Thursday, June 11, 2009


Who Benefits Most From China’s Domestic Demand?

Countries best able to latch on to China's resilient domestic demand will likely see a swifter cyclical recovery — While only one quarter of China’s imports from Asia are for its own domestic demand, rather than its exports, the mix varies amongst countries. The extent to which each economy benefits from China’s domestic demand depends on: (i) How closely each individual country’s export mix is geared towards meeting China’s domestic demand, (ii) How important China is as an export market for each country, and (iii) The degree of openness of each economy.

Imports from ASEAN are more geared towards China's domestic demand, even though NEA has greater overall export exposure to China — China’s imports from ASEAN, particularly Indonesia and Vietnam, are mostly in commodities and therefore are more strongly oriented towards China’s domestic demand. While China is a more important export market for Korea and Taiwan, almost 80% of China’s imports from these countries are in the export-oriented electronics and/or capital goods sectors.

On balance, exports for China’s domestic demand comprise a larger proportion of GDP for Taiwan, Malaysia and Singapore — In all three countries, this is largely a function of the openness of the economy, although for Taiwan this is enhanced by its large export exposure to China (comprising nearly 40% of Taiwan total exports). In addition, Malaysia and Singapore may benefit from commodity exposure (CPO and crude oil for Malaysia, refined oil for Singapore).

Greater urgency for Asia to re-orientate exports to support China's domestic demand — (i) While China cannot lift Asia out of recession now, this could change over the next 5-10 years, as we believe China’s GDP could be 50% that of the US by 2014, up from just 25% in 2007. (ii) China’s domestic market is already so large that Asian firms cannot afford to ignore it, with retail sales overtaking Japan from 2007. (iii) China’s evolving comparative advantages, and the increasing localization of the pan-Asian production chain within China, may imply greater competition rather than complementarity vis-à-vis China in export-oriented manufacturing industries. In recent years, China’s imports from ASEAN have seen a greater shift towards
domestic demand-oriented products, due to both higher commodity prices as well as greater competition from China in the manufacturing space.

Given the evolving nature of China’s comparative advantages, Asian countries could do well to focus on industries where they have a sustainable comparative advantage — These include consumer services, commodity related sectors, and perhaps niche areas within manufacturing. More broadly perhaps, greater economic integration may be the key for Asian economies to remain viable, not just in the face of greater competition from China, but to become sizeable markets in their own right.

To see full report: ASIA MACRO VIEW



With limited scope for price / margin increase, volume growth is the key
■ Overweight on Colgate and Dabur, Neutral on HUL, ITC and Marico

In this report, we (1) analyse trends at FMCG companies as reflected in the results; (2) assess the outlook for the year ahead in light of recent trends. The main insights are:

■ Overall sales growth in the FMCG sector continues at 20%+ with the balance tilted towards price growth in large categories. However, recent product price cuts mean that future growth will be dominated by volumes.

■ Unorganised/regional competition has become more active as expected, and this is partially responsible for the market share losses of larger players. We believe that market shares will settle at June quarter 2009 levels.

■ Although gross margins will expand, the quantum of expansion will be lower than originally estimated due to the recent rally in commodity prices. We estimate gross margin expansion of 55bp for our coverage universe as compared to our earlier estimate of 100bp.

■ Focus on cost control should become even more important in light of reduced scope for gross margin improvement. Operating expenses as a percentage of sales declined 20bp y-o-y in the March quarter and will continue to be a focus area in FY10e, resulting in a 50bp EBIT margin increase for our coverage universe.

■ The sector has recently re-rated and valuations overall look fair. But we see upside for Dabur and Colgate as these are two volume-backed stories in our coverage and hence rate them Overweight. We are Neutral on ITC, HUL and Marico.

To see full report: INDIA FMCG


Annual report analysis

‘The past year has seen a decline in several things which we considered infallible.’ – The opening remark of Infosys’ FY09 annual report aptly brings out the degree of turmoil witnessed by the global economy last year. In its outlook for the current year, Infosys continues to be cautious, but believes that its strong business practices would help strengthen client relationships in the current scenario.
As the Infosys FY09 annual report highlights, the company has sustained performance in an extremely tough year. Manufacturing and Europe (excluding BT) have been the primary revenue drivers, while margins have improved in BFSI and Telecom despite significant drop in revenue growth. What is also noteworthy is that Infosys has invested in increasing its sales force in FY09 substantially, blasting fears of under-investment in the business.

The key highlights of the report are as follows:

Manufacturing gives a stellar performance in a tough year: Manufacturing (and Hi-tech) single-handedly contributed to 62.9% of incremental growth in FY09. Our channel checks indicate that a few large accounts in the US & Europe have ramped up significantly in this vertical.

■ Rupee helps cost control from impacting business investments: Infosys has smartly taken advantage of sharp rupee depreciation (+27.7% YoY) to pump up its business investments. We are heartened by the 200+ additions to sales force, the highest over the last 5 years.

■ Easing capacity utilization to keep capex low, sustain strong cash generation: Seat utilization remains low (1.1x vs. 1.2x over the last 4 years), which should help bring down capex costs over the next 1-2 years. We expect strong accretion to cash, despite a tough FY10E.

■ Lower hedges place Infosys at greater risk in case of rupee appreciation: Infosys had US$506mn in hedges as on 31 March 09, covering just 19% of its net foreign exchange exposure for FY10E. Sharp rupee appreciation (6.5% QTD) could expose the company to greater impact on revenue and margins. We are in no doubt that Infosys will emerge stronger out of this crisis, but
the signs of slowdown expected in FY10E are evident in several measures including capex reductions and headcount additions. We remain cautious on our outlook of recovery for the sector, and maintain our Hold rating on Infosys.

To see full report: INFOSYS TECHNOLOGIES


Retail Limits Power Value & Upside Potential – Downgrade to Sell

Power business continues to add value — Aided by a benign West Bengal Electricity Regulatory Commission (WBERC) and its reasonable tariff orders, CESC’s power business continues to create value. The power business has turned around from losses of Rs1.3bn in FY99 to profits of Rs4.1bn in FY09E.  Retail limits power value and upside potential — CESC extended loans/ advances of Rs2.5bn to SRL in FY08. We estimate Rs5.5bn and Rs8bn will be extended in FY09 and FY10-12, respectively. In the absence of Rs8bn of investments over FY10E-12E, CESC would be worth Rs58/share more and if Rs8bn had not been invested over FY08-09E its value would have been higher by Rs64/share). Not only does retail limit power upside, but there is an opportunity cost in not investing these cash flows into productive power assets.

Stock looks expensive - Downgrade to Sell (3M) — A look at just the parent P/E multiples could mislead investors into believing that the company is trading at an inexpensive P/E multiple of 10.3x FY10E. But if one incorporates the retail business losses, the company looks expensive at 17.9x FY10E. As a consequence we downgrade CESC to Sell/Medium Risk (3M).

Target price hiked to Rs369 — We factor in a higher power business value of Rs388 (vs. Rs333 previously) on our: (1) earnings revision; and (2) lower WACC of 12.1% (13.1% previously). Negative NPV for power business support to retail is Rs58. We increase EV/Sales multiple for the retail to 1.0x FY08 (0.75x) in line with other peers.

Upside risks — Divestment, shutdown, and/or equity fund raising in SRL.

To see full report: CESC


Wireless MOU expected to rise in Q1 FY10, but stabilize a bit lower in the long term
RCOM’s MOU in the fourth quarter decreased by a significant 9% qoq as the effect of the promotional minutes was felt only in half of the quarter. The promotional minutes were removed in the latter part and the tariffs were brought at par with its competitors. The effect of this will be fully seen in the first quarter, and as a result of this, there may be an increase in MOU on a qoq basis in Q1FY2010. However, with penetration rapidly increasing in the B &C circles, where usage is less, MOU may settle down a bit lower going forward. ARPM is also expected to settle a bit lower from the current levels of Rs 0.6.

GSM strategy
The company will soon enter into the postpaid GSM business, for which they have started mass media advertising for the first time. The company has plans of launching corporate offerings and utilizing its cross leveraging with its data card business. The existing CDMA network will enable RCOM to save costs to deploy an altogether new network for GSM, as slight further modifications to the CDMA network will ease the task of GSM deployment. New offer launches in the roaming business, strong brand positioning, selling its own equipments and handsets will add to RCOM’s advantage. Taking this discussion further, we believe the company is well poised for the launch of 3G, as wireless business of RCOM functions on EDGE platform and the cost required for converting an EDGE network to 3G is estimated to be lesser than the cost required for other companies to convert their 2G network to 3G. In this fashion, RCOM is expected to save a lot in 3G deployment. We also believe the impact of MNP will be felt lesser on RCOM, as the company has a huge chunk of low end GSM customers, who may switch to another operator even before MNP is implemented. As far as CDMA business is concerned, the management believes that MNP will require changing of handsets if a CDMA customer wants to switch to GSM. This will make customers reluctant to change their networks. Nevertheless, we believe the cost of retention per subscriber will increase post MNP, which may impact margins up to some extent.

Globalcom business to grow at 3-4% qoq growth in Q1 FY10
RCOM’s Globalcom business grew at 12% in Q4 FY10 on the back of some big contract wins and demand expansion in its Vanco and Yipes business. RCOM believes that this business will not witness such a strong growth in the first quarter as the contract wins are never consistent. Going forward, the Globalcom business is expected to grow at 3-4% on a qoq basis. Dollar depreciation may impact the business somewhat negatively.

Margin expansion to be seen in Broadband business
RCOM has completed the connection of 1 million buildings under its broadband business. The company has been reporting strong margin growth in this business. In Q4 FY09, the company has reported a 247 bps growth in broadband business EBITDA margins. As the company is amassing volumes, it is benefiting from economies of scale, as the company already has a vast broadband network and the only thing it has to do is the last mile connectivity. Due to this reason, a further margin growth is expected. IPTV business is further expected to boost the sales performance. The company’s broadband EBITDA is three times of its respective capex, which itself gives us the measure of its profitability. Management estimates this business to grow at 5-6% every quarter. In the DTH business also RCOM expects a strong growth in market share as the company has got strong distribution network and the technology platform of MPEC4, which provides more number of channels on the same transponder.



UTV Software Communications Limited operates in the verticals of Television, Movies, Broadcasting, Gaming and New Media and is thus close to achieving the status of a 3600 media company. Walt Disney, which is a leading global player in the Media and Entertainment (M&E) Industry, holds 60% stake in UTV.

Investment Rationale
UTV is a 3600 company which is growing across verticals in the media industry. Such a growth is attained by both organic and inorganic means. The company has recently acquired True Games which is involved in online gaming. By having an alliance with Disney the company is able to use its expertise in various fields like gaming animations, distribution of Hollywood movies etc.

The gaming industry is expected to grow manifolds in the coming years in India. Indiagames which is a subsidiary of UTV has 60% market share in India. Even, in the online and mobile gaming industry, the company is involved actively with the subsidiaries and its strategic partner, Disney for designing games which are made to suit the USA customers, as USA is one of the biggest market for online gaming mainly due to the accessibility of internet and mobile phones.

UTV’s broadcasting business is a low cost model thus reducing the gestation period for the company. All of the channels are in a ‘Pay’ and ‘Subscribe’ mode thus generating constant revenues for the company. This segment is expected to break even in FY10 with UTV
Movies already in profit in FY10.

UTV has 35 movies on slate to be released in next two years. Of these around 8‐9 movies are of the budget of more than Rs.30 crs. The company is planning to invest around Rs.900 crs in this segment for next 2‐3 years, and is expected to earn revenues in the range of around Rs. 400 crs in FY10. Also because the company follows a studio model & with the company reducing cost of Production the margins in this segment are set to improve going forward.

To see full report: UTV SOFTWARE


Solution Overview: UPS merges transportation and logistics with funds through its financing arm, UPS Capital. The integrated solutions allow corporations to manage their global orders, control global shipments and optimize global finance. UPS is building solutions to synchronize transportation with key supply chain processes like financing to help their customers achieve untapped financial benefits from having assets and inventory overseas.

Background: UPS’s import and export targets coincide with the transportation lanes that are
strategic to UPS Supply Chain Solutions. These include lanes to and from: Asia, Canada, Latin America, Eastern Europe and Western Europe They are currently focusing on North America, Asia, Europe and U.K. UPS and UPS Supply Chain Solutions which will provide the physical movement of the goods have locations and distribution centers worldwide.

Key Strengths:
• One of the unique products offered by UPS Capital is Global Asset Based Lending. When a U.S. based customer has internationally located inventory, UPS Capital is able to lend against that inventory, if the inventory is positioned in a UPS distribution center, or is in transit using UPS transportation capabilities. UPS’s control of the goods and visibility enables the facilitation of funds when other lenders cannot.

• Enables middle market companies who generally have problems with their bank to monetize non-USA domiciled inventory to increase liquidity.

• If a company ships with UPS, can track the goods from point of factory loading until point of destination, a critical competitive advantage in lending based on inventory

• Can play a unique role as a transactional risk manager between logistics and finance

• Willing to put proportionate share of capital in supply chain finance transactions

• Offers the ability to tie cargo, credit and transaction dispute insurance through their own captive insurance

• The products offered by UPS Capital are appropriate for SMEs as well as Fortune 500.

To see full report: UPS CAPITAL


Depressing performance

Topline in line with expectation: The topline of the company is inline with our expectation and posted a turnover de-growth of 10% Y-o-Y, mainly due to 67% Y-o-Y decline in the sales from its Caraco subsidiary. The decline was largely on account of a very high base in the corresponding quarter last year, contributed by launch of Pantoprazole generic. Indian formulation business grew by 81% to Rs 652.6 crore whereas International formulations businesses, excluding Caraco, have grown by 89%. API sales grew by 64% Y-o-Y; most of the growth was witnessed from international markets.

Operating level deteriorated: Sun Pharma reported dismal performance at its operating level.
The Q4FY09 Operating profit at Rs 375 crore stands below with our expectation of Rs 499
crore. The EBITDA posted a de-growth of 49% Y-o-Y, whereas on a Q-o-Q basis it recorded degrowth of 9% mainly due spike in the other expenses which includes one-off expenses related
to product recalls at Caraco and inventory write offs. Also due to high raw material cost & staff
cost led the margin to shrink. The OPM contracted by 2,590 bps to 33% in Q4FY09.

Bottom Line – Below our expectation: The bottom line of the company was below our
expectation at Rs 395 crore. Despite a higher other income and a lower tax numbers due to creation of deferred tax asset, the net profit declined by 47% to Rs395 crore during Q4FY09
consequent to a sharp decline in the operating profit.

Our View: Sun Pharma Q4FY09 performance was hit by lower sales from Caraco and the
economic downturn, which resulted in a slowdown in the domestic business. Currently, the status of the Detroit facility is unchanged; however the management has indicated that if the need arises, the company could evaluate product transfer options to India from Caraco on a case-to-case basis. For FY2010, Caraco has not provided any guidance, given the uncertainty surrounding its Detroit facility and the lower exclusivity revenues.

Going forward, we expect the slower growth in the business to continue for the next two to three quarters, due to the economic downturn and lack of new product launches from the Caraco facility that is under USFDA scrutiny. However, the company’s track record of delivering consistent and robust growth makes it the best Indian player in the generic space. With a strong balance sheet with over Rs 3,500 crore in cash, Sun Pharma is well positioned to exploit newer growth avenues. Thus we remain positive on the stock.



Power Play

Presence in space starved Mumbai CBD to be value accretive going forward
The commercial business district (CBD) space in Mumbai is a fraction of that available in other major cities of the world. Indiabulls Real Estate (IBREL), with ~ 5 mn sq. ft of projects is a leader in this space. Enquiries for these have picked up sharply and we anticipate increased traction for IBREL going forward. The company has also launched 9.5 mn sq ft of projects and plans to launch an additional 9.8 mn sq ft of projects in FY10.

Power ventures: Firing on all cylinders; PPA tilt could dent RoEs
IBREL is developing three power plants with a total capacity of 3,960 MW. Coal and water linkages are in place for all, and land and environmental clearances for two projects have been bagged. We estimate that 65% of the output will be sold through PPA – diluting RoEs. Thus, we have valued the power division at a P/BV of 1.3x.

Cash is king: Exciting options at hand to deploy cash
IBREL is one of the few realty developers with net cash of INR 22.7 bn. It can utilize this cash for big ticket realty development projects for which the company has bid— Dharavi Redevelopment, New Delhi railway station modernization, etc. The other option is to utilise the cash for meeting the equity commitment for its power plants.

Strong execution capabilities of Indiabulls group
The Indiabulls Group has presence in financial services, real estate, and power segments. The group has witnessed strong growth in revenues, topline, and market capitalization over the past few years. We believe its real estate venture, IBREL, will also benefit from the strong execution capabilities of the group in the future. Outlook and valuations: Triggers in place; initiate with ‘ACCUMULATE’ IBREL is in project execution mode as far as both realty and power businesses are concerned. It will be some time before the operations achieve significant scale and start generating revenues.

To see full report: INDIABULLS REAL ESTATE



• Sona Koyo’s Q4FY09 performance was better than our estimates on account of a better than expected topline growth.

• Net sales for the quarter were ahead of estimates at Rs1.9bn (we saw Rs1.7bn) primarily on account of a strong ramp up in the domestic business. The domestic business grew 37%qoq and 2.5%yoy to Rs1.8bn (we saw Rs1.5bn). Exports, however declined 29%yoy to Rs123mn (we saw Rs178mn).

• The company received compensation for rising raw material costs of the previous quarter (i.e. Q3FY09) in Q4FY09 (a lag of a quarter) from some of its key clients including Maruti Suzuki and M&M and hence its raw material costs (as a % to sales) declined almost 600bps qoq to about 81.5%. Further, driven by aggressive cost rationalization measures (including voluntary compensation cuts taken by the employees) taken by the company, the company was able to improve its operating margins to about 5.3% in the quarter (we saw 4.3%) from an operating loss of Rs94mn in Q3FY09.

• Adjusted for the forex loss, the company posted a loss for the quarter of about Rs46mn (we saw loss of Rs71mn) against a loss of Rs165mn in Q3FY09.

• For FY09, net sales were marginally up 1.4%yoy to Rs6.9bn. Substantial margin erosion (700bps yoy) to 2.3% and a high interest burden at Rs317mn (against Rs118mn in FY08) led to loss of Rs275mn (PAT of Rs230mn in FY08) for FY09.

Other Key highlights:
  • Localisation for CEPS expected to reach about 68% by Jan2010 from 40% currently which would likely help boost margins in FY11.
  • Most of the new business including that from Maruti’s Wagon R and the new Swift, Toyota EFC and the Nissan business would be under the joint venture JTEKT Sona Automotive (as all the new designs would be developed by JTEKT) to whom Sona Koyo will supply some major components.
  • The capex requirement for the next couple of years is going to be minimal and would primarily be investments for balancing equipments.
To see full report: SONA KOYO