Wednesday, July 22, 2009


Blowing bubbles
Money’s too loose in Asia

  • Excess liquidity in Asia raises the spectre of asset bubbles, especially in property
  • The bubble will grow for several years to come if policy-makers don’t step up
  • But lingering growth risks will reinforce caution, pushing asset prices up further
Here we go, again
We’ve been here before. A crisis erupts, markets panic, and policy-makers, reading the news along with everyone else, slash interest rates to pump up growth. In principle, this is perfectly all right. The trouble is, however, that if policy stays too loose for too long, it will blow bubbles. In Asia, liquidity is far too abundant to keep interest rates this low. Yet, it appears unlikely that the region will strike out on its own and tighten while everyone else is stuck in the emergency room. In short, the seeds are being sown for Asia’s next bubble. The world has not changed, it just moved places.

Chapter 1: Still standing

Two points to note. First, liquidity is extremely abundant in Asian financial systems. There is no credit crunch to speak of. Sure, banks have become more cautious since the crisis, but this is a cyclical response and does not reflect a breakdown in the financial transmission mechanism. Second, Asia, unlike other parts of the world, does not suffer from a balance sheet crisis, allowing leverage to build quickly if rates stay low.

Chapter 2: Bubble economics

Monetary policy is far more powerful than a fiscal stimulus, but develops more gradually over time. Low growth and lingering uncertainties are preconditions for bubbles to emerge, as they force officials stay accommodative. Asset price increases can occur even if growth fundamentals appear
unsupportive. In fact, the divergence of asset values from their fundamentals is precisely why the thing is called a “bubble”.

Chapter 3: The trilemma, again

For Asia to tighten independently, it needs to let go of the idea of exchange rate competitiveness. But such beliefs are so deeply ingrained after decades of export-led development that aggressive, independent action appears unlikely.

To see full report: ASIAN ECONOMICS


Strong June Q raises hope

Raising PO to Rs88 driven by stronger June Q; Buy
Exide Industries Q1FY10 PAT at Rs1.22 is up 49% y-o-y and is 20% higher than our estimate, driven by higher margin and volume. We have raised EPS estimates for FY10E and FY12E by 11% and 18% respectively, driven by higher EBITDA margin. Consequently we have raised our DCF based PO to Rs88 from Rs74. We maintain our Buy owing to (1) strong EPS growth of 40% likely in FY10E and (2) attractive valuation as stock is trading at a PE of 12xFY10E after adjusting for the value of the company’s 51% stake in ING Vysya Life Insurance.

June Q beat expectation on better margin and product mix
Strong earnings growth in June09 Q can be attributed to increase in EBITDA margin by 770bp y-o-y to 23.2% owing to (i) decline in cost of lead (ii) FX gain of Rs10mn and (iii) inventory gain. The company also benefited from delayed monsoon that led to stronger demand for UPS and improved the product mix.

Inventory & FX gain to boost FY10E, higher vol in FY11
We expect that nearly 90% of incremental profit in FY10E could come from (1) marginal FX gain in FY10 owing to appreciation of rupee compared to loss of around Rs544mn in FY09, owing to 26% depreciation in value of rupee (2) marginal gain inventory is likely in FY10E compared to an estimated loss of Rs1bn in value of lead inventory in FY09, owing to 46% decline in cost of lead. We expect the company to sustain 16-18% EPS growth in FY11/12E owing to recovery in volume growth to trend line level.

To see full report: EXIDE INDUSTRIES


Performance under high pressure

We continue to view EKC as a structural story with short-term challenges owing to the situation in Iran and domestic gas supply disruptions. The company remains confident of robust growth in 2HFY10 on the back of improved gas availability. The second half of FY09 was a weak period for EKC’s standalone operations, leading to increased inventory at the end of the year. We expect the inventory situation to improve once demand starts picking up in 3QFY10. The product mix continues to improve, with the low-margin industrial business now forming only 10% of the total revenues.

MD&A highlights the big opportunity in the domestic business: Natural gas currently forms only 8% of India’s total energy mix, as against the global average of 24%. Gas supply is expected to increase from 119.98mmscmd currently to 197.09mmscmd in FY11. Demand for CNG is expected to treble at 7% of total gas demand in the next five years. CNG is currently available at only 1% of India 35,000 retail fuel outlets. With the government’s plans to launch city gas distribution
in over 200 cities, demand for CNG vehicles is likely to surge, which in turn would lead to demand for cylinders.

Healthy operating cash flows despite worsening of inventory situation: The Company’s inventory situation worsened in FY09. The company ended the year with almost 10 months of inventory, including finished-goods inventory of 30 days and WIP inventory of 64 days—an indication of the weak demand in 4QFY09. Raw-material inventory also increased by 10 days, as weak demand for CNG cylinders in 4Q precluded inventory reduction. In spite of an incremental investment of Rs2,039m into inventory funding, the company registered positive operating cashflow of Rs1,201m.

Lower-margin industrial business now forms only 10% of overall revenues: The share of the low-margin industrial cylinders business in EKC’s revenues has dropped to 10% after the CPI acquisition. Jumbo cylinders form only 0.3% of EKC’s volume sales, but their high realisations mean they account for 18% of overall revenues. UAE operations now contribute ~60% of the company’s profit. Given the tax incentives at that plant, EKC’s tax rate has dropped from 19% in
FY08 to 10% in FY09.

To see full report: EKC


Q1 FY10 has been an abnormal quarter for the multiplex industry as the producers' went on strike with respect to the revenue sharing issues. There was hardly any content being released for the first two months of Q1 FY10 with only a handful of off-beat movies being released. The multiplex operators tried to show alternate content at their properties but with no success as IPL and the general elections swept all the attention. To make matters worse movie producers from the Telugu and Kannada film industry also joined the strike called by the Bollywood film fraternity. As a result we expect sub-15% occupancies to be reported by the multiplex companies in Q1 FY10. Many multiplex companies operated below capacity by keeping
some of their screens shut for this time period.

The final settlement between producers and exhibitors….
The final settlement between the producers and exhibitors was reached only in the first week of June. According to the new agreement, the multiplexes will have to share 50, 42, 35 and 30 percent for the first, second, third and fourth week respectively for all movies and 52, 45, 38 and 30 percent respectively for all blockbuster movies that manage to collect more than Rs 175 mn only at the six leading multiplex chains.

Abysmal earning numbers expected in Q1 FY10….
We expect abysmal earnings for the multiplex companies in Q1 FY10 on the back of the abnormal quarter witnessed by the industry. We expect all companies across our coverage universe to report an operating loss in Q1 FY10. This will be due to the fixed costs like theatre rentals, employee costs, administrative costs and other operating costs which have to borne by the multiplex operators irrespective of the movie flow and quality of content.

Earnings cut for FY10E….
We have reduced our FY10E earnings estimates for all the multiplex companies under our coverage, keeping in mind the expected Q1 FY10 earning numbers and delay in launch of new properties and a budget-to-forget for the multiplex industry. For the record, no company under our coverage was able to launch any new property in Q1 FY10.

To see full report: MULTIPLEX PREVIEW


In line, yet no spark

Peninsula Land’s (PLL) Q1FY10 results were in line with our expectations, with sales and PAT at Rs1.2bn (I-Sec: Rs1.3bn) and Rs329mn (I-Sec: Rs339mn) respectively. Revenues dipped 7% YoY; however, PAT rose 5% YoY owing to higher interest income on surplus cash & investments. We are upgrading PLL’s FY10E NAV estimates 26% to Rs20.9bn or Rs75/share from Rs16.6bn or Rs59/share on account of Hyderabad project (7mnsqft) addition to the portfolio. Further, we believe that PLL will trade at ~20% discount to its NAV owing to better visibility and improved macro environment. Though the balance sheet and ongoing project portfolio is healthy, we are concerned about long-term value creation from PLL’s land bank; maintain HOLD with target price of Rs60.

Flat earnings. PLL’s Q1FY10 sales and PAT stood at Rs1.2bn and Rs329mn respectively, in line with I-Sec estimates. Q1FY10 revenues were booked from Ashok Towers (Rs310mn), Swan Mills (Rs320mn), Peninsula Business Park-Dawn Mill (Rs250mn) and Center Point (Rs420mn). Further, execution of major projects in Mumbai picked-up in the quarter. PLL has 4mn sqft under construction in Mumbai (at Lower Parel), which will be key to revenue generation in the next few quarters. The company registered 41% QoQ revenue decline; however, owing to high interest
income, PAT declined only 9% QoQ.

NAV upgrade. We upgrade our FY10E NAV estimates 26% to Rs20.9bn or Rs75/share on account of Hyderabad SEZ (~7mn sqft; mixed usage) addition to the project portfolio and better visibility on ongoing projects. We believe the stock will trade at ~20% (earlier estimate of 40%) discount to NAV owing to better visibility on project pipeline and improved macro environment for the sector.

Liquidity remains sound. PLL’s debt-to-equity stands at a healthy 0.4x. PLL’s cash position has deteriorated in the past couple of quarters; however, it remains relatively sound vis-à-vis peers. The company has ~Rs1.11bn cash and Rs4.15bn debt, as on date, with nil outstanding land payment.

Maintain HOLD. Given PLL’s earnings dependence on few key projects, any delay in execution may result in sharp decline in earnings and valuations. However, positive development on the Goa/Nasik SEZ would be NAV accretive. We estimate PLL’s sales & PAT CAGR at 33% & 19% respectively over FY09-11E. At current market price, PLL trades at FY10E & FY11E P/E of 8.3x & 7.5x based on EPS estimate of Rs8 & Rs8.8 respectively.

To see full report: PENINSULA LAND


A few long-term strategic questions for investors

We believe that investors' long-term thinking should concern the following questions in particular:

will inflation trend upward from the present low, due to the gradual rise in commodity prices and the gradual disappearance of the disinflationary effect of the emerging markets? The answer is probably positive, even if this is a very slow process, hence the idea of structurally weak bond performance;

will there be a transfer of growth, economic clout and financial soundness from major OECD countries to emerging countries? The answer is likewise probably positive, hence the idea of substitution of emerging-country securities (public and private) for those of OECD countries, as emerging-country risk is becoming lower than that for the major OECD countries;

will there be a long-run deterioration in the financial position of governments in OECD countries which could go as far as default, due to an uncontrollable build-up of public debt (as a result of lower growth and population ageing)? The answer is again probably positive, hence the gradual loss of the risk-free status of these countries' government bonds, and a very different view of the hierarchy of issuers and interest rates.

To see full report: FLASH ECONOMICS


Jindal Steel & Power (JSPL), part of OP Jindal Group, is the world's largest coalbased, sponge-iron producer with a capacity of 1.37 million ton per annum (mtpa). It is an integrated steel producer having access to captive iron-ore, coal and power. It is also one of the low cost steel producers and enjoys EBITDA margin of ~40%, which is amongst the highest in the steel industry. It has also forayed into high margin power business with 1000 MW capacity. We initiate coverage on the stock and recommend 'STAY INVESTED'


Industry outlook: positive
JSPL is engaged in the businesses of steel and power, the long-term outlook of the
sectors looks positive. Despite expected de-growth in global steel production, we believe India to produce 5-10% higher steel in 2009 due to huge government spending programs on urban and rural infrastructure. Also, demand of merchant power in India is expected to be strong in future due to huge power deficit scenario.

Adding value through backward and forward integration

JSPL has been adding value to its steel plant through backward integration (with
captive raw materials, power) and forward integration (value added products like rail, structural, beams). We expect JSPL's standalone net sales to fall by ~7% YoY in FY10 (due to lower realization from steel products) and increase by 15% YoY in FY11 (due to higher sales volume of steel and power). We expect adjusted EBITDA margin to increase from ~36% in FY09 to ~42% in FY10 and ~46% in FY11 due to higher sales of value added products & power and lower raw materials cost.

Diversified into high margin 'power business' – a cash cow

JSPL diversified into power business in a big way through its subsidiary, Jindal Power Ltd (JPL) which commissioned 1000 MW (4 x 250 MW) power plants in phases during FY08-FY09. Entry into high margin power segment (~80% EBITDA margin, ~45% net margin) will help JSPL to de-risk earnings from commodity (steel) cycle. The subsidiary plans to add another 2400 MW capacity which will increase its total power capacity to 3400 MW by 2013. We expect JPL to contribute ~48% and ~43% to the consolidated earnings of JSPL in FY10 and FY11 respectively.

Mega capacity expansion programs – well on track

JSPL's mega capacity expansion programs are running well on track. The Company targets to become one of the leading steel producers in India thus adding steel capacity through green/brown field expansion at different locations. It also has massive plans to become a leading private power producer in India. The Company plans to come out with JPL's IPO in next 12-months to part finance its expansion program and to unlock value of its power business.

Financials, Valuation and Recommendation

We expect JSPL's consolidated net sales to remain flat in FY10 and grow by 10% in
FY11 YoY. However, EBITDA is expected to grow at a higher rate of 14% each in FY10 and FY11 due to margin expansions. We expect consolidated EPS to be at Rs.231 and Rs.266 in FY10 and FY11 respectively.

At CMP of Rs.2622, the stock trades at 10x, 2.8x and 8.5x FY11 P/E, P/BV and EV/EBITDA respectively. We use SOTP valuation method to value JSPL. We assign 8.3x EV/EBITDA multiple for JSPL's standalone entity which gives a fair value of Rs.1200 per share (8x and 2x FY11 P/E and P/BV respectively). We get the fair value of JPL at Rs.1605 using DCF valuation method (14.4x FY11 P/E). Thus we arrive at the 12-month target price of JSPL at Rs.2805. 'STAY INVESTED'.

To see full report: JSPL



Dr. Reddy’s Laboratories’ (DRL) consolidated recurring net profit soared 160% YoY to Rs2.39bn, as per Indian GAAP. This was ahead of Street & our estimates, mainly on the back of higher-than-expected EBITDA margin, cost savings and lower depreciation. Consolidated operating revenues grew 20% YoY to Rs17.9bn, powered by authorised generics (AG) Imitrex ~Rs2bn) and the US & RoW markets. EBITDA margin expanded 756bps to 22% owing to high-margin AG
Imitrex, favourable currency rate, benefit of operating leverage and cost savings. The management reiterated its FY10 guidance of 10% YoY revenue growth, in rupee terms. Launch of generic Prilosec OTC within a month followed by potential launch of generic Arixtra over the next 2-4 quarters would drive earnings growth. The stock is currently trading at FY10E P/E of 20x.

Strong growth in Q1FY10 powered by AG Imitrex. Boosted by continued healthy revenues from AG Imitrex (~Rs2.1bn or 12% of total), DRL’s consolidated revenues rose 20% to Rs17.9bn, as per the Indian GAAP. Depreciation decreased 13% YoY and 23% QoQ to Rs1bn. Interest costs crashed 46% YoY to Rs122mn due to lower rates and borrowings. Consequently, consolidated recurring net profit spiked-up 160% to Rs2.39bn, significantly ahead of our estimates.

FY10 revenue growth guidance of 10% YoY maintained. Management reiterated its FY10 revenue growth guidance of 10% in rupee terms. The revenue growth is likely to be mainly on the back of a strong Q1FY10 and launch of generic Prilosec OTC next month. This would be followed by potential launch of generic Arixtra over the next 2-4 quarters. Combined potential first-year-revenue upside from these two products is likely to be US$50-85mn. Further, we believe the upside would continue beyond the first year, given the favourable competitive landscape.

Reiterate BUY. Buoyed by multi-year upside from two key products – generic Prilosec OTC (to be launched in mid-August ’09) and generic Arixtra (April ’10 launch) – and healthy growth in base business, we expect DRL to see strong performance in the next two years. Better-than-expected Q1FY10, potential of earnings upgrade (8-10% for FY10E) as well as superiority over peers on the US FDA compliance front, we raise our target price to Rs920/share from Rs854/share.

To see full report: DR REDDY'S LABORATORIES



HDFC Bank (‘HDFCB’) delivered strong net profit growth of ~31% yoy to Rs6.1bn in Q1FY10, ahead of our estimates. The earnings outperformance was driven by strong treasury gains and lower expenses, while credit growth at ~7% yoy was lower than consensus and our expectations.

• Margins stable; NII growth muted due to lower credit growth: HDFCB’s margins were resilient at 4.1% (flat on a yoy basis, while declining by 10bp qoq) owing to (i) traction in CASA deposits – contributing 74% to the incremental deposits sequentially, and (ii) improvement of ~200bps qoq in CD ratio to 71.2%. NII growth was muted at ~8% yoy (Rs18.6bn, as against our estimate of Rs20.1bn), owing to lower asset growth. (See Exhibit 1 in report)

• Treasury gains used to hike provisions: Provisions of Rs6.6bn (up by ~90% yoy) were higher than expected as the bank utilized strong treasury gains booked during the quarter. Loan loss provisions stood at ~Rs6.5bn, resulting in ~120bp qoq improvement in coverage to 69.7%. Part of the rise in provisions is indicated to be due to continued delinquencies on the credit cards and personal loan portfolio. (Exhibit 6)

• Asset quality holds up, restructurings negligible: Gross NPAs inched up marginally 7bp qoq to 2.05%, primarily due to the unsecured retail loans. The bank’s restructured assets (including pending applications) stands at Rs5.8bn (0.55% of gross advances), up by ~Rs2bn over Q4FY09 (0.2% of net advances as of June ’09). (See Exhibit 5 in report)

• Stellar treasury gains, fee income momentum sustained: Other income grew by a stupendous 76% qoq to Rs10.4bn on the back of strong treasury gains of Rs2.6bn (17% of operating profit). Bulk of these treasury gains are indicated to be from money markets. Core fee income (CEB) gained ground, up by ~27% yoy, primarily buoyed by retail transaction fees, credit card charges and trade credit from the whole-sale segment. Retail segment continues to contribute 75% of total fee income. (See Exhibit 3 in report)

• QoQ uptick in CASA; comprises 74% of incremental deposits: CASA ratio improved by ~60bp qoq to 45% as savings deposits witnessed traction with a 10% qoq growth (21% yoy). Notably, CASA deposits contributed 74% to the incremental deposits in Q1FY10. Recovery in savings balances for HDFCB is a function of (i) structurally lower term deposit rates at the industry-level, and (ii) improving contribution from CBoP branches.

To see full report: HDFC BANK


Weak at the core

Though Oriental Bank of Commerce (OBC) saw better-than-expected net profit growth of 16.7% YoY, results were qualitatively weak. While NII growth stood at 9% (higher than our estimates), NIMs remained low at 1.83% owing to low CASA. Other income was buoyed by trading gains of Rs2.36bn (compared with Rs610mn in Q1FY09). While GNPAs increased 8bps QoQ, restructured assets saw sharp surge to Rs55bn in Q1FY10 (7.7% of gross advances) vis-à-vis Rs26bn in Q4FY09 (3.8% of gross advances). We trim our FY10E & FY11E earnings estimates 3.9% & 2.4% respectively, to reflect slower NII progression and higher loan-loss provisions. We lower our target price to Rs210/share (based on FY11E BV of 0.65x). At current market price, the stock trades at FY11E P/E & P/BV of 4x & 0.5x respectively. Maintain BUY. Inability to increase CASA and sharp rise in NPLs remain key risks.

Business growth healthy; NIMs remain low. Business growth was healthy at 25.1% owing to 27.7% YoY advances growth and 23.3% YoY rise in deposits. Both priority sector and retail advances increased 20% YoY each, with 19% YoY growth in housing loans. CASA continues to languish at 23% and, coupled with recent PLR cuts, pressured margins to 1.83%; NII growth stood at 9% YoY in the quarter.

Trading gains buoy other income; ad hoc provisions push-up costs. Noninterest income growth of 88.4% YoY was driven by trading gains of Rs2.36bn (compared with Rs610mn in Q1FY09). Other income (ex treasury) saw muted rise of 5.8% YoY. Operating costs increased 20.3% YoY, with staff costs up 23.3% YoY on Rs350mn provision for wage revision in the quarter. Cost-to-income stood at 41%.

Restructured assets see significant rise. Deterioration in asset quality seemed manageable, with GNPAs & NNPAs increasing 8bps QoQ & 6bps QoQ to 1.61% & 0.71% respectively. However, key surprise was sharp rise in restructured assets to Rs55bn (7.7% of gross advances) from Rs26bn in Q4FY09 (3.8% of gross advances). Provisions were down 27% YoY to Rs1.5bn. The bank booked losses of Rs1.37bn owing to transfer of securities to HTM and wrote-back provisions for investment depreciation of Rs1.22bn in Q1FY10. Provisions for NPAs & standard
assets stood at ~Rs1bn and for restructured advances at Rs225mn.

Maintain BUY on inexpensive valuations. Despite higher-than-estimated net profit growth of 16.7% and operating profits growing a healthy 46.1%, OBC’s performance was qualitatively weak. We trim FY10E & FY11E estimates 3.9% & 2.4% to reflect slower NII progression and increased loan-loss provisions. We lower our target price to Rs210 (on FY11E BV of 0.65x). But at the current market price, the stock trades at FY11E P/E & P/BV of 4x & 0.5x respectively (lowest multiples versus PSU peers). Maintain BUY. Hardening of interest rates and sharp rise in NPLs remain key risks.