The sub-prime issue is now causing a global sell-off as investors continue to dump risky assets amid growing fears about a global credit squeeze--the injection of liquidity by Central Banks, notwithstanding. Man Financial in its latest report says that the Yen has now strengthened to ¥ 115.26/ US$ 1 and could strengthen significantly further due to the vicious cycle as more carry trades get unwound on fears of Yen strengthening.

The recent Indo-US Nuclear deal has widened the rifts between the ruling UPA Govt and the Leftists. This could also lead to political uncertainty during which investor sentiment could be impacted.

Our Sensex EPS for FY08E is Rs 844 (+16.5%) and Rs 1,004 for FY09E (+19%). Earnings growth of the Sensex is expected to slow down from 32.6% in FY07E to 16.5% in FY08E and rise modestly to 19% in FY09E. Even the 19% growth in FY09 has a downside risk due to the lag impact of high interest rates and rupee appreciation. We believe that the 10-year bond yield of 8.0% to 8.2% could mark the peaking out of the current interest rate cycle. In such a scenario, the Sensex range works out between 12,250 to 15,959, which corresponds to a PER of 12.2X FY09E, the report states.

Carborundum Universal (CUMI) is primarily involved in the business of Abrasives and Refractories. CUMI is one of the most integrated manufacturers, with completely backward integrated manufacturing facility right from raw material stage. Increasing demand, focus on exports, new business initiatives and acquisitions is likely to help CUMI increase its sales at CAGR of 32% and Profit at 31% over FY07-FY09E. We initiate coverage on stock with BUY rating.

Investment rational

Upswing in capex cycle to fuel demand for next two years

India is witnessing huge capital outlay on back of continuous rise in GDP growth. The domestic industry has been investing in building up the capacities, which is likely to continue over next two years. This coupled with unviable manufacturing operation in developed countries would propel outsourcing by multinational companies. Principal user industries of abrasives and industrial ceramics like auto, power, coal and cement are likely to see investments worth of USD 263bn over next 3-5 years.

Increasing thrust on exports

CUMI currently derives 78% of revenue from domestic market and 22% from exports. Going ahead, CUMI plans to increase revenues from export to 60%.

Capacity expansion to help meet demand

CUMI plans to invest Rs1.2-1.3bn in expanding capacity of various products like Met Cylinder Project, Super Refractories, Industrial Ceramics, new bonded abrasives plant in Uttarakhand. CUMI has also invested in Chinese JV (capacity of 3000tons bonded abrasives), production is likely to start in Q3FY08, full effect of it would be visible in FY09.

Hidden gems - New business, VAW & non-core assets

CUMI has envisaged an ambitious plan of being US$1bn company in next 3-5 year. To achieve this CUMI has ventured in new businesses like power tools, solar grade silicon carbide powder and bioceramics. Recently, it announced acquisition of 96% stake in VAW (Russia) making it second largest silicon carbide manufacturers. Non-core assets would be used to fund these plans.

Valuations

We expect growth in revenues of 30% and 33% in FY08E and FY09E and net profit to grow by 16% in FY08E and 41% in FY09E (excluding recent Russian acquisition). RoCE is likely to show improvement from 27.8% in FY07E to 35.7% in FY09E. At current market price, the stock discounts FY08E EPS of Rs5.0 by 17.9x and FY09E EPS of Rs13.8 by 12.3x. A key reason behind dull performance in FY08 is company being in investment phase, the enhanced capacities are likely to increase earning power of the company post FY08.Thus, we recommend a BUY on the stock with price target of Rs 233 at which it would discount one year forward average earning (FY08 & FY09) of Rs 11.6 by 20x.

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