Sunday, June 28, 2009

>Gold market enters seasonally soft summer period

Gold prices could retreat during the summer as a still sluggish economy keeps inflation down and seasonal reductions occur in fabrication and investment demand.

Still, some analysts said any summer weakness may be more limited than normal, since financial-sector problems persist and destocking may have already occurred in the jewelry industry.

August gold on the Comex division of the New York Mercantile Exchange fell from a three-month high of $992.10 an ounce on June 3 to a low of $926.50 this week before stabilizing, largely on currency-related factors.

"We expect prices to head lower, possibly to $860 or $840," said Carlos Sanchez, associate director of research with CPM Group. "Weakness would be due to fabrication demand being reduced. Usually, gold-gift-giving holidays occur at the beginning of the year and latter part of the year, not only in developed countries but developing countries like India and Pakistan."

He also said investor activity tends to wane in the summer as many players focus more on vacations than markets.

Sanchez said some of the economic data lately have not been as bleak as in past months. Further improvement could take away some of the impetus to buy gold over the summer, he said.

James Moore, analyst with, expects gold to be "vulnerable" over the summer, perhaps trading sideways to lower. He cited the large net long position of speculators as one reason, which means potential for liquidation. As of June 9, the noncommercials were net long by 201,359 lots for Comex futures and options combined.

Moore said longer term, the potential for inflation should be supportive, but gold could be at risk of a test back below $900.

"Certainly, we're finding good support around the $930 level for now, he said. "But given the fact we haven't seen a step-up in buying interest, maybe we have to go back to the $880 area and maybe even back to the $850 before we can pick up fresh buying."

Bart Melek, commodity strategist with BMO Capital Markets, said subdued jewelry demand and a run-up in longer-term Treasury yields could hold gold back in the next couple of months. There also may be less demand for gold as a hedge since central bankers have indicated the dollar is likely to remain the world's reserve currency. This week's round of U.S. data showed tame inflation.

"A combination of these factors makes gold range-bound for the next quarter or two," Melek said, but added, "There is some risk to the downside."

Seasonal Weakness May Be Limited

Others acknowledge gold's tendency for summer seasonal weakness, but nevertheless look for the market to draw support anyway.

Gold fell with other commodities from mid-July last summer, but soon recovered due to troubles at institutions such as Lehman Brothers, Fannie Mae (FNM) and Freddie Mac (FRE).

"Things don't seem to be quite as dire as they were last summer, in terms of major financial and government institutions on the verge of collapse," said Peter Grant, senior metals analyst with USAGOLD - Centennial Precious Metals. Still, he said, systemic risks have not gone away.

Grant said there is the normal cyclical reduction in jewelry demand, but also a parallel of continued safe-haven interest in gold.

"They are kind of offsetting to some degree, which makes range-trading probably the greater likelihood," Grant said. "But the overall trend is up, and any major surprise with respect to systemic risks could have a very bullish impact on gold."

Jeffrey Nichols, managing director of American Precious Metals Advisors and publisher of, suspects any seasonal influence will be less than most summers. Large jewelry manufacturers have already reduced inventories of raw materials, he said. Like other industries, they didn't want to finance the cost during an economic slowdown.

"There shouldn't be any additional destocking over the summer months," Nichols said.

Otherwise, he said, movements in the dollar could be the dominant theme over the summer, as the metal tends to move inversely to the greenback.

"It's still vulnerable technically speaking, but I think it's likely to hold up at $900 or over," Nichols said. "And after we have a period of retrenchment - which we may have already seen - gold should start rebuilding itself."



Indian Equities - Valuations re-visited

Valuations re-visited. We evaluate market valuations considering different growth assumptions and valuation methodologies. Earnings based valuations, derived from current growth estimates (a CAGR of 14% over FY09-11E) suggest a trading range of 12,500-16,500 for the BSE Sensex for the current fiscal year. Valuation models that do not depend excessively on near term earnings – P/B-RoE and long term DDM – also suggest a reasonable upside.

Special focus: Valuations vs macro variables. An analysis of the relationship between 12 month forward PE multiples and key macro economic variables, suggests a meaningful relationship with IIP and the exchange rate. The relationship with interest rates and inflation is
however not significant.

Near term consolidation. We have been arguing for near term consolidation following the sharp rally, post the election results. A substantial equity issuance pipeline and the weak progress of the monsoon are near term pressure points. But we remain constructive on a 12-18 month view, given the policy freedom available to the new Government and await initiatives herein in the Budget scheduled for July 6.

Portfolio stance. We remain positive on local growth, with a bias towards the investment cycle. We are downgrading Consumer Discretionary from overweight to neutral following substantial outperformance over the last three quarters and concerns over the weak progress of the monsoon. We are also adding weight to IT services, given signs of an improvement in tech spending. We are adding Satyam to our model portfolio.

To see full report: STRATOSCOPE


The current global equity rally has resulted in stock price increase across the board, which include stocks with/without robust fundamentals. Therefore the current rally provides an excellent opportunity to investors to sell/book profits in companies whose business models is not backed by robust fundamentals or those companies whose stock prices have run ahead of their fundamentals. Therefore, we recommend investors to invest the proceeds from the above sales to be invested via our “Conservative Model Portfolio” which includes a better mix of companies with allocation to various sectors.

List of stocks where one can remain invested:

  • Shree Renuka Sugars
  • Reliance Petroleum
  • Reliance Natural Resources
  • Satyam Computers
  • IFCI
  • Power Grid
  • NTPC
  • Larsen & Toubro
  • Reliance Power
  • ITC
  • Petronet LNG
  • Suzlon Energy
  • Infosys
  • Ashok Leyland
  • GMR Infra
  • Nagarjuna Fertilisers
  • Jaiprakash Associates
  • Gujarat NRE Coke
To see full report: STOCK SWITCH


India's new Finance Minister will present a full-fledged budget after a gap of 16 months and under a different set of circumstances. In February 2008, India was entering a phase of lower growth trajectory. On the other hand, current data is suggesting that, the economy is likely past the worst and improving. However, we expect the agenda of the budget to be identical, subject to a few differences. We note that, the previous FM had a far more fractious and demanding set of coalition partners to contend with.

We opine that, the focus of the FM will continue to be on sustaining and improving the rate of GDP growth and that too, equitable (inclusive) growth. Investments in infrastructure, social initiatives and agriculture are expected to continue. While fiscal prudence will be attempted, we expect little change to the Center's fiscal deficit of more than 6% of the GDP. Alternate sources of raising finances like dis-investment, relaxation of FDI norms, auctioning of telecom licenses, etc may be used to fund additional investments.

While issues like FDI relaxations / allowance and implementation of GST may be addressed, other critical issues like labour reforms, pension reforms, etc may need broader political consensus. We expect material developments on the same, if any, to be outside the budget. Tax burden on individuals may be reduced to spur consumption. From the market perspective, any major reduction in the STT burden will positively surprise us. Tax benefits for 'impacted' sectors and employment-generating sectors will be provided, in our view.

Though India was impacted by the global economic slowdown, the GDP growth of 6.7% (CSO advance estimates) in FY09, was the second fastest, globally. We expect the focus of the budget to be on sustaining and improving this rate of growth. To that extent, investments, mainly in infrastructure, are expected to continue. Segments like roads, highways, airports, ports, power, etc are expected to receive continued attention and funding. However, only speedier implementation will make these plans more effective.

We expect inclusiveness to be another corner-stone of the budget. Increased allocations to schemes like SSA, NREGS, mid-day meal scheme, etc will be announced, we believe. With falling growth in agriculture and some uncertainty on the monsoon (till now), we expect further initiatives in agriculture, which also promotes balanced growth and helps in containing inflation.

To see full report: PRE-BUDGET ANALYSIS


First, rabbit holes; now, wings of wax

After the rally, what next?
In February 2009, real estate stocks appeared to be tumbling down a rabbit hole, with no signs of a bottom. As we expected (see report How deep does this rabbit hole go, dated 18 March 2009), stocks rallied due to improving liquidity. Although we still believe that this is a good time to accumulate Indian property stocks for the long term, their 200–300% average rise during the past three months has likely led the market to expect a sharp pullback. Should this occur, we would view it as an entry point. Meanwhile, we think it is advisable to take profits from stocks with wings (and feathers) of wax that are flying too close to the sun.

Rally has been backed by fundamentals
Availability of capital in 1Q CY09 was completely frozen, even while the situation in most of Asia was slowly improving. At that time, it looked like there would be some relief for developers as lenders took on more risk. This has now occurred. There have been instances of banks willing to refinance obligations and some asset sales. Importantly, nearly US$2bn of equity was raised by the developers in the past couple of months. This has definitely eased the liquidity pressure on developers. Developers have also cut prices by 20–30%. This has led to a recovery in residential sales volumes in many parts of India. Although the physical markets remain under stress (especially on the commercial and retail fronts), inventory clearance has indeed started.

The NAV upgrade cycle is still in its infancy
These trends led to some NAV upgrades in the past quarter, including by us (even though we were clearly above the Street back in March). We believe this momentum has just started. Analysing past cycles in India is very tough because most developers have been listed for less than three years. However, past cycles in more-developed markets (such as Hong Kong) show that NAVs can move up by 2–3x from the trough to peak cycle. In India, some drivers of upgrades are obvious. WACC of 16–17% and cap rates of 13–14% at bottom-cycle rents and
volumes were clearly pessimistic. NAV downgrades in 2008 were driven by the capital crunch and demand destruction. There have been some NAV revisions stemming from the improved capital scenario. The upgrade cycle on higher volumes and rising prices (after the recent GDP upgrades) has not yet started.

Approach should change from ‘selling into strength’ to ‘buying on dips’. A near-term pullback would not be a major concern, in our view. Stock markets have often had a 20–40% correction 3–6 months after coming off a bottom.

Stock picking: Keep an eye on the fundamentals
Investors should focus on stocks with relatively better-quality balance sheets and a clear and robust monetisation strategy. Based on our scenario analysis and qualitative framework, we believe Indiabulls and Unitech are best placed, with DLF next. We would also advise caution, however. The recent rally has clearly reduced the valuation proposition of Indian property stocks. We have maintained our Overweight position on India in the regional portfolio, but with a reduced weight (from 2% to 1%). We recommend that investors take profits in Provogue,
Akruti, Ansal and Mahindra.

To see full report: INDIA PROPERTY


  • Overweight mid-caps relative to large caps
  • Mid-cap stocks are trading at 10.7x 12- month forward PE, a 28% discount to large-caps
  • Improving liquidity and growth prospects make them a compelling proposition.
Is mid-cap appeal back?

Following the recent 75% rally from the trough in early March, valuations are stretched; for instance, the Sensex trades at 16.2x 12-month forward PE. For investment ideas, we need to look beyond the frontline stocks — one segment of the market which is interesting is mid-caps, i.e., stocks with a market cap between USD500m and USD1bn. This segment started outperforming its large-cap peers recently and we would be overweight on a 6-12 month view.

The case for investing in mid-caps lies in cheaper valuations, trading at 10.7x 12-month forward PE, which is at a 28% discount to large-caps, while the valuation discount of midcap stocks tends to persist for a longer period of time. On average, in terms of PE, the discount is 17%. Consensus forecasts that mid-cap stocks will grow earnings at a CAGR of 16.2% compared to an 11.5% CAGR for large-cap stocks over March 2009-March 2011e. We believe this makes for a
compelling case for investment in mid-cap stocks.

Our study also highlights that this segment of the market has outperformed large-cap peers historically, and the outperformance is significant on a risk-adjusted basis with a Sharpe ratio of 0.2 vs. the large-caps’ at 0.14. For specific ideas, we provide a screen of stocks from our coverage.

The risks of investing in this segment relate to higher liquidity risk for mid-caps and higher leverage.

With this edition we are launching our new biweekly equity strategy product, India Insights.

To see full report: INDIA INSIGHTS


Geared to excel

Gujarat State Petronet (GSPL) enjoys a well entrenched network of gas transportation pipelines across Gujarat and is all set to benefit from additional supplies from the KG-Basin and increased LNG capacities in India. We estimate GSPL to report impressive net income CAGR of 17% in FY08-FY11E led by 29% gas transmission volume CAGR. Corporate Social Responsibility (CSR) contribution of 30% to the Gujarat Government is the key overhang on the stock. We value GSPL at Rs56/share based on FCFE-DCF methodology assuming 30%
CSR contribution and 13% RoCE over the life of GSPL’s pipelines owing to higher spot contracts, efficient operations etc (versus 12% allowed return by Petroleum & Natural Gas Regulatory Board, PNGRB). If the Gujarat Government were to abolish 30% CSR, GSPL’s fair value would rise to Rs78/share. We initiate coverage on GSPL with BUY rating.

Rising gas supplies imply higher growth visibility. Increasing domestic supplies led by Reliance Industries’ (RIL) KG-D6 field and new LNG terminals would lead to ~2.5x rise in gas supply in the next 3-4 years, thereby improving growth visibility. Gas volume CAGR of 29% would lead to 17% net income CAGR over FY08-11E.

Gas Pipeline Policy – Exceeds expectations. PNGRB has allowed 12% post-tax RoCE on inter-state pipelines. We expect GSPL to generate better returns through higher spot volumes, lower depreciation, leveraging balance sheet and lower effective volume assumption in the first four years of operations.

RIL-Reliance Natural Resources stand-off will not affect GSPL. The market is concerned on diversion of gas supply to Reliance Natural Resources (RNRL), which decreases transmission volumes via GSPL pipelines. But lower gas volumes would lead to higher tariffs as returns are regulated. As spot volumes are excluded while calculating regulated returns, higher spot volumes would be beneficial.

Understated book value; valuations attractive. Due to GSPL’s aggressive depreciation policy, its book value (BV) is understated. GSPL’s FY09 BV/share, at 3.17% depreciation, would have been Rs28.9 versus Rs21.7, which will likely be reported by GSPL. We value GSPL at Rs56, implying adjusted FY09E P/BV of 2x.

To see full report: GUJARAT STATE PETRONET


Upgrading zinc and lead price estimates
Zinc prices dring the month rose to a high of US$1,700/ton, levels last seen trading in Sept'08. Zinc prices have been moving higher since it formed a base around the US$1,000-1,100/ton levels at the start of the year. The stronger than expected resilience shown by the Chinese economy, implementation of huge productions cuts and buying by the Chinese Strategic Reserve Bureau (SRB) led to a surge in imports.

Volumes to witness 21.4% CAGR over FY09-11E
Hindustan Zinc Ltd. (HZL) is set to become the world's largest integrated zinc-lead producer by FY11E. We expet volumes to witness 23.1% CAGR over the period FY09-11. While the volume growth in FY10E would be achieved by the recent de-bottlenecking process, in FY11E it would come from the expansion of production capacity to 1 mtpa (by mid-2010). On our revised metal price assumption, we upgrade HZL's topline by 17.2% in FY10E and 17.1% in FY11E.

Upgrade to BUy with a target price of Rs776
HZL falls in the lower quartile of the global cost drive. Even in an environment of high input costs like coal in FY09, the company managed to keep its costs at FY08 levels. With HZL's ability to contain input costs and a scenario of rising price realisations, we expect OPM to expand 309bps over the next two years. We upgrade our previous earnings by 16.2% to Rs26.8bn in FY10E and by 8.7% to Rs 34.2bn. We expect net cash per share to rise from Rs236 at the end of FY09 to Rs290 by FY11. We upgrade our target price to Rs776/share and change our rating to BUY from Market Performer. Net of cash, the stock is currently trading at 4.2x P/E on our estimated FY11E EPS of Rs80.9.

To see full report: HINDUSTAN ZINC


Leads malted food beverage segment with 70% market share
GSKCH dominates the ~Rs20bn MFB market with its brands - Horlicks, Boost, Maltova and Viva. GSKCH continues to leverage on the strong brand equity of Horlicks and Boost by introducing value added variants of these brands. These variants will be priced at 15-20% premium over existing products. G

New launches from parent's portfolio to diversify revenue base
GlaxoSmithKline plc. U.K. the parent company of GSKCH has a strong and well established product product portfolio of various brands such as Ribena, Sensodyne, Aquafresh, Lucozade, Breathe Right etc. GSKCH plans to launch few products from its parent's portfolio over the next 2-3 years. These products are expected to have a strong demand potential in the Indian market and we believe it will help the company in further strengthening its position in the Indian market.

Huge cash balance indicative of liberal payout policy
With zero debt on its books and operating cash flows of about Rs2bn per annum, GSKCH is a cash rich company. At the end of CY08, it had ~Rs4.7bn (Rs112/share) cash on its books. The company is expected to incur a capex of Rs1.3bn p.a. (maintenance and capacity expansion). We believe that the surplus cash would be utilized to acquire businesses/brands or to reward shareholders in the form of higher dividend payout or a buyback. The company is actively scouting for acquisitions in segments such as nutrition, medicinal and OTC products.

To see full report: GLAXOSMITHKLINE


Company Profile:
Great Offshore Ltd (GOL) is the largest offshore oilfield service provider to upstream oil and gas companies to carry out offshore E&P activities.The Company currently operates in four major business areas viz offshore drilling services, offshore logistics support services, engineering services and port & terminal support Services. GOL owns state of the art vessels which includes two drilling rigs, twenty seven OSVs, one construction barge and eleven harbour tugs. It generates nearly 80% of its revenues from ONGC.

Investment Rationale:

Ventured in port management and single point mooring operations: GOL has forayed in to port management and single point mooring operations by acquiring 100% equity stake in two Hydrabad based companies KEI-RSOS Maritime Ltd. (KEI) and Rajamahendri Shipping & Oilfield Services Ltd (RSOS) with purchase consideration of Rs 1.6 bn. This EPC accretive acquisition is in line with Great Offshore's strategy of maintaining its leadership in the port & terminal and offshore logistics servises.

Strengthening its fleet by adding new vessels: GOL has ordered two new vessels - a jack up shallow water drilling rig and a MSV with an aggregate cost of USD 168 mn and USD 68 mn respectively. The total number of vessel will become 43 with these two additions by FY11.
Currently the company owns 41 offshore support vessels inclusive of two drilling rigs.

Increasing oil Import bills - Creating Strong demand for offshore vessels: The demand for rigs is expected to rise globally in response to increasing crude prices. India is the net importer of the crude oil. Its import bill has rose to USD 76.61 bn in FY09 from USD 48.39 bn in FY07 due to increase in petroleum demand and rising crude prices. This has led the government to intorduce various policies (NELP for instance) to give boost to E&P activities which are expected to create strong demand for offshore service vessels in the near future.

Outlook & Recommendation:
At the current market price of Rs 360, the stock is trading at a P/BV of 1.16x and 0.95x of FY10E and FY11E book value of Rs 310 and Rs 378 respectively.

We recommend BUY rating on the stock with a target price of Rs 454/- (26% upside) in 12 months implying a P/BV multiple of 1.2x of FY11E book value.

Industry Overview
The offshore shipping industry is highly dependent on oil exploration and production (E&P) activities. The global E&P activities continue to be buoyant on account of robust crude prices, strong demand from India and China and tight OPEC supplies. Oil accounts for around 33% of India’s total energy consumption. India faces a large supply deficit, as the domestic oil production is unlikely to keep pace with demand. This makes India a net importer of oil.

To see full report: GREAT OFFSHORE