Wednesday, June 3, 2009


“It gets dug out in Africa or some place. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from
Mars would be scratching their head.”

~ Warren Buffett

No other object is like gold—perfectly useless yet universally treasured for millenniums. A controversy in itself, gold has always been an amazing magnet for contentious debates and opposing views. The abolishment of the gold standard stripped gold of its official monetary role, but inadvertently made it the unoffi cial “money of last resort”. Gold thrives on fears and suspicions of government’s fi at power, reasons for the heightened interest of late in the precious metal. This report delineates the perils and promises of investing in gold and presents a fundamental mechanism (with future scenarios) of gold price movement in this truly interesting time of ours.

The perils of investing in gold
The great peril would be mistaking gold for what it is not: an investment asset, an inflation hedge or a “safe haven”. Gold carries no economic returns and has underperformed equities for most of the time since it has had a price; in the short to mid term, gold price does not even move in tandem direction with consumer prices; and it only becomes a “safe heaven” when (the purchasing power of) money is in jeopardy.

The promises of gold
Yet gold is the market’s best and only credible alternative should fiat currency fail. For a rational investor, gold resembles a market priced, public-traded and non-expiring insurance against the extreme event of hyperinflation. Gold speculators, on the other hand, can trade on and profit from changes in outlook of inflation risks and market sentiment. Gold’s diversification benefits also emerge during times of crisis: a 4-8% allocation of gold might be suitable for a mid-risk portfolio.

Gold from now on
That would hinge on the outcome of the US recovery efforts and the ability and will of the Federal Reserve to mop up excess money supply to keep inflation at bay. Here we present four (in fact, five) scenarios: gold would sink to US$500/oz or lower in case of a Japanese-style deflation or if the Fed achieves recovery while pre-empting inflation with surgical precision; on the other hand, gold would shoot up towards US$2,000/oz if inflation reaches doubledigit levels as the Fed hesitates between choosing to kill inflation or a nascent recovery. A black-swan scenario, however, would be one in which gold bugs have their dream come infl ation and a total meltdown of flat currency.

Following topics are discussed in this report:
  • The nature of gold and gold price
  • Gold: demand and supply
  • Myths, rhetoric and facts
  • Gold-plated countries
  • Histories
  • The Gold Rush
  • Gold equities: leveraged gold play
  • India and gold: A history of fascination
  • IIFL Gold Survey
  • Silver: Gold’s often forgotten cheaper cousin
  • Platinum: the high-octane gold
To start full report: THE GOLD REPORT


  • GDP growth revised at 6.7 % for FY09
  • World Steel production declines 23.6% YoY in April
  • India's Crude oil prod drop by 3.1% in April 2009
  • Gems & Jewellery Exports decline by 34.3% in April 2009
  • Inflation remained unchanged at it's previous week's level of 0.61% YoY

To see full report: MACRO SCOPE


Looking for Value After Market Run-up

GAIL new top pick, TP of Rs339 — Given the recent run-up in the markets, we take a fresh look at our stock recommendations among Indian gas utilities. We now prefer GAIL over other gas utilities driven by recent underperformance (-10% vs. Sensex in the last month) and strong performance by GSPL, our erstwhile top pick (+12%). Our TP increase (from Rs288 to Rs339) is driven by lower WACC and subsidy assumptions, with further upside possible given conservative assumptions on tariffs and no value accretion from city gas.

Maintain Buy on GSPL — While GSPL growth outlook is more pronounced than GAIL, outperformance will likely be contingent on a change in the outcome, likely or perceived, of the social tax issue. We are increasing our TP to Rs70 following our lower WACC assumptions. While we continue with 30% social tax contribution, we are now assuming it to be tax deductible. Further upside could come from partial or complete revocation of the directive by the state gov’t.

PLNG stays Sell; prefer Ggas among city gas distributors — We maintain Sell (3H) on Petronet LNG, the best-performing stock in our universe, outperforming Sensex by 40% in last two months, as a robust global long-term LNG outlook drives uncertainty on the future viability of R-LNG in India. Amongst the city gas distributors, we prefer Ggas, Buy (1L), to IGL, Hold (2M), due to relatively lower regulatory risk and negligible impact of proposed increase in APM prices.

Increasing TPs on lower cost of capital — We are increasing TPs across our universe driven by our lower cost of capital assumptions, which now factor in riskfree rate of 6.5% and equity risk premium of 6.0%.

To see full report: INDIAN NATURAL GAS


We initiate coverage on Crompton Greaves with a ‘BUY’ recommendation and a target price of
INR 320 per share implying an upside of 22% from current levels. We expect Crompton Greaves
to maintain its leadership position in transformers space with robust spending planned in power
generation over 11th and 12th five year plans resulting in robust demand for power equipments.
We believe the increasing synergies arising from the international acquisitions and technological
prowess in high end power T&D products would create significant value going forward.

Power infrastructure to witness heavy investments
The peak power deficit, at 16.6%, is at a multi year high. With demand for power expected to grow at 8 to 10% annually, power supply will face even greater strain. In order to meet the shortfall, heavy investments are planned in increasing the installed capacity of power generation. Huge investments will also be made in increasing inter regional transmission capacity to facilitate transfer of power across the regions. With an investment of INR 1,400 bn ministry of power plans to increase the capacity of integrated national power grid from 17,000 MW to 37,000 MW by 2012.

Strongly placed to tap power growth
Every 1 MW of power generation capacity requires 7 MVA of new transformer capacity addition. Ministry of power plans to increase installed power generation capacity from 147.7 GW to 200 GW which would result in huge demand for transformers. With the installed capacity of 27,000 MVA Crompton Greaves is the largest manufacturer of transformers in India. With the product synergies and technological advancement arising through international acquisitions it is now one of the very few companies having experience in execution of high end power equipment products in which incremental investment will come going forward.

Avantha acquisition a downer
Crompton Greaves recently purchased 41% stake in group company Avantha Power and
Infrastructure Ltd (APIL) for INR 2.27 bn. The entire investment will be towards the equity infusion in APIL’s 600 MW Korba power project. We believe that such non – core investment was made in order to enable the Korba project to reach financial closure as banks disburse funds in proportion to equity contribution. Although the cash outflow is sentimentally negative and could have been utilized for more strategic business purposes it is not likely to have a negative impact on the financials of Crompton Greaves in the long term.

Steep discount to peers unwarranted, BUY with a price target of INR 320
Crompton Greaves has historically traded at a discount to its peers which we believe should narrow down considerably going forward. It did not get the same valuations as its peers due to the fact that it was not as techhmmmnologically superior, had gaps in its product portfolio, lack of presence in high end range of power equipments products and lack of proven track record world wide. But it has addressed these issues considerably through successfully integrating its international acquisitions. Although we still believe that the relative premium of companies like ABB and Siemens will continue going forward primarily due to its strong parentage, the extent of discount shall reduce considerably. We assign a p/e multiple of 16 times FY11E estimated EPS of INR 20 to arrive at a target price of INR 320 per share implying an upside of 22% from current levels.

To see full report: CROMPTON GREAVES


Stepping up structural reform?
  • Pace of reform may disappoint an expectant audience
  • Left of Congress party and debate over the appropriate economic model imply a cautious approach will continue
  • Significant labour market reform remains unlikely
Now that the dust has settled after India’s surprising general election results, we can consider the prospects for reform. With the Congress-led government in a far more comfortable position in Parliament, many expect the pace of change to pick up. Such optimism no doubt helps to explain the post-election leap in Indian markets.

But before we all get too carried away, a couple of observations are worth making. First, while the Prime Minister and many of his cabinet are reform-minded, Sonia Gandhi and her son Rahul are also crucial to decision-making, and they stand to the left of the Congress party. We suspect their priority is not so much business and financial-sector change as promoting the welfare of the hundreds of millions of people in rural areas and the urban poor. Many attribute the party’s electoral success to measures such as the farm loan-waiver scheme and the rural workers employment-guarantee programme.

Second, in view of the acute problems in the West, a global debate is taking place over the merits of a highly liberalised financial system. During the election campaign, many in the UPA coalition suggested one reason India had outperformed during the worldwide recession was precisely because it hadn’t liberalised as much as some, but had maintained a large state-owned banking sector and limits on foreign investment in certain areas.

This is not to say the government will ignore reform during its next five-year term. But it is likely to remain slow and cautious, in our view. In particular, we would be surprised to see labour-market changes intended to make it easier to hire and fire workers. Greater privatisation and cuts to government bureaucracy would provide a much-needed boost to government revenue, but they may be considered a step too far for now. That raises the question of how the huge budgetary shortfall will be addressed. So far, the new finance minister, Mr. Mukherjee, has argued things will look better once the recovery gets under way. He is correct, of course, but recent events have taught us the country doesn’t have just a cyclical budget problem – it has a structural one as well.

To see full report: INDIA WATCH



• Revenues grew by 9.4% yoy to Rs3.74bn, ahead of our estimate of Rs3.32bn led mainly by better than estimated transformer revenues. FY09 revenues increased by 5.5% yoy to Rs9.96bn.

• Transformer revenues showed strong growth of 19.2% yoy during the quarter to Rs2.37bn, while project revenues increased by 4.7% yoy to Rs1.29bn.

• EBITDA margins came in sharply higher than estimates at 15% (+76bps yoy) led mainly by the better than expected
revenue growth and higher transformer margins Resultant, EBIDTA grew 15.2% yoy to Rs561mn. FY09 EBIDTA margins stood at 13.9% (+20bps) and FY09 EBIDTA grew by 7% to Rs1.38bn.

• Interest costs grew by ~3x to Rs139m, led by debt of Rs3.56bn on books as on March 31, 2009 and also due to higher average cost of borrowings.

• PAT fell by 18.7% yoy to Rs237mn mainly due to higher interest costs and a relatively higher tax rate (36.7%)
during the quarter. Actual PAT was however, ahead of estimates of Rs175mn on the back of the higher than expected revenues and margins during the quarter.

• Total order backlog as on March 31st 2009 stood at Rs15.63bn (1.6x FY09 revenues). The transformer orders
constitute 33% of the order backlog, while projects contributed 66% and the balance 1% being meter orders.

• The order inflow for the quarter was Rs6.37bn (~3x Q4FY08 order inflow) as the company booked fresh orders in
the project business. For FY09, order inflow showed strong growth of 33% and came at Rs14.59bn.

• The Board of Emco has cancelled the outstanding 1.7mn warrants to promoters and 10% upfront payment made by
promoters towards the same has been forfeited. The Board has approved a fresh issue of 6.3mn warrants to promoters, to be converted at a price not less than Rs62/share. The promoters’ stake in the company is likely to increase to 40% in case of the conversion of these warrants.

To see full report: EMCO PROJECTS


Flat so far, but better than modest expectations — About two thirds of India’s biggest companies have reported 4Q09 earnings so far, profit growth has been flat yoy (lowest in seven years), but ahead of modest expectations (-5%). This trend is consistent across Sensex companies (21/30), and across Citi’s coverage universe (80/138), but on a broader basis 294/500 companies have done better, growing profits 8% yoy. Mixed performance across companies with 39/80 beating expectations, 29 lagging, and 12 in-line. Bottom-line the 4Q results are a little better than expected, and may be contributing to the improved mood.

Sales slacken further, while margins hold out (again) — Operating trends have tracked the previous quarter (3Q09), sales growth has fallen (2-3% yoy vs. 6-8% expected), while margins remained largely stable yoy and qoq. This weak demand and/or deflationary environment is a distinct negative, particularly given that margin support is likely beginning to erode, in our view. While Jan-Mar'09 could well be a ‘bottom’ quarter (from a real and market mood/confidence perspective), weaker demand vs. margin mix would make a rebound that much harder.

Broader market doing better than market top end — Interestingly, the broader market is doing better than bigger companies, with 294/500 companies recording 8% growth in sales and earnings. This could suggest medium sized businesses have not been hurt as much as the larger ones (big companies did better on way up), challenging ‘Conventional Wisdom’ that mid-cap businesses are more vulnerable and therefore should be valued lower too.

Banks and Cement lead, while Metals and Autos bring up the rear — Domestic cyclicals surprised on the upside, perhaps a result of too much caution built in, while Autos and Metals bring up the rear. The sunrise businesses of the last year, Real Estate and Retailing, do worst – falling 80-90% (not far from expectations).

To see full report: INDIA EQUITY STRATEGY


Consistent performance, PAT impacted by Fx losses

Ipca’s focus on building brands through concentrating on branded formulation business has resulted steady growth in revenues and expansion in operating margins. Company has been consistently outpacing the industry growth in domestic formulation segment driven by increased focus on high growth life style segment. In Q4FY09, revenues grew by 29% to Rs3.1bn on the back of a) 38% growth in export formulation business, & b) 34% growth in domestic formulation business. On the operating front, the company reported a growth of 63% to Rs 533mn in Q4FY09, driven by a) 140 bps reduction in raw material cost & b) 300bps reduction in other expenses. Higher interest cost (up by 71%), tax out go (26.8% vs. 8.5% in Q4FY08) and MTM losses of Rs154mn, the company reported a decline of 65% in the bottom line to Rs 79mn. However adjusting to Forex loss of Rs 154mn and Rs 102mn for provision for investment/ loan in subsidiary, the APAT grew by 30% to Rs 296mn. For FY09, revenue was up by 22% to Rs 12.8bn and APAT was up by 64% to Rs1655mn. At CMP of Rs487, the stock is trading at 6.2x FY10E earnings. We upgrade our price target from Rs637 to Rs660 (8x one year forward rolling EPS of Rs82.5). We reiterate our BUY rating.

Branded formulation continue to grow at robust pace
Ipca’s focus on high margin branded formulation segment continued to drive revenue and margin growth for the company. Though the tender business for FY09 declined significantly from Rs 470mn to Rs 79mn, the overall domestic formulation business grew on the back of significant growth from lifestyle segments like CVS, CNS and Pain management. For FY09 the branded formulation business in export markets and domestic market grew by 49% and 24% respectively. The contribution of high margin branded formulation business in India and other semi –regulated market has increasedto 51% in FY08 from 48% of sales in FY09. Management has given a guidance of 18-20% growth in the topline in FY10E.

EBIDTA margins expanded by 420bps for FY09
Operating margins during the year expanded by 420bps to 20% on the back of 460 bps reduction in raw material cost. The reduction in raw material cost was mainly because of improved product mix and softening of solvent prices driven by reduction in crude oil prices. Going forward we expect, company to maintain similar operating margins.

Adjustment of Forex loss & Provisions
During the year, the company has reported a MTM loss of Rs 756.9mn out of which Rs 495 mn was on account of realized losses on forward contracts and Rs 262mn on account of MTM losses on forward contracts, maturing in next 6 months. The company has transferred Rs305mn in the ‘Foreign Currency Hedging Reserve’ account as MTM losses for the contracts which are maturing beyond 6 months. This amount will be charged to P&L account when this contracts will materialized depending upon the currency movement. Company has sold forward contracts worth $80mn at Rs47.5/USD,which is 43% of the projected export sales in FY10E. The company has also made a
provision of Rs 101.9mn for investment/ loan in Brazilian subsidiary.



With a stable and pro-reforms Congress-led government back in power, expectations of speedy and aggressive policy reforms in the areas of oil product pricing and strategic disinvestment have stoked a handsome rally in OMC stocks. Significantly outperforming the Sensex (14% rise) post the election results, IOCL, BPCL and HPCL have gained 23%, 20% and 24% respectively in just five trading sessions. At current prices, IOCL, BPCL and HPCL trade at 6.6x, 6.7x and 8.5x FY10E EV/ EBITDA respectively, and ~1x BV. At these levels, we believe the potential upside from product price deregulation in FY10 is already built into the stock prices. Also, we are skeptical of any concrete measures being effected on the strategic disinvestment front in the near term. We
also note that free pricing of petrol and diesel is feasible only till crude prices below US$65 /bbl, beyond which product price increases would become difficult to implement. We maintain our Neutral stance on the sector.

New government expected to be committed to reforms
Initial statements made by Congress party office bearers indicate that the incoming government will have firm focus on the reforms process. This implies that there may be some definitive action at last on the refining and marketing sector reforms that have been on ice for a long time. We see several economic and political reasons supporting the reform process currently:

• The relatively low crude prices would result in small increases in domestic fuel prices even after deregulation, making it politically convenient to implement the measure, while having little impact on inflation.
• The government will see a steep drop in its under-recovery burden, which would improve its stretched fiscal position. We see a reduction of Rs50bn from government’s oil bond contribution.
• Disinvestment of government stake in the OMCs will unlock value for the government, while a larger free float for the companies will result in better price discovery.

Lower crude price offers a window for change
Crude prices have cooled down substantially to USD55-60/bbl levels, and global demand continues to be subdued. In this backdrop, we see crude prices trading in a narrow range over the next 12 months, despite the current upturn seen in commodities (tracking the global equity markets). This provides the Indian government a good opportunity to push through a free market pricing regime. At the prevailing crude price levels, this would imply a small increase in
petrol prices and a marginal decrease in diesel prices.

Current prices close to international break-even levels
At a crude price of $55/bbl, the subsidy on petrol and diesel combined is estimated at Rs100bn, 84% lower than FY09 levels. We estimate that at a crude price of US$50/bbl, the under-recovery on petrol and diesel tends to be zero. Even at the prevailing crude price of US$60/bbl, removal of price controls will not result in any substantial increase in prices of petrol and diesel. Some reports indicate that at these levels, diesel prices will in fact be lower by ~Rs0.3/ltr,
resulting in substantial benefits to the economy.



Mumbai - Scrap gold sales in India, the world's largest consumer of the yellow metal, is likely to pick up pace following a sharp rise in local prices, industry officials said Tuesday.

This could be bad news for those waiting for a revival of Indian import demand.

Indian imports had briefly recovered in April due to strong demand during the Akshaya Trithya festival but imports slowed again in May and could fall further in June following the rise in prices.

If the uptrend in prices continue, there could be a repeat of the January-March quarter, when imports plunged to around 1-2 metric tons a month amid strong scrap sales and soaring import prices, traders said.

Spot gold in Mumbai, the largest bullion market in the country, has risen above 15,000 rupees per 10 grams, inching towards the all-time high of INR15,800/10 grams hit in February, prompting investors to book profit by selling their old gold in the market.

"We are seeing (daily) scrap sales of 50-100 kilograms in the last few days. This could double if prices continue to rise," said Ketan Shroff, managing director of Pushpak Bullions Ltd.

Average daily scrap sales in April were around 25-30 kgs.

People are expecting prices to rise to INR16,000/10 grams in the coming days following predictions that spot gold will hit $1,000/oz in the international market, he said.

"Many are waiting for prices to reach those levels before selling," Shroff said, adding most of the sales proceeds are being invested in local equity markets.

India's benchmark Sensex has gained nearly 80% since early March amid rising risk appetite among investors and on improved market sentiment following a clear win for the ruling Congress Party-led alliance in recent elections. Better-than-expected corporate results have also boosted sentiment.

Scrap Sales Picking Up In Smaller Towns

In Jaipur, another major market, scrap gold sales are yet to pick up speed, but as prices continue to advance there could be a rise in old jewelry sales, said Rameshwar Lal Goel, president of the Sarafa Traders Committee.

In Chennai, a major market in south India, scrap sales could rise to around 60-70 kg per day, from the usual average of 30 kg, if prices continue to rise, said Daman Prakash, director of MNC Bullion Pvt. Ltd.

"Scrap sales will not rise to the levels we saw in January-March, but some of the people who missed out during the last rally to INR16,000 will try selling now," Prakash said.

During January-March, average daily scrap sales in Chennai were 80-100 kgs, according to traders.

Shroff of Pushpak Bullions said increasing availability of scrap gold will impact imports in the months ahead.

India imported around 15 tons of gold in May, down from 29 tons in April.

"Banks have enough stocks with them, while jewelry offtake is slow. Fresh orders won't be booked at these levels and we could see negligible imports this month," said Shroff.

In June 2008, the country had imported 24 tons of gold, according to the Bombay Bullion Association.

"Unless prices correct to INR13,500/10 grams, imports are going to be very low for the whole year," said Goel.

He noted prices are unlikely to move downward anytime soon.