficit have resulted in the rupee losing ground against major currencies. Despite the US dollar weakening in 2008, the rupee has weakened against the greenback. On the fiscal front, off-balance sheet items such as oil and fertiliser subsidies, the farm loan waiver and possible wage hikes due to Sixth Pay Commission recommendations, are raising concerns. Despite recent strong trends in advance tax payments, there are worries about possible revenue pressures due to an expected economic slowdown. In recent weeks,we have seen an uptick in nonfood credit growth—26.2% as of June 6.

While India’s external position remains strong, helped by large foreign exchange reserves and a relatively low external debt-to-GDP ratio, investors are worried about the impact of the increasing value of oil imports and FII outflows on the current account deficit. The RBI has clearly indicated that aggregate demand pressures have been on the higher side, despite monetary tightening, and seems focused on alleviating inflationary pressure. It has indicated that key economic drivers—investment and consumption—are strong, contributing to increased demand. In such a scenario, global oil prices and inflationary pressures are likely to determine domestic monetary policy.

In the near term, monetary policy is expected to retain a tightening bias. Any pause or change of direction will depend on inflation. We expect liquidity to remain tight, and, despite advance tax flows, the CRR hike, along with RBI intervention in forex markets, should remove excess liquidity from the system. The increased differential between repo/reverse repo rate is in line with the central bank’s stated policy of maintaining a wider band in uncertain times. Any unexpected increase in government’s borrowing programme leading to higher bond issuances will impact the demand-supply scenario. The average duration of our portfolios continues to be on the lower side, and we are focusing on accrual products. Investors should look to focus on funds such as shortterm floating rate funds, fixed maturity plans, and ultra short bond funds.

Courtesy: Franklin Templeton

Stock Idea - International Combustion (India)

Recommendation: Buy

CMP = Rs 378

Price target: Rs 519

Key point:

• In Q4FY2008, the revenues of International Combustion Ltd (ICL) grew by 20.3% to Rs 29 crore. On a segmental basis, the revenues of the material handling equipment division grew by 9.1% to Rs 20.1 crore whereas that of the geared motor and gear box division increased by a strong 53.6% to Rs 9.1 crore, however, the division’s margin fell sharply by 350 basis points to 11.2%.
• The operating profit of ICL grew by 21% to Rs 5.9 crore during the quarter. The operating profit margin was flat at 20.4% (up ten basis points). The company’s interest cost declined by 25% to Rs 0.1 crore and its depreciation charge rose by 11.4% during the quarter.
• Consequently, the net profit grew by 40.2% to Rs 3.5 crore, which was ahead of our expectations mainly due to a higher than expected revenue growth during the period. The current order book of the company stands at Rs 56 crore of which Rs 49 crore worth of orders are for the material handling division and the balance Rs 7 crore are for geared motor division.
• At the current market price the stock trades at 6.3x FY2009E earnings and enterprise value /earnings before interest, depreciation, tax and amortisation of 2.9x on FY2009E.
• I recommend a Buy option on this stock with a price target of Rs 519 over next 6-7 months.