Wednesday, August 11, 2010


Event: 1Q FY11 Novelis results ahead of Street: Hindalco’s subsidiary, Novelis,
reported excellent results for 1Q FY11, beating Street expectations. Novelis
now appears set to reap the benefits of cost cuts, increasing demand and
growth. Hindalco remains well on track to achieve our 18% above-consensus
earnings estimates for FY11; reaffirm our Outperform and TP of Rs205.

Earnings showing increasing trend: Net sales of US$2.5bn were up 29%
YoY and 5% QoQ as both shipments and realisation were up. Operating
EBITDA of US$282m is up from US$42m reported last year and 38% above
US$205m last quarter. PAT of US$50m compared to a loss of US$1m in the
last quarter. The company was operating at capacity during the quarter,
reporting peak shipments. In addition, results reflected the sustainability of
cost cuts, which did not increase in line with volumes.

On track to achieve FY11E: Our estimate for Novelis’s FY11 EBITDA is
US$967m, which implies EBITDA-per-ton of US$336 and volume of 2.8mt. In
1Q, Novelis achieved EBITDA of US$282m and shipment volume of 0.75mt,
about 30% and 26% of our respective full year assumptions.

Growth plans: Novelis plans to expand its capacity by 10% in the next two
years through brownfield expansion and de-bottlenecking its existing
capacities. The company has a cash balance of US$419m and should be able
to fund its proposed capex from internal accruals.

Extremely bullish outlook: Management expects to exceed US$1bn of
adjusted EBITDA in FY11, and expects FCF of more than US$335m in FY11.
The company expects margin gains from operational efficiencies, product
portfolio optimisation and strong spot pricing. We are building in EBITDA of
US$967m compared with guidance of US$1bn in EBITDA.

Earnings and target price revision
No changes.

Price catalyst
12-month price target: Rs205.00 based on a PER methodology.
Catalyst: Increased confidence in earnings sustainability of Novelis.

Action and recommendation
Maintain Outperform: We believe Hindalco offers good value and has strong
growth drivers. Around 60% of Hindalco’s earnings come from its subsidiary
Novelis, making it minimally dependent on aluminium prices. We think a
recovery in Novelis will be the key driver of earnings in FY11. From FY12
onward, it will start commissioning its three-fold increase in aluminium
capacity, which will be backed, in our view, by 200m of bauxite resources,
making Hindalco the lowest-cost producer.

It remains one of the least expensive stocks regionally at 9.7x FY11E, a
discount of at least 50% to peers such as Chalco (2600 HK, HK$6.69, U, TP:
HK$5.20, Christina Lee) and Alcoa (AA US, US$11.66, O, TP: US$18, Curt
Woodworth) on FY11E.

To read the full report: HINDALCO INDUSTRIES

>INDIA FINANCIALS: Stick to Quality: u/g HDFC and BOI to OW, d/g IDFC and SBI to UW

• We remain positive on India financials against a macro backdrop of
rising rates and accelerating growth. All-round quality is likely to do
better than lopsided deposit or loan franchises, with credit growth and
falling NPL provisions being key earnings drivers. We reshuffle our
ratings and our top picks are HDFC Bank/HDFC, Kotak and IndusInd.

• Rising rates are not a worry, yet, because they are unlikely to affect

growth. Rates are definitely rising, though, across all segments.
Continuing tightness in short term liquidity should put upward pressure
on deposit costs. Bond yields should also harden, given the fiscal
weakness. Lending yields have gone up only in segments, but we expect
a more general hardening with a lag.

• Loan growth and provisions are key earnings drivers, against a

backdrop of the improving economy. NIM expansion is largely done and
the outlook is flat. Fee income is a challenge, as flow businesses are
under pressure all round. This is different from the previous cycle where
non-interest income played a strong role.

• We reshuffle our ratings: a) upgrade HDFC to OW given the strong

loan growth tailwinds, b) BOI to OW because of the asset quality
turnaround, c) cut IDFC to UW on concerns around the flow business
and c) SBI to UW because of high valuations and relative absence of
positive triggers.

• All-rounders in focus. At this phase of the cycle, balance between loan
origination and deposits is important, given liquidity is neither excessive
nor short. We recommend exiting the "origination" shops like IDFC. Our
top picks are a) quality names like HDFC and HDFC Bank and b) Kotak
and IndusInd which are addressing legacy weaknesses in funding
franchises.Our least preferred is SBI, which we think is too richly valued.

To read the full report: INDIA FINANCIALS

>Tata Steel Ltd: Q1FY11 Consolidated earnings preview

Earnings expectations for both standalone and consolidated: TATA reports
consolidated earnings on 12th August. For standalone business, we expect
EBITDA of Rs25bn (+48% y/y, -14% q/q) v/s Bloomberg Consensus (BBRG)
estimates of Rs24.7bn. Our standalone PAT estimates are Rs13bn (+66% y/y, -
35% q/q) v/s BBRG of Rs13.3bn. For the consolidated results, we expect
EBITDA of Rs46.6bn (-2% q/q) and PAT at Rs20.6bn (-25% q/q) v/s BBRG
EBITDA of Rs43.5bn and PAT at Rs18.04bn.

Corus expectations: We expect Corus Q1FY11E EBITDA at $480mn with
EBITDA/MT of $117/MT. While we do not have BBRG estimates for the
same, we believe street estimates are slightly lower than ours. Over the past
few quarters Corus earnings have varied very significantly from ours and
street estimates with Dec-09 and March-10 quarter Corus earnings
significantly above everyone’s estimates while June-09 and Sept-09 were
significantly below estimates. We do admit that even for this quarter (while we
are back to steady state business), given the various moving parts and lack data,
Corus earnings may be significantly below/above our and street estimates.
Corus reported EBITDA/MT of $94/MT in the March-10 quarter with ASP of
$976/MT. Since then, while Corus should see higher iron ore costs (as the new
contracts come into place), coking coal should be on the older and lower priced
contracts. German spot HRC prices have increased by nearly $200/MT in
the Feb-May-10 period. We do not expect Corus ASP to increase $200/MT
q/q, but are building in $74/MT ASP increase q/q and $51/MT cost
increase, and hence our $23/MT EBITDA/MT increase q/q to $117/MT.

3 key variables we would like more clarity on are: a) Given Arcelor’s (MT)
comments that costs would continue to increase into the Dec quarter and 10%
increase in steel prices would be required to maintain EBITDA, we would like
more clarity on Corus’s cost trajectory over next 2 quarters; b) What kind of
capacity utilizations the company expects over FY11E, and c) details on the
potential re-financing of the Corus debt and would it possibly include any
further equity issue (TATA had issued stock to promoters, in May).

Pension assets could likely decline further from March-10 closing levels:
Longer term we continue to believe the pension issue is among the most
important variables for TATA Corus as historically healthcare inflation has been
ahead of asset returns Given that equity markets had come off sharply in the
June quarter, we expect the pension surplus assets to decline further from the
reported number of $217mn. While the current rally in equity markets should
result in pension surplus assets moving up in the Sep quarter, the net surplus has
declined from a peak of $2.1bn as of Mar-08 to $0.2bn in Mar-10 end.

• While we continue to believe that the worst is behind for Corus and unit should
be profitable (operating level) into FY11E, visibility on profitability levels
remains low.

To read the full report: TISCO

>ZYLOG SYSTEMS LIMITED: Q1FY11 results beat expectations

Zylog Systems Ltd’s (Zylog’s) Q1FY11 results beat CRISIL Equities’ expectations. While consolidated revenues were marginally higher than our forecast, the 103% y-o-y growth in
consolidated PAT was a surprise. Q1FY11 consolidated PAT accounts for 27% of our
existing full-year forecast. We will revise our estimates following our discussion with
the company management on key issues such as revenue growth drivers in
Q1FY11, expected salary hike, the likely employee mix and progress on the
integration of Brainhunter. Our back-of-the-envelope analysis suggests that we may
have to raise our FY11 PAT forecast by 10-15%. We continue to maintain the fundamental
grade of ‘3/5’, indicating that Zylog’s fundamentals are ‘good’ relative to other listed equity
securities in India.

Q1FY11 (standalone) result analysis
- Zylog’s Q1FY11 standalone revenues were up 3.5% q-o-q and 22.4% y-o-y at Rs 2.2
bn. The reported revenues for the quarter are 22% of our existing full-year forecast.

- The reported EBITDA margin was 24.4%, up 130 bps q-o-q and up 610 bps y-o-y
mainly on account of lower software development cost, which declined 24.5% q-o-q
and 31.5% y-o-y. Software development cost as a percentage of revenue for the
quarter was 8.7%, down by 320 bps q-o-q and a steep decline of 690 bps on a y-o-y

- Q1FY11 PAT was Rs 345 mn compared to Rs 266 mn in Q4FY10 and Rs 199 mn in
Q1FY10. The q-o-q growth in PAT would have been higher but for a 470 bps
increase in the tax rate to 21.1%. The reported PAT for the quarter is 31% of our
existing full-year forecast.
Q1FY11 (consolidated) result analysis

- Zylog’s consolidated revenues for the quarter were up by 139% y-o-y to Rs 4.6 bn.
Information about Q4FY10 is not available as the company has started reporting
consolidated quarterly results only from Q1FY11. The reported revenues were
marginally higher than our forecast, accounting for 25% of the existing full-year

- EBITDA margin declined by 100 bps y-o-y due to the consolidation of Brainhunter,
which has lower EBITDA margin compared to the parent company.

- The consolidated PAT for the quarter more than doubled to Rs 353 mn vs. Rs 174
mn in Q1FY10 and accounts for 27% of our existing full-year forecast.
Likely earnings upgrade of 10-15% post interaction with the management
We will revise our estimates after we get clarity on key issues such as revenue growth
drivers in Q1FY11, expected salary hike, the likely employee mix and progress on the
integration of Brainhunter

To read the full report: ZYLOG SYSTEMS

>Housing Development Finance Corporation Ltd.

India’s low mortgage penetration rate & favourable
demographics leaves sufficient room for growth…

Expected benefits of more stable & predictable business
model vis-à-vis peers already factored into stock price…


HDFC Ltd.’s (HDFC.IN)/ (HDFC.BO) reported numbers for Q1 FY11 came in marginally lower
than our expectations. HDFC reported an EPS of Rs.23.5 for the quarter, as against our estimate of Rs.24.1, mainly due to a decline of 15% Y-o-Y and 13% sequentially in the Non Interest Income to Rs.1.85 bn. The net interest income grew 34.2% Y-o-Y, but fell 21% sequentially to Rs.8.97 bn in Q1 FY11. Interest expenses increased 10.3% sequentially, which was in line with our expectation (in our various sector reports published since January 2010, we had highlighted that the low interest rate regime would be history and with the RBI continuing to exit from its accommodative monetary policy, there could be an increase in the cost of funds for banks/ NBFCs). In Q1 FY11, the operating income increased 22% Y-o-Y, but declined 19% sequentially to Rs.10.8 bn. However, an increase of 9% Y-o-Y and 57% sequentially in operating expenses resulted in the operating profit rising 24% Yo-Y, but declining 23.6% sequentially to Rs.9.7 bn in the quarter. HDFC’s spread on loans expanded by 3 bps sequentially to 2.34%, on account of its policy of passing on incremental costs to buyers.

HDFC’s loan book grew 16.7% Y-o-Y to Rs.1,016.2 bn (net of loans sold). The “individual loans”
category (comprising 63% of outstanding loans and hence, acting as the key growth driver of
HDFC’s loan book) grew 16.9% Y-o-Y to Rs.641 bn, while loans to corporate bodies were up 18%
Y-o-Y to Rs.360 bn in Q1 FY11. HDFC’s asset quality remained superior, with the Gross NPA
declining 9 bps Y-o-Y to 0.89% in Q1 FY11. Unrealised gains on listed investments amounted to
Rs.167.75 bn in Q1 FY11, as against Rs.116.62 bn in Q1 FY10 (excluding the appreciation in the
value of unlisted investments). HDFC’s capital adequacy ratio stood at 14.8%, while the Tier-I
capital adequacy was 13.6% in Q1 FY11.

Going forward, India’s low mortgage penetration (around 7% of the nation’s GDP in FY10) and
favourable demographics, with nearly 60% of the country’s population below 30 years of age, leaves sufficient room for growth. Management expects HDFC’s disbursements to grow 20-
25% in FY11 and believes that the company will continue to pass on any increase in interest
rates to its buyers and maintain a spread of around 2%. However, HDFC’s life insurance
subsidiary (HDFC Standard Life) could witness delays in terms of break even and listing plans,
following the regulatory changes in guidelines.

Management is also considering new growth avenues. For instance, on July 9, 2010, HDFC
bought an additional 4.028 mn shares of Credila Financial Services, a specialized education loans provider, for Rs. 40.3 mn. Following the acquisition, HDFC's stake in Credila will increase to 51%. HDFC’s business model is certainly more stable and predictable than that of almost any other financial services company in India, though we believe that this is probably already factored into the stock price. In light of these developments, we expect HDFC to post an EPS of Rs.26.2 in Q2 FY11 and Rs.111.5 for FY11. The stock currently trades at a P/E multiple of 26.7x of FY11 (E) earnings and a P/BV of 4.8x FY11 (E) book. We reiterate our rating of Market Perform on HDFC.

To read the ful report: HDFC