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Banking

Company Update

ICICI BANK
Valuations-Too attractive to ignore

INR 493 BUY
September 29, 2008 Vishal Goyal, CFA +91-22-4040 7540 vishal.goyal@edelcap.com Ajitesh Nair +91-22-6623 3358 ajitesh.nair@edelcap.com M B Mahesh +91-22-6620 3027 mb.mahesh@edelcap.com

ICICI Bank stock has corrected sharply in the past couple of weeks and is down 60% YTD and has underperformed Bankex by 14% and Sensex by 22%. We believe investors’ concern on the global environment and the bank’s large FII holding is leading to sharp corrections in the stock. In our view, these concerns are more than factored in the current valuations, and should be used as an opportunity by the long term investors to accumulate the stock. We are positive on fundamental measures taken by the bank from a long-term perspective in moderating balance sheet growth, building liability franchise, and expense control which, we believe, will translate into enhanced ROE (12-13%) in the following 18-24 months. Though uncertainty in global credit markets, asset deterioration over the next two-three quarters, and moderation in balance sheet may restrict the near-term stock performance, at current prices the stock offers 40%+ return over 12-18 months. Adjusted for value in subsidiaries (INR253 per share), the stock trades at 0.65x FY10E adjusted book and 0.8x FY09E adjusted book. The stock is trading below our stressed case value of INR 537 which assumes 0.9x adjusted book and USD 5 bn as value of life insurance. Outlook and valuations: Deep value; maintain ‘BUY’ The bank was prudent in raising capital ahead of time, which is a big support to capital adequacy ratios now when the capital availability is scarce. FY09 will be a year of consolidation for the bank, which, in our view, will give the bank an opportunity to enhance its liability franchise and improve its asset quality. In our view, present stock price is more than factoring in weak FY09 profits and increase in NPA, while cheap valuations for a diversified franchise and decline in NPA in FY10E are being ignored currently. We believe the stock attractively is valued; we reiterate ‘BUY’.

Reuters Bloomberg

: :

ICBK.BO ICICIBC IN

Market Data 52-week range (INR) Share in issue (mn) M cap (INR bn/USD mn) : : : 1,465 / 483 1,113.1 549 / 11,826 6,477.5

Avg. Daily Vol. BSE/NSE (‘000) :

Share Holding Pattern (%) Promoters MFs, FIs & Banks FIIs : : : : 0.0 17.7 38.8 43.5

SOTP - Scenario analysis

Others

(INR per share) FY08 FY09E FY10E Networth Net NPA Assuming $200 mn MTM hit on UK book Book Value adj for 70% of Net NPA Investments in Non-banking Subs BV adj for subs invst. and Net NPA Current Market Price Bank - Price/Book adj for NPA Price adj for subs value/ Adj book (A) Value of subs Life insurance at USD 6.7 bn (Base case) Life insurance at USD 5.0 bn SOTP (Scenario analysis) At 1.3x adjusted book (Base case) At 1.0x adjusted book + subs value At 0.9x adjusted book+ lower subs value (A*1.3+B) (A+B) (A*0.9+C) 671 560 463 706 594 487 779 657 537 (B) (C) 192 131 220 151 253 173 1.22 0.82 (A) 425 31 0 403 34 369 448 39 8 414 41 374 493 1.19 0.73 1.09 0.59 479 32 8 451 47 404

Relative Performance (%) Sensex 1 month 3 months 12 months (10.3) (6.4) (27.3) Stock (25.8) (21.7) (53.4) Stock over Sensex (15.4) (15.3) (26.1)

1,600 1,300

8,000 6,000 4,000 2,000 0

(INR)

1,000 700 400

Sep-07 Mar-08 Sep-08
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ICICI Bank Asset quality deterioration to peak by Q4FY09E We believe the major concern weighing on the stock has been deterioration in asset quality. Though in the near term stress in unsecured and other retail loans will continue, our analysis of various ABS pools rated by ICRA and Crisil suggests that slippages in retail portfolio will peak out post Q4FY09E, which will be a key positive trigger for the stock. It is to be noted that the bank is consciously going slow in retail lending since the past 18 months, much ahead of peers sensing stress building in the segment. Its housing and CV loan portfolio has almost remained steady over the past 12-18 months, while auto loans (ex-CV) have actually declined. With respect to non-collateralised portfolio (viz., unsecured personal loans and credit cards) though it has been aggressive in late FY07 and early FY08, the portfolio has remained steady over the past nine months. Nearly 20% of retail assets, which comprise unsecured loans, contribute ~65% of retail NPA, suggesting high delinquencies in personal loans and credit card segments. Delinquencies in two-wheeler and unsecured personal loan portfolios are expected to peak from Q4FY09. Moreover, additions to NPA should decelerate as the bank sees complete wind down of its small ticket personal loan (STPL) book (roughly INR 10 bn). Corporate asset book continues to be healthy. We expect Gross NPA to touch 5% in FY09 and remain flat in FY10, as additions in retail NPA decelerates. Chart 1: Loan book break-up

International lending 21%

Commercial vehicles 8%

Agri 7% Corporate and project finance 13% Other Retail 2%

Housing loans 30%

Auto loans 7%

Credit cards Two wheelers 4% 2% Personal loans 6%
Source: Company, Edelweiss research

Table 1: Retail portfolio growth— Deliberately going slow
INR Bn Advances Retail loans including CV Commercial vehicles Housing loans Auto loans Two wheelers Personal loans Credit cards Corporate and project finance Agri International lending Q4FY07 1,959 1,277 185 670 192 22 120 54 230 NA 244 Q1FY08 1,983 1,274 170 655 190 26 112 61 243 141 325 Q2FY08 2,071 1,310 170 656 197 29 134 68 291 100 370 Q3FY08 2,155 1,323 180 668 170 35 138 78 299 80 453 Q4FY08 2,256 1,317 190 668 170 35 133 80 292 170 477 Q1FY09 2,256 1,317 190 656 170 35 120 85 292 130 477

Source: Company, Edelweiss research

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ICICI Bank Chart 2: Retail—Primary contributor to overall NPA

100% 80% 60% 40% 20% 0% 1 Others Iron/ steel & products Retail finance
Source: Company, Edelweiss research

2.50% 1.67%

1.56%

1.42%

1.31% 19.76%

71.79%

Shipping Services – finance

Textiles Chemicals & fertilisers

Following are the key reasons why we believe asset quality will show an improvement: 1. ICICI Bank has an outstanding retail book of ~INR 1,300 bn, which has remained flat at current levels for the past five-six quarters. Given the portfolio delinquency behavior in every retail asset product, we believe portfolio delinquency will start flattening in Q4FY09, the rate of growth in NPA is expected to come down. 2. Marginal shift in composition of asset book, mainly due to runoff from personal loan book, especially short term loans, where delinquency levels are higher than in the other retail portfolio. 3. Underwriting likely to improve with slowdown in loans originating from direct sales agents (DSA) to branches where customer credit history is available. Delinquency movement estimates indicate peaking of deterioration We have analysed various pools from ICRA and CRISIL ABS (asset backed securities) and MBS (mortgage backed securities). Based on pool performance, we have tried to replicate this behavior to the loan portfolio to understand delinquency movement. We have made the following assumptions: • • Delinquency pattern witnessed in ABS will replicate the current outstanding loan book. We expect the delinquency ratios to be higher than that reported by securitized pools due to worsening macro conditions. We expect slippages to be higher by 30% for car, housing and CV loans while 40% higher for personal loans from present levels.

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ICICI Bank Table 2: Retail gross NPA
Gross NPA (%) Cars CV Housing Personal loans and credit cards Amount (INR bn) Cars CV Housing Personal loans and credit cards Total retail NPA 3.2 2.0 0.5 1.8 7.5 3.8 4.5 3.6 16.7 28.5 5.6 5.7 12.4 34.6 58.3 5.8 5.7 15.1 39.2 65.8 7.1 5.7 16.1 42.9 71.7 6.6 5.0 17.1 47.3 76.0 6.8 5.0 17.9 50.2 79.9 6.8 7.5 20.4 52.1 86.7 Q4FY06 1.7 1.7 0.1 2.2 Q4FY07 2.0 2.7 0.5 9.7 Q4FY08 3.0 2.9 1.9 16.1 Q1FY09 3.2 3.0 2.3 17.4 Q2FY09E 3.9 2.9 2.4 18.8 Q3FY09E 3.6 2.5 2.4 21.1 Q4FY09E 3.8 2.5 2.4 22.8 Q4FY10E 3.8 3.8 2.2 25.5

Source: Rating agencies, Edelweiss research

Our analysis of asset quality experience of ABS/MBS pools rated by ICRA suggests that delinquencies for housing loan tend to peak at 24-30 months post securitisation, CVs tend to peak at 15-18 months, auto loans (ex-CV) at 15-21 months, and personal loans at 18-24 months. Moreover, deterioration in asset quality generally picks up in the first few quarters before peaking and steadily tapers down in the final stages. While we believe ICICI Bank will experience higher delinquencies in the next two-three quarters on loans disbursed in FY06 and FY07, but post Q4FY09 NPL increase will peak out. With recoveries kicking-in from existing portfolio, lower interest rates, and improving underwriting standards, asset quality is likely to show a much better picture in FY10. Chart 3: Retail GNPA should peak in Q4FY09

1,800 1,600

7.5 6.0 4.5 3.0 1.5 0.0

(INR bn)

1,400 1,200 1,000 800

Q2FY09E

Q3FY09E

Q4FY09E

Q1FY10E

Q2FY10E

Q3FY10E

Advances

Gross NPA
Source: ICRA, Edelweiss research

We are also factoring in NPA ratio of 3.7% for non-retail portfolio in FY09E (primarily wholesale and international) by analyzing the bank’s industry exposure to different segments. Credit spreads for global banks at all-time high Credit spreads for global banks had been hugely volatile over the past week before they dipped on Friday, which are still the highest in the past four-five years. On September 16, 2008, in our note “impact of rising global spreads” we had estimated USD 200 mn MTM losses on the UK investment book which would vary with change in credit spreads. In the absence of any negative news flow, we expect spreads to settle down at or below current levels.

Edelweiss Securities Limited 4

Q4FY10E

Q4FY06

Q1FY07

Q2FY07

Q3FY07

Q4FY07

Q1FY08

Q2FY08

Q3FY08

Q4FY08

Q1FY09

(%)

ICICI Bank Table 3: Change in 5 year CDS spread across time periods

31-Dec-07 A Bank/Brokers America Goldman Sachs Lehman Brothers Bank of America Capital One Bank Citigroup Inc J P Morgan Wachovia Corp Wells Fargo Europe Credit Suisse Barclays Deutsche Soc Gen Standard Chartered UBS Asia HSBC Holdings Kookmin Bank Average ICICI Bank

31-Mar-08 B

29-Sep-08 C

Change in spread B-A

Change in spread C-B

68 120 49 225 73 50 106 60 49 48 46 31 40 46 58 69 76 177

148 290 98 275 171 98 178 97 127 103 98 102 92 140 100 172 144 335

475 160 350 320 155 440 155 158 268 188 150 142 320 125 320 248 400

81 49 50 99 48 72 37 78 55 53 71 53 94 42 103 68 158

327 62 75 149 57 262 58 31 165 90 18 8 30 25 148 104 65

Source: Edelweiss research

FY09: A year of consolidation After years of strong balance sheet growth, ICICI Bank will look upon FY09 as a year of consolidation in terms of balance sheet growth. It is increasingly focusing on spreads rather than growth and balance sheet growth is likely to moderate to single digit in FY09. The bank is deliberately going slow on disbursements in the retail segment; international and corporate banking will be key growth drivers going forward. The bank is focusing on improving its liability franchise incrementally tapping higher retail deposits and targeting CASA ratio of 33% over the next two years. It has been consistently improving market share in CASA deposits; we believe 433 new branches opened in the past two quarters, will prop up CASA base further improving its market share. In our view, with lower balance sheet growth, focus on increasing retail deposits, and addition of branches, the cost of funds will be contained.

Edelweiss Securities Limited 5

ICICI Bank Chart 4: ICICI has increased its market share in CASA deposits

8.0% 6.5% 5.0% 3.5% 2.0% 0.5% FY03 FY04 FY05 FY06 Casa Mkt Share FY07 Branches FY08

1,600 1,300 1,000 700 400 100

Source: Company, Edelweiss research

ICICI Bank has initiated various cost-cutting measures and is focused on optimising the same. Expenses directly linked to loan growth (sourcing expense etc.,) are decreasing, due to 30% decline in retail disbursements in the previous quarter. DMA expenses are also expected to dip this year due to increased branch network. Rate of addition of employees will also decelerate to 5% going forward against 25% in previous years. The bank is aiming to maintain operating expenses growth within 10% Y-o-Y. Chart 5: Operating leverage to help profitability going forward

2.6 Operating Expense/Assets 2.5 2.4

(%)

2.3 2.2 2.0

FY05

FY06

FY07

FY08

FY09 E

Source: Edelweiss research

Edelweiss Securities Limited 6

FY10 E

(Nos.)

ICICI Bank Outlook and valuations: Compelling valuations; maintain ‘BUY’ The stock has corrected sharply in past couple of weeks and is at interesting price levels for long term investing. Adjusted for value in subsidiaries (INR253 per share), the stock trades at 0.65x FY10E adjusted book and 0.8x FY09E adjusted book. The stock is trading below our stressed case value of INR 537 which assumes 0.9x adjusted book and USD 5 bn as value of life insurance. Though uncertainty in global credit markets, asset deterioration over the next two-three quarters, and moderation in balance sheet may restrict the near-term stock performance, at current prices the stock offer 40%+ return over 12-18 months period. We reiterate our ‘BUY’ recommendation.

Table 4: SOTP base case

FY10E Bank Subsidiary Domestic AMC Venture Capital Securities Life insurance General insurance Other subs Value of subsidiaries Total

Method Price / Book % of AUM % of AUM Price / Earnings Appraisal Value PE

AUMs / earnings/ book 449,516 590,000 120,000 1,000 19,763 1,000

Multiple (x) 1.3 5.0% 10.0% 15.0 15.6 15.0

Value of business (INR mn) 584,371 29,500 12,000 15,000 309,208 15,000

ICICI Bank's holding (%) 100% 51% 100% 100% 74% 74%

Value of ICICI Bank's interest (INR mn) 584,371 15,045 12,000 15,000 228,814 11,100

Value per share (INR) 525 14 11 13 206 10 253 779

Source: Edelweiss research

Edelweiss Securities Limited 7

ICICI Bank Company Description Incorporated in 1994, ICICI Bank is India’s second largest bank and the largest among private banks with total assets of about INR 3.6 tn as of March 2008. The bank has a network of 1400 branches and over 3271 ATMs. The bank’s focus is on retail lending with retail financing representing 58% of total loans and advances while International and corporate are the new growth drivers. The bank holds market leadership in almost all its businesses including mortgages, auto loans, commercial vehicle loans, life insurance, general insurance, and asset management. Its subsidiaries ICICI Prudential Life, Pru ICICI AMC, ICICI Venture funds, ICICI securities, and ICICI Lombard are amongst the leading companies in their respective fields. Investment Theme ICICI bank is India’s second largest bank and is well-positioned to benefit from the domestic credit growth. With a buoyant corporate investment pipeline and robust retail asset growth, we expect the bank to post 15%+ CAGR in assets. The new growth engines, international and rural banking, are also operational and would push asset growth as the business matures. ICICI Bank is diversifying its business very rapidly and gaining market share in all the segments it has ventured into. It enjoys considerable pricing power, given its high retail exposure. Its wide distribution reach and growing asset book are enabling a rapid expansion of its insurance, asset management, venture capital, investment banking, and equity brokerage businesses. Key Risks Main risks for ICICI is NPA risk due to its low cumulative provisions. With 65% of retail asset book, it is vulnerable to system-wide deterioration in the quality of retail assets. Moreover, increasing share of non-collateralized assets in retail assets bring in more risk to the bank’s balance sheet. Sharp increase in interest rates can affect the margins, as its deposit mix has higher share of bulk deposits. Their rural and international businesses, which have just taken off, are also exposed to execution risk. Further monetary tightening could impact net interest margins

Edelweiss Securities Limited 8

ICICI Bank

Financial Statements
Income statement Year to March Interest income Interest expenses Net Interest income Non interest income - Fee & forex income - Misc. income - Investment profits Net revenues Operating expense - Employee exp - Other opex Preprovision profit Provisions - Loan loss provisions - Investment depreciation - Other provisions PBT Taxes PAT Reported PAT Diluted EPS (INR) DPS (INR) Payout ratio (%) Growth ratios (%) Year to March NII growth Fees growth Opex growth PPOP growth PPP growth Provisions growth PAT growth Operating ratios (%) Year to March Yield on advances Yield on investments Yield on assets Net interest margins Cost of funds Cost of deposits Cost of borrowings Spread Cost-income Tax rate FY06 8.6 7.9 7.3 2.4 5.0 4.4 8.3 2.4 56.3 18.0 FY07 9.4 9.2 8.2 2.4 5.9 5.9 7.8 2.3 53.2 14.7 FY08 10.7 9.1 8.8 2.1 7.0 7.2 8.1 1.8 50.6 17.8 FY09E 11.0 9.0 9.1 2.4 7.1 7.4 8.8 2.0 50.2 25.0 FY10E 10.9 8.9 9.1 2.5 7.0 7.2 8.8 2.1 46.5 25.0 FY06 65.9 48.1 51.9 57.7 26.3 42.5 26.7 FY07 40.9 45.8 33.5 45.0 51.1 181.3 22.4 FY08 10.1 13.6 21.9 6.1 35.5 30.5 33.7 FY09E 24.6 23.0 5.8 41.0 7.3 15.0 (6.2) FY10E 14.6 17.5 7.2 19.7 24.8 16.6 30.1 FY06 143,061 95,974 47,087 41,899 34,912 8,047 (1,060) 88,986 50,104 10,916 39,189 38,882 7,916 7,768 (260) 407 30,966 5,565 25,401 25,401 28.5 8.5 34.1 FY07 229,943 163,585 66,358 59,292 50,900 7,577 815 125,650 66,906 16,167 50,738 58,744 22,264 21,593 419 251 36,480 5,378 31,102 31,102 34.6 10.0 33.9 FY08 307,883 234,842 73,041 88,108 57,811 12,175 18,121 161,149 81,542 20,789 60,753 79,607 29,046 27,010 623 1,413 50,561 8,984 41,577 41,577 37.4 11.0 33.1 FY09E 348,112 257,118 90,993 80,655 71,129 10,807 (1,281) 171,648 86,240 23,356 62,883 85,409 33,402 33,402 0 0 52,006 13,002 39,005 39,005 35.1 10.5 35.1 (INR mn) FY10E 375,530 271,284 104,246 94,837 83,577 8,448 2,813 199,083 92,488 26,486 66,002 106,595 38,954 38,954 0 0 67,641 16,910 50,730 50,730 45.6 11.9 30.4

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ICICI Bank

Balance sheet Year to March Liabilities Equity capital Reserves Net worth Sub bonds/pref cap Deposits Borrowings Other liabilities Total Assets Loans Investments Gilts Others Cash & equi Fixed assets Other assets Total Balance sheet ratios (%) Credit growth Deposit growth EA growth SLR ratio C-D ratio Low-cost deposits Gross NPA ratio Net NPA ratio Provision coverage Incremental slippage Net NPA / Equity Capital adequacy - Tier 1 Book value (INR) Ratios Year to March ROA decomposition (%) Net interest income/Assets Fees/Assets Investment profits/Assets Net revenues/Assets Operating expense/Assets Provisions/Assets Taxes/Assets Total costs/Assets ROA Equity/Assets ROAE 2.4 2.2 (0.1) 4.6 (2.6) (0.4) (0.3) (3.3) 1.3 8.9 14.6 2.4 2.1 0.0 4.5 (2.4) (0.8) (0.2) (3.4) 1.1 8.3 13.4 2.1 2.0 0.5 4.6 (2.3) (0.8) (0.3) (3.4) 1.2 10.2 11.6 2.4 2.1 (0.0) 4.5 (2.3) (0.9) (0.3) (3.5) 1.0 12.7 8.0 FY06 FY07 FY08 FY09E 57.0 65.4 51.6 25.2 91.4 22.7 1.5 0.7 51.4 1.1 4.7 13.4 9.2 250 34.0 39.6 38.1 24.0 86.0 21.8 2.1 1.0 67.9 1.5 8.2 11.7 7.4 270 14.7 6.0 15.7 24.4 93.1 26.1 3.3 1.5 52.0 1.9 7.4 14.0 11.8 425 5.9 5.3 4.1 25.0 93.6 29.0 4.8 1.8 62.5 2.0 8.8 13.3 9.4 448 1,461,631 1,958,656 2,256,161 2,386,654 8,898 213,162 222,060 104,944 1,650,832 385,219 157,532 2,520,587 8,993 234,139 243,133 197,551 2,305,102 512,560 194,778 3,453,124 11,127 461,571 472,698 211,002 2,444,311 656,484 219,673 4,004,167 11,127 486,885 498,012 216,002 2,573,286 648,069 237,246 4,172,615 FY06 FY07 FY08 FY09E

(INR mn) FY10E 11,127 522,183 533,310 221,002 2,900,185 705,871 270,461 4,630,829 2,670,785

512,087 203,387
170,402 39,807 133,272 2,520,587

676,648 235,930
371,213 39,234 171,443 3,453,124

755,180 359,265
380,411 41,089 212,060 4,004,167

805,339 415,258
296,936 40,056 228,373 4,172,615

901,514 426,787
334,006 38,563 259,174 4,630,829 12.0 12.7 11.0 25.0 96.4 31.5 5.2 1.3 74.6 1.8 6.7 12.8 9.1 479

FY10E 2.5 2.2 0.1 4.8 (2.2) (0.9) (0.4) (3.6) 1.2 12.5 9.8

Edelweiss Securities Limited 10

ICICI Bank

Valuation metrics Year to March Diluted EPS (INR) FY06 28.5 FY07 34.6 FY08 37.4 FY09E 35.1 FY10E 45.6

EPS growth (%)
Book value per share (INR) Adjusted book value/share (INR) Diluted Price/Earnings (x) Price/ BV (x) Price/ ABV (x) Dividend yield (%) Price to income (x) Price to PPOP (x)

4.9
249.6 241.3 17.2 2.0 2.0

21.2
270.3 254.8 14.2 1.8 1.9

8.0
424.8 402.9 13.1 1.2 1.2

(6.2)
447.6 420.1 14.0 1.1 1.2

30.1
479.3 456.7 10.7 1.0 1.1

1.7
5.3 10.9

2.0
4.0 7.6

2.2
4.2 8.9

2.1
3.8 6.3

2.4
3.5 5.3

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Edelweiss Securities Limited, 14th Floor, Express Towers, Nariman Point, Mumbai – 400 021,
Board: (91-22) 2286 4400, Email: research@edelcap.com

Naresh Kothari Vikas Khemani Shriram Iyer

Co-Head Co-Head Head

Institutional Equities Institutional Equities

naresh.kothari@edelcap.com vikas.khemani@edelcap.com shriram.iyer@edelcap.com

+91 22 2286 4246 +91 22 2286 4206 +91 22 2286 4256

Research

Coverage group(s) of stocks by primary analyst(s): Banking and Financial Services:
Allahabad Bank, Axis Bank, Federal Bank, Future Capital, HDFC Bank, ICICI Bank, IOB, ING Vysya Bank, Karnataka Bank, Kotak Mahindra Bank, OBC, SBI, Yes Bank, IDFC, HDFC, LIC Housing Finance, PNB, Power Finance Corporation, Reliance Capital, SREI Infrastructure Finance, Shriram City Union, Syndicate Bank and Union Bank.

ICICI Bank

Recent Research Date 18-Sep-08 Company Future Capital ICICI Bank ICFC Banking Title Price (INR) Recos Accum.

16-Sep-08

Adapting to a tough 322 environment; Visit Note Impact of increase in 628 global credit spreads;

Buy

Event Update
29-Aug-08 28-Aug-08 Wings clipped; 97 Accum.

Result Update
Six reasons why we; Currently prefer SBI over ICICI; Sector Update

Distribution of Ratings / Market Cap Edelweiss Research Coverage Universe Buy Rating Distribution* 101 Accumulate Reduce 58 15 Sell 7 Total 191

Rating Interpretation Rating Buy Accumulate Reduce Sell Expected to appreciate more than 20% over a 12-month period appreciate up to 20% over a 12-month period depreciate up to 10% over a 12-month period depreciate more than 10% over a 12-month period

* 9 stocks under review / 1 rating withheld > 50bn Market Cap (INR) 84 Between 10bn and 50 bn 71 < 10bn 36

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