>MTNL (HSBC)

Downgrade to UW (V); Why give scarce 3G spectrum to MTNL?

• Q1-FY10e results weak; labour costs drive EBITDA negative; we lower our estimates significantly
• We believe MTNL has no viable 3G business case; government better placed to auction scarce 3G spectrum to private telcos
• Downgrade from N (V) to UW(V); reduce TP to INR52 (INR77) as we factor the likely payout for 3G spectrum auctions.

MTNL reported a lacklustre Q1, posting a net loss of INR468mn with revenues declining by c12% sequentially. ARPUs were down c4% q-o-q while EBITDA margins remained in negative territory on higher labour costs (57% of sales). In our view, most investors are focussed on the merger with sister company BSNL (Bharat Sanchar Nigam Ltd, N/R) rather than on earnings. We note that the merger of MTNL with sister company BSNL is dependent on the listing of BSNL and is at least 12 months away in our view, given the priority for 3G and 2G spectrum policy. We believe the disagreement with labour unions as key obstacle to BSNL’s listing.

The continued poor financial performance of MTNL in our view reflects the absence of a
longer term strategy and execution. As per news reports (Economic Times, 20 July 2009)
MTNL is in the process of inviting bids from global telcos to run its 3G operations in Delhi
and Mumbai on a franchise basis for a 10 year period ; a clear acknowledgment in our view of
its poor execution capabilities. However, we believe the chances of MTNL to benefit from
such a structure will be restricted as the state owned enterprise culture of MTNL get in the way
of foreign telcos, restricting their ability to deliver. We believe 3G services require aggressive
marketing capabilities and product innovation, which in our view cannot be delivered by
MTNL in its present form.

Given the scarcity of 3G spectrum in metros, we believe the Indian regulator should
auction it to private players. In our view, the Indian regulator’s objectives of low tariffs
are best delivered by auctioning spectrum among private players.

Valuation and risks- We continue with our approach of valuing MTNL based on its cash
balance, but now are adjusting for the potential payment for 3G spectrum auctions. We are
reducing our TP to INR 52 (INR77) to adjust for the likely payout for 3G auctions and our
new target price leads us downgrade from N (V) to UW (V). The potential merger with its
sister company and the monetization of tower assets represent upside risks to our view.

To see full report: MTNL

>MAHINDRA & MAHINDRA (MORGAN STANLEY)

Core Business Growth Impressive; Remain OW

Investment conclusion: We reiterate our OW and continue to believe that with earnings CAGR of 27% over F2009-11E and trading at 13x F2010E earnings, a 30% discount to the market, M&M is our preferred play for the Indian semi-urban and rural demand upcycle.

Revise price target: We updated our model for F1Q10 and are raising our PT to Rs1,065. Our revision primarily reflects the 14% and 16% increases in our F2010E and F2011E standalone earnings, respectively. We value the core business at Rs780 per share and the non-core business at Rs284 per share, thus arriving at our price target of Rs1,065. At our PT, the stock trades at 16x F2010E earnings and 14x F2011E earnings.

F1Q10 results recap At the standalone level, revenue, EBITDA, and adjusted net income was up 28%, 138%, and 187% YoY, respectively. Backed by 4% YoY realization growth, revenue was right in line with our estimates. A drop in raw material prices and operating leverage lifted margins to 14.4% – up 410bp YoY and 330bp QoQ, and 220bp above our 12% estimate. Net income was Rs4bn, up 187% YoY.

Core operations continue to impress; margins highest in two years: Margins in the tractor division improved 590bp QoQ while those in the automotive division improved 220bp YoY and QoQ. These were the highest margins posted by M&M in two years. We are building in 13.6% EBITDA margins in F2010E.

Consolidated results in line: Revenue was Rs78bn, 4% over last year and 6% QoQ. Net profit of Rs4.3bn was up 5.5% YoY but 27% down QoQ, as the sequential downtick came from high interest costs at Tech Mahindra relating to the Satyam acquisition with no corresponding income add from Satyam.

To see full report: MAHINDRA & MAHINDRA

>RELIANCE INDUSTRIES (ICICI SECURITIES)

Marred by lower GRMs and higher taxation

Reliance Industries’ (RIL) Q1FY10 recurring net income was lower than expected, at Rs36.4bn (12% YoY dip), despite higher-than-expected PBT, owing to higher effective tax rate. RIL factored-in 15% minimum alternate tax (MAT) rate in its reported earnings on account of increase in MAT rate in the recent union budget. The company’s PBT was ~10% higher than I-Sec estimates on the back of lower other expenditure and interest costs. Despite an impressive 27% income CAGR over the next two years, we remain negative on RIL due to concerns about its ongoing court cases with Reliance Natural Resources (RNRL) & NTPC and weak outlook on its refining & petrochemical businesses. Owing to higher tax rate and slightly higher investments made by the company in its retail business, we lower our target price estimate to Rs1,745/share from Rs1,756/share earlier. Refusal by the government to allow tax shield on gas production from NELP blocks would further reduce our target price by Rs30/share. Maintain HOLD.

■ EBITDA declines 3% YoY to Rs59.2bn on lower refining profitability, which was partially offset by higher profitability from the petrochemicals and O&G businesses. RIL saw 52% YoY dip in refining margins to US$7.5/bl due to lower product spreads and lower light-heavy differential. While higher polymer margins led to 32% YoY growth in petchem EBIT, commencement of production from KG D6 field led to 100% YoY jump in O&G segment profitability.

■ Recurring net income dips 12% YoY to Rs36.4bn on higher effective taxation. RIL factored-in effective tax rate of 21% (vis-à-vis our expectations of 11.3%) due to higher MAT rate as per the budget. Interest costs dipped 28% QoQ due to lower interest rates, as LIBOR-linked loans were cheaper 150bps in Q1FY10.

■ Lower earnings estimate, valuations. We lower our FY10-11E earnings estimate for RIL 10-12% due to higher effective tax rate. However, we maintain our EBITDA, and PBT estimates as we maintain our outlook on the company. We also lower target price to Rs1,745/share from Rs1,756/share earlier to reflect the revision in earnings. We value RIL’s extant business, including Reliance Petroleum (RPL) refinery, at Rs1,020/share; retail business at Rs38/share; gas-marketing business at Rs42/share; E&P at Rs798/share; and special economic zone (SEZ) at Rs10/share. Given that the stock is trading at significant 16% premium to our target price estimate, we maintain our negative stance on the company and advise investors to
book profit at current levels.

To see full report: RIL

>INDIAN IT SERVICES (CITI)

2Q09 TPI Index: Signs of Stability; No Acceleration Seen

■ Still down yoy; flattish sequentially — 2Q09 saw Total Contract Value (TCV) down 23% yoy; Annualized Contract Value (ACV) down 29% yoy – however, last year's 2Q was very strong. Sequentially, there is stability – TCV up ~5% qoq and ACV down ~5%. Pace of contraction has stabilized between $17-24b in the last 4 quarters (post a strong 1H08). TPI saw an uptick in May and June but July was soft (partly seasonal) – ties in with Infosys’s commentary post its 1Q results.

■ Some signs of stability; do not expect acceleration in 2009 — TPI does not see a market rebound soon, although the award profile could hint at sustained values through the year. Though pipelines remain strong, decision making is still slow. 2009 TCV could be below $80b – the last time this happened was in 2001.

■ BPO down significantly — TCV was down ~47% qoq; decline was across regions. As per TPI, the limited capital with clients is making them spend more on areas of higher returns – namely, ITO and ADM. However, there is considerable activity in the sub-$25m range, particularly in the staff augmentation segment.

■ ITO helps sustain the overall market — Despite a strong 1H08, ITO held up reasonably well in 1H09. A lot of ADM and Infrastructure bundled deals are happening in the market – a sweet spot for Tier-I Indian IT vendors. YTD there have been over $6b of such deals; more than that of entire CY08.

■ Discernible trends in 1H09 — (1) About half of mega deals awarded have focused on network services. (2) Five of the eight global mega deals were signed in EMEA. (3) Average TCV in Asia Pacific increased by more than 50%, while the other regions experienced declines. (4) In Americas, TCV signed during the past three years has stabilized. (5) Telecom, Transportation, Retail and Diversified Financials were relatively strong and represented ~47% of TCV awarded thus far. (6) Banking, Insurance, Oil & Gas, Consumer Durables were weak.

■ Pricing stable; vendors rational — TPI has seen pricing stabilize in 2Q09. Most of the pricing negotiations are done and conversations are now moving towards leveraging for growth. TPI noted that vendor behavior in pricing has been rational.

■ Demand stabilizing but valuations back at pre-slowdown levels — Latest demand commentary across companies suggests some stability on demand. However, valuations are not too far from 2007 levels (pre-slowdown) and stocks will need positive surprises/earnings upgrades to move up materially. We recommend playing the sector through TCS/Infosys.

To see full report: INDIAN IT SERVICES