Monday, June 15, 2009



The dormant fertiliser sector saw path-breaking policy changes in ’08, which raised hope that stagnant cash-making companies make above-normal profit; however, the global slowdown was a deterrent. We believe the policy changes are a paradigm shift in the operating milieu and domestic fertiliser companies are bound to gain in the medium-to-long term, with improvement in global
environment. But, this improvement is still nascent as only excess inventory is being addressed, with recovery still a few quarters away. Rising crude inspires confidence in recovery of fertiliser prices, which have been hovering near the past low three-year levels.

All policy changes, as on date, have been aimed at attracting fertiliser capacity in India, albeit without success. Our note addresses changes required to make the fertiliser space attractive; some of these are also the focus of policy makers. A few of these structural changes, although radical and with not many takers, could see the light of day and, thereby, favour capacity addition in the sector.

Fixed subsidy and floating MRP. As per the fixed-subsidy policy, the government would allocate a nutrient-wise (NPK) budget for fertilisers in a financial year. If nutrient costs rise, the government would increase the nutrient’s MRP to ensure overall fertiliser subsidy remain within the budget. Pakistan follows such a model, where the government fixes per-kg fertiliser subsidy, while the MRP is determined by market forces. However, as the policy directly impacts farmers, which is the largest vote bank in India, this model may not be popular with the Indian political lobby; however, a modified version of the same cannot be ruled out. A fixed-subsidy policy, in any form, would be a positive for the sector, albeit inconsequential for companies’ profitability.

Uniform subsidy across gas-based plants. A uniform subsidy for all gas-based plants would encourage production efficiency. Such a model would be based on uniform fixed-cost reimbursement & efficiency parameters across all gas-based plants. With improving gas availability (KG Basin gas), a large part of the capacity would be 100% gas-based. We believe this uniform subsidy is aimed at bringing all production plants at a level playing field, thereby shifting to a market-based pricing model vis-à-vis a fixed farm-gate pricing model. These changes would be beneficial for efficient companies such as Tata Chemicals (which uses 5.2Gcal/te of urea) and
Chambal Fertilisers & Chemicals (Chambal; which uses 5.4Gcal/te of urea).

Reform in subsidy payment system. In FY09, government focus significantly increased on timely release of subsidy payment, thereby leading to large working capital funding to fertiliser companies. This increase in focus was aimed at shifting to automation, where subsidy payment is based on fertiliser delivery. If implemented, such a change could be critical and could positively impact the business model of fertiliser companies, reducing their working-capital requirements.

To see full report: FERTILISER


India April industrial production: A higher-than-expected up-tick The Industrial Production Index (IP) rose 1.4% yoy in April versus a (upwardly revised) 0.8% yoy fall in March. The positive IP growth was above the consensus forecast of a 0.1% yoy decline and our expectation of a 0.9% yoy expansion. The monthly momentum (seasonally-adjusted) rose 1.8% mom in April versus a 0.5% mom decline in March (see Exhibit 1).

Both the capital and consumer goods indices showed sequential up-ticks. The Capital Goods Index grew 1.6% mom s.a. versus a 9.1% mom decline in March. This was in line with the Infrastructure Index, which rose 4.3% yoy in April. Production of consumer goods rose 0.8% mom in April versus a decline of 2.9% mom in March. However, on a yearly basis, both the capital and consumer goods indices continued to be in negative territory.

We expect a pickup in activity in 2HFY10. Several large investment plans that were mothballed in part due to election-related uncertainties will likely be put back in place. There are several other reasons which suggest to us that there will be an improvement in investment demand in 2HFY10. Domestic demand indicators such as the Purchasing Manager’s Index, the Infrastructure Index and cement dispatches have shown substantial up-ticks recently. Financial conditions have eased considerably. Historical peak-to-trough declines in the investment cycle
suggest a bottoming out in the first half of 2009, and the economy continues to have significant pent-up demand for investment, especially in infrastructure and in affordable housing. Our GDP growth forecast for FY10 is at 5.8% with risks now to the upside.

We think monetary policy easing is at an end. Policy rates have come down aggressively and there is excess liquidity in the system. We expect the INR to appreciate further against the USD as the stable government and relatively resilient domestic demand become key catalysts for foreign inflows, deleveraging pressures easing further and the basic balance of payments turning positive in FY10 due to the trade deficit narrowing. Our USD/INR targets are at 47.3, 46 and 44.7 over 3, 6 and 12-month horizons.


Capital and Business Concerns Abating, No Transparency Yet

Upgrading PRIL to Overweight: In these volatile markets, it is difficult to time stock calls. However, we believe that two out of three of our concerns on PRIL have abated. Although the stock could be volatile in the medium term, we believe that any dip should be used an as entry opportunity. We are upgrading the stock to Overweight from Equal-weight.

Alleviating concerns about ability to fund the business: PRIL recently raised Rs3bn in equity and has plans to raise another Rs10bn. This is likely to increase its flexibility to fund its growth plans and reduce its financial leverage. More important, the company’s interest costs, which jumped from 3.7% of sales to 4.9% of sales in F2009, is likely to decline to 4.4% sales in F2010, contributing to profit growth.

Business conditions improving: We believe that PRIL’s business environment is likely to recover with an improving trend in IIP growth and consumer sentiment. SSG has seen consistent improvement over the last few months, EBITDA margin has picked up due to benign competition, and we expect the company to report positive operating cash flow for the first time in F2009.

Room for improvement in transparency: In our view, PRIL needs to enhance its transparency regarding consolidated financials, funding, and investment plans in subsidiary companies, and increase the clarity regarding holdings in subsidiary companies amongst other things.

Where could we go wrong? 1) PRIL is unable to raise equity to fund its growth plans; 2) it disproportionately funds its subsidiaries; and 3) it takes large inventory write-offs.

To see full report: PANTALOON RETAIL


Is valuation catch up sustainable?

Cutting estimates on global steel price forecast cut
We are cutting our FY10 and FY11 EPS estimates by 48% and 13%, respectively, following downward revisions to DB's global steel price forecasts. We have seen a sharp expansion in steel equity valuations across world geographies recently on expectations of restocking. Following the expansion in global valuation multiples for steel equities, we are raising TP for Tata Steel to INR410 but believe the valuation expansion might not sustain if we do not see more solid indicators of steel demand recovery, particularly in Europe. Maintain Hold.

Debt covenant reset reduces balance sheet related risks…
Tata Steel has reached agreement with its lenders to reset the covenants on its Corus acquisition related senior debt facility. As per the agreement, testing of Corus’s earnings related covenants will be suspended till Mar’10 without any increase in the current interest costs. We believe that the reset is a strong positive for the company because it eliminates the risk of refinancing compulsions.

.. but earnings recovery still elusive at Corus
Last year, the global liquidity crisis had forced investor attention on Tata Steel to shift from income statement to balance sheet. We believe that though the covenant reset now sharply reduces balance sheet risks, income statement risks will continue to dominate investor mindsets until the European steel industry shows signs of a sustainable rebound.

TP raised to INR410/share; Maintain Hold
Our TP of INR410 is based on a SOTP valuation - Indian operations valued at FY10E EV/EBITDA of 6.4x, UK ops valued at FY10E EV/EBITDA of 5.1x, Asia ops valued at FY10E EV/EBITDA of 2x. Our target price translates into a blended FY10E EV/EBITDA multiple of 5.7x. Upside risks include: tariff barriers in Europe, downside risks include: protracted steel down cycle.

To see full report: TATA STEEL


Run-up Leaves No Room for Error; Equity Dilution an Overhang

What’s changed? More the market... — A significant increase in risk appetite, capital flows and preference for high-beta names have largely driven the 55% outperformance of property stocks over the past 3 months. While ~$1.7bn raised last month (more on the anvil) has eased liquidity, we believe it’s coming at the cost of sizeable dilution, which would take time to digest and act as an overhang.

... than the business — Fundamentals are still weak. Some pick-up is seen in volumes with new launches and B/S concerns addressed, but there are no signs of a meaningful recovery yet. Risk of cancellations/bad debts is high, and there is a marked slowdown in leasing and mortgage growth to 8% in 4Q (vs. 10% in 3Q) despite the recent price/rate cuts. We await sustainability of sales, improved execution and cash flows to get positive.

Raising NAVs and TPs, lower risk ratings; but rally raises risks — We factor in: 1) lower cost of capital of 13-14% (vs. 17-18%), 2) reduced debt, 3) roll-forward to Mar 10E, 4) lower NAV disc. of 15-35% (vs. 35-50%). Trading at an avg. 13% disc. to NAV, the market seems to be pricing in strong recovery that has yet to materialize. Execution risks seem to be ignored. We see risk of disappointment.

India’s narrowing NAV disc. similar to China — This is unwarranted given China’s strong and more sustained recovery in volumes. Trends in China suggest property stocks offer maximum upside when trading around 40% or more NAV disc. But downside risks are high at <20%>

DLF our Top Pick — DLF is our best play. Its proactive measures to address recv worries (without dilution), boost pre-sales and ensure liquidity have differentiated itself. Maintain Sells on Unitech, HDIL, IBREL. With most stocks trading at NAV premiums and equity dilution a likely overhang, we view risk/reward as unfavorable.

To see full report: REAL ESTATE


Quick Comment; Dempo Acquisition – A Value Accretive Proposition

Impact on our views: We are encouraged by Sesa’s proposed acquisition of Dempo’s mining assets and by management’s ability to deliver on its promise to utilize its strong balance sheet to enhance Sesa’s size and competitiveness. In our view, the stock should react positively to this event. However, we would note the very strong performance that Sesa stock has displayed
in the last 3-4 weeks.

Sesa Goa announced that it has agreed to acquire VS Dempo Ltd for US$368mn (Rs17.5 bn) on a debt-free and cash-free basis. This will be funded out of Sesa’s cash balance of US$872mn. Dempo produced 4mt of iron ore (sales were higher at 4.4mt) in FY09. The acquisition would increase the size of Sesa Goa’s 16mt production during the same period by 25%. Based in Goa, Dempo is amongst the largest second tier ore exporters from India. We estimate the acquisition could lift our F10e EPS for Sesa by ~12%.

Looks like a value accretive acquisition to us, especially due to opportunities to share infrastructure in Goa and possibility of further exploration ay Dempo.

EV/t of US$90/t of production looks attractive for Sesa versus global average of over US$200/t of production of the major iron ore producers (and US$160/t for Sesa).

Reserves of Dempo at 70 mt seem to be on the smaller side (18 year mine life) but here too, the acquisition EV/t of US$5/t is less than that of Sesa of US$12/t.

EV/EBITDA multiple for proposed acquisition price works out to be 4x on F09 basis vs. 4.7x for Sesa. In F09 Dempo had an EBITDA margin of 43% vs. that of 51% for Sesa Goa. Notably, Vedanta had bought 51% stake in Sesa at EV/t of US$9 on reserves and US$160 on

To see full report: SESA GOA


Mounting subscribers; waning earnings quality

The Indian telecom industry has grown more than 12 times in five years, from just 33 million subscribers in 2004 to 386 million in 2009. Even at its current size, it proved to be fairly immune to the current economic slowdown with 11% of total base being added in the last quarter of FY09. Today, the industry is at a crucial point with over 50% of net adds coming from rural India. With one of the lowest ARPUs globally, volume growth would be the revenue driver for the industry. We are bullish on the growth momentum. However, at current levels valuations look stretched. We advise cherry picking in the telecom space with preference for companies with higher operational efficiency, low leverage and strong balance sheet. We are initiating coverage on Bharti Airtel with HOLD rating and on RCom and Idea Cellular with UNDERPERFORMER rating.

Fast-track subscriber growth
Mobile subscribers have grown at a CAGR of 63% from 33 million in 2004 to 386 million in 2009. With newer licenses being granted and a host of new policy initiatives like MNP and MVNO, this figure is set to grow further. We expect rural penetration to fuel the future growth with subscriber base reaching 654 million by 2012, at a CAGR of 19.2%. However, the quality of new additions remains a concern and falling ARPU, MoU & ARPM could dent the margins, going forward.

Passive infrastructure – value unlocking
By 2012, we expect the tower base to increase nearly 1.5 times from existing ~2.86 lakh towers with 90% population being covered as compared to ~60% in FY09. Penetrating further into rural areas while maintaining financial viability would require aggressive passive infrastructure sharing. Moreover, we expect new telecom operators to use the infrastructure of existing tower companies. Incumbent operators would benefit by renting out tower services to competitors.

Declining margin
With increasing competition, renting of passive infrastructure, 2G network expansion and rollout of 3G, we expect margins across players to decline in the mobile segment. However, with robust
growth coupled with increasing margins in the non-telecom business, integrated players like Bharti and RCom will be able to arrest the decline in overall margins to a certain extent.

Outlook and recommendation

Indian telecom companies are currently trading at 20x FY10E earnings. Although lower than their historical multiples, the valuations looks stretched given that the benchmark index is trading at 17x and telcos in other emerging markets are trading in the range of 12-14x FY10 earnings. We do not believe this premium is justified. While we believe subscriber led volume growth will continue to be
robust in the foreseeable future, it may not translate into a commensurable EPS growth for all companies. We advise cherry picking among telcos with preference for companies with good quality of earnings, higher operational efficiency, low leverage and strong balance sheet. We initiate coverage on Bharti Airtel with HOLD rating and on RCom and Idea Cellular with UNDERPERFORMER rating.

To see full report: TELECOM SECTOR


We initiate a buy on dips call for Patel Engineering. One can buy at levels from around 300 to 340 for a target of 550 with a time horizon of 3 months. This call presents an upside potential of 40% and 70% for investors.

Investors having a holding period of 1-3 years can invest at current levels for a target of 720.

We have valued the company through SOTP valuations, Valuation of Rs. 720 has been arrived by valuing core operations at Rs. 325(10x EBITDA multiple) per share and Real Estate business at around Rs.325 share (30% discount to market value). Core Operations of the company have been valued at EV/EBITDA multiple of 10, while real estate has been valued at 35% discount to the market value

Key Investment reasons are strong order book (more than 5 times FY08 sales) expertise in complicated and high margin Hydro power and upstream irrigation projects. Leadership in Hydro power projects with 22% market share and prequalification for 12,000 crores of upcoming Hydro Power projects. Huge Land Bank valued at over Rs. 2000 crores. And increasing interest in Power Generation Business.

Quarterly highlights:
March 24 (Reuters) - Patel Engineering Ltd won an order worth 7.99 billion rupees for tunnelling work from the Narmada Valley Development Authority. Order book size stood at 7100 cores in Dec’08.

May: Order worth INR 554.67 Crore was bagged from the Vidarbha Irrigation Development Corporation, Maharashtra for the construction of pump house with pumping machinery, electric overhead travelling crane, switch yard and construction of rising main with manifold and water hammer control device

May: order worth INR 153.37 Crore was bagged from the Himachal Pradesh Power Corporation for the construction and completion of a powerhouse complex for the 111 MW Sawra Kuddu hydroelectric projects in Shimla district.

Order book to cross 9000 Crore by middle of this year with bulk of the orders coming from Hydro sector hydro power related projects (60%), followed by irrigation (20%) and remaining is spread across transportation and micro-tunnelling.

Result Analysis:
Top line grew by a decent 31%: Patel Engineering (PE) registered steady growth in 3QFY2009. Consolidated Sales of the company were in line with our expectations increasing 31% Y-o-Y to Rs495cr (Rs379cr) on the back of a strong Order book of Rs7,100cr. For 9MFY2009, Top-line growth was a tad better at 32% to Rs1495cr (Rs1133cr).

As of 31st March Order book stood at Rs. 9000 Crore

Operating Margins higher than peers: PE enjoys higher Margins than peers as it caters to technology-intensive businesses like Hydro Power and Upstream Irrigation Systems. For 3QFY2009, the company’s OPM at 18.1 %( 15.6%) exceeded our estimates. PE has been clocking high Margins on account of operating efficiencies and having built-in price escalation clauses in place in the contracts. The pass on of incremental costs is high in the Hydro Power and Upstream Irrigation segments (which constitutes a major part of PE’s Order book) compared to other segments like Roads.

Net Profit flat on account of higher Interest cost and Depreciation:
PE posted Net Profit growth of mere 2.2% for 3QFY2009 to Rs39.7cr (Rs38.9cr) in line with our estimates. Interest costs spiked 380% to Rs21.0cr, which was however in line with our estimates. On the Tax front, the company maintains its stance that it is entitled to avail Section 80IA benefits. As a result, it provided Tax at only 18%, which we have not considered in our estimates. We have adopted a more conservative approach and factored in Tax at a marginal rate. For 9MFY2009, PE has provided for Tax at 16% v/s our provision of 30%.

Outlook and Valuation
PE has ventured into the Real Estate sector by transferring the development rights of its Historical land bank to Patel Realty India (PRIL), its 100% subsidiary. It has a land bank of around 1,000 acres spread across Hyderabad (640 acres), Bangalore (106 acres), Chennai (230 acres) and Mumbai (26 acres).

PRIL plans to develop this land bank in phases and has accordingly announced plans for the
Phase I development. Under Phase I, the company is developing around 10% of the total land bank.

IT SEZ Park at Gachibowli, in Hyderabad (2.7 mn. sq.ft):
A corporate park at Jogeshwari, in Mumbai (1.08 mn. sq.ft):
An Integrated Township at Electronic City near Bangalore (12.1 mn sq.ft)

T0 see full report: PATEL ENGINEERING


Madras Cement Q4FY2009 results are sharply below our expectations primarily on account of lower than estimated topline growth, higher raw material costs and losses in the windmill division. Cement revenues increased by 20.4% yoy to Rs6.38bn driven by 6.8% volume growth while realizations grew by 12.8% to Rs4027/ton. The wind power vertical registered 24.7% yoy decline in revenues to Rs40mn consequently registering a loss of Rs75mn. Overall EBIDTA declined by 1.7%yoy to Rs1.69bn mainly on account of 54% increase in raw material cost to Rs743/ton. Net profit declined by 12.3% yoy to Rs736mn (our estimate Rs953mn). During the quarter, MCL entered into contract to source its international coal/pet coke requirement at USD40-50. This is substantially lower than our estimate for FY10. With MCL importing 70% of its coal requirements, we expect significant savings on the coal cost front. We maintain our earnings estimate for MCL at Rs18.8/ share for FY10E and are introducing FY11E estimate at Rs18.9/share. We are increasing our valuation multiple for MCL from 5x to 6x mainly on account of lowering of discount as compared to Shree Cement and better earnings outlook on account of significant cost benefits. We are revising our price target upwards to Rs111 and maintain our HOLD rating on the stock. At the CMP of Rs108, the stock is trading at 5.7x FY10E earnings and USD69.6FY10E capacity.

Result Highlights
MCL’s revenues increased by 21.1% yoy to Rs6.42bn. Cement revenues increased by 20.4% yoy to Rs6.38bn driven by 6.8% volume growth while realizations grew by 12.8% to Rs4027/ton. The wind power vertical registered 24.7% yoy decline in revenues to Rs40mn consequently registering a loss of Rs75mn.

Overall EBITDA declined by 1.7% yoy to Rs1.69bn mainly on account of a 54% yoy increase in raw material cost to Rs743/ton. P&F and Freight expenses were up 14.7% and 13.3%yoy to Rs943/ton and Rs645/ton. However on a sequential basis, the same were down 17% and 4% respectively reflecting fall in prices in international coal and crude oil prices. EBITDA margin for the quarter declined by 613bps to 26.4% which was substantially lower than our estimate of 31.3%.

The cement division registered 2.2% decline in profitability with EBITDA of Rs1.61 bn as the division registered 585bps decline in its EBITDA margin to 25.3%. Cement EBITDA was mainly affected by a 46.6% yoy increase in raw material costs to Rs675/ton. Consequently EBITDA/ton for the cement vertical showed a decline of 10% yoy to Rs1043. However the same was up on a sequential basis by 4% as key operating costs P&F and freight were down by 17% qoq and 4% qoq respectively.

Windmill division on the back of 24.7% decline in revenue slipped into EBIT loss of Rs75 mn.

Interest expense for the quarter increased by 8.8% to Rs299mn while depreciation charge was up 84.5% on account of capacity addition during the year.

Consequently net profit for the quarter at Rs736mn which was sharply below our estimates of Rs953 mn.

To see full report: MADRAS CEMENT

>8% WPI inflation by end 2009/10? (HSBC)

  • Wholesale price inflation, India’s key price measure, may jump to 5-6% by end of calendar 2009 and 7-8% by March 2010
  • Reflects likely impact of strong rise in oil, food and metal commodity prices – the key determinants of WPI
  • Increase in inflation will put paid to another RBI cut and could spook markets
First the good news. India’s key measure of inflation, the Wholesale Price Index (WPI), has slumped from a high of 12.9% in early August last year to 0.1% at the end of May. The latter is comfortably the lowest rate the country has seen since at least the late 1980s, which is as far back as we have data. It could also fall a little further in the short term.

The bad news is that we are approaching the bottom in this measure and are set to see a strong run-up in inflation before the year is out, probably to around 6%. If we are right then this will almost certainly put paid to any chances of a further rate cut, which had already diminished significantly given the prospect of an expansionary budget in July, and could provide a shock to markets.

So why are we concerned? It certainly doesn’t reflect our long-held, relatively strong GDP growth view of 6.2% for the current fiscal year. This is still below trend and, in any case, whole economy output growth has little or no impact on the WPI. Instead, commodity price developments and the movement of the rupee are the biggest influences.

Although the price of commodities such as oil, food and metals are still falling heavily in year-on-year percentage terms, as a matter of simple arithmetic this won’t be the case for much longer barring a huge, sudden and unexpected collapse in prices. On the basis of unchanged commodity prices and a stable USD-INR exchange rate, the year-on-year rate of oil price inflation will be 66% in December, food 24% and base metals 45%.

In practice, as the charts overleaf show, none of the three commodity price series have a perfect relationship with the corresponding components of the WPI (energy, primary articles and manufacturing) but they are not too bad and each point to significant upside risks. By the end of this calendar year, we could be looking at energy price inflation of about 15%, primary at 4% and manufacturing up 4%. Given their respective weights in the WPI, this works out to be a 5½% headline rate of inflation, a big upward revision from our previous 0% forecast and well above consensus expectations. It is also most unlikely to be the peak. We think WPI inflation could reach 7-8% by the end of fiscal 2009/10 – double the RBI’s 4% target and up from our previous 1.8% forecast.

To see full report: INDIA WATCH