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>> Sunday, March 8, 2009

Lupin: Healthy growth

Investors with a long-term perspective can consider accumulating the Lupin stock, now trading at Rs 590. Steady growth in revenues over the years combined with strong presence in key target markets such as the US, the EU and Japan, besides a healthy pipeline in drug filings, underscore our recommendation. At the current market price, the stock is valued at about 11 times its likely FY-09 per share earnings, at a discount to its peers. Consistent historic growth rates also lend confidence.

In the last three years, Lupin has (on a consolidated basis) managed to grow its revenues and earnings at a compounded growth rate of over 29 per cent and 65 per cent respectively. Driven by the renewed focus on generics in markets such as the US and Japan (where it marked its presence through the acquisition of Kyowa), the company is likely to deliver steady growth in future too. That among the Indian generic companies operating in the US, Lupin enjoys the largest share of prescription sales and has the highest per product sales validates our view. That said, its presence in the domestic formulation business too inspires confidence.

However, in the light of the recent credit turmoil, the company’s API business has started showing some early signs of a slowdown. That, however, may not hamper its growth prospects significantly, as the incremental growth in future would rely more on its formulation business, primarily in the US and Japan.

In terms of risk, however, investors may need to closely monitor the developments on the USFDA front. Last November, the FDA had issued Lupin an inspection report (483) listing 15 inspectional observations. The management, however, has since then responded to the FDA on the concerns that were raised. While this certainly is not as grave as the FDA issue pertaining to Ranbaxy, developments on this front nonetheless will require close monitoring. The closure of the issue, hence, would be the key catalyst to the stock’s movement.

Tata Chem: Good yields

The global de-rating of commodity stocks and worries about weakening demand and prices for soda ash have contributed to a sharp fall in the Tata Chemicals stock to Rs 104 levels. However, at its trailing P-E of four times, the stock’s valuation appears to factor in most of the risks to earnings, while ignoring the investment positives.

Though Tata Chemicals’ global soda ash business does face the prospect of both a volume and a price decline from the levels managed in the first nine months, this is likely to be offset partly by higher sales (driven by volumes) in the fertiliser business and continued gains in the salt business.

The company’s soda ash operations are much less vulnerable to global recession than other commodities as they cater mainly to user industries such as detergents and container glass, which face little demand destruction even in a slowdown.

Flat glass, which accounts for about 20 per cent of the global soda ash offtake, is the only user sector facing the prospect of lower offtake now. This segment too may receive a boost if the Chinese stimulus plan really does pep up construction and infrastructure activity in the Asian region.

On the pricing front, Tata Chemicals’ diversified geographic presence has helped; with soda ash contracts in the US and Europe already locked in at higher prices, though contracts in Asia face price erosion.

Even if the soda ash business does see shrinkage in earnings over the new few quarters, the fertiliser business (60 per cent of revenues) appears set to ramp up its earnings performance. The completion (on March 3) of the de-bottlenecking project at Babrala increases the company’s urea capacities from 8.64 lakh to 11.55 lakh tonnes per annum and will bring in realisations linked to import parity prices. Improved gas availability from the Reliance project is also set to improve the margin profile of the urea business.

While phosphatic fertilisers may make a lower revenue contribution on the back of lower output or realisations, input cost pressures in this segment have eased significantly.

Though it too has sewn up several global acquisitions, Tata Chemicals is better placed than its peers in the group in terms of net debt:equity (now at 1:1), borrowing costs (averaging just 6.2 per cent of the outstanding debt) and operating cash flows (both the fertilizer and salt businesses are cash cows).

With the urea expansion already completed and other capex deferred, future cash flows can be deployed to draw down debt on the balance-sheet. The attractive dividend yield of 8.6 per cent on the stock (last year’s dividend was at Rs.9 per share, with a low payout ratio) at current market prices, also curtails downside risks.

BHEL: Powered-up

Investors can accumulate the stock of BHEL, given its consistently strong order inflows, timely capacity expansion measures to meet the increased opportunities and negligible funding issues, despite the tough environment. At the current price of Rs 1,311, the stock trades at about 15 times its expected earnings for FY10.

The market has traditionally awarded a premium to the stock as a result of its highly visible and sustainable growth prospects. Buy the stock on declines linked to broad markets to average costs.

An order backlog of Rs 1,13,600 crore, as of end-2008, speaks of the revenue potential for BHEL over the next two years, though power cuts, component shortage and delays in certain clearances led to lower revenues in the December quarter.

We believe that these issues are inevitable for a company of this size, give the customised component requirement and its dealings mostly with other government organisations such as the State electricity boards.

Operating profit margins too declined to the less than 17 per cent mark on account of higher raw material cost and employee expenses. These two parameters could see some improvement in the coming quarters.

The competitive threat from BHEL’s Chinese counterparts have receded to some extent, given the spate of quality issues raised over the past year regarding Chinese equipment. The appreciating dollar has also helped narrow the pricing gap between the local and Chinese equipment.