Wednesday, January 27, 2010

>A Tale of Two Recoveries (NOMURA)

The aftermath of the crisis should constrain the developed world recovery, but, led by a booming China, emerging markets look set for strong growth.

Our View on 2010 in a Nutshell

• The developed-world recovery looks set to be weak given de-leveraging forces and other legacies of the crisis.
• With good fundamentals and a lack of aftermath issues, the emerging world, particularly Asia, is set to grow strongly.
• Developed-world inflation should stay low amid ample spare capacity, but exchange rate -targeting central banks risk bubbles.
• The main downside risks include a re-eruption of financial distress, a commodity price bubble and premature fiscal tightening.
• A possible upside surprise: animal spirits stir and, with monetary conditions super-loose, help release pent-up demand.
• We forecast an average Brent oil price of $72 in 2010 and $75 in 2011, after $62 in 2009.
• We expect further dollar weakness, especially vs EM, but the yen should gradually trade weaker on MOF intervention.

United States
• The “Great Recession” has ended, but the after-effects of the financial crisis are likely to weigh on the recovery.
• Job market conditions are improving, but business uncertainty should limit job growth and keep the unemployment rate high.
• Typical of the first phase of recovery, ample capacity is likely to put downward pressure on inflation.
• We expect the Fed to focus on an orderly exit from credit easing, but not to hike rates until early 2011.
• Proposals for a jobs-focused fiscal policy must overcome resistance from those worried about adding more to a record deficit.

• We expect sub-par growth given household de-leveraging in the UK and feeble domestic momentum in the euro area.
• The fiscal policy challenge: deliver short-term stimulus within a credible framework of medium-term consolidation.
• Headline inflation is set to rise in the UK and euro area, but underlying inflation is likely to stay very weak.
• We expect the ECB to start gradually removing exceptional liquidity measures but not to start hiking rates until October 2010.
• The BoE MPC faces uncertainties on both sides and we do not expect rate hikes until November 2010.

• We expect the Japanese economy to slow again through H1 2010 but for growth to pick up again in the second half.
• Faster-than-expected excess supply corrections and expanding exports, particularly to Asia, should drive a recovery in H2.
• Given a wider negative output gap, we expect CPI deflation to persist for the foreseeable future.
• The BOJ is likely to adopt additional easing measures, such as increasing long-term JGB purchases, in H1 2010.

• Things look ripe for a paradigm shift – domestic demand is replacing exports as the main growth driver, led by China.
• China: The investment and consumption booms are set to continue and to deliver double-digit growth.
• Korea: We see an inflationary economic recovery in 2010, driven by a prolonged macro stimulus and strong China demand.
• India: With both growth and inflation headed towards 8%, we expect the RBI to lead Asia in tightening monetary policy.
• Australia: Despite less expansionary policies, we see GDP growth quickening on stronger capex, exports and housing.
• SE Asia: Bullish on Indonesia, Singapore and the Philippines; less so on Thailand and Malaysia; concerned about Vietnam.

EEMEA (Emerging Europe, Middle East and Africa) and Latin America
• Key themes in 2010 are the removal of supranational support, fiscal sustainability and the effects of exit strategies on rates.
• CEE will likely be the slowest region to recover. Vulnerabilities persist, especially with banks’ NPLs set to peak in Q2 2010.
• Elections in CEE are a risk, with knock-on effects for fiscal policy sustainability. We see Poland entering ERM-II in Q4 2010.
• South Africa: World Cup and restocking will mask a weak recovery in consumption; we see a change in the SARB mandate.
• Russia should return to stable, if subdued, growth in 2010, supported by oil prices and pent-up domestic demand.
• Turkey should show a strong rebound in 2010, allowing some policy normalisation. Inflation should remain in check.
• Middle East: The Dubai story is a key test of investor confidence in the region; growth momentum should be maintained.
• LatAm: Strong growth in Asia and expansive monetary and fiscal policy are leading to a cyclical recovery.

We expect a strong recovery in most of EM but a shallow one in the developed world.
Two key features of the global economy evident since the financial crisis of 2008 inform our global economic forecast for 2010. The first is that the developed economies, particularly the US and Europe, experienced their worst financial crisis since the Great Depression. The aftermath will cast a long shadow on their recovery. The second is that emerging markets (EM), particularly emerging Asia, after absorbing the initial hit to exports from the crisis-induced collapse in developed-world domestic demand, have performed remarkably well. Continuing this trend, EM economies are likely to post strong domestic demand-driven growth in 2010 (Figure 1).

Looking back, the growth numbers that we expect for the full year of 2009 speak for themselves. The global economy overall likely contracted by almost 1% in 2009, but developed-world GDP likely fell by 3.4% while EM economies expanded by 2.0%. Within EM, there was notable differentiation: EEMEA (Emerging Europe, Middle East and Africa) and Latin America likely contracted by 3.2% and 2.8%, respectively, while Asia looks likely to hit 5.5% growth.

China’s expected 8.5% growth in 2009, in such a challenging global environment, stands out. As well as benefiting from strong domestic growth momentum associated with a 30-year economic development take-off, China, at the outset of the crisis, moved quickly to re-peg its currency against the US dollar and engineer a fiscally and credit-driven investment boom. But India’s expected 6.5% growth in 2009 also merits attention. The world’s two most populous economies were the fastest growing in 2009 and together look like contributing 1.5 percentage points (pp) to likely global growth of -0.9% (put another way, and a bit too simply, had these two economies stood still rather than grown, global growth would have been -2.4% in 2009) (Figure 2).

Looking to 2010, the first point to note is that the global recession is over – the quarter-on quarter contractions in global GDP having ended in Q2 2009 (for the G10, Q3) – and we think will stay over. Recessions are not the natural state for an economy and tend to self-correct over time, with counter-cyclical macro policy hastening the process. This recession threatened to throw the developed world economy in particular into a great depression and deflation, but concerted and unprecedented monetary, fiscal and financial-system policy action headed that prospect off at the pass. Absent another major shock, which we do not expect, the global economy should continue on its recovery path. We forecast global growth of 4.2% in 2010.

To read the full report: A TALE OF TWO RECOVERIES


Dish reported mixed 3Q results. Revenues matched our estimate, and the net loss was better than our expectation. However, operating metrics were uninspiring. We have trimmed our subscription ARPU estimate by about 5% for outer years post weak 3Q trends. This partially offsets the upward revision made to reflect reduced capex due to fall in set-top box prices and increased comfort in future growth potential following US$100m cash infusion from 11% equity sale via GDR. Retain OP with revised TP of Rs55 (from Rs45).

Story on track. We believe that DTH is best media subsector via which to participate in the domestic consumption growth story, and Dish TV is the only pure-play DTH operator. Although 3Q subscription ARPU and gross additions were below our estimates, we do not believe this alters the structural growth course for the company. We expect new subscriber addition momentum (industry adds expected at 8.5m subs for each of the next three years) and gradual improvement in subscription ARPU (5% YoY growth assumed in our model) to drive stock price performance.

Funding in place to meet growth requirement. Apollo Management picked up an 11% stake in Dish TV for US$100m (Rs4.6bn) in November 2009 via GDR issuance. In addition, Rs4bn of final tranche of rights issue (expected to be called in March) would enable Dish to participate in robust DTH industry growth over next three years without needing additional cash infusion.

3Q top line meets estimate, net loss lower than expected. Dish reported 3Q revenues of Rs2.8bn (up 7.7% QoQ and 43.8% YoY), meeting our estimate. However, EBITDA of Rs114m was significantly lower than our forecast of Rs158m due to higher cost of services. The negative surprise at the EBITDA level was mitigated by lower interest expense. As a result, the reported loss of Rs762m was lower than our Rs888m loss expectation.

Earnings and target price revision
We expect lower net losses in FY3/10 (1% lower) and FY3/11 (28% lower), as reduced interest burden should more than offset the negative impact of lightly lower EBITDA. Our new target price is Rs55.

Price catalyst
12-month price target: Rs55.00 based on a DCF methodology.

Catalyst: Sequential improvement in subscription ARPU.

Action and recommendation
Reiterate OP. Dish TV remains our top pick in the Indian media sector. We recommend that investors pare exposure to ZEEL (Z IN, Rs274, UP, TP: Rs130) and accumulate Dish TV. Competitive headwinds in the Hindi GEC (General Entertainment Channel) genre would hurt ad revenue growth for ZEEL’s flagship channel, Zee TV. Dish is currently trading at an EV/sub value of US$203 vs the global average of US$1,468.

To read the full report: DISH TV



At the Oct09 monetary policy, the RBI withdrew some unconventional liquidity support measures and tightened the prudential norms particularly for the property sector. The monetary policy statement clearly shows that those steps represented the first step towards "exit".

In the coming meeting on 29th January 2010, there is an expectation on 50 bps CRR hike. On a more aggressive stance, there is also a slim possibility of Reverse Repo hike at the same time (25 bps) in the policy meeting. The possibility for this measure remains slim as the current market is in a revers repo mode with approximately Rs 80,000 crore parked with the RBI.

To read the full report: MONETARY POLICY


Overall EBITDA in-line; PAT lower than estimate: Overall EBITDA was Rs78b (v/s our estimate of Rs76b), up 46% YoY and 9% QoQ. Reported PAT grew 14% YoY and 4% QoQ to Rs40b, lower than our estimate of Rs41b due to higher depreciation and lower other income.

Better than expected GRM, petchem margins decline: GRM for the quarter was US$5.9/bbl down from US$10/ bbl in 3QFY09 and US$6/bbl in 2QFY10. However, it was higher than our estimate of US$5/bbl, and believe it could be led by higher margin contribution from the new refinery and use of KG-D6 gas. Petchem margins declined QoQ (as expected) to 13.9% (v/s 13.1% in 3QFY09 and 16.5% in 2QFY10) primarily due to higher input cost. However, impact on the absolute profit was lower, due to higher volumes.

E&P profitability impacted by higher depreciation charge; KG-D6 unlikely to reach 80mmscmd by March 2010: E&P EBIT margin was 41.8% as against 58.7% in 3QFY09 and 41.7% in 2QFY10. RIL’s KG-D6 gas volumes averaged 46mmscmd in 3QFY10 (v/s 32 in 2QFY10 and 19 in 1QFY10). Current volumes of ~60mmscmd are unlikely to increase till the capacity in GAIL’s HVJ-DVPL is increased (additional phase-1 capacity of ~10mmscmd in HVJ-DVPL expected by March/April 2010).

Reducing KG-D6 volume estimates; increasing GRM estimates: We are reducing our KG-D6 average volume assumptions for 4QFY10/FY11/FY12 from 65/80/100mmscmd to 62.7/70/95mmscmd. We are increasing our GRM assumption for 4QFY10/FY11 from US$6/7 per bbl to US$7/8 per bbl due to current strong GRM and expected refinery closures, worldwide.

Valuation and view: Adjusted for treasury shares, RIL trades at 11.5x FY12E adjusted EPS of Rs92. Our SOTPbased target price is Rs815/share. Further, we believe there is potential E&P upside of ~Rs239/share. We remain positive on RIL, primarily due to its large E&P potential. Maintain Buy.

To read the full report: RIL


Strong Y-o-Y growth, but sequential disappointment
Escorts reported a profit of INR 234 mn in Q1FY10 (versus a loss of INR 0.4 mn in Q1FY09). Revenues, driven by strong tractor volumes at INR 6bn were up 21% Yo- Y but flat Q-o-Q. Although EBITDA margins improved 260bps Y-o-Y, the sequential decline in excess of 350bps disappointed. The tax rate was also well ahead of expectations.

Margins disappoint but expect improvement ahead

High material costs compress margins
EBITDA margin, at 8.9%, posted a sequential decline of 370bps during the quarter, which was disappointing. While cost-cutting measures led to a sequential decline in other operating expenses (down 110bps Q-o-Q), raw material expenses-to-sales ratio jumped 460bps Q-o-Q. This may be partially attributable to higher commodity costs.

Lower interest costs reflect improved balance sheet strength
The 48% sequential decline in interest costs to INR 67.8 mn reflects the substantial decline in debt with the D/E ratio close to 0.12:1. Also, the absence of any one off / extraordinary items seems to indicate that most balance sheet related issues have been adequately addressed in the past quarters.

Outlook and valuations: Positive; maintain ‘BUY’
We believe Escorts is now more focused with the teething balance sheet issues subsiding. While Q1FY10 results do disappoint, we believe the coming quarters are likely to post better results on account of: (a) the average increase of 3-4% in tractor prices that the company has effected in January; and (b) lower tax rate on account of write offs in the previous years. Further, we expect strong cost cutting measures to flow through in the next few quarters.

On our estimates, the stock trades at a P/E of 11x FY10E and 9x FY11E, respectively, considerably lower than its peers. We maintain our ‘BUY’ recommendation on the stock.

To read the full report: ESCORTS


Tech Mahindra (TechM) reported Q3FY10 results below our expectation due to the ongoing restructuring process with BT account. We believe that demand in the telecom sector has started showing early signs of stabilization, but for TechM, any gain made would be eroded by key account problem. We reiterate our ‘Reduce’ rating.

Below expectation, non-recurring gain boosted topline by Rs1.5bn: TechM’s revenue grew by 4.0% QoQ to Rs11.8bn, ahead of our expectation Rs11.3bn. However, topline included ~Rs1.5bn (last 3 quarters amortization) non-recurring gain from BT restructuring. Excluding this, revenue declined by 9.2% QoQ. For the next quarter, Rs1.5bn would be down by Rs1bn due to one-quarter accounting. BT restructuring helped a one time pay of £126m (Rs9.6bn) that company will amortize over the next four years (~Rs0.5bn/quarter).

Other key highlights – restructuring to give reprieve: 1)TechM used the BT restructuring fee to pay-off debt of Rs4.5bn and Rs3.5bn in Q3FY10 and Q4FY10. 2) The deal restructuring with BT for Barcelona and Strada would help TechM gain definitive volume of work. The company is also reaching a definitive agreement for Andes contract (expected to finalize in Q4FY10). The management was confident of £70m run-rate from BT. 3) Total debt outstanding ~Rs17bn and cash of ~US$140m. 4) The company has total hedged position of $735m (USD-INR @ Rs46.3) and £280 (GBP-USD @ $1.80). 4) EBITDA margin erosion by 198bps (including non-recurring payment) is attributed to lower utilization level and currency appreciation. We believe that margin could be further down next quarter due to lower non-recurring revenue contribution. 5) The performance in non-BT (top 2-10 clients) witnessed growth of 10% QoQ in INR terms, a silver lining of improved business environment in telecom vertical.

Valuation & Recommendation: We believe that BT trouble and subdued IT spending in telecom vertical could reduce earnings visibility in the near term. However, we liked the non-BT revenue growth that would shield further downside risk to our numbers. We reiterate our ‘Reduce’ rating, with a target price of Rs900, a target multiple of 14x FY11 earnings.

To read the full report: TECH MAHINDRA


Provogue (India) is a major player in the branded retail segment and also has a presence in retail development and mall management. The company operates the retail segment under the brand Provogue and the real estate business under the brand Prozone. With the revival in consumer offtake, we expect its retail business to get back to the higher growth trajectory. While the retail business remains the key growth driver, we expect prozone to contribute positively, going ahead. Prozone, with three projects under execution, appears to be in a sweet spot, as these properties would enable Provogue to earn annual rental income and contribute to its earning growth.

In a sweet zone…

Retail expansion on the fast track
Provogue’s retail operations have a pan-India presence with 125 Provogue studios and mega studios (premium segment) and two Promart stores (bargain department stores). With easing rentals and the improving macro scenario, Provogue has stepped up its retail expansion plans. It plans to add 15 Provogue stores and four to six Promart stores annually.

Prozone to start contributing from Q2FY11
Prozone, (75% subsidiary of Provogue), through its 70% held SPV (Prozone Liberty International) plans to build about 15 million sq ft of malls/offices/hotels in Tier II cities of India. Prozone plans to build malls in Aurangabad, Coimbatore, Nagpur, etc. Its Aurangabad property that has a saleable area of 0.83 million sq ft is expected to commence operations in June 2010. Nearly 60% of this property is pre-leased at an average rental of Rs 47 and would add significantly to the revenue and profitability of the company from FY11 onwards.

Financial performance to improve from H2FY10 onwards
With improving consumer sentiments, the retail industry is expected to register enhanced growth momentum. Provogue, with its pan-India presence and strong expansion plans with lower cost structure owing to downward revision of lease rentals of its few properties would be able to enhance its profitability, going ahead.

At the CMP of Rs 65.7, the stock is trading at attractive valuations of 18.7x and 1.1x FY11E consensus earnings and book value, respectively, which are at a significant discount to valuations of other retail companies. We recommend the stock with a 10% upside from current levels as our Pick of the Week.

To read the full report: PROVOGUE