The third quarter has been a positive one for the stock market as the index continued to move to new heights. Led by the large caps, the SEMTRI has registered a growth rate of 9.53% during the third quarter of 2007 while the SEM?7 has grown by 11.78%. As expected, long?term Government of Mauritius bond yields have continued to edge lower with the seven?year bond yield standing at 11.46% during the last auction. Furthermore, as interim and final results have been released, we have substantially upgraded our earnings forecasts and now expect the bond to stock ratio to decrease and stabilize by next June.

With strong earnings figures expected to be released by the hotels and commerce stocks in 2007, the sum of earnings of the market is likely to grow by more than 26% by next April compared to the same period this year (earnings forecast). Hence, with a market cap of Rs 155Bn, the market is currently trading at an upgraded forward PE of 11.60 (using June 08 mean earnings forecast). If hotels and conglomerate stock results reach the upper bound of our forecasts, then market earnings could even hover around the Rs 13Bn mark next April.

The majority of the earnings growth, however, is expected to come from the SEM?7 stocks, which account for more than 75% of total market cap. The sum of earnings of the top seven stocks is forecast to grow by more than 33% in 2007 and by around 18% in 2008.

On a valuation perspective, the earnings upgrade has certainly improved the market valuation at a fair PE of 12.50 using the market discount rate (required rate of return on equity) of 16.15%. Hence, we would expect the valuation of the market to stand at between Rs 160Bn to Rs 170Bn mark by next April. Over the longer term, however, we still forecast earnings growth to converge towards nominal GDP growth and hence expect price growth to follow suit. Therefore, preliminary forecasts for 2009 indicate that the sum of earnings of the top seven stocks is likely to hover around the low to mid teens as the market matures. The market cap of both the SEMDEX and DEMEX already stands at more thanRs 200Bn and accounts for around 90% of forecast GDP. The market is certainly approaching fair value!

■ <B> Sectoral Review and Outlook </B>

● <B>Banks </B>

Both banks have released satisfactory results in line with our forecasts. With the entry of new banks in the domestic market, margins of local operations are likely to remain under pressure in the coming years. Despite this, the foreign components of both banks are expected to sustain decent earnings growth over the next five years.

For this financial year, we would expect similar growth in net income to that of 2007. Just like the wider market, this sector has seen a re-rating in recent years and now we expect stock price growth to converge to earnings growth in the coming years.

● <B>Hotels </B>

Results for hotel stocks are expected to be nothing short of the spectacular this year with strong earnings growth expected for all stocks. As a result, we have upgraded our forecasts on all hotel stocks for 2007. Furthermore, hotels have continued to make acquisitions abroad in order to diversify their revenue stream. While prices have certainly converged to valuation levels for some stocks, the outlook on earnings growth for this sector remains positive as hotels continue to expand and as occupancy ratios remain relatively high and hence, we expect decent performances for most stocks in line with profit growth for 2008 as well.

● <B> Conglomerates </B>

So far, interim results are in line with our forecasts and we would expect results to remain reasonably strong despite a high interest rate environment. Restructuring for both conglomerates is expected to continue to improve the historically unattractive differential between return on capital employed and their respective weighted average cost of capital in the coming years as certain badly performing segments are disposed of or closed down. We are monitoring the market price to stock valuation ratio closely.

● <B>Property and Sugar </B>

Most sugar stocks have been exempt from releasing their interim results and final results for others have been unimpressive. Liquidity in this sector has hence remained low and IRS projects cannot last forever and nor do IRS projects necessarily make sugar stocks attractive. As far as property stocks are concerned, some companies have continued to engage in rather optimistic revaluation of land and buildings in a country where a proper valuation supervisory body does not exist. This, coupled with the current potential for difficulties in the sugar sector, makes us cautious.

● <B> Construction </B>

Despite decent growth at the macro level (with large scale projects in particular), margins have remained under pressure and when combined with higher net finance costs, net profit growth has been constrained and interest cover, return on capital employed and other productivity measures have been unimpressive. Rising costs have certainly impacted on smaller scale construction, and prospects for this segmen remain challenging. Overall, construction companies are trading at high multiples relative to their long?term net profit growth potential.

The low adjusted R2 variable confirms that the majority of the risk that firms face in Mauritius remains diversifiable and that much of the volatility of these stocks can be explained by factors such as liquidity, sectoral shocks, profit announcement, quality of management etc. Furthermore, correlations amongst stocks remain at relatively low levels. Betas for most other smaller cap stocks were statistically insignificant, a function of relative illiquidity, lack of information and lack of interest from foreigners and institutions.

■ <B>Comments about the DEM and wider market </B>

Bar the largest cap stocks, the lack of frequent and quickly disseminated information remains high in the stock market although the planned implementation of quarterly reporting is expected to improve this situation. To improve matters further, we feel that the SEM should make all listed companies release quarterly and final accounts much more quickly (within six weeks of the end of the quarter or financial year) so as to minimize insider trading and reduce the influence that certain large speculators have on the less-liquid stocks. Due to the fact that many of the large cap stocks of the DEM have been exempt from releasing accounts, index performance and liquidity has remained low. If the reporting frequency of the wider market is not improved, there will be further divergences between the growth rates of the top seven stocks and the rest of the market, thereby increasing concentration risk.

■ <B>Recommendation to the Investor </B>

Equity investment should be seen as a part of a well?diversified portfolio comprised mainly of bank deposits and other risk free assets. While the stock market may not witness the same growth as seen in previous years in the medium term, earnings growth and, hence, price growth remain satisfactory. Local mutual funds and insurance companies now offer a wide range of investment products and new investors are well advised to invest in equities through a mutual fund and/or an insurance product route in order to minimize downside risks.

■ <B>Is the stock market a cheap way for companies to raise capital? </B>

Equity markets are certainly another way for companies to raise capital but the required rate of return on equity is always higher than the cost of debt. Investors have the choice between a risk free asset, that is, a Government bond (bank deposits as well) and a much riskier asset, that is, a stock. Hence, investors require a premium for taking this risk in terms of returns. In the case of Mauritius, the current after tax yield on a seven?year bond (a long term investment proxy) stands at 9.74% and the equity risk premium for the entire market stands at 6.41%. This risk premium is determined by adjusting the current mature developed market equity risk premium by a factor that is itself calculated based on the country rating of Mauritius.

Furthermore, one can adjust this premium for each company depending on its risk characteristic. Consequently companies do not raise capital cheaply and need to perform in order for investors to get their due. This is why it is important for companies to be accountable to shareholders and for accounts to be released quarterly and much faster as is done in other world markets.

<B>Investment professionals Ltd</B> (Feedback: [email protected])

Disclaimer:

This analysis report is provided by Investment Professionals Ltd. for information purposes only. Neither the information nor any opinion expressed constitutes an investment advice, an offer or an invitation to make an offer, to buy or sell any fund or stocks. This report does not have regard to the specific investment objectives and financial situation of any specific person who may receive/read this report. Investors should seek financial advice regarding the appropriateness of investing in any funds or stocks and should understand that future expectations may not be realized. Investors should note that the price or value of any funds or stocks may rise or fall. Past performance is not a guide to future performance.

Contributed by Investment Professionals Ltd