>KOTAK MAHINDRA BANK LIMITED: Kotak Prime should grow in line with the car industry

Good story, but in the price; initiate at 2-EW


Kotak is a portfolio of well-run businesses, which, though small, have sustainable positions in their segments and are positioned for continued growth. The core banking business should continue to grow through network expansion while its car finance business, Kotak Prime (KP), should grow in line with the car industry. In the capital markets, Kotak has retained its market positions (although its profits have declined along with industry activity) and is well positioned for an industry recovery, in our view. Its strong balance sheet and broad-based presence also
position it well for inorganic growth. However, at the current valuation of 2.7x 2013E P/BV (one-year forward) and 19.0x P/E (one-year forward) these positives appear to be in the stock. Our 12-month price target of Rs540 is based on its historical average 12-month forward P/E multiple of 18x.


Financing businesses appear well positioned for continued profitable growth: We believe the banking business is well invested and should grow through network expansion – replicating the HDFC Bank and Axis Bank trajectory. Furthermore, the bank should also continue to benefit from strong cross-selling opportunities owing to Kotak’s presence in other financial services businesses. KP’s strong car finance franchise should enable it to grow profitably in sync with the Indian auto industry.


Capital market businesses look well positioned for industry recovery: Profits from Kotak’s capital markets businesses (brokerage and investment banking) have declined as the industry has slowed. However, Kotak has retained its market position in key segments (particularly cash equities and ECM) in these businesses. In the event of a sustained downturn, modest profit growth through cost cuts is achievable, in our view.


Broad-based presence and capital create opportunities for inorganic growth:
Kotak’s well-capitalized position is an asset in an environment in which valuations have been compressed. Its foothold in asset management and insurance mean that Kotak has a platform for inorganic growth across the entire financial services spectrum.


To read report in detail: KOTAK MAHINDRA

>COAL INDIA: Price increases will be hard but still only upside likely

Initiate at 1-OW; a sleeping giant


We view Coal India (CIL) as a core long-term holding in the mining sector given its extremely favourable risk/reward profile. The fact that its adjusted selling price (c45% discount to the seaborne price) looks to have only upside alleviates the coal market concerns around the stock, in our view. We believe investors need confidence about the seven key issues surrounding the stock (highlighted in the report) and that the market is under-appreciating both a potential rebound in volume growth and CIL’s ability to control costs. A hastening of reforms and notified price increases would likely provide significant upside optionality. With a free cash
flow yield of about 7%, valuations look attractive, especially considering the low downside risk to profitability and large cash balance (c26% of market cap). We


■ initiate at 1-OW with a 12-month PT of Rs411.
Higher-than-consensus volume growth feasible: Although the c2% CAGR drop in production over FY10-12E has dented investor confidence, we are optimistic that CIL’s volume growth can rebound to a 5% CAGR over FY12-17E (to 557mt). With only 14% of volume having to come from new mines and tangible measures being taken to address logistics bottlenecks, visibility on a volume rebound has improved dramatically. 


■ Ability to control costs appears underappreciated: Wages are c53% of CIL’s costs and a shift in volume mix towards more efficient subsidiaries (wage/tonne of the most efficient subsidiary is 1/12 that of the most inefficient subsidiary and 1/3 of CIL’s average) and natural attrition of the ageing workforce (expect a c9% drop in employee base over FY11-14E) should offset the impact of rising wage rates, in our view.


■ Price increases will be hard but still only upside likely: We expect price increases for CIL to be less frequent and its sales mix to move away from higher-margin (e-auction and non-power) volumes. Our estimates build in a mere 5% price rise in notified prices in FY14, translating into a 1.5% CAGR in weighted average realisations over FY12-14E. 


■ Near-term issues reflected in price target: Our 12-month price target of Rs411 already factors in a negative Rs41/share for the proposed mining tax. Concerns the government may push CIL to use its cash balance to pay off state electricity board losses are overdone, in our view. Higher dividend payouts would be RoE accretive.


■ Key risks: Key risks to our investment thesis, in our view, include further delays in price
increases, drops in e-auction volumes and adverse regulatory changes.


To read full report: COAL INDIA
RISH TRADER

>HDFC BANK: Focusing on improving operating efficiencies

■ Loan growth targeted to be 4-5% above the industry rate and be balanced across segments: Management expects loan growth to be 4-5ppt higher than the industry loan growth rate, which it expects to be about 17% in FY13. Although loan growth in 3Q FY12 for the corporate segment was low at 15% compared with the overall growth rate of 22%, management expects growth to be more balanced going forward.


■ Management expects the competitive environment in the deposits market to ease as interest rates start to fall. This should enable HDFC Bank to maintain its NIM at about 4%. HDFC Bank expects the large banks to maintain savings deposit rates at 4%, which it sees as an equilibrium price (given that the savings bank deposits involve transaction costs of 2-3% and short-term deposits rates are less than 7%).


■ Credit costs to move up from cyclical lows, but this should be offset by lower countercyclical provisioning: Credit costs (at 0.5% for FY11) have been at cyclical lows due to lower NPA formation and recoveries from written-off pools, but management expects costs to move up to normal levels of 1.2-1.4% in the next 2-3 years. However, it expects the increase to be offset by lower countercyclical provisioning. In FY11, the bank also made higher countercyclical provisions at 0.5% of average advances.


■ Focusing on improving operating efficiencies: With network growth moderating, management plans to improve the C/I ratio by 2-3ppt to 45-46% in the next three years. This should be possible since the burden placed by new branches will be lower. Although HDFC Bank plans to open about 250 branches each year, these will account for a smaller and smaller share of the total network over time.


To read full report: HDFC BANK
RISH TRADER

>WIPRO LIMITED: Some improvement, but still risky

Wipro continues its organisational revamp focused on improving its account mining process. Steps have been taken to simplify reporting structures, standardise back-end processing and external consultants have been asked to bring the best practices. We find confidence returning to management that the company will be able to match peers’ growth going forward despite the uncertainty in the demand environment. However, we believe that the turnaround could take more time and that the execution risks are not correctly priced. The stock is trading at a P/E of 15.7x for FY13 (7% discount to Infosys) and, hence, is not inexpensive. We maintain our 3-UW rating. 


Simplifying organisational structure: Reporting lines have been restructured so that sales and delivery primarily report to vertical heads. Senior level hires are being made to improve processes in both sales and delivery.


End-demand improvement in specific pockets: Wipro has seen end-demand stability since the beginning of the calendar year with traction in BPO and IT Infrastructure. Oil & Gas, BFSI, Retail and Healthcare are the key focus areas and likely growth drivers. 


Acquisition-led strategy to continue: According to management, Wipro’s acquisitions through the decade have had 2.2ppts accretion on the revenue CAGR with an IRR of 22%. With 20% of the current FY revenues from acquisitions, the company is unlikely to relent on its strategy and could continue to focus on smaller acquisitions.


Execution risk makes us cautious: The strong focus on top-line growth could imply a reduced margin focus near term. Given volatile environment and the changing organisational structure, there remains risk to earnings growth, in our opinion. Valuations at a P/E of 15.7x also do not provide much support. We retain 3-UW with PT of Rs360.


RISH TRADER

>INDIAN STEEL SUBSECTOR: Shifting sands: Initiating coverage

We argue that sustained hikes in iron ore export duties have subsidised the domestic steel industry at the expense of miners. This, coupled with the ongoing mining impasse, make us negative on the iron ore mining space, even as stock valuations are attractive. We initiate coverage of NMDC and Sesa Goa with a 3-UW. We see the contours of the Indian steel industry slowly but certainly changing in favour of the large steel producers. JSPL 1-OW is our top pick, given its superior business model and strong growth visibility. We rate SAIL 3-UW, given muted volume growth and cost pressures. Tata Steel (1-OW) offers a favourable riskreward trade-off, given that peak debt is down (c20%), ROE accretive India expansion is closer to commissioning and valuations are already factoring in a negative value for its European operations. We rate JSW Steel as 2-EW, as although negatives are already in the price, the mining impasse would delay a rerating.

■ More bullish on the medium-term outlook for Indian steel relative to iron ore mining:

While global iron ore miners have captured value from rising steel prices, rising regulatory costs in India have capped upside for the Indian miners (read export duties). In fact, India now has one of the highest taxation regimes on iron ore globally, and could increase even further if the proposed mining tax and increase in export duties get implemented. We expect NMDC (3-UW) and Sesa Goa (3-UW) to be negatively impacted by this trend. Furthermore, ongoing government probes into potential illegal mining is a further risk to earnings of Sesa Goa (3-UW) and to some extent on JSW Steel (2-EW).

■ See structural changes in the steel sector benefiting the larger, established players: While we cannot ignore the short-term risk to steel pricing in India (which has held up well relative to global prices, due to currency depreciation and supply disruptions), we expect the larger integrated mills to capture further market share in India at the expense of the sponge iron producers (whose survival is threatened from declining coal and gas linkages). The big mills are also forming JVs with technology leaders globally and improving their product specifications, thus improving long-term margin potential. Domestic overcapacity is inevitable, but there is an opportunity in sub- segments such as value-added long products. We see JSPL (1-OW) and Tata Steel (1-OW) benefiting most from these changes, relative to SAIL (3-UW).

■ Further increase in regulatory costs and exchange rate are key risks: Over and above iron ore prices and the risk of increased Chinese exports, we highlight that a further increase in the regulatory burden for iron ore miners and exchange-rate risks on foreign currency-denominated debt are two issues investors need to keep an eye on.

To read the full report: INDIAN STEEL

RISH TRADER

>SIGNPOST (BARCLAYS CAPITAL)

ESSAY – STEADY AS SHE GOES

SO FAR, SO GOOD!
THIS YEAR IS TURNING OUT TO BE ONE IN WHICH THE GLOBAL ECONOMY (FIGURE 1) AND THE FINANCIAL MARKETS ARE MUCH BETTER BEHAVED THAN THEY WERE IN THE SECOND HALF OF LAST YEAR.

IN THE FOLLOWING PAGES, WE PROVIDE OUR NEW PROJECTIONS (SUMMARISED ON PAGE 5). READERS FAMILIAR WITH SIGNPOST WILL NOTICE THESE ARE ACTUALLY VERY SIMILAR TO THE FORECASTS WE PUBLISHED THREE MONTHS AGO, WHEN WE THOUGHT THAT A “THAW” HAD BEGUN. BUT WHAT HAS CHANGED IS OUR CONVICTION LEVEL REGARDING OUR FORECASTS: WE NOW HAVE RATHER MORE CONFIDENCE THAT REALITY WILL TURN OUT TO BE CLOSE TO OUR PROJECTIONS.

THAT IS NOT THE SAME THING AS SAYING THAT WE CANNOT REVERT TO THE SITUATION WE WERE IN LAST YEAR, WHEN THE APPROACHES THAT USUALLY DO A GOOD JOB AT PREDICTING ECONOMIC ACTIVITY BROKE DOWN, AND PSYCHOLOGICAL FORCES (OR “ANIMAL SPIRITS”) DOMINATED BEHAVIOUR. BUT, THAT RISK APPEARS TO BE FADING, IN MUCH THE SAME WAY THAT THE MEMORY OF A NIGHTMARE DOES SO WITH TIME.

POLICY EFFORTS PAY OFF
IN RECENT MONTHS, IT HAS BEEN CLEAR THAT COUNTRIES WHICH HAVE EXPERIENCED THE BIGGEST POLICY SHIFTS HAVE ENJOYED THE FASTEST AND LARGEST TURNAROUND IN THEIR FORTUNES. ¢ONSEQUENTLY, EMERGING MARKETS (ESPECIALLY IN ASIA) ARE GENERALLY MORE ADVANCED IN THE ECONOMIC CYCLE THAN THE “ADVANCED” ECONOMIES. ONE ILLUSTRATION OF THIS IS PROVIDED BY THE PURCHASING MANAGERS INDICES OR “PMIS” (FIGURE 2). THESE ARE MEASURES OF BUSINESS CONFIDENCE, BASED ON FIRMS’ REPORTS OF THEIR ORDER BOOKS, UNSOLD INVENTORIES, RECENT AND PLANNED PRODUCTION AND EMPLOYMENT AND OTHER FACTORS. FIHEN THE PMIS ARE ABOVE 50, THEN THERE ARE MORE FIRMS
EXPANDING THEIR BUSINESSES THAN CONTRACTING THEM. IF WE COMPARE THE PMIS IN BRAZIL, INDIA AND ¢HINA (BI¢) WITH THOSE IN THE US, EUROPE AND JAPAN, WE SEE THAT THE “BI¢S” HAVE ALL BOUNCED BACK INTO GROWTH-MODE AGAIN; BY CONTRAST, THE “ADVANCED” ECONOMIES ARE STILL FINDING THEIR FEET.

AMONG THE ADVANCED ECONOMIES, WE THOUGHT THAT THE US WOULD SUFFER LEAST, AND LEAD THE WAY IN RECOVERY, AGAIN BECAUSE OF THE SHEER SCALE OF THE US POLICY RESPONSE. AGAIN, THIS LOOKS TO BE THE RIGHT CONCLUSION.

To see full report: SIGNPOST

>USD/INR (BARCLAYS CAPITAL)

INDIA: USD/INR 56 AND DEEP RATE CUTS COMING

# We have revised our FY 09-10 GDP growth forecast to 4% from 5.2%. We see the risks as tilted to the downside.

# We expect the economy to witness deflation from April to October 2009 at least.

# In our view, further loosening of monetary policy is likely to come from significant real effective exchange rate depreciation and policy rate cuts.

# For Q3 09, our repo rate forecast is revised to 3% from 4%, and our reverse repo rate forecast is revised to 1.5-2.0% from 2.0-2.5%.

# We expect further rate cuts in the next few weeks as January IP remains weak, global macro data weaken further and financial markets remain soft.

# Our three-month USD/INR forecast is 56.

To see full report: USD/INR