Sunday, September 27, 2009


Food security in an environment of increasing scarcity

New and ongoing driving forces are redefining the world food situation. Their combined effect, although impossible to quantify, stands to be a challenge for future food security.

Scarcity is expected to define food production in the coming decades, scarcity of water, and energy, exacerbated by climate change. Competition for land will also be fierce, due to land degradation, urbanisation, biofuel crops and potential carbon sinks.

Demand for food is growing, in line with population and income growth. Globalisation and urbanisation are also contributing to dietary preferences switching towards more resource-intensive food.

Still we believe the growing population (nine billion in 2050) can be fed, provided the right actions are taken. This requires sustained productivity growth in the agricultural sector in an environmentally and socially sustainable manner.

Innovation through a cross-sectoral approach is essential. Particularly promising are the fields of ICT and biotechnology, but also ecologically integrated approaches. The latter work with whole systems rather than individual crops and distribute knowledge, power and autonomy to farmers.

While it is critical to boost food production, the world’s systems for producing and distributing food will also need to change, so they can better cope with shocks and stresses, make more considerate use of resources and ensure more equitable access to food.

Smallholder production is one important key. 1.5 billion people live in households depending on small farms. In order to move from subsistence to commercial farming, smallholder farmers need access to education, knowledge, assets, credit, markets and risk management.

Reforms are essential in the areas of agricultural support, food aid, trade liberalisation, support regimes for biofuels and intellectual property rights. The possibility of better global governance mechanisms for food security should be examined. Watching what we eat and what we waste can also go a long way to this end.

Multiple business solutions are available along the food chain for various sectors of industry. For banks, lending to small farmers is an area with untapped potential. And investment opportunities exist all along the supply chain.

To see full report: GLOBAL FOOD EQUATION


Pipers find their tune

Initiate coverage on pipe sector with positive view
We believe Indian pipe producers are poised to benefit significantly from robust global demand. Pipe companies provide strong earnings visibility despite the current uncertain environment. The Indian pipe stocks have significantly underperformed the NIFTY and the mid-cap indices in the past year on a perception that they are leveraged plays on crude oil prices. The Indian pipes sector is quoting at more than a 20% discount to five-year historical average PER. We highlight five Indian pipe makers in this report and initiate coverage on two of these – Welspun Gujarat and Jindal Saw – with Outperform ratings.

Demand outlook strong for welded, sluggish for seamless
Since the oil & gas sector is the biggest consumer of steel pipes globally, the market perceives crude oil prices to be a key indicator of pipe demand. We believe that demand for welded pipes for oil & gas transmission is driven more by structural factors, like long-term infrastructure requirements, new oil & gas sources and the shift to cleaner fuels than medium-term oil price fluctuations. Despite the low oil price, oil & gas pipeline investments in the US look set to rise
in 2009. Consultancy Simdex estimates 326,000km of pipelines will be built in the next five years, which we estimate would require US$78bn worth of pipes.

On the other hand, seamless pipe demand is highly correlated to exploratory activities, which depends on crude oil prices. We do not expect meaningful E&P activity improvements until the second half of 2010.

High visibility in the uncertain environment
The Indian pipe producers offer strong revenues and earnings visibility despite uncertainty in commodity prices. The strong order book positions of the welded pipe producers can provide comfort at the top line. Large planned capacity additions, coupled with strong global demand, may drive top-line growth. Raw materials (plates/coils) comprise 70–75% of the total cost structure. Pipe producers tie up raw-material and book freight rates as soon as they get a new
order, making the steel cost a pass-through. This has enabled companies to maintain their margins despite the steel price volatility.

Key risks – oil prices and Chinese competition
Any signiciant fall in crude prices may cause oil majors to delay their capex plans, which could hurt demand. However, Macquarie Oil economist Jan Stuart expects prices will rise above US$70/bbl in 2010. Competition from China, especially in seamless pipes, is a risk; however this is mitigated by the US and EU imposing anti-dumping duties on imports of Chinese steel pipes.

Welspun top pick amongst pipe producers
Our target prices of Rs375 for WGS and Rs890 for JSAW imply a 14x FY11/2010E PER, at a 20% discount to the global peer average despite their stronger earnings growth over FY10–12E. Our earnings forecasts for WGS and JSAW are 15% and 7% higher than the Street’s as we believe the market may not be fully factoring in earnings from future orders. We prefer WGS for its stronger order book, large capacity additions and margin gains from backward integration.

To see full report: PIPES SECTOR


Radico Khaitan, the country’s second largest IMFL producer, would report improved margins in FY10 as molasses price is probably past its peak for the current sugar cycle. An aboveindustry
volume growth of ~15% in IMFL and increased focus on main line brands (~75% of total volumes in FY10) would provide revenue CAGR of ~10.6% over FY09-11.

However, we believe ongoing volume growth is more likely a recovery from FY08 lows of 12.8mn cases (vs. 13.5mn in FY07) rather than an indicator of a more stable uptrend. Albeit we note the improving outlook on margin and volumes and revise our FY11 EPS estimates by 16%. The stock trades at a ~38% premium to United Spirits FY11 PER which is unjustified in our view. Raise target price to Rs81 but maintain SELL on an expensive 22.7x 1-yr fwd PE.

Lower molasses, improved input mix to boost OPM
Molasses price have likely peaked out in Q3/Q4 of FY09. Current industry estimates peg sugar output between 14-16mn tonnes in the upcoming crushing season beginning from Nov’ 09 with the possibility of a strong rebound in the next season based on previous cyclical performance. Also the company has ~30mn ltrs/pa of dual feed capacity which would utilize grain to counter higher priced molasses, thereby improving input mix.

IMFL volumes to recover, driven by main line brands
In FY08, Radico experienced a ~23% yoy volume decline in its flagship brand, 8PM Whisky which has now been arrested but even then the brand volume may not reach FY06 levels in the current fiscal. We expect the five main line brands to achieve ~17% growth over next two years while overall IMFL sales would witness a steady 15% growth during the same period.

Raise EPS estimates but retain SELL on rich valuations
We note the improved outlook on margin and recovery in IMFL volumes and revise our FY11 EPS by 16%. However, the stock is trading at a ~38% premium to United Spirits FY11E PER which is unjustified given the scale, OPM and profitability of the latter. Retain SELL with revised target price of Rs81 (from earlier Rs66).

To see full report: RADICO KHAITAN LIMITED


C(h)orus getting stronger

Corus turnaround in 2HFY10
Utilization rates at Corus has picked up from 53% in 1QFY10 to >65% in 2Q driven by restocking demand. Improving economic conditions and seasonal factors will enable Corus to achieve ~80% utilization rates in 4QFY10. Increased fixed cost recovery due to improving utilization and beneficial impact of sliding raw material cost is expected to boost gross contribution by ~USD150/t from 3QFY10 onwards. Realisations in Europe have increased by USD60-70/t in the past few weeks and would positively impact EBIDTA in 3QFY10 onwards.

Its Teesside Cast Products (TCP) facility, though operating at low is breaking even at current slab prices. However, the viability of this facility is still questionable in current environment.

Expansion at domestic operations on track
Tata Steel India (TSI) 2.9mt expansion plan is on track to be commissioned in 2010, and would aid earnings expansion in coming years. Its EBITDA/t of USD258/t for 1QFY10, is expected to improve by USD20-25/t over the next two quarters, as benefits of low cost coking coal flow in. Performance will also be positively impacted from the ferro alloys division due to the sharp uptick in realisations.

Strong cost savings initiatives and bouyant steel outlook in Europe should trigger gradual earnings improvement at Corus and should impact earnings positively from 3Q onwards. Efforts are on to generate USD75-100/t of EBITDA at Corus even in a depressed price regime. This, along with strong domestic earnings aided by increase in scale and upsurge in ferro alloys realisations make for a strong case for earnings expansion over the next two years. We thus have revised our target price to INR551 (from earlier INR501), and recommend a BUY.

To see full report: TATA STEEL LIMITED


Hedge the Risk: Buy Energy

To say crude oil prices are important to India’s macro is an understatement. After all, oil prices affect inflation, private consumption, growth, external balances, liquidity, and the fiscal deficit. Our estimates indicate that every US$5/bbl increase in oil prices above US$57/bbl increases the fuel oil subsidy in India by US$3 billion (0.25% of GDP) if domestic fuel prices are unchanged. However, the impact on equity prices depends on the state of capital flows. If flows are strong, Indian equities can overcome rising oil prices (i.e., they correlate positively with crude oil prices as we have seen in recent months). However, if flows weaken, rising oil prices can derail the markets (correlation becomes negative like in 2Q2008). A sudden spike up in oil prices is what investors need to worry about, in our view, especially if it comes with a slowdown in capital flows.

That said, the longer-term situation with crude oil is getting better for India. Indeed, we forecast that India’s net crude oil import bill will remain at US$100-130 billion. That is, we see oil imports declining as a percentage of GDP from 4.2% in F2009 to 3.9% in F2013, despite a rise in demand. This is due to the shift to gas, rising domestic production as well as rising exports from refineries. Rising gas output has other positive macro implications – increased infrastructure investments, lower fiscal deficit, and higher productivity due to lower energy costs.

The most critical factors influencing the energy sector’s price performance seem to be industrial growth and the short bond yield. Given our positive view on industrial growth going into 2010, the sector’s absolute performance is likely to continue for the coming months. Likewise, rising rates will favor the sector’s performance.

Valuations and earnings look to be in good shape for the sector as well. Valuations are around historical averages whereas earnings revisions have been leading the market for the past three months.

Technical factors also favor the sector. Most important, the sector’s six-month trailing relative performance is at a level from where it usually rallies versus the market.

Our global commodities team recently highlighted improving near-term fundamentals in the oil market. Jonathan Garner has turned significantly bullish on the energy sector in both his EM and APXJ model portfolios. Our European strategy team has made Energy the biggest overweight. The Indian Energy sector correlates strongly with EM Energy, and hence these positive views are important. We recommend investors overweight Energy to hedge against the ill effects of a sudden spike in crude oil prices on Indian equities.

Our top pick in the energy sector is Reliance Industries (RELI.BO, Rs2,101). The stock has underperformed the market and we believe that a lot of bad news is in the price. At 11.6x F2011 earnings, we find the stock attractively valued. We are also adding Cairn India (CAIL.BO, Rs262) to our Focus List. Cairn India is a direct play on crude oil prices, which our global commodities team believes are likely to rise. Cairn has underperformed the market year to date. We are funding this change by removing ONGC (ONGC.BO, Rs1,161) which has been a stellar performer.

To see full report: INDIA STRATEGY


Re-engaging on Better Cycle Visibility – BRCM is Top Pick

India will likely require another ~5mn tons of raw sugar imports in F10: Poor monsoons in the key sugarcane growing area in India will likely limit the F2010 sugar production to ~16 mn tons. This coupled with an opening inventory of around 6 mn tons and consumption of around 22 mn tons means that India will need to import ~5 mn tons in F10 (for refining in F11) in addition to the ~5 mn tons imported in F09. A combination of better cycle visibility, higher cane availability in F11, the continuing raw sugar refining opportunity and absence of government intervention to control sugar pricing drives our industry view upgrade. Given the recent underperformance of North Indian millers, Balrampur Chini (OW) is our top sector pick.

Why the government is unlikely to intervene: Our channel checks suggest that the government will look at controlling the sugar price for only ~6 mn tons of retail consumption. Prices for the remaining ~16 mn tons of wholesale consumption will likely be market determined. The government proposal to increase the levy quota from 10% to 20% is a step to protect the interest of retail consumers of sugar, we believe. This move while positive for sugar millers (it cuts out uncertainty of incremental government intervention) will impact near term sugar consumption adversely, in our view.

Where we differ: 1) The government will likely differentiate between retail and wholesale sugar consumers, thereby reducing risk of ad hoc policy changes to control prices. 2) Domestic sugar realizations will likely continue to trend higher in-line with international parity prices. Sugar prices will likely peak in F11. 3) Sugar refining should continue to drive overall earnings in F11, albeit at lower margins. 4) India is unlikely to be a structural importer of sugar; high cane procurement prices will likely incentivize planting, driving capacity utilization and higher operating leverage in F11.

To see full report: INDIA SUGAR



Upside from new tower deals
We have increased forecast revenue / EBITDA over the next three years by 5-8% to account for recent tower deals, and higher incremental external tenancies of ~0.5x (to give total external
tenancies of ~1.0x). RCOM is well positioned to be able to offer end-to-end services (backhaul / network management), and is perhaps being more aggressive and offering greater discounts /
incentives on these deals. We assume EBITDA margins of 52-55%, with monthly revenue / tenant / tower of ~INR30k, as there are still uncertainties on the survivability of some new-comers. We derive an EV of US$7bn for the towers (INR77/share).

More clarity on normalised numbers
We have adjusted FY09 numbers for one-time non-operating gains / losses, provisions, write-offs etc, after the release of the annual report. We estimate underlying NPAT of INR38bn, vs the INR59bn reported, representing a 11% y-y fall. This also adjusts for one-time investment
income from the sale of a 5% stake in the tower business in FY08.

Competitive intensity remains unchanged
Our recent discussions with the company suggest: a) the operating environment remains competitive; b) RCOM is holding its position, with monthly net adds of 2-2.3mn; and c) the revenue outlook is for mid-single digit growth in the upcoming quarter, we believe. Aggressive promotions by new carriers have kept a lid on net add growth for incumbents. With Telenor and Etisalat now making headway with their service launches, pricing has yet to hit bottom. The company’s early repayment of debt is also encouraging; along with continued improvement in wireless business and progress on listing the tower business, this could be another catalyst for the stock.



PSU Banks – strong outperformance ahead

  • G-Sec yields headed south…Time for PSU banks
  • PSU banks gyrate in tune with G-Sec yields
  • G-Sec yields –current forces at play
  • Ample liquidity fails to inspire confidence in G-Sec yields
  • Now, incremental pressure of Govt borrowings to ease...
  • …and favorable regulatory posture to sustain
To see full report: INDIAN FINANCIALS


Some progress made, but key risks still exist; off Conv list, still Sell

What happened
We remove Reliance Power (RPWR) from our Conviction Sell list and raise our TP to Rs128 (from Rs105) primarily to reflect financial closures of Rosa, Sasan & Butibori over last 3 months. Though we believe financial risk has been mitigated to some extent, we think risks relating to fuel, land and offtake of output still exist for several RPWR key projects. Retain Sell with 22% potential downside, as valuations do not reflect risks for its key projects, in our view. The stock is up 26% since we added it to Conv list on May 13, 2009 vs. 35% for Sensex; the stock rose after the election outcome in May. Last 12 months: -3% vs. Sensex +16%.

Current view
While the execution of the Sasan, Butibori and Rosa projects has improved, uncertainty related to fuel, land and off-take of output for RPWR key projects such as Krishnapatnam, Chitrangi, Dadri and Shahapur remains. Krishnapatnam (4GW): No visibility on time frame and pricing of
coal supplies from its mines in Indonesia. Chitrangi (3.9GW): The acquisition of land is still not complete and the off-take is not tied up. Dadri and Shahapur (10.3GW): Progress on these projects hinges on the resolution of the court dispute between RIL and RNRL.

Based on our scenario analysis of the RIL-RNRL court case, we see 48% potential downside to RPWR’s share price in the event it does not receive gas supplies. (For details see our Sept 16 Reliance Infrastructure note, Balance sheet leverage to drive future growth; initiate with a Buy.)

We derive our new NAV-based 12-m TP for RPWR after quantifying the risk associated with the projects by assigning a 10% discount for six individual milestones yet to be achieved. With just 3.1% ROE for FY11E, the stock is trading at 2.7X FY11E P/B, vs. peers’ 2.5X but average ROE of 13%. Note that we lower FY10E-12E EPS by 1%-6% on higher minimum alternate tax of 16% vs. 11% previously. Key risks: 1) Resolution of court case in favor of RPWR; 2) completion of project milestones ahead of our estimated timelines.

To see full report: RELIANCE POWER