Sunday, May 3, 2009

>China gold reserve increase a modest surprise

London - Spot gold rallied to a three-week high Friday after China announced its gold holdings are over 70% higher than it previously reported.

Prices eased later in the day as the market decided the increase, while bullish and somewhat higher-than-expected, was too modest and gradual to drive prices sharply higher.

State-run news agency Xinhua quoted Hu Xiaolian, the head of China's foreign exchange agency, as saying that China's gold reserves had risen 454 tons since 2003 to 1,054 tons, the first public acknowledgment in years that its reserves had changed.

Official Chinese data at the end of March showed the country's gold reserves stood at 600 tons.

Hu, head of the State Administration of Foreign Exchange, or SAFE, which manages the nation's foreign exchange holdings, said China increased its gold reserves gradually and had bought the metal domestically.

At Friday's spot gold price of $910.45 per troy ounce, up 1% on the day, the reserves were worth $30.87 billion.

China's announcement confirmed widespread expectations that the country had been increasing its gold reserves, which partly explained the muted price reaction.

"It's not surprising," said JP Morgan analyst Michael Jansen. "A lot of central banks are being advocated to collect gold."

Analysts have long speculated that China might diversify out of its massive foreign exchange reserves into hard assets like gold.

Comments by Chinese Premier Wen Jiabao last month expressing worries over its holdings of U.S. treasuries only strengthened those speculations. "They've hinted at this before that they're concerned about their exposure to dollars," said RBS analyst Stephen Briggs.

The long timeframe of China's gold purchases also tempered the market's enthusiasm. The amount roughly represents just 3% of the gold produced in the past six years and is less than European central banks that are signatories to the Central Gold Bank Agreement sell each year.

"I think as soon as people realized it's not a year-on-year increase, or a quarter-on-quarter increase, people realized it should not have that big an impact," said Standard Bank analyst Walter de Wet.

Compared with gold exchange-traded funds, which have increased their holdings by over 1,200 tons in just the past two years, the increase in China's reserves is modest, said Gerry Schubert, head of precious metals trading at Fortis in London.

Using the new figures, China became the fifth biggest holder of gold after the U.S, Germany, France and Italy.

Unlike these and most other countries, China's gold reserves are just a small fraction - around 1.5% - of its foreign exchange reserves, a ratio that declined in past years as its purchases of foreign exchange swelled to nearly $2 trillion. RBS estimates the world average is approximately 10%.

Many analysts doubt that China will substantially increase its ratio to that level, as the gold market is not large and liquid enough to handle the amount of buying this would entail, unlike the market for treasury bills, and prices would shoot up enormously.

"From a prudent risk-management perspective, it probably doesn't make sense to diversity too much into gold," said de Wet.

By purchasing from domestic producers, China demonstrated that it has the ability to acquire substantial amounts of gold in a way that is difficult for the international market to track and therefore not disruptive to prices.

Many central banks buy their gold reserves through the international spot market, which is more transparent to market players. "If it's done that way, a prime market counter-party is asked to quote," said Jansen. "People would find out about it and get excited."

The timing of China's announcement didn't appear driven by any obvious rationale, analysts said. UBS' Reade speculated China may be trying to assuage domestic calls for it to diversify into gold.

The announcement came less than a month after the IMF's proposal to sell 403 tons of its gold reserves was endorsed by the Group of Twenty countries at the G20 Summit. China was seen by analysts as a natural buyer for at least some of the gold, which could be done through an off-the-market swap.

China's announcement Friday indicates that while it has been a buyer of gold and may, therefore, be interested in the IMF's gold, it can also satisfy its needs domestically.


>Flash Economics (ECONOMIC RESEARCH)

International capital flows are more destabilising than efficient

In principle the liberalisation of capital flows was supposed to enable an efficient international allocation of savings, thus increasing global long-term growth. However, we see that international capital flows are above all destabilising and that only a small portion of these flows allocate capital efficiently. We provide several examples of the destabilising or inefficient nature of international capital flows:

■ capital flows to and from emerging countries since 2005; finance speculative investments (equities) or households’ foreign currency debt;

■ carry trades in low-interest-rate currencies to invest in high-interestrate currencies, until the crisis;

■ international financing of real estate, i.e. of the household savings shortfall in the United States, and even within the euro zone, in Spain for example. The international financial system must therefore absolutely move towards the financing of productive investments and growth so that in the end the liberalisation of capital flows is not rejected.

In principle the purpose of the liberalisation of capital flows is to enable an efficient allocation of savings, with countries having surplus savings financing economically and socially profitable projects in other countries. However, we see that this objective is far from being reached:

■ on the one hand, and this has been frequently described and criticised, international capital does not flow from rich countries (with high per capita capital) towards poor countries (with low per capita capital), since it mainly flows to the United States, which has a chronic external deficit, from emerging countries (except in Latin America and Central Europe) and Japan, which have external surpluses ;

■ on the other hand, when we look at the nature of the capital flows, we see that corporate capital flows (in productive capital, direct investments) are small compared with financial capital flows.

To see full report: FLASH ECONOMICS

>Equity Weekly Watch (ANAGRAM)

Stress Test for the Bulls ahead

Markets consolidated previous week of gains in this holiday shortened week. The ensuing week is the penultimate week before the last phases of general elections and subsequent results. In the US, government will announce Banking stress test results by Thursday, and tell us what we already know that US banking system is in dire straits.

Domestically, many corporate earnings results were announced in the past two weeks, and most have met expectation save for the real estate sector. DLF has announced horrid quarterly results and the sector is going to receive some stick this week.

Markets are showing strong signs of momentum; by the ensuing week many events are scheduled to put the bulls resolve to test.

Inflation edged up to a seven-week high of 0.56% for the week to April 18, defying expectations of a drop towards zero, with data once again highlighting the persistent problem of stubbornly high food prices amid rigidities in the farm sector. Overall food price inflation, which includes these items and more, rose to 7.39% for the week to April 18 from 6.85% the week before, but off the 10-year high of 11.63 seen in early January.

To see full report: WEEKLY WATCH

>Exide Industries (MF GLOBAL)

In-line Results

Exide's Q4FY09 results came largely in line with our expectations on the PAT front, while the top-line was little below estimates. The demand outlook appears challenging(mainly in the automative segment)during FY10 but we believe that EIL is well placed to sail through it with the help its unmatched distribution network, competitive pricing and increasing backward integration strength. We continue to maintain our positive stance on EIL. BUY with a price target of Rs. 61.

Q4FY09 Resilt Highlights and Outlook

■ Net sales for the quarter stood at Rs 7.98 billion (+0.9% YoY), little below our estimate, as the price cuts became effective for the entire quarter.

■ On demand front pressure from the auto space remained (though it was better QoQ),while the industrial segment maintained a stable growth (primarily coming from inverter, UPS and telecom space).

■ Operating margin at 16.6% (+240bps YoY and +200 QoQ) surprised us positively, indicating that the effect of lower lead prices have started flowing in. As a result, operating profit for the quarter grew 18.3% YoY at Rs 1.33 billion.

■ PAT for the quarter at Rs 682 million was 8.6% higher YoY (21.5% up QoQ) and ahead of estimated Rs 666 million. Net profit for the full year FY09 stands at Rs 2.84 billion, translating inti an EPS of Rs3.6.

■ EIL incurred a total Capex of Rs 1.6 billion for FY09.

■ We introduce our FY11 estimates for EIL, where we estimate 10.5% earnings growth on the back of 19.6% sales growth and 150bps cut in operating margin.

To see full report: EXIDE INDUSTRIES

>Global Economic Outlook & Strategy (CITI)

From the Emergency Room to Intensive Care

■ Conditions in the global economy are looking marginally better. After five months of declines in output and trade that rival the Great Depression, current data point to a slowing pace of contraction in the global economy and a better tone to financial markets.

■ This is consistent with our forecast of recovery later this year or early next, depending on the country. But, this forecast requires further improvement in financial conditions and success in the next stage of financial stabilization — greater transparency on the quantity of losses and how they will be absorbed.

■ In the United States, monetary policy actions appear to be gaining traction and, along with fiscal stimulus now taking effect, likely will buoy demand. Nonetheless, risks of deflation still remain somewhat elevated.

■ In the euro area, the sharpest contraction probably has already passed but the recession is unlikely to end any time soon. We expect the ECB to stop rate cuts at 1% in May and to continue gradual monetary easing with unconventional measures.

■ In Japan, prospects for private domestic demand remain bleak but economic activity likely will stabilize in the second half of 2009, thanks to progress in inventory adjustment and the new economic stimulus package.

■ China’s recovery is gaining momentum, supporting our expectation for 8.5% growth in the second half. Other emerging markets have responded favorably to the G20 decisions, but fiscal concerns have risen in a number of countries thanks to the impact of the slowdown.

To see full report: ECONOMIC OUTLOOK

>Batronics (ICICI Direct)

Dim quarter, but future looks bright...
Bartronics reported its Q4FY09 results with top line at Rs 166.10 crore posting a growth of 56.2% and 21.1% YoY and QoQ respectively. The company surprised on EBITDA margins which stood at 35.23%, improving by 815 bps and 859 bps YoY and QoQ respectively. This was primarily due to invoicing of prior period sales in this quarter. However, the PAT margin declined by 1054 bps QoQ primarily due to higher tax outgo, depreciation and interest expense. The PAT stood at Rs 9.6 crore against our expectation of Rs 13.4 crore, down 52.5% YoY and 61.2% QoQ.

Highlight of the quarter
The company posted a top line of Rs 166.1 crore against its guidance of Rs 95 – 105 crore for Q4FY09. It also managed to improve its EBITDA margins on account of invoicing of prior period sales, the expenses for which were recorded in the last quarter itself. Consequently, the raw material cost as a % to revenue fell from 61% in Q309 to 50% in Q409. However the PAT margin declined significantly due to higher tax outgo (prior period adjustments to the tune of Rs 11.35 crore) and forex loss of Rs 7.27 crores. Without the exceptional items, PAT margin would have been 16.5%

At the CMP of Rs 89, Bartronics is trading at 4.1x its FY09 EPS of Rs 21.57 and 2.1x its FY10E EPS of Rs 42.45. We maintain our target price of Rs 106. Our target price discounts FY10E EPS by 2.5x times. We downgrade the stock to PERFORMER.

To see full report: BATRONICS

>Aban Offshore (CITI)

Reports 4QFY09 Loss

4Q results well below expectations due to asset write-off: Aban reported a 4QFY09 loss of Rs930m vs. our expectation of a profit of Rs1.8bn. The loss was driven by a one-off impairment charge of cRs1.5bn on one of its assets – jack-up Murmunskaya. This was an asset, leased by Aban, which had been lying idle. The company has decided to return the asset to the owner and capex incurred on the same has correspondingly been written off. Sequential PAT was also impacted by lower other income (NOK/US$ exposure hedged).

EBITDA below estimates, witnesses qoq decline: EBITDA of Rs4.3bn was down 9% qoq driven by lower revenues (-7% qoq). Revenues were impacted by: (i) jack-up DD 7 lying idle during the quarter, and (ii) drillship Aban Ice being dry-docked during the quarter. While 1Q EBITDA should recover with commencement of contribution from drillship Aban Abraham, this could be partly offset by higher capital costs on the same.

Idle assets + no improvement in fundamentals; maintain Sell: 4 of Aban’s 20 assets are currently idle (Aban VII, DD2, DD6, DD7), with contracts for another 4 (DD1, DD4, DD5, DD8) ending over the next 6 months. Further, US drillers reporting so far have stated that global demand in the shallow water segment remains weak and that there are not a meaningful number of opportunities to put idle rigs to work. Moreover, with activity still falling and more rigs expected to go idle worldwide, competition for any incremental demand is likely to be fierce.
Consequently, day rates and utilisations could face severe erosion for Aban’s jackups. Maintain Sell/Speculative risk (3S).

To see full report: ABAN OFFSHORE

>Indian IT services (CITI)

IT Services Beat

Hopes of Global Recovery Partly Priced In

Stocks pricing in partial recovery — Tier I stocks have outperformed the market by ~5-15% YTD despite a poor 4Q and muted outlook; due to weak INR and expectations of a recovery. We believe stocks are running ahead of fundamentals.

Mixed view on 2H outlook; turnaround could result in some upside — Some
“green shoots” globally have resulted in hopes of a rebound. Difficult to time a turnaround; has to happen at some point given revenues are declining every quarter. Clarity on turnaround could result in some multiple expansion.

… but slow EBITDA growth over FY09-11E to limit this — Muted sub-10% growth
in EBITDA over FY09-11E (assuming a reasonable recovery) and size issues constraining growth post that, sustainable expansion in multiples looks unlikely.

Changes to estimates/target prices/risk ratings — We are raising our multiples
slightly given that FY10 is likely to be a trough year and the likelihood of global recovery in CY10 seems higher than in the past. High FCF yields should support valuations; our target prices are now based on Sept’09 multiples.

Sector defensive but upside limited; Downgrading TCS; Infosys preferred pick
On a relative to market basis, strong FCF yields for Tier-I stocks make the sector a good defensive. However, lack of growth will limit upside, in our view. Downgrade TCS to Sell. Infosys is our top pick; HCL Tech is relatively inexpensive.

To see full report: INDIAN IT SERVICES

>India Cement Sector (CITI)

Sell: Great Climb; Precipice, or a Controlled Descent?*

Climbers dream — India’s Cement stocks have moved strongly, rising 36% since
January 2009 (18% outperformance relative to Sensex) on the back of: a) Logistics pressures – wagon shortages on General Election compulsions, b) Demand pick up – in-spite of broader market pressures, c) Supply snags – mix of capacity delays and unplanned shutdowns, and resultant d) Cement price momentum – up 5-15% ytd, against odds and expectations. These are all real, but possibly ephemeral, stock value enhancers.

At the precipice, or a controlled descent? — We believe cement prices, profitability, and stock values will all fall and it’s only in the pace of these falls (more likely off the precipice) that our conviction is modest. It’s the over-supply hypothesis, with40% new supply during FY08-11E, ~1.3x the demand growth, and while there is skepticism on capacities coming on stream the capacity bunching up risk only rises. A demand surge is the only safety net to what lies ahead in our view.

At a higher altitude — The cement prices hike, even sharper cost dips, coal price collapse, robust demand levels, and the sheer operating leverage of cement businesses means that cement is likely to be more profitable than we previously estimated. Towards this end, we raise estimates meaningfully, by 42-116% over FY10-FY11E. Further price deceleration (-21% from current level to December 2010E), or demand drops (CIRA estimate +9-10%), are potential pressure points.

Downside from here, we remain sellers — While valuations appear attractive given
earnings upgrades, we see FY10E as peak earnings (FY11E the collapse year). We value the stocks at 4.2-6.3x Sept-10 EV/EBITDA (vs. 4.5-7x Sept-09) and raise TPs by 26-52%. We see biggest downside in Grasim, and the least in ULTC.



Sell: Inline Quarter

Inline FY09 — Biocon's FY09 results were inline with expectations with recurring PAT of Rs2.2bn. While revenues were boosted by the Axicorp acquisition, margins suffered from the low margins in the distribution business. MTM losses of Rs1.5bn led to a reported PAT of Rs931m, down 80% YoY.

Tepid growth, profitability under pressure — Organic revenue growth of 13% YoY was disappointing given the currency depreciation. A 50bps YoY decline in operating margins on a like-to-like basis, despite favourable currency, indicates pricing pressure in the business even after accounting for lower licensing income (down 73% YoY).

Axicorp acquisition on track — Axicorp has won an AOK tender to supply Metformin to all regions in Germany. The contract is expected to generate revenues of c1bn over a period of 2 years. Biocon expects the contract to help expand Axicorp's presence in the German market – which it plans to use as the base for its diabetes franchise in Europe.

Other conf call takeaways — i) R&D expense to increase to cRs800m-1bn in FY10 – looking to take active projects further before licensing; ii) most of the forward forex contracts have been closed, except for a small part in Syngene. Has taken a mix of collar & put options to hedge its forex exposure; iii) Myco mofetil (cUS$150m opportunity) sales to start in 1QFY10; iv) working on tieups with larger players for distribution of biosimilars in regulated markets

Maintain Sell — Biocon's tepid FY09 results (pre forex losses) highlight our concerns about the lack of adequate breadth in its product basket. We believe Biocon's business model remains vulnerable despite efforts to build new growth drivers and maintain our Sell/High Risk recomme ndation.

To see full report: BIOCON

>Pantaloon (CITI)

Sell: 3Q Net Profit Below Expectations as Capital Costs Soar

3QFY09 operational performance strong... — EBITDA margins expanded ~210bps Y/Y and ~20bps sequentially to 10.5%; marginally above our estimates. Management's strategy of outsourcing non core operations to subsidiaries continues, resulting in lower employee costs and improving operating leverage (at the parent level).

...but PAT disappoints as capital costs soar — Despite 52% growth in EBITDA, PAT growth was a muted 7% Y/Y as interest and depreciation expenses rose sharply by 98% and 65% Y/Y respectively. Capital costs as a % of operating profit (70% in 3Q) have been rising steadily over the last 10 quarters.

Reducing EPS estimates — by 18-30% over FY09-11E factoring in: (i) planned equity dilution over FY09E; (ii) 2-16% reduction in net profit estimates as we pare our revenue forecasts and hike capital costs. Our new target price of Rs180 (Rs184 earlier) values Pantaloon (parent) at Rs139/share, based on 15x FY10 PE (maintaining 20% premium to regional peers), Home Solutions and Future Capital are both valued at Rs21/sh of PART.

Debt equity ratios to trend lower, post infusion of funds — We incorporate the impact of the company's plan to raise equity worth cRs2.8bn in our estimates. Consequently, debt equity ratios trend down to 1.4x from 1.8x (for FY10E). That said, our forecasts don’t yet incorporate incremental debt on the equity raised.

Restructuring imponderables remain — Little clarity available on management's plan to restructure the retail and fashion divisions. We view the conversion of PART to a holding company format as a prima facie negative.

To see full report: PANTALOON