Wednesday, April 8, 2009


Cash burn accelerates.....

· We assess the rate at which cash positions of companies will deteriorate.

· The cash positions of Asian corporates are deteriorating quickly. Net debt/equity increased from 17% to 24% in 2008, reversing a near decade long trend of falling debt levels and cash accumulation.

· 2009 will be much worse. Even though revenue across Asia only came off slightly in 2008 (it eased from 24% to 22%), cashflows fell 7%. There is a leveraged impact on the bottom line.

· What will happen to cashflow in 2009 when revenue contracts 9% (as analysts now assume), a shocking step down from 2008? Analysts are only assuming another 10% contraction in cashflow but it could be a lot worse. There is clearly a lot of confidence in the ability of companies to rescue their cash position by cuts to costs and working capital. There are 30 companies in Asia that are assumed to save at least US$1bn from such initiatives.

· Analysts have already been under-estimating cash burn. In the current reporting season, the shocks have been in cashflow. For example, forecasts for China’s 2009 revenue have been revised down 6% since the start of the year, but cashflow forecasts have been cut by 23%. The equivalent numbers are 3% and 35% in Hong Kong, and 10% and 22% in Korea.

· Based on these current optimistic assumptions, the cash shortfall in Asia is set to be US$160bn (ie, the amount that capex and dividend plans exceed operating cashflows). However, a figure closer to US3$00bn would not be a surprise. This has three implications:

· The amount of extra capital required will be enormous. In 2008, US$131bn in debt and US$31bn in equity were raised. Much more will be required this year.

· Capex plans will have to be scaled back, and for some companies this will place their competitive position at risk. It is also very negative for companies that supply capital goods.

. Dividends will need to be cut.

· All our stock screens highlight the usual suspects of Korea and Taiwan at the country level, and autos, transport, tech, capital goods and materials at the sector level. We would not be chasing stocks in these categories until there are more tangible signs of economic stabilisation.

· Figures 7 and 12 contain stocks at risk, either because hopes from cost and working capital cuts are high, or because cash shortfalls are enormous.

· Asia’s financial position deteriorated during 2008. Debt levels rose with net debt-to-equity
increasing from 17% to 24%. This reversed a near decade long trend of falling debt levels and
cash accumulation.

· The increase in debt was greatest in India and Korea, although in Korea’s case, it was a doubling from a low base. Net debt rose in every country except Singapore.

To see full report : ROCKS ON STOCKS

>Ship Building (EMKAY)

Subsidy disbursement – Temporary respite...

· Government commits to pending subsidy disbursement…
The Government of India has approved the subsidy claims of private Indian shipbuilders with respect to all ongoing ship building contracts entered upto 14th August, 2007, the date of expiry of the subsidy scheme. Subsidy will be released as per guidelines, subject to modifications, and on submission of requisite documents. Department of Shipping (Ministry of Shipping, Road Transport & Highways) and Ministry of Defence shall make budgetary provisions for shipyards for subsidy disbursal.

Press reports expect the total liability of the government on this count at about Rs51bn. Subsidy receivable by ABG Shipyard from Government stood at Rs3.1 bn in FY08 (Rs61.4 per share) and is expected to increase to Rs6.8 bn by FY12E (Rs134.4 per share) while that for Bharati Shipyard is Rs1.7 bn as on FY08 (Rs60.9 per share) and is expected to increase to Rs4.4 bn as on FY12E (Rs157.9 per share).

· …To give respite to Indian shipbuilders, though temporary
We believe that the above approval brings much needed respite to the Indian shipbuilders and prima facie serves as a sentiment booster. This is especially in light of miniscule budgetary allocations (refer table below) by the government so far. However, in the absence of committed timelines for disbursal, it will be difficult to quantify when the exact benefit is expected to accrue to the shipbuilders. Further, the subsidy disbursement is presently contingent on delivery of vessels by the shipyards and is not liable for payment in the event of cancellation of the contract. Both ABG Shipyard and Bharati Shipyard have not witnessed any cancellations yet. However, both have\ experienced delays and postponement in delivery schedules to the tune of 7-14 months. Such postponements will result in delayed receipt of subsidy from the government.

· We maintain negative outlook on the industry
We continue to maintain a negative outlook on the industry based on our top-down analysis. We expect no revival in order inflows in the near future and expect cancellations in existing shipbuilding contracts as well as delay and defaults in payments by customers. Order inflows have been the key stock driver for Indian shipbuilders as against earnings growth. In absence of other positive news flows, we believe that lack of order inflows will continue to restrict re-rating of the sector going forward. We maintain our ‘SELL’ rating on ABG Shipyard with target price of Rs63 and ‘REDUCE’ rating on Bharati Shipyard with target price of Rs45 (DCF based).

To see full report: SHIP BUILDING



• There is long term visibility in Power sector in India. Country is likely to remain power deficit for next few years.

• Gujarat, the most industrialized state also has continuously rising demand for power.

• GIPCL is a small Gujarat Govt.PSU with capacity of 557 MW presently, to be expanded to 807 MW by Q2 FY10.

• The company trades at market cap of less than Rs.700 Crore, whereas the average cost of setting 1 MW ranges Rs.3.8 Crore to Rs.5 Crore (i.e. the company of 800MW about Rs.4000 Crore)

• There is easier availability of gas from Domestic suppliers like Reliance and also from international markets.

• The company was earlier lagging in capacity additions, its last capacity addition was in 1999, now it has laid down plans for capacity additions at regular intervals. By FY 2012,it has targeted to achieve capacity of 1350MW.

• Company has healthy debt/Equity ratio of 0.6 times. Power compnies can have Debt/Equity ratio of 70:30, with current Networth of Rs.1140 Crore and Debt. Of Rs.680 Crore, it can easily raise Debt. Of additional Rs. 1980 Crore.

• The company is a regular dividend payer. It paid Rs.2.5/Share dividend in FY08. At CMP Rs.45 it offers Dividend Yield of about 6%

• It has price to Book value of 0.6.

• Company is likely to show fall in bottom line in FY09, compared to FY08, however, once the new capacity starts in next 4months, a sharp jump in results can be seen in FY10. Currently, it is trading at very attractive Market cap/Sales ratio of 0.6 times.

• It is highly under valued compared to peers.

To see full report: GIPCL

>Sterlite Industries India Ltd. (MERRILL LYNCH)


Downgrade from Neutral to U/perform; PO & EPS unchanged
Sterlite is up 50% over the last one month. It is one of the best performers not just in India but also among the global metal stocks. It now ranks among the most expensive metal stocks globally trading at FY10E P/E of 22.5x and EV/EBITDA of 8.9x. Earnings outlook remains dismal. We forecast 4Q profit fall of >20% q-o-q and FY10 fall of 68%. Hence we recommend selling the strong recent rally.

Running ahead of zinc leverage; ally still barely break-even
Zinc (~60% of Group EBITDA post minorities) tends to be the most significant driver of stock performance. Over the four year period of 2004-2007, correlation with zinc was very high at 0.97. This correlation has broken down to just 0.2 over the last five months given that the stock has run up far ahead of zinc price recovery. We believe the beta trade has been played excessively and it is now time to book profit, more so when aluminum division is still barely break even.

Price outlook and demand fundamentals unchanged
The recent rally in the metal sector reflects positive impact of continued commodities buying by China and an increase in confidence in global financial markets. Confidence aside, we have not identified any significant improvement in demand. Hence we believe the recent rally in metal prices will not sustain. From their recent bottoms, ally / zinc / copper are up 8 / 26 / 44%.

Asarco & aluminum capex to drain down surplus cash
On cons. basis, Group has surplus cash of $3.6bn. But this should be drawn down fully to fund Asarco acqn. ($1bn & balance staggered) & Ally capex ($2.5bn). We believe Asarco will be EPS dilutive & negative free cash flows and key negatives.

To see full report: STERELITE INDUSTRIES


Restructuring- Long term positive
In a bid to improve operating performance of its Pharma Solution (CMG) business, Piramal Healthcare is re-aligning its CMG assets by closing down its Huddersfield facility. Company will take one time hit of Sterling pound 10.1mn in FY09 itself. Company will be shifting these contracts to Digwal (India) and Morpeth (UK) facilities. Management has indicated that this restructuring will enable them to improve the operating margins of its Pharma Solution business by 6 to 8 ppt from FY10E itself. The improvement in the margins is driven by a) Close down of Huddersfield facility, b) Increase in early phase pipeline, c) Cost improvement & clinical packaging offerings at Morpeth and d) Strong commercial projects pipeline at Digwal. However, because of shifting of contracts and temporary slowdown in CMG space because of inventory rationalization and destocking at customers end (may last till H1FY10E), company has indicated that its revenue from Pharma Solution business will be lowered by 5% in FY10E over FY09.

We view the restructuring of its Pharma Solution business as long term positive for the company. We have revised our revenue and earning estimates downward because of these restructuring. We have downward our revenue estimates by 11% and 11% and earnings estimates by 9% and 8% for FY10E and FY11E respectively. On the back of downward revision in earnings, our target price has been revised downward by 13% to Rs261. At CMP of Rs194, the stock is trading at\ 8.6x FY10E EPS of Rs22.6.

Why Restructuring?
Piramal’s decision to discontinue its Huddersfield facility (FY09 revenue- Sterling pound 19mn and operating margins < 3%, 93 employees, 30-35% capacity utilization) was mainly aided by the change in the customer’s perspective and also it would be financially beneficiary for the company on the Operating level. The customers of Piramal now prefer to move manufacturing directly to Indian assets of the company without having to go to the European site. On the operating level the company expects anexpansion of 6-8 ppt on the margins mainly driven by a) Close down of Huddersfield facility, b) Increase in early phase pipeline, c) Cost improvement & clinical packaging offerings at Morpeth and d) Strong commercial projects pipeline at Digwal.

Impact of Discontinuation of Plant
Shutting down of the Huddersfield facility by the company will take one time hit of Sterling pound 10.1mn on account of redundancy payments, pension top ups, contract termination costs and other professional fees in FY09 itself. However the company will be shifting the contracts which were in the Huddersfield facility to Digwal (India) and Morpeth (UK) facilities. However, because of shifting of contracts from Huddersfield to other sites, which may take 6-9 months in validation and stability temporary slowdown in CMG space because of inventory rationalization and de-stocking at customers end (may last till H1FY10E), company has indicated that its revenue from Pharma Solution business will be lowered by 5% in FY10E over FY09.

To see full report: PIRAMAL HEALTHCARE


Investment in a promoter group company – a negative surprise

· Acquisition of stake in APIL: Crompton Greaves (CRG) board has given approval to buy a stake of 41% for Rs2.3bn at book value in Avantha Power and Infrastructure (APIL), a promoter group company. These funds are to be utilized for the Korba 1x600mw power plant for which a debt of Rs21bn has already been underwritten, 80% of land acquisition has been completed, water allocation has been done and coal linkage are in place. Another Rs1.6bn worth of equity will have to be raised either by private equity or through group companies, which will result in dilution of CRGs stake (but will not go lower than 26%). APIL is a power generation company having 165MW capacity (by June 2009), expandable to 1365mw (2 plants of 1x600mw each) in various stages. The other stake holders of APIL are BILT, BILT paper and Solaris (all are Avantha group companies).

· Buy-back offer: CRG board has approved a buy-back of shares for Rs2.2bn upto a price of Rs170 per share. Keeping in mind that the APIL stake will be paid in cash and the current cash balance is just about Rs3.0bn, CRG will have to utilize internal cash generation over the next 9-12 months if it wants to complete the buy-back. We believe that only a part of this buy-back will be completed and in the current situation, this offer is largely there to just act as a check on the declining stock price.

· Valuation: At the CMP of Rs106, the stock is trading at 6.9x FY09E and 5.9x FY10E earnings of Rs13.7 and Rs15.3, respectively. The diversification into power generation could yield lucrative cash flows post 2013. However, in the near term this diversification would have a negative impact as the future cash flow commitments to this segment are not known. Also, to maintain its stake in the venture, CRG will have to commit larger sums of money, going ahead. Our Reduce rating stays.

To see full report: CROMPTON GREAVES

>Chemicals Sector (EMKAY)


Mar’09 was marked by price as well as volume stability. In order to have more clarity on the price movement of various chemicals, we have increased the number of products from 19 to 33. Out of the 33 products in our universe, 12 products reported an increase in prices, 7 products reported a decline and prices of 14 products remained stable in Mar’09, indicating a stable price scenario. Emkay chemical index (covering 33 products) almost remained flat since Jan’09. Dealers are in consensus of the view that near term prices should remain stable. However, some volatility in prices cannot be ruled out. Volumes have stabilised with no significant increase on MoM basis in Mar’09. We believe that stable price scenario should continue while more products should report increase in prices in Apr-June’09 quarter. Volumes should pick up further on stable price scenario.

Price stability continues
We have increased the number of products under our coverage from 19 to 33. We saw price stability during Jan-Mar’09 period in most of the products after a sharp fall in Oct-Dec’08 period. Products reporting positive movement in prices have steadily been on the rise, with 7, 10 and 12 products reporting an increase in Jan, Feb and Mar’09 respectively. Products with a stable price scenario also increased to 9, 13 and 14, respectively (Jan-Mar’09). Products reporting decline in prices reduced to 17, 10 and 7 during the same period. Higher proportion of increasing prices and stable prices in our product universe clearly indicates the stability in prices.

Restocking boosted volumes in Jan-Feb’09; expect stable scenario now
After a sharp decline in prices in Oct-Dec’08 quarter, led by lower demand and de-stocking, volumes picked up in Jan-Feb’09 period, mainly driven by restocking at dealer’s and consumer’s level. However, the scenario has stabilised now and dealers expect volume and price stability in the near future. However, some volatility in prices cannot be ruled out.

Outlook – Sustained recovery ahead
As mentioned earlier, we believe that prices of most of the products have bottomed out and should start showing some increase in prices. Many of the products have already shown some improvement in prices. We have seen increasing stability in prices as well as volumes of most of the products during Jan-Mar’09 quarter. We expect Apr-Jun’09 quarter to see a recovery in prices and volumes.

To see full report: CHEMICALS SECTOR