Monday, March 29, 2010

>THE ASIA INVESTIGATOR: Cash...Flows and Flows

Asia ex-Japan: From Negative to Positive Free Cash Flow — Asia post 1998 is very different from the preceding period. Over-investment has given way to more sensible investment ratios, and FCF has turned positive from negative. Cash flow has been used to either repay debt (from a peak of 82% to the current 27%) or raise payout ratios – a double benefit for investors.

Australia: Cash at a Price — The Australian equity environment is overweight cash in at least 3 senses: 1) Corporates are undergeared vs. regulatory requirements and in-house targets; 2) Pension funds are still somewhat overweight cash; and 3) Dividend yields are high relative to cash rates and global comps. We see each of these as constituting a persistent tailwind for Australian equities.

Hong Kong: Repaying the Faith — With the recovery in the real economy, free cash flow generation in Hong Kong has bounced back. Page 22

India: FCF: The Big Turn? — India’s FY10 FCF yield is estimated at only 0.7%. Nearly 45% of the largest companies generate negative FCF, and 4 of 10 sectors are FCF-negative. This at first glance may not look good, but one can’t have it both ways. You can’t ask for growth and investment boom and at the same time expect the rapidly growing corporate sector to generate meaningful FCF. Page 27

■ Indonesia: Generating Cash for Growth — Indonesia’s market attractiveness is based on its better growth prospects, which have to be supported by ability and willingness to spend for growth. Page 35

■ Korea: Cash flow generators — In terms of CF yield analysis, memory, auto, telco, and overseas-exposed construction stocks stand out. Page 40

Malaysia: Tanjong Generates, Genting Retains — Malaysia's FCF yield screen features Tanjong, KLCC Property, Star Publications, Axiata and Genting Malaysia at the top quintile. Page 42

Singapore: Top Cash Flow Generators: Telcos, Media, Offshore Marine — Net cash over assets for STI companies improved to -5% in 09 from -18% in 01 on steady earnings, conservative capital management and higher equity issuance. Page 44

Taiwan: Cash Pile-up — We forecast FCF yield to surge from 4.2% in 10E to 7.7% in 11E. This surge is premised on our assumption that capex will peak in 10E and revenues will grow 14% in 11E. Page 48

Thailand: Strong Growth Momentum Supports Rising Earnings & FCF

To read the full report: ASIA INVESTIGATOR


In a global outperformance phase…

The Indian graphite sector is currently going through a phase of global outperformance in a technology intensive industry on the back of cost competitiveness and sound operations of domestic graphite producers. Graphite demand has started improving globally. An improvement in steel production and robust product prices have led to a fine performance by Indian graphite players in 9MFY10 leaving global peers far behind. Capacity expansion is underway and low cost operations are ensuring better margins as compared to global peers. Hence, we expect Indian graphite companies to continue their outperformance over international players and increase their share in the global graphite market from ~13% in 2009 to ~18% in 2012E. We are initiating coverage on the graphite sector with a STRONG BUY rating on HEG Ltd and an ADD rating on Graphite India Ltd (GIL).

■ Bounce back in steel production to propel graphite electrode demand
Steel demand suffered a sharp drop from Q4CY08 and through much of 2009. This was on account of the global financial crisis that led to a severe drop in EAF steel production and the resultant graphite electrode demand. With the recovery in steel production growth firmly in place, we expect graphite demand to increase by ~17% YoY in 2010 on the back of steel
production scaling back to pre-crisis levels.

■ Ongoing capacity expansion ensures economies of scale
Indian graphite manufacturers enjoy competitive operating advantages with low manpower costs, captive power feeds and strategic location benefits. Brownfield capacity expansion (ranging from 13% to 21%) at existing locations being carried out by both Indian graphite producers
would lead to further cost savings with economies of scale.

■ Low cost structure ensures highest capacity utilisation, margins globally
Indian graphite producers have operated at higher capacity utilisation rates (45-75%) as compared to global peers (35-55%) even during recessionary periods (CY09) due to their low cost structure. Production cuts in response to a drop in demand have been more pronounced for high cost producers in the developed world. Domestic players have weathered the storm better. With the low cost structure being further improved upon, domestic players are expected to enjoy better margins (higher by 500-1000 bps) as compared to global peers, going forward.

Outlook and recommendation
Indian graphite players have remained at the forefront of the recovery in graphite electrode demand globally. Apart from operating at higher capacity utilisation levels and achieving better profit margins as compared to global peers in the last few quarters, they have also announced capacity expansion plans recently. Despite possessing strong business models, the current valuations of domestic players are at a steep discount to global peers and leave room for upside. We are initiating coverage on the graphite sector with a positive view. HEG Ltd is our top pick in the space on account of its single location advantage, higher margins and value accretive investment in Bhilwara Energy Ltd.

To read the full report: GRAPHITE SECTOR


Preface: In 2007, we launched our landmark India NTD (Next Trillion Dollar) report. This report brought out a simple, yet profound, fact: it took India 60 years since independence to generate the first trillion dollar of GDP. Its next trillion dollar (NTD) would take only 5- 6 years, based on 12-15% nominal GDP growth.

This NTD era spells exponential growth for several businesses which, in turn, throws up several investment themes and opportunities. Since our first NTD report, we have captured such ideas in an "NTD Thematic" series. We already see the NTD opportunity playing out in Gas and in Consumer non-durables.

We now release a TRILOGY of reports - Cement, Construction and Engineering - all of which are offer a play on the India NTD theme.

We have lined up many more NTD Thematics in 2010. Stay tuned!

Indian Construction: Work-in-Progress

We believe India's Infrastructure is a 'work-in-progress', and offers significant opportunities for construction. We are bullish on the medium-term prospects of the Indian construction sector driven by: (i) improving order intake, (ii) stable margins, and (iii) value unlocking opportunities. Adjusted for BOT/Real Estate projects, sector P/E stands at an attractive 13x FY11E earnings. Our top picks are NCC and Simplex. We upgrade HCC to Buy and downgrade IVRCL to Neutral.

Improving order intake visibility to revive deteriorated book-to-bill ratio: The TTM book-to-bill (BTB) for our construction coverage universe has declined from 3.9x in FY05 to 2.6x currently. This moderation has impacted near-term revenue visibility and has been caused mainly by delays in order intake due to weak government finances and a challenging credit environment. We believe the macro environment is showing initial signs of improvement; orders from sectors such as roads, power and urban infrastructure are picking up. As L1 projects get converted into orders, we expect end-FY10 BTB of 3.2x against 2.6x currently. NCC and Simplex have diversified vertical, client and geographic mix and are better positioned.

Healthier BTB could boost FY12 execution: Our estimates suggest revenue growth of 19.8% in FY11 and 21.8% in FY12 compared with 9.2% in FY10. While growth rates are improving, they are still lower than the 37% CAGR over FY05-09. Revival in order intake and a healthier BTB could boost execution in FY12 and narrow the growth gap.

EBITDA margins to be stable: During FY10, most construction companies reported improved EBITDA margins despite poor execution, leading to low fixed cost absorption. Margin expansion is being driven by lower commodity prices, project mix change and other company-specific factors. During FY11 and FY12, we expect margins to be largely stable. Bunching up of order intake in the interim period could lead to higher mobilization expenses, resulting in possible near-term margin disappointment.

BOT/Real estate projects provide unlocking opportunities: Investments and advances in BOT/Real Estate (RE) projects for our construction universe have increased from Rs6.6b in FY06 to Rs28.2b in FY09, and are expected to be Rs37.3b in FY10. Of the Rs37.3b investments and advances, BOT projects account for Rs18.6b, RE for Rs15b and others for Rs3.3b.

To read the full report: CONSTRUCTION SECTOR

>Glenmark Pharmaceuticals Limited (NIRMAL BANG)

Snapshot: Glenmark Pharmaceuticals Limited (GPL) is a Mumbai based research-driven, fully integrated pharmaceutical company. It has a global presence with focus on branded generics across emerging markets including India. It has twelve manufacturing facilities in four countries and has five R&D centers.

Investment Rationale
Strong growth in international markets: The Company has strong presence in both regulated as well semi-regulated markets with around 70% of revenues coming from exports.

■ Increasing footprint in domestic markets: The Company follows the strategy of targeting niche areas as a growth strategy to penetrate in domestic markets which enables the company in maintaining margins. It is a leader in dermatology segment in domestic region and continues to be focused in the segment.

Strong research capabilities: It has a strong pipeline of 6 New Chemical Entities (NCEs) and 2 New Biologics Entities (NBEs) in various stages of preclinical and clinical trials and has earned revenues of US$115mn till now from R&D activities, highest ever earned by any Indian company.

Listing of Generics business: GPL has re-organized its generics business into a separate subsidiary called Glenmark Generics Limited (GGL), which contributes around 44% of group’s revenues. It has filed RHP and awaiting SEBI’s approval for its IPO.

■ Increasing profitability via restructuring Balance sheet: Company has taken various steps like reducing debtor’s day and debt on the books to improve the liquidity.

Valuation Recommendation
We believe the revenues of the company will grow at a CAGR of 17.2% over a period of two years from 2010 to 2012E whereas net profit will grow at a higher CAGR of 30.7% during the same period, on account of balance sheet restructuring exercises, cost containment program and management of working capital cycle. We expect the company to earn an EPS of Rs. 17.4 in FY11E and Rs.21.1 in FY12E. At the CMP of Rs. 252 per share, GPL is currently trading at a PE of 14.5x FY11E and 11.9x FY12E EPS estimates, which looks quite attractive when compared to its peers. At Rs. 252 per share the stock is trading at a discount of 24% from our intrinsic price of Rs. 314 per share which is 18x FY11E earnings. With growth triggers like first-to-file opportunities, listing of its subsidiary (not factored in our financials), out-licensing deal for its NCE (not factored in our projections) the stock looks undervalued. We recommend a BUY rating on the stock with a price target of Rs 314 with a long term view.

To read the full report: GLENMARK PHARMACEUTICALS


Cloud-computing – a long-term opportunity: Excitement around the industry growth prospects from cloud computing is building. Our analysis suggests cloud computing is a robust growth opportunity, but over the long term. Among the various cloudmodels, growth will be driven by Business Process as a Service (BPaaS), whereas other cloud models such as Infra-as-a-service and Software-as-a-service (IaaS/SaaS) remain inconsequential for Indian IT companies. While the top-4 IT services companies are investing in these new engagement models, Infosys seemingly is leading the race, closely followed by TCS. (Cloud computing, simply described, offers IT resources to customers without upfront capital commitments).

Near-term growth to remain robust, but led by offshoring: Our confidence in the +20% sector growth expectations (next 2-3 years) continue to increase, underpinned by a secular up-tick in offshoring, in under-penetrated markets and services such as remote management services (RMS). There are several reasons why adoption of RMS will accelerate in the coming years, such as 1) significant fall in hardware costs, 2) declining bandwidth costs, with higher capacity and reliability; 3) introduction of robust remote monitoring tools and, 4) new engagement models that offer better IP and data security

Competitive risks manageable: We continue to expect India to dominate as the most attractive offshoring destination and global competition to remain manageable for the foreseeable future. Loss of vendor agnostic charm, questionable success of M&A in IT services and materially higher blended costs/pricing, would keep competitive pressure from the new “integrated players” at bay. Remain bullish on long-term sector fundamentals. Current valuations (c20x on FY11e) are close to the historic averages and the upside is driven primarily by earnings upgrades. Infosys remains our top pick, followed by HCLT. We do not change any estimates/recommendations in this report.

To read the full report: IT SERVICES