Monday, January 16, 2012

>STRATEGY: Avendus advise cuts in allocations to Two‐wheelers and Consumer, and increases in Commercial vehicles, Passenger vehicles, Cement, Pharmaceuticals, Telecom, Metals and IT Services

Amidst the pervasive gloom, a few signs are pointing to better times returning sooner rather than later. The rapid fall of the Nifty PEG has brought it to within 10% of the band where it stabilized in 2009, before the next rally began. A ‘time‐correction’ could pull down the PEG to
0.7x in 1Q2012. The yield‐gap is down to near its three‐year mean. In the real economy, two lead indicators – Electricity generation and LCVs – are pointing to a rebound in Manufacturing. The missing element – lower interest rates – may be back soon, as seen in the recent fall in
bond yields. Shifts in earnings momentum suggest that sectors with strong links to the recovery are more likely to outperform in 2012. We advise cuts in allocations to Two‐wheelers and Consumer, and increases in Commercial vehicles, Passenger vehicles, Cement, Pharmaceuticals, Telecom, Metals and IT Services.

Steep fall in valuation; Nifty within 10%, three months of stable level
After falling from 2.0x to 0.8x in nine months, the Nifty PEG is within 10% of the range where the Nifty stabilized in 2009, before the next rally began. If prices and FY13 earnings forecasts stay at end‐Dec11 levels, the ‘time‐correction’ could push down the PEG to that range within three months. The yield‐gap to the 1‐year government bond too has fallen close to its three‐year mean, partly due to the fall in the Nifty, but more due to the large fall in the bond yield itself.

Latent signs suggest manufacturing recovery may be impending
Previous cycles saw the Electricity segment of the IIP rebound about six months before Manufacturing. A strong rebound in Electricity has now been under way for 14 months. Another similar lead indicator has been growth in sales of LCVs. Despite the leading indicators being flashed, the rebound in Manufacturing has not commenced. We believe the missing element in this cycle, that was active in the previous economic cycle, is a low interest rate regime. The fall in food inflation in Dec11 is significant as the food segment contributed over half the rise in wholesale inflation during 2011. The fall in the one‐year government bond yield has been a strong indicator of the fall in the Repo.

Tilt away from defensives may have begun
Late 2011 saw sectoral performances begin to shift from previous trends. There is a tilt away from ‘defensive’ sectors and towards stocks with stronger linkages to the next rebound. These changes are linked to the shifts in earnings momentum and have signaled the revival of ‘normal’ sectors such as Cement and Commercial vehicles. For 2012, we advise cuts in allocations to Twowheelers and Consumer and increases in Commercial vehicles, Passenger vehicles, Cement, Pharmaceuticals, Telecom, Metals and IT Services. Our top 10 stocks for 2012 are Bharti Airtel (BHARTI IN, Buy), Hindalco Industries (HNDL IN, Buy), HCL Technologies (HCLT IN, Buy), ICICI Bank (ICICIBC IN, Buy), Larsen and Toubro (LT IN, Hold), LIC Housing Finance (LICHF IN, NR), Maruti Suzuki (MSIL IN, NR), State Bank of India (SBIN IN, Buy), Sun Pharmaceuticals (SUNP IN, Add) and UltraTech Cement (UTCEM IN, Add).

To read the full report: STRATEGY

>ITC: Gold Flake Kings sets the direction of potential price increases in the near term

What’s new: ITC ended last year with a 70 paisa per stick price hike on Gold Flake (GF)
Kings cigarettes (c10% of overall volume). This move will add c1.5% additional EPS for fullyear FY12, with overall volume remaining unchanged. The hike was not surprising as ITC
continues to shape the price of its overall cigarette portfolio to manage the positioning and
price points of its various brands and prepare for punitive taxation the sector is subjected to.
What should we read from this price hike?

What to expect: This price hike in our view creates the cushion and sets the direction of price
increases in the near term. With this change, ITC Classic (INR5.50 per stick), which has a
relatively premium positioning, is the same price as GF Kings. In our view, Classic’s price can
be tweaked upward, should the situation require ITC to do so. Classic and GF Kings are part of the volume mix (c20% of total volume) that is relatively price inelastic and we observe that
consumers of these cigarettes have ‘sticky’ preferences; hence we see limited volume risk.
Nearly three-quarters of ITC’s cigarette volume comes from the lower priced regular segment
(e.g., GF Regular, Navy Cut) and the direction of price increases in this segment will be
relatively more cautious.

Earnings and taxation: Future tax increases on the cigarette business are a common concern. We model c12% excise hike affecting FY13, and in our assessment this single price hike in GF Kings and an additional increase of 50 paisa per stick of ITC Classic can nearly offset the impact of this excise duty hike assumption. We estimate there will still be room for 5-7% hikes across 75% of cigarette volume. We increase our earnings estimate by 1.5% for FY12 to reflect this price hike, but keep FY13-14 earnings almost unchanged as ITC on balance should increase prices selectively and just enough to negate the impact of additional taxation. 

Valuation and risks: With risk aversion on the rise, we see ITC at 22x FY13x PE as
attractively valued. Its defensive business and FY11-15e earnings CAGR of 16% will likely
help it outperform the peer group on the next one-year perspective. We maintain our SOTPbased target price of INR242 and reiterate our Overweight rating. Key downside risks are slower than anticipated progress or loss of market share in growing categories in other FMCG and ITC’s stock price’s sensitivity to excessive taxation shocks.

To read the full report: ITC

>SLOWDOWN IN CHINA: Major driving forces of the Chinese economy are investment, consumption, imports and exports

China, the manufacturing giant of Asia is expected to witness a slowdown in its growth trajectory. Its growth may lose momentum due to the lack of demand from the developed nations. It can partly be blamed on Euro zone’s deteriorating fundamentals. China, the fastest growing economy moderated to its lowest pace in more than two years. China has always been the main source of optimism in the global economy and signs of a slowdown in China, coupled with trouble in Europe, show that industrial commodities are in for a bumpy

The demand for Chinese goods is continuously worsening due to the economic woes in Europe. Exports rose at the slowest pace in almost two years in October as worsening situation in Europe crumbled demand. The weakness in export demand is expected to continue in the near future due to the economic slowdown across the globe.

The Chinese economy is expected to register a second year of below-trend growth because of the headwinds from the global slowdown, domestic housing market weakness and limited room for policy stimulus.

A pause in the growth of China:
The Gross Domestic Product (GDP) of China started decelerating in early 2010 from 11.9% to 9.1% for the latest quarter. The GDP growth rate of the third quarter of 2011 decreased to 9.1% compared to 9.7% and 9.5% growth rates recorded in the first and second quarters, respectively. China's economic growth rate has declined for three successive quarters and further it is expected to be around 8.7% for the final quarter.

The four major driving forces of the Chinese economy are investment, consumption, imports and exports. Let us look at the constituents of the GDP:-

  • Industry sector contributes 47% to the total GDP (inclusive of Investment, Real Estate, Manufacturing, Mining etc)
  • Services sector contributes to 43% of the total GDP, and
  • Agriculture’s contribution to the GDP is 10%
This indicates that China’s economy is heavily relying on the industrial activity and any slowdown in industrial activity will be a pain for the entire economy. China, as an export-oriented economy is dependent on the developed nations (EU, US, UK and Japan). So, if these economies are witnessing a slower growth, then the dependent economies are more likely to face a ripple effect. The global GDP growth has been revised lower to 1-1.5% from 2.5%, this gives a clear indication that all the major contributors to world GDP will face a slowdown. In 2007, the last year before the international financial crisis, China accounted for
only 6.3% of the world GDP. In the following three years the world economy expanded by $7.2 trillion, while China’s economy grew by $2.4 trillion, which means China accounted for 33% of world growth.

To read the full report: SLOWDOWN IN CHINA

>RURAL BUSINESSES: Growth Drivers & Key Challenges

Rural India accounts for nearly 70% (approximately 720 mn) of the total population and plays a critical role in the country's economic development. Apart from being a large consumer market, the availability of cheap labour and low-cost land are key drivers for businesses to penetrate rural areas. In addition, the government's focus on inclusive growth (National Common Minimum Programme), and massive infrastructure development programmes is expected to bridge the rural-urban divide. What was once a fully agrarian market is now evolving into a major consumption market—the Monthly Per Capita Expenditure (MPCE) in rural areas is 1 estimated at INR695, nearly half of urban India's MPCE .

Growth Drivers

• Rising per capita income in rural India:
Almost of half of the rural GDP comprises agriculture relative to less than 20% of national output for overall India. Factors such as higher food prices, increase in agriculture income and a shift from farm to non-farm based employment are expanding the average income levels for rural India (growing at 12% per 2 annum) . Thus, companies, across sectors such as financial services, FMCG, telecom and others, aim to tap the rural market in India.

• Empowerment of rural India through various employment generation schemes:
The NREG Act 2005, which guarantees every rural household up to 100 days of wage employment in a year, has been highly successful in ensuring improved quality of life and enhanced income for rural households. As per estimates, on an average, daily wages have increased INR20–30 per person due to this scheme. This translates into INR 342bn (approximately USD 7.5bn) per annum of additional wages. Other schemes for employment include Sampoorna Grameen Rozgar Yojna, National Food for Work Programme and Swarna Jayanti Gram Swarozgar Yojna.

• Infrastructure development programmes:
The government has initiated a series of rural infrastructure development programmes under the Bharat Nirman project. Under this project, the government would undertake infrastructure building in the areas of irrigation, rural housing, rural water supply, rural electrification and rural telecommunication connectivity. Other prgrammes such as the Rajiv Gandhi Grameen Vidhyutikaran Yojana (RGGVY) and Pradan Mantri Gram Sadak Yogana (PMGSY) have provided a significant boost to rural India.

• Increasing farm credit a boost to rural India:
Through the government's focussed initiative of improving farm credit, rural India is benefiting from access to finance for various agriculture needs. The credit off take from the farm sector increased to USD 59bn in 2008–09 from USD 56bn the previous year. On an average, about 48.6% of total households in India have access to finance through a mix of informal and institutional arrangements. Although households with large land availability tend to receive institutional sources of funds, those with small land (less than one hectare) are mostly dependent on informal sources of funds.

Key challenges

• Weak socio-economic status:
Though India has been successful in reducing poverty levels; the country's population below the poverty line is more than 300 mn (or around 25% of the total population). Rural India accounts for 73% of the poor population in the country. Furthermore, rural areas lack proper healthcare facilities and socioeconomic parameters are weak with relatively high infant mortality rate, poor nutrition levels and low literacy rates.

• Rural development is mostly undertaken through government funds; as a result the execution of several projects under development is delayed. Consequently, significant resources allocated for rural development are under utilised and also lead to cost overruns.

To read the full report: RURAL BUSINESSES


Outlook bleak; low profitability to continue
Indian shipping companies are reeling under the global supply glut which has kept the day rates under pressure. The net profit for Great Eastern Shipping (GE Shipping) is expected to be down 10.3% YoY to Rs1.1bn. Shipping Corp of India (SCI) is likely to be hit the hardest due to its presence in the container liner segment. It is likely to be impacted by higher bunker cost, lower freight rates and higher depreciation and interest costs. It is expected to report losses of Rs149mn at net level vs. a net profit of Rs1,231mn last year. These companies are diversifying
their operations into offshore support and drilling services to ride the downturn in the shipping cycle.

■ Bunker costs remains high; up 39% YoY; container and spot charter segment to remain impacted: Price of bunker oil (fuel for shipping vessels) continued to remain at record levels of $675 per barrel during Q3FY12 vs. $485/bbl last year. We believe this would impact shipping companies and lead to increase in cost of operation. SCI, which is present in the container liner segment, would be most impacted. Its bunker costs increased 125% in Q2FY12, is likely to go up by 63% in Q3 to Rs3.4bn leading to a 827bp decline in operating margins to 9.9%.

 Offshore oil services (drilling) industry too remains under pressure: The offshore drilling industry continued to remain under pressure during Q3FY12. According to the global overall rig utilisation rate remained low at 77.6%, although it improved from 76.5% last year. Offshore rig day rates remained stable, while jack-up market continued to face pricing pressures. Utilisation of jack-up was at 77% vs. 75% recorded last year. Demand for deepwater rigs was strong globally, as fleet utilisation for Semi-subs remained above 80%.

 Top Pick: GE Shipping (Buy with TP of Rs331): We believe GE Shipping is better placed compared to peers due to its diversified presence in the offshore segment and strong under-leveraged balance sheet which is likely to help it take advantage of the current downturn and increase fleet at lower costs. Further, it is expanding only in the offshore segment giving its better visibility and higher profitability

 Neutral on SCI, Sell on Aban: We have a neutral stance on SCI with a target of Rs60. We maintain Sell on Aban Offshore as concerns persist with two of its assets remaining idle and others coming for re-negotiations at the bottom of the day-rate cycle, over-leveraged balance sheet and high exposure in Iran.

Great Eastern Shipping (Buy; Target Price: Rs311)

  • Q3FY12 consolidated revenue is likely to increase 26.8% YoY and 3.9% QoQ to Rs7,049mn, driven by an increase in fleet size and improvement in dry bulk freight rates. Operating profit is expected to grow 30.8% YoY to Rs2,661mn on the back of improvement in offshore profitability.
  • EBITDA margin is likely to improve YoY (up 115bp) but decline QoQ (down 196bp) to 37.8% as higher operating costs continue to put pressure on shipping business’ profitability.
  • However, adjusted net profit expected at Rs1,054mn will be down 10.3% YoY, mainly on account of no profit from sale of ships this quarter.
  • During the quarter, the company sold one GP (general purpose) product carrier (29,100 dwt) and another MR (medium range) product carrier (45,600 dwt).

 Shipping Corp. of India (Hold; Target Price: Rs60)

  •  We expect SCI’s Q3FY12 revenues to increase 13.8% YoY but remain flat QoQ to Rs10,113mn, led by improvement in the liner business and higher freight rates in the dry bulk segment.
  • Operating profit is expected to decline 38.1% YoY and remain flat QoQ to Rs998mn, with operating margin likely to contract 827bp YoY to 9.9% in Q3FY12 vs. 18.1% in Q3FY11.
  • We expect SCI to report losses at net level of Rs149mn from profit of Rs1,231mn in Q2 and losses of Rs1,406mn in Q1FY12. Apart from lower profit from sale of ships, higher interest cost and depreciation will impact this quarter vs. last year. Net margin will in effect contract to 1.5% vs. 13.8% last year.
  • During the quarter, SCI bought two new built supramax bulk carries (57,200 DWT). The company also took delivery of two new built AHTSV (anchor handling tug-cum-supply vessel) of 80 ton and 120 ton bollard pull capacity each.
  • The company also scrapped a chemical tanker ‘m.t. Tirumalai’ (21,035 DWT) and seven Handymax Bulk Carriers of 47,300 DWT each.

Aban Offshore (Sell; Target Price: Rs350)

  • Aban Offshore’s consolidated revenue is expected to remain flat YoY at Rs7,888mn, as rigs continue to remain idle and day rates are lower for new contracts. The current market rates for jack-ups have dropped significantly since the peak in 2008 on the back of lower rig utilisation globally.
  • Operating profit is expected to decline 10.5% YoY to Rs4,625mn, while operating margin is likely to contract 777bp YoY to 58.6% on the back of higher operating and other expenses.
  • Adjusted PAT is likely to decline only 4.9% YoY to Rs718mn, as JV related losses had depressed earnings last year. Adjusted net profit margin in effect is likely to contract only 61bp YoY to 9.1% vs. 9.7% last year and 10.4% in Q2FY12.
  • During Q3, Aban got an extension for the new jack-up Rig ‘Deep Driller 1’ from its operator for a period of 1 year. The contract now ends in Q3FY13 with additional revenues of US$39.2mn (~US$107,500/day).
  • Aban also received an order from ONGC for the deployment of jack-up rig Aban II for a period of 3 years for a total consideration of US$57mn (~$52,500 per day). The contract is expected to commence in Q4FY12.
  • With this, Aban currently has only two rigs (Aban V and VII) idle and ready stacked for operations.


>RANBAXY: Ranbaxy’s generic Lipitor market share rose to 32.5%; gained share from Watson; Dr Reddy’s plans generic Lipitor launch (HSBC)

Ranbaxy’s Lipitor and Caduet total prescription shares grow close to one-third.
Recent data show that Ranbaxy’s generic Lipitor market share rose to 32.5% of total prescriptions in the week ending 23 December 2011 – the third week since the launch of Lipitor generics. Ranbaxy gained share from Watson, which is now in third place with a 29.6% share. Pfizer’s Lipitor maintains a 40% share. Watson still leads in new prescriptions, with a 35.6% share versus 25.5% for Ranbaxy. Ranbaxy’s market share in Caduet has increased to 31% versus 33.6% for Mylan and 35.4% for Pfizer.

Generic market share likely to settle at 62%.
The combined market share for generics (Ranbaxy and Watson) for the week ending 23 December 2011 is at 62.1% versus 62.2% for the week after and 59.2% for the week before. Pfizer has been able to protect the market share of its branded Lipitor through strategic tie-ups and by offering higher rebates.

Generic Lipitor likely to take market share from Simvastatin.
Observing trends in the entire statin market over the past year, we note that the recent entry of generic atorvastatin has taken share from Simvastatin (i.e., the generic version of Zocor). The combined Zocor  and Simvastatin share has fallen from a peak of 49.6% in May 2011 to 43.9% in December 2011. Lipitor + atorvastatin market share stands at 23.4%, slightly off the peak of c24% in the full immediate week after the launch of generic variants. Crestor has been stable with a 12.7% share of total prescriptions for most parts of the year.

Dr Reddy’s plans generic Lipitor launch. 
As per its settlement with Pfizer, Dr Reddy’s Labs (OW, TP INR1,950) is slated to enter the market in June 2012, along with Teva and Mylan. We expect over 90% price erosion with the entry of three more players. We expect the product to generate cUSD50m sales for Dr Reddy’s. Teva has tentative approval.

Maintain Neutral. 
We value Ranbaxy at 20x FY13 EPS of INR20 (a 10% premium to the five-year sector average), adding INR53 for para-IV opportunities. We maintain our Neutral rating, given the lack of a clear path to recover the base business after the consent decree. Upside risk includes earlier-than-expected base business recovery and better-than expected margins. Higher price erosion in generic Lipitor and a slower domestic recovery are downside risks.