Tuesday, August 4, 2009


Downgrade to UW (V); Why give scarce 3G spectrum to MTNL?

  • Q1-FY10e results weak; labour costs drive EBITDA negative; we lower our estimates significantly
  • We believe MTNL has no viable 3G business case; government better placed to auction scarce 3G spectrum to private telcos
  • Downgrade from N (V) to UW(V); reduce TP to INR52 (INR77) as we factor the likely payout for 3G spectrum auctions.

MTNL reported a lacklustre Q1, posting a net loss of INR468mn with revenues declining by c12% sequentially. ARPUs were down c4% q-o-q while EBITDA margins remained in negative territory on higher labour costs (57% of sales). In our view, most investors are focussed on the merger with sister company BSNL (Bharat Sanchar Nigam Ltd, N/R) rather than on earnings. We note that the merger of MTNL with sister company BSNL is dependent on the listing of BSNL and is at least 12 months away in our view, given the priority for 3G and 2G spectrum policy. We believe the disagreement with labour unions as key obstacle to BSNL’s listing.

The continued poor financial performance of MTNL in our view reflects the absence of a

longer term strategy and execution. As per news reports (Economic Times, 20 July 2009)
MTNL is in the process of inviting bids from global telcos to run its 3G operations in Delhi
and Mumbai on a franchise basis for a 10 year period ; a clear acknowledgment in our view of
its poor execution capabilities. However, we believe the chances of MTNL to benefit from
such a structure will be restricted as the state owned enterprise culture of MTNL get in the way
of foreign telcos, restricting their ability to deliver. We believe 3G services require aggressive
marketing capabilities and product innovation, which in our view cannot be delivered by
MTNL in its present form.

Given the scarcity of 3G spectrum in metros, we believe the Indian regulator should
auction it to private players. In our view, the Indian regulator’s objectives of low tariffs
are best delivered by auctioning spectrum among private players.

Valuation and risks- We continue with our approach of valuing MTNL based on its cash

balance, but now are adjusting for the potential payment for 3G spectrum auctions. We are
reducing our TP to INR 52 (INR77) to adjust for the likely payout for 3G auctions and our
new target price leads us downgrade from N (V) to UW (V). The potential merger with its
sister company and the monetization of tower assets represent upside risks to our view.

To see full report: MTNL


Core Business Growth Impressive; Remain OW

Investment conclusion: We reiterate our OW and continue to believe that with earnings CAGR of 27% over F2009-11E and trading at 13x F2010E earnings, a 30% discount to the market, M&M is our preferred play for the Indian semi-urban and rural demand upcycle.

Revise price target: We updated our model for F1Q10 and are raising our PT to Rs1,065. Our revision primarily reflects the 14% and 16% increases in our F2010E and F2011E standalone earnings, respectively. We value the core business at Rs780 per share and the non-core business at Rs284 per share, thus arriving at our price target of Rs1,065. At our PT, the stock trades at 16x F2010E earnings and 14x F2011E earnings.

F1Q10 results recap At the standalone level, revenue, EBITDA, and adjusted net income was up 28%, 138%, and 187% YoY, respectively. Backed by 4% YoY realization growth, revenue was right in line with our estimates. A drop in raw material prices and operating leverage lifted margins to 14.4% – up 410bp YoY and 330bp QoQ, and 220bp above our 12% estimate. Net income was Rs4bn, up 187% YoY.

Core operations continue to impress; margins highest in two years: Margins in the tractor division improved 590bp QoQ while those in the automotive division improved 220bp YoY and QoQ. These were the highest margins posted by M&M in two years. We are building in 13.6% EBITDA margins in F2010E.

Consolidated results in line: Revenue was Rs78bn, 4% over last year and 6% QoQ. Net profit of Rs4.3bn was up 5.5% YoY but 27% down QoQ, as the sequential downtick came from high interest costs at Tech Mahindra relating to the Satyam acquisition with no corresponding income add from Satyam.

To see full report: MAHINDRA & MAHINDRA


Marred by lower GRMs and higher taxation

Reliance Industries’ (RIL) Q1FY10 recurring net income was lower than expected, at Rs36.4bn (12% YoY dip), despite higher-than-expected PBT, owing to higher effective tax rate. RIL factored-in 15% minimum alternate tax (MAT) rate in its reported earnings on account of increase in MAT rate in the recent union budget. The company’s PBT was ~10% higher than I-Sec estimates on the back of lower other expenditure and interest costs. Despite an impressive 27% income CAGR over the next two years, we remain negative on RIL due to concerns about its ongoing court cases with Reliance Natural Resources (RNRL) & NTPC and weak outlook on its refining & petrochemical businesses. Owing to higher tax rate and slightly higher investments made by the company in its retail business, we lower our target price estimate to Rs1,745/share from Rs1,756/share earlier. Refusal by the government to allow tax shield on gas production from NELP blocks would further reduce our target price by Rs30/share. Maintain HOLD.

EBITDA declines 3% YoY to Rs59.2bn on lower refining profitability, which was partially offset by higher profitability from the petrochemicals and O&G businesses. RIL saw 52% YoY dip in refining margins to US$7.5/bl due to lower product spreads and lower light-heavy differential. While higher polymer margins led to 32% YoY growth in petchem EBIT, commencement of production from KG D6 field led to 100% YoY jump in O&G segment profitability.

Recurring net income dips 12% YoY to Rs36.4bn on higher effective taxation. RIL factored-in effective tax rate of 21% (vis-à-vis our expectations of 11.3%) due to higher MAT rate as per the budget. Interest costs dipped 28% QoQ due to lower interest rates, as LIBOR-linked loans were cheaper 150bps in Q1FY10.

Lower earnings estimate, valuations. We lower our FY10-11E earnings estimate for RIL 10-12% due to higher effective tax rate. However, we maintain our EBITDA, and PBT estimates as we maintain our outlook on the company. We also lower target price to Rs1,745/share from Rs1,756/share earlier to reflect the revision in earnings. We value RIL’s extant business, including Reliance Petroleum (RPL) refinery, at Rs1,020/share; retail business at Rs38/share; gas-marketing business at Rs42/share; E&P at Rs798/share; and special economic zone (SEZ) at Rs10/share. Given that the stock is trading at significant 16% premium to our target price estimate, we maintain our negative stance on the company and advise investors to
book profit at current levels.

To see full report: RIL


2Q09 TPI Index: Signs of Stability; No Acceleration Seen

Still down yoy; flattish sequentially — 2Q09 saw Total Contract Value (TCV) down 23% yoy; Annualized Contract Value (ACV) down 29% yoy – however, last year's 2Q was very strong. Sequentially, there is stability – TCV up ~5% qoq and ACV down ~5%. Pace of contraction has stabilized between $17-24b in the last 4 quarters (post a strong 1H08). TPI saw an uptick in May and June but July was soft (partly seasonal) – ties in with Infosys’s commentary post its 1Q results.

Some signs of stability; do not expect acceleration in 2009 — TPI does not see a market rebound soon, although the award profile could hint at sustained values through the year. Though pipelines remain strong, decision making is still slow. 2009 TCV could be below $80b – the last time this happened was in 2001.

BPO down significantly — TCV was down ~47% qoq; decline was across regions. As per TPI, the limited capital with clients is making them spend more on areas of higher returns – namely, ITO and ADM. However, there is considerable activity in the sub-$25m range, particularly in the staff augmentation segment.

ITO helps sustain the overall market — Despite a strong 1H08, ITO held up reasonably well in 1H09. A lot of ADM and Infrastructure bundled deals are happening in the market – a sweet spot for Tier-I Indian IT vendors. YTD there have been over $6b of such deals; more than that of entire CY08.

Discernible trends in 1H09 — (1) About half of mega deals awarded have focused on network services. (2) Five of the eight global mega deals were signed in EMEA. (3) Average TCV in Asia Pacific increased by more than 50%, while the other regions experienced declines. (4) In Americas, TCV signed during the past three years has stabilized. (5) Telecom, Transportation, Retail and Diversified Financials were relatively strong and represented ~47% of TCV awarded thus far. (6) Banking, Insurance, Oil & Gas, Consumer Durables were weak.

Pricing stable; vendors rational — TPI has seen pricing stabilize in 2Q09. Most of the pricing negotiations are done and conversations are now moving towards leveraging for growth. TPI noted that vendor behavior in pricing has been rational.

Demand stabilizing but valuations back at pre-slowdown levels — Latest demand commentary across companies suggests some stability on demand. However, valuations are not too far from 2007 levels (pre-slowdown) and stocks will need positive surprises/earnings upgrades to move up materially. We recommend playing the sector through TCS/Infosys.

To see full report: INDIAN IT SERVICES


QE Jun-09 Earnings: The Final Cut

Quick Comment – Earnings Beat MS Analysts’ Expectations: 93 companies in our coverage universe have reported results for the QE-Jun-09. Aggregate earnings are up 7% YoY (ex-energy down 1% and ex-materials up 18%) against our analysts' expectation of 1% fall (ex-energy 4% fall and ex-materials 8% growth). In terms of surprise breadth, 46 of these 93
companies have reported net profit that exceeded expectations by 5% or more while 34 trailed by 5% or less. BSE Sensex companies have reported a 4 percent fall in earnings ahead of MS analysts’ expectations of 10% fall. At the sector level, consumer discretionary and
energy are the key positive surprises whereas healthcare is the key negative surprise. For the quarter, energy is the best-performing sector with a net profit growth of 38%, followed by consumer discretionary while materials is the worst-performing sector. If one excludes real estate whose earnings were down 76% YoY, financials top the list with a growth of 40%.

EBITDA Margins Rise: EBITDA margins for the sample are up 4ppt (Ex- energy down 155bps and Ex-materials up 5.5ppt). Five sectors have seen margin expansion with energy leading the list and materials and healthcare at the bottom. Revenue growth for the sample is down 12% YoY (ex-energy, up 8%) whereas for the Sensex companies it is down 2% (ex-energy, up 9%).

Broader Market Earnings Ahead of MS Coverage Marginally: 2578 companies in the broader market have reported a 9% fall in revenue (ex-energy flat). Aggregate earnings for the broad market are up 9% YoY (up 5% ex-energy). EBITDA margins for the sample are up 4.2ppt to 23% while ex-energy margins are up 2ppt to 25.3%. Of these 2578 companies, 25% or 636 reported losses while 18% or 468 companies have reported earnings growth in excess of 50% for the quarter.

To see full report: INDIA STRATEGY


Upgrading price target

IRB Q1FY10 results are above expectations on account of better than expected topline in both (BOT and Construction segment) and higher other income (gain on sale of debt investments). Revenues for the quarter grew by 80% yoy to Rs4.14 bn (our estimates Rs3.7 bn), driven by 121% growth in construction revenues and 44.4% growth in revenues of BOT segment. EBIDTA for the quarter at Rs1.66 bn (our estimates (Rs1.52 bn) grew at 41.5% yoy, driven by 46% growth in BOT EBIDTA and 75% growth in Construction EBIDTA. Net profit for the quarter at Rs814.6 mn grew 50.5% yoy, higher our estimates of Rs672.3 mn. On account of increase in MAT to 15% in union budget 2009-10, we are downgrading our earnings by 9% to Rs9.8/share for FY2010. We are introducing our FY2011 earnings at Rs13.2/share, factoring in the increased revenue from E&C segment on account of the recently bagged 4 BOT project worth Rs43 bn. We have upgraded IRB fair value from Rs145 earlier to Rs195, on the back of addition of four BOT projects that IRB has recently bagged. Maintain ACCUMULATE rating.

Result highlights

IRB Q1FY10 results are above on account of better than expected topline in both (BOT and Construction segment) and higher other income (gain on sale of debt investments).

Revenues for the quarter grew by 80% yoy to Rs4.14 bn (our estimates Rs3.7 bn). driven by 121% growth in construction revenues and 44.4% growth in revenues of BOT segment. Growth in BOT segment was mainly on account of contribution from the new Surat – Dahisar project where the tolling started from February 2009.

The Mumbai-Pune project saw revenue growth of 5.9%. BOT revenue growth on a like to like basis (excluding Surat Dahisar, Bihwandi Wada and Khabhbatki Ghat) was at 4%. Since there has been no toll rate hike this year we presume the entire growth is driven by growth in traffic volumes.

Growth in construction segment was on account of execution of new projects like Surat Dahisar and Kolhapur project, which were not there last year.

EBIDTA for the quarter stood at Rs1.66 bn (our estimates (Rs1.52 bn) grew at 41.5% yoy, driven by 46% growth in BOT EBIDTA and 75% growth in Construction EBIDTA.EBIDTA growth was lower than the revenue growth as the share of construction business (EBIDTA margins of 18.4% as compared to BOT EBIDTA margins of 85%) was at 63% as compared to 53% in Q1FY2009. Consequently EBITDA margin for the quarter at 40.1% declined by 1090 bps.

EBITDA margins for the construction business decline by 481 bps on account of lower share of high margin funded construction. Consequently Construction EBIDTA grew by 75% to Rs505 mn. BOT EBIDTA margins at 85.3% improved 104 bps yoy and hence BOT EBIDTA grew by 46.1% yoy.

To see full report: IRB INFRASTRUCTURE


Indian Automobiles – July 2009 Monthly Sales

Growth Momentum Continues

Auto volumes posted positive growth across segments: The positives for the month in terms of YoY growth in domestic sales were: Maruti car sales up 33% YoY, M&M UV sales up 46%, M&M tractor sales (ex PTL) up 21%, Tata Motors MHCV sales up 6% and LCV sales up 44%. July is a slow month; thus sequentially, in terms of domestic sales, only Maruti was up 9% and Tata Motors CV segment was up 8%.

M&M growth momentum maintained: Strong UV numbers (up 46% YoY) at 17K units, while tractors, adjusted for PTL, were up 21% YoY. The company sold 2100 units of Xylo and 3300 units of Scorpio. At 13x one year fwd earnings and 27% F09-11 earnings CAGR, M&M is our top pick in the sector.

Maruti shows 9% MoM growth: Domestic sales were up 28% YoY and company posted impressive 9% sequential growth. While the A2 segment continued to grow, up 38% YoY, strong growth came from A3 segment, up 51% YoY; thus pointing to improving product mix. Based on data disclosed, we expect Maruti was able to maintain its market share during the month.

Tata Motors strong CV numbers: MHCV sales posted growth of 6% YoY, after a gap of 13 months. LCV volume growth continued, and they posted 44% YoY growth. The CV cycle has started recovering but we believe JLR will be a drag on Tata Motors, and we remain Equal-weight on the stock. JLR US numbers for July 09 were down 25% YoY and 9% sequentially

Hero Honda numbers in line, Bajaj comes in flat: Though Hero Honda posted 30% YoY growth, the numbers were in line with expectations and flat MoM. Riding on new launches, Bajaj Auto and TVS posted flat to marginal growth numbers vs. declines previously .Based on data disclosed, we expect Maruti was able to maintain its market share during the month.

Outlook for August: We expect the sales growth momentum to be maintained as volume growth will be aided by pre-festive stocking and low base benefit. Given that the festive season will start from mid-September, most OEMs will start building inventory in the coming month.

To see full report: INDIAN AUTOMOBILES


Which emerging countries have the greatest risk of exposure to triple crisis?

The impact of the international crisis on emerging economies initially entailed considerable pressure on foreign exchange, in similar fashion to a crisis, but this also entailed a banking crisis.

We intend to evaluate the risk of a sovereign debt crisis for a group of emerging economies, and to this end we have come up with a composite sovereign vulnerability indicator produced from weightings on six variables in relation to solvency, liquidity, currency and governance.

Our results show considerable exposure to the risk of a sovereign debt crisis in Iceland, Latvia, Hungary, Estonia, Lithuania and Ukraine, whereas there is little risk of a sovereign debt crisis in Latin America (Brazil, Colombia, Mexico, Chile, Peru and Venezuela), Asia (Indonesia and Malaysia) and South Africa. In all other cases only average risk is perceived (Croatia, Bulgaria, Poland, the Philippines, Romania, Argentina, Czech Republic, India and South Korea).

To see full report: FLASH ECONOMICS



Key points
Profitability to surge on benign raw material prices: Apollo Tyres Ltd (APL)’s profitability was under severe strain in FY2009 due to a steep rise in the prices of its key raw materials, such as rubber and crude oil derivatives like carbon black, synthetic rubber, nylon tyre cord fabric and rubber chemicals. The operating profit margin (OPM) had slumped by 464 basis points year on year (yoy) to 8% in FY2009. However, since December 2008 the raw material prices have corrected substantially while the benefit of a lower raw material cost has not been passed on to the consumers through price reductions. As a result, we expect the profit margin of APL to expand significantly in FY2010, leading to a three-fold jump in its net profit.

Revival in demand to follow overall economic recovery: The economic slowdown severely affected the domestic automobile industry, especially in the second half of FY2009 after the freefall in the global economy in the wake of the Lehman debacle. The resultant jitters were also felt by the auto ancillary industries including tyres. Tyre makers saw a sharp dip in their sales to the original equipment manufacturers (OEMs) and the replacement market, and many were forced to go for production cuts in H2FY2009. However, the tyre industry is showing signs of recovery especially with the significant demand improvement in the passenger car and replacement markets. The ban on the import of truck and bus radials (TBR) since November 2008 has also helped improve the demand for domestic tyres, more so since the Chinese imports have plunged by ~78%. Also, measures like the economic stimulation measures by the government, the passing on of the benefit of the 6% reduction in the excise duty in the later half of FY2009, the lower interest rates and the significantly lower raw material prices are likely to boost the demand environment further.

High on expansions: APL is the market leader in truck and bus tyres, and light truck tyres in India with a significant market share in the passenger car tyre segment. To improve its market share and expand in these segments, the company is increasing its capacity in India from 850 tonne per day to ~1,000 tonne per day by establishing a new greenfield plant in Chennai. This plant will primarily cater to the growing demand from the TBR and passenger car radial markets. In the international market APL has presence in South Africa where it is the biggest tyre manufacturer. To further expand its international presence the company in May 2009 acquired Vredestein Banden BV (CY2008 sales at 307 million euros/Rs2,087 crore), a high-end passenger car tyre manufacturer in the Netherlands with a capacity of 150 tonne per day. The acquistion gives APL access to the European markets and has increased its current production capacity to ~1,200 tonne per day.

Buy-back may not materialise
The company had announced a buy-back of its shares from the open market beginning April 23, 2009 which will be open till March 18, 2010. As part of the buy-back the company intends to buy a minimum of 67 lakh shares (current equity: 50.4 crore shares) at a price not exceeding Rs25 per share. The maximum amount set aside for the buy-back is Rs122 crore. With the market price ruling over the buy-back price since the announcement of the offer and considering our price target of Rs53 on the stock, we do not expect the buy-back to materialise. Hence, we have not factored any reduction in the equity in our estimates.

Key risks

Raw material and exchange rate volatility
Most of the raw materials needed by APL have shown significant volatility over the years based on the demandsupply factors. The prices of crude derivatives, such as carbon black, synthetic rubber, nylon tyre cord fabric and rubber chemicals, move in tandem with the price of crude oil. Also, the price of rubber, which accounts for 58% of APL’s raw material cost, is a key determinant of the company’s profitability and can play spoil sport, as was
seen in FY2009.

Performance of international operations
APL has substantial international presence in South Africa and now in Europe with the recent acquisition of Vredestein Banden BV. We believe that these markets provide a significant opportunity to APL to become a significant global player as the scale and size of the available opportunity has increased. However, the near-term performance of the international business is susceptible to the difficult business environment in these markets.

To see full report: APOLLO TYRES


F1Q10: Back to Profit, Despite No Gov’t. Bonds

Quick Comment – Impact on our views: BPCL reported its F1Q10 results with Rs7.5bn in EBITDA and Rs6.1bn in net profit against losses the same time last year; 40% above our expectations. Earnings included Rs2.3bn in forex gains and Rs3bn in inventory gains. Adjusting for both, profits would have been half. The earnings do not include any government bonds because of the LPG and Kerosene subsidy but do include Rs1.57bn in upstream share because of gasoline and diesel. We would not be surprised if in the future the
government compensates BPCL by issuing bonds worth Rs9.4bn, the under recovery for the quarter.

What We Liked
Improving balance sheet: The company had zero net debt and reported higher interest income than interest costs. In F2009, BPCL had a net interest cost of Rs7.5bn and peak debt-to-equity ratio of 6x.

Subsidy burden under control: For F1Q, BPCL had gross under recoveries of Rs10.8bn and received Rs1.6bn in subsidy support from upstream companies. This under recovery is one-tenth the under recovery in F1Q09. However, it would have been better had the government settled oil bonds on a quarterly basis.

High extra ordinaries: BPCL earned Rs2.3bn in forex gains and Rs3.0bn in inventory with staff costs lower by Rs2.5bn due to certain extra ordinaries last year.

What we did not like
Throughput was down 16% YoY, 14% QoQ, due to a partial shutdown of the Kochi and Mumbai refineries. This also led to BPCL earning a low GRM of US$3.16/bbl, a negative spread of US$0.93/bbl.

We now believe that the government has reduced the uncertainty over future profitability in the R&M sector in India. However, we would prefer that the government issue oil bonds on a quarterly basis or least indicate the calculation mechanism. We maintain our Overweight
stance on and earnings forecasts for BPCL.

To see full report: BPCL