HSBC Research overweight on RPL; target Rs 144

HSBC Research has upgraded their rating on Reliance Petroleum to overweight on higher margin forecasts and with a target price of Rs 144.

HSBC Research report on Reliance Petroleum:

Upgrade to Overweight on higher margin forecasts

Refining margins upgraded

In our report published 22 June 2007, Asian Oils: Swimming against the tide, we upgraded our regional refining margin forecasts to USD 9/bbl for FY08e, USD 9.3/bbl for FY09e, USD 7.5/bbl for FY10e and USD 6.5/bbl long term. We believe that strong global demand and limited supply would extend the plateau of the current refining cycle peak further. Asian refining margins would be driven up by supply tightness in global light oil product, which has triggered arbitrage trades from low margin Asia to the high margin US. Greater global product trade will drive Asian margins upward, closing these arbitrage windows. We have consequently revised our refining margins forecast for RPL with a long term refining margins forecast of USD 11/bbl for the under-construction refinery. We continue to believe that RPL is the best play on expected continued robustness in refining margins. RPL’s under-construction refinery would have high complexity and a superior product slate, which would enable it to produce higher margins on lighter and medium distillates conforming to evolving stringent specifications of its target export markets.

Impact on earnings and DCF estimate – highly positive

In our report Asian Oils: Swimming against the tide, we revised our FY09-10e earnings estimates for RPL by 19-74% on the back of the upgraded refining margin assumptions. We also raised our DCF-based target price for RPL to Rs 144 per share from Rs 87 per share earlier. We have assumed that the refinery would commence its operations ahead of the scheduled start-up date of December 2008 with a 50% capacity utilisation in FY09e. Our target price would be Rs 127 assuming the original completion date of December 2008 (10% capacity utilisation in FY09e). Our valuation based on a composite PE-PB valuation for RIL is about Rs 121 per share. We rate RPL shares Overweight.

Refining margins to remain robust

HSBC has raised its forecasts for Asia refining margins for 2007f (FY08) and 2008f (FY09) by 8% and 9%, respectively. The long-term normalised refining margin assumption is raised 18% from USD 5.5/bbl to USD 6.5/bbl – 30% higher than the consensus. Contrary to consensus, we believe that the global refining industry will continue to see net incremental demand (i.e. incremental demand > incremental supply). Between 2006 and 2009, the demand CAGR estimates by the International Energy Agency (IEA) and HSBC are both 1.9%, which is higher than the market estimate of supply CAGR of 1.4%. Thus, our story of a global refining upcycle remains intact with margins to stay higher for longer in the next few years. In our view, there are three key reasons for maintaining our bullish views on the refining sector: i) robust Chinese demand, ii) stronger than expected US demand, and iii) global supply tightness.

RPL highly leveraged to refining margins

We have consequently upgraded our refining margin forecast for RPL, raising our refining margin forecast to USD 11-15 for FY09-11e with a long-term margin assumption of USD 11/bbl. We continue to believe that RPL is the best play on refining margins with its superior product slate and complexity. This should enable it to produce higher-margin lighter and medium distillates which would conform to stringent fuel specifications in its targeted export markets. RPL is in the process of constructing a 580kbpd refinery near the existing 660kbpd refinery of its parent Reliance Industries (RIL) at Jamnagar. The new refinery is designed to have a lower throughput capacity than RIL’s, but is expected to process heavier crude oil; its complexity will be about 14 on the Nelson index compared to 11.3 at the current refinery.

Valuation

DCF analysis

We have raised our DCF-based target price for RPL from Rs 87 to Rs 144. Our DCF is based on a weighted average cost of capital of 10.6% using a:

* Risk free rate of 8%
* Equity risk premium of 5.5%
* Beta of 1.2x
* Cost of debt of 9%

We have used a 10 year explicit forecast period and a terminal growth rate of 3%. The target price would be Rs127 if the new refinery were to start operations in December 2008, implying capacity utilisation of 10% in FY09e. Our sensitivity analysis shows that the DCF-based valuation for RPL’s refinery would be Rs 123 even if it starts production in FY10e. Our DCF-based target price is sensitive to our long-term refining margin assumption. A USD 1/bbl decrease in our long term-refining margin assumption could lower our target price by Rs 18 per share to Rs 126 per share. We have upgraded our regional refining margin forecasts to USD 9/bbl (FY08), USD 9.3/bbl (FY09) & USD 6.5/bbl long term.RPL with its high complexity and superior product slate could gain the most from expected robustness in margins.We have raised our target price to Rs 144 per share (Rs 87 per share earlier) and upgraded RPL to Overweight.



Buy ITC; target of Rs 176: IDBI Capital

ITC (ITC), the largest cigarette company has diversified into multiple businesses over the years. It holds a dominant position in hotels, paper and paperboards and agri-trading business. It has been successful in rapidly increasing its market share in packaged foods, retailing, and other FMCG products. Over the last three years its revenue has exhibited CAGR of 24% driven by non cigarette business.

The short term pressure on the cigarette business, has dampened the stock performance in recent times. We believe, with the long term strong core business growth, this is the opportunity for investors to enter in the stock. Our SOTP value for ITC is Rs.176/share. At current price, ITC is trading at a P/E of 19.8x on FY08E and 18.1x on FY09E earnings. We recommend ‘Buy’ with 1-year price target of Rs 176 (15% upside).

Investment highlights:

Near monopoly in cigarette market

ITC’s well established brands in cigarette market with 73% share, have created a near monopoly position for the company. With advertising ban on cigarettes and wide distribution network, there is no potential threat to ITC as rest of the players have fragmented market share. ITC is best positioned to benefit by the attractive Indian market where ~85% of the tobacco is consumed through bidis and other products.

Market has over perceived VAT impact

We believe ITC’s stock performance over the last few months was affected more than warranted by negative news flow on the VAT front. The implementation of 12.5% VAT on cigarette will impact volumes negatively following the price hikes by the company. However, we believe that negative impact will not be as substantial as seen in 2002 wherein volumes declined by 9% due to a 15% hike in duties. With rising income levels market is well positioned to absorb the price hikes as against in 2002.

Well positioned in non-cigarette businesses

Transitioning from the tobacco to consumer company, ITC is well positioned to grow across the segments with its growing food portfolio, dominant position in hotels and paper business and, strong rural network. The cyclical businesses are on an upturn and are expected to continue the momentum in medium term. The non cigarette businesses have grown at a CAGR of 41% over the last 2-years. The company is set to benefit from growth in rural as well as urban economy.

Strong balance sheet to facilitate future investments

The steady stream of ~Rs.25,000m cash flow generated from cigarette and paper business have facilitated building new businesses. Company’s strong balance sheet can combat any short term pressures on businesses. The company is continuously ramping up its operations in non cigarette portfolio to capitalize on the growth of respective sectors. It has plans to invest Rs.150,000m to scale up its existing operations.



Hotel Leela Ventures will continue to underperform: CLSA

Hotel Leela Venture's net profit at Rs 1.26 billion for FY07 came in 6% below CLSA forecasts. The stock is trading at 15.2xFY08CL on a fully diluted basis, which is at a discount of 20% to Indian Hotels. With estimated gross gearing of over 200% (including outstanding FCCBs of USD 170million) and major capex plans ahead, research firm expects that the stock will continue to underperform.

Hotel Leela’s revenues grew by a disappointing 16.5% during FY07. Ebitda margin declined by 70bps as inspite of increase in tariffs other expenses increased with increase in advertisement and marketing budgets. However, net profit grew by 72.5% on the back of higher other income from sale of Business Park in Mumbai and non cash interest income on the deposits with Hudco. With no major additions to room inventory before FY10, we expect Leela’s growth to lag its peer group. Further with Bangalore accounting for an estimated 45% of its room revenues, the impact of any correction in tariffs in Bangalore is the highest for Leela.

FY07 results disappoint.

Hotel Leela’s revenue growth at 16.5% during FY07 was subdued to ongoing refurbishment in Mumbai and decline in occupancy in Bangalore by 5%. Leela’s net profits at Rs 1.26 billion for FY07 came in 6% below our forecasts. Ebitda margins declined by 70bps during FY07, a year when there have been strong tariff increases, primarily due to increase in other expenses. According to the management, the other expenses increased due to higher marketing and advertisement budget. Higher other income from sale of the business park in Mumbai to HDFC and interest income on dues from Hudco helped Leela report a net profit growth of 72.5%. 4QFY07 performance was surprisingly poor with Ebitda margins declining by over 10%.

Downgrading forecasts for FY08 by 12.3%

We forecast revenues to grow at 41% in FY08 on the back of commissioning of 103 new rooms in Bangalore and the completion of refurbishment in its Mumbai property. But with occupancies declining in some major cities like Bangalore and Hyderabad, Leela is among the most vulnerable with an estimated 45% of its room revenues being derived from Bangalore. Further all its new properties will come into the market in FY10, including the Gurgaon hotel which we had earlier assumed to be in operation from FY08. Based on the above we are downgrading our forecasts for FY08 and FY09 by 12.3% and 6% respectively.

Valuations reasonable, but…

Hotel Leela is trading at 15.2xFY08CL on a fully diluted basis, which is at a discount of 20% to Indian Hotels. With estimated gross gearing of over 200% (including outstanding FCCBs of USD 170million) and major capex plans ahead, we expect that the stock will continue to underperform. Further at near peak of the cycle, Leela has purchased 3 acres of land in the heart of Delhi for Rs 6.1billion, where according to the management, payback period is about 10 to 12 years.



Indian Hotels FY07 profits in line with CLSA estimates

Indian Hotels' FY07 consolidated profits is in line with CLSA estimates. Given the company’s diversified portfolio across the country and increasingly internationally, Indian Hotels is research firm's top pick in the sector.

CLSA report on Indian Hotels:

Indian Hotels consolidated profits grew by 49% in FY07, in line with our estimates. Future growth will be driven by the group’s plans to add 6,500 rooms over the next three years to its existing inventory of 9,900 rooms. We believe that pricing power will remain with the industry for the next 12months and have upgraded our earnings estimates for FY08 and FY09 by 3% and 6% respectively. Given the company’s diversified portfolio across the country and increasingly internationally, Indian Hotels is our top pick in the sector.

Strong performance: Reflects underlying strength in the sector

42% YoY growth in standalone revenues and 75% growth in profits during 4QFY07 were ahead of expectations. During 4QFY07, occupancies remained high at 83% (+400bps YoY) and ARRs increased by 12% YoY. Other income increased by 163% due to one-off profits from sale of investments. Rise in interest cost is primarily due to merger of the asset management company that owned Taj Lands End, resulting in higher interest costs and decline in licence fees (-15% YoY).

Consolidated results impacted by overseas acquisitions

While standalone profits for FY07 increased by 75%, consolidated profit grew by 49%, even as St James Court continued to be profitable. We believe that the key factors are the higher costs (marketing and renovation/ refurbishment) and lower profitability of international properties which now contribute 1/3rd of total revenues. With the acquisition of Campton Place in San Francisco, the company has fully utilised its FCCB proceeds and future acquisitions will be debt funded. At 77% consolidated gearing as on Mar-07, it has room to raise debt funds.

The international foray: Why?

The company has focussed on international growth even as domestic growth has been very strong. International growth is part of the bigger strategy to have a well diversified portfolio and follow its core customer group to key markets. As international chains grow their businesses in India, Indian Hotels believes that to maintain its market share among the foreign travellers it will also have to go to the home markets of the international chains.

Balance sheet to support capex plans

Of the 6,500 rooms planned to be added over the next 3 years, 1,200 will be under Indian Hotels, 2,000 will be under Ginger hotels and 400 will be in overseas properties. The group will invest nearly Rs8bn over the next two years towards capex and balance sheet will support the growth. Indian Hotels remains our top pick given its diversified geographical spread, increased management contracts and steady ramp up of the chain of budget hotels. Major risk is that key cities like Bangalore and Delhi may see pressure on tariffs in late 2008/ 2009. Encouragingly while in the last one year occupancies have declined in some cities, most notably Hyderabad where supply increased, high tariffs have sustained.



JP Morgan underweight on Titan Industries; target Rs 1125

Research firm JP Morgan is bearish on Titan Industries and given underweight rating on the stock with target price of Rs 1125, implying 3% downside from the current price.

Initiate with UW:

We initiate coverage on Titan Industries (Titan) with an Underweight rating and a March 2008 price target (PT) of Rs 1,125, implying 3% downside from the current price.

Niche player with attractive return on capital:

Titan is among the few specialty retail plays in the country with significant brand equity in watches and jewelry. Unlike multi-format retailers, its additional capital requirements for expansion are low, and it earns an attractive return of more than 50% on its core watch and jewelry business.

Share price drivers:

Our earnings growth estimate is about 10% below the company’s growth target of 40%, which, in our view, could be constrained by: (1) rising competitive challenges in jewelry and watches; (2) margin pressures from stagnating gold prices and rising operational costs; and (3) currency and interest rate dynamics, which could have an impact on exports and discretionary demand in the domestic market.

Investment positives

Organized jewelry growth potential is large

Organized jewelry retailing forms a miniscule 3% of the overall jewelry sales in India, a sector dominated by traditional local jewelers. Given the high growth seen by modern retail across almost all categories and services over the past 3-4 years, this segment is bound to benefit from the retail boom. Although gold continues to dominate jewelry sales, diamond jewelry is likely to form a major proportion of incremental growth for this sector. Being the frontrunner in the still-nascent organized jewelry segment, Tanishq benefits immensely from its strong brand leadership and a wide distribution network across the country. Tanishq scores over local players in terms of strong brand equity (product from Tata group), high quality assurance and wide product designs. Titan is implementing a two-pronged strategy to capture the immense potential of branded jewelry segment, which is growing at 20-25% p.a. Moreover, while the company is striving to increase the share of diamond jewelry in overall sales (via Tanishq brand), it is also targeting the mass segment through its Goldplus stores. From 10 stores currently, the company intends to add another 20 Goldplus stores by FY08. These stores would largely offer 22-carat gold products and target consumers in tier-2 and tier-3 cities. Wide product variety along with gold purity would be key differentiators with regard to local jewelers in these markets. We believe this would be a significant growth driver in the long term and could account for as much as 15% of total jewelry sales by FY09. We forecast total jewelry sales to grow at a CAGR of 22.5% over FY07-10E with sales under the Tanishq brand growing at 20%.

Watch segment continues to be the cash cow

Although the contribution of watches to overall sales is seeing a downtrend, it remains an important contributor to overall earnings, given the higher margins it enjoys. Titan is determined to grow this core category by constantly innovating and launching new styles and technology watches. The company is focusing on increasing the share in premium-end watches while enhancing volume growth by capturing the lower-end through its Sonata brand. We estimate that the penetration level of branded watches is 50% at present, and the company is targeting the mass, unorganized segment with new product launches at lower price points under the Sonata range. We estimate volume growth for Sonata watches to be 10-15% over the next 2-3 years, contributing about 34% to overall watch sales by FY10. Also, the company is investing significantly in mid-to-upperrange watches to benefit from the increasing pattern of multiple ownership in this segment. Although we expect volume growth to be in the range of 6-7% for this category, better product mix is likely to be the key revenue driver going forward. We estimate sales for Titan and other premium watches to grow by 12-14% in the next 2- 3 years. We forecast overall sales for watches to grow at a CAGR of 14% during FY07-10E.

Eyewear and precision engineering: New growth drivers

Titan is investing significantly in new areas such as precision engineering and eyewear retailing. Growth prospects in both these businesses look exciting. The contribution of new businesses such as precision engineering and eyewear to the company’s revenue is quite small, 3% at present, which we believe would more than double to 8% by FY10. Titan is steadily expanding its precision engineering operations by adding new customers and diversifying further into high margin aerospace and the medical space. Aided by growing outsourcing to India, this division is expected to register 66% revenue CAGR over FY07-10E. After venturing into sunglasses under the ‘Fastrack’ brand, the company intends to build its scale in prescription eyewear. This is largely an unorganized market in India, estimated to be about USD 400 million and growing at 15-20% p.a. Titan plans to offer a wide range of products and services at reasonable prices in its ‘Eye+’ stores and would leverage the brand equity of its Titan brand. We estimate eyewear retail to contribute to about Rs1.2 billion of sales by FY10, growing at an average rate of over 75%.

Attractive return on capital and healthy free cash flows

Titan earns attractive returns on capital employed of 50% and 35% for watches and the jewelry segments, respectively. These returns are higher than those earned by domestic retailers such as Pantaloon, Shopper’s Stop and regional retailers. We expect these trends to remain healthy as the capital employed increase lags EBIT growth. We forecast free cash flow to grow from Rs 580 million in FY07 to Rs 1.4 billion in FY09.

Valuation and share price analysis

Share price performance

Titan’s market capitalization has more than doubled over the past two years, driven by strong growth in the watch and jewelry business (rising gold prices). It has outperformed the Sensex by 34% over the past year. The company registered revenue and PAT CAGR of 38% and 20%, respectively, over FY05-07. Investments in new ventures such as precision engineering and eyewear have helped the stock to remain firm. We believe that much of this optimism is priced into the stock at the current level, and that valuations are rich. Given the concerns about rising competition and increasing share of margin-dilutive businesses, we advise that investors avoid entering the stock at the current level.

Valuations

Titan’s stock is trading at the top range of valuations on measures such as P/E, P/sales and EV/EBITDA. The stock is trading at 33x FY08 and 25x FY09 earnings, respectively, based on our estimates. We do not see any significant upside to these valuations. The stock is trading at a PEG of 1.3x, which is in line with the regional jewelry and watch retailers

Price target and recommendation

We initiate coverage on Titan Industries with an Underweight rating and a March 2008 price target of Rs 1125, implying downside of 3% from the current level. Our price target is based on a forward P/E multiple of 25x, which is supported by an earnings CAGR of 30% for FY07-10E. We apply a lower P/E target to Titan than the trading multiples of its domestic peers due to relatively lower growth rates. Our price target implies a PEG of 1.3x, which is in line with the regional average. Using the DCF valuation approach, we arrive at a one-year forward price target of Rs 1,069, which implies a long term earnings growth of 5% and weighted average cost of capital (WACC) of 12%. The table below shows the sensitivity of our DCFbased price target to the terminal growth rate and WACC.



Buy Ratnamani Metals; target of Rs 1368: HDFC Sec

HDFC Securities has maintained buy rating on Ratnamani Metals and Tubes with target price of Rs 1368 (upside potential of 55%)

RMTL has declared encouraging Q4 FY07 results with net sales increasing by 97% y-o-y and 79% y-o-y for FY07 to Rs 1.52 billion and Rs 5.71 billion respectively. Operating Profits increased by 78% in Q4FY07 y-o-y, followed by an increase in PAT of 38% y-o-y to Rs 339.9 million and Rs 174.7 million respectively. Net profit growth was lower than revenue growth, mainly due to a very low tax rate during Q4FY06, compared to full tax during 4FY07.Operating Profit Margins (OPM’s) at 22.4% during FY07 recorded a 252 bps improvement y-o-y aided by a significant decline in manufacturing and other costs as a percentage of sales.

Segmental Performance

Stainless Steel Tubes and Pipes (SSTP)

SSTP segment reported revenues of Rs 2.95 billion in FY07, a growth of 100% over the last year (FY06). Sales volumes in this segment were at 7258 tonnes in FY07, up 55% over FY06. We believe, the growth in this segment has been led by the increasing contribution of stainless steel seamless pipes to overall segment sales. The trend in realizations continues to be buoyant going forward, keeping in line with the robust demand for SSTP pipes.

Carbon Steel Tubes and Pipes

CSTP segment reported revenues of Rs 3 billion in FY07, a growth of 70% over the last year (FY06). Sales volumes in this segment were at 61525 tonnes, up by 57.1% over FY06. The strong growth in volumes was largely contributed by its new facility at Kutch, which commenced operations in January 2006 and is currently operating at full capacity. The management is confident of growth in this segment due to huge demand from project businesses, including refineries and new power plants.

Others

The current unexecuted order book stands at Rs 4.7 billion, which will be executed over the next six to seven months. Of this order, the share of RPL stands at Rs 2 billion. The breakup of order between SSTP and CSTP is Rs 3 billion and Rs 1.7 billion respectively.

Outlook & Valuation

The company has a current order book position of over Rs 4.7 billion for all sizes of SSTP and CSTP pipes, from hydrocarbon majors. The market for SSTP and CSTP pipes is growing continuously due to an upsurge in the crude oil & gas sector, power and food processing industries etc, with new capacities being added in the user segments. We believe RMTL’s earnings in the next 2-3 years would be entirely volume driven and despite competitive pressures from customers, RMTL is all set to report a significant jump in profits, which the markets have not yet fully discounted in the present share price. Going ahead, we expect raw material costs to show a stable to declining trend, which should benefit the company significantly. At the CMP of Rs 883, the stock is currently trading at about 7.7x its FY08E earnings and 5.8x expected FY09E earnings. We maintain our BUY rating on the stock with a target price of Rs 1368 (upside potential of 55%).



Buy McNally Bharat Engineering: Edelweiss

McNally Bharat Engineering’s (McNally’s) Q4FY07 results were below our expectations both on the revenue and the operating margin front on account of higher share of low margin orders being booked in the current quarter. Sales increased by 25% Y-o-Y to Rs 1.71 billion while profits increased by 216% to Rs 64 million. However if we adjust for the other income which was on account of sale of investments then the profits de grew 30% to Rs 14 million. We do not expect this trend to continue going forward as most of its low price orders have already been executed last quarter. In fact we expect the operating margins to increase by 200 bps and 300 bps respectively over FY07 on the back of higher contribution margins in the Steel and the mineral processing sector.

McNally’s order book as on 31.5.2007 was at Rs 10.5 billion. Interestingly, the share of mineral processing and steel (which has the highest margins among its various segments) has increased to 63% compared with 10% in the same quarter last year. The company is L1 bidder in Rs 20 billion worth of orders (steel sector application) which it expects to get allotted in a months time. Including this, the order book would increase to Rs 30 billion which is a growth of 200% order book as on 31.3.2007. This gives a serious visibility over the coming three years and hence we recommend investors to invest from a long term horizon.

We are down grading our revenues, operating profits and PAT for FY08E by 1.5%, 25% and 30% respectively on account of change in our assumptions of EBITDA margin from earlier estimate of 10.2% to 7.8% in FY08E. We expect our earlier EBITDA margin estimates to be now met in FY09E as the revenues from the steel and the mineral processing sector starts contributing in a substantial way. Management has also been guiding for a double digit margin in two years time frame. SAIL; which is the main customer for Mc nally is incurring a capex of Rs 420 billion over the next five years in its RINL, IISCO, Bokaro and Durgapur division which are in the radius of approximately 45 Kms from Mc nally Bokaro factory. The addressable market from this segment alone is Rs 200 billion for the company. Thus, we feel very confident of EBITDA margins improving from hereon.

We are also introducing our FY09 estimates. We expect revenues and PAT CAGR of 43%, and 93% respectively over FY07-09E on the back of improvement in EBITDA margins from 5.6% in FY07 to 10.5% in FY09E. We expect a lack luster price performance in the near term; on the back of below than expected results. But we expect the company to exhibit robust performance in FY09 and hence continue to maintain our positive stance on the company with a long term perspective. At Rs 180, the stock trades at a PE of 16.5x and 8.7x on our EPS estimates of Rs 10.9 and 20.8 respectively. We continue to maintain our ‘BUY’ recommendation.