Wednesday, June 10, 2009


Singapore - Crude oil futures in Asia breached USD71 a barrel Wednesday as traders bet that weekly U.S. crude inventory data will show larger-than-expected drawdowns on an improving global economy.

Data from the U.S. Energy Information Administration later Wednesday may show that crude oil inventories fell by 700,000 barrels, according to the average estimate of analysts surveyed by Dow Jones Newswires.

"Although there is a lack of focus on current supply-demand fundamentals, investors still have one eye watching inventory," said Jonathan Kornafel, director for Asia at Hudson Capital Energy in Singapore.

"If we see another withdrawal, it gives funds and investors one more reason to push prices higher."

On the New York Mercantile Exchange, light, sweet crude futures for delivery in July traded at $71.05 a barrel at 0708 GMT, up $1.04 in the Globex electronic session. July Brent crude on London's ICE Futures exchange rose 83 cents to $70.45 a barrel.

A broad rise in Asian share markets and a weakening U.S. dollar helped oil prices reach a new seven-month intraday high during Asia trading.

"A weaker dollar is definitely a factor that explains some of the movement in price," said Toby Hassal, an analyst for Commodity Warrants Australia in Sydney. "A lot of speculative funds are flowing into the oil market."

Some analysts cautioned that the rise in crude prices was short-lived because demand for gasoline and other products was still weak.

"Demand for petroleum products in the aggregate fell off the proverbial cliff in the week following the U.S Memorial Day holiday," wrote analysts at the Schork Report in a note to subscribers. Meanwhile, "crude oil supplies are flush, as is the capacity to refine it."

In fact, oil prices eventually should fall back in the near-term, said David Moore, commodities strategist for Commonwealth Bank of Australia.

"Oil market fundamentals remain fragile, and there is an anticipatory element in the gains," he said, noting that prices would quickly reverse on weak economic data.

At 0709 GMT, oil product futures were up.

Nymex reformulated gasoline blendstock for July - the benchmark gasoline contract - rose 180 points to 198.47 cents a gallon, while July heating oil traded at 182.56 cents, 180 points higher.

ICE gasoil for July changed hands at $565 a metric ton, up $9.75 from Tuesday's settlement.



The Final Countdown!

A near US$500trn – 10x world’s GDP – is the turnover on global exchanges today! Intrinsically an annuity business, sticky ‘liquidity’ renders the industry quasimonopolistic where ‘winner takes all’. High operating leverage with EBITDA margins of 60-80% as also limited capital needs, albeit a one-time heavy investment, imply strong cash flows. The nascent Indian exchange landscape is finally evolving from ‘only equity’ into an inclusive blend of asset classes (commodities, forex, power, etc) with underlying physicals warranting a 2.5x growth in industry turnover to US$10trn by FY14. Now demutualized and electronized entities, the compelling business model is bound to translate scale into profitability. With exchanges inherently commanding high strategic valuations (CBOT acquired at 55x earnings; NSE valued at $2.3bn), logical for their risk-free model, we believe it’s time for ‘value creation’ on Indian exchanges. We are BULLISH. Financial Technologies, the only listed player in the space and Asia’s largest exchange conglomerate, is our BIG bet.

Business model…flawless: Revenue sustainability (20% CAGR in global volumes for two decades), high operating leverage (60-80% EBITDA margin) and strong cash flows make exchanges a near-perfect business. With liquidity, the key success factor for an exchange, difficult to ‘poach’, entry barriers in the industry are well defined and lend further resilience to the annuity model.

Indian exchanges – on a high: Indian exchanges (US$4trn turnover), synonymous to equity markets, are finally coming of age. Inclusion of varied asset classes – commodities, currencies, power, etc – is set to impart scale and depth to the industry. Based on underlying physicals, industry turnover is expected to reach US$10trn by FY14, primarily spear-headed by the nascent but high-potential commodity exchanges (4x from US$1tr currently).

Time for value unlock: Having undergone a swift evolution, the demutualized and electronic entities have overcome structural inefficiencies. Catching the eye of global players, the big-ticket sector has garnered high strategic valuations (NSE valued at US$2.3bn, MCX at $1.1bn and BSE at $0.8bn), which is now set to convert into market capitalization. We are bullish. In the listed space, our big bet is Financial Technologies. We recommend Outperformer with a price target of Rs2,000 – a 40% upside from the CMP.

To see full report: INDIAN EXCHANGES



We anticipate sugar inventories falling to an all time low of 1.3 months of forward demand in SY10; our assumptions of a 30% rebound in sugar production and an unprecedented 3mt of imports notwithstanding. The tight demand supply should last well into SY11; UP based players are best bets in the upcycle given strong leverage to sugar prices. We initiate on Bajaj Hindusthan (+47%) and Balrampur Chini (+46%) as BUYs and on Shree Renuka Sugars (+25%) as OUTPERFORM.

India’s tightest sugar demand-supply
We expect India’s sugar production to rebound 30% to 19mt in SY-Sept-10 after falling 44% in SY09 underpinned by a 0.5m ha increase in cane acreage (the second highest YoY increase ever) and a 90bps rise in sugar recoveries to 10.1%.

We also anticipate increased imports of 3mt (an all time high) on the back of the recent decision of the government to allow duty free imports.

Sugar inventories will continue to fall, nonetheless, to 2.6mt by Sep-10. At only 1.3 months of forward demand, this will be its lowest level in the last three decades.

Demand-supply will remain tight in SY11 as well implying a 24-30 month up-cycle.

Stronger balance sheets.
The last down-cycle has dented investor confidence but this was accentuated by rapid expansions and the resultant higher capital charges (depreciation, interest).

With the companies out of the capex cycle and profitability rebounding, free cashflow should rise and balance sheets will get stronger; the net debt/ equity for the three companies under our coverage will fall to 50% by SY11.

Further, by-product integration projects would also reduce future cyclicality.

Sugar gross margins to rise above Rs8/kg

The tight demand-supply should reflect in higher sugar prices but the underlying cyclicality is reflected more in sugar gross margins (sugar price – cane costs).

This allows the players to pass on higher cane costs in an up-cycle; this should dampen the impact of irrational cane cost increases over the next two years.

Our regression model suggests normative margins rising to Rs8/kg in SY10; this is 15-20% higher than the previous up cycle given the tighter demand-supply.

We prefer leveraged plays

The UP based players are best placed to ride the up-cycle given their higher leverage to sugar margins. BJH and Balrampur are the largest players here.

We initiate on BJH with a BUY and a target of Rs240 (+47%); its balance sheet concerns will also abate as profitability rises accentuating the operating leverage.

We initiate also BRCM as a BUY and a target of Rs135 (+46%); we also like its integrated model (power, alcohol) which cushions the down-cycle support.

We rate Renuka an O-PF (TP: 165, +25%) due to its relatively lower leverage.

The key risk to our view is irrational government action capping sugar prices.

To see full report: SUGAR SECTOR


Concerns about loan restructuring likely to fade; still Neutral

SBI reported a much larger than previously reported figure for loan restructuring in its detailed financial report. The detailed financial report was published on June 5, 2009. Restructured loans as of 31 March 2009 at the parent level stood at Rs130 bn versus Rs83 bn reported on 9 May 2009 when it announced the results for 4Q2008. Further, the detailed financial statement also reported that Rs90 bn of loans would be restructured in 2009 taking the total value of restructured loans to Rs220 bn. We believe this surprised the market expectations negatively and pushed down SBI’s share price by nearly 4%.

The total loans restructured including those to be implemented in 2009 for SBI would be 4% of loans. Market expectations would likely be impacted by two factors: 1) negative surprises from under-reporting stressed assets; and 2) higher restructured loan levels than reported by its peers thus far. PNB (PNBK.BO) and BOB (BOB.BO) reported stressed asset levels of 3% (proportion of loans restructured, including those to be implemented in 2009), while ICICIB (ICBK.BO) reported 1.4% with the potential of it being revised upward as more borrowers could seek loan restructuring. This could raise market concerns about banks potentially facing higher levels of NPL and credit cost. However, as our Economists believe the economy could get back to trend growth level over the next 24 months, we believe such concerns of the market would likely be transient and unlikely to affect expectations of earnings growth.

Maintain Neutral and 12-m target price of Rs1150 for SBI, based on SOTP methodology. Upside risks: higher than expected demand for loans and lower credit costs. Downside risks: government policies that could negatively influence the economic environment and interest rate outlook.

To see full report: STATE BANK OF INDIA


Liquidity driven TP upgrade, but where's the demand?

Despite upgrading TP driven by liquidity, retain UW on large outperformance
This capital-intensive sector was caught in a pincer of weak operational cashflows and asset-liability mismatch in a tight financial market. Improving liquidity in financial markets is resulting in 55% increase in float (with significant more to go) by financially savvy developers. This reconfirms our view that physical demand is yet to see any significant pickup. Despite the liquidity driven increase in TP by up to 150%, the 147% spike in Realty Index in last 3m leads us to retain UW rating.

Liquidity leads us to increase TP, despite retaining all other assumptions
This capital-intensive sector was caught in a pincer – significant mismatch in operational cashflows and assets-liabilities in a tight financial market resulting in a 90% underperformance from its peak in Jan’08 to the bottom in Feb’09. Improving global financial markets as also support by local banks (with significant growth in outstanding debt and restructuring of old debt) has resulted in a significant lowering of the bankruptcy risk for the sector. Hence, while we retain all other major assumptions, driven by improving liquidity, we cut WACC by up to 200 basis points and a sharp (5-30%) cut in discount to GAV (Gross Asset Value) resulting in up to 150% increase in TP.

But fundamentals are yet to fall in place as seen by the rush to raise equity
(a) Despite the sharp cut in prices of new launches that are redesigned with smaller apartments and fewer amenities resulting in ~60% fall in unit prices and upto 300bp fall in mortgage rates, demand seems to have picked up only at city centric locations of Mumbai and NCR. (b) Developers admit that while worse seems behind, demand is yet to pickup in residential with other verticals being further behind. (c) Data on outstanding mortgages available till Feb’09 have shown a consistent and sharp fall in growth from Jun’06, while outstanding credit to developers has ramped up from Feb’08. (d) Data available for cement demand till Apr’09 indicates no significant pickup in last few months (e) Almost all the fresh equity raising in India seems to have been by developers. Despite most developers being reasonably aggressive and BSE Real being 71% below its Jan’08 peak currently, the sector has seen 55% increase in free float from mid Apr’09. Infact proposed issuances could result in upto 140% increase in free float from mid Apr’09. This clearly indicates their unwillingness to “wait for better times” for diluting. It also raises the threat of significant flow of paper.

Despite the significant increase in TP, retain most company ratings; Risks
Liquidity driven upgrade in TP by up to 150%. However with a 147% spike in BSE Realty Index vis-à-vis 65% for Sensex in last 3m, we retain most ratings (Hold on DLF and Unitech and Sell on Puravankara and Sobha), while downgrading IBREL to Hold as we now do not see the need to “hide” in a good B/S. Risks: Improving macro environment (with higher GDP growth and a better outlook for IT/ITES), aggressive price cuts by developers’ kick-starting demand across regions and across verticals and continuing liquidity in financial markets.

To see full report: INDIA PROPERTY


Government continuity to result in accelerated execution

Mr. Kamal Nath appointed as Union Minister of Road Transport and Highways: Mr Kamal Nath, who had held Commerce and Industry portfolio in previous term (FY05-09) of United Progressive Alliance (UPA) government has been entrusted with an important role as Union Minister of Road Transport and Highways. The key priorities have been identified as: increased focus on execution, improving capital availability and addressing operational issues in consultation with state governments.

National Highway Authority of India (NHAI) project award during FY07-09 has not been encouraging: During FY05-09, total road projects completed stood at 9,819kms; of which projects completed during FY07-09 stood at just 4,575kms. Also, new projects awarded during FY05-09 stood at 11,502kms; of which projects awarded during FY07-09 stood at just 3,571kms. The key reasons for delays in terms of project awards during FY07-09 were largely due to restructuring of NHAI, formation of 'PPP Advisory Committee', introduction of new Model Concession Agreement, etc. Also, restriction in terms of number of bidders for each infrastructure project and Clause 2.1.18 which restricted eligibility of each company to bid for infrastructure projects also affected investor interest. Apart from the above, there were issues in terms of land acquisition, shifting of utilities, execution challenges, etc which impacted project execution.

Revision in concession terms leads to improved viability, 10 projects awarded since December 2008: NHAI has approved higher capital costs, increased concession periods, etc which has led to improved viability. Also, project costs have been reduced through changes in project design. Restrictions in terms of number of bidders for each infrastructure project and also Clause 2.1.18 have been relaxed.

9,531kms of projects have reached RFP stage, expect accelerated project award: Based on our analysis of NHAI projects, 100 projects with total length of 9,531kms and with project cost of Rs1,178b have already reached Request for Proposal (RFP) stage. Of these, bids have already been called for 29 projects with total cost of Rs562b (total length of 3,071kms). Given that a large part of the administrative issues have been sorted, we expect acceleration in terms of project award.

Easing liquidity to aid project financing: The Surat-Dahisar Project (245km, Rs25b), awarded to IRB Infrastructure in February 2008, has achieved financial closure in Febuary 2009 at 12.5% (domestic debt) with Canara Bank and IOB leading the consortium. This project was one of the five awarded in February 2008 (1,095km). Companies with robust cash flows (e.g. L&T, Reliance Infra. and IRB Infra.) are relatively better positioned to address the financing issues.

To see full report: ROADS


Fee income boosts PAT

Rural Electrification Corporation’s (REC) Q4FY09 results are in line with our
estimates on the net interest income (NII) level, where growth came in at 20% YoY. But PAT was much above estimates due to higher fee and other income. Loans grew 31% YoY and asset quality remained healthy with gross NPAs at 0.14%.

Outstanding sanctions at Rs 0.8tn: Loan disbursals remained stable YoY at Rs 44bn in Q4FY09. For the full financial year, disbursals grew by 32% YoY to Rs 166bn; however, sanctions declined by 12% due to the higher base in FY08. The company has outstanding sanctions of over Rs 0.8bn which provide strong visibility on loan growth for the next few years. We expect a 16% CAGR in disbursals over FY09-FY11 and with repayment at 14–15% of loan assets, we project a 23% growth in loan book during the same period.

Margins to be maintained at 4% in FY10: Reported yield on assets improved by ~110bps during the quarter to 11.8% due to a higher PLR and re-pricing of assets, whereas the cost of funds increased by only 86bps as the company raised capital through the issue of commercial paper available at lower costs. Consequently, the reported net interest margin (NIM) improved by ~40bps to 4.25%. We expect the NIM to remain at 4% in FY10 due to re-pricing of loans at a higher rate, but to decline by 20–30bps in FY11.

Higher fees from RGGVY boosted other income: REC receives fee income equal to 1% of loans disbursed under the RGGVY scheme. In Q4FY09, the company disbursed loans of Rs 2.7bn under the scheme. But fee income was higher at Rs 390mn as REC booked income on disbursals made in earlier years as well.

Marginal increase in NPA: Gross NPAs increased from Rs 640mn in Q3FY09 to Rs 690mn in Q4FY09 due to delinquencies on one account. However, the company has started receiving payments from the account in this quarter.

Estimates, target raised but upside limited – Hold: We are raising our FY10 PAT estimate by 6% to factor in higher loan growth and fee income. We also introduce FY11 numbers. PAT is projected to log a 16% CAGR over FY09-FY11. REC may benefit from a possible reduction in risk-weights on government guaranteed loans (constituting ~40% of loan book) from 100% to 20%, which will help it maintain its high leverage and consequently robust ROE.

We are revising our price target to Rs 135 to factor in higher profitability and sustained ROE. We are also assuming a favourable ICAI decision on tax benefits. While we like REC for its strong visibility and asset quality, we believe that absolute returns in the near term will be limited due to the sharp appreciation in stock price in the last three months. Hold.



Satisfactory Performance

4Q’09 PAT up 37% yoy: 4Q’09 PAT of Rs 831 mn is up 37% yoy and is 26% above our estimates. This is primarily on account of significantly higher treasury income of Rs 950 mn booked during the quarter and lower than expected provisions.

Significant moderation in advances growth: Loan book witnessed growth of 9% for FY09.This was primarily on account of 1) management turning cautious in an uncertain environment 2) bank’s focus on containing delinquencies. We favour KBL’s strategy to moderate growth in an uncertain environment and believe this move should benefit the bank in controlling delinquencies going forward. For FY10E management has guided for strong growth of 27% which looks unlikely to us. We expect loan book to grow by ~17% over the next two years.

Margin surprised negatively: Margins decline of ~40 bps in FY09 was a negative surprise (2.22% in FY09 vs ~2.6% last year). However, this was primarily due to the fact that the bank was unable to meet direct agricultural sector lending target and consequently had to invest ~Rs 10 bn in RDIF deposits (earns interest of ~4%) which impacted margins adversely. Further, decline in loan deposit ratio by 5.4% yoy to ~58% also impacted margins negatively. CASA continues to remain weak at 21% and the management intends to improve it by ~300 bps in FY10. We forecast margins to improve by 20bps over the next two years driven by 1) repricing of deposits at lower rates 2) improvement in CASA mix to ~23% by FY11E 3) Improvement in loan deposit ratio by 150 bps.

Improvement in asset quality but restructured assets at ~4.2% of advances: Asset quality improved sequentially for KBL with gross and net NPL declining 2% and 31% respectively on an absolute basis. Coverage ratio improved from 63% in 3Q’09 to ~74% during 4Q’09. However, the bank has restructured accounts amounting to Rs 4.8 bn in FY09 and there are further pending applications of Rs 0.1 bn, totaling to ~4.2% of advances. Most of these loans are standard currently. Delinquencies remained stable in FY09 at 1.5%.Going ahead, we believe that delinquencies could increase to ~190 bps over the next 2 years which would lead to LLP of 76 bps in FY11E vs. 41 bps in FY09.

Revision in estimates: We cut our FY10E and FY11E earnings estimates by 9% and 13% respectively driven by slower loan growth and lower than expected margins. We now forecast profits to decline by 3% in FY10E. We expect the bank to report ROE of ~15% over the next 2 years. We have assumed dilution of 13% at price of Rs 125 per share in FY10E.

Solid franchise at attractive valuation: KBL is one of the cheapest private sector banks in India, trading at P/BV of 0.85x FY11E. Given the expected return ratios and valuable franchise, we believe KBL is an attractive value pick. Based on a normalised ROE of 16.1% (earlier 17%), we value the stock at 1.06x book (earlier 1.4x), implying May’10 target price of Rs.170 (earlier Rs 190).

Risks to recommendation: Higher than expected delinquencies is the key downside risk to our recommendation.

To see full report: KARNATAKA BANK


Margins improved on fall in raw material and fuel costs

Topline flattish as expected: Deepak Fertilisers & Petrochemicals Corp (DFPCL) reported 1.2% YoY decline in revenues to Rs 3.3bn in Q4FY09, which was inline with our estimate of Rs 3.4bn. The revenues were flattish, primarily due to lower revenues from the chemicals business, which stood at Rs 1,674mn in Q4FY09, registering 31% YoY decline.

The subdued performance in the chemicals segment was driven by lower revenues from traded chemicals, which stood at only Rs 17mn in Q4FY09 as against Rs 417mn in Q4FY08. Revenues from manufactured chemicals also witnessed 17% YoY decline on the back of lower realisations due to fall in chemical prices. However, the fertiliser segment registered strong performance
with 78% YoY growth aided mostly by better realisations in speciality fertilisers.

Significant improvement in margins: DFPCL registered significant improvement in EBITDA margins, which improved 152bps YoY and 653bps QoQ to 20.4% in Q4FY09, better than our expectation of 16.9% for the quarter. This was primarily because of lower raw material and fuel costs. Among the raw materials phosphoric acid prices declined 32% YoY, whereas the company has saved ~Rs 320mn on fuel cost due to ~53% YoY decline in naphtha prices.

Strong bottom line growth: DFPCL’s net profit improved 27% YoY to Rs 396mn, above our expectation of Rs 345mn. This was despite a 91% YoY increase in financing costs, which increased because of issued of debentures, driven by improvement in operating performance as well as a 155% YoY increase in other income during the quarter.

Capacity expansion projects on track: The company is currently implementing three growth projects. The 15,000tpa shore-based ammonia storage tank at JNPT has been competed in Q4FY09 and will now give the company the advantage of make-or-buy option in ammonia. This storage tank will reduce the company’s reliance on natural gas as feedstock. DFPCL is also coming up with a 150,000tpa expansion of its existing 300,000tpa nitric acid plant, which will be commissioned by H1FY10. In addition, it is expanding its ammonium nitrate facility at Taloja by 300,000tpa, which will come on-stream by the end of Q2FY11.

Valuations attractive at 6x FY10E earnings: Currently, the stock is trading at a P/E multiple of 5.4x on FY10E. We valued the company at a P/E multiple of 6x its FY10E and provide a target price of Rs 110. The stock has appreciated almost 50% over the past one week and leave lower potential upside from current level. Therefore, we maintain our Hold rating on the stock.

To see full report: DEEPAK FERTILIZERS


Ready for first oil; issues getting addressed; add to Conviction list

Source of opportunity
We add Cairn India to our regional Conviction Buy list based on the following factors: 1) the Rajasthan project is ready to start producing oil within next few weeks; 2) our concerns on the stock have materially reduced as the issues on oil pricing and off-take are getting addressed by the stake-holders; 3) our positive outlook on oil prices for 2H2009E and 2010E; 4) Cairn’s earnings leverage to oil prices and production growth profile being among the best in the peer group. Cairn India, in our view, is the best Indian stock for taking exposure to the improving fundamentals of
the oil market and is now our top pick in the Indian E&P space.

1) Removal of remaining uncertainty over pricing of Rajasthan oil before commencement of production in June 2009; 2) increase in oil prices through 2H2009E and 2010E; 3) completion of Cairn’s pipeline around Sep’09 and ramp-up of production volumes; 4) any success in Cairn’s exploration portfolio; 5) demonstration of EOR potential in Rajasthan.

We reiterate Buy on Cairn India with new NAV-based 12-m TP of Rs290/sh (Rs240 earlier), implying potential upside of 25%. Currently, Cairn stock is implying long term Brent of US$60/bbl vs. our forecast of US$85/bbl from 2013E onwards. The stock is trading at 3.0x EV/DACF for FY12E (on full ramp-up), making it one of the least expensive E&P stocks globally. Based on global price trends, we believe there is limited risk of the price of Rajasthan oil being lower than our forecast of 15% discount to Brent. We updated Cairn’s earnings estimates following release of FY09 results and converted the financials and production profile to March fiscal. As a result our EPS estimates for FY10E-13E have changed by 3% to 174%.

Key risks
1) Delay in oil production, ramp-up, 2) adverse regulatory development.

To see full report: CAIRN INDIA


Management confident of 20% earnings growth in FY10: We met the CMD, Mr Mallaya, of Bank of Baroda to get updates on business growth, asset quality and profitability. The management is confident of achieving its FY10 guidance of: (1) RoA of 1% or above and earnings growth of 20%, (2) loan growth of 23-25%, (3) NIM of ~3% (decline ~20bp in FY10), (4) slippage ratio of ~1.25% v/s 0.94% in FY09, and (5) Cost to Income ratio of <45%.>

Upgrading earnings estimate by 10-12%: We have upgraded our earnings estimate by ~10% in FY10 and ~12% in FY11. This factors in: (1) higher loan growth of 18% in FY10-11 v/s 16% earlier (management guidance of 23-25% in FY10), (2) margin decline of 18bp (v/s 8bp earlier) in FY10 (management sees up to 20bp), and (3) credit cost assumption
of 80bp v/s 100bp earlier.

BoB is our preferred bet among state-owned banks: We estimate RoA of 0.9% and RoE of 18% in FY10-11. We expect BoB to report EPS of Rs61 in FY10 and Rs69 in FY11, an FY09-11 CAGR of 7%. BV would be Rs365 in FY10 and Rs418 in FY11. The stock trades at 1.1x FY10 BV and 6.7x FY10 EPS. We like BoB for its inherent strengths of large branch network, technological advancements, strong international business, extensive client base, relatively low risk loan book and clean asset quality. BoB is our preferred bet among state-owned banks.

To see full report: BANK OF BARODA