Indian Equity Markets - Outlook and Stock Recommendation

Equity markets were unsettled during the second quarter as investors faced two challenges: a deflationary crisis in global credit markets and the inflationary thrust of soaring food and energy prices around the world. Neither challenge has been ‘resolved’ and the implications of each are likely to set the tone of financial markets during the second half of the year.

Mounting inflation threatens to complicate an already challenging situation by constraining consumers’ spending power, eroding corporate profit margins and encumbering the operations of the world’s central banks. Pricing pressures should abate as economies slow.

There is every prospect of a period of sluggish economic activity as the end of the ‘cheap money’ era coincides with an escalation in the global prices of energy and food. However, the long suffering investor should persevere. Threats are obvious but, as sentiment in markets deteriorates, changes in economic and financial landscapes are likely to present attractive opportunities for investment.

It is nearing a year we have been asking our investors to book money out from markets and sit on cash (Our Nov'07 article asking investors to book profit from the market: http://profitfromshortterm.blogspot.com/2007/11/what-to-do-this-diwali.html). We are one of the few market analyst who predicted the market fall at the beginning of the credit crisis. Our recommendation portfolio during this period has delivered a positive growth of 2% as compared to a negative 23% return by the sensex. Neyveli Lignite, Orchid Chemicals, Novartis India, Rallis India, TNPL, Chennai Petroleum have been the star portfolio performer beating the sensex return.

Is it a right time to re-enter stock markets?

Further credit market crisis cannot be ruled out and this converging into a full blown recession looks a high probability. Albeit to this with the recent correction seen in Indian markets quiet a good number of stocks looks undervalued. We are advising our investors to sit on partial cash and invest in frontline stocks with a long term outlook. We also have picked five stocks from the small and Mid cap space that has a potential to deliver extra ordinary returns over the course of next 3
years.

Large Cap Picks

1) Mahindra and Mahindra Ltd (CMP Rs. 572/-)
2) Jaiprakash Associates (CMP Rs. 156/-)
3) Indian Oil Corporation -IOC - (CMP Rs. 396/-)
4) Sterlite Industries (CMP Rs. 618/-)
5) HDFC Bank (CMP Rs. 1215/-)

Mid Cap Picks

1) Chennai Petroleum (CMP Rs. 254/-)
2) Ruchi Soya (CMP Rs. 78/-)
3) Shriram Transport (CMP Rs. 335/-)
4) Gujarat Mineral Development Corporation Ltd - GMDC - (CMP Rs. 247/-)
5) Hindustan Construction - HCC - (CMP Rs. 91/-)

Small Cap Picks

1) Abhishek Industries (CMP Rs. 14/-)
2) Tata Metalinks (CMP Rs. 138/-)
3) Novartis India (CMP Rs. 294/-)
4) Deepak Fertilizers (CMP Rs. 91/-)
5) Hitachi Home & Life Solutions (CMP Rs. 110/-)

A Question of Answers - Mail replies

I am holding SAIL at Rs. 230/- and Gujarat Ambuja Cement at Rs. 118/-. Do you see any recovery in short term?

With cooling commodity prices, I would stay away from metal stocks in the current market. Cement inspite of predicted decrease in Infrastructure growth looks positive.
Investors can take fresh long position in sugar stocks with surging sugar prices. Stocks like Sakthi Sugars and Triveni Engineering looks good.
With falling prices of zinc and lead one can look for fresh investments in battery manufactures like Eveready and Amara Raja.

Are you taking any fresh look into your earlier recommended stocks?

Yes. We are positive on Tamil Nadu Newsprint Limited (TNPL), JK Lakshmi Cement, Rallis India and Orchid Chemicals from our earlier recommendation.

With Neyveli Lignite almost available in half the price from it's peak is it advisable to take a fresh position into this stock?

New power additions are not progressing satisfactorily. Also the current quarter results are way below expectation. Will wait and watch for couple of more quarters.

I have brought Alembic at Rs. 42/-. Is it a worth hold for long term?

Seems to me yes. Pharma sector looks to be a good bet in the current market. Alembic looks good with strong presence in domestic market. We are also positive on Orchid Chemicals and Novartis India.

I have huge position in textile stocks like Arvind mills and Alok Industries? Can I book losses or hold it?

I am not sure about Arvind mills. Alok seems to me a good bet from a longer term. I think government control on curbing cotton exports is set to benefit domestic textile firms.

Can I buy Teledata Informatics, Phoenix Mills at current level?

Sorry I am not tracking both of these companies.

KEI Industries - Growing with Economy

KEI is one of the leading cables manufacturers in India offering a comprehensive range of power cables and housing wires. KEI Manufactures variety of cables namely High Tension (HT) and Low tension (LT) power cables, Control and Instrumentation Cables, other specialty cables, rubber insulated power, control & instrumentation cables. KEI cables are used in a wide variety of industrial sectors, including power and transmission, refining and petrochemicals, oil and gas, cement, metals, telecommunication and fertilizer. KEI also manufactures and sell wide range of steel wires, which have various applications such as manufacturing of springs and fastenings.

The firm has four manufacturing plants in New Delhi, Bhiwadi in Rajasthan and Silvassa along with eight marketing offices across India and one marketing office in Dubai.

With huge capex in the power and infrastructure capacity by the end of twelveth planing commission the order book of domestic cables and wires demand is expected to remain strong. Opportunities for the cabling sector are also ripe in Africa, West Asia and the Gulf region which are poised to make significant investments in the power sector.

Expansion Plans

1) The company HT cables upgradation and LT cables expansion at Bhiwadi is in the final phase of construction and is expected to be operational by April 2008.
2) KEI new manufacturing facility at Chaupanki commenced commercial production in January 2008. The HT cable unit of the Chaupanki facility is in the final phase of construction and is expected to be commissioned by May 2008.
3) KEI is in the process of performing feasibility study to manufacture cables of 132 KV and 220 KV from the existing upto 66 KV. The company has also acquired land for the same.
4) KEI expansion in housewire segment is complete to 2,50,000 kms of capacity. The company revenue during the coming year is expected to increase exponentially.

KEI is in the process of massive brand building and visibility exercise to make “KEI” a household name. This along with the enhanced capacity in the house wire segment is expected to Increase KEI topline significantly.

Positives

1) Strong order demand from middle east, Africa and domestic companies.
2) Increased marketing presence in europe and south africa.
3) Strong business demand and low supply risk.

Risks

1) Increase in raw material prices.
2) Higher interest expense due to ongoing capital work in progress to impact the bottomline.
3) Further equity dilution can reduce shareholders return.

At the current market price of Rs. 63/- the stocks trades at less than 12 times it's fully diluted FY08E EPS of 5.6. We expect the commodity prices to cool down during FY09 with a possible US recession. This together with the full expansion in place is expected to fuel in KEI's bottomline and topline growth. Based on it's FY09E the stock trades at less than 7 times it's expected EPS of 10. Investor with medium risk profile can consider investment into this stock with a horizon of 24 months and a target of Rs. 120/-.

Buy Ashok Leyland - Compelling Growth ahead

Ashok Leyland Limited (ALL) is the Second largest commercial vehicle manufacturer in India, Mainly operating in Medium to Heavy Commercial Vehicle (CV) and Bus Segments. ALL currently exports to over 30 countries in Asia, Middle East and Africa.

Sector Outlook

At the beginning of the 11th planing commission period India has registered a GDP growth of close to 9%. The manufacturing sector has been a significant contributor to this growth. The government initiative of developing road infrastructure on par with developed economies translates into significant growth in Commercial Vehicle (CV) space.

The growth going forward in the CV space will also be attributed to exports of CV and the changing domestic dynamics. The domestic bus segment is seeing a change in product modernity. The city buses with low entry height, stepless entry, air suspension and pneumatic doors emphasized safety, comfort and a faster turnaround time is gaining demand. Ashok Leyland strong presence makes it a first few entrant in this modern buses arena.

Overloading restrictions imposed by most of the state governments on heavy vehicles is also expected to spur demand in CV procurement.

Ashok Leyland Outlook

FY08 did not start of in a good note for ALL. The company registered a 7% negative growth in the first 9 months of this fiscal. We expect the CV market to stabilize in the coming year. The upcoming capacity enhancement during the course of next 2 years and the increase in market share of higher margin business (Defence, Engines and Parts) is excepted to be the key driver for ALL. Currently Defence, Exports, Engines and Spare Parts contributes around 18% of revenue.

Capacity Enhancements

1) ALL is enhancing it's vehicle capacity production from the current 84,000 vehicles to 100,000 vehicles by the current financial year.
2) The capacity of Ennore facility is expected to be increased by 50,000 Vehicles by June' 08.
3) The Company has entered into a joint venture with Ras Al Khaimah Investment Authority (RAKIA) in the U.A.E. to put up a plant for building bus bodies in the U.A.E. This is expected to go on stream by March' 2008.
4) ALL Investment in Uttarakhand is expected to be EPS assertive in 2010. The company is setting up a plant to manufacture 70,000 vehicles.
5) The company JV with Nissan to manufacture and sell LCV range of vehicles is expected to be commenced in 2010.
6) ALL Engine volumes is expected to double in 2 yrs. The company has tied up with Chinese sources for procurement of 25 hp to 75 hp engines.

Acquisitions Progress

The acquisition of AVIA truck unit a czech company is expected to provide the Company with an entry into the East European and Mediterranean markets and will also offer benefit of synergy with the Company’s product development efforts, especially in respect of a modern cabin for the medium vehicles. The acquisition is already EPS assertive.

The Company has signed a Share Purchase Agreement to acquire the entire equity capital of Defiance Testing and Engineering Services, Inc, Michigan, USA. This Company is engaged in the business of providing testing services to automobile OE manufacturers in northern USA. This acquisition is expected to provide significant synergy to the existing business activities of Ashley Design and Engineering Services Division of Ashok Leyland. It will also help ADES to provide greater value-added services to various customers in the USA.

Valuation

At the current market price of Rs. 34/- the stock trades at around 11 times it FY08E EPS of 3.10. Investor with low to medium risk profile can consider investment into this stock with a horizon of 18 to 24 months. The company investment phase is in the verge of partial completion and the investment hereon is expected to get translated in revenues. We recommend a buy rating in this stock with a target of Rs. 68/- based on our FY10E EPS of 4.25.

Risks

1) Slow down in market demand.
2) Continuing increase in input costs.
3) High domestic Interest rates.
4) Margins under squeeze. The Company is pursuing plans to increase the market share of high margin business like exports, non-auto engines and sale to Defence sector to mitigate the impact of margin pressure.