>Indian Power Industry - Current Scenario and Opportunities Ahead

Generation
India has the fifth largest generation capacity in the world with an installed capacity of 152 GW as on 30 September 2009, which is about 4 percent of global power generation. The top four countries, viz., US, Japan, China and Russia together consume about 49 percent of the total
power generated globally. The average per capita consumption of electricity in India is estimated to be 704 kWh during 2008-09. However, this is fairly low when compared to that of some of the developed and emerging nations such US (~15,000 kWh) and China (~1,800 kWh). The world average stands at 2,300 kWh2. The Indian government has set ambitious goals in the 11th plan for power sector owing to which the power sector is poised for significant expansion. In order to provide availability of over 1000 units of per capita electricity by year 2012, it has been estimated that need-based capacity addition of more than 100,000 MW would be required. This has resulted in massive addition plans being proposed in the sub-sectors of Generation Transmission and Distribution.

Transmission
The current installed transmission capacity is only 13 percent of the total installed generation capacity3. With focus on increasing generation capacity over the next 8-10 years, the corresponding investments in the transmission sector is also expected to augment. The Ministry of Power plans to establish an integrated National Power Grid in the country by 2012 with close to 200,000 MW generation capacities and 37,700 MW of inter-regional power transfer capacity. Considering that the current inter-regional power transfer capacity of 20,750 MW4, this is indeed an ambitious objective for the country.

Distribution
While some progress has been made at reducing the Transmission and Distribution (T&D) losses, these still remain substantially higher than the global benchmarks, at approximately 33 percent. In order to address some of the issues in this segment, reforms have been undertaken through unbundling the State Electricity Boards into separate Generation, Transmission and Distribution units and privatization of power distribution has been initiated either through the outright privatization or the franchisee route; results of these initiatives have been somewhat mixed. While there has been a slow and gradual improvement in metering, billing and collection efficiency, the current loss levels still pose a significant challenge for distribution companies going forward.

To read the full report: POWER SECTOR

>ICSA LIMITED: Ready to takeoff

We recently had a conference call with the management of ICSA (India) Ltd. to have an understanding of i) the corporate strategy for their new SMART meters manufacturing facility, ii) new product development, and iii) recent developments within the T&D industry, specifically RAPDRP. ICSA is bullish on the demand potential of the SMART meters facility with peak revenue potential of Rs.1000–1500mn in the next 3-4 years. ICSA is also bullish on Power Quality Management Systems (PQMS), designed to monitor interruptions, durations, voltages etc., at each distribution transformer level. Near-term triggers to the stock include possible order inflow from high margin ESS business from Q3 FY11 onwards, fruition of which could provide an upside to the current order book of Rs.18bn. We reiterate our BUY rating on the stock with a price target of Rs.239/share.

■ Strengthening SMART meter capacity
ICSA has set-up SMART meters manufacturing facility in Andhra Pradesh with a total capacity of 150,000 meters/month at a cost of Rs.260mn. SMART meter is a combination of energy meter and a communication device, which would form a part of smartgrids network in the country. ICSA sees immense demand potential for these meters going forward. Presently, the company is planning to produce energy meters and other embedded solutions like RTU and IAMR in this facility, which would be supplied to its distribution utilities. The company is looking for revenue of ~Rs.1,000–1,500mn/year from this business unit at the peak, which is expected to happen in the next 3–4 years. The company is expecting margins of ~10–12% for energy meters and ~20%+ for SMART meters.

■ Product pipeline getting stronger with Power Quality Management System (PQMS)
ICSA has recently completed a pilot project for installation of a power quality management system (PQMS). PQMS has been designed specifically to monitor interruptions, durations, voltages etc., at each distribution transformer level. This equipment would help to improve power quality. The company expects immense potential for this new product going forward.

■ Expects orders inflow for high margin ESS business by Q3FY11 onwards under RAPDRP
The company is maintaining the same guidance in terms of orders inflow for its high margin ESS business from System Integrators by Q3FY11 onwards under RAPDRP. For SCADA solutions, the company is expecting floatation of tenders after one and a half month. Currently, the company has placed bids for projects worth ~Rs.2bn for ESS business (other than SCADA solutions) and ~Rs.8bn for overall ESS and SCADA solutions. These above said orders are not part of the opportunities available under RAPDRP.

■ Looking for other opportunities available in Oil & Gas and Water segment
ICSA is considering a business opportunity of Rs 16–17bn for its product Intelligent Cathodic Protection System (iCap) from the oil and gas segment in the next 2–3 years. Apart from this, the company is looking for a business opportunity of Rs.21–22bn for its products Intelligent Automatic Water Meter Reading and Agricultural Load Management System from water and irrigation segment in the next 2–3 years.

■ Maintain “BUY”, with a price target of Rs.239/share
We expect a subdued performance in 1Q FY11 – net sales of Rs.3bn, down 2% Y-o-Y and PAT of Rs.247mn, down 27% Y-o-Y. However, we maintain our full year estimates for revenue and PAT despite subdued 1Q as we expect 2H FY11 to be much better than 1H, since generally 60% of revenues get booked in 2H. We thus maintain our BUY rating on the stock with a price target of Rs.239/share.

To read the full report: ICSA LIMITED

>GLOBAL FORECAST: Cooling Trend In Global Growth

Scotia Economics now expects that global growth will advance by 4.4% this year and 3.8% in 2011 (based upon a purchasing power parity weighting of 34 countries), with emerging countries still outpacing the performance of the advanced nations by a considerable margin. This continues a recent pattern of trimming our economic and financial market forecasts to reflect a number of key developments that are restraining activity around the world.

First, we have pared back domestically generated growth in the United States from already soft levels, with the increased economic and financial market uncertainty since late winter further undercutting confidence and business expansion plans. In a chronically weak job market, Americans continue to focus on paying down high levels of household debt. Housing activity has been adjusted lower to reflect downward revisions to sales and building data. The one relative
bright spot in the U.S. outlook continues to be business investment in machinery & equipment as firms take advantage of increasing order books and expanding international trade, though the mildly lower trajectory now projected for U.S. real GDP will likely take a bite out of the comparatively solid pace of earnings growth.

Second, the economic fallout in Europe from the sovereign debt crisis and the budgetary problems in the United Kingdom will progressively ripple through the region and the rest of the world in the second half of the year and in 2011. Beyond the negative economic impact on the region from the financial upheaval, the expected slowdown in domestic spending will dampen activity internationally through reduced imports and the weaker euro. Nevertheless, we have adjusted our 2010 forecast for the United Kingdom slightly higher because of the much better-than-expected results in Q2 attributable to the slowly emerging recovery that preceded the recent turbulence. Looking ahead, the accelerated pace of fiscal consolidation points to a period of slower, rather than faster, economic activity in the second half of this year and into 2011. While 2011 growth prospects for Germany and France will be limited due to fiscal consolidation and an export sector slowdown, the impact will be offset by a pick-up in activity in the euro zone periphery as these countries emerge from recession.

To read the full report: GLOBAL FORECAST

>INDIA STRATEGY: Chart Focus – Evaluating Tail Risk

The Debate: Is the market ignoring the macro pressures on inflation and the micro pressures on profit growth, especially given the premium valuations for equities? Hence, is the market set up for a big sell-off?

Market View: The market has reacted nonchalantly to a tepid earnings season, especially with the larger companies tending to disappoint on earnings. While inflation is a concern, the market seems to hold the view that the pressures will recede, and hence that India’s premium multiples will continue.

Our View: The 99%/1-week VAR (value-at-risk) represents the weekly market move that has a 1%
probability – i.e., the tail risk. When the historical VAR falls, it suggests that the market is increasingly complacent about tail risks. The 99%/1-week VAR is at a level which is consistent with a large sell-off. Going back 25 years, there are seven occasions when the VAR was at its current level (of less than 6%). Eventually, when VAR rises from this level, the market sells off 10% on an
average in a week (with the seven data points ranging from -5% to -13% – Exhibit 2). Note, though, that the historical VAR can remain at low levels for many weeks before culminating in a sell-off (on an average of 65 weeks!). VAR is a good indicator for impending tail risk, but it is not useful for timing the event. Fundamentally, India’s tail risk emanates from either a sharp world recovery (leading to inflation) or a “double dip” (causing a shortfall in funding for the current account).

Conclusion: While tail risk is in play, we do not believe that the market is likely to sell off in a big way anytime in the near future. The market is likely to reach higher levels before such a sell-off happens. History tells us that we may have to wait another year or for another 50% rise in index levels before tail risks play out. The market has spent only six weeks so far at the current VAR level, vs. the historical average of 65 weeks.

To read the full report: INDIA STRATEGY