Sunday, August 2, 2009


Rising Demand, But Oversupply None the Same

Raising demand growth estimates — Demand has been stronger than expected at ~12% in 1QFY10. Based on this and the expected infrastructure impetus, we raise demand growth to 10-11% for FY10-11 (from 9-10%) and maintain 12% for FY12. We support our estimates using 1) a higher GDP growth multiplier of 1.44x vs. 10- year average of 1.23x and 2) expected growth for cement consuming sectors.

Oversupply impact likely shorter; Jan-Jun10 biggest risk — The 114m tpa of capacity (FY08-11) is likely to have the biggest impact in FY11 with an expected surplus of 14m tonnes (6.5% of demand). While we expect a surplus in FY10, strong 1Q prices should prevent a YoY decline in prices. The extent of oversupply should fall meaningfully in FY12, as the demand-supply gap contracts. This has been a precursor to an increase in valuations in the past.

Wait for oversupply impact to get more constructive — Cement companies are going through a beneficial period of robust prices/demand and low costs, reflected in valuations exceeding replacement costs for most majors. The oversupply impact is yet to come, but we believe should come through in the next 6 months. Any near-term slackness in demand could be the pressure point on stock values. We believe then, rather than now, would be the time to get more constructive.

Sell — We change our valuation methodology to replacement cost (more stable parameter) and discount it due to shortened oversupply period and stronger balance sheets. We raise earnings estimates on price/cost trends so far and continue to see FY10 as peak earnings and a sharp fall in FY11. We value stocks at EV/t of US$85-90 (vs. 4.2-6.3x Sep10 EV/EBITDA) and raise our target prices 1- 76%. We see most downside in ACC/ACL, and our preferred play is ULTC.

To see full report: CEMENT SECTOR


Capital Market Linked Businesses Rebound, But NPLs Rise

Quick Comment: Kotak reported consolidated F1Q10 earnings of Rs2.6bn, up 72% YoY and 22% QoQ.

Key trends during the quarter:
1) Growth during the quarter was driven by a rebound in capital market-related businesses. PBT for these businesses increased 93% YoY and 206% QoQ.

2) Credit issues continued with gross NPL levels rising – up 100 bps during the quarter to 3.4%. Most of the increase was concentrated in the small value personal loan segment.

3) Banking business trends remained muted with NII progression still weak and the bank choosing to re-focus the loan book toward lower yielding corporate loans.

4) Tier I increased to 18.3% from 16% in the previous quarter.

We believe that Kotak management has been proactive in managing asset quality through moderation in growth and has a strong balance sheet with high Tier 1. Also, market-related businesses should continue contributing to earnings as capital market activity picks up further. However, stretched valuations lead us to maintain a UW rating on the stock.

To see full report: KOTAK MAHINDRA BANK


Medium risk – Small cap investment idea

At the current price of Rs. 35.25, SOGL is available at 4.7 times its FY09 EPS. We feel that investors could buy the stock at current levels and average on dips to Rs 28 with sequential targets of Rs 42 to Rs 49 in the next 2 quarters.

Company Background
Sabero Organics Gujarat Limited (SOGL) was established in the year 1991 to manufacture specialty chemicals and intermediates for the crop protection business. It then forward integrated in 1997 into manufacturing crop protection chemicals. In order to have a diversified portfolio, SOGL chose one or two key products in each sector such as Acephate and Monocrotophos (Insecticides), Glyphosate (Herbicide) and Mancozeb (Fungicide). As the company was already manufacturing some of the intermediates for these products, it excelled in the technology for manufacturing organophosphorus and dithiocarbamate products.

Apart from sales of unbranded technical and formulations, the Company also established in 1997 its business of branded agrochemical formulations. It launched a full range of products, which included in addition to its own technical based product, other products such as
Ethephon, Cypermethrin, Chlorpyriphos, Dichlorvos, Profenofos, Triazophos, Propiconazole, and Hexconazole etc. The company went public in the year 1994 through an IPO, which was followed up by a Rights Issue in 1997.

SOGL has an extensive manufacturing facility with state-of-the-art sophisticated equipments and PLC based process control. The company is a signatory to the Responsible Care Program and has extensive facilities for treatment of all wastes to meet statutory environmental standards. It has extensive facilities centered on various methods of treatment & mitigation with redundancy including a biological effluent treatment plant, chemical treatment plant, incinerators, by product recovery plant and multiple effect evaporators. All these facilities were extensively upgraded and expanded in FY09.

The company first started manufacturing Organo Phosphorous Pesticide Intermediates, Phosphorus Trichloride (PCL3), Tri Methyl Phosphite (TMP) & Di Ethyl Thio Phosphoryl Chloride (DETC), in 1994. In 1998, SOGL forward integrated into the manufacture of
active ingredients, Acephate and Glyphosate. In 2000, it started production of Mancozeb and also forward integrated into branded formulations, building an all India distribution network. It started exports to asia, Australia & Europe in 1999 onwards. It also then formed subsidiaries in Europe and Australia. In the year 2002 it started manufacturing Monocrotophos and Dichlorovos. It later expanded the export business to Latin America, USA and Africa from 2002 onwards. In the year 2005 it started to manufacture Chlorpyriphos and set up subsidiaries in brazil and Argentina by 2006. It debottlenecked Acephate & Monocrotophos plants in 2008. During the financial year 2008 –09 it undertook a major project to expand Mancozeb, Chlorpyriphos & Glyphosate capacities with majority of the capital investment in Mancozeb.

Company Highlights
  • Manufacturing facility located in Gujarat
  • Recognized export house with more than 65% of its revenues coming from exports
  • Amongst the lowest cost producers in the world for its main products
  • ISO 9001 & ISO 14001 certified
  • R&D Department recognized by Govt. of India
  • Employs 525 people
  • Pioneer industry title by Govt. of Gujarat

Promoter Background
The Chuganee Family promoted SOGL. Its Chairman H J Chuganee has more than 4 decades of experience as a technocrat and was the CEO of Rohm & Haas, India for 15 years. The shareholding of Chuganee family and associated stands at 42% (post warrant conversion – 46.72 lac warrants allotted in June 2009).

The segments of the market that SOGL operates in are:

· Intermediates: PCL3, TMP & TEP
· Technicals: Acephate, Mancozeb, Maneb, Propineb, Zineb, Monocrotophos, Glyphosate, DDVP and Chlorpyriphos
· Formulations: 13 different products sold under different brand names based on own and 3rd party technicals

Planning to Introduce:
· Insecticides: Fipronil
· Herbicides: Trichlopyr, Clodinafob Propargyl Bispyribac Sodium

The company sells its products either as technical/active ingredient, bulk formulations, small pack formulations in customer brand name and small pack formulations in own brand name.

To see full report: SOGL


On the surface, China appears to be leading the world from recession to recovery. After coming to a virtual standstill in late 2008—at least as measured on a sequential quarter- to-quarter basis—Chinese economic growth accelerated sharply in the spring of 2009:
A back-of-the envelope calculation suggests China may have accounted for as much as two percentage points of annualized growth in inflation-adjusted world output in the second quarter of 2009. With contractions moderating elsewhere in the world, China’s rebound may have been enough in and of itself to allow global GDP to eke out a small positive gain for the first time since last summer.

That’s the good news. The bad news is that China’s recent growth spurt comes at a steep price. Fearful that its recent economic shortfall would deepen, Chinese policymakers have
opted for quantity over quality in setting macro strategy, the centerpiece of which is an enormous surge in infrastructure spending funded by a burst of bank lending.

Fearful that its recent growth shortfall would deepen, Chinese policymakers have opted for quantity over quality in setting macro strategy:
Sure, developing nations always need more infrastructure. But China has taken this recipe to an extreme. Infrastructure expenditures (including Sichuan earthquake reconstruction) account for fully 72 per cent of China’s recently enacted Rmb4,000bn stimulus. The government urged the banks to step up and fund the package. And that they did. In the first six months of 2009, bank loans totaled Rmb7,400bn—three times the pace in the first half of 2008 and the strongest sixmonth lending surge on record.

This outsize bank-directed investment stimulus leaves little doubt as to how bad it was in China in late 2008 and early 2009. An unprecedented external demand shock, stemming
from rare synchronous recessions in the developed world, devastated the export-led Chinese growth machine. That triggered layoffs of over 20m migrant workers in export intensive
Guangdong Province. Long fixated on social stability, Beijing moved quickly with massive firepower to arrest this worrisome deterioration. The government was adamant in doing whatever it took to restore rapid growth.

Surging investment accounted for an unprecedented 88 percent of Chinese GDP growth in the first half of 2009:
Yet there can be no avoiding the destabilizing consequences of these actions. Surging investment accounted for an unprecedented 88 per cent of Chinese GDP growth in the
first half of 2009—double the average contribution of 43 per cent over the past decade. At the same time, the quality of Chinese bank lending most assuredly suffered from the rash
of credit disbursements in the first half of this year—a trend that could sow the seeds for a new wave of nonperforming bank loans. Indeed, just this week, Chinese regulators sounded the alarm—telling banks new loans must be used to bolster the real economy and not for speculation in equities and real estate.

A little over two years ago, Premier Wen Jiabao warned of a Chinese economy that was becoming increasingly “unstable, unbalanced, uncoordinated, and ultimately unsustainable.
Prescient words. Yet rather than act on those concerns by implementing a pro-consumption rebalancing, growthhungry China was seduced by the boom in global trade and upped the ante on its most unbalanced sectors. By 2007, investment and exports collectively accounted for about 80 per cent of Chinese GDP. And now in the face of a severe global recession, China has compounded the very problems the Premier warned of—aiming a massive liquidity-driven
stimulus at its most unbalanced sector.

Record bank lending growth of Rmb 7400 billion in the first half of 2009 could sow the seeds of a new wave of nonperforming loans:
This is not a sustainable outcome for any economy—nor sustainable support for the world economy. China must redirect economic growth toward internal private consumption. This may require a compromise on the quantity dimension of its growth outcome. But to the extent that leads to improved quality in the Chinese economy, a short-term growth sacrifice is well worth the effort.

China is aiming a massive liquidity-driven stimulus at its most unbalanced sector — ignoring the most critical lessons of this post-crisis era:
Unlike most, I have been a steadfast optimist on the Chinese economy. Yet I am starting to worry. A macro strategy that exacerbates already worrisome imbalances is ultimately a recipe for failure. In many respects, that’s what the global crisis and recession of 2008-09 are all about. China will not get special dispensation from the most critical lesson of this post-crisis era.


The man who saved India

This is reformatted text of an article that appeared in India's Business Standard newspaper on 22 July 2009 under the same title. It reviews a recent book, India and the Global Financial Crisis, by Dr Y. V. Reddy, who was governor of Reserve Bank of India (RBI) over 2003–08. This period saw exceptional challenges to macro management, and it was largely owing to the pre-emptive – but unpopular – policies of the RBI under Dr Reddy that India managed to avoid a far more debilitating hit from the global credit crisis. The charts on the left have been added for this note and were not included in the newspaper version.

Former RBI governor Dr Y V Reddy’s latest book, India and the Global Financial Crisis, makes for a useful and timely reading, and is a reminder of how pragmatic risk management by a central bank can limit the potential economic damage from shocks. The book is a collection of speeches that Dr Reddy gave during his five-year term as Governor that began in September 2003.

The speeches have been padded effectively with a helpful introduction that offers the relevant context around each speech, and an epilogue that offers more insights on the current crisis. The book has a user-friendly grouping of the 23 speeches under eight thematic chapters, each covering an important issue.

Particularly striking is the inclusion of a speech about what the RBI means to the common person in a book about the global financial crisis. But that only shows the relative importance of communicating with the public rather than only with financial market participants.

Dr Reddy’s tenure as RBI governor coincided with the unexpected surge in India’s economic growth that caught the government and the private sector (including us, market economists) off-guard. The destabilising large volume of capital inflows – which partly contributed to the surge in India’s growth – made matters more difficult for the central bank. India was largely closed financially and hence did not experience the sting from the Asian financial crisis, but last
year’s global credit crisis was different – it almost broke the economy’s back.

There is no doubt in my mind that had it not been for the deft handling by Dr Reddy, India could have been a mini version of Iceland, with the economy buckling under overseas borrowing by Indian companies. Indeed, if that scary scenario had played out, we’d be dealing with a far more serious triple whammy – corporate, banking and fiscal crises triggered by the reversal in capital flows and currency crisis.

The key areas where things began to clash were when the government seemed to go public about some of its preferences but without being prepared for the consequences of its actions. Thus, the opening of the banking and financial sector was being compromised not by the RBI but by the government’s inability to fix its own finances and cut its ownership in stateowned

To see full report: MACRO MANTRA


Margins disappoint albeit business growth…

LIC Housing Finance (LICHF) reported a PAT growth of 18.3% YoY as against our expecations of Rs 160 crores . The disappointment in PAT was owing to the fall in NIM’s which led to lesser than expected NII growth of 7.3% YoY. The silver linning was the spurt in mortage portfolio, which grew 29% YoY (in line with estimates). NIM’s declined by 21 bps YoY and 52 bps QoQ. The fall in margins was mainly due to aggressive cutting of PLR’s and overhang of high cost borrowings of previous quarters. On the asset quality front the GNPA and NNPA stood at 1.51% (2.2% in Q1FY09) and 0.65% (1.2% in Q1FY09) respectively.

Highlight of the quarter
The mortgage loan portfolio grew 30% YoY to Rs 29542 crore with sanctions and disbursement growing by 99% and 60% YoY respectively. Retail sanctions grew by 92% YoY. Special housing loan schemes coupled with overhang of high cost borrowing had taken toll on the margins to 2.45% in Q1FY10. Asset quality YoY has improved on relative as well as absolute basis.

LICHF has significantly grown its loan portfolio over the past few quarters and expects a 30%-40% growth in its core business in the current fiscal with the help of low cost special housing loan schemes. Though this will negatively impact margins in the medium term, but the accretion in market share will offset the loss in margins to some extent and keep the growth ticking. We expect the company to deliver ROE’s in the range of 20%-21% post dilution. We therefore value the core business of LICHF at 1.5x its FY11E ABV to arrive at Rs. 573 for core business value. We also ascribe value to 20% stake held in LIC Mutual fund and revise the price target to Rs.600 per share and assign a Hold rating.

To see full report: LIC HOUSING FINANCE


KG expands earnings

GAIL registered Q1FY10 recurring earnings of Rs7.3bn, slightly below I-Sec estimates of Rs7.6bn, despite higher-than-expected gas transmission volumes of 97mmscmd (I-Sec: 91mmscmd). Recurring earnings dipped 40.2% YoY due to LPG & petchem EBIT declining 31% YoY & 46% YoY respectively and dry well write-off expenses of Rs702mn. Dip in cyclical EBIT was due to lower product prices, despite steep 81% YoY dip in subsidy burden. Natural-gas transmission EBIT increased 35% YoY on the back of natural-gas volumes rising 14.4% YoY. The stock has run-up 27% and outperformed the Sensex 20% over the past month owing to favourable policy decisions. However, the government instructing GAIL to share auto-fuel under-recoveries and possible reduction in HVJ tariffs could create an overhang on the stock. Even after factoring in favourable changes as regards Section 35AD of the Income Tax (IT) Act, we believe the stock is trading at par with our target price estimates. Given lack of any significant short-term trigger, and potential downside due to adverse subsidy sharing formula, we believe long-term investors should book some profits. We downgrade to HOLD from Buy.

LPG & Petchem YoY EBIT dips 31% & 46% respectively due to lower product prices. LPG & Petchem realisations dropped 14% & 47% YoY to US$466/te & Rs66,000/te respectively. This was despite sharp 81% dip in upstream subsidy burden to Rs747mn. Fall in LPG and Petchem EBIT was partially offset by improvement in gas transmission and trading business EBIT that grew 35% and 12% YoY on the back of uptick in gas supplies from the KG D6 block, Petronet LNG and Shell LNG terminals.

Reported net income dips 46% YoY to Rs6.6bn due to lower EBIT from LPG and petrochemical businesses. Recurring earnings were lower at Rs7.3bn owing to drywell expenses of Rs702mn in the quarter.

Valuations not attractive anymore. Post announcement of the subsidy sharing scheme for FY10 and our subsequent upgrade (to BUY from Hold), the stock has run up 27% and outperformed the Sensex 20%. However, inclusion of GAIL in auto-fuel under-recovery sharing and replacement of Section 80-IA with Section 35AD of the IT Act is a negative surprise. Post recent run-up, the stock is trading at 5% premium to our target price of Rs336/share. Though favourable resolution of the Section 35AD issue and better-than-expected petchem & LPG prices could add further upside to our target price, we advise investors to book profits.

To see full report: GAIL


From virtual to reality
  • Prevailing environment expected to be more equity friendly through H2: economic activity profile to stay positive; and earnings downgrade cycle to come to an end
  • Expect the volatility bubble to continue to deflate, risk appetite to move further off the floor and the huge glacier of cash sitting on the sidelines to begin to thaw
  • US Q2 results are coming in significantly better than consensus expectations (with Financials doing particularly well); we raise our earnings and index targets

We stay positive on the outlook for global equity market in the second half of 2009 and we are raising our US and European earnings and index targets (S&P 500 end-09 up to 1020 from 900, FTSE Eurofirst 300 to 960 from 820 and FTSE 100 to 4800 from 4300).

This pro-market view is based on our expectations of a more equity friendly environment in the second half of this year with the economic and corporate earnings headwinds subsiding, as economies around the world move from ‘virtual’ to ‘real’ recoveries and the earnings downgrading cycle comes to an end.

Sure, visibility still isn’t great and further down the line there may be longer-term concerns, such as the possibility of lower trend growth rates in the developed world. But our focus is on the next 3-6 months. And on this horizon things feel far better now than they did back in Q4/Q1 when fears of a ‘Great Depression’ and ‘financial armageddon’ were alive and kicking.

At lot still rests on the macro drivers. These remain critical to the direction of the global equity market, in our view. However, unlike some, we don’t feel that equities need a Vshaped profile to make further gains. In our view, this would be the most surprising outcome for the market given that the consensus view appears to still be looking for some form of economic disappointment. If our economists’ are right and the profile of economic activity stays positive over the next six months, we expect this to provide a supportive backdrop for global equities.

The earnings driver is also featuring prominently at the time of writing, given that we are in the thick of the US Q2 results season. Our detailed analysis of the results that we have had so far provides reassurance with 74% of companies (to-date) beating consensus expectations with, interestingly, financials providing the biggest upside surprise.

To see full report: EQUITY INSIGHT


CESC registered impressive Q1FY10 results, with PAT growing 11.7% YoY to Rs1,050mn versus Rs940mn in Q1FY09; revenues stood at ~Rs.8.1bn versus ~Rs7.4bn in Q1FY09, and EBITDA rose ~44% to ~Rs1.9bn. Q1FY10 results were significantly higher than expected owing to ~Rs1-bn cost-reversal adjustment that reduced other expenses to Rs960mn as against quarterly run rate of ~Rs2.2bn. Part of this cost reversal was adjusted in Q1FY10 tariffs; the adjustment in tariffs would sustain for the next few quarters. Other income fell ~53%YoY owing to higher capex for the Budge-Budge expansion. CESC’s retail business is on course, having achieved cost savings of ~Rs200mn and improved sales to Rs750/sqft in Q1FY10 on account of increasing focus on large-format stores. The stock declined ~22% from its peak in June ’09 and, based on our target price estimate of Rs470/share (~Rs435/share & Rs35/share for the power & retail businesses), we believe the stock is attractively priced. Maintain BUY.

Revenues rise ~3% YoY to ~Rs8.1bn owing to higher demand from Kolkata License Area, with unit sales increasing ~7% to 2,057 KWh. However, a large part of this demand was met by power purchase (which increased ~46% YoY) from the West Bengal State Electricity Board as CESC’s own generation marginally fell ~1% YoY to 1,978mn units.

PAT grows ~11.7% YoY on Rs1.03bn cost-reversal adjustment. CESC’s EBITDA & PAT jumped ~44% YoY & ~12% YoY respectively. This was owing to costreversal adjustment of ~Rs1.03bn that pulled down Q1FY10 other expenses to ~Rs960mn versus normal run rate of ~Rs2.2bn. Excluding other expenses, EBITDA & PAT declined ~15% YoY & ~35% YoY respectively on account of significant drop in other income and slight decrease in CESC’s own generation. However, since a large part of the cost adjustment is a part of tariffs, we believe Q1FY10 results and subsequent quarters would be better than, or inline, with expectations.

Retail business on right track. CESC’s retail business is on course – achieved cost savings of ~Rs200mn and improved sales to Rs750/sqft in Q1FY10 from Rs660sqft owing to shutting down loss-making stores and increasing focus on large format stores.

To see full report: CESC



Marginal 3.2% increase in Top-Line: Ceat clocked a turnover of Rs674cr (Rs653.3cr) during 1QFY2010, indicating a small increase of 3.2% yoy. The Top-line growth was mainly on account of a 15% increase in its Replacement Segment Sales. However, the OE Sales declined by 48% to Rs59cr.

OPM at 15.4%: Ceat clocked an Operating Profit of Rs103.8cr (Loss of Rs0.1cr), which was well above our estimates. The surge in the Operating Profit was primarily on account of a substantial 18.4% reduction in the Raw Material Cost to Rs391.3cr (Rs479.3cr). The company’s OPM for the quarter stood at a highly impressive 15.4%. Going ahead, we expect the company to clock healthy operating margins, although we do not believe that it would be
able to maintain the high levels recorded in this quarter.

Net Profit at Rs60.2cr: Ceat clocked a Net Profit of Rs60.2cr during the quarter (Loss of Rs10.7cr). The company had clocked a net loss of Rs16.1cr in FY2009, which turned out to be one of the worst years for the tyre industry as a whole.

Key Development: On January 25, 2009, Ceat commenced construction work at its new radial tyre plant at Halol, near Baroda in Gujarat, entailing an investment of Rs500cr. The plant would manufacture radial tyres for trucks, buses and passenger cars, and a substantial portion of the production would be exported. The progress of the project is satisfactory and the company expects to start commercial production by October 2010.

To see full report: CEAT