Monday, May 25, 2009


What Happened Last Quarter…

Dr. Reddy’s Laboratories Ltd.’s (DRRD.IN/REDY.BO) performance in Q4 FY09 and the full year FY09 was impacted by an exceptional charge related to impairment of goodwill and intangibles. However, excluding the exceptional charge, DRL’s overall results for Q4 FY09 as well as FY09
were ahead of our expectations, driven by strong sales recorded by generic Imitrex. DRL recorded a net loss of Rs.12.6 bn and Rs.9.2 bn for Q4 FY09 and FY09 respectively, primarily on account of the exceptional charge of Rs.14.6 bn related to the Betapharm acquisition. Excluding the exceptional charge, the company’s net profit for FY09 was up 24% Y-o-Y to Rs.5.5 bn, which was higher than our estimate of Rs.4.8 bn. The company’s topline was up 49% Y-o-Y to Rs.19.3 bn in Q4 FY09 and grew 38% Y-o-Y to Rs.69.0 bn in FY09, which was well ahead of our estimate of Rs.65.0 bn for the full year FY09, driven mainly by the successful launch of the authorized generic version of Imitrex in late November 2008, which recorded sales of Rs.6.8 bn. Excluding generic Imitrex sales, DRL’s topline was still up a healthy 24% Y-o-Y. The company’s EBIDTA margin for FY09 improved by 210 basis points to 19.2%.

Management has guided for a topline growth of 10% in FY10, which is exactly in line with our
earlier expectation. In view of the company’s performance in FY09 and management’s guidance for FY10, we have raised our revenue and EPS estimates for FY10 from Rs.70.7 bn and Rs.35.4 to Rs.74.8 bn and Rs.37.0 respectively. Since we upgraded DRL to ‘Moderate Outperform’ in April 2008, the stock has outperformed the NIFTY by 9 percentage points. Also, the recent approvals received by DRL for its FTF applications, Prilosec OTC and Arixtra, have resulted in improved visibility of its near term big product opportunities. Moreover, management’s recent decision to trim DRL’s global operations clearly indicates that the company is focusing on sustaining its base business growth and improving its margins & RoCE. The realignment of Betapharm (i.e. shifting of most of its manufacturing activities to India), trimming of global operations, reduction in fixed overheads, and improvement in R&D productivity will help bring down DRL’s operating costs. Plus, DRL’s future revenue growth will be driven by at least one ‘FTF opportunity’ that the company expects to enjoy each year for the next 3-4 years. At 15.5x, the stock trades almost in line with the industry average of 15-16x. We reiterate our ‘Moderate Outperform’ rating on DRL.

Key Quarterly Highlights

The company’s topline growth
was driven by the successful
launch of the authorized generic
version of Imitrex in late
November 2008, as well as on
account of a strong performance
from Russia/CIS and favourable
currency movements.

■ DRL recorded a net loss of Rs.12.6 bn and Rs.9.2 bn for Q4 FY09 and FY09 respectively, primarily on account of an exceptional charge of Rs.14.6 bn related to the impairment of goodwill and intangibles in Q4 FY09 arising from the Betapharm acquisition.

With the market now moving to a tender supply model and due to the change in the market drivers, the goodwill had to be evaluated for impairment. As a result, the company took a non-cash charge of $213 mn. Post these charges, the carrying value of Betapharm intangibles and goodwill in DRL’s books stands at approximately €50 mn and €160 mn respectively.

■ Excluding the exceptional charge, the company’s net profit for FY09 came in at Rs.5.5 bn, up
24% Y-o-Y and higher than our estimate of Rs.4.8 bn.

■ In Q4 FY09, the adjusted net profit was up 60% Y-o-Y to Rs.2 bn (excluding write down charges of Rs.14 bn and Sumatriptan exclusive sales).

■ The topline was up 49% Y-o-Y to Rs.19.3 bn in Q4 FY09 and grew 38% Y-o-Y to Rs.69.0 bn in FY09, which was well ahead of our estimate of Rs.65.0 bn.

■ The company’s topline growth was driven by the successful launch of the authorized generic version of Imitrex in late November 2008, as well as on account of a strong performance from Russia/CIS and favourable currency movements. Excluding generic Imitrex sales, the topline was still up by a healthy 24% Y-o-Y. Sumatriptan recorded sales of around Rs.3.5 bn in Q4 FY09.

■ On the back of strong revenues from Sumatriptan, DRL’s US sales were up 192% Y-o-Y in Q4 FY09. Excluding Sumatriptan sales, the company’s US sales grew 44% Y-o-Y (organic growth of 35% Y-o-Y).

■ The EBIDTA margin for the full year FY09 was up 210 basis points to 19.2%, partly due to a decline in SG&A expenses.

To see full report: DR. REDDY'S LABORATORIES


Rating downgrade due to competitive headwinds
In Q4’09, Bharti Airtel Limited (Bharti) posted a revenue growth of 25.6% yoy and 2% qoq, gaining from better-than-market ARPU of Rs. 305 while facing more-than-anticipated drop in share of net adds. Bharti’s share in net adds fell to 17.5% in Mar’09 (our estimates of 20%), as RCOM and other new entrants notched up subscribers with under-cutting in tariffs while rolling out their services in new circles. Moreover, Bharti’s overall market share plunged to 24% in Q4’09 from 24.7% in Q3’09. While we believe that Bharti can easily sustain its EBITDA margins in the near term at ~39%, retention of high-end Metro subscribers is a key challenge for the Company. Besides, the recent surge in the stock price has pushed it above our fair value estimate. Hence, we downgrade our rating to a Hold.

Customer retention is a key challenge
Bharti derives around 40% of its revenues from 11% subscribers, who are present in Metro circles. As newer mobile players are aggressively targeting these subscribers through value added services and attractive tariffs, subscriber retention has become a key challenge for Bharti in order to maintain its market leadership and profitability in the near term.

Scaled up operations and cost rationalization to help maintain margins
Bharti maintains a significant cost advantage over its competitors supported by its scaled up pan-India network and established brand equity. Besides, the Company is constantly keeping a check on its SG&A and payroll costs which is likely to help offset the increasing network operating costs due to rise in rural penetration. Thus, we expect Bharti to maintain its EBITDA margin to around 39% for FY10-11E.

Maintain our estimates and target price
We forecast revenue and EPS CAGR of 18% and 15% for FY09-11E, respectively (excluding associate contribution from Indus towers). Based on DCF valuation, we arrive at a target price at Rs. 817 implying a P/E multiple of 14.6x FY11E EPS.

To see full report: BHARTI AIRTEL LIMITED


Patel Engineering (Rs309)
BUY - Target price: Rs395

Torrent Pharmaceuticals (Rs155)
BUY - Target Price: Rs210

During the quarter ending Mar 09, we expect the company would report the net sales growth of 11.5% to Rs. 8.1bn in Q4FY09 from Rs. 7.26bn in Q4FY08. We expect EBIDTA would go up by 19.5% to Rs. 1.25bn and EBIDTA margin would improve by 100bps to 15.5% on account of higher contribution from high margin order book. We expect RPAT would go up by 36.3% to Rs. 726mn.

During the quarter, the company has bagged an order worth of Rs 7.99bn from the Narmada Valley Development Authority for Bargi Diversion Project in joint venture with SEW Construction Ltd. The company's stake in the project would be around 60% which will translate the order inflow of Rs. 5bn. The project would be executed in three years and provide the EBIDTA margin of around 15%. PEL has an order book position of Rs.71bn as on 31st Dec., 2008 which works out to 3.1x of book to bill ratio at FY09 earnings which is providing strong revenue
visibility for next 3years.

Valuation: At the current market price of Rs 309, the company is trading at PER multiple of 10.2x and EV/EBIDTA multiple of 5.8x on FY10E earnings. We have valued the core business of the company using EV/EBITDA methodology at 6x. Real estate division at 75% discount to value of raw land. Looking at the easing liquidity situation and expected robust order inflow post stable government; we maintain our BUY rating with revised price target of Rs395.

The net revenues for the quarter delivered decent growth of 24.3% y-o-y to Rs.4050mn compared to our estimates at Rs.3768mn mainly on back of strong growth witnessed from key markets like Europe, Heumann and rest of the world as well as better than expected results from contract manufacturing business.

Despite reporting strong growth rate in revenues, the company's EBITDA margins dropped to 13% compared to 15.82% in Q4FY08 due to net forex loss to the tune of 15.8mn, higher staff expenses on account of a new extra urban division, higher R & D expenses and bad debts of Rs75mn in Q4FY09. The tax expense (-Rs.22.3mn) includes MAT credit entitlement to the extent of Rs.159.6mn pertaining to first three quarters of the previous year. The exceptional item of Rs.0.1mn is one time expense towards settlement of a research contract claim for out-ofcourt settlement. The profit after tax for the quarter de-grew by 18.8% to Rs.360.9mn over Q4FY08 mainly due to lower operating profit margins and lower other income reported during the quarter.

View & Valuation: We are revising our FY10 net revenue estimates upwards by 3.3% to Rs.18943.6mn on account of better than estimated revenue growth reported for FY09 and improved revenues from Europe, Brazil, US, Russia and RoW markets. We are downgrading our EBITDA margin estimates for FY10 by 80 basis points to 16.9% mainly due to lower margins reported in FY09 (15.9% on account of forex loss of Rs412mn). We are marginally increasing
our FY10 earnings estimates by 1.94% mainly on account of improved revenue traction and better margins compared to FY09. Currently, the stock is quoting at PE of 5.9x on FY10 EPS at Rs.26.3. We continue to rate the stock as 'BUY' and upgrade our price target by 5 % to Rs.210 based on 8x on FY10 basis.

To see full report: STOCKS UPDATE


A spring haircut but only a trim

Market in a confirmed correction - should be limited to 10%
The market remains in a base- building process, now going into its eighth month. In the process, the S&P 500 has rallied nearly 40% from the March 6 low (666) and is currently down 5.5% off the May 8 high of 930. It still appears to us the S&P 500 is forming a right shoulder of a head and shoulders bottom (see chart in report). To anticipate a directional change in the market we have overlaid a 40- day moving average and 150-day moving average, and the 40-day is just approaching the 150-day. A sustainable cross of the 40-day above the 150-day would be a positive sign that this correction should remain limited. Additionally, cash levels remain elevated, and AMG inflows into domestic equities are not excessive, and levels are supportive of additional recovery highs.

Short levels remain elevated in mega caps and financials
Short levels did fall in late-April by 5% for the first time since December, but levels remain elevated in mega cap stocks and financials. We have adjusted for hedging (selling short) against recent financial equity offerings and short levels are still elevated.

Commodities spring back to life
Energy, grains and soft commodities are positioned to continue their rally. Crude oil is in a confirmed rally and natural gas is just breaking to the upside from a Vbottom. A rally is under way in sugar, soybeans and coffee - and wheat and corn could be next. The correction in the US dollar confirms the commodity rally.

Levels to watch:
First support on the S&P 500 is 845-825 and this range is within a 10% correction. First support on the DJIA is 7900-7750. Should this be a more sizable correction the second level of support on the S&P is 815-780 and on the DJIA 7435-7260. Our upside targets remain intact with S&P at 1055-1065.



Regulatory boost for Renewable power

Sector View:

New: Bullish
Old: Bullish

Investment Conclusion
CERC has published draft regulation on tariff determination from renewable energy sources (wind, small hydro projects, biomass power and non-fossil fuel-based cogeneration projects) which provides for post-tax RoE of around 16% and any variation in the interest charge against the normative rate to be retained by developer. All renewable energy power plants (except for biomass power plants and non-fossil fuel-based cogeneration plants) will be treated as 'MUST RUN' power plants and will not be subjected to 'merit order despatch' principles, thus ensuring stable cash flow. We believe the regulations provide sufficient incentive for increased investment in renewable power projects and increased focus on the Renewable Purchase Obligation to ensure adequate demand.

■ Regulations provide for regulated post-tax RoE of 16%.
■ Interest rate differential from normative, to be retained by developer; this could boost RoE.
■ CDM benefit in initial years may boost post-tax RoE to 22%.
■ Wind and small hydro plants classified as 'MUST RUN'; hence, not subject to 'merit order despatch' principles.
■ Increased investment, particularly in wind power, may benefit equipment suppliers, in our view.

To see full report: POWER & UTILITIES


And when the money runs out?
  • The fiscal lifeboats launched to support the global economy…
  • …have, for some, left the budgetary outlook in a total mess
  • Austerity is the best we can hope for…the alternatives include currency crisis, inflationary dangers and rising default risk
Three strategies to cope with the threat of depression

Three broad strategies have so far been used by policymakers to deal with the credit crunch and
global recession.

Capital has been injected into banks to stop them from becoming insolvent. The aim has
been to prevent a repeat of the multiple bank failures of the 1930s which played such an
important role in turning a recession into a depression.

As interest rates have approached zero, and bank lending remains constrained, some central banks have pursued so-called “quantitative easing” policies, designed to lower a broader spectrum of interest rates (including those on longer-dated government bonds and corporate bonds) and/or to increase the supply of money in the economy. Quantitative easing arguably is designed to pump credit into the economy by bypassing the banking system altogether.

Fiscal easing has become a key part of the story. As private demand has wilted in the light of falls in housing and stock-market wealth, excessive debt levels and the credit crunch, so the public sector has stepped in to shore up overall demand. Tax cuts and public spending increases have become key policy tools in the attempt to prevent a Great Depression mark II. Debts previously held in the private sector are now increasingly being held in the public sector. In the process, John Maynard Keynes has seen a remarkably rapid rehabilitation.

All three of these strategies carry fiscal implications. Capital injections involve government ownership of banks and the banks’ former assets. Although banking assets are hopefully bought cheaply, there is nevertheless a risk for future tax payers if, for example, the assets fall further in value (the converse equally applies: should the assets rise in value, any subsequent realised capital gain can be used to pay down public debt and, hence, relieve the burden on future tax payers). Quantitative easing shackles the central bank to the government in ways unimaginable a handful of years ago. The Bank of England, for example, is now buying gilts. If its actions place a ceiling on gilt yields, might that encourage the government to borrow more? Or might, instead, purchases of corporate bonds and asset-backed securities be funded not by printing money but, instead, by issuing shortdated government paper, thereby increasing government borrowing at the short-end and distorting the slope of the yield curve?

To see full report: GLOBAL ECONOMICS


HFs’ sharply reduce net long in NDX; HF’s selling $ buying €

Large Specs buy gold, oil & 2Y-T’s; sell NDX & US$
Note: Commitment of Traders data reflects positions as of last’s Tues close

Equities: Large specs held steady their net long position in the S&P 500 futures last week while continuing to reduce their longs in the NDX. In recent weeks readings in the NDX had reached their highest levels since Oct 07- when the NDX subsequently fell 6.7% 1month on. Large specs also added to their shorts in the Russell 2000. HFs are still a source of liquidity for the markets but less so with a potential buying power of ~10b, consisting of $6b in the SPX, $1b in the NDX and $3b in the R2000.

Metals: Large specs added to their gold longs last week, while also buying silver and platinum. Additionally they held steady their net shorts in copper.

Energy: HFs covered crude oil last week, while adding to their deep shorts in natural gas. Additionally, they increased their longs in heating oil.

Forex: Large specs bought the Euro last week, while modestly selling the USD. They also covered their net shorts in the Yen.

Interest Rates: HFs increased their longs in the 2-Yr Ts, while covering more of their significant shorts in the 10-Yr Ts. They added to their shorts in the 30-Yr T-Bonds.

M/N and L/S hedge funds’ market exposure continue to improve
Our models indicate both M/N and L/S funds’ market exposure continuing to improve reversing the rapid fall in beta from late March and early April; both are now only moderately underweight equities (pp 3-4). It is potentially bullish for equities if HFs, with substantial cash on the sidelines and facing significantly lower outflows in Q2, return to the markets. M/N HFs were big losers in April because of their sharp drop in beta during much of the rally (see Hedge Fund Monitor, 13 April 2009). We also note a significant shift by funds away from High Quality to Low and from Growth to Value.

Macros sell the SPX, commodities; buy the US$, Emerging Mkts
Our models suggest Macro HFs added to their crowded net short in the S&P 500 last week, while holding steady the NDX. Additionally, they continued to buy the US$ index and modestly added to their shorts in the 10-Yr Ts, while continuing to sell commodities. They also continued to increase their small caps tilt relative to the large caps. We also estimate Macro HFs bought the Emerging markets and the EAFE markets last week.

To see full report: HEDGE FUND MONITOR


Isn’t history bunk?
  • “Progress is cumulative in science and engineering but cyclical in finance” -James Grant (Money of the Mind)
  • “. . . for having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty” Royal Swedish Academyof Sciences announcing Daniel Kahneman as recipient of 2002 Nobel Prize for Economic Sciences.
  • What is financial history if it is not a study of ‘human judgement and decision-making under uncertainty’?
So, what practical use is there in history?
  • History looks at how markets have worked and not how they should work
  • Furthers our understanding of how human decision making under uncertainty works in practice
  • To discover some of the lost secrets of our investing ancestors — the pre-Markowitz (1952) wisdom
  • To recognise a bear, spend time in its company

Defining g the bottom of a bear market
  • When were the best subsequent returns achieved?
  • Calculate hindsight value
  • August 1921, July 1932, June 1949, and August 1982
  • December 1974 would have been the fifth great bottom

  • Value considerations are not enough to find the bottom — Q ratiorelative to geometric mean — equities get cheap and keep getting cheaper
  • Analyse the turning points in these bear markets with the benefit of hindsight
  • Analyse the turning points based on contemporary opinion right and wrong
  • 70,000 WSJ articles — good sample of contemporary opinion
The bear ends when deflation abates
  • Inventory in the system is low
  • Some commodity prices start to stabilise
  • Demand evident at lower price, particularly for luxury goods or goods in structural demand
  • Greater certainty on general price level and valuations more certain
  • Corporate bond rally?
Commodity prices bottom with equities
  • Commodity prices bottom Aug 1921 with equities
  • Commodity prices bottom July 1932 with equities
  • Commodity prices bottom July 1949 with equities
  • Commodity prices bottom Oct 1982 just after equities
  • Copper price bottoms August 1921, June 1932, June 1949 and June 1982
Bonds first, , then equities
  • August 1921: May 1920 government bonds, June 1921 Baa corporates, August 1921 commodities.
  • July 1932: January 1932 government bonds, May 1932 Baa corporates, July 1932 commodities
  • June 1949: October 1948 government bonds, January 1948 corporate bonds, July 1949 commodities
  • July 1982: October 1981 government bonds, February 1982 Baa corporates, October 1982 commodities



India Re-rating & EM One Year On

India Re-Rating
420 million Indians just voted for deregulation, supply-side reform and less government intervention, a marked contrast with voters in the G7 and unambiguously equity-bullish. But investors are only modestly UW India and India now trades at roughly a 40% premium to EM (versus 10-year average premium of 24%) so we expect only modest reallocation to India. (Note India’s forward PE has today jumped from 14.4x to roughly 17.4x - see table 1).

Emerging Markets One Year On…
May 21st marks the one-year anniversary of the cyclical high of Emerging Market equities versus Developed Market equities (chart 1). A dramatic comeback in EM is being lagged by other correlated growth & risk assets: if EM is a faithful lead indicator then we can expect more to come from global Material stocks and the Euro for example (see Charts 2 & 3). The summer risks to relative performance of EM, in our view: Emerging Markets are overbought short-term; US dollar strength due a new risk-aversion event; weak Chinese economic data. Absolute direction of global equity markets will likely be dictated by US consumption.

To see full report: GEM STRATEGY


Promising outlook
ABB Limited (India)’s revenues declined 9.2% yoy to Rs. 14.1 bn in Q1’09 on account of weak order execution. Net profit of the Company was Rs. 784 mn, 33.4% lower than the previous year quarter. This was mainly due to an increase in other expenditures, depreciation charge and interest expenses in Q1’09 vis-à-vis Q1’08. However, on the back of improved order inflows for the Company during Q1’09 and positive recent political developments in the country, we have upwardly revised our estimates for the Company. Our valuation model suggests an upside potential of 16.5% for the Company’s stock price from the current market price of Rs. 617.1. We thus, upgrade our rating from Hold to Buy.

Orders inflows expected to increase:

■ The postponement of several power projects, particularly by private players in FY08, coupled with ABB’s decision to exit rural electrification projects, had led to a flat growth in order inflows for the power division in FY08 vis-à-vis FY07. Orders from government utilities had remained
strong, thereby offsetting the decline in orders from private players.

■ Order inflows of the Company in Q1’09 increased 83% sequentially, mainly attributable to the finalization of orders from Power Grid Corporation of India. The inflows in Q1’09 were the second best ever for the Company. The current order book of the Company stands at Rs. 70.3
bn, representing 1x of FY08 revenues.

■ With a peak power deficit of 16% and growing power needs, India has significant scope to increase its generation capacity. In the medium to long term, we should see robust order inflows for the Company on the back of an increase in government spending in power and other
infrastructure related projects.

To see full report: ABB LIMITED