Tuesday, April 27, 2010

>Greece,Spain,Italy Portugal Banks facing heat (DANSKE MARKETS)

• The decoupling between banks and corporates continues on the back of escalating market fears regarding Greece.

Market comment
In the last few days the Greek situation has spiralled out of control, with Greek treasury spreads reaching new highs relative to Bunds. The latest widening came after it was revealed that there was yet another negative revision of the 2009 deficit number (to 13.6%, with Eurostat warning that it may be even higher). It is hard to guess on the outcome of the ongoing problems, but in the short term Greece should have access to financing through the combined EU/IMF loan package that was agreed upon last week.

The spill-over to Spain, Italy and Portugal was significant and Portuguese banks in particular felt the heat, with senior bank spreads widening by some 50-100bp in the long end. As ever when the focus turns to sovereign debt problems, non-financials have outperformed financials in the credit market. The difference between the two indices is now at its widest level ever.

Currently, iTraxx Europe trades at 86bp while Crossover is at 420bp. Cash spreads have held up reasonably well compared to CDS, although the Tier 1 market has given up a little after performing strongly for a long time. In our view, any substantial widening in both non-financials and subordinated financials, in names not directly exposed to Southern Europe, is a buying opportunity. Naturally, the primary market has been quiet during the week due to the weakness in the market.

To read the full report: CREDIT UPDATE

>What’s next for global banks (McKinsey)

In 2008, as the credit crisis broke, banks underwent near-death experiences on a massive scale. Last year, many enjoyed a recovery that was nearly as abrupt. In the intense uncertainty that ensued, bankers around the world have rightly shifted their focus away from growth and toward survival as they confront ambiguity about markets, risk, regulation, and demand.

Amid such extreme mood swings, long-term structural changes now under way will fundamentally affect banking in the years to come. To understand these changes, we undertook research that combined a historical view of the industry with an analysis of 25 global banks to see how various portfolios of banking businesses and geographic distributions would fare under different macro and regulatory scenarios. Among our findings:

• Under a scenario of lower global economic growth and tough regulatory restrictions, all but emerging-market banking giants will probably destroy value over the next four years.
Funding costs will remain high, further hurting profitability.

• Without any management moves, banks of every type will need more capital—as much as $600 billion over the next five years for the 25 banks we modeled. That suggests a real danger of a capital crunch, further forced asset sales, and the need for additional government help.

• The range of performance by banks using similar business models will widen. Big European banking groups, for example, will see returns on equity (ROE) ranging from 9 to 18 percent.

To arrive at a perspective on these fundamental changes, we turned to scenarios that the McKinsey Global Institute (MGI) developed to help model uncertainty about economic recovery and growth. We adapted these scenarios to include the particular forces that most influence banking returns: inflation and the shape of the yield curve, as well as uncertainties about state intervention, including new capital requirements, consumer protection measures, new rules on risk management, pay caps, and the extension of regulation to the “shadow” banking system.

Two views emerged. The midpoint case foresees prolonged recession followed by subtrend growth, returning within two years to pre-crisis rates. Markets in nearly all asset classes would recover as regulators sought to stabilize the financial system, improve riskmanagement practices, and increase transparency. Moderate regulation of systemically important banks would include pay caps, new rules on exotic products, and tighter capital requirements.

The extreme case envisions a moderate recession followed by structurally slower global growth. Markets would remain severely dysfunctional, and regulators would see banks as utilities, not independent agents, and accordingly attempt to limit their returns and to suppress volatility. Strict regulation would be applied not only to systemically important banks but to smaller entities as well. In this scenario, banks would face much tighter capital requirements.

When we proposed these two scenarios to about two dozen banking leaders and chief strategy officers, the result surprised us. While the current economic evidence seems to indicate that the midpoint case is more probable, our panel concluded that the extreme one was just as likely.

With both scenarios thus in play, we conducted a “momentum” analysis of 25 global banks, together representing about 40 to 45 percent of global industry assets and all major Western and emerging markets, including Brazil, China, Eastern Europe, India, and Russia. We aggregated these institutions into five archetypes: three kinds of universal banks (European, Japanese, and North American), emerging-market giants, and global investment banks. Then we extrapolated current performance into the future, producing a “run rate” forecast—that is, an estimate of how various portfolios of banking businesses and geographic distributions might fare in either scenario if the banks don’t respond to the forces we see shaping the industry in the next few years (see the interactive exhibit on mckinseyquarterly.com). This estimate establishes the baseline.

Our findings suggest that they will be subject to five substantive forces that will
considerably change their fortunes. One key finding is that the capital shortage triggered
by the crisis and recently addressed through several rounds of massive capital raising
will endure and get worse. Our scenarios model both the demand for capital (the amount
needed to finance projected asset growth and meet regulatory requirements) and the
supply (earnings, less the amount likely to be paid out as dividends). In every case, demand
exceeds supply. Capital needs will range from small (investment banks, which have already
raised significant amounts and are holding substantial buffers, anticipating regulatory
change) to vast (emerging-market giants, which will need to finance their growth). Inbetween
are the universal banks, which will have modestly challenging capital needs in the
midpoint scenario and a very challenging problem in the extreme one.

A second factor weighing on returns will be the high and rising cost of long-term funding. Several factors are at work here, beginning with a shift in demand. As part of balance sheet restructuring, many banks are cutting back on short-term, unsecured funding (such as commercial paper) and seeking instead to issue longer-dated debt. Demand will also rise as the longer-dated funding currently on banks’ books expires and is renewed. On the supply side, government asset-purchase programs—quantitative easing—are already being retired. Finally, the market will see greater competition for funds, not least from governments that must finance their deficits. All this implies that prices for long-term funding will inexorably rise, shaving as much as several percentage points off ROE, depending on the scenario.

Given these drags on performance, returns will be weak by the standards of the past decade. Worse, they will be highly uncertain—our third finding. In the midpoint case, industry revenues would grow by 5 percent annually through 2014; in the extreme case, the industry would eke out much less attractive annual growth of 1 percent. Under either scenario, the emerging-markets giants come out on top. The story for the other groups of banks is mixed. In the midpoint case, the European and US universals and the investment banks would generate middling ROEs well below their pre-crisis levels. The Japanese universals’ returns would suffer from a poor macroeconomic environment. In the extreme scenario, all but the emerging-market giants will find it extraordinarily difficult to return even their cost of equity. In other words, these banks will face a challenging period reminiscent of the early 1980s.

Our estimates may be cautious. We did not include, for example, the effects of a liability levy such as the one the Obama administration recently proposed. Instead we modeled this proposal separately and found that if such a tax were adopted globally and imposed on the banks in our model, the effect would be to reduce their ROEs by 0.7 to 1.2 percentage points.

A fourth finding confirms the economic evidence of the past several months: the crisis affected emerging markets, especially Asia, less severely than Western ones. Parts of Asia were the last areas to enter into recession and the first to emerge from it—indeed, China’s economy never stopped growing. Asian banks had less trouble with toxic assets and excess leverage than their counterparts elsewhere did. The crisis served to demonstrate that the balance of power shifts abruptly and powerfully rather than gradually; many Asian banks have vaulted to the top of league tables in one go.

Our research confirms that for the next several years, Asia’s economic might will continue to grow, as will the influence and power of its banks. Indeed, in these markets, banking is likely to grow much faster even than the broader economy, because so much of the population is “unbanked.”1 In both scenarios, all the emerging markets will grow substantially faster than the more mature markets of Europe and North America. Our last finding stands apart from the rest—and offers a ray of light to many banks. The archetypes constitute a form of destiny: emerging-market giants, riding the back of faster GDP growth, will outperform developed-market universals. In many ways, banking is a leveraged bet on the underlying economy. Yet despite that destiny, banks can do a lot about their performance. The model suggests that within archetypes, differences in performance will be even greater in the future than they are today. The crisis has considerably ratcheted up economic volatility, putting an end to the period some have dubbed “The Great Moderation.” This volatility will amplify the existing differences in performance. Even banks that have been dealt a challenging hand can do much to outperform their peers and reward stakeholders.

To mitigate these longer-term structural changes, banks can and should take many strategic steps. The necessary moves include reconfiguring and empowering regulatory strategy, placing big bets on the fastest-growing areas, and rethinking liquidity to treat it like other scarce resources the corporate center manages. Such steps, as well as innovations yet unseen, will be important variables in determining the shape of global banking over the long term.


After seven consecutive quarters of contraction in its loan book, ICICI Bank is now looking to grow its domestic loan book by 20% in FY11. The bank has already made credible progress towards increasing CASA and stabilising asset quality. We expect the bank’s loans to grow at sub-industry rate in FY11, with no material NIM expansion. Provision charges are likely to remain high to meet RBI’s required 70% NPL coverage by 2QFY11. We expect the RoE to remain in single digits until FY12, and view the stock as expensive on PE and PEG basis. We retain REDUCE.

New retail strategy needs time: In contrast to its earlier strategy of discouraging branch-banking and aggressively acquiring new customers through direct-marketing agents (DMAs) and call centres, the bank is now focussing on cross-selling to existing customers. We believe this change in stance will take some time to trickle down to customers. Unlike in the past, the bank is unlikely to be a price leader, as it has more competition from government banks and has fewer products to offer, having reduced its focus on credit-card and unsecured personal loans.

Material NIM expansion unlikely: While the CASA ratio has risen by 12pps to 40% over the past year, NIMs have expanded by only 20bps over the same period. The growing proportion of overseas loans, coupled with the bank’s exit from high-yielding retail loans, has effectively capped NIM expansion. We expect these factors to continue to play out over FY11 as the proportion of overseas loans remains high and the bank concentrates on secured retail lending.

NPLs have peaked, but credit charges may not decline: Gross NPLs have declined by 10% and gross retail NPLs by 16%, since peaking in 4QFY09. However, the NPL coverage ratio of 51% (62%, considering technical write-offs, which are yet to be approved by RBI) remain well below the minimum 70% stipulated by RBI. As such, we expect provision charges to remain high.

To read the full report: ICICI BANK

>INDIAN REAL ESTATE: Residential volume slows; still see value in our Buy stocks

■ Residential data for Jan-Feb 2010 indicates a slowdown vs. 4Q09
Our analysis of recent residential data indicates a slowdown in volume in 1Q10. In Gurgaon, monthly sales fell to about 1,600 units/month in Jan-Feb 2010 from about 2,400 units/month in 4Q09. In the Mumbai region, the average was about 4,100 units/month in Jan-Feb 2010 vs. about 5,700 units/month in 4Q09. We expect sales data from the listed developers with results in April/May.

■ Maintain Buy on Unitech, DLF, Anant Raj and Indiabulls RE
The BSE Realty index is down 9% ytd and has lagged the Sensex (up 2%), which we believe reflects concerns on macro policy tightening, moderation in volumes, and a pipeline of upcoming IPOs. However, we continue to expect steady residential sales for leading listed developers such as DLF and Unitech that have not increased prices across the board as steeply as seen in some Mumbai projects. Our recent Delhi-NCR trip indicated that construction activity is picking up. We also expect office absorption to improve through 2010. We think unsold inventory levels, affordability, developer balance sheets, and discounts to RNAV are more favorable in 2010 than they were in 2008/2009. We therefore maintain our Buy ratings on Unitech (UNTE.BO), DLF (DLF.BO), Anant Raj (ANRA.BO) and Indiabulls RE (INRL.BO); our Neutral on HDIL (HDIL.BO) and Sobha (SOBH.BO); and our Sell rating on Parsvnath (PARV.BO).

■ Some stocks have already priced in falling property rates
While we expect further policy tightening through 2010, our sensitivity analysis
indicates potential value in our Buy-rated stocks at current stock prices. For example, we believe Unitech, Anant Raj, IBREL, and DLF stock prices currently imply well over a 5% yoy decline in residential prices in FY11E, which we believe is unlikely unless economic growth slows down. In fact, our economist is looking for GDP growth of over 8% in FY11.

■ We revise our estimates and 12-m target prices
We revise our FY10E-FY12E EPS by -18% to +11% for our India property coverage in order to reflect key factors that include the phasing out of percentage of completion revenue/profit recognition and changes to other line items such as finance and overhead costs. We revise our 12-month target prices by -20% to +12% for these stocks: Indiabulls RE to Rs214 from Rs269; DLF to Rs425 from Rs463; Parsvnath to Rs112 from Rs118; HDIL to Rs364 from Rs379; Sobha to
Rs280 from Rs250. Our target prices for Unitech and Anant Raj remain unchanged.

To read the full report: REAL ESTATE

>STERLITE TECHNOLOGIES: Strong telecom margin drives PAT (EDELWEISS)

■ Revenue up 15% to INR 6.6 bn
Sterlite Technologies’ (SOTL) Q4FY10 revenues recorded growth of 14.7% Y-o-Y, to INR 6.6 bn, primarily driven by 19.9% Y-o-Y growth in the power transmission business to INR 4.8 bn. The telecom business, however, recorded a mere 2.9% Y-o- Y growth to INR 1.8 bn due to lower execution during the quarter. Telecom’s contribution to the overall revenue fell to 27.5% during the quarter against 30.6% in Q4FY09. On the volume front, SOTL recorded 38.4% Y-o-Y growth in optical fibres volume to 2.2 mn km, while that for power conductors increased 11.5% Y-o- Y to 36,794 MT.

Telecom margin zooms to 31%
During the quarter, reduced raw material (down 598bps to 64.1% of sales) and employee (down 15bps to 2.2% of sales) costs were negated to some extent by increase in other expenses (up 277bps to 17.1% of sales). This led to 336bps improvement in EBITDA margin to 16.6%. This, in turn, led to a robust 43.8% EBITDA growth Y-o-Y to INR 1,101 mn. Further, reduced interest cost (down 31.7% Y-o-Y) and significant improvement in other income helped post strong PAT growth of 57.4% Y-o-Y, to INR 722 mn, during the quarter. In view of improved business outlook and guidance by management, we revise our EPS estimates upwards for FY11E and FY12E by 4.4% and 9.7%, respectively.

Strong visibility; order book up 75% Y-o-Y; expansion on schedule
SOTL’s order backlog recorded a strong growth of 75.2% Y-o-Y, to INR 24.0 bn (0.8x FY11E revenues), with INR 18 bn (increase of 58% Y-o-Y) backlog in power conductors and the balance INR 6 bn (increase of 161% Y-o-Y) in the telecom business. Management has indicated that expansion projects for both optic fibres (expansion to 20 mn km) and power conductors (expansion to 200,000 MT) are on schedule and likely to be completed by end FY12 and FY11, respectively.

Outlook and valuations: Positive; maintain ‘BUY’
We are positive on SOTL, given that both businesses (power and telecom) have favourable demand drivers with significant spending expected in power T&D in India and fibre demand (driven by growing number of mobile subscribers, 3G auction along with pick up in the global fibre market). At our target price of INR 103, the implied target P/E for FY11E and FY12E is 14.5x and 11.8x, respectively. We maintain our ‘BUY’ recommendation on the stock.

To read the full report: STERLITE TECHNOLOGIES


Wipro 4QFY10 results in line, margins surprise positively, elevated attrition a risk; Neutral
Wipro's 4QFY10 results were in line with our estimates. The key highlights were:

1] US dollar revenues were up 3.5% (v/s our estimate of 4% QoQ), 1QFY11 guidance was 2-4.2% QoQ (v/s our expectation of 3-4%). Overall EBIT margins and IT EBIT margins were ahead of expectations on improved acquired company profitability and reduction in non-staff costs. Overall EBIT margins improved by 20bp to 191%, IT EBIT margins increased 60bp to 24.2%.

2] Wipro does not envisage wage inflation in FY11, despite attrition increasing from 13.4% to 17.1% QoQ. Our assumptions build in 7% offshore wage hikes in FY11. This brings wage inflation in line with TCS and Infosys (13% and 14% offshore respectively), given the 8-9% offshore hike in 4QFY10 (effective for two months). We expect IT EBIT margins to fall by 70bp to 22.7% (v/s Wipro's expectation of flattish margins, given our mid-year wage inflation expectation).

3] The company declared a 2:3 bonus and dividend of Rs6/share, reinstating dividend to pre -FY09 levels (after which dividend was cut to Rs4/share).

Our FY11 EPS (Rs34.7) are downgraded by 3% and FY12 EPS are constant (Rs40), incorporating [1] mid-year wage inflation expectations of 7% offshore [2] INR/US$ assumption change from 46 to 44.5. We expect Wipro to post US$ revenue CAGR of 19% over FY10-12 and an EPS CAGR of 13% in the period. The stock trades at a P/E of 20x FY11E and 17.3x FY12E. We maintain Neutral with a target price of Rs760, based on 19x FY12E earnings. Infosys and HCL Tech remain our preferred picks among top tier IT companies.

Wipro 4QFY10 revenue up 3.5% QoQ, guides for 2-4.2% growth in 1QFY11 Wipro's 4QFY10 revenue at US$1166m grew 3.5% QoQ (v/s our estimate of US$1172m and guidance of US$1,162m-1,183m). Constant currency revenue grew by 4.7% QoQ. IT services EBIT margin was up 60bp QoQ at 24.2% (v/s our estimate of 22.6%). Consolidated EBIT margin was at 19.1% (v/s 18.9% in 3QFY10 and our estimate of 18.4%). SGA as a percentage of sales increased from 12.2% to 12.6% (v/s our estimate of 12%). Higher other income at Rs 1.7b (vs our estimate of Rs1.3b), led to a higher effective tax rate of 20.2% (v/s our estimate of 16.1%). PAT was Rs12.1b, up 1% QoQ (v/s our estimate of Rs12.4b). FY10 EPS was Rs31.2 (up 18% YoY)

Wipro guided 1QFY11 growth of 2-4.2% QoQ (v/s Infosys guidance of 2.6%-3.4% QoQ). The company expects to add 11,000-12,000 freshers in FY11 in its IT business. Wipro expects broad-based growth and early signs of recovery in discretionary demand.

To read the full report: WIPRO