Wednesday, May 12, 2010

>GREED & FEAR: The euro end game (CLSA)

The predictable EU/IMF joint €110bn package for Greece has not led to the short-covering trade that GREED & fear had expected. The euro bounced a little late last week but has since
collapsed, while spreads have widened since Tuesday after narrowing somewhat in recent days.
Thus, the euro rose from US$1.32/€ on 28 April to US$1.33/€ on Friday and has since fallen to
a 14-month low of 1.28/€ (see Figure 1). Similarly, the PIIGS spread fell from 282bps on 28
April to 229bps on Monday and has since risen to 321bps (see Figure 2). Such market action is
not impressive given the time, or at least benign interlude, that the announced €110bn should

The lack of a more positive response reflects surely the market’s realisation that this is only the
beginning, not the end, of the deflationary dynamic caused by Euroland’s incompatible mix of
monetary union without political union. There are also the uncertainties caused by the potential
for massive strikes in Greece as will by the issue of whether Germany or other countries’
legislatures will actually pass the agreement. There is also the position of Germany’s

It is true that the deal commits Greece on paper at least to real austerity while the economic
projections seem more realistic. Thus, under the deal, Greece plans to cut the fiscal deficit from
13.6% of GDP last year to 8.1% this year and to 2.6% in 2014 (see Figure 3). While Greek real
GDP is projected to decline by 4% this year and by 2.6% in 2011 (see Figure 4). It is also true
that the only way a socialist government has a chance of persuading private-sector Greeks to
pay their taxes is via a radical reform of the public sector. This is now part of the IMF conditions. Still GREED & fear remains of the view that Greece would be better off opting for a return to the drachma and debt restructuring in line with the sort of classic IMF programme implemented in countless emerging market restructurings before; most particularly as foreigners own about 70% of Greek government debt. Imagine, for example, the boom in Greek tourism that would follow a big devaluation.

To read the full report: GREED & FEAR

>India oil marketing companies: Some more government support, but still inadequate

A lower loss is still a loss
The government has agreed to provide an additional cash subsidy of INR140bn (in addition to the earlier announced INR120bn) to oil marketing companies (OMC) to partly fund losses incurred by the OMCs on the sale of controlled petroleum products – e.g., gasoline, diesel, LPG and kerosene – below market prices. While this is good news for OMCs, we do not believe this is enough.

BPCL and HPCL: We value both BPCL and HPCL using a sum-of-the-parts valuation of the core refining and marketing businesses and investments. We use a combination of PE-based (50% weight) and EV/EBITDA-based (50% weight) multiples.

We use a target PE of 10.0x for BPCL and 9.5x for HPCL on the basis of the last six-month average. We value listed investments at market price and others at book value. We use a target EV/EBITDA multiple of 5.5x for HPCL and BPCL. We also value BPCL’s E&P portfolio at INR50/share. As HPCL’s investments in E&P are still at an initial stage, we have not accorded any value to its E&P portfolio.

The most important risk to our Underweight (V) ratings for both stocks is a complete reimbursement of under-recovery amounts. The generic risks to our ratings include materially higher refining margins and lower oil price and dollar exchange rates, leading to lower under-recoveries than those assumed for our long-term forecasts. Key company-specific risks follow.

BPCL: BPCL is slated to commence production at its 6 MMtpa refinery at Bina during FY11. A faster ramp-up and earlier commissioning are risks. BPCL has an indirect 12.5% stake in a Brazilian oil field BC-30 which reported a discovery recently. We have ascribed about 2bn barrels (at 3P resource level) in place volume to this discovery. Discovery of significantly higher volume is a risk to our rating.

HPCL: We expect HPCL to commence production at its 9 MMtpa joint venture refinery at Bhatinda during FY12. Early commencement of production is a risk to our rating. Additionally, HPCL has invested in upstream exploration blocks. Significant success in these blocks could be an upward trigger for the stock price.

To read the full report: OIL MARKETING COMPANIES

>Godawari Power & Ispat Ltd (ICICI DIRECT)

Powering through integration…
Godawari Power and Ispat Ltd (GPIL) is the flagship company of the Hira Group of Industries that is based in Raipur, Chhattisgarh. While the group has a good presence in the long product segment of the domestic steel industry, with products including sponge iron, steel billets and HB
wire, the power business has been getting more attention in the recent past. GPIL has also been slowly transforming itself into a backward integrated entity with captive iron ore production being ramped up and thermal coal mining awaiting forest clearance. On the back of strong backward integration, we believe the bottomline will grow at a CAGR of 35% during FY10E-FY12E to ~Rs 115 crore in FY12E through margin expansion from ~12% in FY09 to ~22% in FY12E. The topline is, however, likely to grow at a comparatively moderate CAGR of 8% over FY10E to Rs 1010 crore in FY12E.

Backward integration to boost margin expansion
The company has reserves of ~15 MT of iron ore and ~63 MT of coal with it. Iron ore mining has already started and is likely to meet ~85% and ~90% of the captive requirement during FY11E and FY12E. This would help the company to save ~Rs 169 crore in FY12E. In turn, this would
directly contribute to the bottomline by way of expanding the EBITDA margin to ~22% in FY12E. Thus, it is going to be a key trigger for the stock despite a comparatively muted growth in topline.

Focus on power segment to hedge risk in steel business
GPIL has consciously focused on the power segment. We believe it would continue to utilise power as a hedge against possible downsides in steel business. With the expansion of its power capacity to 73 MW the revenue contribution of power would remain stable at ~Rs 136 crore (13% in FY12E). The power business is expected to earn EBITDA margin of ~45% in FY12E on higher usage of waste heat recovery gas and bio mass.

At the CMP of 200.5, the stock is trading at 3.8x its FY11E EV/EBITDA and 5.4x its FY11EPS of Rs 36.9. Looking at the potential value unlocking, we value the stock at 4.5x its FY11E EV/EBITDA. Thus, we are initiating coverage on Godawari Power and Ispat Ltd with a STRONG BUY rating and a target price of Rs 254/share for an investment horizon of 12-15 months.

To read the full report: GODAWARI POWER

>COMMODITY FUND FLOWS: New Products Could Boost Base Metal Investments

Commodity Investments Rebound — We estimate commodity investments at around USD250bn, back to the highs of mid 2009. During the global financial crisis the value of investments halved, but due more to collapsing commodity prices than fund outflows. Latest data show a reduction in net investments, reflecting a broad reduction in risk appetite driven by macro concerns in Europe and China. Notably, gold holdings have been least affected. We expect this to be a temporary pullback.

Significant Relative to the Physical Markets — Commodity investments equate to 10-20% of the value of annual physical demand, but only 1% of futures turnover1.

Index Investments — Account for 60% of the total, and more than half of the growth.

ETFs — Gold dominates physically backed ETFs. However, the launch of a base metal (aluminium) ETF could be an important source of further investment demand growth. The main hurdles are financing and warehousing costs.

Investment Drivers — The main drivers of investments in commodities are: the super cycle theory, portfolio diversification and commodities as a USD hedge.

Investment Impacts — Increased investment has introduced more anticipation into commodity markets. In addition reduced producer hedge selling and increased investment buying has tightened forward markets. In spot markets the results are an upward shift in traditional inventory:price relationship. The most important impact is higher prices.

The Future — We believe investments will be an increasingly important component in commodity markets, at least for the duration of the super cycle. There will be an increasing trend to more active investment strategies.

To read the full report: COMMODITY FUND FLOWS

>F&O Stocks Tracker of Forthcoming Corporate Action from May 13, 2010 to June 12, 2010

To read details: EVENT TRACKER