Friday, June 5, 2009


The Story…

What all can change in a month!

Aban, written off for dead, is back. And if you think about it…what really is the problem with

Sure, oil prices were down. But that was yesterday. Now oil prices are headed back up to the $80
levels and beyond, given the weakness of the US Dollar.

Aah…yes, the company has a bit of debt.

Excellent! That’s precisely what we are looking for these days. We all loooooove companies with
loads of debt these days, don’t we…Because we wanna give them moneys in QIPs, FCCBs, PE, off
balance sheet the way Ramalinga gave to Satyam…whatever…

Short point is: Aban’s twin problems are receding fast, and before you know, they’ll have
disappeared altogether. Let it get some equity, and a whole new company emerges from the

Valuations are totally undemanding at 4-5x earnings. The stock had an all-time high 5.5x higher than its current price.

That’s good news.

Because there is plenty of room for the stock to run before it hits the wall. Global peers in the form of oil services companies are also seeing their stocks do well. No reason for Aban to sit out the party.

Aban could so easily be a Rs.2000 stock…Buy it.

The Slightly Longer Story

Aban Offshore is a stock which moves in line with oil prices like any other stock in the oil and gas service industry. The reason is high oil prices induce oil companies to spend more on exploration and production and this creates demand for offshore as well as onshore oil services which includes drilling rigs. The supply of offshore drilling rigs is tighter than onshore due to which high oil price induced demand results in high dayrates for offshore rigs. Aban Offshore has a fleet of 21 offshore rigs and is naturally a big beneficiary of the high oil price scenario. The company posted a net profit of Rs.5.5 bn in FY09 which is almost 350% higher than FY08. The company’s EBIDTA margins were 55.4% last year indicating the high rates it enjoyed and limited cost. When oil prices started falling from H2 CY08, Aban’s stock started falling and lost almost 95% of its value at the lowest market price while crude lost 77% to fall to less than $33 a barrel.

However with the rebound in oil prices, the stock recovered by almost 5 folds and is trading at above Rs.1000 a share. The second concern was Aban’s balance sheet which has a debt of more than $3 bn which Aban raised when acquiring Norwegian based offshore rig player Sinvest in FY08. By FY08 end, it had an astoundingly high debt equity of 16 which has come down to 11 in FY09 end. The tight credit conditions back then had raised concerns on its ability to deleverage itself, which put additional pressure on the company’s stock.. However considering the present favourable environment, we expect Aban to raise enough funds to refinance the existing debt at better terms and pay back the $150 mn bullet loan that is due on December 2009. We reinitiate Aban with a rating of “Outperform”.

Valuation & Outlook

The outlook of the sector is a function of oil prices and especially the jack up market is dependent on the short term movement of oil prices. Aban’s stock took a severe beating when oil fell from over $146 to less than $33, losing more than 90% of its value. So a reversal on the basis of higher crude prices is expected. Aban tends to secure term contracts and hence redeploying rigs in a high oil price scenario and at better rates gives visibility to its earnings in the up to the term of the contracts. News flow relating to securing new contracts, redeployment of drilling rigs and realizing would be crucial for the stocks re-rating. Currently the stock is trading at a low PE of 4.1 to FY10 earnings. The EV/EBIDTA is 6.5 FY10 earnings.

Key Growth Drivers

■ Rebound in oil prices
The rebound in oil prices from the lows of $30 a barrel to almost $70 has changed the outlook of the offshore oil & gas industry. Historically oil prices and rig accounts (a measure of drilling rig activity) has moved in the same direction. An increase in rig count means that, more rigs are in demand resulting in better day rates and earnings for the rig companies. The offshore space is becoming more and more promising as most of the on land oil has already been discovered. Offshore jack up rigs have witnessed high rates of $200,000 a day in CY08 with high oil prices. Jack up rigs unlike drillships and semisubs are the most responsive to oil prices and considering Aban has sixteen jack ups, the rise in oil prices would multiply its earnings in FY10. The visibility of earnings for FY11 would depend on prevailing oil prices then.

■ Deployment of rigs
Aban has a fleet of twenty one rigs. Currently, sixteen rigs are deployed, out of which five are under short-term contracts that will expire by August 2009. The Indian parent company (on a standalone basis) is in a comfortable position, with only one rig, the FPU, Tahara nearing expiry in July 2009. The company expects it to be re-deployed at a higher rate as the present rate is low in comparison to the market dayrates of other floating units.

■ Favourable environment for fund raising
In FY08, the Sinvest purchase had resulted in a debt burden of $3.1 bn, and a debt-equity of 16, as on FY08 end. Aban’s debt equity ratio currently stands at around 11. We expect Aban to raise enough funds to to refinance its debt, at better terms and lower cost. The company has to meet a $150 mn (Norwegian Kroners bond loan) in December 2009.

Key Risks

The key risk is a fall in oil prices once again which would again dampen the outlook of the sector and result in rigs remaining idle and hence lower earnings. This would also limit Aban’s ability to clear its debt. Technical snags is another risk which may result in actual earnings lower than expected as the rigs would remain docked and drilling delayed.

Company Background

Aban Offshore Limited is India’s largest offshore oil and gas drilling company and owns twenty one offshore assets. The company has two business segments: offshore oil drilling and production services, and wind energy services and wind power generation. Aban’s drilling services include drilling of exploration wells, appraisal wells and production wells. The company has jackup rigs that enable it to achieve a drilling depth of 30,000 feet in a water depth of up to 375 feet, and also owns drillships and semisubmersibles capable of drilling in greater water depths ranging up to 6,000 feet (please refer to Aban Offshore’s rig fleet details on Page 5). Aban has an installed capacity of approximately 65 megawatts in Tamil Nadu connected to the grid of the Tamil Nadu Electricity Board. However, the contribution of the wind business to Aban’s revenues is negligible. Aban completed the acquisition of Norway based Sinvest in CY08, thereby becoming the world’s tenth largest drilling company.

Business Highlights

Aban’s Singapore subsidiary acquired Sinvest in FY08 and was able to deploy six rigs in H1 FY09 at high day rates. For FY09, Aban recorded a growth of 57.6% in revenues to Rs.31.8 bn, on the back of high rates. The company’s net profit rose 351% to Rs.5.5 in FY09. However, the phenomenal growth cooled down towards the end of the financial year and Aban posted a loss of Rs.1.3 bn in Q4 FY09, mainly due to the impairment of its jackup rig, Murmanskaya, which resulted in an increase of 131% in depreciation. The impairment charge was a non-cash expenditure and will not impact Aban’s cashflows.

Aban has two bareboat charter agreements with the Russian company, Arktikmorneftegazrazvedka and has a 50% stake in Deep Venture drillship. The bareboat charter for Murmanskaya will expire in November 2009. Aban has also taken delivery of three new rigs and managed to secure contracts for two of the rigs, though these contracts are short term in nature. All the assets of the parent company are also under long-term contracts until beyond FY10, except the Tahara floating unit, for which the contract expires in mid 2009, though the contract rate for Tahara is much low and it is expected to be re-deployed at the existing, if not better rates. Aban II’s contract expires in May 2010, which we expect to be renewed, as the client is none other than ONGC.

Financial Highlights

Over the period FY05-09, Aban’s revenues grew at a CAGR of 82% to Rs.31.8 bn in FY09. Aban’s massive growth came in FY08, when it acquired Sinvest, which led to the company’s revenues almost tripling from the 2007 level. In FY09, the company reported a net profit of Rs.5.5 bn, which translated into an EPS of Rs.144, six times higher than the FY08 level. In the last five years, Aban’s operating margin has averaged at 52%, but rose to 55% in FY09, on the back of high dayrates and increased deployment of rigs, while the NPM trebled in FY09.

To see full report: ABAN OFFSHORE



In this note, we review performance of the 15 stocks recommended by us post the favourable election outcome on the morning of May 18,2009. The 15 stocks have delivered an average return (assuming equal weights) of 50% against 26% by BSE 200 (comparable Benchmark) since May 15th. Even after computing from May 18th (more cogent as markets freezed on thin volumes on that day), the average return of recommended stocks stood superior at 23% as compared to 8% delivered by BSE 200.

For continued outperformance in the near term especially up till the budget, we thought of weeding out stocks where upside seems capped post recent run-up and replacing them with companies where fundamentals and technicals warrants significant upside from here. Jain Irrigation, ICICI Bank Punj Lloyd Birla Corp and Shree Cement are stocks in which profit booking is recommended. Companies that we advise to add are Everest Kanto, Genus Power, ICSA, Sintex and United Phosphorus. These have been identified on the basis of growth visibility, healthy return ratios, high beta values and valuation comfort.

Stock list, Return & Recommendations given in this report

To see full report: MOMENTUM PICKS


Bottom line: India bottoming out to ~7% growth end-09…
We grow more and more comfortable with our January call of India bottoming out end-09 to ~7% growth. This leads us to hike our growth forecast to 6.3% in FY10 (from 5.3%) and 7.3% in FY11 (from 7.1%), assuming the 2H09 G-3 bottom out our global economics team expects. We have also grown more confident of our long-held twin view of BoP risks overdone/ medium-term constructive INR outlook: read Christy and me here. This, in turn, has led us to push our FY10 BoP
outlook up by US$14bn. Risks: monsoon, US$100+/bbl oil.

…although 4QFY09 ‘upside’ bit of statistical ‘construct’
We do not set much store by the fact that India’s 5.8% 4QFY09 GDP growth beat our (/consensus) 5% expectation. 40bp of the ‘upside’, after all, emanated from a concentrated higher-than-expected growth in construction (7% of GDP), due to an ever so convenient downward revision in its 4QFY08 growth to 6.9% from 12.6%.

Political stability allows pump priming by PSU divestment…
At the heart of our upgrade is a likely fiscal stimulus of 0.5-1% of GDP in the July budget. The convincing re-election of the Congress-led UPA, after all, has opened the door for ~0.5% of GDP of PSU divestment. Our estimates also suggest that the government can borrow an additional Rs500bn/US$10bn, in case the RBI steps in with our expected OMO purchases of Rs1200bn/US$25bn.

… and softer lending rates should support loan demand
There is also greater visibility of our expected 50-100bp bank prime lending rate (PLR) cut by September. A much more politically stable Delhi should be able to muster the comfort to cut PSU bank deposit rates, if CPI inflation softens as we forecast. This, in turn, should fructify our expected bottoming out of credit demand around 15.5% (14%, earlier) by September to fund end-09 recovery.

With 550bp PLR-10y spread muting fiscal/inflation risks…
Won’t a high fiscal deficit/inflation prevent softer lending rates? Not really. True, we ourselves expect a reversal of the easy money policy by April 10, with WPI inflation crossing 5% by March. Yet, even if yields react – as we expect - the ~550bp spread between bank PLR and the 10y is too high to sustain. This should protect our soft lending rate regime until 2HFY11.

…improved BoP outlook easing funding constraints
We have upgraded our FY10 capital inflow projections by US$14bn on a mix of receding international risk aversion as well as domestic political risks. This, in turn, should ease funding constraints given India’s dependence on foreign capital inflows for long-tenor funding. Could appreciation damage recovery? We think not. The RBI will persist, in our view, with its policy preference for a relatively weak INR to support exports. At the same time, the need to block imported inflation from rising oil prices should prevent policy-driven depreciation.

To see full report: ECONOMICS


Areva's T&D in play - Siemens in the fray - ALERT

Siemens AG has joined the fray to acquire Areva’s T&D unit, which is reported be in play, over the last month (Source: Bloomberg). Joe Kaesar, CFO of Siemens, said yesterday that it would look at Areva’s PT&D unit if approached by the latter. Schneider and Alstom are the other companies reported to be keen on Areva T&D. See J.P. Morgan European Capital goods analyst, Andreas Willis’ report dated May 13, 2009, analysing the potential acquisition.

Areva T&D India – large, fast-growing and profitable: 1) Areva T&D reported sales of Rs26.5B and PAT of Rs2.3B in CY08. Over the past 3 years, the company has clocked a tremendous pace of growth, with 45% CAGR in revenues and 84% CAGR in PAT, much faster than its peers. 2) Areva has a transformer capacity in excess of 20,000MVA, making it one of the largest players by installed capacity in India. Areva has been growing its manufacturing capacities and investments in India. 3) Areva clocked an EBITDA margin of 15.4%, making it the most profitable T&D player. 4) Areva has a strong OB at Rs40B and it has been particularly successful amongst private IPPs.

Implications for Siemens India in the event of a successful acquisition: 1) Larger capacity and market share: While Siemens is a long-established player in India vis-à-vis Areva, we believe an addition of Areva’s portfolio would make it a dominant player far ahead of ABB and Crompton Greaves. It would also provide newer manufacturing plants to Siemens and improve profitability. 2) Potential cost savings and synergies due to common customers and manufacturing facilities. 3) Price paid by Siemens Ltd for the local purchase would be a key point of evaluation. Andreas estimates the potential deal value at €4B for the whole unit. 4) Siemens Ltd has a strong balance sheet and is comfortably placed to fund the acquisition out of cash and additional leverage, in our view. Siemens has never done a domestic equity issuance in India. 5) Concerns will remain whether the local sub will get a fair deal.

To see full report: SIEMENS INDIA



Company is a leading Ductile Iron pipes and cast iron pipe manufacturing company. It also offers turnkey solutions in water transport and sewage management. The demand for ductile pipes comes from Govt/ Govt sponsored projects for transportation of potable water and for cast iron pipes - from irrigation / sewage disposal projects. Demand for ductile pipes is growing very fast looking to growing focus of the Govt to provide potable water not only in India but also across Asia and other developing countries.

Company is fully integrated backward, with pig iron plant, sinter plant and captive power plant, as also iron ore & coal mining rights. This kind of integration leads to superior margins for company.

It is thus very cost efficient and large player earning attractive margins. Business is mostly dependent on municipal/Govt orders and is thus immune to economic/business cycle. Under - Accelerated Rural Water Supply Program and Pradhan Mantri Gramodaya Yojana - Rural Drinking Water; significant annual demand for projects and products [pipes] is generated on sustained basis. Through an SPV [wherein company holds 40% stake] it is also setting up a 2.2
million integrated steel plant, fully backed by required iron ore & coal mines. Of this 1.3 million capacity will come on stream by the end of '09 and rest will come on stream by the end of 2010. Captive mining of Ore and coal will also be operational by the same time or slightly latter, so cost of production will be always under tight control.

Company's current working is good and its likely to perform much better in coming years.

RISK: The key concern is Forex derivatives and forex losses. With rupee improving sharply, most of these concerns could be taken care of.

Buy [CMP 36 ] with price target of Rs 60 in 2-3 months. Long term investors can look for still better returns.



Volume to cushion bottomline...
Dalmia Cement reported a sequential improvement in Q4FY09 as net profit increased by 87% QoQ because of an increase in the operating margin by 1170 bps. This was primarily backed by a growth of 29% QoQ in cement sales driven by 30% volume growth. Also, the recent surge in the equity markets has reduced the losses in the investment books.

Highlight of the quarter
Net sales grew 16.9% YoY to Rs 485.0 crore in Q4FY09 from Rs 415.0 crore in Q4FY08. The EBITDA margin has declined by 620 bps YoY due to a 29.3% increase in the total expenditure. Thus, the EBITDA remained flat YoY despite a growth in topline. The net profit has declined by 36.8% YoY to Rs 44.3 crore because of a decline in the operating margin and reported loss in other income of Rs 24 crore. However, on a QoQ basis, the net profit grew 86.7% on account of an increase in the operating margin by 1170 bps and positive other income in Q3FY08.

At the CMP of Rs 137 per share, the stock is trading at 6.9x and 6.6x its FY10E and FY11E earnings, respectively. On an EV/tonne basis, it is trading at an EV/tonne of $73 and $61 its FY10E and FY11E cement capacities, respectively. We are upgrading our rating on the stock to HOLD with a price target of Rs 125 per share.

Higher volumes, realisation back topline growth
Dalmia Cement reported net sales of Rs 485.0 crore in Q4FY09 (up 16.9% YoY) on account of 17% and 13% YoY growth in cement and sugar sales, respectively. A 6.8% increase in sales volumes and 9.7% increase in net realisation drove cement sales. Also, the sugar sales volume and realisation increased by 10.5% and 37.7%, respectively. On a QoQ basis, net sales grew 20.0% on the back of a 29.7% increase in the cement volume and 13.3% growth in sugar realisation.

EBITDA soars QoQ on margin improvement
The EBITDA remained flat YoY but increased 79.2% QoQ. An improvement in operating margin by 1170 bps drove the sequential growth in EBITDA. Total expenditure has also been flat while it increased by 29.3% YoY to Rs 313.0 crore on account of higher power & fuel and freight cost.
The power & fuel cost has increased by 28.7% YoY and 20.3% QoQ to Rs 120.5 crore on account of high cost coal inventory while the freight cost has increased by 46.7% YoY and 46.2% QoQ to Rs 41.7 crore. The employee cost has increased by 70.6% YoY to Rs 18.6 crore. However, the employee cost has declined sequentially by 30%. The raw material cost declined 43.8% YoY to Rs 130.6 crore but remained flat QoQ.

To see full report: DALMIA CEMENT


Colgate’s strong brand portfolio across price points, strong customer connection, an opportunity to expand penetration of oral care in rural markets and favorable margin outlook makes it attractive in FMCG space. Market share gains continue to remain healthy with market share in terms of value in toothpaste category rising 200bps y-o-y to 50.2% in Mar’09 quarter, which further increased to 50.7% in Apr-09 quarter.

Key Developments
Low penetration levels of modern oral care in India provide enough headroom for about 8-10% volume growth in the toothpaste category over the next couple of years. Colgate’s market leadership position coupled with a wide product portfolio covering all price points and strong distribution structure has helped it to increase its consumer base substantially over the past few years, reflected in the consistent market share gains as well. Strong brand equity has helped pricing power for the company too. It undertook a 2-3% price hike across its key brands in April 2009.

Colgate reported top-line growth of 16% and adjusted net earnings growth of 47% y-o-y during Q4FY09. Key highlight was 15.2% volume growth registered for the toothpaste category, which is the best ever reported growth by the company in recent years. EBITDA grew 41% y-o-y helped by 120bp gross margin expansion (on lower raw material costs, freight and excise duties) and lower ad spends.

At CMP of Rs. 474, the stock is trading at 23x its FY09 EPS of Rs. 21.0. At the CMP we recommend a BUY rating on the stock with a target price of Rs. Rs. 545.

To see full report: COLGATE PALMOLIVE



FY 08‐09 ‐ Key Highlights – Performance beats expectation
The FY09 results were better than our expectations, as net sales grew by 37% and PAT grew by 9%. Raw material cost increased to 65% on net sales due to usage of ferrous and non ferrous metals at higher costs. Employee cost has increased by 32% yoy, due to implementation of the Sixth Pay Commission Wage Act, where we can see some respite in the years ahead on account of lower wage cost. As a result total expenditure as a percentage of net sales has increased from 83% to 86%. Operating profits have reduced from 27% to 17% as a result. As a result PAT margins have reduced from 15 to 12%.

Q4 FY 08‐09 ‐ Key Highlights – Future more promising
For the Q4 FY09, net sales grew by 46% and PAT grew by 21%. Raw material cost increased to 66% from 58%. Employee cost as a percentage of net sales has reduced from 16 to 13%. As a result total expenditure as a percentage of net sales has increased from 81% to 84%. Operating profits have reduced from 25% to 19% as a result. Due to higher raw material cost, PAT margins have reduced from 15 to 13%.

Order Book
FY09 has ended the year with an order backlog of Rs. 1170 bln, indicating a book to bill ratio of 4.1x. The order inflow for FY09 has been 596 blns out of which power comprises 74%, industry 17% and rest is international. The order inflow for the next two years seem to be muted according to the management at Rs. 500 billion. Order booking for the 12th five year plan for 100000 MW will soon be taking place in the near future.

Recent Orders
BHEL has won a Rs.7,030 Million Contract for for the main plant package at the upcoming Bela Thermal Power Project (TPP) in Maharashtra, involving one new‐rating unit of 270 MW. The order has been placed by Ideal Energy Projects Limited (IEPL) reflecting the customer’s confidence in the company’s technological excellence and project execution capabilities. An order for a 600 MW thermal power plant has been placed by Korba West Power Company Limited in Chhattisgarh, an Independent Power Producer. It reinforces BHEL’s leadership status in the execution of thermal power projects involving supply of state‐of‐threatt equipment, suited to Indian coal and Indian conditions.

Wage provision
Sharp erosion in margins can be attributed to higher provisioning towards pending wage settlement liabilities and higher material cost. Pay revision of employees of the company is due with effect from Jan 1, 2007. Pending finalization of wage settlement the company is providing for the expected liability and for the period from Jan 1, 2007 to March 31, 2009 it has provided a sum of Rs 2547 crore. Out of the Rs 2547 crore the company has provided about Rs 1729 crore in fiscal ended March 2009 with balance being done in FY08. With the company having provided about Rs 839 crore upto Dec 2008 out of the total Rs 1729 crore for the fiscal ended March 2009, it has provided about Rs 890 crore in the fourth quarter ended March 2009 there by affecting the operating margin of the company. In fact the company's total provision for the fiscal at Rs 1729 crore is higher than the earlier expected Rs 1313 crore and this is largely on account of increased liability on account of change in gratuity plan and higher dearness allowance.

Power Industry
India’s power generation capacity has gone up by about 3,500 MW in fiscal 2009, but the capacity addition was dismal as it was over 68% below the target of 11,061 MW set for the period. Power generation is, however, expected to grow by 4.6% this fiscal as projects with a capacity of 7,730 MW are likely to commence generation in FY10, Centre for Monitoring Indian Economy (CMIE) said. The total installed power generation capacity in India rose by 3,453.7 MW during April‐March 2008‐09. This is 68.8% below the capacity addition target for 11,061 MW set for the period.

Going Ahead ….
The backlog at end‐Mar ’09 (of Rs 1170 blns) was 37% higher yoy. Orders worth Rs 500 bln are expected in FY10, acc to the management. Bulk orders from National Thermal Power Corporation (NTPC) and Damodar Valley Corporation (DVC) are expected to be placed in Q2FY10 according to management. BHEL can get upto 6 orders if L1 and if not upto atleast 5 orders are expected.

Benefit of lower steel prices will come into effect from Q2FY10 onwards. Positive impact due to reduction in raw material cost by 2% will accrue to the bottomline. As the manufacturing capacity will double from 10000 MW to 20000 MW by 2011‐2012, the execution percentage will increase from 29% in FY10 to 30% in FY11.

To see full report: BHEL

To see full report: BHEL


Hindustan Dorr Oliver Ltd’s (HDOL) Q4FY09 results were in line with our expectations. Its revenues grew 77.8% YoY to ~Rs1.9bn backed by robust execution across mineral beneficiation segment. OPM for the period dipped by 595bps YoY to 8.4% owing to higher cost of raw materials at ~83% of net sales. Despite an other income of Rs13mn, net profits fell by 9.3% YoY to Rs87mn.

Fresh order inflows at ~Rs4.7bn: HDOL bagged couple of new orders in Q4FY09, taking the total order inflows in FY09 to Rs9.6bn. The major order bagged during the quarter is worth Rs4.4bn involving commissioning of a greenfield Ore mining & processing facility of 3,000 MTPD at Tumalapalle in Andhra Pradesh on LSTK basis. The process plant, adopting Alkali Pressure Leaching process will be executed in technical collaboration with Bateman, South Africa & is
slated to be completed in 22 months.

Strong Order book at Rs13.1bn: HDOL maintains a healthy order backlog of 1.9x FY10E revenues. The company has already bagged orders amounting to Rs905mn till date in FY10. While metal & mineral beneficiation accounts for ~67% of the total order backlog, environmental management & manufacturing orders score 25% & 5.4% respectively. ~50% of orders in the present backlog emanate from various governmental agencies & are fixed price in nature.

At the CMP of Rs76, HDOL trades at a P/E of 6.9x & EV/EBIDTA of 4.7x its FY10E earnings. We are of the opinion that its current valuations are fair despite the considerable growth shown by the company in the past. We believe HDOL’s capability across successful execution of bigger & more complex projects, requiring prudent working capital management, still remains to be seen. Hence, we value the company at Rs88 (8x FY10E EPS) & maintain our ‘HOLD’ recommendation on the stock.

To see full report: HINDUSTAN DORR OLIVER LTD.


Initiate on Indian 2-wheelers; Sell Bajaj Auto, Neutral Hero Honda

Initiate coverage: Defensive exposure, but well priced in
We initiate coverage on the Indian 2-wheeler automobile industry with a Neutral sector stance and 2 stocks representing 30% of Indian auto industry’s market cap. We like the structurally under-penetrated nature of Indian market and the strong brand franchise of companies under coverage. However, given that valuations have already moved higher (stocks are up 100% on average ytd), risk/reward appears fairly balanced, in our view. The sector is currently trading at an average of 16X FY10E P/E, and offers 20% CAGR earnings growth over FY09E-FY11E. Our positive outlook on the sector is offset by financial market weakness and competitive headwinds, particularly in the premium segment of the market.

Exploring global and Indian industry themes
Themes explored in this report are: (1) oligopolistic nature of the 2-wheeler industry globally – implications for India; (2) structural reasons behind superior earnings growth and returns of Indian 2-wheeler companies; (3) sustainability of Hero Honda’s dominant franchise; and (4) the position of stocks on P/B, CROCI, and DCF-based valuation metrics.

Bajaj Auto – Growth interrupted, rich valuations, Sell
We initiate coverage on Bajaj Auto (BAJA.BO) with a Sell rating and a 12- month FY11E P/E-based target price of Rs705 implying 25% potential downside. We believe that currently the market is overestimating the impact of new model launches on Bajaj Auto’s market share and profitability over FY09E-FY11E. Intensifying competition and macroeconomic demand headwinds in the premium segment of the market are the catalysts likely to drive stock-price underperformance in, our view.

Hero Honda – Structural leader, fairly valued, Neutral
We initiate coverage on Hero Honda (HROH.BO) with a Neutral rating and a 12-month FY11E P/E-based target price of Rs1,399 implying 10% potential upside. We believe that Hero Honda’s market leading growth and returns are already priced in at current levels; as a consequence, we would wait for a more attractive opportunity to gain exposure to this stock.

Key risks include: (1) Competitive pressure from operators such as Honda and Yamaha and (2) macroeconomic headwinds to demand growth.

To see full report: AUTOMOBILES SECTOR