>What lessons can be learnt from Japan’s lost decade?

The worldwide recession that followed the subprime crisis was unprecedented in many
ways, but not so unique that no lessons can be learnt from previous experiences. Japanese’s lost
decade comes probably closest. Both episodes were preceded by the bursting of speculative bubbles, with led to a prolonged banking crisis. In the case of Japan, it took the economy more than 10 years to recover. At the end of the period, GDP was around 20% below the level it would have achieved if capital spending growth had followed more normal patterns. Moreover, the slump in world’s second largest economy was not without repercussions for the country’s trading partners.

Even though this episode was followed by the longest boom in Japan’s post-war history, some
scars have remained, making the economy still very vulnerable to external shocks. Indeed, the country was among the most affected by the subprime crisis, even though its banking sector was not particular exposed to this market. The most obvious sign of weakness is that more than 20 years after its dramatic collapse, the Nikkei is still 75% below its peak reached by the end of 1989. In addition, the government accounts have seriously deteriorated.

Gross public sector debt amounts to almost 200% of GDP, and the government does not have a plan to reduce the debt to more manageable proportions. Finally, the economy is still confronted with substantial overcapacity, which has been weighing on prices. In November, the government declared that the economy went again into deflation. In the coming two years, GDP is expected to grow by around 2%, well above Japan’s potential growth rate, estimated at 0.8%. As a result, excess capacity will gradually dissipate. The Bank of Japan (BoJ) expects the economy to exit deflation in FY2011.

The lost decade
Japan’s lost decade was sparked by the bursting of bubbles in the stock and real estate markets in the early 1990 (cf. chart 1). Between December 1989 and December 1991, stock prices fell by 40%, returning them to their pre 1987 level. The property market started to falter in 1991. Between 1991 and 1993, land prices in the six major cities fell by 30%. These two asset categories might have destroyed JPY 1 500 000 billion in wealth, about three times the country’s GDP1.

In the following decade, the economy was characterised by slow growth, falling prices and
dysfunctional financial markets. Between 1992 and 2002, GDP growth averaged only 0.8%, compared with 4.5% in the preceding ten years. The OECD estimates that over this period, the potential output growth declined to 1.4% on average, down from around 4% before the bursting of the bubble.

To read the full report: JAPAN'S LOST DECADE

>To what extent is the financial crisis to blame for the economic problems in the euro zone?

The economic difficulties in the euro zone are most often blamed on the financial crisis, with the following arguments:

− the banking losses led to the credit contraction;
− the financial markets lost all liquidity and closed down;
− global trade came to a halt due to the contraction in trade credit;
− the fiscal deficits stem from the bailout of financial intermediaries.

However, the economic crisis can also be blamed on problems in the real economy:
− poor productive specialisation (construction) and deindustrialisation;
− excess private sector indebtedness, caused by monetary policies aimed at offsetting deindustrialisation and the weakness of wages.

This weakness is a result of either productive specialisation or distortion of income sharing.
In our view, it is in accordance with the facts to say that the most drastic part of the crisis was due to the financial crisis, but that the permanent, structural part of the crisis was due to the real economy.

To read the full report: FINANCIAL CRISIS

>Debt: No Immediate Concerns But No Complacency Either (CITI)

■ Overall Debt/GDP is high at 143%... — With problems in the EU bringing to the fore issues regarding deficits and debt, India is once again on the radar given its twin deficits and high levels of debt. Despite high deficits, strong growth has resulted in India’s public debt/GDP ratios coming off from the 86% levels in FY05 to 76% levels currently. In contrast, private debt (household and corporate) has risen from 32.5% of GDP in FY00 to 66.2% in FY10.

■ …but deficits are manageable and the banking system is healthy — On the public side, as is known: (1) India funds its deficit through domestic sources and has a large captive demand for bonds, and (2) Growth and rate dynamics give it more flexibility in running deficits without a rise in debt/GDP ratios. As regards private debt: (1) Besides being largely domestic, loan to deposit ratios are 71%, (2) Reserve requirements are high. While external debt has risen, FX reserves currently stand at 5.5x short-term debt/amortizations.

■ No room for complacency, now is the time for further reform — India remains vulnerable to a sudden weakening of nominal GDP growth, which could result in a rise in debt ratios unless underlying government deficit is reduced. We thus believe: (1) adhering to timelines on proposed fiscal legislation (13th FC; GST, DTT), and (2) proposals to reduce subsidies both on oil and fertilizers, are key. To this end, the recent approval of the APM gas price hike is positive.

■ Incremental data is positive — (1) Growth: While the base effect will likely result in a moderation in monthly numbers, growth is now more broad-based, (2) Inflation appears to have peaked with lower commodity prices an added boon, and (3) Deficit could come in lower due to higher telecom revenues.

■ EU impact on financial markets — While we continue to expect gradual medium-term appreciation based on robust growth, strong capital inflows and ongoing monetary policy tightening, we have moderated the pace of INR appreciation. Although the odds of an inter policy hike have fallen, we maintain our call of a +75bp hike in 2010 as India’s growth/inflation dynamics are domestic-driven.

To read the full report: INDIA MACROSCOPE

>GAS SECTOR (GEOJIT)

Growth in chaos
Despite the significant increase in supply from KG-D6, India remains chronically starved of gas. Current estimates of Indian gas demand are in the range of 225- 260mmscmd, while supply is only 155-160mmscmd. There isn’t enough capacity, because policy concerns are holding up investments upstream, midstream and downstream. Installed capacity is not fully available for supply because of pipeline bottlenecks. However, we believe these are teething problems in the early stages of potentially remarkable growth. We have BUY ratings on Reliance, KG-D6 producer, and transmission company GAIL. However, our spotlight is on four mid/downstream players, all rated BUY: Indraprastha Gas (city gas distribution, our top pick), Gujarat State Petronet (transmission, preferred over GAIL), Petronet LNG (importer of LNG) and Gujarat Gas (city gas distribution). Each of these companies faces some regulatory hindrance, but the stocks have outperformed the market over the past year on strong operational performance. Still, we believe valuations remain inexpensive and operational performance has plenty of room to surprise on the upside. In fact, our proprietary analysis of a regulatory blue-sky scenario finds that these four stocks may be trading at near half their potential fair valuations at current prices, which suggests to us that more than a reasonable element of risk is priced in.

“What if” chaos turns to order soon?
Regulatory concerns could be resolved sooner than expected
The existing confusion on regulatory / policy aspects is no doubt a concern and an overhang on the stocks. However, as we mentioned earlier, in our view the current state of confusion signifies the teething problems in a fast changing/growing industry. We also note that key constituents are all aware of the need to end the current scenario and appreciate the need to create an enabling environment. In our view, the first step in this direction could well be the long pending notification of Section 16 of the PNGRB (Petroleum & Natural Gas Regulatory Board) Act, granting power to authorise PNGRB. This would, in our view, be a big relief and could be the beginning of the end of acrimony between PNGRB and the Petroleum Ministry.

We note that Delhi High Court had ruled in January 2010, that PNGRB does not have powers to authorise, as section 16 is not notified, and now PNGRB has appealed against this in the Supreme Court. Recent media reports (Financial Chronicle, “Petroleum Regulator to offer licenses for piped gas network”, 26 April 2010) indicate that the Petroleum Ministry is now considering soon notifying Section 16. Similarly, news reports (Business Standard, “Gas highway authority plan put on back burner”, 28 April 2010) now indicate that the Petroleum Ministry has now put on the back burner the proposal to create a national gas highway development authority. A new regulatory authority, in our view, would have diluted the powers of PNGRB, and thus PNGRB was opposing this. Going slow or even cancelling this proposal would again be positive, in our view, for an early end to the regulatory/policy uncertainty.

Stocks for action
RIL and GAIL offer broadest exposure to the gas story. Petronet LNG, GSPL, IGL and Gujarat Gas all have strong growth in their respective niches. IGL is our favourite among downstream; we prefer GSPL (over GAIL) in gas transmission.

Large demand-supply gap — yet supply is suppressed
The government’s current estimates of Indian gas demand vary from 225- 260mmscmd, while current supply is only 155- 160mmscmd, even after sharp production growth in FY10F on account of KG-D6. The shortage is exaggerated by the lack of pipeline capacity. While exit gas domestic gas production in March- 2010 was up nearly 72% y-y, we think growth could have been 100% without pipeline bottlenecks. This is despite knowing for many years that supply would increase sharply as KG-D6 comes online and LNG import capacities increase. However, we believe supply will remain suppressed for most of 2010 and perhaps into early 2011F. Despite current capacity of 80mmscmd, KG-D6 production is contained at about 60mmscmd. Similarly, despite significant LNG re-gasification capacity increases, spot LNG volumes have nearly dried up.

India did not get ready for new gas
Despite knowing for many years that gas availability would increase, India did not prepare well. Pipelines seem to be the immediate problem, but concerns abound on many issues. Both regulations and regulators are in place, but without key powers. PSCs provide for marketing freedom and market-determined pricing — but the government seems reluctant to release control of pricing and allocation.

To read the full report: GAS SECTOR

>HOTEL LEELA: Margins take hit on higher costs (ICICI DIRECT)

Hotel Leela posted a lower EBITDA margin of 29.1% for the quarter as against the expected EBITDA margin of 37.3% due to incurring of higher other operating costs. Revenues rose 11.6% YoY and 7% QoQ to Rs 135.3 crore, in line with our estimated revenue of Rs 134.7 crore. Net
profit for the quarter stood at Rs 9.4 crore. It declined by 86% YoY, as last year’s profit included exceptional gain of Rs 64 crore on account of reversal of forex losses on adoption of revised AS-11 guidelines.

■ Sales growth in line but margin contracts due to higher costs
The growth in revenue in Q4FY10 was in line with our estimates and it grew 32.7% YoY on account of healthy growth of foreign tourist arrivals in India. FTAs in January-March 2010 grew over 7.8% YoY. Since Leela operates in the premium segment, it derives a majority of its revenues from foreign tourists. As a result, the company has been able to post a robust growth in revenues for fiscal year 2010. However, the operating margin has been impacted by the rise in
other operating costs that led to a 1030 bps decline in its operating margin.

■ Net profit declines sharply on higher depreciation, interest
Interest and depreciation both increased QoQ by 59% and 57%, respectively. This resulted in a 67.5% decline in its net profit. On a YoY basis also, net profits recorded a sharp decline of 86% despite robust growth in sales as last year’s profit included an exceptional gain of Rs 64 crore on account of a reversal of forex losses on adoption of revised AS-11 guidelines.

Valuation
At the CMP of Rs 44, the stock is trading at 14.3x its FY12E EPS and 15.6x its EV/EBITDA. We have lowered our FY11E and FY12E EBITDA by 12.8% and 1.3%, respectively, to factor in higher costs and concerns over timely execution of its projects. However, we believe Leela would continue posting industry-leading sales growth over FY11-12E due to its presence in strategic locations and its brand value. We maintain our BUY rating.

To read the full report: HOTEL LEELA

>ECLERX LIMITED: Revenue Momentum continues (EMKAY)

Revenues at US$ 15.8 mn (+6% QoQ) beat expectations ( Emkay est. of US$ 15.5 mn). However operating margins at 36.6% were down by ~370 bps sequentially on a/c of significant hiring ( co hired 286 employees at a net level during Q4FY10). Profits at Rs 242 mn (+13.5% QoQ,+50% YoY) were lower than expectations driven by lower margin performance and lower than estimated forex gains. Co continues to hire aggressively driven by up tick in revenue/demands (note that co’s increased headcount by ~45% over the year) with further beef up in sales team abroad. It is worth noting that revenue momentum at eClerx continues to pick up with YoY revenue growth continuing to see improvement over the year (refer chart below).

eClerx continues to deliver in line with our positive thesis. We tweak our FY11E/12E earnings upwards marginally to Rs 51.5/Rs 61.5 (V/s Rs 51.3/Rs 60.4 earlier). Maintain BUY with an unchanged March’11 price target of Rs 540.

Revenue growth momentum continues to pick up
eClerx reported March’10 revenues at US$ 15.8 mn (+6% QoQ) ahead of Emkay est. We note that given the improving demand environment, YoY revenue growth momentum at eClerx continues to pick up with YoY revenue growth accelerating to ~48% YoY in March’10 quarter V/s ~13% YoY revenue growth in June’09 quarter ( refer chart below). Operating profits at Rs 261 mn (-6.4% QoQ) were marginally lower than est on a/c of significant hiring during the quarter (net addition at 286, taking overall employee count to 2,863), with overall employee count up by ~45% over FY10. Profits came in at Rs 242 mn(+13.5% QoQ,+50% YoY).

Hiring remains aggressive, does well on reducing debtor days
eClerx continued to ramp up headcount on a/c of the improving macro environment with the overall headcount up by ~45% during the year. Further the company expects the 1st phase of it’s newly acquired Airoli facility (44,000 sq ft) to come on-stream from June’10 onwards. We highlight that co management deserves appreciation in terms of bringing down debtors days to 56 in FY10 (V/s 83 in FY09)

Maintain BUY with an unchanged price target of Rs 540
eClerx continues to deliver in line with our positive thesis driven by improving macro environment. We tweak our FY11E/FY12E earnings upwards to Rs 51.5/Rs 61.5 (V/s Rs 51.3/Rs 60.4 earlier) (our estimates based at US$/INR of Rs 45/$). Co has paid a final dividend of Rs 10/share, taking full year dividend paid to Rs 17.5/share (dividend payout ratio at ~46%). Maintain BUY with an unchanged March’11 price target of Rs540.

To read the full report: ECLERX