Tuesday, November 10, 2009


Divergence, which is a term that technicians use when two or more averages or indices fail to show confirming trends, is one of the mainstays of technical analysis. Here’s a new way to use oscillators and divergence as well as methods to locate entry levels during a trend.

Most technical indicators mirror or confirm price movement. When price moves up, the indicator moves up; when price moves down, the indicator moves down. When prices peak, the indicator
peaks; and when prices bottom, the indicator bottoms. Sometimes, however, a discrepancy occurs between price and indicator movement. That discrepancy is known as nonconfirmation and can be seen most clearly on overbought or oversold indicators as well as on indicators that move above or below a zero line. Many traders only learn to recognize the type of nonconfirmation that occurs at market tops and bottoms, which is the classic divergence. But there are other forms of nonconfirmation I call hidden divergence (HD) that, when present, offer additional profit potential.

Hidden Divergence
Hidden divergences are the opposite of classic divergences. Classic divergence looks for lower low prices accompanied by higher indicator values at price bottoms and higher high prices accompanied by lower indicator values at price tops. Hidden divergences, on the other hand, seek higher price lows accompanied by lower indicator values during up moves and lower price highs accompanied by higher indicator values during down moves. Most hidden divergences signal continuation moves in the direction of the prevailing trend.

Classic divergence is one of the best-known types of nonconfirmation. A divergence is a separation between price and indicator that warns of a possible short- to intermediateterm change of trend. A bullish divergence arises during a down move when price makes either a lower low or a double bottom but the indicator makes a higher low or a double bottom. A bearish divergence occurs during an up move when price makes either a higher high or a double top and the indicator makes a lower high or a double top. Classic divergences can occur at price tops or bottoms and also at price corrections.

In a bullish HD, the indicator makes a lower low, but price makes either a higher low or a double-bottom low. This type of nonconfirmation occurs mainly during corrective declines in an uptrend, but it may also be found on occasion at price retests of the lows. Bullish HDs indicate underlying strength in the security and often make good entry or re-entry points. During its spectacular rise (and before its equally spectacular decline), Micron Technology [MU] displayed many bullish
hidden divergences (Figure 2) in 1995. At point 2, the indicator made a lower low than it had at point 1, but price made a higher low at point 2 than it had at point 1. In May, at point 4, the indicator was lower than at point 3, but the price low at point 4 made a double bottom with the price low at point 3 before price resumed its advance. As the indicator made lower lows in July and August at points 6 and 7 than it had at point 5, price continued to make higher lows. Another double-bottom price low occurred at points 8 and 9, but the indicator made a lower low at point 9, signaling the potential for additional strength.

In a bearish HD, price makes a lower high, but the indicator makes a higher high. This type of nonconfirmation is mainly found during corrective rallies in a downtrend but may also occur during retests of a price top. Bearish HDs signal potential underlying weakness in a security.

To read the full report: TYPES OF DIVERGENCES


Cutting rating and PO to Rs185 on 2Q disappointment
We downgrade Reliance Com from Neutral to Underperform on disappointing 2Q results and consequent 14-17% EBITDA cut for FY10-11E. 2Q FY10 EBITDA came 17% below our expectations, but profit was 15% higher, as depreciation and tax accounting boosted PAT. The EBITDA miss was led by wireless, and we expect the pressure on margins to continue.

Struggle on earnings visibility resumes

Surprise factors knock down wireless revenues & margins
In 2Q FY10, RCom’s wireless ARPU fell 23% QoQ vs. a 9-10% QoQ fall for other majors, and EBITDA margin fell ~580bps QoQ versus a 110-140bps fall for other majors. On its earnings call, RCom indicated that the revenue hit was owing to: 1) change in accounting for handset revenues, 2) lower rural (DEL) rollouts and, hence, lower subsidy income, and 3) lower VAS revenues. Wireless margins were hurt by sharply higher network expenses (+15% QoQ) and higher SG&A. Both the revenue & EBITDA factors appear to be company-specific, leading to our
discomfort on earnings visibility.

“Simply Reliance” tariffs make strong margin uplift unlikely
RCom’s 2Q revenue per minute, at ~47p, ranks lowest among the listed majors, suggesting limited downside from the recently introduced “simply Reliance” tariff plan that implies an rpm of ~35p. Our estimates factor relatively modest margin decline (~60-110bps) going forward, but any strong margin uplift seems unlikely. Stock valuations are unattractive; Bharti is preferred pick RCom currently trades at a PE of 15x FY11E and EV/EBITDA of ~8x FY11E; these valuations imply a premium of 10-25% versus Bharti (Buy, Rs292.85). We expect RCom to underperform, as low consistency of company-level performance will add to industry-level risks due to heightened tariff competition.

To read the full report: RELIANCE COMMUNICATION


The eruption of the global financial crisis in Sep08 led to withdrawal of foreign capital in Oct08-Feb09 and a 10% depreciation in the rupee against the dollar. But the crisis did little to alter the longer-term fundamentals of the economy and its attractiveness as an investment destination. Not surprisingly, and given hitherto cheap equity valuations, capital flows returned from March. This has brought the rupee back to pre-Oct08 levels even as foreign exchange reserves have risen by over USD25bn since Mar09.

Looking ahead, we continue to envision a strong balance of payments position but do not expect the current pace of inflows to continue. Our view that the drop in global output in 4Q08 was largely shell-shock has implications not just for the shape of the recovery in output, but also for financial flows and markets [1]. Capital flows, similar to economic growth momentum globally, dropped more than it should in the aftermath of the collapse of Lehman Brothers. Hence, the recovery in capital flows has also been especially sharp and rapid since March. Going forward, just as growth should moderate to a square-root shape from a ‘V’, capital flows should also moderate to more ‘normal’ levels [2].

From a multi-year perspective, we expect capital flows to rise, though the balance of payments surplus is likely to narrow compared to recent years. As a share of GDP, we expect the capital account surplus to improve from the 0.8% in FY08 (ends Mar09) to 4.5% in FY09 and about 5.5% in FY10. This is stronger than the volume of capital flows witnessed in 2003-06 but far from the deluge ( 9% of GDP) seen in 2007. However, the current account balance is expected to deteriorate steadily over the next couple of years, led mainly by wider merchandise trade deficits. Thus, the balance of payments surplus should narrow to 3.3% of GDP in FY09 and FY10 – smaller than in 2006 and 2007.

Capital account to improve
Annual capital inflows more than doubled to over USD 30bn in 2004-06 from the previous three-year period and surged further to USD 110bn in FY07. This was driven by rising external commercial borrowings (ECBs) and strong portfolio flows. Net foreign direct investments (FDI) also improved markedly, but not as much as ECBs or portfolio capital flows, partly because overseas direct investments have also increased in recent years

India should continue to attract strong capital flows in the near-term. Various FDI confidence surveys (UNCTAD 2008, AT Kearney 2007) rank India as the second most favoured destination for direct investment. Likewise, notwithstanding rising domestic imbalances and inequalities, and a less than ideal pace of reform, India is the fastest growing emerging market in the world, save for China. On the back of this growth outlook, we project net FDI to rise to 1.6% of GDP in FY10 from the 0.5% averaged in FY2003-06. Portfolio capital should remain elevated at 1.5% of GDP in FY10, though it should ease from FY09 when we estimate higher flows due to reversal of FY08’s “shell-shock” outflows.

However, ECBs should be more subdued in the next couple of years when compared to FY06 and FY07. While borrowing norms have been liberalised by the central bank (RBI) in the past year, these inflows are highly cyclical (Chart 1). There are two reasons for this. First, the norms on ECB borrowings ensure that ECBs are allowed only for fixed capital investment – the most cyclical expenditure in an economy. Second, the borrowings tend to be inversely related to domestic interest rates – the opportunity cost of borrowing abroad – making it strongest later in the cycle. Additionally, we do not view the loosened ECB norms as permanent [3]. As such, we forecast net loan flows to rise from an estimated 0.4% of GDP in FY09 to 0.8% of GDP in FY09 and 1.7% of GDP in FY10. The FY10 forecast puts it on par with the net loan flows in the strong economic
growth years of 2004-06, but nowhere as high as FY07.

On the whole, these flows imply a capital account surplus of 4.5% of GDP in FY09 and 5.5% in FY10, i.e., about USD 55bn and USD 80bn respectively.

To read the full report: BALANCE OF PAYMENTS


Disappointing 1H FY10 results; reduced FY10 guidance
Suzlon’s consolidated 1H FY10 revenue was INR89bn, down 11% y-y and representing merely 32% of our FY10F estimate. Suzlon Wind only delivered 406MW of wind turbines in 1H FY10, accounting for merely 17% of the lower-end of Suzlon’s original guidance. Suzlon consequently lowered FY10 shipment guidance to 1,900-2,100MW from 2,400-2,600MW.

Positive outlook in key markets but limited S-T impact
Over the past few months, some positive policy developments have taken place in Suzlon’s key markets: US, India, China and Australia. While we do not expect these to translate into real business momentum in the near term, we are more positive about our current assumption of a 32% y-y shipment growth (2,500MW) in FY11F.

Near term remains windy

Debt restructuring underway; cash remains tight
Suzlon’s net debt to equity ratio reached 160% by September 2009. Suzlon continues to work towards de-leveraging the balance sheet and reducing absolute debt levels through the planned sale of Hansen, refinancing its current debt and fund infusion from promoters. Based on our downward earnings revision, we believe Suzlon runs a risk of not meeting its debt covenants, but management noted that the penalty may only result in slight increase in interest rates.

Await positive catalysts; maintain NEUTRAL
Our revised price target of INR64.0 is based on DCF valuation, representing potential downside of 4%; we maintain NEUTRAL. Over the short term, we expect share price weakness due to poor 1H FY10 results, reduced guidance and risks on order intake. However, we are positive about Suzlon’s long-term potential given our bullish view on the wind power industry.

To read the full report: SUZLON ENERGY


Initiate at Hold; TP of Rs1,165 — We initiate coverage of OIL with a Hold (2L) rating and target price of Rs1,165, comprising: (i) Business valued at P/E of 7.5x FY11E core EPS (@$65 net crude) and (ii) Cash at Rs385/share (Mar- 10E). The core P/E is at a 15% discount to ONGC’s current multiple of 9.0x to factor in OIL’s untested exploration track record ex-Assam. At our target, the imputed EV/boe (1P/2P) is US$8.8/4.8 and headline P/E of 9.3x FY11E. All things being equal, we might reconsider our Hold rating and turn more positive at ~Rs1,050.

Stable operations, looking for growth — OIL, which has predominantly focused on Northeast Indian onshore blocks, has gradually gained exposure to domestic offshore via NELP blocks as well as abroad. Though the strategic shift to reinvest cash flows from the pre-NELP blocks is in the right direction, it will take time to show results, especially given lack of prior experience.

Initiate at Hold: Coming Out of Its Shell

Small in size, but good operating track record — OIL’s 2P reserves at 974 mmboe pegs it at ~1/10th the size of ONGC, though proportion of crude oil at 60% of reserves is higher than ONGC’s 53%. With lifting costs at US$4.6/bbl (FY09), F&D of US$3.7/bbl (FY08), and R/P of ~25 years (on 2P), OIL’s operations are on a solid footing. Though volume growth (boe) of 5% over FY10-12E should remain moderate, it is slightly better than ONGC.

Subsidies: what to expect — We assume upstream bears all of petrol/diesel losses. As auto fuels generate +ve margin at our forecast of $60 (FY10E) and $65 (FY11E+), we factor nil subsidies for upstream in FY10-12E.

To read the full report: OIL INDIA LIMITED