Monday, July 20, 2009


The price has to be right

We retain our contrarian Underperform on ICICI, as we do not see any significant leverage to higher economic growth for this bank in particular.

Loan growth will remain stunted. Near-term loan growth (stand-alone) is likely to stay constrained, not least because the international book is expected to contract at ~10% pa for at least two years. The domestic book should grow, but the compulsion to get the CASA* ratio up to the 30s is expected to prevent run-away growth. We see little upside to our loan growth forecasts, even if economic growth accelerates. (*Current accounts and savings accounts).

Margin improvement gradual. The expected shrinkage of the international book should help margins, as should the increased focus on CASA deposits. This is likely to be offset by the run-off in the unsecured book, which is being replaced by low-yield corporate and home loans. The benefit of a lower risk book is likely to flow through in sharply improved credit costs, but only from FY3/11E.

Asset quality – not a lot of relief. There is no significant relief in loan quality. The retail book continues to be under stress, with the unsecured book remaining the primary source. Wholesale loans remains under pressure, though the number of stressed accounts is not growing and that is a source of some relief. We retain our view that the Rs1tr non-retail book will see
cumulative losses of Rs20bn over FY3/10-11.

Earnings and target price revision
We have reduced our FY10E and FY11E EPS forecasts by 6.4% and 2.2%, respectively. We have introduced FY12E earnings. Our TP increases to Rs517 from Rs436 while we retain our Underperform.

Price catalyst
12-month price target: Rs517.00 based on a sum-of-parts methodology.

Catalyst: Continued fees and asset quality stress in 1H FY3/10E.

Action and recommendation
It is not in the price, yet. ICICI has corrected by 6.5% since Monday. Its P/BV of 1.2x FY10E (ex-subsidiaries), however, still appears high in the face of weak ROEs. Management’s medium-term goal of reaching c. 15% ROE is unlikely to be met even by FY3/12E. This is reflected in the stock’s high PER. At 13.7x on FY3/11E, this is a 21% premium to the Sensex multiple, with earnings CAGR at a mere 14% over FY3/09–12E.

Long-term value, but only at the right price. ICICI’s worst days are definitely over, and the management is walking the talk on consolidation. The improvement in core profitability, however, will be a slow process and we would baulk at paying over the odds for the stock. Retain Underperform.

To see full report: ICICI BANK


Performance to excel

The I-Sec FMCG universe is likely to register lower sales growth, of 10.9% YoY, due to muted sales growth in Hindustan Unilever (HUL) & ITC and lower price growth for most other companies. However, volume growth is expected to be strong for most categories. Lower input costs and excise benefits will result in margin expansion and, hence, we expect operating profits for the I-Sec FMCG universe to grow 21.5% YoY. However, while lower input prices and excise benefits will give relief to the sector, the quantum of margin expansion will vary across companies. We expect robust PAT growth for ITC, Nestlé, Godrej Consumer Products (GCPL), GlaxoSmithKline Consumer Healthcare (GSKCH) and Marico. We expect Asian Paints and HUL to register muted PAT growth. Overall, we expect the I-Sec FMCG universe PAT to grow 20.3% YoY. We prefer ITC, Marico, Nestlé and GSKCH.

Overall sales growth to be moderate, albeit not for all. The FMCG industry is expected to post moderate growth of 10.7% YoY on the back of lower price growth, but robust volume growth. Also, this is likely due to: i) declining exports for HUL and Nestlé, ii) lower growth in non-FMCG business of ITC (Agri & Hotels). We expect HUL to deliver muted sales of 6.6%. ITC would register robust growth of 21.8% YoY in the total FMCG division. However, we expect overall sales growth for ITC to be muted on account of below-par performance in hotels and agri segments.

Margin improvement a reality, but quantum of expansion will vary. With softening of commodity prices and benefits of lower excise, we expect operating profit margin for the I-Sec FMCG universe to expand in Q1FY10. Hence, operating profit growth of 21.5% YoY would be much higher than sales growth. However, the quantum of margin expansion will vary across companies. Categories facing intense competition (Toilet Soaps, Detergent etc) have resorted to rise in sales promotion, price cuts and extra quantity per pack. Categories such as Paints and Edible Oil have trimmed prices. Highly brand loyal categories (such as Coconut Oil, Oral Care, Tobacco, Alcohol, Skin Creams, Health Drinks and Baby Foods) will benefit from reversal of commodity prices and reduction of excise duty.

Outliers. Expect strong PAT growth in GCPL (up 53% YoY), GSKCH (up 32% YoY), ITC (up 24% YoY), Marico (up 37% YoY) & Nestlé (up 31% YoY). But, we expect muted growth in Asian Paints (up 6.7% YoY) and HUL (up 10.3% YoY).

We prefer ITC, Marico, Nestlé and GSKCH. We prefer companies that are present in categories with a mix of parameters that are: i) high volume growth (Biscuits, Noodles, Edible Oil & Shampoos) ii) strong entry barriers (Cigarettes, Alcohol and Baby Food) iii) high brand loyalty (Cigarettes, Alcohol, Baby Food, Health Food Drinks, Sanitary Napkins and Oral Care) iv) lower competitive intensity (Cigarettes, Alcohol, Baby Food and Coconut Oil) v) niche positioning (Saffola in Edible Oil, Navratna in Hair Oil). Given above parameters and valuations, we
continue to prefer ITC, Marico, Nestlé and GSKCH.

To see full report: FMCG SECTOR


Growth up+ risk down+ defensives in = another opportunity
The July FMS shows how a modest correction in equity markets together with a larger one in commodity prices punctured investor confidence and prompted a hasty retreat back toward defensive sectors. This nervous response came despite growing conviction that we are through the worst of the economic problems and still rock-solid faith in the GEM story. It does suggest that any surprise in Q2 results could see markets being squeezed upward into H2.

Past-the-worst conviction rises; inflation scare eases
Investors are convinced that global growth will improve (+79% vs. 78% in June) and that this will lift corporate margins & profits (a net 51% see improvement over the next 12 months). However, a downtick in risk appetite saw a very skittish retreat back into defensive areas. That is, apart from GEM assets, which remain famously popular; and this despite China optimism coming off the boil, only to be replaced by Indonesia - now the most O/W GEM. Meanwhile, inflation fears eased as commodity & oil prices tumbled (a net 14% now see higher inflation, down from 19%) and this stabilised views on how quickly interest rate are likely to rise.

Asset allocators skittish as risk appetite falters
Asset allocators are in wait-and-see mode as overweights in cash (+9%) and equity (+7%) were trimmed, with bond U/W easing to -13% from -15%. Risk appetite fell, with our composite indicator standing at 36 from 38. Average cash balances saw a very sharp jump to 4.7% (vs. 4.2%), with only 12% of investors now reporting higher-than-normal risk-taking in portfolios. Hedge funds are more
active, with leverage rising to 1.2, but net long exposure fell to 23% (from 35%).

Equities good value, but it’s GEM vs. the Rest of the World
Equities are viewed as undervalued by a net 8% of investors, while a net 30% say bonds are expensive (up from 22% in June). But it’s not about value: a net 8% of respondents view GEM as overvalued and yet it is still seen as the only game in town, with nearly half of all investors saying it is the region they want to O/W on a 12-month view (vs. -30% for Eurozone, the lowest reading ever).

Retreat to defensives provides chance to re-load
Having fleetingly been U/W all big 4 defensive sectors last month, investors turned on a sixpence in July with telecom, pharma and staples all recovering strongly, at the expense of materials, energy and industrials. The degree of optimism on EM vs. Eurozone looks dangerously extreme and, more broadly, the retreat to the defensive positioning of February, in our view, provides another
opportunity to reload on cyclical over defensives trades on the expectation of confirmation of real economic growth emerging across all regions from Q3.

To see full report: FUND MANAGER SURVEY


Stay on the front foot

After the rally − what next?
The recent rally in the consumer discretionary and retail stocks in India was breath-taking. In some cases, stocks are up as much as 200% in three months. Stocks are (naturally) taking a breather at this time. The sharp rally makes a defensive stance look more compelling, in our view. We however continue to believe that this as a good time to accumulate ‘beta’ from a longer-term perspective. Staples may outperform by holding ground in a falling market, but most (notably HUVR) seem too expensive to be able to deliver material absolute performance. Macquarie’s regional consumer analyst, Mohan Singh, in his 7 May 2009 flyer, “Going cyclical”, noted that “the excess premiums that consumer staples companies enjoyed in 2H08 due to the credit squeeze and declining consumer confidence levels appear to be dissipating”. This Asia-wide theme was clearly applicable in India.

2010 will see the resurgence of the urban consumer
The last twelve months have been the year of the rural consumer. While samestore- sales (SSS) growth and demand for high-end discretionary goods came under pressure, rural consumption growth was resilient. A good monsoon in 2008 and pump priming by the government helped demand for low ticket items, helping staples companies deliver 15−20% top line growth. Our conversations with consumer companies suggest that the buoyancy of rural demand is likely to
continue driven by continued support from the government unless the monsoon fails. In any case, we believe that the largest delta on company sales growth is likely to be delivered by a resurgence of growth in urban consumer demand.

GDP growth in India has surprised positively, coming in at a healthy 5.8% for 1Q09. Macquarie India economist (Rajeev Malik) has since upgraded his GDP growth forecast for FY10E and FY11E to 7% and 7.5%, respectively. This is likely to spur demand growth for discretionary goods and SSS growth, which is also likely to get a boost in 2H FY10 due to a low base effect. In fact, the first signs of a demand revival have started showing up in reported SSS numbers.

Focus on stocks with upgrade potential
To play the theme of GDP growth recovery, we would recommend that investors focus on stocks which are leveraged to economic growth.
  • Demand perspective: A recovery in GDP growth would lead to upgrades in sales forecasts for Pantaloon (driven by SSS), UNSP and Marico (demand for discretionary products) and ITC (hotels and high-end cigarettes).
  • Cost perspective: After reaching their worst point in 4Q08, debt and capital markets have revived. The de-leveraging story is playing out in the case of UNSP and Pantaloon (see individual notes for further details).

For investors who prefer a defensive stance after the recent rally, we highlight stocks with some element of growth and upgrade potential. We would pick ITC (notably after the union budget) and Marico in the mid cap staples space.

UNSP stands out amongst beverage/consumer companies with a discretionary element. Pantaloon is our top retail sector pick. In both cases, we expect earnings upgrades and triggers on the back of a stake sale and capital raising.

To see full report: INDIA CONSUMER


Resilience through vertical integration

Reliance Industries Ltd (RIL) continues to move forward on growth trajectory with the commencement of gas production from Krishna Godavari (KG) Basin and commissioning of the new refinery. We believe that there could be further positive news coming from exploration & production (E & P) business, which would act as the catalyst for the stock. The company's gas based petrochemical plant helps it to weather the global downturn. We rate the stock as an Outperformer with target price of Rs 2,169.


E & P business has taken off with the KG Basin gas production: RIL operates the block KG-D6 in the Krishna- Godavari basin, which is the largest natural gas discovery in India. The company commenced production of natural gas from KG- D6 block on April 2, 2009. The exploration business is expected to give a boost to the valuation of the company as the blocks under exploration / yet to be explored are likely to have significant reserves of oil and gas. We expect the exploration and production (E & P) business to contribute at least 30% of the company's total EBITDA after the commissioning of KG basin gas production.

Refining earnings to be boosted once the new refinery stabilizes: After the merger of RPL with RIL, RIL's refining
capacity has increased from 33 mn tonnes per annum to 62 mn tonnes per annum. The new refinery i.e. RPL has a distillation capacity of 580,000 barrels per day (bpd). Such a large scale of operations should provide economies of scale, leading to a relatively lower operating cost base. The new refinery has been designed to have a Nelson Complexity Index of 14.0, which makes it amongst the most complex refineries in Asia. Since the new refinery is located in special economic zone (SEZ), it will have significant tax benefits.

Petrochemical cycle down, but gas based cracker limits the impact on RIL: Though the global petrochemicals
cycle is down, gas based petrochemical plants are less affected due to their lower input cost as compared to the plants, which use naphtha as the input. Gas based plants have the cost advantage as the gas price is generally 0.5x of naphtha. The merger of IPCL has helped RIL in acquiring a gas based cracker having vastly superior economics of these plants as against naphtha-based ones. RIL is also building the largest integrated petrochemical complex based on gas as a feedstock with capacity of 2 million tonnes per annum at Jamnagar SEZ. The project is expected to be commissioned by FY2010-11.

Valuation: RIL is currently trading at a P/E of 11.2x and EV/EBIDTA of 7.8x based on our FY2011E estimates. We
have analyzed one year forward multiples of P/E, EV/EBIDTA and P/BV for RIL in the last firve years. Based on the same, we arrive at target price of Rs2,169. At our target price, the stock would trade at one year forward P/E of 13x and EV/EBIDTA of 9x based on FY2011E estimates, which is in line with its normal range except for the brief spurt between June 2007 to January 2008. We rate the stock as an Outperformer.

To see full report: RELIANCE INDUSTRIES


Examining inter-regional dynamics
  • Market share of cement players varies across India. Inter-regional dynamics play an important role
  • Players in the more fragmented South are the major losers; our top sell ideas are India Cements and Madras Cements
  • Our top pick is Shree Cement for its focus in the North and Central regions
We analyse market share trends and capacity addition. Our analysis shows that the divergence in market share trends across regions will persist. Cement companies in North and Central India should be able to retain market share despite potential overcapacity, which will provide some pricing discipline. But we expect the southern market to become fragmented.

We also examine the role of inter-regional dynamics. In the South, moderating demand growth and capacity additions hint at overcapacity. This may cause increased supply of cement to the West, which meets 20% of its requirements from the South. Further new capacity in the
North may also result in volumes being pushed westward.

Forecasts adjusted. We have revised FY10e EBITDA for our coverage universe in a range of -7% to 31%, primarily to reflect change in our volume and price assumptions.

Target prices upgraded; ratings unchanged. We move to average historical EV/EBITDA valuation from trough. We think demand positives are in the price and the sector will lose momentum from here. Maintain UW(V) on ACC, Ambuja, Madras and India Cements.

To see full report: INDIAN CEMENT


Asian Corporate e Governance Pick

How is governance?
In today's Q-Series®: Corporate Governance in Asia, we rate Mahindra & Mahindra (Mahindra) as Improving in India. The company provides a high degree of disclosure on related party transactions and maintains a clear separation between subsidiaries. Separately, senior management have made disclosures to the board that there are no material, financial and/or commercial transactions between them and the company, which could create potential conflict of interest. CRISIL has assigned Governance and Value Creation (GVC) Level-1 to Mahindra for its
ability to create value for all its stakeholders.

Is anything changing?
In our view, management has made recent efforts to improve its governance. For instance, it now provides quarterly disclosure of non-operating items and their overall impact on P&L. Mahindra’s ranking in the JD Power Customer Satisfaction Index (CSI) has improved to fourth from seventh, demonstrating its commitment to delivering value to customers. Mahindra has made efforts to relocate workers from its existing facilities to the upcoming Chakan plant. This highlights management’s ability to work for the benefit of both shareholders by reducing costs, and workers by providing an alternative employment opportunity.

Investment view
We think growth of Mahindra’s UVs and LCVs will remain strong, driven by successful new launches and higher exposure to rural and semi-urban areas. We expect UV and LCV sales to grow 20% and 15% YoY, respectively, in FY10.

Valuation: Buy rating and a price target of Rs860.00
We value M&M on a sum-of-the-parts basis. Based on our target multiple, we value the core business at Rs565/share and the subsidiaries at Rs294/share.

To see full report: MAHINDRA & MAHINDRA


Impressive margin performance in Q1 FY10, sustainability is a concern

Results: Sales growth remains muted, export realizations boost margins

Although BAL’s volumes in Q4 FY09 reduced by 12% yoy, average net realizations improved by 15% yoy on the back of improved product mix and export realizations. The growth in realizations offset the decline in volumes as net revenues grew 1.6%, slightly above our expectations. Total income (net sales + other income) rose 1.5% to Rs 23,385 mn. BAL’s EBITDA jumped by 71% yoy in Q1 FY10; while EBITDA margins expanded 800 bps yoy and 430 bps qoq to 19.5%.
Softening of steel prices and a change in product mix led to an improvement in raw material costs as a percentage of total income (66.2% v/s 75.7% in Q1 FY09 and 68.8% in Q4 FY09). Adjusted net profits were also above our expectations due to higher than expected benefits at the operating level. Adjusted net profits increased by 55% yoy although in this quarter the company continued to pay for the VRS scheme amounting to Rs 458 mn. Net profits are adjusted for a derivative gain of Rs 218 mn.

EBITDA margins not sustainable
With the effect of steel prices reducing, BAL has witnessed a huge surge in the margins. With Aluminium price reduction showing its impact from Q1 FY10, margins expanded by a significant 430 bps in the quarter on qoq basis. Additionally, export realizations also got a boost due to DEPB benefits and the company’s strategy of taking a forward cover with a bottom-side protection of Rs 47/$ against Rs 41/$ earlier. As a result of this alteration, net realizations increased by a
straight 15%. Also, the ramping up of production at Pantnagar plant would add to the excise benefits. However, the company mentioned that the EBITDA margins would not be remaining at the current level of 19.5% in the remaining part of the year. This will be because the company is in the process of launching new models, which would demand increase in marketing expenses and sacrificing of margins on them to gain volumes. We have estimated the full year margins to
reduce down to 18% from current level of 19.5%. The management expects raw material costs to remain stable throughout the year and also expects EBITDA to remain at the Rs 4,500 mn level every quarter.

New launches to provide better positioning

To reposition itself, BAL is launching the 100 cc bike Discover M on 17July, priced at > Rs42,000 per unit and expected to give a mileage of 80 kmpl. The company also launched two variants of Pulsar 150 and 180 in May and the new Pulsar 220 in June. The domestic Pulsar sales have increased to 42,000 v/s 28,000 per month in FY 2009. The company has started to produce a low cost bike, Boxer in China for Nigerian market. It is currently producing 1,000 bikes per month. In
the coming months, this could be ramped up to 10,000 per month due to increasing demand in the African markets. BAL also declared its plans to launch a new bike with KTM in India next year and has also increased its stake in KTM. It will also launch two new three wheelers in August and December, one each in the passenger and goods segments. The company is planning to ramp up production at Pantnagar to derive added excise benefit. In May, it produced 45,000 bikes from there, while in September it intends to increase it to 60,000, thus taking the yearly production to ~ 0.65 mn.

Exports drop on reducing demand Exports contribute ~33% of BAL’s volumes. The first quarter has witnesses a
10.3% drop on a yoy basis due to weaker export sales in April. We believe this to be negative for the company as the company is banking too much on exports. The company expects a revival in exports in the coming quarters.

To see full report: BAJAJ AUTO LIMITED


To see full report: CESC


Supply additions continue to creep up, while South remains weak

Y/Y demand growth looks good, but South India weakness is a concern: India’s June-09 cement dispatches grew 13% Y/Y (+1.3% M/M). We believe a benign base, combined with continued strong demand in North and East India, was the key reason for the strong Y/Y dispatch growth. While we expect the base to stay supportive until Nov-09, we believe the continued slowdown in South India is a concern. The May-09 cement consumption increased only 1% Y/Y in South India, with two of the top three markets (Karnataka and Andhra) declining. Usually, South India does not get affected by the monsoon rains in the July-Sept period. Although 1Q has seen capacity additions of 15MT, we highlight that it does not yet include the large green-field units of Grasim.

Mixed cement price trends: While the J.P. Morgan National Cement Price Index increased 0.7% M/M, pricing trends were mixed across India. Some pockets of Eastern and Northern India continued to see cement price increases of Rs3-8/bag in June/early July; however, most of the South India and pockets of Western India saw price declines. Southern India was the first
off the blocks in terms of capacity addition, and we believe continued ramp up of capacity, combined with weak demand, is likely to see more supplies to Western markets, thus affecting the prices. Although cement prices did not fall over the past three monsoons, we expect price declines this year.

The time frame to achieve capacity ramp up: Over the past three years, the Indian cement industry has added capacity mainly through debottlenecking and small brown-field expansions. However, an analysis of some of the green-field units over the past two years suggests that from clinker commissioning to the ramp up of 70% capacity utilization can take as much as 8-9 months, as the power plant, grinding units and bagging units come in place.

Quarterly results—we expect a record quarter: We expect cement companies to post record earnings and margins in the Jun-09 quarter (please see Figure 6 for details) as the full benefit of higher prices flows through.

To see full report: INDIA HARD HAT