>Thinking ‘outside the box’ on economic policy

• The markets are currently imposing on Europe a more brutal tightening of fiscal policy earlier than expected. But that does not mean that the two other constraints have disappeared: central banks should normalise the settings of their monetary policy as soon as conditions are met, while there is a ‘strong obligation’ to maintain a certain level of growth. How this can be done is not at all clear, and there are fears that the markets will find it difficult to extract themselves from this new ‘Bermuda Triangle’ – not forgetting that the triangle can easily shift from one place to another within the region formed by the advanced countries.

• Recent European experience shows that the management of fiscal policy appears to be a more complicated issue than previously thought: how is the decision made when to cut off stimulus and start coming back to fiscal discipline? Cutting it off too soon is taking the risk of the economy plunging into a new downturn; letting it run for too long could build more investor fears and create a hard landing scenario. Defining the main risk between Scylla and Charybdis is
never easy. Perhaps the choice should depend on the importance of both private domestic savings and the ability to attract foreign capital.

• The decision of the ECB to purchase government bonds on the secondary market has triggered a debate about the impact on its credibility. The latter would be reduced because of too close proximity to the behaviour of governments. From an academic standpoint, a distinction has to be made between an environment of high inflation or of very limited inflation. In the face of high inflation, often related to excessive monetisation of government debt, a central bank’s
independence is its cardinal virtue; if very limited inflation is associated with weak growth and fiscal austerity, greater co-operation between the central bank and the government is more easily understandable.

• The link between the sovereign debt crisis and banking crisis has been borne out historically. However, the aim of the rescue plan for member states from the European Union, with IMF support, no doubt changes the nature of that link. In fact, the plan is designed to head off for a period (almost two years in the case of Greece) the emergence of liquidity risk for the Greek Treasury, with the breathing space gained being devoted to reducing solvency risk via credible public account rebalancing plans. For a short time, therefore, the plan staves off the transfer of risk from the sovereign to the banking sector. It is, in fact, a sort of ‘mutualisation’ of risk between sovereigns: from the weaker to the healthier. In this respect, it is probably not entirely legitimate to link the two types of risk so strongly.

To read the full report: MACRO PROSPECTS

>INDIA TELECOMS: Deleveraging Is Key

• 3G and broadband auction stretches balance sheets short-term: We estimate average net debt to EBITDA for Bharti, RCOM and Idea at 3x in F2011, up from 1.5x currently. After that we expect all to be FCF-positive and lower their debt burden in two years to 1.8x.

• Unlocking value of towers could alleviate debt concerns: We estimate that the value of towers is equivalent to 31%, 54% of market cap for Bharti, Idea respectively and 59% of RCOM’s EV.

• Tariff wars are subsiding: No tariff cut in more than 2 quarters

• Overweight Bharti : Bharti has the strongest balance sheet among our coverage companies, its peak net debt/EBITDA of 2.8x should halve in two years.

• Overweight Idea: Idea’s future capex could be less than the industry average due to higher spectrum per sub; the worst quarter in terms of peak losses is behind us.

• Underweight RCOM: Lower ARPU estimates and forex losses lead to earnings cut of over 25% for F2011/12E. RCOM will likely remain costliest Indian telco even after demerger of towers to Global Tele Infra Ltd. (GTIL)

• Key Risks: 1) Entry of Reliance Industries in Broadband Wireless; 2) TRAI recommendations on excess spectrum charges, etc. Morgan Stanley does and seeks to do business with companies covered in Morgan Stanley Research. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of Morgan Stanley Research. Investors should consider Morgan Stanley Research as only a single factor in making their investment decision.
For analyst certification and other important disclosures, refer to the Disclosure Section, located at the end of this report.

To read the full report: INDIA TELECOM

>MARICO INDUSTRIES: reduce visibility on future growth enginesO (NOMURA)

■ Kaya remains an overhang
As we see it, one of the issues facing Marico is a steady deterioration in the fortunes of its flagship business, Kaya Skin Clinic. High attrition and low consumer retention are unlikely to be resolved quickly, we believe. Our assumptions now build in a loss of INR100mn in FY11F, from our prior assumption of a marginal profit.

■ Margins unlikely to be sustained at current levels
The operating margin for the core business (ex Kaya) is at an all-time high of 14.6%, but we think this is unlikely to be sustained at current levels. We expect rising input costs, lack of pricing power and continuing high A&P spend to suppress margins in FY11F.

■ All positives factored in; risk/reward unfavourable
While we lift our earnings forecasts by 3% for FY11F and 7% for FY12F, we believe current valuations factor in all the positives. On our reading, the stock is trading at 27.3x FY11F earnings — a 38% premium to its long-term average P/E multiple. We believe the risk/reward proposition is unfavourable.

■ Downgrading to REDUCE
Our downgrade to REDUCE reflects our view that, in the near term, the business is likely to face strong headwinds. Margin pressure in the core business, continuing losses at Kaya and rich-looking valuations are key factors in our rating change. Our new sum-of-the-parts valuation is INR118, of which the core business accounts for INR109 (20x FY12F EPS) and Kaya INR9 (2x FY12F sales). Potential downside from our new price target stands at 7%.

To read the full report: MARICO INDUSTRIES

>UFLEX: Packaging profits (ELARA CAPITAL)

■ Strong foothold in packaging market
Uflex is the largest flexible packaging company as well as the lowest cost producer of packaging products in India with a 19% share of the organized market. The company operates as a converter of packaging products with a presence in both the plastic film and flexible packaging business. The unique strength of Uflex is its vertically integrated operations, offering ‘end to end’ packaging solutions to marquee FMCG companies like Unilever, Nestle, P&G, Britannia and Fritolay among others. Thus it captures margins across the value chain – from plastic film production to flexi-pack conversion and to the final packing of a variety of FMCG products.

■ Ambitious expansion plans to become a global player
The company is planning to aggressively grow over FY10-12E with an investment of over USD250mn. Uflex will setup plastic film plants in Egypt, Mexico and Dubai and a flexi-pack plant in the state of J&K. This would enable it to increase capacity by nearly 65% in the plastic business and over 50% in the flexi-pack vertical. We expect the top line and the bottom-line to grow at a CAGR of 22% and 27% respectively, over FY10-13E. The company plans to raise INR2bn by way of right issue in the current year and over INR8bn of debt. We expect net debt
levels to reduce to 0.5x by FY13E from current 1.2x.

■ Steep cost efficiencies, changing business mix to widen margins
The company’s cost efficient raw material conversion play has been the biggest differentiator vis-à-vis peers. It’s conversion price, after attaching profit margins, remains the conversion cost of other global peers. Considering an equal EBITDA margin, Uflex price per kg is nearly 25% lower than international peers, leaving a significant headroom for it to attract large global clients. The company strategy to hike the contribution from flexi-packs to total revenues and to tap the
high margin world markets will play a key role in augmenting EBITDA margins by about 100bps.

Valuation
At the CMP, Uflex trades at a P/E of 4.5x and 3.5x FY11E and FY12E earnings respectively. We believe the stock will undergo a significant P/E expansion on account of its strong foothold in the
packaging market, aggressive growth plans and expectation of improving margins. We have assigned Uflex a target multiple of 6x on its FY12E earnings of INR31.6 per share that derives a per share value of INR190. We initiate the coverage with a BUY rating and a target price of INR190 per share, providing an upside potential of 73% from the current market price.

To read the full report: UFLEX

>Heidelberg Cement India Ltd (ENAM SECURITIES)

Company background: Heidelberg Cement Ltd (HCIL; erstwhile Mysore Cement - MCL) - Incorporated in 1958 and promoted by Mr. S.K. Birla, is engaged in the business of manufacturing & selling cement. HCIL, with a 3.15 mn. tonnes cement manufacturing capacity caters primarily to central India. In July 2006, MCL was acquired by Heidelberg Cement A.G (Global Cement major) – The deal was done at valuation of $109 EV/tonne.

Investment argument
■ Favourable regional exposure: A “Central Region” centric company, HCIL derives 70% of its sales from central, 23% from western and 7% from southern region, where cement consumption
has grown over 19%, 11% & 3% respectively vs. Industry growth of ~ 10.6% in FY 2010.

■ Turnaround post the takeover: From a net loss of Rs 41 crs (adjusted for CY 06) to net profit of Rs 134 crs in CY 09 shows very strong capabilities of the global cement major in turning around the company through excelling the operational efficiencies which have resulted in net cash generation of Rs 495 crs (~Rs 22 cash/share) till CY 2009.

■ Expanding cement capacity to meet the robust demand in the central region: Cement production capacity to be doubled to 6 mn. tonnes from present 3.1 mn. tonnes till March 2012 (CY 12) through brown-field expansion. Heidelberg cement A.G is targeting to enhance its capacity to 15 Mn. tonnes in India by CY 2014.

■ Funding expansion primarily through internal accruals: 70% of the expansion would be funded through internal accruals.

Valuation
We expect the cement demand in the central and western region to remain strong backed by scaling up of rural and government infrastructure spending. Central region is expected to remain in deficit (DD>SS) at least till FY 2012 due to limited capacity addition and robust demand. Our FY12E growth estimates are conservative despite of assembly elections in U.P. in early FY13 and resultant government spending at least 2 quarters prior to that.

At CMP of Rs 48, the company is available merely at 3.7x CY12E EV/EBITDA (implied EV/tonne - US$ 47 vs replacement cost of ~ US$ 100 -110/tonne i.e. ~ 55% discount). Thus, we recommend a BUY on Heidelberg Cement Ltd for a target price of Rs 64 (target EV/tonne – US$ 60). Hence, a potential upside of 33% over a period of 12-15 months.

To read the full report:: HEIDELBERG CEMENT

>MAHINDRA & MAHINDRA (JP MORGAN)

Jun' 10 - Sales growth (+7% yoy) moderates on base effect and production constraints - ALERT

• M&M’s unit sales grew +7% yoy over the month, with unit sales being driven by the three-wheeler and light truck portfolio. The UV and FES segment sales were impacted by production constraints.

• Automotive segment sales growth driven by compact portfolio: While M&M’s automotive sales were up +19% yoy, growth was driven by the three wheeler and light truck portfolio (+125% yoy). UV sales though were flat yoy (off a high base) given production constraints. The management highlighted that shortage fuel injection equipment as well as a plant shutdown (for maintenance) led to the lower sales.

• Tractor sales decline -9% yoy on component shortage: The management highlighted that tractor sales were impacted by shortage of castings and tyres at the vendor’s end. The company though continues to guide for FY11E tractor segment growth of 10-14%, given healthy demand.

• The M&M Renault Logan recorded domestic unit sales of 563 units over June (a growth of +12% yoy).

• M&M commences production of its heavy truck portfolio: Mahindra Navistar Automotives Ltd. commenced production of its 25 ton truck – MN25, from its new manufacturing plant at Chakan. The vehicle is priced at c.Rs.1.5m (ex-showroom Pune). The company will roll out its HCV product portfolio over the course of the year from this facility.

• M&M has commenced due diligence for the bankrupt Korean SUV maker – Ssangyong. The company is amongst one of the six companies that have been short listed for the same. The date for submitting bids has been set as July 20 by the bankruptcy court in Korea.

• Over the month, the stock price (+9% yoy) outperformed the broader BSE Sensex (+6% yoy). We re-iterate our OW stance on M&M – given that the company will benefit from a) expansion into newer product segments b) sustained growth in its traditional segments. Besides, the companies’ subsidiaries (c.30% of stock price) should benefit from a healthy economy, given their presence in high growth segments of the market.

To read the full report: MAHINDRA & MAHINDRA