Thursday, December 17, 2009

>Rebalancing the U.S. Economy for a New Course (WELLS FARGO)

Trading was fundamentally transformed by the European Age of Discovery, which was pioneered by Portuguese navigators, such as Bartolomeu Dias and Vasco da Gama, who set sail down the West African coast, eventually making it to India by the end of the 16th century. The new course broke the stranglehold that the Ottoman Turks had on the overland spice trade and the considerable wealth that it provided. Ferdinand Magellan and Juan Elcano further altered world navigation by 1522 when their expedition circumnavigated the globe. In the 21st century, financial trading has been permanently altered by the global crisis associated with subprime mortgages, structured products and credit default swaps. Yet, there still exists an imperative need to finance economic activity.

Our economic ship has been thrown off course and is still listing. We face three problems. First, how can we right our ship with new and traditional policy tools to regain a sense of stability in the economy? Second, what is our new course and at what speed can our ship move forward? Finally, how has our destination changed in terms of growth, inflation, employment and the dollar?

Economic forecasting, like sailing, requires constant adjustment to changing winds, currents and the occasional hazard. While the worst of the storm has passed, our ship is still struggling against fierce winds. We are far from an equilibrium point in the economy. We continue to anticipate subpar growth in 2010, with both the pace and composition of the expansion being very different than what we are used to or what we may wish. The pace of the expansion is characterized by real growth of 2.2 percent in 2010 with inflation at just 1.8 percent. Positive contributions to growth will likely come from rising consumer spending, business investment—particularly equipment and software, housing and of course, federal spending. Improved consumer spending will reflect the upturn in real personal income due to eventual job creation, a longer work week and rising wages. We expect real incomes to benefit from continued low consumer inflation. Business investment should improve as financing costs remain low and business expectations of final sales improve. Corporate profits will likely grow, which would improve cash flow and provide liquidity for business investment. We expect housing to continue its recovery as income and consumer confidence improve demand and housing finance continues to be supported by low interest rates. Our forecast shows federal spending stimulus will continue to be applied in the first half of next year and will only gradually begin to slow in the second half as election-year imperatives take over. As for trade, global growth and the weak dollar will stimulate exports but rising domestic consumption and increased energy prices will temper some of the positive effects.

Also putting a damper on hopes for a swift recovery are both the disappointing outlook for housing and the slow growth in consumer spending. For our society, the modest pace of expansion implies only slow improvement in the labor market with the unemployment rate remaining high. We expect sustained positive monthly payroll numbers will start to appear in the late spring of 2010.

Already, we sense that the convergence process to a new economic equilibrium has been more difficult than policymakers estimate. Job growth has been non-existent. Credit growth has been restrained and the recovery in housing far less significant than expected. Still, inflation remains subdued as unemployment limits the acceleration in wages and unit labor costs. Our central tendency for inflation, as measured by the Consumer Price Index (CPI), is 1.5 to 2.0 percent. Slow real growth will run into political pressures in the year ahead as economic realities fall short of political rhetoric. Finally, concerns remain about the long-run pace of growth in the economy as well as the ability of the recovery to sustain itself at a pace that meets the expectations of consumers and workers especially as an election nears. It is not clear how much of the recent economic upturn can be sustained without government support. Recent improvements in business surveys and capital goods orders may have peaked, at least near term. The remaining downside risks reflect weakness in the labor market, with implications for income growth and consumer confidence.

To read the full report: U.S. ECONOMY

>Indian Telecom Sector: Waves of destruction Strictly (ANTIQUE)

The competitive telecom space has seen intense tariff war, however, an unseen underlying trend is reshaping the business structure ranging from customer segmentation, distribution, product design. The sector would witness bouts of wars on different flanks and this would have a chain effect impacting Bharti’s leadership and increasing vulnerability of Idea and RCOM.

The government’s twin objective of revenue maximisation with lowest possible tariff levels increases the discomfort for investment thesis.

Sectoral strategy: We recommend SELL on this sector moving our focus from long term to near term.

  • Bharti (TPINR278): Bharti, being the sector leader and having high PAT margin base, would be best suited for the long drawn war. But, the competitive intensity and no earnings growth visibility would warrant EV/EBITDA multiple in line with global peers 5x FY11 EV/EBITDA.
  • Idea (TPINR48): Idea’s vulnerability is highest to ARPM and Spice yet to turnaround has very volatile earnings trajectory. Owing to revenue growth in new circles, higher support from tower business valuation and significant leverage to recovery, we value it at 6.5xEV/EBITDA.
  • RCOM (TPINR145): RCOM faces significant pressure on existing GSM business, whereas GSM expansion is facing competition from new entrants and incumbents. The global business and tower valuations provide the key support, and thereby, we value the stock at INR145.

To read the full report: TELECOM SECTOR

>BANKING SECTOR: Likely beneficiaries if consolidation happens (PRABHUDAS LILLADHER)

Consolidation among PSU banks to remain an unpredictable event: According to our observation, the inability of smaller and some mid-cap PSU banks to fund their growth by raising capital at attractive valuations and at regular intervals is among the primary reasons for the government to be seriously thinking about initiating the consolidation process. The government has been unsuccessful in the past and reasons are well known. However, this time it seems that the government is making some serious move to plan a roadmap for the consolidation process. However, we will prefer more assertive action from the largest shareholder for the consolidation to fructify over the medium term. Though the probability of consolidation in the Indian banking industry could be anybody’s guess, through this note, we attempt to analyze which banks will be in a better position to command a premium purely based on the current and savings account (CASA) per branch metric and regional presence.

Banks having dominant presence in Western India most likely to command a premium over others: Western India provides highest business opportunities and has the lowest allocation of branches at 15.6%, while Southern India has the highest at 28%. Again, Western India contributes 24.8%, Southern India 28.9% and Northern India 18.3% to India’s overall GDP growth. Due to this regional bias in the economic growth, we believe that banks having a dominant presence in these regions and states will be able to command a premium over its peers.

Our methodology focuses mainly on MCAP/CASA: MCAP/CASA ratio is not a standard valuation metric for banks. But our analysis clearly shows that for all listed PSU banks with similar efficiency parameters, this metric trade in a band.

Recommend a basket approach: We recommend investors interested in playing the consolidation theme to own a basket of mid and small sized banks. We prefer Bank of Maharashtra and Dena Bank in Western India, Oriental Bank of Commerce in Northern India, Indian Overseas Bank and Syndicate Bank in Southern India and Allahabad Bank which has a presence in Eastern and Central India. The selection is based on potential acquisition premium, regional presence and valuations.

To read the full report: BANKING SECTOR

>India: Policy action likely as WPI nears 5% in November (NOMURA)

India’s WPI inflation rose more than expected by 4.78% y-o-y in November from 1.34% in October (Consensus 4.20%), led by higher manufactured product prices. We believe that core inflation is starting to rise.

Rising global commodity prices are pushing up input cost pressures, beyond just food prices. With demand is picking up as well, we expect firms to have a greater ability to pass-through higher costs.

We expect WPI inflation to rise to 8.0% y-o-y by March. We expect the policy rate hiking cycle to start in January and we have pencilled in an inter-meeting cash reserve ratio (CRR) hike before that.

India's wholesale price index (WPI) inflation rose much higher than expected, to to 4.78% y-o-y in November from 1.34% in October (Consensus: 4.20%; Nomura: 4.44%). With weekily data on primary and fuel articles already. released, the surprise largely came from the manufactured products index (weighted at 63.75%). which rose a whopping 1.25% m-o-m in November as compared to an average of 0.5% in 2009 (Jan-Oct).

To read the full report: WPI