Tuesday, February 2, 2010

>Eurozone sovereign risk: a hierarchy of countries to watch (ECONOMIC RESEARCH)

Financial markets are highly concerned about the risks surrounding the public finance imbalances present in a number of eurozone countries. This has been represented by the sharp increase in the government bond spreads between the countries seen as risky (Greece, Portugal, Italy, Ireland and Spain) and those of Germany, considered as the reference country.

However, not all the countries should be put on the same level. The situation of public finances has developed differently from one country to another. In Ireland and Spain, the deterioration in budget balances and the build-up of public debt are fairly recent phenomena. In the remaining southern European countries (Greece, Italy and Portugal), public finance difficulties go back a long way.

This article sets out a hierarchy of short-term and longer-term sovereign risks (related to the ageing problem). The results show that: 1) in the short term, and, more importantly, in the longer term, Greece is by far the riskiest country; 2) Ireland and Spain are also risky countries regardless of the timeframe; 3) Portugal presents large-scale short-term risks; 4) Italy is considered to be the least risky among these countries.

The eurozone’s public finances have deteriorated severely. This is especially the case in countries that in the past have shown relatively poor budget management, namely Greece and Portugal, and, to a lesser degree, Italy. It is also the case in economies that are currently experiencing very severe cyclical corrections, following a housing boom that played out against a backdrop of galloping prices and credit, notably Spain and Ireland. All of these countries will see a sharp rise in sovereign risk if they do not implement credible public finance consolidation plans in the near term.

These countries, however, should not all be viewed in the same manner. This article attempts to establish a hierarchy of sovereign risk in countries with poor public finances (Portugal, Italy, Ireland, Greece and Spain). After highlighting the source of these imbalances in the country’s public finances, we have attempted to set out a hierarchy of shortterm sovereign risks using a range of indicators: the primary budget balance ratio, the ratio of public debt to GDP, the government revenue-to-GDP ratio and the ratio of public spending to GDP. Finally, we evaluate the longer-term risks linked to an increase in age related expenditure, based on demographic projections from the European Commission. Of course the crisis is to blame, but it’s structural problems, too

The budgetary situation in eurozone countries has deteriorated sharply due to the financial crisis and the recession. A look back at how these imbalances developed helps to gauge how difficult it will be to resolve them.

In Ireland and Spain, the deterioration in government finances and the build-up of public debt are fairly recent phenomena. In 2000-2007, the budget situation in these countries was fairly healthy, with an average GDP surplus of 0.25% and 1.49%, respectively, compared with an average eurozone deficit of 1.85%.

In the other countries, notably in southern Europe, there is a long history of struggles with public finances. Italy and Greece have always been highly indebted countries whose public deficits are mainly structural in nature, due to the lack of public spending effectiveness and poor budgetary management. Greece and Portugal, and to a lesser extent Italy, have had considerably higher structural deficits than the eurozone average (see graph in report).

To read the full report: EUROZONE SOVEREIGN RISK

>7 Reasons Why Nifty would go to 3800 and Sensex 12800 (EMKAY)

Bulls exhausted; false breakouts globally signal an end to this rally; we hence expect a large correction, which is at least a 50% retracement of the entire run.

First blood

Are you ready for 3800 Nifty?

Multiple trend lines (Fan line) breaks across the world.

5-wave impulsive moves complete; Nifty and Brazil Bovespa remain classic examples, FTSE, DAX, CAC also look complete.

‘Bearish Outside Engulfing’ month for BSE Sensex (CMP-16357, TGT-12800), Metals (CMP-15962, TGT-10500), Autos (CMP-6953, TGT-5000) and Cap Goods (CMP- 13125, TGT-10000).

Ending Diagonals/Bearish Wedges visible on many indices.

Momentum sell offs after negative price/momentum divergence.

Dollar to further spook the markets, DXY bullish reversals in place; target 83-84, INR heading back to 49-50.

To read the full report: NIFTY AND SENSEX


PSU is still an evolving theme in the market. The process of disinvestment started in the early 1990s. The stocks from this space did however; trail the broad market in the 1990s. They have started to find recognition and valuation that justifies their strengths, only in the recent past. If the most visible themes of the last two decades have been IT & telecom respectively, PSU as an asset class has been the silent performer. They are set to emerge as an even bigger part of the market in the years ahead with potential for value creation in excess of what is offered by the broad market over a five-year plus period.

Government plans to raise over Rs 25,000 crore in 2009-10, not only to reduce fiscal deficit but also for expansion of public sector enterprises. The government holdings in listed public sector companies are worth Rs 8.80 lakh crore and if the government dilutes its stakes to 51% in these listed companies, it could lead to an inflow of Rs3 lakh crore at current market prices. A dilution of 10% stake in top 10 PSUs can bring in a whopping Rs 85,000 crore. Thus, the government could earn a substantial sum by diluting its stake in just listed PSUs to 51%

Key Facts:

Since disinvestment started in 1991 PSUs have gained a sizeable and growing share of the Indian market. The Government of India, which has about a stake of about 80% in listed PSUs, is today the owner of 25% of the market capitalisation of the equity market in India. It has reaped gains that are higher than the broad market since disinvestment started in 1991 despite the low prices in the initial few rounds and even as recently as in
the divestment in Maruti and Hindustan Zinc, a few years ago. PSUs today account for about 30% of the market cap on the National Stock Exchange, which has about 1330 listed stocks and counting. To evaluate how PSUs had performed, an analysis of price trends was carried out in 48 PSU stocks that were listed. In the almost 10-year period, this PSU universe has delivered a compounded annual rate of growth (CARG) in returns of 24.2 per cent. During this period, 621 stocks (private players) that have been listed on the NSE for a corresponding period have offered CARG in returns of 13.5 per cent. These numbers shows that PSU stocks have outpaced not just the broad market, but private sector peers, too.

Why Divestment?
1) Government-funded stimulus measures and a soaring subsidy bill have swelled the fiscal deficit. With the economic slowdown impacting revenue receipts, divestment is clearly one route to raising funds to improve the fiscal picture. The fiscal deficit for the year 2008-09 at a whopping Rs 3,30,000 crore, is 21% of the total market capitalisation of the BSE PSU index. Though proceeds of divestment since 2007 have gone into the ‘National Investment Fund’, expectations are that divestment proceeds will now come back into the Budget and help fill the fiscal deficit.

2) IPOs from unlisted government owned companies could well help revive the IPO market and boost the stock market. Both the Congress manifesto and the interim budget emphasised the need for divestment. PSUs where the government stake is much higher than 51% may be the ones where stake sales will be pushed through first

To read the full report: PSU DISINVESTMENT


Voltas has reported a mixed bag of numbers, with flattish topline growth and order inflows but a strong PAT performance. Profits were driven by EBITDA margin expansion of 360bps YoY, with both the MEP and engineering divisions performing well. However, a dwindling order book marked by a drying up of inflows from international operations, puts a question mark on future business growth and stock performance. We lower our earnings estimates for FY10 and FY11 and reduce our target price from Rs 185 to Rs 167. Maintain Hold.

Weak order booking clouds prospects

Revenues flat at Rs 9.9bn: Voltas’ Q3FY10 topline was largely flat YoY while dipping 9.4% sequentially to Rs 9.9bn, falling 9.8% short of our estimate. The electro-mechanical (MEP) division reported flat revenues YoY at Rs 7.1bn, contributing a 72% share. About 61% of the segment’s turnover has been contributed by international operations while the balance came from the domestic business. The engineering products and services (Engineering) division has seen signs of improvement, with 6.8% YoY growth to Rs 1.2bn. In unitary
cooling products (UCP), revenue increased by 26.9% YoY to Rs 1.5bn.

EBITDA margin up 364bps YoY to 8.8%: In line with our expectations, the EBITDA margin improved sharply by 364bps YoY, while dipping 207bps sequentially to 8.8%. MEP has reported an improvement in EBIT margin by 220bps YoY to 8.9%, while the engineering division clocked a 386bps expansion to 13.5%. UCP reported a margin of 12.3% as against -3.2% in the same year-ago quarter.

Adj PAT rises 65%: Reported PAT has increased by 85.8% YoY to Rs 765mn due to margin expansion and profits on sale of property (Rs 93.5mn) booked during the quarter. Adjusting for the property sale, PAT has risen 64.9% to Rs 663mn.

Order book at Rs 39.6bn – concerns persist: The MEP order book stands at Rs 39.6bn, which is 1.2x FY10E revenues of the division, indicating poor visibility for FY11. Of this, the international order book comprises Rs 27.4bn
(including the Rs 7.1bn Yas Retail order which is under suspension).

Maintain Hold: The stock is currently trading at 16x FY11E earnings. We have revised our earnings estimates for FY10 and FY11 downward by 2.1% and 9.7% respectively mainly due to MEP order flow concerns. We maintain our Hold rating on the stock with a revised target price of Rs 167 (17x FY11E earnings) from Rs 185 earlier. We believe the conspicuous absence of international order flows will hamper stock performance in the coming months.

To read the full report: VOLTAS


Phoenix Mills (PML) has posted a net sales growth of 37% YoY to Rs 302mn during Q3FY10, marginally below our estimates. The EBIT margin dropped to 41.2% as against 58.8% in Q2FY10 owing to a sharp rise in SG&A expenses (on festive promotions and one-time repairs), as well as depreciation. The margin squeeze took PAT below our estimates, as it declined 31% YoY and 42% QoQ to Rs 102mn. We expect the commencement of full-scale operations at Palladium (management targets 95% occupancy by March) to drive lease income and profitability going forward. Maintain Buy.

SG&A and depreciation costs crimp PAT

Net sales marginally below estimates: PML’s net sales increased 37% YoY and 14% QoQ to Rs 302mn, against our estimate of Rs 316mn. The luxury mall, Palladium, contributed Rs 39mn to the topline after being operational at 28% of its capacity during the quarter.

High SG&A expenses dent margins: The EBITDA margin dropped 11 percentage points YoY to 58.7% as SG&A expenses shot up 151% YoY and 62% QoQ to Rs 53mn. The spike in costs arose from a one-time charge of Rs 25mn during the quarter – this included Rs 10mn spent on major repair and maintenance for phase I and phase II of High Street Phoenix which occurs every three years, Rs 5mn spent on promotions during the festive season, and Rs 5mn–6mn incurred towards marketing commission and brokerage. In addition, the company booked 100% of CAM (common area maintenance) expenses in Q3 despite earning only 25–30% of CAM revenues from Palladium.

The EBIT margin declined further to 41.2% as against 60.7% in Q3FY09 and 58.8% in Q2FY10. This stemmed from a spike in depreciation cost to Rs 53mn (up 151% YoY and 98% QoQ), as Palladium charges were expensed out of the profit & loss account as against the practice of capitalisation seen in previous quarters.

Palladium to boost lease income: The Palladium mall covers a leasable retail space of 0.3msf. PML has already pre-leased up to 95% of this area, with the mall being 28% operational. The company targets an occupancy level of 95% by March ’10. We expect Palladium to contribute revenues of Rs 110mn and Rs 454mn from Q4FY10 and FY11 onwards at 70% occupancy. Rental revenues for PML are thus projected to expand from Rs 900mn in FY09 to Rs 1.3bn in FY10. This will rise further to Rs 1.7bn in FY11 when the full-year revenue contribution from Palladium starts flowing in.

Maintain Buy: With strong prospects from the ramp-up at Palladium, we maintain our Buy rating on the stock with an NAV-based target price of Rs 223.

To read the full report: PHOENIX MILLS


Redington’s Q3FY10 performance is a confirmation of our view that the demand environment in India and MEA technology markets has staged a strong turnaround. The company reported revenue growth of 13.4% YoY as compared to 5.3% in the preceding quarter, which was marginally ahead of our estimates. Net profit grew at a faster rate of 25.4% YoY as interest expenses decreased 43% due to a favourable interest rate environment. We are revising our earnings estimates and increasing our target price for the stock to Rs 375. Maintain Buy.

No way but up from here

Revenue recovery gets stronger: Redington’s revenues continued to gain momentum in Q3FY10, increasing 13.4% YoY to Rs 35.4bn, 3.5% higher than our estimate. Revenue growth was balanced between India and overseas SBUs at 13.4% YoY each. In volume terms, MEA continued to witnessed higher growth because of geographical and product expansion; however, in reported terms, growth in the region was affected by a 4.4% YoY appreciation of the rupee against the dollar.

Net profit up 25.4% YoY: Net profit growth for Q3FY10 outpaced revenue growth at 25.4% YoY to Rs 447mn – in line with our estimate. This is despite a decline of 13bps YoY in EBITDA margin to 2.3%. Interest expenses declined 43% YoY to Rs 163mn due to better working capital management and favourable short-term interest rates, thus supporting net profits.

Chennai ADC now fully-operational: The 100,000sq ft automated distribution centre (ADC) in Chennai has become fully operational in Q3FY10. The ADC will allow Redington to offer third-party logistic (3PL) services to companies like Cadbury, Sonciwall and Vodafone, besides catering to in-house needs. Three more ADCs are being planned which would lead to rationalisation of warehouses, thus saving on rent expenses (currently ~10% of EBIT).

Infused Rs 1.4bn in Easyaccess NBFC: During the quarter, Redington infused Rs 1.4bn as equity in its 100% non-banking finance (NBFC) subsidiary, Easyacess, taking the latter’s book value to ~Rs 2.3bn. The infusion aimed to comply with RBI norms on minimum equity requirements. With loan assets of ~Rs 4bn and a debt/equity ratio of 0.9x, there is plenty of room for Easyaccess to grow.

Raising estimates and target price: We are increasing our revenue estimate for FY11 by 3.3% while trimming our FY10 and FY11 margin forecast on stronger rupee assumptions. However, earnings estimates for these years stand increased by 0.8% and 6.9% respectively on expectations of a reduced interest burden. We are also introducing FY12 estimates. Our target price has been raised to Rs 375 (from Rs 335) due to the estimate revision and an increase in target P/E multiple from 11x to 11.5x (3-year average FTM) on FY11E. We maintain a Buy rating on the stock.

To read the full report: REDINGTON