Wednesday, March 17, 2010


In the annals of the global pharma industry, 2009 marks a watershed event – when the baton of growth got passed on to the emerging markets (EMs). With US and top five EU markets contributing only ~15% to industry growth, the traditional Big Pharma business model, based on developed markets and patented products, is in a tizzy. Big pharma are aggressively realigning their strategies and resources around EMs and India, a US$30bn pharma market by 2020E, is now a priority destination. The development has profound positive implications for the growth outlook of their India business units as well as for generics partnering with MNCs to implement their new EM strategies (e.g. Aurobindo Pharma and Strides Arcolab). There is growing evidence of MNCs realigning India strategies through multiple strategic/ tactical interventions, and they have also begun to deliver accelerated growth. This “MNC comeback” will hasten consolidation in the Indian pharma market while leading to a likely re-rating of MNC stocks.

Emerging markets – Big Pharma’s new growth frontier: EMs will likely drive 70% of the global pharma growth in FY13 with top seven EMs growing to $400bn by 2020E. This has prompted a Big Pharma exodus to EMs. MNCs have begun to walk the talk on EM strategies – as reflected in dramatic field-force alignments away from developed markets and hectic deal-making activity in EMs. In the new order, India – one of the largest and fastest growing EMs – is now a priority destination for most MNCs.

MNC Pharma in India – dawn of a new era: There are firm signs of India-focused strategy being executed across MNCs – as reflected in a sharp ramp-up in field forces and marked step-up in new product launches. MNCs are now adapting their India strategies to market realities –“branded generics” (off-patent products of competitors) launches are now core to India strategy and differentiated pricing strategies are accepted even for newer molecules. Implementation of the patent regime will further strengthen MNCs’ competitiveness.

Revenue uptick to drive a likely re-rating: Top eight MNC pharma grew 16.7% in 2009 as compared to 9% CAGR over CY05-08. The new initiatives have begun to deliver, and we see MNC pharma embarking on a higher growth trajectory. As already seen for MNC consumer stocks (GSK Consumer Health and Nestle), higher growth visibility may drive a re-rating of MNC pharma stocks.

■ R&D productivity declines, sharp patent cliffs and healthcare cost control focus have choked off pharma growth in developed markets

■ On the other hand, pharma industry is poised for decades of bountiful growth in emerging markets – aided by booming economies

■ Big Pharma are rushing to tap this opportunity by suitably aligning strategies and investments towards emerging markets

■ Driven by solid parent backing, MNCs in India are shedding old dogmas and realigning strategies to market requirements to derive competitiveness

■ Given this, we expect MNCs to stem, and thereafter reverse, the hitherto steady trend of market share erosion in the domestic pharma space

To read the full report: MNC PHARMA

>ASIA STRATEGY: Buy chaos, sell order (CLSA)

As an investment destination, India often suffers in comparison to China, but India’s problems come from tackling its most difficult problems first. We now perceive a tipping point where structural impediments have been sufficiently dismantled to permit a new form of economic growth. Many investors ignore the order evolving out of India’s apparent chaos, while also failing to accept that China’s state-imposed order will one day decompose. This dynamic means that returns from Indian equities are likely to far surpass Chinese equities over the medium and long term.

Structural mispricing of money is ending in India, but not China
India often compares unfavourably to China, but India’s problems come from tackling the most difficult problems first; China has postponed these problems.

China is not working to privatise its financial system or create a more porous capital account.

China is not focused on domestic consumption-driven growth, nor is it moving to a more representative, less corrupt political system.

China’s economic foundations are based on government-determined prices, whereas India has moved materially towards market rates.

The post-mercantilist world will begin in India
India is far advanced on China in developing a private-sector financial system.

India is nearer to a market rate for exchange rates and interest rates than China.

India is less reliant on exports and can move more easily to a consumption-driven economy than China can.

India’s private-sector banking system can more easily provide consumer credit, whereas Chinese credit is still needed to support state businesses, not consumers.

If China does not abandon mercantilism, it will depress inflation and help India to grow.

India’s democracy is starting to look like the USA’s circa 1900
Foreign investors regularly fled from the chaotic democracy of the late-19th Century United States.

The order of the British Empire was an investment illusion.

When India’s democracy works, Indians can be as successful at home as abroad.

To read the full report: ASIA STRATEGY

>LANCO INFRATECH: Amarkantak: Unit 2 Synchronized, Unit 1 operating at 80% PLF; Buy (GOLDMAN SACHS)

What's changed
Lanco Infratech indicated that they synchronized Unit 2 of Amarkantak power plant and expect it’s commissioning during the next quarter. Also, our analysis of data from western load dispatch centre YTD indicates that Unit 1 is operating at 75-80%. Plant Load Factor (PLF) with an average realization of Rs3/kwh in the Unscheduled Interchange (UI) market, and the company expects it to be fully commissioned over next month. Pending resolution of the court case on sale of output of Unit 1, we assume Lanco will sell the output through the regulated mechanism.

The synchronization of Unit 2 and consistent PLF for Unit 1 gives us more visibility on commissioning of Amarkantak power project. Further, our calculations indicate the cash inflows of Unit 1 (since synchronization in May 09) have so far resulted in 21% reduction in capital cost.

We expect the stock’s underperformance versus BSE Power index (14% YTD) to narrow in the medium term primarily due to 1) 2x increase in capacity (2300MW from 750MW) by FY11E on commissioning of i) 600MW of Amarkantak; ii) 133 MW of Kondapalli Phase II; and iii) 1,015MW Udupi plant, and consequently Lanco’s earnings profile to improve in FY11E with the power division constituting 72% of FY11E EBITDA; and 2) rising power deficits leading to strength in the merchant rates. We expect the rates in bilateral market to range between Rs5-7/kwh over the next 6 months.

We raise our 12-m SOTP-based TP to Rs61 (from Rs59.8) to price in Kondapalli Phase III (742MW). We estimate Lanco will deliver 66% EPS CAGR over FY10EFY12E and is trading at a discount to its peers on FY11E P/E and P/B. We have cut our FY10E/11E/12E EPS ests by 2%/7%/4% primarily due to increase in minimum alternate taxes to 18% from 15%.

Key risks
1) Funding constraints necessitating capital raising; 2) Execution delays.

To read the full report: LANCO INFRATECH

>Power Grid Corporation of India (CITI)

Upgrade to Hold (2L) — We move from Sell (3L) as we believe PGCIL should trade in line with NTPC given: (1) the scarcity value (the only listed play on Indian power transmission) vis-à-vis plenty of generators to chose from; (2) the differential between PGCIL’s and NTPC’s RoEs has narrowed; (3) defensive appeal of the business; and (4) stock has underperformed the BSE Sensex by 90% over the past year. This is despite NTPC's ability to make superior ~22% regulated RoE on its core business compared to PGCIL's ~17% and its stronger balance sheet.

Target price increased to Rs116 — We increase PGCIL’s target P/BV multiple to 2.7x FY11E (2.3x earlier), bringing it in line with that of NTPC’s implied target P/BV multiple (from 10% discount earlier). This, along with the roll forward to Mar11 (from Mar10 earlier) and EPS revision, increases our target price to Rs116.

Leverage and shorter execution cycles maximize company RoEs — Under the regulated regime, utilities should ideally leverage to the maximum (interest costs are a pass through) and have high dividend payouts to maximize company RoEs. A shorter execution period reduces the quantum of unproductive CWIP vis-à-vis productive commissioned assets. Intrinsically, transmission line projects can be executed ~50% faster than a generation project which leads to PGCIL’s CWIP being a percentage of net fixed assets than NTPC’s.

Likely achievement of 93% of XIth Plan capex targets — In the first two years of the XIth Plan, PGCIL’s capex of Rs148bn was 27% of the XIth Plan target of Rs545bn. We expect the company’s capex to be Rs360bn in the remaining three years of the plan and to achieve 93% of XIth Plan capex targets.

Our top picks —In order of preference, we continue to recommend Tata Power (TTPW.BO; Rs1,348.35; 1L), NTPC (NTPC.BO; Rs201.30; 1L), Lanco Infratech (LAIN.BO; Rs51.75; 1M) and CESC (CESC.BO; Rs398.00; 1M).

To read the full report: POWER GRID

>BHARTI AIRTEL: Proposed Zain acquisition: Banking on execution (EDELWEISS)

Bharti Airtel (BHARTI) is in exclusive talks with Zain till March 25, 2010, for purchase of Zain’s African assets for an EV of USD 10.7 bn.

Zain Africa: Growth opportunity, though some uncertainties
Zain has presence in 15 African countries with an overall subscriber base of ~41.9 mn in September 2009. Stake in Zain will provide BHARTI entry into the highgrowth African market with 8 of 15 countries of operation at sub-35% teledensity, ~50% higher average ARPU than BHARTI’s India ARPU, and lower competitive intensity. While we believe there are long-term strategic benefits for BHARTI-Zain, integration challenges and regulatory risks are a concern.

Emulation of domestic ‘minutes factory’ model to drive growth, efficiencies
We believe there is considerable scope for value addition by BHARTI in Zain. Zain’s lower profitability vis-à-vis BHARTI, despite 50% higher ARPUs, indicates scope for opex rationalisation. Management highlighted that current tariff levels in Africa are ~10x BHARTI’s India tariffs, while MoU is less than 1/4th of BHARTI’s India MoU. The strategy is, therefore, to emulate the domestic ‘minutes factory’ model by lowering tariffs to spur usage and improve market share and profitability.

Premium valuations but long-term strategic benefits
Based on the deal size of USD 10.7 bn (implied EV/sub of ~USD 255 and EV/EBITDA of 8.9x), BHARTI’s offer for Zain was at ~20% premium to the former’s valuations at the time of deal announcement. If funded through debt, BHARTI would need to raise ~USD 8.3 bn which could hit FY11 earnings by ~20%. We believe the recent ~10% erosion in BHARTI’s market cap likely reflects concerns on the valuation premium for Zain and the near-term dent on earnings. We see material synergies arising via opex/capex efficiencies post integration of Zain.

Outlook and valuations: Execution is key; reiterate ‘BUY’
With competitive pressures mounting in the core domestic business, we believe the proposed Zain acquisition is a strategic positive for BHARTI given: (1) scope for higher growth opportunity; (2) material synergies for BHARTI-Zain combine; (3) high FCF generation in domestic operations to aid expansion; and (4) strong management execution capabilities (commendable execution in the Indian market driven by scale and innovations such as outsourcing of network and IT requirements). We do not rule out near-term overhang on the stock owing to integration uncertainties besides a tough domestic industry environment and imminent 3G auction. We maintain ‘BUY’ on the stock and rate it ‘Sector Outperformer’ on relative return basis. Our earnings estimates remain unchanged as the deal is yet not closed.

To read the full report: BHARTI AIRTEL