>STERLITE INDUSTRIES: Earnings growth to bring back focus

Event
■ Downgrades to base metals: Our global commodities team has downgraded their aluminium, zinc and lead price forecasts. However, we believe that Sterlite’s expansions are now coming through, which should bring the focus back to this stock post its underperformance last year. We have retained our Outperform rating but marginally cut target price to Rs850 from Rs930 earlier.

Impact
■ Downgrading aluminium, zinc and lead price forecasts: We have downgraded FY11 zinc and lead price forecasts by 10% and 12% to US$1,877/t and $1,926/t, respectively. Our global commodities team has slightly changed aluminium price forecasts for FY11 by -3% to US$1,935/t from $1,995/t, respectively.

■ Expansions to drive doubling of profits in two years: Sterlite’s expansions of its zinc, power and aluminium businesses are now nearing completion. Highly profitable zinc business continues to contribute 50% to earnings. A large part of the growth is coming from the power business and expansion at Balco.

■ Lack of approvals can hurt production: Approval for its bauxite mines for aluminium projects is awaiting final clearance. In addition to the high costs that we are building in, we are concerned that due to infrastructure bottlenecks it may not be physically possible to get enough bauxite for full production at its JV ‘Vedanta Alumina’.

■ Coal block auctioning can come as blessing: One of the most awaited mining sector reforms involves auctioning of coal blocks by the government. While the timeline is not definitive, it is expected by end of the year. Sterlite can use its strong balance sheet to acquire resources that have eluded it for some time.

■ Sensitivity to commodity prices is low: An increase of 10% in aluminium price should increase consolidated earnings by 2%. Also, a 10% increase in zinc prices would increase consolidated earnings by 5%.

Earnings and target price revision
■ We have revised our EPS estimates for FY11 and FY12 by -6% and -4%, respectively.

Price catalyst
■ 12-month price target: Rs850.00 based on a Sum of Parts methodology.
■ Catalyst: Coal sector reform, clarity of bauxite linkage for VAL.

Action and recommendation
■ Maintain Outperform: We believe Sterlite continues to offer value, with its strong diverse growth pipeline, strong balance sheet and numerous upcoming catalysts. We think that the strong earnings growth should become the focal point driving the stock price. There also is a possibility of sharp re-rating if Sterlite can resolve its long-standing issues involving the government.

To read the full report: STERLITE INDUSTRIES

>ALPHA STRATEGY: The bank for a changing world

■ We are raising China to Overweight and cutting India to Underweight.
■ China upgrade is based on our view of monetary policy easing ahead.
■ India downgrade reflects a market priced to perfection with earnings risk.
■ Downside risk to earnings is the biggest challenge facing markets in 2H10.

We have raised our recommendation in China to Overweight from Neutral and increased our target for the HSCEI index to 15,800. The key driver of our upgrade is our view that the next major change in monetary policy in China will be an easing. This view stems from the risk of a hard landing in the economy as the expected slowdown in domestic demand is joined by an unexpected slowdown in exports. A more dovish tone on inflation from policy makers has erased the risk of policy tightening that was expected and has paved the way for an eventual easing.

We have cut our recommendation for India to Underweight, from Overweight, reflecting our view that the positives have been priced in and there is a meaningful risk to earnings going forward. Our SENSEX forecast of 19,700 signals we still forecast the market will post positive returns over the next 12 months.

Taiwan is trimmed to neutral reflecting the significant earnings exposure of the market to Europe as well as the risk of margin squeeze from the hike in wages in China. Our sample of technology companies with significant China operations highlights the risk of a 32% drop in pre tax earnings based on the assumption of a 50% increase in labour costs.

The euro zone crisis and a short term peak in Asian GDP growth forecasts implies there is a material risk to earnings forecasts in 2H10. The correction in the market year to date has been driven by multiple contraction as opposed to earnings reductions. We anticipate that the next leg down for the market, which we estimate to be 9%, is likely to be driven by downward revisions to earnings. We view this is a mid cycle correction as opposed to trend reversal and forecast a 23% gain in MSCI Asia Ex Japan over the next 12 months.

To read the full report: ALPHA STRATEGY

>MOSER BAER INDIA: Some Recovery in PV Business But Is it Good Enough?

■ Maintain Sell — PV business showed a good recovery in Q4 with ~25MW of shipments. However, the scale of the business remains small with capacity less than 200MW. Optical media showed YoY growth after four quarters of decline but EBITDA margins at ~20% are way off peak levels of ~40%. Balance sheet remains stretched (D/E is estimated at ~2x) – growth is a challenge. Risks remain high; we await more financial details in the annual report.

■ SOTP-based valuation — Our updated SOTP ascribes a multiple of 1.0x Sep 11E EV/S for PV business (previously 1.8x) given the sharp fall in global comps, 1.0x Sep 11E EV/S for home entertainment (unchanged) and 0.75x Sep 11E EV/Capital Employed for optical media (previously 0.7x). Our new target is Rs65.

■ PV business plans lowered — Revenues were ~Rs5b in FY10 (up ~70% YoY but significantly below our estimates). Management expects to emerge EBITDA positive by end-FY11. Company plans to add ~100MW Silicon capacity in FY11, which is much lower than what was envisaged earlier. We believe risks are high, as the business is small and has significant technology /execution risks.

■ Optical media stable; Home entertainment still small — In optical media, volumes were flat while ASPs declined ~5% in FY10. Management expects prices to remain stable in the short term. Home entertainment revenues are still small – less than 10% of standalone. We expect modest improvement in optical media in the coming years on the back of changing mix towards higher priced new formats.

■ Upside risks to our stock call — (1) Successful equity raising in the PV business. (2) Sharp ramp-up in PV margins. (3) Better performance in optical media than factored in our estimates. (4) Increase in crude prices which improve alternate energy viability and drive more funding towards the same.

■ Transfer of coverage — We are also transferring coverage of Moser Baer to Vishal Agarwal from Surendra Goyal, due to reallocation of coverage resources.

To read the full report: MOSER BAER

>INDIAN PORTS: May cargo volume up 4.5% YoY at major ports; MICT, JNPT volume de-grows

May 2010 cargo volume up 4.5% YoY at 47.8mt: In May 2010, cargo traffic at major Indian ports improved by 4.5% YoY to 47.8mt (v/s 45.8mt a year earlier), better than April 2010 growth of 2.7% YoY.

■ Container, POL cargo boost cargo traffic growth: In May 2010, cargo traffic growth was boosted by double-digit container and POL cargo growth. Container and POL cargo grew by 14% and 10% YoY to 8.9mt and 15.2mt, respectively. Iron ore de-grew by 9% to 7.9mt. Coal and fertilizer cargo were flat YoY at 6.4mt and 1.5mt respectively. Cargo in other categories grew 4% YoY to 7.9mt.

■ JNPT container cargo traffic de-grows 5.6% YoY, total container traffic grows 14% YoY: In May 2010, container cargo traffic at JNPT de-grew 5.6% YoY to 4.3mt and all-India container traffic was up 14% YoY at 8.9mt. Other ports posted healthy container traffic growth in May. Chennai grew by 53% YoY to 2.4mt, Kolkata posted growth of 26% YoY to 0.59mt and Tuticorin grew 10% YoY (0.58mt). The four ports account for 7.8mt of container traffic or 88% of the total
container traffic.

■ Cargo traffic grows at seven ports, Cochin posts highest increase of 28%: In May 2010, seven ports posted growth in cargo traffic, of which Cochin, Kandla, Chennai and new Mangalore volumes grew 28%, 22%, 21% and 12% YoY, respectively. POL cargo, which grew by 37% YoY in Cochin and 38% in Kandla, boosted cargo traffic growth at the two ports.

■ Mundra International Container Terminal (MICT) May volumes fall by 5.5% YoY: In May 2010, MICT posted a 5.5% YoY decline in container traffic to 45,789 TEUs (48,432 TEUs in May 2009). This is similar to a 4.6% YoY decline in April 2010. Since January 2010, volumes at MICT have declined each month. Cumulative volume since January declined by 8.7% YoY to 227,280 TEUs.

To read the full report: INDIAN PORTS

>Gruh Finance Ltd.: “Housing-Rural India” (LKP SHARES)

GRUH Finance Ltd. (GFL) is an NBFC providing housing finance to rural and semi urban India. Modeled to complement the business of its sponsor, HDFC, GFL operates in states and regions offering high growth potential. The strong rural presence combined with an improved macroeconomic environment enables asset expansion. Backed by an underleveraged balance sheet and equity support from the promoter, GFL presents a case for higher growth.

■ Pricing power and low competition are its key strengths: Higher operational and credit costs in rural regions have led most aggressive banks and NBFCs to focus on urban and metro regions. GFL has a strong network to service the under penetrated markets and is compensated by high asset yields. Local knowledge and experience on buyer behavior keeps npas low, translating to higher RoEs of 28% (FY10). Although we expect competition to increase over the next few years, GFL will outpace its competitors with higher profitability and lower delinquencies.

■ Firm growth with balance sheet liquidity - 23% loan book CAGR and 24% PAT CAGR over FY10-13. CAR of 16%, strong internal accruals and continued equity support from HDFC provides growth visibility. An underleveraged balance sheet gives comfort to expectations of scalability. As asset book expands through broadening of customer and geographic diversification, pricing power and lower operational costs (C/I ratio of ~20%) translate to greater traction in NII.

■ Valuation at a discount to peers: GFL trades at P/ABV of 2.3x ABV FY12 as against its historical high of 3.3x. Loan book expansion (23% CAGR asset FY010-FY13), higher profitability (RoE of 29% FY12) and proven track record to tide over adverse interest rate cycles reaffirms our belief in GFL. GFL’s business model with ROE >28% and zero net NPA should command a higher multiple and we recommend a BUY with a price target of Rs345 (3x ABV FY12).

To read the full report: GRUH FINANCE