Sunday, November 22, 2009

>Priced to perfection (MERRILL LYNCH)

Expect correction in Q1; year of consolidation; index target 18,000
2009 has been a big surprise and is on track to be the best year for markets since 1991. The surprise for 2010 can be that it is a year of consolidation rather than the “boom-bust” years seen recently. The last time we had a single digit move in the market was in 2002. While liquidity will likely remain easy for an extended period of time and earnings and the economy are recovering, we think valuations are pricing in a lot of good news. We expect markets to correct in Q1 led by:

1. Rising inflation: We think inflation can hit 5% by December 2009 and get close to 8% by March 2010. Rising inflation has been historically negative for markets on 5 of 7 earlier occasions.

2. Exit policy by Government/RBI: We expect the RBI to start hiking CRR/repo rate in January and the Government will likely start phasing out its stimulus in the budget in February through roll-back of some excise duty cuts.

3. Burgeoning supply of paper: We see supply of paper of nearly $7-8bn (including Government disinvestment) in Q1, which will absorb the surplus liquidity. The de-leveraging by corporates will also mean lower sustainable RoEs.

Government policy key to market
We think the timing of the “exit policy” of Governments/central banks, both in India and developed markets, will be key to markets. The pace of reforms by the Indian Government (disinvestment, infrastructure, GST) will drive re-rating.

Can markets hit their all-time highs?
If surplus liquidity conditions prevail, there is a possibility of bubble like valuations some time during the year. However, we don’t expect this to sustain. Based on historical V-shaped recoveries, markets have fallen 30-40% after hitting earlier highs.

Sector strategy – domestic plays still
Global cyclicals account for 45% of our EPS growth in FY11. However, we still remain O/W domestic plays – banks, infrastructure and autos are our biggest bets followed by pharma.

Most preferred stocks: SBI, Mahindra & Mahindra, Dr Reddys.
Least preferred stocks: Ambuja, Infosys, NTPC

1. Liquidity vs. valuations – Sensex target 18,000
2009 has turned out to be a big surprise. It is on track to be the best year for markets since 1991, though after a disastrous 2008.

Surprise of 2010: A market consolidation
So what can be the surprise for 2010? We expect the “surprise” in markets in 2010 to be a year of consolidation rather than the “boom-bust” years we have got used to over the past few years. The last time we ended a year with a single digit move (either positive or negative) in the market was in 2002 and 2004 was the last year with a move of under 25% in the markets. Our Sensex target of 18,000 for the Sensex prices the market at 15x FY12E earnings. The positives for the market are well flagged:

1. Global liquidity is likely to stay easy for an extended period of time and provides the backdrop for the rally in equities.

2. The Indian economy is recovering and we expect GDP to grow at 7.8% in FY11 vs. 6.2% in FY10. Industrial production growth is likely to accelerate to double digits from a low of 3% early this year.

Can market hit its all time high in 2010?
This is not our base case. But if the easy liquidity conditions globally lead to an asset bubble, we could get equity markets hitting the old highs. However, we do not think the markets will sustain at these levels in 2010.

Even if we look at past history on the 2 occasions that market had fallen more than 50%, it took 294 and 571 days to hit the old peak. This means we should hit the peak between May 2010 and June 2011. Interestingly, on both these occasions, the markets gave a 30-40% negative return in the next 6 months.

Government policies important determinant of markets
We think the Government policies will be an important determinant of markets in 2010.
1. The global central banks and the Governments in developed markets will be a key driver of global liquidity.

Global recovery, no double dip
Global recovery in 2010 supports Indian growth
BofA Merrill Lynch economists expect a global recovery in 2010. We do not share concerns about a double dip, given that economic policy should remain accommodative of recovery. Global GDP growth is forecast to turn around to 4.3% in 2010 (and 4.5% in 2011) from a contraction of 0.8% in 2009 (Table 8). The US, in particular, is expected to see a “square root” recovery to 3.1% in 2010 (and 3.3% in 2011) from the particularly sharp GDP contraction of 2.4% in 2009.

To read the full report: INDIA STRATEGY

>YES BANK: Next generation bank (CLSA:)

A differentiated business model that focuses on niche sectors and aims to maximise revenue per customer by effective cross selling, has enabled Yes Bank to deliver profitable growth in past 5 years. We expect growth momentum to remain strong and earnings to grow at a Cagr of 32% over FY09-12. Building of strong CASA franchise will be important to reduce liquidity risk in the present wholesale funded model. Healthy growth and a consistent track-record, with RoEs of +20%, will support premium valuations. BUY to our target price of Rs335, implying 31% upside.

Unique banking model promises high growth potential
Yes Bank (Yes) focuses on select sectors where it develops domain expertise and offers a full range of financial products / services to companies in those focussed sectors. Its unique business model has helped it to deliver +75% earnings growth over past 3 years with its domain expertise helping better ‘credit risk evaluation’ (in the recent economic downturn Yes had the lowest proportion of stressed assets). Rising demand for non-vanilla corporate loans will help Yes to grow at a cagr of 39%, over the twice sector growth rate.

Earnings to grow at a cagr of 32%, sustainable RoE of +20%
Yes’ multiple relationship model, its presence across the value chain of niche sectors will enable it to earn a healthy RoA of 1.4-1.5% (sector average ~1.1%). Improving share of CASA deposits, higher share of non-vanilla loans will help Yes to sustain NIMs at +3%, higher than the sector.. A wide product and service offering will also enable it to have higher contribution from fee income, supporting the higher RoA. Earnings estimated to grow at Cagr of 32% (FY09-12), sustainable RoEs to be +20%.

Improvement in liability franchise would be the key
Yes is highly dependent on wholesale funding, making it vulnerable to the volatility in liquidity conditions. Over the next 3-5 years, we expect CASA ratio to improve to 200-300bps annually led by (1) more than doubling of branch network, (2) improving branch efficiency and (3) build up of retail deposit franchise. Given its aggressive growth plans, Yes will need an estimated US$500mn in capital in next 4 years.

Valuation premium to sustain; Buy
We believe that Yes’ valuations will track those of its peers (HDFC Bank) in their initial days of operation supported by a healthy growth trajectory, higher profitability and consistent delivery track-record. Our one year price target of Rs335 is based on 3.5x one year forward price/ adjusted book. BUY.

To read the full report: YES BANK


Tata Steel (TSL) has entered into a joint venture (JV) with New Millennium Capital (NML) and Labmag for developing direct shipping ore (DSO) project in Canada. A JV formation (hence profit participation) from an earlier scheduled SPV reflects increased visibility of mines to start operations. TSL has become NML’s largest shareholder with 19.9% stake. Upon completion of a feasibility study by NML for its DSO project, TSL has 180 days to acquire 80% equity in the project. Thereafter, the company is required to fund 100% of the project cost up to US$300mn. The mines have ~100mnte reserves, with 4mnte annualised production tailored to meet Corus’ requirements. Logistics infrastructure concerns could lead to delay in shipments versus management guidance of Q2CY11. Maintain BUY.

Reserves and resources. The DSO project contains 52.5mnte of proven and probable mineral reserves (~58.9% Fe), 3.5mnte measured and indicated mineral resources (~59% Fe), 5.8mnte of inferred resources (~55.8% Fe) and ~40mnte of historical resources that are not currently in compliance with NI 43-101.

Catered for Corus offtake. NML will produce sinter fines (SF) and pellet fines (PF), as per Corus’ requirements. SF will have minimum 64.5% Fe, with size less than 6mm (maximum 15% of 0.15mm). PF will form 10-15% of the production, with minimum 64.5% Fe and 0.075mm size. The fines are developed exclusively to meet Corus’ requirements (market price offtake).

Mining witnesses a spur

Cost profile – Comparison with Iron Ore Company of Canada. The management has guided for US$35/te FOB mining cost from DSO operations. We have compared DSO with Iron Ore Company of Canada (IOC). IOC sells ~77% of total iron ore as pellets, which dipped to 57% in H1CY09 due to reduced profitability. The average operational cost for IOC (past three years) is at US$50/te. With 43% concentrate production, costs have gone down to US$44/te in H1CY09. But NML will be exposed to higher logistics costs as IOC controls its own railway lines.

Logistics hangover could delay proceedings. Carriage of ore from Kivivic (section 4) and Timmings (sections 2 & 3) to ships-hold at Point Noire would involve three intermediate railways: i) Tshiuetin Railway (TSH) ─ 250Kms from Timmings to Emeril/Ross Bay Junction & owned by Naskapi Nation of Kawachikamach, ii) Quebec North Shore & Labrador Railway (QNS&L) ─ 350Kms from Emeril/Ross Bay junction to Arnaud sliding & owned by IOC and iii) Arnaud Railway ─ 30Kms long from Arnaud sliding to ships hold at Pointe Noire & owned by Wabush Mines. While resolution of TSH tariff was expected in Q3CY09, tariff proposals for other two lines were to be submitted in Q3CY09. In the absence of any company announcements, we presume that the proposals have been delayed.

To read the full report: TATA STEEL


Momentum in volume to continue, with multiple drivers for medium term: Strong volume momentum to continue in November 2009 and December 2009, with volumes to remain stable on MoM basis at 83-85,000 units/ month. Volume growth in November would be driven by inventory filling in November due to plant shutdown in December. Improving availability of car finance with re-entry of ICICI Bank, recovery of demand in urban markets and continuance of strong growth in rural markets would be key drivers for growth in medium term.

Upgradation of engines to Euro IV would enable price hikes: Maruti normal changes prices once in a year in January. However, any changes in prices this time would be driven by a) expected roll-back in excise duty, b) increase in RM cost and c) change in emission norms. While price increase for existing Euro IV compliant model might happen as early as January 2010, other models price revision might take place along with engine up-gradation.

Cost inflation to restrict margin expansion: While Maruti is still negotiating RM contracts for steel and other commodities, it would be forced to give some price hikes for commodities as prices have recovered by 30-60% from the bottom levels of 4QFY09. Our interaction with Apollo Tyres indicated that it is in advanced stages of negotiating 10-12% price hike from car OEMs. With significant exposure to forex (Yen imports of 27% of sales and Euro/USD exports of 15% of sales), unhedged forex exposure poses risk to profitability, especially for FY11 where it is totally unhedged.

De-bottlenecking capacity by realigning product mix at both the plants: It is shifting production of Swift Petrol to Gurgaon from Manesar by Dec-09, thereby freeing up ~40,000 units/year capacity at Manesar and utilizing some idle capacity at Gurgaon. This would free-up capacity for fast selling models like Swift Diesel, DZire, A-Star and SX4. However, it is yet to decide on brownfield expansion.

Upgrading earnings, maintain Buy: We are upgrading our earnings estimates for FY10 and FY11, by 3.9% (to Rs76.8) and 3.5% (to Rs85.5) respectively, driven by volume upgrades and export realization upgrades in FY11. The stock is valued at 17.3x FY11E EPS and 12.6x FY11E CEPS. Adverse forex movement and pick-up in non-Euro exports are key risks to our estimates. Maintain Buy with target price of Rs1,650 (~14x FY11E Cash EPS).

To read the full report: MARUTI SUZUKI


HSM close to commissioning; blast furnace 6-8 months away: Bhushan Steel is close to commissioning a 1.9mtpa HSM. Cold trials of the mill have begun. However, the commissioning of a 1.2mtpa blast furnace and coke oven has been delayed by a further 6-8 months. The slab caster and steel melt shop will be initially fed by steel scrap and sponge iron. The company increased its sponge iron capacity by 50% to 1mtpa in 1HFY10 after it commissioned two kilns. The company will further enhance its sponge iron capacity by 340,000tpa by March 2010; and after it completes building its blast furnace and coke oven in 6-8 months its sponge iron/hot metal capacity will rise to 2.5mtpa, paving the way for crude steel capacity of 2.2mtpa.

Foray into ERW pipe business – forward integration: With a capex of Rs12b, Bhushan Steel is setting up a 500,000tpa large diameter (4” to 25”) ERW pipe mill. The project is expected to be complete by October 2011. It will increase captive consumption of HRC and reduce the surplus available for commercial sale.

Raw material integration to rise significantly in 3-4 years: Bhushan Steel has got an allotment of one iron ore mine, two thermal coal blocks and one coking coal block in Orissa and West Bengal. It has also acquired majority stake in Bowen Energy, which has several coking coal tenements in Australia. Consequently, raw material integration is likely to improve significantly.

Capex intensity will keep debt high; cash flows to improve: Total debt increased from Rs81b in March 2009 to Rs95b in September 2009. Phase III expansions to increase the HRC capacity to 5mtpa by the end of FY13, captive mining and other forward integration projects will require capex of Rs25b a year. Therefore, absolute debt levels are likely to rise, though debt/equity ratio will decline from 3.3x in March 2009 to 2x by March 2012 because of increased internal cash flows.

To read the full report: BHUSHAN STEEL