Sunday, March 21, 2010


Tough, tough question. Asian exports have been roaring back, almost touching their previous peak. But, with Western shoppers having seemingly hit the limits on their credit cards, where are all these goods now headed? Vital stuff: it drills to the core of the de-coupling debate. Our answer: yes, shipments to the US have rebounded, but the recent kick for Asia’s trade cycle is coming from regional demand. What’s new, for example, is that more and more goods shipped to China now stay there, rather than being passed on to consumers in advanced markets. Two points to make. First, there is some evidence of export decoupling. Second, if shipments to the West indeed bounce back, even if only temporarily, we’ll have undoubtedly an inflation problem.

Our first chart cuts right to the heart of the matter. Here, we show the volume of imports in the US, the Eurozone, and emerging Asia. European demand, evidently, is not driving Asia’s export cycle, currently. The United States, on the other hand, has seen a strong rebound in import volumes since the depth of the crisis. But, even here, the overall level of imports remains some 12% below its previous peak. Contrast this with Asia: imports in the region, excluding Japan, are now over 6% higher in volume terms than ever before.

At first glance, this points to Asian demand driving most of the regional trade recovery. But, here is the tricky thing: intra-Asian shipments reflect to a large extent supply chain trading, with goods being sent from, say, Seoul, through Taipei, to Shenzhen, before ultimately ending up in a US mall. Thus, as US imports pick up, intra-Asian trading kicks in as well, and even more so, because multiple Asian destinations are required before final sale in the West. Technically, the extensive supply chain implies that intra-Asian trade has a high beta with respect to G2 demand changes. Is this what’s driving the rebound in Asian imports?

To read the full report: ASIA'S EXPORT

>FERTILIZER SECTOR: Emerging from regulatory shackles... (HDFC)

Fertilizer sector stocks have recovered due to the allocation of KG D-6 gas, which has reduced cost and increased utilization levels of fertilizer plants. Many of these plants ran on expensive naphtha or FO / LSHS feedstock. Closed units are also likely to open due to this cost reduction. High population density per unit of arable land and low yields have been the bane of Indian agriculture and one of the most efficient ways to abate the condition is by proper nutrient management of the soil. The consumption of fertilizers in India is expected to grow by 4% CAGR till FY12. Urea is expected to witness a supply deficit of 5.4mmtpa by FY12.

■ Limited land, rising population to drive fertilizers growth
With one of the highest population densities per unit of arable land, farm productivity will have to improve dramatically if national food security is to be ensured. Better nutrient management thus becomes critical. Fertilizer demand is expected to grow at a CAGR of 4% till FY12. But a deficit of 5.4mmt in urea, the most widely consumed fertilizer, is expected by FY12. Phosphatic and potash fertilizers also remain matters of concern due to the lack of indigenous raw materials. While indigenous sources form 5- 10% of raw material requirement for phosphatic fertilizers, there are no known commercial sources of potassium salts in India, raw materials for potash fertilizers.

■ Availability of cheaper feedstock (natural gas) to bring down costs
The use of natural gas will bring down the feedstock cost by over 60% for urea plants running on naphtha or FO / LSHS. This will not only increase utilization of underutilized gas based plants, but help revive closed plants. The reduced cost will also ease the subsidy burden of the government already saddled with a high fiscal deficit.

■ A step towards deregulation and freeing of fertilizer prices
While Urea was under mandatory pricing control under the New Pricing Scheme, Stage-III, the government recommended an MRP for DAP, MOP, MAP, TSP, SSP, Ammonium Sulphate and 11 other complex fertilizers under the Concession Scheme. Recently, the government hiked the retail price of urea and introduced nutrient based subsidy with effect from Apr 1, 2010. Though there have been no further details on the magnitude of subsidies, we believe subsidy per unit of nutrient will be set in such a way that subsidy levels remain virtually unchanged. The new nutrient based subsidy mechanism will prove an important step towards complete deregulation of the sector.

■ Recommendations
We initiate coverage on four fertilizer companies – Deepak Fertilizers (HOLD), Chambal (BUY), Coromandel (HOLD) and Zuari (BUY). Our valuations are based on one year forward EV/EBITDA multiples of the stocks.

To read the full report: FERTILIZER SECTOR


A strong up-tick in the foreign tourist arrivals (up 21% YoY in Dec’09), which makes up for 65-70% of the demand for premium rooms, heralds the beginning of a revival in the hotel industry that was the worst hit by the economic crisis. This is corroborated by the robust uptrend in occupancies and room rates across properties. We estimate that the supply deficiency in the Indian market will further support the RevPAR in the coming years. Supply growth has also abated considerably over the past couple of years, tilting the demand-supply equation in favour of the incumbents. Profitability of market players like Indian Hotels (IH) and East India Hotels (EIH), which took a big hit over FY09-10, is likely to jump sharply in FY11-12. A pick up in the pace of recovery in the Indian and global economies will add further momentum to this turnaround. We initiate with BUY on IH and ADD on EIH.

Strong start to the season: Occupancies and ARRs have been improving sequentially, with room rates in many cities rising between 20-50% from June to December. Many properties have experienced a surge in occupancies, with occupancy rates surging as high as 85%-90% in some properties.

IH—Leader with a diversified profile: IH, with an inventory of 11,596 rooms, has presence in all value segments (premium, mid-market, and budget) in India. A wide footprint in international markets (~25% of revenues) further derisks its profile. Aggressive room expansion will widen IH’s lead over peers in the coming years. IH will benefit from a broad recovery in the Indian economy. Growth momentum will further be supported by: (a) the opening of The Pierre,
New York and heritage wing of Taj Mahal, Mumbai in FY10ii, (b) lower losses in its US portfolio, (c) recovery in the US/UK markets, and (d) strong pipeline of management contracts lined up over FY11-12. Strong revenue momentum will drive a sharp turnaround in EBITDA in FY11ii (up 430bps YoY). We initiate with a BUY and a TP of Rs138.

EIH—Beneficiary of demand buoyancy in metros: EIH manages 2,926 rooms and its presence is restricted to the super premium and premium segment in the domestic market and some management contracts in international markets. We expect EIH’s profitability to reverse in FY11 due to its large exposure (~85%) to metros that are experiencing a strong demand. The re-opening of its flagship property, Oberoi Mumbai (~12%), will be an added boost. We believe EIH will grow earnings at 83% CAGR over FY10-12ii. We initiate with an ADD with a TP of Rs156.

To read the full report: INDIAN HOTELS

>INDIA RETAIL: From Revolution to Evolution (CITI)

What's new? — Our conversations with a clutch of modern retailers reveal that the modern retail sector in India is maturing – the focus has shifted from aggressive revenue growth to a phase where revenue growth, profitability and cash flow objectives have to be balanced.

It's all about the balance sheet — Mending damaged balance sheets is the flavor du jour. Retailers are focused on a) closing unprofitable stores and re-calibrating existing stores, b) making supply chains more robust (to lower inventory costs) and c) debt restructuring (in some instances).

The large vs. the small: a divergence in trends — i) The big are getting bigger – Players like Pantaloon (PART.BO; Rs374.95; 1M) and Shoppers Stop (SHOP.BO; Rs351.25; Not Rated) are expanding, albeit at a slower pace than in the past. In contrast, smaller players like REI 6Ten (REIS.BO; Rs88.35; Not Rated) and Koutons (KRIL.BO; Rs343.20; Analyzed Not Rated) have scaled down operations. Access to capital remains an important differentiator. ii) Asset light strategies – both 6Ten and Koutons are adopting franchisee based models (at least partially), while both Pantaloon and Shoppers Stop have eschewed this model, preferring to maintain control of stores and customer engagement.

Cyclical upsides mitigate structural challenges — The improvement in consumer sentiment and the consequent uptick in discretionary consumption (apparel, footwear), should result in an improvement in profits, and more important, visibility of profits – essential given the capex intensive nature of the industry. Structural challenges such as a) high inventory costs, b) in-store capex costs and c) multiple taxes (service tax, octroi, etc.) will continue to affect returns on capital employed. From a regional perspective, modern retail in India continues to be challenged compared to business models in China/Korea.

Pantaloon is best positioned to capitalize on cyclical upsides — PRIL's business model viability is a big positive, and we note that the company's ability to raise equity funds should incrementally improve, given the viability of its business model.

SOTP-based target price of Rs456 (raised from Rs370) ----- We value parent PRIL at Rs395 (at 25x June11E EPS, increasing premium to regional peers to 30% from 20%, given a) better visibility, b) PRIL's continued dominance of the sector and c) scarcity premium. Our EPS estimates have been pared 11-12% primarily on account of dilution and some modest (<5%)>

To read the full report: INDIA RETAIL


To see the table: GOLD HOLDINGS