Thursday, October 22, 2009



In this document, we derive and analyse the fundamental relationship between an index’s volatility and the correlation and average volatility of its components:

This relationship holds in practice when correlation is above 0.15, and the number of components is above 202.

Section 1 reviews the definition of realised and implied correlation.
Section 2 derives the relationship from fundamentals.
Section 3 evaluates the strength of the relationship using statistical methods.
Appendix A is a short reference of statistical formulas.

To read the full report: FUNDAMENTAL RELATIONSHIP


Potential for Outperformance in Early Stage Growth: OW

Initiate coverage with an Overweight rating and a price target of Rs330, implying 39% upside: We believe valuations for the stock are very attractive, especially in the context of where other private sector banks are trading and the strong growth that we believe lies ahead for this bank. The stock is currently at 16.2x F2011e earnings, 2.3x BV, 9.3x Core PPOP, and is currently generating 20%+ ROE. We expect EPS growth to average 24% over F2010-12 (after factoring in a US$200 million capital issuance in F2011).

Potential for outperformance is large early in its growth cycle: With only 0.5% market share of system loans, Yes Bank in our view is positioned to grow its loan book faster than average, as it is at an inflection point in branch network and asset size. As it delivers on growth, we believe the stock has the potential to mirror the outperformance HDFC Bank and Axis Bank saw relative
to the market in the early stages of their growth cycles.

F2009 performance demonstrated capability: Yes Bank’s solid performance during the liquidity squeeze and impaired loan cycle in F2009 in our view demonstrated the underlying strength of its
management and the processes that it has put into place. While the impaired loan ratio for our coverage rose from 3% as of March 2008 to 5.8% as of June 2009, Yes Bank fared much better, with its ratio rising only from 0.4% to 1.4%.

Catalysts – development of liability franchise and evidence of early-stage growth story panning out: Yes Bank’s low-cost deposit or CASA ratio is currently at only 9.5%, significantly lower than that of peers. However, the bank has now reached critical mass of 100+ branches – as these branches mature and the distribution network expands further, we believe that Yes Bank will be able to organically increase its CASA ratio to 15% by F2012. A rise in low-cost deposits coupled with strong asset/earnings growth will likely be the catalysts that will drive the stock higher.

To see the full report: YES BANK

>ONGC biggest winner in NELP VIII (MERRILL LYNCH)

ONGC likely to be biggest winner in NELP VIII; retain Buy
70 exploration blocks have been offered under the eighth round of New exploration licensing policy (NELP VIII), which closed on October 12. The Tax holiday will be available for any gas that may be produced from NELP VIII blocks (uncertainty on tax holiday for gas from NELP I-VII blocks). We believe ONGC is likely to be the biggest winner in NELP VIII with allotment of 17 blocks including 11 in the highly prospective or high potential areas. Cairn India (CIL) is likely to be allotted two blocks with one block in highly prospective areas. RIL did not bid for any block in NELP VIII. We retain our Buy on ONGC.

Bids received for 36 blocks; Only one bidder for 21 blocks
Only 5 of the 70 blocks offered under NELP VIII were in highly prospective KG basin and 21 blocks were offered in high potential Andaman deepwater and Cauvery offshore basins. No bids were received for 34 out of the 70 blocks offered. There is only one bidder in 21 out of the 36 blocks that received bids.

ONGC may get 17 blocks; 11 in highly prospective areas
Indications are that ONGC is likely to be allotted 17 (operator in 14 blocks) of the 36 blocks for which bids have been received under NELP VIII. ONGC along with its partners is the sole bidder in 13 of these blocks. More importantly ONGC is likely to be allotted 11 of the 13 blocks in the highly prospective or high potential basins for which bids have been received. ONGC is thus
expected to be allotted 4 blocks in the Krishna Godavari (KG) offshore basin (operator in 3, BG operator in 1), 6 in Andaman deepwater (operator in all) and 1 in Cauvery offshore basin (non-operator). If NELP VIII allotment is in line with initial indications, ONGC's blocks in highly prospective areas would rise to 57 (46 NELP) from 46 (35 NELP) now.

CIL may get two blocks in NELP VIII
Indications are that CIL may be allotted both of the blocks it has bid for under NELP VIII. CIL is expected to be allotted one shallow water block in the highly prospective KG basin and one deepwater block in Mumbai offshore basin.

Other winners – Oil India, GSPC & BHP Billiton,
Oil India is likely to be awarded 9 blocks (all in partnership with ONGC). It will be operator in 2 of these 9 blocks. 1 of the blocks in which it is operator is in the high potential Cauvery basin. BHP Billiton is expected to be allotted three blocks. GSPC is expected to be the allotted 4 blocks, all of them in partnership with ONGC.

To see the full report: ONGC


A leveraged play to the recovery in financial services IT spending

Initiate coverage with OW and Jun-10 P/E-based price target of Rs225; 50% upside: Polaris is one of the most leveraged plays in the Indian IT sector to the recovery of the global banking, financial services and insurance industries (BFSI), with 90% of its revenue from this segment. With Citibank already an anchor client and investor, we believe the global recovery is leading to good business traction at Polaris. We expect this traction to drive a 26% EPS CAGR over FY10- 12, leading to a gradual stock re-rating, driving our positive view.

The global financial sector recovery is driving increased spending on technology after a big freeze at the end of 2008/beginning of 2009. Several large Indian IT companies have seen more deal closures from BFSI companies worldwide, and we believe that the mid-cap sector is beginning to see positive momentum now. We expect Polaris to benefit from this, given its significant expertise in the BFSI sector.

Customer traction on the ground: Citibank is Polaris’ largest customer, contributing 40% of revenue and having a 40.6% stake in the company. As expected, Polaris saw a decline in Citibank business over the past two quarters. However, business from Citibank has bottomed out, according to management, and is now growing. Furthermore, Polaris has seen several new project wins, both from existing and new customers (such as HSBC and RBS), and these are
likely to slowly ramp up over the next 6-12 months.

Valuation, price target and risks: We estimate a gradual revenue acceleration leading to double-digit top-line growth in FY11/FY12 when the full impact of ramp-ups shows in numbers. Operating leverage combined with the elimination of hedging losses should drive a good 26% EPS CAGR in FY10-12E, after 13% growth in FY10E. Our PT of Rs225 is based on 11x forward P/E, at a 10-20% discount to other mid-caps in the sector due to its high sector focus. Risks to our
view and PT include high client concentration, and a deterioration in the global financial services sector outlook.

To see the full report: POLARIS SOFTWARE


Allaying execution concerns

Allaying execution concerns - Unitech has provided an operating update on its sales and project execution to date, a pleasant and encouraging surprise on disclosures. Key highlights are:

1. Total Rs40B of sales, 10.1 msf booked this year. The ASP of these sales is Rs3,870psf helped by contribution from commercial projects. Against this our estimate of sales for Unitech for FY10 is Rs62B (at ASP of Rs3,460). Typically, sales bookings are 2H weighted on account of festival season. However, UT does expect the ASP to come down to around Rs3,000psf going forward as contribution from Unihomes (affordable homes) starts to rise.

2. Onsite workforce has gone up +300% in 6 months to 15,600 people. Most of the ramp up is coming in from Gurgaon and Noida projects (core markets).

3. Focus is shifting towards project delivery. Of the total 30msf of ongoing projects (to be delivered over next 3 years):

  • There is 22 msf (10.7K units) of past projects which are expected to be delivered by Mar-11. Of this, on almost 5.7msf (26%), handover and finishing work is going on (i.e. deliveries are being done) and on 11.6msf (52%), structure is ready and internal work is in progress. Inflows and construction outflows on these projects are mostly matched and hence are largely cash flow neutral to the company.

  • Of the new projects (8msf) - on 3.7msf (45% of the projects), initial construction work has commenced. Against the total sales company has received 10-15% of the value as booking amount.

Maintain OW. Our PT of Rs102/share is based on a 2x adjusted FY10E BPS (ROE =20%, COE=16%, G=12%). Key risks to our PT include (a) Approval risk in new market entry; (b) Execution delays; and (c) de-rating of the physical property market (esp. in Mumbai/NCR/Chennai).

To read the full report: UNITECH