How will the appreciating RS bear down on earnings?

We believe that hedging has protected EPS for FY08E but FY09E is still vulnerable to the appreciating RS. Our FY09E EPS assumes a base-case RS-USD equation of 40.5. We have laid out the scenario table outlining our estimated impact on FY09 EPS for various RS-USD exchange rates. We can see that if the RS were to strengthen to 39.0 vis-àvis the USD, the downside to our FY09E EPS estimates from the base case is the range of 8%. This does not include hedging income which we cannot forecast and therefore an upside risk is inherently present. In such an appreciating RS environment there will likely be an accompanying de-rating of our FY09E target P-E by at about 3-4%. So taken together, there could be a downside of about 11-12% to our appraised return of near-30% over a 12-month horizon on account of the appreciating RS. In other words, a 12 month price target of RS 350-355 stands reduced to about RS 315-320. We must be cognizant of the risk to earnings and our target price of an appreciable strengthening of the RS. This should a constant watch point for the investor.

HCLT has strengthen its execution capability by aggressively recruiting quality middle-tosenior management talent

One of the company’s success factors in the recent past has been its improved execution and a good reason for that has been its ability to aggressively hire senior managers from firms such as TCS, Satyam and Infosys (Indian peers) and IBM among the global names. This has helped HCLT close the gap between peers with respect to the enterprise application portfolio.

HCLT unveils its progress on its innovation initiatives but it is premature to predict success yet.

HCLT has focused its mindshare in the last couple of years to move towards a business model driven by IP. It has commercial offerings to address areas such as SOA, MDM, WIMAX etc. These emerging services have not yet turned mainstream but the company is betting on their taking off in the near future. We believe that while such initiatives serve to differentiate HCLT from the Indian IT pack, it is far too early to declare success here. To impact a company of HCLT’s size positively in a meaningful manner, we believe that we will have to wait till FY10E.

What’s noteworthy is that clients have already been signed up for HCLT’s proprietary offering in SOA (called Penstock) and this quickens the pace with which HCLT signs up transformation deals. HCLT is striving to bring differentiation to its pricing model to delink revenues and manpower As part of its efforts to drive an increasing proportion of incremental revenues from outputbased measures as opposed to input-based measures, the company has begun to deploy several pricing models such as risk-reward, outcome-based pricing, gain sharing mechanisms etc. We believe that these still largely remain in the paradigm phase and HCLT’s largest peers such as Infosys and TCS are also articulating such possibilities equally seriously. HCLT is winning its fair share of large deals on the back of its three-pronged business model The company is increasingly on the final stage shortlist in deals that other Indian vendors do not make it to. In those instances it faces Indian vendor competition at the final stage; the most common player it runs into is TCS.

We believe that this is due to the fact that apart from HCLT, the only other Indian vendor with comparable maturity on the Infrastructure Management Space (specifically, remote infrastructure management) and bundling it with application management/optimization is TCS. This strength enables HCLT to win a good proportion of multi-service client deals and the frequency of such client wins is on the rise. Is HCLT diversifying its growth sufficiently and quickly enough? Yes, we believe so. Growth is deriving from investments already made in emerging sub-verticals such as media & entertainment, Consumer Products Group, life sciences and healthcare and telecoms. The company has been following a micro-vertical strategy identifying pockets where it should dominate versus those pockets where it should differentiate. Many of these sub-verticals will grow at least 50% in FY08 over FY07 in USD (admittedly over a smaller base).

In addition, there is low-hanging fruit to be profitably captured in these less penetrated verticals being in the initial stages of the adoption curve. In our view, HCLT’s broad-based multi-service existing model with its top 30 clients (most of them USD 10 mn plus clients) gives the company further flexibility in managing its order books and ensuring that its q-o-q revenue momentum can absorb the impact of incremental investments. Our outlook on valuations From the chart below, we see that excluding that quick aberration in May 2006, HCLT’s valuations are reaching near 2 year-lows. HCLT has lost much of the P-E gains that it has accomplished over the past 20-24 months.

We believe that stock prices will continue to be volatile in the short-term. Observers are trying to assess the multiplier impacts of developments in the US. We believe that HCLT’s valuations have become fairly reasonable for investors at this point in time within the Re contained within 39.5 to the USD. It currently trades at 14.5x FY08E and 11.3x FY09E, and we maintain our ‘BUY’ rating on the stock.

Bhushan Steel

Larsen & Toubro

Crompton Greaves

Grasim Industries

POWER GRID CORPORATION OF INDIA

Since declaring Q1FY08 results on July 20, 2007 Satyam Computer Services has returned -7.8% (negative 7.8%), underperforming the BSE-IT index slightly (-6%), the Sensex (flat) and Infosys (-4.8%). We felt that some amount of correction was due given the run-up prior to the results which we believe has happened. Satyam derives a relatively smaller proportion of its revenues from the BFSI segment relative to its peers such as Infosys and TCS, which is about 24% of overall revenues. Thus, should it not be better placed relative to peers in the current environment? We spoke to Mr. V Srinivas, CFO to understand if Satyam senses any incipient impact of the ongoing weakness in the sub-prime mortgage segment in the US. We also wanted to understand whether the company is doing anything differently to deal with this situation. We asked Satyam 10 questions on the above-mentioned subject, to which, the company responded in the following manner:

Questions and Answers

1. How do you see the environment in the US affecting Satyam?

A. We have just concluded our routine monthly review meeting with the top-40 business unit heads and senior managers. As part of this exercise, we dissect the progress of each client account, review the behavior of all practices and see how these data points emanating from such a granular level feed into shaping our outlook. This is commonly a 3-day exercise. Our August-end review suggests to us that it’s business as usual. We are not seeing any impact as of now on account of the difficulties in the US.

2. Satyam’s application development and maintenance exposure (ADM) has grown over the last four quarters at just over 25% on a y-o-y basis. Hasn’t Satyam’s growth in the recent past accrued from “discretionary” spend? What is the relative ADM exposure in Satyam’s BFSI segment?

A. The ADM market is generally a slower-growth market than the rest of IT-Services such as package implementation, infrastructure management, independent testing and system integration. So, our growth has been very much in line with this trend. We have a higher-than-company average concentration of the ADM type of work in our BFSI segment. To this extent, our exposure to the BFSI segment is relatively defensive.

3. Are you concerned by the increasing concentration of your revenues in enterprise solutions which contributed over 44% of your revenues in Q1FY08?

A. We must deconstruct the composition of this segment that we at Satyam characterize as enterprise solutions. The classical ERP type of applications account for only a part of this (about 30% of overall revenues) with the rest coming from business intelligence, data warehousing, analytics, supply chain management and CRM solutions. Further, only about 50% of the pure-ERP portion (i.e. about 15% of the overall revenues) accrues from new implementations as the balance comes from support (mainly done offshore) which tends to be relatively stable. In essence, therefore, ERP work that one might classify as “discretionary” accounts for about 15% of our overall revenues or about a third of our overall exposure to enterprise solutions. Moreover, a good part of our exposure in enterprise solutions derives from the manufacturing and TIME vertical, outside the BFSI segment.

4. Are there any segments of your BFSI exposure (especially BFS), that you are worried about? Exposure to investment banking clients or any others?

A. Our direct exposure to sub-prime mortgage lenders is negligible, and to the mortgage segment as a whole, is less than 1% of our revenues. Only about 24% of our FY07 revenues came from the BFSI segment, most of the work is done for large, diversified financial institutions. The BFS accounts for about 17% of this while insurance, which is stable, contributes the balance 7%. Our 17% BFS exposure is split roughly equally across the three line viz. commercial/retail banking, financial services and investment banking (or capital markets). Thus, our capital market exposure is about 6% of revenues and though we haven’t seen any indications of any fallout yet in this subsegment, we believe that if there were to be some hiccups in this area broadly speaking, our modest exposure to this places us in a favorable position to manage them.

5. Are you seeing any impact on business that can be termed as “discretionary spending’?

A. High-growth services such as business intelligence, analytics, CRM, SCM and consulting are relatively more discretionary. At the moment they continue to show traction and we so far not seeing a slow-down in such higher-margin discretionary services, but are keeping a watch. We believe that businesses increasingly regard this spend as essential to their competitiveness. More so, we provide such services outside the BFSI segment and largely in the manufacturing and TIMES vertical. Together these verticals contributed about 48% of Q1FY08 revenues).

6. Is it impacting the way you are building order books, building sales pipeline or winning repeat business? New Clients and promised volume growth from existing clients – are they all coming through?

A. There is no change in the near-term outlook for the business. The improvement in pricing is tracking expectations. Our order book is healthy. There are at least 20 large deals up for grabs, each of them of the order of USD 50 million plus and we are in fairly advanced stage negotiations in about 10 of these.

7. Are your hiring plans on track or is there some element of a wait-and-watch policy you are now adopting given this global uncertainty?

A. At this point, hiring is progressing as planned. We have indicated towards hiring about 15,000 – 16,000 people (gross) and that remains.

8. Do you have any mortgage clients in your BPO? If so, what is the impact?

A. Our BPO business has negligible exposure to mortgage clients. We have not seen any impact on our business from the recent events.

9. Are you getting any sense of how CY08 IT budgets of your key clients is shaping up?

A. Clients are yet to firm up their IT-budgets for the forthcoming calendar. We will get a sense from them within a month’s time in October. So far, we cannot see the crisis in the US as affecting our clients’ CY08 IT budgets. We are carefully monitoring the situation and currently feel comfortable about our clients’ engagement levels with us.

10. How will a potential slowdown impact Satyam?

A. A slowdown in the US may set us back by 3-6 months. Today, we are in a better position to manage our order books and if developments in the US unexpectedly slow us down, we can get back on track within a quarter or two. We have flexibility in managing our exposure across clients, practices, geographies. We are seeing traction in infrastructure management and that’s relatively immune to a potential slowdown. So, we do not believe that a slowdown should impact our growth rates beyond a quarter or two.

Valuation:

We believe that Satyam will continue to grow in a good macro environment. Satyam’s BFSI exposure is relatively lower compared to peers and that puts the company in a relatively good position in the event of weakness in this space. The company is likely to post leading-industry growth in FY08 over FY07 (near-40% in USD terms) but this is already partly factored in at current stock price levels. We will watch out for how Satyam manages its margins in the coming quarters which we believe could be a strong stock driver hereon. In the event of a significantly tougher environment in the US affecting corporate spending on a broad basis, the signs of which we have not yet seen, we would prefer players such as Infosys and TCS by virtue of their relatively higher defensive exposure.

Investors are unlikely to rush into buy front-line technology stocks because they believe that the bottom is sometime away as further concerns continue to be priced in. In our opinion, further declines in stock prices hereon only make the risk-reward balance more favorable for investor. We believe that Satyam’s valuations have become fairly reasonable for investors at this point in time. It is at a 20% discount to Infosys on valuations at current levels, which is just about fair and which we believe should not increase. It currently trades at 18.6x FY08E and 14.4x FY09E, and we maintain our ‘BUY’ rating on the stock.

Highlights

Strong brand image in South India

Puravankara is recognized as one of the most prestigious name in the residential real estate in South India. Incorporated in 1986, the company has so far completed 14 residential and one commercial project, covering ~3.77 mn sq. ft. of saleable area.

Project portfolio tilted towards residential, but diversification expected shortly

So far ~95% of the total saleable area of ~3.77 million sq ft is residential real estate such as apartment complexes, villas and townhouses. The company is however increasingly diversifying its portfolio to commercial complexes, office space, malls. Going forward, we expect the percentage of commercial projects in the company’s total sales to increase to 22% from 5% currently, leading to higher realisations and reduced revenue concentration.

High quality land bank

As on July 2, 2007, Puravankara has land bank comprising of 106.8 mn sq. ft. of saleable area. Out of this, 65% of the land is directly owned by the company; for the rest, it holds development rights either solely or through joint ventures (JVs). Puravankara has acquired land at a consideration of INR 7.9 billion (~INR 75 per sq ft. of saleable area), out of which, it has already paid for 88%. The company’s land bank, located across all major cities of South India (Bangalore 73%, Kochi 13%, and Chennai 9%), has been witnessing robust economic development over the years and is expected to maintain their growth momentum, going forward. Further, since a majority of the company’s land bank is within city limits, it is relatively less exposed to correction in property prices and command low capitalization rates as compared with Tier-2 and Tier-3 city land.

JVs, MOUs, and strategic partnerships to drive growth

Puravankara has entered into a JV (49:51) with Keppel Investment Mauritius Private Limited (Keppel), subsidiary of Singapore-based Keppel Land Limited, to develop 2.71 mn sq. ft. of land in Bangalore. This JV will provide the company an opportunity to leverage Keppel’s expertise and experience in developing world-class integrated township projects to scale up its operations. Puravankara has also entered into MOUs with certain strategic partners for the purchase/execution of joint development agreements aggregating to ~43.56 mn sq. ft. of land in and around Chennai, which does not form part of current land bank. This will give the company an opportunity to scale up its operations.

Valuations

Our current NAV estimate range is INR 440 - 445 per share, representing a discount of 10% and a premium of 1% from the IPO price of INR 400-450. We have discounted the cash flows at a WACC of 15% over a period of four years. We expect Puravankara’s MOU with strategic partner, for the joint development of ~43.56 mn sq. ft. of land, to provide an upside to the current valuation. We have valued the MOU at INR 46 per share considering a saleable area of MOU as 21.78 million sq ft (estimated as 50% of the MOU area of 43.56 million sq ft due to lack of clarity on MOU). The valuation of current land bank in combination with the MOU valuation represents a discount of 21% - 9% from the IPO price of INR 400-450. We are comfortable with the valuation at lower band of INR 400 considering successful execution of MOU.

Key Risks

Execution challenge

Till FY07 end, Puravankara has delivered 3.77 mn sq. ft. of land and aims to develop another ~106.8 mn sq. ft. over next 7-8 years. We believe that the company has the execution capabilities and will be able to deliver the same, but the timely completion of these projects is a strong execution challenge for the company. Any delay in the execution of projects will strain its cash flows and valuation, hampering the company’s growth prospects.

Regional concentration

Historically, Bangalore has contributed majorly to Puravankara’s total revenues and is expected to continue to do so. We expect ~76% of the company’s total revenues to come from this region, going forward. This poses a significant regional risk. Any significant correction in property prices in Bangalore or any sort of adverse change in government policies in that region will hurt the profitability and valuation of Puravankara.

Interest rate risk

The interest rates have seen an uptrend during the last year. Given that a bulk of sales are likely in the middle income salaried class, any further hike in housing interest rates will lead to a slowdown in real estate demand and will adversely affect the sales, profitability, and valuation of the company.

Edelweiss on Allahabad Bank

Allahabad Bank’s net profit, at Rs 2 billion (56% higher Y-o-Y), was ahead of our expectations. Its net interest income (NII) growth, at 15% Y-o-Y, and PPOP growth of 12%, was however in line with our estimates. Provisioning was lower than anticipated due to write back of provisions for investment depreciation. Key highlights of the quarter were: 1) Slowdown in advance growth and healthy deposit mop up, 2) sequential decline in net interest margins, 3) strong non-interest income growth with improvement in core fee income and trading profits, and 4) low overall provisioning owing to write back of investment depreciation (specific provisioning were however in line with estimates). We are maintaining our EPS estimate at Rs 17.7 for FY08E and Rs 20.5 for FY09E. The stock trades at 1.1x FY08E book and 0.9x FY09 book. We like the bank for its attractive valuations, good RoE potential and improving fundamentals. We maintain ‘BUY’ recommendation on the stock.

Quarterly results

The bank grew its loans by 24% Y-o-Y to Rs 397 billion in Q1FY08, which was lower than 40% growth witnessed in the past quarters, but in line with our estimates. This was due to non rollout of certain inter bank participation of Rs 3.5 billion, as the bank did not find the offered rates attractive. Further, deposits grew strongly at 26% Y-o-Y to Rs 628 billion. CASA, as a proportion of total deposits, declined to 35%, as the incremental deposit mobilisation has largely been through term deposits.

Margins declined sequentially to 2.6% due to increased cost of deposits and lower investment yields. Cost of deposit increased 10bps Q-o-Q to 6.4%, while yield on advances increased to 10.56% and on investments declined to 7.3% (we believe this is due to one-time impact of interest on CRR received in Q4FY07). It was heartening to see the bank improving its yield on advances, as it effected PLR hike of 75bps at the start of this fiscal.

Non-interest income growth was robust at 22% Y-o-Y, mainly due to higher trading gains and improvement in core fee income. The bank posted trading profits of Rs 94 million as against losses of Rs 137 million in Q1FY07.

Operating expenses grew 7% Y-o-Y as the bank maintained stable cost-to-income ratio at 47%. Write back of Rs 350 million (provision on investment depreciation) helped keep overall provisioning at Rs 245 million; NPA provisioning was higher at Rs 555 million, in line with estimates.




Reduce Finolex Industries: Edelweiss

In Q1FY08, Finolex Industries reported net profit of Rs 245 million up 158% Y-o-Y and 40% Q-o-Q, on account of better regional PVC margins. We have increased our FY08 EPS by 6% to Rs 6.4/share to factor in the strong PVC margins (Q1FY08). We have however downgraded our FY09 EPS by 7% to INR 8.0/share numbers to incorporate higher employee expenses and lower operating margins. Going forward, we expect moderation in PVC margins from current levels. At CMP of Rs 87, the stock trades at 13.7x and 10.9X our FY08 and FY09 EPS estimates of Rs 6.4 per share and Rs 8.0 per share respectively. On an EV/EBITDA basis, the stock trades at 8.9x our FY08 estimates. Even after adjusting for land sale realisation of Rs 3.5 billion and market value of investments in Finolex Cables, the stock trades at 5.9x our FY08 estimates, which we believe, is full valuation for a nonintegrated petrochemical manufacturer. We continue to maintain our 'REDUCE’ recommendation on the stock, but expect positive movement over the short term after the land sale is announced.

PVC resin volume down 15% Y-o-Y and 6% Q-o-Q

PVC resin sales was lower at 34,000 MT compared with 36,219 MT in Q4FY07 and 40,000 MT in 1FY07, as difficulty in procuring VCM (key input for the new PVC plant) continued. The company’s long-term contracts for VCM supply are likely to be effective only September 2007 onwards. Until then, the resin sales are estimated to be subdued. Despite increasing realisations, net revenues were down 9% Q-o-Q to Rs 2.8 billion due to lower PVC
resin volumes.

Gross profit up, led by improvement in regional margins

Gross profit increased 15% Y-o-Y and 25% Q-o-Q to Rs 713 million with improvement in gross profit margins to 25.5% from 18.6% in Q4FY07 on the back of increased PVC margins. The PVC margins, in turn, were higher due to softer ethylene and EDC prices. PVC resin realisations increased 15% Y-o-Y and PVC pipe realisations increased by 10% Y-o-Y, in line with global trends (USD 959/MT in Q1FY08 compared with USD 835/MT in Q1FY07).

Land deal to be announced soon

The company has indicated finalisation of land sale worth Rs 3.5 billion and is expected to make a public announcement of the same by this month end. The cash flow from this sale is expected to accrue only after six months, after the company hands over its Pune premises to the buyer. We expect this land sale to be a positive for the company, since it would help it reduce net debt.

Other quarterly highlights:

Employee expenses were up 46% Y-o-Y and 57% Q-o-Q, as the wages increased 35- 40%.

Interest expenses were lower 89% Y-o-Y and 72% Q-o-Q to Rs 10 million, in spite of debt level of Rs 4.8 billion (similar to debt level in the previous quarter), due to favourable movement in their interest rate derivatives.

Reported other income was at Rs 351 million, including Rs 258 million of exchange gain in procurement of raw materials that we have included in raw material costs.

EPS estimates revision - Maintain ‘REDUCE’

We have increased our FY08 EPS by 6% to Rs 6.4 per share to factor in the strong PVC margins (Q1FY08). We have however downgraded our FY09 EPS by 7% to Rs 8.0 per share numbers to incorporate higher employee expenses and lower operating margins. Going forward, we expect moderation in PVC margins from current levels. At CMP of Rs 87, the stock trades at 13.7x and 10.9X our FY08 and FY09 EPS estimates of Rs 6.4 per share and Rs 8.0 per share respectively. On an EV/EBITDA basis, the stock trades at 8.9x our FY08 estimates. Even after adjusting for land sale realisation of Rs 3.5 billion and market value of investments in Finolex Cables, the stock trades at 5.9x our FY08 estimates, which we believe, is full valuation for a non-integrated petrochemical manufacturer. We continue to maintain our 'REDUCE’ recommendation on the stock, but expect positive movement over the short term after the land sale is announced.

Investment Theme

The Government of India’s (GOI) thrust on irrigation, micro-irrigation, water, and housing projects is expected to drive demand for PVC pipes and fittings that account for more than 57% of the total PVC consumption in India. Finolex Industries is well-placed to benefit from this opportunity directly and through its venture with Plastro and Plasson for drip irrigation projects. The demand for PVC in India is expected to grow at 10% CAGR in the next decade, as the per capita consumption of PVC in India is around 0.8 kg compared with the world average of 4.6 kgs. In spite of the robust demand outlook, we believe that supply of PVC from China could affect PVC margins in India going forward. Also we believe that given the non-integrated nature of the business the earnings is too leveraged to PVC prices and hence at on EV/EBITDA of 5.8X FY08 we believe the stock is fairly valued.

Power Finance Corporation’s (PFC’s) Q1FY08 numbers were ahead of our expectations. Profit after tax (PAT) grew 100% plus to Rs 3.09 billion, primarily driven by foreign exchange gains of Rs 409 million booked in Q1FY08 as against forex loss of Rs 305 million in Q1 FY07. This gain was on account of Rupee appreciation impact on the company’s foreign currency borrowings of Rs 19 billion. Excluding the foreign exchange gains, PAT grew 60% Y-o-Y to Rs 2.78 billion, supported by improvement in margins and higher fee income.

Key quarterly highlights

* Loan book grew 23% and disbursements improved 12.7%.
* Spreads improved 22bps Y-o-Y to 1.93%.
* Net-interest income grew 38%.
* Management and upfront fee of Rs 137 million booked.
* Net NPA declined to near zero levels and provision coverage increased to 70%.

We are revising our EPS estimate upwards by 4% for FY08E to Rs 11.9 and by 2.5% for FY09E to Rs 13.9 (adjusted for tax benefits) to factor in relatively higher margins and better fee income. The stock currently trades at 2.1x FY09 book (adjusted for tax benefits and reserve for doubtful debts) and 14.1x FY09E earnings. We expect RoE to improve to 15% by FY09E from 12% in FY07. The stock price has moved up by 35% in the past one month and valuations appear fair at these levels. We recommend investors to book profit and re-enter the stock at lower levels. However, we continue with our ‘ACCUMULATE’ recommendation from a long term perspective, considering strong industry outlook on the infrastructure space, unique power financing play, and the stock’s inadequate liquidity with only 10% free float.

Disbursement growth to pick up in future

Net interest income rose 38% to Rs 4.15 billion on the back of 23% Y-o-Y growth in loan book and 36bps Y-o-Y expansion in interest margins to 3.67%. The company has disbursed loans of Rs 32 billion, a 12.7% Y-o-Y growth, led by demand for generation (68.6% of the total disbursements) and transmission projects (14% of the total disbursements). We believe disbursement growth will pick up in the coming quarters, posting 30% plus growth for FY08E. This will lead to 25% growth in loan book in FY08E and 22% growth in FY09E.

Margins improved due to re-pricing benefits

Yield on assets improved 87bps Y-o-Y to 9.88% due to hike in lending rates and re-pricing benefits on 3–year reset clause loans. By the end of this quarter, 61% of its loan book is on 3- year reset basis and 34% on fixed basis. We expect yield on advances to improve further as Rs 70-80 billion of loans with 3-year reset clause will be due for re-pricing upwards by 200- 250bps during FY08E.

Higher fee income to kick in

PFC has booked management and upfront fee of Rs 137 million during Q1FY08. We expect the company’s proposed UMPP advisory services and loan syndication contracts, to boost its fee income. Fee income is likely to increase further with the expected launch of Rs 10 billion India Power Fund, as PFC will manage the equity portion of this fund.

Opex/assets remain at low levels

Operating and administrative cost remained low at 3% of the income and 0.1% of the average assets. However, salary scale is due for revision in FY08E (revised every 10 years - last revision was in FY97-98) and we expect employee cost (that forms 40% of the total expenses) to pick up in the coming quarters.

Asset quality remains strong

Asset quality remained under check with net NPAs declining close to zero levels and gross NPA also coming down to 0.06%. Provision coverage has increased from 70% in Q1FY08 from 39% in FY07, as the company raised its provisioning on doubtful assets from 50% to 100%.

Investment Theme

The outlook for PFC remains strong, given USD 155 billion investments lined up in the power sector over FY07-12E, the company’s leadership position in power financing, superior domain knowledge, and lean cost structure. Growth triggers for the stock could be factors such as: 1) ruling for tax benefits on long term infrastructure financing income, which is likely to be in PFC’s favor, 2) the company’s heightened focus on augmenting fee-based income, and 3) option value attached to its private equity investments in terms of performance fees. We expect PFC’s RoEs to increase to 15% by FY09E, driven by increase in leverage to 7x by FY09E and eligible tax exemption (for engagement in infrastructure financing), supported by the company’s lean cost structure and lower provisioning (better asset quality).

Power Finance Corporation’s (PFC’s) Q1FY08 numbers were ahead of our expectations. Profit after tax (PAT) grew 100% plus to INR 3.09 bn, primarily driven by foreign exchange gains of INR 409 mn booked in Q1FY08 as against forex loss of INR 305 mn in Q1 FY07. This gain was on account of Rupee appreciation impact on the company’s foreign currency borrowings of INR 19 bn. Excluding the foreign exchange gains, PAT grew 60% Y-o-Y to INR 2.78 bn, supported by improvement in margins and higher fee income.

Key quarterly highlights

Loan book grew 23% and disbursements improved 12.7%.
Spreads improved 22bps Y-o-Y to 1.93%.
Net-interest income grew 38%.
Management and upfront fee of INR 137 mn booked.
Net NPA declined to near zero levels and provision coverage increased to 70%.

We are revising our EPS estimate upwards by 4% for FY08E to INR 11.9 and by 2.5% for FY09E to INR 13.9 (adjusted for tax benefits) to factor in relatively higher margins and better fee income.

The stock currently trades at 2.1x FY09 book (adjusted for tax benefits and reserve for doubtful debts) and 14.1x FY09E earnings. We expect RoE to improve to 15% by FY09E from 12% in FY07. The stock price has moved up by 35% in the past one month and valuations appear fair at these levels. We recommend investors to book profit and re-enter the stock at lower levels. However, we continue with our ‘ACCUMULATE’ recommendation from a long term perspective, considering strong industry outlook on the infrastructure space, unique power financing play, and the stock’s inadequate liquidity with only 10% free float.

Edelweiss has upgraded their recommendation on Bajaj Auto to accumulate from reduce on greater visibility on volume outlook, new product launch, and margin improvement.

Edelweiss report on Bajaj Auto:

Bajaj Auto’s Q1FY08 results were lower than ours and consensus estimates. Adjusted net profit was down 18.1% Y-o-Y to Rs 2.26 billion. EBITDA fell 23.7% Y-o-Y to Rs 2.75 billion. EBITDA margins were at 13.1%, down 330bps Y-o-Y. We believe the margin outlook for the next 2-3 quarters is much better and margins are expected to improve to 15% on account of price revisions, ramp up of Uttarakhand plant, and launch of a new bike (on September 9, 2007) that is likely to be much more profitable than the company’s other low-end products in the segment. We are upgrading our recommendation on the stock to ‘ACCUMULATE’, post the recent price correction and improving margin and volume outlook for its core business.

Key Highlights

Lower than expected results in Q1FY08

Net sales (at 21.09 billion), were down 4.2% Q-o-Q, primarily on account of falling volumes, though average realisations improved 8.5% Y-o-Y on the back of improving product mix. EBITDA fell 23.7% Y-o-Y to Rs 2.75 billion and EBITDA margins were at 13.1%, down 330bps Y-o-Y. Adjusted net profit was down 18.1% Y-o-Y to Rs 2.26 billion. Further, staff costs, as a percentage of sales, increased 80bps Y-o-Y due to bonuses and increments given in the quarter. In addition, other expenses increased 44bps because of higher advertising expenditure.

Margins set to improve

We expect the company to improve its margins to 15% in the second half of FY08 on back of price revisions, ramp up of Uttarakhand plant, and launch of a new bike that is likely to be much more profitable than the company’s other low-end products in the segment. The new bike’s contribution to the company will be similar to that of Discover. We expect at least 70bps improvement in margins only from lower staff costs on account of non-recurring items worth Rs 150 million.

Other highlights

We believe that outlook for the rest of the year for the core auto business of Bajaj Auto is much better:

We expect margins to improve Q-o-Q Q2FY08 onwards to reach 15% in the second half of the year through the recent price increases on the Platina and Discover 135, and ramp up of its Uttarakhand facility.

Inventory levels have come down to around 4-5 weeks of sales among dealerships, compared to 6-7 weeks in April.

The company is set to launch its new bike on September 9, 2007 which is likely to have a higher margin contribution than the company’s current low-end bikes like Platina. The new product is based on a new digital twin spark swirl induction (DTSSi) technology, to provide higher torque and power together with higher fuel efficiency along with a hot of other features. The management expects to sell 15,000 units of this model initially and ramp up to 50,000 units in 3-4 months.

The company has launched the Pulsar 200cc, the Discover 135cc, and the Pulsar 220cc in the past few months.

The company has test marketed a new fuel efficient 2-stroke three-wheeler in the threewheeler passenger segment, in which it already enjoys a dominant position. Over the medium to long term, the company expects to replace the three-wheeler product range with a light vehicle platform it is currently developing, which it expects to launch in 2009.

The company expects to incur a capex of Rs 4 billion for FY08 for capacity expansion at Uttarakhand and Chakan plant, and a new product launch from the Waluj plant. In addition, the company will start work on the new plant in Chakan for manufacturing the light vehicle. The market value of its investments is around Rs 90.77 billion as on June 30, 2007 as against Rs 86.48 billion as on March 31, 2007.

Valuation

Our EPS estimate stands at Rs 143 and Rs 172 for FY08E and FY09E respectively. At CMP of Rs 2195, the stock trades at 15.3x and 12.8x FY08 and FY09 estimates respectively. Our SOTP valuation for Bajaj Auto is Rs 2,546 per share, with the insurance business being valued as per the agreement with Allianz, and with a 25% holding company discount. We are upgrading our recommendation on the stock to ‘ACCUMULATE’ from ‘REDUCE’ on greater visibility on volume outlook, new product launch, and margin improvement.

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Rolta announced that it has raised USD 150 million (Rs 6.1 billion) through FCCB offering. The company would issue 1,500 FCCBs of USD 100,000 each, which are expected to be listed in Singapore. These are zero coupon bonds with yield-to-maturity of 6.75% p.a. and tenor of 5 year and 1 day. The conversion price is fixed at Rs 737.4. The eventual dilution on account of this issue, on conversion at the stated conversion price, will be 9.4% on the expanded capital base.

The company intends to utilise these funds for acquisition and setting-up new facilities. We believe that given buoyant demand environment, strong growth opportunities exist within various business segments for Rolta. An aggressive approach towards acquisition will enable the company to expand its presence and gain domain skill sets apart from scale. The company has also announced its plan to set up a 5,000 seat facility in Kolkata, which will require an investment of Rs 2.5 billion. We are positive on the management’s capability to utilise these funds effectively, which will prove beneficial to the investors.

Business triggers

Rolta has a number of beneficial factors operating in conjunction, which include:

Acquisitions: As highlighted in our earlier quarterly report, acquisitions will be the immediate short term triggers. We believe that the company is currently pursuing acquisition opportunity at 2-3 targets, of which, one is expected be closed in 2-3 months.

Strong order book: Rolta has a robust order book of Rs 7.5 billion (USD 179 million) as at end of March quarter, executable over the next 18-24 months. This is its highest ever, representing a sequential quarterly growth of 9%. In addition, it has bid for projects worth Rs 15 billion (USD 357 million).

Two JVs with high-revenue potential over the medium-to-long term: Business solutions provided by the JVs cater to both domestic and export markets. Rolta stands to significantly gain by way of technology transfers.

A strong operating environment present in the GIS and engineering IT space: Rolta, with its unique turnkey solutions capabilities and track record of executing large-sized projects, seems to be emphatically exploiting the current operating environment.

High profitability of operations: Rolta enjoys industry-leading EBITDA margins of over 40%, which the company believes will be sustained, going forward.

Investment Theme

Outsourcing of engineering services is expected to reach USD 38-50 billion by 2020 compared with USD 2 billion now, as per the Nasscom, Booz Allen Hamilton study. As one of the leading offshore engineering services firm for manufacturing industry, Rolta is poised to grab the increasing opportunities. The company has entered into two high potential JVs, which are likely to raise its traction in high growth verticals such as power, energy, and defence. Its 50:50 JV with Stone & Webster is pursuing engineering design opportunities in high growth refinery, petrochemicals, and energy sectors in India. Its 51:49 JV with Thales, the French defence and aerospace major, aims at targeting Indian and international defence spend in the area of high-tech warfare.

Key Risks

Key risks to our investment theme include: (a) adequate availability of skilled manpower, (b) substantial proportion of revenues from non-annuity sources, and (c) large proportion of revenues from domestic market.

Valuation

We expect the company to achieve strong organic growth over FY07-09E. In addition, its two JVs - Thales (51% share) and Stone & Webster (50% share) - are also expected to contribute significantly through FY09E, which will shift the company’s growth trajectory to 38-40%. At INR 461, the stock trades at a P/E of 15.0x and 11.0x on our FY08E and FY09E earnings, respectively. Assuming that the FCCB gets fully converted at Rs 737.4, amounting to 9.4% dilution, the fully diluted EPS for FY08E and FY09E would stand at Rs 27.8 and Rs 38.0, resulting in P/E of 16.6x and 12.1x, respectively. Our financial tables do not take into account this impact. We remain positive on the development and maintain our ‘Buy’ recommendation.

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Edelweiss - Cummins (KKC IN, INR 311, maintain Buy)

Cummins India's (KKC) Q4FY07 results surprised us in terms of profitability despite revenue performance being softer than our expectations. For Q4FY07, revenue grew by ~30% Y-o-Y to INR 5 bn, EBITDA grew by ~41% Y-o-Y to INR 823 mn, and net profit grew by ~21% Y-o-Y to INR 657 mn. EBITDA margins expanded by ~130bps Y-o-Y to 16.3% driven by lower other operating and raw material expenses (as a percentage of sales). However, net margins at 13% were lower by ~100bps Y-o-Y due to higher tax rate.

For FY07, on a consolidated basis, revenue grew by ~20% Y-o-Y to INR 21 bn, EBITDA grew by 36% Y-o-Y to INR 3.4 bn, and net profit was up by ~46% Y-o-Y at INR 2.6 bn. EBITDA margins expanded by ~200bps Y-o-Y for the year to 16.3% driven by buoyant demand and pricing scenario. Net margins expanded by ~230bps to 12.6% for the year.

Even though KKC posted strong margins in FY07, the margins outlook for FY08E remains a cause of concern as reduction in import duties, commodity inflation, and exchange rate fluctuations are likely to result in margin pressures. However, we believe that the macro environment is strongly supportive of KKC's growth, going forward, as engines form the core of the capital goods segment and KKC is among the leading manufacturers of diesel engines in India. At our consolidated EPS estimate of INR 16 and INR 20 the stock is trading at a P/E multiple of 20x and 16x for FY08E and FY09E, respectively. We continue to maintain our 'BUY' recommendation.

Welspun (WLSP IN, INR 70, downgrade to Reduce)

Welspun India's (WLSI's) Q4FY07 results were below expectations. Though net revenues increased 21% Y-o-Y to INR 2.49 bn, they were below our expectations of INR 2.73 bn. PAT decreased 4% Y-o-Y to INR 103 mn as against the expected increase to INR 167 mn. EBITDA margin decreased 110bps Y-o-Y to 14.2%, driven partially by slower-than-anticipated capacity ramp-up in the bed linen business. EBITDA grew 12% Y-o-Y to INR 352 mn.

WLSI announced an extension of the ongoing phase II expansion, to add another 10,000 tpa to its existing towels capacity addition, taking it to 41,000 TPA post expansion. It has also reduced the size of its proposed decorative bedding capacity in India to 0.72 mn sets from 1.44 mn sets annually and intends to set up 1.04 mn sets annually in Mexico instead.

For FY07, WLSI's standalone revenues were INR 9.74 bn (up 49% Y-o-Y), EBITDA was INR 1.58 bn (up 28.2% Y-o-Y), and PAT was INR 528 mn (up 27.2% Y-o-Y). Consolidated revenues (including Christy) was INR 12.41 bn and PAT was 456 mn (including a one time expense of INR 130 mn on account of winding-up of some of Christy's facilities in the UK).

We expect WLSI's revenue growth to dampen due to ramp-up in its bed-linen business, INR appreciation, and the resultant pressure on realisations in the coming quarters. Higher interest costs and greater capex are likely to dampen earnings and return ratios further in the coming quarters. At INR 70, WLSI trades at P/E of 7.2x and EV/EBITDA of 7.6x our revised FY08E. We are downgrading our recommendation to 'REDUCE', given the INR appreciation hangover. Any sustained depreciation of the INR from current level would be a key risk to our recommendation.

Deepak Fertilizers (DFPC IN, INR 93, maintain Buy)

We attended the analyst meet of Deepak Fertilisers (DFPCL) post declaration of its Q4FY07 results, wherein the management presented its growth strategies, going forward. Based on our discussion, we believe, the industrial and chemicals divisions (which grew 41.2% and 60.8% respectively in FY07) will continue to maintain the growth momentum. This is because the company's product portfolio caters to high growth sectors such as pharma, agro-chemicals, defense, mining, and infrastructure. We expect DFPCL to increase its capacity utilization significantly from existing ~60% to ~100% with availability of additional gas from Dahej - Uran pipeline, expected to come by Q2FY08 and additional gas from KG basin by Q2FY09. Management has also guided that current gas prices are ruling at higher levels and are expected to soften by the end of this financial year.

DFPCL's isopropyl alcohol (IPA) project has been operational since August 2006 and has contributed revenues of INR 760 mn for FY07. With a capacity of 70,000 tonnes, we expect the project to contribute revenues of INR 2 bn in FY08E. Moreover, the company is on track to start its real estate venture, Ishanya, a design centre and specialty mall located in Pune, in Q2 FY08 and has already booked 76% of the space. The company also owns 5-acre land in the vicinity of its existing mall, which it intends to develop in strategic tie-up with leading hotel chains. DFPCL's 300,000 tpa ammonium nitrate project is also expected to come on stream in Q2FY10. We expect the segment to contribute revenues of INR 1.5 bn in FY10. The company has guided for tying up with sources in the Middle East for supply of ammonia. This additional supply of ammonia also has the potential to increase company's utilization significantly.

Post completion of these initiatives, we expect DFPC's sales and profits to grow at CAGR of 21% and 11.7% respectively during FY06-09E. There exists clear upside to our numbers with increased capacity utilization from the additional gas or ammonia availability and softening of gas prices. At current market price of INR 93, the stock trades at 7.6x and 7.4x our FY08E and FY09E EPS estimate of INR 12.2 and INR 12.6, respectively. Our base case sum of parts (SOTP) valuation, accounting for incremental commodity business EBITDA on gas upside, comes at INR 130 and INR 150 for FY08E and FY09E, respectively. We maintain our 'BUY' recommendation.

Mahindra & Mahindra (MM IN, INR 762, maintain Buy)

Mahindra & Mahindra (M&M) posted excellent performance in Q4FY07, slightly above our expectations. Adjusted net profit, at INR 2.39 bn increased 36% Y-o-Y. EBITDA margin, adjusted for special items, at 11.3%, was down 60bps Y-o-Y and 70bps Q-o-Q due to increased input prices. The extent of the decline for M&M is however lower than most of its peers. Most importantly, the FY07 EBITDA margin has improved 50bps to 12.0%, given higher share of farm equipment and an overall reduction in input costs.

In Q4FY07, the automotive segment accounted for nearly 47% of the incremental Y-o-Y EBIT profit, compared with 15% in Q3FY07 and 52% in Q2FY07. We believe the quarterly difference in the seasonality of the two business segments (where automotive segment has higher contribution in Q2 and Q4, and the tractor segment in the other two quarters) provides stability to M&M's margins and profits.

On our revised FY08 volume assumptions, for both tractors and automotive segments, we have marginally revised the company's standalone parent and core business earnings estimates. We are also dropping our consolidated earnings estimate, given the issues in estimating earnings for a large and diverse range of businesses and in ascribing a single valuation multiple to the consolidated estimates. Henceforth, we will continue to look at the stock on the basis of sum-of-the-parts (SOTP).

We value M&M's investments at INR 421 per share with a 25% conglomerate discount to fair market value. Excluding this, the core business is available at 10.6x FY08E and 9.6xFY09E core EPS, which we find quite attractive. Given reasonable core business valuations and several possible triggers in the next 12-15 months such as ramp up of the Logan (which is margin accretive), launch of the Ingenio, significant value creation potential in the auto component businesses and the new joint ventures, and the expected IPO of Mahindra Holidays (in Q3FY08), we maintain 'BUY'.

Buy India Cements & Madras Cements, Time Frame – 3 months

Cement companies in the South (especially in Tamil Nadu and Andhra Pradesh) raised prices upto INR 10/bag one-two weeks prior to the price freeze on March 9, 2007. South has witnessed sharpest cumulative price increases of ~INR 23-30/bag (INR 3-5/bag for other regions) in Q4FY07. This increases the base for Q1FY08 realizations.

In Apr-May ‘07 as well, Southern manufacturers have raised prices by ~INR 6/bag. Apart from these hikes in the trade segment, some manufacturers in Kerala and Tamil Nadu have rationalized prices between trade and non-trade segment by INR 5-7/bag in May ’07. Some AP manufacturers have also absorbed the benefit of excise duty cut which is profit accretive (South accounts for 82% of India Cements’ and 97% of Madras Cements’ FY06 sales).

We believe that the above will translate into earning surprises.

Accordingly, India Cements’ FY08E revenue is expected to grow by 32.7% led by 18.1% realization increase while capacity additions will be muted in FY08E. Earnings are expected to grow by 47.8% in FY08E

Madras Cements’ FY08E revenue is expected to improve by 35.1% on the back of 16.4% realization improvement and 16% volume growth with 2 mtpa coming on-stream. Its earnings are expected to grow by 49.2% in FY08E.

At a CMP of INR 191, India Cements trades at 1 year forward EV/EBITDA of 5.19x FY08E and 5x FY09E while at a CMP of 2867, Madras Cements trades at 1 year forward EV/EBITDA of 5.1x for FY08E and 4.1x FY09E

Buy Chennai Petroleum, Time Frame – 12 months

Chennai petroleum, a standalone refinery with a capacity of 10.5 mmtpa would be the key beneficiary of the extended refinery upturn. We expect Asian refinery margins to remain firm till 2009 as time and cost overruns on most of the new refinery capacity additions would constrain refinery capacity at least till FY09.

CPCL is also undergoing a debottlenecking of its Manali refinery which would increase its total refinery capacity by 1.0 mmtpa at a cost of just INR 1.3 bn compared to INR 15-18 bn required for a similar green field capacity expansion (HPCL’s Bhatinda and BPCL’s Bina refinery). Assuming INR 10 bn/MMTPA capacity implies value accretion of INR 8.7 bn or INR 58 per share.

Short term triggers remain in the form of exceptionally high existing regional GRMs that could lead to record profits in Q1FY08. CPCL may report Q1FY08 EPS of ~INR 20 per share.

At CMP of 247, CPCL trades at 7.1X and 7.0X our FY08 and FY09 EPS with a FY08 dividend yield of 4.9%. On EV/EBITDA basis CPCL trades at 4.9X and 5.0X times FY08 and FY09 earnings. CPCL’s FY08 Book Value of INR 198 per share implies P/BV of 1.2x. We have a BUY recommendation on the stock.

M & M, Buy – 1 week

M & M is most attractive among the peer group on the back of stability in margins. We expect good quarterly results for Q4FY07 with a 46% yoy growth in adjusted net profit for the quarter.

Scorpio has done well in the last quarter. Also the Logan numbers are expected to be encouraging.

Although tractor sales growth has come off its high rate and has been flat in most recent months, we expect it to stabilize at around 8-10% on back of normal monsoon outlook.

On sum of the parts valuation basis our estimates indicate that the stock is trading at 9x FY08E and 8.3x FY09E core earnings respectively at current market price of INR 733, with the valuation of subsidiaries and investments at INR 411 per share.

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