>INDIAN BANKS' VALUATIONS (DEUTSCHE BANK)

How blue is my sky

■ Advising caution - we could be pushing the limits in valuation
An in-depth study of valuations of Indian financials from the fundamental, cyclical and regional standpoint, as well as multiple sensitivity analyses re-inforce our belief that the sector could be stretched. This in turn implies that positive performance now becomes almost wholly dependent on continued strength of market liquidity. While news flow may not be incrementally negative, material risks remain. We retain our relative preference for private banks.

■ Historical and regional context: valuation cushion seems to be thinning
Indian banks have outperformed regional peers recently and even the valuation expansion has been higher. Private banks are trading at a lower-than-average premium to Bankex, whereas PSU banks’ discount to Bankex has narrowed. Nearly all banks are trading at higher than historical average valuations. Almost all banks are trading at or above the “recovered” valuation in 2004 when the sector last rode out of a downturn. We have also applied Chinese new business multiples
to Indian insurers, even though the former are more profitable.

■ Need aggressive assumptions to justify higher TPs or even current prices
We demonstrate that present stock prices do factor in elevated levels of expectations, except HDFC Bank and PNB. TPs increase by 0-23% under bullish assumptions, not good enough to offer a cushion. A rollover to FY11 as the base leads to positive upside only in three out of 13 cases. Meaningful positive upsides are obtained only when we apply historically highest-ever valuations or highestever premium to Bankex, and to a lesser extent the “recovered” valuation of 2004. Overall cushion appears to be high for HDFC Bank and low for SBI.

■ Key valuation drivers do not support peak-cycle valuations
Outlook for benchmark interest rates – generally a powerful short-term driver of bank valuations – is no longer benign due to large government borrowings and rising inflationary expectations. RoEs face several challenges, particularly for rapidly growing banks. We also demonstrate the interesting strong correlation between earnings volatility and valuations, but also do not see reasons for the volatility to go down in the near future. Structural drivers such as new products, consolidation and legal changes are also unlikely to be forthcoming.

■ Valuations and risks
We value lending businesses on the Gordon Growth model, insurance on appraisal value, asset management on % of AUM and other non-banking businesses on P/E. The key risks to our pessimistic stand are strong flows, particularly in the context of the progressively reduced foreign investor positions in Indian financials relative to benchmarks, and a significant drop in cost of funds improving margins sharply.

To see full reports: INDIAN BANKS

>GAIL (MORGAN STANLEY)

F4Q09 Results: Back on Track

What’s New: GAIL reported an adjusted EBITDA of Rs8.7bn and an adjusted profit of Rs4.9bn for F4Q09. The company had a write back of Rs2.2bn of staff cost in F4Q09, due to excess provision in F3Q09. We believe the company, after a dismal F3Q09, is back on track to meet our F2010 estimates. The key positive surprise in the results was: a) better-than-expected petrochemical
business; and b) Improved margins of the LPG transmission division. However, margins for the gas
transmission division disappointed due to appreciation of the dollar against the rupee. We believe that with the recent dollar weakness and increase in gas transmission volumes from KGD6, GAIL is poised to meet our F2010 estimates for the division.

Improvement in Petrochemical division: Sales volumes grew 4.6% YoY but were down 13% QoQ. GAIL continued to clear its polymer inventory as domestic demand and price realizations improved on a QoQ basis. Price realizations improved by 22% on a QoQ basis, but fell 13% YoY. This led to EBITDA growth of 184% sequentially and almost doubling of its net realizations for the division (EBIT/tonne) on a QoQ basis. We believe that with improving demand for polymers, GAIL should meet our F2010 estimates for the division.

LPG transmission showed a 32% growth in margins on a QoQ basis despite a 6% QoQ drop in volumes. We believe that the increase in margins was due to lower operating costs; however, we need to clarify this with management.

Gas transmission volumes for the quarter increased by 0.5% YoY to 82.5mmscmd. Transmission tariffs for the quarter at Rs877/tscm were up 12.5% YoY. Gas sales were up 12.5% YoY but down 3% QoQ due to shutdown in Panna Mukta Tapti (PMT) gas fields. EBITDA for the division increased 3% QoQ, but dropped 14% YoY due to 25% appreciation of the dollar against the rupee, causing an increase in fuel costs for the division.

To see full report: GAIL

>MACRO DRIVERS AND EM EQUITIES (MERRILL LYNCH)

■ Macro framework for EM equities
We focus on oil, the EMBI spread and USD as our major barometers for growth, risk and flow in emerging markets. We test the sensitivity of EM equity markets to the three macro drivers (table 1). When combined into a simple regression equation, they together explain 86% of the movement in the MSCI EM index. A “fitted” macro framework for MXEF based on the three macro drivers closely tracks the actual index (see chart 1 in report).

■ Comfortable with 500-850 trading range for EM
Our macro framework can quantify the risk to the current level of MXEF. Plugging in the current values of oil, USD and EMBI, the macro framework says MXEF “should be” 8% lower than current actual level. So MXEF is hardly stretched. Using our strategists’ forecasts for oil, USD and EMBI for end-09, the framework says MXEF should end this year 13% down on the current level. We are comfortable with a 500-850 trading range for MXEF in 2009.

■ Stress-testing EM equities
Can MXEF break through the 1000 level? The framework says we would need oil up to $84 & DXY down to 65 & EMBI spread down to 300 - this bullish combo seems unlikely in our view. What needs to happen for MXEF to break below 550? Oil down to $55 & DXY up to 90 & EMBI spread up to 500 - this bearish combo seems unlikely in our view.

To see full report: MACRO DRIVERS

>TECH MAHINDRA (ICICI DIRECT)

Positive disclosure but already priced in…

Tech Mahindra disclosed Satyam’s financial details, which came in above market expectations. The company has stated that these financials details were not audited and the audited numbers could materially be different.

Numbers positively surprise
Satyam, according to the disclosures made by Tech Mahindra, had standalone revenues of Rs 2294 crore for Q3FY09. For January and February the sales were Rs 681 crore and Rs 676 crore, respectively. If one were to aggregate, the annual run rate comes to Rs 8762 crore, which is around $1.75 billion. However, the company has lost significant business and key personnel in March. Thus, we believe the annual run rate could be lower than $1.75 billion. (At the press meet Vineet Nayar had stated that the run rate could settle around $1.3 billion).

The biggest surprise came in on the margin performance front. A 17.5% operating margin was way above expectation of a low single digit margin expectation. We believe that in the near term the company could do well to maintain this level (as there is pressure on revenues in the near term). However, in the long run, cost rationalisation and revenue stability could push up margins (employee rationalisation and further reduction in SG&A costs).

Customer — a lose-win situation
As of March 26, Satyam partially or totally lost around 66 customers and won deals from around 215 existing customers. In total, the company lost business worth $183 million (including $91 million expected over the next 12 months) and won deals worth $380 million.

Litigations – difficult to ascertain financial impact
The company is facing litigations with respect to the acquisitions made by the company in the past as well as US class action law suits, unpaid litigation and unacknowledged claim of Rs 1230 crore. It is too early to ascertain the impact of the same on the financials of the company. However, it could materially impact the performance if the settlements go against Satyam.

To see full report: TECH MAHINDRA