Saturday, May 29, 2010

>The Great Reflation: The Mother of all Financial Experiments

Chuck Prince, the former CEO of Citigroup, who presided over the bank’s collapse, famously remarked in July 2007 that "as long as the music is playing, you’ve got to get up and dance. We’re still dancing.” Shortly after, the music stopped, the financial system broke, and Citigroup and other financial behemoths went under.

To rescue the economy and financial system from near‐total meltdown, the government created
an unprecedented package of bailouts, stimulus, free money and massive fiscal deficits. It succeeded, and a 1930s style debt deflation and depression were aborted. Liquidity, on a vast scale was unleashed into the financial system, demonstrating, once again, the power of such flows to drive up the prices of stocks, commodities and other risky assets.

In The Great Reflation we focus on how the authorities pumped air back into the balloon, and
got the music playing again. Investors and banks, including Citigroup, are back out on the dance floor. However, just because the system was saved, doesn’t mean it has been fixed.

Why do we say that the system isn’t fixed? The major theme running through The Great Reflation is that we have been living through a multi‐decade period of money and credit inflation that started back in the 1960s when the post‐World War II global monetary system (Bretton Woods) began to break down. The Great Reflation is about this inflation and the consequences of the Act II, which is now unfolding.

The Engine of Inflation
Inflation is the biggest enemy of investors in the long run. However, in the short term, inflation
in its early stages is often a wonderful elixir, greasing the wheels of the economy and causing riskier assets like stocks, commodities and corporate bonds to levitate. Euphoria tends to build as people get richer. But, it is important to understand that inflation is an undue expansion of money and credit. It can have the effect of raising the prices of things we consume or the prices of assets that we own or want to buy. But those are the symptoms of inflation that, if extreme, tell us that a bust is coming. In the case of rising consumer prices, the central bank ultimately has to raise interest rates and curtail credit. Recession follows. Or, if asset prices rise on the back of credit expansion, debt servicing ultimately becomes unbearable and asset prices—the collateral—start to fall, but debt levels are fixed in the short term. When people can’t service or repay debt, panics and crashes follow, and the risk of a debt deflation and depression rises dramatically.

Too much debt and falling asset prices caused the depression of the 1930s and almost another
one in 2008‐2009. One Important reason that debt rose to such extremes, both in 1929 and 2007 was that the monetary system had a built‐in inflationary bias. In the 1920s, it was called the gold exchange standard, whereby countries held both gold and currencies in their reserves. In the post‐1971 world, it was called the floating dollar standard or Bretton Woods II. Countries held mainly dollars in their reserves. As a result, the U.S. could inflate at will and foreign countries had to buy the excess dollars on the foreign exchange market if they wanted to prevent their currency from rising. In a world of low and falling price inflation, as was the case after 1982, almost all countries want a cheap currency.

To read the full report: THE GREAT REFLATION

>CAIRN INDIA: Takeaways from India Investor Conference, May 26-28

Takeaways from Mumbai — Cairn India presented at our India Investor Conference on May 26-28. Below are key takeaways.

Operational updates — The company has completed the Barmer-Salaya pipeline section, which should enable Train-III to be ready for production by Jun’10. Production from Mangala would be ramped upto 125kbpd in 2H2010 depending on offtake. The field is currently producing ~60kbpd of crude, being sold to both MRPL and RIL. While the company has already tied-up with MRPL, IOC, RIL and Essar for 143kbpd of output, sales discussions are ongoing with others as well. Besides, three wells have been drilled in the Mangala field to gauge the EOR potential.

2011 will be key year for exploration — Cairn plans to commence drilling in its offshore Palar bock and in Sri Lanka in CY11.Of the five exploration wells to be drilled in the onshore block KG-ONN-2003/1 this year, the company has drilled its second exploration well, which has also turned out to be dry.

4Q results takeaways — Cairn produced 17.5 kbpd of crude from Mangala in 4Q, with average realization of US$67/bbl (implying a 12% discount to Brent) vs. a realization of US$66/bbl in 3Q (13% discount to Brent). Even though production has been ramped up to 60 kbpd, sales ramp-up would likely happen with a lag.

To read the full report: CAIRN INDIA

>Fortis Healthcare: No Major Surprise in FY10, All Eyes on Parkway

FY10 Results No Major Surprise; All Eyes on Parkway — We believe Fortis' response to Khazanah's open offer for Parkway will have a greater bearing on Fortis' valuations than results, which were disappointing at the EBIDTA level.

4Q: Revenues Strong, Margins Disappoint — Recurring PAT at Rs272m was ahead of expectations, though largely on the back of lower than expected tax rate. Revenue growth (+91% YoY), on the back of Wockhardt acquisition, was impressive, but the margin decline (-73 bps YoY & 106 bps QoQ) was a surprise, especially as Wockhardt boasted of significantly higher margins than Fortis’ own hospitals. Interest costs ballooned (+245% YoY) due to loans used to finance the Wockhardt acquisition, but were cancelled out by the income earned on the cash from the rights issue. This along with the lower tax rate led to a 470% PAT growth.

FY10: A Transitionary Year — FY10 remains a transitionary year as the full impact of the Wockhardt acquisition and the recent stake acquisition in Parkway will be reflected only in FY11 financials. Recurring PAT was at Rs695m (+376% YoY) driven by strong growth in Fortis’ own hospitals and the acquisition of Wockhardt hospitals in end CY09 as well as the low base. EBITDA margins expanded 140bps YoY due as newer hospitals turned profitable. Numbers were skewed by 4Q results which accounted for more than a third of FY10 topline and bottomline.

To read the full report: FORTIS HEALTH CARE

>Buy the Macro, Hold the Micro, and It’s Not Expensive (CITI)

India should go up — We get more constructive as: a) Domestic Macro headwinds could well have peaked; worst on inflation, rates and the fiscal deficit possibly over; b) Micro momentum and corporate rationality still in place; rising FCFs, higher ROEs, and reasonable earnings growth (albeit some slackening); and c) India is no longer expensive – trading below its long-term averages. India’s rising dependence on global capital flows, and global volatility, will raise market beta; but looking through we raise our Sensex target index to 18,100 (15X 1yr Fwd PE – long term average), and shift to a more aggressive model portfolio.

Buy the Macro — The deteriorating macro has been a significant headwind for the Indian market/economy; we see a possible turn with: a) Inflation showing signs of peaking b) rate rise trajectory easing domestically and globally, and c) fiscal strains easing with oil prices and 3G auctions. It’s not a tailwind yet; rates will still rise and global capital flows could be disruptive (equities, currency and liquidity), but the macro’s direction could well be turning.

Hold the Micro — The corporate sector is sustaining a sweet spot: a) Earnings should rise 24%+ in FY11 (15% over FY11-12) b) ROEs should bounce to 19% in FY12 c) Business should generate cash flows – FCF yields at 3%+ in FY12 d) Sales momentum is high (15%) and sustaining. While earnings revisions momentum is slackening, and earnings vulnerable to lower commodity prices, India’s corporates in decent shape – growth, balance-sheet and confidence wise

It’s not expensive — India is trading below its long-term PE and PBV averages; is no longer expensive in absolute terms, and returns are looking up too. We see the environment supporting average multiples, which suggests 8-10% upside from here. Macro needs to fully align with the micro for premium valuations (or reverse for discounts); don’t see either yet. More aggressive portfolio with OW’s on financials, Capital Goods, Energy and Auto; UW’s on IT, Utilities and Materials.

To read the full report: EQUITY STRATEGY

>What is the economic outlook for OECD countries?

To see the charts and report: OECD COUNTRIES


Everonn Education’s (Everonn) Q4 results were much higher than expectations with sales surging 192% YoY to Rs1,045mn (vs our estimate of Rs845mn). We reiterate our Buy with a target price of Rs540 considering the consistent growth momentum in VITELS and attractive valuations. We believe the company’s ‘Educating India’ initiative and improvement in revenue per points of presence in the VITELS segment would be upside triggers.

Results beat estimates: Q4 sales surged 192% YoY to Rs1,045mn vs our estimate of Rs845mn. This strong growth was mainly driven by the VITELS and Edu Resource (hardware sales) segments. EBITDA margin expanded 207bp to 30.6% due to higher contribution
of VITELS (49% of overall revenue).

Strong VITELS revenue growth as points of presence increase: The VITELS segment, which grew 184% to Rs508mn, was one of the main contributors to the growth in net sales. The company added 150 schools and 171 colleges during Q4.

Valuations attractive; reiterate Buy: At CMP, the stock trades at 10x FY11E and 8x FY12E earnings, we believe is very attractive considering improvement in financial performance. We reiterate Buy valuing the stock at 11.5x FY12E earnings, translating into a target
price of Rs540.

To read the full report: EVERONN EDUCATION

>NTPC: FY10 Adjusted PAT inline (CENTRUM)

NTPC’s Q4 results were inline with our estimates at operational level. Though reported PAT at Rs20.2bn was lower than estimate due to lower other income, adjusted PAT for the full year was inline. Reiterate Buy.

Q4 PAT marginally below expectations: Sales increased 4.2% YoY to Rs127.3bn, 7.6% above our estimate. EBT, which is the right profitability measure for NTPC’s cost plus model, was inline with our estimate of Rs18.3bn. PAT at Rs20.2bn was 15.1% lower than our estimate due to lower other income.

…but full-year adjusted PAT inline: Adjusted FY10 PAT (after adjusting exceptional items like provision for higher wages, prior period adjustments in sales and income tax refunds) came to Rs89.4bn, inline with our estimate of Rs90.9bn.

To retain 80IA benefit; no MAT at plant level: The management has clarified that there would be no minimum alternate tax (MAT) at plant level. This strengthens our view that plant-level ROEs for NTPC’s projects with 80IA benefit would be ~30%.

FY10 PAF was 91.4% for coal plants and 90.6% for gas plants: FY10 average PAF was ~91%, 200bp lower than what we have factored. But high PAF levels (98.3% for coal plants and 93.8% for gas plants) during Q4 sights improving PAF levels.

Reiterate Buy with target price of Rs260. We believe the stock should trade at 3.0x-3.3x FY11E P/BV, assuming sustainable ROE of ~19% from FY13E, earnings growth of ~14% over FY10-17E, sufficient cash to fund its expansion projects and dividend yield of ~3%. We reiterate our Buy with a target price of Rs260 (including value of Rs8 from the JV projects), which implies a P/BV of 3.0x on FY11E standalone BVPS of Rs82.1.

To read the full report: NTPC