>INDRAPRASTHA GAS (EDELWEISS)

Rise in CNG price in line with estimates

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.

To see full report: INDRAPRASTHA GAS

>INDIA BUDGET (EDELWEISS)

A tightrope walk

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.

>HOUSING DEVELOPMENT FINANCE CORPORATION (EDELWEISS)

NCDs+warrants: the right mix

HDFC is planning to raise up to INR 40 bn through non-convertible debentures (NCDs), issued along with warrants (convertible at a premium). The proceeds will be utilized for subscription to HDFC Bank’s warrants (INR 36 bn) and capital infusion in the life insurance subsidiary (~INR 3-4 bn). We are positive on the structure of the deal as it will provide funding for warrant subscription with minimal impact on profitability and RoEs. The bank’s warrants are due for conversion in December 2009 and HDFC Bank’s stock price is nearing exercise price of INR 1,530/share. Moreover, the stake sale in life insurance/AMC subsidiary is likely to take more than six months. HDFC Bank would gain ~INR 80 per share in book value due to warrant subscription by HDFC.

■ Optional value of warrants to lower effective interest cost
Optional value attached to warrants will result in lower effective interest cost. We believe the tenure of debentures could range from 3-5 years and warrants will be converted into equity shares at a premium (30-50%) in 3-5 years. HDFC is incrementally borrowing 3-year money through debentures at ~7.7% and 5-year money at ~8.25%. Considering few structures around which the product can be built, we expect effective interest cost (considering similar tenure for debentures and warrant conversion) to be ~3.25% (assuming 30% premium to CMP for warrant conversion) and ~5% (for 50% premium). Potentially, the deal can also be structured in a way with varying maturities such that the effective cost is minimal at 0-2% (refer table 1).

■ Earnings revision
As the money raised via NCDs will be utilized for investment in subsidiaries, spreads are likely to compress by 15-20bps (assuming 3-5% effective interest cost). We believe the company will structure the product in such a way that there is minimal impact on profitability and RoEs. We expect core mortgage earnings to post 18% CAGR over FY09- 11E. We are also building in investment profit of INR 3-4 bn over FY10-11E and stake sale in life insurance by FY11E considering improved capital market sentiments. Our EPS estimate now stands revised at INR 94.9 for FY10E and at INR 114.8 for FY11E.

■ Outlook and valuations: ahead of fundamentals; maintain ‘REDUCE’
The outlook on mortgage growth and asset quality has improved since January with change in macro environment and increased availability of capital. We are revising our SOTP fair value for HDFC upwards to INR 2,387 per share for FY11E (equivalent to next 12 months fair value of INR 2,170 per share). As core mortgage book will appear distorted for the next two years due to significant investment in HDFC Bank’s warrants (with no corresponding increase in net worth), we are using equivalent P/E of 17x (as consequent impact on earnings will be minimal). Though we are positive on the improved business outlook, we believe the stock has run up ahead of our fair value estimates. We maintain our ‘REDUCE’ recommendation on the stock.

To see full report: HDFC

>INDIABULLS REAL ESTATE (EDELWEISS)

Power Play

Presence in space starved Mumbai CBD to be value accretive going forward
The commercial business district (CBD) space in Mumbai is a fraction of that available in other major cities of the world. Indiabulls Real Estate (IBREL), with ~ 5 mn sq. ft of projects is a leader in this space. Enquiries for these have picked up sharply and we anticipate increased traction for IBREL going forward. The company has also launched 9.5 mn sq ft of projects and plans to launch an additional 9.8 mn sq ft of projects in FY10.

Power ventures: Firing on all cylinders; PPA tilt could dent RoEs
IBREL is developing three power plants with a total capacity of 3,960 MW. Coal and water linkages are in place for all, and land and environmental clearances for two projects have been bagged. We estimate that 65% of the output will be sold through PPA – diluting RoEs. Thus, we have valued the power division at a P/BV of 1.3x.

Cash is king: Exciting options at hand to deploy cash
IBREL is one of the few realty developers with net cash of INR 22.7 bn. It can utilize this cash for big ticket realty development projects for which the company has bid— Dharavi Redevelopment, New Delhi railway station modernization, etc. The other option is to utilise the cash for meeting the equity commitment for its power plants.

Strong execution capabilities of Indiabulls group
The Indiabulls Group has presence in financial services, real estate, and power segments. The group has witnessed strong growth in revenues, topline, and market capitalization over the past few years. We believe its real estate venture, IBREL, will also benefit from the strong execution capabilities of the group in the future. Outlook and valuations: Triggers in place; initiate with ‘ACCUMULATE’ IBREL is in project execution mode as far as both realty and power businesses are concerned. It will be some time before the operations achieve significant scale and start generating revenues.

To see full report: INDIABULLS REAL ESTATE

>CEMENT FACT SHEET (EDELWEISS)

In April 2009, our cement Index underperformed the Sensex. The BSE Sensex was up by 17.5% against a rise of 11.2% in our cement index. The top outperformers were Jaiprakash Associates and OCL India up by 64.8% and 54.1% respectively. The top underperformers were UltraTech and Century textiles up by 3.0% and 4.6% respectively.

To see report: CEMENT FACT SHEET

>BANKING & TEXTILE SECTOR (EDELWEISS)

This note highlights key observations from our discussions with industry participants (including banks, textile companies etc.) in Coimbatore (Tirupur, Karur and Erode) - targeted at assessing banks’ asset quality and demand outlook. Business of this export-dependent region has slowed down significantly on account of poor global demand and stiff competition. Availability of low-cost Textile Up-gradation Funds (TUF) and foreign currency derivatives (which led to further reduction in
effective cost of funds) have led to huge capacity expansion in the region, which is currently more than double of the demand. We understand that, roughly 60% of loans in the region are under restructuring. Official unemployment data is not available; however considering the capacity utilisation of less than 50% and practice of contract labour in the region, unemployment is expected to have gone up - impacting retail asset quality further. However, this is possibly the worst sample in India and, hence, we cannot generalize the phenomenon for the country. We are getting positive feelers from domestic consumption-based textile companies in other regions. Around ~25%
default rate has been observed in small business loans (below USD 100 K) funded by banks and NBFCs.

Key observations (Textiles sector)
■ In general, export demand is still weak; both pricing and order book is hurting.
■ April-May has been better than Q4FY09 (no orders) for some companies due to demand from Europe.
■ Domestic demand is still good and some companies are setting up local sales counters (domestic business, however, accounts for a small proportion of companies’ business).
■ Apart from general slowdown, international competition is hurting margins badly – for example, Bangladesh gets 10% extra realization for the same quality; Turkey gets higher realization due to better turnaround time and proximity to markets.
■ Companies want more duty drawbacks from the government to compete with Bangladesh; they are also demanding better infrastructure and labour laws to compete with Turkey.

Others
Engineering companies of Coimbatore are relatively better placed and are still seeing order flows. However, even these companies are supplying machinery to textile units under severe pressure; revenue declined 60-70% Y-o-Y (eg. Laxmi Machine Works).

Key observations (Banks/NBFCs)

Loan enquiries going down; more restructuring likely
■ Banks have been liberal in restructuring (more to happen in April-June 2009 than reported); there seems to be no other alternative with banks.
■ Banks, in general, have tightened credit and have reduced exposure wherever possible.
■ NBFCs were very active in small loans segment; they have, however, stopped business now due to high delinquencies.
■ Nearly 20-25% of small business loans (ticket size of INR 1.5-5.0 mn) are delinquent due to business slump.
■ Small business loan enquiries have come down significantly; housing loan enquiries have also declined.

Forex derivative issues are settling down
As 90% of receivables were foreign currency denominated, many companies (irrespective of size) entered into derivatives to lower their cost of funds further (mostly USD/CHF swaps). Banks have taken different approaches to solve the problem; some of them have converted MTM receivables into term loans and some have restructured derivative contracts through embedded contracts, while others are fighting legal battle and have reported NPLs. Most of these cases are closed, either through out-of–the-court/one-time settlements or by term loans.

Retail credit quality: To experience more stress
Retail credit quality is adversely impacted, as bulk of the small ticket loans were taken for business. Nearly ~25% default rate has been observed in small business loans (below USD 100K) funded by banks and NBFCs. Also, the number of shifts has clearly reduced; companies are not even working for two shifts now.

Official unemployment data is not available; however considering capacity utilisation of less than 50% and practice of contract labour in the region, unemployment is expected to have gone up - impacting retail asset quality further.

Though housing prices have not corrected in line with the deterioration in income levels of this region, housing demand has come to a standstill, which portends lower property prices, going forward.

To see full report: BANKING & TEXTILE SECTOR

>THERMAX (EDELWEISS)

MARKED IMPROVEMENT

Energy segment boosts revenue growth; margins above estimates
Thermax’s (TMX) Q4FY09 results were significantly above our expectations, both on revenue growth and profitability fronts. For the quarter, standalone revenues grew 2.8% Y-o-Y to INR 9.5 bn, driven by higher-than-expected growth in the energy segment. Sequentially, revenues grew 19.3% in Q4FY09, a positive surprise after a 1.1% Q-o-Q dip in Q3FY09. Consolidated revenues declined marginally, by 0.4% Y-o- Y, to INR 10.1 bn in the quarter. For Q4FY09, standalone EBITDA grew 5% Y-o-Y to INR 1.3 bn. Standalone EBITDA margins were up ~30bps Y-o-Y to 14.1%. In Q4FY09, TMX posted a forex loss (included other operating expenses) of ~INR 259 mn, excluding which, EBITDA margins stand at ~16.8%. For the quarter, standalone PAT grew 17.1% Y-o-Y to ~INR 943 mn. While depreciation expenses increased 64.5% Y-o-Y to INR 100 mn, effective tax rate was lower ~1,000bps Y-o-Y at 30.3%. Standalone net margin for the quarter was up 120bps Y-o-Y to 9.9%. Consolidated PAT in the quarter grew 27.3%.

Strong order book; intake likely to pick up post H2FY10
TMX’s consolidated order book (adjusted for renegotiated orders) at FY09 end was at INR 30.8 bn. Order intake during the quarter was ~INR 5.8 bn. The scope of a few of TMX’s projects was revised, leading to contraction in the company’s order book. Amongst major orders that were revised, Brahmani Steel’s order value now stands at INR 3 bn (~INR 4.5 bn earlier) and that of Essar at INR 3.8 bn (INR 8 bn earlier). Management expects order accretion to pick up H2FY10 onwards.

Outlook and valuations
Improved visibility; maintain ‘ACCUMULATE’ We are revising up our estimates for FY10 and FY11 for the company on the back of increase in order accretion assumptions for FY10. In spite of the upwards revision we are still projecting a 7% Y-o-Y decline in order accretion in FY10. We have increased our execution period assumptions for the energy business by 30% from prior estimates. Our standalone revenues for FY10E and FY11E are now higher by 9.6% and 16%, respectively, from prior estimates. On the margins front, we now expect a ~20bps Y-o-Y decline at the EBITDA level to 12.5%, compared to earlier expected decline of ~70bps Y-o-Y. Hence, our standalone EPS estimates are higher by 20.2% and 23.1% for FY10 and FY11 at INR 24.1 and INR 29.3, respectively. Subsidiaries contributed INR 0.25 to consolidated EPS in FY09. We believe, if TMX bags a few large orders in the utility segment in FY10, its order backlog at FY10 end could be substantially higher than expectations, leading to higher-than-expected growth in FY11. The stock is trading at a P/E of 16.2x and 13.3x for FY10E and FY11E, respectively. Ex-cash, the stock is trading at a P/E of 15.3x and 11.7x FY10E and FY11E, respectively. We maintain our ‘ACCUMULATE’ recommendation on the stock.

Segmental performance
Revenues from the energy business grew 5.5% and those from the environment business declined 7.4%, Y-o-Y during the quarter. However, margins in the environment segment improved significantly by 640bps Y-o-Y. Management stated that the rise was a one off phenomenon and not sustainable. Further, the energy segment’s margins declined 170bps
Y-o-Y to 13.9%.

To see full report: THERMAX

>TELECOM SECTOR (EDELWEISS)

Telecom – Can VAS salvage falling ARPUs for Indian telecos?

Indian telecos are facing a peculiar situation whereby subscribers are growing at an exponential pace, but incremental subscribers (primarily prepaid) are contributing significantly lower ARPUs. This has raised concerns on future revenue growth and profitability of operators, particularly given increasing competitive intensity and falling tariffs. Value-added services (VAS) are increasingly being considered critical to boost ARPUs as voice services get progressively commoditized. In this context, operators are counting on the introduction of 3G services to enhance data usage, while also enabling to ease the spectrum crunch by shifting voice traffic from congested 2G networks at a lower cost structure.

Our study of the experience in various telecom markets globally, however, indicates that VAS have largely failed to stem ARPU decline, though the share of ARPU has increased substantially. We have studied the trend in ARPUs of top operators in various telecom markets (the US, Japan and Europe). While data ARPU continues to be on an uptrend, blended ARPUs have been declining or at best remained stable owing to a sharply falling voice ARPU component that continues to dominate the customer spend. In our sample universe, over the last 12 quarters, voice ARPUs have declined at ~0.7-4.3% CQGR, while data ARPUs have improved at ~0.6-2.2% CQGR, with aberrations like the US (where data component has grown at ~10% CQGR) and some European countries (where data component has declined Q-o-Q). In our sample universe, only AT&T and Verizon have shown an improvement in ARPUs owing to increasing data ARPUs.

In India, data services still comprise a small proportion of ARPUs at sub-10% levels, and this proportion for the top Indian telecos has barely improved over the last several quarters. At present, given the low telecom spend by incremental customers, absolute data ARPU is also on the decline. We acknowledge that 3G services are yet not available in India, and could drive data usage among subscribers in future. In other telecom markets, despite higher income levels, overall customer spend on telecom has largely remained steady over time, with VAS at best providing stability to ARPUs. For Indian telecos, keeping in view the market conditions, customer profile (large base of prepaid customers) and demographic profile, a deviation from the trend seems unlikely. India, being a price-sensitive market, one can also not rule out the possible commoditisation of VAS services as operators resort to lower price points to drive volumes.


To see full report: TELECOM SECTOR

>FMCG Sector (EDELWEISS)

Marico and GSK: The trend setters

Marico and GSK have been the first companies to report March quarter results. We have listed here the key thoughts and trends that emerge for the FMCG sector from these two results.

Topline and volumes robust in March quarter
Sales growth for both Marico and GSK Consumer Healthcare (GSK) remained robust in the March quarter. Volume growth for Marico remained steady (8% growth in Parachute, 5% in Saffola - 3% Y-o-Y growth in the December quarter). For GSK, volume growth was very high at ~20% (out of this ~6% has come from growth in international business and pipeline inventory of new products).

International markets remains a key growth driver
The international sales of Marico and GSK have grown by 35% and 45% Y-o-Y, respectively in the March quarter. In FY10, growth rate, especially for Marico, is however, likely to come down owing to higher base and lower inflation-led growth in some of its markets. Growth in international markets will be a key factor to watch out for even in the case of Godrej Consumer Products (GCPL), Dabur, and Asian Paints.

Innovation pipeline aids volume growth
Both Marico and GSK have benefitted from their new product launches in the recent past. In the past few quarters, Marico launched Saffola Cholesterol Management and Saffola Diabetic, Parachute Advansed (revitalizing hot hair oil), Saffola Zest and Saffola Rice. GSK too introduced three new prodcuts in the past few quarters (Horlicks Nutribar, Dood, Activ Grow). These new product launches are likely to propel incremental sales growth for the company.

Sharp dip in ad rates expand margins
We had predicted in our report ‘FMCG- Sunny days ahead’, dated November 7, 2008, that ad rates will correct in the March quarter and will help FMCG companies increase margins. In line with our estimates, ad revenues of Zee Entertainment Enterprises (ZEEL) were down 7% YoY (against ~30% YoY growth in H1FY09). For Zee News, ad growth came down sharply from ~39% in Q3FY09 to ~24% in Q4FY09 (largely growth was from new channels). Consequently, EBITDA margins were up 330bps Y-o-Y and 40bps Q-o-Q for Marico, and 203bps Y-o-Y and 980bps Q-o-Q for GSK. We expect the pressure on ad rates to continue in H1FY10, and then see the ad rates firming up in H2FY10 if the economy revives. In case of Marico, ad costs (as a percentage of sales) were down 510bps Y-o-Y and 80bps Q-o-Q in the March Quarter. For GSK, they were down 230bps Y-o-Y and 60bps Q-o-Q. However, both companies expect ad costs to be higher by 200bps for FY10/CY09 over the March 2009 quarter, owing to higher ad investments in new products.

Packaging costs – mixed signals
Packaging costs are partly linked to crude prices and account for 10-15% of costs for most FMCG companies. In case of Marico, it was down 140bps Y-o-Y, while for GSK, it was higher 35bps Y-o-Y, largely due to change in packaging and new launches.

Signs of downtrading visible
In Kaya, same store clinic sales (clinics over a year old) have grown 10% Y-o-Y against 13%
in Q3FY09, which clearly shows that discretionary spends are impacted. Sales growth for
Saffola, although up marginally Q-o-Q, is still lower than the growth seen in H1FY09. This is due to downtrading by consumers to low-cost vegetable oils due to high price differential. We expect the same trend for GCPL and Hindustan Unilever (HUL). In fact, GCPL’s soap volumes are likely to grow faster than HUL’s, owing to down-trading in favour of GCPL’s value–formoney (VFM) platform and the successful launch of Godrej No.1 – Strawberry and Walnut.

Volumes likely to remain robust; margins to expand for other companies
We expect volume growth to remain robust (especially for companies which have a strong presence at lower price points) and margins to expand for most FMCG companies (due to a
mix of lower costs of ad, palm oil and packaging materials) in the March quarter.

To see full report: FMCG SECTOR

>India Strategy (EDELWEISS)

Voting for India!

India: Resilience amidst global turmoil

The Indian market is up over 30% in the past one month, outperforming most EMs. On a YTD basis, however, India is still underperforming several EMs With the Sensex now over 11,000, the market seems to be pricing in two key events:

1. An acceptable election outcome (UPA- or NDA-led government); and
2. Likely recovery in the global economy by CY09 end

* We believe there is a fair chance of a stable government coming to power. Lead 2 indicators, however, do not yet suggest an early recovery for the global economy.

* However, we expect Indian economic growth to remain resilient, with a worst-case GDP growth estimate of over 4% in FY10. Our worst-case fair value for the Sensex is 8,000 (FY10 end) at 10x FY11E worst-case EPS.

* Our recommended strategy is to be overweight domestic-focused sectors: telecom, industrials, consumer discretionary, and BFSI

* Our top large cap picks are Bharti, BHEL, Crompton, Hero Honda, HDFC Bank, SBI, Sun TV and Suzlon.


To see full report: INDIA STRATEGY

>Larsen & Toubro (EDELWEISS)

Too early to cheer

INR 57.8 bn worth orders booked; is the tide turning?
From March 30–April 9, 2009, Larsen & Toubro (LT) has announced orders worth INR 57.8 bn, primarily in power and process verticals. For Q4FY09, the company has announced orders worth INR 51.4 bn (order intake in Q4FY09 will, however, be higher as small-ticket orders have not been announced). Even with the spate of orders in the last week of Q4FY09, we believe the initial order accretion guidance (30% growth) for FY09 is unlikely to be met. While the order accretion growth for 9mFY09 has been strong at 30%, inflows in oil & gas (O&G) have been significantly below estimates; for 9mFY09, O&G order intake has been INR 43 bn (down 32% Y-o-Y). While the current order announcements by LT in the power and infrastructure verticals, is certainly a positive, we believe it is too early to conclude that the same will translate in to higher-than expected order inflows in FY10.

Power and infrastructure likely to drive order accretion growth in FY10
In FY10, LT’s order accretion is likely to be driven primarily by power and infrastructure verticals. In power, LT expects equipment orders from the 11 negotiated tenders from NTPC and DVC. In infrastructure, railways, roads, and airports would remain key drivers; railway orders are, however, expected to pick up significantly only post FY11 on the back of the Dedicated Freight Corridor (planned investment of INR 600 bn by 2016). Although order accretion has been weak in the company’s O&G vertical in FY09, management expects orders to start flowing in from Q1FY10.

Execution issues on 6% book; likely to rise in our view
Currently, our main concern is execution of current orders in the process vertical. LT’s order book is at INR 688 bn (37:63 public versus private; private includes 11% from group development projects); 6% of these could get delayed primarily in metals and real estate verticals, according to the management. We believe this percentage could be higher given that the company’s exposure to key problem verticals of metals, real estate, and O&G is at 40% of the current order backlog.

Outlook and valuations: Uncertainty overhang; maintain ‘REDUCE’
We value subsidiaries at INR 123. Hence, the implied P/E for the parent business is 14x and 12.5x for FY10E and FY11E, respectively. In the face of an uncertain macroeconomic environment, which could put the private sector capacity addition under a cloud, we believe upsides to valuations from current levels are likely to be capped over the medium term. We maintain ‘REDUCE’ recommendation on the stock.

To see full report: LARSEN & TOUBRO

>Economy Release Calendar (EDELWEISS)

Given below is a calendar indicating significant economic events/releases due in April 2009:

* For the Indian economy, the highlight of the month will be the RBI annual policy meeting. Industrial production data for February will also be of interest after witnessing two consecutive months of decline.

* Policy actions across major economies will be of significance against the backdrop of a spate of rate cuts by central banks in recent times. Growth and inflation data across economies will continue to remain of interest with major economies slipping into recession and deflation.

To see full report: ECONOMY RELEASE CALENDAR

>GATEWAY DISTRIPARKS (EDELWEISS)

CFS/ICD container volumes continue to feel the pressure
Growth in container volumes is a function of global trade. Therefore, in the absence of any uptick in the EXIM trade, Gateway Distriparks’ (GDL) container volumes are expected to be under pressure in H2FY09. Management expects volume decline in the fourth quarter to be steeper, to the tune of 20% Q-o-Q. For the full year, CFS volumes are expected to register a decline of ~7-10% Y-o-Y.

Increase in realisation due to higher ground rent likely to be reversed
In a declining volume scenario, realization for the company in the past few quarters has been increasing. The realization in Q3FY09 was at INR 8996/TEU, a growth of 22.7% Q-o-Q, on account of higher ground rent charged. This was due to unwillingness of importers to take container deliveries, which resulted in higher ground rent, translating into higher realisations for the company. We, however, continue to maintain that this kind of trend is unsustainable. Also, the company’s realisation is expected to come under pressure in the coming few quarters.

Capex plans to slow down due to uncertain environment
GDL is expected to go slow on its capex plan in the coming few quarters. 70% of the incremental capex is expected to be in the container train segment, while the remaining will be towards setting up of CFS/ICD. GDL currently owns 13 container rakes and is expected to take delivery of another rake in Q4FY09. Currently, the company is operating 10 rakes on the domestic sector and the remaining on the EXIM route. It is expected to set up three new ICDS at Kalamboli, Ludhiana and Faridabad by December 2009.

Focus on domestic container in railways to boost volumes
GDL continues to focus on domestic segment for container traffic growth in its container train business. The company expects that, with train operators increasing their services and providing last mile connectivity, there will be a shift in volumes from the traditional roadways to transportation of goods by railways which is ~30% cheaper vis-à-vis road transportation. The current market share for railways is ~35%, which is expected to be ~55% in the coming few years.

To see full report: GATEWAY DISTRIPARKS

>Cement Sector (EDELWEISS)

While price correction in FY10 is a near certainty, the frequent question of “how much” yet remains unanswered. Current assumptions by both analysts and companies about the extent of correction are, at best, only guesstimates. While the actual extent by which prices will fall will be known only post facto, in this piece, we attempt to explore “What is likely to be the ceiling of price correction in the sector? While companies slipped into the red in the earlier downcycle, did price corrections result in EBITDA losses? What is different this time around?” Inferences from the past lead us to conclude that sector realisations move in tandem with changes in utilisation rates. Now, with average utilisation expected to correct to 85% in FY10E from 95% currently, we expect FY10 to set the stage for price corrections in the cement sector. Apart from supply side influx, we believe soft demand will further dampen sector fundamentals. We have used base case demand growth of 8% in FY10-11E for our computations. With GDP expected to grow by only ~6% in FY10 and ~60% of cement demand arising from housing (which is not witnessing revival as yet), actual cement demand growth could be lower at ~5-6% in FY10-11E (implying utilisation rate of 82% in FY10E and 75% in FY11E).

In FY03, at 8.7% domestic demand growth and 86.8% utilisation level, sector realisations corrected 13%. Hence, this time around, with a lower demand growth, lower utilisation level, and sharp run up that cement prices have witnessed (during FY06-09E, realisation increase of 74% vis-à-vis 39% cost increase), price fall is likely to be higher. One can argue that players can come together and voluntarily reduce supply and thereby protect prices. However, maintaining market share is an important consideration which makes curtailing volumes through voluntary measures difficult. Also, the reasoning that “the industry is more consolidated now than during the previous downturn which will help avert price cuts” holds little ground in our view as consolidation levels are not too different (capacity share of top 8 groups is likely to be ~62% in FY10E compared to ~60% in FY03).

To see full report: CEMENT SECTOR

>Hindustan Unilever Limited (EDELWEISS)

HINDUSTAN UNILEVER LIMITED

ACCUMULATE

Building Its Defences....

Rural areas leading growth; volume growth to remain focus area
HUL management expects the FMCG industry’s revenues to continue to grow at around 15-18% in FY10. Though growth has been well balanced between urban and rural areas, the latter have somewhat remained insulated from the current global turmoil and have been leading growth. Additionally, low level of penetration in many personal care segments has been driving fairly good volume growth. The company is trying to boost volume growth via higher promotions and discounts, giving higher volumes for the same price, while also reducing prices in select lower-end (mass) brands. HUL expects this strategy to boost volume growth in the coming months.

Re-innovating distribution for efficient demand forecasting
HUL has over 1,200 SKU’s—650 of these are active while only 75-90 are available at most small retailers. Any small retailer generally stocks on an average 35% of the store capacity with HUL’s products. So, for better servicing and demand forecasting, HUL has been working on building a more efficient distribution system with investments in its IT infrastructure and technology. The company has introduced a new system of demand forecasting with a hand held device for each member of sales team to gather store level SKU data. This could help the company in better sales forecasting and servicing its retailers, and boost sales through analysis of this data. The system could also help in reducing both turnover time and working capital.

To see full report: HUL

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