Wednesday, July 1, 2009


US profit cycle close to bottoming

Corporate profits are highly cyclical and the strongest advances occur early in an expansion following employment and other cost cuts. This is true even during sluggish recoveries. Productivity gains are the key feature behind profit gains.

We expect a modest recovery in the US to begin in Q3 2009. Even with moderate growth, cost reductions to date imply a 15%-20% 2H’09 annualized gain in profits as measured in the US GDP accounts.

Pricing power is a deterrent on profit margins. Pricing power trends pose some risk that the upcoming profit recovery falls short of the normal recovery phase. We examine the cyclical forces on margins even back to the Great Depression.

Profits of course have immediate market ramifications but they are also important as drivers for business investment and reversing job losses. The profit recovery in later 2009 is a necessary step toward stemming layoffs as we anticipate for 2010.

To see full report: AMERICAN THEMES



We initiate coverage of Exide Industries with a BUY rating and a 12-month price target of INR92.1, representing 38.5% potential upside. Exide is primarily a play on the strong replacement demand for batteries from the automobile segment, where the past five years’ CAGR has been 12.5%. In addition, power shortages in India have led to strong demand from the power invertor segment. We estimate that Exide will be able to improve its margins from 16.2% in FY09E to 17.9% in FY10E, because the fall in lead prices (41% y-y in FY09) may not be passed on completely in the replacement segment. This should lead to strong earnings growth of 26.8% in FY10E. The stock currently trades at 11.4x (excluding investments in insurance business) FY11 EPS of INR5.2. We believe that given the high demand visibility, high return ratios and strong earnings growth, the stock should trade at 16x FY11E EPS in line with the Sensex multiple it has traded on average over the past five years.

Note that according to the company, it lost INR400mn in FY09 due to translation losses on lead imports because of the depreciating rupee (INR0.5/share). If the currency appreciates, the company could benefit from lower lead prices.

With a new stable government, the likelihood of insurance reforms going through has increased. This may lead to a re-rating of its investment in the insurance business.

To see full report: EXIDE INDUSTRIES


Growth stimulus vs fiscal deficit improvement

Expect 10-15% correction next quarter
Markets tend to correct post-budget with markets giving a positive return a month later in only 4 of the last 11 budgets. The good thing is that expectations of the market from the budget are low. We think the budget will carry forward the reform momentum. However, we believe market correction will be led by (a) expensive valuations at near 17x 1-year forward earnings (b) monsoon fears reversing the recent trend of earnings upgrades and (c) supply of paper.

Budget will try to accelerate growth momentum
We expect the Finance Minister to aim ensuring growth is on track with the fiscal deficit remaining at relatively high levels. The Government will direct its limited resources to the rural poor through continuation of measures like Rural Employment Guarantee Scheme and maybe increased subvention on agriculture loans. We expect the Finance Minister to target a fiscal deficit of 6.2-6.5% (actual may end up at 7.2%) for FY10 with $8bn receipts from PSU sale/3G auction.

Investment allowance for encouraging capital expenditure
For encouraging infra/capex spend the Government may introduce an “investment
allowance” that provides a 25% tax break on capital expenditure. This will be
financed by increase in tax rates marginally to 35% (from 34%). Gainers will be
high capex companies like Pantaloon, Tata Motors, SAIL, Tata Steel and Sterlite.

Tax holidays extended for infra projects/software
1. Extension of tax holiday for infra projects u/s 80IA – gainers Tata Power, Reliance Infra etc
2. Amend Sec 80 IB (9) to confirm tax holiday for gas – Reliance, ONGC
3. Extend tax holiday for software companies – HCL, Tech Mahindra
4. Tax exemption for interest/dividend of infra projects (Sec 10(23G): IDFC
5. Housing loan interest: raise tax exemption limit from Rs150K to Rs250K: HDFC, real estate companies

Excise duty – positive CVs; negative ITC, steel, cement
1. Increase excise duty on cement and steel by 400 bps – negative for steel/cement
2. Increase excise duty on cigarettes – negative ITC
3. Reduce excise duty on CVs by 400 bps – positive Tata Motors, Leyland

To see full report: INDIA STRATEGY


World crude steel production saw some signs of recovery from its trough in the month of May-09. However, it was far away from the normal production level. Steel production in all major steel producing countries/continents increased 7% in the month of May-09 compared to the previous month (Apr-09). However, the production was down ~21% on YoY basis. Japan
(up 13.4%), EU (up 10.7%), US (up 10.5%) and China (up 7%) reported decent recovery on month-on-month (m-o-m) basis.

India and China were only countries among major steel producers which reported increase in steel production on YoY basis. During first five months of CY09, the world crude steel production was down 22.4% YoY led by US (-53%), EU (-44%), CIS (- 33%) and Japan (-42%). On the other side, China (up 0.4%) and India (up 0.5%) reported marginal increase in steel production during the same period.

Steel prices in major global markets were on downtrend in last one month except India. Steel prices in US and China fell by ~11% and ~8% respectively in last one month. Steel prices in India remained at the same level. Indian steel industry urged government to impose a safeguard duty of 25% on imported HR coil and other flat products due to higher imports. However, the government deferred to take any such measures for two months.

To see full report: STEEL SECTOR

>India monsoon covers central India, advances to north

Mumbai - India's annual monsoon rains have covered most parts of the key oilseed-growing central state of Madhya Pradesh, and further advanced towards the northern region, the India Meteorological Department said Tuesday.

The annual monsoon rains will likely advance over northern parts of the country over the next one to two days, the department said on its Web site.

"Now, only some parts of Rajasthan, Punjab and Haryana (in northern India) are remaining, which are expected to be covered in the next one or two days," said a department official, who didn't want to be identified.

Central India is likely to receive moderate rainfall over the next week, the official said.

Conditions are favorable for the monsoon's progress over remaining parts of Uttar Pradesh - a major sugar cane and rice producing state - as well as Uttarakhand, Himachal Pradesh and Jammu and Kashmir, the department said.

Isolated heavy rainfall is also likely over the west coast and northeastern states, West Bengal and Sikkim, Bihar, east Uttar Pradesh and north Madhya Pradesh during the next 48 hours, it said.

The country received normal to above normal rainfall in the last five days, another weather department official said.

India's annual monsoon rains were deficient in June due to a two-week lull in the annual rains that followed the appearance of a cyclone two to three days after the rains hit the country's coast on May 23.

The country's June-September monsoon season is important for summer-sown crops including oilseeds, rice and sugar cane, as 60% of cultivated areas are rain-fed.



Further slide in US base business, consensus forecasts at risk; Sell

What's changed
IMS prescription data indicate that US sales for Ranbaxy have steepened their decline since our last channel checks (from -40% in January 2009 vs. September 2008 to -57% at end-April 2009 vs September 2008). This decline is not restricted to drugs affected by the FDA import alert (-83% by April 2009 vs September 2008) but extends to the rest of Ranbaxy’s portfolio as well (-50% by April vs September). This continued loss of market share will likely make recovery harder, even if Ranbaxy is able to resolve its ongoing manufacturing issues with the FDA.

Ranbaxy’s recent price rise (up 67% over the last three months) has been driven by broader market strength (Sensex up 49% over the same period) and optimism that Daiichi Sankyo’s (Ranbaxy’s majority shareholder) regulatory experience could help in resolving Ranbaxy’s issues with the FDA. Nevertheless, we note that the implied pace of erosion in the base business creates further downside risk to Reuters consensus forecasts for 2009 (flat group sales) and could make consensus forecast of 13% revenue growth in 2010 hard to achieve. Note that our 2010 EPS forecast are 30% below consensus.

On our estimate, Ranbaxy is currently trading at one-year forward P/E of 33.8X (vs. the sector’s 15.8X) and one-year forward EV/EBITDA of 14X (vs. the sector’s 9.6X). Maintain Sell and our Director’s Cut-based 12-m target price of Rs196, implying potential downside of 28%.

Key risks
Upside risk: Favorable resolution of the issues with the FDA. Downside risk: Restrictions by other regulatory agencies.

To see full report: RANBAXY LABORATORIES


For Q2FY09, Pfizer is expected to report 15%YoY growth in net sales from Rs1.63bn to Rs1.88bn due to good growth in both pharma and animal healthcare (AHC) segments. The pharma segment is expected to grow by 15%YoY and the AHC segment by 16%YoY. We expect 270bps decline in EBIDTA margin from 22.6% to 19.9%. This is mainly due to the 470bps rise in other expenses from 26.7% to 31.4% of net sales. We expect marginal decline of 1% in net profit from Rs386m to Rs383m.

Outlook & Valuation
For Q2FY09, we expect 15%YoY growth in the pharma segment from Rs1.30bn to Rs1.50bn. We expect the AHC segment to grow by 16%YoY from Rs199m to Rs230m. Pfizer’s EBIDTA margin is expected to decline 270bpsYoY from 22.6% to 19.9% mainly due to the increase in other expenses from 26.7% to 31.4% of net sales. The net profit is expected to decline marginally by 1% from Rs386m to Rs383m.

The rise in other expenses is due to the increase in marketing expenses for new product launches. Pfizer launched Champix (for stopping smoking), Cyclokapron (reduces blood flow during surgery) and Bovicon (increases milk secretion in animals) in FY08. In the current year, it has launched Acupil (anti-hypertensive) and Trulimax (antibiotic).

Pfizer is likely to merge with Wyeth in India in line with the international merger. We expect the merged company to rank 8th in the domestic pharma market and 2nd among MNC pharma companies after Glaxo SmithKline. As per ORG IMS data of April’08, the merged company would have sales of over Rs10.8bn, market share of 3.0% and growth rate of 11.6% in the domestic market. The merged company is likely to derive synergies from the merger and re-structuring. The merged entity would have higher EBIDTA margin as Wyeth has higher margins than Pfizer.

We expect Pfizer to report 11% CAGR in sales and 13% CAGR in net profit from FY08-FY10. We expect its EBIDTA margin to improve from 21.5% to 22.6% during the same period. We expect Pfizer’s RoCE to decline from 18.0% to 16.7% and its RoE to decline from 17.6% to 16.5% from FY08-FY10. We recommend BUY on the scrip with a price target of Rs993 (17x FY10 EPS) with an upside of 21% over next 12 months.

Major developments
• During the quarter, Pfizer, US acquired Wyeth, US for $68bn (Rs3,305bn). The global acquisition is likely to be completed in H2CY09. In line with the international merger, we expect the two subsidiaries of the parent companies to merge in India.

• The merged entity would have sales of over Rs10.8bn and MS of over 3.0%. It is expected to grow over 11.6% in the domestic market. Since Wyeth has higher EBIDTA margin compared to Pfizer, the EBIDTA margin of the merged entity is likely to improve.

• Pfizer Inc, US has made an open offer through its investment subsidiary to acquire 33.77% stake in Pfizer at Rs675 per share. The offer price was revised to Rs830 on 25th June’09. After successful completion of the open offer, the shareholding of the parent company is likely to increase from 41.2% to 75%.

• About 25% of Pfizer’s sales come from price-controlled products.

• The management expects a double-digit growth in FY09.

To see full report: PFIZER


Tough operating environment in the near term

Patni Computer’s (Patni) net sales at USD 156.4 mn in Q1’09 was ahead of its guidance of USD 154-155 mn, however, it declined 11.4% both yoy and sequentially. In rupee terms net sales stood at Rs 7.76 bn. The fall can be attributed primarily to a 9% decline in volume growth. Moreover, EBITDA margin at 13.9% was 144 bps lower than Q1’08 due to lower utilization and
decline in pricing. Although the Company enjoys high liquidity (Rs. 108 per share) with its investment portfolio and cash position, which provides a strong support to the stock, we expect a tough time for the IT industry to prevail at least for the next three-four quarters. Besides, the stock has shot up over 150% from our last report. Moreover, our DCF valuation gives a fair
value of Rs. 241 for the stock. Hence, we downgrade our rating on the stock from Buy to Hold.

Lower pricing to restrict revenue growth: In Q1’09 there has been a 1.5% decline in pricing. As the economic environment still remains weak and many of Patni’s clients are renegotiating their contracts, we expect pricing to decline by 1-2% qoq for next two-three quarters on constant currency basis. However, we believe that the Company may show some pricing gains in the
first half of CY10.

Volume to remain under pressure in the near-term: Patni has faced substantial volume pressure in recent time due to an overall cut in the discretionary spending. However with early signs of economic recovery visible in developed economies we expect the volume to start picking up from CY10. Moreover, in order to minimize the negative impact of volume decline, the company is focusing on conversion of contracts to fixed price type, which is likely to restrict the adverse impact of volume decline on the margins.

To see full report: PATNI COMPUTERS



Quick Comment: Reiterate OW -- We met with Kishore Biyani, the promoter of Pantaloon Retail. We maintain our investment thesis regarding improving business outlook and availability of capital to fund growth plans. Consumer demand has picked up sharply in the last two weeks, and the company has various alternate funding plans to expand its business. The management has also expressed its intention to improve transparency through better communication with investors. We reiterate our Overweight rating and believe that any volatility in the stock price should be viewed as an entry opportunity.

Consumer demand has recovered sharply: Management is quite surprised by the sharp recovery in consumption across its key categories such as food, fashion, and home (excluding consumer electronics). According to management, consumer spending in these categories is nearly back to the peak witnessed in the last 18 months. Home Retail had been particularly badly hit in this downturn; it is now witnessing a sharp reversal in growth trend, particularly in the furniture and furnishings segments.

Multiple options for capital raising weighed: The company currently has multiple options available for capital raising, including secondary market offering, strategic financial investors, strategic non-financial investor, rights issue, preferential offering, etc. Over the next 1-3 months, the company could conclude/ announce a few of these plans, we believe.

PRIL likely to stop subsidiary financing: PRIL is also evaluating various plans that include private equity investments in subsidiary companies and/or restructuring the group to ensure that Pantaloon Retail does not need to fund non-retail, finance subsidiary companies.

Key management insights in last 12 months: 1) Cost management at every stage of the cycle is important; 2)growth should not be chased but should be well measured; 3) entering new businesses should be calibrated.

To see full report: PANTALOON RETAIL



JMC projects focuses on major construction segment with active presence in Industrial construction and infrastructure projects. JMC has strong expertise in urban infrastructure segment with ~55% of its order book comprising of Industrial and urban infrastructure construction projects. It has a long history of successful project execution in this domain. There is strong growth opportunity for companies engaged in power generation, transmission and distribution. JMC has strong presence in rural and urban water supply segments with ~30% of its order book concentrated on the infrastructure segment, comprising mainly of roads. With the kind of opportunity available in this segment, going forward, the company is expected to maintain its strong order position in this segment.

Key Developments
The company has recommended a dividend of Rs2 per share(20%) and company also plans to raise Rs 40 crore through issue of equity shares on rights basis. Company’s order book stands at at Rs.2,200 crore (1.7x its FY09 sales and 1.5x FY10E sales) of which ~58% consists of Industrial Construction and Buildings segment, Infrastructure projects ~30% and power ~12%. Management has given order book guidance of -2800-3000 crore by FY10 end.

We believe JMC Projects is a good turnaround story and continues to improve its performance as observed from its FY08 and FY09 performance. We believe company will continue to grow at current levels and we expect the margins to settle down at current levels. At the CMP of Rs163 company is trading at 8.4x its TTM EPS of Rs19.3 and 7.0x its FY10E EPS of Rs.23.4. We believe the company is trading at discount to peers and therefore recommend a “BUY” on the stock with a target price of Rs.212 with an upside potential of 30%

To see full report: JMC PROJECTS



Higher sales driven by volumes– SAIL reported Q4FY09 revenue of Rs 11,852 crores, a decline of 12% y-o-y on account of lower realization but an upside of 34% q-o-q led by higher sales volumes. Company has also changed it product portfolio to have higher proportion of value added products

Operating performance –Company has posted an improvement of 87% in its
EBITDA of Rs 2,109.71 crores as compared to Rs 1,128.69 crore in the previous quarter. In the first three quarters of FY09 company had already made sufficient employee wage related provisions arising due to sixth pay commission revisions and so employee cost was lower in Q4 FY09. This is reflected in the operating margin which has increased by 505 bps q-o-q. However operating margins have decline on y-o-y basis on account of higher cost of raw material mainly coking coal. Till March 31, 2009; company has made cumulative wage provisions of Rs 5,287 crores towards employee wage cost on account of 6th pay commission revisions

Key Developments
• For the FY 09 as a whole semis component in sales of steel reduced by 1% to 12%. Going forward company expect to completely eliminate it in FY10.

• Average capacity utilization of saleable steel for the FY 09 was 113%.

• Finished steel inventory for the company as of 31 March stood at 1 million tonnes

• The company has a roughly 4.5 million tonnes of carry over coal quantity booked at $300, it is negotiating with suppliers to lift this quantity over next 3 years.

• The company has closing inventory of 1 million tonne of coking coal, 0.5 million tonees in storage and rest 0.5 million tones in transit.

Cash and cash equivalents
Cash balance of company stands at approximately Rs 18000 crores, if we remove short term borrowings of around 3500 crores, net cash position is Rs 14500. This results in to cash per share of Rs 35.

At current price of Rs 152.35 the stock is trading at P/E of 11.71x FY10E EPS of Rs.13 and it is trading at TTM EV/EBITDA of 7.56x.

We recommend a “BUY” on the stock with a 12 month target price of Rs.192.

To see full report: SAIL


Mixed bag, maintain REDUCE rating

The performance of TVS Motor (TVS) in 4QFY09 was mixed bag. Net sales at Rs 9.1 bn (YoY growth of 21.3%), was ahead of expectation of Rs 8.5 bn. EBITDA at Rs 482 mn (YoY change of 103%) was below our expectation of Rs 568 mn. However, a 279% YoY increase in interest expenses to Rs 139 mn and 63% decline in other income to Rs 11 mn, resulted in company reporting a adjusted net profit of Rs 164 mn, which was below expectation of Rs 233 mn. We have derived 4QFY09 performance by subtracting the 9MFY09 performance from FY09 performance.

At consolidated level, TVS reported an EBIDTA of Rs 1.2 bn vs standalone EBIDTA of Rs 1.8 bn for FY09, indicating the investment phase of the Indonesian venture. Also, higher depreciation and interest expense resulted in TVS reporting a recurring loss of Rs 548 mn.

At CMP of 45, the stock trades at PER of 14.9x and 11.4x and EV/EBIDTA of 8.3x and 6.9x our FY10 and FY11 estimates respectively. We maintain our REDUCE rating on the stock.

Net sales ahead of expectations
TVS motor reported YoY 5.5% growth in volumes to 322,578 units in 4QFY09. Exports grew by YoY 21.2% to 46,923 units, where domestic sales declined by YoY 20.3% to 275,607 units. Net sales increased by YOY 21.3% to Rs 9.1 bn against our expectation of 8.5 bn.

Higher raw material cost puts pressure on EBIDTA
TVS motor reported adj EBITDA of Rs 482 mn was below our expectation of Rs 568 mn primarily on account of, higher than expected raw material cost. Despite a strong increase in average realizations, RM to sales ratio increased by 20 bps YoY to 74.4%.

Increase in interest and depreciation charge restricts profits
Interest expense grew by 279% YoY to Rs 139 mn. Similarly, other income registered a 62% YoY decline to Rs 11 mn. As result TVS reported net profits of Rs 164 mn, which was below expectation.

Consolidated performance reflects the pressure of Indonesian venture
FY09 consolidated EBIDTA is at Rs 1.2 bn vs stand alone EBIDTA of Rs 1.8 bn, reflects the investment phase at the Indonesian venture. Also higher depreciation change of Rs 1.3 bn (against standalone charge of Rs 1 bn) and interest expenses of Rs 745 mn (against standalone charge of Rs 550 mn), resulted in TVs reporting a recurring net loss of Rs 548 mn (against standalone net profit of Rs 329 mn).

Valuation and View
We are not concerned about the domestic business as we expect company to show strong profit growth in FY10. However, there is clear pressure on the Indonesian business, where company has invested USD 50 mn in creating physical assets and expects a recurring brand expenditure of around 5 mn. At CMP of 45, the stock trades at PER of 14.9x and 11.4x and EV/EBIDTA of 8.3x and 6.9x our FY10 and FY11 estimates respectively. Considering the pressure on the profitability and return ratios at consolidated level, we maintain our REDUCE rating on the stock.

To see full report: TVS MOTOR