Sunday, March 11, 2012

>Impact of the budget 2012 on bond yields

We think the budget will likely be marginally positive for bond yields. Our calculations show that the general government borrowing requirement in FY13 can be financed through growth in bank deposits, insurance, mutual, and pension funds. We assume that the government may allow a further US$5 bn of investment by foreign investors in government securities. We also assume that the RBI may do OMOs of the order of Rs300 bn (US$6.3 bn), less than a third of the OMOs in FY12. That said, current long-end bond yields are being artificially depressed due to the large OMOs at the long-end that the RBI has conducted, and would have been higher otherwise. Therefore, we think some fiscal consolidation, and monetary easing at the short end should lead to a steepening of the yield curve. We forecast 10-year bond yields to be in the 7.75%-8.00% range for FY13.

Risks to our expectations
The risks to our expectations of fiscal consolidation come from higher oil prices impacting fuel subsidies, higher phosphate and potash prices impacting fertilizer subsidies, and the economic slowdown persisting into the majority of FY13. Further, an early implementation of the Food Subsidy Bill could further expand the deficit.

The upside on fiscal consolidation comes from larger privatization receipts, including the reauctioning of 2G licenses, greater buoyancy in tax revenues, and a quick pass-through to consumers of higher oil prices—particularly in diesel and LPG. We assess the risks to our fiscal deficit and market borrowing targets for FY13 to be balanced at this stage.

Cross-country comparisons suggests that fiscal consolidation is an imperative
India’s general government fiscal deficit is one of the highest among growth markets. This is largely due to a low tax base, rather than too much spending. Hence, it is imperative that the government increase the tax-to-GDP ratio, and there are low-hanging fruits in increasing revenues. While we expect the FY13 budget to begin fiscal consolidation, we do not envisage the tough, structural reforms that are necessary to lead to a sustainable increase in the tax-to-GDP ratio. These would comprise broad-basing the tax regime, implementing the Goods and Services Tax, and improving tax administration to reduce the extent of the underground economy.

To read full report: BUDGET 2012

>India: Q3 GDP for FY2012 growth decelerates sharply reflecting increased weakness

 The Indian economy is on the brink of registering one of the slowest episodes of growth since the Lehman crisis struck in FY2009. Third quarter GDP for FY2012 witnessed a steep decline and printed 6.1% YoY

The Indian economy is on the brink of registering one of the slowest episodes of growth since the Lehman crisis struck in FY2009. Third quarter GDP for FY2012 witnessed a steep decline and printed 6.1% YoY. While a slowdown as compared to the previous quarter was expected but the quantum of the drop was unexpected.

The below than trend outturn in agriculture was surprising as the year has witnessed high grain procurement levels and crop output has also been robust. The sharp drop is primarily attributable to adverse base effect as last year’s Q3 number has been revised upward significantly. However, on the whole growth prospects remain a victim of a conjunction of domestic and external factors, which will continue to take a toll for some time before we see any substantial improvement towards the latter half of next fiscal.

Manufacturing has not yet ventured into negative territory but its growth has become stagnant and it clocked a marginal 0.4% YoY in Q3. This is the lowest print witnessed for this particular GDP series till date

Services growth is showing signs of slowing and posted 8.9% YoY for Q3.

This slowdown is on expected lines as most of the leading indicators such as cellular connections, cargo traffic, vehicle sales both commercial and passenger are showing a sharp decline in growth as compared to last year

There are strong interlinkages between growth in industry and services. However, it must be noted that in the event of a severe downturn, the services sector tends to be more resilient than industry as is evidenced by the fact that during the last crisis in FY2009 where overall growth declined to 6.8% YoY, industry slumped to 4.5% YoY but services more or less held its own with an average growth of 10% YoY. This is a heartening fact as the latter comprises the lion’s share of our GDP and is likely to cushion our bumpy ride ahead somewhat.

• In Q3 FY2012, mining decelerated by 3.1% YoY as compared to –2.9% YoY previously. The impact of the mining ban is being felt sharply now but is more a governance related problem, which is likely to be corrected by next fiscal.

• Manufacturing has not yet ventured into negative territory but its growth has become stagnant and it clocked a marginal 0.4% YoY in Q3. This is the lowest print witnessed for this particular GDP series till date.

• There is considerable slack in the industrial sector and capacity expansion plans have been broadly postponed in the face of growing input costs, higher borrowing rates and existing spare capacity. The global uncertainty has also exacerbated the bleak investor sentiment.

• Capacity utilization levels for most industries especially the core sectors are also quite low.

• Policy action is trying to address this situation but some time will elapse before it can transmit into the economy and bear fruit.

• On the other hand, the remaining components of industry, viz. construction and electricity have held up pretty well and continue to register encouraging growth. Electricity, gas & water supply grew by 9% YoY
whereas construction posted a sharp increase to 7.2% YoY as compared to 4.3% YoY previously.

Considerable slack continues to remain in the industrial sector
• Services growth is showing signs of slowing and posted 8.9% YoY for Q3 mostly on account of a dip in trade, hotels, transport and communications.

• This slowdown is on expected lines as most of the leading indicators such as cellular connections, cargo traffic, vehicle sales both commercial and passenger are showing a sharp decline in growth as compared to last year.

• Financing, insurance and real estate is also showing slightly lower than average growth due to a decline in credit growth numbers as economic activity has dipped over the past few quarters.

Expenditure breakup

The encouraging aspect of this classification is that private consumption is already showing signs of recovery despite the adverse impediments in the form of high inflation and elevated interest rates. Consumption notched 6.2% YoY in Q3 as against 2.9% YoY previously.

On the aggregate demand side, GDP clocked 6.3% YoY as against 6.7% YoY in the previous quarter.
• The encouraging aspect of this classification is that private consumption is already showing signs of recovery despite the adverse impediments in the form of high inflation and elevated interest rates. Consumption notched 6.2% YoY in Q3 as against 2.9% YoY previously.

• The interest rate sensitive sectors such as automobiles are showing signs of slowdown but the consumption basket primarily comprises of elements, which are inelastic in nature such as food, fuel and housing.

• The consumer non-durables sector in IIP is also reflecting this trend and has shown a sharp increase over the past few months.

• Gross fixed capital formation predictably remains moribund and registered –1.2% YoY as compared to –4% YoY in the previous quarter. These declines have been sharper than that witnessed during FY2009, presumably on account of the fact that there are additional domestic sector worries as well.

• On the external front, imports growth has gathered momentum and stands at 17.3% YoY as against 6.9% YoY previously. Exports growth has come down sharply to 13.1% YoY from the previous 23.3% YoY mostly due to the significant revisions in the export data over the past year.

GFCF performance over the year so far remains the weakest on record

India on the brink of a sharp slowdown

The Indian economy is staring at a significant growth moderation over this fiscal year and attainment of a close to 7% YoY growth looks to be a challenge unless the last quarter growth executes a strong rebound

The Indian economy is staring at a significant growth moderation over this fiscal year and attainment of a close to 7% YoY growth looks to be a challenge unless the last quarter growth executes a strong rebound. The investment cycle is also impaired for the time being and will take some time to pick up again.

We would expect industry growth to remain in the doldrums for a while and since services is interlinked, the trade, hotels component will also witness some slowdown. Commensurately slower credit growth will also weigh on growth. However, government spending continues to remain fairly stable and will moderate the slowdown but must also be treated circumspectly as it has also benefited from positive base effect.

On the global front, the Eurozone seems to have postponed their troubles for a while and the US does not seem to be in any imminent danger of a substantial growth slowdown. This will work slightly in our favour as far as our exports are concerned and will ensure that we do not take too much hit on the growth front going ahead. We would expect a slight improvement in our GDP numbers for the next fiscal.

On the policy front, we feel the RBI will reduce CRR by 50 bps at its next policy meeting before resorting to rate cuts.


>STRIDES ACROLAB: Sold its Ascent Pharma business to Watson

Q4CY11 results beat estimates, healthy performance despite lower contribution from sterile business
 Strides Arcolabs’ (STAR) topline grew 50% YoY to ` 6.98bn, led by higher than- expected revenue contribution from the pharma division at ` 4.08bn (up 63.8% YoY).

 Revenue from specialty business saw a slight moderation in growth during the quarter at ` 2.73bn (up 23.6% YoY) restrained by subdued performance in Brazil, where the company shifted its marketing strategy from distributor channels to its own front-ended model. Licensing income for the quarter stood at ` 1.7bn (Q4CY10: ` 973mn).

 Growth in pharma business was driven by higher-than-expected contribution from HIV segment and high growth in Indian brands. African business also witnessed stable growth amidst civil and political unrest.

 EBITDA margins stood lower by 310bps YoY at 15.6% due to higher other expenses (up 440bps YoY at 25.2% of sales) which included one-off loss of ` 310mn on Brazilian front-ended operations. Adjusted for that, EBITDA margins stood 20%.

 STAR recorded net MTM gain of ` 602mn (includes ` 800mn gain on restatement of assets in Ascent Pharma). PAT after minority interest and excluding extraordinary items grew 85.9% YoY to ` 102mn.

 The management has deferred its guidance for CY12E for the time being due to uncertainity over timely regulatory approvals and outcome of patent litigations. However, they indicated of high growth potential in sterile business, mainly aided by launch of 36 products this year and higher contribution from recently FDA approved Penem facility in Brazil.

Q4CY11 Result
 Revenue grew 50% YoY to ` 6.98bn, mainly driven by higher-than-expected revenue contribution from pharma business at ` 4.08bn (up 63.8% YoY). EBITDA margin for pharma business stood at 11%.

 Specialty business saw a slight moderation in growth at ` 2.73bn (up 23.6 YoY). EBITDA margins stood at 28%. Licensing income for the quarter grew 74.6% YoY to ` 1.7bn.

■ Consolidated EBITDA margins shrunk 310bps to 15.6%, deterred by higher other expenses at 25.2% of sales (up 440bps) which included one-time loss of `310mn on Brazilian operations. Raw material costs too increased to 47.6% of sales (up 90bps YoY) while employee costs declined to 11.6% of sales (down
220bps YoY).

■ During the quarter, interest cost grew 12.4% YoY to ` 507mn while depreciation increased by 70.2% YoY to ` 298mn. PBT excluding extraordinary items stood at ` 285mn (down 1.5% YoY).

■ Extraordinary items (EOI) for the quarter include MTM gain of ` 602mn on net foreign assets, of which ` 800mn was on restatement of assets in Ascent Pharma. The company also recorded loss on sale of investments of ` 20mn.

 PAT, after minority interest and excluding EOI, grew 85.9% YoY to ` 102mn.

Pharma division
■ The company sold its Ascent Pharma business to Watson for AUD 375mn. Ascent Pharma had recorded total sales of ` 8.3bn for CY11 along with an EBITDA of ` 1.05bn. The transaction has been completed as of 24th January 2012. The company will receive USD 265mn from the sale (post tax and after AUD 50mn of debt repayment relating to Ascent). The rest of the proceeds will be utilized towards debt reduction - includes FCCB redemption of USD 116mn (including premium).
 The company’s flagship brand Renerve generates sales of ` 340mn and grew 45% YoY.

 Gross debt position as of Feb-12 stands at ` 22.5bn (Dec-11: ` 25.6bn; Dec-10: ` 20.1bn). Net-debt/equity ratio pulled down to 0.7x as of Feb-12.
 Cash in books stands at ` 10.5bn as of Feb-12 (Dec-11: ` 2.6bn; Dec-10: `3.4bn).
 The company clarified that gross block (incl. WIP) of ` 13bn, as of Dec-11, includes only ` 200mn pertaining to Ascent Pharma. This figure will increase by ` 1bn – 1.5bn as additional capex is incurred.
 Goodwill on books stands at ` 19bn as of Dec-11 and will be reduced by ` 3bn – 4bn after the Ascent Pharma sale.
 Capex guidance for CY12E stands at USD 15mn.
 The management has deferred its guidance for CY12E for the time being due to uncertainity over timely regulatory approvals and outcome of patent litigations.

STAR stands to benefit from the current drug shortages in the US as global players like Hospira experience manufacturing compliance issues. FDA approval to its Bangalore sterile and oncology facilities allows it to move the approved products (25 of them in CY12E) towards commercialisation.

We expect 17% earnings growth over CY11-13E. Increased contribution from sterile segment, turnaround in front-ended Brazilian operations will lead to margin expansion. The divestment of Ascent Pharma business has strengthened its Balance Sheet (Net Debt/Equity - 0.7x) while also its capex cycle is nearing an end. This shall result in higher return ratios going forward. At CMP of ` 533, the stock trades at 11.8xCY12E and 10.1xCY13E earnings. We recommend Accumulate on the stock with a revised target price of ` 583 (11x CY13E earnings).

>SOBHA DEVELOPERS: High visibility, improved cashflow to drive valuations; CL Buy

What's changed
In 4Q, Sobha has launched two projects in Chennai and is on track to launch another residential project in Bangalore. With these, Sobha will have launched 11 mn sqft of residential projects in the last 6 quarters and is in the process of launching 8 mn sqft in FY13. These projects provide sales visibility of Rs78 bn or 16 quarters worth based on the recent quarterly run rate. We expect Sobha to pre-sell residential real estate of Rs16.5-17 bn in FY12 compared to Rs11.2 bn in FY11. This growth of more than 45% yoy is in contrast to the declines seen at most developers in FY12 ytd. We expect this large operational outperformance to be reflected in stock performance as well.

We see a significant jump in operating cashflow in FY13 on increased customer payments and stable/declining interest payments. Based on recent quarterly results, Sobha offers attractive cashflow yield of 12%. We expect operating cashflow to further increase to Rs3.7 bn in FY13 (operating cashflow yield of 14%), as (1) pre-sales momentum remains robust; (2) interest payments will decrease on lower debt level and interest cost, and (3) a large number of launches are planned. Key stock price catalysts include continued improvement in growth visibility as well as cash flow. In addition, our view of affordability and current property pricing levels in Bangalore is constructive.

We reiterate our Buy rating (on CL).Our 12-m NAV based TP of Rs353 is unchanged. Sobha is trading at a 37% discount to our Mar-13 RNAV of Rs392. Ongoing and forthcoming projects provide post-tax cashflow visibility of Rs32 bn against current EV of Rs37 bn.

Key risks
Key risks are lower-than-expected volumes sold and slower execution.

>GODAWARI POWER & ISPAT LIMITED: Pellet paving the way for a prosperous future

A backward integrated business comprising captive iron ore mines and a flexible sales product mix of steel, pellets and power make Godawari Power & Ispat Ltd, GPIL, an interesting investment bet in the midcap steel space. Ramp up in captive iron ore mining and pellet production together with increased steel product sales is likely to result in impressive net sales and EBITDA CAGR of ~23% and ~15% respectively over FY11-14E. We initiate coverage on the stock with a Buy rating and target price of Rs157.

 Flexible business model with rich product portfolio: GPIL has created a strong niche for itself in the midcap steel space through its rich product portfolio forward integrated into HB Wire and backed by backward integration from iron ore and pellets. The product mix of GPIL remains flexible to derive
maximum profitability.

 Pellet making to double in two years, drive earnings: GPIL is doubling its pellet making capacity to 2.4 mtpa by FY14E through the set up of a new pellet plant of 1.2 mtpa at Chhattisgarh at a capex of Rs3.8bn. Pellets result in cost saving on iron ore feed for sponge iron unit and enjoy EBITDA margin of ~40% on spot merchant sales when captive fines are used. We see merchant pellet sales growing at a CAGR of 21% during FY12-14E and account for ~65% of overall pellet production by FY14E thus driving the earnings
of GPIL.

 Captive iron ore back on track: GPIL’s Ari Dongri iron ore mine of 0.6 mtpa results in crucial cost savings for pellet and sponge iron making and is back on track after facing problems on mining and logistics in H1FY12E. We see 80% capacity utilization in iron ore mining for GPIL in FY13-14E.

 Power provides hedge to steel business volatility: GPIL’s 53 MW power portfolio provides a natural hedge for steel business volatility and we expect the company to continue selling a mix of steel and merchant power to maximize returns.

 Solar power foray remains an unrelated diversification: We remain concerned on GPIL’s foray into solar power generation (50 MW capacity at a capex of ~Rs8bn with 70:30 debt: equity) and view it as an unrelated diversification. GPIL has thus far invested Rs1210mn as equity into the project and the project is expected to commission by May’2013. We have not factored the same in our earnings and valuation as
of now and await more clarity on the same.

 Valuations – attractive, Buy: The stock trades at Rs100, which discounts its FY13E EPS and EV/EBITDA by 3.2x and 4.1x. We see earnings growth ahead driven by pellet volumes and value the stock at 4x FY14E EV/EBITDA to arrive at a fair value of Rs157. We don’t factor in any value for the solar power investment by the company as of now. We initiate coverage on GPIL with a Buy rating and target price of Rs 157.

 Key Risks: Lower sales volumes, drop in steel and pellet prices, hike in royalty on iron ore and lower returns from investment into solar power.