>Gold steady; look for equities cue this week

Singapore - Spot gold at USD919.85/oz, down 95 cents since NY close; rally overnight from yesterday's low at USD907.45 was prompted by jump in equities on Wall Street, says Adrian Koh, analyst at Phillip Futures in Singapore. Equities, gold currently positively correlated as both tending to move inversely to USD. "I think if we get some good second quarter earnings (in U.S.) this week, gold could test higher but overall we think the (short-term) trend is still lower," says Koh. Adds, taking 45-day view, test of USD900 still likely with physical demand still weak. Beyond that, USD900-USD1,000 range likely to resume later in year with bias then towards higher prices.

Gold steady; sustained rally unlikely
Gold was steady in Asia Tuesday after rallying in late New York trade Monday.

The rally, which tracked strong U.S. equities, was the first strong upside move since the start of the month but participants aren't convinced that it represents a trend reversal.

"I think if we see some good second-quarter earnings (in the U.S.) this week, gold could test higher, but overall we think the (short-term) trend is still lower," said Adrian Koh, an analyst at Phillip Futures in Singapore.

Mitsui Global Precious Metals said in a note that it was also looking for a test of USD900.

"Right now there are no major push factors significantly capable of extending gold to the upside. The physical market is largely disengaged, waiting for the fall towards $880," the note said.

Mitsui said long exposure on futures exchanges was still excessive at 22.7 million ounces at the end of last week, well above the 2009 average of 20.7 million ounces.

"Therefore, we are concerned that a raft of liquidation action is around the corner as investors look to offload stale long positions," it said.

At 0650 GMT, spot gold was at $919.55 a troy ounce, down $1.25 since the New York close. On Tocom, June 2010 gold was at Y2,770/gram, up Y63.

Spot silver was at $12.83/oz, unchanged from overnight, but traders will be watching silver closely for signs of a relative trend reversal versus gold. Silver is down 22% from its early June highs compared to gold's retreat of 8%.

The Gold/silver ratio is now at 71.7 and a close lower than yesterday's 71.9 would be confirmation ratio is likely to move lower, said ScotiaMocatta in a note.

Platinum was also higher at $1,115.50/oz, up $2.50 and could be bolstered by expectations the U.S. auto sector may show signs of recovery in the third quarter.

Barclays Capital said in a note that the sector could see a "substantial turnaround in output growth," helped by the 'cash for clunkers' vehicle scrapping programme.

India gold futures little changed; INR weighs
India August gold contract on MCX little changed at INR14,599/10 grams tracking slight weakness in overseas gold markets, strong INR. "(Overseas) gold has been pressured by worries over the global economy and broad-based weakness in commodities that was fueled partly by U.S. regulatory pressure to limit speculation in the energy and metals markets," says Debjyoti Chatterjee of Admisi Commodities; he expects MCX August contract to consolidate at current levels and move in INR14,460-INR14,650 range today.

Source: COMMODITIESCONTROL

>STATE BANK OF INDIA (GOLDMAN SACHS)

Three reasons to own SBI; reiterate Conviction Buy

What's changed
We see three reasons to own SBI: 1) at a macro level, we believe SBI would be a key beneficiary of the economy returning back to potential growth level—33% CAGR in earnings for SBI during 2009E-2011E; 2) at a bank-specific level, we see SBI as a long-term player with a sustainable
advantage due to its strengthening competitive position—solid and stable deposit franchise, higher and rising productivity compared with its peer group of state-owned banks with prospects of further improvement through potential mergers with its subsidiary banks in the long term; and 3) likely relative valuation change reflecting the potential cyclical upside to earnings and its strengthening competitive position in the long term. We reiterate Buy, on Conviction list, and our 12-m TP of Rs2,280.

Implications
Trading at 2010E P/PPOP, P/E and P/B of 3.2X, 6.4X, and 1.1X, respectively, versus the regional average of 8.2X, 14.6X and 1.9X, we believe SBI’s valuation presents a compelling investment argument both in relative and absolute terms, within India and in the region. In our view, the market seems to be concerned about a tougher outlook for growth for SBI in 2009 and its lower loan loss reserves. While the tougher growth outlook is factored into our expectations, we believe the risk to capital from low loan reserves is insignificant given SBI’s net NPA/equity ratio of 15% in 2008.

Valuation
We derive our 12-m TP of Rs2,280 for SBI using SOTP methodology. At current multiples, SBI is trading ahead of its historical median of 0.9X P/B. However, given its ROE of 18% for 2010E, we believe it should trade well above its historical median and current multiples.

Key risks
Key risks include: 1) increase in interest rates and 2) deterioration in SBI’s asset quality outlook.

To see full report: SBI

>MUNDRA PORT & SEZ (MACQUARIE RESEARCH)

Concerns not in sync with reality

Event
■ MSEZ has declined significantly by 17% over the past week amid, we believe, unjustified concerns over its earnings post the increase in the Minimum Alternate Tax (MAT) in the union budget, and also over its volumes amid economic concerns. We believe the sell-off is overdone and presents an attractive opportunity to enter the stock.

Impact
■ Not impacted by an increase in MAT: Contrary to perception, Mundra Port enjoys a tax holiday under section 80IAB, which deals with tax benefits for SEZs and not 80IA, which is for infrastructure developers. Under 80IAB, there is no MAT requirement.

■ Volume growth could come in healthier than expected: Volume growth at Mundra Port could surprise on the upside in the near term and come closer to 20–25% over the next 1–2 quarters versus our estimate of back-ended growth in FY10, driven by coal (both 3rd party and Adani power plant), fertilisers and Maruti (MSIL IN, Rs1,102, UP, TP: Rs680, downside: 38%) car exports (13,336 units in June 2009 vs 4,836 in June 2008).

■ Upside to our volume estimates: We are building in 21% volume growth in FY10 and only 13% in FY11. Given the strong traffic growth that could come in 1Q FY10 along with the long-term contracts kicking in earlier than expected, we believe significant upside remains to our estimates.

⇒ Adani power plant ramp-up ahead of schedule: We are currently building in the commissioning of the entire Adani power plant capacity by FY14 (1,500MW by FY12 and the entire 4,620MW by FY14). However, activity on the ground is ahead of our estimates with the first unit of 330MW already commissioned and commissioning of three more units of 330MW is in the advanced stages. The rest of the 5X660MW units could be commissioned by FY12. If the entire capacity of 4,620MW comes up by FY12, the coal requirement of 17.5mn tons could come in by FY12 itself versus our estimate of FY14.

Earnings and target price revision
■ No change.

Price catalyst
■ 12-month price target: Rs617.00 based on a Sum of Parts methodology.
■ Catalyst: Traffic growth in 1Q and 2Q FY10 and any large deals on SEZ land.

Action and recommendation
■ Maintain Outperform with a target price of Rs617: We continue to maintain that MSEZ remains an attractive play for long-term investors, given extensive expansion in capacity, possibly at the port site, and monetisation of SEZ assets over a long period. 1Q FY10 results could surprise on the upside driven by robust volume growth, which could act as a short-term trigger, in our view.

To see full report: MUNDRA PORT

>ROAD INFRASTRUCTURE SUMMIT (JM FINANCIAL)

Driving India’s economic growth – From IT to Infrastructure

■ Ushering in the change by reaching out to investors: We cohosted Mr Kamal Nath, Union Cabinet Minister for Road Transport and Highways. The panel members included other luminaries like NHAI chairman Mr Brijeshwar Singh and Mr Brahm Dutt, Secretary, Ministry of Road Transport and Highways. This was Mr Kamal Nath’s first investor meeting post taking over the Ministry and shows the new and progressive outlook the government has on building infrastructure.

■ Open to suggestions and new ideas that can help improve execution: Mr Kamal Nath emphasized the role of infrastructure and particularly roads in driving the economic growth. He highlighted the importance of domestic demand, in the current global downturn and India’s favourable demographics. The minister reiterated his commitment to achieve development target of 20km of roads per day. His commitment and zeal was seen in his eagerness to listen to
suggestions. He invited suggestions on improving transparency, efficiency in bidding/awarding projects and innovative means of financing to meet the investment target for NHDP. The minister was confident to smoothen out issues on an urgent basis and will look into ways to make road sector projects more investor friendly. He highlighted that his focus was to decentralize and work closely with all stakeholders like various state governments, investors, developers etc. in implementing best practices.

■ Aggressive targets have been well thought-out with clear workplans: The last 2 years have not seen much progress with NHDP projects with only 9 projects being awarded in 2008-09. Mr Kamal Nath explained that even though the progress appeared slow, this was an important phase as the government has gained tremendous experience. Mr Singh presented a detailed work plan to award 126 projects covering around 12,000 km in 2009-10. Of this, 65 projects are expected to be open for bidding in Q2/Q3 FY10.

■ Land acquisition remains a major concern for investors: Investors expressed concern the fact that land related issues caused delays in project implementation leading to cost and time overruns. Mr Nath highlighted that with 80% of land being made available even before bid and balance 20% being notified, risk should get reduced. He also seemed open to increase the availability to 90%. A number of suggestions were put forward: innovative structures for bidding (eg. Swiss Challenge), easy access to superior technology for developers, private investment in projects (eg, NPV based concession period, monetizing land value), relaxing exit clause for developers to allow entry of investors post-completion. Mr Kamal Nath invited suggestions/white papers on these topics directly addressed to him.

To see full report: ROAD INFRASTRUCTURE

>PHARMACEUTICALS - GENERICS (MF GLOBAL)

AN INDUSTRY IN TRANSITION

CONTENTS

• INVESTMENT SUMMARY
• VALUATIONS: LARGE-CAP & MID-CAP GENERICS
• OUTLOOK FOR GENERICS
• RISKS

COMPANIES SECTION

• CIPLA
• BIOCON
• DR. REDDY'S LABORATORIES
• RANBAXY LABORATORIES
• SUN PHARMA INDUSTRIES
• LUPIN
• CADILA HEALTHCARE
• GLENMARK PHARMA

To see full report: PHARMACEUTICALS

>OIL & GAS UPSTREAM SECTOR ( DAIWA)

Ready for an upturn

Summary

■ We believe India’s oil-and-gas exploration and production (E&P) potential is being realised gradually with the success of the New Exploration and Licensing Policy (NELP). We expect E&P activity to pick up significantly over the next few years as blocks licensed out during previous rounds of NELP are explored and developed. The recent success of Reliance Industries (Reliance) (RIL IN, Rs1,893, 3) on the east coast and Cairn India (Cairn) on the west coast has given the sector an additional boost.

■ India is the fifth-largest consumer of oil in the world, and we forecast domestic demand to rise at a CAGR 4-5% over the next three-to-five years. Almost 73% of India’s demand for crude oil and 24% of its demand for gas are met by imports. Thus, new finds have a ready and expanding market. We are bullish on the longer-term prospects for crude-oil prices, and have a forecast of US$84/bbl for 2011 and a long-term forecast of US$85/bbl.

■ We initiate coverage of two pure E&P companies in India − Oil and Natural Gas Corp (ONGC)
and Cairn − with 2 (Outperform) ratings, as the stocks offer 7% and 6% upside potential, respectively, to our six-month target prices. We believe Reliance is also an exciting E&P play,
although its other businesses (such as refining and petrochemicals) are also significant.

To see full report: OIL & GAS SECTOR

>JK CEMENT (ICICI DIRECT)

Company Background
JK Cement, a part of the JK group, was incorporated by acquiring the assets of the cement division of JK Synthetics in November 2004. Currently, JK Cement has grey cement capacity of 4.4 million tonne (MT) and white cement capacity of 0.4 MT. The company is the second largest manufacturer of white cement in India. JK Cement sells cement under brand names Sarvashaktiman (43 grade OPC), JK Super (blended cement) JK White Cement and JK Wall Putty.

The JK Cement Works (Fujairah, UAE) FZC, a subsidiary of JK Cement, has signed an MoU with the Municipality of Fujairah. The company has been allotted limestone mines with reserves estimated at 150 MT.

Investment rationale

To increase cement capacity by 68%
JK Cement’s 3 MT greenfield plant at Karnataka is likely to be commissioned in H1FY10. The new plant will increase grey cement capacity by 68% from 4.4 MT at present to 7.4 MT at the end of H1FY10. On account of capacity additions, we expect JK Cement’s grey cement volumes to grow at a CAGR of 23.2% between FY09 and FY11.

Decline in pet coke prices, entering into high priced South Indian market to boost margins
JK Cement meets 90% of its fuel requirement through petcoke and rest 10% from linkage coal and open market. With crude oil and coal correcting from its peak, petcoke prices have also declined by 25% from its peak. Thus, we expect JK Cement’s power & fuel cost to decline to Rs 785 per tonne in FY10 from Rs 972 per tonne in FY09. Apart from this, JK Cement’s entry into the high-priced South India market will have a favourable impact on blended realisations. Thus, we expect the EBITDA margin of JK Cement to improve from 21.6% in FY10 from 22.6% in FY09.

Presence in high growth market
JK Cement’s sales contribution is 33% from Haryana, 27% from Delhi and UP, 21% from Rajasthan and 19% from Punjab, MP and Gujarat. Most states where JK Cement has a presence are growing faster than the all-India average. As against all-India consumption growth of 11% in April-May 2009, consumption has grown by 27% YoY in UP, 16% in Gujarat & Haryana, 11% in MP and 9% in Gujarat. Going ahead, we expect the northern region (key market of JK Cement) to continue to grow above the all-India average due to incremental demand that will come from the
Commonwealth Games and the hydropower projects coming up in the region. In addition, the upcoming US$90- billion Delhi-Mumbai Industrial Corridor project and the 1,483-km high-speed dedicated freight corridor project will also boost cement demand in North India.

Q1 results expected to be encouraging
With 14% YoY growth in blended sales volume and 5.8% increase in blended realisation, we expect net sales to grow by 20.6% YoY to Rs 414.4 crore. We expect the EBITDA margin to increase by 570 bps to 27.9% due to decline in power & fuel cost and improvement in realisation. We expect the adjusted PAT to grow by 69.8% YoY to Rs 61.3 crore. On a QoQ basis, we expect the PAT to grow 2.6%.

Risks & concerns

Delay in ramping up of greenfield plant

Delay in ramping up of greenfield plant of 3 MT at Karnataka may lead to lower volumes.

To see full report: JK CEMENT

>ITC (ICICI SECURITIES)

Cigarettes to give kick

Budget announcement of nil excise hike for cigarettes is a huge positive for ITC; we expect its cigarettes segment to register volume growth of 5%, net sales growth of 19% and PBIT growth of 18% in FY10E. Complementing this growth, we expect the non-tobacco business’ PBIT to grow a strong 30% YoY in FY10E. Despite the recent run up in its stock price, ITC continues to trade at FY11E P/E of 17.7x, which is not only at a discount to its 5-year one-year forward median P/E of
19.5x but also attractive vis-à-vis peers. Re-iterate BUY and maintain our 12-month target price at Rs238/share.

■ Cigarettes – Expect 5%, 19% & 18% growth in FY10E volume, net sales & PBIT. We expect strong volume growth of 5% in FY10E on the back of nil excise hike and lower base. Due to base effect of price increases and new price hikes, we expect 6- 7% price growth in Cigarettes in FY10E (expect price hikes in some regional brands such as Bristol Filter in the short term). Also, while we expect Cigarettes’ gross sales to grow ~12%, nil excise hike will lead to ~19% growth in net sales and ~18% growth in Cigarettes PBIT in FY10E.

■ Concerns about VAT unwarranted for near term. With Budget announced for most states, we do not expect VAT to increase to 20% in the short term for all states. VAT for cigarettes remains unchanged for the state of Punjab, as per Budget announcement yesterday. Uncoordinated efforts by states to hike taxes on cigarettes will not largely impact ITC due to: i) flow of stocks from neighbouring states ii) high pricing power enabling ITC to absorb the minor impact of VAT increase in few states.

■ Non-tobacco business – All well except Hotels. We expect Non-Tobacco sales to grow 13% in FY10E on the back of strong performance in the paper & paperboard segment. Notably, on account of lower losses in Other FMCG and margin expansion in Paper & Paperboard, we expect Non-Tobacco PBIT to increase 30% YoY. However, we believe Hotels would disappoint and expect 8% decline in FY10E PBIT of the segment.

■ Expect healthy Q1FY10 results. We expect 6.5% YoY volume growth and 25% net sales growth for Cigarettes in Q1FY10E. Overall, owing to poor performance in agri and hotels segments, we expect net sales to grow only 9%. However, due to strong margin expansion in Cigarettes, Agri and Paper & Paperboard, we expect strong PAT growth of 24% in Q1FY10E.

■ Attractive valuations despite recent spike. While the stock has run up 10% in the past two sessions, ITC trades at FY11E P/E of 17.7x, which is not only at discount to its 5-year median P/E of 19.5x but also attractive vis-à-vis peers. Reiterate BUY and maintain our 12-month target price at Rs238/share (FY11E EPS of 20x).

To see full report: ITC

>INDIA STRATEGY (MORGAN STANLEY)

A NEW BULL MARKET?

• New bull markets are started by favorable liquidity conditions and attractive valuations. At the start of the rally (which commenced in March 2009), we had both these ingredients in place. Bull markets make progress as fundamentals improve. Fundamentals can come in various forms,
such as technology changes, favorable demographics, etc., but ultimately all these changes imply upward revision in growth forecasts. The ongoing rally got a shot in the arm with the decisive mandate from the electorate in mid-May, raising hopes that the new government can usher in
reforms that can elevate India’s growth back to its potential rate (7-7.5%) and higher. The budget document and other actions of the past month seem to be affirming the initial faith imposed by the market in this development. So we may be well on course to an improvement in fundamentals. Hence, the question is whether we are in a new bull market. There are three obvious possibilities:

• 1) The bear market that started in January 2008 continues, and we were just in a bear market rally. This means that we will either see new lows or at least retest the October or March lows. This scenario is possible if global markets wobble, the policy stimulus falls short of requirements,
and there is a drought. The bear case in our outlook for the BSE Sensex (9718) brings us close to this scenario, though not precisely to its March low.

• 2) What happened between January 2008 and March 2009 was a correction in the bull market that began in 2003. This scenario seems least probable given the extent to which the market fell in the 14 months from January 2008. At 61%, it was the worst fall of any bear market of the
past. The market convincingly broke its 200 DMA and stayed there for a reasonable amount of time. We had four successive falling tops and bottoms as well. The length of the correction at 61 weeks fell short of historical standards (except for the bear market of early 1990s, which
lasted for 55 weeks).

• 3) A new bull market began in March 2009. The market is now well over its 200 DMA, the breadth has been strong, and the gains are reminiscent of nascent bull markets of the past. The market is up 69% in from its March 2009 low. This compares with 37%, 27%, 25%, and 47% in the first 18 weeks of the previous four bull markets over the past two decades. In our bull-case scenario, the Sensex hits a new high over the next 12 months.

• What do we need to be sure that this sustains as a new bull market? The key difference between the 2003-08 period and now is that global growth is no longer supportive. To that extent, it needs an extra policy push to pull India’s growth rate back to 8.5%. In the near term, a bad monsoon or bad global outcome could delay or derail the fledgling bull market. The skeptic may argue that this “bull market” has not produced new leadership that is normally associated with new bull markets. The best-performing sectors are not different from the sectors that led the previous bull market. For that matter, the worst-performing sectors are the same, namely, Consumer Staples, Technology, and Healthcare. The jury is out on whether this is a new bull market given the lack of new sector leadership, i.e., this could still be a bear market rally. It may take time to confirm the rally (since March 2009) as a new bull market, and it is quite possible that sector leadership changes as this becomes a full-fledged bull market. Our bet is that the consumer will lead the charge and hence consumption sectors such as Autos, Media, Education, Retail, and midcap Staples could be the next bull market’s leaders.

To see full report: INDIA STRATEGY

>DEEPAK FERTILISERS AND PETROCHEMCIALS CORP LTD (GEPL)

OVERVIEW
The Indian chemical industry is all pervading, with chemicals finding applications in a variety of spheres. Having clocked around 8% CAGR growth over the last three years, it is undoubtedly one of the fastest growing sectors and is slated to double in absolute value terms in 2011 when compared to 2005.The Indian fertilizer industry, presently about 22 million tones is the third largest fertilizer producer in the world and constitutes 14% of the global production. Pick of the Week, this week is Deepak Fertilizer & Petrochemicals Corporation Limited (DFPCL), a company that is poised to cash in on the expected upswing in both these sectors. The company is one of the leading manufacturers of industrial chemicals such as methanol, ammonium nitrate, iso propyl alcohol, concentrates of nitric acid, propane liquid carbon-dioxide to mention a few. The company is one of the largest manufacturers of prilled Nitro Phosphate fertilizer and these products are marketed under the brand name Mahadhan. It has recently constructed a specialty mall Ishanya in Pune for interiors and exteriors thus bringing the architects, interior designers, manufacturers / retailers of interior / exterior products under one roof.

INVESTMENT RATIONALE
The company has an extensive product portfolio catering to an array of industries - agro-chemicals, defense, infrastructure, metal treatment mining, pharmaceuticals to mention a few. Owing to the nature of its manufacturing process, the company enjoys the operational flexibility to optimize its product mix depending on the future demand and supply scenario.. This product diversity thus gives DFPCL the flexibility to variate among its products and be in line with the market developments and de risk itself from commodity cycles. The company has technology tie ups with leading manufacturers which gives it the know-how for manufacturing some of its products like ammonia, AN, nitric acid, IPA, and bulk fertilizers. This is further supplemented with an enviable marketing and distribution network for timely supply of its wide range of products across the country. All these capabilities have endowed the company with considerable internal resilience, giving it the chance to rake in profits by concentrating its efforts on the growth opportunities, despite operating in cyclical markets.

The demand for DFPCL products have been rising but the company has not been able to match it through it’s in house capacity owing to a shortage of gas, thus leading to grossly underutilized capacity levels, forcing the company to fulfill the demand by importing (certainly more expensive when compared to producing at its own facilities) & trade (with marginal profits) in the same. This scenario is all set to turnaround hopefully by early next year – as increased domestic gas finds is expected to guarantee a continuous supply to fertilizer manufacturers, thus increasing production levels which leads to increased capacity utilization. The company is developing special crop specific and soil specific micro nutrients in order to give better yield to users. The companies umbrella brand Mahadhan, enjoys strong brand recognition & loyalty, thus enabling it to command premium over other players.

The current trend is to have a complete solution available under one roof. Identifying this opportunity particularly in respect to the office & home décor segment the company has set up a specialty mall Ishanya to take advantage of the growth expected in interiors & exteriors market. Ishanya is also expected to generate considerable income from non lease activities. Income from this venture is expected to contribute substantially in the future.

INVESTMENT CONCERNS
High volatility in input prices and uncertainty as regards to gas availability and pricing is a cause for concern. Companies trading activity (mostly fertilizers) depends on the market dynamics in the future.

VALUATIONS
At the CMP of Rs.74, DFPCL trades 4x its FY10E earnings of Rs.19. Long term investors can add more DFPCL to their portfolio.

To see full report: DFPCL

>INDIAN BANKS (CLSA)

Coming of age

Private banks will emerge stronger

Despite the growth and asset-quality issues facing global financials, Indian banks are likely to sustain their structural growth trajectory, driven by an under-penetrated financial-services sector, a conducive economic environment and a supportive regulatory regime. We estimate a 17% credit Cagr over FY09-14 and believe the current credit cycle is fairly manageable.

Over the next five years, bond-market development will lead to commoditisation of credit and margins will mainly be a function of retail liability franchise. As the distribution network and technological infrastructure become basic requirements - which are insufficient to drive profit on their own - softer skills such as service standards and product innovation will be critical to enhance the franchise. Fee growth is likely to be healthy as a pickup in corporate activity further boosts retail-fee momentum. We expect industry consolidation to continue, but big-scale M&A activity is unlikely. Meanwhile, Tier II public-sector-undertaking (PSU) banks will lose market share at a faster pace. However, regulatory relaxation will help improve the industry’s overall profitability.

Private banks are better positioned to leverage the changing industry landscape, as their superior servicing skills and innovation will drive market share gains in retail liabilities, allowing wider margins. Their ability to generate higher fee revenue means a wider ROE differential between them and the public banks. Our customer survey of 100 small/medium enterprises and 300 individuals highlights evolving customer preferences, suggesting that private banks’ market-share gains are structural. Although a few PSU banks have bridged the technological infrastructure gap to some extent, our on-the ground study suggests that they are significantly lacking on the more important soft skills.

Private banks will continue to grow earnings ahead of their PSU counterparts over the next five years, even as the diversity in profitability increases. We expect the ROE differential between the two segments to expand to 500- 600bps, leading to further widening of valuation multiples. On a three- to five-year investment horizon, we prefer private banks, especially ICICI Bank and Axis Bank, which still offer rerating potential on the back of their improving liability franchise. Be selective on PSU banks, where management continuity remains the key risk. We prefer only Tier I PSU banks for long-term investment. Some non-banking finance companies (NBFCs) like Housing Development Finance Corp (HDFC), Infrastructure Development Finance Corp (IDFC) and Reliance Capital can deliver returns over the longer term as they have built strong liability franchise and domain expertise.

Investment ideas
Our analysis of long-term returns indicates that private banks offer the best positioning to play the continuing story of the Indian banking sector. Their low market share, coupled with their ability to gain more, promises sustained healthy growth trajectory over the next five years. In our view:

■ Private banks could rerate, barring a couple of banks that trade over 4x, even from current levels, as they sustain their healthy earnings growth trajectory and report improvement in ROE.

■ Returns on public-sector banks will vary significantly as the valuation range expands, unlike in the past when most PSU bans have traded in a narrow band. We believe select PSU banks could re-rate marginally from current levels as they maintain stable earnings growth with high ROEs.

■ Short-term variations in the overall-return scenario are possible, especially given the triggers in the form of movement of bond yields (especially for banks like Oriental Bank of Commerce and Corporation Bank, which have a higher proportion of holding in non-held to maturity (HTM) category and are vulnerable to mark-to-market hits), NPL issues (corporate blowout might lead to short-term underperformance for the lead bankers) and other near-term factors. However, in our view, longterm sustainable stock returns are likely to revert to about 20% for private banks and to mid to high teens for well-run PSU banks.

■ Excluding a structural slowdown scenario for the Indian economy, ICICI Bank offers the best risk-reward from a three- to five-year perspective owing to its presence across the financial-services space. ICICI Bank has recently reorganised its operating structure, aiming to improve
profitability, a move that may address the long-due investor concern of frequent equity dilution, stemming from sub-par profitability metrics. Trading at a discount to most of its peers, ICICI may see a structural rerating, if it is able to demonstrate an improvement in its operating metrics to match up with its peers. Over time, we expect ICICI to expand its footprint further into rural banking, micro credit, and even explore overseas M&A. A sharp economic slowdown can expose ICICI to faster changes in its business environment than it can manage, leading to structural pain points like NPL.

To see full report: INDIAN BANKS