>CROMPTON GREAVES: Lower-than-expected EBITDA; board approves demerger

Consolidated 2QFY15 EBITDA at Rs1.7bn (up 4% YoY) was 12% below our estimates, as revenue at Rs34.3bn (up 7% YoY) and gross margin at 31.8% (up 30bps YoY) came 7% and 70bps below our estimate respectively. EBITDA margin at 4.9% (down 10bps YoY) was 30bps below our expectation. Higher tax rate at 46% (vs our estimate of 30%) led to PAT of Rs570mn, 28% below our estimate. We do not change our estimates for FY15, as we expect strong growth in the consumer business in 2HFY15 (led by strong festival demand) and pick-up in execution of high margin order backlog in the power business. The board approved the demerger of the consumer business, with Crompton

holding 25% in the proposed consumer company; balance by the existing shareholders. Whilst the demerger will unlock value, we believe the CMP already factors in this; our TP of Rs185/share values the consumer business at Rs102/share, implied FY16 P/E of 21.4x (6% discount to Havells). We remain concerned around the rising share of MNCs in domestic power, rising competitive intensity in fans, and a fragile recovery in Europe.

Results overview: Consolidated revenues at Rs34.3bn increased 7% YoY led by 13% YoY growth in consumer products. EBITDA increased by only 4% YoY due to a 21% YoY increase in other expenses. Consequently, EBITDA margin declined 10bps YoY to 4.9%. However, PBT increased by 16% YoY to Rs1.3bn due to a 39% YoY increase in other income. The higher share of profits in associates led to PAT increasing by 20% YoY to Rs696mn.

Within the segments, on a consolidated basis, the major revenue driver was the consumer products business which reported a YoY revenue growth of 13% led by strong growth of fans (up 13% YoY) given the extended summer. Pumps and Lighting grew by 7% YoY and 5% YoY. The Power and industrial segment’s revenue grew 5% YoY. A margin improvement was seen on a consolidated basis across segments. Whilst consumer business’ EBIT margin improved 30bps YoY to 12.0% led by

operating leverage, power and industrial systems’ margin improved 20bps YoY and 160bps Yoy to 2.2% and 9.2% led by improvement in the margin of the international power (up 80bps YoY) and industrial (up 690bps YoY) businesses.

On a standalone basis, revenues registered a meagre growth of 8% at Rs19bn led by a 13% YoY increase in the consumer durables business; revenues of power systems increased 6% YoY and industrial system increased 7% YoY. EBITDA increased by only 5% YoY to Rs1.7bn due to a 13% YoY increase in employee expenses. Consequently, EBITDA margin declined 20bps YoY to 8.7%. However, PBT declined by 1% YoY to Rs1.8bn due to a 10% increase in depreciation. Increase in tax rate from 24% in 2QFY14 to 28% led to a 7% decline in PAT to Rs1.3bn.

Demerger approved by board: CRG’s board approved the demerger of the consumer business to Crompton Consumer Products Ltd (CCPL) with effect from 1 April 2015. Upon the completion of the demerger process, CRG would hold a 25% stake in the proposed CCPL and the balance would be held by the existing shareholders of CRG. The shareholders of CRG would be allotted 3 shares of CCPL for every 4 shares held in CRG. CCPL would be listed on the BSE and NSE. Note that there is no change in the shareholding of the minority holders in the demerged entity, as no strategic shareholder has been brought in.

Where do we go from here? Despite revenue and EBITDA being 7% and 12% below our estimate, we are not changing our estimates for FY15, as we expect strong growth in the consumer business in 2HFY15 (on the back of strong festive demand) coupled with pick-up in execution of high margin order backlog in the power business. Note that CRG has bagged recent orders at higher margins, part of which are likely to be booked in 2HFY15 and this should help in margin improvement. For the full year, we model in revenue growth of 14% YoY (vs 8% YoY in 1HFY15) and EBITDA margin

expansion of 150bps YoY in FY15 (vs 20bps in 1HFY15).

However, we remain concerned about the following factors:

■ Europe recovery likely to be fragile: The GDP growth outlook for Europe has been deteriorating with the IMF doubling the probability of the Eurozone re-entering into a recession to 38% in October 2014 from 19% in April 2014. If Europe continues to disappoint, the turnaround of international subsidiaries may get delayed further and the international franchise’s losses may widen. Note that the European region contributed to ~35% of consolidated revenues in FY14.

■ Competition increasing in the consumer business: Within the domestic consumer segment in India, Crompton has a strong presence in the fans segment, which contributed to ~40% of consumer products’ revenues in FY14. However, competition intensified in FY14 with the entry of five new players (Polycab, Schneider, Luminous, Surya and RR Kabel). Competition has increased due to: (1) attractive margins (more than 13% in the premium decorative segment), (2) healthy 24% volume CAGR over FY09-12, (3) rising share of premium and decorative fans (now accounts for 50% of

the market as compared to a fifth five years ago), and (4) shortening replacement cycle (now five years as compared to 7-8 years five years back, as RPMs have increased to 380 from 200 earlier and share of pedestal, wall and table fans which have to be replaced after 2-3 years has increased to 40% as compared to 30% three years back). Given Crompton’s market leadership in this segment, any disruptive strategy adopted by these new players (like cutting prices) could hurt its fan margins.

■ Rising competition in Indian power business from foreign players: Rising competition from foreign players that are competing for Power Grid (PGCIL) tenders and the dismal balance sheets of SEBs have hurt CRG’s power franchise. Its EBITDA margins declined to 11% over FY12-14 vs 14% in FY06-10 and revenue CAGR slowed down to 3% in FY12-14 vs 10% over FY08-12. With foreign players now setting up manufacturing base in India (TBEA and Toshiba), competition should further intensify and this would hurt CRG.

■ Feeder separation, a negative catalyst for the power franchise

The Rs430bn and Rs326bn Union allocation for feeder separation and strengthening of the grid should help in restructuring the balance sheet of SEBs. However, this may not be a positive catalyst for Crompton as any improvement in the balance sheet of SEBs will invite competition from the foreign players. Thus, whilst we assume a pickup in revenue CAGR for Crompton to 16% over FY14-16 (vs 3% in FY12-14) as the balance sheet of the SEBs improve, we assume a margin improvement of only 40bps to 9.1% over FY14-17 vs FY12-14. This is far lower compared to the 13.3% margins reported during FY09-11 when Crompton did not face any competition.

■ Punchy valuations; impact of demerger already priced in: At CMP of Rs191/share, CRG is trading at 15.9x FY16 P/E, a 3% premium to its five-year oneyear forward P/E. Our SOTP value of Rs185/share implies an FY16 P/E of 15.4x. We value the consumer business at Rs102/share (implied FY16 P/E of 21.4x), the standalone power business at Rs31/share (implied FY16 P/E of 17.3x), the standalone industrial business at 20/share (implied FY16 P/E of 11.3x) and international subsidiaries at Rs18/share (15.7x FY16 P/E).

Our implied multiple for the consumer business is at a 6% discount to Havells. We believe the discount is justified given Havells strong consumer franchise, superior range of products with higher revenue CAGR of 18% (vs CRG’s 12%) over FY11-14, and higher average EBIT margin (adjusted for unallocable expenses) at 11.4% (vs CRG’s 9.7%) over FY11-14. We value the standalone power business at a 56% discount based on FY16 P/E to its capital goods peers such as BHEL, Siemens, ABB and Alstom T&D and the standalone industrial business at a 45% discount to capital goods peers such as Cummins, Kirloskar Oil Engines and KSB Pumps. We believe such a steep discount is justified given CRG’s weak power franchise and inferior management quality. Also, we believe CRG’s standalone industrial should trade at a discount to peers given the commoditised nature of CRG’s portfolio.

RISH TRADER

>BAJAJ AUTO (AMBIT CAPITAL)

Conference call takeaways

Bajaj Auto continued to record strong growth in 2QFY15 across most of its business segments, namely export markets (management expectations of 20% volume growth for FY15 driven by healthy growth across most of the export countries) and domestic three-wheelers (on the back of new permit

issuances from Hyderabad, and Delhi). Within domestic motorcycles, whilst Pulsar and Platina continue to do well, there are early signs of recovery in Discover sales (helped by launch of Discover 150). We retain our positive view on Bajaj Auto on the back of its strong and growing exports franchise, opportunity to regain market share in domestic motorcycles (market share perked up to 18.8% in September 2014 vs 16.6% in April-August 2014) and its diversified business model. We marginally upgrade our estimates (FY15 and FY16 net earnings by 3%/2%) and valuation to Rs2,600 (vs Rs2,500 earlier), implying 15.0x one-year forward net earnings.

Key takeaways from the earnings call

■ Domestic motorcycle industry: The management expects domestic motorcycle industry to witness 10-12% YoY growth in 2HFY15. The industry volume growth has been around 12% for Navratri. Furthermore, Diwali is also expected to witness a similar volume growth. Whilst Pulsar and Platina continue to clock healthy volume growth, the management is hopeful of recovering market share in Discover. The recently launched Discover 150 has seen a good opening and currently it retails around 25k units/month. Furthermore, the company plans to launch new variants of Platina and Pulsar by end-FY15.

■ Domestic 3W volumes: The domestic 3W volumes witnessed a strong growth of 39% YoY in 2QFY15. This was mainly driven by new permits as well market share gains for Bajaj in the diesel 3W segment (32% currently vs 25% last year). On the back of new permit issuances in Delhi and Hyderabad, the management expects to sustain a monthly run rate of 26k-27k units in the domestic 3W space for 2HFY15 (vs 22k units/month in 1HFY15 and 15k units/month in 2HFY14). Quadricycle RE60 is slated for launch in 4QFY15 in the domestic market (followed by launch in the export markets).

■ Exports: The company is witnessing strong growth across most of the export geographies. Whilst big existing geographies are clocking in healthy volume (exports to Nigeria increased by 30% YoY in 1HFY15), volume growth in newer geographies such as Mexico has also been strong. The export volumes in 1HFY15 contained an order of 40k units of Discover from Sri Lanka which has been completed. Overall, the company expects export volumes to grow around 20% YoY for FY15. Over the next 4-5 years, export volumes are likely to witness a CAGR of 15%.

■ Realisation: The strong improvement in average realisation (6% QoQ and 5% YoY) was on account of: (a) higher share of 3Ws and better mix within motorcycle and (b) INR depreciation; average export currency realisation was Rs61.5/USD in 2QFY15 vs Rs59.9/USD in 1QFY15. Going forward, the management expects export currency realisation to improve further to Rs61.9/USD in 3QFY15 and Rs62.5/USD in 4QFY15.

■ Margin: The company’s raw material costs as a percentage of sales declined from 69.5% in 1QFY15 to 68.6% in 2QFY15. Whilst commodity prices are likely to remain stable, conversion costs (such as labour) may increase at the vendor level. As a result, material costs may inch up marginally in 2HFY15. The increase in ‘other expenses’ (15% YoY) after adjusting the MTM loss and contribution towards Corporate Social Responsibility (CSR) was due to: (a) increase in packing, forwarding and freight expenses (by Rs370mn) due to higher export volumes; and (b) higher advertisement spends during the quarter (Rs220mn) attributable to the launch of Discover 150. Going forward, the management expects advertising and marketing spends to continue given the launch of new variants of Platina and Pulsar by 4QFY15.

■ Where do we go from here?

We retain our positive view on Bajaj Auto on the back of its: (a) strong and growing export franchise (45% of 2QFY15 revenues); (b) opportunity to regain market share in domestic motorcycles (already the company has witnessed an uptick in market share to 18.8% in September vs 16.6% in April-August 2014); and (c) its diversified product portfolio.

In view of a much better-than-expected realisation in 2QFY15, we revise upwards our average realisation estimates for FY15 (by 1%) and FY16 (by 2%). This also results in a 30bps upgrade to our EBITDA margin estimates for FY15 and FY16. Our absolute EBITDA estimates are upgraded by 3% each for FY15 and FY16. Overall, we upgrade our net earnings estimates for FY15 and FY16 by 3% and 2%, respectively.

RISH TRADER

>STRATEGY: Staying away from the “fright club”

Summary: There are three very good reasons, we believe, for not joining the “fright club” against India being orchestrated by parts of the brokerage community. Firstly, a significant part of the ongoing economic slowdown has been caused by the fact that the supply of equity to the promoter community has been cut off by the European crisis (rather than by the Government of India). Secondly, a number of regulatory institutions which have come to the fore over the past two years (eg. CAG, Competition Commission) will help the Indian economy going forward even though they might result in short term economic costs. Thirdly, India’s GDP data is so compromised that drawing any conclusions about the state of the economy based on this data could result in poor investment decisions.


We reiterate that this is a good time to invest in India as valuations are the most attractive that they have been in a decade (leaving aside the quarter following the Lehman bankruptcy).


It is common knowledge that the Indian Government has played its hand badly over the past four years. For example, with regards to coal scarcity, most of the damage was self-inflicted as the Environment Minister dithered on the “go/no go” areas and then instituted an over zealous process (and arguably faulty) process of checking emissions in the vicinity of Coal India mines. The totality of these measures has probably set back Coal India’s production by 5-7% per annum. Another example of self-defeating intervention is the hasty introduction of GAAR
in the Union Budget. 
However, is the Indian Government so influential that its blunders have bought our economy to its knees? We do not think so. Three other factors have played a powerful role in India’s humbling.


Firstly, a range of problems which prima facie appear to be caused by the Government’s “policy paralysis” are arguably linked to the global seizure in risk appetite.


 The “under-the-table” model was used in the noughties to lubricate our political and bureaucratic system as aggressive promoters sought to build construction, infrastructure, real estate and mining empires. Now many of these promoters simply do not have the means to use this model on such a scale (partly because with the QIP/IPO market shut the most obvious route for financing such large backhanders is gone).


 Promoters these days are quick to blame “policy paralysis” for their inability to get projects off the ground. However, some basic number crunching and discussions with financiers suggest that in many instances these Power, Infra, Real Estate and Mining companies are deliberately throttling the project back because they do not have equity available.


The second reason for not joining the “fright club” is that a number of regulatory institutions which have come to the fore over the past two years will help the Indian economy going forward. The actions of a number of regulators, most notably the CAG and the Competition Commission (CCI) are an obvious antidote to the excesses of the noughties. Whether it be CAG’s pathbreaking report on the 2G maater of the CCI’s landmark action against DLF
for the alleged abuse of its dominant position in Gurgaon, it is hard to blame the Government for these actions.


In the Natural Resources sector almost all the titanic promoters seem have hit a brick wall in New Delhi as they run into an array of opponents in the form of: (a) The CAG which is publishing report after report on different aspects of malfeasance in this sector; (b) The Environment Ministry which is no longer willing to give clearances to projects; (c)
The Supreme Court which is unwilling to let illegal mining continue and which has advocated the use of auctions for all natural resource allocations henceforth; and (d) The relevant Ministry (be it Coal, Petroleum or Mining or Steel) which is unwilling to play ball. It is hard to imagine that our enfeebled Executive is behind such a coordinated blocking of a range of powerful companies.


If the Competition Commission continues its crusade against abuse of dominant positions by market leaders in industries from Real Estate to Cement to Sugar to LPG Cylinders, this should help improve economic efficiency. If the CAG continues its practice of scrutinizing public spending and regulatory decisions in the manner that it has over the past two years, it will revolutionise the way the Indian Government works. Without such interventions from well
meaning regulators and from a powerful judiciary, India could go the way of numerous “banana republics” in Latin America and Africa.



The final reason for not joining the fright club is that our GDP data is so compromised that drawing any conclusions about the state of the economy based on this data could result in poor investment decisions. First and foremost, India’s GDP data is subject to inexplicable retrospective revisions of a material magnitude. For instance, investment demand growth numbers have been revised upwards from 5% YoY and -4% YoY in 1QFY12 and
2QFY12 respectively to 15% YoY and 5% YoY respectively. Secondly, there is limited synchronization between trade data as shown by the national accounts data and the same variables captured by the RBI. And thirdly, the share of ‘discrepancies’ in the CSO’s GDP growth data has risen by 50% from FY05-08 to FY12 (from -9% of the change in GDP to 42% of the change in GDP!).


Clearly, the economy has slowed down sharply. Whilst we were amongst the first to signal such a pronounced slowdown (refer to our macro research from exactly a year ago), we had become more optimistic about the Indian economy in January this year. Our optimism is not being borne out by the current state of the economy but, once
again, this is because the paralytic state of affairs in Europe means that a big swathe of the Indian economy simply does not have equity to fire up the capex cycle. Policy somersaults in New Delhi can’t do much to change that reality.


Investment implications
A significant part of the blame for the dramatic slowdown of the Indian economy lies not with domestic factors but with the freezing of risk appetite in the wake of the European crisis. Our economist, Ritika Mankar, estimates that at least a third of the collapse in India’s growth can be attributed to the slowdown in investment growth which in turn is most profoundly affected by the global risk environment given India’s capital scarce nature. Whilst investment growth accounted for 50% of India’s GDP YoY growth over FY05-08, this share has now fallen to 20% in 4QFY12. Our own modeling process suggests that the global risk environment is the most important determinant of India’s growth engine (30x times more powerful than the repo rate).


This “blame attribution” is important. If investors pull out of India believing that there is something “systemically” or structurally wrong with the country, they will lose a great opportunity to participate in the Indian recovery which will come when global risk appetite recovers. This is main reason why we at Ambit refuse to join the “fright club” of brokers who are sounding dire warnings about what will happen to India if the Government does not do X, Y or Z.
We reiterate that this is a good time to invest in India as valuations are the most attractive that they have been in a decade leaving aside the quarter following the Lehman bankruptcy. We note that over the past decade the 12 month returns from investing in India when valuations are as low as they are now have always been strongly positive - see table below.

We also believe that by focusing on “Good & Clean” (G&C) companies investors can comprehensively outperform the sagging Indian indices. Since inception in March 2011, our G&C portfolios have outperformed the BSE500 by over 20% (on a free float market cap weighted basis). Our latest G&C portfolio (has outperformed the BSE200 and the BSE500 by 52bps and 48bps respectively since publication on 3rd May.

>STRATEGY: India looks oversold

With sellside economists’ GDP estimates being cut regularly (our estimate remains above 7%), with the INR in a free (our target INR/US$56-58), India's star appears to be fading. However, as shown by a series of long term charts in this note, the Indian market is unquestionably ‘cheap’ now. Whilst given the scale of the European crisis and given India's comatose Government, it is easy to be bearish on India, these charts suggest that now is almost as good a time as any to BUY India. The country will rarely look as attractive on valuations when the world economy perks up and when India's growth hits its cyclical peak (v/s the cyclical trough that it is at now).


India appears oversold on long term metrics
India appears significantly oversold on a comprehensive set of relative valuation metrics based on book value, national income and cyclically adjusted earnings (refer to the right hand margin). In fact, India has appeared cheaper than it is at present only once or twice in the last ten years:


 ■ P/B: The Sensex was significantly cheaper compared to current levels only in the year after 9/11 and in the wake of the Lehman crash (exhibit 1).


 ■ P/GDP: BSE500 was significantly cheaper only until 2005. Since then, with the exception of the post-Lehman period, the market has never been this cheap relative to underlying national income. Even in the depths of the Lehman crisis, the market was only 10% cheaper than it is today (exhibit 2).


 ■ CAPE: On CAPE (i.e. cyclically adjusted real P/E), India has only once traded at lower multiples than the current 15x. This rare outcome materialized in the post-Lehman months when it hit 12x (see exhibit 3).


 ■ Even relative to the nominal CAPE for MSCI EM, India has never looked this cheap v/s its peers post CY05 (with the exception of the post Lehman months) with its premium currently crunched to 38% v/s the long term average of 51%.


Investment Implications: Buy Good & Clean stocks
Given that India appears oversold on long term metrics, unless you believe that there is another Lehman on the way, it makes sense to take a bolder approach to buying high-quality, sensibly-valued companies in India. Fifty such companies were highlighted in our "Good & Clean 4.0: the Great 50" note published on May 03, 2012.


Furthermore, leaving our charts aside, it is worth considering the three upcoming catalysts highlighted in our email last week (India Strategy: Blinkered by all the doom & gloom", May 16, 2012) in case your spirit is willing to buy India but the flesh is weak:


1.Change in FM: With the current FM likely headed for a more prestigious but more titular role, the three candidates who appear to be in the frame for the FM’s role appear to be more progressive candidates than the incumbent.


2.More QE from the West: We have seen the QE playbook being rolled out repeatedly by the ECB and the Fed. Given the potential risks to the European banking system and given a pro-growth (hence anti-austerity) leader heading France, it would be very strange if the ECB did not use the monetary fire hose to calm the markets down eventually.


3. Oil: India's oil import bill amounts to 7% of our GDP. Therefore, a 10% fall in the price of oil (from US$110/Brent barrel to US$100) will reduce our current account deficit by 40bps. We are not oil experts but looking at the weakening Chinese economy and listening to the Saudis talk about how they will work proactively to push Brent to US$100, we cannot but feel optimistic.

RISH TRADER

>INDIAN LEADERS & LAGGARDS: Present the top and the bottom quartile of stocks from all major sectors as per “greatness/ structural strength” scores

Why focus on sector level leaders and laggards?
Whilst our “ten baggers” note lists long term investments, investors looking to comply with sectoral benchmarks usually have to focus on identifying the best plays in each sector – ignoring large sectors such as Automobiles or Metals (just because it does not have a representative on the ten bagger list) is not an option for most investors.


Secondly, sectors that are cyclical and hence more volatile in nature necessarily stand to get punished in our “greatness” framework (which penalizes stocks whose fundamentals show volatility). However, such sectors might present tactical opportunities depending on where we are in the economic cycle. Identifying right bets from such cyclical sectors is therefore important.


Finally, identifying candidates for shorting (i.e. using our model to identify firms at the other end of the “greatness” spectrum) also becomes feasible given our latest approach of identifying sector level laggards. 


The strongest leaders and the weakest laggards from our model.


Since by definition, each sector is bound to have top and bottom quartile stocks, a more time efficient way to view the world is to look for:


■ Top quartile stocks as per our greatness model which also appear in the top half of their sectors in our forensic accounting model: Mcleod Russell, Hero, Exide, Elgi Equipment, Cummins, Jyoti Structures, Shree Cement, Castrol, Nava Bharat Ventures, Sadbhav Engineering, Deepak Fertilisers, Coromandel, Zydus Wellness, GSK Consumer, Nestle, ITC, Supreme Industries, AIA, Sterlite Technologies, Bajaj Electricals, CMC, Oracle, Tech Mahindra, Jagran Prakashan, Bhushan Steel, Cadilla Healthcare, Lupin, Aurobindo, Mahindra Lifespace, Oberoi Realty, Prestige Estates, Phoenix Mills, Jubilant Foodworks, Titan, Idea, JBF, Tata Power, Gujurat Gas and Neyveli Lignite.


■ Bottom quartile stocks as per our greatness model which also appear in the lower half of their sectors in our forensic accounting model


To read full report: LEADERS AND LAGGARDS
RISH TRADER

>S.W.O.T. Analysis & Porter Analysis on Real Estate Sector: SOBHA DEVELOPERS

Sobha is a Bengaluru-focused real estate developer. Like many of its peers, Sobha had overleveraged its balance sheet over 2006-08 in order to buy land. However, Sobha is currently the best placed play in the sector due to:


■ A repaired balance sheet: Relative to its peers Sobha follows an aggressive cash collection philosophy. Furthermore, the group has consistently launched new projects of 3msf-4msf each year, delivered more than 11msf over FY08-FY12, and has used its operating cash flows to reduce debt. As a result, net debt:equity ratio has fallen to 0.65x from 1.7x in FY09, debtor days have reduced to around 110 days currently from 173 days in FY09 and advances from customers worth over `2bn on the current liabilities side of the balance sheet are yet to go through the P&L.


■ Strong ongoing cash flows: Despite the tough macro-environment,
Sobha’s ratio of ‘CFO/interest cost related cash outflows’ at 2.0x has been the best amongst leveraged peers for 9MFY12. Also, Sobha has reported 20% YoY growth in sales in 9MFY12 and is on track to launch 9msf-10msf of new projects and complete the delivery of over 2msf during FY12 (FY10 delivery: 1.8msf, FY11 delivery: 4.1msf).


■ Development potential: Sobha currently owns a land bank with developable area of 112msf (saleable area of over 200msf) valued on its balance sheet at a cost of `19.5bn (or `175psf of developable area). Based on our discussions with real estate brokers, the current value of this land is at least 4x its cost. Project development on this land bank over the next 15 years generates a DCF value of `57.2bn or `583/share for the land. However, our base case scenario values this land bank at `36.5bn (`372 per share), 2.0x its cost.


Valuation: In our project based DCF model for Sobha, we conservatively push out cash flows by 2-3 years and assume slower-than-expected execution, sales and cash collection. We also assume that the cost of construction will grow at a faster pace compared to appreciation in realization rates. Using a discount rate of 15% for real estate projects under construction, an FY11 P/E multiple of 8x for contractual projects and valuing its land bank at 2.0x cost, our SOTP model generates a fair value of `462 per share, a 54% upside.


To read full report: SWOT ANALYSIS ON REAL ESTATE
RISH TRADER

>S.W.O.T. ANALYSIS ON BANKING INDUSTRY (KOTAK MAHINDRA BANK)

■ Continued growth in loan book: With an established franchise in retail lending and an improving presence in corporate lending, we expect KMB to deliver healthy 29% CAGR in loan growth over FY11-FY14 (FY07-FY11 CAGR is 28%).

■ NIMs to remain stable: Whilst a growing proportion of lower yield wholesale loans in KMB’s portfolio (40% by FY14E from 32% in 3QFY12) will decrease the bank’s blended yield, a decrease in the cost of funds (due to a higher proportion of CASA deposits going forward and lower wholesale funding costs) will ensure that NIMs remain stable at ~5.1% over FY12-FY14 (~5.1% in FY12YTD on a calculated basis).

■ Lower exposure to credit quality risk: With negligible exposure to stressed sectors such as Power, Telecom, Infra, Aviation and Textiles (0.9% of total net worth) and gross NPAs of 1.1%, we believe that KMB is one of the best placed banks in India in terms of asset quality.

■ Well capitalised balance sheet: With a tier 1 capital ratio of ~16%, Kotak is amongst the best capitalised banks in India. This not only offers the bank an opportunity to acquire businesses for inorganic growth, it also provides enough headroom for the company to leverage its balance sheet and expand its RoE.

■ Fee income to increase sharply: We believe the worst is over for the capital market businesses and we expect capital market related fee income to increase sharply from hereon at 26% CAGR between FY12-FY14 with recovery of the markets (negative CAGR of 22% between FY08-FY11).

Valuation: Our SOTP valuation of the company is `609 (for FY13E, implied consolidated P/B of 3.0x and consolidated P/E of 19.1x), implying 7% upside from current levels. However, if the overall economy improves going forward, the stock could provide significant returns due to higher valuation for both lending and capital market businesses.

To read full report: KOTAK MAHINDRA BANK                  
To read other reports: SWOT ANALYSIS ON BANKING INDUSTRY                                                                         
RISH TRADER

>EICHER MOTORS: Significant outsourcing opportunities from Volvo

With our expectation of market share gains in heavy tonnage trucks, margin improvement and significant outsourcing opportunities from Volvo, we believe Eicher is poised to emerge as a powerhouse in the Indian commercial vehicle industry over the long term.


With 38% market share in the sub-12T truck segment, Eicher is a leader in that segment. However, it has only 3% market share in heavy tonnage trucks (above 12T). Similarly, in motorcycles, it commands a dominant market share in the 250cc and above bikes but has a negligible market share in the overall motorcycle market. Our BUY stance on Eicher is underpinned by four drivers:


■ Eicher looks well suited to capture market share in heavy tonnage trucks on the back of positive user feedback on quality and fuel efficiency, improved availability of spare parts and after-sales network, keen involvement of Volvo and the duopoly industry structure (which makes it vulnerable to competition). In the heavy tonnage trucks segment we expect Eicher to post market share of 8.2% by CY2015 v/s 3.1% in CY11.


■ Volvo Eicher Commercial Vehicles’ (VECV’s) EBITDA margin has expanded to 9.7% in CY11 (from 4.8% in CY09). With increasing market share in the heavy tonnage segment, VECV’s margin has further scope for improvement arising from the narrowing pricing discounts v/s peers, reduction in sales incentives/selling expenses and operating leverage benefits. We factor in an EBITDA margin of 10.2% for core Eicher trucks and buses by CY15 (v/s 9.1% in CY11 and v/s Ashok Leyland’s 11% in FY11).


■ We believe that medium duty engine outsourcing from Volvo carries benefits of opening up more outsourcing opportunities from Volvo, enhancing the R&D capability at VECV and, given its captive nature, reducing the cyclicality of the business.


■ With premiumisation on the rise in the Indian motorcycle market, we believe Royal Enfield is batting on a good wicket given its leadership in the 250cc and above bikes and strong brand appeal. With near doubling of capacity by 1QCY13, we expect volume CAGR of 21% over CY11-CY15.


Valuation: Our DCF model values the motorcycle business at `600/share, implying 9x CY13 EBITDA, a 10% discount to Hero MotoCorp and Bajaj Auto. Our DCF valuation for VECV yields `1,451/share, implying 7.3x CY13 EBITDA (i.e. 5% premium to Ashok Leyland). This gives us an SOTP-based value of `2,051 i.e. 19% upside. Competition from new entrants in the heavy trucks segment, a shift in tonnage dynamics within the truck industry and imposition of royalty by Volvo on VECV at a future date are the key risks to our BUY stance. Rising market share for Eicher in heavy tonnage trucks and margin improvements are the key positive catalysts.


To read full report: EICHER MOTORS
RISH TRADER

>ACCOUNTING THEMATIC: Accounting quality drives investment returns

Along with everything else, accounting quality in India seems to have stagnated at a low level. Our analysis of the last four years of consolidated accounts of the BSE500 (excl Financials) points to continuing divergence in accounting quality within the stock market. The silver lining is that the relationship between good accounting and positive investment performance seems to be tightening over time.


As one would expect, accounting quality varies by sector (see table on the right) with the usual suspects like Realty, Conglomerates and Construction bringing up the rear. More importantly, the change in a sector’s accounting scores over time seem to have a bearing on investment returns (see exhibit 6 on page 5). Ironically, this puts Realty companies in a nice position as, inspite of being the bottom of the class on a blended basis over FY08-11, Realty is one of the most improved sectors when it comes to change in accounting score across FY08-11. Media companies are also in a similar position.


Similarly, accounting scores vary across market cap buckets (see table below right & Section 3). Whilst the “top 50” stocks have the best blended scores across FY08-11, the improvement in accounting scores over FY08-11 has been the greatest in the midcap bucket (bucket 3: the 100 stocks with mkt cap between $0.2-0.6bn).


Most importantly, from an investors’ perspective accounting scores have a clear impact on stock level returns. Whilst this is not apparent when you look at the BSE500 as a whole, when you drill down to the sector level the relationship is clear (see Exhibits below and Section 5). In fact, if you drill down further into a specific market cap segment in a sector (see Exhibit on the right), the link between good accounting and positive investment performance becomes even clearer.


Whilst our analysis uses on an array of accounting ratios to detect financial manipulation by listed companies, the most powerful ratios are:

• CFO/EBITDA or the “cash conversion ratio” fluctuates widely across time and across companies. It appears that whenever promoters want to boost profits (and do a QIP), working capital deteriorates and cash conversion suffers.
• “Other Loans & Advances as a % of Networth” seems to be the most widely favoured route when it comes to pulling cash out of the company (to fund whatever else has caught the promoters’ fancy outside the listed entity).
• “Provisioning for doubtful debtors as a % of gross debtors” also fluctuates significantly across time and widely across sectors and companies. A low score on this metric combined with poor cash conversion is arguably the defining signature of a dodgy set of accounts.

To read the full report: ACCOUNTING THEMATIC
RISH TRADER

>ECONOMY & STRATEGY: Investment Implications; Key Assumptions made in our inflation model and the ‘Hysteresis Factor’ in the Indian context

With 4QFY12 promising plenty of negative newsflow from India and Europe, our Sensex target of 14,500 remains in play in the first two months of CY12. However, from March onwards, we see the situation improving for the Indian equity market thanks to a reversal in the RBI’s monetary policy stance, significant monetary easing in the West and a semblance of order returning to New Delhi’s policymaking. On a 12-month basis, we see the Sensex moving towards 18,000.

Sensex 14,500 remains in play in Q1CY12…

The first two months of CY12 will be a challenging period for the Indian market for three reasons. Firstly, the Q3 FY12 results season promises to be anything but cheerful and is likely to result in consensus’ FY13 EPS estimates being pulled back further by around 3% points. Secondly with key state elections being rescheduled to end by 4th March, policy chaos is likely to persist over Jan-Feb 2012. Thirdly, Europe is set for a tricky couple of months with: (a) Italy and Spain likely to auction US$180bn of sovereign debt from 12th Jan onwards; (b) European banks must report to their central banks by 20th Jan, as to how they will get their core tier 1 ratio to 9%; and (c) The 17 Eurozone countries will attempt to get their Parliaments to approve the 9th Dec intergovernmental agreement by March 2012.

Hence in the opening 2-3 months of the calendar year, our longstanding Sensex 14,500 target remains very much in play.

… but over the course of CY12, the Sensex should veer towards 18,000

From March 2012 onwards we see the tide swinging in India’s favour. Firstly, with the counting of votes for the State elections drawing to a close on March 4, 2012 and with the UPA administration realizing that it is in the last chance saloon, we expect to see more decisive and more reformist policies from the Government (including retail FDI) in the Budget session that is likely to open in mid-March. Secondly, with economic growth waning, core inflation (33% weightage) is likely to ease and presuming no further advances in global commodity prices, WPI inflation in India is likely to moderate thus triggering RBI rate cuts from March 2012. Thirdly, with the Eurozone heading for a recession, which could slow down the nascent American recovery as well, we expect serious monetary easing (including QE) from the ECB, the Federal Reserve and the Bank of England. In totality, we expect this easing to be comparable with what we saw in the months after the collapse of Lehman in CY08.

Hence over a 12-month period, we see a semblance of normalcy returning to the Indian market. Multiplying our FY13 EPS estimate of `1,160 (0.1% above our long standing FY12 estimate of `1,159: see pg 18) with a forward P/E of 15.5x (in line with India’s long term average) gives us a 12-month Sensex target of 18,000.

Stock specific implications

As you would expect, we reiterate our faith in “Good & Clean 3.0: Battleships”. Since its launch on 19th October this portfolio has outperformed the BSE500 by 377bps and 429bps on a market cap and equal weight basis respectively. Our overall family of Good & Clean portfolios has outperformed the market by over 13% points since launch in mid-March last year.

Beyond Good & Clean, our highest conviction BUYs are HCL Tech (HCLT IN, mcap US$5.1bn), Bank of Baroda (BOB IN, mcap US$4.9bn), Ultratech (UTCEM IN, mcap US$6.0bn), Mannapuram (MGFL IN, mcap US$0.7bn), Torrent Power (TPW IN, mcap US$1.8bn), Engineers India (ENGR IN, mcap US$1.3bn), Petronet LNG (PLNG IN, mcap US$2.2bn) and Oberoi Realty (OBER IN, mcap US$1.3bn).

Our highest conviction SELLs are Wipro (WPRO IN, mcap US$18.5bn), State Bank of India (SBIN IN, mcap US$19.5bn), Dabur (DABUR IN, mcap US$3.3bn), LIC Housing Finance (LICHF IN, mcap US$2bn) and Axis Bank (AXSB IN, mcap US$6.5bn).

To read the full report: ECONOMY & STRATEGY

RISH TRADER

>ENGINEERS INDIA LIMITED (EIL): Providing design, engineering, procurement, construction and integrated project management services mainly to the petrochemical and oil and gas refining sectors.

The real Indian engineers
Amongst its Engineering & Construction (E&C) peers, EIL has an unmatched cash flow profile and RoEs (37%-40%). Specific, yet scalable, hydrocarbon engineering and project management skills, a large talent pool and Government ownership drive its competitiveness. Rising investments in the hydrocarbons sector by Government related companies (XIIth 5-year plan suggests 2x XIth plan investments) will fuel EIL’s growth. Whilst there can be near-term growth deceleration, the present valuations (12x FY13 core eps) do not reflect the firm’s competitiveness and its cash flow generating capability.


■ Competitive positioning: STRONG Change to this position: POSITIVE
The E&C sector’s overhang has led to EIL’s stock price declining 37% over the past year despite revenue growth remaining strong (up 40% YoY in 1HFY12) and the firm’s business capabilities being robust. In an industry where companies are shedding strength with rising debt, we recommend EIL due to: Government sponsored enterprises to invest twice in the XIIth plan v/s the XIth plan: The cyclical nature of refinery and petchem investments can lead to a lack of orders for a brief period. But Government sponsored plans to increase their refinery capacity [by 60% (74mmtpa) by investing US$18bn in greenfield capacities and US$13bn in upgradations] will provide EIL with growth visibility over FY12-FY17. Further, greenfield petchem capex is expected to be closer to US$8bn. Slippage risks are low owing to Government support for energy PSUs and fewer procedural problems in expansions.


■ Superlative capabilities with flexibility: EIL’s scalable hydrocarbon engineering/project management skills, extensive experience and Government ownership make its offerings flexible — not only E&C services across the contracts spectrum (design to EPC) but also critical path projects, tweaking the usual EPC models (offering open book estimates, OBE) and entering into longterm relationships (MoUs, nominations) with energy PSUs. The cost-sensitive nature of large projects keeps the threat from the high-cost global majors low.


■ Unrivalled CFOs and RoEs: Over FY08-FY11 EIL leveraged its rising investments by capturing a bigger share of hydrocarbon spend by taking up low EBITDA margin (10%-12%) high volume lumpsum turnkey (LSTK) jobs (144% CAGR) instead of high EBITDA margin (40%) low volume consulting jobs (22% revenue CAGR). Hence, op cashflows (CFO) rose and RoEs moved to 37%-40% from mid-teens earlier, overriding the declining EBITDA concerns.


■ Valuations projecting near-term concerns into long-term? Despite a radically better CFO/RoE profile, EIL’s stock trades in line with peers. Paltry orders in FY12 and a growth deceleration beyond FY13 have led to a gradual derating. We do expect lower revenue growth over FY13-FY15, but believe EIL’s multiple should retrace lost ground as the refinery opportunity gets supplemented with fertilizer capex, thus addressing growth concerns. A higher investible float than many peers addresses low free float concerns.


To read the full report: EIL
RISH TRADER

>CAIRN INDIA: Disappointing deal

■ Vedanta to acquire 51-60% stake in Cairn India: Cairn Energy is expected to sell 40-51% of its stake in Cairn India (it currently has 62.4%) to Vedanta Resources for a consideration of US$6.65bn-US$8.48bn, implying per share value of Rs405. This includes Rs50/share of non-compete fee paid to Cairn Energy for not engaging in E&P operations in Bhutan, India, Sri Lanka and Pakistan for a period of three years. At the acquisition price of Rs405/share, Vedanta has valued Cairn India at ~US$24/boe (2P+2C). Post the open offer (additional 20% at Rs355/share) Vedanta would hold 51%-60% of Cairn India. Cairn Energy’s stake in Cairn India, on the other hand, would reduce to 21.6%-10.6% (fully diluted basis) depending upon the open offer
response.

■ Open offer lower at Rs355/share; lower than our expectations: Given a non-compete fee of Rs50/share, the open offer price has been fixed at Rs355/share. We see limited rationale in paying a non-compete fee for a commoditised business and hence believe that the deal is unfavourable from minority shareholder’s point of view. This differential treatment, we reckon, has been the primary reason for the stock’s correction by over 6% in trade yesterday. While concerned, we expect company fundamentals to provide support at the current levels.

■ Fundamentals intact; management’s lack of sectoral experience a concern: We continue to remain excited about the exploration prospects in the Rajasthan basin, especially the Balmer Hill formation where we expect upgrade in recovery factor going forward. Additionally, prospective exploration resource base of 2.5bn boe (10% recovery) in the Rajasthan block would provide the necessary leg up to resources going forward. However, given the lack of experience of the new management (Vedanta) in running oil & gas operations, we believe that the stock could reflect the above concerns going forward.

■ Downgrade to HOLD: While maintaining our 12-month target price of Rs380, we downgrade the stock from BUY to HOLD, mainly on two counts a) the stock is likely to be range bound given deal closure by 1QCY11 b) concerns on the lack of experience of the new management in handling E&P operations is likely to impact valuation in the medium term. We would however highlight that Vedanta management has delivered superior operational performance in assets acquired historically (Sesa Goa, Hindustan Zinc).

To read the full report: CAIRN INDIA

>INDIAN EQUITY STRATEGY: Staying Bullish, Sensex Target of 22,680

Positive stance continues - Expect markets to be volatile on global cues - recommend BUY on corrections

8.2% GDP growth est. for FY10-11 build in ~5.4% inflation expectation

Credit growth: Systemic credit growth upped 19%, riding on 3G and BWA auction, and is likely to stay strong YoY. Expect 22% credit growth for FY11.

Interest rates: Systemic interest rates likely to rise with next regulatory push. We expect policy rates to rise 75bps with lending rates lagging deposit rates.

Fiscal deficit: Expect consolidation at ~5% of GDP: We believe the government’s attitude towards fiscal discipline and the excess cash flows available warrant a sharp reduction in its borrowing programme.

Strong corporate earnings growth: Our Sensex EPS for FY11E is Rs1,053 and for FY12E, Rs1,260. We note the index is trading at 17x FY11EPS. Our EPS estimates are ahead of consensus by1.8% and 1.2% for FY11E and FY12E.

Volatility measures: Indian IVs:US VIX has been on a decline through the Euro market crisis — points to relatively lower risk aversion for Indian equities. MSCI India index has outperformed MSCI ACWI index on a 12-month relative basis while MSCI EM has underperformed.

Sensex trading band: Sensex valuations
(1) Sensex dividend discount model: Indicates the range 16,360-21,189. We believe the 7.5-8.0% 10-year bond yield could mark peaking of current interest rate cycle; (2) P/BV: Positive divergence in the premium.

Currently the Sensex is trading at 2.8x P/BV FY11, 17% disc. to its LT average P/BV of 3.4x. When it reverts to the mean, an index level of 21,250 is implied; (3) PE basis: On our FY12E earnings of Rs1,260, we expect the index to trade between 17,640-22,680. On projecting the Sensex on earnings yield and current 10-yr bond yield, we do not expect the market to go below 16,100 in
FY10, except on a global sell-off.

Our model portfolio plays out India’s domestic consumption story: Domestic consumption is strong and resilient but rate sensitive. We expect domestic consumption to pan out more rapidly and domestic sectors/stocks that reflect this will witness expansion in valuation premium v/s the markets.

Large cap companies with low leverage will continue to command similar premium valuations. We recommend — focus on large caps and larger niche mid-caps: We are OVERWEIGHT Industrials, Consumer Discretionary, Consumer Staples, Financials (upgraded from Neutral), Healthcare and Software and UNDERWEIGHT Energy, Materials, Telecom and Utilities.

Risks to equity markets: Market risk = the widening deficit in global economies and escalating credit concerns that suggest risks to sovereign defaults. Global aversion would impact mid-cap stocks the most, and they have been the stellar performers. Commodity prices are also at risk given fallout in the European Union and we expect metal prices to be volatile. We do not expect substantial earnings downgrades such as in 2008, as the domestic Indian economy is fairly resilient.

To read the full report: EQUITY STRATEGY

>COLGATE PALMOLIVE: Time to take some profit

Colgate India's earnings performance for 1QFY11 are mixed. Net sales for the quarter are about 2% below our expectation whereas net earnings are about 2% above expectations largely on account of tax provisions. Our estimates remain unchanged above consensus (about 6-10%) however the YTD outperformance (Absolute Performance 28% and Relative Performance 25%) of the stock to some extent reflect that already and accordingly we are downgrading the stock from a BUY to HOLD with a March 2011 target price of Rs 900 reflecting a forward P/E multiple of 22x.

Earnings review - Topline growth for the quarter was 13% marginally below our expectations of 15%. Net sales for the quarter were Rs 5.3bn, a growth of 13% y/y (pq 13% y/y and p4q 16% y/y). EBITDA remained strong led by savings on raw material. EBITDA for the quarter was Rs1,598mn, a growth of 30% y/y (pq 42% y/y and p4q 35% y/y). Net profit for the quarter was Rs1,219mln, a growth of 19% y/y (pq 32% y/y and p4Q 38% y/y)

Key positive and negative takeaways from earnings - Led by raw material savings ebidta margin trends have remained encouraging. For the quarter under review ebidta margin saw improvement by 400 bps y/y and 230 bps q/q . On the negative side topline growth trends have been below expectations .

Outlook - Although monsoon trends are normal, inflation still remains very high therefore we do not envisage any major change in volume and mix trends. Moderation in volume growth also implies that pricing increase will be marginal. Our earnings estimate largely remain unchanged however we expect some upward revision to consensus estimates.

Valuation - Stock is currently trading at P/E multiple of 25x and EV/EBIDTA multiple of 18x on our above consensus FY11 estimates. We believe these valuations adequately refer the strong operating growth momentum of 20% for FY10-12e. Steady earnings, marketshare performance and attractive dividend yield (~4%) are some of the key reasons to assign a hold rating on
the stock.

To read the full report: COLGATE PALMOLIVE

>IDFC: Building appetite (AMBIT)

Operational triggers remain

■ Raises $575mn through QIP at Rs168.25/shr
■ Dilution at ~12% of pre-diluted equity
■ Capital raising signals intent to capitalize on huge growth opportunities
■ Equity raising likely to trigger rating upgrades from independent agencies
■ IFC status. concomittant with higher ratings, to help bring down marginal cost of funds by 15-20bps
■ Maintain BUY at current levels; TP revised to Rs210 on FY12E estimates

To read the full report: IDFC

>ITC: Positive Earnings Cues (AMBIT CAPITAL)

ITC has been a significant outperformer over last three months (absolute 17% and relative 18%). Our review of its balance sheet and earnings expectation suggest that there continues to be an upward bias to earnings growth (18% for FY10-12E) despite some weakness seen in 1QFY11 for cigarette business. We believe the stock can still deliver positive relative outperformance and we
retain our BUY rating on the stock with a March 2011 target price of Rs320.

■ Cigarette business still on solid footing – We believe the recent weakness seen in cigarette volumes is somewhat short term in nature and we expect the company should be able to deliver low positive volume growth in FY11. Over last 12 months it has strengthened its brand portfolio significantly with brands such as Flake Excel and Duke Filter, entered less than 60mm category and augmented its production capacity by more than 20% with the set up of a more than 20 billion capacity stick plant at Ranjangaon near Pune.

■ FMCG business to maintain positive trend – The significant improvement seen in profitability for FY10 (nearly 640bps improvement in EBIT margin) should continue as outlook for both packaged foods and personal product business remains positive. Over last 12 months in case of personal products the company has added significant capacity at its Haridwar plant and also
commissioned new facilities at Manpura, Himachal Pradesh. The nearly threefold increase in capacity implies that the company will be targeting low double-digit volume shares in personal product categories such as Soaps, Shampoo and Skin Cream over next three years. We believe existing players such as Hindustan Unilever, P&G, Dabur and Godrej Consumer will have to
respond suitably to this increased competitive ante from the company.

■ Significant improvement in return ratios – On account of significantly improved working capital management (down nearly 5 days to 34 days in FY10), return on capital for FY10 is nearly 300bps higher v/s our previous expectation of 39%. Considering there is significant headroom for capacity utilization to improve we expect this upward trend in ROCE to continue and touch nearly 56% by FY12.

■ Outlook and Valuation – We expect the company to report 17% growth in topline and 22% in EBIT led by 30% growth in topline and 55% growth in EBIT for non-cigarette business in 1QFY11. Considering positive outlook for its non-cigarette business, improved subsidiary business performance (Surya Nepal and ITC Infotech) and improvement in return ratios, we expect valuations will continue to see improvement. Our target price implies forward P/E multiple of 21x and EV/EBIDTA multiple of 13x and is also consistent with our sum-of-the-parts approach.

To read the full report: ITC

>TELECOM: Demystifying WiMAX (AMBIT CAPITAL)

Four years of operation, more than 500 deployments across 148 countries and only 6.5mn subscribers, is not a very good situation to be in for the global WiMAX industry. Despite this, in India the demand for WiMAX spectrum is equally fierce as was in the case of 3G spectrum. At the end of day 12, pan India WiMAX spectrum auction amount reached Rs106bn, 6x the base price of Rs17.5bn. At the current prices, the government is likely to mobilise Rs320bn from this auction.

Why operators need WiMAX?
Despite years of operations, the broadband penetration in the country is still languishing at 8.75mn subscribers as of end-Mar 2010. The number of subscribers accessing data on mobile is much higher at 150mn subscribers. The higher cost of laying fixed line network coupled with absence of unbundling of local loop has resulted in lower competition in the broadband space from private players, thereby restricting the growth of broadband. Therefore, it is evident that the broadband penetration in the country would take off only on the wireless platform. The 802.16d (fixed WiMAX) is a proven technology with more than 500 deployments globally. The cost of deployment is also much lower than the fixed line penetration. Hence, it will help operators to provide broadband services at much lower prices.

WiMAX allows faster data downloads at a speed of 40Mbps, which is much higher than the download speed available on 3G spectrum. Also, operators who have failed to get 3G spectrum in specific circles, would want to get WiMAX spectrum. Both LTE and IEEE 802.16m aim at meeting the IMT Advanced requirements which is to achieve 100Mbps for mobile application and 1Gbps for fixed-nomadic application. Given the uncertainty about predicting technologies as well as uncertainty about spectrum availability, we expect serious operators to opt for WiMAX spectrum.

What goes against WiMAX?
Given that 802.16m is still being developed as a future of WiMAX, we believe that WiMAX in India would be used to provide retail broadband and enterprise leased line services on 802.16e platform. These services are already being provided on other platforms such as DSL, local cable and CDMA data cards, which restricts the revenue earning potential from this spectrum on an immediate basis. Globally, operators have already made huge investments in HSDPA networks and hence the natural progression would be towards LTE. For WiMAX, however operators need to make fresh investments. Also, to provide coverage on a WiMAX network in metro areas (Mumbai/ Delhi) the no. of sites required would be much higher, leading to higher capex. However, some industry participants believe that 3G and WiMAX are not competing but complimentory technologies and both can co-exist, where 3G would be used for voice and WiMAX for data.

Our View
Though securing spectrum may be a good bet from a long term perspective, we remain concerned about operators’ ability to generate significant revenue compared to the cost of spectrum acquisition. We believe that this investment will generate back-ended payoffs only if WiMAX succeeds as a superior technology platform over LTE. Given the domestic deployment challenges facing WiMAX, we remain cautious on this. In the short term, we anticipate higher debt burden for telecom companies. Hence, we maintain our negative stance on the sector.

To read the full report: TELECOM

>ANDHRA BANK (AMBIT CAPITAL)

Going Strong
■ PAT growth of 19.4% for 4QFY10 to Rs 2.4bn, 60% for FY10 to Rs 10.5 bn
■ Building in 26% loan book growth during FY11E; SMEs and retail to lead
■ Margins at 3.44% for Q4 and 3.2% for FY10; likely to dip by 10-15bps
■ Gross NPA at 0.6% and net NPA at 0.17%
■ Maintain BUY with a marginally revised TP of Rs150

Andhra Bank reported a good set of numbers on the operational front for 4QFY10 with NII at Rs6.56bn, far ahead of our expectations and net profit at Rs2.4bn, a little ahead of our expectations. Although the gross and net NPAs moved up marginally during the quarter in absolute terms (in line with our expectations), the ratios have remained stable while provisioning coverage continues to be healthy (above 80%). Valuation and recommendation: We maintain our BUY recommendation on the stock with a marginally revised TP of Rs150. Our FY11E estimates have undergone a marginal upward revision as a result of which our FY11E ABVPS estimate has inched up to Rs110 (up 4% from our earlier estimate of Rs105). At its CMP of Rs133, the stock quotes at 1.3x our FY11E ABVPS of Rs110.

Combined with a ~5% dividend yield, we continue to back Andhra Bank as one of the safest and consistent-performing investments within the mid-cap banking universe.

To read the full report: ANDHRA BANK

>ABAN OFFSHORE: Asset placement to ease cashflow strain (AMBIT CAPITAL)

■ Two assets placed; day rate disappoints
As expected, Aban announced placement of two of its jackups namely, Deep Driller-1 (DD1) and Aban VII. While DD1 has been placed under contract with a leading domestic E&P operator at a day rate of US$112,000 for a period of one year (plus 2 optional periods of 6 months), Aban VII would work as an accommodation barge at a day rate of US$60,000 for a 6-week duration (~30% lower than our day rate expectation of US$130,000 on a blended basis). However, we also observe that Aban VII would incur marginal opex, implying lower impact (to the extent of ~20%) at the EBITDA level.

■ Two assets remain idle; Abraham deployment key
Aban currently has two idle assets - DD6 and DD8. Our understanding suggests that these assets are likely to be placed by 2QFY11E, against our earlier expectation of 1QFY11E. More importantly, drill ship Aban Abraham (current earnings US$325,000/day) completes its contracted term by end-1QFY11E. We believe that re-deployment of this asset would be critical to the company's earnings for FY11E and thereby to its ability to make good the debt obligation of ~US$375mn for the year.

■ 4Q PAT seen at Rs1.4bn
We expect the company to report PAT of Rs1.4bn (+58% QoQ) in 4QFY10E, implying FY10E earnings at Rs4.1bn (-24% YoY). Earnings for the quarter would be driven by deployment of Aban Pearl and FPU Tahara. We expect the company to report EBITDA of Rs6.1bn (+40% YoY; 17% QoQ), implying margins of 61%. We would like to highlight that our numbers do not factor in write-off of Rs1.95bn for investments made in Petrojack, an entity that has recently filed for bankruptcy. Hence downside risk to our numbers exist in case the write-off materialises.

■ Deleveraging story intact; Maintain BUY
We lower our earnings for FY11E by 13% and for FY12E by 4% driven by: a) lower-than-expected contracted day rates for DD1 and Aban-VII; b) delay in deployment of the two idle rigs; c) re-adjusting our day rate expectation from US$130,000k to US$120,000. Factoring in the above, our target price has been revised downward to Rs1,340 (Rs1,400 earlier). We, however, believe that the de-leveraging theme for Aban remains intact, with the recent deployments reaffirming our view. Hence we maintain our BUY recommendation on the stock.

To read the full report: ABAN OFFSORE

>Uncertainty prevails - Budget reconciliation is the best way forward

President Obama's efforts to converge the Democrats and Republicans on a common plane with respect to Healthcare Reform through a televised healthcare summit held on February 25, 2010 have failed. The Senate Bill with amendments suggested by President Obama was discussed in detail for over seven hours. No headway was made; and it is now clear that the difference in views held by the Democrats and Republicans is too profound to be bridged. Presently, a great deal of uncertainty prevails on passage of the bill. Some major areas wherein Republicans do not appear to agree with Democrats:

■ Inclusion of new people: Republicans do not like the idea of forcefully inducting so many new people in insurance programs, as this would increase healthcare expenses and customers will not get the quality of healthcare they should

■ Increase in taxes: The healthcare spending increase would be funded through taxes at this point in time. Addition of more people could lead to newer taxes and surcharges and will result in increasing out-of-pocket expenses for the Americans

■ Reduction in Medicare spending: Any reduction in Medicare spend will lead to reduced quality of healthcare for the elderly and also result in doctors opting out of the programs, further impacting quality of healthcare

■ Overall increase in healthcare spend: Republicans strongly believe that the proposed healthcare bill will lead to a rise in overall healthcare spending for the US and not serve the primary objective of reducing healthcare expenses

■ Scrap, start all over: Republicans have been critical of the proposed bill and opine that the existing bill is scrapped and reforms are started all over.

Budget reconciliation is the best way forward

Debate over the reforms appears to be 'political posturing' by both parties and each side is firm about their respective ideology. Despite strong opposition from the Republicans, Democrats are not inclined to start the reforms all over. They have set a deadline for passing the reform bill in the next 4-6 weeks. This implies that the only way forward is to opt for the 'Budget Reconciliation' procedure whereby some changes to the already approved Senate Bill can be made and approved by the Senate through a simple majority (51 votes out of 100). The House would also pass the reconciled bill, along with the original Senate bill.

Impact on Indian Generics

Overall, the Senate bill with amendments suggested by President Obama is extremely positive for Indian companies. If President Obama is able to pass the Healthcare Reform Bill through the Reconciliation procedure, Indian generic drug makers could gain as we have discussed in our previous notes on US Healthcare Reforms.

To read the full report: BUDGET RECONCILIATION