Thursday, July 9, 2009


Fuel price hike a surprise, but indicates no reform and no oil bonds

India raises auto fuel prices 6%-9%; but losses continue
The Indian government today (July 1) increased retail prices of gasoline and diesel 9% and 6% respectively in an unexpected move. While this is likely to draw political opposition, we note that oil marketing companies (OMCs) are expected to continue to lose Rs1.6-2.0/lit on fuel sales despite this hike. The prices of cooking fuels (LPG/kerosene) were unchanged.

Hike implies government intention to issue fewer oil bonds in FY10
We believe that the swift price hike reflects the government’s intention to keep its share of the subsidy low. The oil ministry has indicated that upstream companies would bear the entire subsidy burden from cooking fuel losses (source: Wall Street Journal, July 1), implying that the
government would minimize issuance of oil bonds going forward as it tries to keep the fiscal deficit under control.

Fuel price de-control looks unlikely now; also oil prices going up
The ad-hoc increase in auto fuel prices also puts to rest, in our view, recent excitement about structural reforms in fuel pricing. We believe the government indicated that while it is ready for some difficult decisions on fuel pricing, it is unlikely to leave this entirely to market forces at a time when oil prices are likely entering an upcycle. The Union Budget on July 6, 2009 should provide clarity on the subsidy structure for FY10, which we believe would make the government the biggest beneficiary.

Retain Neutral on OMCs; but they are running out of good news
While it is not clear whether OMCs would have lower net under-recoveries in the new subsidy structure, cash flows should improve if the government minimizes deferred subsidy payments, i.e. oil bonds going forward. Though the price hike news is positive for sentiment on OMC stocks, we believe they are running out of good news. As a result we retain our Neutral ratings and target prices on IOC, HPCL and BPCL.

Upstream to bear entire cooking fuel loss = negative for ONGC
If upstream co’s are asked to bear the entire subsidy for cooking fuels, it would be a major negative surprise for ONGC. The upstream subsidy payout has been lower than cooking fuel losses in all the years so far. We remain skeptical on whether the govt would allow ONGC to make more profit at the cost of oil bonds and as a result maintain a Sell rating.

To see full report: OIL SECTOR


PO cut 2%; if no tax holiday on gas, another 15% downside

FY10-FY11 EPS cut by 4-5%, PO by 2%; retain Underperform
In the Indian budget the minimum alternate tax (MAT) rate including surcharges is increased to 17% from 11.3%. It was also clarified that 7-year income tax holiday under Section 80IB (9) would be block wise and not field wise as assumed by us. This meant Rs25/share cut in PO of Reliance Industries (RIL). The MAT rate cut means further cut in PO to Rs1,806/share and 4-5% cut in FY10-FY11E EPS. Uncertainty on whether RIL will get 7-year income tax holiday under Section 80IB (9) for its gas production continues. The hit to RIL’s PO would be another Rs275/share (15%) and to FY10-FY11E EPS if RIL does not eventually get tax holiday on gas production. We retain Underperform on RIL.

No tax holiday for gas output in worst case
A new provision has been inserted to allow 7-year income tax holiday for gas production from blocks allotted under NELP VIII (launched in April 2009 and to close in August 2009). Thus the tax holiday on gas production is prospective. Whether there would be tax holiday for gas produced from blocks allotted under NELP I-VII is still uncertain. This matter is being litigated in courts. The best case is eventual court ruling in ongoing litigation or fresh litigation decides whether gas produced from NELP I-VII gets tax holiday. Thus status quo continues. In the worst case gas produced from NELP I-VII would not get tax holiday.

Another 12-13% cut to EPS and 15% to PO in worst case
RIL started gas production from KG D6 block (NELP I) in April 2009. We estimate hit to RIL fair value of another Rs275/share (15% of current share price) if it does not get tax holiday for gas production. Hit to RIL's FY10E-FY11E EPS would be another 12-13% if it does not get tax holiday for gas production.

To see full report: RIL



For the first time since the beginning of the downturn we have revised up our forecasts for economic growth. We now expect global growth to rise to 2.5% in 2010 compared to 2.0% envisaged in our previous World Outlook from 30 March 2009. The upward revision is due entirely to better prospects for industrial countries, where growth next year is now seen reaching 1.0% compared to 0.3% before.

Most of the upward revision to global growth in 2010 results from a stronger outlook for investment growth (which has risen to 2.0% from 0.1%) and export growth (up to 4.1% from -2.2% before). The improved prospects for exports and investment reflect greater confidence in the effectiveness of authorities’ efforts to restore stability in the financial sector.

In our view the global economic and financial crisis has had two key drivers: (1) the breakdown of the global growth model of the past decade or so, which led to unsustainable international current account imbalances; and (2) the financial crisis, which ensued when the inability of debtors to repay their creditors became evident. As a result, we can expect to see lower trend growth and higher economic volatility, the opposite of what the world economy experienced during the era of the Great Moderation

To see full report: WORLD OUTLOOK


The Show Is About To Begin

Big Test For The Bulls At 15250
The indices witnessed a quiet first half last week as they consolidated in a range and took support at the mentioned level of 14300 only to rebound and end the week on a strong note. There are minor bullish triggers on the pattern and indicator studies hinting at a rally into the resistance zone of 15100-15250 (4500+ on the Nifty) this week. For the Sensex to re-visit and break past its recent high the level of 15250 will have to be taken out on a closing basis. A short-term base has been formed in the 14000-14300 zone (4100-4200 on the Nifty) and only on a close below the same does the uptrend come under threat, which seems unlikely. Broadly the index continues to consolidate within the 14000-15600 zone from which an upside breakout can be expected sometime this month. The moving averages have not been broken even once since the uptrend began in the 1st week of Mar 09 and hence the same needs to be monitored regularly going forward. The charts suggest that the Banking sector might be the biggest beneficiary from the event this Monday. The sector could move up 12-15% within a few weeks. Most Asian markets continue to be safely placed above support levels while the DOW (DJIA) is likely to see a rebound from the 8000-8300 support zone.

Patterns – Nice And Clear
The rally last Friday was encouraging as it helped the indices move above minor resistance levels and negate a bearish “Evening Star” pattern that existed on the daily chart. At this point a new “Ascending Triangle” pattern can be spotted on the hourly chart that should take the Nifty into the 4500-4530 zone.

GAIL – One Step Up
After trading sideways for many weeks the stock has confirmed a major breakout late last week that should lead to sizeable upside in the short and medium-term. A move back to its lifetime high of 367 is likely within a few months or earlier. Anant Raj Industries – Ready To Freeze The stock has developed a strong set-up in the last few weeks. By taking out the resistance of 108 last Friday on good volumes the stock has confirmed the next leg of the uptrend that should take it back close to 145 levels.

Bulls Vs Bears

GAIL (Rs. 316)

The stock stayed in a range for almost the entire month of June 09 and confirmed a breakout late last week. A number of bullish patterns can be spotted calling for a 50+ Rs. move in the coming few weeks. The zone of 285-295 now becomes a base for the rest of this month with minor resistance at 325. The volume activity pick-up last week supported the price action breakout and is a positive sign.

STRATEGY: Buy in the region 310-316 with a closing stop loss below 288 for a short-term target of 350 and 368.

Support: 310 and 295 Resistance: 325 and 350

To see full report: TECHNICAL ANALYSIS


Poor core business performance pressurises Top-line: Sasken recorded a disappointing 9.1% qoq decline in its 4QFY2009 Top-line, which touched Rs168.3cr. This was due to the poor performance of both its Services and Products Businesses. This performance was recorded in spite of the Rupee’s depreciation against the Dollar, with the average realised rate being higher by 2.7% qoq (Rs50.26 v/s Rs48.93 in 3QFY2009). Services revenues, in Dollar terms, fell by a significant 11.6% qoq to US $31.3mn (US $35.4mn in 3QFY2009). In Rupee terms, the Services Business clocked a 9.2% qoq fall. The Networks Business continues to face pressure, given the challenging business environment. The bankruptcy of its key client Nortel is a clear case in point and Sasken had a total of Rs24cr in receivables from this client as on March 31, 2009. Volumes fell 9% qoq and billing rates fell 3% qoq. On the other hand, Product revenues fell by 8.9% qoq, with the key reason being the collapse in Customisation revenues (down by as much as 70.8% qoq), even as Royalty Income (up by as much as 72.8% qoq) and Licence Fees (up 62% qoq) showed healthy growth.

On a yoy basis, in Dollar terms, Sasken recorded a disappointing 10.4% de-growth in Services Revenues. Yet, due to a 26% yoy higher Rupee-Dollar rate (Rs50.26 v/v Rs39.89 in 4QFY2008), Services Revenues in Rupee terms grew by 12.9% yoy. However, core business growth remains a challenge and we expect this to continue until a clear improvement in the business environment materialises. Sasken’s Products Business clocked a disappointing 39.9% yoy de-growth in revenues, in Rupee terms, which was due to a crash in Customisation revenues (down 78.4% yoy) and Licence Fees (down 29.8% yoy), even as Royalties rose by 27.9% yoy. Overall revenues in Rupee terms grew by 7% yoy for the quarter.

Higher Product Margins drive overall Margin expansion: For 4QFY2009, Sasken reported a healthy 344bp qoq expansion in EBITDA Margins due to significantly higher Product Margins (higher by as much as 5,169bp qoq, or 51.7%). On the other hand, Services Margins fell by 103bp qoq. On a yoy basis, Margins rose by an impressive 715bp.

One-time item reduces Bottom-line: Owing to a one-time item related to a write-off of capitalised software product costs, Sasken’s Bottom-line for the quarter crashed by 73.1% qoq and by 73.9% yoy. Excluding this, the Bottom-line rose by an impressive 32.9% qoq and by 28.7% yoy.

To see full report: SASKEN COMMUNICATION


All That Glitters……

…is Copper & Coal — Our preferred commodity exposures to the economic recovery are copper and coal. The fundamental outlook is strongest for copper, coking coal, thermal coal. We are increasingly positive on copper and thermal coal. We are still positive on coking coal and gold and remain negative on iron ore. Potential surprise is greatest in nickel and aluminum.

Risk Turns Positive — Economic indicators are improving, demand is turning, supply constraints will affect some commodities and investors are back.

Short Term Pullback — China’s import growth will slow (inventory building has dragged forward demand). The nascent recovery in demand elsewhere might falter and production restarts are a worry. But investment flows will limit the retreat.

China the Locomotive — China buying has been the driver behind the recovery. But, although demand is recovering, inventory building will not be sustained. The super cycle lives, despite these short term concerns.

Developed World Demand Turning Slowly — In the developed world the fall in demand is slowing. We expect a restocking amplifier in 2010.

Investment Demand is Back — Investment demand is back with a bang. In fact it hardly went away. It could support prices through short term fundamental weakness and drive prices to new highs early next decade.

Supply will be the Differentiator — The outlook for individual commodities will be differentiated by excess inventory stockpiles and supply constraints. Constraints will be greatest in copper and coal, least in aluminium and iron ore.

To see full report: COMMODITY OUTLOOK


Crouching inflation, not-so hidden RBI

RBI will likely reverse easy money policy January/April…
We believe that rising inflation risks – such as today’s fuel price hike – buttress our expectation of the RBI reversing its easy money policy by January/April 10, if our end-09 bottom out materializes. Swing factor: monsoons, with a 5% swing in agro prices impacting inflation by 150bp (Table 5). By the way, do read our oil analyst, Vidya Ginde, on the stock impact of today’ fuel price hike.

This, in turn, leads us to take off our 25bp July policy rate and 50bp October CRR cuts (Chart 1). RBI Gov Subbarao, of course, has been flagging the need to “think” of an exit strategy as growth risks diminish to ward off potential inflation. After today’s hike in petrol (Rs4/l or 9.8%) and diesel (Rs2/l or 5.8%) prices, Delhi also may not insist on further easing, given negative real policy rates and excessive monetary expansion (Chart 2). In any case, Delhi has successfully just orchestrated a 50bp cut in bank prime lending rates (PLR) to support growth.

… as sugar, oil mounts risks to 5% inflation expectations…
We continue to expect WPI inflation to turn up after September, after mid-09 deflation, to strain the RBI’s 5-5.5% comfort zone by March (Chart 3). In fact, we have ourselves hiked our March 10 inflation forecast to 6.1% from 5.2% (Table 2). To begin with, today’s oil price hike – adding 40bp to inflation directly and 80bp overall (Table 3) – was at the upper end of our 5-10% fuel price hike expectation here. While we expect Delhi to avoid further oil price hikes this fiscal, the gap between the implied crude price of domestic fuel prices and the ruling international crude price remains substantial (Table 4). Besides, we up our sugar price forecasts after initial cropping data revealed a 3% decline in farmland (Table 5). Do read our last inflation report here.

… but still expect soft lending rates to support growth
This, of course, begs the question: would RBI action not push up lending rates to impact growth? Not really. We actually expect soft lending rates to persist into 2HFY11 to fund a return to 7% growth. Do read our growth upgrade here.

First, we expect the RBI to calibrate economic recovery with price stability.

Second, we believe that monetary action, by now, is priced into gilts. In fact, swaps are actually signaling 09 tightening, which we find too early.

Third, even if yields do react, we believe that the still too high 475bp spread between bank prime lending rates and the benchmark 10y should cushion lending rates. The PLR-10y spread usually averages ~400bp.

Finally, the last round of lending rate cuts have been funded by deposit rate cuts that have reduced banks’ cost of funds.

To see full report: INFLATION


Union Budget—restocking the punch bowl

India’s Union Budget continued from where the last stimulus packages left off, with a big increase in spending and tax cuts to continue the impetus to growth. The spending measures focused primarily on infrastructure and rural spending, especially NREGA (the rural employment scheme), with the mantra being ‘inclusive growth.’ The tax measures focused on boosting demand by reducing income taxes, the fringe benefit tax, and incentives for investment. The emphasis on GST implementation by 2010 was heartening to shore up the revenue base. In general, we commend the fiscal proposals to boost the economy, and think a short term increase in the deficit is warranted. Although the deficit is higher than expected, we do not think the financing of it will be difficult, even as we wait for more clarity on disinvestment and 3G auction proceeds. There were expectations of structural reforms—insurance, subsidies, divestment, foreign direct investment, among others, most of them unreasonable, which were not met. The budget, however, is a fiscal document and we think the short-term policy objective of stimulating demand will likely be achieved by this budget.

The focus on infrastructure and the rural sector was as expected. Total expenditures are slated to increase by 13% yoy, with capital expenditures rising 27% yoy. The roads sector got a substantially increased allocation while the IIFCL was given greater flexibility as a refinance facility for infra spending. The National Rural Employment Guarantee Scheme—one of the key factors for the Congress victory saw a massive increase in allocation by 140%. Low-cost housing and rural infrastructure also saw significant increases.

On direct taxes, the surcharge on the personal income tax was eliminated, resulting in a net
reduction of 3% in the tax rate. The minimum threshold was also marginally increased. The irritable Fringe Benefit Tax and the Commodity Transaction Tax was eliminated while incentives given to the new pension scheme and for investments in natural gas. The minimum alternative tax for companies who were otherwise enjoying tax benefits or exemptions was raised from 10% to 15%. Overall, the direct tax measures are supposed to be tax neutral. On indirect taxes, there was a firm commitment to introduce the GST by April 2010, some of the earlier excise duty cuts were reversed, duties on gold and silver imports increased, while incentives given to investment related sectors.

Fiscal deficit:
The central fiscal deficit is slated to increase to 6.8% of GDP, higher than our expectation of 6.5%. The consolidated fiscal deficit may rise from 10.1% of GDP in FY09 to 10.4% of GDP in FY10.

To see full report: INDIA VIEWS


Ears On The Ground 9 – Commercial/Retail Demand Remains Subdued

What are we seeing in Investment Property market: 1) Commercial/retail demand continues to be frugal, 2) rentals continue to be re-negotiated (and roll down), however, 3) commercial complex sales (strata based sales to end users) demand is good (small city centre project). Investment Project Tracker introduced inside.

Retail projects first – Whereas construction starts for the new projects have been postponed by several developers (such as DLF, UT etc), ‘specialist companies’ with rental models (Phoenix, Ishaan, Anantraj) continue execution for their ongoing projects, albeit with extended timelines. Pre-leasing volumes have stagnated for the last 6 months – Inorbit Pune (27% locked in), Inorbit Hyderabad (65%), Pune Market City (25%), Kurla Market City etc – though enquiries
from retailers are picking up now.

Rentals continue to correct – Importantly, several old pre-leases have been negotiated down – 15-20% - and mgmt teams are guiding to 20-30% lower rental expectation (Lower Parel – Rs225 psf, Kurla – Rs80-85, Bangalore/Pune/Chennai/Hyderabad – Rs50-70 psf) for
the un-leased portion (versus Jan’09). In addition, retailers want mall developers to share the business risks, and, therefore, revenue sharing (4-20%) is getting increasingly common (in lieu/in addition to minimum fixed rental). Interestingly, while on the renegotiating table for old pre-leases, most mall developers chose to lower rentals rather than forfeiting deposits (6-12 month rental) paid by the retailers, highlighting demand scarcity.

Commercial projects – SEZ pre-leasing remain scarce (or even cancellations of earlier contracts), as indicated by Ishaan, UCP, Anantraj, etc, although there appears to be good (strata sale) demand for small block (100 to 300ksf) well located office complexes (UT’s Chambers
in Mumbai, Signature Tower II in Gurgaon etc) by end users (professionals such as CA, lawyers etc).

To see full report: INDIA PROPERTY


19% ROE; 1.2x Book; 7x Earnings – Top Pick in India

BOI has been the best performing bank in our coverage over the past 3-5 years: This has been driven by continuously improving profitability – in F2009, BOI generated higher ROA than private banks in India did. We expect BOI to keep reporting strong profitability (18-19% ROE in F2010e), allowing its multiples to continue rerating. Our new 1-year target price implies valuation of 9x forward earnings and 5x pre provision.

The bank has been strongest in organic book generation: Excluding capital raisings and property revaluations, BOI has more than doubled its book value in the past four years, exceeding most Indian banks (including private), thanks to its strength in profitability. Unlike other banks that have relied on trading gains to drive earnings, BOI has increased its core profits at a 33% compound annual rate over this period. BOI has also been aggressively providing higher coverage on NPL's – its NPL coverage ratio is 75%.

We expect profitability to remain strong: We are building in 15% volume growth (vs. management guidance of 20-25%) and 25 bps in NIM compression for the year. We have also taken up provisions to about 75 bps of loans. We assume lower capital gains and recoveries compared with last year – and still end up with a 19% ROE forecast. There are not too many
financials in Asia with such high ROE prospects this year. In that context, we think the stock can rerate meaningfully from the current 7x earnings.

Top pick in Indian financials; revised price target implies 35% return from current level: We derive our new target of Rs475 from a probability-weighted analysis of our Bull-, Bear-, and Base-Case scenarios. Even our Base-Case fair value represents about 28% upside from the current level.

To see full report: BANK OF INDIA

>Poor rains may hurt 09-10 sugar output in key India state

Mumbai - Sugar production in Uttar Pradesh, India's second-largest sugar producing state, in the crop year that starts on Oct. 1 may fall 18%-20% from a previous estimate of 5 million metric tons due to delayed monsoon rains, a senior industry official said Wednesday.

"If we don't receive rainfall in next two to three days, we may revise the output estimate to 4 million-4.1 million tons," said the official, who did not want to be named.

India's monsoon rains are likely to remain active over many parts of the country between July 11 and July 13, except in northwestern regions such as Uttar Pradesh, the India Meteorological Department said.

However, the recovery of sugar from cane is likely to be higher than last year, when output suffered due to bad weather in June and July, the official said.

In 2009-10, recovery is expected to rise to 10% of the sugar cane crop from 9% in the current crop year, he said.

The country's sugar output may not improve significantly in the coming crop year, when it is expected to be about 17 million-18 million tons, according to industry officials.

India's sugar output in the current year ending Sept. 30 is expected to be 15 million-15.5 million tons, down from 26.3 million tons the previous year.