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Tata Steel: Dilution blues

Niraj Bhatt  |  Mumbai 

The consolidated debt-equity ratio of the Tata Steel-Corus combine could stay way above 1:1 for a long time.
The total dilution in the equity capital of Tata Steel, after the 1:5 rights equity issue, the convertible preference share issue of 1:7 and the overseas issue, will be about 45-46 per cent on the existing capital base of Rs 609 crore.

The company doesn't really have much of a choice because if it resorts to too much borrowing, the consolidated debt-equity ratio (Corus and Tata Steel combined) could stay way above the 1:1 level for a long time.

Even now, it will stray beyond that limit for a brief period at around 1.3-1.4, till some of the debt is paid off. The management says debt is expensive and perhaps believes that it can buy back the equity after some years, once the borrowings have been repaid.

It is, however, confident that the dilution will not be earnings dilutive and that consolidated earnings should grow at a pace faster than the dilution. That would depend on how steel prices behave in the next couple of years, but it should be possible because the dilution will happen only in stages.
At the current price of Rs 510 a share, the effective cost per share""if one subscribes to the rights issue at Rs 300 a share""is Rs 475. At Rs 475, the stock trades at a multiple of 6 times estimated FY08 earnings and around 5.5 times FY09 earnings. That is not cheap for a commodity play over a two-year horizon.
Also, making Corus a more efficient player will take time. The key to its improved profitability, the supply of low-cost slabs, is unlikely to happen soon, though the cost savings of around Rs 1,500 crore over a a year should help.
The Tata Steel stock has underperformed the market over the past six months though it has recovered smartly from the fall post the Corus announcement, when the price had hit 435 levels.
Aventis Pharma : Rising costs
The performance of Aventis Pharma in the March 2007 quarter was adversely affected by a rising operational cost structure.
As a result, operating profit grew marginally on a y-o-y basis to Rs 49.4 crore in the March 2007 quarter compared with 6.2 per cent growth in net sales to Rs 212.9 crore. Operating profit margin declined 130 basis points y-o-y to 23.2 per cent in the last quarter.
This pressure on margins was owing to adjusted raw material costs as a percentage of net sales rising 60 basis points y-o-y to 48.6 per cent in the last quarter.
In CY06 too, operating profit margin also declined 230 basis points y-o-y to 25 per cent. The lacklustre sales growth in the March 2006 quarter was owing to its export sales falling 11.1 per cent y-o-y to Rs 42.3 crore. Analysts say that was owing to reduced sales in Russia and other CIS countries.
Going forward, the company's ability to manage operational costs would be key to improving its margins. The stock trades at a reasonable 13 times estimated CY07 earnings.
HCL Technologies: Changing fortunes
HCL Technologies reported an improved performance in the March 2007 quarter thanks to an impressive 16.4 per cent sequential growth in its BPO services division, coupled with its focus on large multi-service deals.

As a result, operating profit grew sequentially by 13.2 per cent to Rs 366.7 crore in the March 2007 quarter compared with 7.6 per cent q-o-q growth in its revenues to Rs 1577.1 crore.

Consolidated revenues improved by 7.6 per cent in rupee terms, and 9.5 per cent in dollar terms, sequentially, which was higher than the 5 per cent growth that analysts were expecting.

Operating profit margin also grew sequentially by 114 basis points to 23.25 per cent in the last quarter. In contrast, other players such as Infosys' OPM sequentially fell 100 basis points to 31.73 per cent in Q4 FY07.

HCL had signed six large deals in the last quarter, with five that ranged between $25-50 million, while one was for more than $50 million.

Such large deals contributed about 10 per cent of its total revenues in the last quarter, say analysts. Billing rates, which were 1.7 per cent higher sequentially, helped improve margins by 75 basis points, but the rupee appreciation eroded 50 basis points.
Infosys had grown its revenues in rupee terms for Q4 FY07 on a sequential basis by 3.2 per cent, while for TCS it was a 5.88 per cent q-o-q growth. Meanwhile, in HCL's BPO business, growth was driven by pricing improvements, coupled with the acquisition of a new UK-based client in the insurance segment.
Segment profit margin of the BPO business grew sequentially by 360 basis points to 26.5 per cent in the last quarter. In HCL's core software division, growth was 6.4 per cent sequentially.
Analysts are upbeat about the HCL Tech stock-the stock has been an underperformer in the past year and in the past few quarters, its financials have been improving.
The HCL Tech stock gained over 7 per cent on Wednesday after the strong numbers, and trades at about 16-17 times estimated earnings for year ending June 2008.
With contributions from Shobhana Subramanian and Amriteshwar Mathur

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First Published: Thu, April 19 2007. 00:00 IST