UTV: High valuation

UTV Software's IPO price band discounts earnings between 36 and 41 times

UTV Software has chosen an interesting time to go public. With the markets continuing to hit new highs, demand for IPOs also continues to be high.

But as a company, UTV's operating performance is currently amongst its worst. In the six months to September 2004, its EBITDA margin had shrunk to just 6.99 per cent, compared to 12.56 per cent in FY04.

In fact, UTV's profitability has shrunk even in the previous years - in FY01, its EBITDA margin was as high as 22.48 per cent.

Profitability has been hit this fiscal because of start-up costs relating to the setting up of a domestic and international movie distribution network, and also the shift from co-production of movies to in-house production.

All these start-up costs were amortised last year, and as a result UTV was barely profitable at the pre-tax level (on a consolidated basis) in the six months till September 2004.

Net profit was higher at Rs 3.91 crore, but only because of a deferred tax asset of Rs 3.89 crore. Consequently, it doesn't make much sense to value UTV using FY05 numbers.

Based on consolidated FY04 numbers, UTV had an EPS of Rs 3.2. The price band of Rs 115-130 set for the IPO discounts these earnings between 36 and 41 times.

If such high valuations are to sustain, UTV's new businesses such as its kids channel, Hungama, and its movie production and distribution business must do well.

The problem is some of these businesses are high-risk businesses. At the same time, its other businesses like television content, air time sales, dubbing, ad films etc. could provide a buffer.

On the whole, UTV's revenue growth has been flat over the past four-five years, but what's important is that it was despite a fall in its exposure to Doordarshan (which used to account for as high as 60 per cent of its revenues).

But in order to justify a high valuation, what's more important is that revenue and earnings growth going forward are much higher than historic levels.

Industrial production

Manufacturing continued to propel industrial growth upwards in December, with growth in the Index of Industrial Production (IIP) being 7.9 per cent, while growth in manufacturing was 8.8 per cent. Manufacturing has slowed down from the double digit growth achieved in October, but the growth rate is the same as in November.

Capital goods have been the main driver, growing at 13.3 per cent this fiscal year, much above the growth rates in basic and intermediate goods.

Among industries, the category, "Machinery and Equipment other than transport equipment" has been the star performer this fiscal, rising by 21.9 per cent.

That's a clear indication that companies are now expanding capacities, and investment demand is rising rapidly, although there has been deceleration since October, thanks to the higher base.

With a slew of companies announcing capex plans, the best is yet to come so far as investment demand is concerned. The parallels with the mid-nineties are obvious.

The IIP is up 8.4 per cent this fiscal, while manufacturing growth has been 9 per cent so far. Ten years ago, in 1994-95, the IIP rose by 8.4 per cent, while manufacturing was up 8.5 per cent.

What's interesting is that in 1995-96, the IIP rose by 12.7 per cent, while manufacturing grew by 13.8 per cent. That precedent shows that we can have even higher manufacturing growth in 2005-06.

Also, unlike the mid-nineties, companies are far more cautious about adding capacity, which should ensure that this boom is more sustainable.

Sense and Sensex

The stockmarket reached its lifetime high by crossing the 6700 mark in intra-day trading on Monday. The big question, of course, is whether Sensex stocks overvalued or is there still room for further upside?

One way of answering that question is to see whether price-earnings ratios are justified by earnings growth.

Growth in earnings of the Sensex companies in the last quarter was 38.5 per cent vis-a-vis 24 per cent in Q2FY05 and 27 per cent in Q1FY05. With the trailing price-earning ratio pegged at 16 for the aggregate Sensex stocks, valuations certainly cannot be described as cheap.

But the underlying reality is that aggregate earnings growth has been propelled by only a few companies.

In the December quarter, the top five companies accounted for 88.61 per cent of total earnings growth of Sensex stocks vis-a-vis 78 per cent in the September quarter.

In fact, the top three companies accounted for 78.9 per cent of aggregate earnings growth for the December quarter. This concentration in earnings growth is a cause for worry, especially since it's centred around cyclicals like ONGC, Tata Steel and Reliance.

These companies' fortunes are largely dependent on global commodity prices, which means their growth would be hit if the global economy slows down.

However, analysts point out that growth should be more broad based going forward, with sectors like capital goods, IT and FMCG companies also expected to perform better.

That would be crucial if the Sensex is to maintain current valuations.

With contributions by Mobis Philipose.