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#1R1 stands for Resistance level 1 @1S1 stands for Support level 1 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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The levels given above are with respect to previous closing price on the NSE / BSE. |
Buy / Sell (Sep 24, 2010) Buy Sell Net FII 4254.77 3104.97 +1149.80 DII 1141.44 2021.27 -879.83
Market participants were left gaping with wonder as the Sensex strolled effortlessly past yet another milestone last week. It is the progressively rising tide of overseas fund flow that provided the necessary impetus to take the index above 20,000. Short-covering by bears helped absorb the sales that ensued once the index crossed 20,000.
Some explosive moves are in offing next week as the very heavy September derivative series rolls in to expiry. The open interest is at an all-time high at Rs 2,20,000 crore with Nifty puts accounting for 40 per cent of this figure. High index put call ratio also points towards surfeit of short positions. This means that bears are in a tight corner now and forced unwinding of these short positions can drive prices higher from these levels.
Volumes in derivatives are already at frenzied levels. Daily average volume in F&O segment last week was the highest ever at Rs 1,42,000 crore. FIIs continued to be net buyers through the week, while DIIs were persistently selling.
Oscillators in the daily chart continue in the overbought region but they are declining slightly implying slowing momentum. Interestingly, the 14-week RSI has moved above 73, a zone it last reached in June 2009 and before that in October 2007.
The Sensex closed 450 points higher last week maintaining an up-trend along all time-frames — short, medium and long. The medium term trend in the index is up from the May trough of 15,960. It is obvious that the current vertical rise is the third wave from this low. First target on extrapolation of this move gives us 20,097, that was achieved last week. However, since the second wave was a running correction (with bullish connotations) the third can attain its next target at 21,504.
Investors should however tread a little carefully until the index gets over the hump between 20,000 and 20,100 that is also a psychological resistance. Correction from these levels can pull the index down to 19,500 or 19,350. Halt at these levels will result in a sideways move between 19,350 and 20,000 for few sessions before the index attempts a new high.
Subsequent supports for the index are 18,980 and 18,700. The medium-term view will however be roiled only on a weekly close below 18,500 – the barrier that seemed un-surmountable couple of weeks ago. Presence of the 50-day moving average at this level adds to the significance of this support.
In the week ahead, the Sensex can attempt to rise to 20,320 or 20,660. If the index continues to surge, next target would be 21,052. Short-term supports would be at 19,510 and 19,350.
The Nifty (6,018.3) moved above the magical 6,000 mark on Tuesday. Though there was slight selling pressure thereafter, the index managed to close the week above this mark with 133 points gain. Close near the intra-week high makes the short-term trend positive in the index. It can attempt to rise higher to 6,094 or 6,195 in the early part of the week. If the second target is surpassed, the index can move on to 6,310. Supports for the week ahead would be at 5,865 and then 5,820.
Traders can buy in declines as long as the index holds above the first support. Close below 5,820 will imply that a more serious correction is unfolding that can pull the index to 5,700 or 5,620.
Medium-term trend in the index also continues to be positive. However target for the third wave from 4,786 low gives us the second target at 6,040. Since this target was almost achieved last week, traders and short-term investors ought to tread a little cautiously in the band between 6,000 and 6,100. If this zone is crossed, next target for the third wave is 6,467. Medium-term outlook for the index will stay positive as long as it trades above 5,600.
Global CuesIt was a choppy week for the global markets but most global benchmarks managed a positive close. The jury is still out deciding if the medium-term downtrend from April peak is complete in European and American markets. Asian markets (excluding Japan and China) however continue in a healthy uptrend and benchmarks in countries such as Indonesia, Malaysia, Thailand and Sri Lanka continue to blaze forward.
CBOE Volatility Index moved in a very narrow range between 21 and 24 implying that investors are still cautious in developed markets. As we have indicated earlier, strong close below 21 will denote that a raging bull market is in the offing. Spike in gold to new peak at $1,300 too points towards nervous investors moving some assets in to safer havens.
The Dow too was choppy for most part before closing on a strong note, up 252 points. It has moved beyond the resistance zone between 10,650 and 10,750. Next target for the index is at 11,043. If this is crossed, it will be another shy at the critical 11,300 level.
That the US market is clutching at the flimsiest of reasons to rally is apparent from the fact that though durables goods order in August declined 1.3 per cent, higher that 0.7 per cent recorded in July, markets rallied for the reason that the figure was lower than economists' estimate of 1.4 per cent decline. When viewed against this back-drop, a move beyond 11,300 looks very difficult for the Dow and we could be in for yet another stormy October for global equities.
After testing the key resistance in the band between Rs 1,040 and Rs 1,050, Reliance Industries started to decline and finished the week in negative territory with 2.5 per cent loss. We reiterate our prior view that failure to penetrate the aforementioned resistance will result in the stock consolidating sideways in the Rs 1,000 to Rs 1,050 band, before moving higher. The stock is testing support at Rs 1,000. Short-term traders can initiate fresh long position while maintaining stop-loss at Rs 985 and exit at Rs 1,020 or Rs 1,045 levels. On the other hand, a dive below the support level Rs 980 would pull the stock down to its subsequent support levels at Rs 960 and then to Rs 930
Medium-term trend is down for stock and it stays intact as long as it trades below Rs 1,050. Strong move above this level will mitigate its downtrend and the stock can trend higher to Rs 1,090 in the medium-term.
State Bank of India (Rs 3,144.3)
The stock gradually climbed higher last week, gaining 1.6 per cent. However, it is moving sideways within Rs 3,050 and Rs 3,170 range. Short-term traders should tread with caution as long as the stock remains in this range. A positive breakthrough of resistance at Rs 3,175 would lift the counter higher to Rs 3,250. Nevertheless, a drop below the lower boundary of Rs 3,050 will result in the stock declining to Rs 3,000 or Rs 2,900 in the ensuing week.
Medium-term trend continues to be up for the stock and investors can prolong their holdings with stop at Rs 2,500.
Tata Steel (Rs 629.5)
Tata Steel jumped 4 per cent last week and achieved our initial price target of Rs 625. The stock is currently heading towards our second target of Rs 640, in the near-term. Short-term traders can consider holding their long positions with revised stop-loss of Rs 620. The stock has a long-term resistance at Rs 650 and Rs 660 band. Inability to surpass this zone will result in a minor pullback or correction. Supports for the upcoming week are at Rs 600 and Rs 580.
From this June, the stock has been on a medium-term uptrend. Investors can stay invested with a stop-loss at Rs 550 levels. Next medium-term resistance for the stock is at Rs 700.
Infosys Technologies (Rs 3,040.6)
Last week the stock surged Rs 66 or 2 per cent. Fresh long position should be initiated only if the stock moves beyond Rs 3,065. Initial target for the stock is Rs 3,100 and the next is at Rs 3,145. Key supports for the stock are pegged at Rs 3,000, Rs 2,950 and Rs 2,900. Investors with medium-term perspective can hold the stock with modified stop-loss at Rs 2,700. —
Sizzling Stocks: Punj Lloyd (Rs 132.1)
The stock advanced 12 per cent last week, accompanied with good volume. From significant resistance level of Rs 300 encountered in October 2009, Punj Lloyd has been on an intermediate-term downtrend. However, recording a 52-week low of Rs 104 on August 31, the stock began to rally. As long as the stock trades below the long-term key resistance level of Rs 150, the downtrend remains in place and can decline to Rs 120 or Rs 110. A strong weekly close above Rs 150 will lift the stock higher to Rs 170 or Rs 190 in the medium-term.
Financial Technologies (India) (Rs 1,221)
The stock nose-dived 11 per cent on Friday with heavy volumes after the market regulator turned down MCX Stock Exchange's application to offer trading in equities, debt, and derivatives segment. The stock has tumbled 14 per cent over the week and is hovering well below its 50 and 200-day moving averages. Since January 2010 peak of Rs 1,721, the stock has been on an intermediate-term downtrend. The stock is currently trading just above its long-term key support band between Rs 1,180 and Rs 1,200.
Conclusive fall below this support will accelerate its downtrend and drag the stock down to Rs 1,050 or Rs 900 in the medium to intermediate-term. However, bounce back from the above mentioned support will take the stock higher to its immediate resistance of Rs 1,300 and then to Rs 1,400. —
Outlook positive for IDBI
| Stock Strategy. |
However, as long as it stays above Rs 54, the medium-term outlook would remains positive for the stock.
A close above Rs 68 has the potential to lift the stock to Rs 78.
F&O pointers: Derivative trading presents a positive outlook for MTNL (market lot: 4,000).
The stock has so far witnessed a decent rollover of 28 per cent to October series, most of which is on the long side.
Strategy: Traders can consider going long on MTNL October futures with a stop loss at Rs 60.4 for an initial target of Rs 68 and then Rs 72.
Shift the stop loss to Rs 64.3 (closing day basis) if it opens on a positive note.
IDBI (Rs 154.3): The stock touched its 52-week high on Friday at Rs 154.8. The immediate-term outlook remains positive for IDBI.
Another conclusive close above Rs 154 has the potential to lift the stock towards its all-time high levels around Rs 179 level, though in between Rs 168 could pose a strong resistance.
The immediate support appears at Rs 137.
F&O pointers: The stock also witnessed a healthy rollover of 32 per cent in the long side. However, both call and puts (October series) accumulated open interest.
The current option trading suggests Rs 150 could act as a strong support.
Strategy: Traders can consider going long on IDBI with a stop-loss at Rs 150. Shift the stop-loss to Rs 158, once it moves past that level.
Note: With derivative settlement next week, we advise only high-risk traders to take up positions.
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| Nifty to move in a range of 5,940-6,060 Nifty started the week (20-24 September, 2010) on strong positive note backed by positive cues from global arena. It marched strongly on the very first day of the week, marked its fresh 52 week high gained around 100 points. In Continuation to its upward rally it moved up consecutively higher on the second day of the week also, managed to breach the psychological mark of 6,000, marked its 32 month high. After breaching psychological mark of 6,000 nifty paused for a break, fell slightly, below psychological mark but that was short lived. On the last day of trading week nifty again rose shapely, managed to breach the psychological mark of, 6000 again and close above it comfortably. It gained about 2.26% (133 points) from the last week close. Nifty is expected to remained range bound over the next few days ahead of the F&O expiry which is due on September 30, 2010. Technically, the trend, which is now up, could test its next major resistance around 6,060, and if Nifty crosses this level, it can go further up to test 6,100 level. On the downside, the levels of 5,940 will play major support and a fall below these levels can drag Nifty to 5,880 levels. Nifty is trading above its 05 days exponential moving average on the daily charts, which is expected to provide it a strong support in short term. The technical momentum indicators are still supporting its uptrend move. MACD showing positive divergence and RSI is at 77 levels with positive crossover which is also suggesting up movement. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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Looking Forward Next week Indian bourses are expected to remain volatile as expiry of September 2010 series futures & options contacts is due. During the current series, market have witnessed sharp upward rally on the back of buying spree of FIIs. Market will continue to depend on foreign fund flow which is expected to remain robust given strong fundamentals of Indian economy. The direction of Indian bourses will also depend on global risk appetite which in turn depends on some key economic data from US including the third quarter GDP number and ISM manufacturing index. Back home, Auto, Cement and Steel stocks will remain in focus with lined up release of monthly sales figures for September 2010. On the political front, the verdict on highly sensitive Ram Mandir-Babri Masjid will also closely eyed.
| Daily Movement of Nifty  Daily Movement of Sensex, Net FIIs & MF investment Weekly return on BSE Sectoral Indices | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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ABG Shipyard Ltd (ABG) has performed extremely well in the last one year with 28.3% revenue growth and 27.4% PAT growth. The order book pending execution is almost 4x FY10 sales. This provides comfort and would also ensure revenue growth over the next two years on the back of stable order execution. On quarterly basis , company reported a rise in the EBITDA margin to 27.7% from 21.4% in the immediately preceding quarter. This is more in line with the historical operating margin of ~26% in the last three years. Further, with winter season approaching we could see increase in sea traffic in the coming days which will boost the revenue of the company in coming quarters. Weekly Price Movement of ADR
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| US stocks higher during the week (till Thursday) after the Federal Open Market Committee released a statement showing the interest rates remaining unchanged at 0.25%. Also, the expectation regarding additional measures to be taken by Federal Reserve in the near term uplifted the market sentiment to a certain level. Although, the statement also showed a slower pace of economic recovery in comparison last month. Further, strong quarterly results from Oracle and Research In Motion also pushed the market. On economic front, investors were presented with another mixed batch of economic data, which was unsuccessful in indicating a clear direction for the US economy. Looking ahead, market focus are likely to look to data on durable goods orders and new home sales. Asian market traded mix during the week. Japanese markets moved lower amid investor jitters after China restricted its diplomatic contacts with Japan, after briefly entering positive territory on the yen's sudden weakening on apparent intervention by monetary authorities. The fact that trade between these two economies had increased at a very rapid clip in the last few years. However, Hong Kong shares edged slightly higher with property developers led the gains after the Federal Reserve indicated interest rates will remain low for some time. European markets were mixed during the week. Markets had a strong start to the week on the backdrop of positive outlook about the global economy recovery. The markets were also given some support after Irish, Greek and Spanish government debt auctions attracted decent demand. However, European shares fell to their lowes in more than two weeks, after the U.S. Federal Reserve made a downbeat assessment of the health of the economy coupled with a sharp slowdown in euro zone services and manufacturing growth. Worse than expected U.S jobless claims added to market woes. Further, sentiments in the markets are looking subdued due to lack of any positive trigger. The EU purchasing manager manufacturing index is due next week, along with unemployment rate figures for August which will give some hint about the markets movement. | Weekly return on major Global Indices Data of US and European markets taken from Sept 16 to Sept 23, 2010 Data of Asian markets taken from Sept 17 to Sept 24, 2010 Weekly Change in the Composites of S&P 500
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| Rupee ended the week on mixed note, rising against weaker USD and falling against Euro and Japanese Yen. Rupee continue to march northward against the greenback and strengthened to a four-month high against the US currency. The buying spree by FII in the equity markets as the local bourse strengthened to a 32-month high during the week and optimism over capital inflows pushed INR higher. Further, a weaker USD against major currencies primarily from a lack of yield support also led Rupee higher. The INR was weaker against Euro tracking rise in Euro-zone currency after a series of broadly successful debt auctions within the Euro-zone.
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I don't believe in investing in initial public offerings. Tell me why are there no IPOs in bad markets? Why do they come only in good markets? That's because in good markets people are willing to pay any price for anything.
PARAG PARIKH, CHAIRMAN, PARAG PARIKH FINANCIAL ADVISORY SERVICES
Stock market investing is not just about number crunching and balance sheet analysis. It involves a bit of mind game too. In an interview with Business Line, Mr Parag Parikh, Chairman, Parag Parikh Financial Advisory Services, shares interesting insights on behavioural finance and how investors can use it to make investment decisions. Excerpts:
How does behavioural finance explain the market and its movements?
We all learn that stock markets are efficient and people make rational decisions to maximise their profits. Now, behavioural finance is exactly the opposite. It says that markets are not efficient, especially in the short run. Suppose you find Rs 5 coin on the road when you are walking. Now, why do you think no one saw it, despite so many walking on the road? In the same way, markets are not efficient. Now take the case of people making rational decisions. If this were true, how would you explain people giving money to charities, or spending on parties to celebrate birthdays?
These are not rational acts because money is going out, but people still do it out of their hearts. More often than not, we make decisions from our hearts and not mind. That humans make irrational decisions at every point of time is also the reason why markets are so interesting and have a full industry following it.
How do you integrate behavioural finance into the services you offer?
My idea is to educate investors, to make them know that there are no short-cuts in the markets. The way markets are going up, banks are lending margin money and some of the mutual fund houses are advising investors, it all gives the wrong impression that one can make money in the market by simply buying and selling stocks. These are wrong notions. We cannot sow a seed today and expect it to become a tree tomorrow. It has to go through various stages and seasons to become one.
What we do is adopt a slow and steady approach. Our clients believe in our philosophy of value investing; we don't take money from people just because they are ready to give it us.
So why are you then entering the mutual fund business now?
The minimum entry amount for our PMS business is Rs 5 lakh. By entering the mutual funds space, we can cater to the small investor. He is the person who needs it the most. MF is a very good vehicle to meet their needs.
Here again, we will be different and will not concentrate on amassing AUM. We will concentrate on performance alone, using value-investing and behavioural finance. This is what we did in 2008. When the markets crashed, we went to our clients and told them to give us money!
You have to buy when others are selling and sell when others are buying. This is the basic concept of buying a value.
But unfortunately in the stock markets, investors find a stock less risky if everybody is buying and the stock prices are going up. And they find it more risky, when nobody is buying and the stock prices are down. That's the challenge we have to work with.
How do you use behavioural finance to invest?
We don't have a brilliant team, no one with capabilities to point out exactly how the markets will move! What we instead do is identify a good business, with a credible management and with a good moat around its business, strong network and less debt. We only buy such businesses and at the time they are available at a discount in the market. And when is that? When there is excessive fear in the market. We buy at that time and stay away from the market after that.
With so many companies tapping the primary markets, what is your view on IPOs as an investment vehicle?
I don't believe in investing in initial public offerings. Tell me why are there no IPOs in bad markets? Why do they come only in good markets?
That's because in good markets people are willing to pay any price for anything. The management agrees to sell their shares during good times because they know they will get a much better value for their shares.
And why don't companies come out with IPOs during bear markets? Well, because promoters feel that their share price should be valued higher than the rest of the market.
Why do you think retail interest took so much time to pick up?
Interest is how you see it. With the market picking up, we will certainly see retail activity picking up, as greed will then set in. Markets feed on greed and fear. Interestingly, when the markets offer opportunities for investments, there is immense fear in the market. That is also why only few are successful in the stock markets. We all want instant gratification.
What is your view on the market now? Do you think they are expensive?
See, here again we are following the insanity that the society has created. Now, Sensex has only 30 stocks, while Nifty has 50. Is that the market? No, as there are over 7,000 listed stocks! We are looking at the wrong barometer.
Moreover, how do companies get into these indices? By virtue of their market capitalisations alone. They are all big companies but not necessarily good companies. The market of more than 7,000 stocks outside of it is where the value is. Besides, mutual funds and institutions play with the Nifty all the time, there is no value per se there. A look at the open interest on Nifty will tell you that most institutions are into it already.
So what should retail investors do?
For retail investors, I would say the best time to buy stocks is when they don't feel like buying. And that brings me to the question - who is a retail investor?
An investor isn't someone who invests everyday. He is someone who invests once in probably two years, or whenever there's an opportunity. The rest are all punters. What advice can you give to punters?
'Infrastructure stocks, a good bet'
I think infrastructure should be the driving theme for India. If you compare China and India, the consumption part of GDP is lower in China and is higher in India.
SANKARAN NAREN, CIO-EQUITY, ICICI PRUDENTIAL MUTUAL FUND
The market does offer pockets of opportunity such as infrastructure stocks, where money can still be made. However, investors should not make any sudden shifts in their allocation to equities, cautions Mr Sankaran Naren, CIO- Equity, ICICI Prudential Mutual Fund, when Business Line spoke to him about the Sensex at 20,000.
The Sensex has hit 20,000 again and there is a lot of scepticism about the markets holding up at these levels. Normally markets never correct when everyone expects it to! What are your thoughts on this?
In the Indian markets, there are two types of investors — locals and foreigners. Yes, the locals are very sceptical about the markets and valuations because India is the only market where they invest.
We can afford to be sceptical! The foreign investors don't see growth in their home markets, and thus, find Indian stocks with their strong growth potential, attractive. Local investors have not invested in the markets and local institutions have been consistent sellers in this rally.
You must understand that mutual funds sell only if they have an outflow from their retail investors. We don't operate like hedge funds! In our case, the outflows have been small. However, the industry-wide outflows must be significant, given the consistent domestic institutional selling in stocks that we have seen over the past few months.
One clear theme driving this rally has been domestic consumption. The sectors leading it were consumer durables, to automobiles to FMCGs. What's your take on those stocks now?
I think infrastructure should be the driving theme for India. If you compare China and India, the consumption part of GDP is lower in China and is higher in India. China has a current account surplus while we run a deficit. If you see infrastructure bottlenecks, it is in India that we face them to a large extent. That makes a case for playing the consumer theme in China and the infrastructure theme in India, while the reverse is happening! I think as we approach the retail consumption season with festival sales and so on, this would be cyclically the appropriate time for the consumption theme to peak out.
The ICICI Pru Infrastructure Fund has managed a five-year return of 25 per cent, but has underperformed diversified funds in one year. What's the argument for investing in infrastructure stocks now?
That makes it a good time to invest in the fund. There is a big gap between what has happened on infrastructure and non-infrastructure stocks. Look at the stocks that represent the infrastructure theme; the theme has been a substantial underperformer. Whether you take power utilities, capital goods or even construction stocks they have all underperformed very sharply. If you look at the non-infrastructure space, whether FMCGs, autos, pharma or technology that is where all the outperformers have come from.
Here, consumer stocks have also moved to a premium over the market while infrastructure stocks have seen valuations correct significantly. If you had to invest now, this makes infrastructure a good bet. Valuations in the sector today are much more comfortable than valuations of sectors that have led this rally. I think Indian infrastructure stocks benefit from the fact that demand potential is so high. In the US, for instance, power utilities are dividend yield stocks. In Europe, again, such stocks are not growth plays.
Are infrastructure companies delivering the expected earnings growth?
One factor that is acting against short-term earnings for the sector is the fact that we have had a good monsoon this year. A bad monsoon aids construction activity but a good one leads to a seasonal disruption. This is reflecting in the quarterly numbers. But it does not in any way alter the outlook for the infrastructure sector. We think the period from 2011-2014 will see an infrastructure-oriented cycle.
Another factor is that infrastructure spending is now being driven to a large extent by the private sector and not just by government. If you break it down, power generation capacity is now being driven mainly by the private sector. If you take roads, you have a fair number of projects happening through BOT route. In ports, a number of projects are coming in through the public-private partnership route.
The earnings growth for Indian companies over the past two quarters has not been too high, the earnings for the CNX 500 companies, for instance, has grown only in the single digits. Is that not a risk to the current valuation of 23 times for the market?
The problem is that market valuations have really climbed and stocks have become more expensive. Expectations have risen to a very high level and those expectations are barely being met by earnings.
There is also divergence, where some companies are meeting those expectations while others are not. The problem about valuations is that we cannot today say that Indian markets are cheap. They are expensive relative to rest of the world. For this valuation to sustain, the results have to be good and the GDP outlook has to remain good. If you look at where we were six months ago and where we are now, there is risk. On the positive side, food inflation is not accelerating any more and the monsoons have been good.
What explains the surge in FII inflows in the past month, where over $3 billion of funds has come in within a month? Is it the upward revision in GDP outlook which has made the difference?
In my view, there has been a growth scare in the Western world and a growth scare in China as well. Consequently, all the growth-oriented money has come to India. That has, however, resulted in a situation where the Indian market is no longer cheap. Certain segments such as infrastructure may be cheap, but not the market as a whole.
A lot of the recent inflows into Indian markets are said to originate from passive Exchange Traded Funds who are only chasing the index. Do you thus, see the gap between index stocks and other stocks widening?
I am not sure if that is entirely correct. If a good portion of that money was ETF money then why would we see such a big sectoral deviation in performance? And it is not as if only benchmark stocks have performed. Even smaller stocks within the consumer theme have performed. The advantage with large caps is that they are less dependent on how interest rates pan out. Small and mid-caps are vulnerable to interest rate risks, especially in infrastructure stocks.
We believe interest rates will peak over a six-month period and then one can move from large caps to mid-cap stocks. You are also approaching the busy season in credit, with activity in the short-term money market peaking in March each year.
If retail investors have lost out on this rally, what should they do now?
I would suggest three things. Investors should look out for pockets of opportunity such as infrastructure stocks, which remain attractive. They should invest through systematic investment plans. And they should not make any sudden shift in their asset allocation towards equities.
Understanding P/E multiple to invest wisely
Price to Earnings (P/E) multiple is one of the most commonly used valuation methods in the world of investment. Both individual and institutional investors use it to evaluate equity investment opportunities.
Empirical research validates its ability to explain long-term return potential of a stock. P/E is 'market price of the share' divided by 'earnings per share'. .
P/E is obtained by adding two components — tangible P/E value and franchise P/E value. Tangible P/E value refers to the 'no-growth' or 'zero-earnings retention' P/E value of existing businesses. This means, the firm returns all the excess cash flows to the shareholders and does not invest in the business for expansion or growth.
In this kind of scenario, the company's P/E is simply the inverse of the required rate of return. Required rate of return is the minimum return investors expect for investing in the company's stock, based on its risk-return profile. For example, if required return is 8 per cent and the company has zero growth, its tangible P/E is 12.5.
Franchise P/E (or franchise value) is the present value of a company based on its future investments. This is calculated by multiplying growth factor and franchise factor. Growth factor captures the present value of new investment opportunities. It is calculated using the formula: {g/(r-g)}, where 'g' is the expected long-term growth rate and 'r' is the required rate of return by the investors.
Franchise factor captures the return levels associated with new investments. It is calculated using the formula: {(RoE - r)/ (RoE * r)}, where RoE is the return on equity of a company. For example, let us assume a company has an expected growth rate of 10 per cent, RoE of 20 per cent and investors expect a minimum of 12 per cent. The tangible P/E of the company is (1/12) 8.33 and the franchise P/E is [(10/(12 -10) * {(20-12)/ (20*12)}] 16.67. Therefore, the intrinsic or justified P/E of the company based on its fundamentals is 25 (=8.33+16.67).
If the market P/E of the stock is less than 25, the company is deemed to be undervalued and investors can consider investing in the company and vice versa. This analysis enables a direct examination of the response of the P/E to Return on Equity (ROE) and expected sustainable growth rate of the company.
Growth and growth rates
Sustainable growth rate is defined as earnings retention rate multiplied by RoE. EPS will grow from one period to the next because reinvested earnings will earn RoE. In essence, franchise value is created for the existing shareholders if a company's ROE exceeds its required rate of return.
Furthermore, franchise factor also indicates that a firm has competitive advantage allowing it to generate an ROE greater than the required return. Let us understand the relationship between franchise factor and growth factor with an example. Consider a pharmaceutical firm that has an attractive drug pipeline with significant commercial potential. Its ROE could be high relative to the rate of return required by investors of pharmaceutical stocks.
Hence, this firm will have high growth rate if it retains its earnings. Such a firm can continue to generate a return on equity well above the rate of return required by the stock market, and thus, generates highly positive franchise value. However, if the company retains very minimal earnings with it, its growth rate will be small or negligible. As the sustainable growth rate is small because of low earnings retention rate, its franchise value will also be lower, even though the franchise factor is large.
This brings us to three conclusions based on the P/E analysis. One, P/E multiple of a company is based on its tangible value and franchise value. Second, franchise value sources are franchise factor and growth factor. Third, if a company's expected ROE is equal to or below the required rate of return, it cannot generate any franchise value, as its growth factor will be zero. Hence, investors need to analyse the P/E of the company (among other aspects) before considering investing. Let us conclude this article by applying it to arrive at the P/E of Infosys Technologies Limited based on its fundamentals. Its latest EPS is 109.16, while its current P/E is about 25. Cost of capital (r) for Infosys is approximately 11 per cent, under capital asset pricing model, the scope of which is beyond this article. Let us assume a long-term growth rate of 8 per cent for Infosys.
The tangible P/E of Infosys is around 9.09 (1/11 per cent) and the franchise value is 16.32. The justifiable P/E of Infosys in our example is 25.41. This means, Infosys is fairly valued in the market and investors cannot generate superlative returns by investing in the stock.
If you have a long horizon and haven't taken undue risks, the best bet is to stick to the equity allocations that you are comfortable with and stay with index stocks or good diversified equity funds through systematic investing.
What should retail investors do now, if they have completely missed out on this bull market? "Nothing", said a fund manager with a leading mutual fund when we posed this question to him. Though that answer may have us gnashing our teeth a bit, it is actually not a bad one, under the circum- stances.
Lured back to IPOs?
However, evidence from various segments of the equity market today suggest that some sections of retail investors aren't heeding this advice. For one, from the way the retail response to initial public offers (IPOs) has shot up, retail investors seem to be succumbing to the lure of listing gains once again.
After a series of IPOs that scrounged for retail money, recent ones such as Microsec Financial (retail portion subscribed 11 times), Eros International Media (26 times) and Career Point Infosystems (32 times) met with runaway retail response. This is vaguely reminiscent of the frenzied market of 2007, when IPO allotments were seen as prizes to be secured and every IPO was thought to be a sure-fire listing bet.
Yet, experience tells us that chasing IPOs may be the most risky way to play a bull market that has already run on for some time. While the Sensex has almost made it back to its January 2008 highs, nearly 40 per cent of the 2007 IPO stocks are still in the red for their original investors, with some even trading at less than half their offer price. The reason for this poor show from IPOs is fairly simple. Not only do a majority of issuers time their IPOs to market highs, they usually demand a very stiff price that cannot be sustained under more sober market conditions.
Playing small-caps
Then there is the persisting fancy for small and mid-cap stocks in recent months. From the shareholding patterns, there is evidence that retail investors have been steadily adding to their holdings in the galloping small cap stocks, even as the FIIs have been cashing out. In every bull market, after frontline stocks have become quite expensive, it is usual for experts to predict a 'catch-up rally' based on the discounted valuations of mid- and small-cap stocks.
While this may work in the initial stages of a rally, this bull market has gone on for long enough to make even small and mid-cap stocks look quite expensive. The fact that the BSE-500 today sports a PE of 24 — a marginal premium to the Sensex — and the BSE Smallcap Index trades at a stiff 18 PE, suggests that there isn't much margin of safety here. Small- and mid-cap stocks are not 'value' picks simply because their PEs look low relative to index stocks. Their inherently riskier business means they deserve to trade at a discount.
In contrast to all this, one section of investors that has been playing it extremely safe are the ones in mutual funds. Even as the market (and with it equity fund NAVs) have climbed higher, equity funds have seen outflows shoot up and inflows dwindle. Now, given that mutual funds did see a deluge of inflows at the peak of the previous bull market (October 2007 to January 2008), it is certainly understandable that investors who got in then would want to cash out with a profit.
However, for retail investors, diversified equity funds are certainly a far safer option than IPOs or small and mid-cap stocks. Yes, fund NAVs would suffer damage if the stock market were to correct sharply from current levels. But the damage is likely to be much less than that to individual stock portfolios, given the diversification.
For investors with a more than five-year perspective (which is what equity investing is all about), the Sensex hitting 20,000 should not be cue to move entirely out of equities, stop systematic investing or switch frenetically into those segments of the market that they think are 'undervalued'.
Yes, the vertical climb in the markets so far, current valuations and the recent sluggishness in corporate earnings, all suggest that this is the time to be cautious.
However, if you have a long investment horizon and haven't taken undue risks in the stock market, the best answer, really, is to continue with 'business as usual.'
Stick to the equity allocations that you are com
Query Corner — Ispat Ind nearing medium-term ceiling
Please discuss the future expectation of Ispat Industries. Samaresh Bhattacharjee
Ispat Industries (Rs 22.7): Ispat Industries is in a sideways movement between Rs 17 and Rs 28 since last June. The stock reversed higher from the lower end of this trading range in August and is currently nearing the resistance zone between Rs 27 and Rs 28. Fresh investments in this counter are recommended only on a strong close above this band. Subsequent target zone for the stock is between Rs 37 and Rs 39. Investors with short-term perspective can hold the stock with stop-loss at Rs 20.
Long-term investors can hold with deeper stop at Rs 16.5. The long-term outlook for this stock will turn positive only on a strong close above Rs 39. It is however hard to envisage a move above this level since the move to the peak of Rs 87.4 in December 2007 was recorded when the bull market frenzy was at its bellowing best. The decline that followed in January 2008 clearly shows that it was an unsustainable bubble phase in the stock.
I bought Future Capital Holding at Rs 273 and Fortis Healthcare at Rs 167. What are the long-term prospects for these stocks? Tajuddin Ahmed
Future Capital Holdings (Rs 251): Future Capital Holdings has not yet recovered from the price erosion witnessed in 2008 and it has some way to go before its long-term outlook improves. The stock is facing medium-term resistance around Rs 300 and inability to move above this level can result in a movement between Rs 175 and Rs 300 for few more months. Investors should divest their holdings on a close below Rs 140 as that would imply that the stock can decline to its March 2009 low of Rs 96.
Investors with short-term perspective can hold the stock with stop at Rs 195. Target on a break above Rs 300 is Rs 428 and Rs 510. Long-term view on the stock will improve only on a close above Rs 500.
Fortis Healthcare (Rs 163.5): This stock is currently retracing the up-move recorded from the October 2008 lows. Immediate support for the stock lies at Rs 132 and if it holds above this level, a sideways move between Rs 130 and Rs 190 can follow for a few months. Such a sideways move will be positive from a long-term perspective and can be followed by a breakout above to Rs 221.
That said investors with short- to medium-term perspective should divest their holdings on a close below Rs 130 since that would imply a propensity to decline Rs 116 and Rs 100 over the medium-term.
I am holding Visa Steel and Alpa Laboratories allotted at IPO. What are the prospects for these stocks? K.S. Sujatha
Visa Steel (Rs 39.8): The long-term reversal from the March 2009 trough in Visa Steel halted at the key resistance at Rs 45. The stock made multiple attempts to move beyond this level between October 2009 and April this year. Investors with short- and medium-term perspective can exit part of their holding if the stock reverses lower from this level again. Strong weekly close above Rs 48 will take the stock to Rs 62.
The trend in the stock is, however, down since last April and it can decline to Rs 31 or Rs 27 over the medium-term. Investors with long-term perspective can hold the stock with stop at Rs 27.
Alpa Laboratories (Rs 15.7): The long-term outlook for Alpa Laboratories is negative going by the feeble recovery in this stock last year. It is currently reversing lower from key medium-term resistance at Rs 20. This zone needs to be crossed to take the stock higher to Rs 30. The long-term outlook for this stock will improve only on a strong close above Rs 30.
However, it is quite likely that Alpa Laboratories slides lower to Rs 11 or lower in the medium-term. It appears futile to wait for the stock to rise above its IPO price. We suggest a switch out of this stock at current juncture.
I have bought Surya Pharmaceutical at Rs 103 and Godawari Power and Ispat at Rs 128. What is your outlook on these stocks? Uday
Surya Pharmaceutical (Rs 278.4): Surya Pharmaceutical is one of the stronger performers in the recovery since the first quarter of last year and the stock is currently positioned well above the previous peak of Rs 174 recorded in August 2005. A minor correction is currently in progress and investors with short-term perspective should hold the stock only as long as it trades above Rs 255. This level needs to hold if the stock has to move higher to Rs 350.
Those with a long-term horizon can hold the stock with deeper stop at Rs 160.
Godawari Power and Ispat (Rs 211.1): This stock faces strong intermediate-term resistance at Rs 250. Though it moved above this level in April, it could not sustain there. A medium-term correction is in progress since the peak of Rs 320 formed in April. This decline will receive support from the band between Rs 195 and Rs 210. Short-term investors can hold the stock as long as it sustains above this band.
Supports below Rs 195 are at Rs 180 and Rs 147. Investors with long-term perspective can hold the stock with stop at Rs 140. Target on a close above Rs 320 is Rs 376.
Please give your outlook for the next three to six months for Hindustan Petroleum Corporation Ltd (HPCL) bought at Rs 378. T.P. Bhola
HPCL (Rs 541.6): In our previous review of HPCL in October last year, we had written that fresh purchases should be initiated only on a close above the strong resistance around Rs 450. We had also mentioned that decline from the zone around Rs 400 could result in decline to Rs 325 or Rs 260. The stock reversed higher from Rs 293 in April and has been spiralling higher since then.
Simple extrapolation of the up-move from the October 2008 low gives us the first target at Rs 557. Since the previous peak in April 2004 was also at Rs 538, investors need to be wary in the zone between Rs 530 and Rs 560. Reversal from this zone can drag the stock lower to Rs 420 or Rs 320 over the medium-term. Long-term target on a close above Rs 550 is Rs 720.
Kindly give your views on JBF Industries. Vivek
JBF Industries (Rs 159.4): JBF Industries has key intermediate-term resistance at Rs 144 and the stock has been hovering around this zone since April. It is currently trading above this level and investors can hold the stock as long as it holds above Rs 125. If the stock manages to hold above Rs 125, it will imply that it can move higher towards the January 2008 peak of Rs 208. Supports on a decline below Rs 125 are at Rs 99 and Rs 82.
Despite healthy revenue and margin growth and diversified offerings, execution risks and other challenges dampen prospects.
Product linesaddress multiple segments.
Investors may avoid subscribing to the initial public offer of retailer Cantabil Retail. The offer values the company at 15 times the per-share earnings of FY10 at the higher end of its price band of Rs 127-135, and 13 times estimated FY11 earnings.
Peers such as Koutons Retail and Kewal Kiran Clothing trade at valuations of 12-14 times. Value retail saw valuations revised down following poor performance, inventory build-up and doubts over scalability.
Valuations of Koutons Retail slipped to 11 times now from 20 times in January 2009 . Debt-funded growth has already crushed value retailers such as Vishal Retail and Subhiksha. In this backdrop, despite healthy revenue and margin growth and diversified offerings, execution risks dampen the promise of Cantabil. It faces challenges in the form of developing its regional brand into a national one, sluggish inventory turnover, identifying new store locations, and scaling up its regional operations to cover a national footprint .
Value retail play
Cantabil retails apparel and accessories for men, women and children in the value-for-money category. It has two brands, Cantabil and La Fanso, with a network of 411 stores. Even so, store network is concentrated; over half in the North and a third in the West. Any brand recall that Cantabil enjoys is restricted to these regions. Plans are to widen geographic footprint and grow revenues on the strength of its brands.
The apparel market is fragmented and peppered with trusted local players, national brands and private lines of established national retailers such as Pantaloon. Creating a sustainable national recall for Cantabil is thus fraught with challenges, requiring heavy investments in brand-building and a long time.
Expansion
Cantabil will utilise Rs 25 crore to open 180 stores across the country by end-2012. Plans to open 80 by March 2011 seems a tad tough with issue proceeds in only next month and locations for most stores not identified yet. With same-store sales growth at 10-12 per cent, much will hinge on new store openings.
Large-scale operations will help improve thin margins that are inherent in value retail. However, supply chains have to be effective and inventory turnover quick. Cantabil has a centralised distribution system which serves it well now with its concentrated network.. Geographic expansion may result in higher transportation costs, with significant in-house manufacture and plans to up contribution.
Inventory turnover increased from three to seven months from FY-07 to FY-10 even as working capital turnover dropped from 4.6 times to 2.6 times. Rs 30 crore of issue proceeds will fund working capital. Rs 32 crore will be used to set up a manufacturing plant, operational by end FY-12.
Financials
Revenues grew at a compounded annual rate of 66 per cent and net profits at 71 per cent over three years, attributable in part to a smaller base. Such exponential growth is unlikely to continue.
Operating margins hovered around a satisfactory 10-11 per cent FY-07 onwards. Rs 20-crore repayment of debt is planned from the offer proceeds; debt-funded expansion resulted in pre-issue debt:equity of 2.2 times and net margins of 6 per cent. Debt:equity will fall to 0.31 times post issue.
Still, risks of further debt to fund expansion outside issue objects and equity dilution from this offer remain; the issue doubles the equity of the company. Return on (pre-issue) equity drops from 49 per cent in FY-10 , to 13 per cent (estimated) in FY-11 post-issue equity. The issue is open from September 22 to 27, with SPA Merchant Bankers the lead managers.
Ashoka Buildcon — IPO: Invest
With a sizeable order book from third parties in road and electrical works, the company is in a position to capitalise on the considerable potential in these segments.
Doubling as a developer and a contractor augurs well.
Investors may subscribe to the initial public offer of infrastructure player Ashoka Buildcon. At the upper end of its price band of Rs 297-324, the offer discounts FY-10 consolidated earnings by 22 times and estimated FY-11 earnings by 14 times. Larger players in this space such as Jaypee Infratech and IRB Infrastructure trade at valuations of 21-22 times the trailing earnings. However, Ashoka may have scope for higher growth.
Ashoka doubles up as a construction contractor for third parties in roads and electrical works, whilst developing its own road projects, allowing it to get the most out of the sizeable potential of both segments. It already has a clutch of operational road projects on which it is collecting the toll, with a good number in the pipeline. It has an RMC and bitumen division through which it meets its entire requirement besides sales to other entities.
Double presence
Ashoka has an order book of Rs 1,615 crore (2.9 times FY-10 contract revenues), of which, contracts from third parties account for 87 per cent, in the roads and power segments. With an execution period of about 30 months, the order book provides medium-term earnings visibility. The order book also has reasonable geographic diversification, spread across the States of Chattisgarh, Maharashtra, Madhya Pradesh and Rajasthan among others. The remaining order book pertains to the construction of its own Build-Operate-Transfer (BOT) contracts.
It has ten operational road projects on which tolls are being collected; toll revenues make up about 20 per cent of total revenues. Six projects are in the pipeline, of which, three will turn operational in the last quarter of this financial year and will thus fully contribute to revenues from FY12 onwards. Ashoka also has joint ventures with players such as IVRCL Infrastructures to secure projects.
BOT projects are typically executed through subsidiaries, especially since some of them are secured in consortium. Equity infusion for projects such as its Durg Bypass and Bhandara road project has come from institutions such as IDFC and India Infrastructure Fund.
Hitherto, contracts were primarily secured from the State governments of Maharashtra and Madhya Pradesh. Orders in the pipeline now include those from the NHAI, besides geographically diversifying into Karnataka and Orissa, boding well for the company to secure large-sized orders across the country while also holding a favourable position with the State governments.
A presence in both contracting and developing allows Ashoka to better capture opportunities thrown up in the road infrastructure space than as a developer or a contractor alone. Executing own projects will also help maintain healthy operating margins. The company has a track record of completing projects well ahead of schedule, which, in the case of BOT contracts, is especially beneficial since it indicates earlier inflow of toll revenues.
Backward integration
Besides revenues from tolls and construction, Ashoka derives about 10 per cent of revenues from sale of RMC and bitumen, which offers two benefits.
One, it provides a degree of risk mitigation in the revenue mix. Two, the division addresses the entire requirement of the company for its contracts, helping reduce operating costs and boosting margins, while ensuring that critical raw material is available on time. The company also owns a fleet of construction equipment, which again serves to better operating margins. Rs 25 crore of issue proceeds will fund the acquisition of new equipment.
Financials
Consolidated revenues grew at annual compounded rate of 25 per cent for the past three years, while net profits have grown 49 per cent on the back of lower material costs. Operating margins are healthy, at 27 per cent for FY10, though they are lower than the 32 per cent of FY-09, due to higher contract costs.
OPM for the BOT segment is healthy at about 49 per cent, on par with other large developers such as IRB Infrastructure. Rs 45 crore of issue proceeds will part-finance working capital requirements. Turnover of working capital improved from 1.5 times in FY-07 to 2.4 times in FY-10.
However, debt taken on to fund project development led to high interest outgo, with interest costs eating over 10 per cent of sales from FY-07 to FY09, before falling to 6 per cent in FY-10. Operational BOT projects are converted into intangible assets and amortised over the concession period. Depreciation and amortisation costs are thus on the higher side.
Net margins, therefore, dropped to 8 per cent in FY-10, though this is an improvement over the 4 per cent margins the year earlier. Depreciation costs are likely to remain high, given the planned investments in capital equipment and the three BOT projects that will convert into assets when they are commissioned in 2011.
The consolidated debt-equity pre-issue stands at 2.4 times. Rs 55 crore of issue proceeds will be used to repay Ashoka's debt, while Rs 60 crore will be provided to subsidiaries to repay debt on their books.
Post-issue, consolidated debt will drop to 1.5 times. Interest cover is healthy at 4.7 times in FY-10. This will help it raise debt and achieve financial closure for its other BOT projects.
(Hema Deepak Katariya has filed a civil application before Civil Judge Junior Division, Nasik, on July 31, 2010, to obtain interim injunction against the Issue. Hema Deepak Katariya has filed another application on September 20, before the court as a continuation of the application dated July 23 for an interim stay on the issue. The matter has been scheduled to be heard by the court on September 28, 2010).
Tecpro Systems — IPO: Invest at cut-off
The company's edge in the 'balance of plant' space lies in its well-entrenched presence in coal and ash handling projects.
An established track record of project execution, quality order book and technical collaboration with international players, besides high trajectory of earnings growth strengthen the prospects of material-handling player Tecpro Systems. Investors with a two-year perspective can consider investing in the initial public offer of Tecpro. The offer price of Rs 340-355 discounts the company's consolidated per share earnings estimated for FY-11 by 12-13 times. The valuation is at a good discount to peers such as McNally Bharat Engineering and TRF.
The company and offer
Tecpro Systems provides turnkey solutions in material and ash handling, balance of plant (BoP) and engineering procurement and construction (EPC) contracts. The company has an in-house manufacturing facility in Rajasthan and Haryana to make material- and ash-handling equipment such as stackers, re-claimers and crushers.
Proceeds from the offer would be utilised for working capital requirements.
Forward integration
Of the orders placed for coal handling solutions in the Eleventh Plan, Tecpro is stated to have a 19 per cent market-share in coal-handling systems and a 15 per cent share in ash-handling. It competes with players such as Larsen & Toubro, ThyssenKrupp Industries and Elecon Engineering in the coal-handling space.
In-house manufacturing facility, besides a number of collaborations with international players, may have possibly helped the company bag projects from large companies such as Reliance Energy, Lanco Infratech and SAIL.
As a natural extension of its material-handling services, especially for power plants, Tecpro bid and won a balance of plant work from the Chhattisgarh State Power Generation Company valued at Rs 993 crore. The company has already started execution of this project. That this BoP has added to the overall profitability is also evident from the company's operating profit margins (OPM). From an 11-13 per cent OPM range in previous years, this margin shot up to 15 per cent in FY-10 after the BoP execution started. We expect this contract to act as a good reference point for future projects.
Tecpro's edge in the BoP space also lies in its well-entrenched presence in coal and ash handling projects; these form a significant portion of a BoP package, besides civil work and water treatment plant.
To draw from the expertise of other companies, Tecpro bid for its first BoP project in consortium with infrastructure player Gammon India (for cooling towers) and water treatment company, VA Tech Wabag.
Going forward, the company intends to manufacture and commission cooling towers as well as water treatment plants in-house besides supply and commissioning of coal washeries. With this, the company may be well-placed to consolidate its operations in the power infrastructure sector.
Companies such as BGR Energy Systems, which started off as a service provider to the energy sector moving to BoP and later EPC have been considerably re-rated in the stock market.
Power dominates
While the BoP segment is fast catching up as a key driver of revenues, Tecpro's material handling systems continues to account for a good chunk of its order book. Of the Rs 2,310 core of order backlog (1.5 times FY-10 sales), bulk handling forms a good 45 per cent, BoP and EPC about 30 per cent and the rest from ash handling projects. The order backlog is dominated by projects from the power sector, which account for 80 per cent of the orders.
According to the Central Electricity Authority estimates (as of June 2010), about 148 orders for coal and ash handling each need to be placed under the Twelfth Plan. There were only eight key players offering coal handling works and nine vendors in ash handling as of August 2009. Tecpro's focus on the power segment therefore appears well-timed.
Financials
Tecpro's revenues for FY-10 stood at Rs 1,455 crore, growing 84 per cent compounded annually over the last three years, albeit from a small base. Net profits grew 75 per cent to Rs 109 crore. The company's debt-equity would reduce to less than one post-issue. However, working capital turnover does appear low. Almost a fourth of the receivables were pending for over six months (as of March 2010) and average debtor days was as high as 165. An increase in BoP works may push the company to negative operational cash flows.
Tecpro's BoP project in Chhatissgarh is under litigation as another bidder has challenged the State Power Corporation. While this was dismissed in the High Court of Chhattisgarh, the same is pending before the Supreme Court. Any adverse ruling can impact future revenues. However, the company would not have to reverse revenue booked.
VA Tech Wabag — IPO: Invest at cut-off
Strong foothold in developing nations, sound financials and debt-free status are positives.
A global playerin key water markets.
Investors with a long-term perspective can consider subscribing to the initial public offer of VA Tech Wabag (VA Tech), an Indian water solutions provider with a multinational presence. Well-entrenched in the high-potential water-treatment business, strong foothold in developing nations, sound financials and debt-free status buttress our recommendation.
Backed by well-known private equity players, VA Tech has the unique reputation in the water industry, of buying out its erstwhile Austrian parent; thereby securing for itself a ready reference point in key markets and, more importantly, the benefit of 157 patents held by the Austrian company Wabag.
For domestic investors, VA Tech may be a unique play in the water treatment sector, a space that holds high opportunities, driven by both government mandates as well as the need to conserve and recycle water.
At the offer price band of Rs 1230-1310, the stock would discount its estimated per share earnings for FY-12 by 12-13 times. The price-earnings ratio for FY-10, at 23-25, may seem higher than other infrastructure plays. However, given that the company is more technology-oriented, and relies less on a brick and mortar model, we believe it may not be strictly comparable. As a holder of intangible assets, similar to infrastructure BOT developers, a price-to-book ratio may be a better metric to compare. At 2.4-2.6 times P/BV, VA Tech's valuations are similar to those of infrastructure players.
As VA Tech is in the process of improving profit margins (given the high cost of operations in Europe) of its foreign subsidiaries, investors may have to stay with the stock for at least 2-3 years to derive the full benefits of the operations synergy.
Business and offer
VA Tech provides water engineering solutions such as sewage and effluent treatment, processed and drinking water treatment, desalination and reuse. The company seeks to raise Rs 125 crore through fresh issue and a part offer for sale by private equity investors for Rs 326-347 crore.
It plans to use the proceeds for working capital requirements even as the over Rs 200 crore of cash in hand (as of March), is sought to be utilised for potential acquisitions. At the offer price band, the company's market capitalisation on listing would be Rs 1,300 crore to Rs 1,380 crore, and this at a very low equity base.
Going global
VA Tech's buyout of Wabag Austria, a leading water solution company, from Siemens in 2007 marked its emergence as a global player. The buyout provided access to key water markets. Equipped with Wabag Austria's technology, VA Tech began utilising the same for its various projects in India and abroad.
Through its subsidiaries, VA Tech has presence in key markets in the Middle East and North Africa; being the most water scarce regions in the world, they have been forced to adopt sea water desalination as well as water reuse programmes. With presence in these key markets, besides parts of Europe, China and South East Asia, VA Tech's track record of completed projects in these regions gives it the technical qualification for future projects. Only few players such as Suez Environment and Veolia Water have such vast presence. With a large number of designs and patents, VA Tech is well-placed to tap the opportunities in the above markets.
VA Tech's businesses have been classified as municipalities, industrials, operations (operation and maintenance) and international business. Given that most of the water treatment projects are initiated by local bodies, close to 88 per cent of the company's order book of Rs 2,780 crore (executable over 1.5-2 years) comes from municipalities, local and overseas; the rest come from industrial clients. As municipal projects characteristically come with price escalation clauses, the company is to some extent protected from cost variations.
Margin challenges
Water projects typically offer high profit margins. However, VA Tech may not always be able to capitalise on this fully as a result of subcontracting the execution work to local contractors. However, for a company specialising in design and technology a focused approach to investing in research may be warranted than locking-up resources for execution of projects. As a standalone entity, VA Tech has nevertheless managed OPMs of over 12 per cent. However, this margin is lower at 9.4 per cent (FY-10) on a consolidated basis.
As is the case with many European buyouts by Indian companies, the foreign subsidiary's profit margins are less attractive than the parent, with higher costs of operation. VA Tech has been introducing changes such as decentralising operations and setting up local offices in key developing nations rather than holding a centralised operation centre. The results of this are evident — with consolidated operating margins climbing 5 percentage points (from 4.8 per cent) since the buyout in FY-08. We also expect operating margins to improve further as the orders from countries such as Africa and West Asia increase. International orders currently account for only about 30 per cent of the total orders, leaving large scope for ramp up.
Besides revenue from contracts, VA Tech is also likely to see increased contribution from the operation and maintenance segment. From a 7 per cent revenue contribution this segment accounted for 17 per cent in FY-10. Going forward, increasing BOOT projects, such as the desalination plant in Chennai are likely to ensure a regular stream of revenues. The margins on these are also likely to be high as the rates are fixed for the quantity of water desalinated.
Over the last two years (since acquisition) consolidated revenues expanded annually at 41 per cent to Rs 1,233 crore in FY-10 while profits jumped at a compounded annual rate of 202 per cent to Rs 49 crore. Profits for FY-10 were dented as a result of providing for full taxes, even as the company is seeking legal recourse for relief under Section 80IA of the Income-Tax Act. VA Tech has remained a company with negligible debt and manages operations with client advances.
Open offers: Should investors heed the call or not?
While shareholders need to keep a close watch on the price movements in the run-up to an open offer, other important factors should be considered too.
Anand Kalyanaraman
The far-reaching changes proposed by the Takeover Regulations Advisory Committee of SEBI in July this year seem to have increased the urgency for takeovers and substantial acquisitions under the existing rules. In a little over two months since the report came out, there have been as many as 27 public announcements for open offers — much higher than the monthly average of around seven offers over the two years prior to the report. Major cases include the high-profile offer to Cairn India shareholders in the takeover bid by the Vedanta-led consortium, and the voluntary open offer by the Singh brothers to hike stake in Religare Enterprises.
The trend may gain momentum in the months before the new rules come into force. After all, if the recommendations are adopted in toto, takeovers and substantial acquisitions are set to become much more expensive than before.
But should shareholders bite the bait and tender their shares in open offers? That an offer priced below the prevailing market price during the open offer period should be given a miss is a no-brainer. But it is also important to consider other aspects, such as the likely acceptance ratio, the company's prospects, tax implications, and possibility of counter-offers. The above should also be considered by those looking to buy low and sell high during open offers.
The right price
An analysis of around 50 companies that have been the subject of open offers since January 2009 shows that, in many cases, (more than 60 percent in our sample), the immediate reaction to open-offer announcements is a sharp rise in price of the target company's stock. For instance, in the Nahar Investments open offer last week, the stock zoomed almost 20 per cent to Rs 46 on the announcement day, even higher than the offer price of Rs 40.
The script was similar for Maruti Infrastructure and Shyam Star Gems, which were among the eight open offer announcements made last week. Among older cases in this category are companies such as Maytas Infra and Golden Tobacco.
While a price increase seems logical when market price pre-announcement is less than the announced open offer price, in many cases, price movements do seem counter-intuitive (exceed offer price or increase even when the prevailing price is higher than the offer price). Potential investors should be wary in such cases, as the stocks concerned may be influenced by short-term irrational exuberance.
Here, one factor that really influences price action is the likely acceptance ratio in the open offer — the number of shares likely to be accepted as a proportion of shares tendered by public. Given that under the current rules, open offers need to be mandatorily made for just 20 per cent of the voting capital, only a portion of the shares tendered will be accepted.
For example, if public shareholding in a company is 50 per cent, and the open offer is for 20 per cent, only four out of 10 shares tendered will be accepted, if all public shareholders tender shares. As it stands currently, most companies ( around 70 per cent in our sample) restrict the open offer to 20 per cent. A low acceptance ratio implies that the open offer price will effectively apply to just a small portion of the public shareholder stock, while the remaining shares will continue to be subject to market price vagaries. This could have a telling impact on the stock price.
For instance, in the case of Ranbaxy Laboratories in June 2008, a likely acceptance ratio of only one-third contributed to the share price falling around 3 per cent the day after the announcement, despite the offer having been priced at 32 per cent premium over the pre-announcement market price. Hence, potential investors should consider the overall picture and avoid buying blindly, merely because the offer price is handsome.
That said, in many cases (around 55 per cent in our sample), it was observed that buoyancy in price continues through the run-up to the open offer. For example, in Satyam Computers, and Vulcan Engineers, the stocks rose smartly (72 per cent and 77 per cent) from the announcement date to the date of opening of the offer — much better than broader market moves. The inevitable consequence was a poor response in tender by shareholders (0.04 per cent, and 0.15 per cent respectively), given that going market price was much higher than the offer price.
However, in other cases, such as ABB (where the open offer was priced at a substantial premium of 34 per cent, and the acceptance ratio was around 48 per cent) and Uttam Galva (where the offer price was higher than market price on the date of opening), the offers sailed through.
Post-offer movement
Did shareholders really benefit by tendering or not tendering in the open offers? In a majority of cases (close to 65 per cent in our sample) current market prices are ruling higher than offer prices, and shareholders would have been better off not tendering to the open offer. In fact, in many cases, the stocks also outperformed the broader market.
Vulcan Engineers, for instance, is up 180 per cent from the offer price (Sensex up 16 per cent in comparable period) and Satyam Computers is up 73 per cent. Also, Uttam Galva which had a successful open offer is up around 26 per cent from the offer price. On the other hand, ABB, which also was successful in its offer, is down around 3 per cent from the offer price, indicating that shareholders who tendered made the right choice. While overall, it appears that shareholders who held on would have been better off than those who tendered, it needs to be borne in mind that in a bull market, such as the one we are in currently, a rising tide will lift most boats.
The bottomline seems intuitive: the success of an open offer is heavily contingent on the prevailing prices of the stock during the period of the open offer. While shareholders need to keep a close watch on the price movements, other important considerations too should be factored in.
Future prospects
Shareholder decisions to tender or not should also weigh in the future prospects of the company. In ABB, for instance, investors would have been better off accepting the open offer, given the premium offered over the market price, and the tougher business environment and margin pressures on the company.
On the other hand, in the case of Satyam Computers, it would have been better to reject the offer, given the discount of the offer price to prevailing market price and the financial disclosures at that point reflecting the company's position to be better than expected. If an analysis of the company's fundamentals reveals that the open offer price does not factor in growth prospects, it may be worth waiting for the right price discovery in the open market.
Also, price being favourable, shareholders may consider tendering if a management change carries the risk of eroding business prospects.
Weekend Platter on http://www.indiabulls.com/securities/research/equity_analysis_report/Special_Report_PDF/WP_Sep_24.pdf
Corporate News Headline
• BHEL said it is in talks with SAIL and Vizag Steel to tie up for manufacturing high grade steel, while Korean steel maker Posco may join the proposed joint venture company as a technology partner. (BS)
• BPCL has chalked out a five-year strategy to diversify its business into other core areas like gas, exploration and production, power generation, increasing its market share and refining capacity, a top company official said. (BS)
• Suzlon Energy said it has crossed installations of 5000 megawatt in the country. Suzlon said it has cumulatively added over 5,000 MW of wind power capacity for over 1,500 customers in India across 40 sites in eight States. (BS)
Economic and Political Headline
• The government said it will raise Rs. 670 bn through the issue of short-term treasury bills in the October-December quarter. As much as Rs. 240 bn would be raised in October and a similar amount in November by issuing treasury bills with a maturity of up to one year. The remaining Rs. 190 bn would be raised in December, it said (BS)
• Orders for US capital equipment rebounded in August, signaling business investment is holding up better than some economists projected. Bookings for goods like computers and communications gear climbed 4.1% after a 5.3% decline in July that was smaller than previously estimated, according to figures from the Commerce. (Bloomberg)
• German business confidence unexpectedly rose to the highest level in more than three years in September, suggesting companies can weather weaker demand from abroad as the global economic recovery slows. The Munich-based Ifo institute said its business climate index increased to 106.8 from 106.7 in August. (Bloomberg)
Today market update http://www.indiabulls.com/securities/mailermis/morning-brief/morning-brief-27Sep2010.htm
Arvind Parekh
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