Wednesday, June 9, 2010

>Enough Blood in the Streets?

Almost everything on world markets from stock prices, oil, other commodities, non-dollar currencies, then proceeded into a near panic sell-off while the usual safe-haven assets such as the U.S. dollar, Treasury bonds and gold rose. This was not a happy performance for most investors and those, like us who have been relatively positive on risk assets for some time (new readers can check out our views for the past 18 months on our website which provides back issues). So let’s back up a bit and see whether our relatively positive view needs to be reconsidered. The first point is that readers of this publication and of our recently released book, “The Great Reflation” will know that we are not exactly oblivious to the deep and scary problems of the financial, economic and political world (discussed below). These continue to call for a clear focus on wealth preservation, a profound understanding of risk and return prospects and some sense of timelines and benchmarks to watch closely. So far, the key benchmarks of stability in U.S. Treasury bonds, the U.S. dollar, U.S. corporate bond spreads and low to zero price inflation are still flashing green. This means that the Federal Reserve can continue to pump liquidity into the banking system and economy.

The overall environment, particularly in North America, should remain positive for risk
assets. We think the recent panic in financial markets has been overdone. Having said that, the
economy and financial systems are fundamentally unsound and confidence is fragile, vulnerable
to periodic shocks, like the recent Greek/euro crises. However, recovery from the near collapse
of 2008-2009 is still underway, driven by improving balance sheets and liquidity, the exact
opposite of conditions in 2007-2008 when the economy and financial systems were unravelling.
Further shocks will no doubt occur and will have a significant impact on markets. The rollercoaster ride is still intact and the great reflation has added some steroids. Eventually, the piper will have to be paid, but we think that this can be put off for a while longer. But this view must be tempered with the notion that anything can go wrong at any time with little or no warning— like the euro crisis of recent weeks. Brittle confidence snaps easily and causes financial bloodshed. We think the recent sell-off qualifies, in good part, for Baron Rothschild’s quip about when to buy. While this is no time for complacency, it is probably not the time to lose your nerve.

The big negatives for financial markets are well documented, as are many of the smaller
ones. Frightening news sells well when people are scared and this obviously creates a feedback
loop. The coverage in the press, investment research and subscription services, blogs and TV
have done an excellent job of thoroughly informing us all as to the world’s problems. (Where
were they in 2006-2007 when the problems were being created?). There is no need to cover the
same ground, so we will instead provide our own take on some of the issues.

To read the full report: ENOUGH BLOOD IN THE STREETS?

>Correction in a Bull market? Or beginning of a Bear market?

“When popular opinion is nearly unanimous, contrary thinking tends to be most profitable. The reason is that once the crowd takes a position, it creates a short-term, self-fulfilling prophecy. But when a change occurs, everyone seems to change his mind at once,” wrote Gustave Le Bon in his book “The Crowd.”

For almost fourteen un-interrupted months, stock markets around the globe were climbing higher, recouping $21-trillion of wealth since hitting bottom in March 2009. The global economy was pulling out of its worst recession since the 1930’s, led by locomotives in China, India, and Brazil. On May 4th, a survey taken by JP-Morgan showed that global manufacturing expanded at its fastest pace in six-years in April, as output and new orders surged to new multi-year highs.

In the United States, factory activity was firing on all cylinders, lifting the Purchasing Manager’s Index (PMI), to a six-year high at 60.4 in April, with employers becoming increasingly confident about hiring. Although manufacturing is not a huge component of the US-economy, the factory industry is still where recessions tend to begin and end. For this reason, the factory PMI is very closely watched, setting the tone for the upcoming month and other key economic indicators.

The US-economy added 570,000-jobs during the first four months of 2010, - a sharp contrast to what occurred a year earlier, when the US-economy was losing more than 700,000-jobs /month
during the depths of the “Great Recession.”

To read the full report: BULL OR BEAR MARKET


Essar Shipping Ports & Logistics Ltd (ESPLL) reported an encouraging performance and ended FY10 with 16% revenue growth and 23% PAT growth. The year was eventful for the company as revenue from its new divisions i.e. port/terminals and oilfield services started to make a significant contribution to the topline. During Q4FY10, ESPLL also commissioned its 30 MTPA
bulk terminal at Hazira. This is a captive port to serve the requirements of Essar Steel with which ESPLL has signed a 20 year contract and would be handling iron ore pellets, coal, limestone and finished steel products.

Encouraging performance in Q4FY10
ESPLL reported a 6.5% topline growth in Q4FY10 at Rs 852.6 crore as against Rs 800.6 crore in Q3FY10. Revenue growth mainly came on account of an 8.9% rise in the ocean transport business at Rs 412.7 crore and a 28.1% rise in the surface transport business at Rs 225.5 crore. The port and terminal business reported a stable performance with Rs 113.0 crore revenues while the oilfield services business registered a drop of 24.0% at Rs 101.4 crore. The company posted a PAT of Rs 64.5 crores in Q4FY10.

Contrary to other shipping companies, which have seen a drop in topline in FY10 due to weakness in freight rates, ESPLL reported a 16.6% topline growth in FY10 mainly aided by the rise in revenues from the oilfield services business, surface transport business and port & terminal business. This more than compensated for the drop in the ocean transport business. Going forward, we expect the company to perform well as new port capacity gets commissioned and its shipping and offshore fleet gets ramped up with delivery of 12 dry bulk carriers and two jack-up rigs. We have valued each of the divisions of ESPLL on DCF basis and arrived at our SOTP price target of Rs 93 and maintain our BUY rating on the stock.

To read the full report: ESSAR SHIPPING


Uptick in order inflow indicates growth ahead…

Simplex Infrastructures’ (SIL) Q4FY10 results came below our expectation due to lower-than-expected revenues led by poor execution of overseas orders. However, better-than-expected OPM and lowerthan- expected interest outgo due to efficient working capital management and reduced interest expenses, uptick in order book after eight quarters along with upward revision in FY11 revenue growth guidance to 15-20% (earlier 10%) are key positive takeaways from the Q4FY10 results. We are maintaining our price target at Rs 521 and reducing our recommendation to ADD from BUY earlier.

Uptick in order book and healthy management guidance
In Q4FY10, SIL witnesses an order intake of Rs 2,166 crore and showed an uptick in the order book at Rs 11,491 crore, 2.5x FY10 revenues. The company is currently L-1 bidder of Rs 1,334 crore. Furthermore, the company has now revised its FY11 revenue guidance to 15-20% compared to 10% earlier and expects to maintain the EBITDA margin at 10-10.5%, going forward.

Poor execution in overseas orders lead to disappointing Q4FY10
SIL’s topline in Q4FY10 continued to decline and remained below estimates due to poor execution in overseas orders. However, much better than expected operating margins (up 129 bps sequentially), lower interest expenses due to efficient working capital management and reduction in borrowing cost and a sharp pick-up in order inflows are key positive takeaways from the Q4FY10 results.

At the CMP, the stock is trading at attractive valuation of 11.8x FY12E earning estimates and 1.8x FY12 P/BV considering earning CAGR of 28.1% during FY10-FY12E. Given the management’s focus on quality of the order book and to maintain the EBITDA margin at current levels coupled with the anticipated uptick in the order book, we see a possibility of earnings upgradation, going forward. We are maintaining our price target at Rs 521 and reducing our recommendation to ADD.

To read the full report: SIMPLEX INFRASTRUCTURE

>APOLLO HOSPITALS: Hyderabad cluster lowers pace of growth

Apollo Hospitals’ revenues grew 23.5% YoY to Rs 482.9 crore with the hospital and pharmacy segment’s revenues growing 20.3% and 32.8% YoY, respectively. However, the growth in revenues was below our expectations as revenues of hospitals in the Hyderabad region were impacted by ~10% due to the Telangana issue. Operating margin also declined 70 bps YoY and 320 bps QoQ to 13.0%. With lower operating margin and higher interest costs of Rs 10.7 crore (growth of 115% YoY and 26.3% QoQ), net profit for the quarter declined 33.5% QoQ to Rs
29.2 crore.

Underperformance of Hyderabad cluster lowers pace of growth
During the quarter, revenue and EBITDA both grew by 23.5% and 17.4% YoY, respectively. However, the growth in revenues was below our expectations as revenues of hospitals in the Hyderabad region were impacted by ~10% due to the Telangana issue. Both Inpatient and outpatient volumes in this region declined by 3.0% and 7.1%, respectively. As a result, the operating margin also declined by 70 bps YoY and 320 bps QoQ to 13.0%.

Pharmacy division reports first ever positive EBITDA
This segment reported robust 32.8% YoY revenue growth to Rs 133.3 crore. At the EBITDA level also, Apollo was able to report positive EBITDA of Rs 0.2 crore for the first time despite an increase in number of outlets from 883 in Q3FY09 to 1049 in Q3FY10.

At the CMP of Rs 740, the stock is trading at 13.1x and 11.3x its FY11E and FY12E EV/EBITDA, respectively. The company has constantly maintained its growth trajectory. However, the pace of turnaround in the pharmacy business and subdued performance of subsidiary companies
remains a concern over the medium term. We are marginally revising our target price from Rs 732 to Rs 810, i.e. at 12.5x FY12E EV/EBITDA. We are changing our rating on the stock from BUY to ADD.

To read the full report: APOLLO HOSPITALS


Upgrade to BUY, from Hold
The stock has returned 4% since October 2009 (Sensex: +0.2%) since our HOLD recommendation. We now upgrade L&T to BUY, due to our greater confidence about its earnings growth prospects, as a result of strong order bookings during the last quarter (95% y-y increase) and better execution (revenue growth of 28% y-y). In our view, the risks to order flow and execution have subsided, and we estimate order inflow growth of 25.6% in FY11 (INR803b), revenue CAGR of 30% (backed by a strong E&C order book of INR997b) and earnings CAGR of 25% during FY10-12. Risks to our recommendation and TP include quarterly earnings volatility, a slowdown in order intake, poor execution, margin contraction and dilution from raising capital. Catalysts for the stock include 1) higher than expected orders, 2) unlocking of value in technology services, finance or infrastructure subsidiaries.

Improved order inflow, execution issues behind us
Our concerns on order growth on a high base have been mitigated by visible market opportunity (discussed in the note). Regulatory changes in the infrastructure sector have accelerated the order award process. We forecast INR803b (25.6% y-y) in orders for L&T over FY11 on an
improved outlook resulting from, in particular, public spending on infrastructure development; 70% of our order inflow estimate should come from infrastructure and power. The 12th plan (FY13-FY17) is likely to have an outlay of USD1t (2x 11th Plan), we believe the emphasis on
infrastructure sector will continue during that period as well. We believe execution speed bumps (financial closure, election/ political issues) are behind us, signified by a robust 28% y-y revenue growth in Q4FY10.

Flight to quality in uncertain times
We believe L&T is in a better position to withstand any global crisis compared to its smaller peers. In a scenario of risk-aversion due to uncertainties in the European region, we believe L&T represents a relatively better choice within the sector. The company has successfully demonstrated this by posting 23% earnings CAGR during the FY08-FY10, where several of its peers had earnings decline in at least one of the years.

We arrive at our TP to INR1,933 based on an SOTP valuation of L&T and its subsidiaries. The standalone company now contributes INR1,644 by applying a 14x EV/EBITDA multiple on our FY12E EBITDA estimate (INR1313 based on 15.0x FY11 EV/EBITDA multiple earlier). Our multiple is in line with the 5-year historically traded median multiple. Subsidiaries now contribute INR289 (INR228 earlier) based on their respective metrics.

To read the full report: LARSEN & TOUBRO