>FMCG: Steady growth (ICICI SECURITIES)

I-Sec FMCG universe is expected to post steady sales growth of 14.3% YoY on the back of strong underlying volume growth. Despite a high base, ITC is expected to register volume growth of 8.5% in Cigarettes. On a low base, HUL will deliver volume growth of 9%; but, because of price cuts, sales growth will be restricted to 6.3% YoY. Operating margins for our universe will expand 100bps YoY, albeit decline 160bps QoQ. Increase in input costs and rollback of excise duty will arrest any further margin expansion. We expect paint companies to post >60% PAT growth, while profits of Britannia and HUL are expected to decline. Valuations are high as most stocks are trading at 10-15% premium to historical valuations. We maintain ITC and Asian Paints as our top picks. We drop Marico from our list of top picks as the recent spurt in its stock price leaves limited room for upside.

■ Steady double-digit sales growth to continue. We expect I-Sec FMCG universe to post steady sales growth of 14.3% YoY in Q4FY10E, in line with the 15% YoY growth achieved in Q3FY10. Volume growth is expected to be strong across companies. According to Nielsen retail audit data, 40% of the categories have grown >10% over January-February ’10. ITC will continue to register strong volume growth in Cigarettes – we expect ITC cigarettes volumes to grow 8.5% YoY. On a low base and on the back of aggressive advertising spends, HUL will deliver volume growth of 9% YoY; however, price cuts will keep sales growth at 6.3% YoY.

■ Margin expansion reduces as material cost benefits wither away. Operating margins for the I-Sec FMCG universe are expected at 22.1% in Q4FY10E, implying only 100-bps YoY expansion versus YoY expansion of 260bps, 330bps and 181bps in the first three quarters of FY10. The quantum of margin expansion has come down owing to unfavourable base and increase in prices of raw materials. On a YoY basis, Asian Paints will witness the highest margin expansion (up 528bps), followed by Procter & Gamble Hygiene & Health Care (up 465bps), Kansai Nerolac (up 279bps) and ITC (up 214bps). Britannia’s margins will suffer the most (down 264bps YoY), followed by HUL (down 106bps YoY). As prices of raw materials rise and benefits of old contracts fade away, we expect input costs-to-sales to increase going forward.

■ Robust PAT growth of 19% YoY. We expect I-Sec FMCG universe to register robust PAT growth of 19% YoY. Asian Paints and Kansai Nerolac are expected to post highest growth, of 73% and 62% respectively; Marico, ITC, GSKCH, GCPL and Colgate are expected to witness PAT growth within the 20-25% range. Britannia and HUL will disappoint this quarter, with PAT decline of 11% and 2% respectively.

■ Valuations expensive but not stretched. The BSE FMCG index has outperformed the broader indices by ~35% since the market peaked in January ’08. This performance is despite HUL’s sluggish performance, who is a key constituent in the FMCG index. Most companies are trading at 10-15% premium to historical valuations. We maintain ITC and Asian Paints as our top picks. Marico was our top mid-cap pick in FY10 (over which it outperformed the BSE Sensex by 10% and BSE FMCG Index by 50%); however, post the recent spurt in Marico’s stock price, we drop Marico from our list of top picks owing to limited upside.

To read the full report: FMCG

>UNITED SPIRITS (INDIA INFOLINE)

■ UNSP Q4 standalone volume up 16% ypy; supported a 23% jump in revenues on a like to like basis

■ OPM declines 193bps on higher RM, advt expenses

■ Q4 profit impacted by 81% surge in intesrest cost

■ W&M FY10 revenues remained flat at GBP177mn while PBT dropped 8.5% due to restructuring cost

■ Margin improvement, healthy volumes key poitives but valuations no longer appear cheap at ~14x FY12 EV/E; downgrade to MO but maintain TP of Rs 1,384

To read the full report: UNITED SPIRITS

>Public finances in developed countries: what is the exit strategy?

The increase in public debt registered over the last few years is without precedent (table 1). In each of the main OECD countries, public debt is not on a sustainable path1 (chart 1). This contrasts with past periods, during which emerging markets have appeared more at risk from this perspective (chart 2). The majority of developed countries will have a public debt ratio in excess of 90% in the middle of the decade.

From 2007 to 2014, according to the IMF (2010), the debt ratio in these countries is expected to rise by an average of more than 30 points of GDP, reaching an average of 110% of GDP. Of this increase, 3 points will be related to supporting the financial system (table 2), 4 points to the increased cost of debt, 10 points to automatic stabilisers, 3.5 points to budget stimulus measures and 9 points to losses of tax revenues relating to the decline in asset prices. The widening of deficits is largely structural in nature. The deficit ratio adjusted for cyclical variations is 4.4% in the eurozone out of a total deficit of 6.7 points, with 9.8 points in the UK (out of a total of 13.3 points) and 8.8 points in the US (out of a total of 10.7 points). In the past, this structural deficit has shown a strong tendency to persist.

For the time being, surplus production capacity limits the risk of public debt having a crowding-out effect on private investment. However, the public finance situation calls for credible recovery measures. While budget stimulus measures are intended to boost demand from financially constrained consumers (in their case, the classic system of budgetary multipliers takes full effect), it may for others - the majority - result in the emergence of Ricardian behaviour, i.e. growth in savings in order to cope with the increased cost of future tax increases. While the conventional crowding-out effect does not have an impact, the budget situation - contrary to the situation before the financial crisis - now affects the assessment of risks and may inflate risk premiums (chart 3). This results in a higher cost of debt, making adjustment even more difficult.

This situation could make an end to the until now observed developments characterised by rising debt with no impact on interest payments because of falling interest rates - a kind of "free lunch" (charts 4 and 5).

A high level of debt increases the probability of an interest rate or growth shock resulting in unsustainable debt, with higher debt ratios and a widening gap between the apparent real interest rate and the rate of growth. This configuration makes adjustment even more difficult and in any case presents a number of threats (snowball effect of debt). From this viewpoint, recent data clearly call for a reaction. Furthermore, as a direct consequence of the financial crisis - with an increase in the cost of capital and structural unemployment and a decline in economic activity (Furceri et al, 2009) - the potential level of GDP in the OECD region is around 3.5 points below the pre-crisis level (chart 6).

To read the full report: PUBLIC FINANCES

>A better way to measure bank risk (MCKINSEY)

One capital ratio tops others in foreshadowing distress—and it’s not the one that’s traditionally been regulated.

In response to the global banking crisis, regulators and policy makers worldwide have united
behind efforts to increase financial institutions’ minimum capital requirements and to limit
leverage, hoping to reduce the likelihood of future bank distress.1 As of this writing, the debate over proper capital requirements continues, with major implications for the industry and the economy— yet there have been few specifics on which ratios should be targeted or at what levels.

To shed some light on the discussions, we analyzed the global banking crisis of 2007 through
20092 to identify relationships that different types of capital and capital ratios have to bank
distress.3 Our analysis is observational, based on historical data, and not a real-world experiment, which would have required randomly selected financial institutions to hold different capital levels to gauge their effects. As a result, the findings do not definitively establish how institutions might perform in the future if minimum capital ratios were changed, but we believe that the evidence we provide is a valuable input for current policy discussions.

We found that one capital ratio—the ratio of tangible common equity (TCE)4 to risk-weighted
assets—outperforms all others as a predictor of future bank distress. We also found that requiring a minimum leverage ratio would not have offered any insights that couldn’t have been found by studying the right capital ratio. And, not surprising, we found that a higher bar on capital requirements, while reducing the likelihood of bank distress, comes at an increasing cost.

To read the full report: BANK RISK