Wednesday, June 2, 2010

>INDIA SUMMIT 2010: Growth to stay strong but be alert to inflation and trade deficit risks

Faster than expected recovery in growth: Various economic indicators have surprised on the upside, confirming that the pace of the recovery is stronger than we expected. Industrial production accelerated to 15.1% YoY during the three months ended March 2010 compared with a trough of 0.3% YoY for the three months ended February 2009.

Shift in growth driver from government policies to private sector autonomous demand in 2010: We estimate GDP growth will strengthen to 8.5% in 2010 from 6.4% in 2009. We expect the recovery trend to be sustained even as policy makers gradually withdraw monetary and fiscal policy support.

Risks of a pickup in inflation pressures and a wider trade deficit: Non-food inflation shot up to 8.1% YoY in April 2010 from 2.6% in December 2009. Similarly, the three-month trailing trade deficit jumped to 8.2% of GDP annualized in March 2010 from the trough of 4% in March 2009.

To read the full report: INDIA SUMMIT

>WHITE PAPER: I Want to Break Free, or, Strategic Asset Allocation ≠ Static Asset Allocation

In the English speaking world, we all use keyboards known as QWERTY. However, this well-known keyboard is not optimal. When you prepare to type, your hands rest on the second row of letters known as the home row. Now, you might be forgiven for thinking that the most frequently used letters would appear in this row in order to minimize travel of the fi ngers. However, this isn’t the case. In fact, only 32% of strokes are on the second row, while 52% of strokes are on the upper row. Other such quirks include two of the least used letters in the English language, J and K, positioned on the home row. And this is only the start of a long list of ineffi ciencies with this keyboard.1

So, why do we still use the QWERTY keyboard? The answer lies in historical inertia. QWERTY was originally designed in 1874. It was built to solve a specifi c technological problem with early typewriters: when keys were struck in rapid succession, the hammers that hit the ink ribbon would often jam together. The QWERTY layout was designed specifi cally to slow typists down. Letters that frequently occurred close together in words were spaced irregularly on the keyboard, causing the typist to pause, thus reducing the likelihood of jamming hammers.

So, due largely to technological limits, the fi rst commercially produced typewriters were manufactured with the QWERTY keyboard. Users became adept with QWERTY, and this comfort level acted as a barrier to change. This barrier created enormous inertia such that the majority of us use QWERTY today, despite the fact that more effi cient keyboard layouts are

I maintain that policy benchmarks are the QWERTY of the investment world. They are effectively an accident of history, and if you were starting afresh today, you probably would not come up with a policy benchmark.

It often strikes me that questions surrounding investment are rarely answered from an investment perspective. For instance, when discussing the death of policy portfolios, one of the questions I encounter most often is, “So, how should we measure you?” It appears that many investors prefer measurement precision over investment returns.

In this paper, I argue that policy portfolios and various successors (such as risk parity and life-cycle/glide-path funds) are deeply fl awed from an investment perspective. In particular, two common failings they share are a mismeasurement of risk and an indifference to valuation. I conclude that a strategic asset allocation that alters the asset mix based upon the opportunity set offered by Mr. Market makes far more sense from an investment perspective. (In modern parlance, this translates as a benchmark-free, real return focus.)

To read the full report: STRATEGIC ASSET


Pain in standalone business continues
Mercator Lines' Q4FY10 net profits of Rs214mn were above our expectations of Rs187mn mainly on account of sale of 3 ships in the quarter. Net sales decreased by 10% to Rs4.8bn in line with our estimates of Rs4.9bn. Operating profits decreased by 36% YoY and 8% QoQ to Rs1.2bn (estimated Rs1.6bn) due to negligible contribution from coal mining business and higher operating expenses. It sold 3 assets in the quarter resulting in a profit from sale of ships of Rs293mn which led to adj. net profits grow by 2.5x QoQ to Rs214mn, same as that in Q4FY09.
For the full year, adj. profits declined by 79% to Rs711mn.

Poor performance by the tankers and dredgers: Lower revenue days due to sale of 3 assets and continued pain in the dredgers reflected in the sequential drop in standalone op. profits to decline by 60% QoQ to Rs110mn.

Coal business still at trivial level: The coal mining and trading business generated revenues of Rs1.2bn but an operating profit of Rs16mn only.

Mercator Singapore’s (MLS) performance improves: MLS revenues grew by 12% YoY and 15% QoQ to USD40mn on back of 26% higher revenue days YoY to 1,225days and 21% sequential improvement in TCY to Rs29.7k/d. Sequential improvement in the day-rates also resulted in OPM expanding by 627bps to 56%. Operating profits rose by 29% QoQ to USD22.5mn. Subsequently, net profits surged by 72% to USD13mn.

Capex update: Mercator purchased a product tanker in Q4FY10 for USD9mn. It acquired a bulk carrier at the start of FY11 for USD38mn. In addition, it is also incurring a capex of USD130mn
related to a Mobile Offshore Production Unit (MOPU) and a Floating Storage & Offloading Unit (FSO) to be deployed in H2FY11.

Outlook: We believe the dry-bulk carriers and Jack-up rig are the two main earnings driver for the company as these are mostly contracted. The dredgers’ earnings would remain depressed for at-least next one year. We maintain our earnings estimates for FY11and FY12E.

We upgrade our recommendation to 'HOLD' with a price target of Rs42, discounting FY11E EPS 5x.

To read the full report: MERCATOR LINES


Fleet expansion to drive growth…
Great Eastern Shipping (GE) reported better-than-expected results with an 8.6% QoQ growth in topline, which came in at Rs 766.7 crore. Firm freight rates in the crude (up 39%) and dry bulk segment (up 13%) has enabled GE to report higher revenues despite marginally lower revenue days and a decline of 7% in freight rate for product carriers. GE’s performance stands out as compared to other shipping companies. The company has managed to deliver an admirable performance despite a volatile freight rate environment. GE is also ramping up its fleet (especially in offshore segment), which will be scaled up to 27 vessels in FY12 from the present 17 vessels. Total fleet size will increase to 74 vessels in FY12 from the present 53 vessels. In FY12, GE would be operating at peak capacity and the full impact of the same would be visible in the financials. We maintain our STRONG BUY rating on GE.

Performance improves on the back of firm rates GE’s performance in Q4FY10 improved as its consolidated revenue increased by 8.6% to Rs 766.7 crore on the back of firmness in freight rates for crude and dry bulk carriers. Revenue days in Q4FY10 were marginally lower at 3,374 days compared to 3,402 days in Q3FY10. In spite of lower revenue days, higher TCE per day for dry bulk carriers as well as crude carriers, which increased to Rs 23,963 and Rs 29,322 as compared to Rs 20,964 and Rs 17,778, respectively, in Q3FY10, enabled GE to register an improvement in its revenue and profitability.

Factoring in FY12E earnings, GE is trading at a significant discount to its fair value and the stock is likely to get re-rated. We have valued GE on multiple valuation parameters to arrive at price target of Rs 387. We are maintaining our STRONG BUY rating on the stock.

To read the full report: GE SHIPPING

>Persistent Systems (HSBC)

Initiate OW(V): Superior growth momentum
Uniquely positioned to benefit from growth in next-generation technologies; we expect industry leading growth to continue

Well established relationships with leading global technology companies offer increasing wallet share

Initiate OW(V) and TP of INR500, based on 13x PE FY12e

Superior growth outlook. Persistent, a recently listed company focused on offshore product development (OPD), is well positioned to benefit from the expected growth in next-generation technologies such as cloud computing, enterprise mobility and collaboration tools. The company has delivered industry-leading top line growth over the last five years (c42%) and we conservatively assume 23% annual sales growth over the next three years.

Relationships with global technology companies. Persistent’s clients include 37 companies with revenues in excess of USD1bn (with average R&D spend of c18%). This marquee client base gives it an early mover advantage of working with companies in high growth technologies and significant scope for cross-selling. We expect Persistent’s market share of the Indian OPD market to grow from c13% in 2009 to c15% by 2013 (from c8% in 2006). The outlook is also bright for its start-up clients (c25% of revenues), judging by the upbeat mood of the US venture capital market. Even if the macro-economic environment weakens, the smaller clients seem to be well capitalised as shown by resilient revenues from start-ups in FY10.

Forecasts and valuations. We forecast FY11-13 CAGR of 23% for revenue, 26% for EBIT and 18% for EPS (note that EPS growth will dip in FY12 when tax exemptions expire but bounce back thereafter). The stock is trading at 9.7x PE on our FY11e EPS. As earnings growth continues to surprise, we believe the stock should re-rate and trade at a premium to its peers. Initiate OW(V) with a target price of INR500, based on 13x PE FY12e EPS.

Risks. USD/INR currency, execution and macro-economic risk.

To read the full report: PERSISTENT SYSTEMS


Steady growth lined ahead…
In Q4FY10, Neyveli Lignite (NLC) reported ~44% YoY growth in topline from Rs 766 crore to Rs 1,103 crore compared to our expectation of ~21.5% growth in topline. On the volume front, NLC has delivered de growth of ~8.9 % YoY from 5,044 MU to 4,593 MU in line with our
expectation. In FY10, NLC has witnessed the highest lignite production of 22.3 MT compared to 21.5 MT in the same period last year and simultaneously achieved the highest generation since the beginning of 17,658 MU compared to 17,457 MU for the same period last year. NLC has benchmarked a growth of 8% over the next year targeting an overall generation of 18,758 MU in FY11E.

Despite delays Barsinger progressing well
The first unit of the 2x125 MW Barsinger Lignite project was synchronised in October 2009. The company is still to achieve commissioning, which is expected by June 2010. In the meantime, the company has been able to achieve full production capacity at the Barsinger mine in January 2010. The second unit is expected to achieve synchronisation in August 2010. The Barsinger mine has already commenced operations and achieved full capacity with an initial production of 1.02 lakh tonne lignite in FY09.

Expansion plans materialising well
In addition to the plans under construction of 1,800 MW (thermal and wind plans), Neyveli Lignite has submitted the feasibility report for the Bithnok Lignite mine cum project (2.5 MTPA and 250 MW power plant) and new thermal power project at Neyveli (2x500 MW in lieu of TPS – I) to the Ministry of Coal and sanctions for the same are still awaited.

At the CMP of Rs 144, the stock is trading at FY10 P/BV of 2.3x and FY11E P/BV of 2.2x. The stock looks fairly valued. The plans in lieu of refurbishing the existing capacity at TPS-I are progressing well. Thus, we have upgraded our rating to ADD from SELL with a price target of Rs 151.

To read the full report: NEYVELI LIGNITE