Monday, August 3, 2009


F1Q10: Refining Disappoints, but Gas Is Full Steam Ahead

Investment conclusion: We reiterate our Overweight stance on Reliance Industries (RIL) but lower our earnings by 8% and 2% for F2010/11. Post F1Q10 results, we have 1) increased our effective tax rate from 17% to 21% and 20% in F2010/11, respectively; 2) lowered our refining estimates for RPL due to synchronization-related issues; 3) improved our Petrochemical EBITDA due to stronger-than-expected netbacks. We maintain our target price, however, since we are largely maintaining F2011 estimates and our SOP, which is based on our F2011E earnings.

F1Q10: EBITDA was in line with our estimates but refining margins at US$7.5/bbl were 0.5/bbl lower than expected, although this was compensated for by higher petrochemical and gas divisions. Petrochemical EBIT grew an impressive 21% sequentially and E&P division EBIT more than doubled. RPL margins were a low US$ 5.4/bbl, with the company still not having synchronized all its units. Management expects to fully reach its complexity of 14x by September 2009. Gas volumes were an impressive 19 mmscmd from KG D6 this quarter, and the company is already operating about 30 mmscmd and has clients tied up for 40 mmscmd. Higher effective tax rate of 22% led to 43% increase in taxation and 3% lower profits than we estimated.

We expect RIL to grow 34% p.a. F2009-11, against Sensex growth of 11% during the same period. We estimate RIL will be FCF positive in F2010 with cash earnings increasing from US$4.5bn in F2009 to US$7.4bn in F2010 and US$9.4bn in F2011, and capex hovering in the US$3.5-4.5bn per annum levels.

Our quarterly forecast suggests RIL’s EP business should enable the company to grow 8% per quarter for each of the next three quarters despite lower GRMs and petrochemical netbacks.

To see full report: RIL


Voltamp Transformers Limited is among the top 3 players in building application transformers in the organised market and commands 20% market share in the industrial application transformers, with large installation base of more than 37000 transformers. We expect volumes to grow at a CAGR of ~14.5% over FY09-11 and expect revenues to grow at a CAGR of ~8.5% over the same period. Despite likely moderation in its FY10 earnings, any revival in order inflow in the current financial year on account of amplified focus on infrastructure development from the newly formed government will provide earnings upside in FY11.

Investment Rationale Highlights

De-Risked Business Model
The Company has a unique business model where unlike others, it generates 92% of its revenue from the industrial clients and only about 8% from the SEB’s. Market Leader in Dry Type of Transformers The Company is a market leader in the Dry type distribution segment with 40% market share.

Strong Order Book
The Company has a strong order backlog of Rs 4.75 bn (representing 8806 mva) as on June 2009 which VTL expects to execute in current financial year.

Ramp up in capacity to meet additional demand
The Company plans to increase the installed capacity by 4000 MVA to 13000 MVA. The new facility is expected to commission by August 2009.

At the current market price, the stock trades at 8.05x its FY 10E earnings of Rs 94.60 and 6.75x its FY 11E earnings of Rs 112.84. We recommend BUY with a target price of Rs 1015 based on the P/E Multiple method (9x its FY11E earnings), i.e. a potential upside of 33% from its current levels. We believe the company offers decent opportunity to play on the India T&D sector story.



Sell: 1QFY10 – Very Strong Margins; But Unlikely to Sustain

Strong EBITDA/t in 1Q — This was a bumper quarter for ULTC as PAT rose 58% to Rs4.2bn (13% above estimates), and EBITDA margins were 37% (vs. 30% last year) on higher realizations, strong volumes and lower costs. EBITDA/t grew 29% yoy to Rs1,350/t, substantially higher than in the past.

Surge in volumes — Sales volumes (including clinker) rose 24% to 5.3m tonnes; domestic cement sales increased 17% yoy to 4.5m tonnes due to the commissioning of the 4.9mtpa Andhra Pradesh plant taking ULTC's capacity to 23mtpa. Buoyant demand also supported the growth. We forecast volume growth (including clinker) of 11% in FY10 to 20.2m tonnes.

Good quarter for pricing — Strong demand trends and temporary disruptions in cement supply kept prices firm in 1Q. Average domestic realizations for ULTC rose 9% yoy and 5% qoq to Rs3,700/t. Realizations are expected to decline in coming quarters due to the substantial increase in cement capacity. Prices have already begun to decline in the South, where ULTC's new capacity has come up and which accounted for ~25% of its FY09 sales.

Lower power & fuel costs — Per tonne power and fuel costs fell 20% yoy in 1Q due to (1) lower coal costs as ULTC imports ~40% of usage; (2) benefit of captive power plants, which should meet ~80% of requirements. Per tonne raw material costs rose 9% yoy (23% qoq) due to clinker purchases.

Maintain Sell — While cost pressures will be less of an issue for ULTC in FY10E-11E, price declines are likely to cause margins to fall.

To see full report: ULTRATECH CEMENT


Exploring the power option: Upgrade Sterlite to Buy, on Conv list

Base metals' fundamentals appear bleak, look for other catalysts LME fundamentals remain under pressure from rising inventory since 3Q2008 and restarts from Chinese smelters in 2009 on the back of recent price rises. We remain uncertain over the outlook for the base metals complex, and look for catalysts independent of LME price movements. We adopt GSJBWere Commodities Research team’s recently adjusted LME price assumptions, revise FY10E-FY12E EPS for stocks under our coverage by -17% to 155%, and raise our 12-month TPs by 21%-96%.

Upgrade Sterlite to Buy, on CL: Free option value on power sub
We upgrade Sterlite Industries (STRL.BO) to Buy and add it to our Conviction List, from Neutral, as we believe:

• Current valuation reflects underlying fundamentals of the base business only, implying a free option value for its power subsidiary, Sterlite Energy, which we estimate at Rs137/share.

• Commissioning of the first unit of its 600 MW commercial power plant in December 2009 would be a significant catalyst. We expect this to be followed by three more units of 600 MW each every subsequent quarter.

• The power subsidiary would contribute 35% to earnings by FY12E.

• Recent equity fund raising, although dilutive in the short term, is a positive development as it could potentially enable the revival of the captive power projects at associate group company Vedanta Alumina as well as the 1,980 MW Talwandi Saboo commercial energy project.

Although Sterlite’s power subsidiary fundamentals are not as strong as JSPL’s, we believe it has the potential to enhance the growth and return profile of the company over the long term. We raise Sterlite’s 12-month SOTP-based target price to Rs763 (from Rs389), as we roll forward to FY11E valuation and incorporate the DCF value of its power subsidiary.

Maintain Sell on NALCO, Neutral on Hindalco and Hind Zinc We maintain Sell on NALCO (NALU.BO) due to expensive valuation, weak aluminium fundamentals and frequent coal supply disruptions. We maintain Neutral on Hindalco (HALC.BO) and Hindustan Zinc (HZNC.BO).

Volatility in equity and commodity markets, delays in project execution.

To see full report: METAL SECTOR



Top-line declines 2.7%: Phillips Carbon Black (PCBL) reported a marginal 2.7% yoy decline in its Top-line to Rs291.2cr (Rs299.3cr), in 1QFY2010, despite a 1% increase in the Sales Volume. The company’s sales volume increased by 26% qoq. The imposition of a provisional anti-dumping duty up to $195/MT resulted in the reduced import of carbon black, thereby benefitting the domestic players. The sale of external power increased to Rs9cr (Rs4cr), with the commissioning of the 30MW power generation plant at Durgapur, which again boosted the Top-line as well as the margins.

OPM at 10.9%: The company recorded a 170bps expansion in the OPM during the quarter, to 10.9%. The improved performance on the operating front was primarily on account of an 11.3% decline in the Raw Material Cost to Rs182.7cr. PCBL’s Operating Profit for the quarter stood at Rs31.6cr (Rs27.5cr), up by 15.2% yoy.

Net Profit at Rs20.5cr: PCBL has managed to deliver a good performance on the Bottom-line front. Although the company’s Net Profit was down 10.6% yoy, the performance in the current quarter is extremely comforting when seen in light of its 4QFY2009 performance. In 4QFY2009, the company incurred a huge loss of Rs57.1cr on a Top-line of Rs241.5cr. We
expect the company to perform well in the coming quarters, on account of the recovery seen in the domestic auto industry.

To see full report: PHILLIPS CARBON BLACK


Monetary Policy Preview – Status Quo Likely

Mixed Macro Back-Drop Could Prompt Status Quo — The domestic macro backdrop of the RBI’s monetary policy due on Tuesday 28th July is that of: (1) nascent signs of recovery but the monsoons casting dark grey clouds, (2) benign WPI inflation but soaring food prices, and (3) ample system liquidity but a near doubling of the borrowing program. Given the above, and the fact that since the financial crisis the RBI has aggressively cut policy rates (repo rate by 425bps to 4.75%; reverse-repo by 275bps to 3.25% and CRR by 400bps to 5%), we expect
the RBI to: 1) maintain status quo on rates, 2) continue with its objective of ensuring adequate liquidity, and 3) start tightening in 2Q 2010.

So What Should One Look Out For? — With Governor Subbarao saying that “improving communication at both technical and non-technical levels” and “demystifying the office of the governor” would be among the objectives during his tenure, it will be interesting to hear the RBI’s thoughts on: (1) the extent of system liquidity it is comfortable with and views on reversal of monetary accommodation, (2) balancing a high deficit and ensuring there is no crowding out, and (3) rising food prices and its influence on monetary policy.

RBI's Macro Forecasts — Given uncertainty on the outcome of the monsoons, the RBI could stick with its 6% GDP estimate – made prior to the positive election results. However, we could see higher guidance on inflation (currently 4% by end FY10), as well as some concern on the fiscal deterioration.

Downside Risks to our FY10 GDP Estimates — As mentioned in the 21 July Macroscope (‘Drought – No, Not Yet…But What If?’, CIRA report, with the rains playing truant this year a poor monsoon, or a worse case of a drought (classified as rainfall deficiency of >25%), would impact headline GDP (our base case GDP of 6.8%in FY10E could moderate to 5.8%, or in a worse case to 5.2% levels depending on the extent of damage).

To see full report: MONETARY POLICY


Increase Ownership Down the Cap Curve

• After underperforming the narrow market severely in 2008, the broader market bounced back from its March lows relative to the BSE Sensex. More recently, the broader market has given up some of these gains (about 15% underperformance since early June).

• Trading volumes have started going down the cap curve whereas returns are still better up the cap curve. YoY, the Sensex returns have already turned positive (+8%) whereas the median returns across all listed equities is still negative (-16%). No doubt mid- and small-cap indices have bottomed from their lows but remain significantly off the highs.

• Given our view that growth is likely to turn in the coming months, it is quite likely that broad market earnings growth will accelerate faster than large caps (as we saw in the previous cycle). We are already seeing signs of this in the current earnings season. The broad market earnings growth (ex-energy) has gone from -25% in December 2008 to -15% in March 2009 to 16% thus far in the quarter ended June 2009.

• While mid- and small-caps trade at a discount to large caps as they should over a cycle, given the possible acceleration in earnings growth, these stocks could start trading at premium valuations as they did in 2007.

• Hence we think investors should definitely own stocks down the cap curve. We have identified five such names based on our analyst recommendations. The following pages contain some details on these stocks.

To see full report: INDIA STRATEGY


Out of the red, into the black
As Indian life insurers emerge into profitability, we move our valuation basis from
the opaque new business profits (NBP) to accounting profits.

Exponential growth in profits

All four of the life insurers we cover are expected to break even by FY3/11E. Thereafter, we expect an exponential growth in profits, with ROEs peaking at 35- 40% between FY3/14E and FY3/16E. Key drivers behind this profitability surge:

  • Cost/premium ratios will decline at an accelerated rate, helped by aggressive cost-cutting and an improving share of repeat premiums.
  • A blow-out in asset management fees, with players showing a 50-68% CAGR over FY09-15. By FY15, these fees will have risen from 9% of revenues to 18% (aggregated for the five companies).
Valuations – very cyclical
We have used a dividend discount model to value the businesses – we believe
this is more transparent than the previously used ‘PV of NBP’ method. It isn’t perfect though, and a ‘long-term fair value’ is less relevant because equity market returns (and their secondary impact on sales growth) are an important assumption, which cannot be realistically forecast in a straight line. As with other capital market businesses (such as broking/investment banking), valuations cycle with the markets.

Our positive view of the markets is behind the 9-60% upgrades to the valuations
of the five life insurers, whose parents we cover.

Industry growth strong, but not secular

We retain our view that the Indian insurance industry will continue to grow at a strong pace over the medium term, albeit with greater cyclicality than in the past. Growth will still be driven by a combination of India’s demographics, the low share of equity in household savings and the lack of a formal social security framework. While insurance is the most expensive way for an investor to access the markets, the industry’s strong distribution still gives it an advantage over mutual funds.

In our view, the competitive scenario will follow recent trends: Life Insurance
Corporation will lose market share to the private sector – and the top five players there will continue to consolidate, with most new players probably struggling.

Reliance Capital, HDFC – best plays

We upgrade our valuations of the lifecos, factoring in the near-term upside we have forecast for the equity market. We also upgrade our ratings for Reliance and Kotak, primarily because of the increase in the lifeco valuations. These valuations are well above long-term fair values, which implies the downside will be high if the markets take an adverse turn. Our favourite plays on the sector are Reliance Capital and HDFC.

To see full report: INDIA INSURANCE


Investment Period: 3-6 Months.
We initiate a Buy call on ICSA (India) Ltd with a 58% upside potential on the stock from the current levels. Investment advice is based on strong growth in top line, diversified businesses and strong outlook for the power sector over next 10 years. We expect top line to grow by 30-35% over next two years and our conservative projections suggest that bottom line will grow at compounded annual rate of 15%. Stock is currently trading at 4.6 x its FY09 Earnings and 4.6x and 3.7x its FY10E and FY11E earnings.

Investment arguments:

Strong order Book Position: The order book at the end of the quarter stood at Rs 1915 crore executable over 12-18 months. Embedded Technology segment has order book of Rs 650 crore executable over next 6-9 months and balance is for Infrastructure EPC segment. The order pipeline is about Rs 700 crore.

Allocation Of funds by govt: The RAPDRP(Restructured Accelerated Power Development and Reforms Programme) is the restructured version of APDRP, which has a budget of Rs 50000 crore to be spent over 3 years of which Rs 10000 crore is towards Technology acquisition (the segment which the Company caters to).

Increased allocation of Government projects under Rajiv Gandhi Grameen Viduytikaran Yojana (RGGVY) to 7000 crores up by 27% will have see significant orders coming in for ICSA.

Inorganic Growth: As a part of its inorganic growth, last year ICSA acquired the energy Meter plant of ECE industries in Hyderabad, thereby enabling itself to manufacture energy meters on its own capacity. Moreover in order to enhance the revenue and enjoy the tax benefit, it has diversified into non conventional energy and is setting up a 20 MW capacity wind power project in Andhra Pradesh out of which nearly 10MW has already being commissioned.

Discounted Valuations: Share is trading at 72% discount to its adjusted all time closing high of 587. India power and Infra sector have strong growth ahead, and ICSA will continue to be a part of it.

To see full report: ICSA



BGR Energy Systems Ltd. (BGR) is all set to outperform in the medium term due to huge opportunities in the Power Sector for Balance of Plant Equipments (BOP), robust order book, diversified business model, technological collaborations, likely entry into boiler and turbine manufacturing space and strong balance sheet.

Going forward, BGR plans to cater to variety of clients by expanding existing facilities in India. We believe that the robust order book, diversified business model and technical collaborations with strong management team would help it maintain its revenue growth in the medium term. BGR raised a sum of Rs.3.37bn from equity issuances from private Equity and IPO last year to withstand large capital expansion and working capital needs for the ongoing projects.

At current market price the stock is quoting at 12.2x the FY10E EPS of Rs.25.3 and 9.4x FY11E EPS of Rs.33.0. We recommend ‘Accumulate’ with a target price of Rs.321.

Investment Highlights

Huge opportunity for BOP and EPC contracts in the 11th and 12th Plan
Government of India planned capacity additions of 78,577MW for 11th 5-year plan. Till today, around 91% of the projects are under construction. Despite continuous slippages in the last two 5-year plans, we believe that 45-50GW capacity additions look realistic in the 11th 5-year plan. In addition, the GoI would continue its thrust in the power sector and planned to add 82,200 MW in the 12th Plan.

Robust order book to lead a steep rise in revenue & profit growth
BGR has a robust order book of Rs.95bn with a majority of projects from the Power Projects division. The company has recently won large BOP and EPC orders of Rs 49bn from RRVUNL and Rs. 31bn from TNEB with an expected execution period of 3-4 years. As a result, the company's revenues and profits are also expected to pick up strongly in the next few years.

Diversified business model to enable BGR to de-risk business in the long term.
Though BGR's large order book consists of Central and State Utility orders, it diversified into Air fin Cooler and Oil and Gas Equipment businesses, which can become a major growth drivers in the next couple of years. The company also manufacturers related equipments and products through its divisions and associates. BGR is executing an EPC contract for 1200 MW for RRVUNL which was awarded on international competitive bidding.

Technical Collaborations & Strong management to grab large & complex projects
BGR has technological tie-ups with world leading Power Equipment companies for various products. The company is poised to execute power plants of sizes upto 1,000 MW using the latest technologies. The company has a strong management team with an average experience of more than 25 years. The company has also worked with reputed clients such APGENCO and RRVUNL & other SEBs.

To see full report: BGR ENERGY