Monday, June 22, 2009


Asian Oil and Gas Markets in a Global Context:
Future Strength?
Future Weakness?

Path Ahead?
  • Short-term oil market outlook?
  • Mid-to long-term outlook?
  • Segments/sub-segments of the oil market have very different prospects.
  • Critical to position accordingly.
To see presentation: OIL & GAS


Rise in CNG price in line with estimates

CNG price in Delhi higher by INR 2.1/kg
Indraprastha Gas (IGL) increased the retail price of CNG in Delhi from INR 18.9/kg to INR 21.0/kg w.e.f. from June 16, 2009. The increase encapsulates an INR 2.0/kg increase in CNG price and an INR 0.1/kg increment in applicable taxes. This implies an average price of INR 20.56/kg for FY10 (as the older price of INR 18.9/kg has prevailed for two-and-a-half months of the financial year). However, CNG retail prices in Noida have been left unchanged at INR 22.1/kg.

Price hike in CNG to mitigate impact of rise in input costs
The subsidized APM (Administered Pricing Mechanism) gas supplied to IGL was becoming increasingly inadequate for NCR’s growing demand of CNG. This compelled IGL to buy the costlier imported LNG to meet the shortfall, which raised the company’s input costs. Further, the incremental gas to be sourced from RIL’s KG-D6 basin (after RIL’s production ramps-up to start supplying to the city gas distribution sector, and replaces LNG) is priced much higher than APM gas which itself could face price revisions upwards. Hence, the increase in CNG pricing serves to mitigate the effect of current increase in raw material costs, and also partially alleviates concerns on increase in blended gas costs in future.

Outlook and valuations: Earning estimates retained; maintain ‘BUY’
We had assumed a CNG retail price of INR 20.5/kg and INR 21/kg for FY10 and FY11 respectively. Since the difference between FY10E average actual CNG prices (INR 20.56/kg) and our existing assumptions (INR 20.5/kg) is marginal, we are maintaining our earnings estimates and outlook. We had assumed a sales volume growth of 15.4% for FY10 in line with the high demand expected on account of the commonwealth games (please refer our recent report titled “Regulations and new supplies to energise growth” dated May 06, 2009 for more details), which provides significant upsides to the stock in the short-to-medium term.

At CMP of INR 145, IGL is trading at 9.3x and 8.7x our FY10E and FY11E EPS, respectively, a 2.5x FY10E P/BV and a 4.1x FY10E EV/EBITDA. We maintain our ‘BUY’ recommendation on the stock.

To see full report: INDRAPRASTHA GAS


Has finance already forgotten the crisis?

The consensus is that the crisis will have to cause a trend break in the practices adopted in finance: contraction in demand for complex assets, reduction in risk-taking, changes in trader compensation systems, etc.

But certain recent developments can raise doubts as to whether there is really a trend break:
− the banks’ accelerated repayments of the governments’ capital injections;
− the return of demand for financial assets that until now were supposed to be "toxic";
− renewed speculative bubbles due to the sharp fall in investor risk aversion and excess liquidity.

This latter point shows that central banks’ responsibility in the "financial sector excesses" is even greater than before the crisis.

To see full report: SPECIAL REPORT


Deflation vs. Inflation: The Battle Rages On

US TIPS: We remain positive on longer maturity TIPS BE’s for longer horizon investors. The recent narrowing in BE's provides an opportunity to re-add to long BE positions that we had recommended scaling back on last week.

European IL: We remain short Euro breakevens but see short term risk from oil prices and therefore prefer to sell inflation forward. We analyse cross-country breakeven spreads and recommend selling BTPei35 breakevens against OATei32. The real German government curve looks too flat in the 5-8 year sector compared to France.

JGBi: The rally in JGB inflation linkers has stalled since April. We believe further weakness should provide a selective buying opportunity.

EM IL: the only long duration left
Exposure to inflation-linked instruments remains important in our overall exposure in EM local debt markets. What we have seen in recent weeks is that exposure to real rates is now the best way to express a long duration view. This is because most central banks have now come close to the end of the easing cycle, which means there is little upside at this stage for a plain long duration position. On this basis, we continue to hold recommendations of a long Turkey Feb. 2012 CPIlinker bond and a long Brazil NTN-B 2015 IPCA-linked bond in our portfolio.

Commodities: A very fast increase in oil prices in the coming months could put the embryonic economic recovery at risk. How high could oil go near-term? In OECD economies, our economists believe that $70-80/bbl oil could start to pose a risk to the recovery, while the risks to EM growth would come in at $90-100/bbl.

US economics: Headline CPI came in significantly below expectations with a 0.1% M/M increase in May. Most forecasters missed the tepid rise in energy which benefited from an aggressive seasonal factor to the downside. Core prices were in-line with a 0.1% M/M gain taking the annual rate to 1.8% versus 1.9% in April. Euro area economics: Inflation hit a record low of 0.0% in May. While downside risks dominate in the summer, positive headlines rates are seen before year-end.

UK economics: CPI inflation fell a little further in May, and is expected to continue falling to a trough in September.

To see full report: INFLATION



Monsoon – off to a weak start: YTD seasonal rainfall is 45% below normal. The Met department has indicated that the weakness could continue over the next week. It is early days yet, as June typically accounts for only 20% of the total south west monsoon. But a recovery over the next month is critical, in our view.

Economic significance has decreased, but is still meaningful:
Structurally the importance of agriculture as a percentage of GDP has decreased over the past few decades, from nearly 50% in the early 1970s to about 17% now. But the monsoon is still important for the farm sector, as nearly 60% of India’s agriculture is rainfall-dependent.

Adverse impact on sentiment: Nearly 60% of India’s population lives
in rural areas. Although they do not derive their entire livelihood from agriculture, the sentiment impact of the monsoon on private sector consumption cannot be underestimated. Also, in the recent past, rural India has been driving consumption growth on the back of various government stimuli. This segment is vulnerable to a pull back.

Consumption underperforms: An analysis of weak monsoons over the
past indicates that the earnings impact has been mixed due to various offsetting factors. But consumption-related sectors, i.e. staples, discretionary and telecom, typically underperform both over the July-Sept quarter and the fiscal year in which the monsoon has been weak. We have been cautious on the telecom sector since the beginning of the year and have had an underweight stance on the staples sector over the
last two months. Our overweight stance on the discretionary sector would, however, be vulnerable if the monsoon weakness persists.

To see full report: INDIA EQUITY STRATEGY


Power segment to boost growth

For FY09, Jindal Steel and Power Ltd. (JSPL) reported a strong set of numbers. The net sales (consolidated) of the Company increased by a staggering 97.6% yoy to Rs. 108.4 bn, and the net profit jumped by 140.6% yoy to Rs. 30.1 bn. The Company’s strong results are primarily attributable to the commencement of operations of Jindal Power Ltd. (JPL)’s 1,000 MW merchant power plant (MPP), and a 35.8% yoy increase in the average sales realisation of saleable steel. We continue to hold a positive outlook on the Stock, mainly on the back of the stable revenue visibility in the Power business and the resurgence of domestic demand in the Metal sector. However, the stock has moved up sharply since our last report, and based on our valuations it is fairly valued at the CMP. Thus, we give a Hold rating to the stock.

Rising domestic steel demand to stimulate the Metal segment: We expect JSPL (standalone) revenue to increase by 8–10% in FY10. The recovery in the Automobile industry and an increase in infrastructure investments have encouraged the demand for steel. Further, we expect the demand from the Real Estate sector to increase due to the fall in the interest rates and the sharp correction in the property prices. Thus, along with the revival in the economy and the restoration of demand, we have increased our base metals average realisation estimates for the Company to ~Rs. 38,000 per tonne in FY10.

Power business continues to be a growth driver: We expect JPL’s revenue to increase by 12–15% in FY10. In FY09, JPL has fully commissioned its 1,000 MW MPP that sells power on merchant basis through short-term PPAs; such agreements command high realisations of around Rs. 5–8 per unit. Further, as the new capacity stabilises, we expect production to increase to ~8,000 mn units in FY10, as compared to 6,207 mn units in FY09. The current power deficit situation in the country is expected to persist, and this should further help the Company achieve stable revenue.

To see full report: JINDAL STEEL & POWER LTD.


Company Background
Wipro started out as Edible Oil Company before entering FMCG and IT businesses. Currently Wipro is the third largest software exporter from India.

Investment Rationale

Second Largest player in the Indian IT domain behind IBM: ‐ Wipro is the second largest IT service vendor in the Indian Market behind IBM. We expect the company to leverage its strong presence in India and continue to bag multiple contracts in the coming months, which would aid Wipro in reporting incremental revenues in the coming years. The company has bagged following contracts in the recent months:‐

Six and a Half year contract worth Rs 1182 Cr from Employee State Insurance Corporation.

Order worth Rs 200 CR from LIC.

Company bagged order from Unitech wireless executable over a period of Nine years for an undisclosed sum. In its analyst meet, the management had conceded that Q1 and Q2 of FY10 would be tough for the industry as a whole however the company has stated that it had witnessed a pick up in order placement in Feb‐ March months in FY09. Going ahead the company has stated a build up in order book pipeline as clients that were apprehensive about IT budget and new order placement are expected to go ahead with orders placement. The management stated that offshore spending by customers would increase as they look to reduce cost at their end.

Company has reported a growth of more than 28% in its topline for FY09. Going ahead, with orders form Indian Sector improving and Clients in US and Europe also seeking a reduction in cost and opting for out sourcing Company’s topline is expected to improve in the coming years and expansion of profit margins can also not be ruled out.

The company has cash and bank balance of Rs 4912 Cr on its books that translates to Rs 33.5 per share.

To see full report: WIPRO


Slow earnings recovery

Order inflows likely to revive, but not rapidly
On average, companies in our coverage universe saw a 22% decline in order booking in 4Q FY09 and grew just 8% in entire FY09 (pulled up mainly by strong order inflow for HCC, which grew 143% YoY). We expect an improvement in FY10, but the pick-up in order flow will likely remain moderate owing to high fiscal deficit restraining government spending and a slowdown in private-sector capex. We estimate order inflow growth of 15–20% in FY10 (-50% for HCC, due to the high base in FY09) and 20–25% in FY11.

Earnings growth to be much lower than pre-FY09 levels, in the near term
After a rather forgettable FY09, earnings are likely to pick up from the current fiscal onwards. However, earnings growth is unlikely to reach pre-FY09 levels in a hurry. For companies in our coverage, we expect earnings CAGR of 17% over FY09–11E compared to 52% in FY03–08. We expect slow recovery on account of: (1) low revenue visibility (owing to low order inflows in FY09); (2) depressed EBITDA margins; and (3) high interest costs (despite a significantly lower cost of debt).

Quality of earnings remains weak, equity dilution risk lingers
Our biggest concern about the sector has been negative cash flows generated primarily due to an elongating working capital cycle. We expect the cycle to remain stretched, resulting in: (1) low or negative cash flows; (2) rising debt and low interest coverage; and (3) low return ratios (with ROIC below 12%). This will eventually lead to a series of equity dilutions, as was seen in the past.

Optimism is overdone, we are cautious on the sector
Post elect ion results, all construction stocks have run up significantly on the back of optimism that the new government will push infrastructure spending aggressively. We believe an improvement in earnings is likely to be gradual rather than dramatic, thus leaving room for disappointment. Thus, we believe that construction stocks are not likely to trade at the high multiples they commanded in 2007-08. We are upgrading Simplex to Buy based on our revised valuation and maintain our Sell rating on HCC, IVRCL and NCC.

To see full report: INDIA CONSTRUCTION


Gaining traction; upgrade to Buy
Ride domestic growth, 30% potential upside We upgrade our rating to Buy from Underperform as we expect valuations to mirror market share gain led recovery in domestic business (67% FY11E EBITDA), and we think this will more than offset the known weakness in JLR operations. We reflect this by raising our standalone EBITDA forecasts by 65% in FY10 and 62% in FY11. Our sum-of-the-parts PO of Rs420 factors in NIL contribution from JLR.

Buoyed by domestic operations We expect standalone business to register 54% EBITDA CAGR, on: (1) higher CV volumes due to cyclical rebound in trucks, and a spate of bus orders, and (2) stronger margins, on better vehicle realizations and soft commodity prices. Our EPS estimates of Rs18 in FY10 and Rs30 in FY11 are ahead of consensus.

Financial health on the mend Tata Motors’ debt of ~Rs320bn (debt/equity 1.3x), includes Rs70bn from vehicle financing and Rs25bn customer advances. We however expect leverage ratios to improve on stronger cash flows and likely equity issuance, failing which we expect further monetization of investments. By FY11, we estimate consolidated net debt/EBITDA at 2.3x, net debt/equity at 0.8x and interest cover at 2x.

Sum-of–the-parts value at Rs420 Our PO is based on FY11E EV/EBITDA, and driven by: (1) standalone business valued at 8x, which is a slight premium to mid-cycle sector valuations on market share gains, and (2) JLR at nil value, equivalent to 4.6x, in line with global peers.

To see full report: TATA MOTORS


We recently met the management of Canara Bank and came back convinced about the bank’s ability to deliver a high RoE over the next couple of years. We expect the RoE improvement to be driven by: (i) an improving core performance; and (ii) receding pressure on asset quality. The bank is well poised to accelerate its credit growth, which along with the calibrated strategy of lower growth in FY08, has led to an uptrend in CASA, NIMs and NII (albeit some base effect). Besides the pick-up in credit growth, renewed focus on cross-selling would also contribute to fee income growth. In Q4FY09, the bank surprised positively on asset quality and reported a decline in Gross NPAs, while restructured assets hovered at the industry average. The bank has de-risked its investment book over the year, with AFS proportion in investment book now at 27.5% (duration of ~2 years) from ~37% in FY08. A lower AFS proportion in the investment book implies lesser volatility in earnings going forward. We expect Canara Bank to report 14% CAGR in net profit over FY09-11, with an average RoE of ~21% over the next couple of years. Stock is currently trading at ~1x FY10 adjusted book. We upgrade our recommendation on the stock to Outperformer with a 12-month price target of Rs350.

The key takeaways from our meeting with Canara Bank management are:

Growth strategy – foot on the accelerator!

  • Credit growth in FY08 was restricted to ~9% as the bank’s strategy was to consolidate rather than grow aggressively (28% CAGR over FY05-07).
  • Since July/ Aug ’08 (when the new Chairman took over the running of the bank), the focus has been on returning to growth. In FY09, the bank grew its deposits by ~21% and advances by ~29%.
  • In FY10, credit growth is expected to moderate to 20-22%, in line with RBI guidelines.
■ Outlook for margins – stable!
  • NIMs improved by 36bp qoq to ~2.8% in Q4FY09, as loan spreads expanded with a higher rise in yield on advances than cost of deposits. Management expects NIMs to stabilize around 2.8%.
  • Lending rates are not expected to fall by more than 50-100bp from here unless cost of funds also falls by a similar extent. We believe there is limited scope for reduction in cost of funds, which as fixed deposits would then become unattractive for investors.

■ Gross NPAs contained; restructuring at 1.5%
  • Gross NPAs have come down from Rs25bn in Dec’08 to ~Rs21.7bn in Mar’09 on the back of strong recoveries. The bank’s entire Rs4bn Ratnagiri exposure continues to be a part of its Gross NPAs.
  • While provision coverage ratio of ~31% looks low, Canara Bank management reaffirms that including Rs40bn of write-offs by the bank, coverage ratio stands at 77- 78%.
  • The bank has restructured Rs20.6bn of loans during FY09, bulk of which are payment deferment and not haircut on interest. As of April’09, applications for restructuring worth Rs20bn are still pending, of which the bank does not expect to restructure more than Rs10bn.
■ Expansion plans
  • 200 new branches are expected to be opened this year. Around 77% of all branches are CBS compliant, with a target to reach 100% by March-April’10.
  • Alongside productivity initiatives for the bank’s workforce, about 1,800 young people are expected to be hired to lower the age profile of the employees.

To see full report: CANARA BANK