Sunday, July 4, 2010

>Prospects for Global Defence Export Industry in Indian Defence Market (DELOITTE)

Over the past decade, the Indian Ministry of Defence has put into motion plans for an unprecedented modernisation program of its defence capabilities.

Following the Kargil conflict in 1999, India was confronted with the recognition that much of its
Soviet-era equipment was outdated and obsolescent compared with its regional rivals. India faces the theoretical prospect of a war on two fronts, one with a major power rival (China) and the other with a powerfully-armed middle power that poses potential threats to its homeland security (Pakistan). Both China and Pakistan have significantly expanded their military capabilities in the past decade.

In this context, India has embarked on a major defence acquisition program, aimed at increasing the size, capability and self-reliance of its Defence Armed Forces.

The scale of the planned investments reflects both its need to make up for lost time as well as its expanding economic power. India has seen its economic capacity to fund its capability modernisation expand almost exponentially over the past two decades. During this time India has been increasingly moving towards a more open-market economy, reducing historic controls
on foreign trade and investment and privatising a range of government-owned companies across a range of sectors, from airports to electricity generation to telecommunication firms. This has catalysed India to be one of the fastest growing emerging markets, with its GDP growing by seven per cent each year on an average since 1995. India’s ‘economic miracle’ has been
underpinned by a significant expansion in its advanced manufacturing, engineering and
ICT industries and is forecast to continue. The IMF in 2009 projected India’s GDP would grow in real terms by more than 7.5 per cent on an average from 2010 to 2014. India’s economy
is projected to be 60 per cent of the size of the United States economy by 2025 and second only to China by 2050.

Its acquisition plans include a substantial procurement program for the Army, Navy and Air Force. Realising that the Revolution in Military Affairs (RMA) effectively passed India by in the 1990s, the government is seeking to develop a flexible, mobile and networked defence
force with substantial power projection capabilities.

Many of the assets India is acquiring are at the leading edge of technology, including 180 Sukhoi Su-30MKI aircrafts, Scorpène class submarines, advanced Russian T-90 main battle tanks and state-of-the art information and communication systems. More than USD 42 billion in total defence expenditure is targeted by 2015, of which approximately USD 19.20 billion would be
expected to be spent on capital equipment for the Defence Armed Forces.

Key findings: acquisition plans by each domain
India’s budgeted acquisition plans are expected to see an overall expansion of capital expenditure from approximately USD 19.20 billion by 2015 (Table 1). The Defence Service’s capital expenditure budget is expected to achieve a compound annual growth rate (CAGR) of 10 per cent from 2011 to 2015.

This represents a marginal slow down in budgeted expenditure from the past decade (CAGR of budgeted expenditure of 13.8 per cent from 2003-2010).

Taking account of inflation, however, tempers the estimate of the overall opportunity; when accounting for India’s inflation rate, the real growth in Defence Service capital expenditure is expected to be marginal over the next two years before increasing to a real growth rate of about 5.3 per cent from 2012 to 2015.

Navy and Coast Guard acquisitions
The Indian Government has publicly recognised that India’s expanding maritime responsibilities and interests necessitate enhancement in naval and coast guard force levels. By 2022, the Indian Navy has plans to have a 160-plus ships Navy, including three aircraft carriers, 60 major combatants (including submarines), and close to 400 aircrafts of different types. The Indian Coast Guard is all set to double its force levels and manpower in the next few years and triple it in the next decade in order to protect the country’s maritime zones and assets.

To read the full report: INDIAN DEFENCE MARKET

>FERTILIZER SECTOR: Sowing the seeds of Change (DOLAT CAPITAL)

We expect the sector to continue to gradually re-rate with pro active and favorable policy initiatives. With the step forward on complex fertilizer already in place, we hope that the government would follow through with similar steps on the urea segment.

We believe companies with strong raw-material tie-ups, plans for expansion and offering customized products would lead to higher volume growth. We therefore prefer stock specific approach .We are positive on Coromandel International (CIL) due to its strong business model and GSFC- beneficiary of NBS policy and high earnings visibility.

Relooking the Fertilizer Sector:
The latest Government Policy on Fertilizer Pricing and Subsidy is encouraging and a welcome step in the direction of deregulation of the industry.
We have identified the following drivers for industry that would act as a game changer and would make the sector attractive for the future growth potential which till now witnessed restricted growth due to its controlled regime.

Nutrient Based Subsidy (NBS)
Raw-Material Sourcing
New Investment Policy-4 (NPS-4)

Positive on Complex Fertilizer
The shift in policy regime from product based subsidy to nutrient based subsidy opens a plethora of opportunities for complex players. This change would encourage use of right nutrients as per requirement of soil, thus limiting the excess use of highly subsidized nutrient which has resulted in soil degradation and effected productivity (annexure). With this new policy, players with established raw-material linkages and offering customized products would enjoy an edge over the other players. This in turn shall benefit players like Coromandel International as they have build up strategic tie-ups and strong marketing and distribution networks.

The Nutrient Based Subsidy has also introduced a fixed subsidy regime and has left the market price floating in accordance with the demand and supply situation with a possibility of intervention by Government if the prices rise unreasonably. This has already led to an increase in prices of DAP (Di-Ammonium Phosphate) and MOP (Muriate of Potash) by Rs. 600 per
tonne i.e. 6.4% and 13.5% respectively. This would result in efficient players being rewarded over their counterparts.

The sourcing of raw material is the key to enjoy the fruit of efficiency as it is the most critical factor determining sustainability of business. We believe that this is the key area where Coromandel shall perform better than its peers. Its tie-up with Foskor and Tunisian Joint Venture with GSFC would lead to additional flow of phosphoric acid which would in turn lead
to production growth of 18% and 11% in FY11 and FY12. GSFC will also get access to the additional raw-material and would lead to production of customized complex fertilizers.

We remain positive on the complex fertilizer space and we recommend an accumulate on Coromandel International Fertilizer and a buy on GSFC.

Urea opportunities ahead
Similar to the policy pronouncements for the complex fertilizers, we expect the New Investment Policy IV to address the key issues for the urea segment as well. The key focus shall be to reduce the dependency on imports and encourage capacity expansion in India. The current urea capacity at 20 Mn MT has been stagnant for over a decade now.

We also observe that the expected policy is part of the ongoing series of steps that the government has been taking to move towards deregulation of the sector. The first leg of this has been witnessed with gas replacing all other high cost and unviable feedstocks. Further, the linking of additional production through Greenfield/Brownfield /Revamping to International Parity Pricing (IPP) has brought in the much needed impetus required to attract investments. NPS-III was in effect till 31st March, 2010.We believe ,the NPS-IV which is just around the corner shall continue with the pro active mode and attract capacity expansion. One of the provisions that would be looked into keenly would be revising the floor price which currently is fixed at US $ 250 per tonne.

With the above backdrop, we believe Chambal will stand to benefit as it has recently commenced its brownfield expansion which will make any additional production over and above the cut-off limit qualify for IPP. We assume the volumes to increase from 1.9 MT to 2.1 in FY10 and 2.4MT in FY11E.However,we recommend a reduce on the stock as it is fairly priced and trades at 10.8x FY11E EPS.

To read the full report: FERTILIZER SECTOR

>GRASIM INDUSTRIES:Samruddhi lists today; to be merged with Ultratech by July end (UBS)

Upgrade to Buy after significant underperformance
We upgrade Grasim from Neutral to Buy and remove our short-term Sell rating on: 1) significant underperformance since the fixing of the record date of the demerger of the cement business i.e. 14 May 2010; and 2) compelling valuation at EV/T of US$80/t (US$115-140/t for other larger companies). We do not change our earnings or valuation estimates; we remove the value of the demerged cement business of Grasim (Samruddhi Cement, which lists today) and consequently, lower our price target to Rs2300 (from Rs2,875).

Samruddhi lists today; to be merged with Ultratech by July end
Samruddhi (the demerged cement business of Grasim) lists today on the BSE/NSE. We expect Samruddhi’s share price to mirror Ultratech’s share price in the ratio of 4:7 (i.e. one share of Samruddhi to trade equivalent to 4/7th of Ultratech’s share price) as Samruddhi will be finally merged with Ultratech (four shares of Ultratech to be issued for seven shares of Samruddhi) by July end.

Ultratech to become largest cement player post merger
Ultratech will emerge as the largest pure-play cement company in India with a capacity of 48.8mt. It is planning to add additional 25mt capacity in the next five years. Post merger with Samruddhi, Ultratech’s shares outstanding should increase to 274m from 124.5m shares (124.5+261.7*4/7). Samruddhi’s shares outstanding are 261.7m (including 91.7m shares issued to Grasim’s shareholders).

Valuation: upgrade to Buy; adjust price target to Rs2300
We continue to value Grasim on a sum-of-the-parts basis with Cement on 6.5x EV/EBITDA, VSF on 5.5x EV/EBITDA, and apply a 10% holding company discount to the cement business.

To read the full report: GRASIM INDUSTRIES

>HCC: Gearing up for a full fledged ‘Dasve’ launch by Dec’10; Lavasa visit

We recently visited Lavasa and returned impressed by the preparation for the full scale commercial launch of ‘Dasve’ by Dec’10. Lavasa Corporation Ltd (LCL) has already sold 1,850 apartments and villas till date spanning over 3.5mn sq ft and is confident of handing over keys to buyers by Mar’11 at the latest. The first set of 200 keys was handed over to the customers during Q4FY10. Phase I would have an additional 600 residential units, out of which the soft launch of 250- 300 units is expected to be announced over the next couple of months.

Among other significant developments since our last visit in Dec’09 have been formal launches of ‘Dasvino Town & Country Club’, 50 bed Apollo Hospital, 130 keys Mercure Hotel and an International Convention Centre (1,500 capacity). The Dasvino Town and Country Club has been established via a management agreement with International Leisure Consultants (ILC), Hong Kong and includes a Spa, Gymnasium, floodlit courts for tennis and squash, children’s playroom, specialty restaurants, a business lounge and a pub.

Lavasa listing on cards by Q1FY12
HCC had plans for a potential listing of LCL by Oct-Nov’10. However, given the volatile market conditions that are not conducive for realty IPOs, the same has been postponed to early 2011. The company presently holds a 65% stake in the entity via its wholly owned subsidiary, HCC Real Estate Ltd (HREL). Avantha Group, Venkateshwara Hatcheries and some large private investors together hold the remaining equity. Additionally, eight banks and financial institutions hold ~11% (at an EV of Rs100bn) in the company via DDCDs. We believe the eventful listing of Lavasa shall play a major role in determining HCC’s stock price performance over the next 12months. We retain our BUY recommendation on the stock with a SOTP based price target of INR170.

Lavasa valuation
As per our DCF calculation, LCL has a potential value of Rs57.7bn (~Rs123/share for HCC). While the company expects to execute the project over next 12-15 years, we have taken a longer execution period of ~20 years. We have also assigned a holding company discount of 20% to the final NAV of LCL. Key assumptions for Lavasa valuation are:

  • We have assumed a sale model for the entire area available (~163 mn sqft) given the lack of clarity on the future revenue stream of SPVs; LCL though shall hold a strategic 26% stake in all commercial, hospitality, leisure and social SPVs thereby becoming a perpetual partner in their growth.
  • We have taken a capital value at an average of Rs3,500/sqft for sale of residential development. For land/plot sales, we have assumed a rate of Rs100/sqft. From FY11 we have escalated capital values at ~10% CAGR.
  • Construction cost at Rs1,800/sq ft, escalated at 5% CAGR fromFY12 onwards.
To read the full report: HCC

>BALANCE OF PAYMENTS: BoP remains stable despite larger current account deficit

Current account deficit reaches new high in Q4FY10
India’s BoP recorded a surplus of USD 2.1 bn during Q4FY10, more or less same as the previous quarter. Current account balance worsened a bit from the previous quarter, but was compensated by almost equal increase on the capital account.

Current account deficit stood at ~USD 13 bn during the quarter under review, amounting to ~3.4% of GDP, historically on the higher side. Among the important components of the current account, merchandise balance and private transfers deteriorated, while software earnings improved.

Capital account surplus recovered marginally to ~USD 15 bn in Q4FY10 from ~USD 14 bn in Q3. While FII and short-term trade credit have been robust, ECB has fallen sharply to near-zero in Q4. FDI trend has also been modest in recent quarters.

BoP stages a turnaround in FY10
On full FY10 basis, BoP situation is much healthier over FY09, recording a surplus of ~USD 14 bn against deficit of USD 20 bn in FY09.

On the current account side, considerable decline in invisibles was recorded primarily on the back of lower receipts under miscellaneous services despite a pick-up in software earnings and private transfers. Trade deficit was largely stable at ~USD 118 bn. Overall, current account deficit deteriorated by ~USD 10 bn during FY10.

As regards the capital account, FDI increased marginally, but FIIs and short term trade credit rebounded quite strongly with recovery in global sentiments and risk appetite. ECB, however, disappointed, falling to USD 2.5 bn in FY10 from ~USD 8 bn in FY09.

FII, ECB to determine BoP dynamics in the near term
In the coming quarters, the current account would be influenced by few key factors such as India’s demand for imports, trends in global commodity prices particularly crude oil and movement in exchange rate. We expect India’s import demand to remain strong but weaker demand in western economies would weigh on India’s exports. However, likely subdued commodity prices amidst a weaker global recovery can potentially extend a favourable impact for India’s trade balance.

Persistent and significant appreciation in the INR during FY10 (~13% in nominal terms against USD and ~18% in real terms – 6 currency REER) did not impact trade balance or software earnings in any significant way. However, continued appreciation in REER from current levels could prove unfavourable to these segments. This can potentially deter any improvement in India’s trade balance in the coming quarters. Subdued economic activities in the developed countries are not conducive for an improvement in the invisibles account either.

The critical factor for any large swing in the overall BoP can, thus, come from the capital account only. Within capital account also, FDI is by and large stable. In sum, thus, the dynamics of the overall BoP would be weighed heavily by FII flows, ECBs and trade credit.

To read the full report: BALANCE OF PAYMENTS