Monday, January 25, 2010

>China inflation risk rises as spare capacity dwindles

Beijing - Signs are emerging that spare industrial capacity in China is shrinking, removing what analysts until recently saw as a lid on inflation and encouraging Beijing to tone down some of its stimulus policies.

The global financial crisis aggravated Beijing's perennial worries over excess capacity, which forced down prices for most of last year and prompted Premier Wen Jiabao to describe it in September as the biggest problem facing China's economy.

But data due Thursday are likely to show that consumer prices rose more sharply in December than November and that on-year economic growth quickened to more than 10% in the last quarter of 2009.

Some analysts still say that excess capacity, which could lead to job losses, will help contain inflation in China this year, and that the recent pickup in consumer-price inflation is due largely to rising food prices after recent heavy snow storms disrupted transport.

But power shortages and fast-rising industrial production indicate that demand for goods, such as cars, is growing and may run up against supply constraints as excess capacity dwindles.

"By November and December, actual industrial production levels had already exceeded potential levels," said Sun Wen, an economist with Citic Securities Co. Citic last week raised its 2010 consumer-price inflation forecast to 3.2% from 2.6%.

Inflation could rise as demand begins to outstrip supply, and policymakers appear to realize the situation is changing. Premier Wen Jiabao told a meeting of the State Council Tuesday that the government must "closely watch changes in supply and demand in the market, form an accurate judgment of the situation and increase the precision and effectiveness of macroeconomic policies."

Already, Beijing has raised the share of deposits banks must keep at the central bank, guided money-market interest rates higher and pressured banks to cut back lending. Rising inflation risks could encourage authorities to further tighten monetary policy through interest-rate hikes, for example, and even to curb investments they consider redundant.

Inflation in China also could add to price pressures abroad as Chinese companies import materials such as iron ore and copper to build new plants, while other companies cover rising costs by raising prices on the shoes, T-shirts and mobile phones they sell overseas.

Growing production also indicates that capacity is being used up. Helped by a low base of comparison, industrial output in November rose 19.2% from a year earlier, the fastest growth since June 2007.

But the rapid industrial growth is hitting some speed bumps.

"The unusual early arrival of electricity-supply shortages also reflects that the recovery in manufacturing activities is probably faster than we would have expected," Goldman Sachs economists said in a research note last week. Goldman raised its 2010 consumer-price inflation forecast to 3.5% from 2.4%.

Some economists, however, say spare capacity remains and will help keep inflation to around 3% this year. That's up quite a bit from the 0.9% drop in the first 11 months of last year, but still mild compared with a 5.9% rise in 2008.

"It's too early to say that the economy is overheating," Standard Chartered Bank economist Jinny Yan said.


>Equities in the Coming Decade: Gold Class (MORGAN STANLEY)

Equities finish the decade as the best asset class: Over the past 5, 10 and 15 years equities has been the best performing asset class in India. That said, equities was also the riskiest asset class (measured using volatility in annual returns) over these periods. The one-year bank deposit and the 10-year government bond finished at the bottom in terms of returns for 10-year and 5-year horizons, respectively, disadvantaged by duration. Surprisingly, property was the worst performing asset class for the 15-year period. These conclusions come from our research on returnsand the volatility of these returns across five key assets classes (one-year bank deposit, 10-year government bond, gold, property, and equities represented by the BSE Sensex).

The key debate: There is a view that Indian households have missed the boat by having preferred gold and fixed income assets to equities over the past decade or so. Indian households have reduced their share of equity savings in financial assets from 23% in 1992 to 0% in F2004 before raising it to 10.5% in F2008. The share of physical investments (property, gold and micro businesses) in households’ balance sheet has gone up from 46% in F1995 to 51% in F2008 at acquisition cost. However, our research shows that on a risk-adjusted basis, equities may not have been the best asset class and that gold and property may have been superior asset classes. To that extent, the portfolio choices of Indian households of the past decade stand vindicated. The key debates are a) which asset class is likely to top the return and risk-adjusted return chart in the coming decade and b) whether households are set to change their preferences for various assets. In this essay we focus on the first debate. We shall address the second debate in a separate note in a few weeks from now.

Equities will likely be the best performing asset in the coming decade: We expect the BSE Sensexto deliver annual returns of 14% over the next 10-years based on our residual income model. Our view is that Indian equity returns are likely to be less volatile in the coming decade than in the previous ten years. This view is premised on the starting point of volatility which is ata historical high and the low relative cyclicality in earnings that Indian companies have been exhibiting vis-à-vis the rest of the world. Return volatility in the coming yearsis likely to be reminiscent of the post-1987 period when the volatility in equity returns moderated after hitting a peak. Fundamentals of the Indian corporate are in good shape backed by the strong domestic growth, robust balance sheets, high capital efficiency and the likelihood of decoupling from the rest of the world. Thus, on a risk-adjusted basis, equities are likely to be the most attractive asset class in the coming years.

Gold tepid outlook for the next five years: Gold has delivered positive returns for 12-consecutive years. However, our global commodities team expects annual returns to flatten over the next five years after gold touches a new peak in 2010 and then gradually declines in the subsequent years. (See Peter Richardson’s reported dated December 16, 2009 titled Gold –The Bull Market Reaches Maturity for details).

Property –favorable price outlook: Favorable demographics, rapid urbanization and formation of nuclei families will drive demand for property. Over the past fifteen years, India’s annual income growth of 12.9% exceeded the increase in property prices across eight cities (of 7.9%), highlighting improving affordability.

Bonds and deposits –are likely to continue to underperform: The near term outlook for 10-year bonds is mired by our forecast of rising yields in the US notwithstanding our view that 10-year treasuries are interesting from an ownership, supply and valuation perspective relative to equities. The long-term returns implied in the current yield of 7.6% make bonds unattractive even on a risk-adjusted basis. In a fast-growing economy like India, bank deposits will continue to be disadvantaged by duration and underperform other asset classes.

Our assumptions : For the return from 10-year treasuries, we assumed that the annual coupon was reinvested in one-year bank deposits post the payment of tax at the marginal tax rate. The bank fixed deposit return is the sum total of returns in annual bank fixed deposits together with the return on the reinvestment of post-tax interest earned on the deposit. The tax rate used is the marginal tax rate for individuals. The return on gold is the delta in the domestic gold price, which is determined by the import tariff on gold, the exchange rate and the global gold price. For equities, we have taken the BSE Sensexas the proxy for returns and reinvested post-tax dividends into the Sensex. For measuring return on property, our sample consists of residential properties in various localities across seven cities (Mumbai, Bangalore, Delhi, Kolkata, Ahmedabad, Pune, and Chennai). The gains on property, equities and gold are reduced by the long-term capital gains tax of 10% at the end of the period.

To read the full report: INDIA STRATEGY

>Equity Derivatives Dynamics (MORGAN STANLEY)

Meaningful drop in volatility: Equity markets have experienced a substantial drop in both short and long-term volatility over the past month, with some retracement in the last few days. The VIX has been in the 17-19% range of late, and we have finally seen sellers of longer-dated volatility emerge as well.

Hedging opportunity: While we expect volatility to continue to drop over time, we think the opportunity to buy near-dated options today is quite attractive, particularly for hedging purposes. Potential headwinds include rising interest rates, a strengthening dollar, and technicals associated with a secular demand for hedging.

Cyclical Sector Hedging

Volatility vs. relative pricing at the sector level: While all major S&P 500 sectors have experienced a drop in volatility, the relative pricing of OTM options show more variability, particularly the cyclical sectors. This variability leads to opportunity.

Hedge Cyclicals now: Downside skew is flattest for Tech, Industrials, and Discretionary. This pattern seems counterintuitive to us, and we advocate buying downside puts for the cyclical sectors as a market hedge. Cyclical hedge pricing is attractive relative to broad market hedges as well.

Attractive hedge payoffs: In scenarios where equity markets fall and cyclicals underperform (which is likely if we were to retrace performance), we see payoffs of slightly OTM put option hedges on cyclical sectors of 3x to 8x.

Upside plays in Tech and Energy: Option pricing post the fall in volatility tells us that upside calls in Tech and Energy are relatively attractive, and we would potentially fund them by selling OTM calls in the Discretionary sector.

To read the full report: EQUITY DERIVATIVES


Yes Bank’s Q3FY10 results were above expectations – net profits grew 18.5% YoY (I-Sec: 4.3% YoY) led by 69.5% YoY growth in NII. Credit growth, though high at 71.1% YoY, was broad-based. CASA improved to 10.1% in Q3FY10, while NIMs rose ~30bps YoY to 3.1%. Asset quality improved marginally – GNPAs fell 2bps QoQ to 0.29% – with specific provision coverage ratio at 70.4%. Capital adequacy was healthy at 16.2% (tier 1 at 9.2%). We tweak earnings to factor in higher loan growth, stronger margin and capital dilution in FY10 (from FY11 earlier). With the stock trading at 16.2x FY11E EPS & 2.5x FY11E BV, our Rs335/share target price (at 20x FY11E EPS) implies 23% upside. Maintain BUY. Sharp spike in NPL is the key risk.


Sharp credit growth; margins rise YoY. A 71.1% YoY credit growth, funded by a 63% YoY rise in deposits (with CASA rising 55bps QoQ & 91bps YoY to 10.1%) was the key highlight in Q3FY10. Credit offtake was broad-based and characterised by higher working capital financing this quarter. Management indicated its intent to grow credit at ~2x the industry growth. Overall duration of assets at 15-16 months was lower than 19-20 months for liabilities, indicating a favourable ALM profile in a rising rate scenario. Despite 340bps YoY contraction in yield on advances, deposit repricing and CASA accretion led to a 300bps fall in the cost of deposits, resulting in 30bps YoY NIM improvement. NII grew 69.5% YoY. We expect higher 42% NII CAGR through FY12E due to likelihood of higher-than-estimated credit growth.

Other income (ex-treasury) robust; costs contract. While financial advisory and transaction banking witnessed robust growth, income from financial markets was weak given negligible trading gains and a lull in foreign exchange activity in Q3FY10. Costs, however, decreased 5.4% YoY as Yes Bank added only five branches this quarter and employee costs declined ~15% YoY. We expect branch expansion to gather pace. Cost-to-income should stabilise at ~40% by FY12E.

Asset quality maintained; restructured accounts fall. GNPAs declined 2bps QoQ to 0.29%, though NNPAs rose 1bp QoQ to 0.09%. Specific provisioning coverage at 70.4% was healthy, while overall provisioning coverage was at 270%. Restructured accounts declined Rs219mn in Q3FY10. Outstanding restructured accounts now stand at Rs1.35bn or 0.71% of gross advances.

Strong growth trajectory. We foresee robust credit CAGR of 46% through FY11E, driving NII CAGR of 42%. We tweak earnings marginally to incorporate higher credit growth assumptions and capital dilution in FY10 (from FY11 earlier). Continued strength in other income and well-maintained asset quality will continue to drive ~18% RoE through FY12E. We maintain our 20x FY11E EPS multiple, with target price of Rs335/share implying 23% upside. Reiterate BUY. Sharp inflection in interest rates, chunky slippages and execution are the key concerns.

To read the full report: YES BANK


Company Description: Incorporated in 1980, Superhouse manufactures and sells finishing leather products like footwear, uppers and sports shoes, leather garments, bags, wallets and other leather goods. A US $ 50 million, Superhouse Group has 15 units, with workforce of over 5000 and has its presence in over 35 countries. The textile division contributes nearly 10% in the revenue. The company is having 6 subsidiary companies namely Superhouse (UK), Superhouse (USA) International Inc, Superhouse Middle East FZC, Superhouse R.O. S.R.L., Super House Canada Inc and Super House HK.

Until now, its‘ Allen Cooper’ brand had been enjoying the prestigious patronage of British and European markets. The brand has now stepped into the Indian market and is catering to the requirements of corporate and institutional customers, creating a niche image for its fashion leather products adhering to the high standards that the British have set, Double Duty is a brand owned by Superhouse for marketing safety footwear and garments mainly to Gulf and European countries.

Investment Rationale: Three state-of-art units involved in manufacturing of footwear are ably backed by its three marketing subsidiaries strategically located in USA, UK, UAE & Australia. To add on, it has approved vendors to world-wide brands such as Wal-Mart, Filanto, Auchan, Andre, Shoe Fayre, Hudson Bay, Heckel Securite, Secura and many more. Its in-house tanneries sole division provides finest quality leather soles for foot wears. To meet the exacting demand of clients it also imports leather from Brazil, Italy and Columbia. Superhouse derives nearly 85% of its revenue through exports. Its products are exported to countries like France, Germany, Holland, Australia and South Africa.

During FY07-08, SL spent Rs 40 crore towards expansion to cater exclusively to the US and European markets. SL’s existence for over three decades allows offering its customers the maximum in choice, value & quality. The prospects of the leather industry are so bright that the exports from the country are expected to touch $ 7 billion by 2011-12 from $ 3.6 billion at present. India has around 3% share in the global trade in leather compared to China's 20%. Realizing the growth potential of the leather industry, which occupies a prominent place in the Indian economy, the Government of India has been making significant efforts to promote rapid advancement of the industry.

The government’s measures to offer a slew of incentives for opening of the leather sector to foreign direct investment (FDI) are expected to spur the growth in this sector. The Government has also provided assistance worth 2% of the value of exports to the US and the European Union in the form of duty-free scrips that could be sold for cash.

The stock is forming a rounding bottom price pattern in its weekly chart. Volumes are also in confirmation with the price pattern as they are decreasing then reduced substantially and finally increasing during the formation of the price pattern. The stock is expected to touch Rs 84, which was the level from where the big fall began. At the CMP of Rs 60, the share is trading at a P/E of 4.3x on FY10E and 3.5x on FY11E. We recommend BUY with a target price of Rs 85 in the medium term.

To read the full report:SUPERHOUSE LIMITED


JP Associates (JAL) recorded a robust set of numbers for 3QFY2010. The Consolidated Top-line growth came in mainly on account of robust Construction & EPC (C&EPC) division sales. EBITDA margins also saw an improvement yoy, on account of C&EPC performance. The adjusted Bottom-line exhibited a robust growth, excluding extra-ordinary expenses. Owing to the strong quarterly numbers, the Jaypee Infratech IPO in the pipeline, and overall positive outlook, we have upgraded the stock from Neutral to Accumulate.

All cylinders firing: JAL registered a robust consolidated Top-line growth of 109.2% to Rs2,964cr, against our estimates of Rs2,370cr, mainly on account of the C&EPC division. Sales of the C&EPC segment of JAL posted a robust growth of 130.3% to Rs1,643cr, against our estimate of Rs1,105cr. The Top-line contribution from the Cement segment was mostly in line with estimates, whereas that from the Real Estate segment outperformed our estimates to Rs345.6cr. The EBITDA margin for the quarter came in at 29.9% (as against our estimate of 27.3%), which was a 630bp improvement yoy. The adjusted PAT grew by 86.8%, inspite of a higher tax outflow. However, the reported PAT de-grew by 38.9% yoy to Rs103cr, primarily on account of extraordinary expenses on account of employee compensation expenses (ESOPs) to the tune of Rs212cr.

Outlook and Valuation: JAL has done extremely well on all fronts and, given the robust outlook for the sector, we are expecting the good performance to continue. We have valued the stock on an SOTP basis. JAL’s Cement and Construction business (at 8x EV/EBITDA on an FY2012E basis) contribute Rs87.7/share and Rs65.3/share, respectively, to our target price We have valued JAL’s stake in Jaiprakash Power Ventures on a MCap basis, by assigning a 20% holding company discount, thereby contributing Rs48.6/share. We continue to value JAL’s Real Estate initiative at Rs33.7/share, on an NAV basis. JAL’s Hospitality Division has been valued at 8x its FY2012E PAT, at Rs0.7/share. The unsold treasury stock has been valued at CMP of Rs160, thereby contributing Rs16.5/share. The net debt for the Cement, Construction and Real Estate businesses, for FY2012E, has been deducted. Hence, we upgrade the stock from Neutral to Accumulate, with a Target Price of Rs194.

To read the full report: JAIPRAKASH ASSOCIATES


Cement stocks have run into resistance after rising sharply over the last few quarters on concerns of supply glut in certain pockets of the country later this year. However in this note we focus on three stocks that offer some upsides in terms of their valuations despite the current concerns over the industry prospects. The plants location of these three companies are mainly in areas where large new capacities are not expected to come up in the next 2-4 quarters. Further contrary to expectations, cement prices have begun to rise over the past few weeks on account of varied reasons including shortage of railway wagons, setting in of busy construction season, demand due to commonwealth games, rise in coal prices, disruption in Andhra Pradesh due to agitation, etc.

While JK Cement will benefit out of the recently commissioned 3 MT plant at Mudhol (Karnataka) – total capacity now is 7.5 MW – JK Lakshmi Cement could benefit out of the 1.1 MT expansion that went on stream in last quarter of FY09 (full impact likely in FY10). Compared to the EV/EBITDA and EV/Ton enjoyed by the larger players in the industry of 4.5 and 105 respectively, the valuation parameters of these two companies are cheap even discounting the size difference. Even in terms of EPS, we could see a better numbers going ahead due to higher capacity available for FY10 (despite a fall in realizations – to the extent it happens).

Heidelberg Cement is a subsidiary of world’s fourth largest Cement manufacturer Heidelberg of Germany. Though its expansion plans are not likely to come on stream before FY12, it has some catching up to do compared to the valuations enjoyed by the subsidiaries of world’s 2nd largest producer Holcim (ACC and Ambuja Cement). Further having regard to the weak financial position of the parent, some corporate action and value unlocking as a result of that is also possible (though the timing thereof could be uncertain). Compared to the EV/EBITDA and EV/Ton enjoyed by the MNC players in the industry of 5.5 and 110 respectively, the valuation parameters of Heidelberg is cheap even discounting the size difference.

To read the full report: CEMENT STOCKS