Sunday, July 12, 2009


Industrial Production Recovers in May

• Industrial production (IP) growth recovers to 2.7%YoY in May: This compares with growth of 1.2%YoY (revised downwards from 1.4% earlier) in April and a decline of 0.8% in March 2009. The growth in May was higher than the market’s and our expectations.

• Growth in the manufacturing segment rebounds: Growth in the manufacturing segment picked up to 2.5%YoY in May, compared with 0.4% registered in the previous month. The key contributors to this improvement were food products, other manufacturing industries, rubber, plastic, petroleum & coal products, and basic chemicals & chemical products. Mining segment growth decelerated slightly to 3.7%YoY (vs. 3.9% in the previous month). Growth in the electricity segment decelerated to 3.3%YoY, compared to 7.1% in April.

• Growth in consumer goods improves; capital goods turns less bad: On use-based classification, growth in the consumer goods segment accelerated to 1.2%YoY in May after declining 3.6%YoY in April. Within consumer goods, while the durables segment growth decelerated to 12.4%YoY (vs. 17.2% in April), the YoY decline in the non-durables segment narrowed to -2.3%YoY (vs. -9.1% in April). Capital goods declined 3.6%YoY, compared with a decline of 7.3% in the previous month, helped partly by the low base effect. Growth in basic and intermediate goods decelerated to 3.8%YoY and 6.1%YoY, respectively, in May (vs. 4.7% and 7.3% in April).

• IP growth to stay on the recovery path: Most domestic demand indicators, such as passenger car sales (18.1%YoY in June vs. 8.7% earlier), commercial vehicle sales (-15.1%YoY vs. -18.9% earlier), two-wheeler sales (14.9%YoY vs. 11.5% earlier), and cement dispatches (13.2%YoY estimated vs. 10.8% earlier), are indicating improvement in industrial activity in June.

To see full report: IIP


Compelling story; valuations stretched

Aluminium is least preferred metal; Sell Hindalco & Nalco
Aluminium is our least favoured metal; UBS has cut LME aluminium expectations by 6% for 2010 and 9% in 2011. Earnings for Hindalco are now expected down 22%/27% for FY10/11E but for NALCO, the world’s cheapest producer of aluminium, we have brought profits up 22%/30% in FY10/11E as lower input prices raise margins. We downgrade our ratings on both companies to Sell from Neutral on expensive valuation and weakening demand fundamentals for aluminium globally.

Indian aluminium a long term story
We believe the fundamentals of the Indian aluminium industry are strong. This is primarily driven by two factors: 1) the cost of production in India; given the availability of bauxite and coal in close proximity, and 2) the demand situation in India should improve dramatically driven by growth in the power, automobile and industrial segments. Standardized IRR’s are 16%, at LME aluminium at $1,750.

Key picks
In our coverage universe, we prefer Vedanta Resources, as it offers one of the most compelling growth arguments across diversified resources and has the lowest capex cost/TN & the lowest cash costs/TN. We rate Hindalco and NALCO as Sells given near-term operational issues at Novelis and valuation concerns, respectively.

Valuation: Buy rating on VED and Sell ratings on Hindalco & NALCO For Vedanta, we get our price target of £17.6 per share by taking a 0.75x P/NPV on our base case Mar’10E NPV of $32/share. We maintain our SOTP -based price target of Rs 55 for Hindalco and raise our price target from Rs 190 to Rs 250 for NALCO, based on a target FY10E 15.0x EBITDA (trough) multiples.

To see full report: ALUMINIUM SECTOR


Industry interaction update

Our interaction with industry experts across the BFSI (US, Europe) & Telecom (Europe) from Gartner on the business and IT demand environment pointed to early signs of stability in the North American market. Europe, however, remains troubled, and could lead to continued stress on IT vendors in the current fiscal.

US BFSI seems to stabilizing, but Indian ISPs are still reeling under pressure with services such as Application Development and Package Implementation (where they have greater presence) continue to be rationalized. While consolidation could bring in some short term M&A work, industry experts think it is unlikely to compensate for overall budget decline.

BFSI demand in Europe remains under stress, with critical economies such as the France, Netherlands and Germany still under fire. Consolidation is also far from over in Continental Europe. Offshoring maturity continues to remain low, with clients preferring near shore delivery over the pure play offshore model.

Telecom Service Providers (TSP) have been relatively stable in Europe and could see better budget disbursals in 2H CY09E. However, BT, which is the largest offshorer, continues to be the pain point for ISPs given the restructuring in the BTGS division, and problems in its core Fixed-line carrier business.

Banking and Financial Services (BFSI) -US:

US stabilizing, some up tick in discretionary spend but…: Gartner believes that BFSI IT budgets in North America are seeing signs of stabilization with a marginal recovery in discretionary spending. However, the bulk of the activity is currently focused at opposite ends of the services spectrum, namely Consulting and ITO. Such contracts are currently being awarded to pure play consulting companies such as IBM, Accenture, KPMG, Deloitte, or strong infrastructure vendors such as IBM and HP-EDS who are willing to leverage their balance sheets.

…. Indian vendors (ISPs) are still facing the heat: The sweet spot of ISPs, namely Application Development and Package Implementation (~25% and 20% of revenue respectively), continues to remain under pressure. Gartner’s recent 1Q CY09 IT services update (02 July 2009)
suggests that Consulting, followed by System Integration and Application Development could lead the revival cycle. However, no such signs seem to be visible in the US BFSI sector at present. .

Testing could offer ISPs some relief: ISPs seem to be having better luck with Testing deals (4-7% of revenue), where volumes have witnessed a moderate pick up. However, our channel checks suggest that pricing pressure continues to be intense for these services.

To see full report: IT SECTOR


Edging Towards Recovery

Rebound — After a record seven consecutive losing quarters, global equities bounced by 21% in 2Q09. While some consolidation would be welcome, we think that markets can move higher again in 2H09.

Earnings — Global trailing earnings are now down 41% from the end-2007 peak. Our long-held expectation of a 50% peak/trough fall suggests that we are approaching the final stretch of this earnings downturn.

Valuations — Even given the market rebound, we think that global equities look cheap. P/BV and PEs on trend earnings are still down at 1980s levels.

Welcome To The Twilight Zone — This is the period towards the end of most global recessions when equity valuations are cheap and investors start to anticipate recovery. Share prices rise even though EPS are still falling.

Cheap Recovery Plays — We look towards those regions and sectors where the potential for EPS recovery looks greatest but valuations remain attractive.

Regional Strategy — We prefer the higher-beta European markets to the safer but more expensive US. We generally favour Emerging over Developed Markets.

Global Sector Strategy — We have a balanced sector strategy, which seems appropriate for highly rotational markets. Our favourite cyclical is now Financials. Our favourite defensive is Telecoms.

To see full report: GLOBAL EQUITY QUATERLY


Patience will pay – reiterate BUY

The 900 MHz spectrum advantage
Idea’s GSM 900MHz spectrum covers 47% of the population, which provides it with competitive advantage over new entrants with 1800MHz. The 900MHz spectrum can accommodate ~50% more subscribers per BTS (refer spectral coverage charts – Exhibit 1 and 2) compared to 1800
MHz, thus providing higher ROI. Analysis of revenue market share across circles of Bharti validates that performance in 900 MHz circles is better compared to 1800MHz circles in most circles. We expect Idea to consolidate its position among the top operators in India by virtue of this superior spectrum asset coupled with strong execution capabilities.

Management’s focus on profitability instils confidence
Management has highlighted its focus on profitability as it expands into new circles. In its new markets, management intends to optimize rather than maximize network coverage, which provides us comfort in our EBITDA margin estimates. The reported EBITDA of Idea has been depressed as the EBITDA of older profitable circles has been offset by the losses in the recently launched circles. As the new markets turn profitable we expect a significant growth in EBITDA over the next 24-36 months providing a three-year EBITDA CAGR of 24%.

Adequately capitalized for network expansion and 3G
Idea has guided for a capex of INR60b in FY10 excluding 3G. We expect Idea to generate FY10 EBITDA of INR37.5b which, coupled with existing cash of INR51b, is sufficient to fund its FY10 capex, excluding 3G. We expect Idea to borrow ~USD1b incrementally to fund its 3G plans. Idea had a low net-debt to equity of 0.27x and net-debt to EBITDA of 1.7x which positions it comfortably to take on incremental debt.

Raising TP to INR 85; reiterate BUY
We maintain our BUY rating on Idea and increase our TP to INR85.00 from INR65.00 based on a DCF based core business value of INR60.00 (FY10 EV/EBITDA of 7x) and the stake in Indus Tower valued at INR25.00 (EV/tower of USD150,000 in-line with recent tower asset deals). We recommend Idea to investors with a three to five year investment horizon as earnings growth will accelerate around FY11-12 as profitability of new circles peak and interest burden eases.

To see full report: IDEA CELLULAR


Key Takeaways From Business Update

Voltas published a business outlook update recently. Given below are key takeaways.

Electromechanical segment - largely status quo – Domestic market has been subdued-new inquiries; tendering and execution of orders have been muted. However, liquidity seems to be easing; would help working capital. Current domestic orderbook is Rs13bn. International orderbook of Rs35bn is to be executed by Sept 2010.

Engineering Agency and Services- to show improvement in H2FY10E- Mining and Construction segment has suffered due to low commodity prices and lack of finance. Recent signs indicate that the third party financiers for equipment have adequate liquidity. Overall, Voltas believes that the engineering businesses will start showing improvement in the H2FY10E, while H1FY10E will remain sluggish. Overall it expects FY10E to be flattish in terms of growth while
FY11E could be strong for the business.

Commercial Cooling Products business- Seeing volume growth - Improved consumer sentiment and severe summer have helped volume growth. Secondary sales, i.e., sale by dealers/retailers to the final consumer, of ACs have grown. Overall AC volumes are estimated to have grown a little less than 10% in Q1FY10E; Voltas is estimated to have grown more than the market. Primary sales have been subdued because of stock out situations due to conservative inventory planning. Local mfg. is gaining vis-à-vis imports due to rupee value - a good sign for its subsidiary. Inventories have been liquidated.

To see full report: VOLTAS


Double liquidity creation since May 2009

Global liquidity has grown too fast since the 1990s; during expansion periods, the main cause of liquidity growth has been the accumulation of official reserves in emerging and oil-exporting countries, aimed at stabilising exchange rates; during recessions, monetary expansion in large OECD countries becomes the main cause of liquidity growth.

We may see a new situation appear, which has been visible since May 2009: double creation of liquidity, both in emerging countries and in large OECD countries. This double liquidity creation is accounted for by a divergence in cyclical situations between emerging countries and OECD countries: recovery in several emerging countries, with capital flows returning to these countries; continued anaemic growth in large OECD countries, accounting for the ongoing highly expansionary monetary policies.

The appearance of this double liquidity creation will further amplify global monetary creation, in all likelihood leading to an increased risk of asset price bubbles and a shift in international capital flows and emerging countries’ exchange rates.

To see full report: SPECIAL REPORT


Company Background
Mahindra & Mahindra Financial Services Limited (MMFSL), a 60% subsidiary of Mahindra & Mahindra Limited was incorporated on 1st January 1991 as Maxi Motors Financial Services Limited. One of India's leading non-banking finance companies, focused on the rural and semi-urban sector, the company provides finance for Utility Vehicles (UV), tractors and cars and has the largest network of branches (80% of the districts in India) covering these areas. MMFSL’s product portfolio includes right from finance for two wheelers, tractors, farm equipment, cars and utility vehicles to commercial vehicles and construction equipment. It currently finances 30% of M&M’s sales, which amounts to about 70% of its disbursements.

Indian economy has moved decisively to a higher growth phase. Macroeconomic fundamentals continue to inspire confidence and the investment climate is full of optimism. While agricultural growth will continue to be the major factor that will drive sales, haulage applications are expected to increasingly support the economics of tractors.

MMFSL has 2 wholly owned subsidiaries – Mahindra Insurance Broking Ltd and Mahindra Rural Housing Finance Ltd. It recently started (Feb 2009) to accept fixed deposit from public for the first time in the history of their operations.


Lending in Rural and Semi Urban areas - a priority
The fact that lending in the rural and semi urban areas is considered, as a priority by the Reserve Bank of India (RBI) is best exploited by companies like MMFSL. In fact, being the largest tractor financing company in the country, it is able to position itself favorably for the government subsidies on agriculture and farm equipments. Hence, if one is to believe in the story of rural India leading the economy’s growth trajectory in the future, MMFSL could be one of the companies to look out for. Due to the priority sector status accorded to rural / farm lending, MMFSL is able to garner approximately 3% discount on its borrowing cost for tractor lending and 1% discount for funding utility vehicles. MMFSL is one of the early entrants into the rural and semiurban markets, initially providing financing solely for products of Mahindra & Mahindra Limited (M&M), which has been selling its products in those markets for over 60 years. There is a huge opportunity in these markets and MMFSL is well positioned to
service this population. The organized sector of financial services market in rural and semi-urban areas is likely to continue to experience growth. The key dimensions of its strategy are innovative products, risk adjusted pricing, customer focus, customer convenience, wide distribution, strong processes and prudent risk management.

Perfect Player for the rural and semi urban markets
Credit in rural markets was principally provided by banks from the organized finance sector or by the local moneylenders. There was a large section of the rural population which did not have access to credit largely due to their inability to meet the lending covenants of the banks or because they could not service the high rates of the money lenders. While interest rates charged by PSU banks are in high single digits, their credit appraisal systems are perceived to be rigid and involve considerable paperwork. Further, borrowing from local moneylenders does not involve any paperwork but the interest rates charged by them is in excess of 30% p.a. MMFSL identified this opportunity and positioned itself to service this population. MMFSL adopted simple and prompt loan approval and documentation procedures and offered rates between those charged by the banks and the moneylenders. It had always acted as the ideal option between the organized banking sector and the moneylenders, providing its customers with a mix of personalized, flexible and efficient lending services with customized packages for customers’ every need. MMFSL designs the loan products (both in terms of amount and tenure) based on usage and the economic life of the vehicle. Even the repayments are structured to match the anticipated cash flow to be generated by the borrower, for example monthly or quarterly repayments in case of UVs and semi annual repayments in the case of tractors – matching with the inflows of the borrowers. Sale of UVs depends a lot on the infrastructure activity. Given the expected thrust of the new Govt on Infrastructure, UV sales could do well going forward.

Diversification of products to act as a bridge to greater market penetration
The business model of MMFSL is such that a majority of its loan book comprises of clients from rural and semi urban areas. The fact is that the rural and semi urban population prefers a single unit from where they can get access to all financial services. They should be able to save small amounts, make withdrawals, take loans, remit, buy a mutual fund, buy insurance, pay premiums, lodge claims, and get compensation. All these transactions should be possible from one physical outlet. Considering this factor, MMFSL has diversified its business in such a way that the above-mentioned facilities are provided by them to the rural and semi urban population. This comes as a handy tool for the company to penetrate further into the financial products distribution market of the country especially in the rural and semi urban areas. Currently MMFSL has an extensive distribution network with presence in 25 states and 2 union territories in India through 436 branches.

To see full report: MMFSL

>Asia outlook : commodity bulls back but downside risks remain

Singapore - Commodities markets have returned to the investment spotlight after sharp falls in the second half of 2008, but this could be a case of too much too soon, with macroeconomic risks still posing a big challenge to further price gains.

Even as expectations rise for the return of growth in many parts of the world, much of that has already been priced into the current market, analysts say.

The primary worry is that economic reality and actual demand in physical markets don't yet justify the hype and euphoria in futures markets, which many say is just momentum-driven.

"The market was focusing on future demand, the prospects of supply destruction and concerns surrounding the U.S. dollar and inflation, ignoring the still-poor fundamentals," said BMO Capital Markets in a recent report.

All major metals traded on the London Metal Exchange remained in surplus supply in the first four months of the year, according to the latest data from the World Bureau of Metals Statistics. Most analysts expect the surpluses to persist for at least the rest of 2009.

"The fundamentals of some metals will pose a constraint to further price rises," said David Moore, a commodity strategist at Commonwealth Bank Of Australia in Sydney. "For copper, I'd expect it to be in a surplus (even) next year."

Copper soared 72% in just 74 LME trading sessions, from its recent trough of $3,139 a metric ton in late February to its peak of $5,388 June 11.

"Some of the percentage gains... have been extreme and have largely factored in a moderate recovery in economic growth," Moore said.

But despite this dramatic four-month rally, both JPMorgan and Citigroup have recently made bullish calls, with Citigroup's David Thurtell suggesting copper is only likely to run out of steam around $7,000 a ton.

Physical Markets Not So Bullish Yet

In the physical market, however, participants aren't excited about such forecasts, although many agree the worst may be over.

There are two factors that matter in the second half of the year, according to Tim Tu, president of United Metals Enterprise, a Taiwan-based metals trading house. They are state-sponsored buying in China and overall demand in other economies.

"Is China's State Reserve Bureau going to continue its purchases? Nobody knows. Is metals demand going to continue its gradual recovery? Well, to me the second half looks likely to be the same as the first half or (only) slightly better," he said.

China's SRB bought substantial amounts of industrial metals in the first half of the year, including an estimated 300,000 tons of copper. That was more than the entire inventory currently available on the LME.

Many analysts credit SRB buying for driving the price rally earlier in the year. The fear now is that SRB won't buy more until prices have fallen to lower levels, which puts the onus on demand from rich countries in the Organization for Cooperation and Development to take up the slack.

Moreover, as in 2008, macroeconomic risk remains substantial and could take commodity markets by surprise. If economies fail to recover as expected, that could put a lid on commodities prices, especially after most consumers, particularly China, aggressively restocked in the first half of the year.

According to Bill Thomson, chairman of Hong Kong-based investment management company Private Capital Ltd., monetary policy issues are likely to come to a head sooner rather than later, posing a threat to commodities markets.

Thomson, who is also a senior adviser to Axiom Funds, says the U.S. Federal Reserve faces a crucial choice between letting long-term bond yields rise, crushing any recovery in the housing and consumer markets, or expanding its policy of quantitative easing.

"The 30-year bond yield has been pushing up against a downtrend line that's held since the early 1980s, and sometime this (northern hemisphere) summer, I think it will cross that line and then it will be decision time," he says.

Although many commodity bulls feel sure the Fed will simply crank up the printing presses and buy Treasurys to push yields lower, this is unlikely to happen without a fierce debate, said Thomson. It is certain that the Fed will at least try to talk the dollar and bonds up or make some moves to tighten policy, even if these prove ultimately ineffective, he said.

"I would certainly expect volatility to the downside for commodities in the second half of the year," he said.

Fund Managers Remain Bullish On Commodities

Fund managers, however, are increasingly bullish on commodities, based on an anticipated return to economic growth. Metals-hungry economic stimulus projects getting underway from Chongqing to Chicago, and long-term supply-side fundamentals suggest higher prices on the way, they say.

In a recent survey of 226 fund managers, Merrill Lynch said a net 19% were overweight commodities, compared with just 9% who were overweight equities.

Craton Capital predicts "the secular trend is back" after a sudden, painful interruption. "We suspect the next inflow of funds into commodities will be associated with real demand-supply factors as well as a genuine demand for hard assets," the firm, which manages a global resources equities fund, said in a recent report.

Brokerage UOB-KayHian says commodity prices may be weak for a time if Chinese imports weaken but that "early signs of a recovery in the developed economies will likely trigger a new round of restocking, particularly when interest rates remain low."

United's Tu also said there were signs that demand for finished goods was finally improving, with the worst phase possibly over for home appliances and automotive demand. "It's not reflected in (Chinese) export data yet but it's starting," he said.

That, combined with the fear of inflation and broad expectations of a weaker dollar, make the case for commodities bulletproof, according to a growing number of fund managers.

With most commodities prices in dollars, a weak U.S. currency typically leads to higher commodity prices. Investors also tend to buy commodities as a hedge against inflation.

Investors should, however, be warned that it was pretty much the same consensus that existed at the height of the last rally in July 2008, which was followed by an equally dramatic reverse.



Tracking the Price Performance of BSE500 stocks in major down & up move between
Sept 08 and June 09.

To see report: HIGH BETA


Upgrade to OW(V): Launch & margin increase to drive growth
  • Sales should be boosted by new launch on 18 July; expect it to focus on mileage, a concept with which buyers connect
  • Forex loss reduction and cheaper input costs to drive margins; EBITDA margin to increase by 530bp in FY10e
  • Upgrade to OW(V) from UW(V), raise TP to INR1,220 from INR412; roll forward our DCF to July 2009 from Jan 2009

Banking on the forthcoming launch. With bank financing drying up for consumers, Bajaj Auto has been losing market share to Hero Honda, as the profile of buyers who typically pay cash focus on mileage and resale value over power and styling. We believe Bajaj’s new motorcycle launch later this month will be focused on mileage, to which buyers can better connect. The company’s sales volume should also benefit from a low base. In ‘three- wheelers’, Bajaj is benefiting from replacement demand.

Margin expansion in FY10e. We believe EBITDA margin should expand from 12% in FY09 to 17.3% in FY11e. The reduction in top forex losses should contribute 3%, and the rest should come from raw material benefits and change in product mix. Accordingly, we raise our FY10e and FY11e EPS by 79% and 89% to INR91.4 and INR102.6 respectively.

Upgrade to OW(V). We raise our DCF-based one-year target price to INR1,220 from INR412 and upgrade our rating from Underweight (V) to Overweight (V). At our target price, the stock trades at 13.3x FY10e EPS of INR91.4 and 11.8x FY11e EPS of INR102.6, a 20% discount to its peers. Earlier, our target price implied a one-year forward PE multiple of 7x, which was a historical trough multiple. With the improvement in market sentiment, business prospects and profitability, we believe there is no longer a case for a historical trough valuation.

Catalyst and risks. We believe the launch of the new motorcycle should act as a trigger for the stock. Key risks are lower than expected performance of the new bike and exports, non-availability of bank financing and higher-than-expected input costs.

To see full report: BAJAJ AUTO