Friday, October 21, 2011

>GOLD: Macro and financial factors driving gold returns over the past three years should remain in place for 2012.

Goose with the Golden Eggs

 Gold holds a unique historical status as a non-consumable commodity universally
recognized as a medium-of-exchange. Given the large amount of non-perishable
inventory overhang, traditional demand-and-supply dynamics do not apply in the short
term. In times of macroeconomic stress, financial factors may drive gold prices well
above physical costs of replacement for extended periods of time, thus exhibiting
“bubble-like” characteristics.

 There is a high probability that macroeconomic and financial factors which have
propelled gold prices over the last three years will continue for the next 12 to 18
months. We look at three major macro-financial drivers of nominal and real gold price
returns: denomination effects from inflation and currency adjustments, followed by real
interest rates, and finally financial demand for gold as a safe haven.

Denomination — Nominal gold prices quoted against the US dollar must reflect
changes in the value of the denominator. Common measures of changes in the
purchasing power of the US dollar include consumer price inflation and currency
exchange rates against a weighted basket. This has accounted for some but not all of
the appreciation in nominal gold prices.

Real Interest Rates — Once adjusting for denomination effects, real interest rates
serve as a useful proxy of the value of holding purely financial as opposed to physical
assets, thus capturing the opportunity cost of investing in gold. Given the weak
economic outlook, we expect central banks to keep nominal and real interest rates low,
providing the impetus to drive gold prices higher.

Financial Demand — Lastly, gold has seen an unprecedented amount of financial
demand from both retail investors and central banks seeking a safe-haven against
other asset classes. Given the high level of market uncertainty and continued turmoil
from the euro-zone crisis, this financial demand should continue into 2012.

Gold Price Outlook — We forecast nominal gold prices, which averaged $1220/t oz in
2010, to average $1575 in 2011 and $1950 in 2012.

To read the full report: GOLD

>RELIANCE INDUSTRIES: 2QFY12 results; revise EPS, target, reco

Reliance’s 2QFY12 net profit rose 0.7%QoQ to Rs57bn – 1% below expectation.
Ebitda came 7% ahead as weak refining was offset by better petchem. E&P Ebit
was also higher due to lower DD&A and higher liquids output. Forex losses and
lower other income pulled reported EPS estimates. We have cut FY12/13 EPS by
4/2% primarily to model a $0.2-0.3/bbl cut to GRMs. We also reset our 12m
forward target to Rs950/sh. After recent stock price rally, this implies only a 10%
upside; we revise our reco to O-PF noting also that the stock is again trading at a
premium to global peers with implied E&P value similar to the base BP-deal value.

2QFY12 net up 0.7% QoQ. Reliance’s 2QFY12 net rose 16%YoY/1%QoQ to Rs57bn
(Rs17.4/sh) – 1.3% below estimates. Lower refining was offset by better petchem
while E&P Ebit was also higher than expected on lower depreciation and higher liquids
output. Overall, core Ebit (Rs71.5bn, +9%QoQ) was 9% ahead. However, a large forex
loss (Rs4.4bn) and lower than expected other income pulled reported profit below our
estimates. Reliance also adjusted Rs45bn in translation losses on its forex debt on its
balance sheet driving up reported debt and fixed assets by this amount.

GRMs fall QoQ. Refining Ebit declined 4% QoQ – 10% below expectation led by a
US$0.2/bbl QoQ decline in GRMs (US$10.1/bbl) – US$0.4/bbl below estimates. As in
the last few quarters, Reliance’s realised margins continue to lag the strength in Singcomplex
margins (+US$0.5/bbl QoQ); for the quarter management attributed this to
primarily to softer light-heavy spreads, lower gasoil spread and use of higher cost LNG.

Strong petchem. Petchem Ebit rose 9%QoQ (16% above estimate), though, on
higher margins in polymers and chemicals offset by lower chain margins in polyesters.
A rebound in domestic demand (+21%QoQ in both polymers and polyesters) would
have helped while implied opex was also sharply lower (down 16%QoQ).

Mixed outcomes in E&P. Reliance adjusted the BP-deal from end Aug-11 leading to a
Rs32.2bn cut to E&P gross block; lower DD&A drove E&P Ebit up 4%QoQ even as KGD6
gas volumes declined 4mmscmd QoQ. Our interaction during the analyst meet
indicates that drilling and completions of additional wells may take 2-3 years implying
that a quick rebound in output is unlikely. Monetisation of other discoveries in KG-D6,
NEC-25 etc are also continent on government approvals and are unlikely before 2015.
Reliance also underscored that it has frozen exploration activity pending the outcome
of comprehensive review with BP. Progress in shale-gas is encouraging though, with
the Pioneer JV now producing at 6mmscmd of gas and ~25kbpd of condensate.

We lower EPS by 2-4%. We make several changes to our model, including an
US$0.2-0.3/bbl cut to GRMs, leading to a 4/2% cut to FY12/13 EPS. Lower earnings
and an alignment of NEC-25 resources to recent media comments (1.2tcf) leads to a
5% cut to our Mar-12 fair value to Rs915/sh; we set our 12-month target at Rs950/sh.

Revising rec to O-PF. After the recent rally, this implies just a 10% upside; we are
revising our reco to O-PF. We also highlight that the stock now implies an E&P value
similar to the base-value of the BP transaction (US$7.2bn for 30%) and is again
started trading at a 1-39% premium to peers on earnings based valuation multiples.

To read the full report: RIL

>ONGC: 2QFY12 oil realisation to improve significantly; Buy

Rising net realization and production growth on the horizon; reiterating Buy
We expect ONGC’s oil net realization to jump by 60% QoQ to US$78/bbl in
2QFY12 versus the last four years' average of US$52/bbl, driven by duty cuts and
fuel price hikes implemented by the Government of India in June 2011. Moreover,
ONGC’s newly elected Chairman has indicated production growth of 15% in oil
and 58% in natural gas over the next five years. ONGC’s stock price is currently
implying an upstream subsidy sharing of 50% going ahead, as against 31-42%
historically. Reiterating Buy.

Net realization to rise by 60% QoQ, to US$78/bbl, on lower subsidies
We estimate ONGC to report robust INR73.2bn net profit (+36% YoY, +79% QoQ)
for 2QFY12, on higher net realization of US$78/bbl (+24% YoY, +60% QoQ) and
lower royalty payments for the Rajasthan block RJ-ON-90/1. The sharp increase in
net realization is a result of lower estimated gross under-recoveries (INR204bn, -
53% QoQ), driven by fuel price hikes and duty cuts by the Government of India in
June 2011, as well as seasonally weaker diesel sales. ONGC’s average net
realization has been US$52.4/bbl the last 17 quarters. We assume an upstream
subsidy sharing of 38.7% (in line with FY11), vs. 33% in 1QFY12.

Expected production CAGR of 4.3% in oil and 3.6% in gas in the next 4 years
ONGC’s newly elected Chairman Mr Sudhir Vasudeva recently indicated
production growth of 15% in oil, to 28m tonnes, by FY14, and 58% in natural gas,
to 100mmscmd, by FY17. This is likely to come from the development of marginal
fields (G-1, GS-15, G-4-6, etc.), and the Daman Offshore and KG DWN 98/2 blocks.
We believe production start-up from KG DWN 98/2 is likely to be delayed. We
have built in a production CAGR of 4.3% in oil and 3.6% in gas in FY11-15E.

DCF-based value of INR365/sh; uncertain subsidy sharing the key risk
We value ONGC at INR365/sh, based on DCF, assuming a 12.9% WACC, based
on Deutsche Bank’s CoE assumptions for India (rfr 6.7% and risk premium 8.1%),
and a beta of 0.85. Key risks are vagaries in government policy on fuel pricing and
subsidies, a further increase in oil prices and a fall in oil & gas production.

To read the full report: ONGC


Key Investment Rationale

Plastic consumption in India to grow at 15% CAGR
With India’s GDP growing at 8% annually and plastic products increasingly
finding application in all sectors of the economy, replacing other competing
products such as steel and aluminium, we expect demand to remain robust.
The application of plastic is increasingly evident across sectors including
packaging, agriculture, healthcare, aerospace, electronics and infrastructure.
According to the All India Plastics Manufacturers’ Association (AIPMA), the
domestic consumption has been growing at 10-12% CAGR over the last decade
and is all set to reach the 12.5mn tonnes in 2012 from 9mn tonnes in 2010
which will make India the third largest plastic consumer after US and China.

Innovation & introduction of value-added products: Key to growth & margins
The key USP in any industry that is largely unorganised is to regularly innovate
and come out with niche products at regular intervals. Sintex, Supreme, Astral
Time have consistently followed this thumb rule and thus have been able to
grow at a pace which is way above the industry average.

Plastic composites: Niche high growth engine
Plastic composites are new age products and are ideal replacement for
conventional materials such as steel, aluminium and wood on account of their
durability, corrosion and maintenance free character. The Indian composites
industry has grown at healthy 16-18% CAGR over the last five years, more than
twice the GDP growth rate. The burgeoning manufacturing sector and heavy
investments in infrastructure is expected to provide an impetus to the Rs 63-
bn Indian composite industry, which is expected to grow at 16-17% CAGR.
From our coverage universe, Sintex and Time Technoplast have a presence in
the composites segment while Supreme Industries is currently putting up a
facility to make composite cylinders. These companies will not only benefit
from high growth in these segments but will also enjoy better margins as
compared to their bouquet of conventional plastic products.

To read the full report: PLASTICS INDUSTRY

>MARUTI SUZUKI INDIA: Cutting ests on continuing strike; longer term concerns on margins

What's changed
1) Due to the persistent labour strike at Maruti Suzuki’s Manesar plant and supplier Suzuki Power Train, we cut our volume estimates for Maruti Suzuki to 1.2mn units for FY12E (from 1.35mn), with further potential downside should the current impasse between labour and management continue beyond Oct’11. 2) We believe this will prevent the company from
taking advantage of new capacity at Manesar in the face of demand uptick driven by a) seasonally strong festive season, and b) launch of new Swift model in Aug’11. 3) Due to lower volume estimates, we cut our FY12-14E EPS by 13-15% (revised estimates 20% below Bloomberg consensus), and 12-m FY13E P/E-based TP by 9% to Rs1,071 (from Rs 1,173).

1) Industry-wide – The Society of Indian Automobile Manufacturers believes rising instances of labour unrest in the industry (e.g. tool-down strikes at MRF Tyres and Bosch India over the last two months) are also due to restrictive employment regulations in India (source: CNBC TV18).
As per a study published by the World Bank in Economic Times in Feb’07, there are 47 central laws and 157 state regulations dealing with labour markets, which are at times contradictory and overlapping, preventing efficient framing of employment contracts. 2) Company-specific – Any
worsening in labour disputes could potentially drive structural downside risk to Maruti Suzuki’s margins from higher staff costs in the long run, in our view. Maruti Suzuki’s current staff cost as a percentage of revenue is one of the lowest among peers in India and Asia.

The stock is currently trading at 1.8x FY13E P/B vs global peers trading at 1.5x and 7-year historical average at 2.9x.

Key risks
Greater/longer-than-expected impact of labour unrest and competition; interest rate cycle; volatility in commodity and currency markets.

To read the full report: MARUTI SUZUKI