Thursday, March 22, 2012

>HEADING FOR THE GREAT REPRESSION?: Investing in a world of government-suppressed real yields

Investing in a world of government-suppressed real yields

■ Every credit investor should consider the following: Why are real yields in so many countries near historical lows despite historically poor fundamentals?

■ One key reason is that burgeoning government debt burdens are leading to ever more measures to influence market pricing.

 Financial repression takes many forms, but the primary aim is to keep real yields below market clearing levels. Some policies are already in place, many more will likely follow.

■ Central bank balance sheet expansion alone corresponds to almost half the increase in general government debt in the US, the UK and the Eurozone since 2008 (Figure 1).

 To begin with, repression seems likely to drive more money into risky assets like credit.

■ Longer term, however, history suggests the distortions and even bigger imbalances need to correct with a very negative impact on credit spreads.

■ Even during the benign period, volatility and uncertainty are likely to be far higher than investors have grown used to, thanks to abrupt and far-reaching changes in policy.

To read full report: GREAT REPRESSION

>INDIA BANKS: Socialistic attitude of Govt and regulators add to woes (MACQUARIE RESEARCH)

 Structural de-rating – return ratios to come down sharply
The eternal long-term optimism on Indian banks in our view is unfounded. What gets neglected is the structurally lower growth, rising opacity of the quality of book thanks to restructuring, grossly under-provisioned state relative to regional peers and increasing burden in the form of priority sector/financial inclusion norms all of which is going to exert pressure on earnings and return ratios over the longer term. Leverage ratio is likely to be structurally lower due to Basel III implementation and we expect a deluge of equity capital raising over the next five years. Our earnings are ~15% below consensus for FY13E/FY14E and we expect ROEs to come down from 18.1% in FY11 to 15.7% by FY14E. Our ROEs are around 300bps lower than consensus for PSU banks. HDFC Bank is the only Outperform in banks. Top Underperforms are PNB and SBI.

■ Gearing up for Basel III: Flood of capital raising in next 5yrs
As banks gear up for Basel III beginning 1stJan’2013 to achieve a common equity ratio of 8% and a CAR of 11.5% over the next five years, assuming an 18% CAGR of loan growth, we expect the banking system in India to raise a minimum of US$30bn of equity capital, posing significant dilution risk. Capital required is more for growth than meeting solvency requirements.

■ Socialistic attitude of Govt and regulators add to woes
We believe the socialistic mindset of regulators as well as the government is going to exert more pressure on bank profitability. What is good for customers is not necessarily good for shareholders. The tougher priority sector guidelines, financial inclusion targets and a possible farm loan waiver over the next few years are only going to worsen profitability dynamics. Our analysis suggests that the revised priority sector guidelines could impact margins by c.30bps for private sector banks on a ceterus paribus basis.

■ Asset quality – the pain hasn’t disappeared
While the government announcements with respect to greater coal supplies to power projects do improve sentiment, their track record of implementation leaves much to be desired. Nevertheless pains with respect to gas based power projects and power projects where PPAs are fixed at low prices will continue to face stress as renegotiation of PPAs is unlikely. Our analysis of independent power projects (IPPs) suggests that close to 23,000MW of power projects or 16% of power exposure of banks could be at risk of restructuring or default. Another 10–15% could be contributed by SEBs. NPLs/restructuring related to SMEs, export
oriented sectors etc are unlikely to significantly abate. We are very worried over the moral hazard issue in the agriculture sector. Our worry is also on the underprovisioned state of Indian banks. We expect stressed assets, defined as net NPLs plus restructured assets, to net-worth ratio for the system to increase to a ten-year high of 57% (90% for PSU banks) by FY13. NPL coverage on stressed assets stands at a dismal sub 40% vs. regional peers averaging at 150% plus.

 Valuations – where is the comfort?
Stocks currently are trading above ten-year historical averages on the back of an opaque book which is grossly inflated thanks to restructuring. The 20% re-rating from the recent lows more than adequately factors a ~100bps cut in benchmark rates and aggressive rate cuts are unlikely considering the fiscal and inflation

To read full report: INDIA BANKS

>DISH TV: Consistent market leader with highest absolute share

■ Consistent market leader with highest absolute share
The only listed Indian DTH company, it has the largest subscriber base of 12.5 m (gross for Q3FY12) with a market share of 29.4% amidst strong competition. Dish TV continues to maintain its lead in a six-player market.

■ Stabilizing ARPU (average rate per user)
The DTH segment saw ARPU pressure during FY08-09 due to intensifying competition. Since FY10, the focus has shifted toward profitable growth. Further, Dish TV has the largest number of highdefinition channels, which would further increase ARPU ahead.

This will leverage its HD advantage. The main drivers for ARPU improvement would be value-added services, movies on demand, high-definition TV and the broadcasters’ pricing power. Mandatory digitization is likely to push HD activations. Also, subscriber acquisition cost (SAC) has been under control due to the entry level price hike.

■ Capitalizing on the industry growth and regulatory approvals (digitization mandate) – Opportunity for DTH to enter cable strongholds
Six big players with deep pockets dominate the DTH market. With its maiden launch in mid 2005, Dish TV has the first-mover advantage, and has increased its net subscriber base from 2.2 million in 2007 to 9.5 million by end-Q3 FY12. It has secured FIBP approval to raise up to Rs9.8 billion, having taken this step to build its war chest as digitization momentum gathers steam.

The DTH segment has seen a robust increase in its subscriber base, a 95% CAGR over 2006-2011.

In order to digitize 88 million subscribers, the segment needs capex of Rs 132 billion. 11 organized players have a reach of almost 58% of TV distribution. We believe that only the organized sector players would have the financial muscle to take advantage of this opportunity and hence would be the biggest beneficiaries.

■ Management guidance revised to “Cautious, with a positive bias”
Dish TV’s subscriber additions rose from 0.6 million in Q2FY11 to 0.7 million in Q3FY11. Management has revised its guidance for subscriber additions in FY12, from ~3 million to ~2.6 million. It has attributed the slowdown in subscribers added to the slowing economy and recent price hikes.

Churning would certainly decline because of the actions that have been taken not only by the company (by various promotional offers and good service) but by the entire industry.

■ Turnaround on the cards, though with a delay
Current debt on the books is almost Rs.12,000 million. Of this, Rs.7,500 million is dollar-denominated, Rs.4,500 million is Indian debt. The company has secured approval to raise US$200 million as digitization opens up the opportunity of 70 million analog homes to be converted to digital.

Management had earlier indicated that the company would be free-cashflow positive by Q4 FY12. However, due to the dollar movements and sluggish top-line growth on the fewer activations, this might be delayed to H1 FY13.

■ Valuations
At present, the company is suffering losses at the net level though it has a positive cashflow from operations. Management had guided to positive free cash flow from Q4 FY12. Fewer subscriber additions due to keener competition and a higher churn rate might delay this to H1FY13.

Its competitive edge and mandatory digitization policy by the government would prove catalysts for the company. At present, the stock is close to its 52W low; we see a price target of Rs 80 in next 24 months.

■ Concerns
- The promoters’ stake was 64.75% in December 2011. They have pledged 24.17%.

To read full report: DISH TV

>POLARIS FINANCIAL TECHNOLOGY LIMITED: Investment in IdenTrust and Indigo TX acquisition will boost its Intellect offerings

Company Background
Polaris Financial Technology Limited (PFTL) incorporated in 1993, headquartered in Chennai has a strong global footprint and primarily focuses on Banking and financial services (BFSI) vertical. It has eight out of the top 10 financial services firms globally among its clients. CitiGroup is its largest client, accounting for over 40% of consolidated revenues. The company offers IntellectTM, first pure play Service Oriented Architecture (SOA) based application suite serving retail, corporate, investment banking and Insurance clients. The IntellectTM suite has grown strongly since the last five years of inception and going forward we believe it to contribute significantly to company’s top line and profits.

Investment Rationale
 Banking on Intellect platform to derive growth - ‘Intellect’ suite provides more flexibility Polaris ‘Intellect’ based on Service Oriented Architecture (SOA) fulfills all criteria required for modern Core Bank Software (CBS) replacement demand. It provides an efficient web based real-time modular software solution with excellent user interface. It enables clients, enhanced flexibility and customization as per their requirement and fulfils the criteria of a standardized platform. It also provides a multi-entity solution that can be accessed across countries offering a 360-degree view of a customer and provide a holistic view of data which differentiates it from others. Moreover it does not have the rigidity faced by ‘Bank In Box’ software products solutions like Flexcube, Finacle, BaNCS. We believe features and flexibility offered by Intellect is in par with established players and is well placed to benefit from the core replacement demand in emerging geographies which has less competition and high demand.

 Significant deal wins, robust pipeline for Intellect augurs well for the company
‘Intellect’ has a strong deal pipe of ~US$300 mn in IMEA and APAC region. Intellect has started winning bigger deals in range of US$10-20mn and won US$20 mn deal in Q3 FY12 which is the second largest deal after the RBI deal. We believe RBI deal win of US$55 mn is a big breakthrough which will enable the company to win more deals from PSU and Private Banks in emerging geographies and also help the company to tap immense opportunity present in the central banks CBS market. Polaris investment in IdenTrust and Indigo TX acquisition will boost its Intellect offerings and help win more deals. 

■ Well placed to benefit from Core Banking Software replacement demand
Core Banking Software (CBS) replacement demand around the globe has gained momentum in 2010 and we expect it to continue over the next five years. While US recorded the largest number of CBS replacements in 2006-07 (has slowed down in 2008-09), emerging geographies will now provide the majority of CBS replacement opportunities. Polaris which gets 95% of its Product revenues from APAC and IMEA is well placed to get benefitted from this trend. In the last one year, majority deal wins from Saigon Hanoi Bank of Vietnam, Sonali bank of Bangladesh, Regional Development Bank of Sri Lanka etc has been from emerging geographies and we expect strong deal wins to continue going forward.

Valuation and Outlook
We believe Polaris will deliver strong revenue growth (CAGR of 42.3%) in products business (27.5% of total revenues) due to strong deal pipeline and diversified product portfolio. The services business (72.5% of revenues) is expected to grow at CAGR of 20.5% but has margins in lower double digits. However products business which has higher margins in tune of 20-25% and high growth rate will help the company expand margins going forward. We estimate FY12E and FY13E top line to grow 32.8% and 18.8% Y-o-Y to Rs 21.1 bn and Rs 25.0 bn respectively. The stock currently trades at a P/E of 7.4x and 6.0x FY12E and FY13E earnings respectively which we think is at a discount to its peers considering its high growth rate, strong deal pipeline and high cash and cash equivalents reserve of Rs4.31 bn (~26% of market cap). We initiate the company with a “BUY” rating and have valued the company on DCF basis to arrive at a fair value of Rs 230 (around ~8x times FY13E earnings.) implying an
upside of 36.5% from current levels.

To read full report: PFTL

>HITACHI HOME AND LIFE SOLUTION: Entering tier-II and tier-III cities with low-priced products

■ Positioning into mass premium segment - Hitachi Home and Life Solutions (HHLS) that primarily caters to the premium segment, is now entering tier-II and tier-III cities with low-priced products. The company has launched new range of window and split AC “KAZE” as low price product. This will help the company gain market share in the Room Air conditioners segment in the near future. The company has set a target to capture 10% market share in terms of sales volume, compared to the current market share of 7 %.

 Rural markets offer a big opportunity - Rural consumer durables market is growing by 30% currently, while it is expected to grow by 45% in FY12. Rural markets are expected to post much faster growth than urban markets in medium term led by increased rural Income, increased distribution reach of companies, and customized products for rural consumers. The industry is expected to grow at a compounded annual growth rate (CAGR) of 18% till 2014-15.

■ Outlook & Valuation - The AC industry is expected to grow at 15-20% over 3-5 years, while we expect HHLS to register a CAGR of 14% over FY2011-13E. The decline in EBITDA in FY11 over FY10 was mainly because of the rise in raw material prices (mainly copper). We expect EBITDA margins to improve to 6.1% in FY13E. The forecasted PAT shows decrease of 32% in FY12E mainly due to decline in sales because of climatic change, short summer season and longer winter season. The PAT is expected to rise by 50% in FY13. At current valuations the stock is trading at 9.8x FY2013E EPS. We have arrived at Target Price of Rs142. Hence, we recommend BUY on the stock.

To read full report: HITACHI HOME & LIFE SOLUTION

>National Buildings Construction Corp. (NBCC): IPO Analysis

The National Buildings Construction Corp. (NBCC) is engaged in the business of providing project management consultancy (PMC) services for civil construction projects, civil infrastructure for power sector and real estate development.

Objects of the Issue: To divest 12,000,000 equity shares and achieve benefits of listing.

Investment Rationale
 Operations well diversified, presence in various sectors: NBCC has presence across various sectors. NBCC’s project diversification ranges from PMC, real estate, civil construction and civil infrastructure for the power sector. Though, Project Management Consultancy forms the core of its sales (90%).

 Strong Order Book visibility: As on 31st Jan 2012; the order book for the PMC and civil Infrastructure for the power sector constituted 10,613.68 crore. The total order book constituted of 30.33% from infrastructure, 28.46% from the hospital segment, 25.85% from the institutional construction segment, 9.67% from commercial construction and 2.74% from residential construction.

 Strong Clientele in the Govt. of India (GoI) and its various arms: Projects are awarded to NBCC on nomination basis by the GoI. It has handled various government projects such as infrastructure works for security personnel, border fencing, re-development of buildings etc as well as infrastructure projects such as roads, water-supply systems and so on. Some of its key clients are The Ministry of Defence, The Ministry of Home Affairs, External Affairs, The Ministry of Finance, IIT Patna among others.

 Focus on high value projects: NBCC intends to focus on undertaking projects of high value, above Rs 100 crore in the PMC and civil infrastructure segments.

 Healthy financials: It is completely debt free and has a healthy balance sheet with steady cash flows. As on H1FY12, its cash balance stood at Rs 1368.2 cr, which is ~ Rs 114/share. The company has consistently maintained a dividend payout ratio of 20%.

Key concerns:
 As PMC contributes significantly to the Sales, any decline in this business could adversely affect NBCC revenues.

 NBCC is currently awarded projects on nomination basis by GoI; any change in this policy could pose significant risks to business visibility.

■ Valuation and Investment Argument: At the offer price bands, the issue is quoting at a P/E of 7.3-8.5 its annualized H1FY12 earnings. Most of the infra and construction companies are available at a 7x P/E. Currently, similar companies under the sector are reeling under pressure. However, an intended increase in government spending in infrastructure and a sound order book puts the Company is a sweet spot. Though the business model is concentrated on PMC segment and primary clients being various central and state governments, its steady cash flows, debt free status and dividend yield render the issue attractive. Only conservative investors with defensive mindset can SUBSCRIBE to this issue.

To read full report: NBCC

>Much awaited merger of Tech Mahindra and Mahindra Satyam has got finalised

The much awaited merger of Tech Mahindra and Mahindra Satyam has got finalised with the boards of the two entities having approved the proposal. The swap ratio for the merger is worked out to be 2 shares of Tech Mahindra (face value Rs10) for every 17 shares of Mahindra Satyam (face value of Rs2). As per the managements’ indication, the merger process will take another six to nine months to complete and the record date of the merger would be announced in due course.

Key synergies from the merger
The combined entity would be the fifth largest domestic IT company: The merged entity’s revenues are at around $2.4 billion for the last 12 months (ended December 2011), making it the fifth largest domestic IT company, next to HCL Technologies among the listed space. The entity would be the sixth largest when taking Cognizant Technologies into consideration. In terms of market capitalisation, the merged entity will be at around Rs17,000 crore.

 Diversified revenue stream with strong domain expertise in focused areas: The merged entity’s revenue stream will be much diversified as compared to the current single industry (telecom) exposure of Tech Mahindra. The new entity’s revenue mix will comprise of sectors like banking, financial services and insurance (BFSI), manufacturing and telecom among others. On the other hand, the merged entity would derive synergies from strong capabilities of Tech Mahindra in mobility and system integration whereas the legacy strength of Satyam in the area of enterprise solutions would be the key differentiator for the merged entity. Among geographies, the revenue exposure will be more balanced with 42% accounted by the US, 35% by Europe and 23% by emerging markets.

■ Top client’s concentration will reduce; clients portfolio looks more diversified: Currently, British Telecom (BT) contributes close to 35% of the total revenues of Tech Mahindra, which is likely to reduce substantially to 16.5% in the new merged entity. Further, with around 217 Satyam clients adding to the joint entity, the joint entity will have over 350 clients.

■ Cost benefits to accrue from operational synergies: The joint “Go to market” strategy of the merged entit has already started bearing fruits, with both Tech Mahindra and Satyam working closely in the last one year as a joint entity for the market penetration. In the last one year, the merged entity has won more than 10 deals through this initiative. On the other hand, the joint entity would also have the scale and bandwidth to accrue benefits from the general and administrative (G&A) side of the expenses. Going forward, the management has indicated at an EBITDA margins of 16% from the combined entity.

■ Potential for higher investor participation with increase in free float: At present, Tech Mahindra is having a free float of shares of around 29.1%. Excluding LIC, which holds around 13%, the figure stands at 16.1%. In the merged entity, the free float available for the investors will increase to 50.5%. With increase in free float the investor participation in the merged entity will increase further. Through the merger process, 20.4 crore shares of Satyam will be transferred to Tech Mahindra Trust and 10.34 crore new shares will be issued. Post merger, Tech Mahindra Trust will hold a 10.4% stake in the new entity as treasury shares.

 Other highlights
The management has indicated that C P Gurnani who led the Mahindra Satyam turnaround would be the chief executive officer (CEO) of the combined entity. Sanjay Anand will be the chief finance officer (CFO) and Vineet Nayyar would be the non-executive Chairman. Sriram Papani will lead the enterprise business solutions vertical, Nagesh Kamble will lead the consulting business and Karthikeyan Natarajan would lead the engineering services division. The heads of sales and leaders appointed for specific geographies are
expected to remain unchanged.

There would be no redundancy in respect of employees with the total workforce growing to 75,026 employees. Going ahead the management expects to add to the headcount on a net basis.
The in-organic route to growth would remain as the combined entity would look at acquisitions to fill in gaps in services and enter new markets.

Decision with regards to branding would be taken up in consultation of professional consultants.

■ Valuation: We view the merger of Mahindra Satyam with Tech Mahindra as a positive catalyst for creating a value accretive entity for the future. However, legal hurdles pending with Mahindra Satyam and slowdown in the telecom vertical (main industry exposure for Tech Mahindra) would stand to be a roadblock in the medium term. On a longer-term, the new entity will have a more diversified and scalable revenue stream and operational synergies will create value for the investors. At the current market price, both Tech Mahindra and Mahindra Satyam trade at 10x and 9x their FY2013E and FY2014E consensus earnings respectively. We continue to remain positively biased on Mahindra Satyam. Currently, we do not have any active rating on Tech Mahindra and Mahindra Satyam.


>ORBIT CORPORATION: Plans to launch a slum rehabilitation project, a new project at Napean Sea Road (60,000 sq ft) and another new project at Kemps Corner

Timely clearances of projects hold the key

  Sales booking in Q4FY2012 likely to be better than Q3: Orbit Corporation (Orbit)’s management is expecting presales for Q4FY2012 to be better than in Q3FY2012. In Q3FY2012 the sales booking stood at Rs71.1 crore (32,921 sq ft) which was better than Q2FY2012’s presales of a measly Rs2.41 crore (9,034 sq ft). The company in the third quarter resorted to fire sale (ie bulk selling) in Orbit Laburnum at Gamdevi, Mumbai and Orbit Residency at Andheri-Saki Naka, Mumbai which drove the sales volume. Similarly in Q4FY2012, the company is looking at bulk sales in two of its properties viz Orbit Residency at Andheri, Mumbai and Orbit Terraces at Lower Parel, Mumbai which are at an advanced stage. It has also achieved sales in some of its other projects which would result in sales booking to be better sequentially.

■  New launches to kick in from Q1FY2013: With the amended Development Control Regulation (DCR) now in place, the company expects the approval process to be streamlined. Though the approvals have still not picked up, but the same are expected to gain momentum in a month’s time. As a result the company has
started applying for approvals for its existing under-construction projects, so that the execution can be ramped up. It will also soon start applying for newer projects so that they can be launched by end of Q1FY2013. Any further delay in getting clearances will impact the company’s financials and thus our estimates. The company plans to launch a slum rehabilitation project (SRA) in Santa Cruz (phase 1 of ~100,000 sq ft), a new project at Napean Sea Road (60,000 sq ft) and another new project at Kemps Corner (~100,000 sq ft) by H1FY2013. All of these planned projects are in Mumbai.

■  Looking out for partner in Santa Cruz SRA project: Orbit is in talks with a few property firms from Singapore for partnering in its planned Santa Cruz SRA project in Mumbai, the Orbit Grandeur. It might bring in a partner for project designing expertise or for investment in the project. However the discussions are at a very nascent stage and the deal will take time to materialise. If the discussions fall out as per plan then Orbit would be able to execute the project without any further debt raising.

 ■ Mandwa project to take 6-9 months to get approvals and clearances: The pending approvals and clearances for Mandwa will take approximately six to nine months, after which the company will launch the project and will be able to start construction work. Recently the project had come under the scanner of the Bombay Environmental Action Group (BEAG), which had complained to the Union Ministry of Environment and Forests (MoEF) about large-scale destruction of mangroves. However as per the environment secretary, an inspection of the area was carried out and there was no case of mangroves having been destroyed. The company had applied to the local collector's office for a recreational and tourism zone permit for 200 acres as the land was reserved for that purpose in the regional plan. However, the land is still recorded as agricultural land. It's now over a year since the application has been made, but the company has not received any permission so far. No construction work is being carried out at the site currently. The MoEF has carried out a survey and Orbit is awaiting the final decision from the union environment ministry. The project will not get impacted by BEAG’s allegations.

  Maintain Buy: Poor sales across projects over the last one year due to regulatory uncertainties and absence of new launches due to pending approvals and clearances took a toll on the company. However there have been amendments in the DCR which now create a level playing field for developers and provide regulatory clarity. This will result in pending projects now getting approved, resulting in a pick-up in execution of projects along with launches of new projects. We expect the clearances to start coming in by the end of Q1FY2013. The next couple of quarters need to be keenly watched in terms of the cut in interest rate cycle and the progress on the approvals front for the company. Given the healthy land bank of the company, any quick revival on the clearances front will be a positive for the stock. Further any success in roping private equity in few of its projects will help the company improve its balance sheet. We maintain our Buy rating on the stock with a target price of Rs70. At the current market price, the stock trades at 7.8x its FY2013E earnings and 0.4x its FY2013E price to book value (P/BV).