Saturday, July 17, 2010

>INDIAN EQUITY STRATEGY: Staying Bullish, Sensex Target of 22,680

Positive stance continues - Expect markets to be volatile on global cues - recommend BUY on corrections

8.2% GDP growth est. for FY10-11 build in ~5.4% inflation expectation

Credit growth: Systemic credit growth upped 19%, riding on 3G and BWA auction, and is likely to stay strong YoY. Expect 22% credit growth for FY11.

Interest rates: Systemic interest rates likely to rise with next regulatory push. We expect policy rates to rise 75bps with lending rates lagging deposit rates.

Fiscal deficit: Expect consolidation at ~5% of GDP: We believe the government’s attitude towards fiscal discipline and the excess cash flows available warrant a sharp reduction in its borrowing programme.

Strong corporate earnings growth: Our Sensex EPS for FY11E is Rs1,053 and for FY12E, Rs1,260. We note the index is trading at 17x FY11EPS. Our EPS estimates are ahead of consensus by1.8% and 1.2% for FY11E and FY12E.

Volatility measures: Indian IVs:US VIX has been on a decline through the Euro market crisis — points to relatively lower risk aversion for Indian equities. MSCI India index has outperformed MSCI ACWI index on a 12-month relative basis while MSCI EM has underperformed.

Sensex trading band: Sensex valuations
(1) Sensex dividend discount model: Indicates the range 16,360-21,189. We believe the 7.5-8.0% 10-year bond yield could mark peaking of current interest rate cycle; (2) P/BV: Positive divergence in the premium.

Currently the Sensex is trading at 2.8x P/BV FY11, 17% disc. to its LT average P/BV of 3.4x. When it reverts to the mean, an index level of 21,250 is implied; (3) PE basis: On our FY12E earnings of Rs1,260, we expect the index to trade between 17,640-22,680. On projecting the Sensex on earnings yield and current 10-yr bond yield, we do not expect the market to go below 16,100 in
FY10, except on a global sell-off.

Our model portfolio plays out India’s domestic consumption story: Domestic consumption is strong and resilient but rate sensitive. We expect domestic consumption to pan out more rapidly and domestic sectors/stocks that reflect this will witness expansion in valuation premium v/s the markets.

Large cap companies with low leverage will continue to command similar
premium valuations. We recommend — focus on large caps and larger niche mid-caps: We are OVERWEIGHT Industrials, Consumer Discretionary, Consumer Staples, Financials (upgraded from Neutral), Healthcare and Software and UNDERWEIGHT Energy, Materials, Telecom and Utilities.

Risks to equity markets: Market risk = the widening deficit in global economies and escalating credit concerns that suggest risks to sovereign defaults. Global aversion would impact mid-cap stocks the most, and they have been the stellar performers. Commodity prices are also at risk given fallout in the European Union and we expect metal prices to be volatile. We do not expect substantial earnings downgrades such as in 2008, as the domestic Indian economy is fairly resilient.

To read the full report: EQUITY STRATEGY

>CAIRN: Expect more in Rajasthan beyond known sands

Rajasthan block is the most important asset of this India-focussed E&P company. Cairn has three oil and gas-producing and nine exploration blocks. Rajasthan is the most important of these; we believe it accounts for c95% of Cairn’s current market value. While this is a fair valuation for disclosed estimated in-place oil volume of c6.5bn boe in Rajasthan, we believe there is possibility of significant upside in this onland block beyond the estimated in-place volume. The block currently produces 100,000 bbl/d of oil; we believe Cairn is on track to achieve peak production of c240,000 bbl/d by FY14.

Our analysis shows 40% potential upside in resource base in Rajasthan. Our analysis is based on potential c100% upside in oil-in-place volume from an unconventional oilbearing source, the Barmer reservoir, overlying the main reservoir. Another reason is a set
of geological features (“stratigraphic traps”) that are yet to be explored. Our probability
weighted estimate of the upside is equivalent to c40% of the current resource base. We
ascribe a value for reserves upside that accounts for c16% of our target price.

The upside could ensure replacement of produced reserves for 5-10 years. As per
management, the current focus is on the ongoing development of the Rajasthan asset. Once this is achieved, management is likely to refocus on exploratory drilling in the block, which then could help establish these upsides. These upgrades over the next 2-5 years could ensure reserve replacement for a considerable period. We expect the Barmer formation to commence production in FY14.

Valuation and risks. We have valued Cairn on DCF for production from known reserves and a risk-weighted multiple for reserves upsides. Our FY12e EPS is in line with consensus (oil price assumption USD76/bbl in FY12). We rate the stock Overweight with a target price of INR360. Our target increases by INR48/share if Cairn is exempt from oil field cess. Catalysts are guidance for higher peak production, upgrades of reserves, and exemption from oil field cess. Risks include non-renewal of production-sharing contracts, slower ramp-up of production, lack of reserves upgrades and a lower oil price.

To read the full report: CAIRN

>AXIS BANK: Consistency commands premium (EDELWEISS)

Robust loan growth, coupled with superior performance of saving balances and stable asset quality, were the key highlights of Axis Bank’s Q1FY11 results. PAT was at INR 7.4 bn (up 32% Y-o-Y), in line with our higher than consensus estimates, aided by strong NII growth (up 45% Y-o-Y) and higher other income; this compensated for the relatively higher credit costs. Axis Bank is moving towards a consistent earnings growth trajectory of 30-32% every quarter, which, we believe, could lead to a further re-rating of the stock.

Growth momentum sustained; on course to achieve higher than industry growth. Led by strong momentum in the large corporate segment, the bank achieved 4% Q-o-Q growth, beating the historical trend of decline in Q1. The growth delivered seems remarkable against the backdrop of a significant jump witnessed in Q4FY10. We believe the bank is well on track to achieve above industry growth; we have built in loan growth CAGR of 25% over FY10-12.

Margin decline as expected; superior SA performance
Reported margins declined 38bps, to 3.71%, after peaking at 4.09%, due to impact of higher cost on saving bank balances, coupled with CRR impact and drag due to low yielding agri assets. CASA franchise of the bank has once again come to the fore with saving balances growing 2.5% Q-o-Q, unlike the historical trend. With re-pricing benefit largely over, margins are likely to draw support from the CASA franchise. We estimate NIMs of 3.3% over FY11-12 - a higher
margin trajectory from 2.85% registered in FY07-09.

Outlook and valuations: Re-rating underway; maintain ‘BUY’
Under the new management, the bank is focused on achieving a more rational target (4-5% above industry) rather than beating the industry (grew 2x the industry earlier). This strategy will allow it to build a more formidable retail franchise and achieve consistently higher ROA. We believe the bank can sustain higher ROA of 1.6-1.7% against 1.0-1.2% a few years back, enabling ROE to move closer to 20% in a capital efficient manner. As the bank closes on the gap between ROA of HDFC Bank and delivers consistent earnings, the current discount of ~30% could narrow down to 15-20%. This would effectively translate into a trading range of 3.0-3.2x and price target closer to INR 1,600, an upside of 20% over the next 12-15 months. The stock is attractive at 2.5x FY12E adjusted book and 13x FY12E earnings. We maintain ‘BUY’ on the stock and rate it ‘Sector Outperformer’ on relative returns. Axis Bank continues to be one of our top picks in the space.

To read the full report: AXIS BANK

>COLGATE PALMOLIVE: Time to take some profit

Colgate India's earnings performance for 1QFY11 are mixed. Net sales for the quarter are about 2% below our expectation whereas net earnings are about 2% above expectations largely on account of tax provisions. Our estimates remain unchanged above consensus (about 6-10%) however the YTD outperformance (Absolute Performance 28% and Relative Performance 25%) of the stock to some extent reflect that already and accordingly we are downgrading the stock from a BUY to HOLD with a March 2011 target price of Rs 900 reflecting a forward P/E multiple of 22x.

Earnings review - Topline growth for the quarter was 13% marginally below our expectations of 15%. Net sales for the quarter were Rs 5.3bn, a growth of 13% y/y (pq 13% y/y and p4q 16% y/y). EBITDA remained strong led by savings on raw material. EBITDA for the quarter was Rs1,598mn, a growth of 30% y/y (pq 42% y/y and p4q 35% y/y). Net profit for the quarter was Rs1,219mln, a growth of 19% y/y (pq 32% y/y and p4Q 38% y/y)

Key positive and negative takeaways from earnings - Led by raw material savings ebidta margin trends have remained encouraging. For the quarter under review ebidta margin saw improvement by 400 bps y/y and 230 bps q/q . On the negative side topline growth trends have been below expectations .

Outlook - Although monsoon trends are normal, inflation still remains very high therefore we do not envisage any major change in volume and mix trends. Moderation in volume growth also implies that pricing increase will be marginal. Our earnings estimate largely remain unchanged however we expect some upward revision to consensus estimates.

Valuation - Stock is currently trading at P/E multiple of 25x and EV/EBIDTA multiple of 18x on our above consensus FY11 estimates. We believe these valuations adequately refer the strong operating growth momentum of 20% for FY10-12e. Steady earnings, marketshare performance and attractive dividend yield (~4%) are some of the key reasons to assign a hold rating on
the stock.

To read the full report: COLGATE PALMOLIVE


We recently met the management of BGR Energy (BGR), and came back positive on its project execution, JV with Hitachi for manufacture of BTG equipment, and order inflows.

Robust order backlog and pipeline provides visibility
With several SEBs expected to tender orders of INR 350–400 bn during FY11, BGR’s order pipeline looks very strong. The management is confident of bagging orders of INR 150-200 bn in the current fiscal. The company has already placed bids for two EPC projects in Rajasthan worth INR 6.5 each and one BoP project in Maharashtra worth INR 20 bn, with orders expected to be awarded in the next 3–4 months. The company’s order backlog, at INR 102 bn (2.2x FY11E revenues), continues to provide strong visibility with execution cycle of 24-30 months.

JV with Hitachi to be signed in end July 2010
The JV with Hitachi will provide BGR credible support for its EPC bidding, eventually establishing it as a serious player with long-term visibility. At the same time, BGR continues to enjoy flexibility to go with other vendors for subcritical equipment. The company has already identified land for setting up the 4,000 MW BTG manufacturing facility at a total capex of INR 32 bn.

Revising up FY11 and FY12 earnings
Based on increased order inflow estimate, together with likelihood of strong execution in FY11E, we have revised up our revenue estimate by 8.8% and 3.9% for FY11E and FY12E, respectively. With the company turning cash positive during FY10, we have increased our other income estimate thereby raising our earnings estimate by 21.1% and 13.1% for FY11E and FY12E respectively.

Outlook and valuations: Orders accretion to improve; maintain ‘BUY’
Given strong execution during Q4FY10 and progress on its ongoing projects (details explained overleaf), we expect BGR to continue to grow strong in FY11. New orders would be crucial for continued strong growth of the company in FY12 and beyond. On our revised EPS estimate of INR 40.1 (FY11E) and INR 52.5 (FY12E), the stock is trading at P/E of 18.9x and 14.4x FY11E and FY12E, respectively. We reiterate our ‘BUY’ recommendation on the stock. On relative
return basis the stock is rated ‘Sector Outperformer’.

To read the full report: BGR ENERGY

>BANKING SECTOR: Liquidity is likely to continue to remain stretched until August 2010

(1) scheduled issuances; (2) gradual inflow via government spending; and (3) slow deposit accretion. We believe rising wholesale rates are a precursor to the imminent increase in retail deposit rates (earlier than expectations). Banks highly dependent on wholesale funds (Yes Bank, IndusInd Bank), and NBFCs, could witness pressure on cost of funds. However given the effective transmission via base rate and emergence of pricing power amidst tight liquidity and pick up in credit offtake will positively impact margins.

Liquidity to remain tight unless buoyed by strong deposit growth and increased government spending: Considering the government issuance (Gsec, T-Bills, SDL) calendar and scheduled maturity, and interest due for these instruments, we estimate incremental outflows of ~INR 230 bn over next eight weeks. This is over and above the current repo of INR 568 bn (though redemption of INR 305 bn of Gsecs on July 28 will provide comfort). Post August, advance tax outflow in September and uptick in credit offtake before festive season will keep liquidity under pressure.

Wholesale rates rising sharply; retail to follow suit: Tight liquidity has created pressure on short-term rates; 3-month CP/CD rates are up 150-200bps, to 6% plus levels, and yield curve has started flattening. We believe repo rate hike and current tight liquidity scenario (to prevail for few more weeks) will aggravate pressure on wholesale rates. The trend in deposit mobilisation has not been so encouraging YTD; tight liquidity and rise in wholesale funds will pressurise banks to increase the retail deposit rates sooner than later.

NIMs unlikely to come under pressure soon over the medium term
We believe banks having higher dependence on wholesale funds viz Yes Bank, IndusInd Bank or higher proportion of deposits maturing within six months (adjusting for core CASA) viz ING Vysya Bank, Oriental Bank of Commerce, Kotak Mahindra Bank, and Yes Bank could witness relatively higher pressure on cost of funds. Over the medium term, however, we expect trend in bank margins to be positive, considering effective transmission of rise in deposit cost via base rate and enhanced pricing power amidst tight liquidity and pick-up in credit offtake. As per our recent interactions with NBFCs, most of them have started witnessing increase in funding cost due to rise in wholesale cost (CPs). On analysing the asset-liability maturity profile, we understand that there is no significant mismatch for NBFCs in the near term that can impact their margins adversely. For HDFC and LIC Housing Finance, assets and liabilities maturing within one year are matched effectively; M&M Financial, Magma and Shriram City Union have more assets maturing within one year than liabilities. While in case of PFC and REC, proportion of liabilities maturing in one year is higher than assets, we believe the asset-liability structure (above 80% liabilities fixed and more than 70% assets floating), coupled with pricing power should support margins.

To read the full report: BANKING SECTOR