Tuesday, January 12, 2010

>Understanding the Myth of the Lost Decade

A lot has been written with more to come about the lost decade for equity investors. While it is true that the S&P 500 lost about 10.0% and the government bond market gained 81.82% from 2000 through 2009, the performance profile is lopsided and understates larger discrepancies occurring in other asset classes.

However, before looking at the bigger picture, it is important to break down the returns of the past decade into two time periods: 2000 through 2002, and 2003 through 2009. During the first period, equities lost 37.59% while the bond market gained 35.0%. The strong performance from the government bond market was largely due to the flight to quality following the collapse of the dotcom bubble and the 9/11 terrorist attack in the US. These events forced the Federal Reserve to push the Federal Funds rate down to 1 percent.

During the following seven years, equities and government bonds gained 42.9% and 34.7% respectively. Importantly, during this period, the total return from the bond market was entirely due to interest income. Government bonds were actually down 1% in price over the same period. Conversely, the price return generated from the equity market was 24.5% over this period.

The biggest story about the lost decade is the complete dominance of emerging market equities. The MSCI emerging market index gained 102.4% during this past decade, a significant difference compared to the 10% loss by the S&P 500 over the same period.

The absolute outperformance of emerging market equities over domestic US equities is a continuation of the outperformance from the preceding decade, when the MSCI emerging market index gained 2,408% versus a respectable gain of 432% for the S&P 500. During the 1990s, the government bond market produced a total return of 105.3%, of which only 2.1% was earned from capital appreciation.

Over the entire 20 year period (1989 - 2009), emerging market equities produced an annualized return of 21.7% compared to just 8.1% annualized for the S&P 500. The bond market returned 6.8% annually over this same period of which a very meager 0.70% was attributed to price improvement.

Clearly a key take-away from the return data is that, over long periods of time, returns from the bond market are generally produced from the compounding of interest income rather than from price appreciation.

To read the full report: LOST DECADE


Three years after Bombay Dyeing began developing its historic mill land in Mumbai, completion of the first phase is near and launch of the next phase is imminent. Meanwhile, the polyester business continues to make losses. The company now is not averse to its restructuring. Textiles business is looking up with strength in domestic demand. 90% of its NAV accrues from the undeveloped prime land in Mumbai. The stock trades at 70% discount to NAV and hence offers deep value. Turnaround of the textile business in 2HFY10 will be a near-term trigger.


Developing real estate in prime locations in Mumbai
With the first phase of 0.9m sf of property development at its two mill land sites in central Mumbai nearing completion; Bombay Dyeing is gearing up for the launch of its next phase of development. Company proposes to develop the 4.5m sf Spring mills site in 3 phases, starting from Mar’10. Building approvals have already been applied for the 1.5m sf residential phase and
commencement certificate is expected by Jan’10 end. The Worli site of c.3m sf will be developed in 2 phases from mid’11 onwards with a 0.7-0.8m sf of commercial development being planned.

Looking to cut losses in polyester & textile businesses
In FY09 Bombay Dyeing had Ebit losses of Rs660m on its textiles and Rs726m on its polyester business. While 1HFY10 losses for textile business were Rs223m, company has seen a revival in domestic demand in the segment in 3Q, which combined with cost cutting, is making company hopeful of an Ebitda break-even in 2HFY10. The polyester (PSF) business is still seeing weaker margins with Rs3.5-4/Kg of loss being recorded currently. While recent measure of conversion to gas as feedstock may help reduce costs, the company is not averse to restructuring of the business.

Counting on realty cashflows to improve balance sheet
Of the Rs18bn net debt on its balance sheet, Rs11bn of this is attributable to the capex incurred in textile and PSF business over the past 3 years. Assuming Rs2bn of annual losses from textile and PSF business and Rs1.6bn in interest payments; cash flows from real estate business of >Rs4bn are required to reduce balance sheet stress, which is likely from FY11 onwards.

Trading at an attractive 70% discount to NAV
Our NAV estimate of Rs1,385/share implies that the stock is trading at 70% discount to NAV. While the company remains essentially an asset play, its prime asset quality should attract a smaller NAV discount. Higher discount is attributable to the loss making PSF and textile business. Expected turnaround in textile business in 2HFY10 will be a near-term trigger and any efforts by the company to restructure PSF business will be a positive.

To read the full report: BOMBAY DYEING


Considering increasing growth momentum going into FY11/12, positive indications from Taro acquisition battle and visible upgrade potential from a couple of limited competition opportunities, we are upgrading Sun Pharma and adding it to our Conviction BUY list. We arrive a target price of Rs1,780 /share ascribing 22x multiple to core earnings, add present value of one-time opportunities and assign 50% probability adjusted value to Taro. We expect superior stock performance with strong core earnings growth and potential upgrade opportunities.


Strong growth in Sun’s US generics business
Sun Pharma management remains determined to scale up in the US generics segment with accelerating ANDA filings and exponential growth in controlled substances. With close to 85 ANDAs pending approval, Sun Pharma has one of the largest ANDA pipelines that are likely to provide small but regular upgrade opportunities over the coming years. A few of these, Taxotere and Gleevec could provide substantial one-time cash flows though are a couple of years away.

Scale benefits from potential Taro integration
Taro acquisition could provide a strong base for Sun Pharma in the US generics segment. US market contributes to more than 80% of Taro’s total revenues. It has around 26 pending ANDAs and a strong dermatology franchise. Sun’s management could potentially drive manufacturing and other operational efficiencies resulting in improvement in Taro’s profitability from current c.10% net margins. With US$600m+ of idle cash lying with Sun Pharma, completion of acquisition will help improvement of return ratios. We incorporate a 50% probability of acquisition and assign Taro a value of Rs71.5/share based on 12x one-year forward earnings.

Earnings growth resumes in FY11, potential for further rerating
Sun Pharma returns to reported profit growth in FY11 along with a better core earnings growth profile over the coming years as Caraco losses get into the base. We value Sun Pharma at Rs1,780 per share adding up value of core business and one-time earnings and a probability based value of Taro. We ascribe 22x multiple to Sun Pharma one-year forward core earnings and add present value of cash flows from know exclusivities. We upgrade the stock to a BUY see reducing risks to our positive call. Continued uncertainty related to Taro acquisition, potential increase in tax rate (direct tax code), and appreciation of rupee could pose risk to earnings growth.

To read the full report: SUN PHARMA


According to the recent news flow, the power ministry has plans to permit NTPC to sell power in the open market. This move, depending on which capacity (existing or incremental or unallocated) will be allowed to unleash, will have an impact on the earnings as well as ROEs. However, we believe that the gains are based on:

  • NTPC’s capacity addition ability
  • Merchant rates Quantum of gains allowed to be retained by the generator
  • Merchant power approval may aid re-rating

Backdrop: The current operating capacity of NTPC stands nearly at 27850MW, of which 15% allocation is decided by the Central Government known as ‘Unallocated or free power’. The capacity under construction stands at nearly 18000MW. The targeted capacity addition for FY10 is 3300MW; of this, 500MW has been commercialized and 480MW has been synchronized.

Possibilities for sale of power through merchant route: Assuming merchant rates at Rs4.5kw/hr,
  • Option 1: 15% of the incremental capacity can take the potential company ROE in FY11E from 14.4% to 14.5% and in FY12E from 15.1% to 17.3%.
  • Option 2: 50% and 25% of the unallocated power from the new and existing capacity, respectively, can take the potential company ROE from 14.4% to 16.5% in FY11E and from 15.1% to 18.5% in FY12E.

Valuations and Outlook: The recent run-up in the stock has been sharp on account of the league of power IPOs and valuations enjoyed by them. The company is planning an FPO in February 2010 which will offload 5% of the equity, thereby, raising Rs100bn. We believe that any decision on merchant sales would be positive for the company and further aid re-rating of the stock upwards.

Though the company’s near-term ROEs would improve only on brisk capacity addition and merchant power rates, improvement on the outlook of long-term ROEs would substantially re-rate the stock upwards. At CMP of Rs228, the stock is trading at P/BV of 3x FY10E and 2.7x FY11E. We reiterate ‘Accumulate’ rating on the stock.

To read the full report: NTPC


Early signs of life in the office market
We attended Unitech Corporate Park’s (UCP LN) analyst conference call held on 6 Jan 2010. UCP management seemed hopeful of an improving leasing environment as it has seen leasing inquiries picking up since Sep 2009. This is what other developers have also indicated
over the past two months.

Actual leasing though remains subdued
UCP has managed to lease only an incremental 0.33mn sqft of office space in 1H FY10, while area under letters of intent/agreement to lease has moved up by about 0.2mn sqft. This has taken the total rental generating area to 1mn sqft, while total area under letters of intent/agreement to lease is 2mn sqft.

Office demand set to improve

Construction likely to follow demand
We believe that further construction in UCP properties is only likely to follow firm inquiries for leasing. Chairman Mr. Atul Kapur commented, “We expect the portfolio will continue to benefit from our strategic decision to phase the construction programme in line with both
demand and economic conditions.” This shows that developers are looking to control their future supply to reduce oversupply.

Valuations should stabilise or improve from this point
With an improved leasing environment and stabilised rentals, we expect cap rates to initially remain steady and then improve over the course of the year. This should mean that the NAV of UCP’s portfolio of £518mn as calculated by Knight Frank is close to its bottom.

To read the full report: UNITECH


BGR is a dominant player in the EPC / BoP space, with >20 years in the industry and a strong orderbook of Rs. 120bn. The company is focused on the large, > USD 57bn EPC / BoP opportunity, over FY11-17E, within the power sector and is considered to be one among the top five industry players. The company also has a small presence in the Oil & gas space (4% of orderbook). Given the company’s robust orderbook, credible project execution track record and the strong near term opportunities within the power sector (BGR’s focus area), we believe the company is at the cusp of rapid growth (>37% revenue and PAT CAGR) over the next 3-4 years.

Dominant EPC / BoP player expected to soar on macro tailwinds

Key beneficiary of a > USD 57bn revenue opportunity within the power EPC and BoP space - over the 12th Plan, we expect the power EPC & BoP markets to present additional order inflow opportunities worth ~USD 45bn, representing a ~40% increase in target opportunities;

BGR, we think, will benefit from the perceptible shift towards EPC contracts, away from package based ordering– during the 12th plan, we expect 50% (33% in 11th Plan) of the orders from state utilities and 80% (65% in 11th Plan) of the private sector orders to be awarded on EPC basis;

Ranks high on capabilities; in-house design capabilities provide company with greater control over costs and time schedules - Considered to be one of the top 5 players in the power EPC / BoP market, reflected in a significant portion of orderbook representing repeat orders from clients;

Strong orderbook of Rs. 120bn, comprising 60% power EPC, 35% power BoP and 4% oil & gas - diversified clientele and back-to-back equipment supply arrangements mitigate risks;

Well organized and professionally managed – Core management team comprising of ~30 members with each having an industry experience of ~20-40years.

Managements’ initiatives with regard to working capital management, we believe, will reduce working capital days (excluding surplus cash) from ~165-180 to ~150 over the next three years;

Resilient EBITDA margins (~11%), soaring growth (>37% revenue and PAT CAGR over FY09- 12E) and highly attractive capital efficiencies (~30% RoEs).

To read the full report: BGR ENERGY