Thursday, May 21, 2009



Pair Strategy : Long BHARTIARTL, Short RCOM

Long BHARTIARTL, Short RCOM on a rupee neutral basis

Currently, the May Futures of BHARTIARTL and RCOM are trading at Rs 921.15 and Rs 330.05 respectively, giving the current price ratio (BHARTIARTL / RCOM) of 2.791.

We recommend profit booking at a price ratio of 3.261.

The expected return at the target is 16.8%, computed on gross exposure.

Over the past 1 month, BHARTIARTL has underperformed RCOM as BHARTIARTL has increased by 35.3% as against an increase of 52.3% in RCOM. Hence, the current price ratio of 2.791 is trading at 3x standard deviations below 20 day mean price ratio.

To see full report: PAIR STRATEGY


Beneficiary of stable government

Expect long-term policy formulation for various sectors
We believe there are upside risks to our US$275bn assumption for spending on infrastructure in the XI Plan, given the stability and continuity of the central government. We highlighted four concerns in our projected spending: 1) the pace of project awards; 2) on-the-ground execution; 3) private sector equity; and 4) the cost of funds. With the election outcome, we expect points (1), (3) and (4) to be addressed as orders revive in sectors where substantial background work has been carried out (power, railways and roads), due to likely capital market revival, softening of interest rates and long-term policy formulation. Furthermore, continuity of the government in Andhra Pradesh could sustain momentum in irrigation orders.

Sentiment to improve; earnings momentum to be maintained
We increase our earnings expectations due to: 1) higher order in flow expectations in FY10 versus earlier estimated declines; 2) we think margins are likely to be maintained or there will be lower declines than earlier expected; 3) lower interest regime since the last quarter; and 4) likely revival in capital markets will aid PPP projects benefiting both developers and contractors. Even after these, our order inflow expectations are lower than company guidance (for L&T), and lower than growth rates for others in previous post election periods.

Upgrade L&T (UBS Key Call) to Buy; raise PT for other companies
We launch L&T as a Key Call today. We raise our price target for companies in the sector as we: 1) assume higher near-term EPS growth, 2) roll-forward to FY11; 3) lower our risk-free rate from 7% to 6.3%; and 4) better working capital availability. Our top picks are L&T, Reliance Infrastructure, IVRCL and Lanco.

To see full report: INDIA INFRASTRUCTURE


• The Baltic Dry index was down 15.3% MoM, mainly on account of an increase in China’s iron ore inventory

• More than 50% (MoM) drop in day rates in the tanker segment across all vessels categories

• Increase in supply of VLCCs tonnage is putting extreme pressure on VLCC spot market

• The prolonged ore negotiations pulled the market down as rates declined despite an increase in chartering volumes

• The crude tankers fleet is expected to grow by 19.4 million DWT this year. This is more than double the 3.1% growth seen in 2008

• Hundreds of vessels have been laid up worldwide as container lines try to boost rates depressed by US and European consumer paring spending on Asia-made goods


April was the weakest month YTD for the tanker segment as day rates across all vessel categories declined by more than 50% (MoM). This was mainly on account of a fall in tonnage demand. Despite rising slippage rates and order book cancellations, large quantities of tonnage addition over the next two years are pressurising the freight rates downwards. The tankers market is expected to remain soft due to the subdued economic environment and oversupply of tonnage.

Dry bulk
The Baltic Dry Index declined by 15% MoM. This fall was mainly on account of a rise in iron ore inventory levels in China. The Chinese iron ore inventory increased from 67.44 million tonnes (MT) in March to 69.14 MT in April. We expect the market to remain rangebound as BHP, Rio Tinto and Vale are expected to delay negotiations for as long as possible in the hope that steel demand would pick up. On the other hand, cancellation and delays in deliveries coupled with rise in China’s steel production would have a positive impact on the day rates in the dry bulk segment.

Day rates in the LPG segment across all vessel categories saw a meagre decline of 1-2% in April. Though we expect low day rates for the next few months on account of weak market conditions and increasing tonnage supply the rates will stabilise in the long-term on account of increase in scrapping activities.

To see full report: CEMENT SECTOR


Prefer passenger vehicle plays

Cars & UVs to benefit from easing liquidity environment
We now expect strong growth in passenger vehicles segment at 14%YoY in FY10 and FY11 driven by declining interest rates and easing finance availability. We expect pre-Euro IV emission norm implementation buying and pre-budget buying to further boost demand in Q4FY10.

2 Wheelers likely to show modest growth
We expect 2–wheeler demand to grow 6%YoY and 8% YoY in FY10 and FY11 respectively. Given that we anticipate no easing in financing constraints for the 2W segment, the demand is likely to be driven by growth in rural areas which are less dependent on financing. We expect scooter growth to continue and expect faster growth in scooters ahead of motorcycles.

CV to remain sluggish, LCVs faring better
We expect CV demand to rise 5%YoY driven by growth in LCV segment. While we expect turnaround in industrial activity from Jun-09, we expect M&HCV sales to remain weak as industrial growth in FY10 is likely to remain weak. We expect CVs to grow 15%YoY in FY11 driven by rebound in industrial growth.

Maintain Buy on Maruti and M&M
We expect Maruti’s margins to improve along with improving demand. We expect Xylo launch & higher rural exposure to help drive UV growth for M&M. We remain Neutral on Hero Honda as we see limited scope for further margin expansion from current levels. We maintain our Sell on Tata Motors as we expect further dilution due to high leverage and remain concerned about cash burn at JLR.



Cement dispatches up 13.1% YoY in April 2009

Capacity utilisation at 92% in April 2009; southern region lags

Robust growth

In April 2009, all-India cement dispatches reported a growth of 13.1% YoY on the back of spending in construction activities by the government before election. On an MoM basis, cement dispatches were down 8.1% mainly on account of a drop in capacity utilisation. Capacity utilisation dropped to 92% in April 2009 against 103% in March 2009.

Among major players, Shree Cement, Jaiprakash Associates, Dalmia Cement and Grasim have reported impressive growth of 28.4%, 28%, 23.7% and 21.3% YoY, respectively. Madras Cement and UltraTech Cement have also reported good growth that is higher than the industry average. The strong growth in the dispatches of these players was primarily on account of capacity additions. Birla Corp has reported negative growth of 7.9% in dispatches.

As demand normally slows down post elections and the monsoon season is around the corner, we expect demand to get stalled in the coming months. Apart from this, capacity additions would put further pressure on realisations. However, with softening of coal/petcoke prices, cost pressure for the cement industry has been easing out considerably. Also, most of the cement players have consumed their high cost coal/petcoke inventories. Thus, most players are expected to report sequential improvement in profits. However, the adverse demand supply situation will force cement companies to pass on the savings by reducing prices in the medium-term.

Region wise performance
Among major regions, the northern region has reported the highest growth of 19.6% YoY led by incremental demand from major projects, namely, Commonwealth Games, sewerage line project in Punjab, national irrigation project in Haryana, Delhi Metro, flyover and Delhi airport. Also, re-imposition of CVD and special CVD on imported cement has contributed to growth from northern players. The southern region has reported growth of 12.8% YoY driven by higher demand from irrigation projects. The western region has reported 11.2% growth in dispatches. The central region’s dispatches have reported growth of 10.5% YoY due to spending by the UP government on low-cost housing. The eastern region has reported growth of 8.8%.

To see full report: CEMENT SECTOR


The Flood Continues

Current inflow cycle the longest since the unfolding of Asian bear markets in 2007 — New money to Asian equity funds rose further from US$1.6b two weeks ago to US$1.9b last week. This is the most sustained inflows (10 weeks so far) since November 2007, and in dollar terms average weekly inflows in the past month are now 2.5 standard deviations above historical averages, the biggest since the beginning of the bear market.

As investor risk appetite resumes, money to developed market funds lags — While net cash taken in by all dedicated Emerging Market (EM) equity funds was US$3.6b/week over the last two weeks, Global fund inflows averaged only US$760m/week. Year-to-date, net inflows to all EM funds have been US$17.7b versus net outflows of US$4.6bn for Global equity funds. The cheap money, looking for higher returns, explains why Asian markets have gone from 1x book
value to 1.7x in just three months.

Money chasing Taiwan equity funds, Singapore funds finally gaining traction — Comparing to average weekly inflows between 9 April and 6 May, new money to Taiwan funds tripled to US$378m last week, or 11.4% of their AUM. Singapore equity funds, having been unloved for a while, finally gained traction from overseas investors with inflows last week the largest since May 2008. That said, it is the only fund group for which net flows are negative year-to-date.

To see full report: FUN WITH FLOWS


Best to hold on to a good thing. We recommend investors stay invested in order to play eventual and domestic economic recovery. Fair-to-full valuations of several large-cap stocks prevent us from taking a more aggressive view; we do not see concrete evidence of earnings upgrades yet. We stay with banking and commodities as the best ways to play the economic recovery theme, especially as their valuations are still relatively inexpensive versus those of other sectors.

Stay invested to play possible recovery in economic activity and earnings
We recommend that investors stay invested in order to play (1) likely recovery global and domestic economic recovery and (2) possible earnings upgrades related to economic recovery. We stick with banking and commodities to play the economic recovery theme.

14,000 (+20%) for BSE-30 Index may be possible with earning upgrades, liquidity
In our view, the BSE-30 Index can rise 20% to around 14,000 by end CY2009 with impetus from (1) possible earnings upgrades and (2) continued positive investment sentiment. We do not yet see concrete evidence of sustained earnings upgrades given global and specific domestic issues in several sectors. A liquidity-driven rally based in euphoria alone may not sustain.

Stable government and like-minded coalition partners to help investment sentiment
We see the inevitable formation of the UPA government (262 seats out of 543 in the Lok Sabha in the 15th national elections) as a positive for the market since it represents political and economic stability. Also, the Indian National Congress (INC) is stronger than before with 206 seats against 145 previously. This gives it the strength to push economic reforms without much opposition from its coalition partners.

To see full report: INDIA STRATEGY


INR: Revising Our Target Due to the Strong Election Outcome

Key take-away: We are upgrading our INR outlook, based on our India economics team’s belief that the election outcome is a “huge surprise” for their economic outlook. The four risk factors behind our previous bearish call − a negative macro-dynamic, deteriorating BoP, rising sovereign credit risks and a negative bank NPL cycle – have all greatly diminished following the election outcome, in our view. Instead, the new administration raises the prospect of a stronger growth outlook, economic reforms and a more prudent fiscal policy. We therefore change our USD/INR year-end target to 46 from 53.

General elections – huge surprise: The Indian general election results, announced on May 16, were a “huge surprise” according to our economics team (see India Economics: General Elections Verdict - Hope for a New Beginning, Chetan Ahya and Tanvee Gupta, May 17, 2009). The ruling coalition, led by the Congress party, returned to power by winning 260 of the 543 parliamentary seats (48%). The outcome was far in excess of our team’s ‘optimistic case’ scenario of 170-180 seats. As a consequence of this stronger political mandate, our economics team believes that the new administration will be able to accelerate the pace of economic reforms, including: 1) infrastructure spending; 2) privatization/deregulation; and 3) fiscal management. This, in turn, is likely to improve the growth outlook. Our economics team has raised its 2009 GDP forecast to 5.6% from 4.3% and the 2010 forecast to 6.6% from 6.1%.

INR’s downside risks fade away: The improved outlook for policy reform and economic growth changes our INR outlook to positive. The four risk factors behind our previous bearish call − a negative macro-dynamic, deteriorating balance of payments (BoP), rising sovereign credit risks and a negative bank NPL cycle – have now all greatly diminished, in our view.

Negative macro-dynamic to moderate: We believe that the INR has been undermined by a negative macro-dynamic over the past 12 months (i.e., below-trend growth and external deficit). The external deficit is already on a narrowing trend (we estimate -1.2% of GDP in 2009 versus -3.1% in 2008), but the macro-dynamic headwinds look set to moderate further with the improving growth outlook. As a result, we believe that as a key driver behind the INR’s weakness, the negative macro-dynamic will decline over the second half of this year, returning to a more neutral setting over 2010 (i.e., trend-like growth with a narrowing external deficit).

Safely unwinding the financial account bubble: While India’s current account deficit is likely to persist, the country’s overall BoP is set to improve, in our view. We had previously been bearish on the INR because of concerns of an unwind in India’s financial account bubble. Foreign capital rushed into India during the boom years, especially during the late part of the cycle in 2006-07. This surge of capital caused India’s financial account to balloon five-fold to INR5.3 trillion (11% of GDP) in 2007 from INR1.0 trillion (3.3% of GDP) in 2004. However, capital began to exit when the economic downturn began last year.

To see full report: CURRENCIES


A bullish mandate

The 2009 general election has thrown in a big positive surprise, with the Congress-led UPA coalition positioned to achieve a majority with little external support. With big gains for the Congress party and marginalisation of smaller regional parties, the new government will be well positioned to pursue a stronger reform agenda. With political risk less of an issue, we see the market – still under owned by FIIs – being rerated. Banks, infrastructure plays will be stronger beneficiaries.

Strong mandate for UPA – a big positive surprise

Congress-led UPA wins 263/543 seats – 50 ahead of the most optimistic exit polls.

We see the UPA bridging the nine seat gap to the half-way mark rather easily, as smaller regional parties and independents will vie to join the winning coalition.

The Congress made big gains in the states of Uttar Pradesh, Andhra Pradesh, Kerala and Maharashtra. The Left parties got just 24 seats, versus 59 in 2004.

Dr Manmohan Singh will be the Prime Minister once again. The Congress’ strong
show in UP, however, sets the stage for Rahul Gandhi’s ascent as the next leader.

Strong coalition augurs well for governance

The biggest positive of the elections was vote for stability, reflected in the defeat of opportunistic regional parties. The Congress and the BJP together won 321 seats.

With the strong mandate for the Congress-led UPA alliance and the party’s own tally of 206 seats, bargaining power of smaller partners has eroded significantly.

Reduced political risk will reflect in re-rating of equities

The political risk factor was holding back FII investments - reflected in FII ownership of the market remaining c.20% below the MSCI benchmark.

While radical reform looks unlikely, we are optimistic about higher FDI limits for insurance and retailing and quicker resolution of project specific bottlenecks.

Sensex P/B remains 35% below the historical average. While a 50bps fall in risk premium suggests 25% re-rating, ROAE below mean will limit it to 10-15%.

While FY10 EPS outlook remains geared to global recovery, we see market rerating supporting a 12mth target of 14,000 for the Sensex.

Signals of fiscal consolidation will be key to sustainability of the rally.

Winners and losers

The immediate rally will be broad-based, with focus on large cap, index majors.

Banks and infrastructure plays will be top beneficiaries of improvement in capital market, corporate confidence. ICICI, HDFC also gain from insurance reform.

ICICI Bank, HDFC, Reliance Ind., Reliance Comm. and Sterlite are our preferred picks. We have cut weight for consumers, software in the model portfolio.

To see full report: MARKET STRATEGY


Surprises from consumers

We are impressed by the resilience of the Chinese consumer, evidenced by 9% y-y growth in household spending so far this year. This gives us comfort with our 8% 2009F GDP and V-shaped recovery forecasts, which have been in place since the beginning of the year. While this is a slowdown from last year, the absolute growth is extraordinary amid the global slowdown and reflects, in our view, the secular story of consumption growth in China. We also think consumption growth will start to pick up as fiscal stimulus measures kick in, driving job creation, income transfer, improvement in the social safety net (which should reduce precautionary savings), better infrastructure (to ease physical bottlenecks for rural consumption) and direct subsidies or favourable tax policies. We even look for possible upside risk to our forecasts. Hence, while we maintain our 8% consumption growth forecast for 2009F, our China research team has examined the sensitivity of key sectors of the economy to a possible consumption surprise above this projection. Apart from the obvious consumer staples and retailers, we find that Internet, airlines, autos, telecoms and property are very sensitive on the upside. We round off this report with currently actionable ideas from these sectors.

Consumers have not cut spending
Chinese consumers continued to increase spending in 1Q09, despite the weakest GDP growth in more than a decade.

Consumption growth should remain strong this year
Consumption growth may surprise on the upside later this year, as both employment and income growth are likely to rebound.

Stimulus policies help boost consumption
Contrary to claims that stimulus packages do little to boost consumption, we believe that most of China’s policies are pro-consumption — in the short term as well as the long term.

Consumption is already a key growth engine
Consumption growth in China has not been slow at all, in our view. Investment growth has dwarfed consumption growth — common for developing economies. The “unbalanced” growth model may not necessarily be unsustainable.

Areas with high growth potential
Still-low income levels in tandem with the high income growth of Chinese consumers provide significant potential for long-term consumption growth in China. We see significant potential for
consumption in rural areas, central and western regions, service sectors, and low-income urban households.

What if consumption surprises on the upside?
While we maintain our 8% consumption growth forecast for the year, our China research team has examined the sensitivity of key sectors of the economy to a consumption surprise above this projection. Apart from the obvious consumer staples and retailers, we find that Internet, airlines, autos, telecoms and property are very sensitive on the upside.

To see full report: CONSUMPTION OUTLOOK