Monday, March 22, 2010

>Risk-Trade Trade-Off (CITI)

Indian is a risk trade, but there is a trade-off — Where is India’s place in the ‘Risk Trade’?: Our analysis—using Crude oil as a primary benchmark for risk assets — suggests there are trade-offs, and the following inferences.

India’s correlation with ‘Risk assets’ is positive and rising … — India is clearly part of the risk trade: and this correlation has progressively risen from 9% over 15 years to 30% over the last year, and 46% over the last quarter. Over standard time periods, there are only positive correlations; over shorter periods, particularly when crude has risen hard/sharply, there are periods of negative correlation.

… But lower than other emerging market equity classes — India’s correlations with ‘risk assets’ (36%) are however lower than those of other emerging markets: MSCI EM (57%), MSCI BRIC (59%), and in line with China (34%). The risk trade thus works for India – but better for other EM benchmarks on the way up (India a defensive amongst EM equities, if the risk trade unwinds). There is fundamental backing to this market behavior: India’s FX, the Fisc and inflation are all meaningfully exposed to rising crude.

And correlations turn negative with rapid increases in ‘risk’, and at highs — India’s correlations with ‘risk/crude’ have turned negative in the past with: a) Sharp increases in crude—repeatedly (3/4 times), accompanied by underperformance vs. emerging markets, b) 'High' levels of Crude; Crude above $90 has hurt the market most, in absolute and relative terms. Bottom line: Better emerging equity markets to be in than India when the Risk trade rises sharply, or gets too 'high'.

India’s positive correlation with Crude higher than with other commodities — Interestingly, India’s positive correlation with crude is higher than with a broader commodity basket: CRB index (with a 41% weighting of soft commodities), but the CRB Index is possibly not the best reflection of the risk trade (up 41% in the last 12 months, vs. ~80% for crude), and is thus probably statistically not relevant.

India is part of the risk trade, not ‘the’ risk trade — Play India for India and some risk, not for risk alone (or too much risk). We detail correlations and performance trends across a range of Equity/commodity classes, and time periods, in this note.

To read the full report: INDIA STRATEGY

>INDIA SUGAR: Supplies increasing, as predicted… (PRABHUDAS LILLADHER)

Significant fall in both domestic and international sugar prices: International sugar prices, in terms of raw sugar, fell by 33.1% from the level of 29.9cents/pb and 27.8% in terms of white sugar from the level of US$750/tonne since January 2010. Even domestic prices fell by 17.8% from the level of Rs39.5/kg since January 2010 due to anticipated increase in sugar production (both at domestic as well as international level) in SS2011. Early start of crushing in Brazil and raising the expectation of higher domestic production during the current season from 14.6m tonnes to 16.8m tonnes, consequently led to a decrease in sugar prices.

Higher cane price is an incentive for farmers to plant more cane: Farmers received cane prices in the range of Rs185-250/quintal during the crushing period. This was much higher than the Fare and Remunerative price (FRP) which was fixed at Rs129.8 for the current sugar season at 9.5% recovery. This has given enough incentive to them to plant more cane. Estimates for next year’s sugar production are in the range of 21-23m tonnes, which is 25-36% higher than current year’s sugar production.

Profitability of domestic mill owners impacted: Operating profit per kg for the current sugar season has come down to similar levels as last year at Rs6.3/kg. We expect profitability of mill owners from the sugar segment to get affected next year also even though there would be an increase in the volume of sugar sold.

Further change in sugar prices to depend on monsoon and profit parity with ethanol: In the medium term, we expect raw sugar prices to remain in the range of 19-21cents/pb due to profit parity with ethanol. As per the industry sources, with raw sugar prices above 19cents/pb or crude oil price below US$83/bbl, sugar would be more profitable as compared to ethanol in Brazil. However, with expectation of increase in cane production, in both Brazil as well as India, we expect ethanol as well sugar prices to decrease. Going ahead, monsoon would be the key factor to determine overall domestic sugar production and hence, sugar prices for SS2011.

We re-iterate our ‘Reduce’ rating on the Sugar sector (see ‘India Sugar- Not So sweet’ published on February 16, 2010).

To read the full report: INDIA SUGAR

>Time to revisit sectors and stocks (BNP PARIBAS)

Shift in source of growth from stimulus-driven consumption to industrial production.
We expect acceleration in credit growth and IP; yield curve to flatten as rates tighten.
Feedback from conference: buoyant consumer demand and government policies will likely help capital flows and infrastructure build-out.
Overweight: banks, autos, infrastructure, IT, utilities and pharmaceuticals.

Some things have changed, some haven’t
Since our previous rebalancing of the model portfolio (“Changes in our model portfolio”, dated 14 Jan 2010), bank credit growth, which was hovering at 11-12% around late December, has accelerated to c15%. Industrial growth, rather than consumption growth, is clearly driving economic growth, as we anticipated. Some other data points are new. 1) The recent budget signals fiscal consolidation, albeit by relying on one-off non-tax revenue than on reducing expenditure or by increasing the tax-to-GDP ratio. 2) The budget also provides additional impetus to consumer discretionary with the tax-slab adjustments, leading to an increase in personal disposable income. 3) From our recently concluded Investors’
Conference at Delhi, the key message was that the policy framework in all departments (finance, urban development, roads, external affairs, telecom) would focus on facilitating: a) foreign capital inflow, b) acceleration in infrastructure build-out and flow of private capital to infrastructure, and c) access to free trade.

Slight changes to earnings estimates; retain Sensex target at 21,000
Recent earnings revisions from India BNPP analysts have led to earnings growth forecasts declining in energy (particularly Reliance Industries) and increasing in autos (Tata Motors), real estate (DLF) and IT (Wipro). We forecast 31% Sensex EPS growth for FY11 and 15% for FY12. After the recent earnings revisions, BNPP’s estimates for Sensex EPS are INR840 for FY10, INR1,096 for FY11 and INR1,264 for FY12. On these estimates, the Sensex wouldtrade at 15.6x 1-year forward PE – only 3% higher than the long-term average of 15.1x. On P/BV, Sensex would trade at 15.6x versus the 10-year average of 15.1x.

Overweight: banks, auto, infrastructure, IT, utilities, pharma; Neutral: property
Our sector allocation remains largely intact. We continue to prefer the interest-rate sensitivities. We include property (through IBREL), where we had zero weight earlier. Within banks, we exclude Union Bank, include HDFC Bank, reduce weight on PNB and increase weight on ICICI. Clearly, we move away from PSU banks to private banks. Within utilities, we allocate more weight to merchant-power plays through the inclusion of Adani Power. Within IT, we now focus entirely on IT services; we exclude Tech Mahindra and allocate the weight to Infosys. We also increase weight on Reliance Industries, as we believe the period of severe underperformance for the stock has come to an end.

Top picks: Axis Bank, Dr Reddy’s, M&M, IRB and TCS
Our top picks tie-in with the themes that we highlight. Credit-growth acceleration, infrastructure build-out (particularly roads, urban infrastructure and power), increased boost to consumption leading to further acceleration in discretionaries, and healthy cash flows from companies in developed economies leading to higher IT spending are the key investment themes to consider. We try to find reasonably valued exposures for these themes.

To read the full report: MARKET OUTLOOK


Valuations stretched despite factoring in better environment; downgrade to REDUCE. We find the ICICI Bank’s stock expensive at 1.9XPBR FY2011E despite factoring in an uptrend in its core business (expansion in spreads and decline in delinquencies). We believe that ICICI Bank’s stated target of 15% RoEs may still be couple of years away. Post the recent up-move of 15% over the last month (7% outperformance), we do not find any upside at current levels; downgrade the stock to REDUCE with a target price of Rs910.

We find valuations expensive in light of subdued RoEs in the medium term
We believe that the current valuations are running ahead, despite assuming much better business performance over next two years. Improvement in margins and reduction in delinquencies will push ICICI Bank’s RoEs to 14.8% in FY2012E from 10.2% in FY2010E, in our view. Any further improvement in RoEs is likely to be a function of a higher-than-expected growth, which we believe will be challenging in light of the highly competitive lending environment.

International business continues to remain a drag on overall profitability
International loans account for about 26% of the total loans of the parent book and ICICI Bank
earns about 50 bps spread on the international business. We do not believe that this is likely to be a high RoE business and even as the proportion of international business reduces, drag on
profitability and returns is likely to continue for ICICI Bank for some time. Thus, even as the
domestic loan growth is likely to be about 20%, a subdued international book is likely to result in
a lower overall growth for ICICI Bank. Its international banking subsidiaries had delivered an RoE of 13% (UK) and 3% (Canada) in FY2009, and we do not expect significant improvement out there.

Growth will pick up; but will still remain sub-industry level
ICICI Bank has done commendable work on costs and is currently working on the lowest
cost/assets amongst its peer groups. However in the process, it has vacated/reduced exposures on markets like personal loans, credit cards, 2-wheelers, etc. This coupled with continued rundown of the international business will make above-industry growth very difficult for ICICI Bank. We believe that the lending markets are fairly competitive and to grow faster than the market, the bank might have to compromise on its pricing, which again is not a great strategy in our view. Thus we do not expect a very fast growth for ICICI Bank—16% CAGR growth for FY2010-FY2012E.

To read the full report: ICICI BANK


• Koutons Retail is the largest discount retailer of readymade apparels for men, women and children's in India with its own manufacturing facilities in North India. The company has a pan India presence through its network of over 1,400 Exclusive Brand Outlets (EBO's) in five different formats. With the management efforts to reduce inventory levels and with entry into higher margin children and female apparel retailing segments we expect higher traction in its revenues and profits going forward.

• The company has taken several measures to address the concern of high inventory on books, which included the inventories at manufacturing facilities, existing stores and buffer stock for new stores. The measures include key initiatives like outsourcing of production work, reducing SKU's (Stock Keeping Units) at stores and sharing idle capacities with other manufacturers. These initiatives are not only expected to bring down the inventory level on books but also to enhance profitability.

• 60% requirements coming from in-house manufacturing and absence of intermediaries has enabled the company to witness consistent expansion in margins and to report highest gross and EBITDA margin amongst its peers. Though the increase in outsourcing is expected to put pressure on margins, the entry into high margin children and women apparel retailing segments are expected to substantially compensate for this marginal decline.

• The company primarily operates its retail stores through the franchisee network and considering the macroeconomic condition has cautiously planned to expand the total number of stores to 1,670 by the end of FY12E. The company has also planned to convert some of its existing Koutons stores at premium locations to Koutons Family Stores (KFS), having an average store size of 3,000 sq ft., by acquiring more space within the same premise. This will help in increasing the per square feet revenue and in providing more variety to consumers within the same store.

• The company products include a mix of both formal and casual wear targeting the middle and upper middle class of the society. The company has been able to build 'KOUTONS' as a strong brand among the consumer class supported by its discount retailing model and product offerings for all (men, women and children) in the targeted consumer category that ensures consistent footfalls during trying times as well. Recently, it has also forayed into the footwear and accessories retailing, which is expected to auger well for the future growth of the company.

• The company operates ~95% of its stores on the franchisee model under the FOFO (Franchisee Owned Franchisee Operated) or COFO (Company Owned Franchisee Operated) model, which substantially reduces the capex requirements for store opening from the company side. In return the company assures its franchisee the minimum guarantee to cover for its store running costs, including rentals.

To read the full report: KOUTONS RETAIL