Cummins India: On solid footing

Cummins India has been able to pass on higher raw material cost to customers

Cummins India reported a 80.4 per cent growth in its operating profit in the March quarter, despite net sales growing just 16.17 per cent. In contrast, in the first nine months of FY05, the company reported a 42.4 per cent growth in operating profit, despite a 32.6 per cent growth in net sales.

Raw material cost grew 14 per cent to Rs 211.71 crore last quarter, compared with a 38.5 per cent growth in the first nine months of FY05.

As a percentage of sales, raw material expenses dropped 130 basis points in the last quarter against a 365 basis points increase in the nine-month period.

An improvement in this overhead was mainly because the company was able to pass on higher metal costs to consumers. Besides, the company also managed savings thanks to productivity gains.

Exports in the March quarter rose 71 per cent due to improved sales of 38-litre (K38) and 50-litre (K50) power-generation engines. However, in the domestic market, analysts point out that the company had to contend with sluggish demand conditions for equipment in the waterwell segment.

As a result, domestic sales dipped about 4 per cent y-o-y the last quarter. Domestic sales account for about 60 per cent of total sales, and the drop in growth rate is a cause of concern.

Going forward, the company's increased participation in the parent's global operations is expected to provide the growth stimulus. Exports, therefore, are expected to grow at a faster pace compared with domestic sales.

Further, an improvement in the indigenisation levels for its recently launched products (C & N14 series) are expected to enhance operating margins. Cummins' current share price discounts trailing earnings by over 18 times, which adequately factors in future earnings potential.

Indian Oil

Indian Oil Corporation's results for the forth quarter was another demonstration of how rising crude prices and government policy is wrecking the financials of oil marketing companies.

IOC's profits plunged 52 per cent during the quarter even though sales were higher by 21 per cent. For the full year, the company's profits were down 30 per cent despite sales increasing by 18.39 per cent.

The only saving grace for oil company last year was strong refining margins, which is primarily due to favourable demand-supply dynamics in the region. For the full year, GRMs stood at $6.21 compared to $5.30 in FY04.

However, the government's decision to reduce import tariffs from 7 per cent to 3 per cent led to a drop in GRMs last quarter. GRMs were down to $5.2 from $8.6.

Refining margins are likely to stay at more or less the same levels, as refining capacities are currently operating at relatively high utilisation levels. According to the company's own estimates, refining margin is likely to be sustained at around $5 a barrel in FY06.

Analysts expect the company to increase its throughput following the commissioning of its 6m ton Panipat plant in the third quarter of this fiscal. That should help the company increase its refining contribution.

Despite the financial trouble and the uncertainties, IOC like several other public sector companies maintained its dividend pay-out at 35 per cent (of profit). On a full year profit of Rs 4891 crore, the company paid out Rs 1694 crore as dividend.

Last year, the company had paid Rs 2453 crore out of its Rs 7004 crore profit kitty. Based on the current price, the stock is trading at a dividend yield of three per cent. This is one of the reasons the markets still favours this stock.

HCL Technologies-NEC venture

HCL Technologies has announced another joint venture, this time with NEC Corporation of Japan. The JV will provide offshore led software engineering solutions to NEC, its subsidiaries and their clients. The company has said that it expects revenues of the JV to reach $25 million in three years and between $75 and $100 million in five years.

HCL has adopted the JV model to drive growth on a number of occasions in the past. Giving a client a stake in the JV is an attempt to ensure that business flow from the client is at a rapid pace.

From the client's point of view, there is the opportunity of sharing in the spoils made by the JV, apart from the savings made through outsourcing.

This works as an incentive to provide higher volumes of work, which in turn benefits the vendor. Further, as Deutsche Bank picked up a stake in HCL Tech in lieu of its stake in their JV, there could be other benefits for clients from JVs with vendors.

But not always do JVs work so perfectly. HCL Tech itself had problems in its JV with Perot Systems. The JV agreement ended with Perot buying out HCL Tech's stake for $105.3 million in an all cash deal.

While HCL Tech got a decent bargain in that case, such issues with JV partners cost the company in terms of management time and effort.

Therefore, one would have to wait and see how much HCL Tech will benefit form the new JV. The markets, too, seem to be of the same opinion - the HCL Tech stock ended flat at around the Rs 365 levels on Friday despite the JV announcement.

With contributions from Amriteshwar Mathur, N Mahalakshmi and Mobis Philipose