Wednesday, February 8, 2012

>INDIA EQUITY STRATEGY: India’s Swings: China and the Euro-zone, or Back Home; Look at Home, rather than at China or the euro-zone?

■ India has bounced back quite spectacularly in 2012— The bounce across equity (+15%), FX (+9%) and rates (- 38 bps) markets has caught the investing community by surprise. But where is this coming from? A low base (2011 was terrible), a more decisive turn on lower interest rate expectations or, critically (and a key driver of EM buoyancy (+9.3%)), easing of concerns on a euro zone/China slowdown. It’s probably a combination, but should India really be swinging so wildly to the euro-zone/China’s tune?

 The euro-zone/China matter, but less for India than for EMs — Relative to EMs, India’s a) trade exposure to euro/China is low (it’s a net importer), b) India accounts for only about 4% of EU bank exposure to EMs (euro banks’ deleveraging an overstated risk), c) FX reserves cover relative to off-shore debt is reasonable, and d) doesn’t really participate in China’s growth (vulnerability to a China slowdown is low). This does not make India immune to euro-zone/China troubles, but it is more so than EMs as a group, and distinctly more than the markets seem to suggest (underperforming (-18%) / outperforming (12%) EMs with rising/falling euro-zone/China concerns).

 Look at Home, rather than at China or the euro-zone? — India’s challenges, and potential upsides, lie at home; fiscal profligacy, high inflation, lack of policy/reform and execution challenges. The past years’ global economic challenges were an opportunity for India to break out of its near-EM straight jacketing, but it blew them away on global/euro-zone/China excuses. It needs foreign capital/markets, but we see India’s economic/market trajectory lying in fixing domestic issues rather than global gazing.

 Remain positive: though increasingly the market will likely wait for the economy to catch up — We remain positive on the market: we maintain our 18,400 Dec 12 Sensex target and a Financials-heavy model portfolio. But we do believe it will be a tough grind from here, as the market waits for the economy to signal the recovery that equities have now partly factored in. Our preferred picks: Axis Bank, Adani Ports & SEZ, Maruti, SBI, Dr. Reddy, United Spirits, Havells and M&M Financial Services.

To read the full report: EQUITY STRATEGY

>CUMMINS INC: Buoyant demand boosts performance

Cummins Inc’s Q4CY11 revenue jumped 19% YoY driven by higher demand in truck, construction, power generation and oil & gas markets in North America. Strong growth is witnessed in the global mining markets. Margin surged 130bps to 14.1% on back of strong performance in energy segment. PAT grew a sharp 47% YoY due to robust operating performance. Based on the current forecast, Cummins Inc anticipates revenue to jump ~10% in 2012, with EBIT in the 14.5‐15.0% of sales range.

Strong revenue growth, margins improve
Cummins Inc posted strong revenue growth of 19% YoY in Q4CY11 driven by higher demand in truck, construction, power generation and oil & gas markets in North America. It also registered strong growth in global mining markets. All the segments viz., engine components distribution clocked ~20% revenue growth, barring power generation which posted muted revenue growth. The company stated that demand was weak in China’s construction market and India’s power generation market during the quarter. Margin surged 130bps to 14.1% due to strong performance of its energy segment (EBIT margin up 170bps YoY). However, power generation & distribution segment recorded a margin decline. Operating cash flows improved due to better working capital management and higher operating margin. PAT grew a sharp 47% YoY on back of strong operating performance.

Key takeaways for Cummins India
(1) Volumes in power generation business in the December quarter were subdued, which is likely to impact Cummins India’s revenue growth. However, volumes are expected to pick up incrementally owing to an overall pick up in infra spending. (2) For CY12, Cummins India’s power generation business is likely to grow at ~10% YoY driven by strong government spending on infrastructure, especially roads.

>Mothballing, capacity delays to lead refinery recovery and upcycle over medium term; Asian refiners key beneficiaries of higher cracks

Closures, project delays, demand outlook to drive upcycle in ’12-13E

While the market focuses on weak 4QCY11 results of refiners, we believe the global refining cycle is now heading for recovery and upcycle during 2012E-13E driven by 1) major mothballing of refineries in US/ Europe, 2) delays in new projects, 3) oil demand recovery from 2H12E. We also note there is only limited capacity addition after 2Q12E. Overall, global utilisation has moved up for all years: 2012E-14E. We believe the Asian refiners would be key beneficiaries of rising cracks while US/Europe refiners are plays on WTI-LLS and light-heavy oil spreads.

■ Supply side reaction to weak margins has picked up in US/Europe
We have witnessed announcements of mothballing of about 1.2 mb/d of refining capacity since Sep ‘11, of which 1.1 mb/d will take place until July 2012. In addition to this, we believe about 2.4 mn b/d of refining capacity in the western hemisphere remains under strategic review. This represents about two years of normalised oil demand growth globally.

 Delay in new projects to support refining cycle over medium term
Moreover, we believe delays in new projects have become a central theme in the refining sector driven by delays in logistics, delays in acquiring land, obtaining clearances/permits and some tightness in engineering chain. We find more than half of the 1.5 mb/d likely delays for 2012E are in Asia.

■ Raise Singapore cracks for 2H12E-2013E, normalised 2014E margin
in line with oil forecasts; upgrade Asia refining stance to Attractive We raise our Singapore cracks forecasts for 2012E-13E by 20% and upgrade our refining sector stance to Attractive from Neutral. China will continue to have tight distillate supply over the medium term, in our view.

■ S-Oil, Thai Oil, RIL and Western are our favorite refiners
In Asia we upgrade S-Oil to Buy (CL), Thai Oil, RIL and GS Holdings to Buy, Caltex to Neutral; in US, Western Refining (CL), HollyFrontier, and CVR Energy remain our Buy-rated favorites. In Europe, we prefer the oil producers within the refining/integrated sector: RD Shell and BG (both CL Buy). Key risks: 1)Demand slowdown from weak macro, 2) oil price spike from low spare capacity in 2013E, 3) supply crunch from Iran tension escalation.

To read the full report: Global: Energy: Oil - Refining

>FIRSTSOURCE: Strong deal closures improve FY13 visibility

 Retain Buy on attractive valuation, new PO Rs15
Firstsource saw impressive deal closures during Q3 that increase visibility into FY13 revenue growth. Additionally, we expect company’s EBIT margins to increase nearly 230bps in FY13 on benefits from improved efficiency in execution and operating leverage from revenue growth. We lower adj. FY13/14 EPS by 7% baking in higher transition costs related to deal wins and increased interest outgo. Retain Buy with new Rs15 PO (target 6.5xFY13 adj. EPS) on attractive valuation. Improved op margin, successful refinancing could be next stock triggers.

■ Q3 operating profit ahead of expectation
Revs grew ~1%qoq, 5% ahead of our est with seasonal softness in collections more than offset by ramps in recent deal wins. EBIT was 6% ahead of est led by rev beat but declined 15%qoq on increased transition costs. A1-x loss of Rs71m related to FCCB buy-back led to 68%qoq decline in reported PAT.

■ Impressive pipeline conversion, led by telecom
Company announced 3 deal closures in the telecom segment, worth US$160m & should help post 10% rev growth in FY13 (constant currency terms). We also factor ~150bps op margin improvement from its ongoing restructuring efforts. Collections (10% of rev) remain chief drag on op performance with decline seen in collectible volumes. Forecast FY13 EBIT to grow 94%yoy from low-base of FY12.

■ Cash shortfall of ~US$65-70m appears manageable
Towards ~US$237m of FCCB redemption in Dec 2012, company has a cash chest of ~US$130m and is likely to generate another US$35-40m from normalizing of receivables and free cash from operations. Financing the shortfall of ~US$65-70m appears manageable with Net Debt / EBITDA estimated at ~4x.

To read the full report: FIRSTSOURCE

>SPEICEJET LIMITED: Lacks earnings and asset support

■ 3Q12 results as expected at the operational level: SpiceJet reported a net loss of INR393m in 3Q12 (October-December 2011) vs. a profit of INR944m in 3Q11, 21% below our forecast loss of INR498m and significantly below consensus of INR1.1bn. On a y-o-y basis, the significantly weaker performance was caused by a 7ppt decline in the load factor and a 28% increase in unit costs, only partially offset by a 16% rise in unit revenue. The result was in line with our forecast at the EBIT level. However, a rise in other income above our forecast and slightly lower-than-expected net interest costs helped to narrow losses for SpiceJet and rendered losses 21% below our forecast at the reported level.

■ Lacks earnings and asset support: The better-than-expected yield performance drives the slight increase in our revenue and EBITDAR forecasts, but we increase our FY12-13 net loss forecasts for SpiceJet mainly to account of higher depreciation, lease and staff costs. Further, SpiceJet’s fleet is largely leased, so it does not have any assets to support its rapidly eroding book value.

■ Reiterate UW(V), maintain target at INR15: We continue to value SpiceJet on its average one-year forward EV/EBITDAR multiple of 9x (the average that it traded at in September 2008-March 2010). Applying this to our new estimates gives us an unchanged target price of INR15 (rounded). The slight increases in our EBIDTAR forecasts are offset by increased net debt level forecasts (including capitalised leases). We maintain our UW(V) rating on the stock.

■ Upside risks: Policy risk is key. The proposal to allow foreign airlines to own up to a 49% stake in Indian airlines was agreed upon by key ministers in January 2012 and is now waiting for cabinet approval. If and when this approval is granted, we believe it will likely be a potential positive catalyst for the stock. The other upside risks are a fall in fuel prices, appreciation of the INR versus the USD, and pricing and capacity discipline in the market.

To read the full report: SPICEJET

>CONTAINER CORP OF INDIA: Trade imbalance leads to decline in Exim profitability

Container Corporation of India’s (Concor) Q3FY12 result was marginally better than our expectations with standalone net profit at Rs2,414mn vs. our estimate of Rs2,306mn (variance of 4.6%). Operating profit at Rs2,774mn (down 1.1% YoY), and operating margin at 26.5% were in-line with our estimates at Rs2,713mn and 26.8% respectively. The domestic segment continued to underperform with volumes declining 17.4% YoY and EBIT plunging 10.3% YoY to Rs215mn in Q3. For the 9mFY12 domestic volumes fell by 15% led by IR policy related changes. The Exim segment’ EBIT declined 3.1% to Rs2,273mn despite volumes increasing 7.3% YoY mainly led by an increase in empty running costs. We have marginally tweaked our estimate to factor in slower domestic volume growth, higher other income and provision tax. We maintain Hold rating and target price of Rs1,015.

 Operational performance in-line with expectations: Concor’s Q3 standalone revenue increased 7.7% YoY to Rs10,462mn, 3.4% above our estimate. Operating profit at Rs2,774mn (down 1.1% YoY) was 2.3% above estimate, while operating margin at 26.5% was just 28bp higher than expectations.

 Volume growth continued to remain slower: While Exim volumes grew 7.3% YoY to 555,399 containers, the domestic segment continued with its poor performance with volumes declining 17.4% YoY to 120,108 containers.

 Higher realisations help increase revenues…: Concor’s combined volume grew just 1.9% YoY to 675,507 containers, while blended realisations increased 5.7% YoY to Rs15,488 per container. Average realisations increased 12.6% YoY to Rs16,227 per container in the domestic segment while it grew 4.1% YoY to Rs15,329 per container in the Exim segment.

 … but increase in empty running leads to decline in EBIT margins: Trade imbalance and change in port cargo mix (Export-import) led to a 64% YoY increase in empty flat running cost to Rs360mn (90% of this was in the Exim segment). This led to higher rail freight expenses and decline in profitability margins. Exim segment’s PBIT margins declined 411bp YoY to 26.7%, while it declined just 41bp YoY in the domestic segment to 11.0%. The average lead distance in the Exim segment declined ~30km YoY to 1,037kms while it was flat in domestic segment at 1,430kms.

 Maintain Hold with a TP of Rs1,015: At the CMP, the stock trades at 13.0x FY13E earnings and 7.9x FY13E EV/EBITDA and appears fully-valued. Given the lower profitability growth expected (6% CAGR over FY11-14E) and decline in RoE to 16.1% in FY14 from 18.9% in FY11, we continue to remain neutral on the stock. We maintain our Hold rating and target price of Rs1,015, valuing the stock at 14x FY13 earnings.