Axis Bank

Axis Bank's performance in 2Q09 has laid to rest concerns about whether the bank can pursue growth without sacrificing NIMs, asset quality and profitability. The disclosure of SME loan rating and growth in fee income is particularly pleasing, in our view. Buy, with a new target price of Rs769.10. 

NIMs and profitability improve; asset quality holds up 

Axis Bank’s 2Q09 net interest margins increased both yoy and qoq. We believe asset quality remains good, with GNPLs at 0.9% and NNPLs at 0.4%. Loans grew 54% yoy. About 84% of corporate loans have a rating of 'A' and above. Further, about 78% of SME loans have a rating of 'SME3' (equivalent to an 'A' rating) and above. In addition, profitability in terms of return on average assets improved to 1.34% in 2Q09, from 1.10% in 2Q08. 

Fee income growth continues to surprise positively 

Fee income jumped 91% yoy in 2Q09. Fees from retail banking, corporate and SME loans, capital markets and treasury grew strongly. Cash management throughput increased 350% yoy and placements and syndications grew 52% yoy. Fees from the cards business and from the distribution of third-party products showed robust traction. 

We raise FY09 and FY10 estimates and introduce FY11 numbers 

The bank’s reported NIMs were largely in line with our estimates, and the momentum on fee income should be sustained. We now expect non-interest income to grow about 53% in FY09 (+76% yoy in 1H09), compared to our earlier estimate of 20%. However, we increase provision charges for loan losses, offsetting the impact of higher non-interest income growth. We raise our net profit estimates by 11.7% for FY09 and 7.8% for FY10. We expect profits to moderate in FY11 and grow 16.5% yoy. 

We reiterate Buy with a new EVA-based target price of Rs769.10 

We reiterate Buy, as we believe Axis Bank will be able to maintain profitability and sustain aboveindustry average growth. Our assumptions for cost of equity and terminal spread remain unchanged. However, we have reduced our terminal growth assumption to 3%, from 5%. Accordingly, we cut our target price to Rs769.10 (from Rs791.90). At our target, the stock would trade at 2.5x FY10F BVPS, adjusted for 100% of pre-tax net NPLs.

Tata Consultancy - TCS acquires Citigroup's BPO arm

TCS has announced the acquisition of Citigroup Global Services (CGS), the captive BPO arm of Citigroup, for US$505m in an all-cash deal. As part of the deal, TCS gets assured process outsourcing business of US$2.5bn over 9.5 years. This is in addition to TCS's existing relationship with Citigroup for application development and maintenance, and infrastructure support services, currently at an annual run-rate of US$150m. We estimate the acquired business makes Citigroup TCS's top account. We view the transaction to be near-term EPS neutral. We estimate the transaction values CGS at 8.6x FY09F EBITDA, ahead of the current valuation of Genpact, the closest comparable (7x CY08F EBITDA, as per IBES consensus) and in line with 9x FY09F EBITDA for TCS at current levels. 

TCS acquires Citigroup Global Services for US$505m 

We estimate the transaction values CGS at 1.9x FY09F revenues or 8.6x FY09F EBITDA. According to management, CGS is projected to have revenues of US$278m for CY08 with about a 30% CAGR over the last three years. As part of the deal, TCS get assured “take-orpay” business at the current run-rate – translating to US$2.5bn – over 9.5 years. It also becomes the preferred vendor for incremental process outsourcing work from Citigroup. 

We rate the transaction as EPS neutral in near term… 

TCS aims to fund the transaction with internal cash reserves. We estimate the return on purchase consideration at 8.7% (assuming EBIT margins at 20%, 0 other income and effective tax rate at 18% for CGS for FY09), in line with the current effective post-tax yield on cash balance of about 8%. The transaction should thus be EPS neutral in the near term. Management expects it to turn EPS accretive over the next three years. We believe this would depend on incremental revenue flow; we see limited margin expansion potential, given CGS’s current margins (23.5%) are comparable to TCS’s (25.5% for FY08). Note, about 30% of revenues for CGS are from Citi’s India operations. 

HCL Infosystems - Opportunity in scepticism

A lull in consumer demand and a 17% fall in the rupee in the last six months pose near-term challenges. However, SI order booking is ahead of our expectations and the recent stock price correction provides an attractive entry point, in our view. 

Near-term pain in the core PC business 

Recent industry data shows PC shipments slowed to single-digit yoy growth in the June 08 quarter, as rising inflation and high interest rates hit consumer demand. Rupee depreciation also put a significant burden on margins, while competition in the commercial PC segment has weakened pricing power. However, some of this impact could be mitigated by down-trading from notebooks to desktops, given HCLI's traditional strength in the latter segment. We reduce our EBITDA margin estimate for the segment by 136bp for FY09 to factor in the rupee depreciation. 

SI order wins are a bright spot, execution is now the key 

HCLI announced cumulative System Integration (SI) order booking of Rs1.2bn for April-August 08. These order wins replenished the current order book, which was substantially executable over FY09. Execution is still the key, given the lumpiness of project revenues. We expect new orders to drive 27% growth in SI revenues in FY09, though we expect revenues to remain volatile on a quarterly basis. 

Reselling business stable, rupee depreciation could mitigate ASP decline 

GSM subscriber additions trended up in the past 12 months, taking account of monthly volatility. We expect current momentum in subscriber additions to be sustained in the medium term, with the likely entry of 4-6 new/crossover players in several circles. The depreciation of the rupee over the last three months could help mitigate the decline in ASPs in the near term. However, we could see some near-term pressure on the segment's margins, given the high margin office automation business depends on corporate capital expenditure levels. 

Valuations look attractive, we expect dividends to be sustained 

We cut our FY09-11F EPS by 20-24% on the back of the slowdown in the PC business and rupee depreciation. We expect near-term financial performance to be slowed by these headwinds. Nevertheless, at 5.6x FY09F EPS, valuations appear attractive both historically and relative to peer group. Our base and stress cases indicate adequate room to sustain the present dividend payout in FY09, implying a 7.7% yield. Buy with a DCF-based target price of Rs157 (down from Rs266). 

Bharati Shipyard - Too much pessimism

Bharati Shipyard has a current order book of US$975m, tied up funding for two new yards and procured 90% of its steel requirement. Therefore, execution will generate profits. We estimate 20% order book growth for FY09. Maintaining Buy. 

Execution of order will lead to profit growth 

Bharati is setting up two greenfield yards for US$250m, which it hopes to complete by December 2010, to execute its US$975m order book, which is also due to be largely executed by December 2010. Yard funding has been tied up at 0.8x debt:equity, with about 80% of debt having been drawn already. We believe the balance debt will not be required for another 12 months. Assuming execution completes by FY11, we estimate a 25% FY08-11 earnings CAGR. 

But what about order book growth, steel prices and subsidy 

Ytd, Bharati has received new orders of US$68m, which is lower than our expectation. That said, order flow can be lumpy and we expect additional new orders of US$125m in FY09 (20% order book growth). Further, 68% of order book is from the offshore oilfield sector, which is unlikely to face cancellation risk. Bharati has also procured 90% of its steel requirement, which should protect margins from steel price volatility. But we cut EBITDA margins from 20.4% in FY08 to 17% by FY10F. About 65% of the order book is eligible for subsidy as orders were received before August 2007. Thus, Bharati is entitled to subsidy on execution of orders through FY11. That said, the stock is trading ex-subsidy, in our view. We estimate ex-subsidy EPS of Rs32.6 for FY09, Rs42.5 for FY10 and Rs66.1 for FY11. The stock has recently seen a sell-off on concerns of a change in the MD's commission from 0.5% of profit to the lower of 0.15% of revenue or 1.5% of profit. This should have only 1% impact on FY09F PAT. 

Going very cheap, in our view 

We cut FY09-11F EPS by 15-45%, but estimate a 25% earnings CAGR over FY08-11. The earnings revisions reflect cut in revenue and margin estimates. Based on three-year forward RoE of 22% and CoE of 15.5%, we get a target FY11F P/B of 1.4x (vs 1.7x earlier), which we discount (8.5%) back to FY09F, resulting in a target price of Rs455 (Rs700 previously). On Bloomberg consensus estimates, global shipyards are trading on 4.4x EV/EBITDA and 5.4x PE on three-year forward earnings, while Bharati Shipyard is trading at a deep discount of 2.6x EV/EBITDA and 2.4x PE. We maintain our Buy rating.

Hikal

Ideally poised to capitalise on the increasing opportunities in global outsourcing of key crop protection chemicals and pharma intermediates by MNCs

Established in 1988, Hikal collaborates with innovator companies and offer solutions in contract research, custom synthesis and custom manufacturing. Broadly, the company manufactures bulk agro technicals (crop protection), active pharmaceutical ingredients (APIs) and intermediates.

In 2008, there were many measures taken by Hikal to remove low-margin agrochemicals from its portfolio. As a result, the crop protection business grew only 9% as against the 56% growth of the pharmaceutical division. Pharma sales, therefore, overtook sales of agrochemicals. The share of the pharma division in total sales stood at 50.2% as against 49.8% of the crop protection business in the year ending March 2008 (FY 2008).

In the crop protection business, sales of Thiabendazole to Syngenta, Switzerland, constitutes around 40% of the total agrochemical division sales. Syngenta is expanding and Hikal expects the sales of Thiabendazole to remain at least steady, if not buoyant, going forward. Many products in the crop-protection market are becoming offpatent in the coming years and Hikal has taken necessary steps including expansion of production capabilities to cater to the demand. It is in talks with two such players and will make an announcement. Contribution from the Syngenta group to the agrochemical division is expected to reduce to 25% in 2010-11 because of new products and new clients.

Hikal to bag outsourcing orders for won a big order of manufacturing (outsourcing) patented products from Bayer Corporation. This is a big achievement because it is the only company that will manufacture a patented product whose intellectual property (IP) is still with Bayer. This opens up opportunity to bag outsourcing orders for patented products, where margin is high and competition is very low. The production of the product will start from Q4 of FY 2009.

The shortage of capacities facing western agrochemical companies due to the increase in demand across the entire product chain, particularly active ingredients and select intermediates, has created the necessity for outsourcing. Hikal, with its expanded facilities, is poised to capitalise on these opportunities. The drive towards ethanol for fuel has farmers planting more corn making the farm land more valuable, increasing the value of crops and creating a wider use for crop protection products.

China, the main supplier of crop protection intermediates and actives, has been witnessing changes in export subsidies and strengthening of its currency, the renminbi (RMB), leading to product prices going up significantly. This is an advantage for Indian companies like Hikal to supply crop protection products.

The pharmaceutical division had a rough ride in 2005-2007, when the generic market collapsed and price erosion was severe. It is at this moment that Hikal decided to secure orders to manufacture patented products and rationalise its product stream. The pharma division is now expecting stupendous growth and is very optimistic about contract research and manufacturing services (CRAMS). The company wants to establish itself as among the top companies in the would in the CRAMS business.

Hikal has signed long-term supply agreements with Pfizer and Alpharma to supply API and intermediates. It invested to enhance the capacities of its existing facilities in FY 2008, and is further increasing these capacities substantially. Supplies of products to Pfizer has already commenced. The company is now looking to expand its customer base in the US., Europe, South America and the Far East. The manufacture of two new products is currently under validation by its prospective customers and is ready for commercial production at its US Food and Drug Administration (FDA)-approved facility.

Hikal plans to allot 13,60,000 equity shares to International Finance Corporation at Rs 474 a share, raising Rs 64.46 crore. After this allotment, the equity capital will rise to Rs 16.44 crore. The company still has foreign currency convertible bonds (FCCBs) pending conversion at Rs 745 by October 2010, which will dilute equity by a further Rs 0.72 crore if all FCCBs are converted.

We expect Hikal to register EPS of Rs 36.2 on equity of Rs 16.44 in FY 2009. The share price trades at Rs 459. P/E works out to 12.7.

Thermax

To regain growth from next year after consolidation in the current year

Thermax is a global solutions provider in energy and environment engineering. It offers products and services in heating, cooling, waste heat recovery, captive power, water treatment and recycling, waste management and performance chemicals. The company exports across the globe and recently opened manufacturing operations in China.

The order backlog of the Thermax group stood at Rs 2637 crore end March 2008 compared with Rs 3100 crore in the corresponding period of the previous year. Order intake in the first three quarters of the year ending March 2008 (FY 2008) slowed down, especially in the captive power segment, which was affected by combination of factors such as higher global coal prices, restriction on captive coal linkages for captive power plants with capacity less than 25 MW, and lower grid prices. However, order intake in the fourth quarter of FY 2008 picked up momentum. The order intake of the Thermax group was up by 12% to 731 crore in Q4 FY 2008 and that of Thermax standalone 9.2% to Rs 710 crore compared with the corresponding period a year ago.

The order intake picked up further in the first quarter of FY 2009. Order intake was higher by 46% in the quarter compared with Q1 of FY 2008. Order booking for Thermax standalone was Rs 914 crore in the first quarter. The share of energy was Rs 740 crore and that of environment Rs 117 crore. The consolidated order intake was Rs 964.4 crore, of which the share of energy was Rs 791 crore and that of environment Rs 174 crore. The company’s orders on hand were Rs 2649 crore end June 2008 compared with Rs 2435 crore at the beginning of the financial year.

Hikal received two major orders in the quarter ending September 2008. Its orders in the current quarter included an order of Rs 410 crore from a leading steel maker for setting up a captive power plant for its upcoming blast furnace complex on an engineering, procurement and contract (EPC) basis. It received another huge order from a major refinery to supply pulverised coal fired boilers for their captive cogeneration plant. This order is worth Rs 820 crore and is the single largest order ever for the company. On inclusion of the above two orders, the second quarter will show a strong sequential growth in order inflow and order backlog.

Soaring prices of conventional fuels used for running Diesel Generator (DG) sets, high cost of power supplied by state electricity boards and a favorable policy environment have prompted power-intensive industries to opt for captive generation. Huge shortage in the power industry and capacity expansion across industries will also drive demand for captive power plants, which are more economical and a reliable source of power. Thermax is well placed to leverage on the strong growth in the industry considering its proven technology to generate power from nearly 60 different kinds of fuels (like agri-waste and coal). It is a leading player in the captive power generation systems and undertakes EPC contracts for up to 135 MW power plants.

In the services segment, Thermax provides facility energy management services (FEMS), which basically conducts energy audits for process industries as mandated by the Bureau of Energy Efficiency. In addition to this, Thermax is also targeting the operations and maintenance (O&M) services for its captive and cogen plants. This segment is a recent addition to the portfolio. There is a huge potential for O&M services of power plants as the strategy enables clients to focus on their core business.

Thermax has entered into a 15-year agreement with Babcock & Wilcox Power Generation Group to manufacture and supply utility boilers up to 800 MW. Currently, Bhel is the only major utility power generating equipment maker in the country with a 65% market share. However, in the next few years, there would emerge three-four players including Thermax in the power generating equipment sector in India.

We expect Thermax to register EPS of Rs 26.5 in FY 2009. This is likely to rise to Rs 35.4 in FY 2010. The share price trades at Rs 416. P/E works out to just 11.7.

Automobiles - Advantage passenger cars

Our industry checks suggest that passenger cars have an advantage over twowheelers in terms of demand revival, given the Sixth Pay Commission benefits, new model launches and availability of vehicle finance. Maruti Suzuki and Mahindra & Mahindra remain our top picks. Sell Hero Honda and Tata Motors.

We visited dealers around Mumbai city to get a sense of vehicle demand ahead of the peaksales festival season. Below we outline our key takeaways.

Passenger cars: long waiting period for new models

Maruti Suzuki

.. The company has initiated targeted marketing to gain from the Sixth Pay Commission payout for central government employees. It has asked dealers to recruit four-member teams to restart the ‘Wheels of India’ promotion and target government employees. Dealers expect special schemes to be launched, and hope to get a better market share given limited direct competition in this user segment.

.. The waiting period for Maruti diesel cars has risen to 4-6 months. The recent launch of the Tata Indica Vista has had no impact.

.. The impact of Hyundai’s i10 kappa engine and General Motors’ Spark is limited, as these models also have a waiting period.

.. The effective interest rate for consumers has increased from 12% before the Sixth Pay Commission payouts to 13.5%. ICICI Bank is pushing for floating interest rates for car loans, but customers have been trying to avoid these.

.. Finance availability is tough due to the strict implementation of SIBAL, wherein poor credit history leads to delays in approvals as either the consumer has to get it rectified or senior bank officials have to clear it as an exception with an appropriate explanation.

.. The Zen Estilo seems to be the weakest in Maruti’s portfolio, as its discounts have been higher than for the Wagon R and volumes lower.

.. Inventories are 1.5-1.8x above normal, which may be used up during the festival period. But if demand fails to revive, it may create problems in November-December 2008.

NTPC Ltd - Coal stock shortage

NTPC has delivered lower-than-targeted power generation so far in FY09. Management has indicated a shortfall in 1Q09 mainly due to maintenance shutdowns. There has been little improvement in 2Q09, but the company's coal stocks at its thermal power stations have not increased either. Management had indicated that coal stocks would improve once the monsoon season is over. We take account of the coal stock position at all of its power stations and the generation shortfall (vs set targets). We maintain our Buy rating on NTPC with a target price of Rs202.21 but would turn more cautious on any earnings shortfall from continued shortages in coal supplies.

Coal stock and generation
NTPC has been suffering coal-supply shortages from its linkage mines with Coal India. The three ministries dealing with power, coal and railways have been blaming each other for the increased shortages. While the Power Ministry has been asking for increased coal supplies, the Coal Ministry has said that NTPC produces much more than the rated plant load factors (PLF), thereby causing the shortage in coal stock.

.. Despite our expectation that the coal stock position at NTPC’s thermal stations would improve on seasonality, it has not (see Table 1). NTPC management indicated last month that the lower coal-stock position and implied shortage of supply was due to the monsoon and that the situation would improve once the monsoon rains pass.

.. Although NTPC normally maintains a lower-than-required average coal stock position, an increasing concern is that some plants have “zero” days, or less than one day of stock

Cairn India - Management roadshow highlights

We hosted Cairn India (CIL) on a non-deal roadshow in Singapore last week. While the timelines on oil production from Rajasthan remain unchanged, there is likely to be more news flow on exploration in the short term. In the next six months, seven exploration wells are set to be drilled - six by CIL in its own blocks and one by ENI. Since our DCF valuation does not assume any new exploration success, any positive news on this could add to our valuation.

CIL was represented by 1) Santosh Chandra - Director, Drilling and Petroleum Engineer, and 2) Anurag Chandra - Group Treasurer.

Details

Rajasthan project on track
CIL reiterated it is on track to start producing oil from the Rajasthan block by 2H09, and expects plateau production from the Mangala-Bhagyam-Aishwariya (MBA) fields to be 175kbd. Management said the pipeline from Mangala to Viramgam would be ready in 1H09 and from Viramgam to Salaya in 2H09. All major contracts have already been awarded and pricing for most has been locked in fully.

It sees the greatest reserves potential in the Rajasthan block, in terms of reserves addition from the 1.7bn boe of in-place oil in the small field and tight reservoirs within the block. This would be implemented through the use of enhanced oil recovery (EOR) techniques, which could raise the production plateau and/or extend the plateau period.

Exploration news likely
CIL had ordered two rigs for its Rajasthan oil development, which have arrived. Since the development process will start only next year, management said the rigs would be used for further exploration. The first rig has reached Kolkata and would be used to drill one exploration well in Bihar (block GV-ONN-2002/1, CIL stake 50%), followed by two exploration wells in onshore KG basin (block KG-ONN-2003/1, CIL stake 49%). The second rig would drill three exploration wells in the Rajasthan block.