>ECONOMY (KOTAK SECURITIES)

Budget FY2010 likely to spur infrastructure investment, go slow on fiscal consolidation

• Budget likely to keep GFD/GDP ratio in 6-6.5% range
• Expanded NREGP, Bharat Nirman likely to sustain stimulus to rural economy
• Infrastructure investments may get a boost through annuity-based schemes, funding of SPVs for financing equity component
• We expect tax cuts to stay, but disinvestment of Rs200 bn can help check deficits

Gross Fiscal Deficit (GFD) likely at 6-6.5% of GDP for FY2010E
We believe the Union budget for FY2010 is likely to peg GFD/GDP ratio in the range of 6-6.5%. Since the budget-making exercise is still at a nascent stage, a clear idea of the fiscal gap is yet to emerge. We believe the government is likely to strive to keep GFD/GDP ratio in 6.0-6.5% band as higher than 6.5% on-budget deficit for the centre could (a) make the path of future fiscal consolidation that much more difficult and (b) be a negative with the financial markets, especially foreign investors and rating agencies. At the same time, a deficit lower than 6% of GDP is seen as hampering growth revival and coming in the way of government spending on rural safety nets.

• GFD/GDP ratio below 6% appears improbable as the UPA government is committed to push its mandate for inclusive growth agenda further by expanding National Rural Employment Guarantee Program (NREGP) and Bharat Nirman Yojana

• A 6-6.5% GFD/GDP is considered possible even with expanded coverage of NREGP with the carry-over of unused allocations from last year’s budget

• A GFD/GDP exceeding 6.5% is seen as risking future consolidation and GOI is keen to find ways for additional resource mobilization, including disinvestment, to check the deficit from spinning out of control. A 7% GFD/GDP ratio is seen as potentially triggering negative reactions from important stakeholders in a globalized economy.

Combined deficit seen at about 10% of GDP
We believe it may be possible to contain the combined deficit of the Centre (including offbudget) and States to 10% of GDP as off-budget deficit could be restrained to about 0.5% of GDP with subsidies reforms. State governments’ deficit, with some prudence, could be contained at about 3% of GDP in FY2010E. We understand that officials consider this wide fiscal gap a legitimate counter-cyclical policy that is being adopted by several countries across the globe. In our assessment, fiscal deficits in India should start correcting from FY2010E at a moderate pace.

Subsidies reforms may be difficult
There appears to be is serious consideration of subsidies reforms, but political constraints may still hamper progress therein. While substantive suggestions for reforms aimed at capping GOI’s subsidy bill have been mooted, whether or not these get reflected in the forthcoming budget is a political call for policy makers. The proposals under consideration could possibly include:

• Capping fertilizer subsidies by capping the amount and fixing subsidy per kg of nutrients
• Deregulating prices of petrol and diesel, while retaining price controls on kerosene and LPG with modest price adjustments
• Making provisions for higher food subsidy bill while aiming at reasonable procurement policy

To see full report: ECONOMY

>INDIA STRATEGY (KOTAK SECURITIES)

Best to hold on to a good thing. We recommend investors stay invested in order to play eventual and domestic economic recovery. Fair-to-full valuations of several large-cap stocks prevent us from taking a more aggressive view; we do not see concrete evidence of earnings upgrades yet. We stay with banking and commodities as the best ways to play the economic recovery theme, especially as their valuations are still relatively inexpensive versus those of other sectors.

Stay invested to play possible recovery in economic activity and earnings
We recommend that investors stay invested in order to play (1) likely recovery global and domestic economic recovery and (2) possible earnings upgrades related to economic recovery. We stick with banking and commodities to play the economic recovery theme.

14,000 (+20%) for BSE-30 Index may be possible with earning upgrades, liquidity
In our view, the BSE-30 Index can rise 20% to around 14,000 by end CY2009 with impetus from (1) possible earnings upgrades and (2) continued positive investment sentiment. We do not yet see concrete evidence of sustained earnings upgrades given global and specific domestic issues in several sectors. A liquidity-driven rally based in euphoria alone may not sustain.

Stable government and like-minded coalition partners to help investment sentiment
We see the inevitable formation of the UPA government (262 seats out of 543 in the Lok Sabha in the 15th national elections) as a positive for the market since it represents political and economic stability. Also, the Indian National Congress (INC) is stronger than before with 206 seats against 145 previously. This gives it the strength to push economic reforms without much opposition from its coalition partners.


To see full report: INDIA STRATEGY

>RELIANCE INDUSTRIES (KOTAK SECURITIES)

Reality versus speculation. We analyze the factors that could propel RIL stock about 20% higher from current levels in a hypothetical exercise and conclude that favourable annpuncements on new E&P discoveries hold the key. We see limited scope for positive surprises in the chemical and refining segments and, in fact do not rule out negative surprises. Finally better disclosures may improve sentiment and multiplies; we believe the current level of disclosures leaves a lot of room for improvement.

Valuation 1: Rs 2,300 would entail higher chemical and refining margins and gas reserves
We compute that a fair valuation of Rs 2,300 for RIL stock, based on FY2011E estimates, would entail (1) significantly higher chemical margins (+16-24%), (2) very high refininf margins (US $13.8/bbl and US$12.4$/bbl for RIL and RPET refineries) and (3) additional 16 tcf of gas to be discovered over the next six years. Our SOTP-based 12-month fair valuation is Rs 1650 and fair valution based on FY2011E estimates is Rs1,750.

Valuation 2: Rs2,300 would entail large new E&P discoveries, unchanged margins in others
We estimate that RIL would need to add 51 tcf of additional gas reserves next over the six years without additional contribution from other businesses to reach our fair valuation of Rs 2,300 in our hypothetical exercise. It would be interesting to see if RIL can create further value from gas through forward integration into merchant power generation and city gas distribution.

Valuation exercise 3: Rs1,375 in downside scenario
We calculate RIL's fair valuation at Rs1,375 in our downside scearion of (1) weaker than assumed margins (US$50/ton lower for major chemicals, US$2/bbl lower for refining margins) and (2) higher-than-expected taxation (no income tax exemption for gas production). We also do not rule out lower multiples in case if lower0than-expected earnings.


Disclosures: Higher disclosures can boost positive sentiment and multiples
We believe in the quality of disclosures is not commensurate with the size and complexity of RIL's operations. In our view, higher disclosures will be perceived as a positive by the market and result in a possible re-rating of the stock. On the other hand, continued reticence with regard to disclosures and unexplained mismatches in reported financial statements may result in investors eventually de-rating the stock

To see full report: RIL

>Grasim Industries (KOTAK SECURITIES)

Best is already factored in the price...


Grasim Industries, a diversified player in cement, viscose staple fibre (VSF), chemicals and sponge iron, is set to become the largest cement player in India post commissioning of its new capacities. However, due to demand slowdown, we expect decline in realizations across its core
businesses - VSF and cement, which may result in muted revenue growth between FY08-FY10. Pricing outlook for next one year for VSF continues to remain negative due to adverse global conditions impacting textile exports while oversupply and lower-than-expected demand growth may impact cement realization negatively. Lower realizations are also expected to offset the benefit of reduced raw material prices, thereby keeping margins lower going forward. Along with this, higher depreciation and interest charges post commissioning of new capacities are likely to keep the earnings growth depressed.

We value the company on sum-of-the-parts methodology on FY10 estimates and arrive at a price target of Rs.1600. Our assumptions of better cement prices based on prevailing firm cement prices as well as healthy dispatch growth for FY10 also leaves no stock price upside at current valuations. Though company has got pan India presence and is increasing its capacity significantly, most of the positives related to firm cement prices, low power and fuel costs as well as volume growth are already factored in the current stock price. Hence we initiate coverage with a REDUCE recommendation. We would wait for declines in the stock price for upgrading our recommendation.

Key disinvestment rationale

■ Cement oversupply and moderation in demand to impact cement realizations negatively. Cement demand had registered a growth of nearly 9% between FY06-FY08 driven primarily by strong demand from construction, infrastructure and real estate projects. However, with the slowdown witnessed in the real estate sector and overall moderation witnessed in the GDP growth, cement demand is expected to grow at a CAGR of 7% between FY08-FY10. We expect capacity addition to the tune of 60-70MT between FY08-FY10 while demand is expected to remain subdued in the next two years. We thus opine that, pace of commissioning of new capacities is expected to exceed the demand growth and will likely result in fall in cement prices. We expect cement prices to decline in next one year post commissioning of new capacities from Q1FY10. We have assumed total dispatches of 39 mn tonne and average cement realizations of Rs.3345 per tonne in our estimates on a consolidated basis for the company.

■ VSF division is also witnessing demand slowdown and price declines.
Adverse economic factors such as US recession, declining demand from textile sector and declining exports have impacted the VSF division negatively in terms of volumes as well as prices. Grasim has also further reduced prices by Rs 7 per kg (7.2%) in January, 2009 and we expect prices to remain under pressure due to poor demand from the textile sector going forward. Margins are also expected to remain subdued since company has correspondingly passed on the benefits of cost reduction by reducing the VSF prices because of low demand.

To see full report: GRASIM INDUSTRIES

>Alpha Bet Strategy (KOTAK SECURITIES)

Switching it on. We initiate four new trades-(1)long RIL, short GAIL on positive catalysts for one versus none for the other, (2)long REC, short PEC on lowering of valuation differential, (3) long Ultratech cements, short ACC on market share gains, cost leverage and valuations and (4)long IBREL, short DLF on contrasting business developments.

■ Trade 1: Long RIL, Short GAIL-Relative potential triggers in the near team
We recommend a long Reliance Industries(RIL), short GAIL pair trade given relative catalysts for the stocks which will determine the performance on the near term. We see potential triggers for RIL on account of (1)availability of income tax exemption for gas production, (2)availability of gas for internal consumption and (3)disclosure of reserves. We do not see any positive triggers for GAIL in the near term, which will result in muted stock performance.


■ Trade 2: Long Ultratech, short ACC-Growth for a song
We recommend a long Ultratech Cements, short ACC pair trading offering 10% returns on the following-(1) unjustified valuation premium of ACC trading at US$87/ton on FY2010E production relative to US$77/ton for Ultratech; (2)declining market share of ACC versus gains for Ultratech and (3)cost leverage available from switch over to coal-based captive power plants will reflect in better March 2009 quarter performance versus ACC.


■ Trade 3: Long REC, short PFC-Valuation differential to narrow
We recommend a pair trade of long Rural Electrification Corporation(REC) and Short Power Finance Corporation(PFC) based on the 20% valuation gap between the two despite the two superior ROE profile of REC. REC trades at 1X FY2010E PBR versus 1.2X PBR for PFC.


■ Trade 4: Long IBREL, short DLF-Contrasting business developments
We recommend a pair trade of long India Bulls Real Estate(IBREL) and short DLF on account of (1) IBREL trading a higher discount(52%) to the NAV versus DLF(42%); our comfort on NAV of IBREL is higher, (2) leasing concerns of INREL's Mumbai commercial properties will reduce in the near term while business concerns for DLF will persist for atleast three quarters and (3) we expect weak March 2009 quarter performance from DLF.

To see full report: ALPHA BET STRATEGY

>Trading Tool on MARCH 23,2009

To see full report: TRADING TOOL 23-03-2009