Tuesday, December 22, 2009

>Global: Market themes in 2010 (DANSKE MARKETS)

• In this article we highlight some of the main themes that will shape market developments in 2010.

• In many ways 2010 is likely to be trickier as many issues will be less straightforward than in 2009. Growth will look murkier and some of the life support to the financial system will be turned off creating uncertainty.

• We recommend a slightly defensive stance with investment in high-quality equities and credit. Bond yields are expected to rise.

• Momentum in the business cycle will likely peak in Q1 and hence the tailwind to risky assets from cyclical momentum will fade.

• On the other hand, sustainability should prove itself with US job growth returning in early-2010.

• The ECB is expected to hike before Fed and the gradual withdrawal of liquidity will remove some of the support from low-quality sovereign bonds.

• The wall of money will still be around in 2010 but not to the same extent as in 2009. Hence bond yields should rise. On the other hand, with very low interest rates the search for yield will continue and support high-quality credit.

• The extent of losses in the banking sector is a highly uncertain factor and markets may become more vulnerable to event risk when cyclical momentum fades.

Theme #1: Peak of the cyclical momentum
Risky assets generally thrive when growth is in the early – and normally fastest – stages of recovery. As this year’s brisk recovery has happened alongside massive cost-cutting earnings have been in a ‘sweet spot’. However, much of the fuel driving the recovery is of a temporary nature. The most important factor here is the inventory cycle but fiscal stimulus and the boost to demand from Asian recovery will also fade in 2010. Although we believe other engines will take over and make the recovery sustainable (theme #2) growth is likely to peak at some point.

Theme #2: Sustainability of recovery
Sustainability will be at the core of developments in 2010. We are currently in a positive feedback loop in which the global recovery has raised confidence in financial markets. And with more companies joining the recovery this is luring out more investment plans and denting the massive job cuts. The next phase of the positive feedback loop is very critical. We need to take the step from job cuts to job growth to bring consumers back on a sustainable path to recovery. If private consumption gets back on track it will unleash more investments in the corporate sector and increase the need for rebuilding inventories. The positive feedback loop continues.

Theme #3: Monetary policy exit
The pace of monetary policy exit will be important in 2010. Many securities benefit strongly from the current life support – not least in the low-rated sovereign bond space in Europe and CEE – and will receive less support as the year passes. Liquidity measures will be gradually phased out as already outlined by the ECB (see ECB – Heading for the exit) and the Fed, but liquidity will remain ample during the first half of 2010. When it comes to interest rate policy we believe the ECB will hike rates in August followed by the Fed at the end of 2010. The ECB is expected to move first as the slack in the Euroland economy is smaller and the ECB is more concerned about spurring new bubbles.

Theme #4: Wall of money and search for yield
2009 has been characterised by a wall of money to be invested and at the beginning of the year there were plenty of cheap assets where the money could find a home. This has likely been a major factor behind the strong rally in credit and equity markets, but it also explains why the massive government supply has been absorbed so easily and – in contrast to our expectations – led to a decline in bond yields during the autumn.

Theme #5: Financial losses to be absorbed by banks
As we saw in late-2009 event risk is far from over. Dubai and Greece serve as prime examples. There is still large uncertainty over the amount of losses that yet have to be absorbed by banks. Key areas of uncertainty are: a) central and eastern Europe (CEE) loan losses; and b) losses on commercial property loans in both the US and Europe.

To read the full report: MARKET THEMES IN 2010


SYNOPSIS: We expect a re-rating of the tyre sector over the next few quarters, as concerns on the earnings front are put to rest. The current valuations of tyre companies indicate expectations of a sharp earnings decline (atleast 40%) in FY11E due to concerns on rising raw material prices (rubber prices only 7% below its previous peak) and capacity additions (affecting pricing power). The markets seem to be factoring in a repeat of the FY03-05 period, where profitability was significantly affected due to the above factors. EBIDTA margins declined by 410 bps to 6% and net profits declined by a CAGR of 22% during FY03-05.

While we share concerns on the rising raw material prices, we believe that pricing discipline will be the biggest differentiator. The industry has shown good pricing discipline since FY06. It should be noted that during FY06-FY08, the EBIDTA margins expanded by 500 bps to 11% and net profits increased at a 77% CAGR. This was despite a sharper increase (1.1x) in the rubber and oil prices during FY06-FY08 vis-à-vis FY03-FY05. Even in FY09, when there was a drop in volumes, (resulting in lower capacity utilization), pricing witnessed an uptrend.

We do not expect the ambitious capex plans during FY09-FY13 (gross block to increase by ~58%) to adversely impact tyre pricing as the expansion is more of a necessity than an option. Capacity addition during FY09-FY13 is mirroring long term growth trends. More importantly, capacity additions will happen in a phased manner and can be curtailed if the situation so warrants.

We consider 1HFY10 profitability as abnormal and hence, are factoring in a drop in earnings of 15% to 25% for domestic business in FY11. Barring a further spike in rubber prices, we believe that earnings would surprise positively.

While all the tyre companies will benefit from pricing discipline, we expect Apollo Tyres (ATL) and JK Tyre (JKT) to outperform as the contribution from their recent international acquisitions become more visible in FY11 and FY12. We are initiating coverage on ATL (BUY) and JKT (BUY). We like ATL for its thirst for market leadership with a clear focus on profitability. We like JKT purely from a valuation view.

Pricing discipline - the biggest differentiator
The most important structural change (as compared to FY03-05 period) that lends support to our case is the almost 100% utilization in the truck and bus bias (TBB) tyre segment, which accounts for around 60% of the industry revenues. We have already witnessed pricing discipline in the industry since FY07, which has enabled the players to improve margins despite continuous increase in commodity prices.

Capacity additions - a necessity due to higher utilization levels
Our analysis of the tyre industry and its utilization indicates that the concerns with respect to excess capacity are overdone. Considering the long term growth rate of the Indian passenger car tyre (PC) and truck and bus tyre (T&B) segment of ~12.5% and ~5% respectively, the expansion is necessary. During FY09-FY13, PCR and T&B will add capacity at 12.6% and 7.4% CAGR respectively.

These are planned capacities - coming up in a phased manner
The recent wave of greenfield expansion, which will eventually add 29% to the current capacity, is likely to come up in a phased manner with intermediate review of capacity additions. We believe that the expansion will be curtailed if the situation so warrants, considering the gap between minimum economic size of the plant and the current expansion plans announced by the players.

Only radial capacity additions in T&B segment - is it a concern?
The T&B segment will be witnessing a capacity addition of ~6 mn tyres during FY09-FY13 in the truck and bus radial (TBR) tyre segment. If all the planned capacities are commissioned as per schedule, then TBR would account for 28% of T&B capacity by 2013. An analysis of trends in radialization in some of the other countries indicates that the demand for TBR in India is at an inflection point. Strong focus of the government on road development as well as ban on overloading (since November 2005) are the two most important structural changes that can ensure that India replicates the radialization witnessed in other countries.

Exports - can regain momentum
We expect exports to act as another support factor for ensuring higher capacity utilization levels. The share of exports (tyres sold) after reaching 8.5% in FY05 has declined to 7% in FY09 due to capacity constraints.

Pressure on account of raw material prices - already factored in valuations
Current valuations of ATL and JKT at PER of 6.5x and 2.8x our FY10 estimates are factoring in a sharp drop in earnings in FY11 due to the risk of continued uptrend in rubber prices (rubber is only 7% below its peak). Historically, rubber prices have corrected after such a sharp run up in the prices. Any correction in the prices presents potential upsides.

Rising raw material price does not necessarily mean pressure on profitability
Since FY06, rising raw material prices have not affected the margins significantly, except for the FY09 period. We attribute this to the strong volumes as well as pricing discipline since FY06. Infact, margins have witnessed an upward trend despite rising raw material prices. During FY06-FY08 period, the EBIDTA margins expanded by 500 bps to 11% and net profits increased at a 77% CAGR. This was despite a sharper increase (1.1x) in the rubber and oil prices during FY06-FY08 vis-à-vis FY03-FY05.

Initiate coverage on ATL and JKT
We are initiating coverage on ATL and JKT with a BUY rating. While all the tyre companies will benefit from pricing discipline, we expect Apollo Tyres (ATL) and JK Tyre (JKT) to outperform as the contribution from their recent international acquisitions become visible in FY11 and FY12

To read the full report: TYRE SECTOR


Sobha’s dominant position in the IT capital of Bangalore, which accounts for 86% of its next 5 year development, makes it one of the key beneficiaries of the expected IT sector recovery. With reduced land-bank, infusion from private & public equity strengthening the balance sheet, Sobha is ideally poised to capitalise on the buoyancy in sales volumes. Contractual business is a steady source of cash generation and our target of 25% discount to Mar’11 NAV offers 25% upside. Reinitiate with a BUY.

IT sector recovery to prop up Southern markets
Real estate market in IT heavy Southern India has taken longer to recover with volumes still c.50%+ lower than 1Q2008 levels (other location c.35% lower). This has resulted in muted pricing action with residential prices recovering only by 10% since trough as against 15-30% in Mumbai and Delhi. But with IT majors stepping up the hiring act and wage hikes being given after a gap of nearly 2 years, we believe that real estate markets in Bangalore will soon play the catch-up game. With Bangalore accounting for 85%+ of the next 3 years cashflows, Sobha will be a key beneficiary.

Partial deleveraging already in place and more to come
Over the last 18 months, Sobha has lowered landbank by 29% to 2,875 acres or 174 m sf. Outstanding land payments are also down 58% to Rs1.8bn. Through a combination of public and private equity, the company has lowered debt to equity from 50% to 0.88x. Sobha plans to reduce its leverage further to 0.5x by FY11. For the same, one of the measures is land sales from where Sobha plans to raise Rs4-5bn over the next 2-4 quarters.

Even a modest recovery in volumes enough to stabilise debt
Sobha’s new booking volumes dipped from 3.5m sf in FY07 to 0.9m sf in FY09. Volumes in 1HFY10 are already up to 0.6m sf as apartment sales volume tripled from 20/month in 1QCY09 to nearly 70/month by November. We project sales volumes to jump to 3.5m sf by FY12 same as FY07, even as Sobha expands to newer locations. We note that most of the other real estate developers are planning FY12 volumes to be 1.5-2x of FY07. We like the company’s conservative nature and highlight that, unpaid component of existing sold inventory is enough to fund the ongoing construction costs.

Initiate with BUY, 25% Upside
Here is the fourth and final paragraph (and chapter). Any more “legs” and the pyramid will lose its “point”. In some reports, even four main points may be too many. Remember – you’re busy, they’re busy: use the facts that matter from an investment point of view. These stories are invitations to readers to call you for more details, or to read your more in-depth research.

To read the full report: SOBHA DEV

>Asia Pacific: Transportation: Shipping (GOLDMAN SACHS)

Reiterate attractive sector stance
The containership sector has rallied 45% ytd despite persistent concerns of oversupply, while
MSCI Asia has increased 28% over the same period. The sector is still trading below mid-cycle
multiples, implying 34% upside on avg to our target prices. Hanjin Shipping, OOIL and Wan Hai
have the highest upside to TP. We upgrade NOL to Buy from Neutral following the recent retracement in the share price. Also, we downgrade RCL and Yang Ming to Neutral from Buy after reducing our 2010E estimated returns.

Three favorable factors for freight
Carriers are still suffering deep losses despite a 29% increase in spot rates from trough levels. We assume 15%-20% rate hikes for 2010E, compared with 5%-10% previously. There are three
favorable factors for freight rates underpinning our optimism:

  1. large net losses to drive a cost recovery;
  2. supply growth is slowing; and
  3. demand will likely accelerate.

Higher opex than we initially assumed
Previously, we assumed greater cost-cutting than what many carriers have achieved ytd. Some have been better than others at rationalizing their businesses, like OOIL, Wan Hai and NOL, which is evident in operating margins. Others like Hanjin, CSCL and RCL have been much less successful. Overall, we increase our estimated net losses for 2009E by 22% on avg. We cut our EPS estimates by 19% on avg for 2010E to reflect higher bunker fuel prices, and revise 2011E by -2%. Furthermore, we no longer assume terminal handling charges will decline next year and model in flat THCs. However, we still expect the industry to return to profitability in 2010 and achieve mid-cycle returns by 2011. We reduce our target prices by 8% on avg on lower future returns on fleet for 2010E-11E.

Risks to our sanguine view
Capacity and pricing discipline pose the greatest risks to our positive view of the containership
sector. Macro risks remain, too, such as a double dip recession in the US and/or EU, which could
derail our thesis.

To read the full report: SHIPPING SECTOR


Investment Rationale
Wholesale Voice Business continues to face pressure: The core wholesale voice business continues to remain under pressure due to increased competition. In spite of increased volume the revenue growth is expected to be sluggish due to pricing pressure.

Enterprise and Carrier Data business: The revenues from the data segment have been sluggish over the last 3‐4 quarters, but are expected to improve going ahead as the world economy slowly recovers and corporates increasing their spending. The Enterprise segment has seen price cut over the last few quarters due to slowdown in the global economy.

Capex and BWA Auction: On a consolidated basis Tata Communication had a net debt of Rs 57894.5 million as on FY09 and net debt to equity ratio of 1.13. With the upcoming auction and other capex plans the balance sheet for TCOM would be stretched. TCOM would find it difficult to compete with the larger players like Bharti and Reliance Communication given that they have strong distribution and branding in place.

Valuation: We value TCOM on a SOTP basis with a fair value of Rs 347. We have valued the core business at Rs 91 (EV/EBITDA), surplus land at Rs 177 and the stake in TTSL at Rs 79 (EV/Subscriber).

To read the full report: TATA COMMUNICATIONS

>Moody’s releases report on sovereigns (CITI)

Moody’s pointed out that “2010 will be a tumultuous time for sovereign risk” — Moody’s released a report on sovereigns on December 15. Moody’s pointed out that “2010 will be a tumultuous time for sovereign risk” based on its outlook for “uncertainties surrounding the likely pace and intensity of fiscal and monetary ‘exit strategies’ as governments start to unwind quantitative easing programs.”

Credit implications 1) — We believe that sovereigns will be one focus of the credit markets for the foreseeable future. This is based on: 1) fears that fiscal profiles are deteriorating in many countries due to further increases in expenditures and debt resulting from measures to respond to the financial crisis; 2) the tendency for governments to aggressively issue bonds in domestic and overseas markets compared to corporations and financial institutions; 3) the tendency towards downgrades in sovereign ratings and outlooks; and 4) the increase in trading volume for sovereign credit default swaps (CDS) and volatility seen in spreads compared to other years.

Credit implications 2) — From the perspective of public sector credit, we believe that the keys for maintaining stable credit are: 1) to have sovereigns, government-related institutions, local governments, or depending on the region, international institutions, appropriately and effectively allocate revenue sources in terms of size and timing, etc.; 2) hold down the crowding-out effect; and 3) realize future economic growth and a stable tax revenue structure.

To read the full report: SOVEREIGNS