Tuesday, March 30, 2010

>China Collapse: Are the Bears Out to Lunch?

China has weathered the global financial crisis extremely well. Exports rose 45.7% in February
from a year ago and GDP growth near 10% through 2010 is likely (Charts 1 & 2). In contrast to most developed nations, the Chinese financial system has shown few signs of strain during the downturn. Non‐performing loans (NPLs) are at record low levels and capital ratios at publicly listed banks have been beefed up with rights offerings of around 250 billion yuan over the last few months. Despite these signs of strength, there is a rising chorus of sceptics who argue that the recovery is hollow and that the miraculous growth rates China has achieved over the last 15 years will soon be over.

Of course, these arguments have been made many times during China’s transformation. At its
most basic level, the bear argument is derived from the fact that China has had what is probably the biggest, longest economic boom in history. The logic applied is that the bigger the boom, the bigger the bust. Here are the key arguments supporting the bear case:

Imbalances between China and its debtors have grown relentlessly, which will eventually crack the undervalued rmb and force a limit to U.S. indebtedness.

Excessive dependence on exports combined with a failure to adequately develop domestic consumption leaves China vulnerable to external shocks.

Overinvestment has led to significant overcapacity; corporate profits are threatened and the banking sector is vulnerable to a sharp increase in non‐performing loans, particularly after the credit boom and government stimulus in 2009.

Excess liquidity and volatile capital inflows are leading to frothy asset markets particularly in stocks and real estate.

Inflation is on the rise and the risk of monetary tightening is growing.

Finally, shady accounting and political interference undermines confidence in official statistics and is probably hiding some nasty surprises.

The bear story has a lot of adherents and it is based on assumptions that all the above points
have some validity. A reckoning may well come to pass at some future point but it won’t be soon. Over the time horizon of most investors, it has a low enough probability of occurrence that people should not pay much attention to it. Here’s why.

China’s U.S. $2.2 trillion build‐up of reserves and the flipside—American overindulgence and
excessive debt accumulation—are both clearly unsustainable, yet there are few signs of strain between China and its debtors besides political noise. Despite the financial crisis and the dramatic slowdown in trade between the U.S. and China, the currency peg is intact and the dollar continues to defy its sceptics. China’s stimulus has been successful in bridging the export slowdown with little damage to public.

To read the full report: CHINA COLLAPSE

>SYSTEMATIC INVESTMENT PLAN: A disciplined investment approach

A systematic investment plan (SIP) is a disciplined way of investing your funds. It works on the principle of regular investing. SIPs allow you to invest a prefixed amount for a prefixed interval in a mutual fund scheme of your choice. On the defined date, the amount indicated by you will be
automatically debited from your bank account and invested in the scheme selected by you. Hence, after you have set an SIP you are not required to track the investment dates

Benefit of SIP
• Avoid timing the market: By investing a small amount regularly into the schemes you can avoid the common error of investing larger sums in bull markets (when the markets are at a high) and smaller sums in bear markets (when the markets are at a low)

• Rupee cost averaging: An SIP allows you to invest a pre-specified amount in a scheme at periodic intervals (e.g. one month, three months, etc). Therefore, whenever the market moves down and the net asset value (NAV) of the scheme is lower, you end up buying more units of the scheme. If the market moves up, the NAV of the scheme rises and you will get less units of the
scheme. Hence, the average cost of purchase works out lesser

• Not just savings but investing too: Usually we tend to save some amount but fail to invest the same. An SIP not only imparts savings it invests your capital and frees you from answering the
question of where to invest each time you save

Why SIP in equity funds?
Investments into equities over a longer period have always delivered higher returns. By doing an SIP in an equity fund, you have an opportunity to increase the growth rate of the accumulated capital. A 10-year SIP in an equity fund after accounting for the fluctuations in the market can earn capital appreciation far better than any other investment option available
for retail investors.

To read the full report: SIP

>Contract Research and Manufacturing Services (CRAMS) companies

The Indian Contract Research and Manufacturing Services (CRAMS) companies are on the threshold of a significant opportunity given the expected increase in pace of outsourcing
from India.

Inventory de-stocking coming to an end: We expect the adverse impact of global inventory de-stocking (undertaken by customers) to correct gradually from FY11 onwards as the underlying demand for pharmaceutical products has remained intact despite the global slowdown. Most of the Indian CRAMS players have recently indicated that there will be increased trend towards outsourcing in FY11.

Macro environment favourable for increased outsourcing: We expect a significant traction in the global outsourcing business given the low R&D productivity and intense pressure on the global innovators to generate growth. A large portion of this outsourcing business is likely to be sourced from Asia (mainly India and China).

Entry barriers are high: Given the significant entry barriers in this business, we expect existing players to get a disproportionate share of the business.

India is on the threshold of a big opportunity: India's market share in the global contract manufacturing business is likely to more than double to 7% in 2007-2012 while supply revenues will grow from US$800m to US$3b, giving rise to a significant opportunity for well-established CRAMS players.

Demonstrated skills for CRAMS: We believe that some of the Indian companies have demonstrated strong chemistry and regulatory skills coupled with IPR compliance and low manufacturing costs — the prerequisites for building a successful CRAMS business.

Recommendations: We reiterate our Buy rating on Divi's Labs (17% upside), Piramal Healthcare (19% upside). Consolidation of customer base and delayed paybacks from acquired companies, which were funded through leverage, are the key risks to our positive stance.

To read the full report: CRAMS


OW(V): Diversification through MSK Projects acquisition

■ Welspun’s offer of cINR8bn to acquire MSK Projects implies FY11e EV/EBITDA of 6.2x, which we find reasonable; deal will be EPS accretive, we believe

■ Possible synergies – diversification into infrastructure sector for Welspun while Welspun’s balance sheet will provide support for MSK to bid for large-size projects

■ Maintain OW (V) with target price of INR335; new order flow will be likely trigger

MSK Projects acquisition at a reasonable valuation. Welspun Gujarat, India’s leading pipe manufacturing company has announced the acquisition of MSK Projects (MSKP IN, not rated) – a construction company – for a consideration of INR8bn (75% stake). This implies FY11e EV/EBITDA of 6.2x, an 18% discount to peers, which we believe is reasonable given the lower RoE generated by MSK (14% for FY11e) compared with peers (17%). Note that the acquisition is subject to all necessary approvals.

Deal is EPS accretive. We believe that the deal could be funded through the internal accruals of Welspun Gujarat. Thus, MSK could increase FY11e Welspun’s EPS by 7%.

Possible synergies. We believe synergies from this acquisition may include (1) diversification into the infrastructure sector, enhancing Welspun’s ability to provide its customers with end-to-end solutions to plate-pipe-pipeline laying; and (2) MSK Projects through Welpsun’s balance sheet support likely to bid for large infrastructure projects specifically into the road sector. MSK’s current order book of INR5bn constitutes 40% road projects.

New pipe orders of INR10bn likely to be announced. Bloomberg reports that Welpsun is likely to receive pipe orders of INR10bn. This will increase order book by 14% to INR82bn (revenue visibility of five to six quarters).

Maintain Overweight (V) with target price of INR335. We are positive on the stock, as the company has a strong order book – the largest among peers – and a sound customer base with committed capex plans; and given the rise in crude prices, which has improved the new order book outlook. Based our target PE of 13.5x and September 2011e earnings, we arrive at target price of INR335.

To read the full report: WELSPUN GUJARAT