Saturday, May 16, 2009

>India Macro Flash (CITI)

Elections - Exit Polls Indicate a Fractured Verdict

Polling over - Results on Sat (16 May)...but exit polls indicate a hung parliament — Following the culmination of India’s month-long election process yesterday, exit polls by various media channels have projected a fractured verdict with a close race between the UPA and NDA coalition. While keeping in mind that exit polls had been proved wrong in India’s 2004 elections, the current arithmetic indicates (see table below) that with neither the UPA or NDA coalition likely to come close to the 272 seats necessary to form a government, the Third Front (including the Left Parties) could play a crucial role.

On-going game of political chess — Over the next two days, political leaders will be trying to get to as close to the magic number of 272. However, things are likely to change by the hour due to: (1) changing allies (e.g., while the Left walked out of the UPA govt over the nuclear deal, there is speculation that they could once again provide outside support to the Congress); (2) open-ended
alliances; and (3) regional parties wanting a bigger role.

The next step - Role of the President — According to the Indian constitution, the President appoints the Prime Minister; who is normally the leader of the party/alliance that gets the majority in the lower house. In the event of a hung parliament or a fractured verdict, the President would call upon the leader of the party/alliance most likely to command the support of the majority.

Macro implications — As mentioned in our previous notes, a coalition led by the Congress/BJP would be best outcome. A combination with the Left could put reforms on the back-burner while a non-Congress/BJP coalition would have more implications for stability than policy.

Citi hosting a conference call today with two of India's renowned political and economic experts, Rajdeep Sardesai, Editor-in-Chief of CNN-IBN, and Anil Padmanabhan, Deputy Managing Editor of Mint newspaper, the Indian partner of the Wall Street Journal, for their views on the expected outcome of the elections. Please contact your Citi representative for details.

To see full report: INDIA MACRO FLASH


Crude Oil : Bullish or Bearish?

• Bearish Indicators
>High Inventory levels
>Spare Capacity on the rise as OPEC cuts production

Bullish Economic Indicators
>Upward GDP Revisions
>US ISM Data and China’s PMI Index
>Increased Crude Oil Import by China

• Oil regaining its Negative Co-relation to the depreciating dollar

• Future supply concerns keep us bullish in longer term; however we are bearish in the shorter term

• Most Asian equities discounting $65-US$75/bbl

• Asian Plays on Crude Oil: Cairn India, Australian E&Ps and CNOOC

• Asian Negative Plays on Crude Oil: HPCL, BPCL, IOCL and Sinopec

Asian E&P Stocks: Leveraged to Crude Prices


• High correlation in long term – E&P stocks exhibit a higher correlation with WTI prices in the long term.

• In the recent past, Oil has again started its negative co-relation to the depreciating dollar.

• Australian stocks and Cairn India are not only highly correlated in the long term, but also are most sensitive to change in oil prices.

• Indian State refiners have a negative correlation with crude oil prices due to negative marketing margins on selling of MS, HSD, LPG and Kerosene.

To see full report: CRUDE OIL


Reinitiating Coverage.....

  • Economic slowdown and increase in global refining & petroleum capacities to continue pressurising margins…
  • D6 gas production to drive earnings over next few years…but interest charges set to rise significantly following commencement of gas production
  • Hard to feel overtly bullish about the stock, given its very un-commodity like valuations of 15-17x FY10 Earnings, and EV/EBITDA of 11x

The story......
The global downturn in commodities has severely impacted companies exposed to the commodities sector and Reliance Industries Ltd. (RIL.IN) (RELI.BO) has been no exception. Over the last five years, RIL’s gross refining margin (GRM) witnessed a rising trend and improved from $5 per barrel in FY03 to $15 in FY08. Moreover, the differential between Singapore GRM and RIL’s GRM widened from $2.8 per barrel in FY03 to $7.6 per barrel in Q1 FY09. RIL also benefited from its capabilities to process cheap heavy and sour crude, as a result of the modernization scheme implemented by the company. However, both the petroleum as well as petrochemical cycles peaked in July 2008, following which, the prices of petroleum and petroleum products declined sharply, resulting in severe erosion in the margins of refiners and petrochemical producers. As a result, RIL’s GRM declined to $9.9 per barrel in Q4 FY09, while the difference between Singapore GRM and the company’s GRM narrowed to $4.2 per barrel in the quarter. The recent up-cycle in petrochemicals had lasted for over five years and it will be only prudent to assume that the current downturn will last for at least 2-3 years. We believe that the economic slowdown, coupled with an increase in refining and petroleum capacities across the world, will continue to exert pressure on the margins of refiners for a prolonged period and expect the difference between the benchmark refining margin and RIL’s refining margin to remain at the lower end.

In fact, the going will be much tougher for RIL this time around, as the company had earlier benefited from high import duties (10%) on ethylene polymers and petrochemical products, which have now been reduced to 5%, thus offering very little protection. Moreover, Reliance Petroleum Limited’s (RPL) new refinery has commenced production at a time when the growth in demand for petroleum products is declining globally. Also, there exists a huge threat from Middle East and Chinese companies who have the ability to flood the Indian market with their competitively priced products. We believe that the EBIT margin of RIL’s petrochemical business, which improved from
10.1% in FY02 to 13% in FY09 (and that too on high petrochemical prices), will witness a contraction due to increase in new capacities and demand destruction. The KG D6 gas & oil production will drive the growth in RIL’s revenues and profit over the next few years, particularly in the capital recovery phase, when the profit earned on petroleum will be low. However, there will also be an increase in the company’s finance costs on account of loans taken for its oil exploration business, the interest on which was being capitalized until the start of its commercial production and will now be expensed out. The company’s ongoing litigation with NTPC and RNRL could also act as a dampener and if the court verdict does not come in RIL’s favour, then the valuation of the company’s gas business could take a significant beating. RIL’s other segments, such as Retail and Special Economic Zone (SEZ) development are becoming a drag on the company’s overall performance. On the positive side, RIL’s amalgamation with RPL will result in the unlocking of operational synergies, in the form of cost optimisation and better negotiation abilities for purchasing crude, product placement, freight optimisation, and logistics. Based on our sum of parts valuation, RIL’s value per share works out to Rs.1602, which means that the stock is trading at a 20% premium approximately to its SOTP value. It is hard to justify RIL’s rich valuation, be it on a P/E or EV/EBITDA basis, given the intrinsic commodity nature of its business. We therefore, reinitiate coverage on RIL with a rating of Market Perform with Underperform bias.

To see full report: RIL


India – The countdown begins

Elections in India enter the final phase
■ Results on 16 May are expected to show a fragmented verdict
■ Markets may remain jittery until the formation of new government in early June
However, no sustained economic fallout expected

With the month-long election process nearing an end, markets are gearing up for a new government. Approximately 84% of constituencies have already voted in the first four phases, and the final phase ends on 13 May. Results are expected on 16 May. With none of the parties expected to win a simple majority (50%, or 272, of the total seats), a hung parliament is widely expected. Thus, it is key to watch the strength and composition of the new coalition government coming into power. Markets may remain on a nervous footing during the interim period from 16 May to early June, when the new government will be formed. Though a knee jerk reaction cannot be ruled out, historical clues indicate that markets are driven more by economic fundamentals rather than political events over the medium term. We maintain our forecasts of 5.0% GDP growth for FY10 and USD-INR at 47 by March 2010.

The election process in India, involving 714mn voters (about 60% of the total population) and 543 parliamentary constituencies, will decide the fate of the parties and their candidates by mid-May. Out of India’s 35 states and Union Territories, 10 decide about 75% of the total seats (see Appendix 2). However, given India’s seven national parties,* 48 state parties, and 1,000 registered but unrecognised parties – along with several independent candidates and a voter turnout of 50-55% – a fragmented outcome is widely expected (see Charts 1 and 2).

The election is likely to be closely contested by the Indian National Congress (INC, or Congress), which leads the incumbent UPA (United Progressive Alliance) government, and the Bharatiya Janta Party (BJP), which leads the National Democratic Alliance (NDA). In addition to the number of seats they win individually, their ability to forge alliances with other parties will be important in determining who finally leads the government.

To see full report: INDIA ELECTIONS


Election update—exit polls show Congress-led alliance ahead in close finish

Exit polls put the Congress as the single largest party and the ruling coalition UPA getting the most seats. The average of the polls puts the number of possible parliamentary seats for Congress at 154 and for the UPA at 196. The seats for the BJP are pegged at 146 and its alliance, the NDA, at 187. The Left is estimated to get 35 seats. If the exit polls are accurate, both the UPA and NDA would increase their seats in Parliament at the expense of the Left and other regional parties (see Exhibit 1).

The exit poll results are largely in line with expectations. Internal press polls and the grey market were expecting such an outcome (see The elections—the end of the beginning, India Views, May 11), although the race between the UPA and NDA appears to have become closer. If the exit polls are accurate, then the UPA would likely come to power after building a coalition with some regional parties, including the Left. The worst fears of the market would be alleviated, i.e., the likelihood of the Third Front playing a major role in the new government. However, neither would the best scenario play out— that of a government which does not include the Left parties. We believe the reduction in the seats of the regional parties is a positive sign for decision making. Further, given the experience of the past 5 years, the UPA is skilled at building coalitions, which could provide some comfort that a stable government will ensue post-elections.

Exit polls, however, have a dubious record of predicting the actual number of seats. In 2004, they famously got the results wrong when they predicted a big victory for the NDA, but the UPA won the elections (see Exhibit 2). The official results will be announced on May 16, after which the President will play a crucial role. She may invite either the single largest party (possibly Congress or BJP) or the single largest pre-poll coalition (UPA or NDA) to form a government. According to precedent, the single largest party usually gets invited to form the government (e.g., in 1996). That party will then start the process of building a coalition with regional parties in order to get a majority in Parliament. The entire process must be finished by June 2. We expect uncertainty about the nature and composition of the coalition which forms the next government to continue over the next several days, and equity and currency markets to be volatile as a result.

To see full report: INDIA VIEWS


Sell: A Setback for Corus

Shutdown of Teesside likely — Tata Steel has announced that its Teesside Cast Products (TCP) plant faced the risk of closure, as a consortium of four buyers had terminated the 10-year (from 2004) Offtake Framework Agreement (OFA) to buy ~78% of the plant's production. This comes soon after news that the proposed plant sale to some consortium members may not be completed.

Impact of shutdown — While the proposed closure would not have a major impact on profits (plant sales were at cash cost), this is a setback as it will be more difficult to cover fixed costs and is likely to involve a shutdown cost.

Corus restructuring hits roadblock — Tata Steel has closed service centres in UK; plans to sell aluminium smelters in Europe, and also an 80% stake in TCP in order to restructure Corus' operations. The TCP stake sale was expected to raise US$480m but is unlikely to go through as the buyers have cited financial difficulties. Tata Steel has to repay US$795m in FY10 and US$1.3bn in FY11. While cash as of Dec 2008 was US$1.1 bn, planned FY10 capex is US$1.2bn.

Covenant reset sought — Tata Steel UK has reportedly asked its banks to ease terms of £3bn loan for Corus' acquisition in exchange for a £200m repayment.

Safeguard duty deferred — The Indian government has deferred the industry request to impose a safeguard duty (likely 25%) to slow down HRC imports.

Difficult outlook in Europe — Demand continues to be 35-50% down. £600m savings hinge on hedging gains and plant closures, only the latter is recurring.

To see full report: TATA STEEL


Stressed out

■ US bank stress tests and the bears: not in the same book

■ US Q1 earnings update: non-financials down 30% so far

■ A setback is overdue but could be modest: stay pro-market

At Friday’s close, equities were showing a small gain for 2009, and were the best-performing asset year-to-date, comfortably ahead of government bonds and just nosing ahead of corporates (with high-risk equities ahead of high-risk credit).

Some pundits seem to be taking this as a personal insult. But as we see it, if the banking system is not bust (and the SCAP claims it isn’t), and the world is not facing another Depression, it would have been more surprising had the equity market not bounced sharply since 9 March, when both risks loomed large. The S&P is still down 41% from its high, and 22% since Lehman collapsed, and stocks have still seen their worst-ever decade of relative performance.

So again, we keep an open mind about the 3-6 month outlook, and stay pro-market and probeta. A setback (seasonal and/or technical) seems overdue, but we think it may be modest in scale and duration, and we’re not positioning ourselves for it. It was the rally’s starting point, not the current level, that looked most remarkable to us. And if risk appetite really does rebound, then the riskiest assets may of course outperform further in H2.

Regionally, our overweights are Continental Europe and the GEMs bloc, and our underweight is the US. Sectorally, we stay overweight European and US financials, a selection of cyclical sectors (including mining, construction and building materials and Continental general industrials) and oil. We still avoid utilities, and some consumer-facing areas.

To see full report: GLOBAL EQUITY STRATEGY


Analyst meeting takeaways

Consolidation and transition phase, maintain Hold

We believe that the long period of consistently high earnings growth for Bank of India is over. Loan growth is highly likely to moderate in the present sluggish environment, margins may remain under pressure even if they do not fall much, low-cost deposit ratio has failed to pick up for a long time and asset quality headwinds are increasing. An added element of uncertainty is an imminent CEO change in June’09. TP upside to the current price is also limited-Hold.

Admits to challenges but maintains a ~20% topline growth target for FY10
The management is targeting a 22% loan growth and 20% deposit growth for FY10. Though their medium term NIM target is 3%, they admit that there is pressure on spreads due to high cost of funds and yields dropping sharply. They believe that it could take still another two quarters for the high-cost deposits to run off. They also have the tough task of taking the low-cost deposit ratio (CASA) from 31% to 35% in FY10 – CASA had fallen in FY09 due to strong growth, high term deposit rates and an over-aggressive deposit mobilization campaign.

Asset quality headwinds visible; bank’s disclosures creditably transparent
BoI’s slippages have been rising both on a basic and lagged basis, and Q4FY09 NPL formation was high compared to historical trends. The bank provided the most succinct details on restructured assets that we have seen recently, and their classification norms are arguably conservative. However, the disclosures indicate significant stress: total restructured assets including pending applications 6.3% of loans, 98% of the restructuring bilateral instead of through the industry forum, and SMEs accounting for ~30% of the total restructuring.

Valuations and risks
We adopt a single-stage Gordon Growth model (P/BV-RoE) for valuing BoI, as we do for all PSU banks, leading to a rounded-off target price of INR250/share. Main downside risk includes sharp slowdown in international business and lower fee income growth. Key upside risk includes lower than expected wage revision and pension liabilities.

To see full report: BANK OF INDIA


FY09 Industrial Production ends year on dismal note; down 2.3%YoY in March on back of Capital Goods contraction

Mar industrial production — Industrial production contracted by 2.3% in March, higher than our (+0.1%) as well as consensus expectations (-0.7%); largely due to a surprise contraction in capital goods (-8.2%yoy). On a MoM seasonally adjusted basis production was down 1.3%. Cumulatively, industrial growth during FY09 was 2.4% v/s 8.5% in FY08. Lower industrial numbers will likely result in a revision to the CSO’s 7.1% GDP estimate for FY09 (which incorporates value add industrial growth at 4.8%yoy). Looking ahead, we are maintaining our 5.5% growth estimate for FY10 which factors in an additional 50bps easing in policy rates.

Key data highlights— (1) Besides the contraction in capital goods; consumer goods also remained in negative territory for the second consecutive month down 0.8%, largely on the back of a fall in non-durables. This needs a close watch since production has declined despite stimulus measures undertaken by the govt over past months (2) intermediate goods saw a contraction for the 8th consecutive month; (3) manufacturing production posted an all-time low since the index was conceived; down 3.3%yoy (see p. 3 for detailed breakdown). (4) Encouragingly, electricity production provided some glimmer of hope, up 6.3%yoy from average growth of 2-3% over previous months.

Maintaining forecasts amid mixed macro data— With indicators such as real estate and trade remaining deep in the red; coupled with increasing uncertainty on the election outcome (results are due on May 16); we are currently maintaining our 5.5% GDP estimate for FY10; even as some incremental data is veering towards the positive (cement dispatches, port traffic, telecom subscribers, auto and retail sales).

To see full report: INDIA MACRO VIEW



Hindustan Construction reported lower than estimated revenue of Rs 979.7 Cr (-7% yoy) as a few if its projects failed to reach the minimum threshold limit. The (adj) net profit however, was higher 7% partly owing to 300 bps improvement in operating margins to 15.4% for the quarter.

The FX reversal of losses provided earlier in the year and SAP implementation advisory fee has resulted in other income surging to Rs 24 Cr which in turned boosted reported profit by 94.5%. We have treated reversal of FX losses of Rs 19.33 Cras extraordinary item.

HCC booked orders worth Rs 5200 Cr during Q4FY09 taking the total order book to Rs 16400 Cr.


Due to change in its accounting policy for treating gains and losses on FX borrowings for working capital, the company has reserved Rs 29 Cr of net FX loss in Q4FY09. The reversed amount has been credited to 'Foreign Currency Monetary Items Translation Difference Account' and will be amortised over 3 years. For Q4FY09, Rs 9.67 has been amortised for the same. We have treated FX loss reversal as a non-recurring item whereas the amortisation of the same has been considered as recurring item.

The revenue growth (YoY) which had been decreasing for last 4 quarters finally slipped below zero - marking de-growth. Apart from the general slow down in execution, the de-growth in revenue was also due to failure of some projects to reach the threshold limit of revenue recognition. The bottom line however, witnessed a 7% rise yoy partly due to higher operating margins at 15.38% (+296 bps yoy)

HCC added orders worth Rs 5002 Cr in the Q4FY09 taking the total unexecuted orders to Rs 16400 Cr. The company is L1 for Rs 1000 Cr worth of projects and is currently evaluating projects worth Rs 10,000 Cr.

To see full report: HCC

>Spot gold unchanged; capped by dlr, equities

London - Spot gold prices were unchanged Friday in Europe with gains capped by U.S. dollar strength and mostly higher equity markets.

Market participants said the metal is likely to remain range bound due to little interest from both the physical jewelry market and investors buying Exchange traded funds or bars.

At 0900 GMT, spot gold was trading at $924.60 a troy ounce, down 0.1% from Thursday's close.

Spot gold trade is quiet Friday with the metal attracting little investor and physical interest, said a Switzerland-based trader.

Germany-based physical metal dealer Heraeus said demand for bars "was again very mellow" this week.

Holdings in exchange traded funds remain steady, but aren't rising significantly.

Gold holdings in the New York-listed SPDR Gold Trust ETF rose for the first time since May 6 data showed Thursday to 1,105.62 metric tons from 1,104.09 tons. Holdings have moved only marginally since April 23 and remained unchanged as of Friday data. SPDR is the largest gold ETF.

Gold is likely to remain in a range between $915/oz and $935/oz until there is more clarity on the economic recovery, the Switzerland-based trader said. Market participants will wait for the U.S. to open to provide some direction he said, adding that U.S. April consumer price index and April industrial production may spark some interest when they are released later Friday.

Looking ahead, fundamentals support gold in a $850/oz to $1,000/oz range this year, with the possibility the price could move above the top end of that range next year, the chief executive of AngloGold Ashanti Ltd. said Friday.

The other metals were also mostly unchanged. As of 0900 GMT, spot silver was at $14.01/oz, up 0.1%. Spot platinum was at $1,111.50/oz, up 0.2%. Spot palladium was at $222.50/oz, down 0.4%.

Gold-silver futures trade lower on strong USD

Mumbai - Gold traded unchanged in global market weighed by U.S. dollar strength and higher equity markets but traders and analysts said the metal could trend higher if the dollar weakens. Following the suite gold-silver futures traded lower on Multi Commodity Exchange Friday on selling pressure from higher level and strong dollar. As of now precious metals are taking cues from the global market and traded lower on the domestic front.

The gold June futures traded down by Rs 86/10gm while silver May futures down by Rs 229/kg.

MCX most active gold June contract opened down by Rs 22 at Rs 14,809/10gm. The contract saw movement between Rs 14,751 and Rs 14,830/10gm. At 5.52 pm IST, the contract traded down Rs 86 at Rs 14,747/10gm. Total volumes in June contract recorded 13778 lots.

MCX gold mini the most active June contract opened up by Rs 15 at Rs.14, 785/10gm. The contract saw movement between Rs. 14,740 and Rs. 14,849/10 gm. At 5.52 pm IST, June contract traded down by Rs 82 at Rs. 14,752/10 gm. Total volumes in June contract recorded 17184 lots.

Benchmark silver July contract opened down by Rs 65 at Rs 22,762/kg. The contract fluctuated between Rs 22,600 and Rs 22,895/kg. At 5.52 pm, IST, silver July contract traded down by Rs 229 at Rs 22,598/kg. Total volumes in July contract recorded 13692 lots.

MCX silver mini June futures opened down by Rs 23 at Rs. 22,780/kg. It fluctuated between Rs.22,590 and 22,895/kg. At 5.55 pm mini silver June futures traded down by Rs 204 at Rs 22,620/kg. Total volumes in June contract recorded 20582 lots.

To see full report: COMMODITIESCONTROL