Thursday, October 8, 2009

>Gold's lure for investors makes it a riskier asset

London - The dominant role of investors in gold's rally to a record high this week raises the likelihood of a sharp correction in coming months before the metal rallies to higher prices next year, analysts said Wednesday.

Gold's rally to above USD1,000 a troy ounce has put it out of the reach of many jewelry buyers in gold-loving countries such as India and those in the Middle East. This leaves the market increasingly drifting free of its traditional anchor.

The latest move has been driven by speculators chasing prices higher. Should the dollar correct or inflationary signs prove elusive, a selloff could trigger a stampede for the exit with few buyers willing to take gold except at prices possibly 10% below today's, analysts said.

"If investment is taking over as a real driver of the market, then where does the support come from if investors do decide to pull out of the market for whatever reason," said Tom Kendall, a precious metals analyst at Mitsubishi Corp. in London.

UK-based metals consultancy GFMS in its annual survey last month forecast investment demand will account for 34% of world gold demand in 2009, up from 23% in 2008 and a stark contrast from the year gold began its long bull run in 2001.

In that year, investment demand was 364 metric tons, worth at the time $3.2 billion and a small share of total world demand. GFMS's forecast of 1,770 tons of investment demand in gold would be worth $51.6 billion at Wednesday's price of $1,042 an ounce.

The rapid proliferation of gold investment products catering to institutions, hedge funds and retail investors in the past four years has been responsible for this sea change by making it easier and cheaper for investors to get exposure directly to the gold price, rather than shares in gold-mining companies.

Gold exchange-traded products now have nearly 1,750 metric tons of gold under management, according to Barclays Capital, equivalent to about three quarters of annual world gold production.

Big name hedge fund managers like John Paulson at Paulson & Co. and Greenlight Capital's David Einhorn have captured the spotlight with their big bets on gold - Paulson at one point this year held nearly 9% of the world's biggest gold ETF, according to its regulatory filings - but pension funds and mutual funds have also gravitated to gold for its perceived status as a store of value.

"Ten years ago, there would have been very few funds that would have been active in gold," said Mitsubishi's Kendall. "Today even pension funds are active in gold."

The growing dominance of investors is making the market more volatile and deterring jewelry buyers, who have long been a steadying factor on prices.

Gold's reliance upon investor demand opens the market up to increased volatility, as short-term oriented investors are more likely to sell their positions during corrections, said Barclays Capital analyst Suki Copper, at a conference in London Wednesday.

According to the latest futures data for Comex gold futures, the net speculative long position stood at 28.8 million troy ounces, or 896 tons, and reached record highs in recent weeks.

Jewelry demand, meanwhile, fell by nearly a quarter in the first half to 760 tons, and is expected to fall by 20% for the year as whole, according to GFMS.

The metals consultancy estimates this will leave jewelry demand accounting for 44% of world demand in 2009, down from 70%-80% in recent years.

"[This] makes for a more volatile market," said GFMS chairman Philip Klapwijk. "It tends to lead to more pronounced swings in price because investors chase prices."

Klapwijk said jewelry's share of world demand could drop to a third over the next year, since there is little reason to think the U.S. will raise interest rates or support a strong dollar policy. A situation similar to gold's spike in 1980, when it rose to a record high, in current inflation-adjusted terms, of about $2,221 an ounce and jewelry demand was squeezed out of the market, could occur again as gold prices rise to record highs in 2010 before correcting sharply again.

"It's heading towards that type of extreme, and that type of extreme is nearing what's unsustainable," he said. "The problem is what happens when the music stops."



Bonus party spoiled

Markets on Oct 08, 2009: Negative divergence
Nifty opened in green with positive expectation on Reliance Industries, which recommended a 1:1 bonus share yesterday, but almost gave up all its gains at the end of the session. Nifty has been trading in the range of 4900- 5150, where 4900-mark is quite crucial as the index has taken this support two times earlier. The up-move in the index is not supported by momentum indicators, which continue to remain in sell mode and such a negative divergence acts as a hurdle for markets to move higher. Also, Nifty is unable to cross the swing high of 5110 made on last Thursday, which still remains a strong resistance on the higher side. So, till this range is broken on either side we may see a sideways movement. We maintain our bias down as the trend is heading lower.

On the daily chart, Nifty is trading above its 20 daily moving average (DMA) and 40DMA at 4947 and 4765 respectively, which are crucial supports in the near term. The momentum indicator (KST) had given negative crossover and is above the zero line. The market breadth was negative with 579 advances and 690 declines on the NSE and 1,280 advances and 1,596 declines on the BSE.

On the hourly chart, Nifty is trading around its 20 hourly moving average (HMA) and 40HMA at 5005 and 5027 respectively, which are now resistances in the short term. The momentum indicator (KST) has given negative crossover and is trading below the zero line.

Nifty and Sensex closed marginally in green gaining 17 and 37 points respectively. Of the 30 Stocks of Sensex, Bharti Airtel (down 6.61%) and Reliance Communications (down 6.01%) and Tata Consultancy Services (down 3.36%) were the top losers while ITC (up 3.52%), Cipla (up 4.35%) and Tata Motors (up 5.35%) were the top gainers.

To see full report: EAGLE EYE 09/10/09


Future prospects offset concerns: Hold on raised TP

Fundamentals healthy; valuation rich at US$90-100/bbl implied crude price
We maintain Hold on Cairn India and raise our TP by 18.8%, based on our oil team’s increase in CY10/FY11 oil price forecasts (unchanged beyond CY10/FY11). Following this, we revise earnings forecasts and have also added FY12 estimates. Our Hold rating is based on potential E&P success and positive earnings momentum from the Rajasthan start-up offsetting concerns.

Smooth Rajasthan ramp-up depends on trucking logistics, pipeline schedule
Cairn anticipates that wells/trucking preparations are on track for train I, which recently started to ramp up to 30kbpd, but we believe this and future ramp-ups entail logistical challenges. As for the pipeline, the company warned that inherent project execution risks and weather could pose challenges to its Dec’09 target. Oil price and E&P upside potential hold the key for longer-term outlook In our view, Cairn India offers a good mid-sized India-centric E&P prospect. Cairn has net OGIIP of 3.1bn, net 2P of 815m, and net unrisked resources/prospects of 1.4bn boe, spread over its 14 exploration blocks.

US$ 10-20/bbl swing in Oil price makes or breaks the stock
Our target price is INR240/sh, based on a core NPV of INR248/sh, risked upside of INR29/sh, net debt of INR5/sh, and negative impact of cess at INR32/sh. Upside risk: higher oil realization; large oil & gas discovery; M&A action. Downside risks: further worsening in oil demand on persisting global economic woes; excess supply posing a downside risk to the oil price, slower ramp-up, and production outage and policy issues. (Please see pages 10-12 for further details on valuation
and risks.)

To see full report: CAIRN INDIA


The specialist

Focused company entrenched in its local markets
We initiate coverage on Anant Raj (ARIL) with an Outperform rating and target price of Rs180 (30% upside). We believe that one of ARIL’s biggest strength is that it operates as a ‘local’ business. Nearly 90% of ARIL’s land bank is focused around the National Capital Region (NCR: in north India, around Delhi). This geography is at the forefront of the ongoing revival in the Indian real estate market. After going through a painful period in CY08, which saw a collapse in primary sales and exit by speculators, the NCR has seen a sharp revival in interest. Conversations with the management of three property companies and brokers suggest that the NCR has seen the smartest rebound in residential market volumes. Over 10m sqf of residential property was sold in project launches since March 2009. Meanwhile, enquiries for commercial space have seen initial signs of a pick-up.

Conservative management style – a rare characteristic
Land purchases by developers across India picked up sharply during 2006–08. Unlike many of its peers, ARIL resisted the temptation to add leverage and buy land at peak cycle valuations especially in new geographies where it had no expertise. In fact, ARIL sold assets (including land) and raised funds during that period. This ensured that it emerged from the 2008 downturn as one of few real estate companies with a net-cash balance sheet. ARIL was therefore able to continue its strategy of purchasing attractive land parcels at reasonable rates.
The company also holds a portfolio of yielding assets, which provides comfort on cash inflows (Rs2bn pa expected from FY12E).

Keys risks mitigated – valuation discount unwarranted

  • Attractive valuations: ARIL is trading at a 39% discount to NAV. This is notable given that most Indian property stocks trade at only 5–10% NAV discounts and modest premiums in some cases. This is primarily because of its concentrated land bank and exposure to the commercial and hospitality sectors.
  • Contrarian view on key sub-sectors: As discussed earlier, the focus on the NCR actually works in ARIL’s favour. We also believe the exposure to the commercial and hospitality sub-sectors (62% of NAV) is, in fact, a positive. Our channel checks indicate initial signs of a pick-up in hiring. We believe this is likely to drive demand for space 6–8 months from now. However what is priced into the street’s NAVs and stocks prices are the rent, occupancy and cap rate assumptions from December 2008. This, to us, is clearly conservative. We also expect hotel room rates and occupancy to stabilise in CY10. This view is based on Macquarie’s forecast of a broader economic recovery and reduced concerns of oversupply in this space. We therefore believe that ARIL deserves to trade at a 20% NAV discount – in line with our target NAV discount for its mid-cap peers.

Property outlook – NAV upgrade cycle is still in its infancy
ARIL should benefit from the NAV upgrade cycle, which we expect over the next 2–3 years. Our experience from past cycles in more developed markets (eg, Hong Kong) shows that NAVs can move up by 2–3x from the trough to peak cycle. In India, some drivers of upgrades are obvious. WACC of 15–16% and cap rates of 12–13% at bottom-cycle rents are clearly pessimistic, in our view.

To see full report: ANANT RAJ



In the month of September 2009 we saw a volatility Bond Market. Government bonds yields moved down weak on hope of hike in HTM (Held on Maturity) limits of banks. The RBI (Reserve Bank of India) had indicated that they are evaluating proposals for a hike in HTM category from current levels of 25% of NDTL (Net Demand and Time Liabilities). The market is expecting at least a 2% hike in HTM and a mid year transfer of securities to HTM portfolio from mark to market portfolios. A 2% hike in HTM would mean banks have an additional room of Rs.80,000 crs to absorb government bonds into their books. A mid year transfer of securities from mark to market portfolios to HTM portfolio will enable banks to escape higher provisioning if yields rise further. The HTM news is largely discounted at current levels of yields and if RBI disappoints the market will react negatively.

The 10 year benchmark bond, the 6.90% 2019 bond yield slip down by 25bps & closed at 7.19% levels at the end of the month. The 5 yrs benchmark bond, the 6.07% 2014 bond saw yields move down by 10bps to close at 7.17% levels. On 7th Sep 09 Comments by a senior Finance Ministry official, who remarked that the government was likely to finish most of its planned market borrowing for FY10 by January and was likely to stick to its market borrowing target of Rs.4.51 lakh cr, fanned this view. The 10-year benchmark 6.90%, 2019 government bond ended at Rs.97.27 or 7.2915% yield up from Friday's closing of Rs.96.08 or 7.4673% yield.

Even Corporate bond yields were moved down, 5 yrs benchmark bonds traded at 8.46% levels down by 13bps while 10 year benchmark bonds traded at 8.80% levels. 5 year spreads closed at
122.10bps levels while 10 year spreads closed at 132.10 bps levels on month end.

Indian government's fiscal deficit rose 56.0% on year to Rs.1.823 lakh cr during Apr-Aug, the first five months of 2009-10, accounting for 45.5% of the Budget target. Indian government's total receipts in the first 5 months declined 1.0% to Rs.1.610 lakh cr, while net tax revenues declined 14.8% to Rs.1.068 lakh cr; total spending during Apr-Aug rose 22.8% from a year ago to Rs.3.433 lakh cr. Government's tax collections in August fell 13.1% on year to Rs.32300 cr while gross tax collection in the first 5 months of FY10 declined 11.6% to Rs.1.683 lakh cr.

Inflation as measured by the WPI (Wholesale Price Index) turned positive after 13 weeks in the data as on Sep 5 at 0.12%. As on Sep 12 Inflation rate based on the Wholesale Price Index rose to 0.37% mainly on account of an increase in primary articles and manufactured products. Planning Commission Deputy Chairman says that India's headline inflation rate based on the Wholesale Price Index may move out of the comfort band of 4.0-5.0% by March due to pressure on prices.

To see full report: DEBT OVERVIEW


RLife loses market share for second consecutive month
Rlife’s market share in individual non-single new premium sales declined for a second consecutive month. It was 8.9% in August, down from 10.3% in July and 11% in FY09.

For the overall private sector, some slowdown in growth compared with July but still better than 1Q FY10
Overall private sector growth (y-y) in individual non-single new premium sales in August came in at (-) 4.1%, taking the cumulative growth rate in the year to August to (-) 14.6%. We note there is a significant base effect in play this year, as there was a structural decrease in growth rates in 2H FY09. Hence, we would advise investors not to focus too much on the negative y-y growth seen so far this year.

We would rather look at our de-seasonalised analysis of growth. On this measure, we believe that the August sales data is pointing to full year growth of around 21% in FY10F. This represents a decline from the data for the preceding month, which was tracking a full-year growth rate of 24%. However, it is clearly higher than the trend seen in 1Q FY10, which was hinting at full-year growth of 10-13%.

Overall private-sector growth masks sharp divergence among players
While overall private-sector growth was reasonably strong, we highlight that it masks a sharp divergence in growth rates among various players. This makes it hard to decipher whether the key driver of RLife’s performance in the past few months was on account of the overall sector trend or because of company-specific factors.

We note that growth in August came in almost entirely from three players – ICICI Pru Life, HDFC Standard Life and Birla Sunlife. Private-sector sales in August were up 9% on an m-m basis. However, excluding the above-mentioned three players, there was actually a contraction of 1%, highlighting the contribution of these three to the overall growth figure.

Historically, spikes in market share have been preceded by rapid expansions in distribution networks. Companies benefited from enhanced distribution networks and this was reflected in their market share. In this case as well, it seems that both HDFC Standard Life and Birla Sunlife are benefiting. However, this may not fully explain ICICI Pru Life’s performance, as most of its expansion was done by FY08. On the other hand, we are disappointed with the performance of RLife on this front. We note that RLife has been one of the most aggressive companies in terms of distribution network expansion over the past few years. Hence, we have been expecting RLife to gain market share this year. Performance so far has been disappointing on this count.

Increase in ticket size seen across players
We also highlight a clear trend of increases in ticket size across players, including RLife. This is an indication that it is unit-linked policies that are driving growth, in our view. We also note that the increase in ticket size of those players gaining market share has been even more pronounced and is in fact at the highest level ever.

Maintain REDUCE on RCFT
Using SOTP valuation, we value the company at Rs834/share (target and method unchanged; see Exhibit 8). FY10-11F earnings fine-tuned; REDUCE call maintained. We continue to believe that the risk-reward for RCFT is skewed to the downside. The key upside risk to our valuation: if margins in the insurance business come in higher than we are forecasting. Key to this scenario unfolding would be new premium sales growth coming in significantly higher than we are forecasting.

To see full report: RELIANCE CAPITAL


On a seamless growth path

Key points
Improving demand environment: ISMT Ltd (ISMT), an integrated seamless tube manufacturer in India, is set to benefit from the overall improvement in demand from its traditional user segments of automobile and mining companies. In addition, the company would gain from the efforts taken to expand its product offerings and increase the size of the addressable market by penetrating into energy (boiler tubes) and oil exploration (oil casing and tubing goods) sectors. Moreover, the anti-dumping duty imposed by the USA and European Union on the Chinese seamless tubes will also boost the demand for Indian seamless tubes in
the export market.

New technology, capacity expansion to drive volume growth: ISMT is expanding its tube production capacity at Baramati to 475,000 tonne per annum (TPA) as well as installing a new premium quality finishing (PQF) mill. The technology advantage coupled with the cost saving through the installation of a 40MW captive power plant would provide the right competitive edge to ISMT in the export markets. Consequently, we expect ISMT’s seamless tube sales volume to grow at a CAGR of 27.4% over FY2009-FY2011.

Margins to inch up: Despite a highly competitive environment and the investments made to expand its operations in the overseas markets, ISMT is expected to show an improvement of 50-60 basis points in its operating profit margin (OPM) over the next two years. The margin improvement would be driven by: (1) a favourable sales mix (sales of high-margin power and oil country tubular goods [OCTG] seamless tubes to increase to 45% in FY2011 from 38% in FY2009); (2) saving on the power cost; (3) cost reduction from new technology (PQF mills);
and (4) economies of scale.

Compelling valuations: We expect the company’s profit to grow at a CAGR of 60% over FY2009-FY2011 on the back of a strong demand growth and margin improvement. Considering the strong growth expected in its earnings, we believe that its stock is trading at very attractive valuations of 4.4x its FY2011 expected earnings and EV/EBIDTA of 4.5x. We initiate coverage on ISMT with a Buy recommendation and a price target of Rs62 (valued at 6x its FY2011 expected earnings per share [EPS]).

To see full report: ISMT


Initiating coverage with U-PF

With 5.2GW installed capacity and another 4.6GW under construction NHPC is the largest hydro power company in India. It earns fixed regulated returns (15.5%) like its peers (NTPC and Powergrid), however given the long gestation period of it projects, higher susceptibility of delays and sub –optimal capital structure its return ratios are much lower. At 1.7x FY11 P/B for 6-7% RoE and 25x FY11CL EPS for its EPS growth (13% cagr over FY10-12) we believe the valuations are demanding. Our 12m target price, based on DCF is Rs26/share; we initiate with an Underperform.

Largest play on hydro power
NHPC is the single largest play on hydro power in India with an installed capacity of 5,175MW (including capacity of 51% subsidiary NHDC) and has another 4,622MW capacity currently under construction. ~6,700MW power projects are currently under approval stage and will add to the pipeline of projects going forward.

FY10-14 tariff order – mixed bag for NHPC
CERC (central regulator) has increased the base RoE from 14% to 15.5% (to be grossed up by tax rate) for all central power utilities which is the biggest positive in the FY10-14 tariff order. NHPC should benefit from the way the O&M expenses are being calculated under the new tariff regime and it should reduce its under recoveries going forward (NHPC had Rs1.2bn and Rs4bn under recoveries related to O&M expenses in FY08 and FY09 respectively). The new tariff regulations however increase the volatility of NHPC’s earnings since capacity charge will not be fully recovered during dry periods and there is no provision for “deemed generation” unlike the previous tariff order.

No significant upsides from CDM benefits/merchant power in near term
NHPC has registered two of its smaller projects (45MW each) under the CDM and will be earning ~Rs170m annually from these which will be shared with beneficiaries. We don’t expect any meaningful impact on the financials in the next 2-3 years from the CDM benefits for NHPC as it is unlikely to get any benefits for the existing/under construction capacity where CDM benefits are not part of the feasibility report. Hydro policy 2008 allows upto 40% of the saleable energy to be sold as merchant power from a hydro project. However NHPC can benefit from this only for new projects being planned as it has 100% PPA for it’s existing/under construction capacity.

Valuations are expensive. Initiate with a U-PF
NHPC’s returns profile is much inferior to its PSU peers (NTPC and Power Grid), even though regulation provides for the same 15.5% return on equity investment in projects. Given the long gestation period of its projects and higher susceptibility to delays, capital work in progress (CWIP) has tended to be high. With cost under recoveries in recent years and sub-optimal capital structure, ROEs have remained in the 6-7% range during the last few years. At 1.7x FY11 P/B for 6-7% RoE and 25x FY11CL EPS for its EPS growth (13% cagr over FY10-12) we believe the valuations are demanding. Our DCF based target price is Rs26/share which implies
1.25x FY11 P/B. Underperform.

To see full report: NHPC

>Shipping Review for month ended September 2009 (GEPL)

“Ray of light seen in the dark tunnel; how far to travel remain a question “

Baltic Dry Index (BDI) decreased by 8% on month-on-month (m-o-m) basis as in September 2009
The negative momentum continued with the Baltic Dry Index, a measure of shipping costs for commodities, on signs of increase in tonnage supply, as many new buildings are hitting the water (while less dry bulk carriers are being sold for demolition). At the same time, China's appetite for commodities like iron ore, seems to be fading away at the moment, as steel prices have been steadily plunging in China, which in turn causes many steel companies to cut down their production. According to Fearnley Fond ASA, net growth of the dry-bulk fleet has quickened to between 8% and 9% in the past couple of months, compared with about 3% in the first quarter.

Outlook seems to be grim for capsize over next couple of years
The BCI decreased over 30% month on month, at 2,748 points, while the BHI and BSI increased by 17% and 13% to 974 and 1,740 respectively. According to N. Cotzias Shipping, the Capesize market today (end of September 2009) consists of 825 ships of a total of 149 million tonnes carrying capacity, out of that just 16 capes of 2.8 million tonnes dwt have been scrapped. At the same time, the projected contracted and already under construction vessels that will enter the market until 2016 are 736 units of a total 144 million dwt. Out of these new buildings 429 units, or 80 million dwt are to enter the market by the end of 2010. Until today there are 25 new buildings capes cancelled of which 9 were to be delivered in 2009 and 12 in 2010.This is a mere 5% of the total of new ship orders. Based on this assumption, the Capesize market is headon to be over-capacitated by 90-95% if all current trends prevail.

Tanker day rates remains sluggish, however signs of improvement visible
The tanker segment continued to decline in the month of September 2009, as crude imports have remained low for much of the month whilst demand for motor gasoline in US have just now starting to show signs of recovery. It is important to note that VLCC and Suezmax cargoes bound for the delivery in the United States this month (September 2009) were higher than those delivered in August 2009 as US crude inventories simultaneously continue to decline. Moreover, crude in storage at sea presently stands at around 36 million barrels - a drop of 64% from earlier highs around 100 million barrels during the April-June period. These should be taken as a positive signs that the disparity between oil supply and demand is starting to improve.

To see full report: SHIPPING SECTOR


We expect 9 banks under one universe to report a modest 8% yoy net profit growth in Q2 FY10. The system credit and deposits have expanded by 2-3% qoq during the quarter. For most banks, NII growth would be ahead of loan book growth due to expansion in NIM. We expect UBI, PNB, Axis and Yes Bank to deliver 10%+ qoq NII growth. Margins would start improving across the sector from Q2 FY10 as banks retire their high cost deposits. Provisioning towards investment depreciation will be minimal as bond yields have increased by mere 14bps during the quarter. Asset quality might deteriorate as some of the loans which were restructured under the special restructuring window may have slipped.

To see full report: BANKING SECTOR


Domestic cement consumption has witness a ~13% yoy growth in Q2 FY09 despite a poor monsoon which did not have any visible impact on rural off take. Cement prices in the Northern , Eastern and Central regions have remained stable while those in th South and West fell by Rs2-15/ bag as frsh capacities commenced operations.

Our coverage companies are projected to show a mixed trend in revenue growth ranging from flat (ACC) to 23% yoy for Ultratech driven by volume growth of 19% yoy. Operating margin is likely to expand on account of lower coal cost and higher captive power utilization. Aggregate PAT should grow 17.8% yoy largely driven by strong performance from Ultratech and ACC.

To see full report: CEMENT SECTOR Q2 FY10