Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. This research report has been prepared in whole or in part by research analysts based outside the US who are not registered/qualified as research analysts with FINRA. PLEASE SEE ANALYST(S) CERTIFICATION(S) AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 55. EQUITY RESEARCH 10 January 2011 ISRAEL OUTLOOK 2011 NATURAL AND HUMAN RESOURCES JOIN FORCES TO LIFT ECONOMY
Transcript
Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware thatthe firm may have a conflict of interest that could affect the objectivity of this report.
Investors should consider this report as only a single factor in making their investment decision.
This research report has been prepared in whole or in part by research analysts based outside the US who are not registered/qualified asresearch analysts with FINRA.
PLEASE SEE ANALYST(S) CERTIFICATION(S) AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 55.
EQUITY RESEARCH 10 January 2011
ISRAEL OUTLOOK 2011NATURAL AND HUMAN RESOURCES JOINFORCES TO LIFT ECONOMY
Israel Outlook 2011_COVER.qxp 07/01/2011 12:24 Page 1
Barclays Capital | Israel Outlook 2011
10 January 2011
ISRAEL OUTLOOK 2011 – NATURAL AND HUMAN RESOURCES JOIN FORCES TO LIFT ECONOMY
2011 starts with market at all time high: Tel Aviv’s main indices kick off 2011 at or near all-time highs, with a strong economic backdrop continuing to provide support. While official growth numbers have not been released by the Bank of Israel, the Central Bureau of Statistics estimates that the economy grew 4.5% in 2010. The banking sector is well capitalised, the emerging energy sector remains squarely in focus and the local technology sector is capitalising on the fastest-growing trends in tech. While the markets are high, we still see opportunity. The move to developed markets from emerging was smoother than we expected and opens up Israel to a broader range of potential new investors and flows of capital.
Top Picks for 2011: In December Barclays Capital published its Global Top Picks for 2011. That list included both Teva (covered by Rich Silver) and Israel Chemicals. We reiterate those picks here. In addition, we favor Ratio in the emerging energy sector, Partner in the telecom services sector, Bank HaPoalim in financial services, EZChip and Nice in technology. 2010/11 are the years that Israel moves from a human resource driven economy – tech – to a resource driven economy as natural gas finds combine with the Dead Sea to become a major part of the economic story going forward.
Economy and Politics: Israel’s economic performance is improving. Growth has broadened and strengthened; the economy seems to be well on the way to full recovery. However, inflation is rising and presents a possible macroeconomic risk. Israel will transform from a high debt to a low debt country in the next decade. Production of natural gas is set to provide a financial windfall and force Israel to deal with its surpluses. The political situation appears stuck to us, but given the relative stability should not be a headwind for the economy or markets in 2011, in our opinion.
Risks: Given Israel’s small size the greatest risks we see are external. Any economic weakness in the US, Europe or Asia will certainly be felt in Israel given the high level, over 40%, of exports as a percentage of GDP. The economy will need to balance the threat of inflation, currency appreciation and low global rates to stay on track
ISRAEL OUTLOOK 2011 – NATURAL AND HUMAN RESOURCES JOIN FORCES TO LIFT ECONOMY............................................................................................................................................
BANKS ................................................................................................................................................11 Bank Leumi (LUMI.TA)............................................................................................................................13 Bank Hapoalim (poli.TA) ........................................................................................................................14 Israel Discount Bank (DSCT.TA) ...........................................................................................................15 Mizrahi-Tefachot Bank Ltd. (MZTF.TA) ..............................................................................................16
CHEMICALS & FOOD .......................................................................................................................17 Frutarom (FRUT.TA)................................................................................................................................18 Israel Chemicals Ltd. (ICL.TA) ...............................................................................................................20 MA Industries (MAIN.TA).......................................................................................................................22 Strauss Group Ltd. (STRS.TA) ...............................................................................................................24
TECHNOLOGY...................................................................................................................................27 EZchip Semiconductor (EZCH) .............................................................................................................28 NICE SYSTEMS (NICE) .............................................................................................................................30 Elbit Systems Ltd. .....................................................................................................................................31 Mellanox Technologies (MLNX) ...........................................................................................................33
TELECOMS.........................................................................................................................................35 BEZEQ (BEZQ.TA).....................................................................................................................................37 Cellcom Israel Ltd. (cel.TA) ....................................................................................................................38 Hot Telecommunication System (HOT.TA) .......................................................................................39 Partner Communications Co. (PTNR.TA) ...........................................................................................40
OIL AND GAS: E&P ...........................................................................................................................41 Ratio Oil Exploration (RATIp.TA) ..........................................................................................................42 Isramco Negev 2 LP (ISRAp.TA) ...........................................................................................................43 Avner Oil Exploration – LP (AVNRp.TA)..............................................................................................44 Delek Drilling - LP (DEDRp.TA) .............................................................................................................45 Delek Energy Systems Ltd. (DELEN.TA) ..............................................................................................46 Delek Group Ltd. (DELKG.TA) ...............................................................................................................47
ISRAELI COMPANIES COVERED BY BARCLAYS CAPITAL U.S. ANALYSTS ............................49 Amdocs Ltd. (DOX) .................................................................................................................................50 Ceragon Networks Ltd. (CRNT) ............................................................................................................51 Oil Refineries Ltd. (ORL.TA) ...................................................................................................................52 Orbotech (ORBK)......................................................................................................................................53 Teva Pharmaceutical (TEVA).................................................................................................................54
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Barclays Capital | Israel Outlook 2011
10 January 2011 4
MARKET COMMENT
Israel enters 2011 with the representative TA-25 index near or at all-time highs. The economy has recovered fully from the global recession and the challenges facing the central bank include maintaining the stability of an appreciating currency, keeping interest rates in check with global levels, the threat of rising inflation, and the potential economic influence of newly discovered large natural gas reservoirs off the coast.
We began 2010 on the verge of Israel being graduated to a developed market from an emerging market according to the MSCI classifications. In our 2010 preview we wrote: “In our opinion, the move will involve short-term challenges but should be positive in the long run. We believe that carefully selected Israeli equities provide investors with emerging market returns while exposing them to more conservative developed market risks and stocks that typically pay hefty dividends.”
Evaluating the impact of the move to developed markets is an imprecise endeavour. One concern we did have entering the transition was that the defensive characteristics of the Tel Aviv market when compared to other emerging markets would not be as pronounced in a comparison with developed markets. However, if we evaluate 2010 performance, our fears appear to have been overblown. The TA-25 returned 14.2% in 2010, 21.2% including currency gains. This puts it comfortably within the range of returns in emerging markets; Latin America stands out as having the best-performing markets in emerging markets in 2010. Compared to developed markets, the performance in Israel was trumped only by the OMX Stockholm 30 Index.
With the market ending 2010 near its all-time highs, it is perhaps tempting to call the transition to developed markets a success, especially in the context of the Greece and Portugal upgrades, which both saw market declines immediately after their respective MSCI upgrades. From the outset we believed that Israel would benefit from several factors that were not applicable to the Greece and Portugal experiences. The first is the high percentage of locally driven volume, 70% of the market volume, and the fact that a structural shift to higher equity allocation within overall portfolios is ongoing in Israel. The second is the global nature of Israel’s largest companies and the favorable comparative financials, for example the high level of dividend payouts in the communications sector. Another factor would be the breadth of the local tech market, a market which in our view has always transcended the MSCI emerging versus developed classification.
Our own approach to managing the upgrade has been to add technology stocks to a more prominent position in our coverage and to add the energy sector, which we see as having broad appeal to global resources investors as the natural gas find is being developed by Delek Group on the local side and Noble Energy on the international side. The participation of NOBL has made the discovery a hot topic among a much larger group of investors than would have been the case had Delek been running the exploration and development process alone.
On the more ad hoc, anecdotal side, we have found a high level of developed market investor interest unfolding over the past few months and the interest is cross-sector and growing.
While all of these reasons to point to a successful graduation, we still are watchful of market trends in this area and note that volumes on the TASE have dropped 10% from average 2009 levels. Given global volume trends we are not alarmed by this performance, but we
The TA-25 is at all-time highs and the local economy remains
robust- the graduation to developed markets from
emerging was smoother than expected
Barclays Capital | Israel Outlook 2011
10 January 2011 5
will need to keep watching the volumes as an indication of new international interest in the market in Tel Aviv.
Most sectors of the economy continue to perform well. The real estate sector is notable in that the overwhelming strength of the local market has everyone from the man on the street to the Bank of Israel worried about a property bubble. BoI is implementing new lending and provisioning requirements that discourage speculative real estate purchases. Using the local bond market as an indication of market opportunities’ and investor appetite we would note that in the first 11 months of 2010 (all the data available) has seen ILS 37 billion of non-government bond issuance; this compares to ILS 32 billion for all of 2009.
The energy sector has moved from a negligible percentage of the TA-25 to almost 12% as investors look to play the large natural gas reserves found off the Mediterranean Coast. We recently launched coverage on this developing sector.
Politics
Our general approach to investing in Israel is to ignore short-term political developments and focus on long-term economic trends. When these two factors overlap or contradict is the only time we expect to see the geopolitical have any lasting market impact.
In our view, 2010 was a fairly unproductive year for Israel on the peace front. If anything, the Gaza Flotilla incident in May has set back relations with Turkey and a return to the prior relationship seems unlikely at this point. On the other hand, we believe that strong economy in the Palestinian West Bank has contributed significantly to the lasting calm between Israel.
Direct talks between Israel and the Palestinian leadership took nine months to crystallise and fell apart as soon as a 10-month construction freeze in the Israeli West Bank settlements was lifted. Commentators from AIPAC to J-Street to NY Times Columnist Thomas Freidman have weighed in on the issue and we see it as highly unlikely that our analysis will capture a view that has been missed by all the other experts.
In short, we do not believe that politics played any significant role in determining the market’s direction in 2010. While we have learned to remain sceptical of progress on the peace front, we do not see the current political status quo as one that will radically shift the direction of the economy in 2011.
Market Outlook Given the above discussion and the more detailed economic review below, we are quite confident that certain stocks remain well positioned for further gains in 2011. We would continue to focus on ICL for investors focused on the agriculture/soft commodity industries; the telecom services sector for investors focused on dividend yield, and the emerging energy sector for investors with a high level of risk appetite. ICL from the Israel office and Teva from NY are both Barclays Capital Top Picks for 2011.
Little to no progress registered in this area, and we are not
expecting much in 2011 – but we see little market impact
Barclays Capital | Israel Outlook 2011
10 January 2011 6
ECONOMIC OUTLOOK (This article originally appeared in the Emerging Markets Quarterly, 7 Dec 2010. To view analyst certifications and other important disclosures, please click on the hyperlink above.)
2011 – Economic strength to continue
New policy phase – dealing with strength Israel’s economic performance is improving. Growth has broadened and strengthened; the economy seems to be well on the way to full recovery. However, inflation is rising and presents a possible macroeconomic risk. Israel has been running current account surpluses for some years from gains in high-tech exports. Fiscal accounts have been improving, and on current trends Israel will transform from a high debt to a low debt country in the next decade. Production of natural gas is set to provide a financial windfall and force Israel to deal with its surpluses. The BoI has already increased international reserves to prevent appreciation. In the next stage the government will have to develop supplemental ways to contain appreciation.
Strategy: The shekel remains a good currency to be long, albeit one in which we expect only slow gains on a trade-weighted basis. The Bank of Israel maintains a very tight leash on the exchange rate through its active currency interventions. However, the strength of the economy means that the BoI will allow some currency gains to come through and will be delivering further interest rate hikes as well. A stronger exchange rate will be helpful in terms of containing inflation, although we stress that this is not the main concern right now, given the other more important drivers of inflation (housing) that are relatively insensitive to the stronger currency. Low speculative positioning in the shekel and very favourable long-term BoP dynamics make the shekel a structural long for us, although investors should not be anticipating more than 5-7% pa trade-weighted appreciation (Figure 1). On Israeli swaps and bonds, we remain broadly neutral: we are about halfway through the hiking cycle, which leaves the front end still vulnerable to yield upside, while at the back end of the Israeli curve, the end of the bull flattening trend in Treasuries and Bunds deprives the market of a source of support that had previously existed.
Growth performance has been excellent Israel’s economy appears headed for a full recovery, growing at a rate of 4% y/y in 2010
(Figure 2). Net exports were crucial in the initial stage of the recovery but now consumption and investment have taken over. After a temporary dip in growth in Q3 because of a drop in We view overheating as an increasing risk, and we are increasing our growth forecast exports (-10% q/q, annualized), growth appears to be rebounding in Q4. Previously we had thought that a derailing of the recovery was a risk. Though we are staying with our forecasts, we are more confident and recognise upside risk and possible overheating of the economy. We see growth in 2010 at 3.8%, accelerating slightly to 4.0% and 4.2% in 2011 and 2012, respectively. This assumes continuation of strong trends in consumption and investment into 2011-12. Thus, domestic demand rises while there is a gradual decrease in reliance for net exports as a driver of growth.
Inflation becoming a risk Inflation has been rising in recent months, reaching 2.5% y/y from 1.8% (Figure 3). Most of the increase has been because of food prices, but not exclusively. In our opinion, inflation is becoming a macroeconomic risk in Israel. Pressures on inflation have come from housing where prices are up 20% y/y. Now unemployment is down to pre-recession levels and wages are starting to rise. Finally the government is continuing to increase administrative prices. We expect the pace of inflation to quicken from current levels and stay at 2.7% in 2011. The main factors will be a rise in core inflation, with housing and food inflation remaining elevated but not accelerating. The risk is that growth heats up more and pushes core inflation higher as labour markets heat up.
Monetary policy tightening to continue The BoI has been able to extricate itself from the accommodative monetary policy that existed in 2009 without much collateral damage to the exchange rate and growth. Rates have been increased 150bp and, although still low, are in a more normal range. The BoI has successfully frozen money supply at mid-2009 levels and therefore gone some way towards sterilizing excess liquidity. The currency has continued to appreciate in real terms, but the overall appreciation has been very modest. The BoI has had to accumulate large reserves in its quest to lean against currency appreciation. These reserves have greatly improved the economic fundamentals of Israel, which unfortunately is another reason for currency appreciation. With the policy rate at 2.0%, real rates are negative and the BoI has reasons to keep raising rates to normalize monetary policy and perhaps to quicken the pace slightly. There are still several factors that may cause it to stay with its historically slow pace of tightening. Major global
Figure 3: Wage inflation and core are rising
Figure 4: Government debt ratio falling as planned
Israel: Central Government Gross Debt (% GDP, RHS)
Source: Israel Central Bureau of Statistics, Haver Analytics Source: Israel Ministry of Finance, Central Bureau of Statistics, Haver Analytics
We expect the pace of inflation to quicken in Q4 10 and
acknowledge upward risks to inflation in 2011
With the policy rate at 2.0%, real rates are negative and the BoI has
reason to keep raising rates to normalise monetary policy and
perhaps quicken the pace slightly
Barclays Capital | Israel Outlook 2011
10 January 2011 8
central banks retain their extremely low rates because of continued economic challenges. Thus, the BoI has concerns about capital inflows and currency appreciation pressures.
Fiscal policy gaining strength Fiscal prospects are excellent as revenues have been rising rapidly on higher economic growth. The Israeli government is actively lowering its deficits and debt. It is keeping expenditures under control and the buoyant economy is contributing to revenue collection. Revenues have been increasing at a 10% clip y/y in 2010. The official upper limit on the deficit for 2010 is 5.5%. However, at this time it appears that the 2010 deficit will be between 3.5% and 4% of GDP as revenues have been better than anticipated (Figure 4). In addition, according to the recent IMF report, the government is planning to reduce the deficit to 3% in 2011 and 2% in 2012. In the next few years the government plans to lower the deficit to 1% of GDP per annum. This will help bring overall government debt levels towards the 60% of GDP target sooner. The government is putting a priority on bringing down the level of government debt, which is quite high. If outperformance on revenue continues, tax cuts could be expected.
Exchange rate pressure on balance of payments strength Israel current account surpluses have been supported by high-tech exports, particularly services, as well as government and private transfers (Chart 5). The recent discoveries and development of natural gas will improve Israel’s balance of payments even more over the next few years. The natural gas reserves offshore are currently estimated at 26 Tcf (trillion cubic feet proven and probable), equivalent to about 4.5bn barrels of oil. Two smaller fields (1.5 Tcf) are already producing (Figure 6). Another large field (8.5 Tcf) will be producing in about two years. The largest field, representing half of the reserves, is only now being developed and could be producing in five years. We expect proven reserves to expand faster than they are depleted. At this time energy companies are already producing natural gas at a rate of about 50,000 BOE (barrels of oil equivalent) per day. This is being absorbed into the economy along with about 230,000 barrels per day of imported oil and additional imports of coal. Given total energy consumption of about 125mn barrels per year (equivalents) in all forms of energy, gas reserves could supply all of Israel’s energy needs for the next 40 years. As natural gas production increases, we expect increasing conversion of electricity generation and other operations to natural gas away from coal and oil. In the end, Israel will likely be exporting natural gas and continuing to import oil, with the possibility of eventually becoming a net exporter of energy
The Israeli government is actively lowering deficits and
debt levels
Figure 5: Current account surpluses rising
Figure 6: Natural gas production to expand rapidly
-6
-4
-2
0
2
4
6
8
10
05 06 07 08 09 100
10
20
30
40
50
60
70
Current account balance (USD bn, 12 mth rolling)Trade balance (good and services)Foreign exchange reserves (USD bn, RHS)
050
100150200250300350400450500
2004 2006 2008 2010E 2012E 2014E 2016E
Israel natural gas production (BcF/year)
Tamar comeson line
Leviathan comes on line
Source: Israel Central Bureau of Statistics, Haver Analytics Source: Israel Central Bureau of Statistics, Haver Analytics
Israel is already running current account surpluses and is about to receive a huge windfall from
natural gas production
Barclays Capital | Israel Outlook 2011
10 January 2011 9
(through pipelines and liquids). Total Israel energy imports are running at a rate of USD10bn (-4% of GDP) in 2010. Based on our estimates, Israel’s natural gas production will increase from USD1bn in 2010 to about USD6bn per year in 2016 (2.4% GDP at current prices). While this will be partly offset by higher energy consumption, Israel’s energy trade deficit should decline boosting current account surpluses.
The main macroeconomic risk is that energy production leads to strong currency appreciation, hurting domestic industries. In our view, the accumulation of foreign reserves by the BoI has been an appropriate response to the existing current account surpluses. However, when energy production kicks up, the efforts of the BoI will need to be supplemented. The government will need to use its tax-royalties windfall from energy production in ways that prevent excessive currency appreciation. We expect that it will establish a sovereign wealth fund to channel some of the foreign exchange earnings out of local markets. In addition, the government could use some of the funds to finance major infrastructure improvements that would further improve private sector productivity.
Source: Factset, Barclays Capital (data as close of 5 January 2011)
Barclays Capital | Israel Outlook 2011
10 January 2011 13
BANK LEUMI (LUMI.TA)
The Investment Case
We maintain our 2-EW rating on LUMI as we enter 2011. LUMI led the sector across multiple metrics including ROE, CAR, and cost/income over the last several years and also was the first Israeli bank to resume steady dividend payments, having announced ILS 1.0bn in combined dividends following 2Q and 3Q10 results. We believe that this leadership is already reflected in the shares and see more potential room for upside surprise at POLI in 2011. We see only a temporary impact from the almost certain sale of the state’s remaining 10% holding in the bank, which we expect in early 2011, based on numerous announcements made by the Ministry of Finance in 2010.
The Business Drivers
As Israel’s largest bank by most measures, excluding loan portfolio, there is little in the local economy that does not affect LUMI’s results. A focus since 2007 on shifting attention to the retail and commercial segments of the market has proven to be successful and, we believe, profitable for LUMI. In 3Q10 retail banking amounted to 45% of the loan book, with 21% of the loan book in the commercial banking segment. This exposure was behind the 6% growth in the first nine months of 2010.
One unique facet to LUMI’s strategy is its holdings in non-banking assets in Israel. These assets can add significantly to reported net income and boost ROE in most quarters by at least 1%. Given the tenure of some senior managers and a retirement age of 67 there could be some turnover in 2011.
Upside/Downside Scenarios
LUMI is currently trading at almost 1.1x 2011e BVPS. We see upside to 1.2x based on LUMI’s growth and return profile. With only 9% upside from the current price to our target, we see more upside elsewhere.
Our target multiple could prove to be low if the Israeli economy continues to surprise on the upside, especially if provisions continue to fall below mid-cycle ranges of 0.65% of loans. We could see upside to 1.3-1.4x BVPSe (about ILS 23). Conversely, if the local economy stutters, or if LUMI’s execution falters over the coming quarters, we could see downside to about 0.9x BVPSe (ILS 15).
Valuation Analysis
LUMI has historically traded at 0.8x-1.3x forward 12-month BVPS over the course of an economic cycle. With an average ROE (including all one-time events) over the last ten years of 11%, we believe that our 1.2x BVPS target multiple is appropriate. This is especially true given our view that even investors who appreciate LUMI’s external investment strategy are unlikely to award LUMI with high multiples to manage a portfolio of external investments.
We see POLI as the Israeli bank to own in 2011 and reiterate our 1-OW and ILS 22 PT. At the start of the last economic cycle (2003/2004) POLI was best in-class, but investments in the US subprime market made it the most severely impacted local bank during the global recession in 2007/08. With a new management team in place, a re-focused local investment strategy, and expanding margins across its businesses, we expect to see outperformance from the stock in 2011. Given the improving return profile and better than required CAR we also expect to see dividend payments resume by the end of 1Q11.
The Business Drivers As one of the two largest banks in Israel, almost every economic trend in the country affects POLI. We expect to seed POLI continue to increase its net interest margin in 2011 as local interest rates continue to rise. Since June 2009, POLI has been able to increase both its net interest margin; its core net interest margin has also risen by over ILS 100 million per quarter over the same time period.
Having moved away from a growth strategy, given the global recession, that was directed towards international growth we see several areas of growth for POLI in the domestic market despite its relatively large market share. POLI has always focused on the largest corporate customers in Israel; loans to large corporates make up 44% of total loans. We see a real opportunity for POLI in the faster growing and more profitable commercial segment, which is only 9.6% of loans. We also see opportunities in the mortgage segment which accounts for 18% of POLI’s loan book compared to 22% at LUMI.
Upside/Downside Scenarios
POLI is currently trading at 1.0x 2011e BVPS. We see upside to 1.2x based on POLI’s growth and return profile. With 20% upside to our target, POLI is our preferred Israeli bank.
Our target multiple will prove to be low if the Israeli economy continues to surprise on the upside, especially if provisions continue to fall below mid-cycle ranges of 0.65% of loans. We could see upside to 1.3 – 1.4x BVPSe (about ILS 25). Conversely, if the local economy sputters, or if POLI’s execution falters over the coming quarters we could see downside to about 0.9x BVPSe (ILS 17).
Valuation Analysis
POLI has historically traded at 0.8x – 1.3x forward 12 month BVPS over the course of an economic cycle. With an average ROE (including all one-time events) over the last ten years of 10% and a mid-cycle ROE of 12%-14% we believe that our 1.2x BVPS target multiple is appropriate.
DSCT enters 2011 fully privatised with no share overhangs and for the first time in memory we would say that investors can evaluate the stock on the basis of sector and bank fundamentals rather than trying to gauge the impact of technical factors. The recent rights offering that leaves DSCT in compliance with Bank of Israel capital adequacy requirements should also be good news. That said we believe that DSCT has much work left to do with regard to the actual operations side of the business and a new CEO takes over on 1 January. While Mr Spiegel has spent many years at the bank, much in retail and in NY, we still expect it to take some time to make an imprint. We maintain our 2-EW rating.
The Business Drivers
DSCT re-focused its business on the retail markets several years ago and its loan book is now 45% retail (including housing and small enterprise); its deposit base is 79% retail. We expect to see DSCT take advantage of this base to resume growing faster than the sector in 2011. DSCT made a strong start to 2010, after growing net interest income by 15% in 2009, but growth has been harder to come by since the end of 1Q, in part given the dramatic decline in the credit card business. Credit card net income dropped 21% in the first nine months of 2010 compared to the same period in 2009.
Upside/Downside Scenarios
Trading at 0.67x 2011e BVPS DSCT appears to offer value to investors. Our ILS 9 PT is based on a 0.7x 2011e BVPS. This implies sustainable ROE of 8%; DSCT has an average ROE of 5.6% over the last 10 years. Our target multiple could prove conservative if investors gain confidence that DSCT will be able to deliver more steady results, and we could see the shares trade to around ILS 12, implying 1.0x BVPS. Given the depressed multiple we see limited downside, but do believe the stock could revisit ILS 7 (0.6x BVPS) if results are disappointing over the coming couple of quarters.
Valuation Analysis DSCT has historically traded at or below 1.0x BVPS. For as long as we can remember the stock has offered value to investors willing to invest in a restructuring story. In early 2007 DSCT provided the market with a plan to achieve 13% ROE by 2010, a target that was derailed by recent economic conditions at the macro level and by some micro level issues specific to DSCT. Given its last 10-year average ROE of less than 6%, we see the current multiple as properly balancing upside potential with downside risk and would not recommend investors evaluate the bank solely on the basis of its cheap multiple without attempting to put that multiple into context.
If there were an award for “most reliable bank in Israel,” MZTF would win it, in our view. Over the last several years there have been few quarters, if any, when the bank failed to meet or exceed expectations. We believe the business mix and model are unique to the market and that management clearly has a handle on its operations, in addition to being widely perceived as the best local bank at investor relations. Ironically, it is the strength of the execution that means we expect more upside at other banks where upside is still on the way in 2011, leaving us at 2-EW for MZTF.
The Business Drivers While retail and mortgage banking were areas of great concern globally, the strict lending standards in Israel make this segment one of the fastest-growing and most profitable in the local market. Homebuyers routinely have 40%+ equity and new Bank of Israel standards are considering requiring 50% downpayments. Provisions were 0.36% of totals loans in the first three quarters of 2010, essentially unchanged from 0.38% in the same period in 2009. Despite the relative attractiveness of the sector, and other banks focusing on the retail segment, MZTF managed to grow far faster than the larger banks in 2010.
Looking ahead to 2011 we foresee continued strength and growth in the core business, continued leveraging of the business and reduced costs and a return to more regular dividend payouts; MZTF was the first Israeli bank to pay a dividend post the global recession after 2Q10 results were reported.
Upside/Downside Scenarios
In 4Q10 MZTF stated that it expects to achieve ROE of 15% for 2013. MZTF has historically traded in a range of 0.8x-1.4x forward 12-month BVe; a range it shares with the other Israeli banks. Our ILS 39 PT is based on a 1.2x 2011e BVPS. We believe that, if investor confidence grows, MZTF can sustainably achieve an industry-leading ROE and that its multiple could expand to up to 1.4x BV, implying a share price of ILS 44. On the other hand, expectations that increased BoI focus on the housing market, which some market observers believe is overheated, in the form of more onerous lending practices could reduce profitability and growth for MZTF. Under this scenario, or an economic downturn, we could see MZTF revert to 1.0x BV; this would imply a share price of ILS 31.
Valuation Analysis
MZTF is currently trading at 1.2x 2011e BVPS, in the middle of the range of historical multiples. We currently see the case for potential upside surprise (in the form of better growth, higher margins and profitability) and potential downside surprise (increased mortgage regulation) as equally balanced and do not therefore expect the stock to outperform in 2011.
We reiterate our 1-OW and ILS 42 PT for FRUT. FRUT had a strong 2010 driven at first by restocking of customer inventories and then by organic growth in the sector. Synergies achieved from acquisitions made over the last several years, favourable input costs, working capital improvements, and solid execution have driven margins for FRUT to new highs. We estimate 14.4% operating margin for 2010; this compares to 11.1% in 2009 and compares favourable to past peak highs of 13.8% achieved in 2005. We expect the core strength of the business to continue in 2011.
The Business Drivers FRUT is a pure play flavours company that is benefiting from increased consumer desire for both natural and health related (such as ginseng) food products. Over 60% of FRUT’s products are natural and its fine ingredients business benefits from health-oriented product launches.
While FRUT does count some of the largest multi-national food companies (Danone, Nestlé, Lindt…) as customers, over 75% of its customers are private label and smaller local flavour companies, which we believe to be higher growth. FRUT is also focused on growth in emerging markets; it has expanded its operation in China and has stated publicly on recent quarterly conference calls that it is looking at acquisitions in Latin America.
Upside/Downside Scenarios
Our ILS 42 price target is DCF-based and supported by a peer group EV/EBITDA analysis. FRUT currently trades at about 7.8x 2011e EBITDA, comparing favourably to the rest of the peer group, which is trading at between 6.4x and 11.2x.
Our 2011 estimate is based on 7.6% revenue growth and further margin expansion. All things being equal, if FRUT is able to grow its top line by 10%, we believe the stock could trade to ILS 45. On the downside, if FRUT is only able to grow revenues 5% or less in 2011 than we could see the stock drop to ILS 35.
Valuation Analysis
We believe that FRUT’s pure play exposure to the flavours segment (with no exposure to the more cyclical fragrance segment) and its relatively small size (which is a disadvantage with regard to large multinationals) and focus should combine to allow it to trade in line with its global fragrance and flavour peers. With its relatively strong performance in 2010, up 20% in 2010 compared to 14% for the TA-100, FRUT closed some of the valuation gap compared to its global peers. When FRUT was trading at less than 6x EBITDA in early 2010, the stock was clearly a value stock; we see its current position versus its peers as appropriate and sustainable.
Source: *Thomson Datastream, Barclays Capital (data as close of 5 January 2011)
Barclays Capital | Israel Outlook 2011
10 January 2011 20
ISRAEL CHEMICALS LTD. (ICL.TA)
The Investment Case
We believe that ICL will once again outperform the Israeli market in 2011. If 2010 was about the return of volumes to the potash industry, we believe that 2011 will be about price leverage. We expect ICL to outperform in 2011, as we believe that ICL gained market share in 2010 in key emerging markets and that its non-fertiliser segments provide it with unique balance in a volatile sector. We believe strong fertiliser fundamentals are including growing demand trends, low sector inventories, and supportive agricultural prices, providing ICL with positive momentum heading into 2011. ICL is a Barclays Capital Top Pick for 2011.
The Business Drivers ICL’s core market is potash and in the potash market we see several competitive advantages: 1) Proximity to India specifically where its market share has been at or above 20% for most of 2010; 2) a direct selling strategy in China that has boosted its market share there to over 15%; 3) and an ability to constantly produce potash at low cost given its Dead Sea location that uses evaporation for potash extraction and allows for zero cost storage of inventory.
We believe ICL’s non-fertiliser units provide ICL with a differentiated model. In our view, its position as the number 1 global producer of elemental bromine leaves it well placed in a supply-constrained market that is experiencing positive pricing and volume trends. In addition, we believe its integrated business model in the phosphate market makes its performance products segment a steady opportunity as well.
Upside/Downside Scenarios We believe that our model is robust enough to capture the nuances of all aspects of ICL’s business exposures. Our current model assumes average potash pricing in 2011 of $435/tonne. An increase in that to $475 could see the shares trade to around ILS 70, in our view. This would likely be driven by high end volume demand, at the 60 million tonne level, and continued momentum on pricing.
Our downside scenario envisages the shares trading down to around ILS 48. We see this happening if potash pricing increases and volumes stall from here; while we do not expect potash pricing to fall in 2011, that would clearly be a downside catalyst.
Valuation Analysis
We value ICL using a DCF model based on WACC of 9.7%, terminal growth of 3%, and a long-term tax rate of 20%. We use EV/EBITDA multiples on a comparable basis to compare ICL to its global peers. At 10.9x 2011 EV/EBITDA the stock is in the middle of its historical range of 7-13x and is currently trading at the higher end of the range of the peer group. ICL trades at a reasonable discount on an EV/EBITDA basis to industry leader Potash Corp (~11.8x). It trades equal to, or at a premium to, other stocks in the sector. We believe that this premium is justified due to its strong market share in emerging markets, its ability to meet demand from a large reserve of inventory, and its industry-high dividend payout and yield.
Source: *Thomson Datastream, Barclays Capital (data as close of 5 January 2011)
Barclays Capital | Israel Outlook 2011
10 January 2011 22
MA INDUSTRIES (MAIN.TA)
The Investment Case
Since mid-October, when MA announced that its majority shareholder Koor intends to take the company private in a transaction with ChemChina, the stock has moved from a fundamental opportunity to a stock which is primarily of interest to special-situation investors. The terms of the deal have been modified at least once and in late December Koor announced final terms. Our base case assumption is that the deal will close successfully and that MAIN will cease to be a publicly traded equity sometime in 2011. Investors with a more negative view on the deal concluding successfully point to MAIN’s failed acquisition of Albaugh last September.
The Business Drivers
MA participates in the global market for crop protection. The industry is cyclical and competitive and was challenging in 2009, first due to the global recession and then due to competitive pressures, especially in the glyphosate market. While MA has had well documented profitability issues in 2010, its market share and revenue performance compares quite favourably to its peer group. In addition, current crop price and recent sector news flow have led industry consultant Phillips McDougall to forecast a strong recovery for the crop protection industry in 2011 with glyphosate supply and demand getting back in synch.
Upside/Downside Scenarios As this stock is now trading on deal-related news flow, we see upside to the stock to the last announced agreed upon price for the transaction. That price was ILS 20.3o, but an unconfirmed report in local paper Calcalist on 22 December stated that the deal price may be negotiated downward.
On the downside, we believe that improving sector fundamentals, announced restructurings in Brazil and Israel and a newly signed distribution deal with Monsanto provide support for the stock at ILS 15 if the deal were to be called off.
Valuation Analysis Our PT has been set using a DCF model; in our experience covering the stock investors typically look to EV/EBITDA to provide a framework for valuing MA. In this context, given the restructuring that MA has announced in Brazil and Israel, we believe any attempt to analyse MA at a fundamental level requires considering normalised EBITDA potential. At sales of $2.4bn we estimate that MAIN will generate EBITDA of $280mn. That would mean that MA at ILS 18.05 is trading at an EV/EBITDA multiple of about 10.6x 2011e, which would be at the rich end of the valuation spectrum in our experience. On the other hand if MA is able to return to normalised EBITDA of $375mn then the current multiple of 7.5x could present more of an investment opportunity should the stock remain publicly traded. Our ILS 15 price target would imply EV/EBITDA of about 7x, which we would not view as rich at all.
Source: *Thomson Datastream, Barclays Capital (data as close of 5 January 2011)
Barclays Capital | Israel Outlook 2011
10 January 2011 24
STRAUSS GROUP LTD. (STRS.TA)
The Investment Case
Strauss’ water business in China and its salads business in the US are the main drivers for growth for Strauss. On the other hand, Strauss’ minimal float of only 27% and trading volumes of c$2m per day make this a stock for investors with long-term investment horizons.
The Business Drivers
In the US, healthy eating trends and the joint venture with Pepsi, which drives distribution, are the main keys to the Sabra brand continuing to grow in an expanding market. Sabra also made its first acquisition in the salsa market, which is part of the longer-term strategy for Sabra as it begins to optimise the use of its new production facility in Virginia, USA.
Offering clean water in China through a joint venture with Haier has the potential to lead to upside revisions to our sales forecasts as early as 2011. We expect Strauss Water to also begin expansion of it brand from a relatively small business in the UK to reach more of Western Europe by end 2011 mid 2012.
Upside/Downside Scenarios Our price target takes into account +50% growth in Sabra Salads, 20% growth in Strauss Water (does not include China) and a recovery of the coffee business to double-digit top-line growth.
In our downside scenario the coffee business has a slower-than-expected recovery and currency fluctuations move against the company. Additionally, health food trends in the US begin to slow. In this scenario we envisage the shares trading down to ILS 53.
In the blue sky scenario the only change we make is to the growth of Strauss Water by modelling the China scenario. In this scenario we model the water business to grow to ILS 2bn (c$555m) by 2013 and we would envisage the share price potentially reaching ILS 73.
Valuation Analysis
Strauss trades on a valuation of 22x our 2011e EPS, which is well within the historical range. While slightly rich relative to global comps we believe that the limited float and volumes are what keep the valuation high. For long-term investors with a multiple year investment horizon, we believe STRS remains an interesting idea with significant growth opportunities.
Source: Factset, Barclays Capital (data as close of 5 January 2011)
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TECHNOLOGY
Barclays Capital | Israel Outlook 2011
10 January 2011 28
EZCHIP SEMICONDUCTOR (EZCH)
The Investment Case
We reiterate our 1-OW and $30 PT on EZCH. Our investment thesis is based on three major points. EZCH’s revenue opportunity is growing rapidly. EZCH has proven technology expertise, as demonstrated by its design wins across the relevant customer base. Finally, the long design cycles for network processing units (NPUs), 9-10 years from design win through deployment, mean that as the complexity of the products increases so does the ‘stickiness’ with its customers.
The Business Drivers
EZCH sells network processing units (NPU) to Ethernet switch and router vendors. Its current high speed products are designed-in at five of seven vendors in the metro portion of the network. Of the leading 14 vendors, EZCH counts 11 as customers. Industry consultant Infonetics and EZCH expect that the merchant market for NPUs will grow from 33% of the market to 50% by 2014. EZCH’s addressable market continues to grow with each new product introduced and in 2011 the NP-4 will be launched. EZCH has already stated that the number of design wins that it has already achieved with both existing and new customers positions this opportunity at greater than double the NP-2 and NP-3 opportunity combined.
Upside/Downside Scenarios
We believe that our revenue growth estimates over the next several years could prove to be quite conservative. We estimate 28% revenue growth in 2011 and a mix of business that has Marvell (which we expect to be the largest single customer in 2011) growing to 37% of total sales. As sales to MRVL have higher gross margins (royalty sales) a shift in mix one way or the other can have significant bottom line implications for EZCH.
If Marvell were to increase to 40% of sales and sales were to grow 30%, we could see EPS reach $1.52, implying that shares could trade to around $33. If revenues fall short of our expectations, up 25%, and the mix shifts away from MRVL we could see EPS drop to $1.30, implying that shares could trade to around $27.
Valuation Analysis We value EZCH using a DCF model that is supported by P/E multiple analysis. Our $30 PT equates to 22x our 2011e non-GAAP EPS of $1.42. While there has been multiple contraction in the semiconductor sector and EZCH trades at the high end of Barclays Capital’s semi coverage universe, Cavium (1-OW, covered by Tim Luke) which is in a similar merchant semiconductor market as EZCH currently trades at 32x 2011e EPS. Thus we are quite comfortable with the current valuation.
Source: Factset, Barclays Capital (data as close of 5 January 2011)
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10 January 2011 30
NICE SYSTEMS (NICE)
The Investment Case
NICE’s enterprise software products with a particular focus on the financial services sector make this late cycle software company one of our top picks for 2011. With over $600m in cash on the balance sheet, a strategic investment in the financial software space would, in our view, be a welcome development for the company.
The Business Drivers NICE’s Actimize product line is the fastest growing part of the business. Actimize sells anti-money laundering, brokerage compliance, enterprise wide case management and fraud protection modules. Actimize already is part of an industry that is growing at 15% CAGR and is expected to reach over $4bn by 2013. Just as NICE has close to 40% market share in its workforce optimization built through a combination of organic growth and acquisition, we believe that NICE will grow the Actimize business in the same way.
NICE’s other two businesses, workforce management optimization and large scale security installations are not growing at the same pace as Actimize but do provide NICE with solid cash flows.
Upside/Downside Scenarios
Our current price target models for gross margin remaining flat and top line growth of 14% on a compounded annual basis through 2015.
In the downside scenario we believe shares could trade to around $36. We model for a slowdown of IT spending, creating a more competitive environment and compressing margins back to 62%, with top-line CAGR slowing to 12.6%.
In the blue sky scenario we envisage the shares potentially trading to around $45. Here we model for margin expansion to 65% driven by cost cutting and a positive business mix in favour of services. We also model for a 19% CAGR with acquisition accounting for the bump in growth rate.
Valuation Analysis NICE trades on 17x 2011e EPS including cash and 12.5x excluding cash. We find the valuations compelling, particularly for a fast growing, cash-generative business with $600m in cash that allows for potential M&A activity.
We maintain our 2-Equal Weight rating and $58 price target on ESLT entering 2011. We expect a strong recovery in sales after a difficult 2010. However, we believe that this correction is already reflected in our estimates for next year and we remain cautious on defense spending in general. While Elbit’s electronics- based products certainly address areas of defense that are growing, its backlog trends and results in the first three quarters of 2010 highlight that it is experiencing the same tough trends as the broader defense sector.
The Business Drivers
Elbit addresses some of the fastest-growing segments in defense. Elbit has a strong technology position in aerial vehicles (UAV), and a specialization in the growing segment of electro-optical and communications defense equipment. Elbit has many fully owned subsidiaries internationally and JV’s with many defense peers such as Thales and General Dynamics.
Despite a strong focus on electronics we expect macro sector trends to weigh on the stock in the near term, though we believe that, despite the declining macro trends, Elbit’s technology and growth should outpace that of the sector. Elbit’s geographic mix of sales is unusual in the defense sector, as it exports more than it sells in its home market. We believe its proven ability to successfully enter new markets, such as Australia, should bode well over the medium and long term.
Upside/Downside Scenarios
Our model for 2011 calls for 20% growth off of a depressed 2010. We expect this growth to be supported by the incremental trends in backlog that the company has reported over the course of 2010. We forecast GM to hold steady in the 30% range and for operating margin to reach 9% by the end of 2011.
Our price target is DCF-based and equates to 10.5x 2011e EPS of $5.53. We see this multiple as reasonable in the sector. We believe that our forecasts could prove conservative if ESLT is able to grow faster than we expect and faster than the sector in 2011 based on its geographic and product mix. All things being equal an additional $200mn in revenues could drive the stock to around $60. If, however, our revenue forecast proves to be too aggressive than a decline in sales of $200mn off our base case would result in a stock price of $54, in our view.
Valuation Analysis
While ESLT has in the past traded at a multiple of up to 15x forward 12-month EPS, we believe that there have been structural changes in the defense sector that make multiple expansion unlikely and see our target multiple, which remains high for the group, as appropriate. First, the near-term outlook for defense has weakened as military activity in certain areas begins to decline and overall defense budgets also appear set for cuts, especially in Europe. In addition, as home budgets get squeezed, ESLT’s larger competitors have begun expanding into global markets, thus taking a page from ESLT’s long-standing global/local strategy and increasing competition for ESLT across the globe.
Source: Factset, Barclays Capital (data as close of 5 January 2011)
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10 January 2011 33
MELLANOX TECHNOLOGIES (MLNX)
The Investment Case
We maintain our 2-Equal Weight rating and $23 PT on MLNX entering 2011. In late 3Q and 4Q10 the stock performed strongly driven by a combination of good tech sector fundamentals and perhaps more importantly two significant investments. The first investment is Oracle’s acquisition of 10% of the stock; the second is MLNX’s recent announcement that it intends to acquire Israel-based Voltaire in 1Q11 in its first ever acquisition. Having missed these event-based catalysts, we are reluctant to chase the stock ahead of a year that now includes both product transition and the challenge of integrating a significant acquisition.
The Business Drivers
MLNX is a recognised leader in Infiniband protocol and the intended acquisition of VOLT should cement its position as a leader in end-to-end solutions for Infiniband storage solutions. The overall business is driven by strong demand for storage, Cloud computing and server virtualization applications, all of which remain at the top of the spending plans for CIOs heading into 2011.
In addition to its high market share in high-performance computing applications, MLNX has broadened its end-market exposure to the 10 Gb/s Ethernet market. While we understand the strategic rationale for the merger with VOLT, we do believe that it raises questions both with regard to the ultimate size of the Infiniband market and the long-term operating model of the combined company.
Upside/Downside Scenarios
MLNX currently trades at 22x 2011e EPS of the combined MLNX + VOLT of $1.15 (non-GAAP). Post the transaction, MLNX should still have about $67mn of cash, $1.73/fully diluted share. This is much lower than the almost $6.50/share currently. With the shares currently priced 10% above our price target, we believe that the upside scenario is currently priced into the shares. The five-year average PE multiple for the stock is 27x, so if the stock continues to see multiple expansion to 25x 2001e EPS then the stock could reach $29. We see downside to $20 if the stock trades back down to trough levels of 17x 2011e EPS.
The move to the upside could be driven by continued investor focus on limited pure play investment ideas in the storage sector. The downside scenario could unfold if MLNX were to underperform versus expectations, which happened once in 2010.
Valuation Analysis
In our view MLNX is currently trading on a combination of sector excitement (which has been fuelled by the investment in the shares by ORCL and the intended acquisition of VOLT). MLNX has traded at an average of 27x EPS for the last five years, but most semi stocks are currently trading below five-year averages. While we do not see MLNX as expensive at the current price, we do not see much room for error in the valuation and we are comfortable with our $23 PT based on 20x 2011e EPS.
Source: Factset, Barclays Capital (data as close of 3 January 2011)
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10 January 2011 37
BEZEQ (BEZQ.TA)
The Investment Case
Operating efficiencies, improving revenue per user, mobile data growth, potential for a capital reduction, capital gains from real estate sales and copper repatriation and the fact that it is one of the most heavily traded stocks in Israel are the reasons we make Bezeq our top pick in Israeli Telcos.
The Business Drivers With a solid outlook for the Israeli economy we expect the consumer to remain strong and do not foresee significant macro risks to Bezeq’s business case.
Bezeq’s upgrade of its fixed line network have helped mitigate land line loss as 1) operating expenses have fallen and 2) the broadband consumers have been increasing the monthly package and improving the average revenue per line (ARPL) over all.
On the mobile side of the business the HSPA/UMTS upgrade that launched services in early 2009 has made Bezeq the best performing mobile operator in Israel with increasing average revenue per user (ARPU) from ILS 126 in 2008 to an estimated ILS 138 in 2011.
Upside/Downside Scenarios Bezeq’s ILS 1b in cash payouts over the next three years keep the yield at c.10% for 2011-2013. The potential headline risks from the entrance of MVNO’s, new mobile network operators and potential for regulatory change driven by the Hayek commission may weigh on the stock over the course of 2011 and could have a more negative impact than we expect. If mobile gross margin were to fall to 30% and growth of the transmission business slow to 2% our worst case scenario would out our PT at ILS 10.21. In our blue sky scenario where the risks mentioned above stay in the headlines and do not have a negative impact on margins the stock could trade as high as ILS 11.15.
Valuation Analysis
Bezeq is currently trading at 5.2x 2011e EV/EBITDA, 9.6% FCF and 12.0x P/E Leverage at the company is a solid net debt-to-EBIDTA ratio of 1.1x. The dividend yield ex special payouts is 6.5% and including an ILS 1b cash dividend as part of the capital reduction increases to 9.8%.
Cellcom’s main focus in the 1H 11 will be to recover from the damage done to its public image by the network failure on 2 December 2011. In general, we do not expect many operating surprises from CEL. The launch of its mobile banking platform with an international banking partner is not enough to get us excited about the stock and given the expected volatility driven by negative headlines from the entrance of new competition plus the ongoing developments of the c. ILS 4b in class action suits we believe that CEL should trade at a discount to PTNR.
The Business Drivers Mobile broadband and new competition from MVNOs are the main drivers/challenges for 2011. While these drivers are similar to those of Partner the main difference is that CEL has done an excellent job in the past of reducing costs to the point that the company is run relatively efficiently. Following the network failure in 2 December 2010 we expect that marketing expenses will need to increase as CEL rebuilds its brand recognition.
Upside/Downside Scenarios
Our current price target takes into account the changes in mobile termination rates, tougher competition on pricing per minute and a one time charge for the network failure.
In our worst case scenario we model for lower price per minute of voice, slower pick up of mobile data, increased capex and higher marketing expenses. The resultant theoretical PT is ILS 101.
Our blue sky scenario for Cellcom is all about mobile data. If the trends in mobile data continue to be positive CEL’s first mover advantages to platforms like mobile financial services and the mobile wallet. In the longer term there may be further upside potential if the MVNO entrants fail to gain significant share allowing CEL to increase voice pricing. This scenario would see out price target increase to ILS 121.
Valuation Analysis
CEL currently trades on 5.7x 2011e EV/EBITDA, 10.1x 2011e EPS, has an 10.6% dividend yield and levered at less than 1x net debt/EBITDA. Relative to European altnet peers the valuation appears attractive however; relative to its local peers the shares appear fairly valued in our view.
HOT is Israel’s only cable operator and main competitor to Bezeq. It is the first operator in the market to offer a triple play and in our view the first likely operator to offer a quad play. While HOT’s TV RGUs have both the broadband and telephone RGUs are increasing which shows the strength of the triple play offer. 2011 should be another successful year for HOT which we believe will consolidate its holding in the mobile operator MIRS with the cable business and see EBITDA margins continue to expand towards 50%. We expect the controlling shareholder Patirick Drahi to complete the agreed to deal with Fishman and Yedioth holdings which will consolidate 66% of HOT in his holdings.
The Business Drivers
A strong economic back drop and continued growth in the broadband and telephony business are the main drivers for HOT in 2011. HOT offers the fastest broadband speeds in the market of up to 100mb which gives it a marketing edge relative to Bezeq. On the pricing side mobile broadband is still too expensive to be viewed as a replacement for fixed line broadband.
Upside/Downside Scenarios Our current price target takes into account continued growth of RGUs in the telephone and broadband businesses while the television business will continue to shrink. We also account for cost cutting and purchasing efficiencies which will help expand EBITDA margins from 35% in 2009 to 40% in 2011.
Our worst case scenario which sees our price target fall to ILS 59.5, cost cutting scenarios slow and price increases are not longer achievable in a more competitive market.
In the blue sky scenario where the price target could reach ILS 76 we model for continued cost cutting and more stringent control on capex which would fall from 17% of revenues to 15%.
Valuation Analysis HOT trades at 23x our 2011e EPS of ILS 2.71; 5.3x 2011e EV/EBITDA and is leveraged at 2x 2011e Net Debt/EBITDA. HOT is expected to pay a dividend of up to ILS 500m in 2011 that is positive but pales in comparison to the ILS 3,134 that we are modelling for Bezeq.
Partner has a series of short term projects that, in our view, will lead to long term opportunities. The first is the cost cutting that will help keep margins relatively stable in 2011. Given the expected competition from the entrance of MVNOs this is an important feat. Second is the investment in its new network which will make it the newest and fastest mobile broadband network in Israel.
The Business Drivers
The entrance of the MVNOs and the potential for a new network operator to come into the market in 2011 and 2012 are going to keep things interesting in the Israeli telecom market. Partner is starting 2011 with its new CEO in place with a clear mindset to improve on operations relative to the past two years. While we believe that the negative headlines as new players enter the market while impact the stock the real test will be in the results. Mobile data growth should continue to be a positive driver for the company.
Upside/Downside Scenarios
Our ILS 80 price target takes into account higher marketing expenses, lower voice prices per minute and potential cost cutting. What will work in PTNR’s favour throughout the year is the move that it is making towards offering contract customer’s bundled voice, data and SMS packages that will help keep ARPU at a stable level of near ILS 150.
Our worst case scenario sees Partner losing market share to the MVNOs, slower than expected pick up of mobile broadband and poor execution of the cost cutting plan. In that scenario our price target would be ILS 76.
Our blue sky scenario includes the better than expected data revenues, lower churn and most importantly the addition of the ISP and VOB service from the acquisition of 012 operations (still pending regulatory approval) which may add ILS 10 to our price target bringing the upside scenario to ILS 90.
Valuation Analysis
Partner is currently trading on 9.0x 2011e EPS, 5.6x 2011 EV/EBITDA and a 11.2% 2011e dividend yield. The company is levered at 1.2x net debt/EBITDA. This compares with the European alt peers which trade at 14.7x 2011e EPS, 5.1x EV/EBITDA, 3.9% dividend yield and are levered at 1.2x.
With potential positive catalysts for Ratio coming from certainty around Leviathan, tax changes and the Hanna and David licenses in 2011 we continue to see value in the sector. Ratio is our top pick.
The Business Drivers
The drivers for the business are tied to two main factors: Taxes and demand. Clearly a more benign tax regime than the one initially reported and included in our model which sees a 50% tax applied to all energy resources and taxed at the source would be a positive result for the stocks.
Demand in Israel is still in its early stages of development. With most of Israel’s electricity base load coming from coal we believe that significant natural gas resources could shift the base load to gas. We also see the introduction of card run on natural gas and electricity as providing some upside potential.
Upside/Downside Scenarios Our current price target takes into account Tamar coming online in 2013, Leviathan with a 100% probability of having 16tcf of gas and relatively low probabilities for oil discoveries.
In our downside scenario, where the PT falls to ILS 1.69, the issues around the tax issue continue to weigh and the tests from Leviathan oil prove disappointing.
In our blue sky scenario, where the PT increases to ILS 3.27 we only model in a 100% probability for 16 tcf from Leviathan and increase the probability for an LNG project to 75%.
Valuation Analysis
Ratio trades at a 30% discount to its NAV. We believe that the market is not giving Ratio credit for the additional potential from the two oil drills or from the LNG part of the export story. Also, the market may still be applying a greater discount to Ratio than its peers which until now had discoveries while Ratio only had prospects.
With potential positive catalysts for Delek coming from certainty around Leviathan, tax changes and the Hanna and David licenses in 2011 we continue to see value in the sector but see more potential in Delek Drilling’s parent company Delek Energy.
The Business Drivers
The drivers for the business are tied to two main factors: Taxes and demand. Clearly a more benign tax regime than the one initially reported and included in our model which sees a 50% tax applied to all energy resources and taxed at the source would be a positive result for the stocks.
Demand in Israel is still in its early stages of development. With most of Israel’s electricity base load coming from coal we believe that significant natural gas resources could shift the base load to gas. We also see the introduction of card run on natural gas and electricity as providing some upside potential.
Upside/Downside Scenarios
Our current price target takes into account Tamar coming online in 2013
In our downside scenario, where the PT falls to ILS 0.26, the issues around the tax issue continue to weigh and Tamar does not come online until after 2014.
In our blue sky scenario our PT is ILS 0.44 and the main change is higher off take price for gas.
Valuation Analysis Isramco trades a 27% premium to its NAV. We believe that the premium is coming from a market expectation that the tax regime will be eased further and that Tamar will receive special dispensation. While that may prove to be the case we are wary of modelling that scenario into our PT. We also do not think that market is appropriately weighing the risk that there may be delays to the project as well as higher than expected upfront capex.
With potential positive catalysts for Avner coming from certainty around Leviathan, tax changes and the Hanna and David licenses in 2011 we continue to see value in the sector but see more potential in Avner Oil’s parent company Delek Energy.
The Business Drivers
The drivers for the business are tied to two main factors: Taxes and demand. Clearly a more benign tax regime than the one initially reported and included in our model which sees a 50% tax applied to all energy resources and taxed at the source would be a positive result for the stocks.
Demand in Israel is still in its early stages of development. With most of Israel’s electricity base load coming from coal we believe that significant natural gas resources could shift the base load to gas. We also see the introduction of card run on natural gas and electricity as providing some upside potential.
Upside/Downside Scenarios Our current price target takes into account Tamar coming online in 2013, Leviathan with a 100% probability of having 16tcf of gas and relatively low probabilities for oil discoveries.
In our downside scenario, where the PT falls to ILS 1.69, the issues around the tax issue continue to weigh and the tests from Leviathan oil prove disappointing.
In our blue sky scenario, where the PT increases to ILS 3.27 we only model in a 100% probability for 16 tcf from Leviathan and increase the probability for an LNG project to 75%.
Valuation Analysis
Currently trading on 85x 2011e we believe that as we gain clarity around size of reserves, existence of oil and finality of tax regime that there is room for multiple expansion.
With potential positive catalysts for Delek coming from certainty around Leviathan, tax changes and the Hanna and David licenses in 2011 we continue to see value in the sector but see more potential in Delek Drilling’s parent company Delek Energy.
The Business Drivers
The drivers for the business are tied to two main factors: Taxes and demand. Clearly a more benign tax regime than the one initially reported and included in our model which sees a 50% tax applied to all energy resources and taxed at the source would be a positive result for the stocks.
Demand in Israel is still in its early stages of development. With most of Israel’s electricity base load coming from coal we believe that significant natural gas resources could shift the base load to gas. We also see the introduction of card run on natural gas and electricity as providing some upside potential.
Upside/Downside Scenarios Our current price target takes into account Tamar coming online in 2013, Leviathan with a 50% probability of having 16tcf of gas and relatively low probabilities for oil discoveries.
In our downside scenario, where the PT falls to ILS 11.05, the issues around the tax issue continue to weigh and the tests from Leviathan oil prove disappointing.
In our blue sky scenario, where the PT increases to ILS 18.17 we model in a 100% probability for 16 tcf from Leviathan and increase the probability for an LNG project to 75%.
Valuation Analysis
Currently trading on 67.7x 2011e we believe that as we gain clarity around size of reserves, existence of oil and finality of tax regime that there is room for multiple expansion.
With potential positive catalysts for Delek Energy coming from certainty around Leviathan, tax changes and the Hanna and David licenses in 2011 we continue to see value in the sector. Although the tax on super royalties may weigh.
The Business Drivers
The drivers for the business are tied to two main factors: Taxes and demand. Clearly a more benign tax regime than the one initially reported and included in our model which sees a 50% tax applied to all energy resources and taxed at the source would be a positive result for the stocks.
Demand in Israel is still in its early stages of development. With most of Israel’s electricity base load coming from coal we believe that significant natural gas resources could shift the base load to gas. We also see the introduction of card run on natural gas and electricity as providing some upside potential.
Upside/Downside Scenarios Our current price target takes into account Tamar coming online in 2013, Leviathan with a 50% probability of having 16tcf of gas and relatively low probabilities for oil discoveries.
In our downside scenario, where the PT falls to ILS 956, the issues around the tax issue continue to weigh and the tests from Leviathan oil prove disappointing.
In our blue sky scenario, where the PT increases to ILS 1,870 we model in a 100% probability for 16 tcf from Leviathan and increase the probability for an LNG project to 75%.
Valuation Analysis
Delek trades at a 21% discount to the sum of its parts which we believe still leaves room for upside.
With potential positive catalysts for Delek coming from certainty around Leviathan, tax changes and the Hanna and David licenses in 2011 we continue to see value in the sector.
The Business Drivers
The drivers for the business are tied to two main factors: Taxes and demand. Clearly a more benign tax regime than the one initially reported and included in our model which sees a 50% tax applied to all energy resources and taxed at the source would be a positive result for the stocks.
Demand in Israel is still in its early stages of development. With most of Israel’s electricity base load coming from coal we believe that significant natural gas resources could shift the base load to gas. We also see the introduction of card run on natural gas and electricity as providing some upside potential.
Upside/Downside Scenarios
Our current price target takes into account Tamar coming online in 2013, Leviathan with a 50% probability of having 16tcf of gas and relatively low probabilities for oil discoveries.
In our downside scenario, where the PT falls to ILS 1,001, the issues around the tax issue continue to weigh and the tests from Leviathan oil prove disappointing.
In our blue sky scenario, where the PT increases to ILS 1,351 we model in a 100% probability for 16 tcf from Leviathan and increase the probability for an LNG project to 75%.
Valuation Analysis Delek trades at a 28% discount to the sum of its parts which we believe still leaves room for upside.
Israeli companies covered by Barclays Capital U.S. Analysts
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AMDOCS LTD. (DOX)
The Investment Case
We maintain a 2-Equal Weight rating and $31 price target on Amdocs. Under the company’s new CEO Eli Gelman, the company is focused on accelerating revenue growth evidenced by management’s willingness to increase near-term expenses to fund the company’s future prospects. Limited visibility on when the company could begin to benefit from potential top-line catalysts precludes us from getting excited in the short term about the potential for accelerated top-line growth. We do see the BSS and OSS space as comparatively defensive areas of carrier spending. Thus, given Amdocs’ leadership in the market, we do not expect the company’s revenues to materially diverge from market growth expectations in the mid single-digit range, thereby limiting downside risk to our estimates.
The Business Drivers
Amdocs is a leading supplier of billing and operational support systems for the global mobile carrier community. The company’s service-based business model and multi-year carrier contracts provide healthy revenue visibility and a steady stream of operating cash flow.
Overall, we believe the maturation of carriers’ business models in emerging markets and the transition to more data-centric services in developed markets are likely to fuel an upgrade cycle for back-end systems, which in some cases are more than ten years old.
We look for additional colour on Amdocs’ longer-term growth strategy during the company’s upcoming fourth quarter results in January, as well as its analyst day in February 2011.
Upside/Downside Scenarios
Our $31 price target is based on 13x CY11e EPS of $2.38 (DOX has a September fiscal year). We recently trimmed our estimates for 2011 and therefore have a high level of confidence in our base case. If spending on back-end systems for telecom operators were to accelerate from current levels, than we could see upside in CY11e EPS to ~$2.50-$2.60. On a steady multiple this would imply a share price of ~$33-$34.
On the downside, if spending remains tempered and Amdocs maintains accelerated investment levels, we could see our CY11e EPS drop to ~$2.10, implying potential downside in the stock to ~$25 assuming some multiple contraction.
Valuation Analysis Following our recent estimate reduction, we maintained our 13x EPS multiple to set our price target, a multiple in-line with the company’s five-year average. In addition, DOX has a strong balance sheet with $1.43bn (~$6.40 per share) in cash. Given the limited visibility on the timing of new initiatives to spur faster growth and drive multiple expansion, we see the current valuation as appropriate. Amdocs’ share buyback program limits material downside risk.
We maintain a 2-Equal Weight rating and $12 price target on Ceragon. Our estimates currently factor in continued healthy top-line growth for the company, driven largely by continued demand for its high-capacity microwave solutions in order to support ongoing mobile subscriber growth and capacity needs. Moreover, due to the deployment of its next generation IP based equipment; we also expect the improvement in the company’s gross margins to remain. Thus given our encouraging outlook for the company and that the shares are trading near their historical average, we believe a 2-Equal Weight rating is appropriate.
The Business Drivers
Ceragon is a leading independent provider of high-capacity wireless microwave backhaul systems. Given the lower cost associated with deploying these systems (versus traditional copper lines for example), the company has enjoyed success in both emerging and developed markets as mobile operators look to build out additional coverage to support subscriber growth as well as augment networks in order to provide additional capacity for new data rich services.
In the near term, demand from the company’s largest region – India – has stalled due to various regulatory/security issues. However, over time we expect regional demand to improve, particularly as carriers tee up to deploy new next-generation 3G networks within the region.
Upside/Downside Scenarios
Our $12 price target is based on 16x our CY11e EPS of $0.76. We recently raised our estimates for 2011 driven largely by continued demand strength in international markets as carriers are looking to add additional backhaul capacity to their networks. If investment was to accelerate from current levels, in particular a recovery in demand in India where demand has stalled due to regulatory issues, we could see EPS edge up past $0.80. Using a steady multiple would imply a share price of around $13.
On the downside, if revenues from India did not recover from current levels and operator spending were to stall, we could see EPS in the range of $0.65, implying a share price of around $10 assuming some multiple contraction.
Valuation Analysis Following our recent estimate increase, we maintained our 15x EPS multiple to set our price target, a multiple in line with the company’s five-year average. In addition, Ceragon has a healthy balance sheet, with $52mn in cash and no debt. Given that our estimates already account for continued healthy growth, we see the current valuation as appropriate.
ORL surpassed our expectations in 2009 and 2010 with the upgrades adding significantly to profitability. The merger with Carmel Olefins is providing synergies but with ORL delivering the strongest share price performance of the global refining group, up 60% in US$ terms over 2010 we see better value elsewhere and rate the shares 2-Equal Weight.
The Business Drivers Refining environment to remain weak: Despite a near 2mb/d recovery in oil demand, the second highest growth in 30 years, refining margins in 2010 were almost unchanged from 2009 levels, highlighting just how much spare capacity has been built into the refining system over the past two years. The industry has now struggled through margins that have been barely break-even for two years and we anticipate another challenging year in 2011. We expect profitability for the refining business in 2011 of $165m, up significantly y/y with the new configuration in place for a full year and limited maintenance.
Carmel: With the full consolidation of Carmel Olefins following the merger we expect to see further signs of the synergies the group can achieve. With continued strong demand in Asia for petrochemicals we anticipate another good year for both Carmel and Gadiv.
Upside/Downside Scenarios Our current price target takes into account continued improvement in the petro chemical business as well as improved product yield at the refinery. We also see improving cost basis with the recent conversion to natural gas.
In our downside scenario, if refining margins were to remain at 2010 levels into perpetuity we see valuation at ILS1.5/share.
In our blue sky scenario, if we were to see refining margins return to the levels of the golden age of 2006-2008, our valuation would rise to ILS3.9/share.
Valuation Analysis
Our ORL price target of ILS2.2 per share is based on our sum-of the-parts net asset value calculation. We estimate the group is trading on 12x 2011 earnings compared to the wider European sector at 19.9x.
We maintain our 2-Equal Weight and $13 PT. We continue to believe that the late-cycle nature of Orbotech’s Display test equipment, which is contributing to underperformance this year, will support management’s outlook for flattish sales in CY11 despite our outlook for a 15%-20% decline in CY11 LCD capex and therefore provides solid top-line visibility. We see ORBK’s PCB business flat in 2011 as book to bill for that sector has peaked for the near term. We see higher risk/reward opportunities with other stocks in both the display and test sectors.
The Business Drivers ORBK is a leader in test equipment for both the PCB and LCD businesses, which do not always have the same cyclicality, though both segments were strong coming out of the global recession. Both the PCB business and LCD business have been growing quickly, driven in large part by demand for next generation consumer electronics devices.
The driver for ORBK’s LCD product is the continued growth in volume for glass for LCD TV products and Gorilla glass for “touch” products.
The PCB test market is growing rapidly given the increased complexity and miniaturization of consumer device, smartphones in particular. If past generation were single or double layer PCBS, the new devices are complex and multilayered and the need for testing provided by ORBK has grown in importance.
Upside/Downside Scenarios
We see ORBK fairly valued at the current share price at 12x 2011e EPS and 1.2x BV. Our lower-than-consensus revenue forecast for 2011 is based on flat sales in the PCB and LCD segments and the disposal of the medical business. We see two potential sources of upside to our estimates. The first would be upside surprise in the LCD market, which we view as challenging given the 15%-20% expected decline in capex. On the other hand our flat estimate for the PCB market could prove to be conservative, especially if the segment accelerates in 2H11.
All things being equal, if we were to raise our PCB estimate to 7% for 2011, our revenue forecast would increase to $550mn and EPS would increase to $1.07, implying a potential share price increase to $14. If our forecast proves too aggressive, which would more likely be from the LCD side of the business, we could see sales decline to $475mn, with the shares potentially trading down to $11.
Valuation Analysis
With a valuation of 10x our new CY11 EPS of $1.00 being in line with most equipment peers, we maintain our 2-Equal Weight rating and $13 price target.
Teva is the generic drug industry leader and remains our favorite name in the space. Driving the attractive investment opportunity is a solid, double-digit long-term growth outlook coupled with valuation at historic lows. We believe that investor concerns over lack of earnings visibility are overdone, suggesting limited downside from current levels. With sentiment improvement, which we expect in the coming year, we envision potential stock upside of nearly 50%.
The Business Drivers
Teva is the world’s largest generic pharmaceutical company, with brand and generic products sold globally, top-notch management with a keen strategic focus, strong cash flow/position, and successful M&A record.
In the U.S., Teva has the largest number of generic marketed and pipeline products with limited competition, which drive revenue growth. Ex U.S., where a focus on increased generic utilization has created growth opportunities, Teva’s portfolio breadth and depth has been instrumental in the company growing lead market share positions. Teva’s brand business is led by MS drug Copaxone and supported by its respiratory and women’s health business.
Upside/Downside Scenarios In our view, investor concerns are currently focused on lack of visibility for earnings drivers. We estimate exU.S. revenues to generate the majority of 2011 y/y growth, with economic uncertainty driving some of the concern.
On the brand side, Copaxone faces potential generic competition, with timing uncertain. While Teva guides to peak sales in 2013 (20% of topline in 2009, Teva estimates 6% contribution in 2015), and we and much of the Street do not assume generic competition until 2014 or beyond, a very worst case scenario (less than 10% probability) would assume generic competition in later 2011.
We are confident in our 2011E EPS, which we believe is sufficiently conservative. Potential upside of $0.26, due to U.S. generic product launch timings and competitive delays, leads to 6% upside to our $73 price target, or $77. Conversely, we estimate EPS downside of $0.30, which reflects no y/y exU.S. revenue growth and no generic Lovenox launch. Generic Copaxone competition could result in $0.18 additional downside. We believe the combined worst case scenario, albeit very unlikely, would result in the stock trading around $50.
Valuation Analysis Our $73 price target is derived by using a 14x multiple on our 2011 EPS estimate. Teva is currently trading at 10x vs generic group average of 11.7x, with Teva’s 2010-12 EPS CAGR roughly in line with the group. Teva’s current P/E (and relative to S&P) are near historic lows. Over 2011, we expect multiple expansion to be driven by greater earnings visibility from 2011 financial guidance and solid quarterly results.
We, Joseph Wolf, David Kaplan and Lydia Rainforth, CFA, Amir Rozwadowski, C.J. Muse and Richard B. Silver hereby certify (1) that the views expressed in this research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or viewsexpressed in this research report.
IMPORTANT DISCLOSURES CONTINUED
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Barclays Capital | Israel Outlook 2011
10 January 2011 57
IMPORTANT DISCLOSURES CONTINUED
Stock Rating
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European Aerospace & Defense
BAE Systems (BAES.L) Cobham PLC (COB.L) EADS NV (EAD.PA)
Finmeccanica SpA (SIFI.MI) Meggitt PLC (MGGT.L) MTU Aero Engines Holding AG (MTXGn.DE)
Qinetiq Group PLC (QQ.L) Rolls-Royce PLC (RR.L) SAFRAN SA (SAF.PA)
Nokia (NOK) Powerwave Technologies (PWAV) Research In Motion (RIMM)
Sierra Wireless (SWIR) Syniverse Holdings Inc. (SVR) Tekelec (TKLC)
Distribution of Ratings:
Barclays Capital Inc. Equity Research has 1733 companies under coverage.
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10 January 2011 59
IMPORTANT DISCLOSURES CONTINUED
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EQUITY RESEARCH 2 September 2010
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ISRAEL TECHNOLOGY:PRACTICALLY A BRAND NAMEINITIATION OF COVERAGE
