Infosys valuations steadily sliding

Infy valautions have now come down to about 14x FY13x eps (Rs 160-170 range).

This is now lower than TCS and Wipro.

The question is – whether the structural change the IT services business, and more so Infy, is going through, is over. One repeatedly hears that the days of 30% plus EBITDA margin are over. 20-25% is more sustainable for IT Services. Infy is a long way away from there. Even TVS is around 29%.

So Infy may not be quite have reached the bottom of the trough yet. Though, rupee can save it for sometime, if it dives below Rs 55 in 2012.

How low can the market go in FY13?

Currently the market is trading at about 17x foward,  above its 20 year median level. It clearly needs to come down to the median level, there is nothing happening to suggest the market should trade above long term median range.

The bunched up negatives tends to suggest it should go below the median. How low can the markets go? In the worst case scenario, Sensex tends to down to about 11x forward. Things arent that bad yet.

The local situation has a few positives, the main one being that interest rates which have peaked out. The RBI will not raise them anymore, but may not be able to cut much either. A 50-100 bp drop by Mar’13 is not likely to kickstart demand, either consumer or industrial.

Negatives are several – fiscal deficit will slip further, tax hikes and petro price hikes will spur inflation, the UPA govt has lost credibility..The opposition is doing no better, so we are likely to have a hung parliament in the next elections, so more drift and decay likely.

There is a real danger that both FDI and FII flows may ignore India over the next 2-3 years, or atleast the remaining part of 2012.

More upside than downside in Indian equities

Time to shed some of the pessimism now about Indian equities. One reason is simply the math. The Marketmatrix that we follow suggests there is less downside than upside to the market. As I wrote earlier, the downside to the 2011 forecast held very well thru the year, despite all pervasive negative news

Also, while i havn’t checked advance-decline for 2011 yet, I think this will be better in 2012. This is the most important thing for retail investors. If advance-decline is more than 50%, you will most likely make money.

This is how I think 2012 could pan out –

Likely Sensex Trading Range 2012

As this suggests, Sensex may not fall below 15k for any length of time. If sentiments improve, then the trading range may extend to 19K levels.

Of course, ambient sentiment and data would influence the valuation, which we continue to assume will not fall below 14x forward. Factors in favour of this – inflation seems to have peaked, interest rates will head downward. If Congress does ok in the coming assembly elections, it will help.

Negatives – global macro scene, domestic fiscal deficit which could worsen due to things like food security bill etc.

FY12 9m Sensex trading history – downside held so far

In Feb’11, we had posted the following trading range for the Sensex for FY12 (see post ‘  Market View: Sensex range 15.5K to 18K for FY12‘)

SensexMatrix for FY12

For the first 9 months ending today, the Sensex has held very well above the lower limit of this range.

Sensex trading performance over Apr-Dec'11

Counting today’s close at around 15454, and 184 sessions including Friday, the Sensex has closed below the lower end of the range only 4 times. On the other hand, the Sensex breached the higher end of the forecasted range fully 92 times, or about half the time. This breach was highly front ended. Between 1 April and 4 August, or for about 87 straight trading sessions, the Sensex closed above the higher end. In the 97 trading sessions since then, it has breached this range only 5 times.

So what to make of it? In Feb’11 we were more bearish than most market parcipants. Other forecasts were still in the 18K to 21K range for FY12. While they were right in the initial period, the market came down to our range finally.

Currently, market expectations are in the 13K to 16K range for 2012. In other words, market participants are more bearish than our current range.

Bond Yield comparision still unfavourable for equities

I had written about Earnings Yield and Bond Yield comparision last in March (Earnings yield chart shows markets should go down).

Here is a new chart on the same from an Angel report, this has longer data.

Earnings Yield versus Bond Yield

What this chart shows is not good for the market. While earnings yield has edged closer to bond yields as markets fall, bond yields are still higher, which means markets will remain bearish. As the chart shows, best returns are made when bond yield falls below earnings yield. Lesson for equity investors – hold your horses, a better time to buy will come

Dismal H1 results

The result season got over a while ago, this is a delayed post. The chart shows how poor H1 results have been. It is likely listed companies will see earnings decline in FY12. This does happen too often in India. The last time this may have happened was in FY02, when markets used to trade at 11-13x forward.

Could we see a repeat of that? So far, markets are holding at around 17x FY12 expected EPS. But this could well be the upper limit of trading values for the next 6 months. Right now, no one has a clue on FY13 numbers. Typically, at this time, people will budget a 15-20% growth in earnings in FY13.

So it really depends which way expectations go by around April’12. If by that time market things FY13 will also see degrowth, or less than 10% earnings growth, then we could see valuations correcting to lower end of the Sensex trading range.

Bharat Forge – an amazing PR story

Bharat Forge is one amazing PR story. The company has nothing particularly of note in last several years, yet continues to command high valuations, and media adulation.

The cumulative net profit this company has made in the last 4 years is about Rs 590 crore, or say Rs 150 crore per year on an average. Yet, it has a market cap of  about Rs 7100 crore.

More than the valuation part, it is this huge reluctance the company has in talking about its international operations. It is very hard to find one word on international operations in its quarterly releases. All the company wants to talk abt is stand alone operations (which is the Indian part). And remember, this was the company being feted as one of India’s first MNCs. Really? Its international operations havent made money in several years.

Future Ventures — falling, will fall more..

We had written earlier why this company had no business to exist. The IPO it seems came at par. The company is now trading at about Rs 8, or 20% down in 10 trading sessions.  Must point out the market has been weak in this period. The scrip will go down more. How much? hard to say, but I would imagine it should fall below Rs 5. Hope u didnt invest..

Future Ventures IPO – DO NOT INVEST

Kishore Biyani wants to have your cake and eat it too. But if you love your money, you shouldn’t oblige him this time. This IPO is a piece of trash, avoid it. My main reason for saying this is – I don’t get the reason why this company should exist.

A bit about the business- FVL is like a PE fund, it invests in other companies, where it takes any kind of stake, even single digit. It has majority in a few companies. So far, it has invested Rs 820 crore or so of capital, now it wants to raise Rs 750 crore more. That makes it a very large PE fund. The difference from a fund is that there are no LPs, the standard 2:20 kind of commercial terms of the PE business dont apply, so issue managers can say that dont value this company as a % of AUM.

Some specific objections abt the issue:

• They seem to be stretching their definition of business: They say they will invest in plays on consumption spends. But they also want to set up food parks. Now that is an infra play. Hard to see how that is a consumption play. By that logic u can build roads. They also want to invest in education. Umm..? Just where does the definition of consumption spends end for Future group. Next they will invest in hospitals or two wheelers. Sure education and health are part of PFCE, but then PFCE is 65% of GDP. One group certainly need not try to make a play in the entire lot (tho Tatas, Mahindras etc certainly do that)
• Related Party Agreements:  There is some seriously objectionable stuff here. The company has agreements with other Future group companies, which get paid for various services.

For ex, Future Capital is to get upto 1% of Adjusted Networth for providing provide services like — research service and recommendations regarding Treasury Assets; support resource mobilization in any of its investee companies; advise on mergers and acquisitions; advice on suitable and efficient exits to be made by the Company from the investee companies and provide progress reports…

Similarly, there is a Mentoring Agreement with Pantaloon Retail. which can also get upto 1%. There is Master License Agreement with Future Ideas.. WHAT ROT

• No cap on expenses: In a PE fund, there is a cap on expenses – 2%. Here there is none. More than 2% can go to group companies. And the company itself can run up other expenses. If this a fund, then shouldnt there be a cap on expenses?

• Minority stakes are no good:  How should an investor value the several minority stakes the company has? For ex, 17% in Biba. The comany has buyback clauses for many of its minority investments, which say either an IPO in certain time frame, or buyback. But many of these companies are too small for IPOs. and they wont be able to buyback either. Then what? In investments like ACK, there is no buyback clause
• Poor disclosure: The RHP says the company has exited 3 investments. Why? and at what price? No disclosure of whether they made a loss, which they must have. Poor, dont know how SEBI let it through. What seems like another bad error–

At one point, the RHP says: In terms of the SHA, In terms of the SHA, ITCPL is required to undertake an IPO within a period of 18 months from December 1, 2008. Both SSA and SHA would automatically terminate on the listing of shares of ITCPL. For the purposes of IPO, the Company will not be regarded as a promoter of ITCPL.Both SSA and SHA would automatically terminate on the listing of shares of ITCPL.

18 months ended in May 2010.

• High Valuations paid: They seem to have paid too much for some of their investments. For ex, they have a  small stake in ACK Media, and they have invested at around Rs 100 crore valuation. Thats too much for ACK, which has abt Rs 10 crore of sales. 10x sales..

Infosys PE will be under question now

Infy's likely FY12 trading range

Can Infy hold a PE of > 20x now?