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MINT COLUMN: Educomp’s first-mover gains

MINT COLUMN: Educomp’s first-mover gains
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First Published: Mon, Jun 25 2007. 11 57 PM IST
Updated: Mon, Jun 25 2007. 11 57 PM IST
The Educomp Solutions Ltd stock has appreciated from Rs368 a year ago to its current price of around Rs2,300. It is up 23% in the past week—the trigger being the raising of the permissible FII (foreign institutional investor) ownership limit in the stock to 100% through shares and its recent convertible bond issue. At these elevated levels, the stock trades at a trailing price-earnings (P-E) ratio of around 128.
What’s the secret of its success? One of them is that it offers investors exposure to the huge potential in the growth of quality education in the country. Educomp has been offering animated content for schools, a computer literacy programme to state governments for schools, professional development programmes for teachers and online tutoring. It is now going to set up and manage a chain of branded schools. It is also spreading its wings in the international arena, acquiring a leading education technology company in Singapore this month, which will give it access to schools in Southeast Asia.
But perhaps its biggest advantage is its status as a first mover, a benefit seen from its high profit margins—its net profit margin for FY07 was a huge 26.5%.
Growth has been very rapid, boosted by two recent acquisitions. Fourth quarter profit growth was 97% year-on-year, and analysts expect the pace of growth to be maintained this year. Even then, consensus EPS (earnings per share) estimates for FY08, at Rs35.98, imply a P-E of 63.
With valuations like that, it won’t be long before competitors rush in. And while Educomp has a huge content library, entry barriers in the business are low. But while margins may come down, Educomp has shown that it is flexible and adaptable, getting into related businesses and new geographies with astonishing speed. As long as credible competition doesn’t appear in the market, it will enjoy a huge first-mover premium.
The Sterlite Industries Ltd ADS is trading at a modest premium to its issue price. Metals demand is expected to remain strong this year, with high growth in China, India and Europe offsetting weakness in the US. Brokers have been changing their recommendations on metals stocks, the latest example being Goldman Sachs raising mining giant Xstrata to a ‘Buy’ and upping the price target for BHP Billiton. The global investment bank recently raised its forecast for 2008 zinc prices. (Zinc and lead accounted for 68% of Sterlite’s consolidated profits in FY07).
But commodity prices are notoriously difficult to predict and a better way of looking at prices of metals producers is to compare their valuations. That’s where Sterlite seems to score. Teck Cominco and Xstrata, two of the world’s largest zinc producers, have a one year forward P-E of 13.7 and 10.6, respectively. Hindustan Zinc, of which Sterlite owns 64.9%, has a comparatively low forward P-E of around 6.7. Sterlite currently quotes at a forward P-E of around 8.3 and Macquarie Research says that the value of its aluminium operations (through its 51% stake in Balco) is below that of its peers.
The other way to value commodity stocks is by looking at increases in volume. Production is expected to expand substantially at Hindustan Zinc. Vedanta Alumina, in which Sterlite Industries owns a 29.5% stake, has recently commissioned its alumina refinery and it is setting up a smelter. And the money raised will also fund a power project in Orissa, although that won’t be before FY10.
Of course, not everything is hunky-dory. The squabble between the government and Sterlite over sale of the former’s residual stake in Balco, an erstwhile state-owned company, continues to be messy. Also, because nobody expects metal prices to rise as rapidly as they have last year and as a result of the dilution, most analysts expect Sterlite’s earnings per share for the next two years to show negative growth. But the appetite for the Sterlite ADS shows that the market is willing to overlook short-term earnings and instead concentrate on the value of the company’s resources.
Write to us atmarktomarket@livemint.com
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First Published: Mon, Jun 25 2007. 11 57 PM IST
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