Research Notes – October 28, 2010

Hold on Tech Mahindra

 2QFY11 numbers are higher than street estimates as the result has included so many extra ordinary items.

 Excluding these figures, revenue looks slightly better than market expectations.

 USD revenue growth is at 9.5% q-q, which appears to be a clear positive.

 Adjusted profit is better than market expectations due to lower employee cost, higher utilization and cross currency gains.

 Negatives such as concentrated client base (77% revenue from five clients) and exclusive focus on telecom continue. This may limit bargaining power of the company in the deals it participates.

 Second quarter result points to new deals that are asset heavy, which may lead to volatility in financials going forward.

 Barring faster than expected turnaround in Satyam, very few positives exist for the immediate term and hence the stock has not been upgraded to ‘buy’ and it remains in the ‘hold’ list. However, the scenario may change if the 30% stakeholder ‘BT’ announces a stake sales at a premium or discount to the current market price (Rs.786 range)

Buy Power Grid – TP Rs.130 over one year

 Power Grid Corporation is an underperformer in the market despite its strong growth prospects. Underperformance is up to 21% while compared to MSCI Index.

 It seems that investors’ concerns regarding the FPO of the company, which would be at a discount to the current market value of the stock is affecting market performance of the stock. The issue is slated to open on November 9, 2010 and the government would be diluting 10% of its stake in the company.

 On the growth front, it is estimated that Power Grid is likely to achieve earnings growth at 22% CAGR between FY11- 13.

 Long term growth story remains intact while considering capex plans of the company. Already invested Rs.25300 crore between FY 2008 -10 and another Rs.29600 crore investment is planned in FY11 and 12 for completing its targeted Rs.55000 crore investment in the 11th five year plan.

 It has also plans to invest Rs.69900 crore between FY11-15 to build transmission systems for the ultra mega power projects and independent power projects with a total generation capacity of 55 GW.

 With the FPO proceeds and strong cash flows, the company is expected to have the financial strength to carry out its capex plans.

 Target price has been cut to Rs.130 from the earlier estimate of Rs.140, considering possible delays in the completion of transmission projects and its resultant impact on FY12 earnings estimates. However, the long term story remains intact.

Retain ‘ buy’ on Idea Cellular – TP Rs.85

 Buy call on Idea Cellular is maintained with a one year target price of Rs.85.

 2QFY11 revenue at Rs.3659 crore looks flat q-q and lower than market estimate because of lower than expected average revenue per user at Rs. 167 against the street estimate of Rs.176.

 According to the management, pressure on average realized revenue per user is due aggressive customer acquisition offers from new entrants.

 It seems that average revenue realization is unlikely to fall below the current level and pricing stability is likely back in the industry.

 Operating profit margin declined slightly to 24% in the second quarter from 24.3% earlier due to an increased personnel expenditure after the annual salary revision.

 Idea is expected to roll out 3G network aggressively in the next two –three quarters and profit margin would be under pressure in the initial phase of the roll out. However, margins are likely to expand after the initial phase of the roll out on narrowing losses from new circles and improving profitability from old circles due to price stability.

 Performance of Indus Towers continues to improve with better profit margins of 23.5% q-q and at 42% y-y. Revenue increased by 44% y-y. Company owns 8838 towers in addition to towers shares with Indus. Improving profitability of tower business may prompt Idea and Indus tower joint venture partners to sell or list their tower assets to deleverage their stretched balance sheets.

 Historically, second quarter is generally weak to telecom industry and things would be better in the coming quarters. Idea is expected to launch 3G services in 4QFY11 that may reverse the declining trend in the average revenue per user.

Hold on HUL

 Hindustan Unilever has reported increased revenue for 2QFY11 but the revenue expansion is at the cost of declining margins.

 Second quarter revenue increased by 11.6% on domestic volume growth of 14%, export revenue growth at 17% and ‘others’ revenue growth at 43%.

 However, operating profit margin declined by 170 bps leading to operating profit missing analysts’ estimates by 8%. EPS looks in line with expectations due to higher other income and lower tax outgo.

 Margin at HPC (Hygiene Personal Care) segment continues to be under pressure due to high competition and operating profit margin under segment declined by 220bps at 16.1% and no relief is seen in competition intensity.

 Stock price is up on reports of price increases in certain items but the price revision is just to pass on higher input cost to customers and no way the reflection of easing competition in the market.

 It seems that intense competition resulting to increase in advertising and promotion spent and low pricing power coupled with rising input cost. In this scenario, it seems that the earnings growth may remain muted.

 Target price has been increased from Rs.260 earlier to the present Rs.271as the valuation has been rolled over by a quarter to Septeber 2012. At the current target price, the stock is valued at 26.7 multiple of FY11 earnings and at 23.4 multiple of FY12 expected EPS. The stock is richly priced at the current level (around Rs.290)

Hold on Crompton Greaves – TP raised to Rs.344 from Rs.282

 Weak order intake of 3.4% y-y in 2QFY11 and at 16.5% y-y for second half of the year.

 Order intake was at a slow pace due to slower award of orders from Power Grid Corporation and weak outlook for international subsidiaries in the US and Europe.

 Orders from Power Grid at Rs.960 crore for 1HFY11 was about one fourth of total orders placed for FY10.

 Management expects weak outlook for international subsidiaries to continue for the near term but an improvement is expected from Power Grid orders in the second half of this fiscal.

 Company management has maintained consolidated sales growth guidance for FY11 at 15% y-y with stable profit margins. For FY12, company’s guidance is 15 -18% standalone y-y growth and around 7% sales growth from international subsidiaries.

 Company plans Rs.600 crore capex in FY11for international acquisition.

 On a relative basis, Crompton Greaves appears to be the top pick in the capital goods space and the stock is recommended to hold with a higher target price of Rs.344, as against the earlier price projection of Rs.282 over one year. The new estimate is based on a 20 multiple of FY12 expected EPS.

Buy Gujarat State Petronet – TP Rs.144

 Reiterated buy call on Gujarat State Petronet with a one year target price of Rs.144. The company has reported 2QFY11 results, which appear in line with expectations.

 Sales targets achieved as higher than expected gas transmission tariff and wind power sales offset lower than expected gas transmission volume.

 Operating profit was not in line with expectations because of higher than expected operating expenses.

 EPS at Rs.1.63 is a shade lower due to higher depreciation charges.

 Second quarter volume growth was stagnant due to lower gas demand but it is expected to increase in 3QFY11 as Essar Energy’s Vadinar Power Transmission project is expected to take 1.5 mmscmd and ONGC’s fertilizer plant is expected to take 0.7 mmscmd of gas.

 Recent media reports indicate that Gujarat State Petronet has bagged bids for laying 1439 km Mallavaram – bhilwara Pipeline and 1670 km Mehsana – Bhatinda pipeline. Positives of these projects have not been included in the target price as more details are awaited on these projects.

Reduce Dish TV – TP Rs.40

 Our recommendation is to reduce Dish TV as it seems that the price may drop to Rs.40 range from the current level of Rs.58 over one year term.

 Company’s 2QFY11 revenue grew by 7% q-q while subscriber base increased by 11%. It seems that the ARPU (average revenue per user) is flat despite better than expected increase in subscriber base.

 Operating profit margin at 15.3% is below market expectations due to higher personnel and administrative expenses.

 Company could manage to control program cost, the highest cost for any DTH provider. Program cost increased by 1% only in the quarter. Program cost, which was the main factor aiding margin improvement so far, is going to be re – negotiated with broadcasters in FY12 and any increase in this cost may lead to margin pressure.

 Company’s expectations of ARPU improvement is unlikely to materialize because of strong competition in the DTH sector and competition from cable operators.


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