Thursday, November 19, 2009

>The Asian-US Asset Allocation Debate (DEUTSCHE BANK)

A spirited debate within the asset allocation community has broken out over whether Asian stocks (and EM more generally) can continue outperforming the US into 2010. This is an understandable line of enquiry given Asian economies are no longer growing in isolation, and EM equity markets have enjoyed record inflows this year (in contrast to the US). We provide a synthesis of our tactical views on this issue below:

1.) Asia is at an historically high beta to the US. Corporate Asia’s high and rising operational gearing, coupled with accelerating foreign investor interest, has driven Asia’s equity beta (vis-à-vis the US) from ~zero in the early 1990’s to 1.4x currently. But a high beta bites both ways – we expect Asia to outperform in a S&P500 bull market, and underperform in any material sell-off (there is after all, no free lunch). While these relationships should gradually evolve longer-term as Asia develops its own endogenous demand cycle and anchor institutional investor base, we are skeptical that either Asian stocks or foreign flows will shed their manic-depressive nature in 2010. Moreover if our US colleagues are right on the S&P500 and US policymakers succeed in engineering a lower $US as a reflation instrument, Asian risk assets should enjoy a cracking 1H-2010.

2.) Over the past 15 years, the only period where the US outperformed Asia in a bull market environment was in the late 1990’s when: i.) the US enjoyed a tech-led productivity boom and record FDI flows; ii.) the US fiscal position was strengthening; iii.) the $US was trend appreciating; and iv.) Asia, Russia and LatAm endured wrenching financial crises. We don’t anticipate a repeat confluence of events anytime soon.

3.) There are few grounds for overweighting the US against Asia just yet, based on RV arguments: i.) Asia is trading with a higher fwd DY, cheaper fwd P/B, and the same fwd P/E (lower PEG); ii.) AxJ cyclicals are trading at a large fwd discount to the US; iii.) The relative price level of AxJ vs. the S&P500 has only just returned back up to 1990 levels, and is half that in 1993; iv.) Both regions are 30% off their respective highs; v.) Perhaps most strikingly, Asian financials are trading at a small (fwd PE) discount to US financials vs. an average 16% premium since 1995, and a 70% premium in 2007. Given our long-held view that Asia will likely be gripped in a policyand- currency-induced mini-bubble over the next six months that will disproportionately favour asset reflation plays (see “2006/07 Redux – Asian Overshoot Ahead”, Oct 13), we’d expect Asian financials to again trade at a decent premium to the US in coming months, before conditions eventually turn problematic later next year (when risks around a double dip escalate).

To read the full report: INVESTOR LETTER


Lead indicators point to strong pick-up in growth. Economic data is likely to surprise on the upside, yet expectations of corporate earnings remain muted. Analysts are forecasting 2% growth for FY09-10e and have yet to upgrade meaningfully.

Growth surprises are likely to drive EPS upgrades over the next 2-3 quarters. The Sensex is trading at 12-month forward PE of 17x, indicating limited room for multiple expansion, but we think upgrades will provide support. Our top-down Sensex EPS forecasts at INR920 for FY09-10 and INR1120 for FY10-11 are c6% higher than consensus.

Markets to move higher in the next 12 months as growth surprises on upside, leading to EPS forecast upgrades

Policy tightening may cause markets to stall, but underlying supportive environment will remain intact

We maintain a pro-cyclical view; overweight on banks, industrials, IT and consumer staples

Our economists expect RBI to tighten monetary policy with 200bps of CRR and 125bps of policy rate rises in CY2010. Since monetary policy works with a 12-24 month lag, this is unlikely to restrict growth in FY10-11. Tightening will be the result of a pick-up in growth, so this will be not be a disaster for equities; however, evidence suggests the first move in a tightening cycle causes markets to pause. We think the equity markets will be torn between rising growth expectations and rising rates, which will play out simultaneously over the next 2-3 quarters.

We think the markets will move higher – but with the dampener of the rate rise, only just: end-2010 Sensex target 18,000, Nifty 50 target 5,350, both up 7%. Also, we expect that gains in Indian equities may lag other markets; hence, we are underweight on India in our Asia portfolio.

Our investment strategy remains pro-cyclical. Our overweight sectors are private sector banks, industrials, consumer staples and IT, and our key underweight sectors are materials and healthcare. Our top picks are HDFC Bank, Hero Honda, BHEL, ITC and TCS.

To read the full report: INDIA INSIGHTS


Recent press reports suggest RIL may be looking to acquire refining and oil product marketing (R & M) assets in the US. We continue our thematic series on RIL’s acquisition potential.

We believe that RIL’s stated strategy for inorganic growth, coupled with its increased need for a distribution and marketing network for its high-end products, has enhanced the potential for acquisitions, especially in the qualitydiscerning large US market.

RIL’s need for overseas acquisition. RIL has commissioned its 580kbpd high-end refinery earlier in the year and hence requires a large discerning consumer base. Given its larger share of Euro IV/V compliant gasoline in the product slate, the US would be the natural market for the new refinery. Given the unattractiveness of the domestic retail fuel market, superior quality of RIL’s products and its large production capacity, we believe RIL will benefit from greater control of overseas distribution network to maximise its returns.

Shopping in America

Types of assets that fit the bill. Product differentiation, especially branded products, is essential to enhance the returns in the auto-fuel retailing market. In addition, RIL will likely be looking for a captive product storage and distribution network in the US. Mid-sized auto-fuel marketers with distribution assets could be primary targets. In our view, US-based R & M companies, Tesoro or Delek could be a good fit for RIL (Fig 8). Valero and Sunoco are also a good fit, but quote at the highest 1-year forward EV/EBIDTA (Fig 11).

Build or buy? GRM plunge provides opportunity. Weak demand, coupled with increased capacity, has plunged GRMs to US$ 1.3/bbl (Singapore complex, Fig 5), well below the average operating cost of most refineries. Valero has shut the 235kbpd Aruba refinery. Sunoco has announced plans to shut its 145kbpd Eagle Point refinery. Tesla refinery was recently transacted at a fraction of the price it cost RIL to build its highly competitive export refinery (Fig 6). We feel buying is currently a better opportunity than to build.

Does RIL have the financial muscle? RIL holds US$4bn in cash, US$8bn in treasury stock and if it doubles its current net debt-to-equity of 0.35x it can borrow another US$10bn, ie, a total potential of ~US$22bn. The largest R & M company in the US has a US$12bn EV; the others are less than US$7bn.

Earnings and target price revision
No change.

Price catalyst
12-month price target: Rs2,400.00 based on a Sum of Parts methodology.
Catalyst: Gas pricing settlement and new growth initiatives.

Action and recommendation
Reiterate Outperform. We believe RIL is poised for sizeable volume-driven profit growth, despite cyclical pressure on margins.

To read the full report: RELIANCE INDUSTRIES


L&T set to look more like a conglomerate
FY12 will be a very significant year for L&T as it will herald in changes, including a new management team after 15 years of stable management, key new business initiatives that are beginning to contribute meaningfully to revenues and the possible unlocking of value in some subsidiaries. We attempt to paint a picture of what L&T would look like in FY12 and after based on our assessment of the core business and about 50 key subsidiaries.

FY12 to be critical year of developments for L&T

FY12 will likely be a significant year for L&T for numerous reasons.

Maturing of key businesses: L&T IDPL could see more than 11 projects reach the commissioning stage, while the power equipment business could see robust revenues as boiler and turbine plants’ utilisation improves.

Value unlocking in some of the businesses: L&T’s IDPL and L&T Finance could tap the market for resources to achieve future growth. Even the Infotech business could see a large transaction and listing, possibly earlier than FY12.

Mass scale management changes: The entire senior management staff, which has been at the helm of affairs, will retire in late-FY12. The management of the various strategic business units would form the pool for the next level of senior management. This would also crystallise the SBU structure within the company.

Core business to benefit from upturn in execution
We remain much more positive than the consensus on the upturn in revenue growth as the execution rate on projects picks up. We expect revenue growth of 28% in FY11, which could drive earnings upgrades in the core business. We are 12% above the consensus on FY11 earnings. Moreover, order inflow growth is likely to remain robust in FY11, even from a high base in FY10, boosted by a continued focus on infrastructure and an uptick in the corporate capex cycle.

Capital allocation strategy remains a matter of concern
L&T management views the IT and financial services business as part of the core operations. We suspect the company might attempt to in-organically expand its IT business as scale becomes increasingly critical. We believe the size of investment is an overhang on the stock. Similarly, there is no clarity on the end game in the financial services business, especially given stakes in small regional banks and the requirement of large doses of capital. However, we think the listing of subs in the services business would materially reduce the incremental capital required to be invested in these companies, reducing one of the key overhangs on the stock.

Earnings/valuations of subs underestimated, TP of Rs1,952
Based on our analysis of L&T’s subsidiaries, we estimate the EBITDA contribution to consolidated P&L could increase to 28% in FY12 from the current 17% and may expand further thereafter. Our estimate of the subs contribution to earnings is around 50% higher than the consensus for FY11 and FY12. Based on key value-unlocking events that we think are likely to play out over the next 12 months and clarity emerging on the earnings potential of subs, we arrive at a 2012 March fair value of Rs2,013, building a 15% holding-company discount for subsidiaries. Our one-year target price is Rs1,952, upside of 19%, adjusted for time value.

To read the full report: LARSEN & TOUBRO

>Federal-Mogul Goetz (India) (SUNIDHI SECURITIES)

Company Description:
Federal-Mogul Goetze (India) (FMGIL) was established in 1954 by Mr. H.P. Nanda as a joint venture with Goetze-Werke of Germany. G-WG of Germany is now owned by Federal-Mogul Corporation (FMP), a $6.9 billion global company and one of the leading manufacturers of automotive components in the world. In 2006, FMP acquired majority of holding through two of its entities – Federal-Mogul Vermogensverwaltungs GmbH and Federal -Mogul Holdings Limited and is now a part of Federal -Mogul Corporation, USA who holds the majority of the equity shareholding of its Company. Its six manufacturing units are located at Patiala, Bhiwadi, Parwanoo, Khandsa and Bangalore.

FMGIL is the largest manufacturer of pistons and piston rings in India. It manufactures of world-class pistons, piston rings, valve train and structural components, aluminum alloy cylinder blocks, sintered parts and cylinder liners and other miscellaneous automobile engine components covering a wide range of applications including two/threewheelers, cars, SUVs, tractors, light commercial vehicles, heavy commercial vehicles, stationary engines and locomotive diesel engines.

FMGIL’s product portfolio in the piston segment covers almost the entire range of applications - from small engines for mopeds to large bore locomotives engines. It is also a major supplier for piston and piston rings to the armed forces. In terms of range of engines from the type of fuel used, it caters to petrol, diesel, LPG and CNG segments.

The company’s pistons and piston rings range of products are sold under the brand name “Goetze”, while its sintered products are sold under the brand name “Brico Goetze”.

FMGIL has currently has two subsidiaries – Goetze TPR (India) and Satara Rubber & Chemicals. GTP India is currently engaged in manufacturing steel rings for bi-wheelers while SRCL is currently not engaged in any business or operations.

FMGIL’s sales constitute from sale of our products to OEMs, replacement markets and exports. The sales from OEMs are handled through its marketing offices located at three major cities of India – New Delhi, Pune, and Chennai. The sales for the replacement segment is handled through the stockists and depots located at 22 locations across India while the exports are handled through our head office.

To read the full report: FEDERAL-MOGUL GOETZ