Friday, June 12, 2009


Hong Kong—dumping ground for global liquidity

Hot topic
Hong Kong’s monetary base doubled after September 2008. Along with China, it is one of two Asian economies that has matched the quantum leap in global monetary policy.

Why is narrow money exploding? We think Hong Kong sits at the confluence of three key trends in global liquidity: (1) loose Fed policy; (2) China’s appetite for non-USD foreign assets; and (3) the world’s desire for China-linked assets.

Hong Kong is a small, open economy. We expect a sharp upturn in the second of the year; but global demand will remain a long-term headwind.

Still, the liquidity boom has already proved inflationary for asset prices. We expect it to help reflate the economy and eventually inflate goods prices.

So we’re raising our 2010 growth forecast to 3.8%, from 2.9% previously. (No change to 2009.) We’re also raising our 2009-10 inflation forecasts. — TJ Bond

Asian snapshot: Asia—on track for the yo-yo recovery
Despite one or two months of mixed trade data, Asia is on track for the yo-yo recovery. The next two quarters may favor the small, open economies of Asia. The principle is very simple: as confidence returns and financing conditions ease, pent-up demand for inventories and final expenditure can boost exports very rapidly. What goes down will most likely come back up (the yo-yo). As this happens, the countries that have experienced the deepest contractions could well
post the steepest rebounds.

What to watch: China’s monthly data
Next week is all about the China data. Overall, we expect May to deliver a mixed message, due to China’s position in the cycle (exports to the G3 are still weak) as well as seasonality.

Money: total new bank loans in May should be similar to the level in April, while M2 growth should pick up slightly. Foreign trade: export growth should slow further in year-on-year terms, while import growth should be flat, leading to a slight narrowing of the trade surplus. Industrial output could ease slightly in May from April; however, trends in power usage point to a pick up in industrial momentum. Fixed investment should continue to accelerate in May, underpinned by residential construction as well as fiscal spending.

Finally, Taiwan’s exports should post a sequential increase in May after the
disappointing April outturn.

To see full report: ASIAN NAVIGATOR


Growing via the quality route …

UBI’s ability and focus to grow via the quality route (moderate credit growth coupled with focus on branch expansion to build strong liability franchise), opex under check relative to expansion as a result of adequate rollout of technology infrastructure & business process and, above all, the policy to maintain high loan loss coverage ratio makes UBI command a premium in terms of valuation multiple relative to its peers. We expect the bank to post a business CAGR of 19% over FY09- FY11E. We are initiating coverage on the stock with a target objective of Rs 249 over 12-15 months and rate the stock as PERFORMER.

Focus on Liability franchise + moderation in credit growth
Containing the cost of funds via expanding its low cost liability franchise is the key focus of Union Bank of India (UBI). The bank has plans to add 500 branches in FY10, which will bring traction in low cost CASA deposits. On the lending front, UBI will continue to focus its lending more
towards quality corporates, medium enterprises and the agri sector.

High provisioning to provide cushion to asset quality
As of Q4FY09, the NNPA for UBI stood at 0.35% (NNPA is one of the best for UBI in the PSU space). We can attribute such a low NNPA to the fact that UBI has been maintaining the highest loan loss coverage ratio of more than 83% during FY09. The bank has been using the strong
profitability to provide for NPAs, which has enabled the bank to contain its NPAs.

Superior operating efficiency always a prerogative
Focus on control of opex relative to expansion plans has been the key catalyst for UBI’s growth. Also, 100% of its braches are based on CBS and posses the necessary infrastructure so as to carry on business smoothly.

At CMP of Rs 218, the stock is trading at 1.1x and 1x its FY10E and FY11E ABV, respectively. We believe that with a better business profile, ability to maintain healthy asset quality and garner higher than industry average RoEs will enable the bank to fetch premium valuation multiples. We value the stock at 1.3x its FY10E ABV to arrive at a fair value of Rs 249.

To see full report: UBI


Healthy growth prospects and ‘above industry average’ margins & return ratios warrant higher multiples…

Re-rating to continue…

What happened last quarter
Divi’s Laboratories Ltd. (DIVI.IN/DIVI.BO) delivered an overall decent performance in Q4 FY09, with the reported numbers for the quarter coming in moderately ahead of our expectations. The standalone topline for the full year FY09 was up 15% Y-o-Y to Rs.11.9 bn, which was moderately higher than our estimate of Rs.11.5 bn, while the net earnings at Rs.4.24 bn, up 20% Y-o-Y, was also 2% higher than our estimate of Rs.4.15 bn. The expansion of 70 basis points Y-o-Y in the EBIDTA margin would have been higher, but for a forex loss of Rs.460 mn included under ‘Other expenses’ in FY09. The company incurred forex losses of around Rs.90 mn in FY08. On excluding these forex losses, the EBIDTA margin for FY09 came in at 45%, up around 370 basis points Y-o-Y. Thus, Divi’s managed to maintain its ‘above industry average’ margins in FY09, despite the current subdued market conditions.

In view of the global economic slowdown, Divi’s does expect some pressure on its Custom Chemical Synthesis (CCS) business and has guided for a topline and bottom line growth of 10-15% for FY10. Nevertheless, the company expects the situation to normalise in FY11 and expects a topline and bottom line growth of 20-25% for the year. In view of the company’s moderately better than expected performance in FY09, we are marginally raising our FY10 revenue and EPS estimates from Rs.13.3 bn and Rs.74.17 to Rs.13.7 bn and Rs.75.87 respectively. For FY11, we estimate an EPS of Rs.95.31, marking healthy earnings CAGR of 20% for the FY08-FY11E period. The stock currently trades at 15.7x our FY10E earnings, which is almost in line with the industry average P/E of 15-16x. In view of its healthy growth prospects and ‘above industry average’ margins and return ratios, the stock deserves to trade at higher multiples. Divi’s’ FY09 EBIDTA margin of 45% (excluding forex losses) and return ratios in the range of 39-42% are still the best among the CRAMS players, as well as in comparison to those of its Pharma peers. We maintain our ‘Outperform’ recommendation on Divi’s.

Carotenoids, which were launched in June 2008, brought in sales of merely around Rs.200 mn in
FY09, as against the earlier expectation of about Rs.350-400 mn. Thus, the uptake of Carotenoids in FY09 was slower than expected. However, the company expects a ramp up in FY10. Also, sales of Peptides have been picking up and contributed to around 3-4% of Divi’s’ total revenues in FY09. The company’s cumulative API filings stood at 30 in FY09, as against 28 at the end of FY08. On account of the current market conditions as well as the slower than expected uptake of the CCS business, management now expects a growth of 10-15% Y-o-Y in FY10, though it expects the business to normalise in FY11 and has guided for a growth of
20-25% in the topline and bottom line for the year. For FY10, we now estimate an earnings growth of 15% Y-o-Y and 26% Y-o-Y for FY11. For FY10, Divi’s is banking on API sales of Leviracetam, Iopamidol, and Nabumetone, which will help offset the likely moderate slowdown expected in the CCS business and facilitate a decent topline and bottomline growth of 15%. Overall, we now expect healthy earnings CAGR of 20% for the FY08-11E period. Also, management has been quite efficient in maintaining the EBIDT margin at 40%+, which remains among the best in the Indian Pharma space. In view of the company’s decent growth prospects and ‘above industry average’ margins and return ratios, the stock deserves to trade at higher multiples. Hence, we believe that the stock’s re-rating should continue.

Quarterly Results Analysis (Standalone)
• Divi’s ended FY09 on a decent note, with the topline up 15% Y-o-Y to Rs.11.9 bn and coming in 3% ahead of our estimate of Rs.11.5 bn. The CCS and API businesses now contribute 50:50 to the topline, as against a 40:50 mix in FY08.

• The bottom line at Rs.4.24 bn was up 20% Y-o-Y and 2% higher than our estimate of Rs.4.15 bn.

• The expansion of 70 basis points Y-o-Y in the EBIDTA margin would have been higher, but for a forex loss of Rs.460 mn included under ‘Other expenses’ for FY09. The company incurred forex losses of around Rs.90 mn in FY08, excluding which, the EBIDTA margin for FY09 came in at 45% and was up around 370 basis points Y-o-Y. Thus, Divi’s managed to maintain its ‘above industry average’ margins, despite the current subdued market conditions.

• Carotenoids, which were launched in June 2008, brought in sales of merely around Rs.200
mn in FY09, as against the earlier expectation of about Rs.350-400 mn. Thus, the uptake of Carotenoids in FY09 was slower than expected. However, with the Nutraceuticals facility being commissioned, sales of Carotenoids are expected to ramp up in FY10.

• Peptide sales are also gradually picking up and accounted for 3-4% of the company’s total revenues in FY09 and a further ramp up is expected in FY10.

• Also, API sales from key drugs, such as Leviracetam, Iopamidol, and Nabumetone are expected in FY10. Hence, in spite of some pressure expected on the CCS business (on account of the current subdued market conditions), Divi’s expects a topline and bottom line growth of 10-15% in FY10, on the back of a decent API performance and the ramp up expected from the Carotenoids and Peptide businesses. With the market conditions expected to normalise in FY11, Divi’s expects the growth of the CCS business to remain on track and has guided for a topline and bottom line growth of 20-25% for FY11. The company expectsto maintain its EBIDTA margin at 40%+, going forward.

• In FY09, Divi’s incurred a capital expenditure of Rs.1.41 bn towards capacity augmentation at its manufacturing facilities. The company’s SEZ and EOU units at Visakhapatnam were inspected by the US FDA in FY09.

• In FY09, Divi’s commissioned its Nutraceuticals manufacturing facility, which has commenced commercial operations. The facility, with a state-of-the art beadlet technology, is the first of its kind to be set up in India. The company has fully developed several application products, some of which are being marketed commercially through its subsidiaries in the US and Europe, as well as directly. With the qualifications from new customers, the company’s Nutraceuticals manufacturing facility is expected to ramp up its operations.

• Divi’s has invested its surplus funds in the short-term liquid ultra short-term fund of SBI Mutual fund and its total investments, as of March 31, 2009, amounted to Rs.1.72 bn.

• The company expects to incur an overall Capex of Rs.600 mn for the full year FY10.

• Currently, Divi’s has cash and cash investments of about Rs.2.75 bn, which will be utilised to fund its Capex and working capital requirements.

• The company has foreign currency denominated loans of Rs.470 mn and its total outstanding
loans, as of March 31, 2009, stood at Rs.490 mn.

Price Target
Price targets (if any) are derived from a subjective and/or quantitative analysis of financial and nonfinancial data of the concerned company using a combination of P/E, P/Sales, earnings growth, and its stock price history.

The risks that may impede achievement of the price target/investment thesis are –

  • Setbacks on the clinical research front/pipeline setbacks
  • Slower than expected uptake of the CCS business
  • Inability to bring in strong sales from carotenoids and peptides
  • Litigation setbacks

To see full report: DIVI'S LABORATORIES



Zee Entertainment Enterprises’ (ZEEL) flagship channel, Zee TV, has shown remarkable improvement in ratings, leading to the recent outperformance by the stock. But competition in Hindi general entertainment channel (GEC) space continues to be high. The likely fund infusion in Dish TV can improve ZEEL’s working capital, though we expect the infusion to have limited impact on ZEEL’s long-term valuations in spite of the move boosting sentiment. Sustained improvement in market share will be the key driver for stock performance.

We downgrade ZEEL to HOLD from Buy on account of the recent outperformance
versus the broader markets. We raise target price to Rs190/share from Rs152/share based on 20x FY10E P/E, which is at 20% premium to the Sensex’s current P/E. Historically, ZEEL has traded at 40-80% premium to the Sensex at a time when Zee TV was a clear tier-I GEC player with relatively stable viewership share and lower competition. Our target price implies no upside from the current
market price of Rs192/share. We recommend profit booking in ZEEL.

Improvement in Zee TV’s GRP strong but competition remains. Zee TV has continued its improvement in GRP share and has moved to be a strong contender for #1 spot among Hindi GECs from a poor #3. However, the intense competition in the Hindi GEC space will continue due to the entry of new players and cannibalisation of viewership share by cricket & regional channels.

Fund infusion in Dish TV to have limited impact on ZEEL’s long-term valuations. The premium of Dish TV’s shares to partly paid-up rights provides its promoters an opportunity to reduce their stake so as to pay the remaining Rs8.1bn for the rights. The fund infusion in Dish TV by the promoters and the proposed FCCBs for up to US$200mn will help improve ZEEL’s working capital, but the fund infusion will have limited impact on ZEEL’s long-term valuations.

Downgrade ZEEL to HOLD from Buy on account of the recent outperformance of the stock versus the broader markets. We raise target price to Rs190/share from Rs152/share based on 20x FY10E P/E, which is at 20% premium to the Sensex’s current P/E. Our target price implies no upside from the current market price of Rs192/share. We recommend profit booking in ZEEL.

To see full report: ZEE ENTERTAINMENT


Auto fuel marketing margins set to plunge deeply in the red

R&M companies outlook worsening; retain underperform
Refining margins continue to remain weak. Auto fuel marketing margins, which are minus Rs0.2/l in June 1-15, are expected to slump to minus Rs2.5/l from June 16. A 12-18% price hike would be required to bring auto fuel margins to normal levels. There may be no price hike for 5-7 weeks as the government mulls freeing prices. R&M companies FY10E earnings outlook has deteriorated even as investors are enthused by hopes of reforms. We retain underperform on
R&M companies.

Auto fuel marketing margin deeply in the red (-Rs2.5/l)
Gasoline and diesel prices are up 8-15% in June 1-5 to US$74.2-76.2/bbl from levels in May 16-31. This steep price rise is expected to plunge auto fuel margins steeply in to the red at minus Rs2.5/l. Diesel margins are set to slump in to the red at Rs1.9/l from June 16. Gasoline margins have been in the red since April 2009 but they are likely to slump deep in to the red to Rs4.9/l from June 16.

FY10E margin may slip 18% to Rs0.9/l even if prices freed
We are assuming FY10E auto fuel margin to be Rs1.1/l. Average auto fuel margin up to June 15 is Rs0.65/l. 1Q margin will slip to just Rs0.1/l if auto fuel margin for June 16-30 is indeed minus Rs2.5/l. FY10E average will decline to Rs0.9/l even if auto fuel prices are freed and auto fuel margins rise to Rs1.2/l from 2Q.

12-18% price hike required in auto fuels for normal margins
At current prices 12-18% (Rs4.0-8.0/l) price hike is required in diesel and gasoline to eliminate losses and ensure normal level of marketing margins of Rs1.2/l. A 10% hike in gasoline and diesel prices would take inflation to 6% by March 2010. Thus a steeper hike would mean risk of higher inflation than 6%.

No hike before decision on pricing freedom in 5-7 weeks?
The petroleum minister had indicated on May 29 that government approval for freeing of auto fuel prices would be sought in 6-8 weeks. One wonders whether this means no price hikes for another 5-7 weeks until government decides. If regional prices sustain at current levels pricing freedom would mean 12-18% price hikes, which may be difficult to implement, given inflation concerns.

Singapore refining margin US$4.6/bbl in 2Q09
Reuters’ Singapore refining margins average to date in 2Q 09 is US$4.6/bbl vis-├ávis US$5.5/bbl in 1Q09. US refiner Valero, which made a profit of US$309m in 1Q09, on June 2 guided that it would incur loss of US$261m in 2Q09.

To see full report: OIL & GAS


Strong growth but a pretty penny


We met with the management of Dabur. Management reconfirmed our core thesis. While longer-term prospects remain strong, we believe that after the recent rally, valuations fully reflect potential earnings upgrades.


Hair care remains strong: Renewed focus has driven exciting growth (~30%) in shampoos in FY09. Continued focus and launches of new variants leads management to believe that 25–30% growth in FY10E can be achieved.

Emerging focus on skin care: We expect Dabur to position its recently acquired brand ‘Fem’ at the mid-market and continue with ‘Gulabari’ at the mass end. We also expect skin care launches with an herbal positioning at the higher end from Dabur’s stable. Management believes this category is scalable, with potential to drive overall margins higher.

Volumes to drive growth: Given cost deflation in some inputs and packaging material linked to crude, management expects muted price growth of 2–3% for FY10E. The bulk of the top-line growth is expected from volumes. Continued buoyancy in rural markets will aid 12–15% overall volume growth, in our view.

Retail business update: Management has adjusted the strategy of its retail venture from ‘aggressive expansion’ to a healthier store addition rate of 10–12 stores per annum. Average store size is likely to come down to 1,000 sqf. Management believes that this is a viable business in the medium term. It expects losses to remain limited to around Rs100–120m for FY10E.

Earnings and target price revision

Minor changes to earnings estimates: We are raising our estimates from FY10E onward by 1–2% to account for slightly higher than expected top-line growth in oral care and hair care. We also are raising our target price to Rs105 from Rs100 to account for the change in earnings estimates and aminor change in our WACC assumption.

Price catalyst

12-month price target: Rs105.00 based on a DCF methodology.

Catalyst: Quarterly results; trends in sales volumes and pricing.

Action and recommendation

Maintain Neutral: We remain bullish on Dabur’s longer-term prospects given its consistent track record of delivering 16–18% earnings growth with margin expansion in the last six years. We believe that multiple growth drivers will help Dabur remain one of the fastest-growing FMCG players in India. However, the recent rally and the lack of near-term triggers lead us to believe that the stock is expensive. Balance sheet (net cash) remains strong.

For investors who wish to remain defensive after the recent rally in the broader market, we prefer ITC (ITC IN, Rs195, OP, TP: Rs220, upside: 12.8%) and Marico (MRCO IN, Rs74, OP, TP: Rs93, upside: 25.7%) amongst consumer staples.

To see full report: DABUR


Time to put money to work

Stocks have run up - what next? An infrastructure-focused stable government and return of funding appetite have caused a 15%-72% rally in infra names over the last one-month. Our top picks at this time are: 1) stocks where there is more to look forward to, despite the run-up (eg: RELI, remains OW with new PT of Rs1,500), 2) laggards where potential catalysts are not priced in (eg: TPWR, upgraded to OW with new PT of Rs1,270), and 3) Mid-caps with substantial valuation arbitrage (e.g.: Crompton Greaves, upgraded to OW with new PT of Rs300). L&T, our preferred capital goods pick, appears fairly valued from an absolute perspective but we believe it will continue to outperform BHEL.

Valuations in line with historical averages While valuation multiples for this sector have recovered from the Jan-09 abyss, they are far from the scary zone of Sep-Dec-07, and more in-line with historical averages. An unprecedented phase of investment-friendly stable government, coupled with the fact that projects which were quite nascent 2 years back have made silent progress, should provide valuation support to infra names, in our view. Amongst infra subsectors, we believe power and infra conglomerates will likely outperform their cap goods counterparts, as dormant projects turn value-accretive.

12 catalysts and 12 ministers: Our ‘catalyst scorecard’ in this report tabulates 12 major expected events over the next 12 months and impact on our stocks’ earnings / valuations. Our politics scorecard describes 12 key ministers who would influence infra spending, and the changes they would bring. The government would continue its relentless focus on power, in our view, and we see catalysts in the form of new project announcements, funding tie-ups, faster clearances for dormant projects, bulk tendering of supercritical equipment, nuclear ordering and pick-up in T&D investments. With the Left now out of the government, the UPA may want to improve its track record in stake divestures, private infra projects and non-power infra areas: thus we see road BOTs and airport privatizations picking up pace.



Indian Economy Snapshot

• For the week ending 16 May ‘09, inflation was at 0.61% as against 0.57% for the week ending 18 Apr ’09

• Industrial production for FY09 stood at 2.4% compared to 8.5% in FY08. In Mar ’09, industrial production contracted 2.3%

• May was a great month for the markets. The markets rallied due to important events like the declaration of the election results which saw the UPA getting a unanimous mandate. Realty, metal, capital goods and banking sectors witnessed huge buying interest. Indices hit
the 20% upper circuit on Monday, May 18, after the UPA (United Progressive Alliance) swept the Lok Sabha polls.

• With a clear mandate, the new government may look at certain FDI relaxations while a revival in public sector disinvestments is also expected

• The month of May saw FII inflows to the tune of INR 201,170 million (USD 4,100 million) which accounts for nearly 99% of the FII's total investment in the domestic stock exchanges during 2009.

• FII's have been net sellers in the debt market worth INR 27,110 million (USD 540 million) during the month of May which accounted for 40% of the total FII outflow during 2009 in the debt market.

• India’s GDP grew 5.8% during Q4FY09 taking the GDP growth during FY09 to 6.7%. During FY09, services grew by 9.7%, agriculture grew by 1.6% while industry/manufacturing grew by 3.9%. The core growth outlook for FY10 and FY11 remains subdued, around 5.5% although
one off events may prop-up growth significantly in FY10.

• Exports during Apr ’09 contracted 33.2% year-on-year to USD 10,700 million. With this, India’s exports have contracted for the seventh successive month (since Oct ’08).

• RBI has directed banks to refrain from guaranteeing bond issues of corporate entities. In the absence of bank guarantees, the bond’s will have lower rating due to higher risk profile making them more expensive for the companies

• On Friday (29th May), the Indian rupee climbed to a 3-day high of 47.2 against the U.S. dollar

• Globally, OPEC kept output unchanged which resulted in a surge in crude oil prices above USD 66 a barrel.

To see full report: MONTHLY PE UPDATE


Expanding for the next upcycle; initiate at Buy

Buy. We initiate coverage on Sterlite with a Buy and a target price of Rs748. Its status as one of the world’s lowest-cost metals producers, its energy venture in power-starved India and strong
balance sheet make it one of our top picks in our sector universe.

Low-cost player. Sterlite is one of the world’s lowest-cost manufacturers in each of its business segments, with a balance sheet tough enough to weather the present meltdown. Given its expansion plans, it is on target to touch yet lower production costs in its aluminium, zinc and copper businesses.

Expansion plans on track. Sterlite is moving ahead with its expansion plans in aluminium, zinc-lead and power. The downturn in metals prices has helped it execute these projects at a
lower cost. We expect earnings to rise once metals prices recover.

Power to pack some punch. Sterlite Energy, a 100% subsidiary, is on course to commission a 2,400 MW plant by Jul ’10. The first 600-MW phase would start operations in Oct ’09. Merchant
power is an attractive proposition in a power-hungry nation and should boost earnings significantly, in our view.

Valuation. We use a sum-of-parts method to arrive at a target price of Rs748. We see short-term triggers from the successful exercise of call options in Hindustan Zinc and Balco, as well as from acquiring the US-based integrated copper producer, Asarco.

To see full report: STERLITE INDUSTRIES


Bharati Shipyard’s open offer to Great Offshore
Bharati Shipyard Ltd (BSL) has announced an open offer to acquire 20% equity stake of Great Offshore (GOSL) at a price of Rs 344 per share aggregating to Rs 255 crore. Previously BSL had acquired 55.33 lakh shares at Rs 315 per share (14.89% stake) amounting to Rs 174 crore. Great
Offshore had earlier pledged 14.87% stake with BSL for a loan of Rs 200 crore. BSL is likely to fund the acquisition of GOSL’s share through internal accruals. This open offer is positive for BSL, as it will have a presence in the high margin offshore shipping services segment. Moreover, it is getting a stake in a company that has strong revenue visibility at an attractive price, which is at a discount to the current market price. We feel that BSL will be able to get lesser than the targeted 20% stake in the open offer due to the current market price of GOSL being higher than the open offer price. However, it will be able to increase its stake in GOSL and have effective control of decisions taken by the Board.

At the CMP of Rs 174, BSL is trading at 3.3x FY10E earnings of Rs 52.79 and 2.7x FY11E earnings of Rs 64.44. BSL’s strong order book of Rs 5093.71 crore and relative less exposure to the dry bulk segment provides revenue and earnings visibility. We believe BSL’s diversification into the offshore segment through the open offer to Great Offshore will enable it to have a presence in the high-margin offshore segment. We have valued BSL on multiple valuation parameters using global benchmarks, with a target price of Rs 201, providing an upside of 16%.

To see full report: BHARATI SHIPYARD