CAS RESEARCH DESK • FUNDAMENTAL RESEARCH 28th JULY 2010

 

EXECUTIVE SUMMARY

The current global scenario remains overtly uncertain. Off-late, several investors have a
long list of India-centric concerns as well.

While taking cognizance of such concerns we believe that the Indian economy
continues to be on a strong footing:

• Domestic consumption remains strong

• Revival of investment likely the next big push for growth–capex set for a take-off
in FY11

• Rise in interest rates will be in “baby steps”; not to spoil growth recovery.

Valuations being no longer cheap for India, markets can stay sideways in the next 3-6
months.

Stock selection will be the key rather than betting on overall market movements

We anticipate a couple of investment themes to play out:

• Over the next 6 months, easy liquidity will keep fuelling inflation globally, which
will have both positive and negative implications. To benefit in such a situation,
we believe, one should:

ƒ own: (a) businesses with better pricing power; (b) manufacturers with
stronger vertical integration; and (c) natural asset owners (e.g., mining,
integrated manufacturers); and

ƒ avoid: (a) businesses facing greater competition; and (b) non-integrated

manufacturers (e.g., cement, telecom, auto).

• Accordingly, we believe under the current circumstances, taking account of

valuations as well the below mentioned 5 stocks should be bought now as they
offer significant upside potential.

Top
Top Picks EW Code Current price Target Price Upside (%)
Picks
1 Reliance Industries RELIND 1021 1167 14.3
2 Unitech Limited UNILTD 83 123 48.2
3 Deepak Fertilizers DEEFER 146 172 17.8
4 Lakshmi Energy LAKENE 100 147 47.0
5 CESC Limited CESLTD 388 458 18.0
CAS RESEARCH DESK • FUNDAMENTAL RESEARCH 28th JULY 2010
 

India – Unharmed amidst chaos….

Concerns Our Take

Immediate default fears are arrested.
But, poor competitiveness and weak growth
Is the Europe crisis over? prospects will remain a drag for Europe over
the medium term

Current global uncertainties will increase

volatility and risk aversion. However, the
Will risk appetite wane again? European Union - IMF effort will check
systemic uncertainty and risk aversion from
blowing out of proportions

What will happen to global liquidity? Easy liquidity continues

There is a distinct fear of overheating and

large-scale policy tightening in China. The
key concern is if China slows down, how big
Is China a ticking time bomb?
will be the impact on the global economy?
We would keep a close track of this situation

India’s fiscal situation is improving. But, there

is not much margin for error. Expenditure on
Is India’s fiscal situation out of the woods? subsidies (oil and fertilizer, in particular)
remains the joker in the pack

We believe subsequent hikes in interest

rates will be in small incremental steps.
Increase in long-term bank lending rates will
Will interest rates spike and hurt growth
be mostly back-loaded during the year and
recovery?
confined to ~100bps. This will not derail
credit growth or recovery in general

Typically, Indian industry has been able to

pass on the cost pressure and maintain
margins. However, ability to pass on rising
Will cost pressures spoil the party?
costs can vary considerably across sectors
and companies

While new paper issuance will significant

Will large paper issuance affect Indian supply, we believe steady FII flows will be a
markets? source of support

While India currently is not cheap, it is not

Is Indian stock market too expensive? overtly expensive either. Stock selection is
key to outperform flat broader markets
CAS RESEARCH DESK • FUNDAMENTAL RESEARCH 28th July 2010

RELIANCE INDUSTRIES LTD Buy

Current Price: Rs. 1021 Target Price: Rs. 1167
QUICK DATA
Face Value (Rs) 10
BUSINESS OVERVIEW
Div. Yield (%) 0.6
RELIANCE INDUSTRIES LTD (RELIND) is the largest private player in the refining, No of shares ('mn) 2978.0
petrochemical, exploration & production (E&P) sectors in India. Historically RELIND’s 52-week High/Low (Rs) 1189 / 858
refining and petrochemical segments have been contributing ~90% to its total revenues, NSE Symbol RELIANCE
but that is set to change, as the company scales up its E&P business and is set to BSE Code 500325
emerge as a integrated E&P player. RELIND is also venturing into areas of consumer Edel Code RELIND
Market cap (Rs bn.) 3270.3
retailing and urban infrastructure.

INVESTMENT THEME SHAREHOLDING PATTERN (%)

Promoters 46.6
z Global refining utilisation is expected to improve with: crude demand likely to
MFs, FIs & Banks 9.8
increase on global recovery; >1.0 mbpd of shutdowns in CY09E; and project
FIIs 16.8
slippages/deferrals. We believe refining margins have bottomed and are likely to Others 26.8
revive gradually.
EDELWEISS CLASSIFICATION
z Energy consumption in India from natural gas (currently ~9% due to shortage of Market Cap Large Cap
gas) is set to rise due to production increase from ~132 mmscmd in FY10 to Liquidity High
around 230 mmscmd in FY11E. Based on the demand of gas for power and Relative Reco Sector Outperformer
fertilizers, we believe that an increase in the gas supplies can be easily absorbed Relative Risk Medium
by the country. In fact, we believe that India may have an appetite for more gas Sector Rating Oil & Gas - Overweight
supplies, as the country’s GDP grows above 8.0% CAGR in the next decade which
offers serious opportunities in oil & gas sector. GROWTH METRICS (%)
Year to Mar FY10 FY11E FY12E
z RELIND's strength lies in its ability to build businesses of global size and scale and Revenues 34.7 18.8 2.7
EBITDA 31.9 34.2 17.3
execute complex, time-critical, and capital-intensive projects, which will prove
PBT 12.3 44.2 30.4
advantageous in its huge plans in the E&P sector, organised retailing, and SEZ
Net Profit 5.8 48.8 27.8
infrastructure. Also, there could be a potential upward revision to our estimated in-
EPS 6.2 48 27.8
place reserves. With its foray into consumer retailing and SEZ infrastructure, we
believe, it is an ideal company to play the India story.
FINANCIALS (Rs. mn) (%)
Year to Mar FY11E FY12E
INVESTMENT RISKS
Net revenue 2,421,267 2,487,481
z Natural gas taxation and lower pricing in the RELIND-NTPC case. EBITDA 414,460 485,964
EBIT 285,775 358,440
z Reduction in the duty differential will be negative for the company. PAT 235,325 300,765
Diluted EPS (Rs.) 70.5 90.1
z Rupee appreciation may impact negatively as RELIND is positively leveraged to
the depreciating currency.

z Slow down in global demand could impact RELIND’s refining and chemical
margins.

OUTLOOK AND VALUATIONS

Our outlook on RELIND has improved, as we believe refining margins have bottomed and
will gradually inch upwards. Further, we expect the exploration activity to gain traction in
CY10, and expand the potential for news flow. The stock is currently trading at a P/E of
15.0x and P/BV of 2.1x on FY11E basis and at a P/E of 12.0x and P/BV of 1.8sx on
FY12E basis. Given these attractive valuations and its growth prospects, we believe the
stock offers upside potential in the near term.
CAS RESEARCH DESK • FUNDAMENTAL RESEARCH 28th July 2010

UNITECH LIMITED Buy

Current Price: Rs. 83 Target Price: Rs. 123
QUICK DATA
Face Value (Rs) 2.0
BUSINESS OVERVIEW
Div. Yield (%) 0.1
Unitech Ltd (UNILTD) is currently a leading real estate developer with a pan-India No of shares ('mn) 2,388.0
presence including NCR, Chennai, Kolkata, Kochi, Bangalore, Mumbai, etc. The company 52-week High/Low (Rs) 116 / 61
has over three decades of experience in real estate, construction, and infrastructure NSE Symbol UNITECH
development space and currently has a total land bank of around 9,059 acres in which the BSE Code 507878
company’s share is approximately 7,466 acres. UNILTD real estate projects include Edel Code UNILTD
Market cap (Rs bn.) 19.1
residential complexes, commercial offices, retail malls, IT parks, integrated townships,
golf courses, and amusement parks.
SHAREHOLDING PATTERN (%)

INVESTMENT THEME Promoters 45.0

MFs, FIs & Banks 3.6
z Indian real estate market has grown rapidly in recent years, due to factors such as
FIIs 32.3
rising income levels, rising urban population and increasing nuclear families. The Others 28.3
urban affordable housing market is expected to grow from Rs. 432 bn in 2009 to
Rs. 1749 bn (4x) by 2020 and the urban premium housing is expected to grow from EDELWEISS CLASSIFICATION
Rs. 116 bn in 2009 to 757bn in 2020 (6x) in 2020, which represents a huge Market Cap Large Cap
opportunity for Unitech Ltd. Liquidity High
Relative Reco Sector Performer
z Unitech has strong construction and execution skills with over three decades of Relative Risk Medium
experience in infrastructure and real estate development. The management has Sector Rating Real Estate – Overweight
demonstrated its ability to manage and operate in India’s complex business
environment. The past two years have amply emphasized the same with several GROWTH METRICS (%)

key deliverables—money raising through path breaking QIPs, securing telecom Year to Mar FY10 FY11E FY12E

licenses’, tying up a partner for the telecom venture at attractive valuations in a Revenues 1.8 45.8 36.1
EBITDA (24.5) 20.8 50.5
hostile environment.
PBT (18.8) 15.9 56.6
Net Profit (21.7) 12.2 63.5
INVESTMENT RISKS
EPS (51.5) 12.2 63.5
z Unitech Ltd has launched 26.2 mn sq ft in FY10 itself along with the ongoing 55 mn
sq ft. The execution on such a large scale can pose issuers related to time and FINANCIALS (Rs. mn) (%)
cost overruns and of quality management, which can deplete the value for Year to Mar FY11E FY12E
shareholders of UNILTD. Revenues 42,987 58,500
EBITDA 14,531 21,870
z Our valuation approach for Unitech is justifiable on a land bank valuation basis. A PBT 13,543 21,212
shift in liquidity environment may result in investors valuing cash flows over Net Profit 10,513 17,189
balance sheet valuation, causing severe underperformance of the stock from the EPS 4.0 6.6
current levels.

OUTLOOK AND VALUATIONS

Unitech has shown continued traction in volumes and execution. The improving cash flow
is also reflected in the company’s reducing debt. The demerger of Unitech Infra is
expected to accord additional growth opportunities. The stock is currently trading at a P/E
of 19.0x and P/BV of 1.6x on FY11E basis and at a P/E of 11.5x and P/BV of 1.4x on
FY12E basis. Given these attractive valuations and its growth prospects, we believe the
stock offers upside potential in the near term.
CAS RESEARCH DESK • FUNDAMENTAL RESEARCH 28th July 2010

DEEPAK FERTILISERS Buy

Current Price: Rs. 146 Target Price: Rs. 172
QUICK DATA
Face Value (Rs) 10.0
BUSINESS OVERVIEW
Div. Yield (%) 3.1
Deepak Fertilisers and Petrochemicals Corporation (DEEFER) is one of the leading No of shares ('mn) 88.20
manufacturers of industrial chemicals and fertilisers in India. The company operates in 52-week High/Low (Rs) 140 / 69
three business segments – chemicals, agribusiness and specialty retailing. Amongst the NSE Symbol DEEPAKFERT
business divisions, chemicals contribute 61%, agribusiness 38% and specialty retailing BSE Code 500645
1%. The company has seen capacity underutilizations in the past due to input sourcing Edel Code DEEFER
Market cap (Rs bn.) 11.53
concerns but has now tied up for major agreements for critical inputs like gas.

INVESTMENT THEME SHAREHOLDING PATTERN (%)

Promoters 42.6
z DEEFER is the leader in the Indian Technical Ammonium Nitrate (TAN) market,
MFs, FIs & Banks 10.0
with 30% share. The company plans to increase its TAN capacity further by
FIIs 9.0
300,000 MT by Q3FY11 against 132,000 MT currently, at a capex of ~INR 6.5 bn. Others 38.4
With increased capacity, DEEFER’s market share in TAN is estimated to rise to
~70% in FY12 by replacing the cheaper grade TAN imports. Also, the company is EDELWEISS CLASSIFICATION
set to benefit from the increasing TAN demand on account of the growing demand Market Cap Small Cap
for coal and limestone production. Liquidity High
Relative Reco NA
z With better gas availability, the capacity utilisation of Ammonium Nitrophosphate Relative Risk NA
(ANP) fertiliser is poised to increase from 25% in FY09 to ~80% in FY12. Also, the Sector Rating NA
capacity utilisation of Methanol is expected to increase from 12% in FY09 to 80%
in FY12. DEEFER’s total natural gas requirement is ~0.8 mmscmd and it has GROWTH METRICS (%)

contracted about 0.72 mmscmd i.e. 90% of the requirement. For the remaining Year to Mar FY10 FY11E FY12E

10%, the company buys from the spot market. These agreements will help DFPCL Revenues (10) 20.1 28.3
EBITDA 0.1 12.7 23.7
to achieve high utilisation for its capacities and control volatility in input costs.
PBT 0.1 7.8 30.9
Net Profit (0.1) 11.0 31.8
INVESTMENT RISKS
EPS (0.1) 11.0 31.8
z High volatility in crude prices could adversely impact the company’s raw material
costs and, hence, its profitability. FINANCIALS (Rs. mn) (%)
Year to Mar FY11E FY12E
z Even today, Indian agriculture is largely dependent on the monsoon. Poor Revenues 15,964 20,475
monsoon could, therefore, be a demand dampener. EBITDA 3,292 4,072
PBT 2,263 2,962
z Any delay in the payment of subsidies by GoI or payment of the same by means of Net Profit 1,557 2,052
fertiliser bonds, could strain the company’s working capital cycle. The Indian EPS 17.7 23.3
finance minister has, however, assured that the entire subsidy amount will be paid
in cash and not bonds.

OUTLOOK AND VALUATIONS

Given strong revenue and profit growth prospects over the next two years (with better
capacity utilisation, new capacities), DEEFER looks attractive at current levels.

At CMP of INR 137 (incl. dividend of INR 4.5), DEEFER is available at 7.4x and 5.6x
consolidated P/E and at 4.6x and 3.6x consolidated EV/EBITDA of FY11E and FY12E,
respectively and at 0.97x P/B on FY12E with ROE of 18.4%. Based on 4.5x FY12E
EV/EBIDTA, we value DEEFER at INR 172 per share and recommend a 'BUY'.
CAS RESEARCH DESK • FUNDAMENTAL RESEARCH 28th July 2010

LAKSHMI ENERGY & FOODS LIMITED Buy

Current Price: Rs. 100 Target Price: Rs. 147
QUICK DATA
Face Value (Rs) 2.0
BUSINESS OVERVIEW
Div. Yield (%) 0.5
Lakshmi Energy & Foods Ltd (LAKENE) is India’s largest rice processor with current No of shares ('mn) 63.2
capacity of 1.18 mtpa. The company purchases paddy at the minimum support price 52-week High/Low (Rs) 175.5 / 63
(MSP) declared by the government and sells rice at MSP to the Food Corporation of India NSE Symbol LAKSHMIEFL
(FCI), (75% of output). The balance is sold at marginally higher prices in the open market. BSE Code 519570
The company’s profitability is substantially aided by the sale of by products, which can be Edel Code LAKENE
Market cap (Rs mn.) 6446.4
processed further. In the past few years, the company has scaled up operations
substantially, installing state-of-the-art machinery, which has improved its efficiency.
SHAREHOLDING PATTERN (%)
LAKENE is also involved in power generation using paddy husk. The company has
Promoters 45.0
commissioned India’s largest husk fueled power plant with a 30 MW capacity in August
MFs, FIs & Banks 6.1
2008.
FIIs 26.0
Others 22.9
INVESTMENT THEME

z LAKENE, the largest rice processor in India with processing capacity of 1.2 mtpa, EDELWEISS CLASSIFICATION
still forms less than 1% of the country’s highly fragmented 135 mn tonne paddy Market Cap Small Cap
processing industry. We believe, as the value chain gets more organised, bigger Liquidity Moderate
players will emerge due to better efficiency and better access to working capital YTD Profit Growth 20 to 50%
funding, forcing smaller unorganised millers to shut shop. LAKENE, already the YTD Sales Growth 20 to 50%
largest rice processor in India, is best placed to capture this opportunity.
GROWTH METRICS (%)
z LAKENE has impressively diversified its revenue streams, by expanding its product Year to Mar FY10 FY11E FY12E
portfolio to include Pusa rice and power. This has helped LEAF to mitigate the Revenues 49.3 26.9 19.1

demand risk from FCI. We expect FCI’s rice contribution to revenues to fall below EBITDA 6.5 22.7 12
PBT 8.6 38.4 19.9
40% by FY12 from over 80% seen in the past few years. However, with the
Net Profit 9.5 18.3 18.6
addition of Pusa rice, the element of pricing risk has been introduced for the
EPS 9.5 18.3 18.6
company.

FINANCIALS (Rs. mn) (%)

INVESTMENT RISKS
Year to Mar FY11E FY12E
z FCI continues to be the largest buyer of rice output from LAKENE and any Revenues 13,101 15,606
problems of rice offtake by FCI will affect LAKENE‘s revenues as well as EBITDA 2,839 3,181
profitability. Concerns on this front would not only impact the rice revenues, but PBT 1,735 2,080
also by-product revenues and energy revenues, due to the integration of all Net Profit 1,186 1,406
operations in LEAF. EPS 18.8 22.3

z LAKENE has always dealt with wholesale markets until this point of time and the
lack of experience in retail operations might be a drag on the company in the short
term.

OUTLOOK AND VALUATIONS

Given the company’s improving product mix and likelihood of concerns of FCI offtake
subsiding, LAKENE’s outlook is positive. On the back of strong and steady profitability,
along with high return ratios, valuations look attractive. LAKENE has historically traded in
the one-year forward P/E band of 8–14x.

At CMP of INR 101, the company is trading at a P/E of 5.5x FY11E and 4.6x FY12E.
Based on DCF, we arrive at a fair value of INR 147, and recommend a 'BUY' on the stock.
CAS RESEARCH DESK • FUNDAMENTAL RESEARCH 28th July 2010

CESC LTD Buy

Current Price: Rs. 388 Target Price: 458
QUICK DATA
Face Value (Rs) 10.0
BUSINESS OVERVIEW
Div. Yield (%) 1.0
CESC (CESLTD) is an RPG Group company. It was commissioned in 1899 and since No of shares ('mn) 124.9
then the company has been offering power to consumers in its Kolkata license area which 52-week High/Low (Rs) 451 / 260
has expanded from 5.64 sq miles to 567 sq km over the years. The number of consumers NSE Symbol CESC
has grown from 6,000 to 2.3 mn over time. The company owns and operates four thermal BSE Code 500084
power plants generating 1225 MW of power. These are Budge Budge Generating Station Edel Code CESLTD
Market cap (Rs bn.) 47.83
(750 MW), Southern Generating Station (135 MW), Titagarh Generating Station (240 MW)
and New Cossipore Generating Station (100 MW). Almost 88% of its customer’s
SHAREHOLDING PATTERN (%)
electricity requirement is met from its own generating plants, rest 12% of electricity is
Promoters* 52.5
purchased from third parties.
MFs, FIs & Banks 17.9
FIIs 18.6
INVESTMENT THEME
Others 11.0
z India's per capita consumption of electricity, at ~600 KWh, is much lower than * Promoters pledged shares (% of
share in issue)
5.7
other large economies. With strong growth projected for the economy, the per
capita consumption is likely to increase significantly, keeping demand strong over
EDELWEISS CLASSIFICATION
the long term.
Market Cap Large Cap
Liquidity High
z CESC has a huge expansion plan and intends to increase its capacity to more than
Relative Reco Sector Outperformer
1,725 MW in its license area. The company has been allotted 110 MT of coal block
Relative Risk High
using which it plans setup a power plant. CESC is also seeking growth
Sector Rating Power-Underweight
opportunities in other parts of India in the power space by developing 600 MW
power plant in Maharashtra and is also looking at opportunities to develop ~3,000 GROWTH METRICS (%)
MW in Bihar, Jharkhand and Orissa. Year to Mar FY10 FY11E FY12E
Revenues 8.6 0.5 12.3
z The company has merged Spencer’s retail with itself and plans to unlock value at EBITDA 23.1 27.2 7.0
appropriate time. PBT 12.3 6.7 2.5
Net Profit 5.7 6.8 2.5
INVESTMENT RISKS EPS 5.7 6.8 2.5
z Regulated returns: The company has in the past not been given incentives on
account of plant load factor (PLF) above 80%. We have in our earnings estimates FINANCIALS (Rs. mn) (%)

assumed incentives on account of PLF. Year to Mar FY11E FY12E

Revenues 33,086 37,160
EBITDA 9,590 10,264
z Delay: Escalation in project costs, delay in commissioning of generation projects,
PBT 5,569 5,710
and long gestation periods could impact profitability, if delays are not compensated
Net Profit 4,622 4,740
through tariffs.
EPS 36.8 37.7

z Retail arm – Spencers: The losses in FY09 have significantly increased and the
retail business has also been impacted due to the overall economic environment.
While there have been early signs of improvement any trend reversal could result
in higher cash outgo in retail translating into lower power business investment and
thereby impacting valuations.

OUTLOOK AND VALUATIONS

In FY11, the Budge Budge expansion will add to earnings, while the Haldia and
Chandrapur projects will come up by FY14. With likely PE investment in the retail
subsidiary, we expect surplus cash to be retained for expanding the power project
portfolio, which could lead to further upsides and re-rating. Our SOTP of INR 458
excluding Haldia 600 MW project, Spencer’s and the retail mall, highlights 22.5% upside.
The stock is trading at P/E of 10.2x and 9.9x on FY11E and FY12E earnings,
respectively, and P/B value of 1.1x and 1.0x FY11 and FY12 book value, respectively.
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