Saturday, March 6, 2010


A wild ride

Incremental tightening ahead

Key Points
Consumption is the top investment theme
Residential property market will stay healthy
CPI should average 3% this year
Gradual renminbi appreciation to resume by mid-year
GDP growth about 8-9% in 2010
Key risks: government policy; 2H margin squeeze; big US recovery

First in, first out
Looking back, it is clear that that China began to slow long before the US went into recession (officially in December 2007) and long before Chinese export growth plummeted.

China began to slow at least two quarters before the US because the slowdown was deliberately self-inflicted by a Communist Party leadership worried about overheating.

In mid-2007 Beijing cut off credit flows to two key sectors: construction and real estate, which combined account for about 10% of GDP - a larger share than contributed from net exports (6-8% prior to last year’s collapse).

This self-inflicted slowdown then ran head into the global recession, accelerating the rate of China’s economic decline.

To read the full report: CHINA MACRO STRATEGY

>Union budget FY11: Macro and sector impact (CLSA)

Well balanced
We went into the FY11 Budget looking for one key message – that fiscal consolidation would be a prime objective for the government. In that sense, the Finance Minister has done well; expenditure is being reined in and partial unwinding of the fiscal stimulus has happened, which will leading to a 1.4ppt reduction in the fiscal deficit targeted for FY11, at 5.5% of GDP. There is, no doubt, a greater reliance on non-tax revenues, including disinvestment/3G auction receipts, but we see other ‘politically difficult’ steps like the increase in fuel prices, following the hike in urea prices a week ago, as indications that the government will be serious about taking bolder moves on these fronts. There were positive signals on continuing with rationalisation of taxes as well.

The government is targeting a 20% rise in tax revenue, which we believe is fairly realistic, given the rebound in the economy (and consequently the visible buoyancy in consumer spending and corporate profits), the 2ppt hike in excise duties and the surprise moves to levy a 5ppt import tariff on crude oil and hikes excise duty on petrol/diesel. On expenditure, the government has, as we hoped, reined in subsidies and growth in non-plan spending, helped by the relief from one-offs like the Pay Commission related arrear payments and the fact that social development schemes like NREGA have achieved critical mass; on the other hand, outlays on key infrastructure sectors like roads have continued to go up. The Rs400bn budgeted from disinvestment is a stretch, but with +Rs250bn set to be achieved in FY10, we believe the risk of gross slippage is not high.

The changes in corporate tax/income tax and the fix on the service tax rate suggest that the FM is pushing for rollout of the GST regime and the new Direct tax Code by FY12, as indicated in his Budget speech. The announcements on establishing an apex regulator for financial sector, licences for new private banks, a regulator for the coal sector and the decision to restrict payment of oil subsidy to cash (rather than oil bonds) are all positive steps, in our view. Follow through will be important, though.

The moves towards fiscal consolidation will help sustain confidence in the Indian growth story, particularly because a pick-up in the investment cycle is critical for acceleration in GDP growth to c.8.5% and further earnings upgrade (from forecast +25% Sensex EPS growth) in FY11. We are positive on capital goods plays like BHEL, L&T, private Banks like ICICI and O-WT materials as well. However, 1H will be choppy for equity markets, given weak global markets, the large domestic equity pipeline and continued monetary tightening by the RBI; inflation pressures remain high and some of the Budget provisions (hikes in fuel prices, enhanced thresholds for income tax slabs, service tax on air/rail freight services) will further add to headline WPI inflation.

Sectors negatively impacted by the Budget are Oil & Gas (3ppt rise in MAT rate will see 2.5% EPS cut for Reliance, squeeze in margins for refiners IOC, BPCL, HPCL), Consumers, especially ITC (where excise duty was up by a higher than expected 15%), Telecoms (based on MAT rate increase). On the other hand, the Pharma sector will gain from higher tax incentives for R&D, Autos will benefit from the unexpected tax breaks on personal income.

What surprised … and what disappointed (see detail in report)

To read the full report: UNION BUDGET

>Indian Banking System: Q3/9M FY09-10: Performance Review & Outlook

The current ICRA research is an update on the performance of 43 Indian Banks during Q3 / 9M FY09-10. We have included 26 public sector banks and 17 private sector banks in the current analysis. These banks would account for over 90% of the Indian Banking System assets as on December 2009.

Overall profitability indicators have been maintained during the nine months ended December 2009 for the Indian Banking System with net profits as a percentage of average total assets at around 1.04%. Improving interest margins compensated for a decline in the non-interest revenues and rise in credit costs. Some downward pressure on overall profitability expected next year due to rise in credit provisions and adverse impact of likely rise in bond yields.

Sharper decline in the cost of funds compared to the yield on earning assets led to improvement in interest margin for most banks in Q3FY10 compared to the previous quarter. Interest margins likely to remain strong for next 2-4 months as banks reap benefit of reduction in deposit rates and expected rise in credit portfolio. Future interest margins will depend on impact of higher interest to be paid on savings deposits and impact of introduction of ―Base Rate‖ for lending from April 2010 and the systemic liquidity levels.

While credit growth has been muted in the current year, we are witnessing some traction since December 2009 and given the sizeable undisbursed sanctions, credit off-take expected to pick up from the current quarter.

NPA levels have risen in the current year leading to some deterioration in the reported asset quality and solvency indicators. ICRA expects gross NPA % to rise to 3.25-3.75% in next two years as compared to around 2.40% as on December 2009.

Expected rise in bond yields to adversely impact pre tax profits next year by 10-20%.

Capitalisation levels for the Indian Banking System is remains comfortable with overall capital adequacy of around 14% and Tier I of around 9.5% as on December 2009 though some specific banks (especially public sector banks) require equity capital to meet their business plans for the next two years.

Public Sector Banks will require capital of over Rs 1 trillion over next two years to maintain capital adequacy of 12% and meet business plans, while private sector banks are adequately capitalised for the time being though some of them will require capital to manage growth aspirations and also dilute the promoters’ holding to the levels required by the RBI.

To read the full report: INDIAN BANKING SYSTEM


Company Profile
Incorporated in 2007, DQ Entertainment (International) Limited is one of the leading producers of animation, visual effects, game art and entertainment content for the Indian as well as global media and entertainment industry. The company is a producer, co-producer and global distributor of TV series, direct-to-home videos and feature films. DQ Entertainment also creates art games for online, mobile and next-generation consoles. The company has also forayed into production and distribution of live action television and feature films & recently moved from a pure outsourcing service model to one where it does most of its projects on a co-production model along with large animation studios, as well as developing their own Intellectual Property (IP) content.

DQ Entertainment with its Production, Sales, Licensing and Distribution centers in India & abroad has a work force of 3500+(2788 permanent employees and 712 freelancers and trainees).

Low-risk business model
The strength of DQE lies in its low risk business model i.e entering into intellectual property ownership & distribution. The model not only helps the company in generating production margins but also helps in acquiring rights to earn licenses revenues.

Robust Order Book
DQE has a strong order book worth USD 95.07 million (Rs. 4,567.16 million approx.), providing high levels of earning visibility. More than 80% of FY10 revenues are identified with over 40% of the order book already in various stages of production & balance to commence during the year.

Diversified client base
The company has a client base of over 90 companies which includes internationally recognized brands such as, the Disney Group, Nickelodeon, American Greetings, BBC, Moonscoop Group, ZDF-Germany, Australian Broadcasting Corporation and NBC Universal to name a few.

Innovative in-house animation techniques
DQE has developed several in-house animation techniques and technologies, which the company believes have given it an advantage over its competitors.

Capitalize on the growth of the animation industry
At an estimated size of USD 494 million in 2008, the Indian animation industry is miniscule as compared to the global animation industry with estimated revenues of USD 68 billion in 2008.This leaves huge growth potential for the Indian animation industry which is likely to reach a size of about USD 1095 million by 2012. The company intends to capitalize on such growth factors by leveraging its international experience and expertise in this sector to the domestic animation industry.

Continued focus on co-production business model
The company intends to continue entering into co-production agreements to obtain larger percentages of the global, cross platform intellectual property and distribution rights in its productions

Acquisitions, strategic investments and joint ventures
DQE plans to grow through acquisitions of, strategic investments in and joint ventures with creative companies to ensure co-development of global intellectual property on a partnership basis.

To read the full report: DQ ENTERTAINMENT

>Indian Steel: Steel majors raise prices post budget 2010 (UBS)

SAIL has increased prices by Rs600; JSW Steel by 2%
SAIL has increased steel prices by Rs600/t post the 2% hike in excise duty announced in the government’s annual budget. JSW Steel raised its prices by 2%. Our channel check indicates similar price hikes by Tata Steel. Average prices in India before the budget were Rs34,800 for HRC and Rs32,500 for wire rods (including 8% excise duty and 4% VAT).

Other Asian companies such as JFE and Nippon Steel raised prices
JFE and Nippon Steel raised their export steel prices by US$200/t (previously around US$550-600 versus the domestic price of around US$800).We believe this is largely in anticipation of higher raw material contract prices and could be positive in the near term as it highlights steelmakers’ ability to pass on raw material price hikes. However, we remain concerned global overcapacity (especially in China) and tightening measures in China could lead to softening of steel demand and prices in H210.

Key near term event—raw material negotiations
BHP will be in Tokyo next week to negotiate coking coal contracts with Japanese steel makers. We believe it could press for quarterly price contracts, as an alternative to annual benchmark prices. Spot coking coal is more than US$200/t versus the contract price of US$129/t last year. Iron ore spot (CIF China) is around US$138/t versus the contract price of US$61/t last year.

We remain cautious on the Indian steel sector
We believe it will be difficult for the sector to outperform in a rising cost scenario. We would prefer mining names over steel names. However, we think Indian steel companies could outperform Asian peers due to higher iron ore integration (most Indian companies import the bulk of their coking coal requirements).

To read the full report: INDIAN STEEL


Eventually the government after much delays and controversies has managed to announce the schedule for 3G/BWA spectrum auction. According to the notice inviting bids from telcos, 3G auction would start on April 9, 2010 while BWA auction would follow 2 days after close of 3G auction. For 3G, a minimum of 3 slots of 2xMHz each in the 2.1GHz band would be offered at a pan-India reserve price of ~Rs34bn. This figure is above the average of the respective asking prices of DoT and the finance ministry.

To read the full report: 3G POLICY