>Oil Marketing Companies (JM FINANCIAL)

Kirit Parikh Committee – Logical recommendations but implementation difficult.

■ Logical recommendations: The Kirit Parikh Committee report has recommended a series of measures to make fuel prices in India sustainable and viable. These recommendations include increasing Kerosene prices by Rs6/lit (c.65% increase), increasing LPG price by Rs100/cylinder (c.30% increase) and totally eliminating the subsidy on Auto fuels – Petrol (or Motor Spirit) and Diesel. The Committee has also recommended that the under-recovery on LPG and Kerosene could be shared by the upstream companies like ONGC and OIL in a graded method based on the prevailing crude price.

■ but implementation unlikely to be easy: These recommendations make economic sense and we would be happy to see them implemented. We believe that increasing Petrol price is the easiest option as the increase required to bring Petrol price to International parity price is just c. 8% or Rs4/litre. In diesel, the increase required to eliminate under-recovery is just about 6% or c. Rs2/litre. However, given the concerns on inflation (particularly food articles inflation), we believe that it may not be easy to implement even a small increase in diesel price. We also believe that it will be impossible to implement a 65% increase in Kerosene price and a 30% increase in LPG price and the only solution is to increase the product prices in a phased manner (if international prices do not increase in the meantime).

■ Unless implemented fully, impact on under-recoveries minimal: We estimate FY10E total under-recoveries to be c. Rs451bn with LPG and Kerosene contributing c. Rs313bn and Rs138bn under-recovery due to Petrol and Diesel. These estimates are based on current crude and product price and current forex. LPG and Kerosene subsidies make c.69% of the total under-recoveries and if the prices of these products are not raised, this will be just another committee with one more report.

■ Impact on companies: The Oil Marketing Companies – Indian Oil, Bharat Petroleum and Hindustan Petroleum are likely to benefit primarily by way of improved cash flow. ONGC and OIL India would benefit as there would be a clear and transparent method of calculating the under-recovery. The biggest beneficiary of the recommendation is likely to be GAIL, which has not been mentioned and is therefore likely to be excluded from the under-recovery process. In FY10E, GAIL has already borne under-recovery of Rs9.9bn in 9MFY10 and therefore on an annualized basis, EPS of GAIL would improve by c. Rs6.7/share.

To read the full report: OIL MARKETING COMPANIES

>HINDUSTAN UNILEVER LIMITED (JM FINANCIAL)

■ Building a steadier tomorrow for itself: The cover page of HUL’s 2002 annual report read: “We do not inherit the world from our ancestors. We borrow it from our children”. We are keen to believe that HUL’s laundry price adjustments (c.12% cut in Surf, c.25% in Rin) and all other initiatives to offer ‘better consumer value’ reflect steps towards building a steadier future for itself. 4-5%-pts market share losses in laundry/soaps over past 12 months coupled with prolonged period of sub-peers growth rate highlighted that HUL’s stance of aggressive price hikes and margin-consciousness (we suspect some of this was even at the cost of product quality) weren’t really the most optimum strategies in a fiercely competitive market place. Given its distribution muscle, a right price-cum-quality value mix is perhaps a good first-step to help HUL address the issues. In our end-Dec’09 management meeting, HUL’s CFO had indicated that the company remains committed to participating in the huge growth opportunity in the Indian
market, even if (hypothetically) it brings with it the need to lower its operating margin-profile from the current level. Refer our report “CFO meeting notes: portfolio, premiumisation & profitability” dated 23 Dec 09 for details

8-10% earnings and TP cut; will there be light?

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■ Near-term earning weakness imminent; cutting FY11-12E EPS by 8-10%: While HUL’s aggressive ‘competitive growth’ strategy appears to be the right step, near-term earning weakness is imminent. As per our workings, the pricecuts are likely to result in 5-6% cumulative drop in laundry realization over FY10- 11E and a 225-250bps compression in soaps & detergents segment gross margin. We estimate Surf and Rin’s share in HUL’s laundry revenue to be 30-35% and 15-20% respectively. Note that the cumulative drop in laundry realization over 2003-04 (P&G price war) was c.6%. We have, however, cushioned some margin impact by building in moderation in A&P growth going forward as: (a) HUL has already hiked spends aggressively in FY10, (b) Lower prices may gradually replace A&P. We are also assuming that HUL’s cost savings plan will continue to yield results.

■ Reducing target price to Rs253; continue to prefer ITC for a premium growth profile: We have lowered our FY11-12E EPS by 8-10% based on the effected price adjustments (P&G yet to react but is quite likely to), ‘equalization’ of prices of other Surf and Rin SKUs and building in slight cut in Wheel as well. Our revised EPS estimates for FY10-12E are Rs10.0, Rs10.6 and Rs12.2. We continue to prefer ITC on account of its premium growth profile. Refer our note on ITC “Portfolio power: multiple drivers of growth” dated 25 Jan 10 for details.

To read the full report: HUL

>ACC LIMITED (IIFL)

ACC’s 4QCY09 result was considerably below our expectation. Standalone sales increased 2% YoY to Rs19.2bn, against our estimate of Rs19.4bn. PAT declined 7% YoY to Rs2.8bn against our estimate of Rs3.7bn. The negative surprise was primarily due to an unexpectedly steep fall in realisations, coupled with an increase in other expenses. Realisation dropped on account of a sharp fall in prices in the key central and south regions. Prices have recovered sharply in the central region, which accounts for ~25% of ACC’s total cement volumes. We expect the positive news flow from the central region to boost the performance of ACC’s stock in the short term. That said, the valuation is not cheap; we continue to prefer Ambuja Cement, which has a better regional mix and reasonable valuations, in our view. We have tweaked down our estimates, and retain REDUCE on ACC.

Sharply below expectation

■ Muted volume growth: ACC's cement volumes declined 2% YoY on account of poor demand in the south and capacity constraints in other regions. A major part of ACC's expansion in Bargarh, Orissa, was completed in 3QCY09. The 3mtpa expansion in Wadi, Karnataka is likely to start by mid-2010 (about six months later than the original schedule). The delay in expansion in Wadi is likely to lead to moderate volume growth in CY10.

■ QoQ realisation fall steeper than expected: ACC's cement realisation increased 4% YoY but declined 9% QoQ. Prices in the central region have rebounded sharply. However, with likely depressed prices in the south and moderate price declines in other regions, we expect the overall realisation to remain under pressure in CY10 as well.

To read the full report: ACC

>INDIA BUDGET: Muted expectations!!!! (HSBC)

We expect that the budget for the fiscal year ending March 2011 is unlikely to represent a major shift in government policy. A gradual winding down of fiscal stimulus, a 15-20% rise in government expenditure, and building in robust economic growth of 8.5-9% is likely to lead the government to project a lower deficit (of 5.5%). However, given that most of the lower deficit number is on account of cyclical rather than structural factors, our economist, Robert Prior-Wandesforde, believes the RBI may raise rates at or shortly before the next policy on 20 April 2010, given the combination of this modest budget disappointment and more inflation upside surprises. Risk of this may blunt any budget related enthusiasm for stocks.

■ FY2010/11 budget unlikely to unfold any major stock catalysts other than higher spending plans in key areas

■ Sectors likely to benefit: Infrastructure, Construction & Engineering, Banks on higher spend

■ Stocks impact: Positive – L&T, BHEL, IRB, Voltas, Banks, HCL Tech; Negative – BPCL, HPCL, ACC

Notwithstanding our expectation of a muted market impact, there may be select sectors that could benefit from higher spending (construction & engineering, infrastructure) and higher growth + rates (banks), but oil marketing and cement companies (in the South) run the risk of a negative market reaction given the sharing of subsidy burden and lack of pricing power.

Key downside risks are 1) likely optimistic revenue projections in case economic growth fails to pick up, and 2) large borrowing by the government to fund the deficit potentially crowding out private borrowers.

Please refer our summary of macro and sector related impacts of the budget inside.

To read the full report: INDIA BUDGET