Macquarie Research, The Japan natural disaster & the US Event

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US Economics Comment
The Japan natural disaster & the US
Event
􀂃 The devastating earthquake and tsunami in Japan could affect the US economy
through several key channels.
Outlook
􀂃 Our view that a weak US$ should persist is intact- we do not expect this event
to derail the broad, structural decline in the real trade-weighted value of the dollar
that we observe seems to have been underway for several years. Notably, history
suggests natural disasters do not necessarily preclude a weaker JPY.
􀂃 Furthermore, our oil economist argues that the Japan events are bullish for oil in
the near-term. A weaker, trade-weighted US$ is generally associated with higher
oil prices (see “A weak dollar is high oil’s silver lining”, Macquarie Economics,
March 11th 2011). As a result, we expect any movement in the JPY/USD rate on
concerns on the impact of the natural disaster on growth, and on the injection of
sizeable new monetary policy support from the Bank of Japan, could be
overwhelmed by other macroeconomic forces. Indeed, the trade-weighted US$
index continues to hold around its fresh lows of early last week.
􀂃 A competitive dollar should also be favourable for US machinery exporters in the
medium-term. This was the third largest US export category to Japan in 2009, and
shipments could ramp up as reconstruction efforts accelerate.
􀂃 The Fed is on standby should long-term treasury yields rise sharply -While
stories are surfacing of a Japanese sell-off in US treasuries, our Japan economics
team do not expect substantial capital repatriation. At present, there is also little
evidence of sharply-rising long-term US borrowing costs, for example with 10-year
treasuries yields down marginally from their close last week.
􀂃 Nonetheless, if interest rates were to ratchet up quickly, we expect the Federal
Reserve would err on the side of supporting growth and do more to keep
borrowing costs contained, if necessary. While our central case is not for QE3, we
expect policymakers will still maintain the flexibility to do more if a real risk to
growth materialises, and should reiterate this position in this week’s Fed meeting.
􀂃 The nuclear catastrophe should drive some important shifts in the US
energy mix. In particular, we expect increasing policy emphasis on natural gas. In
our view, this would be a key positive for US growth.
􀂃 Some supply disruptions - The read-through from the US semi-conductors
sector, arguably an important benchmark given the concentration of producers in
Japan, is currently for at least near-term supply chain disruption. This suggests
interruption to US production of some downstream durable goods, though the
share of US advanced technology imports from Japan suggests the impact on
total US output should not be disastrous. At the same time, temporary disruption
to auto production in Japan, the country’s largest export to the US, could be good
news for US auto producers, with underlying US domestic demand looking firm.
We note that US producers are already adding to market share, and this could
add to the momentum, particularly if the Yen were to rise from here.

Infosys Technology Ltd.: Resuming Coverage with a Neutral Rating : Baird

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Infosys Technology Ltd.: Resuming Coverage with a Neutral Rating
Action
We are resuming coverage with a Neutral rating. We expect strong growth to continue in
offshore IT Services, and expect Infosys to participate. While we expect continued strong growth,
we are Neutral-rated at 23X C2011E EPS given the potential for industry growth deceleration,
limited margin expansion (INFY currently has industry-leading margins), and potential stock
underperformance if the overall stock market became increasingly volatile.
Summary
* Participation in strong secular shift to offshore IT Services. We expect the continued strong
growth in offshore IT, driven by overall market growth, shift to offshore, and some pricing
benefits. We believe Infosys will grow revenue at least in line with the overall market over the
next few years (likely 15-20%+).
* Industry-leading margins leave little room for improvement. Infosys has generated roughly
30% operating margins over the past couple years. While the progression has been admirable,
we believe there is limited room for improvement, and consider it possible that the company
passes on certain projects to preserve margins, potentially limiting growth relative to peers.
* Long-term pattern of execution. Over the past several years, the company has executed well
to plan. We expect this pattern to continue.
* Strong balance sheet. With about $6/share of cash and no debt, we believe this provides
flexibility for M&A, share repurchases, and dividends.
* We are valuation sensitive. While we acknowledge strong growth and execution, we would
prefer to buy around 20X C2011E EPS (currently 23X), given the potential for revenue growth
deceleration, limited margin expansion, and the potential for stock underperformance if the
markets weakened.
* Price target $75. Our price target reflects 22X C2012E EPS, a similar multiple as the average
over the past five years. We use 25X for Cognizant, which has grown more rapidly than Infosys
over the last several years.

eBusiness/IT Services Nominal exposure to Japan; Impact should be minimal at worst in the near term :: JP Morgan

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• Nominal exposure to Japan. Indian IT companies have about 1-2%
direct exposure to Japan, which we believe is too meager to impact
financial performance. There might be an additional 1-2% indirect
exposure, but again, we do not think that there will be worrying impact.
Moreover, companies have business continuity and disaster recovery
plans in place to deal with such disruptions in business. Some of the IT
companies including Infosys have already suggested that their
operations have not been perceptibly affected.

India Packaged Foods- Much on the Platter :: JP Morgan

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• Big conversion opportunity. Low per capita consumption, rising income
levels, changes in consumption patterns and demographic changes (younger
population and more working women) should drive significant growth for
packaged foods category in India. Entry of new players and growing scale of
modern retailing would further facilitate introduction of more products and
higher impulse purchases. Packaged food consumption at 1.4% of GDP is well
below 2-3% for other emerging markets.
• Lifestyle changes are becoming more pronounced and are influencing
demand for packaged foods. Affordability, convenience, taste, quality and health
benefits are becoming key considerations for increasingly busier and affluent
consumers. Growth in modern distribution/cold chain, packaging innovation
provides platform for packaged food companies to capitalize on these trends.
• Competition seems more focused on innovation than discounting, which is a
key positive for the sector. Innovation has been a substantial driver for revenue
growth and we expect this pace to increase further as companies count on rising
income levels and consumer uptrading. In order to garner higher market share
and sustain robust growth rates, new product launches have picked up a
substantial pace over the past 2-3 years. Maggi (Nestle), Horlicks (GSK), Knorr
(HUL), and Saffola (Marico), are the key umbrella brands that have successfully
extended to new categories. Companies are expanding the universe of
opportunity by adopting new users and usage occasions.
• Margin expansion opportunity still exists. Commodity inflation remains a
challenge (particularly for packaging). However, we see more pricing power
(relative to HPC space), premiumisation across food segments and a benign
agri-commodity price outlook as positive margin drivers. Aided by better
volume and SG&A leverage, we expect EBITDA margins to expand by 30-
40bps for Nestle India and GSK Consumer in CY11E.
• GSK Consumer (OW) and Nestle India (N) are the preferred plays on the
strong growth potential for packaged food industry in India. They have strong
franchises and would be key beneficiaries from any softening in agriculture
commodity prices. We estimate 21-22% EPS CAGR for them over CY10-12E,
which is amongst the highest in our coverage universe and expect these stocks to
sustain premium valuations. ITC (OW) and HUL (UW) also have exposure to
packaged foods with 9% and 5% of respective revenue contribution. Other plays
in this segment are Britannia (NR), Pepsico India, Cadbury India, GCMMF,
Heinz India, Agro Tech Foods (NR) and Venkys India (NR).

Macquarie Research, G7 acts on forex And promise of more from BOJ

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G7 acts on forex
And promise of more from BOJ
Event
 A G7 meeting has produced a commitment to joint intervention to prevent
excessive yen strength. BOJ Governor Shirakawa has suggested that this
would be complemented by further monetary easing.
Coordinated intervention pushes yen weaker
 After a telephone meeting of G7 finance ministry and central bank officials the
statement read “the authorities of the United States, the United Kingdom,
Canada, and the European Central Bank will join with Japan, on March 18,
2011, in concerted intervention in exchange markets”, as we argued was
likely in our note on Monday 14 March.
 Intervention tends to be more effective when there is a coordinated approach.
Moreover, the effect is also more powerful when interest rates are zero, as the
excess domestic liquidity means that there are not the same issues with
sterilisation. Theoretically, Japan could buy every US$ asset in the world with
no domestic monetary consequences. Aggressive intervention from Japan in
FY03 was effective in turning the yen away from the ¥100/$ level. We will not
be able to see the scale of the intervention until early April.
 The intervention in FY03 also showed that if intervention can establish
credible defence of a particular level, then asymmetric risk will push the
exchange rate in the opposite direction. This seems likely to be the beginning
of a weakening trend for the yen and, more broadly, it should reduce the risk
of financial market instability.
BOJ set to complement G7
 The BOJ seems likely to hold an unscheduled meeting in order to produce a
complementary policy response. Shirakawa has said “The Bank of Japan will
pursue powerful monetary easing”. This is open to interpretation, as the BOJ
already describes current policy in these terms, and it has a history of
hyperbole in policy comments. However, during the previous period of forex
intervention the BOJ pursued a parallel expansion of its balance sheet.
 A more intriguing question is whether the BOJ might take a more genuinely
radical approach. This seems unlikely to us, but there is the possibility that if
the government issues reconstruction bonds to fund a fiscal package, then
these could be bought by the BOJ. This idea has been dismissed by Economy
Minister Yosano, although he is noted for his conservative approach that does
not seem suited to the current situation. Direct purchases of government debt
issuance would probably require a change to the BOJ law and, if it happened,
it could be seen as the first step of debt monetisation.
 The next step in the policy response is likely to be the outline of a government
spending package in response to the disaster. At the moment the focus is on
the emergency response to the humanitarian crisis and the nuclear leakage,
but we should soon start to see indications of a fiscal plan.

Bernstein Research, IT Services: 7 Reasons Japan-Induced Pullback is Buying Opportunity on Accenture, Sapient, Cognizant :

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Highlights
We see more compelling buying opportunities for key stocks in our coverage in the wake of the Japanesenuclear-
fear-induced pullback in stocks (see Exhibit 1). We especially think Accenture's stock is very
compelling ahead of its March 24th earnings report. Sapient's recent pullback is very overblown, in our
view. Cognizant is attractive, with Accenture's upcoming report a likely positive catalyst for sector
sentiment. Infosys could offer a positive trading opportunity, ahead of its initial FY12 guidance in April.
In today's piece, we outline seven pertinent reasons to support this "buying opportunity" argument for these
stocks, particularly for Accenture, which we featured as our best idea in our January 12th research
(Accenture, Cognizant, Infosys: Seeing Bullish Demand Progression; ACN Top Idea; Raising ACN, INFY,
CTSH Targets) and reinforced in our March 3rd research piece after another round of industry checks (IT
Services: Updates on Our Favorable Demand Progression Thesis and Stance on Accenture as Top Idea):
 Reason #1 – Japan and Asia/Pacific are not big enough revenue sources for our covered stocks to
be a significant risk for them, as shown in Exhibits 2 & 3. We estimate only about 2-3% of
Accenture's and Visa's revenues are from Japan. And, Japan represents immaterial amounts of revenues
at Cognizant, Infosys, Sapient, ADP, Paychex, and MasterCard.
 Reason #2 – We maintain our stance that Accenture's upcoming report for the February quarter
should show significant upside to consensus revenue and bookings. And we think Accenture's FY11
revenue growth guidance of 8-11% (in local currency) is substantially beatable (note this guidance was
raised from 7-10% in the fiscal Q1 earnings report). That said, despite this room for upside we see to the
FY11 outlook, we think it may be prudent for Accenture to keep its official FY11 guidance in place for
now and hold off on raising its guidance until later this year (e.g., to avoid setting an expectation that it
will "beat and raise" every quarter, and to foster the healthy psychology of investors feeling comfortable
that there's room for upside to guidance). See Exhibit 4 for a comparison of our Accenture estimates
(which we think are conservative) to consensus.
 Reason #3 – Certain periods of fear in the past had relatively little impact on IT services demand,
and we anticipate the current fears about Japan's nuclear issues could have similarly low impact:

Outside of the global financial crisis of 2008-2009 (which shocked IT services clients into a mode of not
making decisions), we've witnessed other periods of fear in the past that have not rendered substantial
consequences to IT services demand. For example, past fears that had little impact on IT services
demand include: debt crisis in Greece in late 2009 and early 2010; swine (H1N1) flu in 2009; Avian
(bird) flu in Asia in 2003 and in Europe in 2005; and various terrorist attacks (excluding those in the US
on 9/11/01), such as the 7/7 London bombings in 2005 and the Madrid train bombings in 2004.
 Reason #4 – We reiterate that a transformational phase of IT services demand has begun and is
unlikely to be stopped anytime soon, given the multi-quarter nature of transformational services work.
For instance, systems integration initiatives (e.g., ERP software deployment) at large companies often
take over a year, and stoppages of such initiatives midstream generally do not occur, unless very negative
circumstances hit close to home. To elaborate on this topic from our prior research:
 How long will this phase of much-improved systems integration demand last? We see ingredients in
place for this phase of demand to last multiple quarters (e.g., more than one year), partly due to
substantial work that didn't get done during the financial crisis (i.e., pent-up demand). Also, we note
that large companies generally cannot implement systems and/or transform business processes in less
than 6 months (i.e., often takes a year or more). Moreover, we underscore our ongoing view that the
primary risk to systems integration demand is a major macro-shock to clients' decision making, while
periods of poor GDP growth (if it occurs without people being shocked by it) should not cause major
problems for the demand of top consulting / systems integration businesses.
 Reason #5 – Latest industry checks reveal no cause for worry about supply chain effects (or ripple
effects) that could stem from issues in Japan: After completing a big round of industry checks for our
March 3rd research piece, we have further revisited demand trends over the past couple of days to see if
we can find any signs of demand issues stemming from Japan-induced fears. We hear general worries
from some investors that issues in Japan could cause supply chain disruptions for companies around the
world (i.e., for clients of IT services firms). However, it does not appear that such supply chain issues
(e.g., delays in getting parts) are prone to cause any significant disruption to systems integration and
application development deals at firms like Accenture, Cognizant, and Infosys, nor should such issues
cause disruption to multi-channel commerce, web advertising, and trading/risk management deals at
firms like Sapient.
 Reason #6 – The systems integration and application development deals that are now being
initiated in this improved phase of demand are supported by a huge amount of planning work that
was completed in 2010, with this planning work evidenced by the major strength we saw throughout
2010 at several leading strategy consulting firms.
 Reason #7 – Large companies (i.e., key clients of top IT services firms) are showing willingness to
invest in more transformational deals, which generally seem unlikely to be eschewed by turmoil in
Japan. We reiterate that we see momentum building in consulting / systems integration demand: Recall
our research emphasis that high-end consulting demand was very strong throughout CY10, reflecting
clients' efforts to plan new initiatives after having been substantially stalled amidst the decision-making
shock during the 2 years of the global financial crisis. After this significant planning work that has been
completed, we see strong evidence today that clients have moved into a mode where they are much more
willing to invest in transformational initiatives (i.e., deal types that are key to Accenture), with
implementations now moving forward.


Investment Conclusion
Summary view on Accenture (Recap)
We rate Accenture outperform (and our top idea). We see demand patterns progressing in Accenture's
favor, as we think strong management consulting demand (in 2010) has now progressed into improved
demand for systems integration deals (including more "transformational" initiatives), along with decent
prospects for outsourcing bookings to be strong in the February 2011 quarter. As a result, we see further
upside to the Street's revenue and EPS expectations. We also think Accenture can achieve its FY11 margin
expansion target, despite starting FY11 with Y/Y margin contraction in fiscal Q1.
 Distinctive Accenture attributes against large tech stocks: Our January 12th research piece showed that
Accenture has distinctive attributes (revenue growth, ROIC) relative to other stocks that are trading at
high free cash flow yields, and we thus contend Accenture deserves a position high on investors' lists of
core tech stock holdings.
 Favorable demand progression pattern: We forecast 11.6% revenue growth for ACN in FY11 (a
forecast that we think is conservative), and we contend ACN is secularly capable of 8-10% revenue
growth, and with this growth much less reliant on economic trends than is perceived (as explained in our
research on IT services cyclicality). Also, we reiterate that strong management consulting demand
(which we witnessed throughout 2010) will likely now progress in upcoming months into improved
demand for ACN's systems integration and outsourcing services. Stated differently, we anticipate a
favorable demand progression from clients' planning efforts into implementation projects and operational
support, as clients' appetites to invest have improved.
 Above-consensus estimates: This favorable demand progression pattern is prone to enable Accenture to
achieve further upside to the Street's revenue expectations in FY11 (ending in August). As such, we
conservatively forecast FY11 revenue growth of 11.6%, which is 1.3% higher than consensus. And we
forecast FY11 EPS of $3.21, above consensus of $3.16 (which has nudged up recently from $3.14).
 Growth resiliency: Also, while some worry about Accenture's revenue growth and bookings outlook in
light of economic uncertainties, we reiterate our view that demand improvement in the IT services
industry does NOT require substantial GDP improvement, but rather the absence of shocks to clients’
decision making — likely making leading IT services firms (e.g., Accenture, Cognizant) more resilient
than other tech firms that are more wed to GDP trends.
 Margins fine: After reporting a Y/Y drop in operating margin in the November quarter, we think
Accenture will likely prove skeptics wrong by achieving its goal of 10-20 bps of margin expansion in
FY11.
Ratings across Computer Services stocks
We have outperform ratings on Sapient, Accenture, Cognizant, and ADP. We have market-perform ratings
on Visa, MasterCard, Paychex, and Infosys. And, we have an underperform rating on CSC.


Performance of Stocks Since Earthquake in Japan
Exhibit 1 shows the performance of Computer Services stocks (compared to the S&P 500 and Nasdaq)
from March 9 to March 16. Interestingly, since March 9, Accenture, Sapient, Cognizant, and Paychex
underperformed the S&P 500 by over 1%.
Especially for Accenture, Sapient, and Cognizant (the stocks we favor most due to prospects to report
fundamental upside), we see their recent pullbacks as compelling buying opportunities


Revenue Mix from Japan and Asia/Pacific
The exposure of Computer Services firms to Japan is quite low (see Exhibit 2), with a maximum revenue
exposure of 2-3% for Accenture (i.e., our estimate drawing from our Accenture FX model) and a similar
exposure of 2-3% for Visa (i.e., our estimate based on Nilson data).
Looking at exposure to the Asia/Pacific region (see Exhibit 3), though Accenture and Infosys have
meaningful exposure at 12.7% and ~10%, respectively, a significant portion of their Asia/Pacific revenue is
from Australia (rather than from Japan and surrounding areas).


Accenture: Our estimates versus consensus and guidance
Exhibit 4 conveys our Accenture estimates versus consensus and guidance.
Note: We maintain that our estimates for the February quarter and for FY11 are prone to be conservative.
February 2011 quarter
 For the February 2011 quarter, we are forecasting 12.5% Y/Y revenue growth, which is higher than
consensus of 10.6%. Accenture's revenue guidance calls for $5.60 to $5.80 billion, with the high end of
this range implying +12.0% Y/Y revenue growth and the low end implying 8.2% Y/Y revenue growth.
 We are forecasting February quarter EPS of $0.72, which is 1 cent higher than consensus of $0.71.
Fiscal year 2011 (ending August 2011)
 We are forecasting 11.6% FY11 revenue growth, versus consensus of 10.3% (which has been upwardly
revised by 0.2 percentage points since January 12). Accenture's FY11 guidance calls for 8-11% revenue
growth (in local currency).
 We are forecasting $3.21 in FY11 EPS, versus consensus of $3.16 (which has been upwardly revised by
2 cents since January 12). Accenture's FY11 EPS guidance range is $3.08-$3.16.
Fiscal year 2012 (ending August 2012)
 For FY12, we are somewhat conservatively forecasting revenue growth of 7.0% (on top of our aboveconsensus
revenues for FY11) and EPS of $3.61, versus consensus of $3.53.



Our Related Research and Summary Points
 Recent industry checks on Accenture and demand: Following an additional round of industry checks at
the end of Accenture's February quarter, our March 3rd research piece (IT Services: Updates on Our
Favorable Demand Progression Thesis and Stance on Accenture as Top Idea) underscored our favorable
demand progression thesis and positive stance on Accenture, as we think later-cycle systems integration
demand is kicking into gear. We see strong signs of demand momentum and believe Accenture has
moved into the "sweet spot" of its demand cycle, with clients now showing a propensity to invest in more
transformational systems integration deals (reflecting an important progression beyond the fast-payback
deals that were predominant earlier in the demand recovery cycle). And, barring a macro-shock to
clients' decision making, we see multiple reasons to expect that this strong phase for Accenture-type
systems integration demand should last multiple quarters. Other pertinent points from our March 3rd
piece:
 "Short-listed" services firms should get disproportionate revenue lift: As the demand recovery
progresses, top services firms that have effectively gained share within the budgets of existing clients
(i.e., as clients have consolidated their suppliers over the past couple of years) should be boosted to
elevated revenues from core clients. In other words, during the financial crisis, we think top firms like
Accenture and Cognizant garnered a higher percentage of spending at a number of large, existing
clients (i.e., at the expense of lower-tier firms). So, as these existing clients add to their spending,
Accenture and Cognizant should naturally derive disproportionate growth.
 BPO signings should be poised to show some improvement: We reiterate that Accenture's momentum
(over the last year) in the management/operational consulting arena has very likely positioned the
company to win certain types of outsourcing deals (e.g., industry-specific BPO deals). As a result,
Accenture's outsourcing business should achieve improved bookings in the February quarter.
 Cloud demand has further progressed, but not key to next-12-months growth in the consulting /
systems integration market. Cloud-related spending to date has largely focused on data center
initiatives (e.g., virtualization) and relatively small "discovery" projects to help clients evaluate/plan
for the cloud era. We now see more evidence of software-related cloud initiatives (e.g., clients
engaging consultants to help in piloting cloud software usage). But, we still think it's premature in the
near term to expect major spending on cloud software deployment and integration initiatives.
 HP's weakness should not be an issue: We think concerns in late February about Accenture, Cognizant,
Infosys, and Sapient stemming from HP's weak results were overblown. We think systems integration
demand is thriving; and we see no reason to alter our "favorable demand progression" thesis. And, we
think weakness in HP's services business is attributable to HP having a very different business mix and
company-specific issues, as we explained in our February 23rd research piece (Quick Take - Weakness at
HP Should Not Have Negative Implications for Accenture, Cognizant, Infosys, Sapient).
 Favorable demand progression; ACN as top idea: Our evaluation of Accenture against other tech
stocks suggests its distinctive attributes may be underappreciated, and our January 12th research piece
(Accenture, Cognizant, Infosys: Seeing Bullish Demand Progression; ACN Top Idea; Raising ACN,
INFY, CTSH Targets) featured Accenture as our top idea. Moreover, in this research piece, we
explained our "favorable demand progression" thesis.
 Leading indicators: As detailed in our November 12th research piece ("IT Services: Rebound Happened;
Cisco Brings Concerns; What Now? Still See Encouraging Leading Indicators for ACN, CTSH), we see
solid reasons to believe the leading indicators of discretionary services spending trends are still showing
generally positive signs; these reasons stem from our checks with key contacts in the consulting market
and our analysis of consulting bookings results, temp labor data, and staffing firms' growth trends.



 Cloud Computing: While some are concerned that cloud computing could hurt demand for systems
integration services, we reiterate our research conclusion that cloud computing should be a net
opportunity for Accenture. For details, here's the link to our 4/7/2010 research piece on this topic:
Accenture: What Impact Will Cloud Computing Have on ACN's Demand & Business Model? Views,
Info Ahead of Analyst Day.


Valuation Methodology
Our target prices for IT services stocks are derived by applying multiples to our forward estimates of
earnings and cash flows. Our target multiples are determined based on our assessments of historical priceto-
forward-earnings multiples, after considering each company’s growth prospects relative to historical
levels. Our target multiples are also influenced by the results of our DCF analyses across various financial
scenarios for each company.
More specifically, for IT services and offshore services firms, our target share prices are derived by
applying the following P/E multiples to our calendar 2012 EPS estimates: Accenture 15.3x, Sapient 22.4x,
CSC 6.4x, Infosys 20.2x, and Cognizant 24.0x.
For processing companies, our target share prices are derived by applying the following P/E multiples to
our calendar 2011 EPS estimates: MA 13.5x, Visa 15.3x, ADP 20.1x, and PAYX 20.3x.
As an alternative method of calculating our latest $14.75 target share price on Sapient, we apply a target
P/E multiple of 18.4x to our 2012 EPS estimate with a 28% normalized tax rate assumed (i.e., EPS of 71
cents), while also giving Sapient valuation credit for its $1.67 of cash per share. This target multiple is
supported by Sapient's takeover prospects, substantial room for margin expansion, and long-term growth
prospects in attractive segments like multi-channel commerce, Internet advertising, and trading/risk
management.
As alternative method of calculating our target share price on CSC, we apply an EDS-takeover multiple
(i.e., FCF multiple of 12.05x) to our estimate of CSC's "normalized" free cash flow (i.e., FY10 FCF
excluding the impact of lower DSO).
Also, note that, in addition to prospects for stock appreciation, Paychex, ADP, CSC, and Accenture offer
meaningful dividend yields.
Risks
The primary risk to consulting names (Accenture and Sapient) achieving our target share prices is the
potential for pressures on discretionary services spending. In addition, negative economic news flow can
weigh on the sentiment (and valuation multiples) of consulting stocks, and Accenture's stock has a tendency
to be pressured by appreciation of the US dollar (due to Accenture's substantial international exposure).
The primary risks to IT outsourcing companies’ (e.g., CSC, HP/EDS, Perot) fundamentals include contract
restructurings/terminations (a significant risk for CSC) and the shift of IT outsourcing work to offshore
labor centers (a threat to CSC). Further, our research shows the emergence of the offshore/remote
infrastructure outsourcing business, which will enable Indian firms to move into the core market segment of
CSC, and this trend will add pressure to CSC. It is prone to cause some cannibalization of CSC’s existing
infrastructure outsourcing revenues and some share loss to Indian and niche players moving aggressively
into the offshore/remote infrastructure outsourcing business. We also maintain a concern about CSC’s high
balance-sheet accruals. The risk to our underperform rating on CSC is that restructuring efforts and new
strategies could drive EPS improvement and share price appreciation.
Risks facing our target prices on Indian IT services stocks (e.g., Infosys and Cognizant): We still maintain
longer-term concerns about rupee appreciation (see our 10/22/07 research call for an analysis of factors that
could affect future moves in the Indian rupee), margin contraction (due partly to increasing needs,
especially for Infosys, to invest in onshore capabilities and industry-specific solutions), tax rate
normalization (i.e., tax rates for top Indian firms should jump to north of 20% when the STPI tax haven in
India expires), and meaningful hurdles related to supply and competition.


An underlying risk to achieving our target prices on Paychex and ADP is cross-selling leverage failing to
materialize, causing expectations of long-term earnings growth to be revised. In addition, weak U.S.
employment growth can hurt the stocks' valuations, present a challenge to their margins, and incrementally
pressure their revenue growth. Downward pressures on interest rates can mar sentiment and reduce ADP’s
investment income from both client funds (float) and corporate investments (note that the yield on
Paychex's float portfolio does not have material room for downside).
A number of risks could prevent our target prices on MA and V from being realized, including:
 We see a number of potential competitive threats, which could transpire over the long term, e.g.,
encroachment from mobile payments and alternative payment providers (e.g., PayPal), growth of
competitive international networks (e.g., China Union Pay), and some possibility of banks moving into
the card network business.
 Regulatory change (e.g., related to interchange) is an ongoing risk, and substantial litigation is pending
against MA and V, with MA more exposed to possible future litigation liabilities since V has an escrow
fund and bank shareholder stock buffering its earnings exposure.
 Weakness in consumer spending and any hiccups in the revolving credit market can hurt volume and
transactions growth.
 MA and V can lose revenues if a card issuing bank converts to different a debit card brand, or shifts
issuance of credit cards from one brand to another. They can also lose revenues if merchants succeed in
shifting more debit volume from signature debit to PIN debit.
 Obstacles to cross-border travel activity can hurt the cross-border revenues earned by MA and V.
 Besides being affected by general spending activity, MA's and V's growth rates are materially affected by
moves in gas prices in the United States. For MA and V, gas purchases account for about 6% and 10%,
respectively, of U.S. payment volume (and likely account for higher percentages of U.S. transactions.

Weekly US oil data Upheaval beats s/d news : Macquarie Research

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Weekly US oil data
Upheaval beats s/d news
The latest weeklies are boring in the sense that they do not change our
impression of the constructive trends developing in the US. These data also pale
in significance to the world-shaking events in Japan and the latest twists and
turns of the black turtle of markets that is the ongoing upheaval across MENA.

Declining food inflation and rising cost pressures : centrum

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Declining food inflation and rising cost pressures
Inflation in Feb 2011 rose to 8.3% from 8.2% in Jan 2011 despite the sharp fall in food
inflation. The rise is attributed to the sharp increase in cotton and oil seed prices. While
there is some reciprocal rise in manufactured product inflation to 4.9%, the broader
assessment indicates intensifying margin pressure and declining pass-through coefficient.
While the risk of further escalation of costs persists, we believe further monetary
tightening could hamper the growth outlook.

IPO, Grey market premium : PTC India, Lovable, SBI Bond : March 20, 2011

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Company Name	Offer Price	Premium
	(Rs.)	(Rs.)
Lovable Lingerie Ltd.	205 (Upper Price Band)	55 to 60
PTC India Financial Services	26 to 28	Discount
SBI Bond	10000	290 to 300

Indian Telecoms GSM incumbents going strong - Feb net adds; Active subs in Jan at 71% : JP Morgan

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• India added 14.7m GSM subs in February, a strong number with
7% M/M growth. This was driven by strong adds at Vodafone and net
gains at Videocon vs. a net loss in January.
• GSM incumbents don’t see adverse sub impact in February: Idea’s
net adds are flat M/M at 2.5m – a good number in our view – while
Bharti’s net adds declined slightly to 3.2m from 3.3m in January but still
a healthy number. Vodafone added a strong 3.6m subs in February, up
14% M/M. These strong adds from the GSM telcos suggest little impact
from MNP driven churn. We continue to believe the impact from MNP
is not on volumes but more so on pricing as telcos make efforts to retain,
acquire high-end subs.
• BSNL’s net adds have declined by ~30% to 1.5m from 2.2m while
Uninor’s net adds slowed by about the same rate to 1.3m from 1.8m.
• Active subs – Bharti, Idea, Vod stack up better: with 93%, 90% and
78% of their reported base showing up as VLR (as of January 2011) are
leading the pack while RCOM has 66%, Aircel at 60% and some new
operators like S Tel and Etisalat at 41% and 34%. Overall for the market,
TRAI believe that 71% of India’s base is active implying penetration of
46% vs. 65% reported. See page 2 for more details.
• Smaller % of active subs 􀃆 sub metrics appear better for some, but
focus on minutes, ARPM: With a lower number of active or “revenue
generating” subs than reported subs, the per user metrics (ARPU, MOU)
for RCOM appear meaningfully better while those for Bharti and Idea
are slightly better. However, in our view this does not impact underlying
operations which we continue to view via total minutes on the network
and realization per minute carried


TRAI has been released VLR (Visitor Location Register) based subscriber data since
December 2010. According to that, 70.4% of India’s reported sub base was active in
December and 71.1% in January.
Implied penetration for India is ~19pp lower – positive for growth: Penetration
implied by VLR is 44.5% and 46.1% for December / January vs. reported penetration
of 63.2% and 64.7%.


Bharti, Idea, Vod stack up better: with 93%, 90% and 78% of their reported base
showing up as VLR (as of January 2011) are leading the pack while RCOM has
66%, Aircel at 60% and some new operators like S Tel and Etisalat at 41% and 34%.
It is important to note that VLR data includes active subscribers on the last working
day of the month. A sub may be registered in HLR (Home Location Register) but not
in VLR if his/her device is switched-off, outside of the coverage area or not
reachable.

Credit Suisse : India Telecoms- - So what does 3G really mean in India?

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India Telecoms Sector-----------------------------------------------------------------------------------------
So what does 3G really mean in India?


● With all four 3G spectrum holders in Mumbai having launched
their services, we decided to conduct field trials to understand the
quality of various services, as well as the tariffs on offer.
● Data download speeds have improved significantly over the
GPRS speeds seen earlier, but are still a far cry from the
promised high speeds that we are awaiting from 3G. Further,
tariffs are not lower than comparative wireline tariffs and hence
could be a deterrant to mass uptake.
● Video calls are available on MTNL, Bharti, RCOM networks – and
are of acceptable quality. Mobile TV services are available with
Bharti, RCOM and Vodafone, and are of exceptionally good
quality with around 30-50 channels being offered by each
operator. However, on both video calls and mobile TV, we believe
tariffs are prohibitively high for these to gain mass acceptance.
● We see little upside to our estimate of 3G contribution to mobile
EBITDA staying below 5% three years after launch. However, we
remain positive on overall fundamentals and retain OP on Bharti
and Idea.

Petronet LNG – U-turn : RBS

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We upgrade PLNG from Sell to Buy and raise our TP from Rs57 to Rs150. Lower KG-D6 gas
production has dramatically improved the growth prospects for LNG, especially as new
pipelines become operational. Given a lack of regulation, we also see potential for the annual
escalation in regas tariffs to continue.

Macquarie Research: Lead market solid, supporting price

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Commodities Comment
Lead market solid, supporting price
 Lead is the only LME metal to be trading at a higher price today than at the
start of the month. Lead gave up less ground in the recent sell-off but has still
bounced strongly in the latest rally. Are there any good reasons for this? The
latest demand indicators and physical market price signals (premiums, scrap
prices and treatment charges) are positive. LME stocks are high but Chinese
data suggest de-stocking in the world‟s largest market and total reported stocks
are not very high. In the medium term the potential for demand growth is clear
but there are supply side challenges. Overall the lead market looks solid to us.

Gujarat Co-operative Milk Marketing Federation Ltd - JP Morgan -India Packaged Foods Overview

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Gujarat Co-operative Milk Marketing Federation Ltd (GCMMF) is a state-level
conglomeration of milk cooperatives based in Gujarat and has 2.9mn producer
members. It is the largest dairy and food manufacturer in the country and its leading
brand ‘Amul’ holds strong consumer franchise across dairy products. The company
benefits from its strength across its supply chain. It sources milk daily from 2.9mn
producers and has an efficient nationwide distribution system. Its value-for-money
and high quality products enjoy strong consumer affinity.
It has 13 district cooperative milk producer unions affiliated to it, which procure milk
from dairy farmers and produce various value-added products. GCMMF collected
3.32bn litres of milk in FY10. It is also the largest exporter of dairy products from
India.
It enjoys dominant shares in icecream, milk, butter, cheese, yoghurt and milk powder
categories. GCMMF has nearly doubled its revenues over past three years.

Benchmark Junior Exchange Traded Fund: Invest ::Business Line

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Looking for a high-risk, high-return portfolio that is sure to rebound when the stock market recovers? The basket of stocks making up the Junior Nifty index seems to be your best bet.

You can acquire this basket by simply buying units of the Nifty Junior Benchmark Exchange Traded Fund (Junior BEES), which tracks the Junior Nifty index. We offer three reasons to buy this ETF:

MORE RESILIENT

Made up of stocks that are neither slow moving large-caps nor untested mid-caps, the Junior Nifty portfolio offers a good balance between growth and quality.

As the Junior Nifty is supposed to be an ‘incubator' for the Nifty, it doesn't feature companies with a very low market cap that suffer from poor liquidity or high impact cost (the tendency of the price to swing if big deals are put through in the stock). Both are usually risks with mid or small-cap stocks.

Currently, the stocks in the Junior Nifty carry an average market capitalisation of about Rs 14,400 crore.

Stocks in the CNX Midcap basket in contrast, average only half this market capitalisation (Rs 7,100 crore). They are also much larger in terms of sales and profits and may withstand risks such as rising input costs and interest rates better.

The Junior Nifty is heavily tilted towards banks, financial services, pharmaceuticals and capital goods, sectors likely to benefit from secular growth in the Indian economy over the long term.

These sectors offer a good buying opportunity today, as they have borne the brunt of the recent market fall.

Between November 2010 and now, the Junior Nifty BEES has seen its unit price fall by 22 per cent. Its price-earnings multiple (PE) has dropped from 21 times trailing 12-month earnings to just 15.

The Junior Nifty is today available at a discount to the CNX Midcap index (PE of 16.5). It obviously carries a sizeable discount to the Nifty (PE of 21).

HIGH-BETA

The Junior Nifty has always been one of the indices to make the best of bull markets (while also suffering the worst damage in a meltdown). The index' 124 per cent return in 2009, as the markets rebounded from a trough, was the highest among the various indices (Nifty returns 71 per cent, Midcap index 95 per cent). The index's three-year return at 12.2 per cent is well ahead of the Nifty (6.5 per cent) as well as the Midcap index (7 per cent).

Investors in the Junior Nifty BEES must however watch out for the following.

One, this ETFs value can drop like a stone during a market decline. Remember that it lost 64 per cent in the 2008 fall. It is therefore, not for risk averse investors.

Two, market prices of ETFs can diverge quite a bit from their underlying NAV. Therefore, check the underlying NAV of the fund before you punch in the price, while buying units through the stock exchange.

Three, given the high-beta nature of this ETF, a five-year plus holding period is a must to give the investment time to recoup any losses from a market fall.

A unit of Junior BEES traded at Rs 105 on March 18.

India Strategy – Lower gov't cash helping liquidity :: RBS

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The recent Rs1.2trn liquidity improvement in the repo markets (end December to early
March) has been primarily driven by the Rs1.1trn decline in government cash balances over
the same period.
Government cash balances down to the minimum mandated levels
According to the Reserve Bank's latest weekly statistical supplement, central government
cash balances with the Reserve Bank had declined to the minimum mandated level of Rs1bn
for the week ended 4 March 2011, down from Rs275bn the week earlier. Government cash
balances with the Reserve Bank peaked at Rs1,062bn for the week ended 24 December
2010. As such, government cash balances have declined Rs1,061bn from their peak (this
data is available on a weekly basis). The high level of government cash balances was a key
contributor to tight liquidity, in addition to loan growth outpacing deposit growth.
Banks' net repo borrowing has declined by roughly the same amount
Net bank repo borrowing under the Liquidity Adjustment Facility (LAF) of the Reserve Bank
declined by Rs1,209bn from its peak of Rs1,705bn on 22 December 2010 to Rs496bn on 4
March 2011 (this data is available on a daily basis). Net bank repo borrowing was Rs557bn
on 11 March 2011, representing 1.1% of commercial bank deposits. These recent levels are
in line with Reserve Bank's comfort levels of the LAF being at (+/-) 1% of the net time and
demand liabilities of banks versus the 3.6% levels at the peak in late December.
Liquidity could tighten a bit with a build up in government cash balances
According to the revised estimates for FY11 in the recently published FY12 budget
documents, the government expects a net increase of Rs150bn in its cash balances for FY11
(implying a year-end cash balance of Rs189bn versus Rs39bn at the end of FY10). This
would imply an increase of Rs188bn from current levels, which could lead to some tightening
in liquidity.

Britannia Industries (Not Rated) - JP Morgan -India Packaged Foods Overview

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Britannia is a leading packaged foods manufacturer in India with strong presence in
biscuits category where it enjoys 35% share. It also has presence in bakery products
(bread, rusk, cakes etc) and dairy products (cheese, milk, flavored milk etc). Over
past four years Britannia has doubled its turnover, however profitability has lagged
on account of firm input cost inflation and rising competition in biscuits category.
Strong brand equity. In the recent 2010 Nielsen brand equity survey Britannia was
rated the topmost foods brand in India and was the fifth ranked brand across all
categories in brand equity. It is one of the very few brands in the country which has
enjoyed such high brand equity for several years.
Innovation is a key strength. Britannia has been very innovative in biscuits segment
launching successful brands like Good Day and Nutrichoice. It has introduced new
products, pack sizes besides exploring new distribution channels (BPOs, kiosks at
bus, railway terminals etc) to propel topline growth. It has been fairly active in
diversifying its portfolio towards non-biscuits categories like dairy (flavored milk
based drinks, various cheese variants) and very recent foray into breakfast meals
(under Healthy Start brand).
Premiumisation is a key focus area for the company. It has witnessed steady
increase in share of premium products in its overall portfolio. Its strategy of
introducing premium biscuits in smaller pack sizes has supported faster growth for
this sub-segment. Focus on value added offerings (healthy, indulgence, on the go
snacks) bodes well for better margin profile in medium term as per management.
Volatile commodity costs and high competitive intensity are key risks for
margins as per management. Britannia’s EBITDA margins of 5% (vs 7-8% 2 years
back) are amongst the lowest for branded FMCG players in India. Management
noted that volatile input costs (wheat, sugar, milk) coupled with rising competition
(from ITC, Parle) have been key reasons for margin drag. However they are
optimistic that calibrated price increases and better product mix will help in
improving margin profile going forward.
Enhancing distribution reach. Another focus area for the company is to further
strengthen its distribution network. It currently directly reaches 850,000 outlets while
the overall reach is 3.5mn outlets. The company operates through 2,500 urban
distributors and a large number of rural redistribution stockists.

Macquarie Research, Tech Express- Regional Supply chain - Quake impact

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MacqTech Express
Regional Supply chain - Quake impact
Event
􀂃 Our Japan tech team assesses the implications from the devastating quake in
Japan. The three key areas to focus on are 1) physical production damage
(Shin-Etsu, Tokyo Electron, Renesas), 2) supply chain/logistical disruptions
(semi-wafer, connectors, passives), and 3) psychological impact (memory spot
price, battery, TFT-LCD). Near-term disruption is likely in semi-wafers, memory,
and connectors, leading to spot price strength in areas like DRAM/battery, but
downside for PC cost structure and smart phone supply chain. While the focus
is on plant damage and supply chain logistics, we caution that a bigger negative
impact to regional tech would arise from a prolonged power rationing as a result
of the nuclear power plant issues in Japan.
Impact
􀂃 Semi wafer - disruption. Damian Thong’s checks indicate Shin-Etsu’s
Shirakawa fab (300mm) saw no major damage, but restoring production may be
complicated by the need for inspection/repairs, logistical disruption, unstable
power, and close proximity to Fukushima nuclear plant (60-70km away). Shin-
Etsu has ~30% unit market share in 300mm wafers and accounted for >1m
units/mo of supply vs demand of 3.6m units/mo in 4Q CY10, of which ~75% is
used in memory. Shin-Etsu is the #1 supplier to Elpida and #2 supplier to
Toshiba, thus if output is disrupted for an extended period, we expect there to
be wafer shortages throughout the chip industry, which may be compounded if
there is disruption to MEMC's 300mm wafer production plant in Utsunomiya as
well. SUMCO, the second supplier (0.4m units/month of excess capacity), could
benefit, but wafer shortages could overall curb memory chip production and
cause a spike in pricing, leading to pressure on the PC and smartphone supply
chains.
􀂃 Connectors-impacted. George Chang’s check show limited physical damage
to Hirose’s plants, but potential supply chain impact due to issues at smaller
part suppliers. Hirose has ~21% global share in connectors (Molex is its biggest
competitor), thus potential impact could be felt in handset/smartphone space.
􀂃 Passives - some impact. Japan is ~70% of passives global share. There is no
physical damage to the plants of vendors like Murata, TDK and Taiyo Yuden,
but short term impact in production and supply chain is likely and may lead to
some spillover to other vendors such as Semco (high end MLCC) and
potentially Yageo at the mid-to-low end. Nippon Chemi-Con's major plants are
located in the northeast so there could be production disruption to its aluminium
capacitor which could impact motherboard, TV, and power supply chain.
􀂃 Displays - neutral impact. Our LCD checks indicate minor damage to AGC’s
tanks for small/medium panels, but GLW’s furnaces are operational. IPS’s 6G
fab could see some shutdown, but Sharp is intact. We see limited impact in
LEDs. Overall, we believe any shutdown or prolonged supply chain disruption
from power outages would help panel makers firm up pricing negotiations
Outlook
􀂃 We expect near-term disruption from the quake damage as well as supply chain
issues. While the near-term headlines and focus is on the production damage
and supply chain disruption from the quake, we believe an overlooked but
potentially more lasting impact could come from any extended power shortage
or rationing, as this would lead to severe dislocation of the supply chain and a
likely downwards revision in the end demand outlook.

Agro Tech Foods (Not Rated) - JP Morgan -India Packaged Foods Overview

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Agro Tech Foods: Key products
Category Key brands
Vegetable Cooking Oil Sundrop
Popcorn Act II
Peanut butter Sundrop
Source: Company reports and Euromonitor.
Agro Tech Foods is a 48% associate of the US food major ConAgra. It is present in
the edible oil segment with Sundrop brand and other products include Act II popcorn
and peanut and chocolate pudding under Sundrop brand.
Takeaways from recent post earnings conference call:
Distribution expansion & brand building are key action points for Act II. From
nearly 54K stores access in 2007, ActII is now sold across 350K stores (up from
300K stores in early 2010). Management aims Act II to reach 0.5mn outlets over next
year and has long term target of reaching 1.5mn outlets.
Improving portfolio mix. Besides divesture of low margin Rath edible oil brand and
strong focus on popcorn, the company is looking to scale up its presence in peanut
butter category. They are looking to manufacture this product locally this calendar
year (to save on import tariffs and improve profitability) and have acquired land in
Gujarat to set up a plant for the same. Company has divested their low margin Rath
edible oil brand to Cargill in December. As a result, management expects margins
will benefit overall with this divesture.
Overall management expects value added non-edible oil products to grow over
50% in terms of revenue. They may consider introducing a third brand in their
portfolio (leverage parent Conagra’s portfolio perhaps). Would target niche segments
(with potential minimum category size of Rs1bn) where they can enjoy pricing
power.

JSW Steel -Opportunity in IT : Macquarie Research

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JSW Steel
Opportunity in IT
Event
 Income tax raid on JSW gives an opportunity: NDTV reports on an income
tax (IT) raid have created nervousness in the stock. We believe that JSW is a
professionally run company and we don’t think anything major will come out of
this inquiry. The business outlook has improved for JSW and we believe it is a
good pick given these declines. We maintain our Outperform with a target
price of Rs1,200.

India Strategy – Core inflation is back : RBS

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February's headline WPI of 8.3% surprised market expectations of 7.8% as core
manufacturing inflation surprised to the upside. Seasonally adjusted mom core
manufacturing product inflation reached record levels for the 2004-05 inflation series.
February headline yoy WPI of 8.3% vs Bloomberg consensus of 7.8%

JP Morgan: RBI expectedly raises rates by 25 bps; signals continuation of anti-inflationary stance

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India: RBI expectedly raises rates by 25 bps; signals continuation of anti-inflationary stance

RBI raises policy rates by 25 bps in line with market expectations and signals continuation of its anti-inflationary stance March inflation forecast revised up to 8% oya from 7% on non-food manufacturing and oil price concerns RBI expresses concern on slowdown of investment momentum and its implications for growth in FY12 While encouraged by the extent of fiscal consolidation being attempted in FY12, the Central Bank worries about higher-than-budgeted subsidies pressuring expenditure management RBI reduces its FY11 current account deficit forecast to 2.5 % of GDP from 3.5% of GDP

GSK Consumer (Overweight) - JP Morgan -India Packaged Foods Overview

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Synonymous with malted beverages. GSK Consumer is the market leader in
India’s malted food drinks category with over 70% share, and enjoys strong brand
equity with a pan-India distribution network. It benefits from astute marketing and
innovation, which in our view should continue to support market share gains and mix
enhancements.
Growth strategy based on nutrition, widening distribution reach, and
expanded product portfolio: We expect the company to deliver 21% earnings
growth over CY10-12E based on high growth prospects for the processed foods
category, a strong and differentiated product portfolio, and favorable margin outlook.
It is one of the few companies in the consumer space that does not face significant
competitive challenges. Diversification of the product portfolio (towards high-growth
segments like instant noodles, biscuits & energy drinks), expanding direct
distribution reach and rising scale of modern retailing should support healthy sales
growth.
Margins to benefit from price hikes and moderation in A&P spend. We expect
margins to trend up despite high commodity prices owing to its high pricing power
and superior gross margin profile. Ad spend, currently at peak levels of 16%, is
likely to drop from CY11/12 as new products ramp up, further supporting margin
expansion.
Improvement in return ratios; Use of cash will be crucial. We expect better
working capital efficiency and limited capex requirements to support high FCF
generation. GSK had cash and equivalents amounting to Rs225/share (c10% of
MCap) as of Dec’10. We believe an increase in the dividend payout remains a strong
possibility in coming years given the lack of suitable inorganic growth opportunities
in the domestic market.


GSK Consumer (Overweight)
We base our target price on PEG of 1.5x which is in line with average PEG ratio for
Indian consumer staple companies. Our Dec-11 price target is Rs2580, implying
CY11E and CY12E P/E of 29x and 25x respectively, is supported by an earnings
CAGR forecast of 20% over CY11-13E and led by strong volume growth and rising
penetration of processed foods in the country.
Key risks to our recommendation and price target are: (1) slowdown in consumption;
(2) significant raw material inflation; (3) aggressive competition; and (4) the entry of
new players in the malted food drink space.

Telecom: Feb GSM SIM net adds - strong growth and solid show from incumbents :Kotak Sec

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Telecom
India
Feb GSM SIM net adds – strong growth and solid show from incumbents. India’s
GSM operators (excluding RCOM and TTSL) added a net 14.7 mn SIMs in the month of
Feb 2011 versus 13.7 mn in Jan. Bharti, Idea and Vodafone continued their solid
growth, together accounting for 63% of net adds. Nevertheless, these are SIM net adds
and the absolute numbers bear little meaning – market share and trends do, of course.
Bharti and Idea are on track to meet our end-March 2011E SIM base estimates.

Tata Sponge Iron: Buy ::Business Line

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In a volatile pricing environment for steel, low leverage and high levels of integration provide a good margin of safety for profits. One such company, Tata Sponge Iron, appears to be an attractively priced bet at Rs 317 or 5.6 times trailing twelve month earnings. Captive power, long-term arrangements for iron ore with parent Tata Steel and a 45 per cent stake in coal mines that are to be commissioned in 2013 provide the company with room to manoeuvre and possibly bolster margins over the next two fiscals.

While the company's valuation is on a par with peers such as Prakash Industries and MSP Steel and Power, higher levels of capacity utilisation and tight operations with mines in close vicinity compared with peers make Tata Sponge Iron a preferred play in the sponge iron space.

BUSINESS

Tata Sponge Iron has the capacity to produce around 3.3 lakh tonnes of sponge iron at a facility in Orissa. Sponge iron is an intermediate in the production of steel and is utilised by secondary steel producers in arc furnaces as a complement to scrap.

Utilising sponge iron as an input for steel production has a host of advantages, including a more optimal composition of ‘furnace' input and lesser dependence on imported scrap whose supply and prices are more volatile. Just under 44 per cent of the company is controlled by Tata Steel and Tata Sons. The company operated at 92 per cent utilisation levels in the last fiscal, maintaining this in the current fiscal too.

Sales and net profits have grown at 37 and 14 per cent to Rs 485 crore and Rs 58 crore, respectively, over the first nine months of FY11 compared with the same period last fiscal.

The company has seen no capacity additions since 2007. Net sales have moved from Rs 455 crore in FY08 to Rs 520 crore in FY10.

Net profits have moved from Rs 96 crore to Rs 85 crore, thanks to a higher raw material bill which has outpaced sponge-iron realisations. Operating margins have hovered between 28 per cent (in the most recent fiscal) and 37 per cent.

However, favourable dynamics for sponge iron prices with increasing demand from steel alloy producers (who operate utilising arc furnaces) is likely to work in the company's favour, enabling it to enjoy operating margins of 15-20 per cent.

Working in favour of the company's net profit margins is the fact that there is no debt to service and stable depreciation expenses. This should also serve the company well in its effort to bring its coal mines on-stream.

Around 25 km from its Orissa plant are the iron ore mines the company has leased to parent Tata Steel. These mines supply the company with high-quality iron ore at rates considerably lower than those in the spot markets.

Similarly, the company has a 45 per cent stake in a venture that been allotted coal mines with reserves of around 120 million tonnes. Bringing these coal mines on-stream by FY13 will be a key move for margin expansion as the company's coal bill accounts for 60 per cent of raw material costs.

PRICE OUTLOOK

Sponge iron prices are up around 25 per cent over the last three months tracking steel prices, which are up as a result of the spike in input costs.

With several evolving supply side constraints for steel scrap, including curtailed exports from Russia (third largest exporter mulling a ban) and Japan (the second largest scrap exporter), there is the possibility of increased demand for sponge iron, driving up prices.

This is despite falling iron ore prices as secondary steel producers turn to an increasing proportion of sponge iron as a furnace input.

The major challenges for the company include the substantial hike in input costs as Coal India increased prices of high-grade coal by 30 per cent last month