Wednesday, May 13, 2009

>Daily Calls (ICICI Direct)

Sensex: We said, "Index now moves closer to previous crucial levels of earlier years, all between 12316 and 12671 ... profit-booking at higher levels cannot be ruled out." Index did correct over 170 points on profit-booking before closing flat. Realty Index outperformed with 8.6% gain. A/D ratio cooled down, though it held +ve 3:1.

The action formed a High Wave pattern, indicating a pause on suspected profit-booking. Bulls will be interested if the Index today trades strongly above its head at 12198. Failure to achieve that can see further profit-booking, especially if it breaks High Wave's low of 11985. Larger trend remains positive above the Green line.

To see full report: CALLS 130509

>Daily Market & Technical Outlook (ICICI Direct)

Key points
■ Market Outlook — Open flat to negative
■ Positive — FIIs, MFs buying
■ Negative — Crude rising again

Market outlook

■ Indian markets are likely to open flat with a negative bias. Our markets rallied yesterday. We expect some profit booking to creep in today. We again saw a bear trapping yesterday and the Nifty climbed almost 150 points from its low of the day. The major contribution came from
heavyweights like Reliance and Bharti

■ The Sensex has supports at 11900and 11760 and resistances at 12280 and 12470. The Nifty has supports at 3640 and 3610 and resistances at 3740 and 3780

■ Asian stocks were trading flat in the morning session with a positive bias. The Shanghai and Taiwan indices were up nearly 0.5%, while the Nikkei and Kospi were trading marginally in the green

■ The Dow rose on Tuesday as investors scooped up defensive shares, including Pfizer while energy companies' stocks climbed as oil hit a six-month high. However, the S&P was little changed and the Nasdaq fell as financial and technology shares declined after leading the
recent rally from bear market lows

■ Stocks in news: Bajaj Auto, Pantaloon Retail, IOC and Reliance

Recent development: India’s industrial output dipped by 2.3% in March this year as the country’s industries were adversely impacted by a sharp fall in exports and cut in spending by local consumers

To see full report: OPENING BELL 130509


Is the problem really "financial capitalism"?

The term "financial capitalism" describes a situation where companies are managed based solely on shareholders’ objectives, and not the objectives of wage earners, governments, suppliers, consumers, researchers developing new products, etc. Distortions can then result from the existence, during the cycles, of an abnormally high and stable return on equity target chosen by the shareholders, which in principle leads to decisions that give priority to achieving short-term profits, increasing debt leverage and risk, and squeezing wages, especially during a recession period.

We can date the beginning of the changeover to financial capitalism in the United States and the United Kingdom to the late 1980s, and to the mid-1990s in Spain, Italy and France; but it is not clear whether this changeover has occurred in Germany, and the case of Japan is even less clear.

In order to identify the effects of financial capitalism, we can therefore look at:

- whether there was a change in corporate management in the mid-1980s in the United States and the United Kingdom; and in the mid-1990s in Spain, Italy and France;

- whether we see a difference between the management of companies in Germany and Japan and the way it is carried out in the United States and the United Kingdom.

We find:

- that the signs of financial capitalism (debt leverage, rise in profits and dividends, offshoring, etc.) did appear at the expected dates in the countries where financial capitalism clearly set in;

- but that they also appeared in Germany and in Japan, which casts a doubt: are we seeing the effects of "Anglo-Saxon capitalism" or of the new global corporate management model?

"Financial capitalism" is a system where corporate management decisions are taken solely in the interest of shareholders, and not the company’s other stakeholders: wage earners, governments, suppliers, consumers, researchers, etc.

Moreover, company shareholders are currently formulating demands for high and stable return on equity despite economic cycles, which in theory implies:

- giving priority to projects that provide short-term profits;

- increasing debt leverage and risk in order to boost the return per share;

- squeezing wage costs, particularly in a period of economic slowdown.

We will try to examine the reality of these supposed effects of financial capitalism.

To see full report: SPECIAL REPORT

>India IT Services (MORGAN STANLEY)

Quick Comment: Read-through from CTSH Results

Comforting but Not Euphoric: We believe the industry’s revenue outlook still appears to be scraping the bottom. CTSH reported revenues marginally ahead of guidance, but earnings were in line with consensus expectations. Q2CY09 guidance is for +2% qoq revenue growth and is in line with consensus expectations. Adjusting for ~4% higher working days in Q2, revenue
guidance implies sequential decline in Q2 (vs. +1% qoq adjusted revenue growth in Q1) on a like-for-like basis.

2009 Guidance: CTSH maintained full-year revenue guidance but lowered GAAP EPS guidance by 1 cent, to US$1.53, primarily due to FX losses and lower other income.

Management is not seeing any signs of a material rebound in 2H: However, the pace of revenue decline does not appear to be accelerating materially.

Revenues and margins for India IT services vendors have been less volatile than those of their regional technology peers have. Consequently, although the revenue decline was not as severe in the last few quarters, relative revenue growth rates are likely to be muted in the event of a turnaround, we believe. Expectations of a sharp turnaround or sharply improved growth rates appear a bit stretched, in our view.

Valuations are key: CTSH currently trades at 18x consensus C09e EPS, a 10-40% premium to India IT peers, which are now trading at 12-15x FY10e EPS for an EPS CAGR of 0-5% during the FY09-11e period. We believe P/E multiples for the sector could erode over the coming quarters.

To see full report: IT SERVICES


Growth revives but margins a tad lower

Early signs of revival in mortgage demand
After a dismal third quarter in which loan approvals declined 8% YoY as HDFC turned cautious on developer loans, approvals improved reasonably with 17% growth YoY. Net of sell-downs to HDFC Bank, outstanding loans grew by 17% YoY. Management has guided to an 18-20% loan growth target for FY10E (with most of the rise coming in the last two quarters).

Excess liquidity takes toll on margins. Other income surprises positively
In the aftermath of the domestic liquidity crunch during 2Q–3Q FY09, HDFC carried excess liquidity which took its toll on spreads (down 11 bps YoY). Going forward, spreads are expected to remain stable with an upward bias as repricing of liabilities kicks in.

Asset quality and operating efficiency remarkable as always
Despite market concerns, GNPA ratios (both 180 and 90-days past due) continued to improve YoY, a trend we have seen throughout the current fiscal.

Raising our target price to reflect greater comfort on demand
HDFC has delivered in a difficult environment: its asset quality is at a 10-year low, and spreads have been maintained showing negligible impact of SBI's lower interest rate loan gimmick. The only concern is on demand, though signs of a revival are evident. The stock currently trades at 15x earnings (sub-value at Rs 588.) Given this backdrop and HDFC’s sustainable core RoE (upwards of 25%), core business can trade upwards of 20x earnings. We upgrade our target price to Rs 2,378 from Rs 1,943. Buy.

To see ful report: HDFC


Beware of slowdown in govt expenses

The strength of the fiscal stimulus in the second half of FY09 has been a key reason for demand in several sectors to move ahead of growth consistent with the current level of GDP growth and investment activity. While the fiscal stimulus should continue, the amount of expenditure is unsustainable in light of the elevated levels in 2H FY09. We believe demand in sectors such as cement, steel and twowheelers would have benefitted significantly from the stimulus and pre-election spending. Our economist, Sonal Varma, forecasts a slowdown in this spending and expects a 10.3% combined fiscal deficit in FY10. We believe that demand for cement, two-wheelers and steel could see some slowdown as expenditure growth cools off. We would advise investors to reduce weightings specifically in the cement and two-wheeler sectors.

We believe central government expenditure would have likely grown 35% y-y in FY09 and 42% y-y in the second half, as enhanced spending came into play. This is based on government numbers from April 2008 to February 2009 and our estimates for March 2009 We believe that demand strength in sectors such as two-wheelers, cement and steel, despite relatively weaker economic growth and investment cycle, is a direct result of this stimulus.

Given the weakness in revenues, we expect growth in government expenditure to start to fall. Our economist projects expenditure to grow 25% in 1H FY10 and then decline 2% in 2H FY10, bringing the full-year FY10 expenditure growth to 9.1% y-y, ahead of the government’s estimate of 5.8% y-y. We continue to assume large fiscal slippages and believe spending numbers are unlikely to be higher than our estimates, since a higher stimulus is likely to be harmful from a long-term fiscal perspective. Thus, there is little scope to be more positive than this on the government’s ability to stimulate the economy, in our view.

While there is likely to be a gradual pick-up in activity and demand from households and the private sector, this might not fully offset the slowdown in government expenditure. The impact of lower government expenditure should begin to be felt in the second half of FY10.

There has been a broad rally in the markets based on the green shoots of recovery. While not denying the structural growth resilience of economy, we note that expectations in some sectors have run ahead of fundamentals based on the demand pick-up. We advise caution in these sectors, the key ones being cement and two-wheelers.

To see full report: EQUITY STRATEGY

>Global Bank Rating Trends Q109 (Fitch Ratings)

This publication continues the series dating from the beginning of 2006, and presents data for the four quarters up to and including Q109. Data from Q105 are included in earlier publications. New charts showing the distribution across rating categories are also included in this publication.

Global Overview
Significant economic pressures continue, particularly in some emerging markets, although the crisis conditions following the bankruptcy of Lehman Brothers on 15 September 2008 have abated. This is partly due to the liquidity and capital support from the governments and the acquisitions of weaker banks by stronger banks. In addition to their willingness, the ability of sovereigns to continue to support their banking systems has received increased focus recently. Fitch Ratings forecasts that the real economies of many developed economies will contract significantly in 2009. Fitch also forecasts world GDP will decline by 2.7% this year, although growth in the BRICs (Brazil, Russia, India and China) is expected to remain positive at 3.2%.

Elsewhere in emerging markets, there has been increased attention on banking operations in eastern Europe, and several eastern European countries have received IMF assistance.

Negative rating actions in Q109 remained high, although the number was lower than the peak in Q408. Fitch took 188 negative rating actions in Q109, compared with 266 in Q408. The reduction was mainly caused by less negative rating actions in emerging markets in Q109, while negative rating actions in developed markets remained high. In contrast, there were no positive actions in emerging markets and only a small number of positive actions in developed markets in Q109. This resulted in the worst ratio of negative to positive actions since the series began in Q105 (−12.5).

There is also substantial negativity in the Outlooks assigned to banks’ Long‐Term Issuer Default Ratings (IDRs) globally in Q109. The number of global Negative Outlooks has exceeded the number of Positive Outlooks since end‐Q208. The global ratio of Negative to Positive Outlooks deteriorated significantly, to −16.2 at end‐ Q109 from −9.6 at end‐Q408 (see Chart 1). By end‐Q109, the ratio stood at −11.3 in developed markets (end‐Q408: −6.2) and −24.0 in emerging markets (end‐Q408: −15.0). Significant differences remain among regions in both developed and emerging markets. In developed markets, this ratio varied from −3.7 in the developed Americas to −25.0 in developed Europe. In emerging markets, the ratio at end‐Q109 ranged from −2.4 in the emerging Americas to −75.0 in emerging Europe.

The percentage of Fitch’s global bank ratings universe with Stable Outlooks continued to decline moderately (see Table 1). However, the majority of ratings (66.1%) had Stable Outlooks at
end‐Q109. Most of the remaining banks had Negative Outlooks at end‐Q109 (24.1%). In addition, 1.5% of bank ratings were on Positive Outlook.

The negativity in Fitch’s bank ratings suggests the negative trend will continue. This is somewhat mitigated by Fitch’s view on sovereign support within the banking sector (see “Updated Support Rating Floors for Major Banks in High‐Grade Sovereigns”, dated 9 April 2009). Fitch’s Support Rating Floors in many developed markets remain at relatively high levels and therefore limit downgrades in Long‐ Term IDRs.

Trends in Rating Outlooks and Watches

Developed Markets
Although 68.6% of bank ratings in developed markets still had Stable Outlooks at end‐Q109, the proportion of Negative Outlooks increased to 19.5% (end‐Q408: 16.6%). There was an increase in Negative Outlooks in developed Asia during Q109. However, the largest numbers of Negative Outlooks at end‐Q109 were in developed Europe (50) and the developed Americas (22), with no change in the number from end‐Q408. The ratios of Negative to Positive Outlooks have deteriorated significantly in the developed markets overall and particularly in developed Europe and developed Asia (see Chart 2). In addition, there were 38 Negative Watches in developed markets at end‐ Q109.

To see full report: GLOBAL BANKS

>Hedge Fund Monitor (MERRILL LYNCH)

HFs short 10-year T-note to levels not seen since April ‘05

Large Specs buy gold, 2Y-Ts; sell NDX, oil, US$ and 10Y-Ts
Note: Commitment of Traders data reflects positions as of last’s Tues close
Equities: Large specs decreased their net long position in the S&P 500 futures last week while also continuing to pullback on their crowded longs in the NDX. In recent weeks readings in the NDX reached their highest levels since Oct 07- when the NDX subsequently fell 6.7% 1month on. Large specs also added to their shorts in the Russell 2000. HFs are still a source of liquidity for the markets but less so with a potential buying power of ~$9b, consisting of $6b in the SPX and $3b in the R2000.
Metals: Large specs marginally added to their gold longs last week, while aggressively buying silver. Additionally they modestly added to their net shorts in copper.
Energy: HFs sold crude oil last week to go net short, while adding to their deep short position in natural gas. Additionally, they marginally increased their longs in heating oil and moved sharply back into a crowded long in gasoline.
Forex: Large specs covered the Euro last week, while modestly selling the USD. They also added to their net shorts in the Yen.
Interest Rates: HFs increased their longs in the 2-Yr Ts, while increasing their significant shorts in the 10-Yr Ts. They also added to their shorts in the 30-Yr T-Bonds.

M/N and L/S hedge funds’ market exposure continue to improve

Our models indicate both M/N and L/S funds’ market exposure continuing to improve after falling rapidly in late March and early April; both still remain underweight equities though (pp 3-4). It is potentially bullish for equities if HFs, with substantial cash on the sidelines and facing significantly lower outflows in Q2, return to the markets. M/N HFs were big losers in April because of their sharp drop in beta during much of the current rally (for reference see Hedge Fund Monitor, 13 April 2009). We also note a significant shift by M/N and L/S funds towards Low quality from High. Low quality has significantly outperformed in this rally, but that may be changing.

Macros sell the SPX, commodities; buy the NDX, US$, 10 Yr-Ts
Our models suggest Macro HFs added to their crowded net short in the S&P 500 last week, while buying the NDX. Additionally, they continued to buy the US$ index and modestly covered their shorts in the 10-Yr Ts, while selling commodities. We also estimate Macro HFs were flat the Emerging markets and bought the EAFE markets.

To see full report: HEDGE FUND MONITOR

>Lanco Infratech (ICICI Securities)

Steadyfast Growth....

As per our recent interaction with the management of Lanco, the execution of its power projects is continuing at a fast pace. We expect the company to start commercial operations of Amarkantak-I (300MW) in the next 1-2 months. Lanco’s operational capacity will rise to 2,000MW from 500MW in the next 15 months. Other projects expected to be commissioned are Kondapalli-II (October ’09; 366MW capacity), Amarkantak-II (November ’09, 300MW capacity), hydro projects (20MW capacity) and Udipi (April ’10; 600MW capacity). Also, the EPC segment will witness growth as power projects worth ~Rs100bn and 4,000MW capacity are expected to achieve financial closure in the next 12 months. The recently won 3,000MW power projects, Rajpura & Dhopave, and the Vizhinjam port project will provide additional impetus to orderflow. Given the visible growth in Lanco’s EPC orderbook, discounted valuations for the power portfolio and healthy execution of its power projects, we maintain BUY on Lanco with revised target price of Rs274/share from Rs206/share.

Liquidity concerns overdone. Lanco’s cash & cash equivalent and outstanding debt was at Rs10bn and Rs53bn respectively as of end Q3FY09. We believe this is adequate to fund the company’s capex. Cumulative capex for under-construction power projects of 4,000MW capacity was at Rs168bn, of which ~Rs65bn has already been expended, with an equity contribution of Rs22bn (34% of the total project cost). We expect Rs20-25bn equity requirement for projects under
construction over the next three years; this could be met by annual cashflows from the EPC business (~Rs4bn) and operational power plants (~Rs4-5bn). We believe that current reserves are sufficient to meet equity requirements of planned projects that are yet to achieve financial closure. Lanco’s foreign exchange risk from equipment purchase post the buyer’s credit utilisation breaks even at ~Rs49. The company’s real-estate portfolio is cashflow neutral; its residential segment has
advances of Rs3bn (2.5mn sqft sold of 4mn sqft) and equity contribution of Rs2.6bn, with ~Rs6bn debt outstanding. The company has slowed down the execution of the commercial portfolio and will await better environment to launch its projects.

Valuations. We raise our NAV estimates to Rs60bn or Rs274/share from Rs45bn or Rs206/share earlier. Based on FY09E, FY10E & FY11E EPS estimates, the stock is trading at P/E of 14.4x, 12.2x & 8.6x respectively. We expect earnings to remain stable as revenues from EPC division (50% contribution) are dependent on execution of internal power projects and earnings from power plants would steadily increase owing to commissioning of new projects. Lanco is trading at FY11E P/BV of 1.6x. Maintain BUY.

To see full report: LANCO INFRATECH


Educomp Solutions’ standalone revenues grew lower than expectations at 56% YoY and 27% QoQ to Rs1.84bn (I-Sec: Rs1.94bn). With higher admin costs, depreciation and interest, operating profits before taxes (OPBT) declined 9% QoQ to Rs500mn. OPBT margin declined 10.7ppts QoQ to 27.2% (I-Sec: 34.3%). PAT rose 73% to Rs545mn after Rs369mn write-back of forex loss on MTM of FCCBs (as per the option provided in amended AS11). The management has guided for Rs10-10.5bn FY10 consolidated revenues and Rs2.1-2.2bn PAT, implying 58-66% YoY growth, broadly in line with market expectations. With lower-than-expected Q4FY09 results and in line FY10 guidance, we expect the stock to be under pressure in the short term. Educomp’s diversified business model is less prone to slowdown with strong annuity-based cashflows providing high and sustainable growth visibility in the long term. We believe robust growth momentum will continue in Smart_Class and K-12 schools, which are the key growth drivers for the company, while ICT and other businesses/acquisitions would supplement the strong growth. The management expects better financial performance from subsidiaries/acquisitions in FY10. We expect 43% CAGR each in consolidated revenues and PAT over FY09-11E. Maintain BUY with Rs2,950 price target (at FY10E P/E of 26x).

Strong traction in Smart_Class, with 120% YoY revenue growth to Rs1.1bn in Q4FY09. Educomp added 258 schools to its Smart_Class portfolio, taking the total to 1,737 (surpassing its guidance of 1,700) and covering +1.98mn students. The management has guided for healthy Smart_Class school additions (to cover 2,800- 2,900 schools) in FY10. To ensure continued robust growth in Smart_Class, Educomp plans to: i) add 40 sales personnel to the existing 180, ii) increasingly provide hardware upfront to the schools, thereby reducing cashflow requirements, iii) improve logistic facilities and iv) outsource resource co-ordinators. We expect
strong 53% CAGR in Smart_Class revenues over FY09-11E.

K-12 initiatives on track. At present, Educomp has 14 operational schools with 14,000+ students. Admissions have started for six more schools and three schools would be added by June ’09. Educomp has visibility for 20 more schools in FY10. We expect 46% revenue CAGR from K-12 initiatives over FY09-11E.

ICT and other businesses/acquisitions. Educomp has guided to add 5,000 schools in ICT for FY10. Pre-school brand, Roots to Wings, is present in 169 centres, while Eurokids has more than 450 pre-schools; the management intends to have presence in >1,000 pre-schools in the next two years. Raffles Millennium International Institute is operational in Delhi and would also be started in Bangalore.

To see full report: EDUCOMP SOLUTIONS