>Indian IT services (CITI)

IT Services Beat

Hopes of Global Recovery Partly Priced In

■ Stocks pricing in partial recovery — Tier I stocks have outperformed the market by ~5-15% YTD despite a poor 4Q and muted outlook; due to weak INR and expectations of a recovery. We believe stocks are running ahead of fundamentals.

■ Mixed view on 2H outlook; turnaround could result in some upside … — Some “green shoots” globally have resulted in hopes of a rebound. Difficult to time a turnaround; has to happen at some point given revenues are declining every quarter. Clarity on turnaround could result in some multiple expansion.

■ … but slow EBITDA growth over FY09-11E to limit this — Muted sub-10% growth in EBITDA over FY09-11E (assuming a reasonable recovery) and size issues constraining growth post that, sustainable expansion in multiples looks unlikely.

■ Changes to estimates/target prices/risk ratings — We are raising our multiples slightly given that FY10 is likely to be a trough year and the likelihood of global recovery in CY10 seems higher than in the past. High FCF yields should support valuations; our target prices are now based on Sept’09 multiples.

■ Sector defensive but upside limited; Downgrading TCS; Infosys preferred pick — On a relative to market basis, strong FCF yields for Tier-I stocks make the sector a good defensive. However, lack of growth will limit upside, in our view. Downgrade TCS to Sell. Infosys is our top pick; HCL Tech is relatively inexpensive.

To see full report: INDIAN IT SERVICES

>India Cement Sector (CITI)

Sell: Great Climb; Precipice, or a Controlled Descent?*

■ Climbers dream — India’s Cement stocks have moved strongly, rising 36% since January 2009 (18% outperformance relative to Sensex) on the back of: a) Logistics pressures – wagon shortages on General Election compulsions, b) Demand pick up – in-spite of broader market pressures, c) Supply snags – mix of capacity delays and unplanned shutdowns, and resultant d) Cement price momentum – up 5-15% ytd, against odds and expectations. These are all real, but possibly ephemeral, stock value enhancers.

■ At the precipice, or a controlled descent? — We believe cement prices, profitability, and stock values will all fall and it’s only in the pace of these falls (more likely off the precipice) that our conviction is modest. It’s the over-supply hypothesis, with40% new supply during FY08-11E, ~1.3x the demand growth, and while there is skepticism on capacities coming on stream the capacity bunching up risk only rises. A demand surge is the only safety net to what lies ahead in our view.

■ At a higher altitude — The cement prices hike, even sharper cost dips, coal price collapse, robust demand levels, and the sheer operating leverage of cement businesses means that cement is likely to be more profitable than we previously estimated. Towards this end, we raise estimates meaningfully, by 42-116% over FY10-FY11E. Further price deceleration (-21% from current level to December 2010E), or demand drops (CIRA estimate +9-10%), are potential pressure points.

■ Downside from here, we remain sellers — While valuations appear attractive given earnings upgrades, we see FY10E as peak earnings (FY11E the collapse year). We value the stocks at 4.2-6.3x Sept-10 EV/EBITDA (vs. 4.5-7x Sept-09) and raise TPs by 26-52%. We see biggest downside in Grasim, and the least in ULTC.

To see full: INDIA CEMENT SECTOR

>BIOCON (CITI)

Sell: Inline Quarter

■ Inline FY09 — Biocon's FY09 results were inline with expectations with recurring PAT of Rs2.2bn. While revenues were boosted by the Axicorp acquisition, margins suffered from the low margins in the distribution business. MTM losses of Rs1.5bn led to a reported PAT of Rs931m, down 80% YoY.

■ Tepid growth, profitability under pressure — Organic revenue growth of 13% YoY was disappointing given the currency depreciation. A 50bps YoY decline in operating margins on a like-to-like basis, despite favourable currency, indicates pricing pressure in the business even after accounting for lower licensing income (down 73% YoY).

■ Axicorp acquisition on track — Axicorp has won an AOK tender to supply Metformin to all regions in Germany. The contract is expected to generate revenues of c1bn over a period of 2 years. Biocon expects the contract to help expand Axicorp's presence in the German market – which it plans to use as the base for its diabetes franchise in Europe.

■ Other conf call takeaways — i) R&D expense to increase to cRs800m-1bn in FY10 – looking to take active projects further before licensing; ii) most of the forward forex contracts have been closed, except for a small part in Syngene. Has taken a mix of collar & put options to hedge its forex exposure; iii) Myco mofetil (cUS$150m opportunity) sales to start in 1QFY10; iv) working on tieups with larger players for distribution of biosimilars in regulated markets

■ Maintain Sell — Biocon's tepid FY09 results (pre forex losses) highlight our concerns about the lack of adequate breadth in its product basket. We believe Biocon's business model remains vulnerable despite efforts to build new growth drivers and maintain our Sell/High Risk recomme ndation.

To see full report: BIOCON

>Pantaloon (CITI)

Sell: 3Q Net Profit Below Expectations as Capital Costs Soar

■ 3QFY09 operational performance strong... — EBITDA margins expanded ~210bps Y/Y and ~20bps sequentially to 10.5%; marginally above our estimates. Management's strategy of outsourcing non core operations to subsidiaries continues, resulting in lower employee costs and improving operating leverage (at the parent level).

■ ...but PAT disappoints as capital costs soar — Despite 52% growth in EBITDA, PAT growth was a muted 7% Y/Y as interest and depreciation expenses rose sharply by 98% and 65% Y/Y respectively. Capital costs as a % of operating profit (70% in 3Q) have been rising steadily over the last 10 quarters.

■ Reducing EPS estimates — by 18-30% over FY09-11E factoring in: (i) planned equity dilution over FY09E; (ii) 2-16% reduction in net profit estimates as we pare our revenue forecasts and hike capital costs. Our new target price of Rs180 (Rs184 earlier) values Pantaloon (parent) at Rs139/share, based on 15x FY10 PE (maintaining 20% premium to regional peers), Home Solutions and Future Capital are both valued at Rs21/sh of PART.

■ Debt equity ratios to trend lower, post infusion of funds — We incorporate the impact of the company's plan to raise equity worth cRs2.8bn in our estimates. Consequently, debt equity ratios trend down to 1.4x from 1.8x (for FY10E). That said, our forecasts don’t yet incorporate incremental debt on the equity raised.

■ Restructuring imponderables remain — Little clarity available on management's plan to restructure the retail and fashion divisions. We view the conversion of PART to a holding company format as a prima facie negative.

To see full report: PANTALOON