DJ India BRIC Picks & More
India boasts 15 stocks on the Dow Jones BRIC 50 Index. The Dow Jones India Titans lists 15 entities including the 15 on the Dow Jones BRIC 50 Index. In this post, I look at all 15 of the Dow Jones BRIC 50 Index. And a further 5 from the Dow Jones India Titans. I also look at 3 other entities which I follow. You can look at my quantitative analysis here. You can also assume that I have positions in all stocks which I have rated buy.
Reliance Industries: This stock is number one on the Dow Jones India Titans and is considered a core holding by many in India. The management is strong with excellent execution capabilities. Over the five years ended 3/31/2008 its earnings grew at 30% annualized. Over the past three years very substantial investments have been deployed for growth. During the coming economic expansion, I expect earnings to continue to grow albeit at a slight lower rate of 26%. With the kind of capacity expansion witnessed over the economic cycle, it makes sense for management to focus on managing growth before seeking new expansion aggressively. The debt equity ratio is at 59% which I consider reasonable for a capital intensive business. It trades at a price to book of 2.6. The multiple applicable to expected average earnings during the upcoming business cycle assuming growth at 26% for 7 years with a terminal growth rate of 9% is 20.33 for an investor targeting an annual return of 20%. A 25X multiple was paid for the past five years peak earnings when the stock hit its 52 week high. The average earnings over the prior five years was Rs 98/share. My bear target is Rs 1,533 and if oil prices collapse below $50/bbl for an extended period of time, I can see the share trading at Rs 900. On the upside, I have a bull target of Rs 3,500. I view a fair price of the share at Rs 1,979.
Bear Target = Lower off (1) Average Earnings Over Past 5 Years * 20.33 and (2) Peak Earnings Over Past 5 Years less One Standard Deviation * 20.33.
Fair Price = Higher off (1) Average Earnings Over Past 5 Years * 20.33 and (2) Peak Earnings Over Past 5 Years less One Standard Deviation * 20.33.
Bull Target = Peak Earnings Over Past 5 Years plus One Standard Deviation * 20.33.
Infosys Technologies: This stock is number two on the Dow Jones India Titans and is considered a core holding by many in India. The management is strong with excellent execution capabilities. Over the five years ended 3/31/2008 its earnings grew at 29% annualized. During the coming economic expansion, I expect earnings to continue to grow albeit at a slight lower rate of 25%. There is considerable upside to this growth estimate because it includes a presumption of a considerable slow down in the US financial services spend; this is a very important vertical for the company. Personally, I believe that IT services will be a beneficiary of the turmoil in the financial services market - the extensive M&A activity will likely result in significant IT integration investment. In addition, after significant head count reduction, the focus on enhancing productivity will be huge. IT services plays a critical role in enhancing productivity and integration. The company is largely un-leveraged. It trades at a price to book of 5. The multiple applicable to expected average earnings during the upcoming business cycle assuming growth at 25% for 7 years with a terminal growth rate of 9% is 19.52 for an investor targeting an annual return of 20%. A 26X multiple was paid for the past five years peak earnings when the stock hit its 52 week high.The average earnings over the past 5 years was Rs 50/share. My bear target is Rs 973. On the upside, I have a bull target of Rs 2,057. I view a fair price of the share at Rs 1,116.
DLF: This stock is number ten on the Dow Jones India Titans and is considered a core holding by many in India. The management is strong with excellent execution capabilities. The company is a relatively new listing which makes valuation a difficult task. During the coming economic expansion, I expect earnings to continue to grow albeit at a slight lower rate of 26%. This is a contrarian play as the markets are very negative on the real estate space; I personally see a major long term growth opportunity, with significant short term risks.For a real estate company, the leverage is a very reasonable 59%. I pay tribute to the management for having had the vision to reduce leverage from 435% during 2006, and 279% during 2007. The challenge will be to generate positive operating cash flows through reduction of inventory without causing price destruction; this will not be an easy task and it is for this reason that I perceive significant downside risk. Working capital management also needs to be sharpened up. There is some scope on the expense cycle through supply chain management, but there is much scope for better management of receivables. DLF trades at a price to book of 2.38. The company owns a large land bank, largely acquired at prices below fair market value. The company has a long history of success (while unlisted) in creating developmental profits. My bear market target is set at 2 times book, with fair value set at book value plus 10X prior year earnings.
Cairn: A relatively recent listing in the Exploration & Production business makes for difficulty in valuation. I value them at 1.4X proven reserves (estimated at 755mbbl), growing from 17,500 bpd at 30% per year to a peak of 175,000 bpd. The bear target uses oil prices of $60/bbl, the fair price $70 and the bull target $80. In my opinion, the equilibrium price of oil is $50-$60, being the estimated marginal cost of drilling in ultra deepwater. The demand side fundamentals remain strong and this is balanced by adequate supply, including incremental supply from Brazil, GOM and Saudi. With the demand and supply in balance, I would expect long term prices at equilibrium. That said, with demand increasing in emerging markets, it is likely that today's prices will reflect tomorrows consumption due to forward buying by commodity users. However, with the absence of leveraged players and financial investors who do not use the commodity, it is unlikely that the price of oil will display the same exuberance as of the recent years. Cairn's UK management is exceptionally talented. They possess the intellectual property to identify and convert Exploration opportunities into real production. Their financial structure model is unrivalled. They have a long history of creating shareholder value; they have a tendency to return shareholder value once it is created. Having shrunk the equity base following a return of shareholder value, they are ready to leverage their intellect and grow rapidly once more.This stock is number eleven on the Dow Jones India Titans; I consider it "the" E&P opportunity in India.
Reliance Communications: This stock is number twelve on the Dow Jones India Titans. I rate this stock on valuation. The history as a listed entity is limited, which makes it difficult to value. However, I have every confidence that a 24% growth rate is achievable. There is considerable upside to this target growth rate, however, management needs to demonstrate the ability to manage and execute growth. My reservation on RCOM is that I find ADAG group as able to compete on price very well. Unfortunately, on product and service quality, they inevitably run a very distant second. In my view, the ultimate winner is the one who finds the right balance between quality and price - price alone does not win the market. Over the past two years very substantial investments have been deployed for growth. During the coming economic expansion, I expect earnings to grow at at least 24%. It trades at a price to book of 1.7. The multiple applicable to expected average earnings during the upcoming business cycle assuming growth at 24% for 7 years with a terminal growth rate of 9% is 18.4 for an investor targeting an annual return of 20%. A 37X multiple was paid for the past two years peak earnings when the stock hit its 52 week high.The average earnings over the prior two years was Rs 18/share. My bear target is Rs 306. On the upside, I have a bull target of Rs 531. I view a fair price of the share at Rs 339.
Tata Steel: The company is thirteenth on the Dow Jones India Titans. As luck would have it, this stock has been beaten down to a value to the extent that I believe the market is mis-pricing the risks. The company is owned by the Tata Group and led by the formidable Mr. Ratan Tata. It trades at 0.59 times book. With over 100 years of creating shareholder value, the group clearly has strong management and execution credentials. With the acquisition of Corus, they also embraced globalization enthusiastically. Unfortunately, I do not see the group as having financial strategic savvy which is ever-so-important in creating shareholder value in our global world: (a) The debt to equity ratio stands at 157%. This enhances the risk of future dilution which may be required to pay down the debt; alternatively, it might mean the reduction of interests overseas through a foreign listing of the steel business outside India. (b) The business in India, which is significantly different from the unregulated global market was not separated following the acquisition. (c) Why did the group not think to adopt a financially and tax effective structure, similar to the one adopted by Cairn or Vedanta - one where the foreign entity owns an interest in the Indian entity - the public shareholding for the India steel business would be what was traded on the Indian bourses, while the foreign interests including the holding in the Indian entity could have been traded on an international bourse. Ultimately, while the above matters are important, it is not the end of the world. Structures can add value, not create it. The multiple applicable to expected average earnings during the upcoming business cycle assuming growth at 4.5% for 7 years with a terminal growth rate of 9% is 8 for an investor targeting an annual return of 20%. In valuing Tata Steel, I have used 4.5% growth assuming a dilutive or partial foreign asset disposition event will occur. A 11X multiple was paid for the past five years peak earnings when the stock hit its 52 week high.The average earnings over the past 5 years was Rs 64/share. My bear target is Rs 513, while the stock recently traded at below Rs 300. On the upside, I have a bull target of Rs 1,048. I view a fair price of the share at Rs 602.The steel industry will continue in strength as the demand for infrastructure and industrial growth in India is immense; additionally, it is not over in China either.
Satyam, Tata Consultancy Services, Tata Motors; all Titans not on the BRIC Index and Sesa Goa, Biocon and GMR which are liquid mid caps which I follow, will be covered in another post.
Reliance Industries: This stock is number one on the Dow Jones India Titans and is considered a core holding by many in India. The management is strong with excellent execution capabilities. Over the five years ended 3/31/2008 its earnings grew at 30% annualized. Over the past three years very substantial investments have been deployed for growth. During the coming economic expansion, I expect earnings to continue to grow albeit at a slight lower rate of 26%. With the kind of capacity expansion witnessed over the economic cycle, it makes sense for management to focus on managing growth before seeking new expansion aggressively. The debt equity ratio is at 59% which I consider reasonable for a capital intensive business. It trades at a price to book of 2.6. The multiple applicable to expected average earnings during the upcoming business cycle assuming growth at 26% for 7 years with a terminal growth rate of 9% is 20.33 for an investor targeting an annual return of 20%. A 25X multiple was paid for the past five years peak earnings when the stock hit its 52 week high. The average earnings over the prior five years was Rs 98/share. My bear target is Rs 1,533 and if oil prices collapse below $50/bbl for an extended period of time, I can see the share trading at Rs 900. On the upside, I have a bull target of Rs 3,500. I view a fair price of the share at Rs 1,979.
Bear Target = Lower off (1) Average Earnings Over Past 5 Years * 20.33 and (2) Peak Earnings Over Past 5 Years less One Standard Deviation * 20.33.
Fair Price = Higher off (1) Average Earnings Over Past 5 Years * 20.33 and (2) Peak Earnings Over Past 5 Years less One Standard Deviation * 20.33.
Bull Target = Peak Earnings Over Past 5 Years plus One Standard Deviation * 20.33.
Infosys Technologies: This stock is number two on the Dow Jones India Titans and is considered a core holding by many in India. The management is strong with excellent execution capabilities. Over the five years ended 3/31/2008 its earnings grew at 29% annualized. During the coming economic expansion, I expect earnings to continue to grow albeit at a slight lower rate of 25%. There is considerable upside to this growth estimate because it includes a presumption of a considerable slow down in the US financial services spend; this is a very important vertical for the company. Personally, I believe that IT services will be a beneficiary of the turmoil in the financial services market - the extensive M&A activity will likely result in significant IT integration investment. In addition, after significant head count reduction, the focus on enhancing productivity will be huge. IT services plays a critical role in enhancing productivity and integration. The company is largely un-leveraged. It trades at a price to book of 5. The multiple applicable to expected average earnings during the upcoming business cycle assuming growth at 25% for 7 years with a terminal growth rate of 9% is 19.52 for an investor targeting an annual return of 20%. A 26X multiple was paid for the past five years peak earnings when the stock hit its 52 week high.The average earnings over the past 5 years was Rs 50/share. My bear target is Rs 973. On the upside, I have a bull target of Rs 2,057. I view a fair price of the share at Rs 1,116.
DLF: This stock is number ten on the Dow Jones India Titans and is considered a core holding by many in India. The management is strong with excellent execution capabilities. The company is a relatively new listing which makes valuation a difficult task. During the coming economic expansion, I expect earnings to continue to grow albeit at a slight lower rate of 26%. This is a contrarian play as the markets are very negative on the real estate space; I personally see a major long term growth opportunity, with significant short term risks.For a real estate company, the leverage is a very reasonable 59%. I pay tribute to the management for having had the vision to reduce leverage from 435% during 2006, and 279% during 2007. The challenge will be to generate positive operating cash flows through reduction of inventory without causing price destruction; this will not be an easy task and it is for this reason that I perceive significant downside risk. Working capital management also needs to be sharpened up. There is some scope on the expense cycle through supply chain management, but there is much scope for better management of receivables. DLF trades at a price to book of 2.38. The company owns a large land bank, largely acquired at prices below fair market value. The company has a long history of success (while unlisted) in creating developmental profits. My bear market target is set at 2 times book, with fair value set at book value plus 10X prior year earnings.
Cairn: A relatively recent listing in the Exploration & Production business makes for difficulty in valuation. I value them at 1.4X proven reserves (estimated at 755mbbl), growing from 17,500 bpd at 30% per year to a peak of 175,000 bpd. The bear target uses oil prices of $60/bbl, the fair price $70 and the bull target $80. In my opinion, the equilibrium price of oil is $50-$60, being the estimated marginal cost of drilling in ultra deepwater. The demand side fundamentals remain strong and this is balanced by adequate supply, including incremental supply from Brazil, GOM and Saudi. With the demand and supply in balance, I would expect long term prices at equilibrium. That said, with demand increasing in emerging markets, it is likely that today's prices will reflect tomorrows consumption due to forward buying by commodity users. However, with the absence of leveraged players and financial investors who do not use the commodity, it is unlikely that the price of oil will display the same exuberance as of the recent years. Cairn's UK management is exceptionally talented. They possess the intellectual property to identify and convert Exploration opportunities into real production. Their financial structure model is unrivalled. They have a long history of creating shareholder value; they have a tendency to return shareholder value once it is created. Having shrunk the equity base following a return of shareholder value, they are ready to leverage their intellect and grow rapidly once more.This stock is number eleven on the Dow Jones India Titans; I consider it "the" E&P opportunity in India.
Reliance Communications: This stock is number twelve on the Dow Jones India Titans. I rate this stock on valuation. The history as a listed entity is limited, which makes it difficult to value. However, I have every confidence that a 24% growth rate is achievable. There is considerable upside to this target growth rate, however, management needs to demonstrate the ability to manage and execute growth. My reservation on RCOM is that I find ADAG group as able to compete on price very well. Unfortunately, on product and service quality, they inevitably run a very distant second. In my view, the ultimate winner is the one who finds the right balance between quality and price - price alone does not win the market. Over the past two years very substantial investments have been deployed for growth. During the coming economic expansion, I expect earnings to grow at at least 24%. It trades at a price to book of 1.7. The multiple applicable to expected average earnings during the upcoming business cycle assuming growth at 24% for 7 years with a terminal growth rate of 9% is 18.4 for an investor targeting an annual return of 20%. A 37X multiple was paid for the past two years peak earnings when the stock hit its 52 week high.The average earnings over the prior two years was Rs 18/share. My bear target is Rs 306. On the upside, I have a bull target of Rs 531. I view a fair price of the share at Rs 339.
Tata Steel: The company is thirteenth on the Dow Jones India Titans. As luck would have it, this stock has been beaten down to a value to the extent that I believe the market is mis-pricing the risks. The company is owned by the Tata Group and led by the formidable Mr. Ratan Tata. It trades at 0.59 times book. With over 100 years of creating shareholder value, the group clearly has strong management and execution credentials. With the acquisition of Corus, they also embraced globalization enthusiastically. Unfortunately, I do not see the group as having financial strategic savvy which is ever-so-important in creating shareholder value in our global world: (a) The debt to equity ratio stands at 157%. This enhances the risk of future dilution which may be required to pay down the debt; alternatively, it might mean the reduction of interests overseas through a foreign listing of the steel business outside India. (b) The business in India, which is significantly different from the unregulated global market was not separated following the acquisition. (c) Why did the group not think to adopt a financially and tax effective structure, similar to the one adopted by Cairn or Vedanta - one where the foreign entity owns an interest in the Indian entity - the public shareholding for the India steel business would be what was traded on the Indian bourses, while the foreign interests including the holding in the Indian entity could have been traded on an international bourse. Ultimately, while the above matters are important, it is not the end of the world. Structures can add value, not create it. The multiple applicable to expected average earnings during the upcoming business cycle assuming growth at 4.5% for 7 years with a terminal growth rate of 9% is 8 for an investor targeting an annual return of 20%. In valuing Tata Steel, I have used 4.5% growth assuming a dilutive or partial foreign asset disposition event will occur. A 11X multiple was paid for the past five years peak earnings when the stock hit its 52 week high.The average earnings over the past 5 years was Rs 64/share. My bear target is Rs 513, while the stock recently traded at below Rs 300. On the upside, I have a bull target of Rs 1,048. I view a fair price of the share at Rs 602.The steel industry will continue in strength as the demand for infrastructure and industrial growth in India is immense; additionally, it is not over in China either.
Satyam, Tata Consultancy Services, Tata Motors; all Titans not on the BRIC Index and Sesa Goa, Biocon and GMR which are liquid mid caps which I follow, will be covered in another post.
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