>The dollar/euro exchange rate: Potentially, very significant instability

Since the start of 2009, the dollar has depreciated against the euro as a trend. This depreciation is no longer due to the same causes as before the crisis: the US external deficit has shrunk drastically, but the changeover to virtually zero dollar interest rates has led to massive capital outflows from the United States, and this is currently the cause of the dollar’s weakness.

However, the dollar/euro exchange rate may prove to be very unstable:

■ for the dollar to depreciate against the euro, the sum of the US external deficit and the capital outflows from the United States must outweigh the purchases of dollars by central banks in emerging and oil-exporting countries, which want to stabilise their exchange rates against the dollar;

■ a faster rise in interest rates in the United States than in the euro zone, a rise in risk aversion after an unfavourable shock or a fall in the oil price due to sluggish growth would lead to a reduction in the borrowing positions in dollars or long positions in euros that would stop the depreciation of the dollar against the euro.

We might therefore see (in 2011?) a drastic changeover to an equilibrium where the dollar appreciates markedly against the euro once again, something that would obviously be a serious problem for the US administration.

To read the full report: DOLLAR/EURO

>Pidilite Industries Ltd. (HDFC SECURITIES)

Company Background & Business Profile
Incorporated in 1959, Pidilite Industries Ltd. (PIL) is a pioneer and market leader in the field of consumer and specialty chemicals in India. PIL has a wide range of products, which find application in construction, plastics, textiles, paper, leather, paints & engineering industries. The product range includes Adhesives and Sealants, Construction & Paint Chemicals, Automotive Chemicals, Art Materials, Industrial Adhesives, Industrial and Textile Resins and Organic Pigments and Preparations. Most of the products have been developed through strong in-house R&D.

PIL has a number of established brands and a large distribution network of dealers, sales representatives, offices & retail outlets spread throughout the country. The company's brand, Fevicol is one of the most trusted brands in India and the largest selling adhesives brand in Asia. The other major trusted brands include Dr. Fixit & Roff (construction chemicals brands), MSeal (sealant brand), Cyclo (automotive chemicals brand), Sargent Arts (art materials brand) & Hobby Ideas (hobby & craft products)

PIL’s manufacturing facilities in India are located in Gujarat, Maharashtra, Himachal Pradesh and the Union Territory of Daman. In addition, the group also has manufacturing plants overseas in the US, Brazil, Thailand, Singapore, and Dubai. PIL has also been active in international acquisitions & incorporated subsidiaries in Singapore, USA, Thailand, UAE and Brazil.

Geographically, PIL operates in two divisions - India & Other countries. India contributes 90% to the total sales (in FY09), while other countries contribute the remaining 10%. Exports account for 9.5% of the total turnover in the Indian company. The company exports its products to Middle East, Africa, South East Asia and SAARC.

PIL has 13 overseas subsidiaries (4 direct & 9 step-down) viz; Pidilite USA Inc., Pidilite do Brasil, Pidilite International Pte Ltd, Pidilite Middle East Ltd, Pulvitec do Brasil Industria Commercio de Colas, Jupiter Chemicals (L.L.C.), Pidilite Indonesia, Pidilite Speciality Chemicals Bangladesh Pvt Ltd, Pidilite Innovation Centre Pte Ltd, Pidilite Industries Egypt - SAE, Chemson Asia Pte Ltd, Pidilite Bamco Ltd (Thailand), Pidilite Bamco Supply Services Ltd (Thailand) & Pidilite South East Asia Ltd. (Thailand). PIL also has 4 Indian subsidiaries viz; Bhimad Commercial Co Pvt Ltd, Madhumala Traders Pvt Ltd, Pagel Concrete Technologies Ltd & Fevicol company Ltd. Out of all these subsidiaries only four are major ones viz; Pidilite USA Inc., Pulvitec do Brasil Industria Commercio de Colas, Jupiter Chemicals (L.L.C.) & Pidilite Bamco Ltd. These together contribute almost 94% to the total revenue of all subsidiaries (in FY09). PIL has significant manufacturing and selling operations in USA & Brazil. The Brazil & US subsidiaries together contributed 80% to the total subsidiaries turnover in FY09 & 85.6% in H1FY10.

Most of the above subsidiaries are wholly owned by PIL, except for Pagel Concrete (India) & Pidilite Bamco (Thailand), which are 75% subsidiaries & Bamco Supply Services (Thailand), which is 49% subsidiary of PIL.

Business Segments
PIL operates under three major business segments viz branded consumer and bazaar/ craftsmen products, speciality chemical business & others.

A] Branded consumer and bazaar/craftsmen products: This segment is a major contributor to PIL’s revenue, which accounts for 73% to its total turnover (standalone in FY09). The segment broadly constitutes Adhesives & Sealants, Construction & Paint Chemicals and Art Material. Adhesives & Sealants constitute around 50% of the total sales (in FY09) and largely include sales of Fevicol and other sealants like M-Seal. Construction & Paint Chemical sub segments account for 17% of total sales (in FY09), while art material sub segment constitutes around 6% of total sales for FY’09.

B] Industrial Specialty: PIL is operating in this segment since its incorporation and the first product manufactured under this segment was pigment emulsions. This segment accounts for 21% of total sales (in FY09). The segment constitutes Industrial Adhesives, Industrial Resins & Organic Pigments & Preparations, which largely cater to various industries such as textiles, chemicals, FMCG, rubber, automobiles etc. Industrial Adhesives contribute 7%, while Industrial Resins & Organic pigments and preparations contribute 8% & 6% respectively to the total sales.

C] Others: Others segment constitutes VAM (Vinyl Acetate Monomer) manufacturing unit, which was demerged into PIL w.e.f 1st April 2007. VAM is a key raw material used by PIL (accounts for 20% of the total raw material costs) for a wide range of adhesive products. VAM-based polymers are commonly used in the production of plastics, films, laminating adhesives, elastomers, inks, water-based emulsion paints, adhesives, acrylic fibers, glue, cosmetics and personal care products, floor tiling, safety glass, building construction, finishing and impregnation materials, coatings. Besides captive consumption, PIL also sells VAM in the market, which constituted 6% to the total sales (in FY09). However, recently the company has shut down its VAM plant, since it became cheaper to import VAM rather than manufacturing, as VAM prices came off much steeper than the raw material (ethylene) cost, and the industry as a whole was carrying the high cost VAM inventory.

To read the full report: PIL

>Back to normal: Economic recovery and policy exit

■ Economic fundamentals (growth, inflation and profitability) to recover substantially. The economy is expected to recover further in 2010 with GDP growth to rebound to about 10.1%. 1Q GDP growth is expected to be higher while that in 2Q and 3Q would fall; 4Q should see some rebound. From a QoQ perspective, GDP growth is expected to be more stable and would rebound gradually. As we bid farewell to deflation and move into moderate inflation, CPI is expected to rise by about 2.6% and PPI by about 3.5%. Demand is to rebound rapidly providing strong support for industry earnings growth; industry earnings growth is expected to rise sharply by 30%.

■ Revival of end-user demand with investment growth normalising. With the upturn in the economic climate and improvement in resident expectations, consumption growth is expected to accelerate. Global economic upturn and external demand are expected to drive export recovery. Contribution from exports to economic growth is expected to turn from a fairly large negative contribution to a positive one. End-user demand – demand that does not involve further production process, generally referred as consumption and exports – is to become the key driving force of economic growth and its effect in supporting GDP growth would exceed that of investment. Government investment is expected to fall and investment growth is to normalise.

■ Policy to gradually normalise after a period of proactive and moderate easing. Around mid-2010, policy is expected to turn from an extremely loose stance towards neutral. Interest rate raise is expected in 2010 with an increase of 27-54 ppts. New loans are expected to fall to RMB7-8 tn. The RMB exchange rate may appreciate slightly by about 3-5%. Proactive fiscal policy is expected to continue but structural changes may occur of policy focus; it is estimated that the budget deficit would account for about 2.9% of GDP, with a size of about RMB1 tn. Fiscal policy would move from one single emphasis on maintaining economic growth to multiple emphases of stimulating internal demand, spurring employment and guaranteeing sustainable economic growth.

■ Liberalisation of monopoly industries and encouragement of private capital participation to be the major theme of structural adjustments. We expect the government to aggressively liberalise monopolies and control as well as to encourage private capital participation in service sectors such as oil, railway, telecommunications, municipal public utilities and such social sectors such as healthcare, social insurance, education and media, hence forming of new growth sectors.

To read the full report: CHINA ECONOMIC OUTLOOK

>OM METALS INFRAPROJECTS (SBICAP SECURITIES)

Om Metals Infraprojects Ltd (OMIL) is the largest hydro-mechanical equipment supplier in India with a market share of over 60 percent. The company has nearly 4 decades of experience in successful execution and completion of turnkey hydro-mechanical contracts for hydropower and irrigation. The company presently has Rs 636 crore worth of order book, which is 3.5x of its H1FY10 annualised sales and it is expected to be completed in the next 3 years.

We believe that value unlocking from its real estate business will be a major fillip for the valuation of the company. The value of its land bank is at Rs 248 crore (Rs 26 per share). We initiate coverage on the stock with 'BUY' rating.

■ Largest hydro-mechanical with a healthy order book: The company is the largest hydro-mechanical equipment supplier in India with a market share of over 60 percent and nearly 4 decades of experience in successful execution and completion of turnkey hydro-mechanical contracts for hydropower and irrigation. The company presently has Rs 636 crore orders book, which is 3.5x of its H1FY10 annualised sales and it is expected to be completed in next 3 years. This provides substantial medium term revenue visibility. In addition, the company has submitted bids for more projects and they expect to take the total tally of order book to over Rs 800 crore by FY10.

■ Huge value unlocking from the real estate business: The company has nearly 1.5 million Sq.ft of saleable land bank situated at Hyderabad, Jaipur, Mumbai, Faridabad, Kota etc This land bank is valued at Rs 248 crore which works out to Rs 26 per share. The company has a 35 percent stake in a 2.6 lakh Sq.Ft. SRA project in Bandra, Mumbai. This project will be completed in next 3 years and a total profit of Rs 117 crores is expected to accrue to the company on project completion. The company also generates real estate revenue from a hotel in Jaipur, lease revenue from a multiplex in Kota and a Toyota show room in Jaipur.

■ De-risking strategy through infrastructure forayed: The Company has recently forayed into the Infrastructure segment by winning two contracts for the development of a port and an SEZ in Pondicherry. The SEZ project is multi-product SEZ spread over 860 acres and the company has a 20 percent stake in it. The company has a 50 percent stake in the port project in Pondicherry, which is to be developed in next 5-6 years. Both projects are excepted to be developed through separate SPV's.

■ Valuations: We have valued the company by the 'Sum of the Parts' valuation method, in which we have taken the value of its core business and the BV of its land bank for the purpose of valuation. At the current price of Rs30, the stock is trading at 7.3x and 5.3x of its core FY10E and FY11E earnings respectively. As per our Sum of the Parts valuation, we recommend a buy on the stock with a price target of Rs39 thus providing an upside potential of 30%.

To read the full report: OM METALS INFRAPROJECTS

>HINDUSTAN UNILEVER LIMITED (MORGAN STANLEY)

Quick Comment: We remain UW due to: 1) potential earnings growth volatility; 2) potential increase in competitive pressures from P&G; 3) potential rise in input cost pressures; and 4) potential slowdown in revenue growth. We spoke with management and here are the key takeaways from our conversation:

■ No conclusive slowdown in consumption: Contrary to the sharp slowdown reported by AC Nielsen for the industry for October-09 (from 14.8% in H1F2010 to 5.9% in Oct-09); there are no signs of a significant slowdown at the ground level. However, consumer downtrading in categories such as laundry continues and sharp price rises are also causing consumer downtrading in tea. Although there is no conclusive evidence of consumer demand slowdown yet, the company is closely monitoring the potential impact of high food inflation on FMCG consumption.

■ Soap brands relaunched, PP growth steady: HUL has relaunched all its soaps brands and has deployed its complete portfolio to improve its market share. Management is hopeful of improving market share and believes that the current signs may not be reflective of the potential underlying trend. Personal products segment growth remains steady for HUL, contrary to the slowdown demonstrated by the AC Nielsen retail off take data.

■ Ad spend likely to be under 12% in F2010: HUL’s ad spend to sales ratio was around 13% in H1F2010. However, H2F2010 ad spend to sales ratio is likely to be lower and hence the F2010 ratio is likely to be under 12%. However, during the six months ended Mar-09, HUL’s ad spend to sales ratio was 10%. Hence it is likely that the ad spend to sales ratio may witness an increase in H2F2010 yoy.

■ Tax rate likely to be at 23%: HUL’s tax rate in H1F2010 was around 23.2%, it is likely that F2010 tax rate will be in a similar range. The tax rate during the six months ended Mar-09 was around 20% and it is likely that HUL may witness 300 bps rise in the tax rate in H2F2010.

To read the full report: HUL