Tuesday, September 29, 2009


Taking the Bait…S&P 500

We still think that equities will trade in a broad range for an extended period. The current rally is typical of what follows major bear markets and is not, in our view, the start of a new multi-year bull market. However, we now think it can run on for longer than we previously
expected, so we are upgrading our year-end S&P 500 target.

We previously expected the S&P to end the year at 900, with a near term stretch target of 1100 (14x two-year forward earnings). We think equities will now trade above this, in large part because earnings will be higher than we previously anticipated. We now expect 2009 and 2010 earnings to be $55 and $70, respectively. This implies a year-end 2009 fair value of 1050 ($70 EPS on 15x). A higher multiple would justify a higher target, but we don’t see a compelling reason why equities should trade significantly richer in the current environment, despite low official interest rates.

With risk assets in a sweet spot (growth momentum improving, rates are on hold, and liquidity measures plentiful) for at least the next 2 quarters, we think the market will trade away from our fundamental valuation before growth and earnings concerns resurface and potentially disappoint expectations built in equities. At 1200, however, we would turn cautious unless there has been a material change in the fundamentals.

What worries us? 1) There is now a strong consensus view that equities will trade higher into year-end, yet few clients hold this view with high conviction; 2) the simultaneous rally in both bonds and equities highlights a strong divergence in views on growth, which will at some stage need aligning; 3) earnings/margin expectations are following the normal pattern of cyclical
cost underestimation; and 4) all asset views are highly aligned to a depreciating US dollar.

To see full report: EQUITY STRATEGY


Mgt meeting induces confidence
We hosted MphasiS management at our DSP ML Corporate day at Mumbai. Management vision of achieving US$2bn revenues over next 2-3 years including inorganic initiatives and confidence in maintaining ~22% EBIT margins during FY10 which is inline with BAS-MLe reinforces our long term bullish stance on the stock. We also raise earnings estimate by 3% for FY10e and FY11e to factor AIG captive unit acquisition and raise PO to Rs750 at PEG of 1x in line with 2 yr EPS CAGR of 15% vs. 14% earlier. Our revised PO implies target P/E of 15x FY10E (Oct. yr end).

Expect margins to sustain at current levels
Expect EBIT margins to maintain at current levels of ~22% for FY10, in line with BAS-MLe. Increase in seat utilization, consolidation of facilities and increasing share of high margin ITO business to help sustain margins. Besides we see minimal risk to margins from rupee appreciation as ~70% of its 12 months US$ revs are hedged at favorable USD/INR rate of Rs47-48.

Pricing cuts with HP factored in 3Q results
While MphasiS continues to see pricing pressure in sectors such as telecom & manufacturing, pricing pressure in Banking, finl services & insurance (~40% revs) has subsided as per management. Even with HP, management indicated that pricing is market driven and its recent master service agreement with HP factors low single digit pricing cuts, in line with market. We believe 3Q results factors recent pricing agreements and margins unlikely to surprise on the downside

Share of ITO to increase
Expect revenues to cross US$1bn by FY10E (BAS-MLe at US$1.05bn) and highlighted vision of reaching US$2bn revenues over next 2-3 year; including inorganic initiatives. Share of ITO revs to grow from 19% (FY09) to ~ 30% (FY12e).

To see full report: MPHASIS LTD


Steady Progress: Execution Is Key

Steady progress — Both Apollo and Fortis reported strong results for the first three quarters of FY09, with positive trends on occupancy and pricing. Although Apollo’s pharmacy operations remained a drag on overall profitability, the hospitals division continued to excel. Fortis, on the other hand, was buoyed by an impressive turnaround at Escorts, removing a key overhang for the stock.

Expansion plans — Despite tighter availability of capital, Apollo and Fortis maintain aggressive expansion plans. While Fortis intends to add c.4,000 beds by 2012 (organic and inorganic), Apollo plans to add c.3,000 beds over the same period. We see these as additions as exceptions, rather than the rule, for the sector, as smaller players adopt a more cautious stance. Inability to grow, due to scarcity of capital, may also trigger consolidation, which should favour larger players.

Low leverage offers comfort — The sector is largely under leveraged (net D/E of 0.33x in FY10E), especially given it is still in an investment phase. Both Apollo and Fortis appear comfortable on the funding side, at least with respect to the next 1-2 years, in our view. Beyond that, however, efficient execution and ability to generate cash from the existing set of hospitals will be critical.

Risks to growth — While we remain positive on the long term prospects for the sector, the current macro environment, especially falling income levels, could pose some risk to demand and impair the ability to take price hikes. At the same time, capital constraints could hinder expansion plans at the aggregate level, although Apollo and Fortis appear comfortable on this front.

Apollo is our preferred play — We expect hospital stock valuations to be subdued over the near-term as execution risks, low capital efficiency, and lack of sufficient liquidity (due to low market cap), continue to weigh on multiples. Apollo Hospitals (1M) remains our preferred play in this space at these levels, based primarily on its attractive valuation, while we retain our Sell (3H) rating on Fortis Healthcare.

To see full report: INDIAN HOSPITALS


Still very long and now less defensive

  • Aggregate longs remain near a record level
  • Investors report a significant reduction in the defensive sector bias
  • HY exposure has also increased, though investors remain less long than in high grade
  • However, cash inflows also remain near a record level, mitigating the warning signals coming from positions for now
To see full report: GLOBAL CREDIT SURVEY


Investment Rationale:
• The Company will invest Rs 2.1 billion to double the production of poly film by 2011-12, which will be funded through a mix of debt and equity , due to which its annual EPS to climb to Rs 10 for 2011-12

• The Company will increase the current capacity of PET thin film from 30000 TPA to 57000 TPA by the last quarter of calendar year 2010

• The Company expects to earn about Rs 10 million a year by selling the carbon credits

• It has been saving on power cost by switching to different fuels from time to time• The Company has forward as well as backward integrated manufacturing facilities

• The Company has sales tax exemption till 2012 on its second film line of 12,000 TPA capacity

• Despite its strong financial performance and good client base, the Company is trading at a PE(x) of only 2.94 against the industry average of 27.20

• In 2009, the Company has a low debt to equity ratio of 0.40 and a high interest coverage ratio of 6.98 thus signifying a low financial leverage

• The Company is a low cost producer of Engineering Plastics compounds and blends which provides it a major edge vis a vis competition.

• Many of the raw material manufacturing companies are present in the organized sector on account of high capital costs required for setting up a unit

• Technological developments play a very important role in this industry. In India there has been a slow progress in the technology adoption and up gradation

• Trade barriers in US, EU and Brazil continue. Turkey has also imposed an antisubsidy & anti-dumping duty on Indian PET Film producers

• The major raw material supplies are expected to remain stable barring the price fluctuations attributable to volatility in Crude Oil prices and the resultant effect on the petrochemical value chain.

To see full report: ESTER INDUSTRIES

>EAGLE EYE ON 30/09/09

Momentum slowing down

Markets on Sep 29, 2009: Range-bound day

After opening positive the market consolidated in a very narrow range of 5020-4990 throughout the day. Nifty is trading in an upward parallel channel and taken support from the middle line of the channel i.e. 4900. The upper end resistance of the channel is 5100-5151, which is also our short-term target. Nifty is trading above 4750 level, which acted as strong resistance earlier and has now become an important support going forward. Sensex is trading above the bullish island reversal pattern i.e. 15275, which will act as a very strong support in short run. Nifty is currently trading above 20 daily moving average (DMA) and 40DMA i.e. 4837 and 4728 respectively,
which are crucial support levels going forward. The momentum indicator (KST) has given a negative crossover and trading above zero line.

On hourly chart, Nifty is trading above 20 hourly moving average (HMA) and 40HMA i.e. 4986 and 4966 respectively, which are crucial support levels in immediate run.

Momentum indicator (KST) has given positive crossover and trading above zero line. Market breadth was positive with 734 advances and 537 declines on the NSE. Nifty ended positive with 48 points and Sensex with 160 points. Of the 30 stocks of the Sensex, Sun Pharmaceutical
Industries (up 5.5%) and Tata Consultancy Services (up 4%) were top gainers, while State Bank of India (down 2%) and Ranbaxy Laboratories (down 2%) were in red. Information technology sector stocks were trading with positive momentum and expected to move up.

To see the full report: EAGLE EYE 300909

>FOMC statement seen as neutral to supportive for gold

Analysts described the post-meeting statement from the Federal Open Market Committee Wednesday as neutral to supportive for gold futures.

Some suggested the ongoing low-interest-rate environment will mean further pressure on the dollar and eventually lead to inflation, both of which tend to lead to the buying of gold.

Yet, some also said the Fed's lack of fear over inflation may also cool market sentiment, perhaps meaning sideways trading for a while.

The FOMC left the federal-funds target at zero to 0.25%, as expected.

The Fed officials said economic activity picked up but will remain weak for a while yet. They also said inflation is likely to remain subdued "for some time," meaning interest rates can remain low for an "extended time." The statement indicated the Fed will extend mortgage-security purchases into 2010 but complete Treasury purchases in October.

In the aftermath of the FOMC statement, December gold on the Comex division of the New York Mercantile Exchange ticked up from around $1,012 an ounce a few minutes ahead of time to $1,019.70 five minutes later, before gradually backing off.

"I think you could probably see higher prices for the medium term on the basis that low interest rates are going to help stimulate what the stimulus spending was trying to do," said George Gero, vice president with RBC Capital Markets Global Futures.

For starters, eventual economic recovery may mean eventual inflation, observers said.

"The Fed made the statement that things are improving, although there are some problems with employment that are going to limit the rate of recovery," said Bart Melek, global commodity strategist with BMO Capital Markets. "But at the same time, they have said they will continue to provide liquidity in the system broadly."

Even though the Fed doesn't see inflation on the horizon, gold investors may see an increased chance of rising price pressures farther down the road, he continued.

Even if inflation does not kick in, "the concerns will mount, especially from those looking for that and who participate aggressively in the gold market," Melek added.

Adam Klopfenstein, senior market strategist with Lind-Waldock, said he doesn't anticipate inflation becoming an issue before late 2010 or early 2011. Still, he said, the Fed intentions could mean further pressure on the dollar that helps gold.

Furthermore, some market participants may not want to pile all of their money into foreign currencies such as the euro, he said.

"Gold is the most advantageous play if you don't want to be involved with any type of currencies," he said. "Even though the euro has had a nice rally, people are questioning whether they want to have all of their money in euros at this point. So people are saying, 'get me in the real reserve currency in the world, which is gold.'"

Gero said that whenever there are pullbacks due to profit-taking, or selling by those who have already bought at lower prices, fund buying often emerges on a scaled-down basis.

"If it does trigger inflation and rates continue to stay low, that is a formula that helps gold maintain purchasing power," Gero said. "And it continues to put pressure on the dollar."

Dan Cook, senior market analyst with IG Markets, doubts the FOMC statement will have a major impact on gold either way. In particular, he cited the portion in which policy-setters expressed doubts about inflation for the foreseeable future.

"They are still saying inflation is not going to be an issue for some time, and that might kind of stifle the run we've seen in gold," Cook said. "We might hover around this $1,000 level for a little while here. I wouldn't be surprised to see us move sideways for a little bit."

Klopfenstein said he anticipates increasing volatility with two forces at work in the market.

Selling on one level will come from those with profitable long positions who want to book profits, as well as others concerned about the strength of physical demand from India, he said. Support will come, however, from those concerned about more dollar weakness.

"I think it's going to be continually going up over the long term," Klopfenstein said. "But I think in the short term, it's susceptible to a sell-off."