AIA Engineering: Buy

Investors with a long-term perspective can consider taking exposures in the stock of AIA Engineering (AIAEL), a manufacturer of impact, abrasion and corrosion-resistant high chrome parts. At current market price, the stock trades at about 23 times the expected per share earnings in FY2008. On the back of an estimated global market of Rs 12,500-crore for mill internals used in mining and cement sectors (growing at about 4-5 per cent per annum) we believe, AIAEL, the second largest player in the product category in the world, is well placed to capitalise on this increasing demand. This apart, the threefold expansion in capacities, and a strong clientele with the likes of Holcim, Lafarge and Cemex also lend more confidence to the company's business prospects.

AIAEL's decision to expand focus on global mining and utilities holds immense potential; given that currently only about 10-15 per cent of the mill internals in the mining industry are hi-chrome. However, the demand for these hi-chrome products is likely to be driven by substitution of conventional products. For the quarter ended December 2006, cement, utilities and mining contributed about 52 per cent, 34 per cent and 14 per cent respectively of the company's domestic revenues. However, in the overseas market, the entire revenues were contributed by the cement sector. Revenue contribution from the cement sector on the domestic front is likely to sustain given that cement companies, despite the price control imposed by the government, have not scaled down their expansion plans. In addition to this, since the cost of consumables as a percentage of cement production costs is only about 1.5 per cent, it is unlikely to affect the margins of AIAEL.

Since more than 70 per cent of the company's total revenues come from replacements, there is a low possibility of any significant drop in demand during a downturn in the capital spending cycle. Furthermore, the proposed backward integration (either by acquisitions or setting up a new plant) for sourcing Ferro chrome and the setting up of a captive power plant, could lead to improved operating margins. However, delay in expansion plans, lower than expected capacity utilisation and a sharp rise in raw material cost remain the principal risks to our recommendation.

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Monsanto: Buy

Investors with a long investment horizon can consider exposure to the Monsanto India stock at the current price levels of about Rs 1,400. Though the company's recent financial performance has been unimpressive, long-term prospects for the domestic seeds business, on which the company is now refocusing, are bright. Given that the business is research-driven and technology intensive, entry barriers to the business are high, translating into good growth prospects for entrenched players such as Monsanto India.

The recent listing of Advanta India, which has a global presence in the seeds business, is also likely to lend greater visibility to this business, on the bourses. The growth prospects for the conventional herbicide business, though modest in the near-term, also appear stable for players such as Monsanto, given the robust product pipeline and the focus on premium, less price-sensitive segments of the market. The Monsanto stock trades at about 14 times its trailing 12-month earnings per share.

Seeds business

Though crop protection, with a focus on herbicides, has traditionally been the key revenue driver for Monsanto India, the company has been increasing its focus on the hybrid seeds business over the past couple of years. The seeds business accounted for 53 per cent of Monsanto's sales in 2005-06, up from 21 per cent five years ago, while the contribution of the herbicides business fell from 65 per cent to 31 per cent. The increasing shortfall of key food and commercial crops, the rising pressure to step up farm productivity (Indian yields of most crops are far below global averages) and the economics of adopting high-yielding seed varieties for the farmer are the demand drivers for high-yielding seeds.

However, plant breeding (developing new seed varieties) is a specialised business that involves a fairly long gestation period and calls for considerable research strengths and access to proprietary germplasm. In this respect, the backing of Monsanto India's parent — Monsanto US, a global leader in the seeds and traits business, and the latter's strong product pipeline — is a strong positive for Monsanto India. Monsanto India currently markets seeds in India under the Dekalb brand name (a global brand) and focusses mainly on maize (corn).

The demand growth

The demand for maize in the Indian market has consistently raced ahead of available supplies. Going forward, the demand growth for corn is likely to be strong on the back of expansion in the organised poultry industry and the growth in corn-based snack foods and starch-based industries. Though adoption of hybrid maize seeds has sharply increased sharply in the Southern States, considerable potential for hybridisation exists in the Northern states, where about 70 per cent of the maize acreage is still under conventional varieties.

In the herbicides business, Monsanto has traditionally focussed on branded specialty products through well-recognised brands such as Leader, Roundup, Machete and Fastmix. However, price competition in this business is high, with several domestic players emerging as low-cost manufacturers of agrochemical formulations. Since the profitability of new products tends to wane quickly after the initial years, success in this business depends on a robust product pipeline and a steady stream of launches, apart from the company's brand equity.

Though Monsanto is well-placed on this front on account of its global product pipeline and focus on commercial crops and food grains, it is not immune to price competition. This appears to be the key reason for the company's recent sale of its Leader herbicide business to Sumitomo and its increasing focus on the seeds business.

These rationalisation efforts also explain the company's unimpressive financial performance in recent quarters, after a steady pace of earnings growth in earlier years.

However, only investors willing to wait for two-three years should invest in the Monsanto India stock now.

The final quarter of the financial year is usually a poor one for agrochemical companies such as Monsanto India, given the seasonality of the business. Moreover, though long-term prospects for its businesses are bright, the company's near-term financial performance could be modest on account of the ongoing shift in business focus and the restructuring efforts.

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Tanla Solutions: Hold

Investors with a high risk appetite may retain their exposure in the Tanla Solutions stock. At the current market price, the stock trades at a price earnings multiple of 20 times its 2006-07 per share earnings.

Our `Hold' recommendation on the stock is predicated on the fact that the company was only recently listed with a relatively short earnings history and its concentrated exposure to the non-voice mobile segment.

We had recommended investors to subscribe to the initial public offering made by Tanla Solutions in the price band of Rs 230-265 per share in mid-December and remain sanguine about its prospects. This is also evident from the strong financial performance of Tanla for the latest quarter and the year ended March 31, 2007. Investors can use any weakness in the broad markets to step up exposure in small lots.

The company's core strength lies in catering to a cross-section of the mobile messaging market, which has robust growth potential.

The company aims to capitalise on the multi-year growth potential of the non-voice mobile market that is broadly segmented into short messaging service (SMS) and multimedia messaging services.

Tanla offers telecom-signalling products to mobile operators; aggregation services (by acting as a single point interface between content developers and mobile network operators) and offshore services in the area of application hosting and infrastructure management. Its blue-chip clients include leading mobile operators in the UK such as 3G, Vodafone and Virgin Mobile.

Several research outfits have projected that messaging services will be a crucial experimental ground for mobile companies and Tanla's principal growth engine over the next few years. At the same time, the company has also indicated that it is conducting research in the area of telemetry and telematics. The company is likely to start marketing some of these technologies and products in the coming years.

The key risks, as we had spelt out in the IPO analysis, stem from high client concentration, slowdown in growth of 3G services if the price points for service prove to be too high, penetrating the new growth markets such as the US, and margin pressures arising from stiff competition in the aggregation services market in UK.

Of the Rs 420 crore raised through the IPO, the company has set aside a chunk for general corporate purposes, which include acquisitions that will provide it the beachhead in the US/Asia-Pacific markets.

Identifying the right acquisition target/s and integrating the acquisition with its offshore centre in India can prove a risky proposition.

Financial pep

In the latest quarter ended March 31, 2007, the company recorded consolidated revenues of Rs 78 crore and post-tax earnings of Rs 34 crore. On a sequential basis, the former have grown 37 per cent and the latter 47 per cent.

In the latest quarter, the operating profit margin dipped to 46.4 per cent from 52.2 per cent on a sequential basis. For the full year 2006-07, the operating profit margin was 49.8 per cent, down from 55.7 per cent.

Since the margin continues to be robust, there is no near-term concern, but over the next year maintaining the operating margin broadly in the 40 per cent range holds the key to sustaining post-tax earnings growth.

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Voltas: Buy

A well-diversified and relatively unique business in the engineering sector distinguishes Voltas from other listed companies. A strong position in the electro-mechanical products business, attractive margins from the engineering and agency segment and expected turnaround in the unitary cooling products division augur well for Voltas' earnings growth.

With a sound footing in West Asia, the company is well-poised to capitalise on the construction boom and the resultant cooling systems demand in the region. Voltas appears to be a good investment option in the engineering segment from a three-year perspective. At the current market price, the stock trades at about 18 times its likely earnings for FY-08, based on an expected 30 per cent annual growth in earnings from FY06-08. The marginal premium vis-à-vis other players appears justified, given the diversified nature of the business and the few listed players.

Business

Voltas is an air-conditioning and engineering solutions provider. While the company's primary business is providing comfort air-conditioning requirements for homes and offices, malls, airports homes and multiplexes, it also operates in areas which require monitoring of temperature, humidity, or treatment of air. The users in this segment include steel and power plants, petrochemicals facilities and laboratories. The company is also into manufacturing of material handling equipment and provides agency services for selling textile machines and construction and mining equipment. This diversification should provide cushion for the company against any slowdown in any one segment.

Electro-mechanical segment, the driver

The Indian heating ventilation and air-conditioning (HVAC) market is dominated by Voltas, Blue Star and Carrier. The demand for office space, largely driven by the IT and IT-enabled service companies, has led to huge potential for the HVAC players. With few organised players in this sector, the above-mentioned companies should, among them, share the business opportunities. This apart, the increasing number of malls and multiplexes and the upcoming Special Economic Zones offer much scope for the HVAC business. Voltas has already executed projects in these segments. While Voltas appears evenly poised with competitors in making gains from the above-mentioned prospects, the company has an edge in the following areas of its business:

International strength: In the overseas market, Voltas is better known as a mechanical, electrical and public works contractor, including HVAC services. Of the total current order-book of Rs 2,400 crore, about Rs 1,300 crore is derived from international markets. Among its overseas markets, Voltas can be expected to benefit from the construction boom in West Asia. This region accounted for 27 per cent of the company's FY-06 revenues. The company's ability to compete with top players in the region such as the Emirates Trading Company has enabled it to become a sub-contractor for Bechtel.

Potential in airports: Voltas won projects of the value of Rs 160 crore in electro mechanical projects for the Hyderabad airport and appears keen to participate in the bidding for Mumbai and Delhi airports as well. With the upgradation and modernisation of airports in India gathering pace, Voltas may see increased bidding opportunities in this area. The company's earlier airport projects such as the Bahrain International airport and the new airport in Hong Kong, are likely to serve as reference points and give it the edge.

Key role in the retail story: India's success in the retail space may well depend on the availability of cold storage and warehousing solutions. Since a chunk of the investments in this area is in fresh food, this would require support in terms of cold chains, refrigerated transport and industrial refrigeration. Voltas, which is already an established player in this field, has further strengthened its position through a tie-up with Netherlands-based Besseling Group. The latter is a turnkey solutions provider for storage of horticulture. Voltas has secured an order from Adani Agri-Fresh for refrigeration systems. We expect Voltas to benefit from this segment, which may also offer slightly better margins than regular HVAC projects.

Improvements in other divisions

The engineering agency division of Voltas has over the last three quarters shown a propensity to make an increasing contribution to revenues. For the quarter ended December, 20 per cent of the revenue came from this division. Increased demand for construction and mining equipment and in-house manufactured forklifts are likely to drive revenues.

We view this as a positive, as the operating margins from this division are far superior to the 6-7 per cent OPM in the electro-mechanical segment. The company's unitary division, which consisted of room air-conditioners and refrigerators, was a drag on the company's margins.

Now, with the shutting down of this unit in Hyderabad and its relocation in tax-friendly Uttaranchal and the closing of the unprofitable refrigeration section, may see some improvement in margins. The company, among the top players in the room air-conditioning systems, has seen a 30 per cent growth over FY-07 in this area. We expect the increasing purchasing power of consumers to create robust demand for the product.

Voltas is a low-debt company with large cash coffers. Any growth through the inorganic route could be earnings accretive without much equity expansion. Further, any plan for liquidating real estate, after it shut down the Hyderabad unit, may unlock further value. We have not factored these positives in our valuation.

Risks: The OPM of Voltas, which is at less than 6 per cent, may take a hit if there is a hike in the price of raw material such as copper and aluminium, given that a number of its international contracts operate on a fixed price basis.

The company faces stiff competition in the room air-conditioning segment from Chinese products and the unorganised market. This may cause pressure in pricing and, consequently, margins. Any political unrest in West Asia or slowdown in construction in the region would affect revenue flow for Voltas.