Saturday, October 31, 2009


Hike in provisioning for property loans from 0.4% to 1.0% could increase incremental funding cost by 60-65bps
Do not expect banks to pass on the incremental cost in the near term; move by RBI more a sign of caution
RBI measures will likely curtail run away property price growth, bringing expectations in line with our estimates

Risk weight on standard loans towards real estate sector increased from 0.4% to 1%. This move by the Reserve Bank of India (RBI) was on the back of the banking system’s increased exposure towards the real estate sector (up 42% y-o-y in Aug 2009) and the increase in restructured assets in the same sector over the past 12 months.

Impact analysis
Incremental funding cost could rise by 60-65bps. The majority of loans to borrowers (including developers) are typically linked to each bank’s Benchmark Lending Rate (BLR). Consequently if banks raise the BLR it will impact all borrowers and not specifically real estate developers. The recent move by the RBI will likely only impact incremental borrowings.

RBI policy should bring expectations in line with estimates

Do not expect banks to pass on incremental cost in the near term. Since the increase in provisioning requirement is for standard assets, it would be taxing on the borrower to pay a
higher credit cost despite meeting obligations on time. As a result we do not expect banks to
pass on the hike in the near term unless the asset/loans turn sub-standard. Our banking analyst expects the impact on banks of absorbing the higher provisioning will not be sufficiently meaningful to cause them to hike interest rates charged to large developers in near term.

Recent fund raisings have strengthened balance sheets. Most large property developers have raised fresh equity capital over the past 6 months thereby bringing down their
balance sheet leverage and leaving them in a comfortable position to fund growth over the next 2-3 years. We do not expect a 50-60bps interest rate hike to dent earnings or valuations meaningfully.

Policy move should bring expectations in line with our estimates. Property price appreciation of 15-25% in the past 6 months has been much ahead of our expectations and stock valuations have been implying further 25-40% price growth over the next 12-18 months. We believe the RBI’s attempt at increasing the cost of credit and curtailing incremental credit to the sector could lower expectations to be in line with our estimate of 10-15% over the next 12-18 months.

Stock implications: Indiabulls Real Estate and AnantRaj, with net cash positions, are relatively better placed against other coverage peers like DLF, Unitech and Housing Development and Infrastructure in the event of any rise in interest rates.

To see the full report: INDIAN PROPERTY


Why buy now? Improving fundamentals, lagging valuations
There are four reasons that trigger our more positive view on the sector:

1) Volume surprise – YTD yoy volume growth of 23% for Hero Honda, and sequential recovery for Bajaj Auto have so far been significantly above our, consensus, and managements’ stated expectations. We believe the industry is experiencing a demand growth upcycle, with double-digit growth likely to continue for the next 2-3 years, driven by rising penetration, investments in infrastructure and macroeconomic recovery.

2) Margin surprise – As shown by two consecutive quarters of significant margin surprises, we believe the market is underestimating the impact of operating leverage and companies’ ability to defend above-trend margins. As a result of these two points, we believe an earnings upgrade cycle for the sector is likely to continue for the next four quarters.

Earnings upgrade cycle to continue; U/G Hero Honda, Bajaj Auto

3) Lagging valuations – Based on our revised estimates, Indian 2-wheeler stocks are trading at mid-cycle valuations and at a steep discount to the MSCI India index. We believe this offers a compelling entry point into high cash-flow-generating businesses that have strong franchises in an oligopolistic market. We also observe that 2w stocks outperformed the index during early stage of economic recovery during 2002-04.

4) Concerns on monsoon and commodity costs – In our view, valuation case is most appealing for Hero Honda, which has underperformed the BSE Auto Index (by 30%) and BSE Sensex (by 12%) over the last three months. The stock is now trading at mid-cycle multiples and a 25% discount to MSCI India. We believe market may be overly concerned about monsoons and rising commodity costs, as we discuss in this report.

We upgrade Hero Honda (HROH.BO) to Buy from Neutral and raise our 12m target price to Rs1,912 (from Rs1,399) based on 16X FY11E EPS. We also upgrade Bajaj Auto (BAJA.BO) to Neutral from Sell, and raise our 12m target price to Rs1,566 (from Rs705), also based on 16X FY11E EPS. We raise FY10E-12E EPS for Bajaj Auto by 53%-70%, and for Hero Honda by 22%-37%.

Downside: 1) Labor unrest, 2) slowing macroeconomic growth, 3) greater than- expected success of competitors. Upside (Bajaj): 1) Continued labor unrest at Honda Motors, 2) re-entry of private banks in 2-wheeler financing business.

To see the full report: AUTOMOBILES SECTOR


Tata Steel registered lower-than-expected Q2FY10 results with PAT declining 58% YoY to Rs9.02bn. Topline dipped 17% YoY and was 7% below I-Sec estimates. This was owing to 3% QoQ degrowth in realisations, a seasonal phenomenon owing to: i) monsoons impacting demand and ii) holidays capping consumption in the North and East. Also, sales of ferro alloy fell 53% YoY. However, impressive cost performance led to sequential margin improvement (300bps). Higher fund mobilisation of ~Rs27bn in H1FY10 (net of ~Rs24bn repayment) led to increased interest outgo (15% QoQ). Maintain BUY

Impressive cost performance. Increased usage of low-priced coking coal, and reduction in power & fuel and freight costs led to 3% QoQ fall in overall costs (with flat production). Higher other expenses (up 9% QoQ) imply higher dependence on third-party rerollers and conversion agents.

Start of price war in the South does not augur well for industry. While flat products division has been able to service the robust auto market demand and is holding inventories commensurate to service level agreements, the long products division is facing structural short-term margin pressure. Our channel checks suggest that JSW Steel (aggressively marketing from SISCOL) has managed to snatch market share from RINL (with current inventory of 0.4mnte), which now offers high carbon wire rods at MS wire rod prices. Also, premium of Tata Steel to JSWS (in wire rods) has reduced to Rs500/te for some customers in the South and business has started getting relocated to the eastern markets (such as Ranchi).

Also, volume pressure led to October ’09 being hit harder than October ’08. While the price war has resurfaced, demand has been lacklustre on both B2B and B2C fronts. Floods in Andhra Pradesh and Karnataka in October led to a sharp drop in offtake. As consumer sales dip, the project segment (ex wire rods) too has come under pressure owing to lack of interest from real-estate majors. While the segment targets run rate of 75,000tpm, only 50% has been achieved for October deliveries (as on date). We continue to see high levels of dealers/end-users’ stock in eastern & western markets (Tata Steel’s long product inventory stands at 0.13-0.14mnte).

Way forward. Wire rods (17% of long product sales) are the main contributor to margins of Tata Steel’s long products division. Continuous undercutting by JSWS in the South will pressurize margins of the wire-rod segment (except WR3, which is 6ktpm). Also, with a 4-mnte market and dominance of ISPs, probability of a price war and margin erosion is high. Prices will drop even further once JSWS’ 0.6-mtpa wire rod mill is fully operational. Also, JSPL has started trial rolling of 2-3 grades of wire rods from Nalwa plant. While Tata Steel is capacity-constrained, contribution-based product mix will require expanding coverage to cater to demand from all segments; there is need for focus on strutcurals (absent at present) and TMT production.

To see the full report: TATA STEEL

>Dull is good (J P MORGAN)

Portfolio strategy –– The most important event for our strategy in coming months is that nothing happens, or better, nothing surprises and volatility and risk fade. This means a further flight out of cash into bonds and equities. We stay short cash against high-yielding assets.

Economics –– Global forecast is on track for recovery, with growth at 3.7% in H2

Fixed Income –– We are trading the range, carry and yield compression

Equities –– Banks are benefiting from asset reflation, a stabilization in housing prices and the prospect of dividend increases next year.

Credit –– A new regulatory framework is likely to alter the hybrid capital market in Europe. OW Tier I issued in 2009, UW Tier I with call after 2011.

FX –– Rising risk of dollar upward correction. Take part profit on USD shorts.

Alternatives –– Investors interest in hedge funds is increasing.

A sense of calm has started to pervade markets, with many assets now moving in narrow ranges and others just trending gently. This may not be great for active managers, but is heaven sent for the rest of us after all the fireworks of the past two years. It reduces the destructive urge to delever our finances all at the same time, and helps rebuild markets and asset values. It keeps us short cash and long assets that pay income.

The message from economic data is that a global recovery is taking hold and is spreading. Many investors still doubt it is sustainable. We believe it is, at least through next year, and find it too early to speculate about what happens afterwards. Our own growth forecasts are in stationary mode, as there is no need to upgrade projections with data tracking well. The consensus of forecasters still lags our growth numbers, but we sense that most active managers
have already bought into the recovery story. Indeed, our US surprise index is hovering around neutral now. Hence, our strategy is based less on any further upgrades of growth forecasts and more on a sense of stability.

Stability is most painful for assets that thrive on fear. That means cash. Since March, we have seen a steady and global flow out of cash into assets with a proper yield –– equities and bonds. This is not over. An informal look at the global portfolio share of cash (Chart p. 2) hints that with cash returns staying at zero, we are probably only half way into the move out of cash.

The main recipient of flows out of cash has been bonds, as the yield pick up from cash was most stark, especially to banks where demand for corporate loans is falling. But the flow into bonds should ultimately be self destructive as it steadily lowers future potential returns. The average yield on the Barcap.

To see the full report: JP MORGAN VIEW

>Oil steady in Asia; bulls seem reluctant

Singapore - Crude oil futures were little changed in Asia Friday as bulls seemed reluctant to start another run before seeing more positive macroeconomic signs.

On the New York Mercantile Exchange, light, sweet crude futures for delivery in December traded at $79.77 a barrel at 0705 GMT, down 10 cents in the Globex electronic session. December Brent crude on London's ICE Futures exchange fell 21 cents to $77.83 a barrel.

The market is generally listless, with the front-month Nymex crude contract hovering around $80 a barrel.

"There's been very little movement (today)," said David Moore, commodities strategist with Commonwealth Bank of Australia.

Oil hit $80.46 a barrel in the previous session after the U.S. Commerce Department reported a 3.5% annualized increase in third-quarter gross domestic product. But market participants appear cautious in making another run, as they doubt the soundness of the recovery.

"GDP growth this past quarter was positive only because of all the government stimulus programs," said Mike Sanders with Sander Capital Advisors.

Once the U.S. government decides to cut public spending and raise interest rates, which it will need to do inevitably in the future, the economy could dip again and bring down oil prices with it, say some analysts.

Before crude and petroleum products inventories show any signs of dwindling, the market will likely continue to take cues from macroeconomic reports and monetary policy, with U.S. employment data and a Federal Open Market Committee announcement due next week in focus.

Nymex reformulated gasoline blendstock for December--the most traded gasoline contract--gained 40 points to 202.30 cents a gallon, while December heating oil traded at 207.70 cents, 17 points lower.

ICE gasoil for November changed hands at $638.50 a metric ton, down $5.50 from the last settlement.