Thursday, December 31, 2009


There have been five overriding themes for our investment letters during the past year.
Below we list and review them.

1) Expanding liquidity drives financial markets, particularly when it occurs in the face of a sub-par but recovering economy and weak price inflation. This is the sweet spot in the cycle we so often talk about, and it is the best of all times for stock and corporate bond prices when perception of risk abates.

2) The Great Reflation underway since late 2008 has done its first job - aborted what surely would have been a full scale depression at least on the scale of the 1930s. That was Act I.

3) No one should believe that the huge reflation underway will make the economy and financial system whole again. The private sector debt excesses were far greater by 2008 than they were in 1929. A good part of the reflation effort is to transform private debt into public debt, and this will surely create another, different debt monster. As the year draws to a close, credit rating agencies are starting to downgrade sovereign debt and credit default swaps (CDSs) and are showing increased concern that some major developed countries are going to have problems servicing their debt (e.g. Japan, U.S., etc.). The markets are starting to tell us that Governments with brittle, over-extended fiscal positions will soon have to put in place credible fiscal consolidation -- tax increases, expenditure cuts, decline in services, etc. This means more deflation, more uncertainty.

4) Zero interest rates in the U.S. together with Federal Reserve asset purchases, much of it low quality, has done its job of inflating asset prices which improves balance sheets. Better financial markets greatly help capital raising ability, further strengthening balance sheets. As a result, they are much improved. The question is over sustainability. Fears of renewed asset bubbles have surfaced, complicating Fed and other central bank decision making. Do they risk tightening too soon or too late? Does a middle ground exist? Zero interest rates are an extreme anomaly and cannot last unless the U.S. economy remains permanently depressed and in deflation like Japan has been for 20 years. This seems unlikely but cannot be ruled out.

5) The great flaw in the international monetary system has allowed the U.S. - the key reserve currency country in the world - to run up a $4 trillion tab with foreign central banks and has created excess liquidity and asset bubbles in countries buying those dollars. It has also contributed mightily to the destruction of savings and investment in the U.S., and has created massive disequilibria in the global economy and financial system. Economics 101 tells us clearly that all disequilibria eventually get corrected. The interesting questions are how and when? That will be the story for Act II of the drama and it hasn’t been written yet.

As the year 2009 draws to a close, there is clearly an aura of unreality. We barely survived a near-death experience nine months ago. However, the pain and the fear for most people were brief. It was not like the 10-year depression in the 1930s that changed attitudes
for two generations.

To read the full report: RISK & UNCERTAINTY

>Top 10 Questions for 2010 (ECONOMIC RESEARCH)

1. Will the recovery become self-sustaining? Viewed from the depths of despair earlier this year, even the mild turnaround in the global economy in recent months is nothing short of remarkable. But while the economies of the U.S. and Canada may have stopped falling around the middle of 2009, the recovery has been tepid so far, and that’s even with a heavy assist from government spending. Conditions are gradually falling into place for a firmer and self-sustaining recovery next year, especially with employment finally stabilizing and business confidence perking up. Even so, the conventional wisdom that the upturn will remain subdued by past standards looks quite compelling. The main reason: the U.S. consumer simply is not going to ride to the rescue for global growth as it has so often in the past. Accordingly, we look for GDP growth of around 2½% in both countries next year (Chart 1); that’s not bad under normal circumstances, but it’s disappointing in the wake of the worst single year for U.S. growth since the 1940s.

2. Has the jobless rate peaked? The unemployment rates in both Canada and the U.S. ticked down last month, and recent hiring intention surveys have picked up, sending a tantalizing hint that the worst may be over on the job market front. However, it may be a tad premature to sound the all-clear note just yet, especially in the U.S., where the recovery will still be too modest to generate solid job gains for some time yet (Chart 2). The employment outlook is generally more positive in Canada, due to the relative strength in job-rich domestic spending areas such as housing and consumer spending. However, in both countries, we look for the unemployment rate to be lower a year from now.

3. Will China’s growth remain strong enough to drive commodities higher? To paraphrase our Global Commodity Strategist, Bart Melek, “Commodity markets have performed much better than anyone would have dared to predict at the beginning of 2009, when global depression chatter was rife and massive deleveraging and panic selling were the order of the day. Depression was averted thanks to massive government spending in China, the U.S., Europe and elsewhere totalling some $2.2 trillion, zero interest rates and various central bank liquidity measures.

4. After a powerful rebound, are stocks due for a correction? We have long maintained that the real distortion in equity markets this year was not the massive 65% bounce from the March lows, but the depth of those March lows. Much of the rebound in stocks occurred in the first two months after the lows were hit, driven by the realization that the global economy and credit markets were stabilizing, with a helping hand from extremely accommodative monetary policies globally. While the annual gains in many major equity markets in 2009 are certainly impressive—the TSX is currently just shy of a 28% rise this year, vying for the best performance in 30 years—they are by no means highly unusual, especially in a recovery phase.

5. Is the Canadian housing market set to pop? It seems many are falling over themselves to pronounce that the Canadian housing market is in a bubble, partly because it has been able to fully recoup all of its (fleeting) recession losses in a matter of months (Chart 4). If anything, we believe the risk is that the market will get even hotter in the first half of 2010, ahead of impending interest rate hikes and the Harmonized Sales Tax in B.C. and Ontario at mid-year. There is bound to be at least some modest correction in the second half of next year, almost certainly in sales, and possibly in prices.

To read the full report: TOP 10 QUESTIONS


Steel – The Worldsteel Association estimated November global steel production at 107.4 mln tonnes (-2.1% MoM, +22.4% YoY) and 75.0% utilization. Sequentially, US production held at 6.0 mln tonnes (-0.5% MoM, +26.9% YoY) as the ongoing cyclical recovery offset seasonality while China production declined to 47.3 mln tonnes (-8.7% MoM, +37.4% YoY). Spot iron ore fines imports into China rose by 9% to $115/ton delivered, lifting spot prices 66% above contract after adjusting for freight. This compares to consensus expectations of roughly 25%. Amongst our coverage, CLF and X own iron ore mines. US mill utilization rates declined 2.9% points to 62.0% for the week ending 12/18.

China Spot Iron Ore Prices Move Higher, Midwest Weather to Impact Appalachia Coal Supply

Coal – Platts reported that weather related power failures hampered production at many facilities in Central Appalachia and rail deliveries were delayed by as much as 4 days in many regions. Color from rail operators suggest that delayed shipments will be deferred and not cancelled under force majeure. Weekly coal shipments rose 0.4 mln tons from the prior week to 20.5 mln tons (-5.8% YoY) and power generation rose 0.7% YoY to 80.2 GWH as heating degree days came in at 141,1 above last year. In an abbreviated week with thin volumes, OTC CAPP coal for 1Q10 delivery eased $0.65/ ton to $51.50 while PRB fell $0.50 to $8.90/ton. Spot natural gas settled down $0.32/MMBtu on the week to $5.55/MMBtu after three weeks of strong gains.

Specialty Metals – In a media interview, Osaka Titanium (largest sponge producer in Japan) said they would keep capacity utilization at 45% to cope with excess inventories and aero related demand that is unlikely to recover until 2011. LME nickel surged $0.72/lb this week to $8.45/lb, a positive for stainless steel prices. Titanium scrap turnings rose $0.05/lb to $1.15/lb, well above the March bottom of $0.35/lb.

Non Ferrous – LME aluminum remained at $1.00/lb while global inventories rose 1% to 4,938k tonnes. LME copper rose 4% to $3.21/lb and global exchange inventories rose 1.6% to 678k tonnes. In November, Global aluminum production declined 8.4% YoY to 1.9 mln tonnes, while daily production gained 6% MoM to 44k tonnes

To read the full report: METALS & MONITOR

>Pondy Oxides & Chemicals Ltd (HDFC SECURITIES)

Company Background: Pondy Oxides & Chemicals Ltd (POCL) incorporated in 1995, is one of the India's leading metals, metallic oxides and plastic additives producers. POCL has broad based operations, manufacturing of Lead, Litharge Red lead, Zinc oxide, Lead sub Oxide, and solid and liquid stabilizers of PVC.

POCL has two subsidiary companies - M/s Baschem Pharma Ltd (100% subsidiary) at Maraimalai Nagar in Tamilnadu to manufacture liquid stabilizers, Epoxy oil and paint driers (manufacturing facilities since closed) and M/s Lohia Metals Pvt Ltd (51% subsidiary), which has an annual capacity of 12,000 tonnes of metal refining. Baschem Pharma Ltd is currently, solely engaged in trading activities and hence does not contribute any significant revenues/profits to the consolidated financials of POCL.

POCL has four different product divisions:

  • Metallic Oxides Division
  • PVC Stabilizers Division
  • Smelter Division
  • Zinc Division

POCL also had a battery-producing unit, which was sold off in 2007, as it did see scope in that segment of business.

POCL has its manufacturing facilities in Pondicherry and Tamilnadu. The factories for Metallic Oxides Division and Plastic Additives Division are situated in Pondicherry while the factories for Smelter Division and Zinc Refining Division are located in Tamil Nadu. It has a capacity of 12,000 Tonnes p.a. for Metallic Oxides, 6,000 Tonnes p.a. for PVC stabilizers, 5,000 Tonnes p.a. for oxides & refining and 14,400 Tonnes p.a. for Smelter division. A part of the production of lead oxide is used captively by plastic additives unit. Similarly Zinc and Lead are used captively for manufacture of oxides and alloys.

POCL earns ~ 60% from metals division, 20% from the oxides division and another 20% from the plastic additives division out of its overall sales. In the metals division lead metal forms ~80% of the sales while zinc forms the remaining 20%.

The products of the company are consumed by various industries namely, Tyres & Ceramics (Zinc Oxide), Cable sheeting (Lead oxides), Galvanizing units (Zinc).

POCL has large clientele which includes big names like Amara Raja Batteries, Exide Industries, J K Tyres, Supreme Inds, Kisan, Shriram EPC, Chemplast and MRF Ltd to name a few.

POCL is a recognized export house and mainly exports lead metal. Even though plastic additives are also exported, they form a small part of the total exports of the company. The export margins of the company are higher and stabler than the domestic margins.

Stability in the metal prices (especially lead) could lead to better volumes and consistent profits.
The business of POCL to a large extent is dependent on the metal prices especially lead as huge fluctuations in the metal prices create pressure on the margins of the company. Lead is a very corrosion-resistant, dense, ductile, and malleable bluegray metal. The metal prices have been quite unfavorable for POCL during FY09 and therefore led to fall in its overall margins during the period. The metal prices have stabilized since the start of this fiscal and hence has led to high volumes. POCL is also dependent on Zinc to some extent though lead is its main product.

Higher focus on exports could lead to better margins and efficient working capital management
POCL is also into export sales, mainly of lead metal. The exports have not been very high till now, for instance the first half of FY10 saw export sales of ~Rs 10 crores. The company is in H2FY10 focusing on improving on this front and increasing its exports sharply. POCL expects exports to form 50% of the total revenues in H2FY10. Exports form a key to the overall business structure of POCL. The robust export situation in H2FY10 could lead to better topline and bottomline for FY10. Export realizations are based on LME prices, while domestic prices at times quote lower than LME prices. Further export sales are made against sight L/C and receivables are realized faster.

Higher utilization of capacities to lead to economies of scale and spread of fixed costs
Till H1FY10, POCL did not utilize its plants to its full capacity. At the end of FY09, POCL had installed capacity of 33,460 MT of Metals and Metallic Oxides and 6,000 MT for Plastic Additives. It manufactured 10,104 tonnes of metals & metallic oxides and 4105 tonnes of plastic additives in FY09. Post H1FY10, it has started to utilize almost 100% capacity in the metals and metallic oxides segment. This will enable the company to reduce its per unit cost and also lead to a spread of fixed costs which could eventually lead to better margins for the company.

Shift to LME based pricing for sales and purchases to help POCL earn stable profits
Earlier, POCL used to make its sales and purchases on a spot market basis and hence there was no assurance of maintainable profits, as the raw material price fluctuation could not always be passed on to its customers. In FY09, POCL took a hit on its profits because of this reason, as, the huge volatility in the raw material prices especially lead metal could not be passed on to its customers leading to a fall in its profits.

To read the full report: POCL


Robust Cash Flow To Help Strengthen Balance Sheet
We are in the up-cycle of the sugar sector with acute shortage of sugarcane and there by acute shortage of sugar. Higher cash flows and negligible capex would help Balchini to improve its balance sheet and strengthen it further.

Lower Debt = Lower Interest Cost = Better Profitability
The higher free cash generation by Balchini will enable it to reduce its debt, thereby reducing the interest cost. Lower interest cost would result in better profitability, despite pressures on the operating profitability due to high sugarcane cost.

New Power Policy - "Santa's Gift
The new UP govt power policy has two key positives for the co-gen segment. Firstly, UPPCL has increased the power tariff by approximately 30% to around Rs 4 per unit effective from 1st October 2009. The state has also proposed a policy where they will facilitate sale of 10% bagasse based power through open access. This is during the season. UPPCL has further allowed 50% of off-season power through open access, which is from alternate fuel like Coal, etc. The balance 50%, would be bought by the grid at their own discretion for which they will have to fix up a tariff based on coal as feedstock. This would give a boost to the co-gen revenue not only during the up cycle but also during the down cycle mainly due to rising power deficit situation in the state of UP.

Moderate Sugar Volumes coupled With Higher Sugar Prices To Boost Revenue & Shoot Up Profitability.
The revenue from the sugar segment has been growing at a CAGR of 36% for the period between FY08-FY10E. The co-gen division has also performed moderately with 10% CAGR for the same period, however distillery division performance has been disappointing. The total revenue has been growing at 32% CAGR for the period between FY08- FY10E. We expect the profit to grow at 117% CAGR between FY08-FY10E on the back of rising sugar prices.

To read the full report: BALRAMPUR CHINI

Wednesday, December 30, 2009

>The dollar/euro exchange rate: Potentially, very significant instability

Since the start of 2009, the dollar has depreciated against the euro as a trend. This depreciation is no longer due to the same causes as before the crisis: the US external deficit has shrunk drastically, but the changeover to virtually zero dollar interest rates has led to massive capital outflows from the United States, and this is currently the cause of the dollar’s weakness.

However, the dollar/euro exchange rate may prove to be very unstable:

for the dollar to depreciate against the euro, the sum of the US external deficit and the capital outflows from the United States must outweigh the purchases of dollars by central banks in emerging and oil-exporting countries, which want to stabilise their exchange rates against the dollar;

a faster rise in interest rates in the United States than in the euro zone, a rise in risk aversion after an unfavourable shock or a fall in the oil price due to sluggish growth would lead to a reduction in the borrowing positions in dollars or long positions in euros that would stop the depreciation of the dollar against the euro.

We might therefore see (in 2011?) a drastic changeover to an equilibrium where the dollar appreciates markedly against the euro once again, something that would obviously be a serious problem for the US administration.

To read the full report: DOLLAR/EURO

>Pidilite Industries Ltd. (HDFC SECURITIES)

Company Background & Business Profile
Incorporated in 1959, Pidilite Industries Ltd. (PIL) is a pioneer and market leader in the field of consumer and specialty chemicals in India. PIL has a wide range of products, which find application in construction, plastics, textiles, paper, leather, paints & engineering industries. The product range includes Adhesives and Sealants, Construction & Paint Chemicals, Automotive Chemicals, Art Materials, Industrial Adhesives, Industrial and Textile Resins and Organic Pigments and Preparations. Most of the products have been developed through strong in-house R&D.

PIL has a number of established brands and a large distribution network of dealers, sales representatives, offices & retail outlets spread throughout the country. The company's brand, Fevicol is one of the most trusted brands in India and the largest selling adhesives brand in Asia. The other major trusted brands include Dr. Fixit & Roff (construction chemicals brands), MSeal (sealant brand), Cyclo (automotive chemicals brand), Sargent Arts (art materials brand) & Hobby Ideas (hobby & craft products)

PIL’s manufacturing facilities in India are located in Gujarat, Maharashtra, Himachal Pradesh and the Union Territory of Daman. In addition, the group also has manufacturing plants overseas in the US, Brazil, Thailand, Singapore, and Dubai. PIL has also been active in international acquisitions & incorporated subsidiaries in Singapore, USA, Thailand, UAE and Brazil.

Geographically, PIL operates in two divisions - India & Other countries. India contributes 90% to the total sales (in FY09), while other countries contribute the remaining 10%. Exports account for 9.5% of the total turnover in the Indian company. The company exports its products to Middle East, Africa, South East Asia and SAARC.

PIL has 13 overseas subsidiaries (4 direct & 9 step-down) viz; Pidilite USA Inc., Pidilite do Brasil, Pidilite International Pte Ltd, Pidilite Middle East Ltd, Pulvitec do Brasil Industria Commercio de Colas, Jupiter Chemicals (L.L.C.), Pidilite Indonesia, Pidilite Speciality Chemicals Bangladesh Pvt Ltd, Pidilite Innovation Centre Pte Ltd, Pidilite Industries Egypt - SAE, Chemson Asia Pte Ltd, Pidilite Bamco Ltd (Thailand), Pidilite Bamco Supply Services Ltd (Thailand) & Pidilite South East Asia Ltd. (Thailand). PIL also has 4 Indian subsidiaries viz; Bhimad Commercial Co Pvt Ltd, Madhumala Traders Pvt Ltd, Pagel Concrete Technologies Ltd & Fevicol company Ltd. Out of all these subsidiaries only four are major ones viz; Pidilite USA Inc., Pulvitec do Brasil Industria Commercio de Colas, Jupiter Chemicals (L.L.C.) & Pidilite Bamco Ltd. These together contribute almost 94% to the total revenue of all subsidiaries (in FY09). PIL has significant manufacturing and selling operations in USA & Brazil. The Brazil & US subsidiaries together contributed 80% to the total subsidiaries turnover in FY09 & 85.6% in H1FY10.

Most of the above subsidiaries are wholly owned by PIL, except for Pagel Concrete (India) & Pidilite Bamco (Thailand), which are 75% subsidiaries & Bamco Supply Services (Thailand), which is 49% subsidiary of PIL.

Business Segments
PIL operates under three major business segments viz branded consumer and bazaar/ craftsmen products, speciality chemical business & others.

A] Branded consumer and bazaar/craftsmen products: This segment is a major contributor to PIL’s revenue, which accounts for 73% to its total turnover (standalone in FY09). The segment broadly constitutes Adhesives & Sealants, Construction & Paint Chemicals and Art Material. Adhesives & Sealants constitute around 50% of the total sales (in FY09) and largely include sales of Fevicol and other sealants like M-Seal. Construction & Paint Chemical sub segments account for 17% of total sales (in FY09), while art material sub segment constitutes around 6% of total sales for FY’09.

B] Industrial Specialty: PIL is operating in this segment since its incorporation and the first product manufactured under this segment was pigment emulsions. This segment accounts for 21% of total sales (in FY09). The segment constitutes Industrial Adhesives, Industrial Resins & Organic Pigments & Preparations, which largely cater to various industries such as textiles, chemicals, FMCG, rubber, automobiles etc. Industrial Adhesives contribute 7%, while Industrial Resins & Organic pigments and preparations contribute 8% & 6% respectively to the total sales.

C] Others: Others segment constitutes VAM (Vinyl Acetate Monomer) manufacturing unit, which was demerged into PIL w.e.f 1st April 2007. VAM is a key raw material used by PIL (accounts for 20% of the total raw material costs) for a wide range of adhesive products. VAM-based polymers are commonly used in the production of plastics, films, laminating adhesives, elastomers, inks, water-based emulsion paints, adhesives, acrylic fibers, glue, cosmetics and personal care products, floor tiling, safety glass, building construction, finishing and impregnation materials, coatings. Besides captive consumption, PIL also sells VAM in the market, which constituted 6% to the total sales (in FY09). However, recently the company has shut down its VAM plant, since it became cheaper to import VAM rather than manufacturing, as VAM prices came off much steeper than the raw material (ethylene) cost, and the industry as a whole was carrying the high cost VAM inventory.

To read the full report: PIL

>Back to normal: Economic recovery and policy exit

Economic fundamentals (growth, inflation and profitability) to recover substantially. The economy is expected to recover further in 2010 with GDP growth to rebound to about 10.1%. 1Q GDP growth is expected to be higher while that in 2Q and 3Q would fall; 4Q should see some rebound. From a QoQ perspective, GDP growth is expected to be more stable and would rebound gradually. As we bid farewell to deflation and move into moderate inflation, CPI is expected to rise by about 2.6% and PPI by about 3.5%. Demand is to rebound rapidly providing strong support for industry earnings growth; industry earnings growth is expected to rise sharply by 30%.

Revival of end-user demand with investment growth normalising. With the upturn in the economic climate and improvement in resident expectations, consumption growth is expected to accelerate. Global economic upturn and external demand are expected to drive export recovery. Contribution from exports to economic growth is expected to turn from a fairly large negative contribution to a positive one. End-user demand – demand that does not involve further production process, generally referred as consumption and exports – is to become the key driving force of economic growth and its effect in supporting GDP growth would exceed that of investment. Government investment is expected to fall and investment growth is to normalise.

Policy to gradually normalise after a period of proactive and moderate easing. Around mid-2010, policy is expected to turn from an extremely loose stance towards neutral. Interest rate raise is expected in 2010 with an increase of 27-54 ppts. New loans are expected to fall to RMB7-8 tn. The RMB exchange rate may appreciate slightly by about 3-5%. Proactive fiscal policy is expected to continue but structural changes may occur of policy focus; it is estimated that the budget deficit would account for about 2.9% of GDP, with a size of about RMB1 tn. Fiscal policy would move from one single emphasis on maintaining economic growth to multiple emphases of stimulating internal demand, spurring employment and guaranteeing sustainable economic growth.

Liberalisation of monopoly industries and encouragement of private capital participation to be the major theme of structural adjustments. We expect the government to aggressively liberalise monopolies and control as well as to encourage private capital participation in service sectors such as oil, railway, telecommunications, municipal public utilities and such social sectors such as healthcare, social insurance, education and media, hence forming of new growth sectors.

To read the full report: CHINA ECONOMIC OUTLOOK


Om Metals Infraprojects Ltd (OMIL) is the largest hydro-mechanical equipment supplier in India with a market share of over 60 percent. The company has nearly 4 decades of experience in successful execution and completion of turnkey hydro-mechanical contracts for hydropower and irrigation. The company presently has Rs 636 crore worth of order book, which is 3.5x of its H1FY10 annualised sales and it is expected to be completed in the next 3 years.

We believe that value unlocking from its real estate business will be a major fillip for the valuation of the company. The value of its land bank is at Rs 248 crore (Rs 26 per share). We initiate coverage on the stock with 'BUY' rating.

Largest hydro-mechanical with a healthy order book: The company is the largest hydro-mechanical equipment supplier in India with a market share of over 60 percent and nearly 4 decades of experience in successful execution and completion of turnkey hydro-mechanical contracts for hydropower and irrigation. The company presently has Rs 636 crore orders book, which is 3.5x of its H1FY10 annualised sales and it is expected to be completed in next 3 years. This provides substantial medium term revenue visibility. In addition, the company has submitted bids for more projects and they expect to take the total tally of order book to over Rs 800 crore by FY10.

Huge value unlocking from the real estate business: The company has nearly 1.5 million Sq.ft of saleable land bank situated at Hyderabad, Jaipur, Mumbai, Faridabad, Kota etc This land bank is valued at Rs 248 crore which works out to Rs 26 per share. The company has a 35 percent stake in a 2.6 lakh Sq.Ft. SRA project in Bandra, Mumbai. This project will be completed in next 3 years and a total profit of Rs 117 crores is expected to accrue to the company on project completion. The company also generates real estate revenue from a hotel in Jaipur, lease revenue from a multiplex in Kota and a Toyota show room in Jaipur.

De-risking strategy through infrastructure forayed: The Company has recently forayed into the Infrastructure segment by winning two contracts for the development of a port and an SEZ in Pondicherry. The SEZ project is multi-product SEZ spread over 860 acres and the company has a 20 percent stake in it. The company has a 50 percent stake in the port project in Pondicherry, which is to be developed in next 5-6 years. Both projects are excepted to be developed through separate SPV's.

Valuations: We have valued the company by the 'Sum of the Parts' valuation method, in which we have taken the value of its core business and the BV of its land bank for the purpose of valuation. At the current price of Rs30, the stock is trading at 7.3x and 5.3x of its core FY10E and FY11E earnings respectively. As per our Sum of the Parts valuation, we recommend a buy on the stock with a price target of Rs39 thus providing an upside potential of 30%.

To read the full report: OM METALS INFRAPROJECTS


Quick Comment: We remain UW due to: 1) potential earnings growth volatility; 2) potential increase in competitive pressures from P&G; 3) potential rise in input cost pressures; and 4) potential slowdown in revenue growth. We spoke with management and here are the key takeaways from our conversation:

No conclusive slowdown in consumption: Contrary to the sharp slowdown reported by AC Nielsen for the industry for October-09 (from 14.8% in H1F2010 to 5.9% in Oct-09); there are no signs of a significant slowdown at the ground level. However, consumer downtrading in categories such as laundry continues and sharp price rises are also causing consumer downtrading in tea. Although there is no conclusive evidence of consumer demand slowdown yet, the company is closely monitoring the potential impact of high food inflation on FMCG consumption.

Soap brands relaunched, PP growth steady: HUL has relaunched all its soaps brands and has deployed its complete portfolio to improve its market share. Management is hopeful of improving market share and believes that the current signs may not be reflective of the potential underlying trend. Personal products segment growth remains steady for HUL, contrary to the slowdown demonstrated by the AC Nielsen retail off take data.

Ad spend likely to be under 12% in F2010: HUL’s ad spend to sales ratio was around 13% in H1F2010. However, H2F2010 ad spend to sales ratio is likely to be lower and hence the F2010 ratio is likely to be under 12%. However, during the six months ended Mar-09, HUL’s ad spend to sales ratio was 10%. Hence it is likely that the ad spend to sales ratio may witness an increase in H2F2010 yoy.

Tax rate likely to be at 23%: HUL’s tax rate in H1F2010 was around 23.2%, it is likely that F2010 tax rate will be in a similar range. The tax rate during the six months ended Mar-09 was around 20% and it is likely that HUL may witness 300 bps rise in the tax rate in H2F2010.

To read the full report: HUL

Tuesday, December 29, 2009

>How could 2010 possibly be worse than 2009 or 2008?: REAL WEALTH REPORT

2010 Gala Forecast Issue ...

My Top Five 2010 Forecasts!

The financial storm of 2008 and 2009 will go down in the record books as two out of three of the most devastating in history.

Why do I say “two out of three?” Because 2010 promises to be another record year of wild swings, market traps, misguided Wall Street and Washington advice, and based on everything I’m seeing ahead, the most dangerous year of all for investors.

How can that be when 2009 is closing out its final days with signs that the economy and markets are improving?

How could 2010 possibly be worse than 2009 or 2008?
I’ll answer these questions in a moment. First, let’s review where the world has come from before I get to my forecasts and where it’s heading in 2010.

So far in the last two years we’ve seen the failures of Merrill Lynch, Lehman Brothers, Bear Stearns, Wachovia, WaMu, Citigroup, Fannie and Freddie, AIG, GM, Ford, Chrysler, and more. Never mind that all but Lehman were bailed out by Washington, or should I say
you and I, the taxpayers. They failed, period.

Our economy and financial system suffered a massive heart attack and a stroke. But as I will show you, they remain in intensive care and on life support.

We’ve also witnessed a devastating collapse in residential real estate markets, with property prices in some areas of the country down as much as 70% from their pre-crisis highs.

In 2008 and 2009 alone, there were over 7.1 million foreclosures, with another 2.4 million on the horizon for 2010. On December 31 of this year, 1 out of 4 homeowners will find themselves upside down on their homes, owing more than their property is worth.
Their biggest financial asset down the tubes.

We’ve also seen the worst stock market routs since the Great Depression.

The Dow lost 35.9% from its 2007 high to its 2008 low. Then another 26% in the first three months of 2009 before surprising almost everyone and rallying back smartly for the balance of this year — with most investors and analysts completely missing the rally, or worse, getting caught on the short side of the markets.

But even those figures hide the damage done in the markets in 2008 and 2009. All told, in real inflation-adjusted terms, the Dow Industrials lost 50% of its value in 2008 and 2009.

Even worse, from its all-time, inflation- adjusted high which occurred when the Dow was at 11,908 in November 2000 — before the Federal Reserve started printing trillions of dollar of
fiat money — the Dow Industrials have lost an amazing 77.9%. And that’s after giving effect to its rally since March.

At its March low, the Dow had lost nearly 89% of its purchasing power since the year 2000 — rivaling the Great Depression.

Meanwhile …

Gold soared to a record high of $1,226 an ounce, up more than 400% since 2000.

To read the full report: GALA FORECAST


Awaiting growth, for now. With key issues of liability management, asset quality, unsecured loans and international banking being addressed to a great extent, the management is awaiting loan growth, resulting in better leverage and RoEs. We also believe that faster growth, funded by core deposits, would be crucial for improving RoEs, resulting in higher valuations for the bank. However, RoE in the near term is likely to be driven by lower provisions and lower costs. Retain ADD.

Retain positive view, but valuations do not provide big upsides
We are increasing our TP for ICICI Bank to Rs880 from Rs850 earlier, mainly to factor is somewhat higher valuations for its insurance business. We value ICICI Prudential Life at Rs230 bn (EV of Rs87 bn + appraisal value of Rs143 bn on factoring 19X NBV FY2011E). The per share value of ICICI Prudential Life works out to be Rs140 per share (for 74% stake and 10% holding discount) from Rs115 earlier. The additional capital requirement for ICICI Prudential is likely to be negligible on account of somewhat slower growth in the current fiscal and seemingly higher cost control. While we retain our positive view for ICICI Bank, upsides might be limited (after an already 8% up-move over last 3 trading sessions)

Image makeover – learning from its mistakes
In a recent meeting, the management highlighted its initiatives to change the general perception
about the bank. Some of these aspects are very important and quite commendable as well, in ourview:

(1) The management is trying to project a very soft image of itself across all customers and
different from its earlier ‘know all’ approach.

(2) The bank is trying to build personal relations with its customers and has been increasing its
branch banking focus, compared to its earlier strategy of pushing customers towards ATMs and
internet, which never allowed any relationship to be built between the customer and the bank.

(3) Most of the loan products would be done by the bank and the use of DSA has been reduced to
bare minimum – should ensure better loan writing and better service.

(4) Media interactions are being handled only at the highest level and dissemination of information taken very seriously – a key issue which also precipitated the crisis last year.

Awaiting loan growth; strategy focused on secured credit
The management reiterated its focus on secured retail and domestic corporate loans — mainly mortgages, auto and project financing. Mortgage disbursements for ICICI Bank have increased to about Rs6 bn per month, as compared to Rs1-2 bn per month over the previous 2-3 quarters. ICICI Bank seems to be back in the auto loans business and intends to grow the portfolio at a faster pace from now on. Further, the traditional business of infrastructure finance is likely to be a big focus area and likely to grow at a fast pace, even as most other segments slow down or even decline.

Unsecured loans unlikely to be a focus area in the near term
We believe that the bank is willing to lose its market dominance in the personal loan and credit cards segment. With these being scale businesses and the bank might not be able to run profitable businesses on a smaller scale, the bank might even look at reducing the book further. The focus is only on its own customers and current volumes in both these businesses are negligible.

International book also likely to shrink
The current bond issuance of $750 mn was placed at a fine rate of 2.93 bps over LIBOR. Also, the spreads have reduced somewhat on its other papers. However, the current spreads are still high and the intent is to slowly scale back its international book. While concerns on asset quality and ALM mismatch have reduced, the overseas operations still don’t seem to be profitable with margins at just 0.5%. International book accounts for 27% of total parent loan book and a declining trend out here is likely to curtail the overall loan growth for the bank; however, it would be positive for margins.

Liability focus working well
We believe that one of the key challenges and a crucial business trend for ICICI Bank would be its ability to grow its CASA deposit franchisee. Post the crisis in 3QFY09, the bank has worked well to improve its core deposits. The strategy of focusing on low-cost deposits over the past few quarters appears to be paying off— savings deposits are averaging about Rs 12 bn every month. However, growth in current deposits (similar to experience of other industry participants) has been sluggish. Significant addition in bank branches can help the company improve its CASA deposits in the future. We model CASA deposit growth of 21% yoy in FY2010E (CASA proportion at 33% as of March 2010) and 21% in FY2011E (CASA proportion at 37% as of March 2011).

Margins to improve on back of deposit re-pricing
A clear focus on correcting its liability profile, steep yield curve currently (wholesale deposit rates are very reasonable) and slower loan growth augur well for margins of ICICI Bank. However, its strategy of not growing its high yielding personal loans and credit cards coupled with high competition in mortgages and project finance will restrict margin growth for the bank. We assume margins of 2.7% (increase of 35 bps) in FY2010E and 2.8% (increase of 8 bps) in FY2011E.

Asset quality under control; should see better trends
We believe that the incremental addition to NPLs (especially the unsecured NPLs) has slowed down in recent months and other segments are also witnessing positive trends with incremental restructuring being low. Overall asset quality trends are behaving well. While we are still modeling delinquencies at around 2% for FY2010E and 1.7% in FY2011E, the trend could be better and could result in upsides. The net delinquencies (net of recoveries) are expected to fall from 1.8% in FY2008 to 0.7% in FY2011E. Hence, credit provision requirement for ICICI Bank is likely to fall from 1.7% of average loans in FY2009 to 1.2% in FY2011E and 1.0% in FY2012E – the biggest driver to profitability.

To read the full report: ICICI BANK


Key takeaways from our management meet with Jaiprakash Associates (JPA) are: i) strong volume growth in cement besides low-cost production and better market mix, ii) robust ~Rs400bn EPC orderbook, predominantly in house, iii) execution of 13.5GW power portfolio proceeding as per plans – merger of unlisted power holding company into listed subsidiary and iv) robust 11.5mn sqft sale of real estate YTDFY10 & soft launch of Jaypee Greens Sport City spread over 2,500 acres. We believe market concerns on funding can be alleviated via: i) annual operating cashflow of Rs10-12bn, ii) sale of treasury shares, currently valued at Rs27bn, iii) securitisation of its power portfolio worth Rs27.5bn and iv) fund raising initiatives of ~Rs40bn in both power and real estate. We expect consolidated revenue, EBITDA and PAT CAGR to be 37%, 40% and 38% in FY09- 12E. We maintain BUY with sum-of-the-parts (SOTP) target price of Rs171/share.

Cement volumes strong. YTDFY10 cement despatches rose 32% YoY to 6.3mnte and crossed 1mnte/month in November ’09. JPA recently commissioned 1.2mnte plant in Gujarat and expects to add 3.5mnte capacity at Baga/Bagheri in North India by February-March ’10. We factor in 36% volume growth to 10.4mnte in FY10E.

Robust EPC order pipeline. The Yamuna Expressway and Karcham Wangtoo are progressing well, likely to be completed by March ’11 & May ’11 respectively. JPA recently bagged Rs11bn contract for developing the inner ring road at Agra. Besides current EPC contracts of Rs400bn, predominantly in house, we estimate additional Rs200bn EPC contracts from in-house power portfolio and real estate construction.

Significant option value exists in power and real estate. With 700MW operational assets and 2,820MW projects under implementation (1,000MW transmission rights), JPA is likely to have ~8.8GW power portfolio by December ’15. The merger of its unlisted power holding company into its listed subsidiary would unlock value, in our view. Besides, JPA sold ~12mnsqft YTDFY10, aggregating upfront collections of ~Rs7.5bn. Also, JPA recently soft launched Jaypee Green Sports City, spread over 2,500 acres. JPA intends to raise Rs25bn via IPO for its real estate and Rs15bn via FPO/QIP during February-March ’10, which would further unlock value.

To read the full report: JAIPRAKASH ASSOCIATES


We initiated the coverage of Uflex Ltd and set a target price of Rs.118.00.

It is a largest Integrated Flexible Packaging Company in Asia and One of its kind in the World, having a turnover of USD 600 million.

Uflex had issued Foreign Currency Convertible Bonds (FCCBs) of the nominal value of USD 85 million out of which FCCBs of nominal value of USD 68.6 million were outstanding.

It recently bought back FCCBs worth $47 million leaving $21.6 million FCCBs outstanding.

Uflex has sold 51% stake of the distillery unit that is part of the wholly owned subsidiary UBIO Chemicals.

Net sales and PAT of the company are expected to grow at a CAGR of 17% and 12% over 2008 to 2011E respectively.

To read the full report: UFLEX LIMITED


A Dampener — The US FDA’s warning letter to one of Ranbaxy’s plants in Ohm Labs does not appear material from a financial perspective – we see a worst case impact at c.2%-3% and c.5% of core sales and EPS respectively, and believe the FTF pipeline appears secure. However, it will likely affect confidence w.r.t. the stock, given Ranbaxy’s history with the FDA. While the stock could trade weaker next week, we would view any dip as an enhanced buying opportunity.

Warning Letter at Ohm Labs — The FDA has issued a warning letter to Ranbaxy's liquid manufacturing plant at Gloversville (NY), citing cGMP violations (inspected in Jul/Aug 2009). It is one of the three plants in Ohm Labs; the others did not have any material deviations. Ranbaxy has engaged a consulting firm (PRTM Inc) to address the issues.

BUY: A Dampener But Negligible Financial Impact

Small Unit; Negligible Financial Impact — Ranbaxy has indicated the plant accounts for under 10% of US (c.2%-3% of total) sales. Sales would continue and while approvals are likely to be on hold, there are not too many major filings pending approval from this plant. We leave our estimates unchanged. In a worst case scenario, where the issue escalates and the plant is closed down, this could affect c.2%-3% and c.5% of our CY11E recurring sales and recurring EPS

FTF Pipeline Appears Secure — The major FTFs (where site transfers have / are being effected) appear to be filed from the other Ohm Labs plants. We therefore do not see any fresh risk to this pipeline or its valuation from this development.

Could Impact Sentiment — While this development, by itself, does not appear to have a material impact on financials or the key drivers, it is likely to affect recently rising confidence levels w.r.t. the stock among investors, given its past issues with the FDA. We would view any share price weakness as an enhanced buying opportunity, given limited fundamental impact and also potential catalysts over the next one to three months (integration plan with Daiichi, strong earnings, Flomax launch).

To read the full report: RANBAXY

>Commercial Vehicle Sector Update December 2009

I. Summary
The Indian Commercial Vehicle industry grew substantially by 95.5 per cent from 23,370 in November 2008 to 45,692 in November 2009. The Government Stimulus Package coupled with low base effect continued to aid the domestic sales growth for the month. The domestic sales grew by 98 per cent on account of growth in both LCV and MHCV segments. The MHCV segment grew by 132.7 per cent while LCV segment grew by 74.5 per cent. The exports too (for the first time in 12 months) grew at a convincing 76.9 per cent.

The domestic CV sales for the period of April-November 2009 grew by 12.4 per cent (Y-O-Y); from 270,335 units to 303,961 units. The growth in CV sales came in primarily from LCV segment which grew at robust 27.4 per cent from 134,705 units in April-November 2008 to 171,604 units in the same period last year. However, the MHCV segment remained subdued with a decline by 2.4 per cent. On a YTD basis, exports stood lower by 22.3 per cent at 26,126 units in April-November 2009 as against 33,628 units in the same period of the previous year.

II. Detailed Segmental Performance Analysis

1. Domestic Sales
The domestic CV sales surged up in November 2009. Lower base effect coupled with improvement in the economy led to growth in the domestic CV sales for the month. The CV sales for the month grew by 98 per cent over November 2008. The <= 3.5 tonnes, LCV goods carrier drove the growth by adding around 7242 units over the November 2008 sales. >16.2 tonnes to <=25 tonnes MHCV goods carrier too supported the growth with sales of 6010 units.

2. Exports
The trend for exports finally confirmed the change in direction in the month of November, growing at an impressive 76.9 per cent as against the exports in November 2008. This was the first time in the year that exports registered a convincing positive trend. Although, a part of the growth came due to the lower base effect of the previous year, even on an M-o-M basis the exports showed a positive trend growing at 27 per cent. The GC category continued to drive the exports. The LCV GC the largest segment of the exports added around 1322 units over the exports in November 2008, growing at 88 per cent. The MHCV GC segment was the next important segment with exports of around 1320 units in November 2009.

III. Company-level Statistics: Top three companies (mentioned in report)

IV. Industry News

Mercedes Benz India, received a bulk order of 150 and 100 trucks each from BGR Energy and Souwmya Mining in December 2009.

Premier Ltd launched 1.5 tonne light commercial vehicle (LCV) Roadstar in December

To read the full report: VEHICLE SECTOR

Monday, December 28, 2009

>Why Are Banks Holding So Many Excess Reserves?

The buildup of reserves in the U.S. banking system during the financial crisis has fueled concerns that the Federal Reserve’s policies may have failed to stimulate the fl ow of credit in the economy: banks, it appears, are amassing funds rather than lending them out. However, a careful examination of the balance sheet effects of central bank actions shows that the high level of reserves is simply a by-product of the Fed’s new lending facilities and asset purchase programs. The total quantity of reserves in the banking system refl ects the scale of the Fed’s policy initiatives, but conveys no information about the initiatives’ effects on bank lending or on the economy more broadly.

The quantity of reserves in the U.S. banking system has grown dramatically over the course of the fi nancial crisis. Reserves are funds held by a bank, either as balances on deposit at the Federal Reserve or as cash in the bank’s vault or ATMs, that can be used to meet the bank’s legal reserve requirement. The level of reserves began to rise following the collapse of Lehman Brothers in mid- September 2008, climbing from roughly $45 billion to more than $900 billion by January 2009 (see the chart on page 2). While required reserves—funds that are actually used to fulfi ll a bank’s legal requirement—grew modestly over this period, this increase was dwarfed by the large and unprecedented rise in the additional balances held, or excess reserves.

Some commentators see the surge in excess reserves as a troubling development— evidence that banks are hoarding funds rather than lending them out to households, fi rms, and other banks. Edlin and Jaffee (2009, p. 2), for example, identify the high level of excess reserves as the “problem” behind the continuing credit crunch—or, “if not the problem, one heckuva symptom.” Other observers see the large increase in excess reserves as a sign that many of the steps taken by the Federal Reserve during the crisis have been ineffective. Instead of restoring the fl ow of credit to fi rms and households, they argue, the money the Fed has lent to banks and other fi nancial intermediaries since September 2008 is sitting idle in banks’ reserve accounts.

These views have led to proposals aimed at discouraging banks from holding excess reserves. The proposals include placing a tax on excess reserves (Sumner 2009) or setting a cap on the amount of excess reserves each bank is allowed to hold (Dasgupta 2009). Mankiw (2009) notes that economists in earlier eras also criticized the stockpiling of money during times of fi nancial stress and favored a tax on money holdings to encourage lending. Relating these past issues to the current situation, he remarks that “with banks now holding substantial excess reserves, [this historical] concern about cash hoarding suddenly seems very modern.”

In this edition of Current Issues, we argue that the concerns about high levels of reserves are largely unwarranted. Using a series of simple examples, we show how central bank liquidity
facilities and other credit programs create—essentially as a by-product—a large quantity of reserves. While the level of required reserves may change modestly with changes in bank lending behavior, the vast majority of the newly created reserves will end up being held as excess reserves regardless negligible. This process has clearly not taken place. After presenting our examples, we explain why the money multiplier is inoperative in the current environment, where reserves have increased to unprecedented levels and the Federal Reserve has begun paying interest on those reserves. We also argue that a large increase in the quantity of reserves in the banking system need not be infl ationary, since the central bank can adjust short-term interest rates independently of the level of reserves by changing the interest rate it pays on reserves.

Central Bank Lending: A Simple Example
To clarify how the types of policies implemented by the Federal Reserve over the course of the financial crisis affect individual banks’ balance sheets and the level of reserves in the banking system as a whole, we present a simple example. Consider the balance sheets of two banks, labeled A and B (Exhibit 1). Focus fi rst on the items in black. On the liabilities side of the balance sheet, each bank has started with $10 of capital and has taken in $100 in deposits. On the asset side of the balance sheet, both banks hold reserves and make loans. For simplicity, we assume that the banks are required to hold reserves equaling 10 percent of their deposits, and that each bank holds exactly $10 in reserves.

To read the full report: CURRENT ISSUES

>TELEPEDIA: Indian wireless base touches 500m (PRABHUDAS LILLADHER)

Subscriber net addition strong in November 2009: Subscriber net additions garnered by telcos were highest ever in November 2009, with net additions of ~17.5m subscribers, a growth of 5.4% MoM and 70% YoY.

Tata Teleservices’ (Tata’s) solid performance continues: Tata’s net additions were at 3.3m subscriber in November 2009, up 290% YoY but a dip of 14% MoM. Tata has added ~16.8m subscribers over the last five months post the launch of their GSM services. Mumbai & Maharashtra added 0.46m subscribers or 14% of the overall net additions of Tata for the month of November 2009.

Bharti Airtel’s (Bharti’s) net additions back to ~2.8m mark: Bharti added 2.8m subscribers, up 4% MoM. It had maintained a stable run-rate of ~2.76m subscribers YTD for CY09. Increase in competitive offerings like per second billing and attractive outgoing calling options, has hurt the subscriber market share of Bharti by 160bps YTD.

Reliance Communication’s (RCom’s) net additions jumps to 2.8m: RCom added ~2.8m subscribers (CDMA+GSM), up 33% MoM. It has launched aggressive schemes like pay per call, flat 50paise/min and per second billing which has started resulting in buoyant subscriber net additions.

Vodafone Essar (Vodafone) net additions down to ~2.8m: Vodafone subscriber net additions slowed to 2.8m, after a strong October month where they added 3m subscribers. With this pickup, they have bucked their trend of slower net additions over the last six months. Vodafone, too, has started offering the ‘per second billing’ scheme.

To read the full report: TELECOM SECTOR


Capturing opportunities in growing edible oil market: KS Oils (KSO) is a market leader in the Rs130bn mustard oil market, with 11% market share (FY09). It also has ~30% market share in branded mustard oil segment (current market size of ~Rs39bn) which is expected to grow at ~25% CAGR, going forward. By FY11, the company is expanding its mustard oil crushing capacity by ~3x (of its FY09 capacity). We believe that the multi-product brand portfolio will push KSO to capture the growing branded mustard oil market. Further, KSO is expanding ~4x of its FY09 refined oil capacity by FY11. We believe that a strong market presence in mustard oil, strong brands and rich experience in edible oil industry will help KSO capture the ~Rs600bn refined oil market in India.

Striding towards sustainable growth

Capacity expansion will support growth: KSO is expanding its capacity across segments like crushing, refining and vanaspati by ~3x, ~4x and ~2x (its FY09 capacity), respectively by FY11. We believe that it would support KSO to attain ~40% plus FY09- 12E volume CAGR. We believe that KSO Sales and PAT would grow at FY09-12E CAGR of ~31% and ~33%, respectively. We expect contribution from the sales of high margin branded mustard oil to go up in the future and consequently, increase overall EBITDA margins of the company. However, this growth in the EBITDA margins would be offset by rising contribution of low margin refined oil business to total sales, going forward.

Backward integration through palm plantation: KSO has acquired a land bank of 34000 hectares for palm plantations in Indonesia. This will ensure a steady supply of crude palm oil for its refining business and EBITDA margin is expected to be ~50% once the plant matures in 3-4 years. KSO has further acquired 23,000 hectares in Kalimantan in Indonesia. We have not considered any income from these palm plantations since the income would start accumulating from FY13.

Valuation: Based on one year forward P/E, KSO is trading at a discount to its global as well as domestic peers despite having higher earnings CAGR and higher return ratios (RoE). We are positive on the stock on account of its strong edible oil market presence, its growth potential and discounted valuation. At present, stock is trading at near to lower end of its historical forward P/E band of 8x-14x. Hence, we recommend ‘BUY’ the stock.

To read the full report: K S OILS


In Q2’10, Sterlite Industries Ltd.’s (SIL’s) net sales declined by 7.7% yoy to Rs. 60.9 bn. The Company reported a yoy increase in production of Copper (12.3%) and Zinc/Lead (14%) but Aluminium production was down (29.7%) due to complete ramp down of BALCO plant 1 smelter. EBITDA plunged by 26.3% yoy to Rs. 13.7 bn, primarily on account of a steep decline in nonferrous metal realisations. However, the LME Copper (Cu), Aluminium (Al) and Zinc prices have recovered sharply from the lows of last year, driven by the expected recovery in the global economy and the strong demand from China. Going forward, we continue to hold a positive outlook for the Company, on the back of a sharp recovery in the metal prices. However, we believe the stock is fairly valued at the Current Market Price (CMP) of Rs. 847 and thus we reiterate our Hold rating on the stock.

Economic recovery helps Sterlite post a strong qoq performance

Metal prices to remain stable: The LME Aluminium prices have rallied sharply since February 2009, driven by China's State Reserve Bureau's (SRB's) restocking and an expected recovery in the economy. However, we do not expect further rally in the LME Aluminium prices in the near term, especially with the LME inventory piling up. On the other hand, LME Copper prices have rebounded sharply from the low levels witnessed in December 2008, driven by a strong demand for the metal in China and brighter outlook for the global economy. Although we do not expect any substantial increase in the LME prices from the current levels, we have upwardly revised our base-metals average realisation estimates for the Company following the recent rally in the LME prices. Thus, we expect Cu, Al, and Zinc realisation to be ~USD 5,650 per tonne, ~USD 1,835 per tonne and ~USD 2,000 per tonne, respectively in FY10.

To read the full report: STERLITE INDUSTRIES

Rolta repurchases US $ 15.00 Mn FCCBs taking the total buyback to US $ 53.31 Mn (PRESS NOTE)

MUMBAI, December 24, 2009 – Rolta India Limited is pleased to announce that it has further repurchased US $ 15.0 Million of the outstanding Foreign Currency Convertible Bonds’s ( FCCB’s), of the original issue of Zero Coupon FCCBs of US $ 150 Million due in 2012. The Bonds of the accreted value of US $ 17.8 Million have been repurchased at a discount of 15.25% resulting in a gain of US $ 2.80 Million (approx Rs.13.00 crores).

In June 2009,the company had, through a tender offer, repurchased FCCB’s of the accreted value of US $ 43.67 million at a gross repurchase value of US $ Rs 32.75 million resulting in a gain of US$ 10.92 million ( Rs 53.50 crores). The aggregate accreted value of all repurchase of FCCB’s till date is US $ 61.47 million ( Face Value $ 53.31 million) and total amount paid aggregates US$ 47.75 million resulting in a gain of US $ 13.72 million (approx Rs 66.50 crores) giving an average discount of 22.3% to the accreted value on all buybacks. This gain has been appropriated into P&L and Reserves in the financial statements of the company. The Company has diligently worked to effect these repurchase transactions to not only take advantage of the window of opportunity provided by government regulations, but also to adopt procedures that kept the interest of investors in focus. With this the company has been able to repurchase 35.5% of the initial issue of Bonds and the aggregate principal value of the Bonds remaining outstanding will be US $ 96.69 Million following completion of this repurchase which are due for redemption in June 2012.

About Rolta
Rolta is an Indian multinational organization that has executed projects in over 40 countries. Rolta serves these markets by providing innovative solutions in Enterprise Geospatial Information Solutions (EGIS), Defense & Homeland Security; Enterprise Design & Operations Solutions (EDOS); and Enterprise Information Technology Solutions (EITS). Rolta, through its joint venture with the Shaw Group Inc. USA – Shaw Rolta Ltd. – provides comprehensive Engineering, Procurement and Construction Management (EPCM) services to meet turnkey project requirements of power, oil, gas and petrochemical sectors. Rolta's joint venture with Thales, France – Rolta Thales Ltd., develops and provides state-of-the-art C4ISTAR information systems, Military Communications, Digital Soldier and Vehicle System solutions, covering the entire “sensor to shooter” chain, under transfer of technology from Thales. Rolta, headquartered in Mumbai, employs over 4500 professionals with countrywide infrastructure and international subsidiaries across the globe. The Company has benchmarked its quality processes with the world's best quality standards. Rolta is accredited with the prestigious BSI ISO/IEC 27001:2005 certification, the ultimate benchmark for information security; the BSI ISO/IEC 20000-1:2005 IT Service Management Standard; and the Company has been assessed at Maturity Level 5 of the Capability Maturity Model Integrated CMMI SW version 1.1 in 2006. The Company is now engaged in upgrading to Maturity Level 5 of version 1.2. Forbes Global has ranked Rolta amongst the "Best 200 under a Billion" for four times in six years. Rolta has been included in the S&P Global Challengers ListTM 2008, by Standard & Poor’s. This List identifies 300 mid-size companies worldwide that have shown the highest growth characteristics along dimensions encompassing intrinsic and extrinsic growth. ROLTA was ranked at the #1 position in Human Relations (HR), and at the 3rd position in overall ranking in the 2009 DATAQUEST survey of Best Employers in the IT sector. The Company is listed on the NSE in cash and F&O segment and forms part of CNX IT, NIFTY Midcap 50 and CNX 500 indices. The Company is also listed on BSE 'A' group and forms part of BSE Midcap, BSE 200, BSE 500, BSE IT and BSE TECK indices. The Company's GDR is listed on the Main Board of London Stock Exchange and its FCCB's are listed on the Singapore Stock Exchange.

Sunday, December 27, 2009

>What will happen if the oil price falls to USD 40 per barrel again in 2010?

One should absolutely not underestimate the possibility that the oil price will fall to USD 40 per barrel again in 2010: growth in OECD countries will decline significantly from its 2009 trend; the speculative oil stockpiles may shrink; there is still enormous excess production capacity and OPEC’s discipline may disappear if oil prices start to fall.

The effects of far less expensive oil in 2010 are known: stimulation of consumption, but negative inflation again in OECD countries, and therefore extension of the period of highly expansionary monetary policy since consumption will remain sluggish; difficulties for some oil-producing countries: Russia, Iran, Venezuela; appreciation of the dollar against the euro.

1. It is entirely possible that the oil price will slip back (to USD 40 per barrel??) in 2010.
2. What would happen if the oil price fell back to USD 40 per barrel in 2010?

The consequences of a low oil price again in 2010 are quite clear:

a) Stimulation of consumption in OECD countries, as in the second half of 2008 and at the beginning of 2009, by the fall in energy prices, and hence a decline in inflation (Charts 8A
and B), which bolsters real wages (Chart 8C).

b) As inflation will become very low again and growth will be very modest, despite the fall in the oil price, monetary policies in OECD countries are likely to remain highly expansionary.

c) Oil-producing countries that need a high oil price to balance their budgets (Russia, Venezuela, Iran, Chart 10A) will again face problems.

d) Pick-up in the dollar against the euro; it is well known that when the oil price is high, the dollar depreciates against the euro (Chart 11); this is in all likelihood accounted for by the fact that oil-producing countries invest a substantial part of their dollar-denominated oil revenues in euros.

To read the full report: OIL

>Indian mid-cap construction (MACQUARIE RESEARCH)

We spoke to managements of various mid-cap construction companies to discuss key issues. We are very positive on the space and believe the recent underperformance is an excellent accumulation opportunity. We think valuations are at very attractive levels of 10–11x FY11E earnings with a very strong order inflow cycle about to begin. The stocks have come under pressure due to shortterm issues like the Dubai credit crisis and statehood demand for Telangana.

Valuations extremely attractive with substantial growth: The mid-cap construction space has underperformed the broader indices recently and trading around 10x FY11E (adjusted for subs valuations) due to short-term irritants, despite we believe substantial growth opportunities beginning in FY11. Interestingly, most of these companies have recently raised equity financing, so the risk of dilution is also substantially reduced in the near term.

Near-term sentiment spoilers are temporary in nature: The issues like the Dubai credit crisis and a separate statehood issue in Telangana have created a dampener on stock prices. We strongly believe that these issues are temporary with no material impact and create an opportunity to accumulate these stocks.

Substantial structural opportunity to support long-term earnings growth: We expect order inflow in the infra space to strongly rebound in FY11 as governments get their acts together on sectors like roads, ports and continued push in power. In the near term, top-line growth will likely rebound in FY11. Roads, which were around 30% of order backlog, have reduced to close to 10–15%. Roads itself are likely to witness order inflow of US$10bn in FY11. Even without roads, the order backlog for the space remains healthy at 3x last year’s revenues.

Lower interest costs can provide upside to earnings estimates: Interest costs have reduced by 150–200bps for construction companies in 2H FY10, which have yet to be reflected in earnings. Recent fundraising will further help in lowering interest costs, which are not built into consensus estimates.

Subsidiary valuations are becoming material: For all the three companies, BOT (Build-Operate-Transfer) assets are getting commissioned gradually, which will start contributing to earnings while new BOT assets are being added to the portfolio, hence enhancing the size and valuations. Also, we believe valuations for all these companies’ real estate portfolios have
bottomed out and present upside to the valuations.

All three stocks seem attractively placed for the short and medium term: We like all the three companies at current valuations with near-term triggers in place. NJCC and PEC have near-term triggers in the form of Q3 FY10 earnings, while in the case of IVRCL, visibility on BOT revenues and the settling down of the Telangana issue will likely be the triggers.

To read the full report: INDIAN MID-CAP CONSTRUCTION


Privatization of container rail operations has enticed 16 players, including incumbent Concor, to the space since 2005. These players are eyeing 3% (97m tonnes) of the overall freight market by trying to shift volumes from road to rail. Operators can ‘create the market’ by offering integrated, value-added logistics solutions with last mile connectivity. However, to attain these capabilities and garner higher volumes, operators need to invest heavily in hard infrastructure. As the business entails a longer gestation period, scale and efficiency (utilization and turnaround times) are extremely critical to generate returns of 15%+ on capital employed. In view of their competitive strength, and thereby ability to attract volumes and drive strong earnings growth, we believe Concor, Arshiya and Gateway Distriparks (GDL) are well positioned to generate superior returns. Reiterate Overweight on the sector.

Integrated service offering to attract volumes to rail: While the number of operators appears high at 16, we believe there are enough volumes. With 500 rakes expected to be operational by FY12/13, players are eyeing only 3% (97m tonnes) of the overall freight market. However, volumes are required to be shifted from road to rail, for which operators have to offer timely, reliable and value-added services with last mile connectivity and customized solutions.

Returns linked to turnaround times and utilization levels: Container rail is a highly capital-intensive and long gestation business with hefty investments required in rakes (capacity) and rail sidings (cargo consolidation and value added services, etc) to attract volumes. Hence, asset turnaround time and utilization levels assume greater relevance for an operator to derive economies of scale and be profitable. Once an operator achieves critical mass, we believe it can earn RoCE of 15%+, which can be further augmented by offering integrated services.

Attractive valuations; Overweight: We believe operators need deep pockets to survive the long gestation period. In this context, Concor, Arshiya and GDL possess the competitive edge in terms of funding and strong infrastructure to secure higher volumes. Arshiya and GDL are fast attaining scale, and their rail operations are likely to turn profitable in FY11, supported by an expected upturn in the trade cycle. With 12-30% earnings CAGR over FY09-12E and attractive stock valuations, we are Overweight on the sector and Outperformer on the three stocks.

To read the full report: CONTAINER RAIL


1H’10 results uninspiring… Suzlon reported consolidated 1H’10 Sales -7.5%, EBITDA -88% and reported net loss of Rs10 bn vs. Rs2 bn loss in 1H’09. Costs were higher on increased fixed costs on new facilities (capacity ~2x to 5.7 GW in FY09-10) and lower WTG delivery volumes (-62% YoY in 1H’10 to 406 MW).

… but debt woes easing: Investors’ worries on high debt and its serviceability are easing as Suzlon sold Hansen’s 35.22% (of its 61.28%) stake to raise US$370 mn. The company has repaid US$780 mn worth of acquisition loans through combination of Hansen stake sale and refinancing from a new US$430 mn offshore facility from SBI. It may also convert promoter’s Rs12 bn loan to equity through preferential/ or rights issue (see Annexure I).

Global demand rising

Visibility improving; ~23 GW of wind capacity addition probable: Improving global economic scenario, continued policy support and higher credit availability has led to better order visibility for WTG companies. Developments over last 6M are promising- a) ~$1.7 bn cash grants have been infused in the system; b) MoM improvement in order inflow to 350 MW/month (from 150 MW/month in Aug) + large framework on-shore orders being placed (954 MW to REpower); c) ~700 MW wind projects commissioned after debt tie-ups. d) Gamesa estimates wind projects under development at ~23 GW, with ~2.2 GW projects to be ordered soon; and e) Iberdrola, EDP, Duke have not just raised wind capacity targets but also raised funds for future expansion (Exhibit 14).

Indian regulations bode well for Suzlon’s growth; market size may increase from 1.5-2x to 4 GW/pa: Regulatory changes in the form of new RE tariff norms (15.8% PT-ROE) and draft regulations for RE Certificates are a precursor to national RE Purchase Obligation (RPO), which has been agreed to by Forum of Regulators at 5% for 2010, & 1% increase p.a. till 2020. We think Indian markets will inch to 4 GW/p.a by CY’11 from ~1.5-2 GW/pa currently.

Price target lowered to Rs95; Maintain Buy: Post Hansen divestment, there is lack of clarity on Suzlon’s consolidated balance sheet. We have cut our estimates to factor in lower volumes; unconsolidated Hansen (considered as profit from associates) and introduced FY12E (Exhibit 18). We have changed our valuation methodology from DCF to a one-year forward PE multiple, and now value Suzlon Wind at 15x FY12E earnings, at a 25% discount to current peers’ average (20x), while REpower and Hansen are valued at 18x. We get a Mar’11 target price of Rs95 for fully diluted equity of Rs3,835 mn including Rs1.0 bn YTM for out-of-the-money FCCB. Maintain Buy as- a) we remain optimistic on recovery in wind taking lead from positive commentary by Siemens, REpower & Crompton; b) regulatory push & market expansion in India; c) easing debt concerns; and d) management’s focus to legally integrate REpower in FY11E.

Risks: Oversupply concerns in China and their possible global foray could lower WTG prices. 200 MW variation in volumes will vary earnings by ~7%.

To read the full report: SUZLON ENERGY