>Tech Mahindra acquires 51% stake in Comviva (JM Financial)

Comviva to strengthen mobile VAS offerings

Tech Mahindra acquires 51% stake in Comviva: Tech Mahindra has announced the acquisition of 51% stake in Comviva Technologies for a total consideration of `2,600mn. This includes upfront payment of `1,250mn and deferred payment of `1,350mn over a period of 5 years based on performance targets. Comviva had FY12 revenues of US$70mn with mid-teen
EBITDA margins. The transaction values Comviva at 1.3x FY12 EV/Sales and 8.6x FY12 EV/EBITDA assuming 15% EBITDA margins. Management expects the deal to be EPS accretive for Tech Mahindra. As per our calculation, the transaction adds c.1.5-2% to FY14 EPS.

Strategic intent of the acquisition: Comviva provides solutions in mobile data, integrated messaging, mobile payments etc. Acquisition of Comviva is in-line with TechM’s strategy of (a) investing in emerging areas such as Network, Mobility, Analytics, Cloud and Security, and (b) focusing on nonlinear growth. TechM already has presence in mobility solutions through its
subsidiary CanvasM, which contributes c.2% to total revenues currently. Comviva acquisition should further strengthen TechM’s VAS offerings particularly in the field of VAS infrastructure management and Mobile payment and platforms. The acquisition will also enable TechM to cross-sell Comviva’s offerings to its telecom clients.

Other details: The acquisition will add c.1,500 employees to TechM. Airtel is the largest client of Comviva and top-10 clients contribute c.85% to total revenues. Comviva derives c.30% revenues from VAS managed services and c.70% from platform-based solutions. Post deal closure, TechM will own 51% stake in the company, Bharti group 20%, PE firms 9% and employees the balance. Comviva had cash and cash equivalents of c.`320mn at end-Jun’12.
 
Maintain BUY rating with target price of `1,260 based on 12x 1 year forward P/E.

RISH TRADER

>NATCO PHARMA: Copaxone remains the key value driver:

Risk-reward remains favourable
􀂄 Strong operating performance in FY12: Natco posted 15% sales growth forFY12 at `5.2bn. During FY11, the company had divested one retail pharmacy store in US (sales of $10mn). Excl the US retail sales, underlying sales were stronger at 27%. EBITDA at `763mn was up 25% YoY while margins at 14.7% were higher 120bps YoY. The margin increase was driven by better product mix (lower US retail). Adjusted net profit at `596mn was up 2.8% YoY primarily due to higher taxes (at 26.1%). Domestic oncology sales at `1.5bn grew by 22% YoY driven by both volume and price increase.


􀂄 Base business earnings to be steady: We expect base business earnings to witness 9% CAGR for FY12-14 with FY13/14 EPS at `20/`22.9. We expect FY13/14 sales growth to be 11%/13% with EBITDA margins at c.20%.


􀂄 US opportunities to unfold in FY13; Copaxone remains the key value driver: We estimate NPV value/share of `275 for the 4 US opportunities. The earliest of the US launches will likely be Lansoprazole (Rx/OTC; `11/share) expected in FY13. Lanthanum launch is likely in FY14 (`13/share). The district court decision in the Copaxone litigation is expected near-term. Our NPV value of `160/share assumes 75% probability of launch reflecting the regulatory approval risk. We see a tentative approval for Natco’s filing as a key trigger which will raise the probability to 100% (independent of the litigation outcome; full value of `213/share). Our estimates for Copaxone are conservative and assume a 4-5 player market – earlier launch can provide upside to JMFe. Lenalidomide (at 75% probability) accounts for an NPV value of `91/share – although timelines are stretched.


􀂄 Maintain BUY; raise Mar’13 TP to `458 (from `375): We raise our FY13E EPS by 13% to `20.0. We introduce FY14 EPS of `22.9. Our Mar’13 TP of `458 is based on 8x FY14 base EPS and `275 for the US opportunities. Given litigation/regulatory actions expected in the near term, we see the risk-reward as favourable for the stock. Maintain BUY. Risks to our call are delay in approvals and negative outcome in litigation.

RISH TRADER

>LARSEN & TOUBRO: High investments in non-core and long gestation businesses

Best positioned to tide over the slowdown


■ Growth slowdown inevitable, but concerns exaggerated: L&T is one of the most diversified and the largest E&C player in India. It has far out-paced competition particularly on profitability thanks to 1) its highly integrated operations, 2) strong preference from private sector clients, 3) economies of scale, and 4) stringent risk management and controls. We believe that the concerns on slowdown, though not unfounded, but are exaggerated given 1) high order replacement ratio (>1.3x) despite sluggish environment, 2) superior cash flow generation and 3) strong long term potential.


■ Re-focus on globalisation – a step in the right direction: While L&T is considered one of the largest E&C players globally; it derives only c.10% revenues from international markets. However, with domestic outlook weakening substantially, the company has stepped up efforts in overseas markets, primarily Middle East. While this presents several near-term challenges, primarily stiff competition from Korean and European counterparts (much larger presence and are well entrenched in these markets), it will provide important geographical diversification, which is a step in the right direction in our view. The efforts have also started to pay off with some important break-through in the last year or so.


■ Near-term earning expectations need to be reset lower, but core returns healthy: Current earnings expectations need to be reset lower, in our view; we highlight that our standalone EPS estimates are c.11% below consensus as we have built in conservative set of assumptions on order inflows, margins, asset utilisation etc. While core business returns are set to decline from current levels (RoIC at 32.3% in FY11), they should remain enviable and healthy (we estimate c.22% in FY13-14E period).


■ Stock cheap by historical standards, opportunity to enter: After the recent correction, stock is trading at 11.7x FY13E EPS (adjusted for conservatively assigned values to non-standalone businesses), which is c.15% discount to Sensex (vs historic premiums of over 25-30%; the discount is similar to the ones during 2009 bottoms). We believe valuations have more than factored the impact of slowdown, while long-term fundamentals remain strong. We initiate coverage with BUY and Dec’12 TP of `1,275.


■ Key concerns: 1) High investments in non-core and long gestation businesses, 2) impending changes in business structure, 3) continuing deterioration in macro environment.


To read the full report: L&T
RISH TRADER

>POWER FINANCIERS: Power Finance Corporation (POWF) & Rural Electrification Corporation (RECL)

Light at the end of the tunnel

■ POWF and RECL are best placed to leverage on the massive investment opportunity: Over the next five years, c.$236bn is estimated to be invested in the power sector as India scales-up infrastructure in generation, transmission and distribution. REC and POWF are best positioned to leverage on the massive investment opportunity given a) IFC status which gives exposure limits advantage, easier access to ECBs. IFCs have a competitive edge over banks given better asset-liability profile. Further, most banks are approaching their sectoral limits for infrastructure sector which should reduce competitive intensity for specialised power financiers like POWF and RECL.


■ SEB default unlikely – losses may have peaked, tariff hike trend encouraging: SEBs have been under financial distress due to non-revision of tariffs, non-payment of subsidies and high merchant power rates. However, recent measures offer hope that their finances will improve going ahead led by a) 5-40% tariff hike across states over the last 18 months (Exhibit 2). Further, 3 of the 4 states (TN, UP, MP, Rajasthan) that account for c.70% of cash losses have already raised/proposed to raise tariff while UP will raise tariff post election early next year. b) APTEL facilitating suo-motu tariff increase by the regulator. c) Increasing pressure from lenders to improve finances by raising tariffs/improving efficiency. d) Declining power purchase costs which would provide much needed relief to SEBs. These measures are a step in the right direction and we believe financial position of SEBs will improve going forward, implying that default from SEBs for POWF and RECL is unlikely.


■ Fuel availability - A key risk: Coal and gas availability, in our view, is a significant threat which could restrict power supplies and impact financial viability of projects. Coal supply has been severely hampered due to a) Coal India unable to achieve sufficient production growth, b) delayed environmental clearances, c) infrastructure bottlenecks, d) blending limitation in existing plants, e) pricing issues on imported coal from Indonesia and Australia. However, recent steps by government to scrap go and no-go policy and granting environment clearances to some delayed projects should reduce this concern over the medium term (3 years); though fuel availability remains a key near-term risk which could lead to restructuring of projects (especially IPPs in the capacity range of 50Mw-100mW) and result in some NPV loss for power financiers.


■ Initiate coverage on POWF and RECL – BUY with TP of `205 and `220 respectively - recent SEB/government measures and decline in wholesale rates should act as key catalysts: POWF and RECL have de-rated significantly over the past 12 months due to concerns over financial health of SEBs (POWF currently trades at 0.95x 1yr fwd book, down from a peak of 2.9x; while RECL at 1.1x 1yr fwd book, down from a peak of 2.9x. Going ahead, we believe recent SEB/government measures and decline in wholesale borrowing rates from 1QFY13 (which will impact spreads positively) should act as key catalysts for stock outperformance. We initiate coverage on POWF with Mar’13 TP of `205 – current valuations are attractive at 0.9x FY13E book with dividend yield of c.5% (based on FY13E dividend). We value the stock at 1x FY14P/B (at 1.05x Mar’14 ABV - adjusted for bad and doubtful debt reserves) Initiate coverage on RECL with Mar’13 TP of `220 - current valuations are attractive at 1x FY13E book with dividend yield of c.5% (based on FY13E dividend). We value the stock at 1.1x FY14P/B (at 1.15x Mar’14 ABV - adjusted for bad and doubtful debt reserves).


To read the full report: POWER FINANCIERS
RISH TRADER

>The Banking Laws (Amendment) Bill, 2011

On 22 March 2011, the government tabled the banking laws (Amendment) Bill, 2011 in Lok Sabha. The bill proposes a number of amendments to the existing regulation of banking sector. The overarching theme is to allow banks more flexibility in strengthening their capital and empower the watchdog role of Reserve Bank of India (RBI).

# SOE banks to have additional tools and flexibility for raising capital

# Proposal to remove 10% restriction on voying rights

# Proposal to impose restriction on holding 5% or more in a banking company without prior approval of RBI.

# Empowering RBI's role as regulator

To read the full report: BANKING LAWS

>RELIANCE INDUSTRIES: Refinding growth

■ Petrochemical margins unlikely to sustain: We believe petrochemical margins would be under pressure in FY11E and FY12E due to increased supplies, particularly from Middle East. We arrive at the petrochemical margins by estimating operating rates based on global and Indian demandsupply, considering Middle East capacity additions and adding a domestic manufacturer ‘premium’. Annexure 7 lists the estimated margins and operating rates in petrochemicals business.

■ Refining margins to improve gradually: Refining margins have been under pressure over the last c. six quarters due to decline in demand and negligible refinery shutdowns (c.1.9mnbbl refinery capacity shutdown in CY09 while addition of c.1.5mnbbl capacity). However, we believe the margins seen in CY09 are unsustainable based on simple refinery economics and margins are
unlikely to decline from the levels seen in 3QFY10E. We factor in a slow revival in GRMs and estimate GRMs at $9bbl and $10bbl for FY11E and FY12E respectively based on light heavy spread and global demand-supply scenario.

■ High margin E&P business to start contributing substantially: The full impact of cash flow from KG is expected to be reflected in FY11E as production ramps up to 80mmscmd. With clarity on gas sales case between RIL-RNRL, we believe that full potential of the Exploration and Production business will ensure visible growth. Further, Reliance has started scouting for opportunities in unconventional energy (shale gas, oil sands) which could provide longer term benefits. Given the visibility in gas price, we value known predominant gas fields (KG D6, NEC and Coal Bed Methane blocks) on DCF basis and other fields on EV/BoE or EV/EBITDA.

■ Initiate with BUY: With two large businesses – refining and E&P – likely to show an improvement, we initiate with a BUY rating and target price of Rs1,260. This indicates an annualized upside of 18% on previous closing price. We use the SOTP method - valuing refining and petrochemicals business at 7x EBIDTA - and arrive at a value of Rs269 for petrochemicals business and Rs379 for refining business. We value E&P business at Rs572/share.

To read the full report: RELIANCE INDUSTRIES

>PETRONET LNG: 4QFY10 marginally lower than our estimate (JM FINANCIAL)

■ Marginally lower PAT: Petronet LNG reported 4QFY10 sales at Rs23,855mn, lower than our estimate of Rs24,860mn by 10% primarily due to gas volume being lower at 92TBTU against our estimate of 97TBTU. EBIDTA at Rs.202mn was lower than our estimate of Rs2,278mn by 13% on the back of lower volumes. However, higher than estimated other income (Rs331mn against estimate of Rs171mn) ensured that PAT at Rs974mn was only marginally lower than our estimate of Rs984mn.

■ Volume led growth in the near-term: Over the next three quarters, we expect volume led growth for Petronet LNG. For 1QFY11E, we had estimated that GSPC would import three cargoes, and the first cargo has recently been imported. In our previous report, we factored in LNG for Pragati Power and ONGC (C2-C3) extraction in 2QFY11E and 3QFY12E. However, with lack of clarity on Pragati Power and ONGC contracts, we defer volumes from both potential customers by one quarter each. Hence, we now estimate Pragati Power start-up in 3QFY11E and ONGC in 4QFY11E. However, our volume estimate for FY11E remains unaffected due to this change.

■ We retain our regas margin assumption: In our previous note, we highlighted the impact of the gas purchase cost on the company and estimated net regas margins at Rs27.0/mmbtu in FY11E. The 4QFY10 regas margin at Rs26.9/mmbtu is in line with our estimate and hence, we do not change the regas margin assumption.

■ Valuations; March’11 target price Rs91, BUY: Since our last report dated 25th January, 2010, Petronet LNG stock price has risen by c.7.5% from Rs76 to Rs81.8. With no change in volume or margins as highlighted above, we retain our target price of Rs91, indicating an upside of 11% from current levels and maintain our BUY rating.

To read the full report: PETRONET LNG

>Transmission & Distribution (JM FINANCIAL)

Competition growing
■ Chinese lead PGCIL’s transformer ordering with 91% mkt share…: Chinese steal the show by bagging 6 out of 9 projects ordered in the transformer space by PGCIL during the peak-ordering season of Jan-Feb’10. In value terms, Chinese viz. Baoding & TBEA Shenyang bagged orders worth Rs6.2bn out of the total Rs6.8bn, with a market share of ~91%. BHEL (BUY, Rs3,000)
and Crompton Greaves (BUY, Rs510) were the Indian players who bagged orders worth Rs233mn and Rs144mn respectively.

■ …aided by favorable currency movement: The Chinese currency depreciated 12.8% in last 1 year, inline with US$ decline of 13.1% (see Exhibit 2), leading to export competitiveness of the Chinese in India. Unfavorable currency movement can also loom a threat on BHEL and L&T, but with government machinery propagating domestic manufacturing, we will not be unduly concerned.

■ However, IEEMA is against unfair competition from China: The Indian Electrical and Electronics Manufacturers' Association (IEEMA) is already voicing against the 15-20% unfair advantage to Chinese firms and has been advising a safeguard duty to protect domestic manufacturers. We think a safeguard duty demand by Ministry of Heavy Industries (MHI) is likely.

■ 30% of transmission business trickled to sub-contractors: PGCIL ordered out tower packages worth Rs14.2bn in Jan-Feb’10 and a noteworthy point was the emergence of erstwhile sub-contractors competing against established companies. ~70% of business (see Exhibit 3) remained with Tata Projects, Jyoti Structures (BUY, Rs200), Kalpataru Power (BUY, Rs1,350) and L&T. We remain positive on the space on increasing orders from IPTCs and States too; competition remained one-off.

To read the full report: TRANSMISSION & DISTRIBUTION

>Oil Marketing Companies (JM FINANCIAL)

Kirit Parikh Committee – Logical recommendations but implementation difficult.

■ Logical recommendations: The Kirit Parikh Committee report has recommended a series of measures to make fuel prices in India sustainable and viable. These recommendations include increasing Kerosene prices by Rs6/lit (c.65% increase), increasing LPG price by Rs100/cylinder (c.30% increase) and totally eliminating the subsidy on Auto fuels – Petrol (or Motor Spirit) and Diesel. The Committee has also recommended that the under-recovery on LPG and Kerosene could be shared by the upstream companies like ONGC and OIL in a graded method based on the prevailing crude price.

■ but implementation unlikely to be easy: These recommendations make economic sense and we would be happy to see them implemented. We believe that increasing Petrol price is the easiest option as the increase required to bring Petrol price to International parity price is just c. 8% or Rs4/litre. In diesel, the increase required to eliminate under-recovery is just about 6% or c. Rs2/litre. However, given the concerns on inflation (particularly food articles inflation), we believe that it may not be easy to implement even a small increase in diesel price. We also believe that it will be impossible to implement a 65% increase in Kerosene price and a 30% increase in LPG price and the only solution is to increase the product prices in a phased manner (if international prices do not increase in the meantime).

■ Unless implemented fully, impact on under-recoveries minimal: We estimate FY10E total under-recoveries to be c. Rs451bn with LPG and Kerosene contributing c. Rs313bn and Rs138bn under-recovery due to Petrol and Diesel. These estimates are based on current crude and product price and current forex. LPG and Kerosene subsidies make c.69% of the total under-recoveries and if the prices of these products are not raised, this will be just another committee with one more report.

■ Impact on companies: The Oil Marketing Companies – Indian Oil, Bharat Petroleum and Hindustan Petroleum are likely to benefit primarily by way of improved cash flow. ONGC and OIL India would benefit as there would be a clear and transparent method of calculating the under-recovery. The biggest beneficiary of the recommendation is likely to be GAIL, which has not been mentioned and is therefore likely to be excluded from the under-recovery process. In FY10E, GAIL has already borne under-recovery of Rs9.9bn in 9MFY10 and therefore on an annualized basis, EPS of GAIL would improve by c. Rs6.7/share.

To read the full report: OIL MARKETING COMPANIES

>HINDUSTAN UNILEVER LIMITED (JM FINANCIAL)

■ Building a steadier tomorrow for itself: The cover page of HUL’s 2002 annual report read: “We do not inherit the world from our ancestors. We borrow it from our children”. We are keen to believe that HUL’s laundry price adjustments (c.12% cut in Surf, c.25% in Rin) and all other initiatives to offer ‘better consumer value’ reflect steps towards building a steadier future for itself. 4-5%-pts market share losses in laundry/soaps over past 12 months coupled with prolonged period of sub-peers growth rate highlighted that HUL’s stance of aggressive price hikes and margin-consciousness (we suspect some of this was even at the cost of product quality) weren’t really the most optimum strategies in a fiercely competitive market place. Given its distribution muscle, a right price-cum-quality value mix is perhaps a good first-step to help HUL address the issues. In our end-Dec’09 management meeting, HUL’s CFO had indicated that the company remains committed to participating in the huge growth opportunity in the Indian
market, even if (hypothetically) it brings with it the need to lower its operating margin-profile from the current level. Refer our report “CFO meeting notes: portfolio, premiumisation & profitability” dated 23 Dec 09 for details

8-10% earnings and TP cut; will there be light?

.
■ Near-term earning weakness imminent; cutting FY11-12E EPS by 8-10%: While HUL’s aggressive ‘competitive growth’ strategy appears to be the right step, near-term earning weakness is imminent. As per our workings, the pricecuts are likely to result in 5-6% cumulative drop in laundry realization over FY10- 11E and a 225-250bps compression in soaps & detergents segment gross margin. We estimate Surf and Rin’s share in HUL’s laundry revenue to be 30-35% and 15-20% respectively. Note that the cumulative drop in laundry realization over 2003-04 (P&G price war) was c.6%. We have, however, cushioned some margin impact by building in moderation in A&P growth going forward as: (a) HUL has already hiked spends aggressively in FY10, (b) Lower prices may gradually replace A&P. We are also assuming that HUL’s cost savings plan will continue to yield results.

■ Reducing target price to Rs253; continue to prefer ITC for a premium growth profile: We have lowered our FY11-12E EPS by 8-10% based on the effected price adjustments (P&G yet to react but is quite likely to), ‘equalization’ of prices of other Surf and Rin SKUs and building in slight cut in Wheel as well. Our revised EPS estimates for FY10-12E are Rs10.0, Rs10.6 and Rs12.2. We continue to prefer ITC on account of its premium growth profile. Refer our note on ITC “Portfolio power: multiple drivers of growth” dated 25 Jan 10 for details.

To read the full report: HUL

>Industrials and Power Utilities (JM FINANCIAL)

■ Industrials will continue with good results. However, the transformer sector – which includes ABB, Areva and smaller transformers companies like Voltamp, Emco and Indo Tech Transformers – is an exception, as demand <>

■ T&D EPC companies’ results are likely to improve on enhanced order inflows and improving international T&D demand.

■ Power Utilities - NTPC will post good results because of 4% higher generation while Tata Power will see de-growth in revenues (-4.8%) due to flat generation.

■ Our top picks for the sector remain BHEL, Crompton, Kalpataru Power and Suzlon.

■ India has added ~3.7 GW in 3Q FY10 (8.1 GW in 9M FY10).

■ Base deficit stood at 9.5% for 3Q FY10, while peak deficit remained at 12.7%. Higher gas and nuclear availability offset lower hydro generation.

■ Lower seasonal demand and higher volumes led to decline in spot rates (average price of Rs5.3/kWh, while the peak was at Rs8/kWh on power exchanges.

To read the full report: INDUSTRIALS & POWER UTILITIES

>SUZLON ENERGY (JM FINANCIAL)

■ 1H’10 results uninspiring… Suzlon reported consolidated 1H’10 Sales -7.5%, EBITDA -88% and reported net loss of Rs10 bn vs. Rs2 bn loss in 1H’09. Costs were higher on increased fixed costs on new facilities (capacity ~2x to 5.7 GW in FY09-10) and lower WTG delivery volumes (-62% YoY in 1H’10 to 406 MW).

■ … but debt woes easing: Investors’ worries on high debt and its serviceability are easing as Suzlon sold Hansen’s 35.22% (of its 61.28%) stake to raise US$370 mn. The company has repaid US$780 mn worth of acquisition loans through combination of Hansen stake sale and refinancing from a new US$430 mn offshore facility from SBI. It may also convert promoter’s Rs12 bn loan to equity through preferential/ or rights issue (see Annexure I).

Global demand rising

■ Visibility improving; ~23 GW of wind capacity addition probable: Improving global economic scenario, continued policy support and higher credit availability has led to better order visibility for WTG companies. Developments over last 6M are promising- a) ~$1.7 bn cash grants have been infused in the system; b) MoM improvement in order inflow to 350 MW/month (from 150 MW/month in Aug) + large framework on-shore orders being placed (954 MW to REpower); c) ~700 MW wind projects commissioned after debt tie-ups. d) Gamesa estimates wind projects under development at ~23 GW, with ~2.2 GW projects to be ordered soon; and e) Iberdrola, EDP, Duke have not just raised wind capacity targets but also raised funds for future expansion (Exhibit 14).

■ Indian regulations bode well for Suzlon’s growth; market size may increase from 1.5-2x to 4 GW/pa: Regulatory changes in the form of new RE tariff norms (15.8% PT-ROE) and draft regulations for RE Certificates are a precursor to national RE Purchase Obligation (RPO), which has been agreed to by Forum of Regulators at 5% for 2010, & 1% increase p.a. till 2020. We think Indian markets will inch to 4 GW/p.a by CY’11 from ~1.5-2 GW/pa currently.

■ Price target lowered to Rs95; Maintain Buy: Post Hansen divestment, there is lack of clarity on Suzlon’s consolidated balance sheet. We have cut our estimates to factor in lower volumes; unconsolidated Hansen (considered as profit from associates) and introduced FY12E (Exhibit 18). We have changed our valuation methodology from DCF to a one-year forward PE multiple, and now value Suzlon Wind at 15x FY12E earnings, at a 25% discount to current peers’ average (20x), while REpower and Hansen are valued at 18x. We get a Mar’11 target price of Rs95 for fully diluted equity of Rs3,835 mn including Rs1.0 bn YTM for out-of-the-money FCCB. Maintain Buy as- a) we remain optimistic on recovery in wind taking lead from positive commentary by Siemens, REpower & Crompton; b) regulatory push & market expansion in India; c) easing debt concerns; and d) management’s focus to legally integrate REpower in FY11E.

■ Risks: Oversupply concerns in China and their possible global foray could lower WTG prices. 200 MW variation in volumes will vary earnings by ~7%.

To read the full report: SUZLON ENERGY

>HINDUSTAN ZINC (JM FINANCIAL)

Missing the zing thing…

■ Largest integrated zinc producer globally by FY11 - Hindustan zinc with ~5.9% (CY2008) share in total global production is currently the fourth largest zinc producing company globally. Expansion of lead-zinc metal capacity from the current 762ktpa to ~1mtpa by June 2010 will
catapult it to the top position globally.

■ Low cost producer with captive mines & captive power - Its high grade captive mines (Zn 11.4%; Pb 1.9%) with a mine life of over 20 years, represent 25m ton of equivalent zinc metal and 6.1m ton of lead metal. Captive power plants (437 MW) meet ~80% of its requirements placing it in the lowest deciles of global cost curve. Decline in international coal prices and sourcing from domestic linkages will reduce power costs further.

■ Zinc medium term price outlook to remain subdued- We believe that the recent run-up in zinc prices (55% YTD returns) would be capped due to slowing imports from China, high inventory levels and incremental supplies of ~1.1m ton of Chinese smelting capacities waiting on the sidelines. ILZSG expects a surplus of ~ 299k tons in 2009 and ~ 397k tons in 2010. Zinc is trading at ~US$1,900/ton on LME which is 47% higher than the 90th percentile cash cost of US$1,296/ton.

■ Valuations – Presence in the lowest deciles of global cost curve, aggressive capacity ramp up to 1mtpa (June 2010) and strong balance sheet with net cash of Rs228/ share, positions the company to benefit the most in case of demand and price recovery. However, a subdued price
outlook for zinc coupled with a sharp run up in stock price (~144% YTD) caps further upside. We value the stock at Rs 787/ share based on 5x FY11E EV/EBITDA. We initiate coverage with a HOLD rating.

To see full report: HINDUSTAN ZINC

>ROAD INFRASTRUCTURE SUMMIT (JM FINANCIAL)

Driving India’s economic growth – From IT to Infrastructure

■ Ushering in the change by reaching out to investors: We cohosted Mr Kamal Nath, Union Cabinet Minister for Road Transport and Highways. The panel members included other luminaries like NHAI chairman Mr Brijeshwar Singh and Mr Brahm Dutt, Secretary, Ministry of Road Transport and Highways. This was Mr Kamal Nath’s first investor meeting post taking over the Ministry and shows the new and progressive outlook the government has on building infrastructure.

■ Open to suggestions and new ideas that can help improve execution: Mr Kamal Nath emphasized the role of infrastructure and particularly roads in driving the economic growth. He highlighted the importance of domestic demand, in the current global downturn and India’s favourable demographics. The minister reiterated his commitment to achieve development target of 20km of roads per day. His commitment and zeal was seen in his eagerness to listen to
suggestions. He invited suggestions on improving transparency, efficiency in bidding/awarding projects and innovative means of financing to meet the investment target for NHDP. The minister was confident to smoothen out issues on an urgent basis and will look into ways to make road sector projects more investor friendly. He highlighted that his focus was to decentralize and work closely with all stakeholders like various state governments, investors, developers etc. in implementing best practices.

■ Aggressive targets have been well thought-out with clear workplans: The last 2 years have not seen much progress with NHDP projects with only 9 projects being awarded in 2008-09. Mr Kamal Nath explained that even though the progress appeared slow, this was an important phase as the government has gained tremendous experience. Mr Singh presented a detailed work plan to award 126 projects covering around 12,000 km in 2009-10. Of this, 65 projects are expected to be open for bidding in Q2/Q3 FY10.

■ Land acquisition remains a major concern for investors: Investors expressed concern the fact that land related issues caused delays in project implementation leading to cost and time overruns. Mr Nath highlighted that with 80% of land being made available even before bid and balance 20% being notified, risk should get reduced. He also seemed open to increase the availability to 90%. A number of suggestions were put forward: innovative structures for bidding (eg. Swiss Challenge), easy access to superior technology for developers, private investment in projects (eg, NPV based concession period, monetizing land value), relaxing exit clause for developers to allow entry of investors post-completion. Mr Kamal Nath invited suggestions/white papers on these topics directly addressed to him.

To see full report: ROAD INFRASTRUCTURE

>INFORMATION TECHNOLOGY SECTOR (JM FINANCIAL)

Industry interaction update

Our interaction with industry experts across the BFSI (US, Europe) & Telecom (Europe) from Gartner on the business and IT demand environment pointed to early signs of stability in the North American market. Europe, however, remains troubled, and could lead to continued stress on IT vendors in the current fiscal.

US BFSI seems to stabilizing, but Indian ISPs are still reeling under pressure with services such as Application Development and Package Implementation (where they have greater presence) continue to be rationalized. While consolidation could bring in some short term M&A work, industry experts think it is unlikely to compensate for overall budget decline.

BFSI demand in Europe remains under stress, with critical economies such as the France, Netherlands and Germany still under fire. Consolidation is also far from over in Continental Europe. Offshoring maturity continues to remain low, with clients preferring near shore delivery over the pure play offshore model.

Telecom Service Providers (TSP) have been relatively stable in Europe and could see better budget disbursals in 2H CY09E. However, BT, which is the largest offshorer, continues to be the pain point for ISPs given the restructuring in the BTGS division, and problems in its core Fixed-line carrier business.

Banking and Financial Services (BFSI) -US:

■ US stabilizing, some up tick in discretionary spend but…: Gartner believes that BFSI IT budgets in North America are seeing signs of stabilization with a marginal recovery in discretionary spending. However, the bulk of the activity is currently focused at opposite ends of the services spectrum, namely Consulting and ITO. Such contracts are currently being awarded to pure play consulting companies such as IBM, Accenture, KPMG, Deloitte, or strong infrastructure vendors such as IBM and HP-EDS who are willing to leverage their balance sheets.

■ …. Indian vendors (ISPs) are still facing the heat: The sweet spot of ISPs, namely Application Development and Package Implementation (~25% and 20% of revenue respectively), continues to remain under pressure. Gartner’s recent 1Q CY09 IT services update (02 July 2009)
suggests that Consulting, followed by System Integration and Application Development could lead the revival cycle. However, no such signs seem to be visible in the US BFSI sector at present. .

■ Testing could offer ISPs some relief: ISPs seem to be having better luck with Testing deals (4-7% of revenue), where volumes have witnessed a moderate pick up. However, our channel checks suggest that pricing pressure continues to be intense for these services.

To see full report: IT SECTOR

>TECHNICAL ANALYSIS (JM FINANCIAL)

The Show Is About To Begin

Big Test For The Bulls At 15250
The indices witnessed a quiet first half last week as they consolidated in a range and took support at the mentioned level of 14300 only to rebound and end the week on a strong note. There are minor bullish triggers on the pattern and indicator studies hinting at a rally into the resistance zone of 15100-15250 (4500+ on the Nifty) this week. For the Sensex to re-visit and break past its recent high the level of 15250 will have to be taken out on a closing basis. A short-term base has been formed in the 14000-14300 zone (4100-4200 on the Nifty) and only on a close below the same does the uptrend come under threat, which seems unlikely. Broadly the index continues to consolidate within the 14000-15600 zone from which an upside breakout can be expected sometime this month. The moving averages have not been broken even once since the uptrend began in the 1st week of Mar 09 and hence the same needs to be monitored regularly going forward. The charts suggest that the Banking sector might be the biggest beneficiary from the event this Monday. The sector could move up 12-15% within a few weeks. Most Asian markets continue to be safely placed above support levels while the DOW (DJIA) is likely to see a rebound from the 8000-8300 support zone.

Patterns – Nice And Clear
The rally last Friday was encouraging as it helped the indices move above minor resistance levels and negate a bearish “Evening Star” pattern that existed on the daily chart. At this point a new “Ascending Triangle” pattern can be spotted on the hourly chart that should take the Nifty into the 4500-4530 zone.

GAIL – One Step Up
After trading sideways for many weeks the stock has confirmed a major breakout late last week that should lead to sizeable upside in the short and medium-term. A move back to its lifetime high of 367 is likely within a few months or earlier. Anant Raj Industries – Ready To Freeze The stock has developed a strong set-up in the last few weeks. By taking out the resistance of 108 last Friday on good volumes the stock has confirmed the next leg of the uptrend that should take it back close to 145 levels.

Bulls Vs Bears

GAIL (Rs. 316)
The stock stayed in a range for almost the entire month of June 09 and confirmed a breakout late last week. A number of bullish patterns can be spotted calling for a 50+ Rs. move in the coming few weeks. The zone of 285-295 now becomes a base for the rest of this month with minor resistance at 325. The volume activity pick-up last week supported the price action breakout and is a positive sign.

STRATEGY: Buy in the region 310-316 with a closing stop loss below 288 for a short-term target of 350 and 368.

Support: 310 and 295 Resistance: 325 and 350

To see full report: TECHNICAL ANALYSIS

>DISINVESTMENT (JM FINANCIAL)

Opportunity to reduce deficit

As widely covered in the press, Government is expected to announce list of candidates for disinvestment program shortly for reducing the fiscal deficit. In this note, we attempt to look at business profiles (including financial snapshots) of likely companies in the expected disinvestment initiative. Disinvestment can be in the form of (a) offer for sale in unlisted companies (through IPO or direct stake sale to strategic investor) and (b) divestment
in listed companies.

In the interim budget for 2009-10 (announced in Feb-09), Government indicated that fiscal deficit for FY10E is likely to be ~Rs3.32 trn (~5.5% of estimated GDP) on account of continuation of major government schemes such as National Rural Employment Guarantee scheme (NREGS), Jawaharlal Nehru National Urban Renewal Mission (JNURM) and
implementation of Sixth Pay Commission. With declining direct/indirect taxes and continued expenditures, disinvestment program would assume more importance to reduce the deficit.

Except 2004, no major disinvestment in past: As shown in Exhibit 1 in report, we find that most significant amount of Rs155bn was raised in FY04, when fiscal deficit was 4.5% of GDP. Disinvestment program in FY04 (which included offer for sale of petroleum companies) was undertaken by the then ruling BJP government.

Plenty of options available at the moment: We enclose profile of likely companies for the ensuing disinvestment program. As seen in Exhibit 2 in report, the total net sales /net profit of all listed government companies are Rs 13.7/1.1 trillions respectively while unlisted government companies have net sales/profits of Rs4.0/0.3 trillions respectively.

To see full report: DISINVESTMENT

>RETAIL SECTOR (JM FINANCIAL)

Mantra for retail success in India – Read between the lines of consumer spending patterns!
Retail performance is fundamentally affected by the consumer’s willingness and ability to spend.

The Achilles' heel:
Weak Demand = Slowdown in new store roll-outs; restructuring to infuse cost efficiency of existing stores.

Drop in Footfalls = Slowing Same Store Sales = Lower Inventory Turnover = Higher Working Capital = Liquidity Pressures

The Opportunity – A Sunrise Sector!
Despite the current headwinds, well positioned to leverage revival in consumer demand emanating from a stable government; anticipated change in regulatory policies and fall in reality prices


The story line seems all wrong but ……..
“Standing on the threshold of a retail revolution and witnessing a fast changing retail landscape, India is set to experience the phenomenon of a global village. India presents a grand opportunity to the world at large to use it as a business hub. A ‘Vibrant Economy’, India tops A T Kearney’s list of emerging markets for global retailers. The 2nd fastest growing economy in the world, the 3rd largest economy in terms of GDP in the next 5 years and the 4th largest economy in PPP terms after USA, China & Japan, India is rated among the top 10 FDI destinations.”

- Source: India Retail Report 2007

The level of exuberance was high for an industry that had worked wonders in developed markets. An opportunity to grow exponentially was seen with India being the favored destination for retail – a growing population; good demographics, under-penetrated modern trade. What went wrong for an industry projected as the “sunrise sector” to fall out of favour for both consumers and investors? Was it a case of “too much too soon” or was it “not understanding the Indian consumer psyche combined with a general global slowdown”? The optimism of the last two years seems to have died down burdened by the woes hitting the industry – was it misplaced optimism or are there some hidden jewels that will shine in the future?

INDUSTRY
The retail industry, tagged as a sunrise sector on the Indian landscape 3 or 4 years ago was expected to emulate the retail revolution of the west. Now the long-term opportunity for modern trade in India, due to the current economic turmoil amongst other things, is being questioned. The road ahead for modern trade in India will be exemplified by a period of painful restructuring. Mergers, regulatory changes, acquisitions and consolidations will be the forte going ahead and only a few big players will survive the current chaos.

The Retail Opportunity in India
The uniqueness of the organised retail revolution in India has been exemplified by the wide demographic consumer spectrum it caters to. Formats had been created to achieve maximum operational efficiency and augment profitability when targeting an identified consumer category.
India has tremendous potential in Modern Trade with a highly under-penetrated organized retail market - 4% of the total retail sales US$ 322 bn (2006) as per the study conducted by ICRIER

Retailers were extremely enthusiastic to leverage this nascent opportunity. The last few years have witnessed retailers funding their expansions through the equity route with Vishal Retail, Koutons and Provogue hitting the equity markets with their primary offerings. Trent had a rights issue whilst Pantaloons and Indiabulls undertook private placements. Retailers increased their use of equity and debt financing. Internal accruals which were previously used to finance close to 30 per cent of retailers funding requirement fell to a mere 12 per cent, leading to gradual increase in gearing and borrowing cost.

To see full report: RETAIL SECTOR

>INFOSYS TECHNOLOGIES (JM FINANCIAL)

Annual report analysis

‘The past year has seen a decline in several things which we considered infallible.’ – The opening remark of Infosys’ FY09 annual report aptly brings out the degree of turmoil witnessed by the global economy last year. In its outlook for the current year, Infosys continues to be cautious, but believes that its strong business practices would help strengthen client relationships in the current scenario.
As the Infosys FY09 annual report highlights, the company has sustained performance in an extremely tough year. Manufacturing and Europe (excluding BT) have been the primary revenue drivers, while margins have improved in BFSI and Telecom despite significant drop in revenue growth. What is also noteworthy is that Infosys has invested in increasing its sales force in FY09 substantially, blasting fears of under-investment in the business.

The key highlights of the report are as follows:

■ Manufacturing gives a stellar performance in a tough year: Manufacturing (and Hi-tech) single-handedly contributed to 62.9% of incremental growth in FY09. Our channel checks indicate that a few large accounts in the US & Europe have ramped up significantly in this vertical.

■ Rupee helps cost control from impacting business investments: Infosys has smartly taken advantage of sharp rupee depreciation (+27.7% YoY) to pump up its business investments. We are heartened by the 200+ additions to sales force, the highest over the last 5 years.

■ Easing capacity utilization to keep capex low, sustain strong cash generation: Seat utilization remains low (1.1x vs. 1.2x over the last 4 years), which should help bring down capex costs over the next 1-2 years. We expect strong accretion to cash, despite a tough FY10E.

■ Lower hedges place Infosys at greater risk in case of rupee appreciation: Infosys had US$506mn in hedges as on 31 March 09, covering just 19% of its net foreign exchange exposure for FY10E. Sharp rupee appreciation (6.5% QTD) could expose the company to greater impact on revenue and margins. We are in no doubt that Infosys will emerge stronger out of this crisis, but
the signs of slowdown expected in FY10E are evident in several measures including capex reductions and headcount additions. We remain cautious on our outlook of recovery for the sector, and maintain our Hold rating on Infosys.

To see full report: INFOSYS TECHNOLOGIES

>KARNATAKA BANK (JM FINANCIAL)

Satisfactory Performance

■ 4Q’09 PAT up 37% yoy: 4Q’09 PAT of Rs 831 mn is up 37% yoy and is 26% above our estimates. This is primarily on account of significantly higher treasury income of Rs 950 mn booked during the quarter and lower than expected provisions.

■ Significant moderation in advances growth: Loan book witnessed growth of 9% for FY09.This was primarily on account of 1) management turning cautious in an uncertain environment 2) bank’s focus on containing delinquencies. We favour KBL’s strategy to moderate growth in an uncertain environment and believe this move should benefit the bank in controlling delinquencies going forward. For FY10E management has guided for strong growth of 27% which looks unlikely to us. We expect loan book to grow by ~17% over the next two years.

■ Margin surprised negatively: Margins decline of ~40 bps in FY09 was a negative surprise (2.22% in FY09 vs ~2.6% last year). However, this was primarily due to the fact that the bank was unable to meet direct agricultural sector lending target and consequently had to invest ~Rs 10 bn in RDIF deposits (earns interest of ~4%) which impacted margins adversely. Further, decline in loan deposit ratio by 5.4% yoy to ~58% also impacted margins negatively. CASA continues to remain weak at 21% and the management intends to improve it by ~300 bps in FY10. We forecast margins to improve by 20bps over the next two years driven by 1) repricing of deposits at lower rates 2) improvement in CASA mix to ~23% by FY11E 3) Improvement in loan deposit ratio by 150 bps.

■ Improvement in asset quality but restructured assets at ~4.2% of advances: Asset quality improved sequentially for KBL with gross and net NPL declining 2% and 31% respectively on an absolute basis. Coverage ratio improved from 63% in 3Q’09 to ~74% during 4Q’09. However, the bank has restructured accounts amounting to Rs 4.8 bn in FY09 and there are further pending applications of Rs 0.1 bn, totaling to ~4.2% of advances. Most of these loans are standard currently. Delinquencies remained stable in FY09 at 1.5%.Going ahead, we believe that delinquencies could increase to ~190 bps over the next 2 years which would lead to LLP of 76 bps in FY11E vs. 41 bps in FY09.

■ Revision in estimates: We cut our FY10E and FY11E earnings estimates by 9% and 13% respectively driven by slower loan growth and lower than expected margins. We now forecast profits to decline by 3% in FY10E. We expect the bank to report ROE of ~15% over the next 2 years. We have assumed dilution of 13% at price of Rs 125 per share in FY10E.

■ Solid franchise at attractive valuation: KBL is one of the cheapest private sector banks in India, trading at P/BV of 0.85x FY11E. Given the expected return ratios and valuable franchise, we believe KBL is an attractive value pick. Based on a normalised ROE of 16.1% (earlier 17%), we value the stock at 1.06x book (earlier 1.4x), implying May’10 target price of Rs.170 (earlier Rs 190).

■Risks to recommendation: Higher than expected delinquencies is the key downside risk to our recommendation.

To see full report: KARNATAKA BANK