Sunday, July 26, 2009


US: Thinking Ahead

• 10Y Treasury yields have risen 150bps since the beginning of the year, begging the question as to whether 3-4% is the 2H09 trading range or yields will fall back into the 2-3% range that prevailed from Jan09 to Apr09

• The case for higher yields has strengthened because a recovery story has gained traction. But for yields to remain above 3%, the market has to remain focused on inflation and not deflation. The inflation outlook remains the primary driver of Treasury yields; the growth outlook and supply outlook remain secondary

• Contrary to the common view that supply has been pushing yields up at the long end, we think that the market has merely repriced itself in 2Q09 to reflect better macro data and lower risk of deflation

• With recovery now being priced in, what is the most reasonable yield curve scenario ahead?

• A simple regression model suggests that 3-4% is a reasonable trading range for 10Y yields in 2H09.

• 10Y yields above 3% are consistent with expectations for positive GDP growth, core PCE inflation staying above 1% and upward pressure on 3M Libor in 2010

• As there are still question marks as to how strong deflationary pressures are and how strong recovery will be, yields are unlikely to rise above 4% in 2H09

• As the inflation outlook remains key, and inflation should remain low in the near-term, 10Y yields are more likely to fall into the 2-3% range than rise into the 4-5% range in 2H09

• Until the Fed starts to hike rates, the 2Y/10Y curve is likely to continue to exhibit a flattening bias into rallies and a steepening bias into sell-offs

To see full report: INTEREST RATE STRATEGY


Ramp up continues

Zee News (ZNL) registered healthy Q1FY10 results, with ad revenues growing a moderate 22.7% YoY to Rs1,091mn and subscription revenues growing 25.2% YoY, albeit but declining 7.2% QoQ on account of seasonality. The positive impact of elections on ad revenues was negated by the general slowdown. Cost rationalisation paid off, with 310bps QoQ increase in EBITDA margin to 18%. PAT of Rs119.2mn was impacted by higher-than-expected finance costs of Rs77mn (ISec:
Rs58mn) on account of debt increasing to Rs2.25bn from Rs2bn at end- Q4FY09. While ZNL’s channels continue to gain GRP shares in most markets and costs in the new business segment remain under control, the increasing debt & high interest costs pose a risk to ZNL’s valuations. Increase in competition in Bengal and poor performance of Zee Tamizh is also a drag. We maintain BUY on ZNL, with target price of Rs45/share based on FY10E EV/sales of 2x.

Ad slowdown negated positive impact of elections; Pay TV revenues down QoQ on seasonality. Ad revenues grew 22.7% YoY to Rs1,091mn, with the positive impact of election-related ad spends negated by the ad slowdown. Subscription revenues grew 25.2% YoY, but were down 7.2% QoQ owing to seasonality, with DTH revenues growing 52% YoY to Rs100mn. Existing business segment revenues declined 3.4% QoQ, while new business segment revenues increased 5.8% QoQ.

EBITDA margin improved 310bps QoQ to 18% driven by 14% QoQ decline in programming costs and the shutdown of Zee Gujarati channel. SG&A costs increased 11.4% QoQ on higher carriage fees owing to addition of two new channels – Zee 24 Ghantalu and Zee UP News. New channels losses remained flat QoQ at Rs169mn, while existing business EBITDA margin increased 580bps to 41.9%.

PAT impacted by high interest charges. In spite of higher-than-expected EBIT, ZNL reported PAT of Rs119.2mn compared with I-Sec estimates of Rs123.4mn, mostly due to higher-than-expected finance costs of Rs77mn (I-Sec:Rs58mn). Debton -books at end-Q1FY10 stood at Rs2.25bn, up from Rs2bn at end-Q4FY09. Cash outflow for the quarter included Rs200mn in gross block, Rs300mn in Movies acquisition and Rs150mn in working capital.

Maintain BUY on ZNL, with target price of Rs45/share based on FY10E EV/sales of 2x. The stock currently trades at FY10E P/E of 17x and EV/EBITDA of 8.3x.

To see full report: ZEE NEWS



Yes Bank’s Reported PAT of Rs.100 cr. for Q1FY10 (84% y-o-y growth) ahead of our estimates. This was driven by better net interest income (NII) and higher treasury gain. NII grew 45% Y-o-Y and 5.5% sequentially to Rs.163 cr. Balance sheet growth moderated with advances growth at 26% Y-o-Y and 2.2% Q-o-Q to Rs.127Bn, whereas deposits grew 22% Y-o-Y to Rs.153Bn. Asset quality for the quarter improved sequentially with Gross NPA and Net NPA at 0.48% and 0.24% as against 0.68% and 0.33 % in Q4 FY 09 respectively.


Moderating Balance Sheet Growth: The balance sheet growth of the bank moderated to 24.6% in Q1FY10. The advance book for the bank grew by 26% YoY to Rs.12671 crore from Rs.10052, while the deposit base showed a modest growth of 22.2% YoY to Rs.15342 crore by the end of Q1FY10. CASA ratio improved to 9.48% at the end of Q1 FY 10 from 8.91% in Q1 FY 09.

Strong NII growth as NIM improves: Despite some moderation in Advances growth NII showed a strong growth of 45% (Y-o-Y) as NIM improved by 20 bps to 3.1% both on sequentially and on year on year basis as liabilities were re-priced and credit deposit ratio improved to 82.6% as against 80% and 76.7% in Q1 FY 09 and Q4 FY 09 respectively. Cost of funds decreased to 8.10% as against 8.40% in Q1 FY 09 whereas yield on advances stood at 12.5% Q1 FY 10 as against 11.6% in Q1 FY 09.

Mixed performance by different Fee Income streams: The bank’s noninterest increased by 61.7% Q-o-Q to Rs.145cr. primarily due to higher income from financial market stream (Rs.85 cr. in Q1 FY 10 as against 33 in Q4 FY 09). Fee from financial advisory increased by 24% Q-o-Q owing to better capital market condition. Traditional transaction banking income remained flat
sequentially at Rs.25 cr. Fee from third party products stood at Rs.9.9 cr.

Improving Asset Quality: Asset Quality improved sequentially as Gross NPA and Net NPA in percentage terms decreased by 20 bps and 9 bps. However on a yearly basis Gross NPA increased nearly 3 times although on a very low base. Going forward we believe asset quality to be under pressure, however we have assumed a lower slippage ratio of 1.25% and 1.75% for FY
10E and FY 11E as against 1.5% and 2.25% respectively as business environment has improved. Restructured asset stood at Rs.119 crs. i.e. 0.94% of advances as on end Q1 FY 10, which is well under control.

Well Capitalized: Capital Adequacy Ratio for the bank stood at 17.63% with Tier I Capital at 10.28% and Tier II at 7.35%. We believe this provides adequate cushion to grow its balance sheet given its growth aspiration.

To see full report: YES BANK


Strong Q1 Helps FY Earnings Outlook; Move to EW

Investment conclusion: Wipro’s operating performance exceeded our expectations in the June 09 quarter. Margins were maintained across various businesses, and free cash flow yield improved to 7% on an LTM basis. Q1 performance set a strong base for FY10e. Despite sluggish revenues, we believe Wipro could deliver stable earnings for the year, and we are upgrading Wipro to EW with a price target of Rs410.

June 09 Results: Wipro reported revenues of US$1033m (+1.3% qoq, -3.3% yoy) and met its
guidance. Q2FY10 guidance of US$1035m -1053m implies 0-2% qoq growth for Q2. Operating margins improved across various businesses yoy.

Conference-call takeaways: 1) Mgmt expects pricing pressure to prevail on parts of the business through the year. 2) Mgmt expects to maintain IT services’ margins if the environment stabilizes where it is currently. 3) Financial services, BPO, manufacturing and retail saw
some stability during the quarter.

Raising estimates: We are raising our FY estimates for Wipro by ~11-20% for FY10-11e to factor in stable margins for the year and adjusting tax rates for FY11-12e post the extension of STPI tax holiday for one more year. Given the steep run-up in the stock price over the last two weeks, Wipro currently trades at ~16x FY10e EPS in an uncertain environment. We would wait for market expectations to rationalize or indicators of a meaningful pick-up in the tech spending environment before turning more constructive on the stock.

To see full report: WIPRO



Welspun Gujarat's Q1FY10 results have been better than estimates.
  • Top line growth of 72.4% YoY
  • EBIDTA increased by 74.2% YoY, aided by foreign exchange gains
  • Increase in PAT to the tune of 94.3% YoY
  • Order Baclog of Rs 68bn
  • Valuation & Rating
To see full report: WELSPUN GUJARAT


Eclipse over, brighter days ahead…

The Q1FY10 result reported by Visa Steel came in pretty much in line with our expectations. The company after suffering significant losses for the last couple of quarters posted a net profit of 10.07 crores ( estimate 9.6 crores) in Q1FY10. Higher production, stabilization in realisation, fall in raw material costs and appreciation in INR against the USD helped the company to recover from its worst ever performances (during H2FY09). With the better prospect for domestic steel production and demand and thereby for coke, the outlook is appearing brighter for the company going ahead.

Highlight of the quarter
The net sales came at Rs 254.1 crore, almost similar to Q1FY09 figure, however, down by 11.2% Q-o-Q. EBITDA margin though fell by 1570 bps Y-o-Y, however, bounced back into positive territory against Q4FY09. Despite posting profits,the PAT on a Y-o-Y basis fell by 79%. Production volume on the other hand have improved both Y-o-Y and Q-o-Q.

Though overall prospect looks brighter than before, however, we remain cautious on the stock considering short-term uncertainty. In this scenario we value the stock in terms of P/ BV. Considering the recent development and the short-term uncertainty we value the stock at 0.8x of its FY10E book value of Rs 31.1, which takes the target price to Rs 25, a negative return of 7.4%. Thus, we upgrade the stock from UNDERPERFORMER to HOLD.

To see full report: VISA STEEL


Paying heavy interest …

Tech Mahindra reported 5.9% increase in revenues for Q1FY10 at Rs1113.0 crore (2% growth in constant currency). EBITDA margins dropped 180 bps qoq to 25.2%. Profit at Rs131.6 crore declined 43% qoq. The huge fall in bottom line was due to increase in interest outgo on account of debt taken for the Satyam acquisition. Exceptional item of Rs8.5 crore in relation to the write down off investment made in Servista in Q2FY09 also impacted bottom line.

Highlight of the quarter
The highlight of the quarter was the greater than expected interest payment for the debt taken for the Satyam acquisition. The interest outgo for Q1FY10 was Rs57.1 crore (ICICIdirect estimate Rs55 crore) compared to Rs2.3 crore in Q4FY09. The company has an outstanding debt of Rs2380 crore on its books as on June, 2009. Forex loss of $12 million lead to other income loss of Rs26.1 crore (ICICIdirect estimate of other income was Rs10.9 crore) compared to Rs7.8 crore in Q4FY09 also dented the profitability of the company. During Q2FY09 the company had made an investment in a UK based SI, Servista, for which it had to take a write down of Rs8.5 crore.

The company continues to see a decline in the traditional BT business which has been made up in Q1FY10 by the start of the Andes deal. The company expects pricing pressure from BT going ahead. Higher than expected interest expense and forex loss has made us revise down our FY10E EPS by 13%. We maintain our Hold rating on the stock with a price target of Rs720.

To see full report: TECH MAHINDRA


The financial crisis is not sparing the private equity industry. High uncertainty and a dearth of debt financing are making acquisitions difficult. The volume of new buyouts has slumped dramatically. The recession is hurting private equity (PE) funds’ highly leveraged portfolio companies particularly hard. Asset write-downs and lower returns are likely. Last year, European buyout funds lost over 25% in value on average.

But obituaries are premature. Two qualities help the private equity industry in the present crisis. Firstly, many (but not all) PE funds have considerable capital reserves. They can use these reserves to support portfolio companies or to seize new investment opportunities. Secondly, more and more companies are in need of restructuring. Here, private equity can leverage its traditional strengths.

Recession can be a good entry point. A historical comparison shows that the returns of the top PE funds are higher the lower GDP growth was in the year they first invested (vintage year). This suggests that PE funds benefit from price falls during a recession. However, the higher macroeconomic risks need to be taken into account, too. Moreover, not every potential seller is willing to accept drastically lower prices.

Private equity must adapt to new conditions and focus on old strengths. The market is currently highly sceptical of mega or highly leveraged buyouts. The focus is therefore shifting to small and mid-sized acquisitions and minority stakes. There is also growing interest in investments in emerging markets. In future, returns will be driven less by cheap debt and more by the traditional strengths in the operational and strategic modernisation of the portfolio companies.

To see full report: OBITUARIES


Sell: Decline of ~8.5% in Revenues and ~900bps in Margins QoQ

Revenues/margins significantly below expectations — Mindtree reported 1Q10 revenues of $62.1m, down ~8.5% qoq (CIRA expectation: $67.7m). EBITDA margins declined ~900bps to 16.6% and receivable days worsened to ~86 days (4Q09: 70 days). Significantly higher other income of Rs332m (4Q09: loss of Rs480m) resulted in higher than expected profit after tax of Rs567m.

FY10 guidance revised down post 1Q — MindTree management has revised its FY10 guidance lower just three-months after issuing full year guidance. Revenues are now expected to be $255m-270m (earlier $290m-300m) and net profit is expected to be ~Rs1.5b-1.8b (earlier Rs1.9b-2.0b).

Other highlights of 1Q results — Volumes declined ~3.4% while pricing declined ~3.8% sequentially, mainly due to fixed price contract slippages. Net forex gain in 1Q was Rs305m (loss of Rs493m in 4Q).

Tier-I vs. Tier-II: Increasing difference in trends? — While Tier-I players like TCS and Infosys have delivered good results in 1Q, smaller players like MindTree have struggled. We believe this is due to: (1) Discretionary proportion is higher for Tier-II players in most cases, and (b) More deals today are multi-year deals in maintenance, BPO and infra – where Tier-I players are better placed.

Maintain Sell; Revised guidance still not conservative — MindTree’s earlier guidance implied ~5-7% CAGR in revenues qoq from 2Q-4Q to meet FY10 guidance, a stretch in our view (see ‘Indian Tech’ report, 10 June 2009). Present guidance implies ~2-6% growth and risk of disappointment remains. The stock has appreciated meaningfully over the past few days along with the sector. Post this disappointment we see meaningful downside ahead. Maintain Sell.

To see full report: MINDTREE


Keep Buying the Dips

• India Is in a Sweet Spot
With relatively low institutional ownership, strong global and local liquidity, the prospective bottoming out of the growth cycle, reasonable policy momentum, the coming recovery in earnings growth, strong corporate balance sheets, stable politics, and fair valuations, Indian equities are in a sweet spot. We would continue to buy the dips in the market. Our June 2010 target for the Sensex of 17,000 implies a return of 15%. Our bull-case scenario takes the market to an all-time high in 12 months.

• Risks: Global and Local
The local risks are a failure of the monsoons, a surge in crude oil prices, failure on policy execution, and too much equity supply, where the global risk is another round of financial market difficulties. While valuations are not at levels that can completely absorb these shocks, we are comfortable taking risk given India’s better relative position in a world facing tepid growth rates and the low probability we assign to all these events happening at the same time.

• Our Portfolio Position: Moderately Aggressive
The only reason why we keep some dry powder is that we are unsure of the global situation. If the global economies improve, there is scope for more aggression with our portfolio. In the meanwhile, we believe that consumer and infrastructure sectors will lead the growth recovery and, hence, market performance. Accordingly, we are overweight Consumer Discretionary and Industrials in our model portfolio.



Bail-out or no bail-out: What effect on euro-zone long-term interest rates?

We will start off from the following ideas:

1- Some euro-zone countries may be faced with a public debt crisis in the future (rise in public

indebtedness leading to a funding problem, hence a rise in interest rates and insolvency risk, or at least inability to finance expenditure);

2- If these countries enjoy the solidarity of other euro-zone countries (in one form or another: loans, joint issuance, monetisation by the ECB, etc.), their public finance problem will be "spread out" over the whole zone; different sovereign debts of euro-zone countries should then be expected to become similar, with an average level creditworthiness (tightening in spreads, negative swap spreads);

3- If the no bail-out clause remains valid, this country will either be in crisis, or find a solution outside the euro zone (IMF). We would then be in a rationale of debt differentiation (widening in spreads, with the most solid countries enjoying low interest rates);

4- It is worth noticing that, until the crisis, there was a different rationale, which was key in the mind of the euro’s creators: convergence towards the interest rates of the most solid countries (Germany) for all euro-zone countries, with the credibility of the euro-zone’s rules.

To see full report: SPECIAL REPORT


SOE Divestment Policy: Missing the Big Picture?

India government is sitting on considerable assets: Our very broad estimate indicates that the total market value of government companies is US$406 billion. Our estimate, which we believe is conservative, excludes central government assets in the form of infrastructure facilities and operations that are not yet corporatized.

India’s divestment plan on a slow track so far: India has so far collected only about US$14.4 billion from divestment over a period of 18 years, an average of US$800 million p.a. About 87% of the divestment receipts are from the divestment of stakes without transferring management to the private sector.

Opposition to divestment protects only a narrow section of the population: The common concern is that divestment will result in job losses in the public sector. In our view, this argument misses the bigger picture as it focuses on a very narrow portion of the population. The total work force employed in quasi government entities (including public sector undertakings) of the central government is 5.9 million people, just 1.4% of the total workforce.

Formal efforts to protect labor actually work against labor’s interests: India is likely to add 141 million to its working age population of 750 million by 2018, according to estimates by the United Nations. Restrictive labor laws now in place have been a deterrent to employers, forcing them to prefer capitalintensive options over production. We believe the solution to rising unemployment in India is more flexibility, not less.

Gains from divestment can outweigh job losses in privatized PSUs: The government could, we believe, easily collect US$15-20 billion per annum for the next three to four years from divestment and invest this in rural and urban infrastructure. Indeed, we believe this would trigger a matching amount of investment in manufacturing by the private sector, boosting overall employment.

To see full report: SOE DIVESTMENT POLICY


Sugar business drives bottomline...

Dalmia Cement Q1FY10 results were broadly inline with our
expectations. Net profit grew 16.1% YoY and 32.3% QoQ basis. For Dalmia cements given the restricted presence in the Southern region and likely expectation of an over supply scenario in south which will translate into low return ratios, we maintain our HOLD rating on the stock.

Highlight of the quarter

Net sales grew 32.9% YoY to Rs 551.7 crore in Q1FY10 from Rs 415.0 crore in Q1FY09 due to higher cement and sugar volumes. The EBITDA margin has declined by 180 bps YoY to 27.8% primarily due to decline in margins from cement business. EBITDA has reported YoY growth of 24.7% to Rs 153.4 crore. The growth in EBITDA was mainly contributed by Sugar division. Interest expense have increase by 19.2% YoY to Rs 41 crore while depreciation has increase by 50.8% to Rs 30.2 crore due to capitalizations of Andhra Pradesh (AP) Plant The net profit has reported growth of 16.1% YoY and 32.3% QoQ to Rs 58.6 crores.


At the CMP of Rs 141 per share, the stock is trading at 6.4x and 6.3x its FY10E and FY11E earnings, respectively. The stock is trading at 4.4x and 4x EV/EBIDTA. Given the restricted presence in the Southern region and likely expectation of an over supply scenario in south which will translate into low return ratios, we maintain our Hold rating on the stock with price target of Rs

To see full reporrt: DALMIA CEMENT


Reserve currency debate – more than meets the eye

In March 2009, China triggered a debate by recommending to reform the international monetary system with a new super reserve currency. Many viewed this as a challenge to the USD’s role as the world’s dominant reserve currency. Since then, confidence in the greenback has been persistently dogged by fears that central banks might diversify their foreign reserves away from dollars.

To shed more light on the subject, we examined the history and evolution of the international monetary system. While we make no bold claims as to the outcome of this debate, we hope to shed some light on what we consider to be the more important issues in this debate.

We believe that the debate goes beyond the fireworks pressurizing the USD and its reserve currency status. To us, these calls are symptoms to a larger and more pressing problem that manifest itself most as a shortage in global trade finance. With the American consumer saving and not spending, the US is no longer able to maintain its long-held role of supply dollars for the expansion of the global economy and world trade without imperilling its fiscal position.

Suffice to say, this is not the first time the dollar’s status has been questioned and neither is it likely to be the last. Talks about adding the CNY to the IMF’s Special Drawing Rights (SDR) basket of currencies is not a new development. Ironically, the last time the SDR was expanded was in 1971 when Bretton Woods ended. Except that today we not talking about ending, but about the need for some form of new Bretton Woods system after the global financial crisis in 2008.

Nonetheless, the objective of expanding the SDR was the same then and now. The goal was to get other countries to help the US in its role to supply currencies to support world economic and trade activities. We see this as part of an evolutionary process where the post-WW2 world economy shifts its dependence solely on the US economy to other G7 nations. And today, the growth driver of the world economy has and is continuing to move away from the G7 nations towards the G20 economies. The lesson learnt in the 1970s was that while other currencies came to play a bigger role in the internationalization of the SDR, the dollar continued to dominate
the scene.

Apart from expanding the SDR, there is the other issue about creating and promoting the use of a new super reserve currency for payments in trade and investments. To us, this goes beyond the call to abandon the USD as the world’s chief reserve currency. Implicitly, and more importantly, this call to reform the international financial system may also be a proposition to abandon the flexible exchange rate regime that exists today. The common goal of Bretton Woods in 1944 and the search for a new Bretton Woods today is to rebuild the world economy via stability in exchange rates and commodity prices so that businesses can plan and implement investments. The use of a single currency by most countries as payments will be difficult to achieve without returning to a fixed exchange rate regime.

And before the world rushes to believe that the SDR will replace the USD, it must answer one simple question. Just as the US had to convince the post-war world that the USD would be “as good as gold” at Bretton Woods in 1944, China must first convince the world that the SDR will be “as good as dollars”.



How big is Asia?

Let’s be honest, it’s the only reason we’re all getting out of bed each morning. No matter the extent of credit crunching in other parts of the world, Asia is still around and, if things turn out right, it should one day be the largest market by far. Over a billion Chinese consumers – enough said. But, how big is the region, really? Papers are full of references these days. Take car sales, for example. Year-to-date, more cars have been sold in China than in the United States. Not bad, although US shoppers are taking a little time out for the moment, and the numbers may reverse again when they return. Elsewhere, turnover on the Chinese stock market is now higher than in New York, and even turnover in Asia ex Japan and China is roughly equal to that in the US; that’s a watershed, arguably, although the numbers are flattered in each direction by both overly bouncy Asian investors and their still despondent US counterparts.

These are all snippets. What about the numbers that matter: consumption and investment? We keep reading various estimates and forecasts, so we thought it would be worthwhile to settle the matter once and for all. Here’s what we did: we took nominal expenditure in USD dollar terms for 2008, converted at market exchange rates. For the projections, we used long-run forecasts for real growth. Using nominal growth rates introduces too many distortions as inflation varies a lot across countries. So we deem our approach defensible. What’s the bottom line? Asia isn’t going to carry the world. But incremental consumption growth is already helping to offset the weakness in the West. Moreover, in terms of investment spending, Asia rules the day. Those who benefit are commodity exporters and producers of investment machinery. Those who want to tap into an Asian consumer market have growth to look forward to, but scale can only be achieved by exporting to the
West. Asia is getting bigger, time to get out of bed.

To see full report: CHART OF THE WEEK