Friday, February 26, 2010

>India Budget: Realistic and Progressive (MORGAN STANLEY)

In the Right Direction: The market’s rally post the budget reflects a realistic and progressive F2011 budget.
The government is achieving fiscal consolidation program which is positive for earnings growth and market performance. The key risk factors in what seems to be a very strong growth environment are a combination of rising inflation and fragile risk appetite. We remain positive on Indian equities and are buyers of dips. Going forward, we expect to see policy action on rates to pre-empt demand side inflation.

a) Yield curve flattening is likely more certain – the government's market net borrowing is estimated to fall
13% in F2011 – this is positive for banks, especially public sector banks. Indeed, given the conservative
estimates on the budget the likelihood is that the borrowing program is lower than expected.

b) Consumption will likely stay strong – the increase in excise taxes is offset by reduction in personal taxes.

c) The balance of government spending is shifting from ‘non-plan’ to ‘plan’ expenditure with benefits to
infrastructure and rural spending. We are positive on industrials particularly for the second half of 2010.

d) Overall, change to earnings is insignificant – the cut in corporate tax surcharge is neutralized by the change in MAT, in our view. Costs are slightly higher on the back of increased fuel costs and excise duty. On the other hand, we think that stronger growth and improving pricing power represent upside risks to earnings estimates.

e) Tax reforms are on track for implementation in F2012. A new company law, the food security bill and possible energy sector reforms are likely in the coming months. Divestment target of Rs400 billion should be reassuring to the market as a signal for further reform on top of Rs250 billion to be achieved in F2010.

>Character of Recovery: Yes, It Is Very Different This Time

Production: Slow But Catching on Nicely
Industrial production was slow to catch on to the recovery but in recent months has improved sharply (top graph). The manufacturing sector continues to make progress for both auto and non-auto components. Over the last three months there have been double-digit gains in high-tech and 8.7 percent gains in manufacturing ex-high-tech.

The most recent ISM report indicated expansion in orders, production and employment along with longer delivery times. Therefore, the outlook remains positive for production.

Sales: On Track and Not Far off the Usual Recovery Pace
Real manufacturing and trade sales have generally followed the typical recovery path, although the pace of sales is below trend. This is to be expected given the rebalancing of the American household balance sheet and the limitations on credit given the new ethic of caution on the part of both borrower and lender (middle graph). For 2010 our outlook is for real final sales growth of less than two percent which is down from the 2.5 percent of 2007 with much of the weakness centered in personal consumption spending.

Employment: Economic Outlier, Political Problem, Policy Driver
The outlier in this pretty economic recovery picture is employment (bottom graph). While recent months have seen a decline in the loss of jobs there is clearly a pattern of below-average job recovery as the economy has improved. There are obviously two problems—supply and demand.

On the supply side, the U.S. has had an issue for years of an oversupply of low-skilled and semi-skilled workers and a shortage of high-tech scientists and engineers. In an era of the closed U.S. economy of the 1950s-1960s, increases in U. S. production were met with increased demand for workers of all types, and as such the excess supply of low-semi skilled workers was not as apparent. Meanwhile, the immigration of health professionals, engineers and scientists continued to make up for a shortage of domestic professionals.

In the 21st century, we deal with the realities of a global trading/production model. In this case, increases in U.S. domestic demand are not met by an equal increase in domestic supply. On the contrary, increases in domestic demand are frequently met by increased imports. In this way, the response in the domestic job market lags the rise in domestic demand. Yet, on the supply side, many workers are unable to respond to changing skills demand since the development of human capital often takes more time than the market desires. Two results are evident in recent data. First, job growth lags economic recovery. Second, many unemployed are unemployed because of a mismatch of skills—not just due to weakness in the economy.

To read the full report: CHARACTER OF RECOVERY


To quickly revert to the high GDP growth path of 9 per cent and then find the means to cross the ‘double digit growth barrier’.
To harness economic growth to consolidate the recent gains in making development more inclusive.
To address the weaknesses in government systems, structures and institutions at different levels of governance.

India among the first few countries in the world to implement a broad-based counter-cyclic policy package to respond to the negative fallout of the global slowdown.
The Advance Estimates for Gross Domestic Product (GDP) growth for 2009-10 pegged at 7.2 per cent. The final figure expected to be higher when the third and fourth quarter GDP estimates for 2009-10 become available.
The growth rate in manufacturing sector in December 2009 was 18.5 per cent - the highest in the past two decades.
A major concern during the second half of 2009-10 has been the emergence of double digit food inflation. Government has set in motion steps, in consultation with the State Chief Ministers, which should bring down the inflation in the next few months and ensure that there is better management of food security in the

Fiscal Consolidation
With recovery taking root, there is a need to review public spending, mobilise resources and gear them towards building the productivity of the economy.
Fiscal policy shaped with reference to the recommendations of the Thirteenth Finance Commission, which has recommended a calibrated exit strategy from the expansionary fiscal stance of last two years.
It would be for the first time that the Government would target an explicit reduction in its domestic public debt-GDP ratio.

Tax reforms
On the Direct Tax Code (DTC) the wide-ranging discussions with stakeholders have been concluded - Government will be in a position to implement the DTC from April 1, 2011.
Centre actively engaged with the Empowered Committee of State Finance Ministers to finalise the structure of Goods and Services Tax (GST) as well as the modalities of its expeditious implementation. Endeavour to introduce GST by April, 2011 People’s ownership of PSUs
Ownership has been broad based in Oil India Limited, NHPC, NTPC and Rural Electrification Corporation while the process is on for National Mineral Development Corporation and Satluj Jal Vidyut Nigam. This will raise about Rs 25,000 crore during the current year.
Higher amount proposed to be raised during the year 2010-11.

Fertiliser subsidy
A Nutrient Based Subsidy policy for the fertiliser sector has been approved by the Government and will become effective from April 1, 2010.
This will lead to an increase in agricultural productivity and better returns for the farmers, and overtime reduce the volatility in demand for fertiliser subsidy and contain the subsidy bill.

Petroleum and Diesel pricing policy
Expert Group to advise the Government on a viable and sustainable system of pricing of petroleum products has submitted its recommendations.
Decision on these recommendations will be taken in due course.

Improving Investment Environment
Foreign Direct Investment
Number of steps taken to simplify the FDI regime.
Methodology for calculation of indirect foreign investment in Indian companies has been clearly defined.
Complete liberalisation of pricing and payment of technology transfer fee and trademark, brand name and royalty payments.

Financial Stability and Development Council
An apex level Financial Stability and Development Council to be set up with a view to strengthen and institutionalise the mechanism for maintaining financial stability.

This Council would monitor macro-prudential supervision of the economy, including the functioning of large financial conglomerates, and address interregulatory coordination issues.

To read the full report: BUDGET 2010-2011

>Nuclear Power revival in India (MACQUARIE RESEARCH)

A new Asian dawn for nuclear power led by China and India
We released a thematic report on Asian nuclear power on 18 February 2010 (Hunting Stocks-A new Asian dawn for nuclear power). Outlook for nuclear power in Asia looks increasingly favourable amidst fast-growing electricity demand in China and India. China and India are poised for a substantial expansion in their nuclear electricity generation capacity. The IAEA projections imply that Asia and the Middle East will account for 52% and 66% of the global nuclear power capacity by 2020 and 2030 respectively versus 29% in 2008. In
this note, we focus on nuclear opportunity in India.

Positive but long-drawn benefits
India is in the midst of a nuclear power renaissance. The country has rejoined the international nuclear community after more than three decades in the wilderness. However, we believe it is likely to be a lengthy process, with the opportunities best seen from a long-term perspective for equipment manufacturers and the power generation sector.

Nuclear still a very miniscule part of India’s power plans
Power from India‘s nuclear power plants contributed to just 3% of the country‘s installed capacity base at the end of April 2009, and nuclear power still provides just 2% of India‘s total electricity generation. A further 2.8GW in net capacity is being constructed now, which will take India‘s net nuclear power capacity to over 7GW –7.8GW in gross capacity – by the end of the current 11th Five-Year Plan in 2012. Even before the Nuclear Supplier‘s Group waiver, India had aimed to have 20GW of capacity by 2020. However, now that India has joined the international nuclear community, these targets are likely to be scaled upward.

NPCIL, the nodal agency, driving growth
Government-owned NPCIL is responsible for constructing and operating India‘s
commercial nuclear power plants. It has 17 nuclear power stations in operation, and one entering into operation now. Five more nuclear power plants currently are under construction. NPCIL is preparing to build more power reactors, backed by improving access to nuclear fuel and technology.

Foreign investment starting to kick in
Fuel supply agreements have been signed with countries like France, the US and Russia post the 123 agreements and NSG waiver that guarantee uninterrupted uranium fuel supplies for its nuclear power reactors and unrestricted transfer of technology. Also, international players from Russia, France, etc are expected to
put up 6-8GW of nuclear power plants in the near future for which sites are being finalised already. Construction opportunity for players like L&T, BHEL, HCC, etc could be as large as US$4-5bn from this in the next couple of years.

Power equipment manufacturers could be key beneficiaries
Indian power equipment manufacturers now have an opportunity to supply spares and components not only to indigenous power plants but also to manufacturers of power plants based on foreign technology. Firms that may benefit in the manufacturing sector include L&T and BHEL, Gammon and HCC. Private utilities would still have to wait until India signs subsequent agreements to make the NSG waiver and 123 agreements operational.

To read the full report: NUCLEAR POWER

>Indian Housing Finance companies: Ready for a takeoff once again

Given India’s rapid population growth, increasing urbanisation and rising affordability the housing finance market will continue growing. However, given increasing competition in the sector from banks, HFCs with access to low cost funds, better operational and credit cost control, and better service quality will find life easier. In a supportive macroeconomic environment and with competition from banks likely to reduce due to the new base rate regime, we initiate coverage on LIC Housing with a “Buy” stance.

Structural Growth Drivers in Place
An underpenetrated mortgage market (~Mortgage to GDP at 7% vs ~80% for USA and 12% for China), favourable demographics (60% of population <> years), increasing urbanisation and improving affordability will ensure that
demand for mortgage loans will continue to grow at a healthy pace (FY00-10 CAGR of 24%).

However the road ahead is not smooth
However, given the perpetual competition from banks, lower spreads, highly rate sensitive customers, HFCs need to exhibit the following key characteristics to compete successfully:

Access to low cost funds and liquidity: Whilst the importance of low cost of funds has always been obvious, Sep-08 brought home the importance of having access to liquidity.

Credit appraisal skills: This is particularly hard in India given the weakness of credit bureau data and difficulty in credit enforcement.

Quality of customer service: This is the key differentiator in a commoditised market where banks are bound to have lower cost of funds.

Cost efficient structure: Critical if an HFC is to competitively price its loans and still maintain profitability.

A growing and underpenetrated market
Against the backdrop of an economy growing at a 10 year CAGR of 7%, mortgage disbursements have risen at a CAGR of 24% over the last decade and the total mortgages outstanding have increased to ~Rs, 4,100 bn at Dec’09 (vs ~Rs. 1,200 bn five years ago). We see this trend continuing due a variety of reasons none of which are particularly contentious. At around 7%, the mortgage:GDP ratio in India is amongst the lowest in the world (see figure 2). A huge shortage of housing units (~25 mn), limited availability of housing finance, the limited reach of HFCs and Indians traditionally being averse to credit had been the major reasons behind low mortgage penetration in India. But this trend is changing, with more Indian households becoming more open to credit, increased availability of home financing and with increasing construction of affordable housing units.

Some socio-economic trends are also helping on this front:

Increasing urbanization and nuclearisation: India is increasingly becoming an urbanized country (urban population is~31% of total population vs 28% a decade ago) with people migrating to the cities in search of employment. This is leading to higher demand for household units in urban areas where availability of housing finance is higher than in rural areas. Moreover from being a nation of joint families, India is increasingly becoming a nation of nuclear families (average family size has come down to ~5 vs 6 in 1981) leading to higher demand for housing units.

Increasing affordability: Various surveys show that more Indian households are entering into higher income brackets leading to improving affordability despite increased in property prices. Whilst there is no independent data on long term affordability trends (CRISIL’s data dates back to FY02 – see Figure 3), the data provided by HDFC Ltd. shows that affordability has increased four-fold over last fifteen years as rise in salary levels have kept pace with the increase in property prices (see figure 4). Low interest rates and greater availability of housing finance has further improved the overall affordability factor.


>India Infoline Limited (ICICI DIRECT)

Next delta missing for steep growth…
India Infoline (IIFL) has diversified its core business of equity broking to a widespread bunch of financial services. Broking revenues contribute ~55-60% to the total topline, financing income ~22-23% while insurance distribution & online media contribute 10% to the total income. IIFL commands ~3.7% market share of total market volumes clocking Rs 3700 crore daily volume and generates higher-than-industry average yields of ~8 bps due to higher share from the retail segment (~60% of total turnover). We expect IIFL to maintain a stable market share. This will lead to revenue CAGR of 14% (FY12E Rs 1431 crore) and PAT CAGR of 19% (FY12E-Rs 246 crore).

Higher broking yields to help 17% CAGR in broking income
IIFL has a market share of ~3.7%. With the anticipated average daily market turnover rising from current levels of Rs 90,000-95,000 crore to Rs 1,20,000-1,25,000 crore by FY12E, we believe yields will stabilise around 8 bps (comparatively higher than peers). This should help it to generate brokerage income at 17% CAGR over FY09-FY12E to Rs 844 crore.

Financing business to be driven by margin funding, LAS
We expect the financing book to grow from the current Rs 1200 crore to Rs 1480 crore by FY11E and Rs 1710 crore by FY12E implying 21% CAGR over FY09-FY12E. Margin funding, which constitutes ~40% of the funding book will allow yields to be maintained at 15-16%. This will enable 13% CAGR in NII to Rs 333 crore by FY12E.

Higher operating leverage leads to lower than peers EBIDTA margins
EBIDTA margin fell from 33% and 39% in FY07 and FY08, respectively, to 30% in FY09. The margins are lower compared to listed peers on account of higher proportion of owned branches resulting in higher operating ratio of approximately 18%. The company has lately shifted to the blended model, which will improve its EBIDTA margin to 32% by FY12E.

At the CMP of Rs 111, the stock is ruling at 13.3x and 12.8x its FY11E and FY12E EPS, respectively. The stock has historically traded at a premium to market multiples due to its diversified revenue stream and higher than industry blended yields of ~8 bps. RoEs are expected to stay in the range of 13-14% in the next two years. Since we do not expect steep rise in bottomline till FY12E, we have not ascribed any premium to the market multiple (15x FY11E EPS) thereby valuing the stock at Rs 121/share.

To read the full report: INDIA INFOLINE