Sunday, May 31, 2009


When it Rains, it Pours

The sharp rally in Asian assets is accompanied by both a rapid expansion of domestic liquidity and optimism about Asia prospects “relative” to the rest of the world. While relative growth optimism about the region is valid — strong fiscal, bank and household balance sheets are supportive — lingering risks need to be factored in. A sub-par recovery path in G2 on top of still significant inventory overhang would stall re-stocking momentum, and China’s investment-driven growth engine could worsen excess capacity.

Recent data confirm that economies are bottoming in the region. The growth rate bottomed in 4Q08, but even for countries still experiencing sharp contraction in 1Q09, like HK, SG and TW, we expect growth to turn sharply positive on a SAAR basis by 2Q09.

We remain fundamentally bullish on Asia FX over the medium to longer term. While we could see a near-term pull-back after a sustained run, we expect the longer-term appreciation story to remain intact on external flows, further anchored by CNY’s growing undervaluation as the dollar weakens. Our most aggressive FX appreciation expectations vs. spot in 12 months are in KRW, IDR and MYR.

Forces of “inflation” are currently winning over “deflation” – While we don’t foresee any monetary tightening in the near-term, we remain biased to pay rates (MY, TW) or steepeners (SG, TH) with the exception of IDR bonds, where we like being long on improving IDR sentiment, carry and BI accommodation.

Sovereign credit spreads are now close to or even tighter than pre-Lehman levels, so we see little value in going outright short protection on Asia CDS. We see more relative value opportunities with the Indonesia-Philippines CDS spread gap narrowing to 80-100bps and going long cash to play the negative basis.



Positives priced in...

Though we are confident on Sesa Goa’s ability to push incremental 1-2mnte sales annually in Chinese spot markets on: i) increasing market share at the cost of domestic private miners, ii) leveraging well established dealer and end-user contacts in Chinese markets and iii) given the increased Chinese dependence on imported ore after ~50% closure of domestic capacities, earnings surprise will be hard to come by as: i) margins get diluted since incremental ore is mined from high-cost Karnataka mines and ii) prices remain range-bound in the absence of demand recovery (with Chinese steel makers asking for a 45-50% contract price cut). The stock has run up ~100% in the past three months and trades at historically high FY10E P/E of 7.5x. We downgrade Sesa Goa to HOLD from Buy with revised target price of Rs152/share.

While volumes are secured… We do not expect significant downside risk to our FY10E and FY11E volume estimates of 17mnte and 18mnte respectively based on Sesa’s increased market share at the cost of small-scale domestic miners (which form 55-60% of India’s export share). Also, at the current iron ore price, 50% of Chinese iron ore capacities are loss making (operational costs at US$67-70/te). While increased spot exposure due to dealer inventory build-up might be
temporary, the management’s focus to increase contract sales (at ~20% with 3- 4mtpa in long-term contracts) via aggressive marketing push will at least help maintain Sesa’s current market share in Chinese exports.

…we expect no positive earnings surprise. We do not expect significant earnings surprise on: i) volumes as incremental volumes will flow in from low margin Karnataka mines (suffering from high transportation costs), lowering the earnings sensitivity to volumes and ii) prices as we expect spot market prices to remain mostly range-bound within ~US$60-66/te with little short-term upside, which translates into a blended realisation of US$44/te for Sesa. However, rupee appreciation (~7% post elections) is a key downside risk.

Downgrade to HOLD. The stock has run up ~100% in the past three months and is currently trading at historically high valuations – at FY10E P/E (cash adjusted) and EV/E of 7.5x and 4.7x respectively. Also, rupee appreciation is a key risk to revenues. While we are not lowering our volume estimates, we do not believe there is significant upside risk to our earnings. We maintain our benchmark valuations of 50% discount to global peers and value Sesa at FY10E EV/E of 4.2x. We downgrade Sesa to HOLD with target price of Rs152/share from Rs141/share.

To see full report: SESA GOA


Global Banks

"Changing of the Guard"

Global view since 1999 - 2009
Top 20 financial institutions by market capitalisation, $bn, 1999-2009

Source: Financial Times of London



News stories
■ ZenithOptimedia forecasts advertising revenues for Indian media
■ Pudhari newspaper launches in Mumbai
■ Balaji announces annual financial result for the year 2008-2009
■ Aegis Group launched OOH media company Hyperspace.
■ Diamond Comics expands into children’s television
■ Zee Entertainment acquires a 40% stake in Zee Studio from Resource Software Ltd
■ Facebook launches Indian language interface
■ Ybrant acquires Latin American online advertising network, Dream Ad.

■ Share price data
■ Radio audience analysis
■ Leading newspapers in English and Hindi language

To see full report: INDIA MEDIA MONITOR


Oracle Financial Services Software (Oracle FSS) declared Q4FY09 numbers significantly surpassing our estimates backed primarily by strong license fee bookings. Profitability also showed a marked increase partly due to the depreciation of the Rupee v/s major currencies. In view of the run up in price we downgrade the stock to Outperformer.

Product business posts strong growth
The company’s product business segment registered revenues of Rs. 7949 mn for Q4FY09, growing by 6% QoQ and 25% YoY. Noteably, a larger part of the growth was contributed by higher license fees bookings (Rs.1490mn) which grew 59% QoQ, a rare feat in the current uncertainties. However continued INR depreciation v/s major currencies has also been a contributing factor to this growth due to the company’s no-hedge policy.

Higher margin maintenance income increasing
Oracle FSS earned maintenance fees of Rs. 3627 mn for FY09 a growth of 48% YoY. Share of maintenance revenues has increased to 20% from 18% in FY08. We expect this to further go up to 22%.

Jump in margins
Operating margins for FY09 increased by 7% to 26.5% backed by cost curtailment measures and benefits from INR depreciation. This was in spite of a Rs. 291mn impairment loss taken by the company in Q4FY09. Net margins also improved by 770bps YoY. The company also recorded a higher interest income of Rs. 771mn on higher free cash flows resulting in higher net margins of 26.8% compared to 17.5% reported last year.



Regulators move in the right direction…

The Central Electricity Regulatory Commission (CERC) came out with the draft “Tariff Norms for Renewable Energy Projects” in May 2009. The tariff policy will regulate renewable energy projects, which are central sector generating stations or generating stations with composite scheme for sale of electricity to more than one state. The different renewable energy projects for which tariff is determined in the manner suggested under these tariff norms includes wind, small hydropower plants, biomass, bagasse, solar PV and municipal solid waste. The steps taken by the regulator were pointing in the right direction with regard to being clear on the tariffs for renewable energy projects. Several parties to the policy will submit their comments and suggestion on the policy. Developers, to whom the tariff norms are applicable, will find comfort in the fact that the preferential tariff is to be determined for a period of 13 years. The tariff will be determined on a competitive basis after the debt service obligations are covered.

Suzlon Energy, PTC India and Tata Power would be the immediate beneficiaries of the tariff norms. We believe the move is in the right direction. This will lead to increased investment in the renewable energy space.

Policy norms proposed under the New Tariff Norms
We have tried to focus on the impact of the norms on the wind energy sector in the event update.

Tariff design
Under the earlier norms, SERCs were prescribing a varying approach for tariff design. In the recommendation given by the CERC, under the new tariff norms, they have suggested a levelised tariff mechanism. Such a tariff mechanism will be applicable over the preferential tariff period of 13 years. Since the levellised tariff takes into account the extra cash flow requirement by the project for servicing the debt in the initial phases of the project it will help the developers to manage cash flows properly. At the same time it will not lead to a significant burden on utility.

Debt equity ratio
The debt equity ratio has to be considered as 70:30. If the equity actually deployed is more than 30% of the capital cost, equity in excess of 30% shall be considered as normative loan. If the deployed equity is less than 30% then actual equity will be considered for determination of tariff.

Capital cost
The capital cost for wind energy projects shall be Rs 5.15 crores per MW for FY09-10. It will be linked to an indexation formula for computing the capital cost for projects coming after FY10.

■ Tariff structure
The tariff on renewable energy consists of the following fixed components. It includes
1. Return on equity
2. Interest on loan capital
3. Depreciation
4. Interest on working capital
5. Operation and maintenance expense

Return on equity: It is proposed that the preferential return at the rate of 16% will be allowed in case of renewable energy projects. The developer shall be entitled to avail the 80IA benefit under the Income Tax Act, which will result in the MAT rate being applicable for the initial 10 years. This will translate into a pretax return on equity of ~17% for the initial 10 years. Beyond 10 years, the normal corporate tax rate of 33.66%will be applicable. This will translate into a pre-tax rate of return on equity of ~23%.

Interest on loan capital: A normative loan tenure of 12 years has been specified for claiming interest rate on a normative basis in tariff determination. The benchmark interest rate is prescribed as 100 basis points above the SBI PLR prevalent as on April 1 of the relevant period.

Depreciation: After considering the normative repayment tenure of loan over the initial 12 years, the commission has prescribed the rate of depreciation. The estimated useful life of the asset is distributed into two parts. The first part will be 12 year over which the loan capital can be serviced by the developer by way of depreciation. Hence, it has been proposed as 6% for the initial 12 years.

Interest on working capital: Interest on working capital will be calculated at the average SBI short-term PLR prevalent for the period (April 2008 – March 2009). For the calculation of working capital the commission has prescribed the following line items.

  • Operation and maintenance expense of one month
  • Receivable equivalent to 1.5 months of energy charges
  • Maintenance spare @ 15% of operation and maintenance

Operation and maintenance expense
The regulator has prescribed the operation and maintenance expense for FY2009-10 at Rs 6.5 lakh per MW for the first year. CERC has also prescribed an escalation factor of 5.72% per annum from FY11 onwards.

To see full report: POWER SECTOR


Meltdown over, time to solidify

Sector upgraded to Overweight: Our upgrade is premised on stabilizing metal prices after a sharp rally and improving business confidence. Aluminium prices have risen 16% from their Dec 2008 lows while copper and zinc have surged 59% and 43%, respectively. However, steel prices remain mostly unchanged at US$425/tonne. Prices of base metals have increased 30- 50% in Nov 2008 and are stabilizing at the current level. Besides, we believe that weakening dollar would further give support to the commodity prices going forward.

Return of business confidence the main trigger: We believe this price stabilization is the result of arrest in demand decline and decline in inventory as a result of production cuts, destocking and the return of buyers on increased business confidence.

Earnings unchanged, but valuations upgraded: We have not revised the earnings estimates but upgraded ratings of metal stocks within our coverage on improved business confidence over last two months, based on China’s rising Purchase Managers Index (PMI). A stable government in India and increased business confidence would lead to higher investment and consumption, which would ultimately lead to a re rating of the sector.

Valuing stocks on underlying commodity prices: We have valued stocks on the basis of underlying commodity prices, which we expect to remain stable going forward. We have considered the ratio of stock and underlying commodity prices to arrive at our target
price under an optimistic scenario.

Top Buy - Tata Steel; Top Sell – Nalco: We have upgraded Hindalco to Accumulate (Reduce) and JSW Steel to Accumulate (Reduce) as steel and base metals prices have stabilized and we do not expect further declines from current levels. We prefer Tata Steel and JSW Steel to SAIL, given the higher sensitivity of their earnings to steel prices. We retain Sell on Nalco with a
price target of Rs240.

To see full report: METAL SECTOR


Price Target Achieved:
Gujarat NRE coke has appreciated by about 54% since our last recommendation dated Apr. 15, 2009 (quarterly pre-view) wherein we had recommended a Buy with a price target of Rs 41 looking at the expected mismatch in the domestic coke market. Gujarat NRE being the largest private sector player in the Low Ash Metallurgical Coke (LAMC) would be the direct beneficiary of all the positive developments in the coke and Steel industry.

Well poised to weather the storm ………
Equipped with upcoming green field capacity, Gujarat NRE coke is braving the slowdown in the Steel Industry- the principal consumer of coke. Gujarat NRE coke is adding up 0.25 mmT of capacity which is ready in times of falling Global Steel production and prices but relatively stable production and prices in India. Gujarat NRE Coke is the largest independent coke manufacturer that owns coking coal mines in Australia. With backward integration, Gujarat NRE is assured of the raw material it requires for making of Low Ash Metallurgical Coke (LAM Coke), thus controlling its costs.

Enhanced backward integration to favour the company:

Currently, Gujarat NRE Ltd. is sourcing about 30% of its raw material from its own Australian mines and rest from the spot market. With enhanced production from the Australian mines, the Guj. NRE Ltd. expects to meet its 100% requirement by FY2011. This will help the Indian operations to be secured on raw material front in scenario of volatile coking coal market though at the annual bench mark contract rates.

Gujarat NRE to benefit from demand- supply mismatch:

A wide gap of approx. 26 mmT of coke is existent in the Indian coke market, which will be benefiting Gujarat NRE coke. Coke being an essential input for Steel making through blast furnace route, the suspension of production cuts will keep the demand intact in the Indian market. With increased capacity of 0.25 mmT coming in June.’09, Gujarat NRE will enjoy the economies of scale vis-à-vis its competitors. It has also embarked on the expansion of its capacity by another 1 mmT expected to be commissioned by FY2011.


At CMP of Rs 42, the stock quotes at an EV/EBIDTA of 2.5x for FY2011E earnings. The coke prices are expected to be stable with upward bias. LAM Coke being a critical input the Steel making process through blast furnace route and the supply being restricted due to limited availability of coking coal, the down side for the coke prices is limited. Secondly, the fortunes of coke- making industry are hinged upon that of Steel making industry- the latter lifting 90% of the production. With stability seen resuming in Steel making industry, the coke prices are expected to be robust, though it may not reach the highs scaled in CY2008. At CMP of around $395 per tonne we are of the belief that the coke is rightly priced. Hence, we advise our clients to book profits in the
stock and re-enter at lower levels although we have positive outlook on the sector and the company as a whole.

To see full report: GUJARAT NRE COKE


Domestic revenue to remain robust; but exports may be under threat In Q4’09, Cipla posted a 21.8% yoy growth in sales to Rs. 13.7 bn, delivering in-line domestic growth and lower than - expected growth in exports. The Company’s EBITDA margin improved to 25.5%, up 748 bps yoy, gaining from lower material costs and favourable exchange rate. The net profit increased by 40.9% yoy to Rs. 2.5 bn and the net profit margin expanded by 251 bps yoy to 18.5%. We value Cipla based on DCF valuation, which gives a fair value of Rs. 246. Although, in our view, domestic revenues are likely to remain robust, exports may come under threat due to FDA deviations. Thus, we downgrade the stock to Hold.

Robust growth in domestic revenue: We project stable expansion of Cipla’s domestic revenues, which forms 45% of the Company’s gross sales, supported by strong domestic demand for generic drugs as customers are attracted towards cheaper alternatives for expensive innovator drugs. A robust demand offtake coupled with Cipla’s market leadership position lend support to our

upward revision of estimates for growth of domestic sales by 0.5% to 15% in FY10 and 14% in FY11.

However, exports at risk from FDA deviations and Cipla Medpro takeover: We expect Cipla’s exports to come under threat if the Company fails to rectify or comply with the nine deviations pointed by USFDA in its manufacturing processes at the Bangalore plant. Thus, non-compliance would put 27% of Cipla’s total sales at risk - Cipla draws 10% of its total sales from US and 17%
from sales of anti-AIDS drugs in Africa under the President's Emergency Plan for AIDS Relief (PEPFAR) which requires USFDA approval. Furthermore, Cipla’s 20-year supply arrangement with Cipla MedPro in South Africa, which contributes 7% of total exports, may be impacted due to built-in marketing and sourcing conflicts if the latter is acquired by Adcock.

To see full report: CIPLA LIMITED


This note highlights key observations from our discussions with industry participants (including banks, textile companies etc.) in Coimbatore (Tirupur, Karur and Erode) - targeted at assessing banks’ asset quality and demand outlook. Business of this export-dependent region has slowed down significantly on account of poor global demand and stiff competition. Availability of low-cost Textile Up-gradation Funds (TUF) and foreign currency derivatives (which led to further reduction in
effective cost of funds) have led to huge capacity expansion in the region, which is currently more than double of the demand. We understand that, roughly 60% of loans in the region are under restructuring. Official unemployment data is not available; however considering the capacity utilisation of less than 50% and practice of contract labour in the region, unemployment is expected to have gone up - impacting retail asset quality further. However, this is possibly the worst sample in India and, hence, we cannot generalize the phenomenon for the country. We are getting positive feelers from domestic consumption-based textile companies in other regions. Around ~25%
default rate has been observed in small business loans (below USD 100 K) funded by banks and NBFCs.

Key observations (Textiles sector)
■ In general, export demand is still weak; both pricing and order book is hurting.
■ April-May has been better than Q4FY09 (no orders) for some companies due to demand from Europe.
■ Domestic demand is still good and some companies are setting up local sales counters (domestic business, however, accounts for a small proportion of companies’ business).
■ Apart from general slowdown, international competition is hurting margins badly – for example, Bangladesh gets 10% extra realization for the same quality; Turkey gets higher realization due to better turnaround time and proximity to markets.
■ Companies want more duty drawbacks from the government to compete with Bangladesh; they are also demanding better infrastructure and labour laws to compete with Turkey.

Engineering companies of Coimbatore are relatively better placed and are still seeing order flows. However, even these companies are supplying machinery to textile units under severe pressure; revenue declined 60-70% Y-o-Y (eg. Laxmi Machine Works).

Key observations (Banks/NBFCs)

Loan enquiries going down; more restructuring likely
■ Banks have been liberal in restructuring (more to happen in April-June 2009 than reported); there seems to be no other alternative with banks.
■ Banks, in general, have tightened credit and have reduced exposure wherever possible.
■ NBFCs were very active in small loans segment; they have, however, stopped business now due to high delinquencies.
■ Nearly 20-25% of small business loans (ticket size of INR 1.5-5.0 mn) are delinquent due to business slump.
■ Small business loan enquiries have come down significantly; housing loan enquiries have also declined.

Forex derivative issues are settling down
As 90% of receivables were foreign currency denominated, many companies (irrespective of size) entered into derivatives to lower their cost of funds further (mostly USD/CHF swaps). Banks have taken different approaches to solve the problem; some of them have converted MTM receivables into term loans and some have restructured derivative contracts through embedded contracts, while others are fighting legal battle and have reported NPLs. Most of these cases are closed, either through out-of–the-court/one-time settlements or by term loans.

Retail credit quality: To experience more stress

Retail credit quality is adversely impacted, as bulk of the small ticket loans were taken for business. Nearly ~25% default rate has been observed in small business loans (below USD 100K) funded by banks and NBFCs. Also, the number of shifts has clearly reduced; companies are not even working for two shifts now.

Official unemployment data is not available; however considering capacity utilisation of less than 50% and practice of contract labour in the region, unemployment is expected to have gone up - impacting retail asset quality further.

Though housing prices have not corrected in line with the deterioration in income levels of
this region, housing demand has come to a standstill, which portends lower property prices, going forward.

To see full report: BANKING & TEXTILE SECTOR