Friday, June 26, 2009


Higher capex in KG-D6

Niko’s FY09 annual results disclosures reveal a 23% increase in the Phase-1 oil and gas development cost at KG-D6 to US$8.2bn. Gas production is currently at 28msmcmd and Niko expects this to reach peak of 80 by Dec-09; we model a Jul-10 peak. It also expects to receive approvals for the developments of the nine satellite fields in KG-D6 and for the six discoveries in NEC-25 in FY10 but is still targeting MN-D4 drilling only in mid-2010. Overall, the disclosures yield little incremental information on the three blocks that it co-owns with Reliance, though.

A 23% increase in Phase-1 oil and gas development costs in KG-D6. Niko’s FY09 annual results disclosures reveal a 21% increase in the Phase-1 project cost of the D1-D3 gas development to US$6.3bn (from US$5.2bn earlier). This indicates that overall project costs could be ~$1.5-2bn higher than the US$8.8bn (to be spent by FY12) indicated in Reliance’s 2006 development plan. In addition, the capex for the MA oil project has also increased to US$1.9bn (ex of FPSO which may cost US$0.7bn) from US$1.5bn earlier. The consortium has spent US$4.8bn on the gas project by end-FY09 and US$1.2bn in the oil project; we expect the rest to be spent in FY10.

Niko expects peak gas production by Dec-09. While Niko is silent on current MA crude production, data from India’s Ministry of Petroleum indicate that field produced 10kbpd in May. Niko expects MA to reach 38kbpd by end-FY10. Niko’s impairment test assumptions also indicate that pricing for MA oil could settle at a 10% discount to Brent. KG-D6 gas production is currently at 28mmscmd; Niko expects peak of 80 by Dec-09. We continue to model in 80 by Jul-10 as full production is contingent on completion of Gail’s pipeline expansion projects; these are likely only by 4QFY10. Overall, we model 43mmscmd in average for FY10 (Niko guidance of 50, estimates submitted to the government of 62-74); every 10mmscmd adds 5-7% to EPS.

MN-D4 drilling likely only in mid-2010. Reliance also drilled three successful wells in KG-D6 in FY09 with key discoveries in the Pleistocene (L1) and near the 2tcf R1 prospect besides one successful well in NEC-25. Reliance is currently drilling two more exploration wells in KG-D6 and one appraisal well in NEC-25 but exploratory drilling in the key MN-D4 block is unlikely before mid-2010 as it had guided for earlier. Niko also expects to receive approvals for the developments of the nine satellite fields in KG-D6 (US$5.9bn capex, 2.2tcf recoverable) and for the six discoveries in NEC-25 in FY10.

No reserve/resource disclosures. Overall, Niko’s disclosures yield little incremental information on the three blocks that it co-owns with Reliance. In particular, it did not provide disaggregated reserves/resources updates. Higher disclosure or intensive drilling is key for Reliance’s stock; especially as we expect refining/petchem margins to remain soft. We are downgrading FY10-12CL EPS by 2-4% to factor in the higher capex in FY10 (higher DDA, lower other income) and the deeper 10% discount for MAoil. We also reduce our fair value estimate by 1% to Rs1,925/sh but note that this does not factor in the potential Rs160-225/sh impact of the RNRL court case ruling.

To see full report: RELIANCE INDUSTRIES


At an inflexion point

Key points

Operating performance to get a boost: IDBI Bank, which had been operating on a wafer thin net interest margin (NIM) of around 1% in the past, is expected to see some improvement on the margin front, as ~69% of its deposits are likely to get re-priced at lower rates in the current fiscal. The bank is also substituting its high-cost borrowings with deposits in order to contain its cost of funds. Not only that, it has also stepped up efforts to increase the share of its high-yielding retail loans. Thus, the bank’s operating performance is expected to improve in FY2010 even in the face of challenges like low CASA and weak margins.

More impetus from capital infusion: At 11.6% IDBI Bank’s capital adequacy ratio is above the regulatory requirement but lower than the preferred level of 12%. Since the bank evidently has little room to grow its balance sheet without raising capital, the government proposes to infuse capital into it. A capital infusion will be a major catalyst for the bank as it would facilitate the bank’s efforts to achieve higher growth and profitability, and thus lead to the re-rating of the stock.

Investments, the hidden wealth: What’s more, the bank’s huge portfolio of quoted and unquoted investments could be another major source of funds when needed. The bank could unlock value from these investments and boost its profitability. Some of the companies in which IDBI Bank holds a significant stake include NSE, LIC, IDFC, IFCI, NSDL, CARE, ARCIL and SIDBI. These major investments collectively contribute about Rs42 to our SOTP valuation of the bank.

Attractive valuations: IDBI Bank is expected to improve its core business gradually as its NIM expands from 1.06% in FY2009 to 1.3% in FY2010 on a conservative basis. We expect the bank’s RoE (excluding revaluation reserves) to increase from 12.1% in FY2009 to 13.8% in FY2010 and to 14.3% in FY2011. At the current market price of Rs106, the stock is trading at 5.8x its FY2011E EPS, 0.8x its FY2011E BV and 1.0x its FY2011E ABV. We have valued IDBI Bank using the SOTP valuation method as per which its core business of banking is valued at Rs118 per share (at 1.1x its FY2011E ABV). Considering this along with the value of the bank’s investment portfolio and subsidiaries we arrive at a price target of Rs169 over a period of 12-18 months. This implies an upside of ~60% from the current levels. We initiate coverage on IDBI Bank with a Buy recommendation.

To see full report: IDBI BANK


Mantra for retail success in India – Read between the lines of consumer spending patterns!
Retail performance is fundamentally affected by the consumer’s willingness and ability to spend.

The Achilles' heel:
Weak Demand = Slowdown in new store roll-outs; restructuring to infuse cost efficiency of existing stores.

Drop in Footfalls = Slowing Same Store Sales = Lower Inventory Turnover = Higher Working Capital = Liquidity Pressures

The Opportunity – A Sunrise Sector!
Despite the current headwinds, well positioned to leverage revival in consumer demand emanating from a stable government; anticipated change in regulatory policies and fall in reality prices

The story line seems all wrong but ……..
“Standing on the threshold of a retail revolution and witnessing a fast changing retail landscape, India is set to experience the phenomenon of a global village. India presents a grand opportunity to the world at large to use it as a business hub. A ‘Vibrant Economy’, India tops A T Kearney’s list of emerging markets for global retailers. The 2nd fastest growing economy in the world, the 3rd largest economy in terms of GDP in the next 5 years and the 4th largest economy in PPP terms after USA, China & Japan, India is rated among the top 10 FDI destinations.”

- Source: India Retail Report 2007

The level of exuberance was high for an industry that had worked wonders in developed markets. An opportunity to grow exponentially was seen with India being the favored destination for retail – a growing population; good demographics, under-penetrated modern trade. What went wrong for an industry projected as the “sunrise sector” to fall out of favour for both consumers and investors? Was it a case of “too much too soon” or was it “not understanding the Indian consumer psyche combined with a general global slowdown”? The optimism of the last two years seems to have died down burdened by the woes hitting the industry – was it misplaced optimism or are there some hidden jewels that will shine in the future?

The retail industry, tagged as a sunrise sector on the Indian landscape 3 or 4 years ago was expected to emulate the retail revolution of the west. Now the long-term opportunity for modern trade in India, due to the current economic turmoil amongst other things, is being questioned. The road ahead for modern trade in India will be exemplified by a period of painful restructuring. Mergers, regulatory changes, acquisitions and consolidations will be the forte going ahead and only a few big players will survive the current chaos.

The Retail Opportunity in India
The uniqueness of the organised retail revolution in India has been exemplified by the wide demographic consumer spectrum it caters to. Formats had been created to achieve maximum operational efficiency and augment profitability when targeting an identified consumer category.
India has tremendous potential in Modern Trade with a highly under-penetrated organized retail market - 4% of the total retail sales US$ 322 bn (2006) as per the study conducted by ICRIER

Retailers were extremely enthusiastic to leverage this nascent opportunity. The last few years have witnessed retailers funding their expansions through the equity route with Vishal Retail, Koutons and Provogue hitting the equity markets with their primary offerings. Trent had a rights issue whilst Pantaloons and Indiabulls undertook private placements. Retailers increased their use of equity and debt financing. Internal accruals which were previously used to finance close to 30 per cent of retailers funding requirement fell to a mere 12 per cent, leading to gradual increase in gearing and borrowing cost.

To see full report: RETAIL SECTOR


On Friday, 26th June 2009, the NSE will adopt the free-float method to calculate its benchmark indices from the existing full-float market capitalization method. This is expected to result in significant reshuffling of portfolio by fund managers of index fund in order to align their existing portfolio to the free-float methodology.

Under the Free-float methodology, market capitalization is calculated by taking the share price and multiplying it by the number of shares readily available in the market. Instead of using all of the shares outstanding like the fullmarket capitalization method, the free-float method excludes locked-in shares such as those held by promoters and government.

The free-float method is seen as a better way of calculating market capitalization because it provides a more accurate reflection of market movements. When using a free-float methodology, the resulting market capitalization is smaller than what would result from a full-market capitalization method.

Effect on components: L&T – biggest gainer, ONGC – biggest loser

Stocks which are expected to see its weightages coming down are ONGC, NTPC, Sail, Bharti Airtel, TCS, Power Grid, Wipro, DLF, Reliance Power, Wipro, BHEL etc. due to lower free float. However, Infosys, ICICI Bank, L&T, HDFC and HDFC Bank will stand to gain from this change as their weights will almost double from their current levels due to higher free float.

Impact on sectors- Banks, Engineering to gain the most

Sectors benefiting the most are Banks (weightage to increase from 11.25% currently to 17.24% post changes), followed by Engineering (weightage to increase from 3.26% currently to 7.50%), Cement (from 1.80% to 2.60%), Auto (from 3.63% to 4.35%), IT (from 9.10% to 10.10%). Sectors worst affected are Oil & Gas (from 9.68% to 3.78%), Power (11.98% to 6.09%), Telecom (9.45% to 7.41%), Metals (7.88% to 6.31%) & Real Estate (2.70% to 1.71%).

To see full report: NIFTY


Fairly valued

GSFC saw 245% rise in Q4FY09 PAT to ~Rs984mn vis-à-vis ~Rs286mn in Q4FY08, higher than I-Sec estimates. This was owing to: i) benefit of ~Rs548mn in fertiliser division, pertaining to prior period and ii) Rs580mn excise reversal on GSFC winning an old litigation. Adjusting for these one-time items, overall results were inline with our estimates. Caprolactum division saw loss for a consecutive quarter, of ~Rs209mn, mainly owing to weak demand, given global slowdown in auto industry. DAP business significantly gained from the change in fertiliser policy in FY09, which allows import parity pricing. GSFC saw ~109% rise in FY09 PAT to ~Rs5bn, which is unlikely to sustain. We downgrade our earning estimates owing to: i) considerable fall in international DAP prices that would impact revenues ii) loss in caprolactum business iii) inventory- & high raw material costrelated pain impacting DAP business in H1FY10. Our SOTP evaluates GSFC at Rs163/share (Rs168/share earlier) based on: i) core business valued at Rs132/share, assuming FY10E P/E of 7x on adjusted EPS & ii) investments at Rs31/share. The stock has already outperformed and risen 128% since January’09 that we believe fairly valued; downgrade to hold.

GSFC may require contributing 30% PBT for social development fund from FY10. Although GSFC has not yet contributed the required 30% PBT towards Gujarat government’s social development fund in FY09; this may happen FY10 onward

Pain in DAP business expected in H1FY10. We expect FY10 revenues to decline, in line with fall in international DAP prices. Inventory write-down and temporary price mismatch may lead to pain in H1FY10 in DAP business.

Caprolactum business may not revive in short term. Uncertainty in the global auto industry has made an impact on caprolactum business demand; however, cheaper input prices have helped the company limit losses.

Stock outperforms – 128% returns since January ’09; downgrade to HOLD. We downgrade our FY10E EPS ~18% owing to issues in the DAP and caprolactum businesses. We value core business at FY10E P/E of 7x on adjusted EPS and investments at Rs31/share based on market value. The stock has outperformed since January ’09 and, we believe, is fairly valued at current market price. Downgrade to HOLD. Key upside risk to our call is GSFC not requiring 30&% PBT contribution to the social development fund.

To see full report: GSFC


We had initiated coverage on GNL on May 29, 2008 at a price of Rs.125.05 and recommended to accumulate on dips to Rs.106-110 band for a target of Rs.154. The stock subsequently made a high of Rs.133 on June 13, 2008. The stock later underperformed in line with the other small/midcaps and touched a low of Rs.70 on March 06, 2009. It later recovered and made a high of Rs.126 on June 03, 2009. Currently, the stock is quoting at Rs.101.80.

Company Profile:
Grindwell Norton Ltd. (GNL) came into being when a technical collaboration in 1967 between Grindwell and the then world leader in abrasives – Norton Company, USA, grew into a financial collaboration in 1971. GNL is a 51.3% subsidiary of Saint Gobain (SG) of France and India’s leading manufacturer of Abrasives (bonded, coated and super abrasives), Silicon Carbide and High Performance Refractories.

Q1CY09 Result Update
GNL recorded a 2.9% degrowth in revenues on a Y-o-Y basis in Q1CY09 and 2.3% fall Q-o-Q at Rs.114.3 cr. This was mainly on account of sharp fall in volumes and value of each of GNL’s products. Bonded abrasives witnessed fall of 15-20% in volumes, coated abrasives saw a fall of 5% whereas thin wheels volumes improved by 5% in Q1CY09. Performance Plastics and refractories also witnessed a volume degrowth of 10% and 15% respectively. However, the others division, which accounts for revenue from the Project Engineering has done well during the quarter.

The total expenditure fell by 3.3% Y-o-Y and by 3.8% Q-o-Q. Raw materials and staff cost have risen 250 bps and 150 bps respectively as a percentage of sales in Q1CY09. Staff cost increased on account of 6% hike in salary and higher wages post settlement been paid at one of GNL’s plant. Power and fuel cost has dipped by 170 bps Y-o-Y and 220 bps Q-o-Q as a percentage of sales. With the full-fledged commencement of operations at the Bhutan Plant in July 2009, the power and fuel cost could further see a dip on consolidated basis, which could ease the pressure on the margins. Other expenditure has dipped to 18.6% as a percentage of sales. Although the sales have dipped, control in costs have led to margin expansion by
40 bps Y-o-Y and 140 bps Q-o-Q to 14.3%.

Despite the benefit of excise and income tax for 5 years at the HP plant, GNL continues to pay 31% tax rate as the plant hasn’t been fully utilised. GNL has managed to keep its PAT margins at the same level of 10.4% in Q1CY09. During the quarter, GNL earned an EPS of Rs.2.1, down by 5.7% Y-o-Y and down by 4% Q-o-Q.



The centre of gravity of the global economy and for large corporations is being transferred to Asia at an increasing pace

We believe that the centre of gravity of the global economy and for large corporations will move - at a more rapid pace after the crisis - towards Asia, which includes China, India and other Asian emerging countries (but not

Japan directly):

- the growth gap between Asia and large OECD countries (United States, Europe, Japan), will widen further, which is likely to give rise to a new wave of offshoring to Asia and rapidly increase the weight of Asia in the global economy and in global trade;

- the vigorous growth in Asia will gradually drive up commodity prices, which will generate a new weakening in growth in large OECD countries;

- the necessary savings, be it to finance fiscal deficits or the needs of companies and banks in large OECD countries, will increasingly come from Asia, and this will gradually increase the weight of Asia in financial markets and in terms of company ownership.

To see full report: FLASH ECONOMICS


Dividend is king?

We analysed 82 companies with market cap of over US$1bn on trend in dividends in FY09 and see if there is any correlation with stocks performance. Interestingly in a year when profits grew by only 6% (for this universe), 42 companies declared higher dividend/ share than in

FY08 and only 23 companies declared lower dividend. Of the companies that declared a higher dividend, 79% have outperformed the Sensex in the last one year. In the same period, 57% of companies that have declared lower dividends have underperformed the Sensex.

Over the last one month, 33% of the 43 companies have underperformed the Sensex, but only 17% of the 24 companies underperformed the Sensex. The above indicates that in uncertain times companies expected to pay higher dividends will likely outperform and as risk appetite returns, as in the last one month, a higher proportion of companies that have paid lower dividends, but may have more exciting “stories” and potentially higher risks, tend to outperform. The average outperformance for companies that increased dividends was 29% over the last one year and 14% in the last one month. In uncertain times, dividend it seems is indeed the king.

We looked at companies with market cap of US$1bn

Of the 82 companies with market cap of over US$1bn, 42 companies have declared higher dividend/ share in FY09 vs FY08, 23 companies declared lower dividend.

Financials, particularly PSU banks, have declared higher dividends in FY09. Consumer, utilities and healthcare companies are other sectors where many companies have declared higher dividends. Materials, industrial and 4-wheeler companies have declared lower dividends.

It is interesting to note that in a year of uncertainty and slowdown, over 59 of the 82 companies have declared higher or unchanged dividend, a likely pointer to the fact that the outlook within India is not very gloomy.

Stock performance vs dividends

79% of companies that declared higher dividend have outperformed the Sensex in the last one year and the average outperformance was 29%. The nine stocks that underperformed had an average underperformance of 12%.

On the other hand, 57% of the companies that declared lower dividends underperformed the Sensex over the last one year and the average underperformance was 15%.

The trends over the last one month are equally interesting. Of the companies that have declared higher dividends, 33% underperformed the Sensex, but only by 6%, whereas the 67% that outperformed, had an average outperformance of 14%.

Of the stocks that have declared lower dividends, only 17% underperformed the Sensex in the last one month by 6% on an average. The 83% stocks that outperformed had an average outperformance off 13%, not very different from the basket of stocks that declared higher dividends.

We believe that in uncertain times, stocks that are likely to maintain or increase their dividends are likely to do better over a longer time period. In the short term, even as risk appetite returns, the average performance of companies that declare higher dividends is comparable to the presumably riskier universe of stocks that have declared lower dividends.

To see full report: MARKET STRATEGY


Evaluating synergies on potential Bharti-MTN deal

  • Potential Bharti-MTN synergies include lowering procurement costs and replicating low-cost/high-usage model at MTN
  • Deal uncertainties and probability of sweetening the offer for MTN shareholders raise short-term concerns
  • Retain OW(V). Raise TP to INR977 (from INR876) as we over our multiples to FY11e. 3G factor supports our argument roll

The objective of this report is to identify potential synergies not yet reflected in our forecasts (we include a sensitivity analysis), particularly on capex per base station, and to explore potential benefits of a shift to the low-cost, high-volume ‘minute factory’ model. We also discuss the legal and regulatory issues around the deal.

While the potential deal is marginally EPS accretive (4% for FY11e), we believe most of the synergies are medium to longer term. Uncertainty over pricing, execution, and dilution are likely to be a drag in the near term while clarity on synergies, shareholder structure and longer-term use of FCF could be positive.

Procurement synergies and low cost high usage model. Our analysis suggests that MTN’s cost per unit of capex (base transceiver station, or BTS) is c3x times higher than Bharti’s, suggesting potential procurement synergies in a post deal scenario. We note that certain local market level factors may limit upside (c5-14% to DCF). Further, we see scope for MTN to replicate the Bharti-style ‘minute factory’ model, creating significant cost-competitive advantages. This implies a fundamental shift in the business model, and the possibility of competitors replicating the same cannot be ruled out.

We maintain our Overweight (V) and raise our target price to INR977. As we roll over our valuations to FY11e, our estimates remain conservative (8% below consensus on FY11e earnings). The possibility of 3G auctions makes FY11e relevant and, unlike consensus, we are factoring in the potential 3G impact. Possible INR appreciation offers potential earnings upside. Risks for Bharti include poor monsoons and higher spectrum charges.

We believe move to pursue MTN reflects Bharti’s view that marginal opportunities in Africa are better than in India. Some GEM investors may prefer a pure geography play to improve control over their portfolios. In our view, there is a broad-based scepticism on the likely synergies and formal guidance from Bharti management will be critical.

To see full report: BHARTI AIRTEL


Shadow banking moves from private banks to central banks

Leverage dynamics in play

Global leverage is largely unchanged from the summer of 2008 to now. Assets went up US$6tn, but capital went up thanks to Chinese retained earnings and the US taxpayer. Asia’s low leverage puts it in a superior position to Europe. China’s releveraging is very healthy – so is Brazil’s. Most of Europe is unsustainable in our view

Asian banks in a global context

Asian banks have the lowest leverage and highest ROE. European banks have the lowest ROE and highest leverage. Our global ranking puts CCB, Stan Chart and BOC among the most attractive banks in our universe of 195 banks. Korean banks are a problem, in our view.

RBS sale of Asian businesses

Robert Law and Anand Pathmakanthan thrash out the details of the RBS sale of Asian assets. Questions on costs and asset quality are a problem and the franchise is wide rather than deep. But it is worth something to a newcomer – but not to existing giants such as HSBC and Standard Chartered, in our view.

IMF Study of Federal Reserve balance sheet

Central banks now account for almost one-third of the assets of the top-ten banks globally. Conflicts of interest arise when central banks are both the marginal buyer and seller of credit. Central banks’ policy is everything and will determine equity valuations – not earnings! Read on inside.

To see full report: BANK REFLECTIONS