Sunday, January 10, 2010

>“One chart to rule them all”: why U.S. stocks cannot have just started a major long-term bull market

Our primary reason for remaining cautious on U.S. (and European) equities is that most people are still treating this recession as a garden-variety inventory-correction one, instead of a credit-collapse recession different in character from any other developed-nation recession in the last century other than 1930s America and 1990s Japan. But an even bigger-picture view makes us wary over a longer time frame. The best way to gain this perspective is to examine what drove the 18-year bull run in U.S. stocks from 1982 through 2000 (excluding the credit bubble build-up and internet mania, which were real but minor factors across most of those years). We latched onto this idea when David Rosenberg made some comparisons of today with 1982. We have pushed his comparisons much farther in report.

From the standpoint of an investor in U.S. stocks, the world of 1982 could not have been a less hospitable place. Everything that could go wrong had gone wrong. Inflation and interest rates were sky-high, which reduces stocks’ value because companies’ future cash flows are worth much less or, alternatively, you can earn a better risk-adjusted return by buying bonds instead. The Fed was doing nothing to provide the market with liquidity. Government deficits were relatively low, meaning deficit spending was not contributing much to output growth – and because total government debt was low, fiscal stimulus had a lot of room to run. Households had meager income, little debt, and a high savings rate, meaning they also were not contributing much to growth. The housing supply was tight, and the dollar was high.

Government actions were unfriendly toward businesses and wealthy individuals, and therefore toward corporate profits and capital creation; we had high tax rates, oppressive regulation, and a heavy bias towards unionism and protectionism. As a result, corporate profit margins were near all-time lows.

It is not surprising, then, that investor sentiment and equity valuations were at deep historical lows on any metric: price/earnings multiples, price-to-book multiples, dividend yields, and anything else one could measure. But – and this is the key – things had nowhere to go but up. Every one of those depressing trends was about to reverse. From a shareholder’s perspective, the world looked better and better for the next 18 years. On top of that, shareholders got a boost from a once-per-century trend that was every bit as important: baby boomers increasingly entered their peak years for productivity, earnings, and savings, and they plowed an increasing portion of those savings into stocks. That pushed prices and valuations even higher.

Today we are at nearly the polar opposite of 1982: apart from the current credit bubble collapse, which is nowhere near done, everything that could go right for stocks has already gone right. Short-term interest rates are at zero, inflation is zero, Fed-supplied liquidity and fiscal stimulus have never been higher, the government’s and households’ coffers are now tapped out, government policy towards businesses and capital is accommodating and can only get worse, people expect 2010 profit margins to be back near their all-time highs, and baby boomers are just about to leave their peak earning years and become a huge drag on markets instead of a huge boost.

With all of these factors currently working for stocks, and with most investors thinking “the recession is over” and everyone will get right back to bubble-year behavior, it is not surprising that investor sentiment and valuations are now high. As we did last January, we display our key valuation chart, which tracks the price/earnings ratio using a trailing 10 years of inflation-adjusted earnings (to sidestep problems both with earnings cycles and with faulty earnings forecasts)

To read the full report: U. S. STOCKS


Interaction with mgmt increases our confidence
Our recent talk with Anil Chanana, CFO, grew our confidence regarding a demand revival. We believe HCL Tech will be able to at least match its larger peers in USD revenue growth, and that our previous estimates of 2.0-3.0% q-q growth through FY11 (versus 3.0-3.5% for peers) may prove conservative. As a result, we raise our FY10-11 revenue and EPS estimates by a modest 1-2% and 2-5%, respectively. HCLT shares have returned 18% since its 1QFY10 results (versus the Sensex which is up 11%), but we believe that there is more steam left given our revised TP of INR420.00. We see HCL Tech as a credible alternative to the larger names, where valuations seem stretched. Furthermore, in the likelihood of a strengthening USD/INR environment over the next few quarters, HCL Tech’s earnings are better protected as lower INR revenue would be offset by fewer hedging losses.

What’s new? New deals, EAS recovery signs, BPO reorg.

1) HCL Tech’s deal flow has started to pick up after a relatively quiet two quarters even as several of the USD2.65b deals signed in FY08-09 (with Nokia, Xerox, Viacom, etc, Exhibit 5) have begun to contribute steadily. We estimate that in the December quarter, HCL Tech may have won about USD350m of new deals. 2) Infrastructure services (19% of rev., doubledigit
q-q growth in the past two quarters) may continue to provide an edge. Management sees about USD60b of deals being renewed globally over the next 2-3 years, a significant portion of which would require infrastructure services. 3) We believe Axon can prove to be an important asset in FY11. The enterprise application services (EAS) market is showing signs of an early recovery (e.g. HCL Axon’s recent SAP implementation deal win with GSK). We also see HCL Tech and Axon increasingly cross-selling their services to accounts beyond EFH Oncor and Dr. Pepper. 4) The BPO restructuring is on track – the enhanced Liberata insurance platform has led to a USD200m deal from the UK-based Equitable Life, its first customer since the July 2008 acquisition. Furthermore, the Control Point business now has a new CEO, Rick Valencia, a well-regarded industry veteran, as HCL Tech intensifies its efforts to improve its US BPO operations.

Raise TP to INR420.00, more steam left in the rally
We raise our DCF-based December 2010 TP to INR420.00 (Exhibit 7) from INR365.00 set for June 2010. Our target price implies an FY11 P/E of 15.3x, which is still at a significant discount to the larger peers which are trading at 19-22x. If we exclude the forex losses to normalize our FY11E EPS, our implied target FY11E P/E is even lower at 14.0x.

To read the full report:HCL TECHNOLOGIES

>Agri Marketing Summit 2009 (MOTILAL OSWAL)

We attended Agri Marketing Summit ’09 to get an update on the evolving structure of agri marketing in India and the increasing role of private players in improving the efficiency of the agri marketing value chain.

Key takeaways from summit
We came back incrementally positive on the unfolding opportunity in agri marketing and its potential to prop up agri GDP growth. Our key takeaways are: (1) Model APMC Act needs to be more flexible to facilitate its implementation in true spirit, (2) Investment in agri marketing reforms will be evaluated on risk-return profile, (3) Information and communication technology will play a crucial role, and (4) Development of organized retail in food products has become a necessity for transforming the agri marketing network in India.

Challenges ailing agri marketing in India
Despite the realization on the difference that agri marketing can make, little headway has
been made over the last decade on account of inherent structural challenges in the Indian
agricultural system. These include: (1) lack of implementation of APMC Act, (2) lack of
a single unified market, (3) inadequate private investment, and (4) few risk mitigation
platforms in Indian agriculture.

Huge room for private investment; multiple avenues of growth
The conference highlighted the immense opportunity and increasing role of private players in improving efficiencies in the agri marketing value chain. Promoting private investments in marketing infrastructure will lead to increased efficiency in planning, management and operation of even the existing infrastructure. Avenues for involvement include contract farming, PPP in agri marketing, direct marketing, and terminal markets among others.

Food processors, organized retailers to benefit
We believe agri marketing reforms, when implemented, could have significant implications on food processors and retailers through cheaper inputs, stable supply of raw materials and customized produce in terms of quality. We see low level of organized food processing (~10%) and meager organized retail penetration in food and grocery opportunities, which could be tapped in the coming decade. This would benefit organized food and grocery retailers and processed food companies.

To read the full report: AGRICULTURE MARKETING



We expect PAT for I-Sec Fertiliser universe to decline 29% owing to high base – P&K business base was high on account of companies having benefited from rising P&K prices. Nagarjuna Fertilizers & Chemicals (Nagarjuna) is likely to witness a strong quarter on the back of increased capacity and higher trading volume; Chambal Fertilisers & Chemicals (Chambal) would see muted profitability. Improving international urea prices and expectation of a new policy has created a buzz around fertiliser stocks. We believe international urea prices, which have improved with demand pick up, would remain rangebound owing to significant capacity addition over the next three years. Ukrainian companies’ proposals for medium-term contract with government of India (GoI), at US$270/te for 3-5mnte further supports our belief about urea prices remaining rangebound. We believe there would not be any significant positive surprise on the policy front, post NPS- 3 expiry in April ’10. Tata Chemicals is seeing steady progress in brownfield urea project – However, gas availability and long-term gas contract would remain critical.

High base effect continues…

High base effect continues to impact GSFC and RCF. Owing to impact of inventory gains in the P&K business in base year’s profit, Gujarat State Fertilizers & Chemicals (GSFC) and Rashtriya Chemicals & Fertilizers (RCF) are likely to post significant profitability decline YoY.

Nagarjuna to post strong results on low base. Nagarjuna is expected to report 24% jump in EBITDA owing to increased production capacity and higher trading volumes. PAT is expected to rise 2.9x YoY to Rs179mn versus Rs46mn in Q3FY09.

International urea prices have crossed the US$300/te mark. Companies such as Tata Chemicals, Chambal and Nagarjuna are the key gainers as they have completed the debottlenecking exercise.

Urea prices unlikely to see sharp rally. We expect urea capacity addition of ~18% globally over the next three years and demand to rise 3.5-4.5% YoY. This implies that demand-supply mismatch is unlikely (in ’08, the mismatch had sharply driven up urea prices). That countries such as Ukraine are willing to sell urea to the GoI at US$270/te for a 3-5 year period, further proves that suppliers too are not expecting a rally, thereby attempting to lock in for the medium term.

To read the full report: FERTILISER SECTOR


Strong earnings for 1QFY10 should be driven by higher sugar prices. Bajaj Hindusthan, the largest Indian sugar company by capacity, is likely to report earnings on 8 January. We expect 1QFY10 stand-alone profit of INR755m, compared to a loss of INR559m in 1QFY09 (one-time forex loss of INR273m). Earnings strength is primarily due to higher sugar prices (+125% y-o-y to INR32/kg), even though sugar sales volumes may decline 13% to 175m kgs due to low sugar opening inventory.

  • We expect strong stand-alone 1QFY10 earnings of INR755m, driven by a 125% y-o-y rise in sugar prices
  • Updates also expected on power business, fund raising plans, and sugar business outlook
  • We rate the stock Overweight (V) with a target price of INR270; key downside risk: higher sugar cane costs

Key focus will be on an update on the power business and fund raising plans. Bajaj Hindusthan recently announced power capacity expansion plans of 400MW. In its 1QFY10 results announcement, we expect the company to provide an update on equipment ordering, government approvals, and fuel linkage. In addition, the company may announce equity issuance plans, if any, to fund capex on new power capacities.

Sugar production, cane cost, and levy price update. We expect an update from the company on the sugar business, which includes progress in the current crushing season that started in November 2009; likely cane costs, as the sugar price has increased; a likely rise in the levy price – 20% of production supplied to government at fixed price, currently INR13.8/kg – announced by the government; and the status of ethanol price revision.

We rate the stock Overweight (V) with an INR270 target price. We remain bullish on sugar cycle, and diversification into the power business should be positive for the company but has execution risk. Our target price is the midpoint of PB-based (target PB multiple of 2.5x on FY11 BVPS) fair value of INR310 and EV/EBITDA-based fair value of INR230. Higher cane cost is key downside risk to earnings.

To read the full report: BAJAJ HINDUSTHAN


Infinite Computer Solutions Ltd (Infinite) is a provider of infrastructure management, intellectual property (IP) leveraged solutions and IT services focused on the telecom, media, technology, manufacturing and healthcare industries. The services offered span from application management, packaged application, independent validation and verification, managed platform & product engineering services.

Large clients aiding growth…

Marquee client base
Since inception, the company has maintained its policy of working with global companies. Its performance over the years has been a direct result of growth of its top clients. The company counts Verizon, IBM, ACS, AOL and Fujitsu among its marquee clients. The consistency of its performance is evidenced from the fact that over the past years its top clients have remained the same, even during times of vendor consolidation.

Performance delivery during challenging times
The company has seen its revenues grow 44% in FY09 even on the back of the global slowdown, which resulted in the muted performance of the Indian IT industry. Larger peers like Infosys and TCS grew by 30% and 22%, respectively.

Domain knowledge
The company has developed domain expertise in the telecom industry. Infiniti has had long-term relations with Verizon. AOL has helped it move from conventional services to higher value-added services like IMS, IP leveraged solutions and convergence among others.


  • The company derives a high percentage of its revenues (92% in H1FY10) from its top 10 clients and 89% of its revenues from the US geography. Any reduction in spend from top clients could have a material impact on the performance of the company
  • CARE has assigned an IPO grade of 2/5, which reflects below average fundamentals compared to listed firms

The half yearly annualised EPS for FY10E on post-IPO fully diluted equity works out to Rs 16.8. At the offer price band of Rs 155-165, the IPO is available at 9.2x the lower price band and 9.8x the upper price band of its FY10E annualised post-issue EPS. The stock is reasonably priced from a valuation perspective. We advise our clients to SUBSCRIBE for listing gains.

To read the full report: INFINITE COMPUTER SOLUTIONS