Buy Call - Two quarters of strong performance and good order pipeline

Polaris has undergone a painful restructuring into a products-cum-services player. Two quarters of strong performance and good order pipeline are encouraging.

Investors with a penchant for risk can consider taking exposure in the Polaris Software Lab stock with a one/two-year perspective. Two straight quarters of robust financial performance with a sharp jump in operating margins, good pipeline of business across Tier I/II global banks, and reduced dependence on Citigroup, its largest client, lend confidence to the stock.

At the same time, the company remains exposed to risks arising from heightened competition in the banking products space, product acceptance, efficacy of its cross-selling capabilities across the banking and financial services space and execution issues on large projects. At the current price levels, the stock trades at a price-earnings multiple of 14 times its likely per-share earnings for 2006-07 on a conservative basis.

PAINFUL RESTRUCTURING

Since its merger with Orbitech in 2003, Polaris has passed through a troubled phase in restructuring its overall business model.

Its transition from a pure software services player to a hybrid model focussed on product-cum-services catering to the banking, financial services and insurance (BFSI) industry has been a slow process, with the first signs of turnaround evident in its financial performance and order pipeline.

In terms of structural changes to the business model, Polaris has created six sub-verticals within the BFSI space, which are: Retail banking and credit cards; consumer finance and mortgages; insurance; capital market and wealth; corporate banking and cash; and enterprise solutions and mainframe.

Around this, Polaris has created three distinct growth engines, as spelt out in the 2005-06 Annual Report:

Intellect product (its core suite)-led services, in which it has secured business wins from clients in the UK, West Asia, Latin America, Australia and Nordic region.

This is likely to be a high-margin business as it is IP-led playing to the strengths of its core products suite.

Domain-led services, which will be used to secure business from Wall Street Banks such as JP Morgan Chase or Bear Stearns. Generally, projects or solutions that are bagged on the strength of vertical expertise typically enjoy a reasonably high margin.

The senior management of Polaris has indicated that for 2005-06, 10 per cent each of the revenues can be categorised as intellect-led and domain-led services. As these two services start contributing more to revenues in the coming years, the operating margins and bottomline will expand significantly.

Application Maintenance services are typically the low-margin business, which are likely to come under greater pressure.

IMPROVED FINANCIALS

For the first half of 2006-07, Polaris' financial performance has turned out to be quite impressive. Not only did the company log two successive quarters of double-digit sequential revenue growth, its operating profit margins have also perked up. At 15.5 per cent in the first quarter-ended June 30 and 17.9 per cent in the second quarter-ended September 30, the operating profit margins were three and five percentage points higher than the same period in the previous year.

This is encouraging, as it creates the prospect of pushing up margins to 20 per cent in the coming quarters. As the Asia-Pacific region contributes over 30 per cent of its revenues, margins are lower. With rising contribution from Europe and the US, the overall margin picture may start moving northwards. For instance, in the latest quarter, the onsite billing rate per hour in Asia-Pacific was $41.5 compared to $68.3 across Europe and the US.

ORDER PIPELINE

The company's efforts in strengthening its sales and marketing organisation over the past year are beginning to pay off. As of September 30, the company has 53 large global banks as its customers, comprising 15 AAA accounts (with revenues of $ 10 million or more), 14 AA ($5 million to $ 10 million) and 24 A ($ 1 million to five million).

These suggest the good client mining potential from these customer accounts. In the latest quarter, the company added 14 clients, including three global banks. Recently, the company inaugurated a specialty centre for technology solutions for the investment banking industry called `Capital' in Hyderabad. Seven out of the top 10 investment banks are the customers of Polaris serviced through this centre.

The contribution from Citigroup as its single largest client has been coming down steadily. In the latest quarter, Citigroup contributed 48.7 per cent of revenues, down from 51.7 per cent in the first quarter and 57.7 per cent in the corresponding previous period.

The contribution from the high-margin intellect-led business has also been going up. It contributed 16.65 per cent of overall revenues in the second quarter, up from 14.9 per cent in the previous quarter.

The robust order-book creates scope for this contribution to increase steadily in the coming quarters, with an improvement in its overall margins.

Technical Analysis and recommendation of nine stocks for short term and mid term

Agro Dutch Industries (Rs 24.7): This stock is in a long-term downtrend. It has not been able to recover from the slide it witnessed since October 2005. The stock is currently reversing after hitting its 200-day moving average positioned at Rs 29. A small spike was witnessed on Friday, which can take the price to Rs 27 or Rs 29. Exit in this rally if you are a short-term investor. Long-term investors can hold this stock with a stop at Rs 22. A breakout past Rs 30 is required to take the price towards Rs 36 and then Rs 41.

State Trading Corporation (Rs 158.6): This stock is moving in a broad range between Rs 70 and Rs 200 since 2001. Short-term resistance for this stock exists at Rs 160. This level needs to be breached for the stock to rally to its previous highs of Rs 212. The narrow range bound moves seen since September is encouraging. An upward breakout is possible. So hold the stock with a stop at Rs 135.

Bharat Forge (Rs 376.9): The movement of Bharat Forge since late July can be fit in to an upward moving channel that has the upper boundary at Rs 425. That is the target for this stock over the medium-term. Hold with a stop at Rs 345. If Rs 345 is breached, the stock can head lower towards Rs 320.

Suzlon (Rs 1474.6): When the price was at Rs 954, we had analysed Suzlon, as follows: The momentum is picking up in both the daily as well as the weekly chart of Suzlon since it formed a higher bottom at Rs 910. Long-term investors can hold with a stop-loss at Rs 750. Buying in dips is also recommended with the same stop-loss. Price can move to Rs 1,400 or Rs 1,500 in one year's time. The price has already achieved the long-term target set out by us. If the momentum continues, the scrip can head upwards towards Rs 1,942 and then Rs 2,167. Fresh buying can be made at this point with a stop at Rs 1,370.

Geometric Software (Rs 115.4): A study of the volumes of Geometric Software reveals that maximum interest was displayed by the investors in this stock in 2002 and 2003. The trading interest is picking up slightly since October this year. The stock has been moving in a range between Rs 80 and Rs 130 since September 2005. It has made three attempts to get past the high of Rs 130 since then. Entry at this level is not recommended, as the price is positioned near the upper end of the range. Wait for a close above Rs 140 before going long with a target of Rs 172 and a stop at Rs 225.

Polyplex Corporation (Rs 114.6): This stock had lost 70 per cent from the high of Rs 279 made in September 2005. The recovery seen since June lacks conviction. Long-term support for the stock exists at Rs 100. Exit the stock if Rs 100 is breached. Price would have difficulty rising above Rs 170 in the next three months.

Jyoti Structures (Rs 128.8): This stock has made a stunning recovery from the July lows of Rs 59. Chart patterns suggest consolidation taking place at higher levels. Once the resistance at Rs 130 is breached, we can see a rally to Rs 175 or Rs 185. Hold the stock with a stop at Rs 108. Fresh longs can also be initiated here with the same stop.

Everest Kanto (Rs 503.5): This stock has been one of the stronger performers in the post-June rally in the mid-cap stocks. The price scaled a new all-time high of Rs 518 in late September and since then there has been a consolidation in a narrow band between Rs 460 and Rs 520. Positions can be taken in this band with a stop at Rs 450. The price has the potential to move upwards to Rs 608 and then to Rs 703 over the next one year.

Gokaldas Exports (Rs 629.7): This stock is moving in a band between Rs 600 and Rs 700 since September. Since this move comes after a sharp upward move from Rs 452, it can be construed as a consolidation move with an impending upward thrust to Rs 800 or Rs 850 over the long term. For the short term, the price will face resistance from the zone between Rs 660 and Rs 700. Fresh positions can be initiated is dips with a stop at Rs 580.

Source

BUY Call - While business outlook remains strong, containing costs will be the key to determining earnings growth

While business outlook remains strong, containing costs will be the key to determining earnings growth.

Healthy business growth, improving asset quality, a relatively de-risked bond book, and undemanding valuation lend credibility to the Vijaya Bank stock. Investors can consider fresh exposure to the stock at theits current price of Rs 53 with one/two-year perspective.

Insipid performance of the bank until last year is one of the reasons for the poor valuation of athe stock.

While net interest income has remained under pressure, bad loans piled up.

However, things are gradually changing now. Through a sharper focus on recoveries and stricter credit monitoring, Vijaya Bank has been able to bring down the level of net non-performing assets (NPAs) to 0.6 per cent in September 2006 against 1 per cent a year ago.

Further, the bad loan coverage ratio has also improved from 68.1 per cent a year ago to 78.5 per cent now.

This, coupled with excess floating provisions of Rs 30 crore (or 30 per cent of the net NPAs), is likely to provide cushion to the bank in case of loan delinquencies. This is also likely to keep provisioning charges lower over the next few quarters.

Business outlook

For the September quarter, the bank recorded a healthy 24 per cent growth in business volumes. Its business reached Rs 50,000 crore six months ahead of the target date, and the bank has set a goal of Rs 60,000 crore to be achieved by FY-07.

While its loan book has grown by about 25 per cent, pressure on margins still persists. The bank's cost of funds rose by about 30 basis points in the September quarter, affecting its net interest margins (NIMs).

Though yields on advances have improved, rising deposit costs along with a marginal fall in low-cost deposit base have resulted in NIMs declining by about 22 basis points. At 3.12 per cent, NIMs are still healthy and on a par with industry average.

Containing costs is likely to be a key element in determining earnings growth and, thus, holds greater significance. For Vijaya Bank, various technology-based initiatives are likely to help bring down the operating cost. The bank also has the leeway to re-deploy its excess investments in SLR in its loan book; this is expected to improve its margins over the medium term.

With the bank's credit at 61 per cent of deposits, there is still headroom to increase its loan book. If this happens, margins and profitability are likely to improve.

Investment portfolio

The bank's investment portfolio appears largely insulated from interest rate risk. This is because over 70 per cent of its holdings in government securities are under the held-to-maturity (HTM) category.

The continuing decline in bond yields this quarter is likely to have a positive effect on its bond book in the coming quarter or two.

At its current price, the stock quotes at a price-to-book multiple of 1.3 times against 1.5-1.6 times for most other public sector banks. The return on shareholder funds has improved sharply to 20 per cent.

The bank is likely to generate and sustain return on shareholders' funds in the 15-18 per cent range over the next year or two. This appears healthy and is enough to support the valuation of the stock and provide a cushion on the downside.