Investor's Eye
[June 17, 2013] | | |
| Summary of Contents
PULSE TRACK RBI mid quarter policy review: maintains status quo on rates and cautious view on inflation As expected, the Reserve Bank of India (RBI) maintained status quo on the key policy rates (repo rates at 7.25%, cash reserve ratio [CRR] at 4%) in its mid quarter policy review. In view of uncertainty in global economy (particularly US) and India's high current account deficit, RBI refrained from monetary easing. The apex bank also stressed on the need to contain the CAD at sustainable levels (2.5% of the gross domestic product [GDP]) and achieve a sustainable decline in inflation for monetary easing. To spur growth, the RBI urged the government to create a favourable atmosphere to accelerate private investments and implement the pending projects. Given the RBI's discomfort over food inflation and CAD, we expect the RBI to remain cautious about monetary easing in the near term.
STOCK UPDATE Persistent Systems
Recommendation: Buy
Price target: Rs600
Current market price: Rs506 Upgrade to Buy
We have recently interacted with Mr Rohit Kamat, chief financial officer of Persistent Systems Ltd (PSL), to discuss the current state of business and concerns around the US immigration bill. The commentary on demand environment continued to remain optimistic, with decent visibility in the deal pipeline, though there is some softness in the deals conversion on product engineering services (PES) side of business. The deal closures are taking more time as compared with time taken two years back (however, we could witness some improvement on a sequential basis). On the intellectual property (IP)-led business side, the management expects a quarterly uptick in Q1FY2014E after a soft Q4FY2013 (on sequential basis). Overall, the management expects H2FY2014E to be better than H1FY2014E on account of revenue acceleration from HP Client Automation (HPCA) deal (IP-led revenues). The EBITDA margin is expected to decline sequentially in Q1FY2014E (in line with earlier commentary) on account of onsite wage hike (2%) and visa costs (approximately $1 million) coupled with initial knowledge transfer cost of HPCA. Depreciation in the rupee is unlikely to negate the margin headwinds in the current quarter as the currency benefits were only for one month (June 2013). On the impending US immigration bill, the management expects a potential negative impact of 100-150 basis points on the margin in FY2015E (PSL will be relatively less affected from the impending bill among the Indian information technology [IT] companies).
Overall, there is no marked departure from the earlier management commentary, with expectations of revenue growth ahead of the National Association of Software and Services Companies (Nasscom) guidance and a decline in the margin in FY2014E (based on current USD/INR of Rs54; however, if the rupee continues to stay at around Rs57-58 level over Q2FY2014E-Q4FY2014E, it will negate majority of the margin headwinds for FY2014).
Valuation: We continue to maintain our positive stance on PSL's business model and management bandwidth to take the growth forward and believe it as among the best managed company in the mid-cap IT space with best-in-class margin profile. Further, given its highest offshore revenues among the Indian IT companies, there will be materially lower impact on the margin from the impending US immigration bill. At the current market price of Rs506, the stock trades at 9.7x and 8.5x earnings estimates for FY2014E and FY2015E (based on USD/INR of Rs54 and Rs53.5 respectively). Given the room for potential upgrades from the consistent rupee depreciation coupled with recent correction in the stock (corrected 12% in the last three months), we have upgraded our rating to Buy from Hold with a price target of Rs600. Mahindra & Mahindra
Recommendation: Buy
Price target: Rs1,129
Current market price: Rs989 M&M to consolidate automotive component business
Mahindra Systech to consolidate auto component business
Mahindra entered into an agreement with CIE Automotive (CIE), a Spain-based component player, for forming up a consolidated company that would merge the automotive (auto) component business of Mahindra and Mahindra (M&M; held under the Systech Group, which contains five companies [Mahindra Forgings, Mahindra Ugine Steel, Mahindra Composites, Mahindra Hinoday and Mahindra Gears]), and the forging business of CIE in Spain and Lithuania.
The business would be merged under Mahindra Forging, which would be rechristened as Mahindra CIE. Mahindra CIE would continue to be listed on the stock exchanges. M&M would hold 20% stake in Mahindra CIE while CIE would hold about 51% of the merged entity.
Mahindra to sell stake in Systech business; to pick 13.5% stake in CIE
As part of the agreement, M&M would sell its stake in Systech division to CIE for a consideration of Rs670 crore. The stake sale would be in Mahindra Forgings (52.65% stake for Rs393.08 crore), Mahindra Hinoday (64.96% stake for Rs268.96 crore) and Mahindra Composites (30.38% stake for Rs10.01crore). Also, M&M would invest Rs340 crore (paid on account of acquiring other partner's stake in Mahindra Ugine Steel), which would form the consideration for the deal.
M&M would invest Rs740 crore to get a stake of 13.5% in CIE. It would invest the sum at price of Euro 6/share as against the current price of Euro 5.57/share.
Mahindra CIE alliance to be larger component player with global reach
The Mahindra CIE alliance would lead to formation of a larger component player with combined sales of Rs15,000 crore (Euro 2.2 billion) having operations across the USA, Europe and Asia. While M&M would benefit from CIE's presence in the USA and the Chinese market, CIE would benefit from M&M's presence in the emerging markets like India. Further both M&M and CIE would consolidate their position in the European market.
Also, the product profile would be complimentary as M&M is focused on the utility vehicle and commercial vehicle components while CIE is focused on passenger car space. Further, Mahindra CIE would use M&M's cost competitive manufacturing base in India to expand presence in the Asian region, while the alliance can use CIE's manufacturing base in Mexico to expand presence in the US market.
Valuation
Mahindra CIE would emerge as a strong alliance in the auto component space. With complimentary product segments and markets, the deal is a win-win situation for M&M and CIE.
We are maintaining our stand-alone estimate for M&M. We have marginally increased our price target accounting for additional investment in CIE (valued at the investment cost). Our price target stands revised at Rs1,129 per share. We maintain our Buy recommendation on the stock.
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