Saturday, February 27, 2010

>GREED & FEAR: No reprieve (CLSA)

One week on and “oversold” markets want to celebrate the fact that Greece has been given a one month reprieve to get its fiscal house in order. While it is natural that investors would like to forget about the problem, in GREED & fear’s view it is clear that the real crisis over Greece and the rest of the PIIGS lies in the future not the past.

The past week has made it clear that German public opinion, and therefore the German political process, will not tolerate a crude bailout of Greece; even if it is via “subtle” off balance sheet guarantees and the like. For example, why should Germans agree to a bailout of Greece with its statutory pension age of 61 when Germans do not receive pensions until the age of 67? Meanwhile, the level of fiscal austerity being demanded of Greece, namely a decline in the projected fiscal deficit from 12.7% of GDP in 2009 to 2.8% of GDP in 2012, is in GREED & fear’s view wholly incompatible with the reality of Greek democracy. In this respect the charge by the Greek Prime Minister George Papandreou over the weekend that the country was being treated as a “laboratory animal” by the European Commission is a reflection of the prevailing “Club Med” mentality.

The reality is that this drama will come to a head sooner or later. And with Greece needing to raise €20bn in the next three months it could be sooner, especially as some other “Club Med” countries also face significant debt refunding schedules between March and May. Thus, Spain and Portugal have €31bn and €11bn of government debt maturing in the next three months.

Macro traders should therefore keep on the long recommended PIIGS spread trade (see Figure 1). Investors should also assume that there will be further negative pressures on the euro, which implies continuing strength in the US dollar. In this respect Otmar Issing, a former member of the European Central Bank’s executive board, is quite right to argue, as he did in an article in the Financial Times on Tuesday (“A Greek bail-out would be a disaster for Europe”, 16 February 2010), that a bailout of Greece would undermine the foundations of European monetary union and, therefore, the credibility of the euro.

All this means that the future of the euro as a hard or soft currency will be determined, as noted here last week, by whether Europe’s politicians opt for the hard or soft option (see GREED & fear – Hard or soft in Europe, 11 February 2010). But until Europe passes this stress test the market is likely to assume bailouts and the like, so accustomed have investors become to the moral hazard generated by government guarantees in the Greenspan and Bernanke eras.

But what investors need to remember is that this is a crisis not centred on Washington. GREED & fear remains sceptical whether Germany will really opt for a bailout, or even a “fudge” option. And if it does not the deflationary consequences will come as a real shock to markets. Meanwhile, it goes without saying that the fundamental flaw in Euroland is the incompatibility of having monetary union without political union. This was always understood by the eurosceptics in Britain, like the great Margaret Thatcher, though naturally the Euro-enthusiasts will try and spin the latest crisis to argue for the need for political union. They are unlikely to

Meanwhile, with European issues dominating the headlines, focus has switched away from Asia for the moment. Still GREED & fear remains convinced that sell-offs caused by Greece and the like represent great buying opportunities in Asia since this further assures a continuing environment of very low interest rates in the West which can only generate excess liquidity bound for Asia. Who, for example, is talking about exit strategies in Europe right now?

To read the full report: GREED & FEAR

>Benefit from Budget 2010-11 (RELIGARE SECURITIES)

Budget has proposed reduction in tax plan making more money available for common man to increase consumption.

GDP – growth expected at 7.2% in 2009-10 and 8.5% in 2010-11
Additional Banking License to Private players / NBFC
Growth– Manufacturing sector grows 18.5% in Q3 FY2010
Fiscal deficit– pegged at 6.9% for 2009-10 and 5.5% for 2010-11
Lower rolling fiscal deficit targets for 2011-12 at 4.8% and 2012-13 at 4.1% of GDP augur well for Market.
Disinvestment– Rs. 25000 cr to be raised by disinvestment in PSUs.
Government borrowing – Net borrowing by govermnt in 2010-11 is lower than expectation, standing at Rs. 3.45 lac crore. Gross borrowing stands at Rs. 4.57 trillion.
Infrastructure thrust – Rs. 1.73 lac crore allocation to infrastructure development. This stands at 46% of the total planned allocation.
Water resources– emphasis on rain water harvesting and eco-friendly measures
Foreign Trade– boost to export sector by extending interest subvention on select exports, standing at 2%.
Budget Estimates

  • Plan Expenditure – stands at Rs.3.73 trillion, rising 15% from previous year
  • Non Plan Expenditure – stands at Rs.7.36 trillion, rising 6% from previous year
  • Fiscal Deficit stands at Rs.3.81 trillion.

To read the full report: BENEFITS FROM BUDGET


Source of opportunity
We downgrade Nestle India to Sell and add it to our Conviction List, from Neutral, on valuation grounds and revise our 12-month target price to Rs2,376 from Rs2,362. We believe Nestle India’s current valuation is expensive as it trades on a one-year forward rolling P/E of about 29X, which is high compared with its long-run average of 25X. Although Nestle India remains structurally well positioned to deliver strong 19% topline CAGR in FY09-FY12E given its exposure to low-penetration processed food categories and urban skew, we forecast flat gross margins in FY10E driven by a spike in raw material costs.

Expensive valuation overshadows strong topline; down to Sell

Nestle India’s current absolute P/E and 35% P/E premium relative to our India consumer staples coverage are both about one standard deviation above their long-run trends. With EPS CAGR moderating from 28% in FY06-FY09 to 22% in FY09-FY12E given a high base and limited margin expansion, we expect mean reversion of its P/E. We also believe Nestle India would need to continue investing in brands to maintain its high topline growth.

We revise our 12-month target price to Rs2,376 based on 26X March 2011E time-weighted EPS (from Rs2,362 based on 26X December FY10E EPS previously) in order to capture earnings 12 months ahead. We also lower FY10E-FY12E EPS by 2%-4% post FY09 results. Moreover, our target price is backed by Director’s Cut analysis that indicates Nestle India is currently trading above the sector trendline despite a trajectory of moderating CROCI.

Key risks
Upside risks include significantly better top-line growth than our forecasts on the back of strong domestic demand, increased penetration, new launches and higher exports; a fall in input costs that could result in much better margin expansion than we estimate.

To read the full report: NESTLE INDIA

>Asia Energy: Getting Bullish on Oil Services (MORGAN STANLEY)

We are becoming incrementally positive on offshore drillers, key being our positive view on the jackup market. We expect utilization for international jackups, currently under 80%, to reach significant levels of 85% by mid-year and 95% by year-end. We expect E&P capex to increase substantially in next few years, and hence highlight two stocks to play on our bullish view on offshore drillers:

1) COSL is our preferred play on E&P capex with China, with strong earnings growth for the next five years. We expect COSL to spend US$2 bn in the next two years; add eight more jackups and three more semis. COSL has exposure in the offshore China region, and in the overseas offshore market following the acquisition of Awilco.

2) Aban has deployed twelve of its sixteen jackups with long-term contracts of one to three years. Increased utilization rates due to rising E&P capex should be a positive, as it increases the probability of idle assets deployment and increases the efficiency of currently deployed assets. Anan currently has four idle jackup assets and three coming up for redeployment in F2011 and F2012. We believe Aban will be able to deleverage its balance sheet through diluting equity. We expect the pain of debt repayment to subside for the next two years, and believe Aban will be able to service its debt with operational cash flows.

We have marked to market our refining margin assumptions for Q110 to $5/bbl from $3.5/bbl, thereby increasing our 2010 full-year estimate by 10% from $3.7/bbl to $4.1/bbl.

To read the full report: ASIA ENERGY

>ADANI POWER: 1,320MW project award in MP is positive (UBS)

Adani Power has been awarded LOI for a 1,320MW project in MP
Adani Power (APL) has been awarded Letter of Intent (LOI) by Madhya Pradesh Government to develop 1,320MW power project at Chhindwara. The project is like a Case 2 bid (similar to UMPPs) and has significant advantages for Adani Power in the form of; a) land availability, b) state government support for obtaining fuel linkages, c) water availability, d) support for infrastructure facility by MP Govt. The project also has a good mix of regulated and open capacity.

The project may be commissioned in FY14/FY15
As per the LOI, the first unit of 660MW is to be commissioned in 2Q FY14 and the second unit by end-FY14. We believe Adani Power has made reasonable progress on this project as the company has already invited EPC bids for the project.

We don’t include under development/under planning projects in valuation
In our current price target, we only include 6,600MW of commissioned/under construction capacity (4,620MW Mundra and 1,980MW Tiroda). We don’t include 3,300MW and 6,600MW of under development and under planning projects respectively. As highlighted in our initiation report, Adani Power: An emerging utility major dated 25th November 2009, this could add ~26% in our price target.

Valuation: Maintain Buy and price target of Rs130
We derive our PT using a plant-by-plant DCF (for 6,600MW of commissioned/ under construction capacity), assuming COE of 13.2%. Developments in APL are similarly positive for its parent entity, Adani Enterprises (AEL); APL contributes ~62% of our SOTP-based PT of Rs550 for AEL (maintain Buy).

To read the full report: ADANI POWER