Tuesday, June 16, 2009


Quick Comment – What’s new: In the RIL-RNRL case, the Mumbai High Court has given a judgment upholding the plea of RNRL on getting assured gas supplies from RIL at US$2.34/mmbtu. The court has also asked the two counter parties to come up with an agreement over supplies within a month, based on Bloomberg.

What could happen? We believe this decision will be
challenged at the Supreme Court. RIL is already producing close to 25 mmscmd of gas and contracted to 37 mmscmd of customers and selling to power plants as well as fertilizer plants at US$4.2/mmbtu. Some of the power plants include ADAG group (Samalkot plant in Andhra Pradesh) and we believe these agreements will
not be hampered though there is clause in the agreements which suggests the deal is subject to court approval of the RIL-RNRL case.

Our utility team believes that RNRL or its affiliate
companies will take close to at least 2 years to build a power plant (gas based); similar for NTPC’s expansion plans in Gandhar and Kavas. Hence, in our earnings we have assumed US$4.2/mmbtu for RIL’s gas F2010 and F2011. Thereafter we have assumed US$2.52/mmbtu (average of US$2.34 to be sold to RNRL and US$2.7 to be sold to NTPC) for 40 mmscmd of gas which would go to RNRL and NTPC in our earnings; so the current judgment makes no impact to our earnings even if this does go to the supreme court and it gives the same judgment. The quantum of revenue impact due to lower
gas price equates a US$1bn a year effective F2012.

We would use any volatility in the stock to enter RIL –
which has outperformed SENSEX by 23% YTD. Our understanding is RNRL cannot use the gas to trade and has to be the consumer of the gas (or its affiliate company) and hence the two year assumption in our earnings is real. However if the supreme court rules for a higher gas price of US$4.2/mmbtu for the NTPC/RNRL gas we would
have to raise our earnings by 15-20% and target price by approximately Rs380/share in the long term, all else equal.

To see full report: RIL-RNRL


Asia and the global economic crisis: Challenges and opportunities

Regional economic outlook

In recent years economic development in the emerging markets of Asia has been driven chiefly by booming exports. Between 2004 and 2008 real gross domestic product (GDP) in the region rose by an average of 8% per annum, catapulting Asia to what is by far the most dynamic region in the world. But now, with world trade languishing under the global financial and economic crisis, Asia is feeling the full brunt of its reliance on exports. Everywhere in the region shipments abroad are in free fall, triggering an economic slump the likes of which we last saw during the 1997/1998 Asian crisis. Region-wide we are forecasting economic growth of 2.7% for this year (against 6.3% in 2008), which is very modest by Asian standards; and that this has not turned negative is down to the heavyweights China and India. With the exception of Indonesia, all other major emerging markets are set to shrink this year, some of them substantially. But in all probability Asia will be spared a protracted period in the doldrums on the grounds of its relatively robust banking system, record currency reserves, low foreign debt and hefty current account surpluses in the past years. Of course, the Asian emerging markets are not a homogenous group of countries. Consequently the factors just mentioned apply more to one country and less to another. In South Korea, for example, the corporate sector has quite a high
level of foreign debt.

Capital flows to emerging markets collapse
What is striking about the current situation in Asia is the very marked gap in performance between the individual countries. Our growth forecasts for 2009 currently range between +6.5% for China and -6% for Singapore. Of course, wide national differentials also exist in other regions, but they generally refer to whether a country is looking at contraction of just 1% or as much as 10%. One Asian country really feeling the pain of the present crisis is South Korea. For this year we are penciling in GDP contraction of 3.5%. Following a dramatic slump in business activity in the fourth quarter of 2008, due mainly to a sharp downturn in investment and extremely anemic exports, the economy stagnated in the first quarter of this year. We do not expect it to pick up until the second half of 2009, when world trade also starts to claw its way back. The marked depreciation in the South Korean won versus the US dollar and Japanese yen should certainly be a help. Although in recent weeks the won has made up some of its previous losses, it is still trading a good 25% lower versus the Japanese currency than last summer. This naturally boosts the South Korean export industry’s competitiveness.

China: Worst already over
The Chinese economy lost a lot of steam in the course of last year. Whereas real GDP growth in the first quarter of 2008 was still powering ahead by 10.6% year-on-year, by the fourth quarter it had slowed to barely 6.8%, slipping further in Q1 2009 to 6.1%. The repercussions of this plunge are considerable, with an estimated 20 million migrant workers forced to return to their home provinces after losing their work in the former boomtown regions along China’s eastern seaboard and in the south of the country. The situation on the labor market in general is extremely tense with the current level of growth not enough to provide the jobs needed, particularly for the new entrants to the workforce. Oxford Analytica estimates that more than 60% of this year’s university graduates will be unable to find employment.

India: Relatively small export sector keeping economic fallout in check
The Indian economy is naturally also feeling the pinch of the global crisis. However, given that exports make up only around 20% of India’s gross domestic product, the collapse in world trade is denting its macroeconomic development far less severely than in other Asian emerging markets. The still-strong domestic focus is thus proving a comparative strength in the present situation.

Southeast Asia: Mixed picture
Central banks and governments in Southeast Asia are similarly trying to contain the impact of the global financial and economic crisis on their countries by loosening their monetary policy and launching national stimulus packages. This year, Indonesia will probably be the only of the three big ASEAN states (Indonesia, Malaysia and Thailand) to notch up positive economic growth. Domestic demand has proved fairly robust so far and, given the size of the home market, this is keeping the negative repercussions of slack foreign demand on economic growth in check. We are looking for real GDP growth this year of around 3.5% (2008: 6.1%).

Asian growth model set to change
Asia’s growth model is characterized by a strong focus on external trade. Its export success story can be explained largely by the availability of a huge potential labor force and considerable wage cost advantages vis-à-vis its international competitors. And it has been buoyed on the currency front. The Asian emerging markets’ currency relations with the US have frequently been dubbed the ‘Bretton Woods II’ system, harking back to the fixed exchange rates and massive foreign exchange market interventions for the major international currencies in the post- World War II years. But unlike the official Bretton Woods regime that lasted into the 1970s, Bretton Woods II is an informal, non-contractual arrangement featuring the US as the core country with the Asian emerging markets on the periphery. The Asian currencies are undervalued relative to the US dollar to facilitate exports by these countries and smooth their integration into the global economy. So far the Asian countries have used the resulting trade surpluses versus the US to purchase American securities. This, in turn, has maintained exchange rate relations and kept interest rates low for the United States.

To see full report: ECONOMIC CRISIS


How blue is my sky

Advising caution - we could be pushing the limits in valuation
An in-depth study of valuations of Indian financials from the fundamental, cyclical and regional standpoint, as well as multiple sensitivity analyses re-inforce our belief that the sector could be stretched. This in turn implies that positive performance now becomes almost wholly dependent on continued strength of market liquidity. While news flow may not be incrementally negative, material risks remain. We retain our relative preference for private banks.

Historical and regional context: valuation cushion seems to be thinning
Indian banks have outperformed regional peers recently and even the valuation expansion has been higher. Private banks are trading at a lower-than-average premium to Bankex, whereas PSU banks’ discount to Bankex has narrowed. Nearly all banks are trading at higher than historical average valuations. Almost all banks are trading at or above the “recovered” valuation in 2004 when the sector last rode out of a downturn. We have also applied Chinese new business multiples
to Indian insurers, even though the former are more profitable.

Need aggressive assumptions to justify higher TPs or even current prices
We demonstrate that present stock prices do factor in elevated levels of expectations, except HDFC Bank and PNB. TPs increase by 0-23% under bullish assumptions, not good enough to offer a cushion. A rollover to FY11 as the base leads to positive upside only in three out of 13 cases. Meaningful positive upsides are obtained only when we apply historically highest-ever valuations or highestever premium to Bankex, and to a lesser extent the “recovered” valuation of 2004. Overall cushion appears to be high for HDFC Bank and low for SBI.

Key valuation drivers do not support peak-cycle valuations
Outlook for benchmark interest rates – generally a powerful short-term driver of bank valuations – is no longer benign due to large government borrowings and rising inflationary expectations. RoEs face several challenges, particularly for rapidly growing banks. We also demonstrate the interesting strong correlation between earnings volatility and valuations, but also do not see reasons for the volatility to go down in the near future. Structural drivers such as new products, consolidation and legal changes are also unlikely to be forthcoming.

Valuations and risks
We value lending businesses on the Gordon Growth model, insurance on appraisal value, asset management on % of AUM and other non-banking businesses on P/E. The key risks to our pessimistic stand are strong flows, particularly in the context of the progressively reduced foreign investor positions in Indian financials relative to benchmarks, and a significant drop in cost of funds improving margins sharply.

To see full reports: INDIAN BANKS


F4Q09 Results: Back on Track

What’s New: GAIL reported an adjusted EBITDA of Rs8.7bn and an adjusted profit of Rs4.9bn for F4Q09. The company had a write back of Rs2.2bn of staff cost in F4Q09, due to excess provision in F3Q09. We believe the company, after a dismal F3Q09, is back on track to meet our F2010 estimates. The key positive surprise in the results was: a) better-than-expected petrochemical
business; and b) Improved margins of the LPG transmission division. However, margins for the gas
transmission division disappointed due to appreciation of the dollar against the rupee. We believe that with the recent dollar weakness and increase in gas transmission volumes from KGD6, GAIL is poised to meet our F2010 estimates for the division.

Improvement in Petrochemical division: Sales
volumes grew 4.6% YoY but were down 13% QoQ. GAIL continued to clear its polymer inventory as domestic demand and price realizations improved on a QoQ basis. Price realizations improved by 22% on a QoQ basis, but fell 13% YoY. This led to EBITDA growth of 184% sequentially and almost doubling of its net realizations for the division (EBIT/tonne) on a QoQ basis. We believe that with improving demand for polymers, GAIL should meet our F2010 estimates for the division.

LPG transmission showed a 32% growth in margins on
a QoQ basis despite a 6% QoQ drop in volumes. We believe that the increase in margins was due to lower operating costs; however, we need to clarify this with management.

Gas transmission volumes for the quarter increased by
0.5% YoY to 82.5mmscmd. Transmission tariffs for the quarter at Rs877/tscm were up 12.5% YoY. Gas sales were up 12.5% YoY but down 3% QoQ due to shutdown in Panna Mukta Tapti (PMT) gas fields. EBITDA for the division increased 3% QoQ, but dropped 14% YoY due to 25% appreciation of the dollar against the rupee, causing an increase in fuel costs for the division.

To see full report: GAIL


Macro framework for EM equities
We focus on oil, the EMBI spread and USD as our major barometers for growth, risk and flow in emerging markets. We test the sensitivity of EM equity markets to the three macro drivers (table 1). When combined into a simple regression equation, they together explain 86% of the movement in the MSCI EM index. A “fitted” macro framework for MXEF based on the three macro drivers closely tracks the actual index (see chart 1 in report).

Comfortable with 500-850 trading range for EM
Our macro framework can quantify the risk to the current level of MXEF. Plugging in the current values of oil, USD and EMBI, the macro framework says MXEF “should be” 8% lower than current actual level. So MXEF is hardly stretched. Using our strategists’ forecasts for oil, USD and EMBI for end-09, the framework says MXEF should end this year 13% down on the current level. We are comfortable with a 500-850 trading range for MXEF in 2009.

Stress-testing EM equities
Can MXEF break through the 1000 level? The framework says we would need oil up to $84 & DXY down to 65 & EMBI spread down to 300 - this bullish combo seems unlikely in our view. What needs to happen for MXEF to break below 550? Oil down to $55 & DXY up to 90 & EMBI spread up to 500 - this bearish combo seems unlikely in our view.

To see full report: MACRO DRIVERS


Positive disclosure but already priced in…

Tech Mahindra disclosed Satyam’s financial details, which came in above market expectations. The company has stated that these financials details were not audited and the audited numbers could materially be different.

Numbers positively surprise
Satyam, according to the disclosures made by Tech Mahindra, had standalone revenues of Rs 2294 crore for Q3FY09. For January and February the sales were Rs 681 crore and Rs 676 crore, respectively. If one were to aggregate, the annual run rate comes to Rs 8762 crore, which is around $1.75 billion. However, the company has lost significant business and key personnel in March. Thus, we believe the annual run rate could be lower than $1.75 billion. (At the press meet Vineet Nayar had stated that the run rate could settle around $1.3 billion).

The biggest surprise came in on the margin performance front. A 17.5% operating margin was way above expectation of a low single digit margin expectation. We believe that in the near term the company could do well to maintain this level (as there is pressure on revenues in the near term). However, in the long run, cost rationalisation and revenue stability could push up margins (employee rationalisation and further reduction in SG&A costs).

Customer — a lose-win situation
As of March 26, Satyam partially or totally lost around 66 customers and won deals from around 215 existing customers. In total, the company lost business worth $183 million (including $91 million expected over the next 12 months) and won deals worth $380 million.

Litigations – difficult to ascertain financial impact
The company is facing litigations with respect to the acquisitions made by the company in the past as well as US class action law suits, unpaid litigation and unacknowledged claim of Rs 1230 crore. It is too early to ascertain the impact of the same on the financials of the company. However, it could materially impact the performance if the settlements go against Satyam.

To see full report: TECH MAHINDRA


It's Getting Better, and Here’s Why

Macro is looking up: While some incremental data have yet to recover (exports, industrial production), we think India will do better on the back of (1) election results, (2) an improvement in the investment climate, both domestic and global and (3) signs of thawing credit markets. Our revised GDP numbers of 6.8% in FY10E and 7.8% in FY11E are investment-led and assume stability on the consumption front.

How and where will this growth come from? We think focus on the following will drive growth: (1) facilitating infrastructure development, (2) sticking to the Inclusive Growth Mantra, (3) improving the business environment – rationalize taxes, land, labor, (4) education and (5) opening up and out: global integration and financial liberalization.

Wild cards – can swing both ways: While we expect growth momentum to be stable and deeper, there are wild cards: (1) Agriculture – an El Niño threat is hanging large, but food stocks are a buffer. (2) Global capital markets – India needs capital; it is there today, but will it continue? (3) Oil and commodities – rising prices will hurt but lower prices will benefit. (4) Expectations are high, but promises stand a better chance of delivery due to the new monitoring
mechanisms in place.

Financial markets — Although the RBI is close to the end of its easing cycle, yields will likely stay in the 6% to 7% range due to (1) the possibility of one last cut and (2) the RBI’s continued participation in the borrowing program. The rupee, which has gained ~6% after the election results, is likely to strengthen further in the medium term due to (1) higher growth and (2) increased capital flows. However, in the immediate near term like most other emerging market currencies, the rupee is likely to oscillate between “risk aversion” and “return to risk.”

To see full report: INDIA MACROSCOPE


Budget FY2010 likely to spur infrastructure investment, go slow on fiscal consolidation

  • Budget likely to keep GFD/GDP ratio in 6-6.5% range
  • Expanded NREGP, Bharat Nirman likely to sustain stimulus to rural economy
  • Infrastructure investments may get a boost through annuity-based schemes, funding of SPVs for financing equity component
  • We expect tax cuts to stay, but disinvestment of Rs200 bn can help check deficits

Gross Fiscal Deficit (GFD) likely at 6-6.5% of GDP for FY2010E

We believe the Union budget for FY2010 is likely to peg GFD/GDP ratio in the range of 6-6.5%. Since the budget-making exercise is still at a nascent stage, a clear idea of the fiscal gap is yet to emerge. We believe the government is likely to strive to keep GFD/GDP ratio in 6.0-6.5% band as higher than 6.5% on-budget deficit for the centre could (a) make the path of future fiscal consolidation that much more difficult and (b) be a negative with the financial markets, especially foreign investors and rating agencies. At the same time, a deficit lower than 6% of GDP is seen as hampering growth revival and coming in the way of government spending on rural safety nets.

  • GFD/GDP ratio below 6% appears improbable as the UPA government is committed to push its mandate for inclusive growth agenda further by expanding National Rural Employment Guarantee Program (NREGP) and Bharat Nirman Yojana
  • A 6-6.5% GFD/GDP is considered possible even with expanded coverage of NREGP with the carry-over of unused allocations from last year’s budget
  • A GFD/GDP exceeding 6.5% is seen as risking future consolidation and GOI is keen to find ways for additional resource mobilization, including disinvestment, to check the deficit from spinning out of control. A 7% GFD/GDP ratio is seen as potentially triggering negative reactions from important stakeholders in a globalized economy.

Combined deficit seen at about 10% of GDP
We believe it may be possible to contain the combined deficit of the Centre (including offbudget) and States to 10% of GDP as off-budget deficit could be restrained to about 0.5% of GDP with subsidies reforms. State governments’ deficit, with some prudence, could be contained at about 3% of GDP in FY2010E. We understand that officials consider this wide fiscal gap a legitimate counter-cyclical policy that is being adopted by several countries across the globe. In our assessment, fiscal deficits in India should start correcting from FY2010E at a moderate pace.

Subsidies reforms may be difficult
There appears to be is serious consideration of subsidies reforms, but political constraints may still hamper progress therein. While substantive suggestions for reforms aimed at capping GOI’s subsidy bill have been mooted, whether or not these get reflected in the forthcoming budget is a political call for policy makers. The proposals under consideration could possibly include:
  • Capping fertilizer subsidies by capping the amount and fixing subsidy per kg of nutrients
  • Deregulating prices of petrol and diesel, while retaining price controls on kerosene and LPG with modest price adjustments
  • Making provisions for higher food subsidy bill while aiming at reasonable procurement policy

To see full report: ECONOMY


Bank of India reported net profit of Rs.810.4 Crore during Q4FY09 in line with our expectations. During Q4FY09 bank reported a net profit of Rs.810.4 Crore as compared to Rs.757.1 Crore in Q4FY08 a increase of 7% (y-o-y). Key triggers for banks are Other Income was higher on back of strong fee income growth (up 103% y-o-y) and trading gains (up ~273% y-o-y). Operating Performance was slightly worse than expectations on account of higher operating expenses, which increased 23.5% q-o-q on account of higher wage costs and a non recurring investment to migrate all bank branches to the core banking system, decline of Net Interest Margin, and higher cost on account of branch expansion and branding. Net Interest Margin had significantly decline from 3.38% in Q3FY09 to 2.98% in Q4FY09.

Key Developments

• Interest Earned increased 3% q-o-q to Rs 4493.1 crore on account of at 6% qo- q growth in loan book

• CASA ratio declined 120 bps q-o-q to 30.5% as deposit mobilization campaign in December 2008 brought in mostly Fixed Deposits

• Capitalization remains comfortable with Tier I capital ratio at 13.0%, giving room for balance sheet expansion and additional fund raising

• Management is planning aggressive channel expansion of ~150 branches and ~500 ATMs in FY10

• Majority of bank’s advances are concentrated in the corporate sector (~48%) with the rest coming from SME (22%); agriculture (14%) and retail (15%). Management expects a similar profile of advances to be maintained in FY10

• Management expects incremental credit demand to come from the infrastructure (power, roads and telecom) and services (hotel and hospitals) sector

• Management indicates that it has been able to deploy resources towards advances and investments while parking minimal amount of funds with the RBI through reverse repo

Healthy Business Growth

The total business has grown by 26% to Rs. 3,34,440 crore in Q4FY09 as compared to Rs.2,64,804 Crore during Q4FY08. Advances have grown by 26% to Rs.1,44,732 crore in Q4FY09 as compared to Rs.1,14,793 Crore during Q4FY08 and deposits grew by 26% to Rs.1,89,708 Crore in Q4FY09 as compared to Rs.1,50,012 Crore during Q4FY08. Advances grew on the back of strong retail loan book which now constitute 79% of the banks advances while deposits grew on the back of huge demand for Term Deposits which stood at Rs.1,59,487 Crore in Q4FY09 as compared to Rs. 1,26,010 Crore in Q4FY08.


• At current price of Rs 324 the stock is trading at 1.14x FY10E BV of Rs. 465 and 4.62x FY10E EPS of Rs. 70.

• We believe that Bank of India has low valuations (~1.2 FY10E BV/s) compared to public sector banking peers, moderating business growth (~18- 20% advances growth expected in FY10) will be positive as it will allow management to focus on asset quality and improving funding mix, stabilizing NIMs ~3% as high cost differential interest rate deposits run off or are repriced in next two quarters and CASA ratio of 35% is achieved in H2FY10, asset quality headwinds will likely subside as economy improves

• We recommend a “BUY” on the stock with a 12 month target price of Rs. 465 giving an upside potential of 43% from current level.

To see full report: BANK OF INDIA



The current psychology in world stock markets is clear. A growing number of markets have returned to their pre-Lehman levels in mid September 2008, and those that have not have room for more “catch up” (see Figure 1). Such a psychology is what can continue to drive the S&P500 higher in the short term towards GREED & fear’s 1,000-1,050 bear market rally target, just as it can also drive stocks in Asia higher which are still below pre-Lehman levels.

Still at this point it also has to be noted that there is one macro risk which has emerged that potentially threatens stock markets in the short term. That is that the US dollar index is now around the same level where it found support in December last year (see Figure 2). The index fell to an intraday low of 78.3 on Tuesday and closed at 79.5 on Wednesday. If the index breaks this key technical level convincingly and its decline proceeds to accelerate, then a collapsing dollar could become a major negative for equities in stark contrast to the gently declining US dollar which has been a bullish driver for equities, particularly Asian equities, in recent months.

That said, GREED & fear still does not expect this full-scale dollar collapse to happen now. Rather the view here remains that the collapse comes later and that the recent dollar decline reflects renewed risk appetite causing the dollar to become the funding currency of choice for a new carry trade. This also suggests that the dollar will be due a decent rally when equities correct. Still the dollar collapse risk must be noted this week given the currency’s decline to a key technical level. A dramatic decline in the dollar, as opposed to a gradual depreciation, could in no way be viewed as positive for equities since it would signal a loss of independence for US monetary policy.

Originally scheduling a trip to India after the country’s general election seemed like a good idea to GREED & fear. But clearly in a certain respect the action has already happened. The Sensex is up 23% since the result of the poll was announced on 17 May while the benchmark index is now “only” 29% below its all-time high of 21,206 and 7% above the level reached prior to the Lehman collapse.

If this is the case, GREED & fear is fortunate in the sense that a reasonable overweight position in India was maintained in the relative-return portfolio prior to the election’s result while a 30% of the Asia long-only portfolio was also invested in India, which was subsequently raised to 34% after the result (see GREED & fear – flash, 18 May 2009). It is also the case that GREED & fear has seen nothing in India this week to cause a severe questioning of the long-held view here that a structural bullish position towards the market should be maintained by specialist emerging market investors and indeed by global investors in general.

Indeed, if there is a risk to the market it is probably in the short term. The Sensex has moved a long way in a hurry as sidelined foreign investors reacted to the surprisingly decisive election result. As a result, there is talk of US$15bn of equity issuance in the pipeline while hopes of positive reform initiatives are also high for the budget announcement due in early July. There is also the risk that, with crude at US$67/bbl, the oil does not have to move too much higher before it starts to influence sentiment negatively towards India.

To see full report: GREED & FEAR