>INDIA STEEL: Global weakness a concern, but India stocks discounting a distress scenario

■ Action: Stocks are building in distress; we recommend buying

After the recent correction, India steel stocks are factoring in steel prices of USD550/t (current prices ~USD630/t), at which close to 50% of global capacity should turn unprofitable despite the fall in raw material prices, as per World Steel Dynamics. We don’t expect such a capitulation in steel

prices to be sustained and hence remain positive on the sector. We prefer integrated steelmakers such as TATA Steel and SAIL in our coverage universe, although TATA Steel is our top pick, given near-term catalysts such as 2.9 mtpa expansion by FY12.

■ Catalysts: Q3FY12 to be weak, but a recovery likely from Q4FY12

We expect Q3FY12 to be a weak quarter on: 1) a seasonal slowdown and 2) companies still using high-cost raw materials. However, with lower raw material costs and seasonal improvements in the demand scenario, Q4FY12 should record an earnings rebound, in our view.

■ Valuations: Stock price correction sharper than earnings downgrade

We believe steel stocks in general have been de-rated as stock prices have come off more than the cut in consensus earnings estimates. Current multiples for global peers are close to 10.5x P/E and 5.6x EV/EBITDA, while India steel stocks are trading at 5-6x P/E and 4.5-4.7x EV/EBITDA.

India steel stocks have generally traded in the range of 8-12x P/E and 5-7x EV/EBITDA (during the past five years).

In this report, we cut target prices for steel firms under our coverage by 20- 30%, driven by the 15-25% earnings estimate cuts and 5-10% cut in target multiples as we believe stocks should trade near the low end of historical multiples, as we don’t expect a significant recovery in the steel cycle given headwinds from global economic uncertainties (although nor do we expect a deterioration in the steel cycle from current levels).

• We don’t expect utilization issues for India firms as even 5-6% demand growth would keep domestic steel demand-supply balanced.
• While coking coal prices have fallen to USD240/t (from USD300/t in Q2FY12), iron ore prices have rebounded to USD140/t (from USD120/t in Oct-11). This is an ideal scenario for India steelmakers, in our view, as they are dependent on imported coking coal, but source iron ore locally.

To read the full report: INDIA STEEL

RISH TRADER

>CEMENT SECTOR: Low base of last year to result in strong despatches growth in November ‘11

Top three players (ACC, Ambuja and UltraTech) in the Indian cement industry have cumulatively reported 16.1% YoY despatches growth for the month of November ’11 benefitting from the low base of last year. Last year, the despatches declined 19.8% MoM in November ‘10 after posting a robust 20.4% YoY growth in October ’10. We believe the industry will report ~15% despatches growth in the month and maintain our growth assumption of 5.5% for FY12E. The industry will have to grow at ~8.6% between Dec ’11- Mar ’12 to achieve the growth rate we forecasted. Cement prices have started improving post monsoon and pan- India average increased by ~8% to Rs270/bag in the last two months in expectation of demand revival in 2HFY12E. We do
not foresee a steep hike in cement prices from current levels and maintain our cautious stance on the sector considering a sluggish demand scenario (housing construction activities and real estate
sector are under pressure). We maintain Sell on ACC, Ambuja and Ultra Tech considering expensive valuations. We have a hold rating on Grasim and Shree Cement and Buy on mid-cap stocks including India Cements, JK Cement and Orient Paper & Industries.

■Steep volume growth of top three players: Top three players of Indian cement industry cumulatively recorded 16.1% YoY volume growth in November ’11 benefitting from the low base of last year. Ambuja Cements recorded 29.2% YoY (and 2.8% MoM) growth in despatches to 1.83mt. UltraTech and ACC’s despatches\ grew 16.3% YoY and 5.2% YoY to 3.09mt and 1.83mt respectively.

■ November ’11 despatches growth could be ~15%: We believe that industry despatches for the month of November ’11 could be ~15% considering the stellar volume growth of top three players who control ~35% market share of cement industry. The primary reason for a steep growth is the low base of last year as in November ’10, industry’s volume had declined 19.8% MoM after a 20.4% YoY growth in October ’10.

■ Cement prices increase post-monsoon: Dealer interactions reveal that pan- India average cement prices have increased by ~8% to Rs270/bag over the last two months in expectation of

demand revival in 2HFY12E. Average price in North, Central and East regions increased by 10-13% in the last two months, while in South and West regions it increased by 3-4%. We do not foresee a steep hike in cement prices from current levels and maintain our cautious stance on the sector considering the sluggish demand scenario (housing construction activities and real estate
sector are under pressure).

■ Maintain Sell on large caps; prefer mid-caps due to attractive valuations: We maintain Sell rating on large cement companies (ACC, Ambuja and UltraTech) considering the expensive valuations. We maintain Hold rating on Grasim and Shree Cement and Buy on mid-caps under our coverage (India Cement, Orient Paper & Industries and JK Cement).

To read the full report: CEMENT SECTOR

RISH TRADER

>SIEMENS INDIA: De-rating likely as earnings growth moderates

■ A long-term strategy with near-term headwinds: We recently attended Siemens’ analyst meet where management reiterated their long-term strategy of 1) high-tech product innovation with focus on environmental solutions; 2) launch of value-priced SMART products catering to specific needs of emerging markets like India & China; and 3) expansion of local manufacturing & indigenization of products. With these initiatives, Siemens aim to gain market share & drive productivity improvements to support margins. While this long-term strategy appears promising, several headwinds should prevail in the near term, such as weakening demand, pricing pressure, forex fluctuations, commodity prices, & delays in delivery pickups. Siemens remains cautious on the near-term outlook.

■ Earnings growth likely to taper off further: Given decline in order intake and muted growth in order backlog (c2%) due to the non-repetition of large Energy orders, we believe sales growth is likely to moderate to low double digits going into FY12-13e. In addition, the visibility on growth remains low as Siemens derives c50-55% of its sales from short-cycle orders driven by Industrial and Institutional capex, which is under pressure due to rising interest rates and weakening business sentiment. Also, Siemens’s strong EPS growth in two of the past three years has been driven primarily by improvement in margins, which we believe will moderate going forward, driven largely by the normalization of margins in Power Transmission (c33% of group EBIT). Hence, we expect earnings growth to moderate further to c8.5% in FY12e and c14.4% in FY13e.

■ Currency fluctuations a key short-term risk: Margins in the Q4 results were negatively impacted (c440bps) due to a forex loss of INR1.6bn, which included both actual losses on imports & mark-to-market on currency hedging contracts. As Siemens is a net importer (imports c40% of components; exports c25% of sales), an exchange loss on rupee depreciation implies that either the company has unhedged exposure to imports or has different forward contracts on imports & exports. In either case, we believe that continuing weakness in the INR is likely to impact margins further in Q1.

■ Lower our FY12/13e EPS by c7%/10%; maintain Neutral rating, cut TP to INR765 from INR940: We are lowing our FY12/13e EPS by c7.4%/c10.2%, driven largely by our reduced revenue expectations (as we were already cautious on margins). On our new estimates, valuation remains rich with the stock trading at c25.7x FY12e PE. We believe the stock is likely to de-rate further as earnings quality has declined, business outlook has deteriorated, and the likelihood of further open offers has diminished. Our target price is derived from our preferred EVA valuation model and implies a 12m fwd target multiple of c24.4x on 24m fwd estimated EPS of INR31.4.

To read the full report: SIEMENS INDIA

RISH TRADER

>BANKING SECTOR: Loan loss provisions under the Moody's stress tests

SECTOR QUICK COMMENT

We benchmark the loan loss provisions factored into our Axis and SBI estimates with the stress test assumptions outlined by Moody’s recently. For Axis, forecast LLPs of INR65bn over the next two years compare with INR44.2bn that would be required under the ‘adverse scenario’ and INR89.5bn under the ‘extremely adverse scenario’. For SBI, expected LLPs of INR344bn would become INR244.3bn and INR496.2bn for the two scenarios, respectively. Based on our current conservative LLPs, Axis trades at 1.6x FY13F ABV for an ROE of 18.4% and SBI trades at 1x FY13F ABV for an ROE of 17.1%.

In the current credit cost cycle, we expect loan loss provisions for the Indian banking sector to increase from 72bps in FY11 to 119bps in FY12F and 123bps in FY13F – due to credit quality deterioration in sectors like power, aviation, SME etc. This compares with the past peaks of 156bps in FY97 and 119bps in FY04. In their recent Banking System Outlook for India, Moody’s has detailed two stress case scenarios for asset quality – Adverse scenario and Extremely adverse scenario. The following table summarizes Moody’s assumptions for probability of default, loss-given-default and expected loss for the various loan categories under these two scenarios.

In this note, we try to benchmark the provisions we have built into our estimates for Axis Bank and SBI through the next two years with the provisions that would have to be made under the two scenarios outlined by Moody’s.

· We apply the expected loss percentages under Moody’s adverse and extremely adverse scenarios to the loan book outstanding at the end of 2QFY12.

· Moody’s loan classification does not explicitly carve out ‘rural’ loans – the expected loss percentages are our assumptions.

Key points to note:

1) Axis Bank - The loan loss provisions built into our estimates for the next two years are INR65bn. This compares with INR44.18bn of losses that we believe would be likely under the adverse scenario and INR89.5bn under the extremely adverse scenario.

2) SBI - The loan loss provisions built into our estimates for the next two years are INR344.15bn. This compares with INR244.25bn of losses that we believe would be likely under the adverse scenario and INR496.15bn under the extremely adverse scenario.

3) Our current FY13F PAT for Axis and SBI is INR42.8bn & INR138.7bn – 12% and 6% below Bloomberg consensus, respectively.

4) AXSB currently trades at 1.6x FY13F adjusted book value, one standard deviation below its historical mean of 2.4x one-year forward ABV. Our TP of INR1,400 implies 2.4x FY13F ABV of INR 584 and 14.1x FY13E EPS of INR 99.62 for an ROA of 1.3% and ROE of 18.4%.

5) SBI trades at 1x FY13F ABV, one standard deviation below its historical mean of 1.7x one-year forward ABV. At our TP of INR2,400, SBI trades at 1.55x FY13F ABV of INR1,299 and 8.1x FY13F EPS of INR 209.67 for an FY13F ROA of 0.9% and adjusted ROE of 17.1%.

To read the full report: BANKING SECTOR

RISH TRADER