>YES BANK

Back to Yes!

Event
 Upgrade to Outperform: Over the past 3 months, YES Bank stock has underperformed the wholesale funded institutions by ~18% which we believe is unwarranted. We consider current levels a good opportunity to accumulate the stock. Upgrade to Outperform and TP raised to Rs415 from Rs380.

Impact
 Falling wholesale rates and improving CASA should help margins: With wholesale rates having corrected very sharply (down 250bps from the recent high on 30 March 2012) and current account savings accounts (CASA) expected to improve steadily in the next few years, we believe margins are likely to rise from 2.8% to 3.2% in the next three years. Higher margins should give YES Bank a cushion against a possible credit cost rise due to asset quality issues.

 Asset quality – too much fuss unwarranted: We think the market is overly worried about YES Bank’s asset quality which is probably the reason why the stock has underperformed relative to other wholesale funded institutions. Firstly, YES Bank has a very well-diversified portfolio with no concentration in any specific sector. Secondly, its quantum of restructured assets is well below that of peers. Thirdly, exposure to stressed sectors like infrastructure, iron and steel, textile etc is lower than its larger private sector peers. Fourthly, there is too much worry about its off-balance sheet activities. If one looks at riskweighted assets (RWA) as a proportion of total assets, YES Bank’s number is the lowest among large private sector banks, indicating that off-balance sheet transactions are not much different or riskier than for others. Finally, we have
already built in credit costs increasing virtually from nil levels last year to 50- 55bps in the next two years. Our numbers take into account an expected three-fold increase in gross NPLs over the next 2 years.

 Return ratios to be very healthy despite equity dilution: Despite the increase in credit costs and a 15% equity dilution factored into our numbers, we expect ROA of 1.4% and ROE of 20% in the next three years on average.

Earnings and target price revision
 We are marginally fine-tuning earnings. We raise our TP by 9% to Rs415 as we roll forward our valuation to FY14E.

Price catalyst
 12-month price target: Rs415.00 based on a Gordon growth methodology.
 Catalyst: Strong growth in profit, greater traction on CASA deposits.

Action and recommendation
 Favourable risk-reward, one of our top picks in financials: The stock trades at 1.6x FY14E P/BV (1.8x if we exclude equity dilution). It is now below its historical average valuation and risk-reward is very favourable at current levels. YES Bank is one of our top picks in the financial space.

To read report in detail: YES BANK

>HDFC Ltd – SWOT Analysis

■ Structural de-rating in the making; Downgrade to UP
We downgrade HDFC Ltd to an anti-consensus Underperform rating from Outperform with a TP of Rs550, which offers 17% downside. We believe a structural de-rating is likely because the quality of earnings and ROE reported is being driven more by its corporate book and aggressive accounting practices. Mortgage profitability is declining structurally and regulations have become adverse. All this would make it tougher for HDFC Ltd to sustain its super-normal multiples/valuations. Though near-term catalysts are absent, the de-rating call is more a longer-term view as the stock appears fundamentally overvalued.


■ ROE driven by corporate book; getting riskier structurally
Over the past eight years, HDFC has increased the share of the corporate book (loans to real estate developers, lease rentals etc) in the overall loan portfolio from 29% to 37%. The issue is that housing loan profitability has been falling structurally and the company has been resorting to higher-risk non-retail categories to drive up ROE. We estimate the non-retail book now generates more than 30% of ROE and contributes more than 65% to HDFC’s profits.


■ Retail housing loan profitability falling structurally
Over the past several years, competition in retail housing has picked up, and some of HDFC’s peers have grown at exceptional rates. The premium product pricing that HDFC Ltd used to enjoy no longer exists. Competition is intense and likely to increase since banks have limited opportunities in the corporate segment this year. Retail business ROE has also been affected by regulatory changes and we estimate the retail business now generates a poor ROE of around 13-14% compared with 20%-plus five years ago.


■ Accounting practices used to inflate earnings and ROE
Over the past two years, HDFC Ltd has been adopting aggressive accounting practices by passing provisioning through reserves and also making the adjustments for zero-coupon bonds (ZCBs) through reserves. We believe FY11 and FY12 earnings are overstated by 38% and 24% respectively and reported ROE would have been 600 and 400 bps lower at 16% and 18% respectively if the adjustments had been made through the P&L. In other words, earnings growth has been managed, in our view.


■ Regulations – another overhang
We also think investors are underestimating the longer-term implications of regulatory changes and consequently this also presents a strong case for derating in our view. The regulator has increased the provisioning requirements, has banned pre-payment charges, and asked for re-alignment of rates for old and new customers, all of which could have an impact, especially in a predatory pricing environment. We also expect capital requirements to be increased, similar to the banking and NBFC sector, and this is one big event risk (with a high probability of happening) that the market is not factoring in, in our view.


■ TP cut by 30%, driven by sharp cut in multiples
We cut our TP by 30% to Rs550 on account of a sharp reduction in our target multiple. We are now valuing the core business at 2.0x P/BV compared to 4.0x previously. The reduction in multiple is on account of: i) lower retail business ROE driven by lower spreads in the retail business and higher capital requirements; and ii) a sharp reduction in corporate business ROE driven by factoring in credit losses and higher capital requirements.

To read report in detail: HDFC
RISH TRADER

>INDIA CEMENT SECTOR: Competition Commission of India (CCI) on the verge of levying penalties for cartelisation

Costs, capacity & cartel = cash out


Cash out time
Cement stocks have witnessed a strong rally in the last 12 months, outperforming the Nifty by 36%, driven by the longevity of pricing discipline. With stocks trading at 18-19x PER and the chances of a hefty penalty from the Competition Commission of India (CCI) looming ahead, the risk/reward appears unfavourable. Moreover, with continued capacity additions and rising costs, earnings growth should remain elusive for at least another two years. We remain Underweight on the Indian cement sector.


Cement price at all-time highs – where is the money?
Our study of 16 cement companies shows that since 1996, i.e. in the last 15 years, the incremental EBITDA made by these companies cumulatively was just US$2bn, and the bulk of this came just in the three years from 2006-08. We believe that the cement industry is again in a phase where the fight will be to sustain earnings, and we don’t see things changing over the next three years. Costs, costs, and costs – and will keep rising


In the past four years, production costs have risen 50%, and this includes subsidies, like diesel and coal from Coal India. Rising costs have helped improve price discipline, and the industry has been able to raise cement prices by 35%, but this is not enough for margin expansion. Unfortunately, the cost rises have been structural and may require substantial changes like captive coal mines, etc to reverse; we think this is at least three years away.


Capacity still outpacing demand
We are expecting 50mt of additional capacity in the next two years, while incremental demand is likely to remain less than 35mt. This will keep cement capacity utilisation below 80%. Also the installed capacity share of the top three companies in the country has fallen from 45% (in FY08) to just 38% now. On the other hand, demand growth has declined from an average of 10% pa in the past four years to around 6-7%. With our muted view of the investment cycle and reduced affordability of real estate, we don’t see demand growth exceeding 8% pa over the next two years.


CCI on the verge of levying penalties for cartelisation
CCI finished hearings against 42 cement companies in late February and should be ready with penalties by April. We expect penalties of about 7% of total revenue (last three years’ average), equal to 5-6% of market cap for every year of investigation. Global experience tells us that stocks correct by 20%+ on such penalties. See our report Investigations & Oversupply (June 23, 2011).


Costly – Valuations expensive and building in a bull cycle
Cement stocks are now trading at all-time high valuations, with well above trough-cycle earnings. To justify current valuations, we need EBITDA margins to improve by 50%, which looks highly unlikely given oversupply. Moreover, we are not sure if the companies will be able to retain these earnings in view of the possible penalties. We would sell into this rally. Our key sell ideas are ACC, Ambuja and Ultratech.


To read report in detail: INDIA CEMENT SECTOR
RISH TRADER

>INDIA BANKS: Socialistic attitude of Govt and regulators add to woes (MACQUARIE RESEARCH)

■ Structural de-rating – return ratios to come down sharply
The eternal long-term optimism on Indian banks in our view is unfounded. What gets neglected is the structurally lower growth, rising opacity of the quality of book thanks to restructuring, grossly under-provisioned state relative to regional peers and increasing burden in the form of priority sector/financial inclusion norms all of which is going to exert pressure on earnings and return ratios over the longer term. Leverage ratio is likely to be structurally lower due to Basel III implementation and we expect a deluge of equity capital raising over the next five years. Our earnings are ~15% below consensus for FY13E/FY14E and we expect ROEs to come down from 18.1% in FY11 to 15.7% by FY14E. Our ROEs are around 300bps lower than consensus for PSU banks. HDFC Bank is the only Outperform in banks. Top Underperforms are PNB and SBI.


■ Gearing up for Basel III: Flood of capital raising in next 5yrs
As banks gear up for Basel III beginning 1stJan’2013 to achieve a common equity ratio of 8% and a CAR of 11.5% over the next five years, assuming an 18% CAGR of loan growth, we expect the banking system in India to raise a minimum of US$30bn of equity capital, posing significant dilution risk. Capital required is more for growth than meeting solvency requirements.


■ Socialistic attitude of Govt and regulators add to woes
We believe the socialistic mindset of regulators as well as the government is going to exert more pressure on bank profitability. What is good for customers is not necessarily good for shareholders. The tougher priority sector guidelines, financial inclusion targets and a possible farm loan waiver over the next few years are only going to worsen profitability dynamics. Our analysis suggests that the revised priority sector guidelines could impact margins by c.30bps for private sector banks on a ceterus paribus basis.


■ Asset quality – the pain hasn’t disappeared
While the government announcements with respect to greater coal supplies to power projects do improve sentiment, their track record of implementation leaves much to be desired. Nevertheless pains with respect to gas based power projects and power projects where PPAs are fixed at low prices will continue to face stress as renegotiation of PPAs is unlikely. Our analysis of independent power projects (IPPs) suggests that close to 23,000MW of power projects or 16% of power exposure of banks could be at risk of restructuring or default. Another 10–15% could be contributed by SEBs. NPLs/restructuring related to SMEs, export
oriented sectors etc are unlikely to significantly abate. We are very worried over the moral hazard issue in the agriculture sector. Our worry is also on the underprovisioned state of Indian banks. We expect stressed assets, defined as net NPLs plus restructured assets, to net-worth ratio for the system to increase to a ten-year high of 57% (90% for PSU banks) by FY13. NPL coverage on stressed assets stands at a dismal sub 40% vs. regional peers averaging at 150% plus.


■ Valuations – where is the comfort?
Stocks currently are trading above ten-year historical averages on the back of an opaque book which is grossly inflated thanks to restructuring. The 20% re-rating from the recent lows more than adequately factors a ~100bps cut in benchmark rates and aggressive rate cuts are unlikely considering the fiscal and inflation
dynamics.


To read full report: INDIA BANKS
RISH TRADER

>STERLITE INDUSTRIES: Restructuring Version 2.0e

Event
■ 2nd Attempt at restructuring: After an aborted attempt in 2008, Sterlite Industries seems to be getting close to attempting another restructuring. Management had highlighted its intent to resolve the equity holding of VAL by March’12. Instead of separate business verticals, this time management appears to be considering merging everything into one holding company, virtually creating a dual listing structure. Based on our scenario analysis, even in a worst case, Sterlite could have 25-30% upside. Maintain Outperform.


Impact
■ Dual listing structure in offing: It is not difficult to see the rationale for this restructuring. Investors have been looking for a simpler structure, while Vedanta has been grappling with the mis-match of cash flows among its various businesses. This means Vedanta is likely looking to merge everything into one holding company, almost mirroring Vedanta PLC, except for perhaps Konkola Copper Mines (where it has a minority partner).


■ Vedanta Aluminium (VAL) – expected structure reduces risk for Sterlite: VAL appears to be the prime trigger of this restructuring exercise as it is lossmaking and has no near term solution. Investors have been concerned that the entire VAL stake would be passed on to Sterlite shareholders. However, under the proposed merger structure, if the liability is not assumed by Vedanta PLC, it will be distributed across all the merged entities.


■ Merger ratios – scenario analysis indicates Sterlite well below worst case: We have assumed 3 scenarios, based on current stock prices, consensus target prices and the worst case for Sterlite. Assuming the market cap of the merged entity remains the same as the current sum of parts market cap of the entities to be merged (at US$19bn, see Figure 12), even under our worst case assumption Sterlite’s implied stock price comes to Rs157.


■ Proforma estimates of the merged co: The merged company would have a consolidated Net Profit of US$2.5bn and trade at around 9.5x PER based on the peer group valuation. This implies market cap of US$24bn as compared to the current sum of parts market cap of US$19bn. Some of this would be driven by reducing the holding company discount as minorities reduce.


Earnings and target price revision
■ No change.


Price catalyst
■ 12-month price target: Rs149.00 based on a Sum of Parts methodology.
■ Catalyst: Clarity on merger ratios, streamlining the holdings


Action and recommendation
■ Maintain Outperform: Given past experience, investors may find it tough to believe that the restructuring would not hurt minority shareholders. But our analysis does indicate undervaluation for Sterlite. In particular we would buy on any dips.


To read the full report: STERLITE INDUSTRIES
RISH TRADER

>RELIANCE POWER: Merger of necessity? (MACQUARIE RESEARCH)

Event
■ On Sunday, 4 July, the Boards of RPWR and Reliance Natural Resources Limited (RNRL, NR) approved a scheme of amalgamation of the companies in a 4 (RNRL) for 1 (RPWR) share swap. Our initial thought is that this transaction is done out of necessity rather than value creation. An investor call is being held before market tomorrow. We retain our Underperform.

Impact
■ Look like a defensive move, rather than value creation: The recent RNRLRIL Supreme Court decision highlighted that the Government has ultimate control of how gas supply in India is allocated. RNRL itself has no power projects of its own – it’s essentially trading the gas – against the Government’s desire to allocate gas to end users and not traders. Therefore in our view, the absence of any gas assets in RNRL meant that this transaction was done as a necessary step to ensure gas allocation, rather than for value creation.

■ Pro forma accounts – RPWR still expensive: We provide a snapshot of pro-forma accounts of the transaction. The Price/Book Value (P/BV) after adjusting for the potential goodwill created from the transaction, sees the metric worsen to around 3.2x P/BV. Stripping out cash + investments implies a P/BV of 11.8x highlighting the early stage of the execution cycle for the combined RPWR-RNRL entity.

■ Other RNRL assets more speculative: The only real fundamental value that RNRL could bring to RPWR shareholders, in our view, is the undeveloped gas assets. Again, it seems that RPWR has paid an enterprise value of ~US$1.4bn for this more speculative upside. We need to do more valuation work around these assets.

■ Finer details on conference call tomorrow morning: at 8:15am (India time) to discuss the transaction. Call details within the note.

Earnings and target price revision
■ No change.

Price catalyst
■ 12-month price target: Rs107.00 based on a DCF methodology.
■ Catalyst: Details of gas pact between RIL-RNRL within the next month.

Action and recommendation
■ Underperform, with the stock trading at approximately a 40% premium to our valuation. With financial closure only achieved for 17% of its project pipeline, we believe there is still a long way to go regarding project execution.

To read the full report: RELIANCE POWER

>STERLITE INDUSTRIES: Earnings growth to bring back focus

Event
■ Downgrades to base metals: Our global commodities team has downgraded their aluminium, zinc and lead price forecasts. However, we believe that Sterlite’s expansions are now coming through, which should bring the focus back to this stock post its underperformance last year. We have retained our Outperform rating but marginally cut target price to Rs850 from Rs930 earlier.

Impact
■ Downgrading aluminium, zinc and lead price forecasts: We have downgraded FY11 zinc and lead price forecasts by 10% and 12% to US$1,877/t and $1,926/t, respectively. Our global commodities team has slightly changed aluminium price forecasts for FY11 by -3% to US$1,935/t from $1,995/t, respectively.

■ Expansions to drive doubling of profits in two years: Sterlite’s expansions of its zinc, power and aluminium businesses are now nearing completion. Highly profitable zinc business continues to contribute 50% to earnings. A large part of the growth is coming from the power business and expansion at Balco.

■ Lack of approvals can hurt production: Approval for its bauxite mines for aluminium projects is awaiting final clearance. In addition to the high costs that we are building in, we are concerned that due to infrastructure bottlenecks it may not be physically possible to get enough bauxite for full production at its JV ‘Vedanta Alumina’.

■ Coal block auctioning can come as blessing: One of the most awaited mining sector reforms involves auctioning of coal blocks by the government. While the timeline is not definitive, it is expected by end of the year. Sterlite can use its strong balance sheet to acquire resources that have eluded it for some time.

■ Sensitivity to commodity prices is low: An increase of 10% in aluminium price should increase consolidated earnings by 2%. Also, a 10% increase in zinc prices would increase consolidated earnings by 5%.

Earnings and target price revision
■ We have revised our EPS estimates for FY11 and FY12 by -6% and -4%, respectively.

Price catalyst
■ 12-month price target: Rs850.00 based on a Sum of Parts methodology.
■ Catalyst: Coal sector reform, clarity of bauxite linkage for VAL.

Action and recommendation
■ Maintain Outperform: We believe Sterlite continues to offer value, with its strong diverse growth pipeline, strong balance sheet and numerous upcoming catalysts. We think that the strong earnings growth should become the focal point driving the stock price. There also is a possibility of sharp re-rating if Sterlite can resolve its long-standing issues involving the government.

To read the full report: STERLITE INDUSTRIES

INDIA STRATEGY: Is it raining enough s enough?

Event
Monsoon 8% below normal: The India Meteorological Department (IMD he IMD) reported that rains in the week end ended ed June 16 were 8% below normal normal. It has also reported that there may be a temporary weakening of the monsoon over the next week week, with no major advance over central and eastern India. Although it is still early days, the q question is: uestion is this a cause for concern? Maybe not not, because there’s no clear pattern pattern; however ; however, monsoon worries may heighten inflation expectations and can dampen sentiment sentiment.

Impact
■ There’s no clear pattern; June does not set the pattern for the entire season season...: ...: Normal rains are defined as falling within 10% of the long long-term average normal. Since 1901, there have been 35 instances when June rainfall has fallen short by more than 10%, and on 24 of these instances the overall monsoon season turned out normal. Also, i in the last 25 years, there have n been five ins instances when June received above tances above-normal rainfall while the remaining months (and the en entire season) were rendered rain tire rain-deficient.

■ …b but can ut dampen sentiment and increase inflation worries worries.. ..: Food ood inflation remains the key concern for the government government, and it has been banking
on a normal monsoon for food prices to ease ease.

■ …and can lead to RBI hiking rates faster than expected… expected…: The latest inflation point of 10.2% YoY was higher than expected, impacted mainly by rise in prices of primary articles articles, while food inflation eased , eased. However, a deficient monsoon could raise worries about a rebound in food inflation. While there is a general expectation of a 2 25 bps hike at 5 the next meeting, any concerns around a persistent high level of inflation can make RBI move on rates much faster than expected expected.

■ ... can also slow down private consumption consumption: High inflation and rising rates could strike a double whammy for priv private ate consumption consumption, particularly urban , consumers. Rural demand was resilient last year but could come under pressure in case monsoons were to worsen.

Outlook
While it is too early to judge, a deficient monsoon can impact agricultural (Khari Kharif) output, inflatio f) inflation, sentiment n, and ultimately private consumption consumption.
Per Persistent high inflation could sistent also prompt RBI to raise rates faster than expected. Such a scenario could impact early cycle consumer discretionary sectors such as autos and telecom and interest rate rate-sensitive real estate. We believe that a an interesting play within consumer staples would be to switch n from HUL (HUVR IN; INR257; TP 210; Underperform) to ITC (ITC IN; INR294; TP 335; Outperform). In past rain rain-deficient years years, we have seen HUL underperformi underperforming relative to the market during the June ng June-September period and ITC outperforming the market (see Fig Figs 5 and 6) 6).

To read the full report: INDIA STRATEGY

>INDIAN WIRELESS SECTOR: BWA auctions ended with three major negative consequences

Event
■ BWA auctions ended with three major negative consequences for the alreadybeleaguered
Indian telecom sector. First, the pan-India winning price of Rs128.47bn (US$2.74bn) per slot was well ahead of anyone’s expectations. Second, it led to a fractured verdict, with the largest incumbents coming out croppers with no circle wins, except for Bharti, which won in only four circles. Lastly, in a repeat of 2003, we are seeing the birth of four new players in the Indian telco space. While one could dismiss their entry citing competition only for wireless data, this clearly thwarts the future growth option for incumbents from wireless data during the next five years. Of the four new entrants, most notable is Reliance Industries, India’s largest company, which began the remarkable telecom foray in 2003 of what is now called RCOM.

■ We are clear that one needs a serious reassessment of Indian telecoms, and the hope of consolidation to reduce the number of players to a workable seven or eight is just that – hope. We reiterate our Underperform ratings on the entire listed operator space – Bharti, RCOM, Idea, TCOM and MTNL. In our view, all of it is ‘dead money’ for the next six to nine months. We believe that the only event worth investing in may be RCOM attaining a cash infusion on the 26% stake sale at a good premium.

Impact
■ RCOM, Vodafone, Idea and Tata are notable absentees from the list of BWA spectrum winners. Aircel Maxis continued to surprise in BWA (as in 3G) with wins in eight circles. BSNL and MTNL have been allotted BWA spectrum in 20 and two circles, respectively (the third pan-India BWA slot).

■ The biggest surprise winner is Infotel Broadband, which won all 22 circles (pan-India) for US$2.74bn. Other surprise winners were QUALCOMM (QCOM US, US$35.03, Outperform, TP: US$50.00, Phil Cusick) in four circles, Tikona (unlisted) in five circles and Augere (unlisted) in
one circle.

■ Within hours of the BWA result release, Reliance Industries disclosed that it has acquired a 95% stake in Infotel Broadband by infusing approximately US$1.02bn and that RIL would pay US$2.74bn to the government for Infotel’s BWA spectrum. This marks the reentry of RIL into telecoms, and the fresh capital infusion would help Infotel launch its services targeted at corporates/ enterprises by next year. Although no capex plan has been disclosed, we believe that the size of RIL’s balance sheet (US$46.3bn) and its annual operating cashflow of US$4.4bn would be able to fund expansion in the scope and scale of the telecom business over time and a potential entry into the whole gamut of services, chiefly voice.

Outlook
■ Headwinds galore for the incumbents, in-market consolidation a pipe dream unless regulations change; valuations expensive as downgrades start coming through: MNP implementation could occur by September 2010, which could lead to a 7–8% correction in ARPU, entirely led by postpaid. We view the regulatory framework on M&A as the key hurdle for inmarket consolidation, even while supply of new capacity continues unabated.

To read the full report: WIRELESS SECTOR

>ICSA: Stress due to revenue mix to continue (MACQUARIE RESEARCH)

Event: ICSA reported FY10 results that were in line with expectations. We are reducing our estimates on margins, as the projects business continues to dominate order book. In addition, we reduced our target price to Rs197 from Rs205.

Impact
■ Results in line with expectations: ICSA reported FY10 revenue growth of 11%, which was in line with our expectation. However, margin at 20.4% was slightly lower than our estimate, due to continued domination of infra projects in revenues. FY10 PAT stood at Rs1.3bn (vs our estimate of Rs1.34bn). We are maintaining our revenue estimates, which call for growth of 23% in FY11 and 20% in FY12.

■ Change in mix continues to affect margins, as expected: The shift towards the lower-margin infra projects segment continues. The high-margin software product business accounted for only 32% in 4Q FY10 and 34% for the full year.

■ We build in margins risk, due to higher mix of projects in overall revenues: We have reduced our FY11 and FY12 estimates to build in a margin decline to 20.3%, as we expect the current revenue mix to continue in FY11 (36% coming from software division and 64% coming from the projects business).Our previous margin estimate was 21.4%.

■ Order book is healthy at Rs18.4bn: Although the order book stands flat YoY, the composition has changed significantly. The projects business constitutes at 81% of order book in FY10 vs 66% in FY09.

Earnings and target price revision
■ We have reduced our EPS estimates for FY11 and FY12 by 9% each, building in lower margin due to the projects business. In addition, we have reduced our target price to Rs197 from Rs205.

Price catalyst
■ 12-month price target: Rs197.00 based on a DCF methodology.
■ Catalyst: Higher revenues and margins from next quarter.

Action and recommendation
■ Stock attractive at 4.9x FY11 earnings: On our current FY11 EPS estimate of Rs31.5, the stock is trading at 4.9x. Our target price of Rs197 builds in margin risk due to low-margin infrastructure projects. We expect the revenue mix and margins in FY11 to be the same as in FY10.

To read the full report: ICSA

>SIEMENS INDIA (MACQUARIE RESEARCH)

Event
■ Siemens reported 2Q10 earnings of Rs1.8bn, which were largely in line with our estimate of Rs1.9bn. Margins significantly surprised on the upside, which was offset by lower-than-expected revenues. We have increased our target price to Rs542 from Rs440, as we have rolled over to the average of FY11/12E; however, we still maintain an Underperform rating, as we believe the stock has already built in a sharp turnaround in growth.

Impact
■ Margins surprise, however unsustainable at these levels: EBITDA margin stood at 12.9% in 2Q10, and if we adjust for the forex loss of Rs700m, margin stood at 16%. However, this high margin is mainly due to high-yield historical projects, which are likely to be over soon. We expect the margin to stabilise at 11.5% in FY11 and FY12.

■ Pricing pressure in projects business, product margins holding on:
Management said that there are pricing pressures in the projects business due to intense competition. However, product margins are stable at the moment.

■ Clear signs in industrial capex pick-up, order inflow growth back in +ve trajectory: Order inflow in 2Q10 stood at Rs22.4bn (+20% YoY), and the order book stood at Rs134.5bn (+40% YoY). Management said that though there was a good repeat demand in the industry automation and drives business, industry solution remains soft currently.

■ HVDC/800kV PGCIL order could aid growth: If Siemens were to win the Rs60bn HVDC/800kV order from Power grid (PGCIL IN, Rs110, Not rated), it could lead to significant revenue inflows for the company. Siemens is competing with ABB for this order, which is likely to be given out in CY10.

Earnings and target price revision
■ We have increased our 9/12 FY10E and 9/12 FY11E EPS forecasts by 13% and 12%, respectively, to factor in higher EBITDA margins. We also are rolling over our valuation to the average of FY11E and FY12E 20x EPS from the average of FY10E and FY11E EPS earlier.

Price catalyst
■ 12-month price target: Rs542.00 based on a PER methodology.
■ Catalyst: Margins settling around 11–11.5%.

Action and recommendation
■ Earning growth does not justify historical multiples: The stock is trading at 27x Sep’11 and 26x Sep’12 earnings. Even after building in an upturn in order inflow, earnings growth should remain at a 15% CAGR over the FY10– 12 period, as the company faces competition from new entrants and takes longer gestation-period contracts. Earnings growth should not go back to 30% levels to justify historical multiples of 30x. We maintain an Underperform rating on the stock.

To read the full report: SIEMENS INDIA

>India Wireless: 3G Auctions(MACQUARIE RESEARCH)

Event
■ The auctions for 3G and the Broadband Wireless Access (BWA) spectrum are set to start on 9 April 2010 (Detailed time table of auctions in Figure 5). We look at implications for Indian telcos and the likely bidding behaviour. We maintain our view that prices discovered from the auctions will likely surprise on the upside.

Impact
■ Prices likely to surprise on the upside given tremendous interest. We believe likely cash outflow for pan-India 3G and BWA spectrum to be ~US$2bn and ~US$750m-1bn, respectively. We expect fierce bidding given only 3 slots are available for 3G and 2 slots for BWA in most circles. We expect incumbents Bharti, RCOM and Vodafone to bid aggressively for pan-India 3G, Idea to bid aggressively in about 12-15 circles and Aircel to bid most aggressively in existing 2G strongholds numbering about 5-6 circles. Tata Teleservices (Not listed) is also likely to bid aggressively for 3G spectrum in about 15-16 circles, where they have already established a 2G GSM presence.

■ Auction guidelines validate our negative investment thesis on MTNL as it outlines that MTNL needs to match the highest bid price in both Delhi and Mumbai (We expect a US$750m combined outgo for the two cities). For the 3G slot reserved in each of the 22 circles, state-owned operators, MTNL and BSNL, would need to match the price discovered through the
auction process and are subject to the same payment terms as private telcos.

■ Bharti balance sheet will be stretched post Zain acquisition. We note Bharti’s balance sheet will be the most stretched in the sector (FY11E Net Debt/Equity of 1.4x and Net debt/EBITDA of 2.8x) post 3G auctions, assuming the Zain Africa acquisition goes through post regulatory approvals. (See Figure 1).

■ Commercial launch of 3G only in Dec 2010 or later. Even though auctions are being held in April, spectrum will likely not be made available for network rollouts before September 2010, and rollouts will take another 3-6 months.

■ Spectrum will be allocated through a simultaneous ascending e-auction comprising two stages. The ‘Clock Stage’ will establish the final winning bidders and a common winning prize for all lots of spectrum bands in a service area. The ‘Frequency Identification stage’ will be a random identification of frequencies performed automatically by Electronic Auction.

■ 3G spectrum comes with stringent rollout obligations for winners. If the 3G winner does not achieve its rollout obligations (detailed on page 5), it shall be allowed a further period of one year to do so. On failure to do so, even within the extended period, the spectrum assignment shall be withdrawn by Govt.

Outlook
■ Reiterate Underweight on India Telcos on bleak growth outlook and premium valuations. Expect wireless KPIs for listed telcos to continue to deteriorate for next two quarters; we see downside risks to consensus estimates for FY3/11E. Indian telcos trade at a significant premium to the region on EV/EBITDA with comparable growth and lower dividend yields - Bharti at 7x, Idea 5.8x, and RCOM 5.9x FY3/11E vs the Asia telcos average of 4.3x. We expect this premium to narrow as India’s growth premium subsides.

To read the full report: INDIA WIRELESS

>RELIANCE INDUSTRIES: Riding global GRM gains (MACQUARIE RESEARCH)

Event
■ Our global refining team believes that gross refining margins should improve faster than consensus forecasts. We believe RIL shall be a key beneficiary, given its recently doubled capacity and highly complex facilities. We raise our target price for RIL by 3% to Rs 1,293/share. RIL is one of our top regional sector picks.

Impact
■ The global refining team is bullish on GRMs due to an anticipation of improvement in middle distillate balances, led by the economic recovery. While Asian gasoline demand is driving gasoline cracks currently (~US$13/bbl, up 2.5x from Oct-Dec 2009), middle distillate cracks are expected to rise from the present US$7/bbl levels to US$15/bbl by 2013.

■ RIL stands to benefit heavily from the spurt in crack spreads. Reliance’s high-complexity refinery has a high proportion of light and middle distillates (especially diesel) in its product slate (~75% in total). Thus, RIL is poised to take maximum advantage of the anticipated rise in distillate cracks, through a larger positive impact on its GRMs vis-à-vis Singapore Complex margins.

■ Above consensus earnings forecasts. We are raising our GRM forecasts for RIL by US$0.8/bbl for FY11, and forecast a corresponding 3.7% increase in FY11 earnings for RIL. We now stand ~25% above consensus.

Earnings and target price revision
■ We are hiking RIL’s earnings forecasts by 3.7% for FY11 and 2.2% for FY12, and our target price by 3% to Rs 1,293/share.

Price catalyst
■ 12-month price target: Rs1,293.00 based on a Sum of Parts methodology.
■ Catalyst: Exploratory upsides, and a decision of RIL-RNRL court case.

Action and recommendation
■ We anticipate a strong 4QFY10 for Reliance, and maintain our Outperform rating on the stock. We recommend RIL as one of our top sector picks, as it benefits from the upswing in GRMs (see fig 2) apart from the volume ramp-up of KG basin gas.

To read the full report: RIL

>INDIA OIL AND GAS: CRUDE OVERDRIVE (MACQUARIE RESEARCH)

Event
■ Crude price upgrade. Macquarie’s oil economist, Jan Stuart, has upgraded the WTI crude oil forecast by 13-18% for 20010E–13E and long-term forecast from US$75/bbl to US$85/bbl.

■ Upstream companies’ gain. We sharply upgrade our target price for Cairn India by ~15% as it is India’s only crude oil pure-play. We also upgrade ONGC, OIL & RIL by 2-4%. We re-affirm our switch recommendation from ONGC and Cairn India to RIL and OIL.

Impact
■ Stronger fundamentals. Fundamental data have turned and finally show tightening oil supply and demand balances. Inventories are still high. But it now appears that they did fall late last year and that inventories should normalize quite quickly over the course of this year. The driving force toward leaner balances is demand growth in emerging economies. That will become
especially obvious once OECD oil consumption stops falling next quarter.

■ We also raise our Long Run oil price. We use $85/b WTI as a proxy for long-term cost of incremental supply, after taking a fresh, in-depth look at cost-structures and margins of Canadian oil sands projects.

■ GRM estimates remain unchanged: Our refining margins estimates remain unaffected by the increase in crude assumptions, since GRMs follow their own demand-supply dynamics, which we believe is improving.

■ Cairn India to gain the most as it is an oil pure play: We upgrade our target price by ~15%. Our near-term earnings upgrade is slightly less steep though (+13% FY11E & + 10% FY12E) given a slow production ramp-up.

■ ONGC, OIL positive impact partially offset by subsidy: Although, there is no clear subsidy-sharing mechanism as yet, the government does tend to increase ONGC & OIL’s subsidy burden as oil prices rise. This takes away a bulk of the upside. Hence we believe gains to these companies would be diluted, and hence upgrade ONGC and OIL’s target prices only mildly by 2.5% and 2.0%, respectively.

■ RIL is not significantly leveraged to crude with only 4% of its turnover coming from crude oil. Nevertheless it is not burdened by subsidies and it is an operationally leveraged business. We upgrade RIL’s target price by 4%.

Outlook
■ GAIL and Reliance Industries remain our top sector pick. We believe both are poised to witness a volume and margin expansion. RIL’s upstream KGD6 gas ramp-up is poised to nearly double GAIL’s gas transmission volumes. While GAIL’s petrochemical margins are poised to improve, we believe RIL’s recently doubled refining capacity is well-timed to capitalise on a rebound in gross refining margins.

To read the full report: OIL & GAS

>JINDAL SAW LIMITED: Hidden value in Rajasthan (MACQUARIE RESEARCH)

Event
■ We spoke to management of Jindal Saw Limited (JSAW) to get an update on the business. We remain confident that JSAW will be able to grow its order book as the demand outlook is improving. Rajasthan iron ore mines are likely to get environmental clearance by 10 April. We believe these mines can add more than 20% to our valuations. Adjusting for investments, JSAW is trading at a modest 6.0x FY12E PER.

Impact
■ Iron ore mines provide 20% upside potential to our valuations. JSAW has received approval from the government for mining of two iron ore mines in Rajasthan. As per a third-party appraisal report, these mines have iron ore resources of 129m tonnes (avg Fe content 30%). Even after factoring in higher cost and low Fe content, we believe these resources have a value of
US$250m based on NPV.

■ Land acquisition will be a key catalyst. JSAW plans to start beneficiation of mine by August 2010, if it receives the environmental clearance. The block is on the non-forest land; hence, forest clearance should be easier. We think the biggest challenge will be the acquisition of land, as the area covers 71,590 households. We do not believe the market is ascribing any value to these resources, which can change if the project gets these statutory clearances.

■ Welded pipe order book set to improve: The pipe orders from the MENA region have picked up, as is evident from some of the recent orders. Pipe orders from Iraq, which were held up due to the election, will now be awarded. GAIL’s tenders for three new pipelines have been delayed, and orders are now expected to be awarded in June quarter. We expect JSAW to maintain the order backlog in the current quarter and grow it significantly over the next six months.

■ DI strong, seamless improving. Order flows in the DI pipe segment remain strong. JSAW is currently making a margin of US$225/t, and the company is confident of being able to raise prices to pass through coal and iron ore prices. Seamless pipe demand is improving, but large orders will likely take a further three to six months to materialise.

Earnings and target price revision
■ No change.

Price catalyst
■ 12-month price target: Rs242.00 based on a Sum of Parts methodology.
■ Catalyst: i) New orders and ii) timely commissioning of new facilities

Action and recommendation
■ Upside risk to our earnings estimates. Management is guiding for production of 850–900k tonnes and a margin of Rs10,000/t in FY11E. Our estimates for production and margins are 8–12% and 5% lower, respectively.
■ Our SOTP-based target price of Rs242 includes Rs208 (14x FY11E PER) for the pipe business and Rs34 (70% discount to market value) for investments.

To read the full report: NUCLEAR POWER

>ASIA STRATEGY: Value buying opportunities emerging

Event
■ We provide an update on valuations, key cyclical indicators, and where we see value emerging across the region after recent market volatility.

Impact
■ With global economic growth firming – albeit in fits and starts -- and monetary conditions likely to remain very loose for an extended period of time, the macro backdrop is, broadly speaking, supportive of healthy equity market conditions. Earnings forecasts are also far from unreasonable, in our view, compared to previous recoveries. All this adds up to a healthy outlook for Asian equities on a 12-month view (for more details on this see our recent note “Asia strategy: Would you buy Asia at 2.5xP/BV? You should!”, 2 February 2010).

■ But in the near term, Asia ex Japan is likely to remain range bound or even drift lower. Current valuation levels in many cases make for an underwhelming near-term risk/reward trade-off, and key cyclical indicators such as earnings revisions1 and the OECD LI (that are tightly correlated with Asian markets) are falling and are likely to continue to do so in the near term.

■ It is hard to overstate the importance of the fact that our earnings revisions indicator is falling – average returns are -25% when it is falling and Asia ex Japan has risen only once when this indicator has been falling and that was way back in 1991, when China's economy was about 7% of its current size, India had a GDP per capita of US$315, and Korea‟s export-to-GDP ratio was
about half what it is today.

Outlook
Despite this subdued near-term outlook for equity markets, there are pockets of value in Asia:

• Stocks that are plain and simply cheap, in an absolute level sense, have a high probability of outperforming. This applies under all market conditions. The best valuation metric to use here is P/BV and our latest screen features quite lot of Korean stocks (as it usually tends to) but also a surprisingly high number of Hong Kong/China stocks.

• China. China has been treated harshly in the recent sell-off, with the market the second worst performing this year. We say harsh because we don't think China deserves this high-beta status – its earnings growth is relatively stable, it has a strong structural element to its growth rate (making it relatively resilient to external shocks), and it has policy flexibility. Looking ahead, with valuations now really quite attractive, growth likely to remain strong, earnings expectations very reasonable, and 2Q by far and away the (traditionally) strongest quarter for China, now is a very good point to start accumulating China stocks.
  
• Telcos. Not sexy. And some argue that they are a value trap. But telcos are, by far, the cheapest sector in Asia ex Japan and many of the stocks feature heavily on our screens for both value and dividend yield. With the balance of risks to markets skewed slightly to the downside in the near term, the odds of this sector continuing its recent run of outperformance is high, in our view.

To read the full report: ASIA STRATEGY

>LARSEN & TOUBRO (MACQUARIE RESEARCH)

Event
■ We met L&T management as part of our Oil & Gas Yatra with focus on hydrocarbon business. We also revisit scenarios where L&T’s order inflow is likely to fall short of the guidance of 30% growth as some of the large ticket orders remain undecided.

Impact
■ Order inflow pipeline reasonable, timing remains a concern: L&T is currently pursuing a number of opportunities in the hydrocarbon space from clients like ONGC (ONGC IN, Rs1100, UP, TP: Rs919 – Jal Irani), BPCL (BPCL IN, Rs542, OP, TP: Rs695 – Jal Irani), HPCL (HPCL IN, Rs344, OP, TP: Rs460 – Jal Irani), etc. There are opportunities also emerging in the Middle East. However, key project awards from ONGC continue to experience delays, which can impact order inflow targets.

■ Vertical integration has made L&T more competitive: L&T is much more comfortable regarding its competitiveness vis-à-vis Korea on account of vertical integration and capacity addition. L&T has recently added an offshore installation vehicle in JV with Sapuracrest, which had to be outsourced earlier, and created an offshore fabrication yard in Oman and fabrication yard capacity at Hazira and Powai. Moreover, competitive intensity has also reduced as some of the new entrants rethink strategy after cost overruns.

■ L&T likely to fall short of target of Rs200bn order inflow in 4QFY10: L&T needed order inflow of Rs200bn in 4QFY10 to achieve its guidance of 30% growth in FY10 while only Rs38bn of orders have been announced so far. However, the company is L1 in numerous projects while there are order inflow possibilities from oil majors, roads and power projects.

■ Couple of large orders can still swing the needle: L&T is pursuing large orders from ONGC (B-193), Oman airport order and its in-house Rajpura power project which can each add US$1bn to the order inflow.

■ Sensitivity to order inflow shortfall is limited: In case of order inflow growth of only 20% as against guidance of 30%, order backlog would fall short by only 9%. The impact on revenues and earnings over next two years would be limited to 2–6%, respectively.

Earnings and target price revision
■ No change.

Price catalyst
■ 12-month price target: Rs1,841.00 based on a Sum of Parts methodology.
■ Catalyst: execution delivery and order booking in 4QFY10

Action and recommendation
■ No long-term impact from miss in order inflows in 4QFY10: In case L&T achieves Rs150bn order inflow instead of the required Rs200bn, our view is it would look like a big miss, but the sensitivity to earnings is not much. Also, over a 12–15 month view, we remain positive on the stock as execution has bottomed out in 3QFY10, infra capex remains strong and there was pick-up in private capex in 2HCY10.

To read the full report: LARSEN & TOUBRO

>RELIANCE INDUSTRIES: 4QFY10 shall be an inflection point

Event
■ During April – Dec 09, RIL has doubled refining capacity and added one of the world’s largest gas facilities, and yet earnings have stagnated due to more than halving in GRMs. We believe a recent tripling in GRMs, further gas rampup and shift to cheap in-house gas shall herald 4QFY10 as an inflection point.

■ We forecast a 39% QoQ rise in RIL’s 4QFY10 PAT. Our scenario analysis (Fig 1) suggests a Rs 15–25bn QoQ PAT growth due to the above factors.

Impact
■ Sustained and significant rise in GRMs: Singapore GRMs have tripled QTD to US$ 6.0/bbl from near 10-year low of US$ 1.7/bbl during Oct-Dec 09. Our sensitivity analysis shows a US$ 2.5-4.0/bbl QoQ rise in GRM adds Rs 13-21 bn to PBT. We believe RIL enjoys a double leverage to rising GRMs: (1) Our regional refining team believes that the rise in margins is sustainable and forecasts a rise in refining margins from US$ 3.5/bbl in 2009 to US$6/bbl in 2010. Nearly 1m bpd of refining capacity has closed globally, and during CY10 capacity closures is forecast to exceed additions (Figs 2 and 3)

(2) A potential widening in light-heavy crude price differential shall further significantly benefit Reliance as it has amongst the world’s most complex refineries. High refined product inventory levels (Fig 5) has constrained widening of light-heavy spreads. A strong growth in US economy (5.9% in 4Q09 actual) has recently spurred demand and hence could cut inventory.

■ Ramping up of KG-D6 gas production: We believe RIL’s KG-D6 production has increased to ~60 mmscmd from an average of 45mmcmd during 3QFY10, a 33% QoQ jump. Production plateau of 80-89mmscmd is unlikely until end CY-10 though, once GAIL India (GAIL IN, Rs400.10, Outperform, TP: Rs506.00) expanded HBJ pipeline is fully commissioned.

■ Reduction in operating costs: RIL has switched over from imported LNG, which costs ~US$9/mmBTU for in-house use to KGD6 gas saving it US$ 2- 4/mmBTU. We estimate a PBT increase of Rs 2-5bn QoQ.

■ Petchem margins also higher: We estimate that polymer integrated margins are up 13.3% QoQ and polyester margins have risen 2.8% (Figs 6, 7 & 8)

Earnings and target price revision
■ No change

Price catalyst
■ 12-month price target: Rs1,207.00 based on a Sum of Parts methodology.
■ Catalyst: New oil & gas finds, and potential acquisitions.

Action and recommendation
■ RIL is one of our top picks. We believe the company is not only poised to witness strong and highly visible earnings growth over the next two years, but sharply enhanced upstream exploration activities and likely corresponding finds shall sustain growth in the longer term.

To read the full report: RIL

>Nuclear Power revival in India (MACQUARIE RESEARCH)

■ A new Asian dawn for nuclear power led by China and India
We released a thematic report on Asian nuclear power on 18 February 2010 (Hunting Stocks-A new Asian dawn for nuclear power). Outlook for nuclear power in Asia looks increasingly favourable amidst fast-growing electricity demand in China and India. China and India are poised for a substantial expansion in their nuclear electricity generation capacity. The IAEA projections imply that Asia and the Middle East will account for 52% and 66% of the global nuclear power capacity by 2020 and 2030 respectively versus 29% in 2008. In
this note, we focus on nuclear opportunity in India.

■ Positive but long-drawn benefits
India is in the midst of a nuclear power renaissance. The country has rejoined the international nuclear community after more than three decades in the wilderness. However, we believe it is likely to be a lengthy process, with the opportunities best seen from a long-term perspective for equipment manufacturers and the power generation sector.

■ Nuclear still a very miniscule part of India’s power plans
Power from India‘s nuclear power plants contributed to just 3% of the country‘s installed capacity base at the end of April 2009, and nuclear power still provides just 2% of India‘s total electricity generation. A further 2.8GW in net capacity is being constructed now, which will take India‘s net nuclear power capacity to over 7GW –7.8GW in gross capacity – by the end of the current 11th Five-Year Plan in 2012. Even before the Nuclear Supplier‘s Group waiver, India had aimed to have 20GW of capacity by 2020. However, now that India has joined the international nuclear community, these targets are likely to be scaled upward.

■ NPCIL, the nodal agency, driving growth
Government-owned NPCIL is responsible for constructing and operating India‘s commercial nuclear power plants. It has 17 nuclear power stations in operation, and one entering into operation now. Five more nuclear power plants currently are under construction. NPCIL is preparing to build more power reactors, backed by improving access to nuclear fuel and technology.

■ Foreign investment starting to kick in
Fuel supply agreements have been signed with countries like France, the US and Russia post the 123 agreements and NSG waiver that guarantee uninterrupted uranium fuel supplies for its nuclear power reactors and unrestricted transfer of technology. Also, international players from Russia, France, etc are expected to
put up 6-8GW of nuclear power plants in the near future for which sites are being finalised already. Construction opportunity for players like L&T, BHEL, HCC, etc could be as large as US$4-5bn from this in the next couple of years.

■ Power equipment manufacturers could be key beneficiaries
Indian power equipment manufacturers now have an opportunity to supply spares and components not only to indigenous power plants but also to manufacturers of power plants based on foreign technology. Firms that may benefit in the manufacturing sector include L&T and BHEL, Gammon and HCC. Private utilities would still have to wait until India signs subsequent agreements to make the NSG waiver and 123 agreements operational.

To read the full report: NUCLEAR POWER

>INDIA WIRELESS SECTOR: Aircel, Idea rise; Bharti, Vodafone stable (MACQUARIE RESEARCH)

Event
■ GSM operators (excluding the GSM SIMs of RCOM and Tata Tele) added 13.9m SIMs in January 2010, suggesting an accelerating trend, following 12.5m SIMs added in December, 11.1m in November, 10.3m in October and 8.6m in September. We caution investors that multiple SIM ownership is increasing and that accelerating SIM addition will likely not translate into revenue growth. As greenfield operators Uninor and S Tel ramp up their GSM services, we expect competition to intensify, hurting the revenue market share and profitability of GSM incumbents. We reiterate our Underperform rating for all Indian wireless telcos under our coverage.

Impact
■ Industry net adds reaches 13.9m, helped by ramp up of Uninor, S Tel. Uninor and S Tel ramped up their operations, with Uninor capturing 33% of net add share in its eight circles and S Tel cornering 20% net add share in its three circles in January.

■ Key notables in January net adds: Aircel, Idea – positive. Both Aircel and Idea registered sharp increases in net adds in January, with Idea reporting MoM growth of 33% (up from MoM decline of 33% in December) and Aircel reporting MoM growth of 21% (up from MoM growth of 4% in December). Idea’s net add growth chiefly came from Bihar and Gujarat, while Aircel continued its strong performance in Tamil Nadu.

■ Monthly net adds for Vodafone remain stable. Vodafone added 2.74m subscribers in January (vs 2.79m in December and 2.78m in November), while Bharti added 2.9m in January the same as that in December.

■ Price cut contagion is likely to spread to key segments of postpaid/ corporate, wireless data, international roaming and SMS. Further ramp-up and rollout of services by greenfield entrants will likely lead to a further cut in prepaid and increasingly aggressive on-net pricing. Tata DoCoMo has started this with its Buddy plan, which includes unlimited friends. Furthermore, MNP remains a negative catalyst for price cuts by incumbents to stay competitive in the segments of postpaid/corporate, wireless data, international roaming and SMS. Key risks to the downside emanates from our current EBITDA per minute estimate of 14 paisa for Bharti, 12 paisa for Idea and 12 paisa for RCOM in FY3/11, as EBITDA margin dislocation will likely be much higher.
Outlook

■ Reiterate Underweight view on India Telecom stocks. We expect wireless KPIs for listed telcos to continue to deteriorate for the next two quarters, and we see downside risks to consensus estimates for FY3/11. Valuations remain pretty full, in our view, while industry consolidation is at least 12–18 months away. If the share prices were to correct by 10–15%, we could become more positive.

To read the full report: WIRELESS SECTOR