Sunday, December 27, 2009

>What will happen if the oil price falls to USD 40 per barrel again in 2010?

One should absolutely not underestimate the possibility that the oil price will fall to USD 40 per barrel again in 2010: growth in OECD countries will decline significantly from its 2009 trend; the speculative oil stockpiles may shrink; there is still enormous excess production capacity and OPEC’s discipline may disappear if oil prices start to fall.

The effects of far less expensive oil in 2010 are known: stimulation of consumption, but negative inflation again in OECD countries, and therefore extension of the period of highly expansionary monetary policy since consumption will remain sluggish; difficulties for some oil-producing countries: Russia, Iran, Venezuela; appreciation of the dollar against the euro.

1. It is entirely possible that the oil price will slip back (to USD 40 per barrel??) in 2010.
2. What would happen if the oil price fell back to USD 40 per barrel in 2010?

The consequences of a low oil price again in 2010 are quite clear:

a) Stimulation of consumption in OECD countries, as in the second half of 2008 and at the beginning of 2009, by the fall in energy prices, and hence a decline in inflation (Charts 8A
and B), which bolsters real wages (Chart 8C).

b) As inflation will become very low again and growth will be very modest, despite the fall in the oil price, monetary policies in OECD countries are likely to remain highly expansionary.

c) Oil-producing countries that need a high oil price to balance their budgets (Russia, Venezuela, Iran, Chart 10A) will again face problems.

d) Pick-up in the dollar against the euro; it is well known that when the oil price is high, the dollar depreciates against the euro (Chart 11); this is in all likelihood accounted for by the fact that oil-producing countries invest a substantial part of their dollar-denominated oil revenues in euros.

To read the full report: OIL

>Indian mid-cap construction (MACQUARIE RESEARCH)

We spoke to managements of various mid-cap construction companies to discuss key issues. We are very positive on the space and believe the recent underperformance is an excellent accumulation opportunity. We think valuations are at very attractive levels of 10–11x FY11E earnings with a very strong order inflow cycle about to begin. The stocks have come under pressure due to shortterm issues like the Dubai credit crisis and statehood demand for Telangana.

Valuations extremely attractive with substantial growth: The mid-cap construction space has underperformed the broader indices recently and trading around 10x FY11E (adjusted for subs valuations) due to short-term irritants, despite we believe substantial growth opportunities beginning in FY11. Interestingly, most of these companies have recently raised equity financing, so the risk of dilution is also substantially reduced in the near term.

Near-term sentiment spoilers are temporary in nature: The issues like the Dubai credit crisis and a separate statehood issue in Telangana have created a dampener on stock prices. We strongly believe that these issues are temporary with no material impact and create an opportunity to accumulate these stocks.

Substantial structural opportunity to support long-term earnings growth: We expect order inflow in the infra space to strongly rebound in FY11 as governments get their acts together on sectors like roads, ports and continued push in power. In the near term, top-line growth will likely rebound in FY11. Roads, which were around 30% of order backlog, have reduced to close to 10–15%. Roads itself are likely to witness order inflow of US$10bn in FY11. Even without roads, the order backlog for the space remains healthy at 3x last year’s revenues.

Lower interest costs can provide upside to earnings estimates: Interest costs have reduced by 150–200bps for construction companies in 2H FY10, which have yet to be reflected in earnings. Recent fundraising will further help in lowering interest costs, which are not built into consensus estimates.

Subsidiary valuations are becoming material: For all the three companies, BOT (Build-Operate-Transfer) assets are getting commissioned gradually, which will start contributing to earnings while new BOT assets are being added to the portfolio, hence enhancing the size and valuations. Also, we believe valuations for all these companies’ real estate portfolios have
bottomed out and present upside to the valuations.

All three stocks seem attractively placed for the short and medium term: We like all the three companies at current valuations with near-term triggers in place. NJCC and PEC have near-term triggers in the form of Q3 FY10 earnings, while in the case of IVRCL, visibility on BOT revenues and the settling down of the Telangana issue will likely be the triggers.

To read the full report: INDIAN MID-CAP CONSTRUCTION


Privatization of container rail operations has enticed 16 players, including incumbent Concor, to the space since 2005. These players are eyeing 3% (97m tonnes) of the overall freight market by trying to shift volumes from road to rail. Operators can ‘create the market’ by offering integrated, value-added logistics solutions with last mile connectivity. However, to attain these capabilities and garner higher volumes, operators need to invest heavily in hard infrastructure. As the business entails a longer gestation period, scale and efficiency (utilization and turnaround times) are extremely critical to generate returns of 15%+ on capital employed. In view of their competitive strength, and thereby ability to attract volumes and drive strong earnings growth, we believe Concor, Arshiya and Gateway Distriparks (GDL) are well positioned to generate superior returns. Reiterate Overweight on the sector.

Integrated service offering to attract volumes to rail: While the number of operators appears high at 16, we believe there are enough volumes. With 500 rakes expected to be operational by FY12/13, players are eyeing only 3% (97m tonnes) of the overall freight market. However, volumes are required to be shifted from road to rail, for which operators have to offer timely, reliable and value-added services with last mile connectivity and customized solutions.

Returns linked to turnaround times and utilization levels: Container rail is a highly capital-intensive and long gestation business with hefty investments required in rakes (capacity) and rail sidings (cargo consolidation and value added services, etc) to attract volumes. Hence, asset turnaround time and utilization levels assume greater relevance for an operator to derive economies of scale and be profitable. Once an operator achieves critical mass, we believe it can earn RoCE of 15%+, which can be further augmented by offering integrated services.

Attractive valuations; Overweight: We believe operators need deep pockets to survive the long gestation period. In this context, Concor, Arshiya and GDL possess the competitive edge in terms of funding and strong infrastructure to secure higher volumes. Arshiya and GDL are fast attaining scale, and their rail operations are likely to turn profitable in FY11, supported by an expected upturn in the trade cycle. With 12-30% earnings CAGR over FY09-12E and attractive stock valuations, we are Overweight on the sector and Outperformer on the three stocks.

To read the full report: CONTAINER RAIL


1H’10 results uninspiring… Suzlon reported consolidated 1H’10 Sales -7.5%, EBITDA -88% and reported net loss of Rs10 bn vs. Rs2 bn loss in 1H’09. Costs were higher on increased fixed costs on new facilities (capacity ~2x to 5.7 GW in FY09-10) and lower WTG delivery volumes (-62% YoY in 1H’10 to 406 MW).

… but debt woes easing: Investors’ worries on high debt and its serviceability are easing as Suzlon sold Hansen’s 35.22% (of its 61.28%) stake to raise US$370 mn. The company has repaid US$780 mn worth of acquisition loans through combination of Hansen stake sale and refinancing from a new US$430 mn offshore facility from SBI. It may also convert promoter’s Rs12 bn loan to equity through preferential/ or rights issue (see Annexure I).

Global demand rising

Visibility improving; ~23 GW of wind capacity addition probable: Improving global economic scenario, continued policy support and higher credit availability has led to better order visibility for WTG companies. Developments over last 6M are promising- a) ~$1.7 bn cash grants have been infused in the system; b) MoM improvement in order inflow to 350 MW/month (from 150 MW/month in Aug) + large framework on-shore orders being placed (954 MW to REpower); c) ~700 MW wind projects commissioned after debt tie-ups. d) Gamesa estimates wind projects under development at ~23 GW, with ~2.2 GW projects to be ordered soon; and e) Iberdrola, EDP, Duke have not just raised wind capacity targets but also raised funds for future expansion (Exhibit 14).

Indian regulations bode well for Suzlon’s growth; market size may increase from 1.5-2x to 4 GW/pa: Regulatory changes in the form of new RE tariff norms (15.8% PT-ROE) and draft regulations for RE Certificates are a precursor to national RE Purchase Obligation (RPO), which has been agreed to by Forum of Regulators at 5% for 2010, & 1% increase p.a. till 2020. We think Indian markets will inch to 4 GW/p.a by CY’11 from ~1.5-2 GW/pa currently.

Price target lowered to Rs95; Maintain Buy: Post Hansen divestment, there is lack of clarity on Suzlon’s consolidated balance sheet. We have cut our estimates to factor in lower volumes; unconsolidated Hansen (considered as profit from associates) and introduced FY12E (Exhibit 18). We have changed our valuation methodology from DCF to a one-year forward PE multiple, and now value Suzlon Wind at 15x FY12E earnings, at a 25% discount to current peers’ average (20x), while REpower and Hansen are valued at 18x. We get a Mar’11 target price of Rs95 for fully diluted equity of Rs3,835 mn including Rs1.0 bn YTM for out-of-the-money FCCB. Maintain Buy as- a) we remain optimistic on recovery in wind taking lead from positive commentary by Siemens, REpower & Crompton; b) regulatory push & market expansion in India; c) easing debt concerns; and d) management’s focus to legally integrate REpower in FY11E.

Risks: Oversupply concerns in China and their possible global foray could lower WTG prices. 200 MW variation in volumes will vary earnings by ~7%.

To read the full report: SUZLON ENERGY


Prices Rising in All Regions — Carbon steel prices are slowly moving higher as the arbitrage gaps between US/European and China prices close, and raw material prices increase. We believe there is additional upside potential for steelmaking raw materials as the northern hemisphere summer starts (with the concomitant seasonal construction increase). In our selection we prefer raw material-integrated and spot price-focused steel producers.

China Cost Position Deteriorates — Higher raw material costs are leading to higher proportionate costs for China, as raw material costs are US$-based and the renminbi is pegged. We believe the short-term demand outlook for China is supportive and cost pressures and lack of raw material access will moderate the impact of any potential future slowdown on other steel-producing regions.

China Strength Feeding through to Raw Materials

OECD Restocking to Accelerate — Inventory restocking slowed in December, as consumers protected fragile balance sheets and kept working capital levels low. We anticipate a re-acceleration of the restocking process as price momentum improves and seasonal demand lifts in 1H2010.

Operating Rates Recovering — Global steel production has recovered, with production reaching 107.5mt in November (+22.4% YoY, but -4.2% MoM) and operating rates at 77% also significantly better than 69.8% in November 2008. Asia posted another strong production month in November (66.8mt, +23.5%). and now constitutes >62% of global production.

China: Raw Materials — Iron ore import volumes for November were 51.07mt (+12.3% MoM). Domestic iron ore production was another monthly record at 86.78mt (+4.1% MoM and +19.4% YoY). Coking coal imports of 2.9mt were 29.4% up MoM, and export volumes were at 74.7kt compared to 129.1kt in October.

Short-Term Positives Increase — Restocking activity is modest, but supportive of demand in the near term, and raw material price settlements are expected to support steel prices (the key driver of shares) into 2010e. Although the short term outlook looks positive, we have not turned structural bulls due to the high levels of excess capacity in the system. We remain selective on our outlook for steel companies, and cautious on the full year outlook for 2010. We prefer companies with raw material integration and spot price focus in the near-term.

To read the full report: STEEL PICTURE BOOK