Reliance Energy: Weak current

Continued purchase of high-cost power from third parties will prove detrimental.

Reliance Energy's performance in the June 2007 quarter was adversely affected by its inability to pass on higher cost of electricity purchased from third parties entirely to its customers, coupled with a rise in cost of materials.

As a result, operating profit (excluding other income) declined a whopping 70.5 per cent y-o-y to Rs 37.59 crore in Q1 FY08, while its total operational income grew 41.5 per cent to Rs 1624 crore. Operating profit margin also declined a staggering 880 basis points y-o-y to 2.3 per cent in the last quarter.

The stock declined 1.4 per cent to Rs 688.75 on Wednesday. The company sold 2.49 billion units in the June 2007 quarter, a growth of 12 per cent y-o-y. Its realisations were estimated at Rs 5.22 per unit in Q1 FY08 as compared to Rs 4.26 per unit a year earlier.

However, the company's purchase of electricity also jumped 16.5 per cent y-o-y to 1.34 billion units in the last quarter, which resulted in its cost of electrical energy purchased jumping 113.9 per cent y-o-y to Rs 671.1 crore in Q1 FY08. Higher unit realisations on a y-o-y basis in the last quarter did not fully offset higher cost of electricity from external sources.

In addition, the company also had to grapple with the cost of materials as a percentage of total operational income rising 135 basis points y-o-y to 18 per cent in the last quarter.

Meanwhile, in the company's EPC and contracts division, its order book was Rs 5,035 crore at the end of Q1 FY07.

Analysts feel operating margins could remain under pressure, if REL continues to purchase large quantities of high-cost third-party power. The stock trades at 19 times estimated FY08 earnings.

Zee Entertainment: Positive signal

Zee Entertainment surprised the market with some splendid numbers for the June 2007 quarter. Better viewership ratings resulted in a strong 47 growth y-o-y in advertising revenues and together with a 27 per cent rise in subscription revenues, Zee's top line grew 35 per cent to Rs 392 crore.

With expenditure in check, operating margin improved by about 750 basis points y-o-y to 30.5 per cent and operating profit grew a smart 81 per cent to Rs 120 crore. The net profit (before minority interest) at Rs 81.3 crore was up a smart 51 per cent y-o-y with help from higher other income.

Its flagship channel, Zee TV, has been seeing a growth in viewership, thanks to improved content. The channel continues to take initiatives to improve programming and in the second half of the year, a second channel also in the entertainment channel but focused on youth, Zee Next, will be launched.

The ongoing price freeze on pay channels, by which the Zee bouquet price was reduced to Rs 42 from Rs 75 earlier, restricted the growth of subscription revenues.

In fact, subscription revenues fell sequentially. However, the regulators should be mandating the use of CAS in more areas and as a consequence, subscription revenues for Zee should get a boost.

While the number of DTH subscribers will continue to grow, there is also competition emerging in the sector with Sun-Astro and Reliance planning to hit the market by the end of the year.

There is little doubt that Zee's programming has improved significantly over the last couple of years, which is why stock has been an outperformer post the restructuring of the firm.

However, the run-up in the price by about 45 per cent in the last six months to Rs 326 currently has been huge. At this price, the stock trades at 40 times estimated FY08 earnings and 31 times FY09 estimates and prices in near-term upsides.

With contributions from Amriteshwar Mathur and Shobhana Subramanian