Tuesday, May 4, 2010

>Whither the patchy US recovery?

Last week, US share prices rose on continued expectations of an economic recovery. On
Friday, however, the Goldman Sachs news and fresh doubts about the strength of the economy
sent the stock market lower.

On the policy front, Fed chairman Ben Bernanke testified before the US Congress. He noted
that while the economy was experiencing a gradual rebound, numerous problems remained,
including the real estate market and the credit crunch.

The Fed also released its Beige Book survey of regional economic conditions last week. While
the general tone of the report pointed to a modest recovery, many districts were characterized
by a mixture of strong and weak data. In some districts, even the report’s authors seemed
unable to determine whether the economy was advancing or retreating. In my view, this
suggests that the US recovery is still patchy at best.

* Bernanke far more cautious on economy than market participants
Turning first to Mr. Bernanke’s testimony, the Fed chairman adopted a cautious tone compared
with the market’s strong expectations for recovery. He began by saying that the 5.6% GDP
growth reported in 2009 Q4 (q-q annualized) was a sign that the inventory adjustment that
followed the Lehman crisis had finally ended and that production was once again expanding.
However, the flip side of this view is that the recovery in production may be only a temporary
phenomenon that will end once manufacturers complete their inventory buildup. In other words,
the economy could stall again unless private final demand picks up. The Fed chairman
specifically pointed out this possibility in his testimony.

Mr. Bernanke also argued that the economy has been supported by demand from a very large
fiscal stimulus, but that private demand will become more important as the stimulus winds down
between now and end-2010. In a sense, this was a warning that we should not expect the
existing demand structure—which is reliant on government spending—to persist.

A look at the seven-page manuscript for Mr. Bernanke’s speech shows only the first page and a
half devoted to positive economic news, while most of the remaining 5 1/2 pages deal with
potential risks and appropriate responses. I think Mr. Bernanke is being careful not to take too
optimistic a view of the current situation.

While noting that the jobs situation is finally improving, for example, the Fed chairman
expressed serious concerns about the fact that, as of March, a record 44% of the unemployed
had been without jobs for more than six months.

Historically, people unemployed for more than six months experience a significant deterioration
of vocational skills and face severe difficulties in finding their next job.

* Bernanke has begun to talk about decline in private loan demand
Mr. Bernanke also argued that a key cause of the continued drop in US bank lending to both
individuals and businesses is falling loan demand, which he attributed to the weak economy and
to the fact that many borrowers are in such a poor financial position that they are no longer able
to borrow.

I was hoping to see a more direct acknowledgement that soft loan demand was attributable to
impaired private-sector balance sheets. Nonetheless, the Fed’s latest Senior Loan Officer
Opinion Survey, referred to by the chairman in his testimony, highlights a continued decline in
corporate loan demand. Although the scale of the decline has eased compared to before,
survey respondents still indicated that demand for commercial and industrial loans had
weakened over the past three months

To read the full report: US RECOVERY

>End game for the RIL-RNRL saga in sight? Revisiting the scenarios

Court case outcome likely expected in next few days
According to Reuters, the final verdict on the Reliance Industries (RIL) vs. Reliance Natural Resources (RNRL, not covered) gas dispute is expected in the next few days, prompting us to revisit the possible scenarios and their impact on RIL, RNRL, as well as Reliance Power (RPWL) and Reliance Infrastructure (RELI). We have currently built in a midpoint gas price of US$3.27 for the gas supply from RIL to RNRL from FY12E onward as our base case and have assumed that the government would extract its share of D-6 revenues at its directed gas price of US$4.2/mmBtu from RIL.

Favorable result for RIL – anything better than previous judgment While we have assumed a midpoint price of the disputed gas volumes, recent stock movements suggest the Street is largely pricing in a repeat of the previous court judgment, in which RIL was asked to start selling gas immediately at US$2.34/mmBtu. Therefore, 1) not having to supply gas to RNRL, or 2) at a gas price of US$4.2/mmBtu, or 3) supply cheap gas only upon completion of RPWL’s power plants would all be positive for the stock, in our view. Gas price of US$4.2/mmBtu implies upside of Rs17/sh for RIL’s D-6 valuations. Assuming no gas supplies to RNRL and hence to RPWL’s gasbased plants, we estimate RPWL to have downside of about 50% from current market price. Though RELI would be indirectly impacted owing to its 45% stake in RPWL, we believe this is already reflected in RELI’s share price.

Favorable result for RNRL – immediate gas as at US$2.34/mmBtu: Assuming RNRL wins a direct verdict and RIL has to start supplying gas to it immediately at US$2.34/mmBtu, we estimate a negative impact of Rs40/sh to RIL – D-6 valuation impact of Rs20/sh and E&P exploration impact of Rs20/sh. We estimate RIL’s FY11 EPS would decline by 7.5%. For RPWL, we estimate upside of 16% vs. 38% for RELI from current levels, as we believe some benefit of cheap gas is already reflected in RPWL’s share price. However, a verdict in RNRL’s favor would create uncertainty over RIL’s existing gas sales agreements with power companies like NTPC, Lanco Infratech, GVK and GMR.

Buy RIL (on CL) and RELI, Sell RPWL for potential court outcome
With market’s low expectation on positive outcome for RIL, we think the stock would benefit from removal of court case overhang. We continue to prefer RELI over RPWL given its infrastructure/power exposure and inexpensive valuations.

To read the full report: RIL-RNRL

>Model Portfolio and Focus List: Going Underweight Consumer Discretionary

To read the report: INDIA STRATEGY

>India Cements 4QFY10 results below estimates, hit by provisioning for staff costs; Buy (MOTILAL OSWAL)

India Cements’ 4QFY10 results were below our estimates, with EBITDA of Rs1.26b and recurring PAT of Rs294m, impacted by higher staff cost (up ~37% QoQ). Key highlights:

Volumes grew by 27% to 2.95mt, driven by commissioning of new capacities. Realizations were up 3.2% QoQ (but down 16.2% YoY) at Rs3,125/ton.

EBITDA margins declined by 12.3pp YoY (~40bp QoQ) to 13.1%, impacted by higher staff costs due to higher provisioning for employee benefits.

4QFY10 IPL revenue was Rs307m and EBITDA was Rs207m.

The management indicated that cement prices were recovering and realizations were higher by at least Rs10/bag during 4QFY10.

The company sold its 3% stake in Bharathi Cement to Vicat but it did not disclose the consideration and profit from stake sale.

Valuation and view: We maintain our EPS estimates. The stock is valued at 17.2x FY11E EPS (fully diluted, extreasury stock), 8x FY11E EBITDA and US$83/ton (at 15.5mt capacity). Valuations are attractive considering bottom of the cycle earnings. Maintain Buy with a target price of Rs166 (US$95/ton FY11 capacity – a 15% discount to replacement cost).

To read the full report: INDIA CEMENT


Asset quality concerns abate; strong re-rating candidate; BUY. We expect Indian Bank to get re-rated as key concerns regarding its asset quality have abated significantly. The quarter saw a sharp decline in restructured loans (down 30% qoq). The new management is confident of asset quality and is targeting nil net NPLs by March 2011. Core earnings remained strong with PAT at Rs4.1 bn (up 4% yoy), supported by strong growth in NII (up 40% yoy). The stock trades at 1XFY2011E PBR, despite near 20% RoE. Reiterate Buy with TP of Rs280 (45% upside).

Strong core operating performance; margins stable at 3.7%
Indian Bank reported net interest income (NII) of Rs9.3 bn (up 40% yoy). The company’s net
interest margin (NIM) was at 3.7% for FY2010 supported by a reduction in cost of deposits:
(1) CASA deposit ratio as of March 2010 was 32%, which was a marginal improvement compared to December 2009, (2) falling cost of overall deposits which more than offset the decline in lending yields of 50 bps (as per our estimates) during the quarter (3) improvement in CD ratio by 300 bps to 71%. We are building more conservative estimates into our margins (30 bps decline by FY2012).

Restructured assets decline >30% qoq
Indian Bank’s restructured assets, one of the highest in the industry, declined 32% qoq to Rs34.5
bn driven by upgradation (having completed one year of satisfactory servicing). The slippage from these loans has been marginal at less than 1% of loans while incremental restructuring was at Rs2.1 bn (35 bps of loans). Priority sector lending, textiles, commercial real estate, and SME were the main sectors which saw upgradation during the quarter. We note that a lot of concerns
emanating from its restructured pool have receded significantly and this should lead to a re-rating of the stock.

Net NPAs increased from a low base; provision coverage (excluding write off) healthy at 72%. Gross NPA for the quarter was flat qoq at Rs5.1 bn (0.8% of loans) while net NPA increased
marginally bank as the bank wrote off loans during the quarter. Consequently, provision coverage declined to 72% from 83% in the previous quarter (including written off is at 94%). The bank changed its provision policy during the quarter to a more conservative practice, providing 100% for all loans that are below substandard. Hence, loan loss provisions for the quarter were higher at Rs2 bn. Further, the bank has also made a floating provision of nearly Rs1 bn. We currently model a delinquency ratio of 1.5% in FY2011E (about 1% in FY2010) and 1.0% in FY2012E to factor the credit risk that the company may be exposed to.

To read the full report: INDIAN BANK


Investment Rationale

IFCI is one of the oldest NBFC involved in activities like Project finance, financial services, Non project specific assistance nodal agency for SDF and corporate advisory services.

Along with its above core business it has a huge amount of investments in listed and unlisted stocks which can all get valued close to Rs. 2500cr [like NSE, Hindalco and Tata DVRs with Rs. 250cr each] and also a huge land bank of 7.5lac sq feet in prime locality of Mumbai and Delhi.

It has a healthy capital adequacy ratio of 20%.

They have cleaned their entire NPA, now the book is carrying standard loans of Rs. 7000 cr backed by equal amount of borrowings.

Going further the government proposal of giving fresh banking licenses to FIs / NBFC’s could be positive news for the company. IFCI is looking to enter commercial banking.

The main trigger for the stock could be the process of inducting a strategic investors, which would invest fresh funds and unlock the value of the company. This will add on to the premium to the current stock price.

Due to improved outlook for financial services and increased value of investments & Property. The strategic investor should assign a higher value to IFCI [ w are expecting Rs 75-80 per share], which could lead to rise in stock prices. Investors can BUY at current price with limited downward risk and reasonable returns in medium term.

Risk and Concerns
The delay in roping in the strategic investor may continue to cause sluggishness in stock, but this can only delay the value unlocking.

To read the full report: IFCI