Tuesday, March 16, 2010

>ASIA STRATEGY: Value buying opportunities emerging

■ We provide an update on valuations, key cyclical indicators, and where we see value emerging across the region after recent market volatility.

■ With global economic growth firming – albeit in fits and starts -- and monetary conditions likely to remain very loose for an extended period of time, the macro backdrop is, broadly speaking, supportive of healthy equity market conditions. Earnings forecasts are also far from unreasonable, in our view, compared to previous recoveries. All this adds up to a healthy outlook for Asian equities on a 12-month view (for more details on this see our recent note “Asia strategy: Would you buy Asia at 2.5xP/BV? You should!”, 2 February 2010).

■ But in the near term, Asia ex Japan is likely to remain range bound or even drift lower. Current valuation levels in many cases make for an underwhelming near-term risk/reward trade-off, and key cyclical indicators such as earnings revisions1 and the OECD LI (that are tightly correlated with Asian markets) are falling and are likely to continue to do so in the near term.

■ It is hard to overstate the importance of the fact that our earnings revisions indicator is falling – average returns are -25% when it is falling and Asia ex Japan has risen only once when this indicator has been falling and that was way back in 1991, when China's economy was about 7% of its current size, India had a GDP per capita of US$315, and Korea‟s export-to-GDP ratio was
about half what it is today.

Despite this subdued near-term outlook for equity markets, there are pockets of value in Asia:

  • Stocks that are plain and simply cheap, in an absolute level sense, have a high probability of outperforming. This applies under all market conditions. The best valuation metric to use here is P/BV and our latest screen features quite lot of Korean stocks (as it usually tends to) but also a surprisingly high number of Hong Kong/China stocks.

  • China. China has been treated harshly in the recent sell-off, with the market the second worst performing this year. We say harsh because we don't think China deserves this high-beta status – its earnings growth is relatively stable, it has a strong structural element to its growth rate (making it relatively resilient to external shocks), and it has policy flexibility. Looking ahead, with valuations now really quite attractive, growth likely to remain strong, earnings expectations very reasonable, and 2Q by far and away the (traditionally) strongest quarter for China, now is a very good point to start accumulating China stocks.
  • Telcos. Not sexy. And some argue that they are a value trap. But telcos are, by far, the cheapest sector in Asia ex Japan and many of the stocks feature heavily on our screens for both value and dividend yield. With the balance of risks to markets skewed slightly to the downside in the near term, the odds of this sector continuing its recent run of outperformance is high, in our view.

To read the full report: ASIA STRATEGY

>Transmission & Distribution (JM FINANCIAL)

Competition growing
Chinese lead PGCIL’s transformer ordering with 91% mkt share…: Chinese steal the show by bagging 6 out of 9 projects ordered in the transformer space by PGCIL during the peak-ordering season of Jan-Feb’10. In value terms, Chinese viz. Baoding & TBEA Shenyang bagged orders worth Rs6.2bn out of the total Rs6.8bn, with a market share of ~91%. BHEL (BUY, Rs3,000)
and Crompton Greaves (BUY, Rs510) were the Indian players who bagged orders worth Rs233mn and Rs144mn respectively.

…aided by favorable currency movement: The Chinese currency depreciated 12.8% in last 1 year, inline with US$ decline of 13.1% (see Exhibit 2), leading to export competitiveness of the Chinese in India. Unfavorable currency movement can also loom a threat on BHEL and L&T, but with government machinery propagating domestic manufacturing, we will not be unduly concerned.

However, IEEMA is against unfair competition from China: The Indian Electrical and Electronics Manufacturers' Association (IEEMA) is already voicing against the 15-20% unfair advantage to Chinese firms and has been advising a safeguard duty to protect domestic manufacturers. We think a safeguard duty demand by Ministry of Heavy Industries (MHI) is likely.

30% of transmission business trickled to sub-contractors: PGCIL ordered out tower packages worth Rs14.2bn in Jan-Feb’10 and a noteworthy point was the emergence of erstwhile sub-contractors competing against established companies. ~70% of business (see Exhibit 3) remained with Tata Projects, Jyoti Structures (BUY, Rs200), Kalpataru Power (BUY, Rs1,350) and L&T. We remain positive on the space on increasing orders from IPTCs and States too; competition remained one-off.

To read the full report: TRANSMISSION & DISTRIBUTION


The launch phase of the ‘green stimulus’ is over – we estimate USD521bn was allocated to climate change measures by the end of 2009

Delivery in 2009 was weaker than expected at an estimated USD82bn

Beyond the stimulus, we see continued commitment to low-carbon growth in recent government budget plans

Delivering the green stimulus

Spending is due to reach USD248bn in 2010, focusing on rail, grid, energy efficiency and renewable energy

The era of announcing green stimulus measures as part of government recovery plans has ended. Since our first report a year ago, we estimate the fiscal commitment to climate-change measures has risen 21% from USD430bn to USD521bn (see A climate of recovery, February 2009).

We estimate actual spending in 2009 was USD82bn, around 16% of the total. That is less than our November 2009 estimate of USD94bn, largely due to our reduced expectations for China and South Korea (see Taking stock of the green stimulus, November 2009). Elsewhere, Australia, Canada, France and the US are now on track to spend their stimulus funds. We expect spending to rise in 2010 as a result, hitting 45% of the total. China will continue to lead the pack with an estimated 39% of the total USD248bn. The European Union and US will follow with around 18% each. Rail, grids, energy efficiency and renewables get the largest allocations.

Beyond the stimulus, recent budget proposals in China, India and the US will boost the low-carbon economy. In China’s 2010 budget, spending on environmental protection is projected to rise by more than 20%. In India, clean-energy measures amount to over USD1bn. In the US, the Obama administration’s 2011 budget request increases allocations to environmental and climate-change measures 46%, some USD21bn more than actual spending in the 2010 budget.

To read the full report: CLIMATE CHANGE


This report focuses specifically on the services sector because of the central importance of services to India’s current economic expansion. Whereas the East Asian economies’ success has largely been built on the development of export-oriented manufacturing, India’s recent growth has been led by the dynamism of its services sector – particularly high-end, knowledge-intensive services exports. Services have consistently grown at a faster pace than the economy as a whole since 1991, when the reform effort was kicked off in earnest. They now occupy some 60 per cent of India’s GDP, based on the WTO definition of services which includes construction. Manufacturing, by contrast, has maintained a stubbornly static share in the economy at around 20 per cent, while that of agriculture – still far and away the largest employer – has dwindled. Productivity growth in India, unlike virtually all other regions of the world, has been strongest in services (IMF 2006).

This is not to say that developments in other sectors are unimportant; nor that the profile of India’s economy will remain static over time. Already, for example, there are signs of an acceleration in the growth of India’s manufacturing sector. But to date, it has been services that have led the way; and their sheer size within the economy means they will continue to have a critical role.

This is an unusual growth path. In terms of per capita income India remains a poor country. Yet the services-dependent profile of its economy is much closer to that which has typically been associated with middle-income developing countries. In general, development of the services sector occurs after developments in agriculture and manufacturing. In India’s case, the reverse has occurred.

How can the services boom lead to sustainable growth?
For the reformist approach that has led to India’s recent growth to be politically sustainable in the medium to long term, it must demonstrate benefits to all strata of society. The key imperative for Indian policy-makers is to improve the situation of a huge and growing, but relatively low skilled, rural working class. This means creating vast numbers of appropriate jobs. But the main driver of growth in the economy since 1991 has been a knowledge-intensive sector, which is never likely to become a mass employer of low-skilled labour. How to resolve the two?

Fieldwork in the course of this study suggested that, in the minds of many participants in the Indian economy, there is a plausible route by which services-led growth could lead to broader-based development, and consequently to job creation on the necessary scale. Put simply, this would involve growth of dynamic services export sectors such as Information Technology–Information Technology Enabled Services (IT–ITES), and the income that growth brings to the country, providing a major stimulus to domestic demand and hence catalysing reform and growth in other sectors – including infrastructure development, construction, manufacturing and retail. It is the consequent growth in these other sectors, particularly manufacturing, which might be expected to provide the bulk of the required jobs over time.

To read the full report: INDIA'S SERVICES SECTOR


We met L&T management as part of our Oil & Gas Yatra with focus on hydrocarbon business. We also revisit scenarios where L&T’s order inflow is likely to fall short of the guidance of 30% growth as some of the large ticket orders remain undecided.

Order inflow pipeline reasonable, timing remains a concern: L&T is currently pursuing a number of opportunities in the hydrocarbon space from clients like ONGC (ONGC IN, Rs1100, UP, TP: Rs919 – Jal Irani), BPCL (BPCL IN, Rs542, OP, TP: Rs695 – Jal Irani), HPCL (HPCL IN, Rs344, OP, TP: Rs460 – Jal Irani), etc. There are opportunities also emerging in the Middle East. However, key project awards from ONGC continue to experience delays, which can impact order inflow targets.

Vertical integration has made L&T more competitive: L&T is much more comfortable regarding its competitiveness vis-à-vis Korea on account of vertical integration and capacity addition. L&T has recently added an offshore installation vehicle in JV with Sapuracrest, which had to be outsourced earlier, and created an offshore fabrication yard in Oman and fabrication yard capacity at Hazira and Powai. Moreover, competitive intensity has also reduced as some of the new entrants rethink strategy after cost overruns.

L&T likely to fall short of target of Rs200bn order inflow in 4QFY10: L&T needed order inflow of Rs200bn in 4QFY10 to achieve its guidance of 30% growth in FY10 while only Rs38bn of orders have been announced so far. However, the company is L1 in numerous projects while there are order inflow possibilities from oil majors, roads and power projects.

Couple of large orders can still swing the needle: L&T is pursuing large orders from ONGC (B-193), Oman airport order and its in-house Rajpura power project which can each add US$1bn to the order inflow.

Sensitivity to order inflow shortfall is limited: In case of order inflow growth of only 20% as against guidance of 30%, order backlog would fall short by only 9%. The impact on revenues and earnings over next two years would be limited to 2–6%, respectively.

Earnings and target price revision
No change.

Price catalyst
12-month price target: Rs1,841.00 based on a Sum of Parts methodology.
Catalyst: execution delivery and order booking in 4QFY10

Action and recommendation
No long-term impact from miss in order inflows in 4QFY10: In case L&T achieves Rs150bn order inflow instead of the required Rs200bn, our view is it would look like a big miss, but the sensitivity to earnings is not much. Also, over a 12–15 month view, we remain positive on the stock as execution has bottomed out in 3QFY10, infra capex remains strong and there was pick-up in private capex in 2HCY10.

To read the full report: LARSEN & TOUBRO