Wednesday, October 7, 2009


Disruption first, consolidation later

Downgrading sector and stock views: We have been caught by surprise by the tariff announcements in the last two days – by the extent of cuts, the timing and the need for such severe cuts at one go without really testing the resultant elasticity. We downgrade our sector outlook to Underweight, as we foresee inevitable competitor responses likely in a matter of days, in different shape and form, from Bharti Airtel, Vodafone Essar and Idea Cellular. While longer-term value may well emerge, the likely barrage of competitor responses and associated negative noise will likely cap any meaningful near-term re-rating. We thus recommend that investors avoid Indian telecoms, as a dynamic game of price positioning plays out over at least the next two to three quarters. We cut earnings and target prices across the board and downgrade Bharti to Underperform. We maintain our Underperform ratings on Idea and MTNL.

Within the sector, we see relative value in the most efficient player – Bharti: This rapid rebasing in pricing by an incumbent (as announced on Monday) will seriously affect and threaten smaller, regional and startup operators, perhaps shortening the period before which industry consolidation inevitably takes place. While we would view this as ultimately a structural positive for Bharti, which we believe is the best positioned of all the operators to weather an intense period of irrational price competition, the timing of possible industry consolidation is too uncertain to consider this in our investment recommendation.

Price cuts and promotions are not new in Indian wireless; what is new is that one of the three wireless incumbents has done it: This marks a major shift in industry dynamic and is fundamentally different from a smaller, unprofitable player resorting to price cuts (which we had anticipated earlier).

Price plans of all kinds are being tried out, all having a dilutive impact on ARPM and, more important, ARPU as MoU elasticity is not evident: Tata DoCoMo launched a per-second pricing plan on GSM and a fixed price per call on CDMA (unlimited duration per call) in July 2009, and now we have a flat rate per minute tariff offering. The other key tariff positioning is an ‘unlimited bucket plan’ offer that is seen in many other markets but has not been seen in India. However,the large GSM incumbents may be capacity-constrained on 2G. However, that may change if 3G spectrum is awarded. Without 3G, however, the response from incumbents may be focused on on-net calls to prevent the existing subscriber base to move away to the competition. The lack of MoU elasticity is a key driver of our downgrades in the sector.

We cut Bharti’s EPS by 12.5%, 27.5% and 28.7% for FY10E, FY11E and FY12E, respectively, with a new DCF-based TP of Rs320 (FY3/11E PER 12.8x), down from Rs525. We cut Idea’s EPS by 37%, 86% and 72%, respectively, with a new TP of Rs35, down from Rs70. We build in sharp drops in ARPM (16% for Bharti, 18% for Idea) in the current quarter. If Bharti stock were to go down to around Rs300 (FY11E PER of 12x), then we think longer-term investors should start to accumulate. However, value arguments in near term will hold little weight as the likely rounds of competitive responses play out in the next two to three quarters.

To see full report: INDIA WIRELESS

>US: Long end dominates ... for now (DBS)


• Developments at the long end currently matter more to the steepness of the USD yield curve than what happens at the front end and the Treasury curve is likely to continue to flatten into rallies and steepen into selloffs

• With 10Y Treasury yields approaching 3%, the current bull flattening will soon be over and should give way to bear steepening in 2010

• Many expect rate hikes from the Fed in 2010, but rate hike expectations alone are not enough to produce a flatter Treasury curve – the curve will bear flatten substantially only when the Fed hikes rates

• The first Fed hike will mark the onset of the bearish curve flattening trend in Treasuries, but before that front-end steepening in the Fed Funds-to-2Y segment in 2010 is more likely to produce a steeper than flatter 2Y/10Y curve

• Historically the 2Y Treasury yield can trade at a wide 150-200bps spread to Fed Funds before the first Fed hike without causing the 2Y/10Y curve to flatten considerably.

To see full report: INTEREST RATE STRATEGY


The recovery is here, within reach… But we are nevertheless going to have to differentiate between the technical factors that will temporarily boost activity data, giving the illusion of new-found growth, and the underlying trend, which is extremely fragile.

It’s like the elastic band that has been stretched too far and which sprang back when economic activity stopped hit the buffers at year-end. Just the simple upturn in production and the ratchet effects transmitted through global trade, with its internationalised chain of value-added, seems likely to generate a marked rebound in growth in the second part of the year. Not forgetting that the inventory cycle (less downsizing followed by rebuilding) could also bolster the trend by adding a supplementary spurt to output.

Our projection takes these technical factors into account, with an upwardly revised second-half growth figure, also synonymous of emergence from recession, for most industrialised countries, as early as Q3.

But if the elastic is to be stretched even further and lead to strong, self-sustained growth, we will need other traction factors on the demand side which, in our view, are likely to be missing. In other words, the underlying trends will end up by taking over to guide the global economy along a sluggish postbubble growth path, the time it takes to clean up global finance. The global reduction in indebtedness is a lengthy process that will doubly constrain private consumption, especially in countries where the credit boom erred on the side of excess. The scars of
the crisis will still be discernible in 2010, with growth rates on either side of the Atlantic far lower than those traditionally observed during a recovery phase after such a deep recession. However, given the scale of the stimulus injected into the economy, the transition to this less leveraged growth regime is very likely to be gentle and the risk of a relapse is, in our view, low, in the short-term at least.

Sooner or later, however, the fiscal and monetary drips that are artificially keeping growth going will have to be removed. The question of timetable is critical since the idea is to remove the stimulus neither too early to avoid stopping the emerging recovery in its tracks, nor too late, to avoid committing new excesses, with their potentially inflationary (real and financial) cocktail. At all events, this question of an exit strategy will preoccupy the markets over the coming months. From the monetary policy angle, central banks have two strengths to help them successfully
see this arduous task through. First, they have considerable credibility in view of the success
of their nominal anchoring policy. Second, they can talk up to guide market expectations. On the fiscal front, the field of communication currently lies fallow and the authorities’ credibility is at quite a low ebb – two vacuums which it will be necessary to try and fill, even though it is well known that it will be extremely difficult to remove the stimulus lifesupport system in a sluggish growth environment.

To see full report: PERSPECTIVES


First-Mover Advantage; Initiating at Overweight

Best way to participate in India’s rapidly growing Satellite TV industry: Our Rs55.90 price target for Dish TV shares implies 34% upside from the current market price. Given Dish TV’s first-mover advantage, we project healthy and sustainable earnings growth over the next
3-4 years. At 7.1x EV/EBITDA and EV/sub of US$118 on our F2012 forecast, DTIL is at substantial discounts to its global peers considering its EBITDA growth profile. Hence, we find DTIL’s valuation attractive.

Satellite TV subscriber base to expand at 37.9% CAGR in F2009-13E: Consumer demand for digitalquality reception and a wider array of TV channels should drive growth in Satellite TV, popularly known as DTH (direct-to-home) in India. As the fragmented LCO industry (Local Cable Operator, owner of the last mile in cable TV networks) responds slowly to this challenge,
Satellite TV’s penetration of pay TV households should grow from 14.4% at end-F09 to 30.7% at end-F13.

India’s No. 1 DTH operator, with ~36% market share: DTIL’s net subscriber base of 4.3mn at end-F09 should enable it to scale up to 9.4mn subscribers in the next four years, conservatively adding ~20ppt of incremental market share. We expect revenue to log a 41% CAGR through F13, supporting a jump in DTIL’s EBITDA to Rs9,894 mn from a loss of Rs1,233 mn in F09. Pressure on ARPU’s and subscriber acquisition costs should ease starting in F12 as large players achieve critical scale.

Market is unduly pessimistic, we believe, on competition, possible funding issues, and Dish TV’s profitability. These concerns should ease as Dish TV breaks even in 2HF11 and funds its capex adequately.

Where we could be wrong: Threats from DTH competitors, cash burn, and problems in raising funds for the next growth leg could all prove worse than we expect. Also, DTH’s progress may abate if the cable industry can consolidate quickly and start investing to maintain its share of the pay TV market.

To see full report: DISH TV


Risky proposition
A lot has been written, interpreted and analyzed about the spat between RIL and RNRL from
RIL’s perspective, while the RNRL angle has been given a miss. Here we once again focus on the RIL-RNRL imbroglio, but discuss and present an impact analysis for RNRL.

RNRL's business model
RNRL's main business is likely to be sourcing gas from RIL and supplying the same to the group’s gas-based power generation projects. That apart, the RNRL-led Consortium has also won 4 blocks under CBM-III and is the second largest player in terms of CBM acreage in India. It has an acreage of 3,251 sq km. The company has also won a block in Mizoram under the NELP-VI round. Applications have also been submitted to MoPNG and PNGRB for grant of authorisation to RNRL to set up a city gas distribution network in Mumbai, Delhi and in the National Capital Region (NCR). Currently, RNRL is engaged in coal supply for which it has entered into freight contracts for transportation of coal from Korba to the Dahanu Thermal power station.

Outcome of the RIL-RNRL spat - Critical to business model of RNRL
RNRL’s business model revolves around sourcing natural gas from RIL. RNRL has an
agreement with RIL for sourcing gas from the latter’s block in the KG-Basin. This is based on
the Gas Supply Master Agreement (GSMA). Thus, GSMA represents potentially all the
company's assets.

As RNRL is currently active only in one business area, viz. management of fuel services for
affiliate companies, outcome of the court ruling is likely to be the critical variable impacting its
stock price. Pending the outcome, we have carried out a scenario analysis to gauge the likely
impact of the outcome of the legal tussle on RNRL's stock price.

Scenario I - RNRL loses the court case
If the outcome is not in favour of RNRL, the stock could see a significant correction on the
bourses. We believe that the market is currently ascribing significant value to the RNRL stock
in anticipation of a positive outcome of the court case. This is visible from the premium valuation
the stock is fetching in terms of P/E and P/BV.

Scenario II - RNRL wins the court case
In the event of RNRL emerging victorious from the legal battle, the stock would react positively.
However, the stance on the Marketing Margins allowed to be charged as well as timing of the gas
flows would determine the stock price movement. We have arrived at four scenarios on this front. We have assumed the required rate of return from investment/discount rate at 14.0% for calculation of value of the company’s gas business.

As is apparent from the Scenario Analysis, RNRL's future is not only dependent on the outcome of the legal tussle with RIL, but also on uncertainties regarding matters such as the level of Marketing Margins allowed to be charged and likely compensation for opportunity loss (in event of winning the case), which would impact its Fair Value.

To see full report: RNRL


Resistance @ 5150

The Nifty recovered sharply from yesterday’s low and has opened in green on strong global cues. On the lower end 4900 again acted as a good support and still remains a crucial support. However, the upmove in the Nifty is currently not supported by the momentum indicators. On the upside, 5150 remains a crucial resistance. So, the Nifty is in the range of 4900-5150.

On the hourly charts, the KST momentum indicator has a given a positive crossover and is trading below the zero line. The Nifty is trading above the 20-HMA and 40-HMA, ie 5029 and 5019 respectively, which are support levels in the immediate run. The market breadth is positive with 1,052 advances and 193 declines.

To see full report: HIGH NOON




Distillate crack spreads should widen, although part of this is captured in the futures curve contango. Good news for refiner stocks.

The current state of affairs in the refinery sector is a mirror-image of the “excellent” industry conditions and euphoric investor expectations that prevailed in 2006 and 2007. Inventories of distillate fuels are at an all-time high, while consumption is plummeting. Distillate cracks are down $25 from their record high 16 months ago and projections of refineries’ earnings are gloomy (Chart 1, top panel). Valero shutdowns and layoffs add to the negativity.

This pessimism about the refining outlook is overdone and a contrarian strategy is warranted. Structural shortages of distillate products, caused by rapid shifts in government fuel content regulations, will resurface at a time when economic prospects are improving. Obvious beneficiaries are distillate refining margins and refining stocks.

Our research shows that distillate crack spreads will soon widen as global economic growth strengthens. Some of this may be priced into the distillate forward price curve. As a result, we anticipate onlytactical opportunities (i.e. not “buy and hold”) from the long side.

One asset that has not anticipated a cyclical rebound in crack spreads is refining stocks. Refinery stocks are at the low end of their long-term range in absolute terms as well as relative to the broad market (Chart 1, bottom panel). The reason is that market participants believe that global refining capacity is in oversupply and therefore refining margins will stay low for the foreseeable future. Furthermore, some analysts are proclaiming the end of the distillate era, suggesting that massive investments in diesel capacity will not bring positive returns.



Elecon Engineering Company Limited is a leading manufacturer of mission critical Material Handling Equipment and Power Transmission Solutions for Defence, Mining, Power, Steel, Plastic, Sugar and Cement amongst other sectors. We believe, with an established set-up, Elecon
Engineering would be among the key beneficiaries of the increased investment in sectors such as power, cement, mining and steel, which contribute significantly to its bottom line. Further, the changes in the product mix, entry into the wind energy segment, coupled with a healthy order-book, lend greater confidence to its earnings visibility. We expect revenues to grow at a CAGR of ~20% over FY09-11 and expect net earnings to grow at a CAGR of ~24% over the same period. Leading player in MHE and Industrial Gears segment Elecon Engineering is a leader in industrial gears with a market share of 26% and also has a dominant presence in the Material Handling Equipment.

De-Risked Business Model
Elecon Engineering offers a range of products and solutions for various industries which helps the company to distribute the risk across a wide spectrum of industries.

Strong Order Book
The Company has a strong order book of Rs 15490 mn, of which Rs 13040 mn (84.18%) is from the Material Handling Equipment segment and the rest Rs 2450 mn (15.82%) is from the Industrial Gears segment.

We possess a positive outlook on the MHE and the Power Transmission business of the company. However we don’t see any significant business traction from the wind mill and wind mill gear box segments in the near term. At the current market price of Rs.96, the stock trades at 15.5x its FY09 earnings of Rs 6.19, 14x its FY 10E earnings of Rs 6.87 and 10x its FY 11E earnings of Rs 9.50. We recommend Accumulate with a target price of Rs 114 based on 12x its FY11E earnings i.e. a potential upside of 19% from its current levels.

To see full report: ELECON ENGINEERING


Over the past few months two-wheeler volumes have been on a steady rise, primarily driven by strong in rural volumes. However off late there have been indications of a recovery in urban volumes. To understand the ground realities, we conducted a dealer survey for two wheeler manufacturers with focus on tier-I and tier-II cities. Our coverage encompassed 30 dealers from cities of mumbai, Delhi, Chennai, Hyderabad, Nashik, Bangalore, Ahmedabad, Jaipur, Nagpur, Indore, Coimbatore, Amritsar and Vadodara. Hero Honda dealers accounted for 47% of the dealers surveyed while 37% were Bajaj Auto dealers and remaining 17% were from a mix of TVS motors and multi-brand dealers. Most of the dealers felt that the current festive season would be better than previous year and the current growth trend is likely to peak out following the festive season.

  • Festive season a key driver for growth
  • Economic recovery improving consumer sentiment
  • Manufacturer's efforts vital for enhancing brand value
  • Credit availability improving but still below historical highs
  • Outlook remains positive
  • Stocks adequately factoring near term earnings growth
To see full report: AUTOMOBILE SECTOR