Saturday, September 5, 2009


• Implied long term returns seem attractive: One way of looking at market valuations is to find out the number of years it could take the market to reach a certain level. In our base case, using our residual income model, the BSE Sensex (used as a market proxy) could take about nine years to breach 50,000 from its current level. If the assumptions are made optimistic, the period to 50K shrinks to seven years. When we last did this exercise in January 2007, we had estimated the road to 50K to be around 13 years. To that extent, Indian equities are distinctly cheaper than they were in early 2007 (index level was around 14,000). Even in our bear case, investors may still go home with double-digit long-term returns, something which they could have not have expected for most of the past three to four years save for the period starting November 2008.

• Critical success factors: The critical success factors for returns and hence the period to reach 50K include some obvious ones such as GDP growth, interest rates, the inflation rate, and the success of India’s infrastructure roll-out and fiscal consolidation. A less obvious but increasingly accepted factor is global risk appetite, which has a bearing on the expected rate of return and hence the actual rate of return. Some of the least obvious factors include the pace at which Indian companies globalize, the rate of wage increases, the investment rate, the estimated asset life in the books of accounts, and capital structure alterations.

• Short-term volatility an opportunity: The short-term outlook is mired by excessive volatility that the market is going through as it grapples with the pace of growth recovery versus the prospects of Central Bank tightening both at home and abroad. Other factors such as equity supply, monsoons, and crude oil will also influence share prices. Indeed, the market is pricing in almost all the growth recovery that we are forecasting in the coming six months.

• 12-month and 10-year outlook both look rewarding: However, we see more growth in F2011 and that is not in the price. More importantly, for long-term investors, our residual income model suggests that the market is delivering an equity risk premium of 6%. Put another way, the market is likely to deliver a long-term annual return of 13% same as the 10-year trailing return. This is based on an assumption that earnings will grow at 15%. If instead earnings compound annually at say 19%, the returns could be around 18% compounded annually for the next 10 years. Versus long bonds, equities appear to be at fair value. A bit more than half the index value is ascribed to future growth, which is more or less in line with history, whereas growth is likely to be better in the coming 15 years compared to the trailing 15 years (industrial growth averaged 7%, GDP growth averaged 6.9%, and BSE Sensex earnings CAGR was 13.9%).

• Sensex target a tad higher: Our Sensex target for June 2010 is 17,600 (600 points higher than our previous June 2010 target as we adjust F2009 earnings for actual numbers). The bull case implies upside of 41% from current levels, while we think the market is unlikely to go below
its post election result day level in our bear case. Key catalysts could be reforms and infrastructure spending, although investors should be prepared for heightened volatility, which could make trading a less-rewarding strategy compared with “buy on dips and hold”.

To see full report: INDIA STRATEGY


The real GDP growth moderated to 6.7% during FY09 after an average growth of 8.8% in the preceding 5iyears. In the light of severe global financial crisis and the subsequent recession, FY09 growth was commendable. The year witnessed interested dichotomy though. The H FY09 was characterized by rising inflation due to hardening international commodity and domestic food prices while the second half witnessed a sharp decline in inflation and economic activity impacted by deterioration in the macro environment. Responding to these worsening conditions, Government announced three stimulus packages and RBI opted for significant monetary expansion. With Q1 FY10 GDP growth at 6.1% yoy, the economy has started showing early signs of stablisation, albeit not recovery. Nevertheless, the RBI target of 6% growth in GDP for 2009-10 with upward bias is likely to be achieved.

  • RBI currently faces multiple challenges
  • FY10 GDP growth targeted at 6%
To see full report: RBI

>MARUTI SUZUKI- Domestic Growth Trajectory Improves (CITI)

Buy: Aug09 – Domestic Growth Trajectory Improves

What's New? — MSIL reported solid domestic sales growth over the month (+29% y/y, substantially above expectations) driven by the A2 segment (+c39% Y/Y) and the A3 segment, which continued its solid growth streak – up 44% y/y, though MoM sales reported a decline.

Domestic Volumes Guidance Revised Upwards for FY10 — to 10%, from earlier guidance of 5%. Management notes that both footfalls to showrooms and customer inquiries remain healthy. We factor 10% for FY10 but believe there are upside risks to these estimates.

Model Mix Continues to Improve — The model/revenue mix is increasingly tilted toward fresher/younger products. Management noted that while models < 5 years are now just < 40% of volumes, from a revenue perspective these account for 60-67% of revenues, underscoring that the realisation mix continues to improve.

Exports strong, but growth rate not sustainable — The growth this month is accentuated by a low base. Management also noted that export volumes are being stimulated by the fiscal incentives in Europe – the probability of volume growth decelerating from this monthly trend rate is somewhat low.

Mixed Impact of Festive Seasons — Growth in the domestic market is also slightly accentuated because in Aug08, the period of 'Shraddh' had occurred – a period when buyers typically eschew purchases. This year, Shraadh will occur in the month of Sept, but mgmt doesn’t expect it to impact volume growth as it will be offset by the "Navraatra" festival, an auspicious period when buying revives. Maintain Buy (1L).

To see full report: MARUTI SUZUKI


An excellent proxy for India’s strengthening capex cycle

Ratnamani is India’s largest manufacturer of stainless steel pipes and tubes and is a preferred supplier of various EPC contractors (like L&T, BHEL), fabricators and engineering consultants
worldwide. It also has a SAW pipe division which caters to the requirements of the oil and gas transmission industry.

Investment argument
India’s market leader in the stainless steel tubes and pipes industry characterised by high value add and superior ROCE’s Ratnamani is India’s largest and a globally recognised company
in the high margin stainless steel tubing business which is a niche segment with few players across the globe.

Revenues linked to a diverse range of industries with different capex cycles. Contrary to the perception of being a small SAW pipe manufacturer catering to just the oil and gas sector, Ratnamani is actually a supplier of critical components to oil and gas refineries, petrochemicals and power generation sectors which have huge capex projects lined up for execution.

Carbon pipe segment to add to the growth with a renewed vigour. Having received all the API approvals for its SAW pipe manufacturing facilities and capability to produce pipes of varied dia’s, Ratnamani now plans to aggressively bid for big ticket pipe tenders floated by GAIL and other players.

Despite Ratnamani’s subdued revenue visibility in the near term (order book of Rs 350 cr) we believe that the large order book’s of EPC contractors (executing the power and hydrocarbon
related projects) gives us the necessary confidence that the order inflow will increase with the execution cycle.

Risk factors
Slowdown in the capex in user industries and margin pressure on account of increased competition.

Ratnamani is a niche player with superior ROCE’s, high free cash flows (consistently +ve cash flow from operations) and a high scalability potential. With capex on thermal power projects about to take off in a big way and refinery capex activity gradually picking up (huge projects lined up), Ratnamani is expected to benefit from the derived demand for its products. We believe that once the execution of these large projects gathers momentum, Ratnamani will see a massive order inflow and earnings growth. At current valuations, the company offers an extremely favourable risk-reward proposition and we recommend BUY on Ratnamani with a price target of Rs 148

To see full report: RATNAMANI METALS


Gov’t Tamiflu orders much ado about nothing; reiterate Conv Sell

The Indian government, which had a stockpile of 10mn Tamiflu capsules, has exhausted 75% of its stockpile and is looking to raise its stockpile by further 20mn capsules, according to media reports (Economic Times, Aug 11). Of these, Hetero Pharma is reported to be supplying half of the order (10mn units), while the remainder is being sourced from various suppliers. One of the suppliers cited is Ranbaxy, which according to a Sep 2 Bloomberg report has secured an order to
supply 900,000 units to the government.

Per an Aug 22 report in the Economic Times, the government’s price for these orders is Rs270 -Rs275 per 10 capsules, or Rs27 per Tamiflu capsule. We note that this equates to Rs24.3mn in terms of incremental revenue upside for Ranbaxy based on the reported order for 900,000 units. This translates to US$0.5mn (0.03% of our 2009 sales est) for Ranbaxy, which we view as inconsequential. However, in the unlikely event the government permits retail sales of a generic version of Tamiflu, we believe this may provide significant upside potential to Ranbaxy. Ranbaxy’s superior distribution network and marketing strength in India could lead to greater market share and higher sales volumes, command a higher retail selling price, and generate improved margins. To date, there has been no concerted effort to allow retail sales of a generic version of Tamiflu, on concerns that the drug could either be hoarded or used indiscriminately, which could lead to the H1N1 virus developing resistance to the drug.

Ranbaxy has outperformed the broader market by 20% (up 23.4% vs. BSE Sensex’s +3.5%) since Aug 10, when the government’s order for 20mn units was announced. We believe Ranbaxy’s share price movement has been driven in part by news flow surrounding the company’s ability to supply Tamiflu to the government. Even if Ranbaxy secures these orders, the incremental upside won’t justify the recent price movement, in our view. We reiterate Sell (on Conviction Sell list) on Ranbaxy and maintain our Director’s Cut-based 12-m TP at Rs196.

Key upside risk: Resolution of the USFDA issue.

To see full report: RANBAXY LABORATORIES


Mixed results, lower sales compensated by lower subsidy burden

Oil and Natural Gas Corporation Ltd.'s (ONGC's) net sales were down 25.8% yoy to Rs.148.8 bn in Q1’10, on account of a drop in production volumes, lower price realisations (USD 58 per barrel vs. USD 69 per barrel in Q1’09), and the discontinuation of the trading of MRPL products since April 2009. However, the EBITDA margin stood at 64.3%, improving by 567 bps yoy due to lower subsidy burden, which was down 95.6% yoy to Rs. 4.3 bn. Also, employee costs were down 13% yoy to Rs. 2.5 bn. Net profit, however, declined 26.5% to Rs. 48.5 bn, mainly due to an increase in DD&A expenses related to the cost of two dry wells written-off in the KG offshore basin.

Proposed subsidy-sharing formula provides relief – The Secretary of Petroleum recently announced that under-recoveries on the sale of domestic LPG and kerosene will be borne by the Government. This has brought enough reasons to cheer for upstream companies such as ONGC.
At current exchange rates and crude oil prices hovering at around USD 70 per barrel, Oil Marketing Companies (OMCs) are expected to incur around Rs. 300 bn of under-recoveries on the sale of LPG and kerosene.

Delay in production, cause for concern – Three platforms that were to come up in fiscal FY09 were delayed and the delay continued into the first quarter as well, leading to a decline in the expected production. Though production from one of the projects, C-Series, is likely to start soon, the other two platforms may be delayed further.

To see full report: ONGC


Embedded to save resources…

ICSA (India) is a Rs 1100-crore company, with embedded products and infrastructure project services as offerings. The company primarily addresses the energy saving needs of Indian power
distribution companies (DISCOM) as they face huge aggregate technical and commercial losses. ICSA has unique metering products for the power sector like intelligent automatic meter reading (IAMR), theft detection device (TDD), distribution transformer monitoring system (DTMS), which are patented and others for pipeline application.

Business model
The company has almost 70% of its current order book of Rs 2010 crore from infrastructure project and services while the rest is from embedded solution, which is executable over the next 18 months. Previously, the company used to derive almost 65% of its revenue from embedded products but due to delay in release of funds by the government for Accelerated Power Development and Reforms (APDRP) II scheme and Rajiv Gandhi Grameen Vidyutikaran Yojna scheme (RGVVY), the company’s revenue mix has changed completely. The company has a strong in-house built in capabilities with an R&D team of 120 people, who do high value added work, beginning from research, product design, product development, product testing and pilot deployment. Low value services like manufacturing of hardware and deployment is outsourced. Therefore, it has a capital light revenue model for embedded solutions.Therefore, the embedded products business is high margin and is less capital intensive whereas the infrastructure project services are low margin and capital intensive projects. This is the reason that the EBIT margins and return ratios for the company have dipped and will be under stress in the near term.

Going forward
Since we are at the mid way mark of the Eleventh Plan proposed by the government to improve the status of DISCOMs, we believe the funds under APDRP II and RGVVY will start getting released by the end of FY10. This will help he company to get huge incremental orders for its embedded solution. This will once again change their revenue mix to 60:40 for embedded products to infrastructure services from 40:60 today. This will not only bolster its operating margin but also boost revenue growth as well as return ratios.

The company is currently trading at more than 48% discount to other midcap IT players in terms of P/E(x) FY11 EPS or EV/EBITDA(x) FY11 EBITDA. It is trading at very attractive valuations given its return ratios and huge order book size.

To see full report: ICSA INDIA LIMITED



Harrison Malayalam Ltd (HML) is engaged in many businesses including tea and rubber plantations, aqua and plant tissue culture, engineering and clearing & shipping. However, tea and rubber production contribute 90% of total revenues. The company owns roughly 23,417 hectares of land. Of this, around 6,030 hectares is used for tea plantation. Almost 7405 hectares is used for rubber plantation while the rest is used for fuel wood and other plantations. HML owns nine tea estates in Kerala and one in Tamil Nadu. The company produced 17.1 million kg of tea and 12.0 million kg of rubber in FY09. HML also produces smaller quantities of a variety of other exotic horticultural crops like areca nut, banana, cardamom, cocoa, coffee, coconut, pepper and vanilla as well as limited quantities of organic tea and spices.

Soaring tea prices
Tea prices have surged above Rs 130 per kg, almost 30% higher than last year. A decline in tea production due to severe drought conditions in key tea exporting countries like Kenya and Sri-Lanka has resulted in a radical rise in tea prices in international markets. Simultaneously, lower area under tea cultivation coupled with truant monsoons has led to lower production in India further aggravating the situation. With incremental consumption growing at a 3.8% CAGR over 2000-2007 and the relatively lengthy gestation lag of a tea plant, which typically lasts for around five years, we believe that tea production is unlikely to register any significant growth in the near term. This, in turn, would keep tea prices firm, going forward.

Volatile crude increases natural rubber prices
Volatile crude prices have lead to an increase in synthetic rubber and natural rubber prices. Despite increasing imports, prices of natural rubber have remained buoyant throughout 2009 on the back of a shortfall in global production. Rubber imports by tyre companies have reached about 79,573 tonnes during April to August 2009 as compared to 24,264 tonnes during the corresponding period. A shortfall in rubber production has lead to an increase in natural rubber prices to Rs 110 per kg. This would result in a significant improvement in the company’s margin from the rubber segment as the rubber division contributed 50% of the company’s revenue.

To see full report: HARRISON MALAYALAM


Upgrade to Hold: Worst Appears Behind

Upgrade to Hold (2M) — We believe the risk reward is more balanced post the recent underperformance & lower risk on R&D, leading us to lower risk rating to Medium. We reduce FY10/11 core biz EPS estimates by 9%/5% (building in a slower pace of recovery) but raise TP to Rs250 (roll over to 15x Sep '10E).

Lower risk; More reasonable valuations — We were worried about the risk from Oglemilast-related newsflow. With that behind us, and following a c.17% fall in the last two weeks, we believe risk is lower. At c.12x FY11E EPS, there appears to be no upside built in for R&D, while all R&D cost is expensed. We thus view the risk on Glenmark to be similar now as that in most other generics stocks.

Encouraging trends in the base biz — Growth has picked up in all markets in 1QFY10, as credit availability and currencies stabilized, leading to a smart QoQ rise in financials. We believe the worst is behind, with forecast sales and PAT FY09E-11E CAGR of 19% and 35% respectively. Cash flow is set to rise, as capex and working capital are reined in, allowing Glenmark to correct its high leverage.

Don’t rule out R&D — Despite setbacks on two of its lead NCEs, Glenmark’s R&D pipeline could be a key value driver. Its capabilities have been validated by three deals with large partners (income: US$117m). Progress on melogliptin and crofelemer would be key to watch out for. With our view that no value is currently built in for R&D in the stock, this could provide a clear catalyst.

Why not a Buy? — There are multiple moving parts in Glenmark's biz. While early signs on the core biz indicate that the worst may be behind, it is difficult to gauge the pace of recovery. R&D is another factor that could swing margins either way. Thus, while more positive than before, we await confirmation that the early signs of recovery are sustainable before getting more constructive.



A pure banking play...

Bank of Baroda (BoB) is the third largest public sector bank (PSB), differentiating itself on account of higher share of international business, conservative approach and qualitative growth. We expect its profits to grow at 18% CAGR over FY09-FY11E to Rs 3117 crore while market share is likely to consolidate at current levels.

Business growth: Conservative yet consistent
The balance sheet of BoB grew at 26% CAGR to Rs 227406 crore. This resulted in an improvement in its market share from 3.5% to the 4% level in the last three years in spite of stiff competition from private banks. BoB has cautiously not reduced BPLR below 12%. Most loans
are now priced near PLR, reducing sub-PLR loans gradually, whereby margins are maintained at 2.6-2.7%. We anticipate balance sheet growth of 17% CAGR over FY09-FY11E to Rs 310995 crore. The bank’s stressed assets (GNPA and restructured) are lowest among comparable PSBs at approximately 4.2% of advances. This gives some comfort on asset quality concerns.

Productivity improving due to CBS implementation and employee mix
In spite of high growth, employee strength has reduced from 39529 to 36838. This hasimproved productivity whereby business per employee is up 28% CAGR to Rs 7.6 crore in FY09 from Rs 4.6 crore in FY07. Also, profit per branch has improved from Rs.40 lakh to Rs 80 lakh in three years.

We value the core business of the bank at 1.1x FY11E ABV, a discount of 20% to it P/ABV multiple of 1.4x as per single stage Gordon growth model due to uncertain market conditions. We have considered cost of equity at 13.9%, perpetual growth of 3% and sustainable RoE of 18%. This translates into fair value of Rs 514 per share for the bank. With RoE of 17-18%, RoA of over 1%, NIM@ 2.6-2.7%, well controlled asset quality and a well diversified loan book, we believe the bank’s valuations at 0.95x is quite attractive. We value its 25% stake in UTI. AMC at Rs 18/ share (valued @4% of weighted average AUM for the previous three months). Hence, on an SOTP basis we have arrived at a target price of Rs 532 and rate the stock as an OUTPERFORMER.

To see full report: BANK OF BARODA