Sasken Communications – UPDATE… (BSE: 532663; NSE: SASKEN)

Wow!!! We like this! While the prices of real estate in Bangalore have stabilized, why has Sasken communication gone up in Value?
For starters, the stock is up > 60% since we last wrote about it last month. Yes we agree that the stock was close to 80% down from its 52wk high, but what the heck!
Wasn’t it a golden opportunity to average out to a decent price and maybe exit at the next up move if you felt skittish? We hear people screaming out “Falling Knife” and won’t fall for that one. Well that’s where those who test the business model WIN.

IT is the next in thing…
Well, we are not saying this. Its’ the GURUS who are saying it. We always maintained this ever since we starting writing on it late in 2007. (Refer: Ab kya hoga?)

We believe that the long term IT story is pretty strong. Margin may come under pressures, business model will change, and the sector will look more like cyclical over a decade from now and probably there will be a shakeout with some bruised and battered companies.
The trend could also change, slower growth, more controlled performance, steady dividends and yes acquisitions. Finally there will be winners.

Let get fundamental…

1. There are a few things that we look at in a company when we invest into it (at least this is the philosophy that we believe in).
2. Is the company in a domain in which it has a first mover advantage?
3. As a result has the company able to maintain a top slot in the sector?
4. Are there catalyst that we dethrone the company in the near future?
5. Is the business model in for a fundamental change in the future/is threatened by forces (external or internal)?
6. Is the company favorite / dumped by the street for a longer lengths of period in time (in simple terms – valuations)
   

The results are good or bad?

Sasken reported Q4FY 2008 numbers yesterday and while we see them in the comfortable, the street seems to be reiterating its SELL mantra. We believe that the street has got it right as far as next 2-3 quarters are concerned.

Citi (analyst Surendra Goyal, a good friend of ours) has a SELL report in the market reiterating very valid concerns in the short term. But we disagree with him certain macro fears he puts forth.

Metrics would continue to drag, performance might be subdued and risk could look overwhelming. We believe the opportunity might come over a longer period (12-18 months) is

1. Telecom space (where the company operates) improves as a result of continued penetration in the domestic and Asian markets. We would see revenue growth steady and continuous
2. Margins hitting bottom and then reverting back to saner levels of higher double digits (possibly mid-teens).
3. Employee costs stabilizing over the next 18 months as a result of overall lackluster employment opportunities

Sasken for now has done two important things to keep nervous investors some comfort.

a) Given a 40% dividend on a INR 10 FV share. This translate into a dividend yield of little under 3%, so this is a positive, a minor one you would say. But we conclude a positive nevertheless.
b) Sasken board has approved for a buyback upto INR 40 crores, an authorization for buying shares upto INR 260 / share. CMP at around INR 144. We believe that even though this also will not really lift EPS materially. The signal from management at the moment is the company is undervalued. We believed this for the last 3-4 months.

Time to speculate, then?

Well we believe that there will be lots of activity in this counter from now on. The triggers are the buyback, dividend stripping and bullish traders getting in the make a quick buck while the undertone is positive.

The safety net is therefore stronger than before. However, we think that investors should look at this counter only for a fundamental story rather than a speculative opportunity.

Easier said than done.

We think we could see this counter moving up nicely to around INR 220-240 effortlessly. So a good 40-50% from here in the next 3-6 months. Over a longer term however, we continue to maintain that the upmove could be a lot more painful than it appears. Investors who entered this counter at various levels starting at INR 300-400 price band have caught a falling knife and made a few deep cuts to themselves.

But were they intelligent enough to buy some more when it reached INR 86 (all time low) a few weeks ago?

We don’t know that for sure.

Until next time….

UPDATE: Gold fever - It still ain't what it used to be....

Gold: Is it a Consolidation phase ($900-$950 level) or things are really going wrong?

What is going on behind the scene?

Gold still remains the best bet in precious metals. Gold has given an annualized return of 46.28% YTD and around 40% annualized since we wrote our first thesis and recommendation on gold (see article date January 21, 2008). Gold roared to a lifetime high of $1,030.80/ troy oz. on March 17, 2008 but then tumbled to a two-month low of $872.90 in early April in a broad commodities sell-off. It has bounced since then and stood around $935 an ounce on April 15, 2008. There has been increasing media reports and speculation about future of gold. In our opinion, the concerns like, “is the bull run over”, “has gold seen its golden season”, are baseless and we have reasons for our strong view. Many on the street are also arguing that the shining in gold was due to the increased money flow in the commodities complex (Commodity ETF’s/funds), however we think this remains one of the factor but certainly not the underlying one, gold has its own reasons supporting the price movements.

The answer to the first question in the headline is affirmative and second question is negative.

Recent concerns/factors working for gold:

1. Strong fundamentals: Increasing supply concerns from South Africa:

Gold still enjoys the case of strong fundamentals where demand is still more than supply (see our previous analysis "Gold: its ain't the fever what it used to be Jan 2008")

South Africa (SA) is one of the top producers of gold. In terms of 2007 mine production it accounted for around 11.1%, Just behind China which enjoyed 11.3% (see production chart). Lately SA is having growing imbalance between the power consumption and generation. As a measure of regulation and in order to control things, SA govt. is controlling all the power allocation to all the business’s which primarily includes gold mining. As per last update, SA govt. is now allocating around 90% of the power which the mines used to consume earlier. This is regardless of which mine is producing how much in terms of efficiency and cost, hence even if the producer may want to allocate 100% or more of the power to some low cost and more efficient mines and keep certain high cost mines closed , it has no option but to suffer on rising costs for non-efficient mines.

As per experts and power industry consultants the power problem is a structural problem on account of lack of build up of new generation facilities coupled with increased usage and bad weather, hence the situation might take around 2-3 years to get fully normalized. Major gold producers like Gold Fields, Anglo American (400,000 ounces shortfall) have already announced reduced production guidance on account of power shortages.

Source: http://www.goldsheetlinks.com/production.htm
Source/further readings supporting the thesis: 2007 world gold production fell marginally and 2008 output to stabilize – GFMShttp://www.mineweb.com/mineweb/view/mineweb/en/page33?oid=50465&sn=Detail

2. Renewed demand from Asia particularly India: Seasonality

Though there is no denial of the fact that demand was subdued in India and China due to high gold prices, the fact remain that gold is the party essence for every celebration in India. This time the pullback is attributed to or rather spurred because of the wedding season (ending May 2008) and The Akshaya Tritiya festival (May 7, 2008). Jewellery demand may see a major spur due to these two reasons. We have studied the data from 1970 for gold demand and came to the conclusion that gold does have seasonality factor. The first and fourth quarters are the periods when there was rise in gold price on account of higher demand, while the second and the third quarters were seen as quiet or flat demand during the particular year. Having said that, the analysis is based on normalized data and we have removed specific outliers to improve data quality.

Source/further readings supporting the thesis:
Indian demand keeping gold markets alive
http://www.mineweb.com/mineweb/view/mineweb/en/page33?oid=50690&sn=Detail
Return to gold by Eastern jewellery markets means price may have bottomed
http://www.mineweb.com/mineweb/view/mineweb/en/page33?oid=49719&sn=Detail
Citigroup warns of waning gold investment, seasonal slack - but positive long term
http://www.mineweb.com/mineweb/view/mineweb/en/page33?oid=50688&sn=Detail

3. IMF sales – a perspective. The gold for sale is different from the rest!

The recent announcement from the US Treasury on 25th February, approving in principle the proposal for the IMF to sell some of its gold reserves, marked a reversal of policy and generated a knee-jerk reaction in the gold market, with prices dropping by $10 to close at $938 that day.
It looks as though any sales by the IMF will be restricted to 400 tonnes used in a previous sale and repurchase agreement – and in any case would be made within the existing CBGA sales Agreement. The market is right to remain unfazed!

This looks very much like the gold that was used in sale-and-repurchase transactions with the IMF in 1999 and 2000. In these transactions the IMF sold gold to Brazil and Mexico at prevailing market prices and then immediately accepted it back at the same price in settlement of financial obligations of those countries to the IMF. While the net effect on gold holdings was zero, the gold thus accepted was entered onto the IMF's books at the prevailing market price rather than the official price of SDR35/ounce. In accordance with the IMF Articles the equivalent of SDR35/ounce from the proceeds of the sales was retained in the General Resources Account. The increase in the value of the gold held on the balance sheet was deemed to offset the liabilities of Mexico and Brazil to the IMF.

There are three things which needed to be noted in this regard as observed by Crockett Committee:

Firstly the undertaking-sale of gold-should be qualified in important ways that limit its impact on the gold market. In the first instance, the amount should be limited to the 400 tons I mentioned, without envisaging any additional sales.

"Secondly, the sale should take place within the existing Central Bank Gold Agreement, that is to say it would not be additional to sales already programmed by central banks, but would be accommodated by reductions in the amounts of gold that the central banks might sell under the Central Bank Gold Agreement.

"And thirdly, we have emphasized that the sale should be undertaken in a very careful way in terms of their periodicity amounts and manner of sale such as not to disturb the market.

Source/further readings supporting the thesis:
IMF sales – a perspective. The gold for sale is different from the rest!
http://www.mineweb.com/mineweb/view/mineweb/en/page33?oid=48222&sn=Detail
Swiss Central Bank gold sales – further analysis
http://www.mineweb.com/mineweb/view/mineweb/en/page33?oid=49939&sn=Detail

Picking beaten angels : SREI (BSE:523756, NSE:SREINTFIN)

In our quest to provide timely advice to investors, we have been putting in a lot of time and efforts off-late to find out value stocks. Recent market crash has given us some opportunities in finding beaten angels and one such angel we believe is SREI (BSE:523756, NSE:SREINTFIN)

Why we like SREI
With 25% of the construction equipment financing market, SREI is India’s largest private NBFC with over Rs.6, 500 crs of assets under management. A 50:50 JV with BNP Paribas will help the company to aggressively expand its business with having access to low cost funds and to expand on its Project financing business.

With net NPA of approx 0.3%, strong management, domain expertise, expected BV of Rs.60 for FY08 and Rs.75-80 for FY09, SREI is available at 1.75x FY09 expected BV. We believe that last 20 years of knowledge in the equipment financing business will help SREI to make a formidable entry in Project Financing business.

With the additional kicker of QUIPO, SEZ, Ports and Roads projects which we have not included in our estimations, we believe SREI is attractively priced at the current valuations. The allotment of 2.5 crs warrants by promoters to themselves at Rs.100 per share is a big positive. We expect the stock to trade at 2.5x FY09 BV in the next 9-12 months.

Let’s dig deep

SREI is India’s largest construction equipment finance private NBFC located out of Kolkata. The company holds 25% of the India’s equipment financing market with IDFC, ICICI Bank and few other players sharing the rest. Promoted by the Kanoria family, the company has a 2 decade history behind it.

SREI has assets more than Rs.6, 500 crs under management and its activities include financing of construction equipments, equipment leasing, project finance and renewable energy equipment financing. SREI has floated subsidiaries for merchant banking, syndication services and forex services. Currently more than 90% of the revenues and profit comes from the equipment financing business, but project finance and equipment leasing are expected to contribute significantly from FY08 onwards. Now we will discuss all the businesses in detail:

1. Equipment Financing
Equipment expenditure is estimated to be 20-25% of the construction outlay which is estimated to be 40-45% of the infrastructure spending. While the government has plans to spend $250bn on infrastructure in next 5 years, the opportunity is just too big for SREI.

The company raises money from all available sources including banks, bond markets, public deposits and multilateral agencies. With an average borrowing rate of 8% in FY06 and 9% in FY07, the company’s operational expenses are just 2% due to its high ticket size transactions. With average yields of approx 13%, the company also maintains an interest rate reset clause in all the agreements to take care of the rising interest rates.

At 3QFY08 end, SREI had Rs.6, 500 crs of assets under equipment financing. This is up from Rs.3, 500 crs at FY07 end. For an effective utilization of its assets, SREI frequently utilizes the route of securitization. As SREI book the income over the life of the asset and not at the time of securitization, it maintains a conservative approach and provides a smooth sales pattern. Now we will discuss the major step taken by the company to make it big in the business.

A 50:50 JV with BNP Paribas
Considering the expertise developed by SREI, BNP Paribas and SREI has formed a 50:50 JV for the equipment financing business. Under the terms of the agreement, the equipment financing business will flow from SREI into the JV and BNP will introduce Rs.775 crs as their contribution. Out of this Rs.775 crs, approx Rs.375 crs will flow to the parent company which they will utilize to grow the Project Finance business which is mentioned below.

The JV will help SREI to have access to low cost funds and to utilize the world-wide expertise of BNP in this business. At the same point in time BNP will get access to the growing Indian equipment financing

Competition from banks is a major threat to SREI for the business, but as the banks are not willing to lend money to small contractors, the area where SREI operates and specializes, it is difficult for banks to make any sizable impact.

SREI intends to have a Net worth of Rs.800 crs and with a leverage of 8x-10x, the company aims to build a book of Rs.6, 000- 8, 000 crs from its current Rs.4, 400 crs (post securitization). The company in first nine months of FY08 has been disbursing loans of roughly Rs.300 crs per month.

2. Project Financing
SREI is trying to make big into project financing business where the Net Interest Margins (NIM’s) are lower in the range of 2.5% to 3.5%. The projects would specifically be in the infrastructure space only, as the company has good understanding of the same.

With getting Rs.375 crs from JV and roughly Rs.250 crs of cash infusion by promoters over a period of 1 year by converting the warrants into shares, the company plans to have a Net worth of Rs.800 crs for the business. With a leverage of 8x-10x, the company again aims to build a loan book of Rs.6, 000 – 8, 000 crs over a period of 2-3 years.

SREI is in serious talks with many parties for the project financing, but will announce the actual details only after the completion of all formalities.

3. Stake in QUIPO
QUIPO Infrastructure Equipment Limited (QIEL) is India’s largest renting out construction equipment company. SREI holds 17% of the company and it is supported by Construction Industry Development Council (the apex industrial body formed by the Planning commission and the Ministry of Surface Transport, Government of India).

SREI is in talks with other shareholders of QUIPO and intends to raise its stake in the company. In last few quarters, SREI has raised its stake to 17% from 15%. The estimated value of QUIPO is Rs.1, 500 crs and SREI stake of 17% can be valued at Rs.235 crs.

Positives
1. Excellent asset quality – With its gross NPA less than 1% and provisioning exceeding 80%, the asset quality is comparable to that off HDFC and IDFC. With its excellent track record, we can assume the management to deliver best results in this aspect.
2. BNP Paribas association – We expect that SREI would be able to increase its NIM as they would be having access to low cost funds from BNP. With its predominant position in the infrastructure equipment financing business, growing Indian economy and steady relationships with its clients, the opportunity is huge for the company.
3. Low tax rate – The Company is expected to have its tax rate at 9%-12% over the next 3 to 4 years as it keeps on paying MAT.
4. Strong Book Value – SREI had a book value of Rs.47 at FY07. We expect the same to increase to Rs.58-60 at FY08 and Rs.75-80 at FY09. We have not factored in any of the money infusion by promoters at Rs.100 and any major appreciation from the project financing business.
5. Warrants allotment to promoters – In Nov 07, the promoters allotted 2.5 crs shares to themselves with a conversion price of Rs.100 per share. On April 1, 2008, promoters converted 72 lac warrants into shares. After the entire conversion, the promoters holding will go up to 35% from its current 20.1%.

Take off - Point

One of the biggest deals cracked by the company was of recently allocated Rs.25, 000 crs Ganga Express Highway project. SREI is the sole advisor to the UP government for the project. The company is going to play a key role in project management and advisor for the project. The advisor fee of roughly 1% of the project cost is to be shared between SREI and UP government. SREI will receive its share of Rs.100 – 125 crs over a 5 year period. We believe that if SREI management can figure out some mechanism to get the entire amount upfront through some bill discounting route that will add a one time Rs.6.5 to the book value.

Other Major Initiatives
1. SEZ – SREI is developing 2 SEZ’s, one auto SEZ where SREI holds 89% of the equity and another one in collaboration with QUIPO where SREI holds 50%. Both the projects are close to 1000 acres of land development and involve hundreds of crs. As there is substantial time involved for the cash flows to happen, we have not included them in our calculations.
2. Road projects –SREI under one of its subsidiaries has got 7 road projects worth Rs.4000 crs and 950 kms where SREI holds anywhere from 26% to 49%.
3. Port project –SREI is developing a port in Rewas where the initial capex is as high as Rs.4000 crs and the project is expected to be profitable at the net profit level post 2014. Again we are not including the same into our calculations.

Pressing the button

We believe that SREI with its strong fundamentals, strong domain expertise, JV with BNP Paribas, low NPA and strong management is available at reasonable valuations. We expect SREI to trade at 2.5x-3x of its FY09 BV in next 1 year. We expect an appreciation of 50% from the CMP of Rs.140 in next 9-12 months time frame.