Saturday, June 27, 2009



The Indian cement industry posted a staggering growth for the seventh consecuare tive month during May 2009 as the dispatches found rising on the increased infrastructure and rural housing activity across the nation. All India cement production witnessed healthy growth of 11.9% YoY and dispatches of 10.8% YoY. All regions witnessed healthy growth, however northern region among them witnessed highest growth rate 26.3% YoY on back of the increased infrastructure spending and demand from the construction for the commonwealth games. Southern region witnessed sluggish growth rate of 4.1% YoY due to acute power cut problem and low demand in the region. Central, Western and Eastern regions dispatch growth of 11.0%, 8.3% and 7.2% respectively.

The all India cement prices had crossed Rs. 250 per bag in May. The strong grip witnessed in cement prices is mainly on account of strong dispatch numbers posted by cement companies and continual delay in commencement of new capacities

Average coal prices have now come down from their July'08 peak of $200 and expected to remain around $68. Given the significant correction in international coal prices and pet coke prices, major beneficiaries will be those manufacturers who primarily rely on imported coal as a raw material in production process.

Demand in Apr-May had picked up mainly due to Government infrastructure projects and will come down by end of june-09 with the onset of monsoons. Cement prices could fall by up to 10% in the coming months, pushed lower by new supply and slower construction activity during monsoon season. However, with a likelihood of a fresh impetus to infrastructure and housing sector in the forthcoming budget, utilization levels may improve.

To see full report: CEMENT UPDATE


Earnings Barometer

With Q4FY09 earnings broadly beating Street’s expectations, an analysis of the quality of reported numbers becomes increasingly important. We have analysed quarterly results of BSE 2001 companies (excluding BFSI) for the quality and nature of reported earnings and discussed in this report companies that have one or more issues mentioned below:

1) Amendment in AS 11 used to defer MTM losses on fluctuation in foreign currency monetary items.
2) Early adoption of AS 30 w.r.t. derivatives contracts.
3) Deviation from accounting standards / guidance notes / GAAP.
4) Change in accounting policy.
5) Auditor’s qualification/comments.
6) One timers, other income and exceptional items significantly impacting PAT.

Significant observations

Amendment in AS 11 to facilitate deferment of MTM losses
In FY09, AS 11 was amended, providing companies an irrevocable option to either continue charging foreign exchange difference on long-term foreign currency monetary items through the P&L account as provided in erstwhile AS 11 or retrospectively (for all accounting period commencing on or after December 7, 2006) follow the amended treatment that provides for the following:

1) Exchange difference on long-term foreign currency monetary borrowing incurred for acquisition of depreciable capital asset can be adjusted to the carrying cost of the respective asset and depreciated over the balance life of the asset.

2) Exchange difference on other long-term foreign currency monetary items (not related to acquisition of a depreciable asset) can be accumulated in ‘Foreign Currency Monetary Item Translation Difference Account’ and amortised over the balance life of the long-term asset/liability or till FY11, whichever is earlier.

Many companies, including Bajaj Hindusthan, Educomp Solutions, GE Shipping, GMR Infra, Hindustan Constructions, IOCL, Jindal Steel, Jubilant Organosys, Sterlite Industries, Tata Motors, Welspun Gujarat, amongst others, have opted to account for foreign exchange fluctuations as per the amended AS 11. The recent amendment allows foreign exchange losses on long-term monetary assets to be charged to the balance sheet and deferred instead of being charged in the year in which they originate.

On an aggregate basis, forex loss of INR 153.1 bn for FY09 has not been charged to the P&L and deferred to be charged in future years.

With a reversal of the trend and now the INR appreciating against USD, companies that had deferred MTM losses by adopting amended AS 11 will book forex gains with a lag.

Early adoption of AS 30 with respect to derivatives
AS 30 allows companies to classify hedges as fair value hedge and non-fair value hedge. The new standard allows the loss/ gain on effective non-fair value hedge (cash flow hedge / hedge of a net investment in a foreign operation) to be accumulated in reserves instead of charging it to the P&L, to be ultimately adjusted in the P&L account for the period in which the transaction is closed or net investment in foreign investment hedged is disposed.

Quarterly Earnings


Many companies including Ashok Leyland, GE Shipping, Great Offshore, Tata Motors amongst others, have adopted AS 30 w.r.t. derivatives accounting.

On an aggregated basis, MTM loss of INR 9.8 bn for FY09 is charged to the balance
sheet instead of being charged in the P&L.

Deviation from accounting standards / guidance notes / GAAP

Reliance Communications has continued its policy of charging forex fluctuation on borrowings related to acquisition of fixed assets to the carrying cost of fixed assets. It has, however, not opted for the amended AS 11.

Jindal Saw has not provided for the MTM losses on outstanding derivatives contracts.

Change in accounting policy


IOCL has changed the accounting policy of charging know how/ license fee related to production process as a revenue expense to capitalising the same as an intangible asset.

Tata Teleservices has changed the accounting policy for term of amortising the subsidy.



Budget F2010 – Tilting Policy Bias toward Growing the Pie

First key policy signal from the new government: Investors are likely to watch the budget announcement on July 6 closely as this will be first major policy announcement from the new government and will be a reflection of the government’s priorities. Will the budget live up to the market’s expectations? We think the budget will provide positive signals, indicating the government is keen to make progress in policy reforms.

Growing the pie is as important as redistribution: Despite the slow pace of reforms during F2006-2008, positive global factors ensured strong GDP growth. However, in the current environment where global growth is likely to be sub-par, the government will need
to move on economic reform. We expect the government to take a balanced approach, with adequate focus on reviving growth and sending the right signals to the private sector.

What do we expect from the budget? We expect the budget to focus on the following themes: (a) announcing a clear plan to improve the health of public finances; (b) augmenting resources through a divestment program; (c) committing to an increase in infrastructure spending; (d) implementing a goods and services tax (GST) scheme; and (e) maintaining the push on social sector spending but without straining the fiscal deficit further. Our expectations for FDI liberalization remain low.

Stock market implications – will history repeat? Our India Strategist, Ridham Desai, highlights that history does not favor a move up in the market in the month post the budget. However, he argues that this time, since we expect the finance minister to deliver a reform-oriented budget, history may not necessarily be relevant.

To see full report: STRATEGY & ECONOMICS


The Global Economy in One Place

Bottom in place: Following three quarters of outright declines, global GDP returned to positive, though very subdued, growth (quarter-on-quarter) in 2Q09, according to our latest estimates, and thus even a tad earlier than we expected two months ago (see Exhibit in report).

Asia leads, US and Europe lag: Global bottoming entirely reflects a bounce in Asia in recent months, led by China initially and now becoming visible in Japan, India and other parts of the region. Also, Latin America, especially Brazil, appears to have turned up. The US and Europe (West and East) are lagging and have yet to turn around – still a story for later this year, we think.

The deepest recession, the weakest recovery: We continue to look for a very tepid global recovery, and the risk of setbacks along the path is high. On our forecasts, global GDP will only return to its pre-recession peak level of 2Q08 by the middle of 2010. In the G-10 advanced economies, only about half of the total GDP peak-to-trough loss of some 4.5% during the recession will have been recouped by the end of 2010.

Bouncing between L and V: Risks around our baseline scenario are unusually high in the face of an unprecedented shock and an unprecedented policy response. We present updated ‘reasonable’ bull and bear scenarios that describe V- and L-shaped paths (p. 5-7). Reality will
probably lie somewhere in between, but markets may well switch between expecting one or the other several times over the next few quarters.

Central banks won’t dare to rock the boat: We expect most major central banks to keep rates at current exceptionally low levels until well into 2010 (p. 11). Also, quantitative easing will likely be unwound only very gradually. Thus, excess liquidity is likely to grow further in the foreseeable.

To see full report: GLOBAL FORECAST


Standing tall

Sun TV Network’s Q4FY09 results were strong with revenues and PAT growing 12% YoY and 25% YoY to Rs2.75bn and Rs1.14bn respectively. EBITDA margin jumped 1760bps YoY to 81.8%, but EBIT margin was tempered on higher amortisation of acquired Movie rights. The radio business reported Rs332mn revenues and Rs688mn loss (Sun TV’s share) in FY09, which was higher than the guidance. FY09 consolidated revenues were at Rs10.4bn and PAT at Rs3.68bn. Sun TV witnessed the strongest growth among media companies in a relatively
tough quarter as regards advertising. This highlights the strength of its market position and regional ad market. We marginally lower FY10E & FY11E EPS estimates to Rs11.1 and Rs13.1 respectively. We raise our target price to Rs262 from Rs184 based on FY11E P/E of 20x. We upgrade Sun TV to BUY from Hold; recommend buying on dips.

Q4FY09 revenues grew a strong 11.9% YoY in a tough quarter, when most media companies witnessed a decline in advertising revenues. Sun TV’s strong revenue growth was driven by regional advertising, which was also the case for Zee News and Jagran Prakashan.

DTH revenues propelled growth, contributing Rs840mn revenues or 40% to the overall Pay TV revenues. Sun TV reported Rs2.1bn and guided for Rs3-3.2bn Pay TV revenues in FY10 driven by DTH revenues.

Radio losses high at Rs688mn in FY09 versus Rs403mn loss in FY08, driven by expansion. Radio revenues increased to Rs332mn in FY09 from Rs89mn. Cash infusion by the foreign partner, Astro Malaysia in the radio business to increase its stake from 7% to 20% will help Sun TV meet operating losses.

Upgrade to BUY. Sun TV has been able to sustain its growth trajectory in a relatively difficult year for media companies, which indicates the robustness of its business model. We raise our target price to Rs262 from Rs184 based on FY11E P/E of 20x. We upgrade Sun TV to BUY from Hold; recommend buying on dips.

To see full report: SUN TV


Decline in oil consumption due to the price rises in 2007 - 2008: Temporary or permanent?

The surge in the oil price in 2007 and early 2008 caused a drastic decline in global demand for oil that still continues today, even though the oil price has fallen dramatically.

We seek to ascertain whether this decline in demand is temporary or permanent, and thus whether it corresponds to a structural change of behaviour. The prospects for the oil price for the next few years are obviously very different in the two cases.

In order to analyse this issue, we look at:
- trends in global demand for oil in the 1980s, after the oil shocks in the 1970s;

- the trend in oil-consuming activities (industry, housing, transport);

- the trend in the efficiency in the use of oil (consumption per car or per inhabitant for example).

We conclude:
- that the short-term changes in oil demand (decline for 2 to 3 years, then recovery) after a sharp rise in the price are linked to the cycle (industrial, transport);

- but that periods of rise in the oil price, even followed by declines, lead to an irreversible improvement in energy efficiency in transport and industry, as well as overall.

To see full report: SPECIAL REPORT


Key Calls

Still positive on equities, the main drivers remain supportive, but looking to reduce some risk in Cyclicals when/if ISM prints above 50:

Credit stabilisation – most credit indicators back to pre-Lehman levels. New issuance well accepted.

Fiscal and monetary policy actions tracking into real economy. “Money illusion” at work.

Steep yield curve – the most recent short end sell-off is premature in our view.

Macro momentum troughing – economic data flow is showing signs of stabilisation, admittedly from an extremely low level.

Earnings trough near – analysts to move to a phase of outright upgrades. The trend ex-financial margins might not need to structurally move lower.

Inflation backdrop positive – we believe investors could be surprised by how low inflation remains for longer. Asset reflation; not inflation. The return of “Goldilocks”.

Attractive Valuations – trend P/E for Europe at 12.5x, P/S at 0.9, DY significantly beating risk free.

Inflows to come - consensus is still underweight equities.

We acknowledge the negatives of overbought technicals, backup in mortgage rates, rising oil price.

Key risk: Credibility driven bond sell-off, but we believe yields should be rising due to supply-demandimbalance, flows, change in growth/inflation outlook. Above 4.5% on 10Y US impact could be -ve.

Key trades:
- Continue OW on Equities and Cyclicals. Triggers to reduce risk potentially coming in Q4, some Defensives are starting to look interesting and we would look to close OW Cyc /UW Defensives then.

- Earnings revisions and quality to re-emerge as drivers of stock selection

- OW Europe vs US

  • Key longs: Materials, Industrials, Discretionary
  • Key shorts: Utilities, Pharma, Staples
To see full report: EQUITY STRATEGY


Robust 28% yoy revenue growth, 3,500ckm added to the network during the year
During the quarter PGCIL witnessed a 28% yoy jump in revenues to Rs18.6bn against Rs14bn in the corresponding period last year, after adjusting for rebates, FERV and Rs2.5bn tax paid. PGCIL lost a dispute against the tribunal for service tax on transmission of power. Adjusting for this, the transmission division reported a 24% yoy growth. Revenues from load dispatch and communication schemes witnessed a 60% jump to Rs1.3bn. Consultancy divison's contibution to the revenues continued to decline for the 4th straight quarter as its share stood at 3% against 5% last year.

Despite providing for wage revision, operating margin expands by 145bps yoy
During the year the company provided Rs2.4 bn towards wage revision. As a result of this its full year operating profit margin was lower by 30bps yoy. During Q4 the company has provided for Rs1-1.4bn towards wage revision. However, healthy revenue growth enabled the company to expand its operating margins by 145bps yoy during Q4 FY09.

Strong PBT performance
PGCIL's PBT grew by 161% yoy before adjusting for extra-ordinaries and 30% after adjusting for extra-ordinaries. The transmission segment spreadheaded this growth with 152% jump in PBT.The division's PBT margin expandedbyppt yoy to 36% against 17.7% in the corresponding period last year.Telecom division continued to report losses at PBT level, however margins improved to(27.3%) againt(54.8%) last year.Overall the company has witnessed 18ppt expansion it its PBT margins during the quarter.

To see full report: POWER GRID

>2009 Estimates of Fundamental Equilibrium Exchange Rates

When we first published our estimates of fundamental equilibrium exchange rates (FEERs) in July 2008 (Cline and Williamson 2008), we stated that this was intended to be a regular series
of publications. This policy brief updates those estimates in light of the momentous changes in the world economy during the past year. Many of those changes, notably changes in actual exchange rates, should not influence FEERs, except insofar as we allow a range of variation of the target current account balance. But equally clearly, one does expect some of the changes, notably forecasts of the prices of oil and other commodities, to be important determinants of equilibrium exchange rates.

A major consequence of the global financial crisis has been a further rise in the already overvalued dollar, as investors have turned to the United States as a relatively safe haven. A larger overvaluation implies a larger external deficit, after the two-year or so lag from the exchange rate signal to trade flows. Similarly, the rise in perceived risk combined with the reduction in high domestic interest rates in some countries for counter cyclical purposes has ended the “carry trade” and contributed to a strengthening of the yen in particular, reversing the currency’s gap from its previous estimated FEER, from a significant trade-weighted overvaluation in 2008 to a small undervaluation today.2 The extreme and unusually synchronized global recession has also caused major reductions in oil and commodity
prices, a second potentially important cause of changes in FEERs. Finally, the most severe postwar global recession may have changed investors’ perceptions of long-term relative growth
prospects across countries, although it is too early to judge this definitively.

To see full report: EXCHANGE RATES


Operating leverage to have limited earnings impact
In FY09, BHEL provided prior period wage arrears/gratuity arrears of Rs6.7b (total arrears at Rs17.3b). Adjusting for prior period arrears, BHEL’s FY09 EBITDA margin is 18.9%. In FY11, we expect BHEL’s EBITDA margin to expand 260bp to 21.5%, indicating operating leverage. However, EBITDA CAGR of 31% translates into PAT CAGR of only 25% due to decline in other income from Rs7.9b in FY09 to Rs4.5b in FY11E. Decline in other income is mainly due to fall in cash balance from Rs96.2b in FY09 to Rs46.7b in FY11E. Cash balance is expected to fall due to: (1) Lower customer advances on the back of stagnation / marginal decline in annual order intake, (2) Faster unwinding of customer advances due to strong execution, (3) capex of Rs42.1b during FY10 &FY11 and (4) actual cash payments of Rs20b+ towards wage arrears bhmentioned above.

Stagnation in annual order intake to impact working capital and thus cash levels: Order intake and customer advances for the same had increased substantially during FY06-FY09. Annual order intake witnessed exponential increase from 3.4GW in FY06 to 17GW during FY09, up 400% in 3 years. This resulted in balance sheet cash increase from Rs41.3b in FY06 to Rs96b in FY09, an increase of 132%. During FY09-FY11 we expect stagnant order intake leading to fall in cash balance to Rs46.7b by FY11. This cash reduction will be accentuated by increase of cash requirement in faster execution (revenue CAGR of 23% during FY09-FY11). Also, BHEL will entail cash outflow of Rs20b during 1QFY10 for the wage provisions made during FY09.

Capex plan of Rs100b+ to increase capacity to 20GW by FY12: BHEL plans to increase its power equipment manufacturing capacity from 10GW to 15GW by March 2010 and to 20GW by March 2012. BHEL plans to spend Rs100b+ for this expansion plan During FY09, company spent only Rs11b, indicating that the majority of capex would happen during FY10-FY12.

Valuation and view: We expect FY09-11E revenue CAGR of 23% and EPS CAGR of 25%. The stock currently trades at a P/E of 23.2x FY10E and 18x FY11E. We maintain Neutral with a price target of Rs2,033/sh (18x FY11E earnings).

To see full report: BHEL