Monday, February 1, 2010

>Will the Global Economy Expand in 2010? (WELLS FARGO LIMITED)

The seizing of financial markets that followed Lehman Brothers’ failure caused the global economy to fall into its deepest recession in decades. By the spring of 2009 industrial production in the 30 countries that comprise the Organisation for Economic Cooperation and Development (OECD) had plunged more than 15 percent from year-earlier levels (Figure 1).

Incredibly, it could have been far worse. The governments of the world’s major countries averted catastrophe at the height of the crisis by taking steps to prevent a wholesale collapse of their financial systems via recapitalization, loan guarantees and increased deposit insurance. In addition, major central banks slashed policy rates to unprecedented levels, and many implemented programs of “quantitative easing” to provide further stimulus. Governments in most major countries opened the fiscal taps. There are signs that the medicine is having its desired effects and that growth is returning to most economies. Industrial production in the OECD nations rose 5 percent from its nadir in March 2009 to September, although it remains 13 percent below its February 2008 peak.

The global recovery is being led by Asia where growth turned positive again last year. The financial systems of most Asian economies were not nearly as levered as their western counterparts, so banks in the region were able to ramp up lending again. In addition, most Asian governments responded to the crisis with expansionary fiscal policy. The year-over-year GDP growth rate in China rebounded to a strong 9 percent in the third quarter of 2009, but the expansion is not confined to only China. Many other countries in the region, including the large economies of Japan, Korea and Taiwan, are posting positive growth rates again.

Major economies appear to be stabilizing as well. The U.S. economy expanded at an annualized rate of 2.2 percent in the third quarter, and monthly indicators point to growth in excess of 4 percent in the fourth quarter. The temporary effects of fiscal stimulus certainly played a role in the positive outturn in the third quarter, but recent increases in core measures of retail sales and capital spending indicate that there is more to the story than simply fiscal stimulus. Both the Euro-zone and Japan registered modest increases in real GDP in the third quarter, and growth likely remained positive in the fourth quarter.

Will the global economy slip back into recession again? Probably not. Production was slashed much faster than final demand in most economies, which led to sharp declines in inventories. The unprecedented liquidation of inventories appears to be coming to an end, and producers should continue to boost production to bring output back into alignment with final sales. In that regard, stimulus measures enacted late in 2008 and in 2009 are helping to boost activity. Most western economies should post positive growth rates over the next few quarters. That said, the modest global upturn that appears to be underway remains fragile, and self-sustaining recoveries, especially in the most advanced economies, have not yet been firmly established.

The Dollar Should Appreciate Modestly versus Major Currencies
The dollar strengthened significantly in late 2008/early 2009 as risk aversion spiked. U.S. Treasury securities are considered to be the safest assets in the world, and massive buying of U.S. government bonds by foreign investors contributed to the dollar’s strength. However, the greenback gave up most of its gains over the balance of 2009 as investors turned less risk averse. With stock markets rising in most countries and corporate bonds rallying, the safety of low-yielding U.S. Treasury securities is not as compelling as it was in early 2009 when worst-case scenarios did not seem farfetched.

Looking ahead, the currency strategy team of Wells Fargo projects that the dollar will trend modestly higher against most major currencies. Investors suspect that most major central banks, including the Federal Reserve, the European Central Bank and the Bank of England, will be on hold until the second half of 2010. Therefore, expected changes in short-term interest rates will not have as much of an influence on exchange rates as in the past. As the U.S. recovery gathers steam, foreign investment flows into long-term securities (e.g., corporate bonds and equities) and direct investment inflows should resume, helping to lift the greenback. In addition, the decline in the U.S. current account deficit will exert fewer headwinds on the greenback than it did earlier this decade when the dollar was trending lower. The dollar has already bounced back a bit since early December as U.S. economic data have been stronger than expected on balance.

However, most “commodity” and emerging market currencies should continue to trend higher versus the greenback in the quarters ahead. The global recovery will likely cause most commodity prices to drift higher, which should help to support “commodity” currencies (e.g., the Aussie dollar). In addition, rising levels of risk tolerance will clear the way for capital to flow to “risky” developing countries, which should put upward pressure on many of those currencies.

The global economy is starting to bounce back from its deepest recession in decades, although industrial production in the OECD nations remains well below the peak that was reached in early 2008. That said, purchasing manager indices generally remained in expansion territory in the fourth quarter, suggesting that the expansion remains intact. Most regions of the world are starting to grow again with Asia clearly in the vanguard.

The major governments of the world averted catastrophe in the fall of 2008 by taking steps to prevent the global financial system from collapsing. In addition, most major governments enacted fiscal stimulus programs to shore up economic activity.

Not only have interest rates been reduced to unprecedented lows, but major central banks have enacted “quantitative easing” programs via unconventional purchases of private sector assets. Central banks in some countries (e.g., Australia and Norway) have started to hike rates again, but the Fed, the ECB and the Bank of Japan remain firmly on hold.

The deep global recession and the collapse in commodity prices caused inflationary pressures to recede significantly. Commodity prices have risen off their lows, but elevated unemployment rates have kept a lid on wage inflation. Although we forecast that CPI inflation rates will trend higher this year, we do not project a return to runaway global inflation à la the 1970s.

To read the full report: GLOBAL ECONOMY


Budget support keeps IOC in black in 3Q; Underperform: In 3Q, the government finally confirmed budget support to compensate R&M companies for subsidy. Indian Oil (IOC) accounted only 63% of budget support, which means recurring EPS of Rs26.3 in 9M. Outlook for 4Q is weak, despite recovery in refining margins. Hence, a cut in consensus FY10E EPS of Rs35.1 appears likely. IOC’s FY10E earnings outlook is better than peer,s but it is not cheap at 10.6x FY10E EPS. We retain our Underperform rating on IOC.

3Q refining margins at US$3.7/bbl, lower than in 1H: IOC’s refining margin weakened to US3.7/bbl in 3Q FY10, thereby pulling down the 9M average to US$4.8/bbl from US$5.4/bbl in 1H.

Better outlook than peers but not cheap

9M EPS Rs26; 63% of budget support accounted in 3Q: In 3Q, the government confirmed budgetary support of Rs71bn to IOC toward the FY10E subsidy hit. IOC accounted only Rs44.8bn (63%) in 3Q. IOC also got compensation from upstream companies to cover the entire auto fuel subsidy. This helped IOC remain in the black (EPS Rs10), despite weak refining margins in 3Q. 9M EPS stands at Rs26.3. IOC’s 3Q EPS would have been higher, at Rs17.1, and 9M at Rs33.4, if the entire budgetary support of Rs71bn was accounted in 3Q.

Poor 4Q outlook; downside to consensus FY10E EPS: IOC’s 9M EPS is Rs26.3. The outlook for 4Q is poor, despite a likely recovery in refining margins. IOC's share of the 4Q LPG-kerosene subsidy is expected to be Rs61-69bn, while budget support would be just Rs26.2bn. Without more support, 4Q EPS is likely to be Rs2 and FY10E EPS is likely to be Rs28.2 (close to BoFAML’s estimate). However, a cut in consensus FY10E EPS (Rs35.1) appears imminent.

To read the full report: INDIAN OIL


India Cements’ 3QFY10 results were below our estimates, with EBITDA of Rs1.16b and adjusted PAT of Rs271m, due to a sequential decline of Rs20/bag in realizations and cost inflation of Rs11/bag QoQ.

Volumes grew 38% to 2.76mt, driven by commissioning of new capacities. Realizations were Rs3,028/ton, a decline of Rs20/bag.
Decline in realizations, coupled with overall cost inflation of Rs11/bag resulted in EBITDA/ton decline of Rs32/bag to Rs21/bag. EBITDA margins declined by 16.6pp QoQ (~10.4pp YoY) to 13.5%.
The management indicated that with cement prices recovering current realizations were at 3Q average and Rs10/bag higher than December 2009 exit prices.
Expects to announce, within a month, acquisition of a coal mine in Indonesia with reserves of 30mt for US$20m.

Downgrading estimates: We are downgrading our estimates for FY10 by 13.5% to Rs12.9 and FY11 by 31.9% to Rs6.8 to factor in below-estimate results, severe pricing pressure in its key market and a cost push. We factor in sequential improvement in realizations of Rs5/bag in 4QFY10 and a decline of Rs10/bag in FY11 from the FY10 average (flat over 4QFY11).

Valuation and view: With very high operating leverage and relatively high gearing, India Cement would be one of the biggest beneficiaries of improvement in the operating environment in South India. The stock is valued at 16.7x FY11E EPS (fully diluted, ex-treasury stock), 8.5x FY11E EBITDA and US$77/ton (at 15.5mt capacity) in a trough year. Buy with a target price of Rs135.

To read the full report: INDIA CEMENTS


What’s Inside

  • Key takeaways- management meeting, interviews, channel checks
  • Round up on news flows- regulatory and company-specific
  • Banking sector round-up- Credit growth, interest rates and liquidity
  • Update on insurance and mutual funds– Flow, market share
  • Valuation– Price performance, comparative matrix, P/B band charts
  • Take a look!, ‘Banking Calendar’, links to our recent reports
Takeaways-management meeting, interview, channel check
A key take away from our management meetings was that banks are not looking to raise lending rates even if RBI raises benchmark rates by 50bps as they have some cushion due to re-pricing of high cost deposits. Another positive takeaway was that while the credit growth in past one year was led by project financing, banks are now seeing pick up in working capital demand also. Retail delinquencies have peaked and banks with greater share of retail loans are expecting sharp fall in slippages in 2H (HDFC Bank’s 3Q results corroborated this). Our recent interactions with branch officer of a mid-sized PSU bank indicates that while banks
may be taking some interest rate risks by offering fixed-rate mortgage loans, they
continue to be highly vigilant about the quality of new borrowers.

Banking sector round-up – banks outperform market
Key highlight in past one month was a rebound in credit growth from 11% in Dec- 09 to 13.7% in Jan-10 led by a) disintermediation - banks withdrew investments in mutual funds and directly lent to corporate, b) pick up in disbursements driven by rising demand for working capital credit. Pick-up in credit growth, strong start to the results season (HDFC Bank and Axis) led to the outperformance of banking stocks in past two weeks. Most PSU banks are trading at the higher end of their valuation band and 25-40% premium to their five year average valuations whereas private banks are still trading at a discount.

Update on insurance and mutual funds- Nov/ Dec 2009
In spite of positive base effect, during Nov-09 private sector insurance companies reported only 14% YoY growth in APE-based new business premiums (NBP), sector premiums however grew by 22% led by LIC. In Dec-09, AUMs of mutual funds declined by 19% MoM to Rs6.7tn (up 61% YoY) largely due to redemption of debt investments by banks. Since Aug-09 (when RBI banned entry loads), equity schemes of mutual funds have not reported a single month with net inflows in equity schemes; Rs75bn of total net outflows between Aug-Dec 2009.

To read the full report: INDIA BANKS


Commodities have started the year strongly. The success of global stimulus packages, cheap credit and dollar weakness fuelled a doubling of the HSBC Metals index in 2009. With global economies set to continue to recover and the dollar forecast to remain weak, we expect metals and bulks demand to remain well supported.

Too strong, too soon

At current levels, however, we would not be chasing commodities. While we have raised our 2010 price forecasts by 13-30% for metals and bulks, our estimates indicate a 10-15% fall from current spot levels. The biggest threat, in our view, lies in the impact of governments globally, particularly China, winding down stimulus packages. Rebounding metals supply is a further concern. At current prices, we believe that virtually all aluminium, copper and zinc producers are making money. This should ensure that meaningful surpluses remain over 2010-11 in these markets.

Our preference remains in bulk commodities, where China’s import dependence continues to grow. Recent spot pricing strength highlights the current tightness in iron ore and coal markets. Against consensus estimates for 2010, we are now broadly in line for copper, zinc and nickel but remain lower for aluminium (-5%). In the bulks, for 2010 we are higher against consensus for coking coal but in line for iron ore and thermal coal.

To read the full report: METALS & MINING


Hotel Leela, a well established hotel player in the premium segment, operates over 1,500 premium segment hotel rooms. The locations to which it operates include Mumbai, Bengaluru, Goa and Kovalam. The company enjoys high ARRs in Bengaluru and Goa properties due to its brand recognisition. Since company derives its major chunk of revenues from foreign tourists in leisure destinations and from IT/BFSI segments in business destinations, the company is well placed to reap the benefit of the overall improvement in tourists’ traffic in both these segments.

Time to check in…

Hotel sector in a turnaround phase Hotel sector is going through the turnaround phase with the recovery signs getting visible from overall improvement in the tourists traffic across business and leisure destinations. At the same time with a lesser expected upcoming room supplies due to cutback announced earlier by various real estate players, the outlook for existing hotel players have significantly improved.

Addition of new rooms to spur revenue growth for FY11E and FY12E The company is currently working on two major ongoing projects. This includes hotel at Chanakyapuri, Delhi which is expected to get completed before Commonwealth games and hotel at Adyar beach Chennai. Post completion, the company’s inventory will increase to about 2,250 rooms. With these additions along with improving RevPAR (revenue per available room) we expect revenue to grow by 35.0% and 25.0% for FY10E and FY11E respectively. Apart from this company also owns plots of land in Agra, Hyderabad and Pune.

To continue to witness robust quarterly performance going forward In Q3FY10, Leela reported robust QoQ growth in revenues and first ever positive growth on YoY. Going forward in Q4FY10, we expect the company to post even better results compared to last year and the current quarter due to lower base effect, rise in occupancy and incremental revenue flow from its two new five star hotels Leela Palace Kempinski, Udaipur and another hotel in Gurgaon.

Valuation At CMP of Rs.46.8, the stock trades at 14.2x FY12E EPS and 13.3x FY12E EV/EBITDA. We believe the company would continue to witness the growth in revenues due to improvement in foreign tourist arrivals (FTAs) data and limited room supplies due to sharp cutbacks. Our FY11E and FY12E EPS growth estimates stand at 74.6% and 30.0% respectively. Investments in this counter can be considered with a short term upside of 10%.

To read the full report: HOTEL LEELA