Wednesday, August 4, 2010

>GLOBAL FORECAST: Cooling Trend In Global Growth

Scotia Economics now expects that global growth will advance by 4.4% this year and 3.8% in 2011 (based upon a purchasing power parity weighting of 34 countries), with emerging countries still outpacing the performance of the advanced nations by a considerable margin. This continues a recent pattern of trimming our economic and financial market forecasts to reflect a number of key developments that are restraining activity around the world.

First, we have pared back domestically generated growth in the United States from already soft levels, with the increased economic and financial market uncertainty since late winter further undercutting confidence and business expansion plans. In a chronically weak job market, Americans continue to focus on paying down high levels of household debt. Housing activity has been adjusted lower to reflect downward revisions to sales and building data. The one relative
bright spot in the U.S. outlook continues to be business investment in machinery & equipment as firms take advantage of increasing order books and expanding international trade, though the mildly lower trajectory now projected for U.S. real GDP will likely take a bite out of the comparatively solid pace of earnings growth.

Second, the economic fallout in Europe from the sovereign debt crisis and the budgetary problems in the United Kingdom will progressively ripple through the region and the rest of the world in the second half of the year and in 2011. Beyond the negative economic impact on the region from the financial upheaval, the expected slowdown in domestic spending will dampen activity internationally through reduced imports and the weaker euro. Nevertheless, we have adjusted our 2010 forecast for the United Kingdom slightly higher because of the much better-than-expected results in Q2 attributable to the slowly emerging recovery that preceded the recent turbulence. Looking ahead, the accelerated pace of fiscal consolidation points to a period of slower, rather than faster, economic activity in the second half of this year and into 2011. While 2011 growth prospects for Germany and France will be limited due to fiscal consolidation and an export sector slowdown, the impact will be offset by a pick-up in activity in the euro zone periphery as these countries emerge from recession.

To read the full report: GLOBAL FORECAST

>INDIA STRATEGY: Chart Focus – Evaluating Tail Risk

The Debate: Is the market ignoring the macro pressures on inflation and the micro pressures on profit growth, especially given the premium valuations for equities? Hence, is the market set up for a big sell-off?

Market View: The market has reacted nonchalantly to a tepid earnings season, especially with the larger companies tending to disappoint on earnings. While inflation is a concern, the market seems to hold the view that the pressures will recede, and hence that India’s premium multiples will continue.

Our View: The 99%/1-week VAR (value-at-risk) represents the weekly market move that has a 1%
probability – i.e., the tail risk. When the historical VAR falls, it suggests that the market is increasingly complacent about tail risks. The 99%/1-week VAR is at a level which is consistent with a large sell-off. Going back 25 years, there are seven occasions when the VAR was at its current level (of less than 6%). Eventually, when VAR rises from this level, the market sells off 10% on an
average in a week (with the seven data points ranging from -5% to -13% – Exhibit 2). Note, though, that the historical VAR can remain at low levels for many weeks before culminating in a sell-off (on an average of 65 weeks!). VAR is a good indicator for impending tail risk, but it is not useful for timing the event. Fundamentally, India’s tail risk emanates from either a sharp world recovery (leading to inflation) or a “double dip” (causing a shortfall in funding for the current account).

Conclusion: While tail risk is in play, we do not believe that the market is likely to sell off in a big way anytime in the near future. The market is likely to reach higher levels before such a sell-off happens. History tells us that we may have to wait another year or for another 50% rise in index levels before tail risks play out. The market has spent only six weeks so far at the current VAR level, vs. the historical average of 65 weeks.

To read the full report: INDIA STRATEGY


Strong volume growth: Action Construction Equipment (ACE) reported sales of Rs1.3bn, a 60% YoY (in line with our expectation Rs1.3bn). Revenue increase was on the back of both, a lower base in Q1FY10 and increased volumes. The company saw significant increase in volume across all product ranges. ACE maintained that it could have done higher volumes for the quarter if it was not for loss of productivity on account of Oracle implementation. We expect the strong volume growth to continue, given the robust demand from infrastructure and alleged activities. There was an increase in EBITDA margins by 170bps YoY to 8.4%, primarily due to lower other costs. We expect EBITDA margins to improve in 10-10.5% range for FY11 as volume growth will help better capacity utilization.

PAT increased by 136% YoY to Rs80m from Rs34m in Q1FY11. This was on the back of higher EBITDA margins and lower (decrease of 37% YoY) interest cost of Rs4.9m.

New product offerings: ACE has started selling ‘Motor graders’ from the current quarter. It will also introduce a new product, ‘Mobile telehandlers’ by December in current year.The current market size of this product in India is bout 70-80 units per annum. However, if approved by defence for their specific requirement, the market could be ~1000 units per annum from defence itself.

Attractive Valuation: On the back of a substantial improvement in liquidity situation, both with NBFCs and Banks, coupled with an improving demand scenario, ACE is well placed at this point in time to take advantage of this increasingly positive scenario. At the CMP of Rs56, the stock trades at 10.6x FY11E and 7.9x FY12E earnings, respectively. We maintain ‘BUY’ on the

To read the full report: ACE

>JK CEMENT: Taxing times; Quaterly Update

Higher tax rate squashes bottom line
The operating performance of JK Cement (JKC) was in line with our expectations, but the lower net profit (due to a higher effective tax rate) was 15.2% below our estimates. JKC reported a 21.8% YoY growth in revenues thanks largely to a strong expansion in volume due to the addition of new capacities. The EBIDTA margin has declined by 1,280 bps YoY to 17.2%. The PAT for the quarter weakened 58% YoY (32.8% QoQ) to INR295mn.

Higher volumes, white cement shield profitability
Volume (including both grey and white) increased by 22.0% YoY to 1.34mn tonnes but blended realizations for the quarter were down by 0.2% YoY (1.2% QoQ) to INR3,882 per tonne as compared to INR3,889 per tonne in Q1FY10 due to sales in the low price South Indian market.
However, higher proportion of white cement sales (17.2% in Q1FY11 vs 16.3%in Q1FY10) helped cushion a sharp fall in realizations. Rising overall cost pressures were visible during the quarter as the cost per tonne increased 18% YoY (1.3% QoQ) to INR 3,214 as compared to INR 2,724 in Q1FY10. The EBITDA per tonne stood at INR668 as compared to INR1,165 in Q1FY10.

Maintain BUY with a target price of INR220
Though we expect margins for cement companies to be under pressure in the medium term due to the cost push and a decline in cement prices, JKC earnings are likely to be (partially) supported by stable white cement prices and a strong volume growth. Besides, the company is also trading at a more than 50% discount to its replacement cost as well as its large cap peers. Thus we are maintaining our BUY rating on JK Cement with an unchanged target price of INR220.

To read the full report: JK CEMENT

>BAJAJ ELECTRICALS: Result Update First quarter FY 2011

Bajaj Electricals (BEL) posted a healthy 35.2% growth in net sales for 1QFY2011, mainly on the back of strong growth in the lighting and consumer durables divisions, which grew 52.5% and 43.9%, respectively. Net sales at Rs483.9cr (Rs358.0cr) were slightly above our expectations. However, OPM declined to 8.4% (10.0%) on higher raw material costs. Interest costs fell to Rs5.7cr (Rs8.6cr) in 1QFY2011. Overall, PAT increased 37.3% to Rs22.5cr (Rs16.4cr). The carry
forward order book in the E&P division currently stands at Rs810cr. We remain Neutral on the stock.

Top-line growth momentum continues: The company maintained strong growth across segments during 1QFY2011. The lighting business grew 33%, while the luminaires business grew 78% during the quarter. In consumer durables, the appliances business grew 40%, Morphy Richards grew 48%, while fans registered 46% yoy growth. The E&P business registered mere 8% yoy growth for the quarter on a high base (82% growth in 1QFY2010).

Outlook and Valuations: We maintain our positive outlook on the company on the back of a comfortable order book position in the E&P business and normal monsoons expected this year, which augurs well for the consumer durables business. We expect sales to register 20.6% CAGR to Rs3,241cr in FY2012E from Rs2,229cr in FY2010. Currently, the stock is trading at fair valuations of 14.7x and 11.9x FY2011E and FY2012E EPS, respectively. We maintain a Neutral on the stock.

To read the full report: BAJAJ ELECTRICALS

>LUPIN: Result Update 1QFY2011

Lupin reported in-line 1QFY2011 results. The company continued its strong traction both in the US (Lotrel and Antara) as well as in the domestic (field force expansion) market. Though a delay in the launch of OC products in US is marginally disappointing, it’s unlikely to change the competitive scenario in the segment. We maintain an Accumulate on the stock and reiterate it as one of our top picks in the sector.

In-line results: Lupin reported net sales of Rs1,312cr (Rs1,285cr), which was in line with our estimates on the back of continuous traction in the US and domestic formulation segments. The company reported OPM of 20.0% (17.9%), up 210bp yoy on higher gross margins and exceeded our estimates. Net profit stood at Rs196.3cr (Rs140.1cr), up 40.1% driven by top-line growth and OPM expansion.

Outlook and Valuation: Lupin is at a discount of 7-23% to larger peers like Dr. Reddy’s, Sun Pharma and Cipla, which we believe is unwarranted given the scale achieved by the company in the last few years. We have valued the company at 18x (10% discount to large peers). The stock is currently trading at 20.1x and 16.1x FY2011E and FY2012E earnings, respectively. We maintain an Accumulate on the stock, with a Target Price of Rs2,099 and reiterate it as one of our top picks in the sector.

To read the full report: LUPIN