Niko’s FY09 annual results disclosures reveal a 23% increase in the Phase-1 oil and gas development cost at KG-D6 to US$8.2bn. Gas production is currently at 28msmcmd and Niko expects this to reach peak of 80 by Dec-09; we model a Jul-10 peak. It also expects to receive approvals for the developments of the nine satellite fields in KG-D6 and for the six discoveries in NEC-25 in FY10 but is still targeting MN-D4 drilling only in mid-2010. Overall, the disclosures yield little incremental information on the three blocks that it co-owns with Reliance, though.
A 23% increase in Phase-1 oil and gas development costs in KG-D6. Niko’s FY09 annual results disclosures reveal a 21% increase in the Phase-1 project cost of the D1-D3 gas development to US$6.3bn (from US$5.2bn earlier). This indicates that overall project costs could be ~$1.5-2bn higher than the US$8.8bn (to be spent by FY12) indicated in Reliance’s 2006 development plan. In addition, the capex for the MA oil project has also increased to US$1.9bn (ex of FPSO which may cost US$0.7bn) from US$1.5bn earlier. The consortium has spent US$4.8bn on the gas project by end-FY09 and US$1.2bn in the oil project; we expect the rest to be spent in FY10.
Niko expects peak gas production by Dec-09. While Niko is silent on current MA crude production, data from India’s Ministry of Petroleum indicate that field produced 10kbpd in May. Niko expects MA to reach 38kbpd by end-FY10. Niko’s impairment test assumptions also indicate that pricing for MA oil could settle at a 10% discount to Brent. KG-D6 gas production is currently at 28mmscmd; Niko expects peak of 80 by Dec-09. We continue to model in 80 by Jul-10 as full production is contingent on completion of Gail’s pipeline expansion projects; these are likely only by 4QFY10. Overall, we model 43mmscmd in average for FY10 (Niko guidance of 50, estimates submitted to the government of 62-74); every 10mmscmd adds 5-7% to EPS.
MN-D4 drilling likely only in mid-2010. Reliance also drilled three successful wells in KG-D6 in FY09 with key discoveries in the Pleistocene (L1) and near the 2tcf R1 prospect besides one successful well in NEC-25. Reliance is currently drilling two more exploration wells in KG-D6 and one appraisal well in NEC-25 but exploratory drilling in the key MN-D4 block is unlikely before mid-2010 as it had guided for earlier. Niko also expects to receive approvals for the developments of the nine satellite fields in KG-D6 (US$5.9bn capex, 2.2tcf recoverable) and for the six discoveries in NEC-25 in FY10.
No reserve/resource disclosures. Overall, Niko’s disclosures yield little incremental information on the three blocks that it co-owns with Reliance. In particular, it did not provide disaggregated reserves/resources updates. Higher disclosure or intensive drilling is key for Reliance’s stock; especially as we expect refining/petchem margins to remain soft. We are downgrading FY10-12CL EPS by 2-4% to factor in the higher capex in FY10 (higher DDA, lower other income) and the deeper 10% discount for MAoil. We also reduce our fair value estimate by 1% to Rs1,925/sh but note that this does not factor in the potential Rs160-225/sh impact of the RNRL court case ruling.
GSFC saw 245% rise in Q4FY09 PAT to ~Rs984mn vis-à-vis ~Rs286mn in Q4FY08, higher than I-Sec estimates. This was owing to: i) benefit of ~Rs548mn in fertiliser division, pertaining to prior period and ii) Rs580mn excise reversal on GSFC winning an old litigation. Adjusting for these one-time items, overall results were inline with our estimates. Caprolactum division saw loss for a consecutive quarter, of ~Rs209mn, mainly owing to weak demand, given global slowdown in auto industry. DAP business significantly gained from the change in fertiliser policy in FY09, which allows import parity pricing. GSFC saw ~109% rise in FY09 PAT to ~Rs5bn, which is unlikely to sustain. We downgrade our earning estimates owing to: i) considerable fall in international DAP prices that would impact revenues ii) loss in caprolactum business iii) inventory- & high raw material costrelated pain impacting DAP business in H1FY10. Our SOTP evaluates GSFC at Rs163/share (Rs168/share earlier) based on: i) core business valued at Rs132/share, assuming FY10E P/E of 7x on adjusted EPS & ii) investments at Rs31/share. The stock has already outperformed and risen 128% since January’09 that we believe fairly valued; downgrade to hold.
■GSFC may require contributing 30% PBT for social development fund from FY10. Although GSFC has not yet contributed the required 30% PBT towards Gujarat government’s social development fund in FY09; this may happen FY10 onward
■Pain in DAP business expected in H1FY10. We expect FY10 revenues to decline, in line with fall in international DAP prices. Inventory write-down and temporary price mismatch may lead to pain in H1FY10 in DAP business.
■Caprolactum business may not revive in short term. Uncertainty in the global auto industry has made an impact on caprolactum business demand; however, cheaper input prices have helped the company limit losses.
■ Stock outperforms – 128% returns since January ’09; downgrade to HOLD. We downgrade our FY10E EPS ~18% owing to issues in the DAP and caprolactum businesses. We value core business at FY10E P/E of 7x on adjusted EPS and investments at Rs31/share based on market value. The stock has outperformed since January ’09 and, we believe, is fairly valued at current market price. Downgrade to HOLD. Key upside risk to our call is GSFC not requiring 30&% PBT contribution to the social development fund.
We had initiated coverage on GNL on May 29, 2008 at a price of Rs.125.05 and recommended to accumulate on dips to Rs.106-110 band for a target of Rs.154. The stock subsequently made a high of Rs.133 on June 13, 2008. The stock later underperformed in line with the other small/midcaps and touched a low of Rs.70 on March 06, 2009. It later recovered and made a high of Rs.126 on June 03, 2009. Currently, the stock is quoting at Rs.101.80.
Company Profile: Grindwell Norton Ltd. (GNL) came into being when a technical collaboration in 1967 between Grindwell and the then world leader in abrasives – Norton Company, USA, grew into a financial collaboration in 1971. GNL is a 51.3% subsidiary of Saint Gobain (SG) of France and India’s leading manufacturer of Abrasives (bonded, coated and super abrasives), Silicon Carbide and High Performance Refractories.
Q1CY09 Result Update GNL recorded a 2.9% degrowth in revenues on a Y-o-Y basis in Q1CY09 and 2.3% fall Q-o-Q at Rs.114.3 cr. This was mainly on account of sharp fall in volumes and value of each of GNL’s products. Bonded abrasives witnessed fall of 15-20% in volumes, coated abrasives saw a fall of 5% whereas thin wheels volumes improved by 5% in Q1CY09. Performance Plastics and refractories also witnessed a volume degrowth of 10% and 15% respectively. However, the others division, which accounts for revenue from the Project Engineering has done well during the quarter.
The total expenditure fell by 3.3% Y-o-Y and by 3.8% Q-o-Q. Raw materials and staff cost have risen 250 bps and 150 bps respectively as a percentage of sales in Q1CY09. Staff cost increased on account of 6% hike in salary and higher wages post settlement been paid at one of GNL’s plant. Power and fuel cost has dipped by 170 bps Y-o-Y and 220 bps Q-o-Q as a percentage of sales. With the full-fledged commencement of operations at the Bhutan Plant in July 2009, the power and fuel cost could further see a dip on consolidated basis, which could ease the pressure on the margins. Other expenditure has dipped to 18.6% as a percentage of sales. Although the sales have dipped, control in costs have led to margin expansion by 40 bps Y-o-Y and 140 bps Q-o-Q to 14.3%.
Despite the benefit of excise and income tax for 5 years at the HP plant, GNL continues to pay 31% tax rate as the plant hasn’t been fully utilised. GNL has managed to keep its PAT margins at the same level of 10.4% in Q1CY09. During the quarter, GNL earned an EPS of Rs.2.1, down by 5.7% Y-o-Y and down by 4% Q-o-Q.
The centre of gravity of the global economy and for large corporations is being transferred to Asia at an increasing pace
We believe that the centre of gravity of the global economy and for large corporations will move - at a more rapid pace after the crisis - towards Asia, which includes China, India and other Asian emerging countries (but not
Japan directly):
- the growth gap between Asia and large OECD countries (United States, Europe, Japan), will widen further, which is likely to give rise to a new wave of offshoring to Asia and rapidly increase the weight of Asia in the global economy and in global trade;
- the vigorous growth in Asia will gradually drive up commodity prices, which will generate a new weakening in growth in large OECD countries;
- the necessary savings, be it to finance fiscal deficits or the needs of companies and banks in large OECD countries, will increasingly come from Asia, and this will gradually increase the weight of Asia in financial markets and in terms of company ownership.
Dividend is king? We analysed 82 companies with market cap of over US$1bn on trend in dividends in FY09 and see if there is any correlation with stocks performance. Interestingly in a year when profits grew by only 6% (for this universe), 42 companies declared higher dividend/ share than in FY08 and only 23 companies declared lower dividend. Of the companies that declared a higher dividend, 79% have outperformed the Sensex in the last one year. In the same period, 57% of companies that have declared lower dividends have underperformed the Sensex.
Over the last one month, 33% of the 43 companies have underperformed the Sensex, but only 17% of the 24 companies underperformed the Sensex. The above indicates that in uncertain times companies expected to pay higher dividends will likely outperform and as risk appetite returns, as in the last one month, a higher proportion of companies that have paid lower dividends, but may have more exciting “stories” and potentially higher risks, tend to outperform. The average outperformance for companies that increased dividends was 29% over the last one year and 14% in the last one month. In uncertain times, dividend it seems is indeed the king.
We looked at companies with market cap of US$1bn
■ Of the 82 companies with market cap of over US$1bn, 42 companies have declared higher dividend/ share in FY09 vs FY08, 23 companies declared lower dividend.
■ Financials, particularly PSU banks, have declared higher dividends in FY09. Consumer, utilities and healthcare companies are other sectors where many companies have declared higher dividends. Materials, industrial and 4-wheeler companies have declared lower dividends.
■ It is interesting to note that in a year of uncertainty and slowdown, over 59 of the 82 companies have declared higher or unchanged dividend, a likely pointer to the fact that the outlook within India is not very gloomy.
Stock performance vs dividends
■ 79% of companies that declared higher dividend have outperformed the Sensex in the last one year and the average outperformance was 29%. The nine stocks that underperformed had an average underperformance of 12%.
■ On the other hand, 57% of the companies that declared lower dividends underperformed the Sensex over the last one year and the average underperformance was 15%.
■ The trends over the last one month are equally interesting. Of the companies that have declared higher dividends, 33% underperformed the Sensex, but only by 6%, whereas the 67% that outperformed, had an average outperformance of 14%.
■ Of the stocks that have declared lower dividends, only 17% underperformed the Sensex in the last one month by 6% on an average. The 83% stocks that outperformed had an average outperformance off 13%, not very different from the basket of stocks that declared higher dividends.
■ We believe that in uncertain times, stocks that are likely to maintain or increase their dividends are likely to do better over a longer time period. In the short term, even as risk appetite returns, the average performance of companies that declare higher dividends is comparable to the presumably riskier universe of stocks that have declared lower dividends.
Potential Bharti-MTN synergies include lowering procurement costs and replicating low-cost/high-usage model at MTN
Deal uncertainties and probability of sweetening the offer for MTN shareholders raise short-term concerns
Retain OW(V). Raise TP to INR977 (from INR876) as we over our multiples to FY11e. 3G factor supports our argument roll
■ The objective of this report is to identify potential synergies not yet reflected in our forecasts (we include a sensitivity analysis), particularly on capex per base station, and to explore potential benefits of a shift to the low-cost, high-volume ‘minute factory’ model. We also discuss the legal and regulatory issues around the deal.
While the potential deal is marginally EPS accretive (4% for FY11e), we believe most of the synergies are medium to longer term. Uncertainty over pricing, execution, and dilution are likely to be a drag in the near term while clarity on synergies, shareholder structure and longer-term use of FCF could be positive.
■ Procurement synergies and low cost high usage model. Our analysis suggests that MTN’s cost per unit of capex (base transceiver station, or BTS) is c3x times higher than Bharti’s, suggesting potential procurement synergies in a post deal scenario. We note that certain local market level factors may limit upside (c5-14% to DCF). Further, we see scope for MTN to replicate the Bharti-style ‘minute factory’ model, creating significant cost-competitive advantages. This implies a fundamental shift in the business model, and the possibility of competitors replicating the same cannot be ruled out.
■ We maintain our Overweight (V) and raise our target price to INR977. As we roll over our valuations to FY11e, our estimates remain conservative (8% below consensus on FY11e earnings). The possibility of 3G auctions makes FY11e relevant and, unlike consensus, we are factoring in the potential 3G impact. Possible INR appreciation offers potential earnings upside. Risks for Bharti include poor monsoons and higher spectrum charges.
■ We believe move to pursue MTN reflects Bharti’s view that marginal opportunities in Africa are better than in India. Some GEM investors may prefer a pure geography play to improve control over their portfolios. In our view, there is a broad-based scepticism on the likely synergies and formal guidance from Bharti management will be critical.
Shadow banking moves from private banks to central banks
■Leverage dynamics in play
Global leverage is largely unchanged from the summer of 2008 to now. Assets went up US$6tn, but capital went up thanks to Chinese retained earnings and the US taxpayer. Asia’s low leverage puts it in a superior position to Europe. China’s releveraging is very healthy – so is Brazil’s. Most of Europe is unsustainable in our view
■ Asian banks in a global context
Asian banks have the lowest leverage and highest ROE. European banks have the lowest ROE and highest leverage. Our global ranking puts CCB, Stan Chart and BOC among the most attractive banks in our universe of 195 banks. Korean banks are a problem, in our view.
■ RBS sale of Asian businesses
Robert Law and Anand Pathmakanthan thrash out the details of the RBS sale of Asian assets. Questions on costs and asset quality are a problem and the franchise is wide rather than deep. But it is worth something to a newcomer – but not to existing giants such as HSBC and Standard Chartered, in our view.
■IMF Study of Federal Reserve balance sheet
Central banks now account for almost one-third of the assets of the top-ten banks globally. Conflicts of interest arise when central banks are both the marginal buyer and seller of credit. Central banks’ policy is everything and will determine equity valuations – not earnings! Read on inside.
The delay in the onset of the monsoon and rising El Nino risks has revived memories of the market selloff during the drought of 2002. Water reservoir levels are already low and a poor monsoon season could hurt farm incomes and impose additional fiscal burden. Whether this scenario plays out will, however, depend on the progress in July. Autos, consumers and cement stocks are vulnerable, but a fall in consumer stocks would provide attractive entry opportunities in our view.
2009 season starts on a bad note ■ Overall rainfall for the season until Jun 17 has been 45% below normal, with 28/36 metrological divisions receiving rainfall below the long-term average. ■ Water levels in reservoirs are at 10% of capacity (vs norm of 14% for Jun). ■ According to Australia’s Bureau of Meteorology, the signs of a developing El Niño, which usually lead to drought in Asia, have strengthened during the past fortnight.
India’s gearing to monsoon now lower, but rural boom can be hit ■ The share of the monsoon-dependent kharif crop has declined. Since 1987, agri output fell in only 5/8 years when monsoon rainfall was +5% below average. ■ The area under irrigation (now 43%) has been rising steadily, albeit gradually. ■ With agriculture now accounting for only 18% of GDP (versus 33% even in the early 1990s), the Indian economy is far more resilient to a poor monsoon season. ■However, a poor crop will deflate the current buoyancy in farm incomes. At a time of +10% fiscal deficit, there is little room for further fiscal support.
Domestic plays –autos, cement, consumers are vulnerable ■ Linkage of monsoon with market performance is weak. However, in 2002, the Sensex fell 10% in the six weeks to end-July as the drought was established. ■ Autos (BSE Auto Index -16%), cement stocks ACC, Ambuja, India Cement (down 14-30%) were hit. Among consumers, HUL fell 13%, but Nestle, ITC outperformed. ■ Cement initially saw a rise in despatches, but supply concerns started to dominate. ■ Earnings for consumers, autos held up well, while cement was hit by rise in supply. ■ While stocks in all three sectors are vulnerable to correction, we would see a lower price points in consumers as attractive entry opportunities. ■ Soft commodities could be beneficiaries with prices moving up due to lower supply. ■ Tea output is already forecast to be 5% lower.
Jury not out – wait until July ■ The month of June accounts for just 20% of sowing activity for foodgrains. ■ 35% of the season’s rainfall, 50% of sowing takes place in July. Watch for updates on El-Nino, trends in spatial distribution of rainfall (more critical than total rainfall).
Page Industries Ltd. (PIL) Q4FY09 results were in line with our expectations. Better realization and higher volumes resulted into a growth of 25.4% in net sales (YoY). Lower material cost helped in improvement of operating margins by 180bps. However, higher depreciation and employee cost (due to increased capacities) negated this to a certain extent. With increased capacities, strong brand image and pan India presence, we feel the company is well poised to capture the growth in volumes and value. We reiterate our BUY recommendation on the stock with a revised price target of Rs.612 (12x FY11E) in the next 12~18 months.
Q4FY09 result analysis:
■ PIL sold 8.35mn pcs in Q4FY09 (39mn pcs in FY09) vs 6.8mn pcs in Q4FY08 (31mn pcs in FY08). The average realization in Q4FY09 has improved to Rs.67.5 per pc (Rs.65.3 per pc in FY09) from Rs.66.2 per pc. (Rs.62.1 per pc in FY08).
■ The operating margins improved by 180bps to 17.2% mainly on account of lower raw material prices which declined by 220bps (as a % of sales).
■ PAT grew by 27.7% to Rs.55.6mn vs Rs43.5mn in the last corresponding quarter. PAT margins were under pressure mainly due to higher depreciation. We expect margins to improve as no more incremental capex is required.
■ The current capacities of the company stand at 74mn pcs p.a. up from 54 pcs p.a. These capacities would be enough to take care of demand for at least next two years. ■ The working capital turn over ratio (on an annual basis) improved from 4.5 in FY08 to 5.3 in FY09.
■ PIL had paid a dividend of Rs.17 per share for the year FY09 and had also declared interim dividend of Rs.9 per share for FY10.
■ Total no. of EBOs (Exclusive brand outlets) currently stands at 46 stores which PIL plans to augment to 100 stores in the next two years.
Are the consequences for the yield curve very different according to whether excess liquidity leads to inflation or a rise in asset prices?
Global liquidity is extremely abundant. Until 2008 this was due to the rise in official reserves, since 2008 it has been due to very expansionary domestic monetary policies, and in the recent period is has been accounted for by both these causes.
We would like to look at the effects of the very abundant global liquidity on yield curves:
− if they brought back inflation (which will not be the case, but this is what many financial market participants believe), there would straight away be a rise in long term interest rates and yield-curve steepening;
− but if inflation cannot return, due to the situation of massive under-employment, and if there are asset price bubbles because of excess liquidity (emerging country equities, credit), it is not certain that yield curves will steepen less, because of the correlation between bond yields and returns on other available assets;
− the case of commodity prices is obviously somewhere in between.
This shows that, even though excess monetary creation no longer leads to inflation in prices of goods and services in contemporary economies, it can nevertheless lead to a rise in long-term interest rates.
1 - Excess liquidity, but disappearance of goods and services inflation, excluding commodities Global liquidity is extraordinarily abundant.
− until early 2008 mainly owing to the accumulation of official reserves in Japan and in emerging and oil exporting countries;
− since the start of the crisis, due to the extremely expansionary monetary policies implemented in OECD countries;
− since the spring of 2009, there has again been accumulation of official reserves in emerging countries, due to capital flows returning to these countries, which is causing a renewed appreciation in their exchange rates.
Back to secular growth path; upgrade SBI to Buy, add to Conv. list
Turning constructive on improved growth outlook We believe the Indian economy and the financial sector are returning back to a potential growth path, post a period of adjustment to the intense dislocation in the global economic environment. We now turn constructive on Indian financials due to better fundamentals: 1) we forecast aggregate net income growth for the sector to rebound strongly from a subdued level of 1% in 2009E to 32% in 2010E and 23% in 2011E due to acceleration in loan growth, rising NIM and stable credit costs; 2) we forecast ROE to rise from 13% in 2009E to 17% in 2011E reflecting a pro-cyclical environment. We raise our 2009E-2011E EPS by up to 73% and our 12-m TP for stocks under our coverage by 26%-115%.
We see GARP ideas despite rally in stock prices We turn constructive from our earlier cautious stance which was based on concerns about potential increase in NPL and credit costs. We note that the run-up in share prices since the lows seen in March 2009 partially reflects the improved outlook for the operating environment. However, we highlight potential GARP ideas based on sustained earnings growth, underperformance relative to benchmark index and inexpensive valuations despite the run-up.
Upgrade SBI to Buy, add to Conviction list; PNB to Buy from Sell We upgrade SBI (SBI.BO) to Buy and add it to our Conviction list and reiterate Buy on Axis (AXBK.BO). Further, we upgrade PNB (PNBK.BO) and IOB (IOBK.BO) to Buy from Sell and Neutral, respectively; we also upgrade BOB (BOB.BO) to Neutral from Sell.
Add IDFC to Conviction Sell list; downgrade IBFSL to Sell We downgrade HDFC (HDFC.BO)and ICICIB (ICBK.BO) to Neutral from Buy as we believe current valuations factor in potential upside from their respective operating fundamentals. We downgrade IBFSL (IBUL.BO) to Sell due to a strong price rally and concerns arising from a weak 4Q2008 performance. We maintain Sell on IDFC (IDFC.BO), and add it to our Conviction list, and on KMB (KTKM.BO); we maintain Neutral on HDFCB (HDBK.BO).
Key risks Setback to growth expectations for the economy, rise in interest rates (policy rate as well as long bond yields), and deterioration in credit quality of loans for banks.
Ahluwalia Contracts India Ltd. (ACIL) is a premium player in contracting and caters to industrial, real estate and infrastructure segment. A healthy order book of Rs.41.5 Bn provides revenue visibility of 3.6 years. Increased contribution from Government Contracts (32% of order book) enhances certainty in the order book. ACIL has been awarded the time critical Commonwealth Projects which exhibits its quality and timely execution skills. With proven execution skills, strong promoter pedigree and sound financials with positive free cash flows, webelieve that ACIL is attractively place d. We initiate coverage with a BUY recommendation and a 12 months price target of Rs.108 which discounts its FY11E EPS of Rs.15.5 by 7x.
Investment Rationale
Huge opportunity in infrastructure segment: ACIL is actively bidding for Urban Infrastructure Projects (especially projects under the JNNURM scheme) and is currently associated with projects like Metro Rail in Mumbai, Delhi and Bangalore, Airport development in Ranchi etc. Under the JNNURM scheme, projects worth Rs.692 Bn are to be allocated over the next 3 years thereby providing ACIL a substantial opportunity landscape in the Urban Infrastructure space.
Healthy order book position to enhance revenue visibility: ACIL has a current order book of Rs.41.5 bn (3.6x FY 09 E sales) catering to residential, commercial retail, hospitality and healthcare segment. The company is currently executing time critical commonwealth projects worth Rs. 8.9 Bn (20% of order book) thereby exhibiting its credibility of timely execution. Going forward, ACIL will increase focus on infrastructure and Government projects which would perk up the order book quality. ACIL, currently, has an order pipeline worth Rs.10 bn.
Out of woods.....poised for high growth: The Company has recently received its long pending payment from Emaar MGF for commonwealth games village project which has addressed the short term concerns, thereby infusing sufficient liquidity in the project and ramping up execution.We expect ACIL to clock a revenue and net profit CAGR of 30.3%and 23.6% respectively between FY 09E and 11E.The company has been generating positive free cash flows in the past 2 years. We expect it to continue generating positive free cash flow in the next two years.
Valuations: At CMP, the stock trades at 7.9x its FY10E earning and 5.4x its FY11E earning. We initiate the coverage with a BUY recommendation and a 12 months price target of Rs.108 which discounts its FY11E EPS of Rs.15.5 by 7x.
CNG price in Delhi higher by INR 2.1/kg Indraprastha Gas (IGL) increased the retail price of CNG in Delhi from INR 18.9/kg to INR 21.0/kg w.e.f. from June 16, 2009. The increase encapsulates an INR 2.0/kg increase in CNG price and an INR 0.1/kg increment in applicable taxes. This implies an average price of INR 20.56/kg for FY10 (as the older price of INR 18.9/kg has prevailed for two-and-a-half months of the financial year). However, CNG retail prices in Noida have been left unchanged at INR 22.1/kg.
Price hike in CNG to mitigate impact of rise in input costs The subsidized APM (Administered Pricing Mechanism) gas supplied to IGL was becoming increasingly inadequate for NCR’s growing demand of CNG. This compelled IGL to buy the costlier imported LNG to meet the shortfall, which raised the company’s input costs. Further, the incremental gas to be sourced from RIL’s KG-D6 basin (after RIL’s production ramps-up to start supplying to the city gas distribution sector, and replaces LNG) is priced much higher than APM gas which itself could face price revisions upwards. Hence, the increase in CNG pricing serves to mitigate the effect of current increase in raw material costs, and also partially alleviates concerns on increase in blended gas costs in future.
Outlook and valuations: Earning estimates retained; maintain ‘BUY’ We had assumed a CNG retail price of INR 20.5/kg and INR 21/kg for FY10 and FY11 respectively. Since the difference between FY10E average actual CNG prices (INR 20.56/kg) and our existing assumptions (INR 20.5/kg) is marginal, we are maintaining our earnings estimates and outlook. We had assumed a sales volume growth of 15.4% for FY10 in line with the high demand expected on account of the commonwealth games (please refer our recent report titled “Regulations and new supplies to energise growth” dated May 06, 2009 for more details), which provides significant upsides to the stock in the short-to-medium term.
At CMP of INR 145, IGL is trading at 9.3x and 8.7x our FY10E and FY11E EPS, respectively, a 2.5x FY10E P/BV and a 4.1x FY10E EV/EBITDA. We maintain our ‘BUY’ recommendation on the stock.
The consensus is that the crisis will have to cause a trend break in the practices adopted in finance: contraction in demand for complex assets, reduction in risk-taking, changes in trader compensation systems, etc.
But certain recent developments can raise doubts as to whether there is really a trend break: − the banks’ accelerated repayments of the governments’ capital injections; − the return of demand for financial assets that until now were supposed to be "toxic"; − renewed speculative bubbles due to the sharp fall in investor risk aversion and excess liquidity.
This latter point shows that central banks’ responsibility in the "financial sector excesses" is even greater than before the crisis.
US TIPS: We remain positive on longer maturity TIPS BE’s for longer horizon investors. The recent narrowing in BE's provides an opportunity to re-add to long BE positions that we had recommended scaling back on last week.
European IL: We remain short Euro breakevens but see short term risk from oil prices and therefore prefer to sell inflation forward. We analyse cross-country breakeven spreads and recommend selling BTPei35 breakevens against OATei32. The real German government curve looks too flat in the 5-8 year sector compared to France.
JGBi: The rally in JGB inflation linkers has stalled since April. We believe further weakness should provide a selective buying opportunity.
EM IL: the only long duration left Exposure to inflation-linked instruments remains important in our overall exposure in EM local debt markets. What we have seen in recent weeks is that exposure to real rates is now the best way to express a long duration view. This is because most central banks have now come close to the end of the easing cycle, which means there is little upside at this stage for a plain long duration position. On this basis, we continue to hold recommendations of a long Turkey Feb. 2012 CPIlinker bond and a long Brazil NTN-B 2015 IPCA-linked bond in our portfolio.
Commodities: A very fast increase in oil prices in the coming months could put the embryonic economic recovery at risk. How high could oil go near-term? In OECD economies, our economists believe that $70-80/bbl oil could start to pose a risk to the recovery, while the risks to EM growth would come in at $90-100/bbl.
US economics: Headline CPI came in significantly below expectations with a 0.1% M/M increase in May. Most forecasters missed the tepid rise in energy which benefited from an aggressive seasonal factor to the downside. Core prices were in-line with a 0.1% M/M gain taking the annual rate to 1.8% versus 1.9% in April. Euro area economics: Inflation hit a record low of 0.0% in May. While downside risks dominate in the summer, positive headlines rates are seen before year-end.
UK economics: CPI inflation fell a little further in May, and is expected to continue falling to a trough in September.
• Monsoon – off to a weak start: YTD seasonal rainfall is 45% below normal. The Met department has indicated that the weakness could continue over the next week. It is early days yet, as June typically accounts for only 20% of the total south west monsoon. But a recovery over the next month is critical, in our view. • Economic significance has decreased, but is still meaningful:Structurally the importance of agriculture as a percentage of GDP has decreased over the past few decades, from nearly 50% in the early 1970s to about 17% now. But the monsoon is still important for the farm sector, as nearly 60% of India’s agriculture is rainfall-dependent. • Adverse impact on sentiment: Nearly 60% of India’s population lives in rural areas. Although they do not derive their entire livelihood from agriculture, the sentiment impact of the monsoon on private sector consumption cannot be underestimated. Also, in the recent past, rural India has been driving consumption growth on the back of various government stimuli. This segment is vulnerable to a pull back. • Consumption underperforms: An analysis of weak monsoons over the past indicates that the earnings impact has been mixed due to various offsetting factors. But consumption-related sectors, i.e. staples, discretionary and telecom, typically underperform both over the July-Sept quarter and the fiscal year in which the monsoon has been weak. We have been cautious on the telecom sector since the beginning of the year and have had an underweight stance on the staples sector over the last two months. Our overweight stance on the discretionary sector would, however, be vulnerable if the monsoon weakness persists.
For FY09, Jindal Steel and Power Ltd. (JSPL) reported a strong set of numbers. The net sales (consolidated) of the Company increased by a staggering 97.6% yoy to Rs. 108.4 bn, and the net profit jumped by 140.6% yoy to Rs. 30.1 bn. The Company’s strong results are primarily attributable to the commencement of operations of Jindal Power Ltd. (JPL)’s 1,000 MW merchant power plant (MPP), and a 35.8% yoy increase in the average sales realisation of saleable steel. We continue to hold a positive outlook on the Stock, mainly on the back of the stable revenue visibility in the Power business and the resurgence of domestic demand in the Metal sector. However, the stock has moved up sharply since our last report, and based on our valuations it is fairly valued at the CMP. Thus, we give a Hold rating to the stock.
Rising domestic steel demand to stimulate the Metal segment: We expect JSPL (standalone) revenue to increase by 8–10% in FY10. The recovery in the Automobile industry and an increase in infrastructure investments have encouraged the demand for steel. Further, we expect the demand from the Real Estate sector to increase due to the fall in the interest rates and the sharp correction in the property prices. Thus, along with the revival in the economy and the restoration of demand, we have increased our base metals average realisation estimates for the Company to ~Rs. 38,000 per tonne in FY10.
Power business continues to be a growth driver: We expect JPL’s revenue to increase by 12–15% in FY10. In FY09, JPL has fully commissioned its 1,000 MW MPP that sells power on merchant basis through short-term PPAs; such agreements command high realisations of around Rs. 5–8 per unit. Further, as the new capacity stabilises, we expect production to increase to ~8,000 mn units in FY10, as compared to 6,207 mn units in FY09. The current power deficit situation in the country is expected to persist, and this should further help the Company achieve stable revenue.
Company Background Wipro started out as Edible Oil Company before entering FMCG and IT businesses. Currently Wipro is the third largest software exporter from India.
Investment Rationale Second Largest player in the Indian IT domain behind IBM: ‐ Wipro is the second largest IT service vendor in the Indian Market behind IBM. We expect the company to leverage its strong presence in India and continue to bag multiple contracts in the coming months, which would aid Wipro in reporting incremental revenues in the coming years. The company has bagged following contracts in the recent months:‐
■ Six and a Half year contract worth Rs 1182 Cr from Employee State Insurance Corporation.
■ Order worth Rs 200 CR from LIC. ■ Company bagged order from Unitech wireless executable over a period of Nine years for an undisclosed sum.In its analyst meet, the management had conceded that Q1 and Q2 of FY10 would be tough for the industry as a whole however the company has stated that it had witnessed a pick up in order placement in Feb‐ March months in FY09. Going ahead the company has stated a build up in order book pipeline as clients that were apprehensive about IT budget and new order placement are expected to go ahead with orders placement. The management stated that offshore spending by customers would increase as they look to reduce cost at their end. ■ Company has reported a growth of more than 28% in its topline for FY09. Going ahead, with orders form Indian Sector improving and Clients in US and Europe also seeking a reduction in cost and opting for out sourcing Company’s topline is expected to improve in the coming years and expansion of profit margins can also not be ruled out.
■ The company has cash and bank balance of Rs 4912 Cr on its books that translates to Rs 33.5 per share.
■ Order inflows likely to revive, but not rapidly On average, companies in our coverage universe saw a 22% decline in order booking in 4Q FY09 and grew just 8% in entire FY09 (pulled up mainly by strong order inflow for HCC, which grew 143% YoY). We expect an improvement in FY10, but the pick-up in order flow will likely remain moderate owing to high fiscal deficit restraining government spending and a slowdown in private-sector capex. We estimate order inflow growth of 15–20% in FY10 (-50% for HCC, due to the high base in FY09) and 20–25% in FY11.
■ Earnings growth to be much lower than pre-FY09 levels, in the near term After a rather forgettable FY09, earnings are likely to pick up from the current fiscal onwards. However, earnings growth is unlikely to reach pre-FY09 levels in a hurry. For companies in our coverage, we expect earnings CAGR of 17% over FY09–11E compared to 52% in FY03–08. We expect slow recovery on account of: (1) low revenue visibility (owing to low order inflows in FY09); (2) depressed EBITDA margins; and (3) high interest costs (despite a significantly lower cost of debt).
■ Quality of earnings remains weak, equity dilution risk lingers Our biggest concern about the sector has been negative cash flows generated primarily due to an elongating working capital cycle. We expect the cycle to remain stretched, resulting in: (1) low or negative cash flows; (2) rising debt and low interest coverage; and (3) low return ratios (with ROIC below 12%). This will eventually lead to a series of equity dilutions, as was seen in the past.
■ Optimism is overdone, we are cautious on the sector Post elect ion results, all construction stocks have run up significantly on the back of optimism that the new government will push infrastructure spending aggressively. We believe an improvement in earnings is likely to be gradual rather than dramatic, thus leaving room for disappointment. Thus, we believe that construction stocks are not likely to trade at the high multiples they commanded in 2007-08. We are upgrading Simplex to Buy based on our revised valuation and maintain our Sell rating on HCC, IVRCL and NCC.
■Ride domestic growth, 30% potential upsideWe upgrade our rating to Buy from Underperform as we expect valuations to mirror market share gain led recovery in domestic business (67% FY11E EBITDA), and we think this will more than offset the known weakness in JLR operations. We reflect this by raising our standalone EBITDA forecasts by 65% in FY10 and 62% in FY11. Our sum-of-the-parts PO of Rs420 factors in NILcontribution from JLR. ■Buoyed by domestic operationsWe expect standalone business to register 54% EBITDA CAGR, on: (1) higher CV volumes due to cyclical rebound in trucks, and a spate of bus orders, and (2) stronger margins, on better vehicle realizations and soft commodity prices. Our EPS estimates of Rs18 in FY10 and Rs30 in FY11 are ahead of consensus. ■ Financial health on the mendTata Motors’ debt of ~Rs320bn (debt/equity 1.3x), includes Rs70bn from vehicle financing and Rs25bn customer advances. We however expect leverage ratios to improve on stronger cash flows and likely equity issuance, failing which we expect further monetization of investments. By FY11, we estimate consolidated net debt/EBITDA at 2.3x, net debt/equity at 0.8x and interest cover at 2x. ■Sum-of–the-parts value at Rs420Our PO is based on FY11E EV/EBITDA, and driven by: (1) standalone business valued at 8x, which is a slight premium to mid-cycle sector valuations on market share gains, and (2) JLR at nil value, equivalent to 4.6x, in line with global peers.
We recently met the management of Canara Bank and came back convinced about the bank’s ability to deliver a high RoE over the next couple of years. We expect the RoE improvement to be driven by: (i) an improving core performance; and (ii) receding pressure on asset quality. The bank is well poised to accelerate its credit growth, which along with the calibrated strategy of lower growth in FY08, has led to an uptrend in CASA, NIMs and NII (albeit some base effect). Besides the pick-up in credit growth, renewed focus on cross-selling would also contribute to fee income growth. In Q4FY09, the bank surprised positively on asset quality and reported a decline in Gross NPAs, while restructured assets hovered at the industry average. The bank has de-risked its investment book over the year, with AFS proportion in investment book now at 27.5% (duration of ~2 years) from ~37% in FY08. A lower AFS proportion in the investment book implies lesser volatility in earnings going forward. We expect Canara Bank to report 14% CAGR in net profit over FY09-11, with an average RoE of ~21% over the next couple of years. Stock is currently trading at ~1x FY10 adjusted book. We upgrade our recommendation on the stock to Outperformer with a 12-month price target of Rs350.
The key takeaways from our meeting with Canara Bank management are:
■Growth strategy – foot on the accelerator!
Credit growth in FY08 was restricted to ~9% as the bank’s strategy was to consolidate rather than grow aggressively (28% CAGR over FY05-07).
Since July/ Aug ’08 (when the new Chairman took over the running of the bank), the focus has been on returning to growth. In FY09, the bank grew its deposits by ~21% and advances by ~29%.
In FY10, credit growth is expected to moderate to 20-22%, in line with RBI guidelines.
■ Outlook for margins – stable!
NIMs improved by 36bp qoq to ~2.8% in Q4FY09, as loan spreads expanded with a higher rise in yield on advances than cost of deposits. Management expects NIMs to stabilize around 2.8%.
Lending rates are not expected to fall by more than 50-100bp from here unless cost of funds also falls by a similar extent. We believe there is limited scope for reduction in cost of funds, which as fixed deposits would then become unattractive for investors.
■ Gross NPAs contained; restructuring at 1.5%
Gross NPAs have come down from Rs25bn in Dec’08 to ~Rs21.7bn in Mar’09 on the back of strong recoveries. The bank’s entire Rs4bn Ratnagiri exposure continues to be a part of its Gross NPAs.
While provision coverage ratio of ~31% looks low, Canara Bank management reaffirms that including Rs40bn of write-offs by the bank, coverage ratio stands at 77- 78%.
The bank has restructured Rs20.6bn of loans during FY09, bulk of which are payment deferment and not haircut on interest. As of April’09, applications for restructuring worth Rs20bn are still pending, of which the bank does not expect to restructure more than Rs10bn.
■ Expansion plans
200 new branches are expected to be opened this year. Around 77% of all branches are CBS compliant, with a target to reach 100% by March-April’10.
Alongside productivity initiatives for the bank’s workforce, about 1,800 young people are expected to be hired to lower the age profile of the employees.
The government will present the Union Budget in the Parliament for the balance months (August-March) of FY10 on July 6. The budget is set to be presented against a backdrop of the government grappling with conflicting objectives of supporting growth and containing fiscal deficit. Given the fiscal constraints the government faces at the moment, any significant tax concessions or large direct government stimulus expenditure seem unlikely. However, programmes targetting rural employment generation, low cost housing, weaker sections of the society are likely to continue. The budget’s focus is likely to be on inclulsive growth, infrastructure, small and medium enterprises (SMEs), and labour-intensive and export-oriented industries (textiles, leather, gems and jewellery, etc). Agriculture will continue to be favoured. The UPA, both in its manifesto and the interim budget, had emphasised on divestment. Hence, one can expect the same to be on for discussion in the current budget.
Apart from the duty and tax cuts on budget wish lists, companies expect the government to promote investment. Construction companies expect an increase in funding for roads, irrigation, and in both rural and urban infra schemes. FMCG companies expect the government to boost the rural economy by increasing allocation for various agriculture-centric and employment generating schemes. In the metals sector, companies expect the government to help PSU steel companies to increase capacity and grant of infrastructure status for steel sector. The 3G auction issue for telecos is also expected to be touched upon in the budget, as it may generate additional funds of INR 250-400 bn. The wish list of oil & gas companies includes deregulation of auto fuel prices making domestic auto fuel pricing linked to international crude oil prices up a level (e.g, below USD 75/bbl). However, it is uncertain to what extent this proposal will go through, since an alignment to international prices will imply significant fluctuations in gasoline and diesel retail prices.
However, in case of most reforms (including 3G auction and oil price deregulation), only general directions and broad guiding criteria are expected in the upcoming budget. Detailed announcements and quantitative specifications are likely to follow in a staggered manner, in consultation with the specific ministries.
Inclusive growth, infrastructure to be key focus areas Supporting growth will be the foremost objective of the upcoming budget. The government has repeatedly emphasized that its focus is “the common man” and, hence, it prefers the growth process to be as “inclusive” as possible. Amidst subdued job scenario across the economy, the government is likely to demonstrate its commitment to generating employment. There are also talks of sector-specific stimulus measures, particularly labour-intensive, export-oriented industries and SMEs. The government has also stated that concerns raised in the interim budget, especially with regard to sectors hit badly by the global financial crisis—textiles, leather, and gems and jewellery—will be addressed in the budget. The measures may include interest rate subsidies and tax subsides. Representatives of the export sector are also seeking a market development fund to support the sector.
Agriculture will continue to be favoured. The government is likely to introduce new initiatives in rural infrastructure, such as, widen the irrigation cover, apart from increasing the corpus of the Rural Infrastructure Development Fund (RIDF) to ensure greater availability of funds. Government initiatives are expected to ensure better credit disbursements to agriculture, and increase agriculture input subsidies.
The budget may include some announcements on public sector-led infrastructure spending, including new initiatives in power sector development, improvement of railway infrastructure, upgradation of port infrastructure and capacity building in airlines and airports. The reintroduction of infrastructure bonds and investment allowance is on the wish list of corporates.
High fiscal deficit a concern; but small scale projects to continue The government has expressed the need to contain the fiscal deficit within reasonable limits. Certain government sources have indicated that they will attempt to contain the combined (Centre and States) fiscal deficits within 11% of GDP. However, given the sharp revenue slowdown the government is currently facing, this target appears ambitious unless there is a significant turnaround in the economy.
Accordingly, the government’s ability to provide any further dose of large and generalized stimulus for the economy will be limited in the current budget. However, the government will continue with small scale projects such as providing land at zero pricing for the economically weaker sections (EWS) and lower income groups (LIG) under the Model Real Estate Regulation Bill, increasing the minimum wages under the NREGA scheme to INR 100/day, and providing food security.
Can there be any significant tax reductions? Given the difficult business environment, demands from industry have been strong to reduce corporate tax rates or remove the surcharge on corporate income tax. Wish lists also include maintaining the reduced indirect tax rate and increasing tax free thresholds on income tax so as to not depress consumption.
However, the government is currently facing sharp revenue slowdown and there is no immediate need to be populist. Hence, there is no realistic expectation of a significant reduction in taxes. Tax concessions, if any, will only be token and largely for uplifting sentiments.
There is a possibility of rationalisation of income tax slabs yielding benefits to tax payers particularly at the lower end of the pyramid. The existing limit of INR 0.10 mn of tax exemption under Section 80C could be revised upwards.
On the other hand, to help interest rates to soften further, the government may consider reducing administered interest rates for small saving schemes like postal deposits. This will help banks reduce deposit rates and, in turn, lending rates.
Goods and services tax (GST) The government is keen on speeding up the streamlining of the tax system with the introduction of the Goods and Services Tax (GST). The finance minister has proposed to set April 1, 2010, as the date for introducing GST. Currently, there are parallel systems of indirect taxation at the central and state levels. Each of the systems needs to be reformed to eventually harmonize them.
Some of the steps the government needs to take with regard to GST are: (1) harmonize central excise and service tax rates; (2) eliminate end use/region based exemptions; (3) set up a body to recommend constitutional amendments, if any, needed to implement a uniform GST; and (4) give clarity on how import duties will be merged with GST. It remains to be seen how many of the above-mentioned issues will be addressed by the finance minister in the budget.
The GST rate may be pegged at 10-12% against the current 8-12% Cenvat rate, 10% service tax rate, and 12.5% VAT rate. There is also a possibility of introducing GST with differential rates for different goods and services with gradual unification of the rates over time.
Fringe Benefits Tax (FBT) Another long-standing demand from corporates is the removal of the Fringe Benefits Tax (FBT). Corporates have been opposed to FBT, not just on account of the added tax burden, but also because of the huge additional paperwork and accounting complications involved. Given the miniscule FBT collections (~2% of the total direct tax collection), there is a view that FBT may be removed in the budget for certain sectors. However, removal of FBT does not gel with UPA’s focus on “the common man”.
Securities Transaction Tax (STT) The wish list of the capital market includes abolishing Securities Transaction Tax (STT). Several market participants, however, feel that abolishing STT will be low in the priorities of the government as such a move will not offer any significant help for “the common man”. Another option for the government can be to reduce the STT (from the current 0.125%) instead of abolishing it altogether. There is also a possibility that if the STT is abolished, it will be replaced by another tax, such as long-term capital gains tax.
Expectations high on a roadmap for divestment … With the economic slowdown impacting the government’s revenue receipts, divestment is one route to raise funds to improve the fiscal scenario. IPOs from unlisted government owned companies could help revive the primary capital market. Indian National Congress’ (INC) manifesto and the interim budget both emphasized the need for divestment.
PSUs in which government’s stake is significantly higher than 51% may be the ones where stake sales will be pushed through first. Thus far, a majority of the amounts raised from divestment have come in from sale of minority stakes in companies, rather than strategic sale and residual sale. This suggests that the government is likely to lean towards divestment of minority stakes in PSUs through the IPO route. However, strategic sales in loss-making companies too may be considered.
Given that government holding in many public sector banks (PSBs) is near 51% and statute prohibits further dilution. The government will have to resolve this issue to ensure that PSBs are able to raise funds by diluting their equity base. Divestment may not occur in PSBs or at the most it could be restricted to non-strategic banks. However, the government may relax the 51% statute, thereby keeping the control in its hands and at the same time garnering the much-needed capital. The governement is not likely to be aggressive on divestment in the infrastructure sector, as it will be sensitive to opposition from employees and other stakeholders.
Potential listing candidates include Oil India, NHPC, Coal India, RINL, Manganese Ore, Cochin Shipyard, and Air India. The government may also look at follow-on public offers in BPCL, HPCL, IOC, and ONGC, and stake sales in BSNL and LIC.
… and for increasing FDI cap The proposal for increasing the FDI cap in retail and insurance was raised by the United Progressive Alliance (UPA) government in the 2004-05 Budget. However, opposition from Left parties eluded consensus on the issue.
FDI is not currently allowed in multi-brand retail, thus curbing mega-international stores like Walmart, Tesco, and IKEA from entering Indian markets. Although allowing FDI in retail is on the wish list of the middle and upper classes, as it will boost the service quality, available choice as well as pricing, we doubt if such a proposal will find a berth in the forthcoming budget, as introduction of such norms will adversely affect employment generated by local stores.
Currently, 26% foreign equity is allowed in insurance companies. Expectations are that over the next two-three years, this will be raised to 49%, as it will help bring in more resources and experience to Indian insurance companies. This may not happen in the forthcoming budget itself. However, the government may take an initial step in this direction and chart out a future roadmap for the same.
