Valuation: A DCF valuation of PM yields a price of $74, an upside potential of 44% to Friday’s (09/19) closing price of $51.4. The valuation model is sensitive to changes in short-term revenue growth (10.1%), sustainable net profit margin (11.4%) and sustainable cost of equity (9.3%). PM’s y-o-y revenue growth for the last two quarters has been in the 14% range and net profit margin has been in the 11-12% range. PM’s revenues are well diversified geographically and it operates in a stable tobacco industry; a cost of equity of 9.3% is quite conservative for such stable firms.

Valuation: A DCF valuation of Mechel (MTL) yields a price of $29/ADR, an upside potential of 52% to current price of $19. We have arrived at this valuation after using extremely conservative sustainable cost of equity of 14.2% and a low short-term revenue growth rate of 20.1%; MTL’s TTM revenue growth rate is 62% while it’s at 22.5% in the last three years. In the last three years, MTL’s net margin has been in the 11-13% range and we have used the lower end for sustainable net profit margin in the model. In the last five years, MTL has traded in a PE range of 2.1 to 14.8 and at an expected 2008 EPS of $5.68 the stock should trade in the range of $12-$84.

Written on 8/19/08

ArcelorMittal (MT)
Current Price-$75.51
Target Price-$105

Valuation: A DCF valuation of ArcelorMittal (MT) yields a price of $105/ADR, an upside potential of 39% to today’s closing price of $75.50. In the last three years, MT has traded in the PE range of 5 to 13; at an estimated FY-08 EPS of $13.23 the stock should trade in the $66-$169 range. MT also has 14 million shares to be repurchased of the total 44 million buy-back for FY-08.

Sector Analysis: ICICI Bank (IBN) is India’s largest private sector bank - it belongs to the International Banking group. Oflately, fortunes of international banks have been tied to the US financial sector; IBN’s correlation to Financials SPDR (XLF) in the past six months is 0.86. In simple terms, IBN traded in-line with the US financial sector for the past six months and dropped by 50%; underperforming India’s BSE Sensex which fell by 15% during the same period.

There are many reasons for IBN’s decline but a major influence has been the issues facing the US banking sector. So, the obvious question that investors have regarding banking stocks is: “what if the story of US banks' asset write downs and earnings losses is repeated in emerging markets such as India?” However, there are a few subtle differences between Indian banks and their US counterparts that make Indian banks less likely to follow the same path.

Sector Performance

Nike (NKE) belongs to the consumer discretionary sector, a sector which we have been underweight since we started seeing some signs of an economic downturn in the US in June (2007) when an inverted yield curve puzzled everyone. An inverted yield curve is almost always a leading indicator of an economic slowdown since forward yields are low in one of the two circumstances; either the GDP growth is expected to decline or inflation is expected to decrease.

However, with central banks worldwide having trouble keeping inflation at bay, the possibility of decline in GDP growth was more realistic. A decline in GDP wouldn’t bode well for the consumer discretionary sector and so we have been underweight on that sector for quite some time now.