Nucleus Software Exports

Investors with a medium-term perspective can consider buying Nucleus Software Exports. The stock’s structural downtrend that commenced from Rs 600 was arrested in the support band between Rs 39 and 42. Since this low the stock has been on an intermediate-term uptrend. In May, the stock breached its 200-day moving average and is currently trading above its 50-DMA too.

We are optimistic on the stock and believe that it has the potential to rally up to Rs 175, in the medium-term term.

Investors can buy the stock with stop-loss at Rs 87. Short-term traders can buy with a target of Rs 122 and stiff stop at Rs 105.

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Allied Digital Services Ltd

nvestors with a two-year horizon can buy the shares of Allied Digital Services (Allied Digital), given a healthy change in its business-mix towards services and synergies from acquisition of En Pointe Global Services.

At Rs 423, the stock trades at eight times its likely 2009-10 per share earnings, leaving reasonable scope for capital appreciation.

Allied Digital provides IT infrastructure management and technical support outsourcing services. It primarily acts as a support-partner for IT infrastructure products — desktops, laptops, servers, network software, routers and the like.

Allied delivers its services through its own facilities and centres spread across 132 cities and follows a ‘direct’ model rather than a franchisee model. Through the inorganic route, the company has also made a significant entry into the US market.

Domestically too, the company has a list of clients across verticals such as BFSI, telecom and manufacturing, which increasingly and constantly require considerable hardware maintenance and technical support services, providing further opportunities for Allied Digital.

This is supported by the fact that PC and laptop shipments have increased in India even as the growth, worldwide, continues to be sluggish. Government, Education and Banking verticals have helped sustain growth, according to a recent report from IDC.

The domestic hardware industry is set to grow at a compounded annual rate of 11.4 per cent to Rs 98,816 crore by 2013. IT and IT-enabled services are expected to grow at a compounded annual rate of 22.5 per cent to Rs 86,517 crore by 2013.

Growth in IT infrastructure will entail delivery of technical support and services as well as IT infrastructure management, a good portion of it remotely, thus benefiting players such as Allied Digital.
Changing business-mix

The company has witnessed a rapid change in its business-mix over the last couple of years.

From having 70 per cent of its revenues coming from hardware-intensive deals, Allied Digital now derives 55 per cent of its revenues from services and the rest from delivering solutions that have huge hardware components.

This is reflective of the fact that the company has been able to go up the value chain in terms of its offering.

There are multiple benefits from this shift that could accrue for Allied Digital. One, this component of revenues enjoys better margins through better billing rates.

Two, most of the services for clients abroad are being delivered remotely, through its network operation centre, security operation centre, help desk and technical BPO. This optimises costs for the company.

Finally, most of the services revenues turn out to be annuity revenues by virtue of long-term annual maintenance contracts signed with clients, lending revenue visibility over the long-term.
Inorganic growth

In 2008, Allied Digital acquired an 80.5 per cent stake in En Pointe Global Solutions, a US-based IT infrastructure management and remote management services provider for $30 million.

Apart from strengthening its remote services offering, the acquisition allows Allied Digital to cross-sell to En Pointe’s many clients.

A strategic entry into the US, the biggest outsourcer, has also been made possible through this acquisition. This is evident from a couple of large deals that the company has managed in the US. En Pointe is expected to contribute $60-62 million in revenues to the company in the current fiscal.

Much of the work carried on by En Pointe is also being offshored to India. Over time, the entire operations are envisaged to be transitioned to India. This drastically optimises costs for Allied Digital.

The company has had a 30-32 per cent increase in call volumes to its BPO over the earlier quarter and its order book executable over the next two-three quarters indicates a higher services component. This suggests that the company is poised to maintain a fairly healthy margin profile.

Since its listing in 2007, Allied Digital has witnessed healthy growth rates in both revenues as well as profits. For the 2008-09, the company saw its revenues grow by 90 per cent to Rs 565 crore, while net profits grew by 83 per cent to Rs 79.6 crore.

In the recent June quarter, Allied Digital witnessed a 72 per cent growth in revenues to Rs 158.9 crore over the same period last year, while net profits grew 44 per cent to Rs 22.7 crore.

Competition from more integrated players such as CMC and HCL Infosystems may, however, pose pricing pressures.

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Indian Bank

Fresh investments can be considered in the Indian Bank stock. Over a two-year horizon, the bank has room to expand its net interest margins, even as it delivers strong credit growth. Indian Bank is a mid-sized public sector bank with almost 40 per cent of its branches in Tamil Nadu. It is one of the first movers in the public sector to migrate to core banking solutions.

At the current price of Rs 134, the stock trades at about 4 times its trailing one-year earnings and near its book value of Rs 135.

The bank has posted high earnings growth in recent quarters boosted by surging net interest income, without much help from one-time treasury gains.

Not only has Indian Bank seen steady business growth in the past few quarters, it has strong profitability ratios (with Return on Equity and Return on Assets at 23.3 per cent and 1.62 per cent respectively, as of March 31, 2009) and superior asset quality (net NPA ratio of 0.4 per cent). It has managed to improve net interest margins (3.6 per cent) while other banks have seen margins contracting.

The bank has a comfortable Tier-1 capital adequacy (12 per cent against mandatory 6 per cent) and has sufficient head-room to raise capital.
Advances Book

Indian Bank’s loan book is focussed predominantly on large and medium corporates (50 per cent of the total credit) followed by retail and agricultural lending; the last two have aided the bank’s overall advance growth in recent times.

Indian Bank’s advances grew at a compounded annual rate of 29 per cent during the period 2004-09.

However, for the quarter ended June 30, advances growth moderated to 17 per cent, partly attributable to companies postponing their capex in view of the General Elections and the Budget.

For Indian Bank, corporate credit grew by a modest 14 per cent. Sequentially, Indian Bank saw its credit-deposit ratio moderate from 71.4 per cent to 67.7 per cent; this is the below the industry average.

The lower credit-deposit ratio will not allow the bank to benefit much from falling rates as the deposits are deployed in lower yielding assets.

Financials

For the period 2004-09, the bank’s net profit grew at an annual rate of 32 per cent. Indian Bank continued this momentum in the June quarter with a net profit growth of 52 per cent, thanks to net interest income growth and ‘other income’ accretion.

Core non-operating income accounted for a low 7.5 per cent of the total, among the lowest in the public sector space. Improvement in net interest margins (NIM) from 3.17 per cent to 3.56 per cent helped the bank post strong top-line growth despite the moderation in advances.

While Indian Bank is one of the few to have witnessed improvement of NIM this quarter, the trend can be expected to receive support over the medium term as the benefits of the deposit rate cuts actually start flowing in.

A modest increase in low-cost deposits and retirement of bulk-deposits helped the bank reduce its cost of funds, propping up the NIMs.

A cost-income ratio of 42 per cent results in better operating efficiency than most of its PSB peers.

The bank’s provisions fell by 28 per cent in the latest quarter as incremental slippages were low.

The recent RBI mandate to shift the floating provision account reduced the bank’s provision coverage, increasing its net NPA ratio to 0.4 per cent from 0.18 per cent.

The gross NPA ratio of 0.91 per cent places it among the better banks in terms of asset quality; after factoring in restructuring in the last few quarters.
Outlook

Indian Bank may witness higher-than-industry credit growth, given the expected pick up in corporate credit offtake with the recovery gaining pace.

As the bank enjoys high levels of capital adequacy, it is well-positioned compared to most of its mid-sized peers to expand its advances book.

The key concern for the bank is the agriculture portfolio turning sticky due to a weak monsoon; however, the government can be expected to step in on this count.

Though Indian Bank has restructured a significant 8.4 per cent of its loan book, the amount sacrificed in restructuring is low (1.2 per cent of total restructured amount as of March 2009) limiting the losses on this count.

While the bank’s credit-deposit ratio has improved in the last few years from 49.8 per cent for 2004-05 to 71.4 per cent for 2008-09, there has been a moderation in the recent quarters.

Margins may come under pressure, if the ratio does not improve. Reviving equity markets can be expected to boost fee income.

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Direct Taxes Code Explained

What are the changes made with reference to residential status by the proposed Direct Taxes Code, 2009?

The Act presently classifies individuals into resident and ordinarily resident, resident but not ordinarily resident and non-resident.

In the case of a resident but not ordinarily resident (RNOR), income accruing or arising or deemed to accrue or arise outside India or received or deemed to be received outside India is not taxable in India unless such income is from a business or profession set up and controlled in India.

The tax code proposes to do away with the classification resident but not ordinarily resident. This would mean that Indians working abroad would be classified as resident even if they fall under the category of resident but not ordinarily resident and, consequently, such income would be taxable in India.

How is income classified under the draft code?

Income is to be classified as income from ordinary sources being (A) income from employment, (B) income from house property, (C) income from business, (D) capital gains, (E) income from residuary sources and as income from special sources which in the case of a resident assessee would be income by way of (i) any lottery or crossword puzzle, (ii) race, including horse race or (iii) card game or any other game or gambling or betting.

What are the changes with regard to computation of capital gains?

The distinction between short-term and long-term capital gains is done away with and the income from transfer of an investment asset is to be computed under the head capital gains.

The term investment asset is defined to mean a capital asset not being a business asset.

A capital asset is defined to mean every property other than a business trading asset.

In computing capital gains the deductions are (a) the amount of expenditure incurred wholly and exclusively in connection with the transfer of the asset (b) the cost of acquisition of the asset and (c) the cost of improvement of the asset.

If the investment asset has been held for more than one year the deductions that are permitted are (a) the amount of expenditure incurred wholly and exclusively in connection with the transfer of the asset, (b) the indexed cost of acquisition of the asset, (c) the indexed cost of improvement of the asset and (d) the amount of relief for rollover of the asset.

The base year for the benefit of indexation is to be taken as the financial year 2000-01 and if an assessee has acquired an asset prior to April 1, 2000, the fair market value as on April 1, 2000, can be substituted as the cost of acquisition at the option of the assessee.

Deduction in respect of rollover of investment asset is computed for an individual or Hindu Undivided Family on the basis of the formula {A * (B+C+D)}/ E.

A is the amount of capital gains arising from the transfer of the original asset; B is the amount invested for purchase or in construction of the new asset within one year before beginning of the financial year in which the transfer of original investment asset is effected; C is the amount invested for purchase or in construction of the new asset during the financial year in which the transfer of original investment asset is effected.

D would be the amount deposited in an account in post office in accordance with the Capital Gains Deposit Scheme of the Centre in this behalf, by the end of the financial year in which the transfer of original investment asset is effected and E is the net consideration received as a result of the transfer of the original asset.

The deduction is permissible in respect of investments in certain new assets (such as land, residential house or investment in capital gains scheme) specified in the bill.

What are the deductions that are permissible to an individual under the code?

An individual can claim a deduction in respect of the following:

- Rs 3 lakh in respect of permitted savings, which would be taxed when withdrawn.

- Tuition fee paid for full-time education of two children in a university, school or educational institution situated in India

- Interest on loan taken for higher education of the individual or his relative for eight years

- Health insurance premium of up to Rs 15,000. In case of the insurance taken by an individual for a senior citizen, Rs 20,000 would be allowed as deduction.

This deduction is available in respect of premium paid for the individual, the spouse, any dependent child of the individual and any member of the Hindu Undivided Family.

- Expenses on medical treatment in respect of prescribed diseases and ailments of the individual, the spouse of such individual, the dependent children or dependent parents of the individual of up to Rs 40,000, and if the ailing person is a senior citizen, then the amount would be Rs 60,000.

- Expenses on medical treatment, nursing or training and rehabilitation of a disabled dependent suffering from specified disabilities of up to Rs 50,000 and in case of a person suffering from severe disability of up to Rs 1 lakh.

- Rs 50,000 as deduction to a person suffering from certain disabilities and if the disability is severe, Rs 1 lakh

How are loans treated?

An amount of loan or deposit borrowed or repaid otherwise than by an account payee cheque or account payee draft and exceeding Rs 20,000 including interest thereon at the time of repayment is to be treated as income in the hands of the recipient.

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3i Infotech

Investors with a one/two-year horizon can buy the shares of 3i Infotech.

The stock trades at a modest valuation despite a blended business model, a favourable geographic-mix and strong deal wins in recent times.

The current price of Rs 71 discounts the company’s likely 2009-10 per share earnings by four times, leaving ample scope for capital appreciation.
Service-mix

3i Infotech has three different kinds of offerings — software products, regular IT services and transaction processing. IT products contribute 31 per cent of the revenues, while services and transaction processing contribute 36 per cent and 33 per cent respectively. This model, with a blend of margins- and volume-based services, makes for a holistic service-mix.

Such a service-mix may also insulate the company from cuts in IT discretionary spends, as services and transaction processing address critical operations such as payment processing, mutual funds transactions, insurance payments and basic banking operations.

A more integrated offering becomes necessary in the current environment where clients are engaged in vendor consolidation and may look for vendors with end-to-end offerings in a given vertical. Despite the move away from software products to lower-margin services, 3i Infotech’s operating profit margin continues to sustain at 20 per cent levels.
Geographic mix

Geographically, the company’s footprint in the US has improved to contribute 53 per cent of revenues, largely due to the acquisition of Regulus Group, with much of the rest contributed from India, West Asiant and Asian countries (Europe contributes only six per cent of revenues). Most Indian IT players have experienced an increase in contribution from the US geography over the past year. The National Association of Software and Services Companies (Nasscom) has indicated that the US market and the financial services vertical are stabilising; this makes for a favourable geographic mix for 3i Infotech.

In the recent June quarter, the revenues grew 27.7 per cent over the June 2008 quarter, to Rs 602 crore while net profits grew 8.3 per cent to Rs 63 crore. A slower growth in net profits may be attributable to the steep increase in interest and depreciation. The company may take up a QIP offering to reduce its debt burden; it has already bought back a significant portion of outstanding FCCBs. Valuations appear modest even after factoring in possible equity dilution.

Recent large deal wins span a range of offerings - with orders for anti-money laundering solutions for State Bank of India, banking and treasury products for primary dealers in India and West Asia and domestic e-governance solutions. The company has an order book of Rs 1,450 crore as of June 2009 -about 63 per cent of 2008-09 revenues.

3i Infotech has an equal split between fixed-price and time & material billing modes, which ensures optimal resource planning and realisations.

The company maintains a negligible bench at any point in time

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