>HOUSING FINANCE: Still have defensive quality

Whilst outperforming the bankex (HDFC by 27% & LICHF by 64%) in CY12, the housing finance stocks have underperformed the bankex (HDFC by 23% & LICHF by 13%) YTD given concerns on margins. These concerns were accentuated by declines in yields for most of the HFCs in Q1. We think we may have seen the worst in terms of margins for the HFCs given that most of the margin deterioration was due to the increase in cost of funds and not yields. Also, NPLs for the sector have remained low. We see this as the most defensive sector in the financials space, retaining LICHF as our top pick. DEWH has the highest upside potential, but any re-rating appears to currently be held back by perceptions around governance, though the operating performance has remained robust.


Results broadly in-line
Current quarterly results have been broadly in line with our expectations;
a) Loan growth for HFCs we cover remained > 20%, given that the disbursement growth was in excess of 20%; no significant increase in repayments even after abolition of prepayment penalties.
b) Gross NPLs declining on YoY basis, although on QoQ basis they have deteriorated slightly due to the seasonal impact for Dewan and LIC Housing.
c) NIMs have fallen on a QoQ basis for most HFCs, which is seasonal as well as due to the rise in cost of funds. However LIC has negatively surprised as the increase in cost of funds was more than our expectations.


Still remains the most defensive area in financial sector
We view this sector as the most defensive in the financial sector given:
a) Growth rates should remain high given that affordability is still good and we have not seen any indication of a significant reduction in demand from anywhere in India other than Mumbai.
b) NPLs should remain low as we are yet to see heavy job losses. In addition, most loans in India are for own use so this is the last asset a person would likely default against. Also, the LTVs have come down with the RBI reducing the maximum LTV from 95% to 80% over the last couple of years. c) NIMs have been declining for a few quarters, but we think we may have seen the bottom given yields are expected by us to increase in coming quarters with teaser rate loan repricing (for LICHF) and incremental loan portfolio at a higher yield than the average yield of the portfolio.


Dewan looks attractive but LICHF remains our top pick
On a relative as well as absolute basis, DEWH looks attractively priced given a 20% ROE, in excess of 25% loan book growth and around 20% earnings growth and the stock trading at just 0.9x FY13E book and 5x FY13E earnings. However, perceived corporate governance issues due to promoters’ relatives involved in real estate activities means that the stock’s performance may remain subdued in near term. Hence, although we have just 5% upside on LICHF compared to 78% upside on DEWH, LICHF may well do better in the near term given no corporate governance noise and our expectations for an increase in NIM. At 4.3x FY13E P/BV HDFC looks appropriately priced and we do not see much upside given it already trades at a premium valuation. We have tweaked our estimates for HDFC and DEWH to incorporate FY12 results with no resulting changes to our FVs.


Risks to the investment case
The sharp rises in the interest rate environment, high property prices in some locations and economic slowdown have resulted in a meaningful reduction in demand for housing in the two biggest cities, Delhi and Mumbai. Were rates to continue at these high levels and the economic environment were to deteriorate significantly we could see growth rates for the HFCs coming down.


To read report in detail: HOUSING FINANCE

>INDIAN BANKING: Savings rate deregulation – Early trends

The current macro environment (high interest rate differential between SA and fixed-term deposits) and SB deregulation in Oct 11 have made SA deposit acquisition more challenging and competitive. Post deregulation, smaller new generation private banks that have raised rates have seen higher SA momentum, while large private sector banks are witnessing early weaknesses and PSU banks have seen a deterioration in SB deposits mobilisation. We expect smaller new generation private sector banks to gain market share at the cost of PSU banks in the initial phase. We expect the high SA interest rate environment to last only until small new generation banks reach the inflection point in terms of SA ratio, which also depends on how rate cuts pan out.


Macro environment not conducive for SA deposits growth
We expect the flight of deposits from savings accounts to fixed-term deposits to continue in FY13 as we expect liquidity conditions to remain tight for the rest of the year and interest rates to remain high in spite of an additional forecast 75bps cut for the rest of FY13. Further, we believe it would be reasonable t assume that the three new generation private sector banks that have increased their SA interest rates are likely to continue to offer higher SA interest rates than competitors to maintain their competitive advantage in terms of pricing differential.


SB Deregulation – divergent trends
Small new gen banks - Rate hikes helped initial gains: Since SA deregulation, Yes, Indusind and Kotak (not rated) have increased rates which has helped them to gain significant momentum on SA deposit mobilization (incremental SA deposit market share from 1% in Q1 FY12 to 4% as of Q4 FY12). Large Private banks – Holding the fort for now: Large private banks have managed to hold on to their CASA ratios and market shares over the last couple of quarters. ICICI, HDFC Bank & Axis Bank managed to maintain their SA ratio at 27.9% from Q1 to Q4 FY12.


PSU banks – Losing market share: The top 5 PSU banks have continuously lost market share (their combined SA market share decreased from 26.6% in Q1 FY11 to 25.2% in Q4 FY12 & SA ratio decreased from 26.4% in Q1 FY11 to 24.7% as of Q4 FY12).


How long will the high SA interest rate environment last?
Competitive positioning on key SA drivers...
Most banks have devised their current strategy based on their current positioning on four key SA drivers: (a) Interest rates; (b) rural branch network; (c) service quality; & (d) product portfolio. Three large private sector banks (ICICI, HDFC Bank and Axis) and SBI look better placed to handle higher competition while some of the larger PSU banks like, Union, PNB, BOB & BOI will likely continue to lose market share as the smaller private players gain market
share.


... has determined banks’ current SA strategy
Large private banks (ICICI, HDFC Bank, Axis) are increasing their rural network, SBI is offering incentives (reducing minimum balance to zero) to increase incremental market share. PSU banks excluding SBI are offering Auto Sweep on SA accounts.


High SA rates will last for the next 12-18 months
Higher SA rates are highly dependent on how the rate cycle pans out and how quickly the new generation banks increase their SA Ratios. Based on our analysis, we calculate that a 25% SA ratio would be the tipping point for YES bank while the corresponding number is 35% for Indusind assuming a 75 -100 bps rate cut (see Table 15 &16), at which point the new generation banks may be forced to think long and hard about offering higher interest rates. We believe higher SA rates will last for the next 12-18 months, after which banks will likely be forced to revisit their high SA rate strategy.


To read report in detail: INDIAN BANKS
RISH TRADER

>BIOCON: PFE deal termination was a body blow; Concerned with AxiCorp

BIOS’ shares have had an uninspiring run post the termination of the PFE deal, which dealt a body blow to its biosimilar insulin aspirations. Whilst the deal is now terminated, it will continue to throw its shadow over future earnings, thanks to an aggressive accounting policy that will see BIOS shift biosimilar insulin R&D costs off the P&L. This, along with use of a creative transaction structure for AxiCorp, leaves us frustrated with corporate governance standards at the company, and we downgrade our accounting and corporate governance rating from AMBER to RED. Stripping out biosimilar insulin (90% valuation haircut) and Dificid, BIOS is currently trading at ~12x FY13E EPS. We cut our FV by 47% to Rs. 186 (from Rs.350 earlier) and switch to SELL.


PFE deal termination was a body blow
Earlier in the year, BIOS’ biosimilar insulin aspirations were dealt a body blow following the termination of its global development and commercialization deal with PFE. This sent the shares down by ~10% on the day, with shares continuing to drift post Q4’FY12 results earlier in the month. Post the deal’s termination, the focus now shifts to BIOS’ internal progress on the biosimilar insulin program.


Another incidence of aggressive accounting policies
There has been considerable confusion over the timing and accounting treatment of PFE milestones through the P&L, as BIOS currently has deferred revenues of ~Rs.4930m on the balance sheet. In our experience, globally, post a deal termination, the balance of deferred revenues lying on the balance sheet is typically recognised in year-1 as a one-off revenue item. This is in line with matching principle as the revenues from a terminated deal should not ideally be matched against costs of another deal (internal or external). Based on the guidance provided by the management, we believe that the company is likely to recognize the deferred
revenue in line with R&D costs associated with biosimilar insulin program in a particular year. We see this accounting policy as aggressive (the auditors have drawn an emphasis in this regards). This marks the third instance of aggressive accounting with regards to recognition of income/costs for biosimilar insulin. We believe it will lead to consistent over-reporting of EPS (and potentially over-valuation) to the tune of 20% every year during FY13-15 while also leaving investors blind-sided with the clinical spend and progress in biosimilar insulin development.


Concerned with AxiCorp “circular” transaction
In April ’11, BIOS sold its 77% stake in AxiCorp to existing minority investors for a ~EUR40m valuation, ~33% higher that its acquisition cost of EUR30m, and implying a P/E of ~7.4x. However, the nature and structure of the transaction raises eyebrows as BIOS used a creative deal structure at the time of acquisition that allowed it to pay ~EUR16m cash for AxiCorp but required it to transfer the rights to biosimilar human insulin and glargine for Germany to AxiCorp for EUR14m. Our analysis indicates that BIOS received only ~EUR5m in cash for the divestment, which is surprising given that AxiCorp had a net profit of ~EUR5m in FY11. Moreover, while it seems that BIOS made a profit of ~EUR10m on the transaction, in reality, there was a cash loss of ~EUR10m and a notional loss of ~EUR21m in buying back the IP rights. Despite this, the deal structure ensured that BIOS was not required to report any loss on sale in the P&L.


Cash drain not reflected in EPS – Valuing BIOS on SOTP
With the PFE deal terminated, we see little reason to own BIOS shares in the wake of only modest growth prospects for the base business. We expect the FCF generation to be further pushed out by 2-3 years resulting in a haircut of ~90% on rNPV of insulin deal from Rs.40 to


To read report in detail: BIOCON
RISH TRADER

>EDUCOMP SOLUTIONS

Not convinced about overall governance


Educomp’s fortunes appear to be declining fast in light of reduced funding from banks. We reiterate our view that the SPE will be consolidated once India converges to IFRS from 2013 onwards which will lead to negative OCF and FCF and D/E c.2:1. Management now
has admitted this. Our concerns on overall governance policies go further, principally: a common address of the auditor and the registered office of Edu Smart; cost allocation of resource coordinators and high turnover of company secretaries at Edu Smart. We change corporate governance rating from Amber to Red, lower our FV from Rs220 to Rs110 and downgrade our stance from Neutral to Sell.


See no improvement in stretched cash flow situation
We turned our long-running SELL stance on Educomp (since May 2009) to Neutral in August 2011 citing valuation. Our key thesis then was that an 80% fall in the stock price was factoring in most of the core business and overall governance issues. However, we now see growing reasons to question the sustainability of the core business model and also highlight some new
governance issues which need answering by management. With Educomp’s K- 12 initiative not growing as per expectations and its core business, Smart Class, likely to falter on growth due to funding requirements, we think that there are likely to be further earnings downgrades.

• Incremental securitization of smart class difficult – At the start of the

model, Edu Smart used to get Rs60 for every Rs79 securitized from banks

meaning a cost of debt of 10%. This quickly declined to Rs54 for every

Rs79 securitized resulting in cost of debt of 14% and zero cash balance for

Edu Smart at the end of year 1. While we had expected in May 2011 that

this funding would fall to Rs50 due to rising securitization costs, it has

actually declined to 45. Now either Educomp is paying securitization costs

of 22.25% in return for Rs79 securitized or it is securitising only Rs65 to

keep the rate at 14%. The shortfall of Rs14 implies that Edu Smart will find

it incrementally difficult to pay Educomp, thus stretching its cash flows.

• K-12 segment not that strong as perceived – Our channel checks of

Educomp’s K-12 schools in 2012 suggest no major improvement over 2011,

especially in schools which have been operational for more than 3-4 years.

The only segment that could have helped Educomp in offsetting concerns

of its core business is the K-12 segment, but things are not improving

enough to make any meaningful impact.

• Overall governance issues in the SPE are questionable: In our research

we notice that the statutory auditor of Edu Smart and registered address

of Edu Smart is same. We believe this compromises independence,

especially given any sense of excessive closeness between company and

auditor will naturally concern investors given longstanding concerns about

the structure of Edu Smart. Additionally, we are concerned about the cost

allocation of resource coordinators which should have been booked by

Edu Smart but is being booked by Educomp which is negative for minority

shareholders of Educomp. Furthermore, the high turnover of company

secretaries at Edu Smart also makes us uncomfortable on overall

governance policies.

Valuation: structurally declining model of core business
In our opinion, securitisation has always been a precursor to a big downfall and Educomp must have learnt this by now. Educomp currently trades at a FY13E P/E of 11.6. Our research indicates that growth in the smart class segment (60% of revenues and 90% of EBIT) is set to deteriorate as securitization of smart classes becomes incrementally more difficult. Moreover we are wary about the corporate governance standards of the company. We downgrade our EPS estimates by 50%. SELL Educomp.


To read report in detail: EDUCOMP SOLUTIONS
RISH TRADER

>GLOBAL LIQUIDITY: Opportunity in adversity? (ESPIRITO SANTO)

Given liquidity pressures and heightened capital requirements, EU banks are reducing exposure to Asia, including India, creating an opportunity for Indian banks to capitalise on. Our top plays on this being Bank of Baroda and SBI. Moreover, in a year with a $5.2bn wall of FCCB redemptions, we think there are likely to be opportunities appearing from FCCB mispricing. The FCCB’s of companies such as Educomp, Rolta and Suzlon look like interesting opportunities.


The objective
The stage is set for another round of liquidity infusion by the major global central banks, at a time when domestically bank credit growth is showing signs of significant moderation (16% YoY vs. 24% last year). This note analyses the extent to which changes in global liquidity have impacted the availability of resources to the domestic commercial sector, especially at a time when a) European banks are expected to deleverage ahead of the EBA core Tier 1 capital requirement and b) huge FCCB refinancing/restructuring needs have arisen for Indian corporates.


The impact of EU banks deleveraging on Asia
Continental European (ex UK) banks account for approximately USD 70bn of0 bank claims in India, and if including the UK, then European banks in total account for 45% of the total claims on India. While no significant deleveraging was noted by the UK in Q3’11, other European banks have reduced exposure by USD 5bn from Q1’11 to Q3’11. Given their robust liquidity and capital and strong presence in Asia, both HSBC (Buy) and Standard Chartered (Buy) are well positioned to capitalize on the deleveraging of European banks, as our banking analyst Shailesh Raikundlia explains in his report of 6 February 2012: “HSBC, Standard Chartered: Opportunities in Adversity”.


Indian banks exposed to this opportunity
We think PSU Banks are best placed to gain access to critical dollar funding to exploit this opportunity given quasi sovereign guarantees. Among the PSU banks under our coverage we recommend Bank of Baroda (BOB IN, BUY) as our top pick to play this theme, given its international loan book constitutes 26% of advances, and its 15% QoQ international growth in Q3FY12. Our second choice to play this theme would be State Bank of India (SBIN IN, BUY), with its international loan book of Rs. 1.3tn.


Is India facing a foreign funding crunch?
The data suggests that despite fears of a contraction in foreign funding, actually foreign funding (notably ECBs and FDI) has played an important role at a time when domestic sources have contracted. The biggest test this year in terms of foreign funding of corporate India will be the USD 5.2bn of Indian FCCB redemption coming up, pretty much all of them underwater, so requiring restructuring, refinancing or replacement with other forms of borrowing, such as
ECBs.


How much risk do the FCCB redemptions pose?
Whilst the FCCB redemptions pose a challenge, the fears around the issue means that opportunities are likely to arise in FCCB mispricing. We review examples from historical price/yield movements of these instruments and present FCCBs of companies that provide high YTMs (yield to maturity), as well as relative safety of principal.


The FCCBs of companies such as Educomp, Rolta look like interesting opportunities to us, and even the Suzlon situation with multiple tranches on very high YTMs is worth us monitoring. First Source, Tulip IT, REI Agro, Jaiprakash Power, Videocon Ind., Sintex, JP Associates, Welspun Gujarat, Bharat Forge are all trading at high YTMs with relatively low probability of default given leverage, higher interest coverage and respectable credit ratings implying easier
access to international and domestic funds. We think GTL Infra and Suzlon look like candidates for restructuring with haircuts, and 3i Infotech looks to us to be the most likely candidate for default given its weak core business.


To read full report: GLOBAL LIQUIDITY
RISH TRADER