Investment Ideas: NIIT Technologies

A good order-book, balanced geographic spread and the recent acquisition of Room Solutions lends confidence to the stock.

At Rs 198, the NIIT Technologies stock is a good choice for investors with a one/two-year horizon. The stock trades at a multiple of 11 times its trailing consolidated four-quarter per-share earnings. Investors can use any weakness linked to the broad market to step up
exposure.

The company's focus on select key verticals such as BFSI (banking, financial services and insurance) and transportation, a strong order-book position, the balanced geographic mix and the recent acquisition of the UK-based Room Solutions is encouraging. The risks to our recommendation are the integration issues surrounding Room Solutions, any sharp rupee appreciation vis-a-vis the dollar and supply-side manpower-related issues affecting mid-size companies.

Financial contours

In the quarter ended June 30, the company reported a 15 per cent sequential (quarter-on-quarter) growth in revenues to Rs 191 crore. This, however, includes the revenue contribution from its acquisition, Room Solutions, from May. If we ignore that, the sequential growth works out to 4.3 per cent.

Over the past four quarters, the sequential organic growth has been declining, which is not so healthy, but the operating profit margin has remained stable in the 19-20 per cent bracket.

In the latest quarter, the OPM has fallen marginally to 19 per cent largely on account of Room Solutions (with higher onsite revenues) from 20 per cent on a sequential basis. Despite a 17-per cent hike in offshore salaries and 5-6 per cent onsite, the company has managed to maintain its operating margins.

This has been aided to some extent by a reduction in SG&A (selling, general and administrative) expenses.

NIIT Technologies can use multiple levers such as an improvement in BPO margins, enhanced contribution from offshore, and better control over SG&A to shore up margins. At present, the BPO segment contributes only about 6 per cent of revenues, with the balance coming from
software services.

The company has $90 million worth firm orders executable over the next 12 months. In the latest quarter, the company won new business worth $38 million, including a $20-million order from an existing client in the transport space.

This highlights the cross-selling opportunities and mining the potential of NIIT Technologies' top five or top ten clients.

The acquisition pep

In early May, the company acquired 51 per cent in Room Solutions, a UK-based IT solutions firm (with intellectual property) focussed on the insurance space.

Through this acquisition that focuses on the property and casualty space, NIIT is trying to plug a gap in its insurance portfolio. With revenues of $25 million, NIIT Technologies will be acquiring Room Solutions for about one times revenues.

This is also likely to complement the company's presence in life and pension space. Since Room Solutions has a large client base in the property and casualty space evenly spread out, it opens up cross-selling possibilities, the impact of which will be felt over the next one year.

According to NIIT Technologies, there will be near-term margin pressures on account of integration and transition costs of Room Solutions, but that will be recovered over the next couple of quarters.

Apart from building its offerings around an integrated IT and BPO platform, the company also recently forayed into the emerging area of remote infrastructure management and managed services.

It announced last week that it has set up a 50:50 joint venture with the Switzerland-based Adecco, a global major in HR services.

Source: Business Line

Investment Ideas: Gujarat NRE Coke

Improving outlook for coke and cost-savings from backward integration are likely to have a positive impact on the company's profitability.

Encouraging outlook for coke, gains from ongoing expansions and backward integration, improving revenue mix and attractive valuations add fire to the Gujarat NRE Coke stock.

Investors can consider exposure at the current price of Rs 68 with a one/two-year perspective. The stock trades at a multiple of seven times its likely FY-07 per share earnings on an expanded equity base.

Improved market outlook

The market for metallurgical coke, after going through a weak phase last year, is now beginning to look up. International coke prices, after touching the historic high of about $420 a tonne in 2004, have corrected considerably since.

At about $180 a tonne now, the prices appear to have bottomed out. However, prices have gained by $20-30 per tonne over the last month and are likely to stabilise at these levels.

On the other hand, the prices of coking coal (primary raw material for making coke) are showing signs of softening after remaining firm over the last one year. This is indicated from the recent negotiations between Nippon Steel of Japan and BHP Billiton; long-term prices were contracted 8 per cent lower than the FY-06 level.

The demand for coke is likely to remain upbeat on the back of increasing requirements from user segments, especially the steel sector. India has largely been a buyer of coke, with more than 85 per cent of the imports coming from China. China's growing appetite for resources has resulted in domestic demand for commodities soaring to unacceptable levels.

Consequently, the Chinese government has adopted restrictive measures, including curbing coke exports, thus creating an imbalance in the global market. The growing need to feed China's expanding steel industry, along with the buoyancy in the Asian markets, is likely to augur well for the coke market over the medium term. Back home, the deficit in the coke market at about four million tonnes per annum now is expected to increase seven-fold over the next five years.

Growth Initiatives

Gujarat NRE Coke is the largest non-captive manufacturer of met coke with an annual capacity of one million tonne. It has two plants and is in the process of adding a third in Dharwad, Karnataka. The last is expected to begin production by July 2007, taking the company's total
capacity to 1.4 MTPA. It recently commissioned a steel plant (steel bars) and co-generation power plant in Kutch. This is likely to diversify its revenue base and de-risk its earnings in the long term. The total planned capital expenditure is Rs 410 crore and the company has tied up 50 per cent of this. It proposes to raise the balance through debt and equity over the next couple of years.

Exports picking up

Gujarat NRE's revenue from the export of met coke has been growing rapidly, albeit on a smaller base. Volumes have risen five-fold in FY-06, while revenues have more than doubled. Over the next year or so, Gujarat NRE expects to increase the share of its exports to 25 per
cent of its production from 20 per cent now. The company's clientele — including Hindustan Zinc, Nirma, Gujarat Heavy Chemicals, Kalyani Steels and Birla Copper — in the domestic
market lends credibility to its growth expectations.

Backward integration

Gujarat NRE Coke's recent overseas acquisitions of coking coal mines are likely to assure long-term supply of input. It has acquired two mines in Australia, which together have reserves of about 375 million tonnes. Gujarat NRE has received two shipments of about one lakh tonnes from NRE No.1 colliery that it acquired last year. We view this as a strong positive, as it would help the company reduce input costs.

Gujarat NRE recently picked up a stake in Pike River Coal Company (a subsidiary of New Zealand Oil and Gas) along with a contract to take four lakh tonnes per annum of its hard coking coal over the life of the mine.

The company has also acquired a stake in Australian exploration companies, Rey Resources and Zelos Resources, which are mining and mineral prospecting entities. The move would provide Gujarat NRE access to thermal, coking coal and uranium in Australia, and gold and copper in South America where the two companies are now prospecting.

We have, however, not factored in the impact of this development into our valuations, owing to the uncertainty about the commercial operations of the acquired entities.

Key concerns

The rising level of debt is likely to result in a higher interest outgo over the next couple of years. Higher depreciation charges may also impact its profits. However, the expected cost savings from backward integration offer protection on the downside. An appreciating rupee also remains a risk.

Investment Ideas: Dishman Pharma

Investments can be considered in the stock of Dishman Pharma, which currently trades at Rs 206. Since its initial public offer a couple of years ago, the stock has had a stellar run, rising almost six-fold since. Dishman's business profile is getting more diversified and the business mix is poised to get better.

Investors could buy the stock in small lots and look to step up exposures on any declines linked to the overall market movement. At the current price, the stock trades at a shade over 15 times its expected per-share earnings (on a diluted basis, assuming full conversion of FCCBs) for FY08, which, in our view, is not too demanding in the context of growth prospects.

>From an almost negligible contribution a few years ago, the contract research and manufacturing services segment accounts for over half of Dishman's revenues. We expect this segment to be the principal growth driver over the next few years. Dishman's strategy of working with innovator companies to supply inputs for molecules on patent is its key differentiator; it also ensures better margins.

>From catering to one client (Solvay), Dishman has expanded this roster to include the likes of Merck and GSK, to name a couple. Approval of its facility by the US Food and Drug Administration should trigger supplies into that geography, a lucrative market. Importantly, a
widening customer base should also help allay investor apprehension about the risks associated with an excessive dependence on a single client.

Dishman's recent acquisitions are complementary in nature, as it plugs gaps in its portfolio of offerings. The key would be the integration of the Swiss-based Carbogen-Amcis, an outfit that is comparable with Dishman in revenues. Though this may result in margins trending marginally downwards, it should be more than compensated for by the significant addition to topline.

In the marketable molecules business, which is a mature category, we expect steady growth, with an improvement in operational metrics once the benefits of Dishman's foray into China for setting up a manufacturing unit kicks in.

Source: Business Line