Wednesday, November 25, 2009

>Which bonds will struggle when fund flows reverse?

The tailwind of mutual fund flows
Net inflows into corporate bond mutual funds have had a big price impact over the past year – bigger, we think, than most investors generally realize. When these flows stabilize, as they obviously will at some point, or possibly reverse, we see a potential softening or reversal in performance for those names that have so far outperformed due to the technical pressure from mutual fund inflows. This concern motivates the bond-level investigation which is the focus of today’s Credit Line.

Bonds exposed to flow reversals
Our bond-level estimates indicate that credit with high “flow betas” are both lower-rated and more cyclical. We use our estimates of flow beta to screen for the bonds in both IG and HY with the highest sensitivity to mutual fund flows. These bonds have substantially outperformed the
market since the bottoms in March, and we expect they would soften disproportionately when mutual fund flows stabilize (or even reverse).

Still long Sterling
Sterling-denominated corporate bonds have recently underperformed on hawkish comments by the BoE and rising long-term rates. We continue to like the Sterling space, given its higher spread valuations and liquidity premia compared to other currencies. We also think carry and spread tightening should compensate for potential increases in rates. We reiterate the buy recommendation on our long BBB sterling basket.

To read the full report: CREDIT STRATEGY

>Home loans – Demand returning, pricing pressures to continue

We had discussions with banks to get an update on the home loan market in India.

Pressure on pricing to continue in the near term. Banks have been extending their discounted home loan rate schemes, basing their decision on marginal cost. While Axis Bank has entered with its own discounted rate scheme for new home loans, PNB and SBI have extended the time period for which their low rate scheme will be applicable. With loan growth in other segments remaining moderate, at best, and demand only now returning, we do not see banks being in a hurry to raise home loan rates until they see definite signs of overall interest rates in the system hardening (likely to happen towards the latter part of FY10 or early FY11).

Demand coming back. For the home loan market, volume seems to be the name of the game at present, with emphasis on expanding book rather than focussing on margins. The combination of lower property prices, attractive interest rates and aggressive promotions does seem to be working, and banks are seeing a progressive pickup in disbursals. With rates likely to remain soft, we expect growth to continue, with 2H FY10 better than 1H.

Asset quality has held firm. Asset quality of the home loan portfolio in general has proved remarkably resilient. Banks estimate NPLs at approximately 1% in their portfolio, a figure that has been steady through the cycle. While there may be some deterioration from these levels in view of the continued sluggishness in the economy, any significant decline may be precluded because of the following factors:

Banks have been conservative with their lending. The target base remains the salaried customer with a regular source of income. Monthly instalments are capped at 50–55% of net monthly salary. Loan-to-value is 75–80% for the new loans, with the average for the total loan portfolio significantly below that.

Banks have been proactive in handling cases of financial stress, with the preferred method being extending the tenor of the loan.

Demand for housing remains high, and the majority of borrowers are owner-users rather than pure investors. Hence, they prefer to pay the monthly instalments even in times of financial stress.

Among banks in our coverage, we believe that Axis Bank, ICICI Bank and SBI should be the main beneficiaries of the revival in home loans, given their relative importance in the overall portfolio (see Figure 1 on page 2). However, the pickup in the case of ICICI Bank may be more muted, in our view, given its higher interest rates on home loans relative to peers.

To read the full report: INDIA BANKS


And the Consensus Is…

Asia ex: Developed world is toast, let's toast the future, Asia and GEMS — Investors are very downbeat on the prospects for the developed markets. Asia ex based on 2010E data will generate ROE equal to the average seen in the last 10 years. For this, investors will pay 10-year average P/BV. Japan and the USA will do the same in terms of ROE, but their P/BV is 30% below mean. Asia’s saving grace is EPS growth forecast outperformance. If it dips, beware. Page 3

Fun With Flows: Resumption of inflows to emerging markets, but not too exciting for Asian funds — New money intake by all dedicated emerging market equity funds last week recouped earlier outflows, totaling US$2.5b as per EPFR. Comparing to $1.5b received by GEM funds, Asian fund inflows were not even half of that, at US$627m only. In terms of flows relative to asset size, they are behind those to Latin America equity funds, but similar to the magnitude of EMEA fund inflows. Page 15

Market Sentiment — Market sentiment has turned a bit cautious with MXASJ hovering around 400 in the last two months. Our sentiment indicator for the region has rolled over from its peak recorded in mid-September to +0.35 standard deviation above mean last week. Market wise, investor appetite has weakened the most in India and Taiwan, whereas sentiment in Singapore, which lagged other markets earlier, has just started picking up recently.



For Q2’10, Cairn India Limited’s (CIL’s) net revenues declined 28.3% yoy to Rs. 2,297.8 mn. This decline was largely due to a 31.7% yoy fall in average price realisations to USD 59.6 per boe. However, the Company’s adjusted net profit was up 4.3% yoy to Rs. 3,058 mn. We are excluding the reversal of the exceptional provision of Rs.1,637.1 mn for a past-profit petroleum payment pertaining to Ravva that was due to the Government of India. Accordingly we have excluded the same from Q1’10 results as well. We have valued the Company using NPV of CIL’s assets suggesting a target price of Rs. 256 implying a discount of 8.9% on the current market price of Rs. 281. Thus, we are changing our rating from Hold to Sell.

TP retained; rating downgraded

No significant change in assets: Our target price has largely remained unchanged from the previous quarter and we believe that the current rally in the stock price is not justified as Cairn has not discovered any new fields and is focused on developing its current assets. We have assumed a peak production of 175,000 bopd from Rajasthan after accounting for other smaller fields that will become operational at a later stage. Also, the Ravva and CB fields are maturing and decrease in production from these fields is a cause for concern.

Mangala field commenses production: Cairn India Ltd. has started commercial production from its Mangala (RJ ON-90/1) field. Mangala production continues to build as per plan with average gross production of 5,991 bopd in Q2; currently producing 10,000 bopd. The field is expected to produce 30,000 bopd in Q3’10, and is likely to reach a peak production of 1,25,000 bopd by June 2010. The Centre has allowed private refiners to qualify as additional buyers of Rajasthan crude, which is a positive for Cairn, with Essar and RIL already lining up as prospective buyers.

To read the full report: CAIRN INDIA


We reiterate our cautious view — Hotel stocks have outperformed Sensex by 22% over the last 3 months; we see more downside potential than upside. Current valuations look to discount strong recovery in FY11E (close to peak EBITDA of FY08) and ignore dismal low occupancy of 53% (down 11%), 21% fall in ARRs for 1HFY10; and risks of competition and supply overhang.

Expensive on PE, EV/EBITDA; not cheap on P/B either —The sector is trading at 24.5x FY11 PE, 16.6x FY11 EV/EBITDA, much above the 5-yr historic median of 22x PE and 15x EV/EBITDA, and at a significant premium to Sensex. On P/B, it’s not cheap either, trading at ~1.8x. India Hotels looks a good relative asset play, but valuations are not compelling yet at 1.9x P/BV.

Some pick-up in Occupancy, but not enough — Occupancies at 57% in Sept’09 (vs.53% in 1H) and expectations of a further 2H pick-up (better business season) are not enough for operating leverage to play out, we believe, as the risk remains this falls short of threshold occupancy levels of ~65% on an annual basis. Furthermore, with a 21% YoY decline in ARRs, and key Mumbai properties still not operational, we see higher risks of earnings disappointment.

Reducing estimates, but TP raised — With a dismal 2Q, and despite building in higher occupancy for 2H, we cut EPS for FY10-11E. Our TPs rise however as we roll 1-yr-frwd PEs to 17-18x (vs. 11-14x) at a premium to Sensex (15x), recognizing op lev potential and preference for asset plays; but this is at a discount to the sector median, given near-term earnings uncertainty.

Likely catalyst — 1) potential capital raising/stake sale, 2) significantly higher insurance claim on settlement for loss of profit (in case of IH and EIH); and 3) sharp YoY growth off a low base in 4QFY10, though partly priced in.

To read the full report: HOTELS SECTOR