>From Financial Recovery to Real Recovery (CITI)

■ A solid gain in real output is evident in 4Q 2009 without the help of substantial one-off stimulus. Consumption, trade and (less favorably) inventories have all surprised to the upside in recent reports.

■ Employment data could show outright gains, if mild, before long.

■ Inflation expectations receded meaningfully in early December, and consumers noted a highly favorable pricing backdrop in the latest Michigan survey.

■ Downside surprises to the inflation path beyond November headlines may further cement recovery expectations, which have boosted all risky assets in tandem.

■ Real-side economic recovery, albeit gradual, will follow. But the speed and scope of 2009’s market turnaround makes a repeat performance highly unlikely.

■ In particular, credit markets have sharply outperformed equities, with BBB-rated long-term corporate total return since early 2007 +22.8% vs -18.0% for the S&P 500.

Early Cycle Recovery, Mature Market Rally
A negative feedback loop of tightening financial conditions and ever-worse real economic fundamentals is now showing the earliest hints of reversal. While the wounds in labor markets and consumer balance sheets run deep and sectorlevel problems remain, enough healing seems to have taken place that fundamentals bear a chance of surprising somewhat positively in the coming year. Such true positive feedback effects are typical of sustained expansions. Far from “one and done,” a solid gain in real GDP in 3Q could be followed by a quarter of growth in excess of 3% either in 4Q or 1Q 2010 (Our forecast for the two-quarter period averages 2.8%. Pricing and production data will help further quantify tracking estimates for 4Q 2009 GDP this week).

Labor market data suggest mild outright gains in employment may be possible soon, not at some distant period ahead (see figure 1). While recovery in some data series are more pronounced than others, surveys of both current and expected economic conditions by consumers improved significantly through early December. Total consumer spending continues to grow, post the removal of one-off stimulus (see figure 2). Consumption, trade and (less favorably) inventories have all surprised to the upside in the most recent reports.

While consumer-related share prices have risen sharply for nine months already, the rebound in consumer spending has been deemed impossible by enough market participants and pundits that it remains truly noteworthy. (Please see last week’s Morning Comments for discussion.) Real consumer spending appears to be on track to grow as much as 2% in 4Q 2009 above the level of 3Q, which rose 3% with “cash for clunkers” inducement. Three months ago, we expected real consumption to nearly flatten (+0.2%) on payback from the strong 3Q gain.

Of particular interest in the latest Michigan sentiment data, consumers noted their long-term inflation expectations fell back toward record lows (+2.6%). They also noted the highest prevalence of price discounting for consumer durables on record (see figure 3). Downside surprises to U.S. inflation data might seriously jar perceptions of a long-promised inflation rise that away from crude oil and commodities has yet to materialize. Stable purchasing power removes another threat of recessionary relapse.

To read the full report: PORTFOLIO ECONOMICS

>Changing Landscape of IT - ITES Outsourcing (KPMG)

■ Acceptance of Outsourcing as a mainstream option: Organizations have explored new ways of doing business; implemented emergency measures to improve cash flow; overcome negative growth and slipping margins in order to survive. KPMG International’s 2009 study “Nearshore
Attraction: Latin America Beckons as a Global Outsourcing Destination” reveal that businesses are looking at outsourcing to play a leading role in the coming months to aid economic recovery.With an increase in the number of firms outsourcing, the strategy has gained greater acceptance as a means of freeing up working capital, converting fixed costs to variable and gaining access to global best practices.

■ Leveraging global business needs

■ Mitigating risk and uncertainty

To read the full report: ITES OUTSOURCING

>BHARTI AIRTEL (KOTAK SECURITIES)

Relief rally without any signs of relief—an opportunity to cut exposure. We reiterate our current negative outlook on Bharti and recommend using the recent stock outperformance to pare exposure. Better-than-expected December 2009 quarter earnings are likely spurred by higher STV bookings and higher minutes elasticity. However, sector fundamentals remain weak, pricing may yet to bottom out and the full impact of pricing competition will reflect only in the March 2010 quarter. REDUCE.

A rally without legs—use it to reduce exposure
We believe that the recent rally in Bharti’s stock price may have been driven by (1) relief on pricing post Uninor’s ‘rational’ launch pricing, (2) expectations of reasonable and significantly better-than feared December quarter earnings, and (3) other potential technical factors. However, we continue to believe that it is too early to take a call on the duration of irrational price competition or the extent of damage it causes to the industry structure. We discuss our views on each of the above ‘positive’ developments below.

Uninor’s rational launch pricing may turn out to be a lull before another storm
We would be wary of viewing Uninor’s relatively rational launch pricing as early signs of pricing
stability in the market; notions of pricing having bottomed out may be even riskier. Incumbents
and new entrants both continue tactical price cuts spanning local & NLD calls, roaming charges,
and SMS services. More importantly, there are initial signs of price competition in the post-paid
market, especially in the metros. In addition, new network launches are still not over; Tata
Docomo is yet to launch in a few circles, Uninor has launched only in seven circles, Etisalat-DB
Telecom is close to its initial network launch. We would not rule out another big bang price cut
from one of the incumbents, cross-over licensees, or new licensees over the coming months;
lower-than-expected network traffic will likely trigger the pricing action.

December quarter earnings may not reflect full impact of recent price cuts
Higher-than-expected minutes elasticity and positive impact of revenue booking of large volumes of STV (special tariff vouchers to avail of discounted tariffs) sales may mean a better-than-initially feared December quarter earnings. But we highlight three reasons why Dec 2009 quarter earnings will be a poor indicator of underlying earnings, in our view—(1) a part of the minutes elasticity will be purely seasonal, on account of the festive season, (2) higher STV sales bookings (extent of positive impact would depend on the timeframe of amortization) are non-recurring in nature and (3) tariff discounting has happened in steps, and at various times in the middle of the quarter; thus, the full quarter impact of discounted tariffs will not reflect in Dec 2009 earnings.

To read the full report: BHARTI AIRTEL

>Wealth Creation Study 2004-2009: Findings (MOTILAL OSWAL)

Objective: The foundation of Wealth Creation is in buying businesses at a price substantially lower than their “intrinsic value” or “expected value”. The lower the market value is compared
to the intrinsic value, the higher is the margin of safety. In this year’s study, we continue
our endeavor to cull out the characteristics of businesses, which create value for their
shareholders. As Phil Fisher says, “It seems logical that even before thinking of buying any common stock, the first step is to see how money has been most successfully made in the past.” Our Wealth Creation studies are attempts to study the past as a guide to the future and gain insights into How to Value a Business.

Concept: Wealth Creation is the process by which a company enhances the market value of the
capital entrusted to it by its shareholders. It is a basic measure of success for any commercial
venture. Wealth Creation is achieved by the rational actions of a company in a sustained
manner.

Methodology: For the purpose of our study*, we have identified the top 100 Wealth Creators in the Indian stock market for the period 2004-2009. These companies have the distinction of having added at least Rs1b to their market capitalization over this period of five years, after adjusting for dilution. We have termed the group of Wealth Creators as the ‘MOSL - 100’.

The biggest and fastest Wealth Creators have been listed in Appendix I and II on page 41 and 43, respectively. Ranks have been accorded on the basis of Size and Speed of Wealth Creation (speed is price CAGR during the period under study). On the cover page, we have presented the top 10 companies in terms of Size of Wealth Creation (called THE BIGGEST), the top 10 companies in terms of Speed of Wealth Creation (called THE FASTEST), and the top 10 companies in terms of their frequency of appearance as wealth creators in our Wealth Creation studies (called THE MOST CONSISTENT).

To read the full report: WEALTH CREATION

>ROADS & HIGHWAYS – NEXT BIG LEAP : Projected investments in Roads in 11th plan (KR CHOKSEY)

Roads
Indian road network is second largest in the world aggregating 33 lakh kilometers. Road transport is a crucial link in connecting cities and villages of India handling more than 61% of the freight and 85% of the passenger traffic in the country. National highways constitute only 2% of the total road network length; however it carries nearly 40% of the traffic on Indian roads. Number of vehicles has also been growing at an average pace of 10.2% per annum over the last five years and the 11th five year plan, is targeting a growth of 9%. India needs better road networks as the cargo and passenger traffic is expected to grow at an annual rate of 13-15%. Investments in road sector during 11th five year plan is projected at Rs 3,66,843 crore at 2006-07 price levels.

Outlook
Golden Quadrilateral is 97% complete, while 27% of the work is being completed in the North, South, East, West (NS-EW) Corridor project. Government has also enhanced allocation to National Highway Development Programme (NHDP) by 19.3% to Rs 12,966 crore in 2008-09. Under the proposed plan of NHAI, still 821 km under NS-EW Phase I&II and 10,034 km under Phase III are to be awarded. Government also expects 36.1% of the total investments from the private sector. Hence there is significant opportunity for the companies working under Public Private Partnership (PPP). With the annual passenger traffic growth expected at 12% to 15% per annum and cargo traffic expected to increase by 15% to 18%, the National Highway Development Programme (NHDP) envisages a total investment outlay of US$ 50-60 Bn over the next 5 years.

Revamp under UPA 2.0
The UPA government’s re-election will provide five years of political stability to push vital reforms and boost the economic growth. Mr.Kamal Nath’s appointment as Minister for Road Transport and Highways was a major revamp strategy and a “Beginning of New Era” in changing the face of the Indian Roads & Highways landscape. In order to strengthen the Indian road network Mr. Nath has proposed a mammoth task to “build 20kms a days or 7,000 kms a year or 35,000kms in the next 5 years”.

Steps already taken
■ Handing over 80% of land at the time of award and the remaining during construction.
(Previously 50%).

■ Removal of Clause 3.5.2 of RFQ which restricted bidding to the top 5-6 bidders will now ensure greater participation.

■ Viability gap funding (VGF), which earlier provided 20% at funding during construction phase
and 20% during O&M, now the entire amount will be provided during the construction phase, thus improving the cash flow streams of the developers.

■ Estimated project cost has been increased by 20% for projects where Detailed Project Reports (DPR) was completed before 2007 and by 10% for projects where DPRs were completed post 2007.

To read the full report: ROADS & HIGHWAYS