Saregama India: Hold

Recommendation: Hold

S. Vaidya Nathan

SHAREHOLDERS of Saregama India (till December 5, Gramophone Company of India) could stay invested.

This is because the stock's valuation may improve over the next couple of years, as it is well placed to capitalise on a growing market -- in the conventional way and through the Internet.

Saregama India's stock has been singing a different tune in the second half of 2000, after touching an all-time high in excess of Rs 2,000 in the February-March period.

For a stock that once had barely any takers, its changing fortunes in the stock market is indeed a major turnaround. With media and IT stocks in favour, the company was thought to be well-placed to capitalise on the Internet. This, coupled with some institutional buying, lifted the stock to valuation levels clearly not of sustainable nature.

But in keeping with the trends in the TMT sector, the stock has suffered a value erosion of close to 75 per cent from its highs. At its current price of around Rs 500, the stock trades at a price earnings multiple of around 45 times its sustainable earnings for 2000-01.

The current valuation levels, though a touch on the high side, seem more in line with the company's prospects. But given its strengths in the music business, the almost unparalleled archive that could be leveraged to great effect and better financial position, the stock may well consolidate at around the current levels.

Saregama's performance this fiscal also points to improvement in the operational profile. In the July-September quarter, it reported a 30 per cent rise in revenues and a doubling of its sustainable post-tax earnings stream.

A tight leash on expenditure -- mainly on account of lower wage costs -- helped improve the operating profit margins by 1.50 percentage points. The company has effected a 30 per cent cut in its workforce and taken a sizeable charge of Rs 2.80 crore for this purpose. This has led to lower wages.

The overall expenditure profile could also help drive revenues. There has been 86 per cent increase in promotional expenses and a sizeable rise in the raw material bill as well. Apart from better operating margins, the sharp reduction in debt has led to a steep fall in interest costs.

For the latest quarter, the interest cost was Rs 0.30 crore (Rs 1.46 crore in the corresponding previous quarter). With depreciation rise also muted, the net profit margin rose by seven percentage points. Much of this appears to be sustainable.

Volume growth in terms of cassettes sold was 52 per cent in the first four months of 2000-01. Compared to 1999-2000, there was a four percentage point rise in operating profits, suggesting that the picture for the whole year could be significantly higher. It could also improve once the company is through with the one time charges for cutting its workforce.

As for its operations, Saregama appears to be capitalising on its rich archives to create customised and niche products to improve the revenue stream. It is also offering a customer customisation package on the Internet through Hamaracd.com.

The company has acquired a few significant regional labels over the last couple of years. These moves should strengthen the company's hold in the music market. Much the same would come about on the plans to digitise its entire library and set up an audio software unit that could cater to the large number of FM channels likely to hit the deck.

It is a matter of concern that there is still a question mark over transparency levels with regard to the operations. The recent merger of RPG Music International and Gramco Music Publishing has happened without a clear indication of the implications though it would mean a 15 per cent rise in equity.

Of equal importance is the fact that the company no longer has a free-run for titles, especially in the Hindi film songs market. It may have to spend sizeable sums in acquiring titles compared to the past and yet rest content with much smaller share than in the past.

This could have adverse long-term implications which may be neutralsied to some extent, if the music of the 1990s does not have the same kind of archival richness as the titles in the Saregama fold. Even by sharing the market, Gramophone could still maintain good growth rates, given demand.

How the company handles the opportunities and threats of the Internet may have a significant bearing on long-term growth, but the company has made a good beginning. Given the fairly bright prospects, shareholders can stay invested. The company also has a listed outfit, Saregama Plc, which caters to the overseas Indians' market (the stock is listed on the London Ofex Exchange for small companies).