Sharekhan Trading Call

Trading Call
Date: 04/01/2006 | Company Name: RELCAP | Call Type: Go Long
Stop Loss/ Reversal: 435.0000
Buy/Sell Price Rs.: 457.00
Current Price Rs.: 458.30
Potential P/L%: -0.1200
Target: 537
Remark:
Investment Argument: The stock has posted a double bottom at Rs415. It has witnessed a break-out above the medium-term trendline and the trendline is now a support. The 40-DEMA and the trendline at Rs435 are support levels. On the upside the stock could test the Rs473-537 range. Buy the stock with a stop loss of Rs435 for a target of Rs537.

Business Today - Sensex

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Stocks for 2006

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Happy New Year !

Happy New and Very Profitable Year 2006 !

Software: Scalability’s the name!

Introduction

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2005 has indeed been an eventful year for the Indian software industry. In many ways, the year can be considered as a landmark one, where numerous events unfolded. Large deals were signed, acquisitions were made, growth was witnessed in some companies, de-growth in others and so on. But the conclusion is undoubtedly that the growth story continues to play out in offshoring. As regards index performance, the BSE Infotech index’s performance has been neck-to-neck with the benchmark, the BSE Sensex. In fact, since the beginning of the year until very recently, the Sensex had actually outperformed the IT index. The recent strong rally in technology stocks has enabled the index to come on par with the Sensex in terms of year-on-year returns.

What was different in 2005 as compared to 2004?

The year 2005 was characterised by a strong performance from the Indian software industry. Earlier in the year, at the end of FY05 (March), NASSCOM’s reports showed that the software industry grew at its fastest pace since the dot-com bust. This is ample proof of the resilience of the country’s software industry. The long-term players have proved their ability to stick it out in difficult times and this will only make these companies stronger in future. The offshoring story continued to play out, amidst occasional bouts of paranoia from the US, UK and EU (continental Europe) about job losses. But clearly, the noises that were made against offshoring of jobs in 2004, particularly at the time of the US presidential elections, have died down. Corporations globally are, no doubt, conscious of the need to remain competitive and thus, focus their energies on their core competencies, leading to ever-increasing offshoring. The highlight of the year was, undoubtedly, the signing of the landmark ABN Amro deal. The deal, worth US$ 2.2 bn, was partly given to Infosys, Patni and TCS, apart from Accenture and IBM among the global technology majors. This has proven to the world, the ability of Indian software companies to execute deals of a global nature across diverse geographies, such as the US, Europe and Latin America by leveraging their global delivery networks. Taking an industry perspective, we expect more such deals to be signed in future and global reach and size will play an increasingly important role in deciding who gets the largest share of the spoils. The major ‘theme’ of the year, we would say, was that of scalability - scalability in terms of manpower, infrastructure, size and global reach. This is the major factor that we believe will be crucial for any Indian software company if it has global ambitions and hopes to compete against the Accentures and IBMs of the world. This was again reflected in the ABN Amro deal. To put it in numbers, TCS, the biggest of them all, crossed the US$ 2 bn mark during FY05, while Infosys is expected to do so in FY06. Satyam is expected to cross US$ 1 bn in revenues in FY06, making it the fourth Indian software company to achieve the ‘hallowed turf’.

The sector outperformer: Satyam

From the table below, it can be clearly seen that Satyam has been the major gainer in 2005. This has been due to the market re-rating the stock upwards. In the past, Satyam’s performance has been fairly inconsistent when compared with the top-tier companies. As a result, it had been trading at a big discount to Infosys. But during the past 2 years, Satyam has started to perform impressively, driven by its package implementation business that has grown at a CAGR of over 60% in that period. This has resulted in the stock’s valuations improving, reducing the gulf that separated it from Infosys. Of course, Infosys still gets a considerable premium to Satyam, but it has been steadily reducing. Going forward, we expect the package implementation business to continue to be the major growth driver for Satyam. Software: Key gainers in 2005

	24-Dec-04	23-Dec-05	% Change
Satyam Computers	409	711	73.8%
i-flex solutions	625	1,037	66.0%
NIIT Limited	176	287	62.8%
Geometric Software	73	111	50.8%
HCL Technologies	359	525	46.3%

The laggard: MphasiS BFL

In 2005, there were no losers in absolute terms from the software companies under our coverage. However, there were certain companies whose stock performance was far from satisfactory. After all, at the end of the day, one must compare relative performance as a measure of evaluation and not absolute performance. MphasiS BFL has faced some trouble in the recent past in maintaining consistent, industry-beating growth rates. The company’s major divisions - IT services and BPO – have, at different times, faced problems growing on a consistent basis. But the biggest problem faced by MphasiS BFL has been the inability of Barings, its largest shareholder, to sell its stake. The sell-off fell through during 2005, when Barings could not find a buyer that would give a satisfactory price. As a result, since then, sentiment on the stock has been poor and has contributed in a big way to its relative under-performance. Software: Laggards in 2005

	24-Dec-04	23-Dec-05	% Change
Kale Consultants	75	88	16.9%
PSI Data Systems	101	115	14.4%
MphasiS BFL	138	152	9.9%
NIIT Technologies	152	162	6.8%
Hexaware Technologies	121	126	4.4%

What to expect in 2006?

Indian software companies are increasingly beginning to show their clout in the global technology industry. The ABN Amro deal is just the beginning and we expect a lot more from the sector, going forward. Indian companies’ inherent advantages, like low cost and highly skilled labour, time zone differential, enabling regulatory environment, mastery of the art of global delivery, execution excellence and strong relationships with Fortune 1000 majors, are expected to enable them to continue to grab the lion’s share of the global offshoring pie. As we had mentioned in our ‘Reflections 2004’ write-up, the demand for technology solutions globally will be concentrated among a few players. This has certainly been the case in 2005 and is expected to continue. Indian software companies continue to climb higher up the value chain, as witnessed by the increasing share of higher-end services like package implementation, infrastructure management services, systems integration and consulting in the overall revenue mix. This is expected to continue, as these companies invest more in these businesses. Going forward, it will undoubtedly be a different ballgame competing against the likes of Accenture, IBM and Cap Gemini in their own space, where they have been the incumbents for many decades now. Thus, the building up of domain expertise is a critical factor that cannot be ignored. Security will be another key issue to watch out for in 2006, particularly in the BPO industry. This industry has seen scorching growth rates, as global corporations make a beeline for India as the ‘back-office of the world’. But recent incidents involving breach of security and leakage of confidential data have put the spotlight on security issues. We would like to mention here that these security issues are not unique to India – they occur all over the world and undoubtedly, while there is always room for improvement, targeting India alone will not do any good. The BPO business is not expected to get impacted, except, of course, for the ‘negative publicity’ that these issues generate. Given that, often, the credibility of the ‘supposed sting operators’ themselves is questionable, over the longer term, there will not be any major impact.

To sum it all up, as we had mentioned last year as well, it is clear that the cost arbitrage factor is becoming less relevant than it was before. Of course, it is still a big factor, but its importance is now beginning to reduce, as quality of work and domain expertise takes over. With Indian software companies getting increasingly into higher-end work, this will become more of a trend. The ‘Return on Investment’ factor will be closely watched and clients are now increasingly starting to work with the Indian companies on a more strategic level as partners in their growth. In other words, it is becoming more of a ‘strategic relationship’ now, as opposed to a mere ‘tactical relationship’ earlier. Watch out for scalability, movement up the value chain and domain expertise this year, as the industry moves into the next phase of growth!

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Hindu Businessline Recommendations

BUY >> TATA Steel, BHEL, TNPL,
>> VisualSoft, Vijaya Bank

HOLD >> Thomas Cook, Bajaj Hindustan

Ignoring the Herd - Outlook Money

In 1559 when the first tulip bulbs arrived in Holland and Germany, people fell in love with the exotic Turkish flowers. Soon speculators entered the tulip market purely for monetary gain and trading tulips became popular. Speculation led to high trading volumes and merchants and shopkeepers began to vie with one another for tulip bulbs.

Flower power. At the height of the tulip mania, in 1635, single tulip bulbs were being exchanged for as much as four tons of wheat, silver cups, two casks of wine and four oxen. It was bizarre as people sold homes, livestock, everything for the privilege of owning tulips, on the expectation that prices would continue to rise.

By 1636, tulips were being traded like stocks on the Amsterdam stock exchange. Smart players began to liquidate their tulip holdings as prices rose. Tulip prices weakened rapidly. Panic seized the market. Within six weeks, tulip prices crashed by a catastrophic 90 per cent and more.

Obviously tulips have little practical value. So, what could cause people to behave so irrationally? Nobody has a definitive answer but over the centuries, we’ve seen this collective insanity time and again. It’s a herd mentality–everybody rushes off to buy something and then suddenly, everybody stampedes in the opposite direction!

Economics theory is based on the assumption that individuals act rationally and consider all available information before making a decision. However, the tulip-mania and all the financial bubbles that have followed offer strong evidence that this is often not true.

All things being equal, in a rational market the fundamentals of a company should determine its market price. However investors usually overreact, often wildly, first pushing prices up too high and then pushing them too low.

A recent example can be culled from Infosys. In the first quarter of this fiscal, it delivered slightly disappointing results though the longterm prospects remained benign. Everybody sold and the stock price fell to Rs 1,900. Investors who kept their heads and bought at Rs 1,900 soon saw the price shooting back to Rs 2,650.

Similarly, a stock like Bharti Televentures Ltd, which had huge start up costs and capital outlay, offered windfall gains to those who recognised its intrinsic value. The stock traded below Rs 50 in 2003. Now it is priced at over Rs 300.

Most investors chase momentum and focus on rising stocks, rejecting those that fall. This causes them to overlook quality companies at low prices. This irrational behavior provides excellent opportunities if you can detach yourself from the crowd and move in the opposite direction.

This is the underlying rationale of ‘contrarian investing’. Contrarians do not risk money by blindly following the crowd; they look for opportunities when crowds act irrationally. Historically, contrarian strategy has paid off. The greatest investment guru, Benjamin Graham and his greatest chela, Warren Buffet are contrarians.

The mutual fund industry is eager to employ this strategy. Kotak MF and Tata MF have recently launched contra funds and the SBI Magnum Contra fund launched in July 1999 is one of the best performing diversified equity funds.

Conceptually, contrarian investing looks easy; buy when others are selling and sell when they are buying. But it’s easier said than done. Says Nitin Jain, fund manager SBI Mutual fund: "To think differently is certainly not easy. You might end up buying stocks in a contrarian manner and might just have to wait too long till others buy. Thus, your fund may not have performed at all for 2-3 months. It’s a skill to pick stocks ahead of others."

Picking stock ahead of others is what SBI’s Magnum Contra has done well. They bought top holdings like Cipla and BHEL some nine months ago. SBI’s Magnum Contra has been a consistent top performer. It has yielded 92.8 per cent over one year, 81.8 per cent for three years and 48.2 per cent on a 5-year CAGR basis. Jain further explains that contrarian investing involves ignoring over-heated sectors and picking the ignored ones.

Spot the difference

Contrarian investing is similar to value investing. A value investor also invests in undervalued stocks with long term potential. So what’s different?

Nilesh Shah, President Kotak Mutual Fund: "Value investors look more at the valuations such as the P/E multiples, Price/Book value etc. The focus is thus on value. A contrarian approach involves picking up quality stocks when the markets are ignoring them purely for temporary reasons like changes in government policy, competitive environment or the business environment."

The top picks in Kotak Contra are I-flex, PNB, EID Parry and Tata Steel. I-flex enjoys a lower valuation compared to its peers and the fact that Oracle has a stake could mean huge growth in the order book of I-flex. Most investors sold the stock after the rise once the Oracle news became public. Kotak bought it then, reviewing the long term potential.

The markets also seem to have ignored the growth potential in PNB and bought it purely for treasury profits. Similarly, EID Parry is not only a sugar business but it also has investments in fertilisers. These stocks are contra picks. Will they deliver? Only time can tell. Contra funds warrant a medium to long term horizon.

Tata Mutual Fund is the most recent entrant in the contrarian space. Says Ved Prakash Chaturvedi, Tata Mutual Fund "Contra strategy works well in an over heated market. Post the bull run of 2000, people who had invested in sectors like auto, metals, cement and engineering taking a contrarian view fared better. Over the long term, contra funds can deliver top returns". For their Contra fund, sectors like FMCG, fertilisers, tractors, pharma and oil refining and marketing are Tata Mutual Fund favourites.

Bottom-line

Several fund managers have demonstrated that they can implement the contrarian strategy effectively. The success of contrarian management depends on sticking consistently to the philosophy. Shah explains, "Over a period of time, what matters sticking to the contrarian philosophy and delivering good returns at the same time. The challenge is to get that balance".

Typically, contrarian investing involves less initial risk, since purchase prices are usually at the low end of valuations. Historically, stock markets move in cycles. The contrarian concept, like any other investment philosophy, will cycle in and out of favour. Diversification cannot be over-emphasised. Putting all your eggs in one basket is dangerous. The contrarian approach should be adopted only as one component of a diversified portfolio.

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