Steeling the thunder

PENNY WISE

Operating profit27.1885.42 OPM (%)7.5916.36 Net profit35.7854.83 EPS(Rs)11.417.19  The company's financials improved dramatically in FY05 since it was able to pass on the increasing raw material prices, mainly those of scrap, to its customers. Scrap costs account for as much as 63 per cent of Musco's raw material costs.  However, prices of scrap have been volatile in the current quarter which might pose problems for Musco. Explains Rajarathnam, "when prices go up our customers are reluctant to compensate us immediately. However, now that prices have been falling, they want us to pass on the benefit from day one."  The company, according to him, will pass on the gains from lower raw material costs to customers. In the case of ferro alloys, which account for about 23 per cent of raw material costs, a price-variation clause has been built into contracts with customers and therefore the company will not suffer.  The realisation per tonne improved to almost Rs 50,000 per tonne in FY05 from Rs 35,000 in FY04, and according to the company, should not fall in FY06.  The demand for steel from the forgings sector is expected to pick up mainly because of the export orders bagged by forgings manufacturers, whose share of exports increased from 6 per cent in FY97 to 19 per cent in FY04.  Among Musco's main customers are Bharat Forge and Amtek Auto. Demand for forgings from the domestic market has been flat over the last seven to eight years and stood at 0.51 million tonnes in FY04.  However, with car sales rising, automobile manufacturers would require a larger quantum of forgings, thereby pushing up the demand for alloy steel. Similarly, stronger automobile and capital goods sales should stimulate the demand for bearings, in turn creating demand for alloy steel.  Multinational bearings firms such as SKF and FAG are outsourcing larger quantities from India. The upturn in the capex cycle should also generate greater demand for alloy steel which is used in equipment for power plants, heavy duty generators and earthmoving equipment.  Analysts estimate that the demand could be between 10 and 12 per cent annually over the next two years.  The company is gearing up to meet the higher demand .The capacity of the alloy steel plant, which is 110,000 million tonnes per annum (mn tpa) at present will be increased to 240,000 mn tpa in two stages by FY08, the capacity increase in FY06 being about 30 per cent.  The capex will cost Rs 100 crore, of which around Rs 50 crore would be financed through long-term borrowings. The company believes that even after these borrowings, its gearing would be within manageable limits. In FY06, the company plans to spend around Rs 45-50 crore.  At the current price of Rs 100, Musco is trading at four times consensus FY06 stand-alone earnings of Rs 24. Analysts say earnings could grow at a CAGR of 35 per cent over FY05-07.  They believe the stock is reasonably valued given that the company would generate strong cash flows of around Rs 200 crore between FY06 and FY08.  While that may be true, any slump in export demand for the automobile ancillary sector, resulting from a global slowdown of the automobile industry could in turn dampen the demand for alloy steel.  

RESEARCH CALLS
SBI (buy, target price Rs 810)
UBS Investment Research has upgraded SBI from neutral to buy and its price target from Rs 490 to Rs 810. UBS says the upgrade is driven by SBI's stronger-than-expected loan growth and easier liquidity in the banking system, which should help the bank to raise adequate resources to fund credit growth without pressure on margins.

UBS has also upgraded its earning estimates by 18 per cent for FY06 and 25 per cent for FY07. However, it says SBI's share price has been vulnerable to bond yield movements as its bond portfolio is more exposed to rising bond yields than some other large banks.

While bond yields have eased, any further pressure on yields could impact SBI more than those of other banks. It adds that SBI's valuations are the cheapest among the banks it covers.

Pantaloon Retail (buy, target price Rs 1,500)
CLSA has termed Pantaloon Retail a buy, noting it is at the forefront of the revolution in organised retailing. It notes that while systemic and execution risks are present, the company has exhibited the ability to manage the fast pace of growth to become the only retail chain with a pan-Indian presence.

Changing lifestyle and consumption patterns, increasing consumerism and availability of retailing space are driving growth in organised retailing.

Being the market leader with exceptionally strong growth potential and given the initial stages in a growth sector, Pantaloon's steep valuations will sustain.

Balaji Telefilms (buy, target price Rs 120)
Merrill Lynch has maintained its buy rating on media stock Balaji Telefilms with a price target of Rs 120. Balaji has reported a 16 per cent rise in Q4FY04 sales to Rs 54.40 crore and a 22 per cent drop in net profit to Rs 9.60 crore. Merrill has expressed optimism that Balaji is coming out of its investment phase after launching 14 new shows in FY05.

While the cost of these launches has hit financials, benefits should start accruing from Q1FY06. Merrill Lynch also anticipates a resumption of double-digit growth in net profit from Q1FY06, led by investments made in new show launches, especially in the ones on STAR Plus and Sony apart from a hike in programme rates for its serials on STAR Plus.

Merrill notes that the recent rerating of the stock would be supported by the success of Balaji's show launches on Star Plus and Sony and entry into movie production.

Tata Motors (outperformer, target price Rs 475)
Enam Securities has maintained its outperformer rating on Tata Motors, prompted by the company's impressive FY05 results. Enam attributes the strong revenue performance to a 20 per cent growth in CV volumes in Q4FY05.

It also notes that Tata Motors focus on new product launches will serve them well going forward. However, the firm points out that any slow-down in infrastructure spend by the government, increase in interest rates and lower-than-expected GDP growth could impact CV volume estimates.