Saturday, September 12, 2009


Improving outlook reflected in the price

Fundamental outlook improving but valuation full
Although we believe the outlook for GSK is slowly improving, we maintain our Neutral rating. A better pipeline, creative M&A that has not, to date, destroyed value (as we had feared) and the increasing reflection of generic Advair risk in consensus forecasts, thus minimising downside risks, have steadily improved our perception of the stock. However, despite this, we still expect margin and generic pressures to lead to earnings declines 2010-2013 leaving the stock fully valued at current levels hence our Neutral rating.

Improving outlook from pipeline and M&A
Key improvements in our view on GSK include: 1) Pipeline. Following positive Phase III data on Benlysta (lupus), Menhibrix (meningitis vaccine) we recently added £1.2bn in risk adjusted sales for these products to our model. Approval of both could lift 2015E EPS c8%. 2) GSK’s acquisition policy has, to date, not destroyed value as we feared. Acquisitions such as Stiefel have been largely value-neutral. “Capital-lite” deals such as product licensing from Aspen, and Ranbaxy and an HIV JV with Pfizer increase optionality and leverage GSK’s existing infrastructure. 3) Consensus Advair forecasts of £4.2bn in 2013 now reflect greater Advair generic risk reducing downside risks on generic newsflow.

Longer term margin pressure slows growth. Valuation full
However, our continued Neutral rating is predicated on: 1) Slow EPS growth outlook. Despite the improvements, we continue to forecast 10-13E EPS CAGR of -3% due to Advair generic competition from 2011 in EU and 2013 in the US, and margin pressures (faster growth of lower margin consumer and EM businesses, increasing sales of in-licensed products and price pressure in developed markets. 2) Valuation: GSK looks fully valued, trading close to our 1,200p DCF-based price objective and on a sector average P/E of c10x despite a significantly worse
growth outlook ’10-‘13E EPS CAGR of minus 3% vs the sector average of +5%.

To see full report: GLAXOSMITHKLINE


Insufficient upside given risks
The key to near-term share price performance remains US Victoza (GLP-1 analogue) approval timelines following concerns on thyroid safety, with a definitive decision now likely by the end of the quarter. Our valuation scenarios suggest balanced risk-reward through the process, with c10% downside to DKK290 on a 2-3-year delay (the scenario reflected in our forecasts), but c12% upside to DKK360 on a timely approval. We maintain our Neutral rating, given: 1) Investor sentiment on delay may drive share price downside below our FV estimate in this scenario; 2) There are limited other catalysts beyond Victoza near term, and 3) We see better opportunities elsewhere in the sector near term.

FDA decision remains tough to call
In our opinion, the FDA decision on Victoza remains tough to call. Factors suggesting a possible timely approval include clinician support for the class, given the attractive efficacy and weight-loss profile, no increase in calcitonin (a marker of thyroid safety) seen for up to 2 years, and no C cell cancers in 5,000 treated patients. However, factors that continue to drive our caution include the mixed FDA advisory committee vote on thyroid safety and concern that FDA may still request formal re-submission of data or request additional data.

Limited other data catalysts
We see limited other data catalysts beyond US Victoza approval short term. While the late-stage pipeline is progressing, with a number of Phase III trials due to commence shortly, data from these are not expected for over 12 months. Nearterm data is likely restricted to Phase II data for NN1731 (“SuperSeven”, haemophilia) and Phase II data for once-weekly GLP-1 analogue (semaglutide) and follow-on insulin analogues (SIBA and SIAC) at ADA 2010.

To see full report: NOVO NORDISK


The end of easing

What to expect as policy makers reverse

Risk assets are in the sweet spot. Investors see looming recovery but policy remains at recession-combating levels. The focus will soon turn to the end of easing and, beyond that, the policy tightening phase.

We expect a below-par recovery. So while easing may soon end, tightening will probably not start until 2010 – well into 2010 for many developed economies. Markets, however, look ahead, and when the focus turns to a prospective tightening, we think investors should:

• Sell equities as the strong relief rally is partly reversed. We expect developed equities to settle into a wide range-trading environment for an extended period. Emerging market equities will likely remain high beta, but we expect medium-term structural outperformance to continue.

• Rotate into late cyclicals and quality defensives. Also expect market performance to increasingly reflect the divergent outlook for domestic growth in various regions.

• Buy forward volatility in rates, and expect still-steep curves. End of easing increases volatility for rates, while the curve is likely to be structurally steeper than in the prior cycle. In equity derivatives, we like positioning this view directly via variance swaps, and directionally via diagonal put spreads.

• Buy EM currencies and reflation laggards (SEK in G10, KRW in EM). Currency markets will focus on fiscal strength and high beta/high rate currencies that have lagged to date.

• Stay long credit, but expect lower returns. The big risk to credit is double-dip, not the end of easing.

To see full report: CROSS-ASSET STRATEGIES


Investment Rationale

Robust growth from Hydropower
India has a huge mismatch in thermal and hydro power capacities. India has total estimated and identified hydro power potential of ~148,700 MW of which only 36,878 MW has been constructed so far, leaving huge untapped hydro power potential. As per 11th & 12th Five year plan Government of India has planned 45,585 MW (2224 MW commissioned till March’09) of new hydro power generation capacity by FY17.

Government push to Irrigation
To enable better utilization of water resources and irrigation, central Govt has initiated Accelerated Irrigation Benefits Program (AIBP) and allocated Rs.350 bn for FY10. These plans also is expected to lead to a substantial spend towards hydromechanical segment which in turn will provide big opportunity for OMIL.

Market leadership & proven track record in Hydro mechanical segment
OMIL enjoys a little over 50% market share in hydromechanical segment with over 35 years of proven track record. With OMILs efficient service offering across the value chain in the business enabled it to successfully execute over 50 projects across 18 states, including some historic and landmark projects. With every new project completion OMIL continues to strengthen its leadership position and has proven its credibility as the most preferred vendor/partner.

Stringent prequalification pose as major entry barrier
Hydro mechanical projects are of high importance as its efficient implementation is must for not only timely power generation but also for the safety of nearby villages. The tendering follows the ICB (International Competitive Bidding) process. The bidders are evaluated on technical expertise, size and most importantly on the number and size of successfully completed similar projects. On the back of OMILs unmatched past track records of successful execution of mega projects the company successfully pre qualifies for all the tenders it bid. At the same time these criteria pose
as biggest entry barrier for the new entrants in the segment.

Huge order book and high margins provides future growth visibility
OMIL has a strong order book of over Rs.6.2bn, executable over a period of 3-4 years providing a strong visibility of the earning potentials. Furthermore the order book is set to increase substantially just by the fact that NHPC alone is awaiting clearance for 6731MW of projects which will pose an opportunity of over Rs. 15 bn - Rs .25 bn of hydromechanical projects. There is a clear visibility that OMIL will grow over 30% CAGR for next 3 years. On the back of its cost efficient practices, timely execution of projects and presence in the entire value chain OMIL enjoys superior margins to its

Diversification towards other businesses to exploit the opportunities
To explore the newer opportunities OMIL along with a partner has won the tender to develop Pondicherry SEZ (Owns 18.5%) & Pondicherry Sea Port (50% ownership) on BOOT basis. Apart from these OMIL in a consortium has also won a SRA project in Bandra to develop 0.4mn sqft of construction space where OMIL enjoys 35% ownership. The above mentioned projects are expected to take off in next 12 months. In our projections we have not considered any upside from this vertical, as and when it happens it will lead to further re-rating of the stock.

We expect OMIL’s revenue and profits to grow at CAGR of 37% & 23% respectively, between FY09-FY11F. At CMP of Rs27.4 the stock is trading at 8.5x FY10F EPS of Rs 3.2 and 6.9x FY11F EPS of Rs 4, which is at a substantial discount to its peers in the Engineering business. We have not considered any revenue from the potential projects in real estate and infrastructure segment. Given the robust macro outlook, strong order book, market leadership, stringent entry barriers, impressive margins, net debt free balance sheet, strong project execution ability and much cheaper
valuations; we initiate BUY recommendation on the stock.




The Bombay Stock Exchange’s (BSE) Oil & Gas index has underperformed the broader Sensex by 13% over the past three months, which we believe is due mainly to uncertainty surrounding key issues such as KG-D6 litigation and subsidies, among others. With most concerns priced in and several emerging positive catalysts, we believe risk-reward is becoming favourable. The sector’s 1Q FY10 earnings were above consensus estimates, due mainly to auto fuel sharing by upstream and inventory gains for oil marketing companies (OMCs). Although we still do not believe that the
Indian government will deregulate auto fuels or bear all cooking fuel losses, the concern about subsidies has abated considerably due to several positive statements of intent, lower y-y prices and retail price increases. The other positives include stronger petrochemical prices and the likely positive impact of recent direct tax code proposals. We raise our earnings estimates and outlook for most stocks under our coverage.

We upgrade GAIL (PT: INR390) and Cairn India (PT: INR300) to BUY (from Reduce).
Apart from gas volume increases, GAIL is benefiting from firm petrochem prices and a reduced subsidy burden. With an increased share of regulatory transmission (allowed 12% post-tax ROCE) earnings, we believe GAIL could re-rate as a utility company. Start of production from the Rajasthan Block is a near-term catalyst for Cairn, in our view. We continue to believe there remains potential upside in the Rajasthan Block.

We upgrade ONGC (PT: INR1,410) to BUY (from Reduce). ONGC shared only auto fuel losses in 1Q FY10. At our oil assumptions, we estimate very little auto fuel losses for FY10/FY11. It would be considerably positive for ONGC if it were to share only auto fuel losses going forward. Conservatively, we assume that upstream would also share 16.5% of cooking fuel losses. Removal of the ad-hoc approach to subsidy sharing will be the key to a re-rating of ONGC, in our view.

We upgrade Reliance Industries (PT: INR2,000) to NEUTRAL (from Reduce). We believe the market has priced in downside from the adverse High Court decision on KG-D6. With the final hearing in the Supreme Court commencing soon, and apparent urgency for all parties (including government), we believe the issue is in the end-game. Although the ongoing dispute will remain an overhang in the near term, we believe that once it is resolved market attention will shift to the company’s significant earnings growth prospects and upside from its large E&P portfolio.

We upgrade Indian Oil (PT: INR600) and HPCL (PT: INR360) to NEUTRAL from Reduce, and maintain NEUTRAL on BPCL (raise PT to INR525). Although OMCs were made to share all cooking fuel losses in 1Q FY10, we assume the burden will be reduced, based on government statements. We believe a clear policy on subsidies is critical for these stocks to re-emerge as long-term investment ideas.

To see full report: INDIAN OIL & GAS



Favourable enviornment for standalone operations
Hindalco’s low cost domestic operation is highly leveraged to aluminium prices. Aluminium prices have jumped sharply from its lows (~45%) triggered by strong recovery in China underpinned by tied up inventory at LME. Leadership in downstream products and monopoly in specialty alumina helps it fetch additional premium over its domestic peers. Domestic operations are well funded and equity contribution for ongoing greenfield projects will be met through internal accruals.We expect a 23% CAGR in its domestic operations over 2010-2102e.

Novelis drag is behind as pain is priced in
Novelis is expected to turnaround in FY11 on the back of potential cost savings and fading overhang of price ceiling contracts. Improving demand environment, stable metal premium and potential MTM gains from sharp pullback in metal prices will help ease cashflow pressure in the coming quarters. We expect operating margins to return back to 7-8% levels in FY11 (last achieved in FY06) on the back of 7% revenues growth and cost savings yields.

High leverage to weigh on growth prospects
Easing credit markets has significantly improved outlook on Hindalco’s balance sheet. Gearing ratios at 1.1x FY11 remains comfortable as fund raising initiatives help ease concerns on short
term liquidity and growth prospects. Though we remain optimistic on its brownfield expansion projects however its ambitious Greenfield projects are likely to face delays on account of regulatory delays and timely financial closures.

Cost competitiveness and high leverage to metal prices makes Hindalco an attractive proposition in the current environment. Novelis carry’s short term risk in terms of earnings and cashflow offers a favorable earnings proposition in FY11. We initiative coverage on this stock with SOTP price of INR127 per share. we recommend a BUY with potential upside of 21% from current levels.

To see full report: HINDALCO INDUSTRIES


Significant improvement across all key parameters

Increase in return ratios expected to assign higher multiples to
stock…valuation at 0 .8x Book appears very enticing…

The Story

A few quarters back, we had subscribed to IDBI Bank Ltd.’s (IDBI.IN)/(IDBI.BO) long-term growth story, based on its improving return ratios and technology driven expansion plans, despite some legacy issues.

“IDBI isn’t a growth stock, so don’t look for eye-popping growth here. It’s a good, old-fashioned
value play, the way value plays ought to be. And we don’t see much price downside from hereon. “


(From First Global’s, “IDBI Bank Ltd. (IDBI.IN)/ (IDBI.BO): Contours of a turnaround are visible,”
dated July 30, 2008).

The price of the IDBI stock was Rs.77 then…hasn’t done too badly at all, for a value play…

IDBI has been exhibiting a significant improvement across all key parameters, such as growth,

margins and asset quality. The bank’s net interest margin, which had remained below industry
average, has also begun showing signs of improvement and was up from 0.80% in FY07 to
1.06% in FY09. According to management, IDBI is targeting a net interest margin of 1.2% for
FY10. Of late, the bank has been focusing aggressively on the retail segment, with its retail
advances increasing by 47% Y-o-Y to Rs.249 bn and agricultural advances recording a stellar
growth of 314% Y-o-Y to Rs.63 bn in FY09.

IDBI is targeting the retail segment both to garner higher deposits, as well as increase its loan

disbursements. The Net NPA ratio stood at 0.92% in FY09, as against 1.12% in FY07. At the end of August 2009, IDBI has 578 branches and 1006 ATMs spread across 360 centres and intends to set up more branches over the next year, thus taking its total number of branches to 750 by March 2010. This will help garner more of Current Account and Savings Account (CASA) deposits. In FY09, IDBI Fortis Life Insurance Company Limited (a joint venture with a holding of 48%) recorded a Gross Written Premium of Rs.3.19 bn, as against Rs.119 mn in FY08. IDBI is also looking to extend its operations beyond the domestic market and has already received approval for setting up a wholesale bank branch at Bahrain, an offshore banking unit at Singapore, a category-I branch at Dubai International Financial Centre (DIFC) and a representative office at Shanghai. Going forward, management has targeted a growth of 25-28% in advances, which, we believe, is achievable, given the strong pick up in demand in the infrastructure segment, where IDBI is well positioned due to its established client relationships and strong appraisal skills. Management has targeted a growth of 32-35% in deposits for FY10.

Outlook and Valuation
We expect IDBI to post an earning per share (EPS) of Rs.3 for Q2 FY10 and Rs.13.6 in FY10. The stock currently trades at a forward P/E multiple of 7.9x FY10 earnings and a forward P/B multiple of 0.8x FY10 book value, as against an average of 5.9x and 1.0x for public sector banks. More importantly, IDBI has a number of strategic investments (apart from the investments in Subsidiaries that have significant potential value, which we believe, could fetch a value of around Rs.10 per share over and above its book value. Taking into account the additional value of these investments, IDBI is available at an attractive price to book value of 0.7x its FY10 book value, as compared to its peers in the public sector and private sector that are quoting at a price to book value of 1.0x and 1.5x respectively. We expect IDBI’s improving return ratios to assign higher multiples to the stock and therefore, reinitiate coverage with a rating of Outperform.

To see full report: IDBI BANK


JSPL stands to gain from new spot tariff norms

Regulator favours low-cost players; JSPL remains our top sector pick
Fresh data points from regulators on the short-term market suggest (1) that the Central Electricity Regulator (CERC) is looking to set a short-term price cap of INR11/kWh vs. INR5-6/kWh as proposed earlier; and (2) low-cost power producers will continue to make good returns. Our sensitivity analysis shows that if shortterm rates remain at INR6/kWh, then JSPL’s earnings could increase by 12% in FY10E and 18% in FY11E. For Tata Power, earnings could be up by 4% in FY10E. JSPL remains our top sector pick.

New CERC policy favours low-cost players
The CERC’s latest regulations on the short-term price ceiling suggest a cap on the super-normal returns for high-cost gencos (naphtha + DG sets). However, a price ceiling of INR11/kWh implies that the low-cost gencos such as JSPL could potentially earn RoEs of 47% (only for power). Note that JPSL’s cost of power generation could fall from INR2.75/kWh in FY10E to ~INR0.8/kWh by FY12E, which would ensure high profitability even if merchant tariff were to fall to INR3.5/kWh, in line with regulated tariff levels. Potential earnings upside of 12% in FY10E and 18% in FY11E for JSPL A simple sensitivity analysis of our earnings model suggests that if short-term tariffs remain at similar levels throughout Q1FY10, an average of INR6.4/kWh in FY10E and INR6/kWh in FY11E, then JSPL’s earnings could increase by 12% in FY10E and 18% in FY11E. Note that our earnings estimates are above consensus by 7% in FY10E and 18% for FY11E. Likewise, for Tata Power, earnings could go up by 4% in FY10E and 6% in FY11E at the consolidated level.

Reiterate JSPL as our top pick
Recent statements by the Ministry of Power seem to suggest continued slippage in new power capacity addition programmes. We find that JSPL is possibly the only large-cap utility stock trading at a discount to NPV. Our target price of INR4150/sh implies that power assets valued at 19.7x FY10e and steel assets at 10x FY10e. Note that JSPL’s earnings are understated by 15-20% in FY10E due to cost front-loading in power. For investors looking for exposure to regulated markets, NTPC emerges as a better player vs. peers. Reliance Power continues to be our top Sell-rated stock. Key risks include delays in implementation, the imposition of a regulatory cap on the spot tariff below INR4/kWh, and a significant drop in fuel costs.



Strong iron ore market to continue as Chinese imports slow

Feature article
The latest Brazilian iron ore exports for August were extremely high.

Latest news
Base metal prices were mixed on Friday. Zinc, lead and copper closed higher on the day while nickel closed 3.4% lower, continuing nickel’s trend through the week. Nickel closed 7.8% lower than the previous Friday’s close, while copper was down 3.1% for the week and aluminium fell 2.7%. Lead was the clear outperformer this week, up 9.7%, after supply disruptions in China related to heavy metals poisoning.

US employers cut payrolls by 216,000 in August, following a 276,000 drop in July. Construction payrolls were cut by 65,000 and factory payrolls were cut by 63,000, while there were 10,000 retail jobs cut. The unemployment rate rose to 9.7%, the highest rate in 26 years.

Around 560 union workers from BHP Billiton’s Chilean copper mine Spence are threatening to strike if the company does not accept a proposed 5.5% pay rise, plus 15 million pesos ($27,125) bonuses for each worker. The union says that the company’s counter offer was insufficient and that “official negotiations” will start on Monday. We are projecting that Spence will produce 180,000t of copper this year. Over the next three to four months, labour contracts that affect up to 2.7mtpa of copper mine supply, 17% of forecast 2009 mine supply, will need to be renegotiated. Spence is the first major copper mine to enter negotiations and may provide a signal for other forthcoming negotiations.

Rio Tinto confirmed on Friday that it has suspended iron ore contract negotiations with Chinese customers, although it continues to deliver ore at provisional prices. Iron ore chief executive Sam Walsh said he expected talks to resume, but didn’t know when: “Remember that we have our negotiators detained.”

Australian thermal coal exports continued at a rapid pace in July, with 12.8mt shipped at an annualised rate of 151mtpa. Thermal coal exports through July were up 11.3mt (16%) and running at an annualised rate of 140mt. Australia exported a total of 126mt of thermal coal in 2008.

Australian metallurgical coal exports in July were above year-ago levels for the first time this year, with 12mt shipped at an annualised rate of 141.5mtpa. This was up 8.9% YoY, though 2.6% down MoM. For the year through July, exports were down 9.1Mt (11.7%), including a 3.9mt (8.3%) fall in hard-coking coal exports and a 5.1mt (17.2%) fall in semisoft/PCI coal exports.

Australian met coal exports to China in July totalled 3.7mt, against 3.5mt in June and 3.9mt in May. Australian exports have proven a reasonable one-month lead indicator of Chinese import demand this year and suggest another strong month of import demand, over 4mt.

Taiwanese steelmaker China Steel Corporation raised its prices for October/November by 8.6% or $50/t to $590/t for HRC. This compares to a Chinese HRC price of $477/t ex-Vat, or $588/t inc VAT.

To see full report: IRON ORE MARKET


Downgrade to Sell: Fundamental Positives Fully Priced In

Current valuations are rich, downgrade to Sell — Our downgrade to Sell (from Buy) on CLGT is predicated on: 1) Stock has outperformed peers and the broad market by 35% and 41% respectively in the last year; 2) Current valuation of 23x FY11E P/E implies flawless execution and in our view doesn’t price in dual risks of decelerating growth (lagged monsoon impact) and impact of higher tax rates; 3) Relative P/E to the broad market at 1.5x is at the higher end of the
trailing five-year range, and 4) The specter of a lagged monsoon impact inhibits a further re-rating from current levels.

CLGT continues to execute per plan — Key takeaways from recent company meetings: 1) Management not unduly concerned about the monsoons, and think the impact, if any, will be with a 6-12 month lag; 2) Cost pressures remain elevated (up ~7% Y/Y) but sequentially (1QFY10 vs. 4QFY09) have dipped ~3- 5ppt, and have now stabilized at those levels and 3) There is some flexibility on ad spends as these are a function of brand roll outs and competitive intensity.

Tweaking estimates — We increase FY10E EPS by 11%, but reduce FY11E by 2%. The increase in FY10E reflects lower ad expenses, while the cut in FY11E reflects a sharp up-tick in the effective tax rate to 25% (from 17% in FY10E). Our FY11E revised estimates are 6% below consensus estimates (Bloomberg); we are in-line with consensus for FY10E.

New target price of Rs585 — Our target price is increased to Rs585 (from Rs523) due to: 1) Roll forward from Sept-2010E to Mar-2011E, and 2) Increase target P/E multiple to 21x (from 20x), in-line with other mid-cap companies. Key risks to our Sell include: 1) Ad expenses substantially lower than forecast, and 2) Production at Baddi ramped up, which could lower the effective tax rate.

To see full report: COLGATE PALMOLIVE