The reasons why the liquidity is likely to be invested again
Central banks are creating an enormous quantity of liquidity in their drive to support the economy, borrowers, banks, etc. The main question is to ascertain whether, as in Japan, this liquidity will remain unused and the deflationary equilibrium persist, or whether it will be invested again, probably in assets requiring no debt leverage, since the deleveraging is continuing, which also rules out a pick-up in credit.
We see three reasons why there is reason to believe that the liquidity will eventually be invested again:
1. American or European investors (savers) will probably not be prepared to receive a return on their savings (portfolio) that is permanently close to zero;
2. as central banks are also buying private assets, and not only public ones, the result will normally be a rise in the prices of these assets, which may encourage investors to buy them;
3. the surge in monetary bases can lead to a loss of confidence in money, and consequently a flight from money that will encourage savers to buy tangible assets, but not goods (in the hyper inflationary rationale of the past).
■ “Just a matter of time when new rollouts withdraw their promo/launch schemes” - Bharti not reacting with any tariff reductions : Bharti highlighted the pullout of freebies by Rcom in the first 90 days of their launch & sighted reasons that such freebies is not a sustainable model to lure subscribers over the long term. Engagement of such freebies over the longer term would impact the profitability of operator employing such schemes more than the incumbents.
■ Interconnection usage charge (IUC) cut may impact profitability marginally: The recent IUC cut from Rs 0.3 to Rs 0.2 effective 1st April 2009, would have a marginal impact in FY10 (~Rs 500m) which can be easily absorbed. However, the effect of such pass through’s by new rollouts in their aggressive schemes is yet to be seen.
■ Network operating costs (NOC) to stabilize with traction built up in Indus & Bharti Infratel: NOC has risen from 11.6 % of revenues in Q1FY08 to 16.3% in Q3FY09. This rise is attributed to higher energy costs and incremental rural rollouts. Management believes the NOC would start stabilizing or marginally come down in the next couple of quarters with increase in sharing of Indus & Bharti Infratel.
■ 3G auctions would be on top radar of new Govt., expects rollout in 3-6 months post spectrum allotment: Bharti expects the 3G auction by July 2009 with the new Govt. taking over. We believe that sooner the 3G spectrum auction concludes, better it would be for incumbents like Bharti (whose VAS revenues are close to mere 10% of ARPU).
■ Valuations: Bharti is expected to report revenue & EBIDTA CAGR of ~15% over FY09-FY11 period. Superior subscriber profile, healthy balance sheet, higher visibility of cash flows and absence of Mobile Number Portability (MNP) regime places Bharti as our top pick in the sector. Moreover, with ~91m wirelesssubscribers, Bharti would continue to demonstrate leadership in plans innovation and leverage the scale benefits.
■ Conclusion — We believe the knee-jerk reaction in the Glenmark stock to the US FDA warning letter requiring the company to stop selling three products (all morphine based) is overdone. The impact on financials will be minimal, in our view, and the issue is not reflective of any quality or manufacturing problems.
■ FDA clamps down on unapproved drugs — The FDA has issued warning letters to 9 firms (incl. Glenmark), asking them to stop marketing certain unapproved narcotic pain medicines. The letter to Glenmark relates to formulations of morphine sulphate (15 & 30 mg tablets, 20mg/ml & 20mg/5ml solutions). The FDA allows 60 days to stop manufacturing & 90 days to stop all shipments.
■ Not company specific — This is part of the FDA’s attempt to clamp down on drugs that have not gone through the proper approval process. These drugs are usually ones launched prior to 1938 (categorized as “grandfather drugs”) before the establishment of the current approval process. In June '06, the FDA issued guidance on its stand on the unapproved drugs & the steps it intended to take in regard to this matter. These warning letters are a part of that process.
■ Small products, marginal impact — As per management, the products in the warning letter have revenues of cUS$1m (<1%>
■ Could there be more? — This is an ongoing process & there may be other products that could be affected in future. It is, however, difficult to determine the exact impact although it is unlikely to be material.
London - Future International Monetary Fund gold sales are unlikely to depress the price of gold because central banks seeking to diversify U.S. dollar would be likely buyers, as recent data shows.
The G20 concluding statement this week said the IMF is going to raise $50 billion for low-income countries and part of that money is proposed to come from IMF gold sales.
IMF Managing Director Dominique Strauss-Kahn said the sales refer to the 403.3 metric tons already under discussion and still subject to U.S. congressional approval. No further sales were planned, he said.
Gold prices initially fell 3.5%, dipping below $900 a troy ounce, on Thursday's statement but, were the sales to go forward, analysts said they would be slow, orderly and absorbed by central banks.
"Central banks such as those in China, Russia and Japan are obvious counterparties to this kind of sale," Morgan Stanley analyst Hussein Allidina said.
Allidina said those central banks could diversify their large U.S. dollar holdings and buy IMF gold off-market, therefore limiting the affect on gold prices on the spot and Comex market.
The IMF has in the past sold gold to members off-market. For example between 1999 and 2000 the IMF sold 12.9 million ounces to Mexico and Brazil in authorized off-market transactions, some of which was sold back to the IMF.
The IMF has 3,217.30 metric tons of gold reserves, making it the world's third largest official holder of gold behind Germany and the U.S.
Like the U.S. and the Bank for International Settlements, the IMF adheres on an informal basis to the Central Bank Gold Agreement, a pact between 17 European central banks to sell no more than an agreed 500 tons of gold - worth about $14.5 billion at current market prices of around $900 a troy ounce - between them each year. The current five-year agreement ends Sept. 26 and analysts expect a new one to be negotiated.
Before any IMF sale happens, 85% of the fund's shareholders need to approve the proposal. Since the U.S. has 17% of the votes, it has a de facto veto over the proposal.
There are strict rules over how gold would be sold by the IMF - on its Web site, it says approval to sell gold would be granted only if the sale could be conducted in a way to minimize disruption to the gold market.
"The market managed to absorb CBGA sales and still move higher," said Philip Klapwijk, head of U.K.-based GFMS Metals Consulting.
European countries that are signatories to the Central Bank Gold Agreement have sold 80 metric tons of gold since the end of September 2008, when the final year of the agreement began, according to data in March.
"IMF sales don't necessarily mean trouble as long as investors continue to buy. It could also be attractive to central banks with large U.S. dollar holdings," Klapwijk said.
Recent data for central bank gold holdings from the World Gold Council shows there is interest among central banks to increase the percentage of gold in their foreign reserves.
In the first quarter of 2009, Russia's gold holdings rose by 29.8 tons to 523.7 tons at the end of March. Gold now makes up 4% of the country's total foreign reserves, from 2.2% at the end of 2008, the WGC data shows.
Russia's Alexei Ulyukayev, first deputy chairman of the Bank of Russia, said February the bank plans to continue buying gold to increase the proportion of reserves held in the metal.
Russia is not the only possible gold buyer. Ecuador's gold holdings more than doubled in the first quarter of 2009 reaching 54.7 tons from 26.3 tons at the end of 2008. This took gold as a percentage of foreign reserves to 31.6%, from 9.8% previously.
And in the same time period, neighboring Venezuela saw its gold holdings rise from 356.4 tons to 363.9 tons, or from 23.4% of its total foreign reserves to 35.5%, the data showed.
Were the 403.3 tons, or about 12.9 million ounces estimated at around $11 billion, of IMF gold sales to happen, it wouldn't be the first time the fund sold gold, nor the most it has sold. Klapwijk said in the 1970s, when the fund sold gold, prices remained fairly strong.
"When the IMF does sell gold it means things aren't going well, so a lot of people want to buy it," Klapwijk said.
Concerns about paper currency have also fueled interest in the precious metal and both Russia and China in recent days have called for the diversification of reserve currency, away from the U.S. dollar.
UBS analyst John Reade said he expects the gold sales to be approved and for them to happen over a two- to three-year period.
"In the current environment an additional 100 tons or 200 tons of gold sales per annum are almost insignificant compared to the changes taking place in investment," Reade said, maintaining UBS' forecast for gold to average $1,000 an ounce in 2009.
Cadila Healthcare entered into an agreement with the US-based pharma major Eli Lilly for the discovery and development of drugs in the area of cardiovascular research. Under the agreement, Lilly would have an option to license any resulting molecules at different stages. Cadila Healthcare would receive potential milestone payment of up to $300 million and royalties on sales upon the successful launch of any compounds. The exact impact on earnings will not be ascertained because of lack of information. However, we view this development as positive for the company as it demonstrates the R&D capabilities of Cadila Healthcare. We reiterate our Buy rating on the stock with a target price of Rs339.
R&D pact with Eli-Lilly Cadila Healthcare will be responsible for identifying potential drug candidates and developing them through to Phase II Human proof-of-concept. Lilly will provide the potential molecules and expertise and feedback for clinical, regulatory and research work. Collaborative research program may continue for a span of up to six years. Cadila Healthcare would receive potential milestone payment of up to $300 million and royalties on sales upon the successful launch of any compounds derived from the research program.
Impact on Cadila Healthcare Management has not disclosed the exact details of the deal in terms of financial implication and how and when company will get milestone payments, etc. However, seeing the potential milestone payment, we believe that this is a risk-reward sharing kind of a deal where Cadila Healthcare will be working with innovators as a development partner. Cadila Healthcare will bear the pre-clinical and early stage (Phase I & II) development cost, while the partner is responsible for late stage development. Inlieu of this, Cadila Healthcare will get milestone on successful competition of each stage and percentage royalty of global sales. Milestone amount will be higher in the later stage. We expect Cadila Healthcare to start work on this project from FY10E onwards.
■ Cash levels at Asian funds rose 90 bps from 3.4% to 4.3% last month — Comparing this with the average of last 15 years, it is 90 bps higher. With the strong technical rebound over the past 3 weeks as well as the resumption of inflows, we believe that Asian funds may have put some money back into stock markets this month, as they did in Dec for the year-end rally. In this regard, current cash weights are likely to stay around the historical average. At the bottom of bear markets, cash tends to be well above average.
■ It's all about China again — China ties Singapore as the most overweight market at Asian funds, the first time ever for China. Global funds have gone neutral on China and their country weight is now at a record high 2%. Meanwhile, GEM funds’ underweight in China has narrowed to the smallest in two years.
■ Early signs of GEM funds narrowing their underweight position in Asia ex — GEM funds are 460-bp underweight Asia versus 540bps in November 2008. The last time GEM funds went overweight this region was in 2003, and it took 13 months for them to move from a 450bp underweight to +35bp overweight.
■ Investors becoming skeptical with regional markets up 23% from March low — In the week ended March 25th, new money going to offshore Asian funds dropped to just US$78m versus US$409m in the week before, according to the EPFR Data. Rotation back towards commodity/material plays seems underway as GEM funds have taken in US$2b, the most in three months.
Gujarat State Petronet (GSPL) has borne the brunt of adverse developments such as 30% profit sharing with the Government of Gujarat, delay in arrival of KG gas (due to the Gas Allocation Policy), execution risks of new pipelines and deteriorating fundamentals of the Spot LNG markets. As a result, the GSPL stock witnessed a steep 66% correction on the bourses from its highs. Nonetheless, we expect the company to remain on high growth path with concerns receding on the economics of Spot LNG and KG gas expected to flow during the year. We have arrived at a Fair Value of Rs42 (at a higher cost of Equity of 17%) from Rs80 for the stock factoring in the 30% profit sharing (barring which our Target Price would stand revised at Rs60) and assumption of backended volume growth. We recommend an Accumulate on the stock.
■ Deeper connectivity and Exclusivity in Gujarat: A strong industrial base, a developed gas transportation infrastructure and better connectivity with the end consumers have led to a steep increase in demand for natural gas in Gujarat. GSPL, being the largest gas transporter in the state, stands to benefit from the same.
■ Increasing Transmission volumes to improve fundamentals: We believe that GSPL is the best play on the improving gas supplies in the country. Robust Spot LNG dynamics, increase in re-gasification capacity at Dahej, Hazira and commissioning of the new R-LNG terminal at Dabhol are likely to provide an opportunity to GSPL to transmit additionalR-LNG volumes going ahead. RIL is also likely to start production from its KG-D6 block next month, which will augment GSPL’s volumes during the latter part of FY2010. Overall, we estimate GSPL's volumes to increase significantly in FY2010E posting a robust CAGR of 20.2% over FY2008-10E from 16.8mmscmd to 24.7mmscmd.
■ Negative developments, major Execution risks factored in: Various negative developments such as 30% profit sharing with the Government of Gujarat, uncertain volume outlook and Execution risks involved in building and capitalisation of new pipelines are largely factored in and thus, limiting further downside from current levels.
Break in the weather? A lull in the US economic storm
■ There may be relief in the short run ■ Consumption and housing stabilizing, government spending ramping up ■ But the financial system and wealth losses remain longer-term threats
The economy and financial system remain fragile but there are signs that in the short run at least, real GDP will return to positive growth from as early as the second quarter. Consumption and housing are showing firmer signs of stabilization, while the government spending ramp-up, together with some tax cuts, will shortly enter the growth mix. After falling heavily in the second half of last year, there are actually signs that consumer spending will be positive as early as the first quarter.
Meanwhile, new home supply is now at its lowest since 2001/2002, suggesting the new home inventory overhang is gone. Existing home inventory is still an issue given that the rate of foreclosures is still high, but we think its ability to further push down homebuilding is just about over, and that will end the drag on GDP that has been averaging about 1% annualized per quarter over the past couple of years.
Inventories will probably stop being a drag on growth, and start being a contributor from the second quarter, as inventory liquidation slows.
But it’s not all good news, because capital spending, exports, and profits are likely to keep falling for a good few quarters yet at quite a rapid rate. And the return to positive GDP growth is going to be a ‘jobless recovery’ for a while, sending the unemployment rate to over 9%. This is likely to see core PCE inflation fall to nearly zero by the end of 2010, so we expect the deflation fears to persist and intensify, despite the Fed’s continuing to rapidly create money out of thin air and expand its balance sheet.
In addition, it is far from clear that the Treasury Secretary’s latest plan to heal the financial system will work. If not, then 2010 could see the economy do a double-dip into recession again. But over the next few months, sentiment on the economy may improve for the short run.
■ Where will NPL’s go? It’s a tough one — a) We say 4% (2.3% currently); b) Analyst estimates range from 3-6%; c) Banks don’t have a fix on numbers – but all suggest a meaningful escalation; and d) Historical peak is 25%. We don’t believe anyone has the answers – but we pose questions, and try to answer them.
■ When will book values erode? At 9% NPLs — The sector breaks even at 8.7% NPL levels – to reach this level NPLs will have to rise 4.5x current levels. We believe this scenario is still far off and therefore unlikely to play out. However, NPL range for individual break-evens is quite wide (between 6-27%).
■ How much do earnings get impacted? 20% for every 1% rise in NPLs — With every 1% rise in NPLs: a) Earnings are hit about 20%; b) Assuming 50% loss rate, charge-offs rise 100bps; c) ROEs decline by 2.5ppt; and d) Book values are pulled down by 2.5%. We currently factor an avg 130bps of credit charges.
■ What happens if NPLs rise to 7%? — 7% is above the highest end of current street estimates and can be seen as a potential stress case. At 7%, NPLs will rise to 3.5x of current levels and will result in: a) Sector earnings declining 73%; b) Banks still make some returns, albeit a low 4%; c) Book values are still 6% higher than current levels; and d) Loan losses rise to 310bps (2.5x current levels).
■ What about restructuring loans? — It does complicate reporting and makes it harder to gauge the underlying health of assets; leads to an understatement of reported NPLs (will likely be lower than our estimates). In our 4% sector NPL estimates, we implicitly assume 20-30% of restructured assets turn into NPLs.
■ Who are the most exposed? Government banks, ICBK, Axis — Government banks in general are more vulnerable to rising NPLs: a) Will erode book earlier (8% NPLs vs 11% for private); and b) Have more earnings impact for each 1% rise in NPLs (21% vs 17%). CBI and Canara are the most vulnerable; SBI the least (most earnings cushion). ICICI is more exposed from an earnings perspective. It "only" needs a trebling of NPLs before earnings are wiped out but has a much larger capital cushion – a 1% rise in NPLs impact book value by 1.5% (2.5% avg). After ICBK the largest impact on earnings is felt on Axis (among private banks).
■ Concerns might be overdone; remain overweight — We expect NPLs to rise meaningfully and remain an overhang. However, we believe concerns might be overdone and possibly factored into stock prices. Maintain overweight on banks.
Stock Update >>Dishman Pharmaceuticals and Chemicals
WOCKHARDT
Revenues for the quarter are expected to move up by 17.6 % to Rs 8961 mn. The main revenue drivers are expected to be domestic formulations and formulations exports driven by traction in US. Margins for the quarter are expected to be lower from 24.9 % to 22.1 % for the quarter. Higher staff costs and other expenses have been the main reason for the decline in margins on account of new acquisitions. Profits for the quarter are expected to to be lower at Rs 719 mn for the quarter after accounting for forex losses of Rs 338 mn.
The company has yet to leverage its assets in regulated markets and biotech facilities getting scalability. We believe the FCCB redemption is a foregone conclusion. We have removed equity dilution from our model and factored redemption of the FCCB which would involve around Rs 7.3 bn which has been factored in increased loans in CY 09. We have factored interest rates on the new loans at 14 % for the CY 09. We have also reduced revenue estimates by 7.2 % for CY 09 on account of lower traction in regulated markets especially UK, France and Germany. We reduce our EPS estimates by 9.76 % to Rs 22.5 for CY 08E and by 38 % to Rs 22.3 for CY 09E. As a result of downgrade in earnings we downgrade our price target by 50 % to Rs 100 based on 4.48x CY 09E. The stock would continue to face weakness till clarity emerges on the FCCB repayment. We downgrade our rating to Outperformer on the stock.
Dishman Pharmaceuticals and Chemicals
We are reducing our revenue and earnings estimates for FY09 & FY10E mainly on back of removal of revenues estimates for two breast cancer products of Carbogen Amcis (CA) business and one anti-cholesterol product of Solvay's Vitamin D & chemicals business due to possible delay in launching of these products. In addition, the company management has indicated that there will be a shortfall of Solvay's Eprosartan Mesylate revenues for 4 months from January 2009 to April 2009. We are also introducing our FY11 initial estimates for Dishman Pharmaceuticals and Chemicals (Dishman). Despite downward revision in revenue and earnings estimates for FY09 & FY10E, Dishman is set to grow at a double digit for the next two to three years mainly on back of its strong innovator client relationships, expansion of existing contracts and addition of new contracts in pipeline. The stock is currently available at attractive valuations at PE of 10.9x on FY09 and 6x on FY10E diluted earnings basis. We maintain 'BUY' rating with the price target of Rs.155 leaving upside of 58% from current levels for next one year time frame.
Adequate revenue flow from the CRAMS segment despite temporary setback from breastc cancer products: We are marginally downgrading our Contract Research and Manufacturing Services (CRAMS) revenue estimates by 2% to Rs.7.37bn in FY09 and by 8.7% to Rs.8.67bn in FY10E due to shortfall of 4 months revenues from Eprosartan Mesylate in Q4FY09 and removal of revenue estimates for 2 breast cancer products (US$5mn in FY09 & US$10mn in FY10E). The high margin CRAMS business that contributes more than 70% to total net revenues, expects to grow at a CAGR of 17.8% from FY08 to FY11E mainly on the back of consistency in revenue flow from base business of CA segment and Solvay.
Wider innovative client base to act as cushion for CRAMS business: Dishman has currently got predominant presence in the global CRAMS market by maintaining long lasting relationship with global pharmaceutical innovator clients. By reducing dependency from single client (current ratio between Solvay to Non Solvay- 20:80), Dishman has expanded its client exposure to key global pharma majors like AstraZeneca, Boehringer, Ferro Corporation, GSK, J&J, KRKA, Merck, Nippon Gosai, Novartis, Pfizer, Sanofi Aventis and Sepracor.
Implications From Conference Call With Pakistan's Lucky Cement
■ Conference call with Pakistan's Lucky Cement — We hosted a conference call with Mr. M.A Tabba, CEO of Lucky Cement, one of Pakistan's largest cement companies by capacity, to get a better sense of export trends. India and Pakistan have some common export markets. Mr. Tabba's comments about cement supply-demand dynamics, pricing trends and export potential suggested that there would be keener competition in export markets, export realizations could fall 15-20% and cement exports from Pakistan to India could dry up in FY10. His views were largely in line with ours.
■ Changing trends in cement export markets — Mr Tabba expects Pakistan cement exports to be 10m tonnes in FY09-10 − 30% by land to Afghanistan and 70% by sea to the Middle East and Africa. India is no longer a viable export market for Pakistan due to low domestic prices and the drop in the Indian rupee. Demand growth for cement exporters is expected to come from Iraq (reconstruction), South Africa (ahead of the Soccer World Cup) and Africa (rising per-capita income in commodity-intensive economies), compensating for likely declines in Oman, Qatar, Abu Dhabi and Dubai.
■ Weak outlook for export pricing — The biggest worry is cement pricing in export markets. Exports are likely to face stiff price competition once new capacities are commissioned in Saudi Arabia, Iran and India. The industry expects the average export price for FY09 to be US$50-55/t and forecasts a decline to US$42-47/t in FY10. Lower prices would adversely impact large cement exporters in India, such as UltraTech Cement and Ambuja Cements.
■ Pakistan has cement surplus — At 38m tonnes of capacity and domestic demand at ~20m tonnes, Pakistan has large surplus for exports. We expect a surplus in India as well due to the completion of several large projects in CY09. As exports may not be a viable route to deflect oversupply, it would add further pressure on domestic prices in India.
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