Wednesday, February 3, 2010

>Ten for ’10: Top cyclical themes for 2010 (GOLDMAN SACHS)

Maintaining pro-cyclical bias in 2010 Our overall view of Asian cyclical stocks for 2010 is constructive, supported by our constructive view of the global/regional economies. Continuing growth in Asian economies is likely to be strengthened further by recovery in western economies. High operating leverage, boosted by structural cost reductions, is likely to boost earnings recovery as the cycle recovers. Our team is forecasting a 14% CAGR in sales over 2009-11 from the cyclical lows of 2009, helping a 53% growth in operating profit.

Key themes for 2010
There are three themes that underpin our regional stock picks: (1) bullish, out-of-consensus view on steel and lagging plays on commodities; (2) deeply discounted transportation sector; and (3) post-2H2009 rally, which stocks are not yet fully pricing in the expected recovery. That said, the margin for error has narrowed following the 2H2009 rally. A potential tightening in China may not change the underlying fundamentals, but could spook the markets. As such, stock-picking will become more important in 2010 and a stronger focus on valuations is warranted.

Our most actionable buys
Based on our 2010 themes, our ten best long ideas for 2010 are: Kawasaki Kisen, OOIL, EVA Air (all deeply discounted transportation stocks), JFE Steel, Kobe Steel, Yanzhou Coal, China Coal, China Shenhua (bullish metals/resources), GS E&C, IVRCL (valuations not yet pricing in recovery). We have also recently added FCC and THK to our Conviction Buy list; we also like JDC Moly, Itochu, Bajaj Auto, Wan Hai, Sumitomo Metal & Mining, and TSRC. These are all stocks that have a combination of company-specific attributes and attractive valuations – and stocks we would look to add to positions should there be any near-term weakness on perceived tightening in China and elsewhere.

Our least favorite ideas
We are cautious on selective machinery/capital goods names like Dongfang Elec, BHEL, Kawasaki Heavy; metal processors (Chalco, Nalco); auto suppliers (Cheng Shin Rubber, Toyota Boshoku); overvalued transport names (HMM, China Eastern); firms with uncertain outlook and generous valuations (Yunnan Chihong, Jiangxi Copper, Daewoo E&C).

To read the full report: ASIA CYCLICALS


3Q earnings disappoint: GMR’s 3Q net profit was down 85% y-o-y to INR92m (HSBCe INR395m – 35% decline, consensus INR547m – 10% decline) due to 1) lower power business profitability and 2) losses at associate companies (Homeland Energy). The decline in the power business was due to the short-term impact of lower plant load factor (PLF) resulting in lower generation. We expect these power plants to return to normal operations, with no impact on our FY11-12 earnings. Airport EBIT was up 34% q-o-q, driven by 13% q-o-q growth in passengers and 96% q-o-q growth in roads on lower operating expenses (Table 4).

UW(V): Payday remains a long way off
  • 3QFY10 results below expectations due to short-term impact of power business profitability and associates’ losses
  • Expansion plans in power will take time to bear fruit; in the interim, earnings to decline at 12% CAGR over FY09-12
  • We cut our already below consensus FY10 earnings by 19% but maintain FY11-12 earnings. Reiterate TP of INR51.9, implying –13.4% return

Project progress (Table 2): A key positive is the recently received approval to increase the capacity of its 1050MW under-construction Kamalanga project by 350MW (33% increase) with no change in the timeline of the project. With this additional capacity, GMR’s power capacity under development has increased to c8GW.

Estimate change: We reduce our FY10 earnings by 19% to incorporate lower than expected 3QFY10 profitability. However, we maintain FY11-12 estimates as we expect the power plant to return to normal operations going forward.

Why we’re still cautious: The stock has underperformed the market by c15% in the last 45 days. We believe there may be a further 13% downside from current levels because 1) nearterm pressure (we estimate earnings fall at a 12% CAGR in FY09-12 vs. consensus estimates of 28% growth); 2) power projects are long term (the first project is not scheduled to start operations until 2012) and hence carry execution risk; and 3) projects have long payback periods and face regulatory risks — as long-term investments, they are also exposed to the economic cycle. In our view, the current valuation doesn’t factor in execution, tariff, funding and regulatory risks. Reiterate INR51.9 TP and UW(V) rating.

To read the full report: GMR INFRASTRUCTURE


Hero Honda: Strong performance continues
Hero Honda (HH) continued its robust performance with sales of 0.39 mn units, implying growth of 24% Y-o-Y and 4% M-o-M. This growth, in spite of strong competition (particularly from Bajaj Auto’s Discover), underlies the strength of the company’s brand and rural reach. HH plans to launch three new products/variants in the next two months to counter the highly anticipated Honda’s CB Twister.

Year begins on a strong note

Maruti Suzuki: Domestic segment drives growth
Maruti Suzuki (MSIL) reported robust volumes of ~96,000 units (up 33% Y-o-Y; 13% M-o-M). Domestic volumes were up 21% Y-o-Y and 14% M-o-M. These strong numbers reflect a certain degree of restocking with dealers after the company registered over 100,000 retail volumes in December, partially on account of higher discounts and purchase preponement (as vehicle prices were expected to rise in January). While we expected the domestic volumes to remain strong, the continued uptick in exports (despite withdrawal of scrappage incentives) surprised positively.

Tata Motors: Cars provide the boost
While Tata Motors’ (TTMT) M&HCV segment continued a strong run (up 170% Y-o- Y; 2.6% M-o-M), boost to volumes came from the passenger vehicle segment (up 21% Y-o-Y; 52% M-o-M) due to new product launches (Manza) and inventory restocking. The LCV space continued robust performance (42.5% plus Y-o-Y), driven by Ace and Magic. Magic is receiving tremendous response as a suburban/rural mass transport vehicle. Nano continued its run-rate of ~4,000 units.

Mahindra & Mahindra: Robust numbers
Mahindra & Mahindra (M&M) continued to grow in the tractors (up 69% Y-o-Y; 38% M-o-M) and UV space (up 52% Y-o-Y; 20% M-o-M), with overall volumes being the highest ever. While the underlying robust trend is unmistakable, the monthly volumes also reflected seasonal trends (January tractor volumes tend to be higher than those of December). The sub–tonne, Gio, seems to be garnering reasonable volumes, as reflected in the 159% growth in the goods carrier segment.

Outlook: Strong start to the new year
Aided by buoyant economic growth, automobile volumes across segments continue to be extremely robust. In addition, there is possibility of preponement of demand in February on account of an anticipated increase in excise duties. Despite possible hiccups in the form of higher interest rates/excise duties, we expect demand to remain strong in FY11. The Y-o-Y growth may, however, temper on account of a higher base.

To read the full report: AUTO SALES UPDATE


Aban’s Q3FY10 net profit of Rs894 mn is below expectations on account of higher deprecation and tax rate and lower profit from its 50% JV Venture Drilling. Revenues at Rs8.41 bn (our expectation- Rs8.93) registered growth of 19.7% sequentially as 4 new rigs (DD2, DD5, DD7 and Aban Abraham) commenced operation. However since the 3 Jack rigs started working in November 2009 and Aban Abraham worked only for half of the quarter (on account of some technical issues) we see that the quarter does not reflect the full revenue potential from new contract operations. EBIDTA at Rs5.2 bn, (our expectation Rs5.2 bn), grew 14.6% qoq. Depreciation for the quarter at Rs1.35 bn was higher by 36% qoq as depreciation on Aban Abraham (which commenced operation this quarter) was charged for the entire quarter. Higher number of rigs operating in Middle East (where the withholding tax is comparatively higher), increased Aban’s tax rate to 55.5% as compared to 50.6% in Q3FY09.

On account of higher than expected tax rate we are downgrading our FY2010 earnings estimates for Aban by 7.2% to Rs90.5 /share and FY2011 earnings by 8.2% to Rs190/share. Post declaration of results Aban’s stock fell more than 10%. We would like to highlight that consensus net profit expectation was close to Rs1.7 bn. Though the quarterly numbers were sharply below consensus expectations we believe that, the street is neglecting positives from the results. Considering that the revenue potential from new contract operations was not captured fully during the quarter, EBIDTA margins at ~60% are very impressive and management has highlighted that the same are pretty much sustainable (except for adverse movement in currency). With Aban pearl commencing operations in Q4FY2010 we expect Aban’s revenues and earnings to get significant momentum going forward. The stock is trading at attractive valuations of 12.5X FY2010 earnings and 6X FY2011 earnings. We upgrade our rating from HOLD to ACCUMULATE with revised price target of Rs1325.

Revenue growth of 19.7% qoq despite partial contribution from new contracts
Revenues for the quarter stood at Rs8.41 bn (our expectation- Rs8.93) and registering flattish yoy growth, however was up 19.7% sequentially as 4 new rigs (DD2, DD5, DD7 and Aban Abraham) commenced operation. However since the 3 Jack rigs started working from close to November 2009 and Aban Abraham worked only for half of the quarter (on account of some technical issues) we see that the quarter does not reflect the full revenue potential from new contract operations.

EBIDTA up 14.6% qoq – margins at 61.7%
Even after flattish revenue growth, EBIDTA for the quarter stood at Rs5.2 bn, (our expectation Rs5.2 bn), registering a growth of 10.1% (14.6% qoq). We would like to highlight that margins were positively impacted on account of termination of rigs O&M contract with Premium Drilling (PD). As a result, EBIDTA margins for the quarter have surprised us positively at 61.7% (our expectations 58.4%) registering a yoy expansion of 538 bps. Considering that the revenue potential from new contract operations was not captured fully during the quarter and with Aban Pearl commencing operation in Q4FY2010, EBIDTA margins at ~60% are very impressive and management has highlighted that the same are pretty much sustainable.

To read the full report: ABAN OFFSHORE

>ANDHRA PRADESH IRRIGATION: Conf Call Takeaways: Funding Constraints Delay Execution

Conference call on irrigation projects in Andhra Pradesh (AP) — We organized a conference call with Mr. S.K. Joshi, Principal Secretary (Projects) to the Government of Andhra Pradesh, Irrigation and Command Area Development, to discuss the current status of irrigation projects in AP. The following are key takeaways from the call.

The Jalayagnam project — Started in 2004 the Jalayagnam project consists of 86 projects including 44 major and 30 medium irrigation projects, eight modernization projects and four flood bank strengthening projects. The program targets to irrigate ~10.5mn acres of land. All of these projects have been awarded to contractors.

Funding structure of these projects — The initial total capital outlay was Rs1,797bn, of which Rs474bn has already been spent. Out of the remaining Rs1,323bn to be spent, ~Rs780bn is earmarked for four major projects, which leaves ~Rs543bn for "other" projects. According to current status, the funds of Rs543bn on "other" projects can be spent over the next five years. According to Mr Joshi, the execution of four major projects totaling ~Rs780bn will spill over beyond the next five year period.

Current funding status — 1) FY10E spend to be lower than initial budget and FY09 spend. AP irrigation spend in FY10E expected to be ~Rs120bn vs. a budget of Rs170bn and spend of Rs148bn in FY09. 2) Bills pending from June 2009 onwards. Irrigation bills totaling ~Rs48bn are outstanding with AP Govt. and the
payment period has increased from two months to six months now and is expected to stay at six months for some time. As a result, contractors have slowed execution.

Central Government funding — 1) If a project is declared a National project, then 90% of funding required will be provided by the Central Government. 2) In case a project comes under AIBP/Prime Minister's Special Project Scheme, 90% of project cost is reimbursed if it is in a drought prone/tribal area and 25% of project cost is reimbursed if it is in any other area. The Pollavaram project is expected to be announced as a national project shortly. On a steady state basis, one can expect ~Rs30-40bn/year from Central Government for AP irrigation projects.

Effect of the Telangana agitation — The division of AP, if and when it happens, is not expected to impact execution as there are clear cut state division procedures. However, the current agitation may have impacted State Government revenues which may increase funding shortfall acuteness, and slow down work.

Reinforces our view of rising near-term risks to execution of AP irrigation projects — 29% of IVRCL’s OB is from AP irrigation dept. We maintain our Hold/Medium Risk rating on IVRCL (IVRC.BO; Rs388.80; 2M) as, given impending negative newsflow on AP irrigation, the shares could weaken in the near-term.

To read the full report: ANDHRA PRADESH IRRIGATION