Please Share:: 
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
“In business, I look for economic castles protected by
unbreachable ‘moats’.” Warren Buffett
Edelweiss Value Index
Edelweiss Value Index (EVI) is an effort to search through a basket of potential
stocks, using multiple value factor model that gives consistent return along with
steady outperformance. This screener is in contrast with the popular notion that
India is a “growth” market, where investors do not mind paying a high price for
alluring earnings prospects. Value investing has been popular since it has made
more consistent returns than growth stocks, albeit with lesser volatility. Valueinvesting
looks to buy companies that are trading below their intrinsic value, but
whose true worth is eventually recognised. This margin of safety safeguards us
against adverse future developments. These securities typically have low prices
relative to earnings or book value and often have a higher dividend or cash flow
yields, coupled with low debt. Value managers quest for opportunities that have
been overlooked by the market, perhaps because an industry is out of favour or at
times not allowed by the extreme pessimism.
Further analysis shows that it is not just stock selection based on low Price/Book
value which has worked well. Investors who used combination of “value” filters —
such as high dividend yield, high cash flow yield and interest coverage — were
rewarded equally.
Methodology
EVI is a framework for measuring the efficacy of a select set of fundamental factors
blended with certain quantitative disciplines. Equally weighted long only basket of
top 25 stocks is created, considering four factors:
Book value
Dividend yield
Interest coverage
Cash-flow yield
Edelweiss Gems (EVI universe)
ONGC (Our oil & gas analyst Niraj Mansingka)
Growth in crude and natural gas production: ONGC’s crude production is expected to grow at 3.4% over FY11-
14 as the crude production from western and eastern India starts production. Natural gas production is also
expected to grow at CAGR of 5.1% over next 3 years. The growth in production is commendable considering
that the global majors are struggling to maintain their current production rates.
Downside risks on earnings protected: We model upstream share at one-third of total under recovery and
expect FY12E crude average at USD 90/bbl on the back of strong crude price momentum, ONGC’s nominated
crude is expected to fetch net realization at USD ~61/bbl (FY11E @ USD ~59/bbl), leading to FY12E EPS at
INR 32.3/share, an increase of 16% over FY11. ONGC faces lower risks on correction of crude prices as the
lower earnings from lower crude prices is offset by lower subsides.
Attractive valuations: Recent correction in the stock price has moved ONGC to attractive valuations. At CMP of
INR 272/share, ONGC is trading at 8.5x FY12E EPS, which compares favorably with the past five-year range of
9-11x.
PTC India (Our power analyst Shankar K)
PTC India (PTC) is a leading integrated power trading company with ~40% market share in power trading with
presence in coal trading and power project development and financing. Currently, the company has access to
13 GW of power capacity through long-term PPAs, with equity stakes in multiple projects.
Earnings to double by FY13, triggered by higher margins and volumes: PTC’s current 18 bn kWh power trading
volume is expected to catapult 150% by FY13E and triple by FY15E to 57 bn kWh. This growth is expected
solely from long-term high-margin PPA-based trades. The power tolling business (350 MW) expected to
commission in H2 FY12, will be greatly margin accretive (margins expected at 30-40paise/kWh versus 4-5
paise earned in normal trading business).
Diversification to garner further volumes: The company has diversified into power generation, tolling, project
financing and coal trading for captive power capacities, which will garner further volumes.
Deregulation to be margin accretive: CERC has abolished margin cap on long-term trades and raised it on
short-term trades to 7 paise/kWh from 4 paise. This is likely to boost PTC’s margins substantially from FY11,
especially as long-term trading volumes rise (which have virtually no limit on margins).
Bharat Electronics
Bharat Electronics (BEL), one of India’s largest defense public sector undertakings (PSU), specialises in
manufacturing defense electronics. It is likely to be a key beneficiary of the anticipated increase in defence
capital expenditure (at 40% CAGR, to USD 30 bn, by 2012; source: Assocham). Further, domestic companies,
including BEL, are likely to benefit from key changes in government policies, notably the offset clause (30% of
an order must be sub-contracted domestically).
Strong order book, equivalent to nearly two years of revenues: Even without the offset clause, its order book is
slated to grow over the next few years. The offset clause (potential opportunity USD 12 bn) could also add to
the order book over the next three years because of steady demand for its existing product range.
Strong balance sheet; steady earnings growth: BEL has an estimated cash balance of ~INR 35.7 bn (INR
446/share), which enables it to scale up facilities for incremental orders or plan acquisitions. We expect
adjusted earnings to post 14% CAGR in FY10-12E, while order book may grow at 14% CAGR, excluding
potential upsides from the offset clause.
Tata Steel (Our metals analyst Prasad Baji)
Higher iron ore prices auger well: Tata Steel, whose Indian operations are one of the world’s lowest cost
producer due to high captive raw material linkages, will outperform in a scenario of rising raw material prices
and rising global demand for steel. With continued uptrend in prices of iron ore and coking coal and upswing in
demand in H1CY11, steel players across the world have resorted to increase product prices. A similar situation
has also been witnessed in India, where HRC prices have increased by over INR 4,500/t since end of December
2010. This augers very well for Tata Steel India’s operations, as it remains 100% captive for iron ore and 55%
captive for coking coal. While European margins will be low due to lack of raw material integration, we
anticipate EBITDA/t to rise in Q4FY11 on the back of higher steel prices, thereby negating the impact of
increased cost. However, the Indian operations will benefit significantly from higher steel prices and will see
margin expansion.
India expansion will boost growth and de-risk the company: Tata Steel India’s expansion is on track for
commissioning by end-FY12 and will drive strong 27% volume growth in India operations in FY13. With this
expansion, share of the more profitable and relatively easier to forecast India operations will rise in
consolidated volumes and EBITDA, besides reducing earnings sensitivity to steel prices.
The stock is trading at 4.5x FY12E EV/EBITDA, at 26% discount to mid-cycle of 6.2x and 20% discount to
peers.
Oriental Bank of Commerce (Our banking analyst Nilesh Parikh)
Though we expect pressure on margins to continue, declining credit costs may partially support earnings; also
given the provisions that bank has created for second pension option, there are likely to be limited surprises on
account of higher-than-expected retirement costs.
Slippages touched a high of 2.2% during the Q3, however we believe, they have peaked at the current level.
After touching a high of 3.3% in Q2, margins contracted during Q3 by 20bps, reflecting the (short-term)
nature of liability profile, exposing margins to higher downside risk in a rising interest rate environment.
Despite the near term headwinds, stock’s valuation at 0.9x FY12 book are attractive given the reasonable
ROEs of 18-19%.
Syndicate Bank (Our banking analyst Nilesh Parikh)
Over the past three quarters, margin expansion has played out well (up 123bps to 3.58%); however, with CD
ratio touching a high of 80%, we expect margins to come under pressure going forward.
After a weak loan book growth over H1 (3.5% YTD), the momentum picked up during Q3FY11 touching 6% Qo-
Q.
Syndicate Bank’s incremental slippages in Q3FY11 came in a tad higher at INR 4.0 bn (1.7%) against INR 3.15
bn run rate during the previous two quarters. A few large accounts contributed INR 1.5 bn to slippages, which
management expects to upgrade/recover before end of the current financial year.
The stock is currently trading at 0.9x FY12E adjusted book and 4.3x FY12E earnings, delivering RoEs of ~20%.
The risk-reward continues to remain favourable at current valuations.
Live tracking & back-test results
We have back-tested the screener on
BSE-200 universe for the past 10 years
(since June 2000). The cumulative
performance plotted herewith comprises
of the top 25 companies out of the
universe. As anticipated, results look
promising, considering the hypothesis is
applied on smaller universe of top 200
most liquid stocks. Further, sincere effort
has been made to back-test hypothesis
so as to cover two market cycles,
ensuring results are not excessively
skewed towards bull or bear run.
Major observations:
At no point in time, neither NIFTY nor BSE200 index has been able to match cumulative returns given by portfolio
of our top 25 value stocks. In fact, the top 25 value portfolio has never given negative returns during the 10-year
period.
The top 25 value portfolio has maintained the hit ratio of 100% Y-o-Y, whereas NIFTY has maintained the same at
65% since the past 10 years.
Edelweiss value index has consistently outperformed benchmark indices.
The top 25 value basket has given an average return of 10.2% per quarter and maintained hit ratio of 69% Q-o-Q,
whereas NIFTY has yielded average 4.7% return and had hit ratio of 61% over the past 10 years.
Assumptions
(I) Universe
EVI has been back-tested using BSE-200 universe. The cumulative performance discussed in the report is
based on the basket of top 25 stocks. Financial stocks have been ranked separately using price to book as
other factors would have no clear meaning for financial stocks.
(II) Our database has been carefully developed to minimize look-forward bias: Many researchers use
databases which make simple or even simplistic assumptions about when new information became available.
Frequently, this means that their “out-of-sample” results are actually contaminated by information that would
not have been available at the time. Obviously, investors should be skeptical about the results from such work.
We believe our database does not suffer from this problem.
(III) Portfolio rebalancing: Portfolio is constructed on the basis of quarterly results available as on 15th February,
31st May, 15th August and 15th November. Prior to August 2010, rebalancing has been done on the basis of
old quarterly results timeline.
(IV) We consistently look at total returns: Many market participants look solely at prices. But, it is important
for investors to be aware of the total returns available from stocks, in the form of capital gains (via price) and
income (via dividends). Quite a lot of factor effectiveness research looks solely at price returns, but we
consistently use total returns in our research.
(V) It is important to note that Edelweiss Value Index do not account for transaction costs including the bidask
spread and the market impact of buying and selling.
(VI) Hit ratio: signifies number of month’s portfolio has given positive returns out of total sample period.
APPENDIX
Factor definitions
(I) Price to book: A low ratio indicates good value, but can also be an indication of lackluster growth and/or profitability
prospects. We have considered latest book value for price to book value calculations
(II) Dividend yield: A high ratio indicates high earnings growth and/or rising payout ratio, but can also indicate lackluster
growth prospects. We have considered TTM dividend for dividend yield calculations
(III) Free Cash flow yield (FCF to EV): A high ratio indicates efficient working capital management and/or high
depreciation and/or high net income. We have consider last reported free cash flow and latest EV for calculations
(IV) Interest coverage ratio: A ratio used to determine how easily a company can pay interest on outstanding debt. The
interest coverage ratio is calculated by dividing a company's earnings before interest and taxes (EBIT) of one period by the
company's interest expenses of the same period. The higher the ratio, the better the company is equipped to pay interest on
debt.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
“In business, I look for economic castles protected by
unbreachable ‘moats’.” Warren Buffett
Edelweiss Value Index
Edelweiss Value Index (EVI) is an effort to search through a basket of potential
stocks, using multiple value factor model that gives consistent return along with
steady outperformance. This screener is in contrast with the popular notion that
India is a “growth” market, where investors do not mind paying a high price for
alluring earnings prospects. Value investing has been popular since it has made
more consistent returns than growth stocks, albeit with lesser volatility. Valueinvesting
looks to buy companies that are trading below their intrinsic value, but
whose true worth is eventually recognised. This margin of safety safeguards us
against adverse future developments. These securities typically have low prices
relative to earnings or book value and often have a higher dividend or cash flow
yields, coupled with low debt. Value managers quest for opportunities that have
been overlooked by the market, perhaps because an industry is out of favour or at
times not allowed by the extreme pessimism.
Further analysis shows that it is not just stock selection based on low Price/Book
value which has worked well. Investors who used combination of “value” filters —
such as high dividend yield, high cash flow yield and interest coverage — were
rewarded equally.
Methodology
EVI is a framework for measuring the efficacy of a select set of fundamental factors
blended with certain quantitative disciplines. Equally weighted long only basket of
top 25 stocks is created, considering four factors:
Book value
Dividend yield
Interest coverage
Cash-flow yield
Edelweiss Gems (EVI universe)
ONGC (Our oil & gas analyst Niraj Mansingka)
Growth in crude and natural gas production: ONGC’s crude production is expected to grow at 3.4% over FY11-
14 as the crude production from western and eastern India starts production. Natural gas production is also
expected to grow at CAGR of 5.1% over next 3 years. The growth in production is commendable considering
that the global majors are struggling to maintain their current production rates.
Downside risks on earnings protected: We model upstream share at one-third of total under recovery and
expect FY12E crude average at USD 90/bbl on the back of strong crude price momentum, ONGC’s nominated
crude is expected to fetch net realization at USD ~61/bbl (FY11E @ USD ~59/bbl), leading to FY12E EPS at
INR 32.3/share, an increase of 16% over FY11. ONGC faces lower risks on correction of crude prices as the
lower earnings from lower crude prices is offset by lower subsides.
Attractive valuations: Recent correction in the stock price has moved ONGC to attractive valuations. At CMP of
INR 272/share, ONGC is trading at 8.5x FY12E EPS, which compares favorably with the past five-year range of
9-11x.
PTC India (Our power analyst Shankar K)
PTC India (PTC) is a leading integrated power trading company with ~40% market share in power trading with
presence in coal trading and power project development and financing. Currently, the company has access to
13 GW of power capacity through long-term PPAs, with equity stakes in multiple projects.
Earnings to double by FY13, triggered by higher margins and volumes: PTC’s current 18 bn kWh power trading
volume is expected to catapult 150% by FY13E and triple by FY15E to 57 bn kWh. This growth is expected
solely from long-term high-margin PPA-based trades. The power tolling business (350 MW) expected to
commission in H2 FY12, will be greatly margin accretive (margins expected at 30-40paise/kWh versus 4-5
paise earned in normal trading business).
Diversification to garner further volumes: The company has diversified into power generation, tolling, project
financing and coal trading for captive power capacities, which will garner further volumes.
Deregulation to be margin accretive: CERC has abolished margin cap on long-term trades and raised it on
short-term trades to 7 paise/kWh from 4 paise. This is likely to boost PTC’s margins substantially from FY11,
especially as long-term trading volumes rise (which have virtually no limit on margins).
Bharat Electronics
Bharat Electronics (BEL), one of India’s largest defense public sector undertakings (PSU), specialises in
manufacturing defense electronics. It is likely to be a key beneficiary of the anticipated increase in defence
capital expenditure (at 40% CAGR, to USD 30 bn, by 2012; source: Assocham). Further, domestic companies,
including BEL, are likely to benefit from key changes in government policies, notably the offset clause (30% of
an order must be sub-contracted domestically).
Strong order book, equivalent to nearly two years of revenues: Even without the offset clause, its order book is
slated to grow over the next few years. The offset clause (potential opportunity USD 12 bn) could also add to
the order book over the next three years because of steady demand for its existing product range.
Strong balance sheet; steady earnings growth: BEL has an estimated cash balance of ~INR 35.7 bn (INR
446/share), which enables it to scale up facilities for incremental orders or plan acquisitions. We expect
adjusted earnings to post 14% CAGR in FY10-12E, while order book may grow at 14% CAGR, excluding
potential upsides from the offset clause.
Tata Steel (Our metals analyst Prasad Baji)
Higher iron ore prices auger well: Tata Steel, whose Indian operations are one of the world’s lowest cost
producer due to high captive raw material linkages, will outperform in a scenario of rising raw material prices
and rising global demand for steel. With continued uptrend in prices of iron ore and coking coal and upswing in
demand in H1CY11, steel players across the world have resorted to increase product prices. A similar situation
has also been witnessed in India, where HRC prices have increased by over INR 4,500/t since end of December
2010. This augers very well for Tata Steel India’s operations, as it remains 100% captive for iron ore and 55%
captive for coking coal. While European margins will be low due to lack of raw material integration, we
anticipate EBITDA/t to rise in Q4FY11 on the back of higher steel prices, thereby negating the impact of
increased cost. However, the Indian operations will benefit significantly from higher steel prices and will see
margin expansion.
India expansion will boost growth and de-risk the company: Tata Steel India’s expansion is on track for
commissioning by end-FY12 and will drive strong 27% volume growth in India operations in FY13. With this
expansion, share of the more profitable and relatively easier to forecast India operations will rise in
consolidated volumes and EBITDA, besides reducing earnings sensitivity to steel prices.
The stock is trading at 4.5x FY12E EV/EBITDA, at 26% discount to mid-cycle of 6.2x and 20% discount to
peers.
Oriental Bank of Commerce (Our banking analyst Nilesh Parikh)
Though we expect pressure on margins to continue, declining credit costs may partially support earnings; also
given the provisions that bank has created for second pension option, there are likely to be limited surprises on
account of higher-than-expected retirement costs.
Slippages touched a high of 2.2% during the Q3, however we believe, they have peaked at the current level.
After touching a high of 3.3% in Q2, margins contracted during Q3 by 20bps, reflecting the (short-term)
nature of liability profile, exposing margins to higher downside risk in a rising interest rate environment.
Despite the near term headwinds, stock’s valuation at 0.9x FY12 book are attractive given the reasonable
ROEs of 18-19%.
Syndicate Bank (Our banking analyst Nilesh Parikh)
Over the past three quarters, margin expansion has played out well (up 123bps to 3.58%); however, with CD
ratio touching a high of 80%, we expect margins to come under pressure going forward.
After a weak loan book growth over H1 (3.5% YTD), the momentum picked up during Q3FY11 touching 6% Qo-
Q.
Syndicate Bank’s incremental slippages in Q3FY11 came in a tad higher at INR 4.0 bn (1.7%) against INR 3.15
bn run rate during the previous two quarters. A few large accounts contributed INR 1.5 bn to slippages, which
management expects to upgrade/recover before end of the current financial year.
The stock is currently trading at 0.9x FY12E adjusted book and 4.3x FY12E earnings, delivering RoEs of ~20%.
The risk-reward continues to remain favourable at current valuations.
Live tracking & back-test results
We have back-tested the screener on
BSE-200 universe for the past 10 years
(since June 2000). The cumulative
performance plotted herewith comprises
of the top 25 companies out of the
universe. As anticipated, results look
promising, considering the hypothesis is
applied on smaller universe of top 200
most liquid stocks. Further, sincere effort
has been made to back-test hypothesis
so as to cover two market cycles,
ensuring results are not excessively
skewed towards bull or bear run.
Major observations:
At no point in time, neither NIFTY nor BSE200 index has been able to match cumulative returns given by portfolio
of our top 25 value stocks. In fact, the top 25 value portfolio has never given negative returns during the 10-year
period.
The top 25 value portfolio has maintained the hit ratio of 100% Y-o-Y, whereas NIFTY has maintained the same at
65% since the past 10 years.
Edelweiss value index has consistently outperformed benchmark indices.
The top 25 value basket has given an average return of 10.2% per quarter and maintained hit ratio of 69% Q-o-Q,
whereas NIFTY has yielded average 4.7% return and had hit ratio of 61% over the past 10 years.
Assumptions
(I) Universe
EVI has been back-tested using BSE-200 universe. The cumulative performance discussed in the report is
based on the basket of top 25 stocks. Financial stocks have been ranked separately using price to book as
other factors would have no clear meaning for financial stocks.
(II) Our database has been carefully developed to minimize look-forward bias: Many researchers use
databases which make simple or even simplistic assumptions about when new information became available.
Frequently, this means that their “out-of-sample” results are actually contaminated by information that would
not have been available at the time. Obviously, investors should be skeptical about the results from such work.
We believe our database does not suffer from this problem.
(III) Portfolio rebalancing: Portfolio is constructed on the basis of quarterly results available as on 15th February,
31st May, 15th August and 15th November. Prior to August 2010, rebalancing has been done on the basis of
old quarterly results timeline.
(IV) We consistently look at total returns: Many market participants look solely at prices. But, it is important
for investors to be aware of the total returns available from stocks, in the form of capital gains (via price) and
income (via dividends). Quite a lot of factor effectiveness research looks solely at price returns, but we
consistently use total returns in our research.
(V) It is important to note that Edelweiss Value Index do not account for transaction costs including the bidask
spread and the market impact of buying and selling.
(VI) Hit ratio: signifies number of month’s portfolio has given positive returns out of total sample period.
APPENDIX
Factor definitions
(I) Price to book: A low ratio indicates good value, but can also be an indication of lackluster growth and/or profitability
prospects. We have considered latest book value for price to book value calculations
(II) Dividend yield: A high ratio indicates high earnings growth and/or rising payout ratio, but can also indicate lackluster
growth prospects. We have considered TTM dividend for dividend yield calculations
(III) Free Cash flow yield (FCF to EV): A high ratio indicates efficient working capital management and/or high
depreciation and/or high net income. We have consider last reported free cash flow and latest EV for calculations
(IV) Interest coverage ratio: A ratio used to determine how easily a company can pay interest on outstanding debt. The
interest coverage ratio is calculated by dividing a company's earnings before interest and taxes (EBIT) of one period by the
company's interest expenses of the same period. The higher the ratio, the better the company is equipped to pay interest on
debt.
No comments:
Post a Comment