Friday, July 9, 2010

>Global: The return of risk aversion (SCHRODERS)

• Doubts about sovereign creditworthiness and the economic recovery have led to a horrid performance from equity markets in the second quarter. With government bonds in the US, Japan and Germany rallying, risk aversion has increased sharply.

• We remain confident in our baseline forecast of a modest global recovery but do not see a quick solution to the sovereign crisis. Furthermore, near term cyclical indicators look set to turn down as the boost from the inventory cycle fades and investors are likely to be debating the double dip through the summer.

• However, on our measures markets are already behaving as if we have gone back into recession given the outperformance of the more risk averse areas and equity valuations are looking attractive again. Consequently, we maintain a modest tilt toward risk assets, hedged by holding some high quality bond exposure, gold and by avoiding the Euro.

Eurozone: Will the Eurozone double-dip?
• Weakness in Southern Europe is likely to continue for some time. This is likely to have both a direct impact on aggregate growth along with indirect impacts which include trade channels, financial markets, and the spread of contagion to sovereigns. Will the sovereign debt crisis cause a double dip recession?

• Taking a close look, we think downside risks to wider Eurozone GDP growth are limited. The weakness of the Euro has already boosted export orders, though more export oriented member states are more likely to benefit than the rest. As a result, Eurozone growth is expected to remain positive, but will be more uneven across member states.

To read the full report: ECONOMIC VIEWPOINT

>Stress case suggests moderate downside (DEUTSCHE BANK)

While we are maintaining our baseline view of Indian economic growth moving back to the 8-9% GDP growth trajectory driving corporate earnings growth in India (and hence maintaining our year end Sensex target of 22,000), 3QCY10 should see equity markets being swayed by dramatic waves of risk aversion We have attempted to provide a framework for investors by running a stress test for the BSE Sensex companies and determining the likely downside risk from a moderate global risk event. Our stress tests indicate that there is a ~14% downside risk to our base case Sensex earnings forecast of 1095 for FY11. In case our stress tested scenario pans out, BSE Sensex earnings in FY11 would rise by only 12% relative to our currently estimated Sensex earnings growth of 30%. Based on our stress tested EPS and applying the current market multiple of ~16xFY11 earnings, the fair value of the BSE Sensex would be 15,100. We believe that this provides a reasonable floor value to the Indian market, in a moderate global risk scenario.

Declining oil prices – a strong tailwind for India
Our global commodities team expects oil prices to soften in 3QCY10 and remain weak into the end of the year before recovering in 2011. We believe declining oil prices will result in a strong tailwind for India’s domestic economy as well as its balance of payments. A downdraft in global oil prices should help take considerable pressure off an inflation-wary government of India and allow it to
perhaps extend the recent bold deregulation of petroleum products to diesel. The government’s recent decontrol of petroleum prices and the promise of extending this to diesel have been seen as a strong game changer and bring back faith in the Indian government’s commitment to make bold decisions that a popular democracy generally constrains it from implementing.

India’s share in regional inflows has ratcheted up sharply
The improving domestic macro situation and India’s unique domestic consumption model has perhaps been the critical factor for the country’s out performance relative to its other large emerging market peers. India’s share of regional inflows in 2010 YTD underscores this thesis. India’s share of regional (Asia ex China/Japan) FII flows (2010 YTD) has ratcheted up sharply to 48%. This compares favorably to 2009, when India received only 29% of regional inflows (with Korea having seen the largest flows then), and 2004/2005 when the share stood at 30%
and 33% respectively.

Model Portfolio tilted partially towards defensive plays
Driven by our expectation of a volatile 3QCY10, we have added a more defensive bias to our model portfolio. While we continue to overweight Banks, Industrials and Automotives, we have also shifted Telecom as a non-consensus overweight. Despite strong under performance since May’10, we have gone underweight on Metals as we believe that global headwinds and regulatory concerns will keep investment flows into commodities depressed. Other underweight sectors are: energy, healthcare and Cement. Our Top Buys are: M&M, Maruti, Zee, Axis Bank, HDFC Bank, Lanco, L&T, BHEL, Asian Paints and Tata Steel.

To read the full report: EQUITY STRATEGY


"Let every man divide his money into three parts, and invest a third in land, a
third in business, and a third let him keep in reserve."

-Talmud, circa 1200 BC - 500 AD1

This letter is the start of a process we will, in the future, develop into a more useful and
practical asset allocation framework for investors’ portfolios that reflects our macro view,
concerns about the general riskiness of the financial world and a variety of issues that go into the
asset allocation process.

As a starting point, it is important to understand what real long-run rates of return have
been for different assets.2 Good data exists on developed country equity markets by sector and
on real estate. For example, most people know that the real long-run return on U.S. equities is
about 6.5%. Small-cap stocks outperform large companies by a wide margin, value stocks
outperform growth stocks, also by a wide margin, and small value stocks easily outperform small
growth stocks. However, small companies have much greater volatility and business risk.

It is also well known that the real return on bonds lags the real return on stocks, but risk is
much less. In a portfolio, the inclusion of some bonds along with stocks lowers risk faster than it
lowers returns up to a point.

To read the full report: ASSET ALLOCATION


Tata Power's deal with Olympus Capital implies a US$2bn value for Tata's mine stake, which is lower than our attributed value of US$3.1bn. This leads us to lower our estimate for the mine stake to Rs305/share and roll back our SOTPbased target price to Rs1346. Consequently, we downgrade to Hold from Buy.

New deal with private equity player values Bumi stake at US$2bn
Tata Power has entered into a deal with private equity player Olympus Capital to sell 15% of its stake in the special purpose vehicles (SPVs) that own 30% of KPC and Arutmin. The 15% stake is valued at US$300m, implying a total equity value of US$2bn for Tata Power’s stake in the coal mines. The company has issued differential rights shares to Olympus Capital that are subject to capital protection arrangement. The capital protection arrangement is expected to be serviced either by funds from coal SPVs or by Tata Power.

Funds to be used for debt repayment and mine acquisitions
Tata Power’s management stated that it planned to use the proceeds to reduce debt related to coal mine acquisitions (US$694m outstanding as of March 2010) or to acquire additional coal mines overseas in order to ensure long-term fuel supply for its upcoming power projects. Currently, it has a take-or-pay arrangement of 10.1+20% MT with Indonesian coal mines and captive coal blocks at Mandakini (2.5MTPA) and Tubed (2.3MTPA) in India.

Power projects are on schedule
Tata Power plans to add 1,138MW of capacity in FY11, including the first unit of the Maithon project (1,050MW), for which a fuel-supply deal is already in place. Mundra UMPP is 52% complete, while management says the IEL Jojobera project is likely to happen in 2QFY11.

We revise our value estimates for the mines and downgrade to Hold
We had valued the company’s coal mines stake at US$3.1bn (US$2.5bn including a 20% holding discount, or Rs485/share). We now lower our estimate in the light of the deal, and value the company’s coal stake at US$2bn, which implies US$4.2 EV/ton for mine reserves (US$6.5/ton previously). We lower our SOTP-based target price to Rs1,346 (fromRs1,519) and downgrade to Hold (from Buy). The stock currently trades at 2.9x our FY11F book value.

To read the full report: TATA POWER