Bill Belchere, Regional Economist, Macquarie said that he is expecting the Fed to cut the rates by 25bps which may go to 50 bps and would see a relief rally in case of 50 bps cut. He said that 50 bps cut would raise questions regarding growth. He believes that the US, EU economies may slow down in Q1 of next year. Contrary to this, he said that Asian markets with more domestic dependence will see good indutrial production figures and a softening in first half of next year may be seen. He believes that China, India and Indonesia are seeing good domectic economies. High beta markets dependant countries on exports like Taiwan and Korea may be challenged.

He further said that softer global manufacturing growth are seen and it is tough for the emerging markets outperformance. Fed's decision to cut the rates may only cause a short blip in global markets. About RBI, he said that the Indian central bank is likely to stay on hold for now and India is likley to grow at around 9%.

Event

We revisit HDFC’s earnings forecasts by rolling over into FY3/07 actuals and FY3/10E and incorporating its recent equity placement into the numbers.

Impact

Robust business model.

HDFC Ltd’s mortgage business model is extremely robust. Its lack of a deposit franchise is offset by a super-efficient cost structure, and its superlative asset quality means that it can translate the superior ROA of a non-bank into the leverage of a bank, leading to a top-ofclass ROE. For the last three years, HDFC has shown ROE in the region of 30%, while most banks peak at 22–24%.

Equity issuance – at very strong valuations.

This ROE is now set to fall to the mid-20s as the bank diluted capital via a private placement to Citigroup and Carlyle late last month. This issue was done at an historic P/BV of 7.8x and an historic PER of 28x. This means that its BVPS rises by 65% in FY3/08E, more than offsetting the drop in ROE.

Subsidiaries a key driver.

Subsidiaries now account for 30% of HDFC’s valuations, primarily driven by HDFC Bank and HDFC Standard Life (unlisted). The life insurance business is at an inflexion point; while it saw market share slipping in FY3/07, we expect a strong bounce-back this year as both product and distribution issues are reconciled.

We expect that HDFC’s subsidiaries will continue to contribute significantly to growth over the next couple of years. In fact, HDFC’s non-life sub, which Chubb recently exited as the JV partner, should also start to perform strongly from FY3/09E, once a new collaborator is found. We have not captured this upside yet in our valuations.
Earnings revision

We revise our EPS estimate for FY3/08E downward by 3%, with no change in EPS for FY3/09E. We increase our FY3/09E BVPS by 30% to Rs 417; our FY3/10E ROE stands at 23.6%. Consequently, we raise our target price by 7% to Rs 2,202.

Price catalyst

12-month price target: Rs 2,202.00 based on a Sum of Parts methodology. Catalyst: 1QFY3/08E results - expected to show resilience to a systemic slowdown in home loan growth.

Action and recommendation

HDFC’s P/BV does scare investors – the equity placement brings it down from 8x to 5x. However, with 30% of this coming from subsidiary value, ROE in the mid-teens and consistent 20%+ EPS growth, we find this more than acceptable. We retain our Outperform on the stock and assign it a 6% weighting in our portfolio.

Satyam an outperformer; target of Rs 542

Event

Using our proprietary margin analysis framework, we conclude that for FY08, there will be an EBITDA margin erosion of 261bps for Satyam. However, we believe Satyam is a good candidate to cross the tier-1 valuation chasm based on strong revenue growth, its converging ROE with Infosys and focus on high-growth engineering services business. We maintain our long-term Outperform rating on the stock, but cut our FY08 EPS forecast by 7%.

Impact

In our proprietary margin analysis, we quantified the effect of ‘sorrow’ factors like a stronger rupee regime (Macquarie’s forecast for FY08 is Rs 40.3 per USD) and wage inflation, and ‘joy’ factors like pricing power and various productivity gain levers. Satyam has USD 650 million of hedging on its books. Based on the 58% natural hedge available to the company and our economics team’s exchange rate forecasts, our calculations suggest that the realised Re rate for Satyam in FY3/08 will be Rs 42.5 per USD. Re appreciation will shave of 248bps from Satyam’s EBITDA margin in FY3/08. Rising wages will dent this by a further 466bps. We have assumed a 15% rise in offshore wages and a 4% increase in onsite wages. The above negatives will be partially offset by levers like better pricing power (163bps), productivity gains (75bps), improvement in the offshore-onsite mix (19bps), an increase in utilisation (22bps) and SG&A leverage (173bps).

Earnings revision

Because of adverse exchange rate movement, we have cut our FY3/08E EPS from Rs 25.8 to Rs 24.0 and our FY3/09E EPS from Rs 31.7 to Rs 30.9.

Price catalyst

12-month price target: Rs 542.00 based on a PER methodology. Catalyst: Large deal wins (>USD 50 million) or an acquisition to penetrate Europe/Japan or building product capabilities.

Action and recommendation

We have cut our earnings forecasts marginally as well as our price target. We maintain our Outperform rating on the stock, with 16% upside from the current level. In the short term, there could be some weakness as Satyam may cut its guidance for FY3/08. However, for long-term investors, it remains an attractive pick in our view.



Neutral on Wipro

Event

Using our proprietary margin analysis framework, we have quantified the effect of ‘sorrow’ factors such as a stronger Rupee regime (Macquarie forecast for FY08 is at Rs 40.3 per USD), wage inflation and ‘joy’ factors such as pricing power and various productivity gain levers. We conclude that for FY08, there will be an EBITDA margin erosion of 388bp for Wipro. This large impact (relative to its peers) is due to its weak hedging position (2 months of net forex inflows compared with the 4 months for Infosys and 7 months for Satyam); coupled with absence of software business and limited pricing power. We downgrade the stock to Neutral from Outperform and cut our FY08 EPS forecasts by 20.3%.

Impact

Wipro has the least amount (USD 600 million) of hedge available among the Tier-1 IT companies. This is sufficient to protect margins only till June 2007. For the full FY3/08, the average realised USD/Rs exchange rate works out to Rs41.1. The rupee appreciation should reduce the EBITDA margin in FY3/08 by 467bp, which is the highest compared with its peers. Rising employee cost, both onsite (4%) and offshore (15%), will result in further decrease in EBITDA margins by 443bp in FY3/08. Coming to some rescue of the EBITDA margin are the levers such as higher price realisation (111bp), productivity gains (78bp), further offshore movement of work (19bp), increase in utilisation (13bp) and SG&A leverage (300bp). We note that Wipro’s margin protection levers are small primarily due to a weaker pricing power and absence of software products business.

Earnings revision

Owing to the negative exchange rate movement, we reduce our EPS estimates for FY3/08 and FY3/09 from Rs 25.2 and Rs 31.1 to Rs 19.8 and Rs 23.4, respectively.

Price catalyst

12-month price target: Rs 499 based on a PER methodology.

Catalyst: Initiatives in the products space or winning large deals (>USD 100 million) or acquisition to penetrate Europe/Japan.

Action and recommendation

We have cut our earnings forecast and revised our price target from Rs 673 to Rs 499. We downgrade Wipro to Neutral from Outperform, and we expect a negative surprise in the 1Q FY3/08 results. There are news reports that the company is looking at a major acquisition in Germany to expand its business in Europe’s largest economy. This may pose an upside risk to our recommendation.



TCS an outperformer; target Rs 1399

Event

Using our proprietary margin analysis framework, we conclude that for FY08 there will be an EBITDA margin erosion of 261bps for Tata Consultancy Services (TCS). However, we believe TCS can adjust to the new paradigm thanks to diversification of its delivery base in near-shore locations like Latin America and Eastern Europe, initiatives in the products business, and inorganic growth potential. We maintain our Outperform rating on the stock, but cut our FY08 EPS forecast by 13%.

Impact

Our proprietary margin analysis quantified the effect of ‘sorrow’ factors like a stronger rupee regime (Macquarie: FY08E Rs 40.3 per USD) and wage inflation, and ‘joy’ factors like pricing power and various productivity gain levers. WTCS started the current financial year with USD 1.1billion of currency forwards and options. This, coupled with 42% of natural hedging provided by its foreign exchange expenses and investments, is enough to shield margins until July 2007. Our calculations suggest that the realised foreign exchange rate for TCS will be Rs 41.4 per USD in FY3/08. The adverse impact of Re appreciation will result in a lowering of its EBITDA margin by 351bps in FY3/08. An increase in onsite wages (4%) and offshore wages (15%) will have a further negative impact of 399bps. The good news is the positive impact of levers like pricing (122bps), productivity gains (88bps), further offshore movement of work (17bps), an increase in utilisation (18bps) and SG&A leverage (244bps).

Earnings revision

Primarily due to the adverse exchange rate movement, our FY3/08E and FY3/09E EPS have been cut from Rs 54.7and Rs 73.1, to Rs 47.8 and Rs 62.9, respectively.

Price catalyst

12-month price target: Rs 1399 based on a PER methodology.

Catalyst: US listing or an acquisition to penetrate Europe/Japan, or some large deal wins (>USD 100 million).

Action and recommendation

We have cut our earnings forecasts and revised our price target from Rs 1654 to Rs 1399. We maintain our Outperform rating on the stock, with 22% upside from the current level. In the short term, there could be some weakness as TCS may guide for slow EPS growth for FY3/08. However, for long-term investors, the stock remains attractive in our view.



Infosys an outperformer; target of Rs 2437

Event

Using our proprietary margin analysis framework, we conclude that for FY08 there will be an EBITDA margin erosion of 210 bps for Infosys. However, we believe Infosys can adjust to the new paradigm thanks to its pricing power, initiatives in the products business and inorganic growth potential. Despite cutting our FY08 EPS forecast by 8.1%, we maintain our Outperform rating on the stock.

Impact

In our proprietary margin analysis, we quantified the effect of ‘sorrow’ factors like a stronger rupee regime (Macquarie’s forecast for FY08 is Rs 40.3/USD) and wage inflation, and ‘joy’ factors like pricing power and various productivity gain levers. Infosys has USD 1billion of hedging on its books. Based on the natural hedge available to the company and our economics team’s exchange rate forecasts, our calculations suggest that the realised Re rate for Infosys in FY3/08 will be Rs 41.6 per USD. Rupee appreciation will shave off 335bps from the EBITDA margin in FY3/08. Meanwhile, rising wages will dent this by a further 377bps. We have assumed a 15% rise in offshore wages and 4% increase in onsite wages. The above negatives will be partially offset by levers like pricing (147bps), productivity gains (77bps), further offshore movement of work (25bps), an increase in utilisation (37bps) and SG&A leverage (217bps).

Earnings revision

Because of adverse exchange rate movement, our FY3/08E EPS has been cut from Rs 83.7 to Rs 76.9, and our FY3/09E EPS been lowered from Rs 113.4 to Rs 103.9.

Price catalyst

12-month price target: Rs 2,437.00 based on a DCF methodology. Catalyst: Winning a couple of greater than USD 100 million deals or acquisition around Europe/Japan penetration.

Action and recommendation

We have cut our earnings forecasts marginally and revised our price target from Rs 2,671 to Rs 2,437. We maintain our Outperform rating on the stock, with 25% upside from the current level. In the short term, there could be some share price weakness as Infosys may cut its guidance for FY3/08 when announcing 1Q FY3/08 results in the second week of July. However, for long-term investors, it remains an attractive pick in our view.

Macquarie - GAIL


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Macquarie Research reports on Suzlon Energy:

"With Areva’s recent move to remove the 50% acceptance condition from its offer for REpower without raising its target price, the deadline for both Areva’s and Suzlon’s offers for REpower (at €140ps and €150ps, respectively) has been extended to 4 May. Although uncertainty remains, it appears that the French elections could cloud Areva’s offer and that the bid price is levelling. We have spoken with Suzlon’s management since our last notes (Suzlon: three triggers for the stock, 7 March 2007, and Can this REpower Suzlon?, 12 Feb 2007), and we provide our updated view below."

Impact

"We cannot think of a better fit and reiterate our view that this deal is strategically very positive. The bid jump-starts Suzlon’s move into the European market, which still accounts for over half of the global market and is the only market in which Suzlon’s presence to-date is minimal. The deal, at €150, represents short-term financial pain: it is likely to be 14.5% EPS dilutive for FY3/08."

"Suzlon and REpower are the fastest and second-fastest-growing wind turbine companies in the top ten. We reiterate that they complement each other in three ways: Entry into Europe, especially Germany (the largest wind market in the world), France (one of the fastest-growing) and the UK, where REpower is strong; access to high-end 5MW turbines and REpower’s world-class R&D team; greater supply-chain leverage."

Synergies are real, but are there any downsides?

"Component shortage effects REpower has more than many of its peers, and relieving them would be positive for both top and bottom lines, enabling them to deliver real gains."

"Regarding product cannibalisation, we do not see much between Suzlon’s 2MW and REpower’s three 2MW products."

"Is the offshore market as exciting as it is made out to be? REpower’s cutting edge 5MW turbines, the largest commercial products in the world, are suited to the offshore market, which is expected to take off in 2010."

"Let’s look at the price again and at our updated EV per MW meter. At the current €150 per share, the deal is still DCF positive (about 7%), and our updated meter is showing USD 0.9 m per cumulative MW installed, which we regard as less than demanding given that REpower is a relative newcomer in the industry."

Key risks

"We see risk in expecting better margin improvements than are achievable. Our expectations are lower than those of Suzlon management given the following."

"Suzlon’s yet-to-be-proven ability to squeeze margins from its acquisitions."

"No listed firms other than Suzlon and Gamesa have achieved double-digit margins in recent years, and Repower has not since 2002."

Price catalyst
"12-month price target: Rs1,251based on a DCF methodology."

Catalyst:
"Continued globalisation and successful M&A implementation.

Action and recommendation
"Although the deal is mildly DCF positive, we have not included it in our valuation given Suzlon’s untested ability to improve margins and the remaining uncertainty about the bidding. maintain Neutral, with a target price of Rs1,251."

Macquarie Punj, Macquarie Tata Steel, Merrill Lynch HCL TECH result, Merrill Lynch UTI Bank, MONEY TIMES 23-29 APR


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