Thursday, January 7, 2010

>2010 US Equity Outlook: The Shape of Things to Come and Seven Trades

Seven questions on the shape of things to come
Our fundamental thesis remains that after a corporate over-contraction, the necessary expansion underway to meet existing demand will maintain pressures for a cyclical recovery into 2010. Enterprise spending and hiring will determine the speed of recovery and its sustainability. Instead of a detailed baseline and alternative scenarios, we discuss seven key questions:

Q1. After cost-cutting, how much upside remains for earnings? Significant.
Q2. How severe will a possible double-dip be? Is it priced in? Modest, a ‘W’ in growth rather than in the level of GDP; market is pricing in flat-to-down earnings.
Q3. Will monetary tightening derail the equity recovery? No. It should have only a temporary impact on US equities.
Q4. Will the dollar turn in 2010? Bad for US equities? We see the dollar rallying with US rates, but not ruling out upside for equities; energy is most vulnerable.
Q5. How are investors positioned after the massive rally? A large asset allocation underweight in equities persists; inflows will come only after rates turn up.
Q6. Will the financials outperform? We think so: current underperformance exceeds that in the Great Depression; they are cheapest on normalized earnings; and employment is a key driver of relative performance.
Q7. Will emerging markets continue to outperform the developed markets? Bulk of outperformance reflected multiple expansion not earnings growth; relative valuations have run up and so we prefer DM stocks with EM exposure over EM.

Revised targets, market & sector strategy
We revise up our EPS estimate for the S&P 500 in 2010 to $80.8 ($77.8) and our S&P 500 target to 1325 (1260). Across asset classes, we see the biggest upside for equities; but our sector allocations make us already overweight in a beta sense and so we stay fully allocated. Across sectors, our largest overweight remains the financials, and the largest underweight energy. We move health care from underweight to neutral as diminishing uncertainty about reform lifts multiples.

Seven trades for 2010
(i) Significant recovery upside but also downside risks: Best of both worlds basket, high-quality stocks cheap on normalized earnings;
(ii) M&A up cycle beginning: Buy acquisition targets;
(iii) Rising rates: Long brokers (XBD) and short REITs (IYR);
(iv) Stronger US dollar: Long retailers (RTH) and short energy (XLE);
(v) Overweight US versus emerging markets: Long US financials (XLF) and short EM financials;
(vi) Flows follow: Stay with value over growth;
(vii) Uncertainty to decline: Short S&P 500 12m forward volatility.

To read the full report: US EQUITY STRATEGY

>Sugar rally getting stronger (MERRILL LYNCH)

Reiterate BUY as sugar price at Rs40/kg is ahead of target
Rise in sugar price by 20% in last month to Rs40/kg in Delhi wholesale market compared to our assumption of Rs32/kg in FY10E (YE Sep) is likely to yield significant upside. Key drivers for sugar price rally are (1) concern of further production shortfall in India owing to restrictions on raw sugar imports (2) poor quality of sugarcane; and (3) surge in international price on poor output in Brazil.

We reiterate Buy on Sugar stocks on attractive valuation amidst rising prospect of the tight sugar market lasting until FY11E (YE Sep 2011). Robust profit in Dec09 Q to be reported in Jan 2010 is likely to be the key trigger.

Uttarpradesh ban on raw sugar import hurting supply
We have learnt from newspaper reports as well as sugar mills that Uttarpradesh is yet to lift the ban on imports of raw sugar into the state imposed since Nov 2009 in order to protect farmer’s interest. The ban could last until Mar 2010, i.e the end of sugarcane crushing season. At present about 0.7mt of raw sugar is held up at ports including 0.55mt of Bajaj Hindusthan and 0.065mt of Balrampur Chini.

If govt does not allow import during crushing season, then mills will see an increase in cost of production by Rs1/kg and may not be able to import additional quantity, which in turn will affect supply.

Weaker cane quality in current season affecting supply too
Amount of sugar recovered per tonne of cane in Uttarpradesh and Maharashtra in the first three months of current season (Oct09-Dec09) is about 20bp lower y-o-y and total sugar production is flat. This is below our estimate of 11% growth in India’s sugar production to16.2mt driven by 50bp increase in recovery. Lower recovery could lead to about 15mt of sugar production in India, which along with restricted raw sugar import could tighten the supply and drive up price further.

Poor production in Brazil supporting international price
International raw sugar price (SB1 Cmdty) has gone up 25% in last one month following reports of 30% decline in sugar production in Brazil between 16 Nov 2009 and 16 Dec 2009. Recent shift in usage of cane in Brazil in favour of ethanol has further boosted the outlook of tighter sugar supply globally.

Maintain Renuka as top pick owing to its stock pile
Renuka sugar, the largest raw sugar refinery of India, being based out of Karnataka and West Bengal is unaffected by Uttarpradesh’s import ban. We expect Renuka to be the biggest beneficiary of rising sugar price in FY10 owing to its 0.4mt sugar stock at cost of Rs23/kg and contract for another 1.2mt raw sugar.

To read the full report: SUGAR RALLY


A strong recovery in domestic cyclicals, mixed performance of defensives and divergence amongst global cyclicals will mark the 3Q reporting season, beginning this Friday. Overall profits for Sensex as well as for our universe would be up 27-29% YoY, on our estimates.

• While headline profit growth would be flattered by the year-ago period’s low base (profits had dropped 14% YoY in 3QFY09 for our coverage), an acceleration in revenue growth (to ~20% from sub 5% in the previous three quarters) too would contribute to strong profit growth.

• Beyond YoY comparisons, absolute profits (as well as EBITDA) during the quarter will likely be 10-20% higher than even 3QFY08 levels for our universe. Sequentially (QoQ), aggregate profits are likely to have grown for the fourth consecutive quarter, with revenues growing for the second consecutive quarter.

• All sectors, save four (Capital Goods, Cement, IT Services, Financials), would likely report acceleration in YoY profit growth from the previous quarter. Also, all sectors except five are likely to report double-digit profit growth.

• Autos and Commodities, two sectors that were the first to be hit by the slowdown last year, will likely report the strongest growth and be the biggest contributors to growth during 3QFY10; we reckon they would contribute over three fourths of our universe’s profit growth. These two sectors will also contribute over two thirds of the quarter’s revenue growth.

• Domestic consumption-linked sectors will show continued momentum. We expect Auto sector to maintain margins sequentially as higher commodity costs are offset by operating leverage and better product mix. Revival in urban demand will buoy results of retailers which will report modest acceleration in revenues and sharp uptick in profits as Shoppers Stop reports a profit from loss in December 2008 quarter. Same store sales could exceed 40-50% in some formats for Pantaloon during the quarter.

• Capital Goods, Telecom and Financials will be the laggards during the quarter. The decline in Capital Goods would be due to last year’s extraordinary gains at L&T (otherwise it will likely report strong operating performance). The Telecom sector will likely report deterioration in core performance as well, as increased competition takes its toll. Lower trading income and weak credit growth will hurt financials results.

To read the full report: EARNINGS PREVIEW


Major Players in the private Sector: Among the private players, ICICI was leading
again with 25%, followed by Bajaj Allianz by 17% & Reliance by 14% holding the major market share in the general insurance segment. These 3 players' aggregate to 55% of the total market share in the private insurer segment.

Growing Market Share of Private Players

  • Over the last 6 years, the market share of the private insurer has grown to 40% in 2009, from 19% in September,2004 .
  • On the other hand the PSU players were unable to cope up with their counter parts and witnessed a fall in their market share to 60% in FY09, from 81% in FY04.

Segment wise growth
  • The motor Segment clocked a growth of 7% in its total gross premium income. However the total share of this segment has slipped to 39% in Apr-Sept 09, from 40% in Apr-Sept 08.
  • Meanwhile the growth of health insurance was 16% and the market share of the segment grew to 22% to Rs.3905 Crs in Apr-Sept 09, from 21% in Apr-Sept 08.
  • The general Insurance industry grew by 24% year on year from Oct 08 to Oct 09 to Rs.3330Cr from Rs.2676Cr in the last year.
  • In the Private players, the Y-o-Y fall in the market share of the Insurers like ICICI fell by 20%, Bajaj by 13% and Reliance by 4% witnessing 14% fall in the over all market share among the private insurers. At the same time, HDFC ERGO Gross Premium Income heightened by 141% due to the immense rise in their market share.
  • Among the public players United India is leading as it rose by 3% while the other 3 witnessed a fall in the market share.
  • The overall holdings of the private players in the general insurance industry grew by 2% from 41% in Oct 08 to 43% in Oct 09. On the other side the holding of public sector fell by 2% from 59% in Oct 08 to 57% in Oct 09.

To read the full report: GENERAL INSURANCE


Pricing concern looms despite improved regional mix
All India retail prices have fallen 5-30% qoq Sep-Dec'09 period in response to higher supply, The pricing pressure has been severe in Southern (up to 40% correction) and Central (down ~25%) regions, where ACL has a miscule presence.

CY09-11 revenue CAGR to lag volume growth of 8.4%
We model in sales volume of 21mtpa, a yoy increase of 12.6% and 4.4% in CY10 and CY11 respectively driven by completion of major capex at Bhatapara, Rauri, Dadri and Nalgarh units.

Margin to improve post Bhatapara plant commencement
ACL meets its partial requirement of clinker from ouside as a result of which it's 9M CY09 margin stood at 28.2%, significantly lower than to its peers like ACC (34.6%) and Ultratech (32.7%).

To read the full report: AMBUJA CEMENTS LIMITED