Monday, December 5, 2011

>EUROPEAN CREDIT OUTLOOK 2012: fasten your seatbelts

Slaves to the Euro crisis
We would expect a small rally at the start of 2012 as risk appetite rises, asset
allocation into credits occurs and the probability grows of a greater policymaker
response. We would start the year with an overweight-30% on high-grade credit,
but we would not be wedded to this view for long if the sovereign prognosis
remains bleak. We see a trading market rather than a directional market for 2012
as the sovereign crisis continues to determine much of the direction of credit.

Know your benchmark in 2012
“Rich” or “cheap” is more than just about spread to Bunds now. We urge investors
to keep an eye on credit spreads vs domestic government bond spreads next
year. French names have repriced significantly wider lately because of poor
relative value vs. French sovereigns. In our view, German credits look good value
versus their sovereigns, as do UK and Dutch credits. Spanish and Italian nonfinancials
look tight. French non-financials look fair rather than great value.

Non-financials fairly safe for another year
We still see “core” non-financials faring relatively well next year, even if recession
hits. Maturing corporate debt isn’t demanding, cash holdings are strong and
spreads already discount a further earnings drop of about 25%. Defensiveness
and capital preservation remain paramount for credit selection, in our view.

The great opportunities as well as risks
Loan refinancings are a lot more demanding next year (€500bn) and banks are
preoccupied with deleveraging. We don’t think this means the end of loan
financing for large-cap, “relationship” non-financials, but funding could become
trickier for mid-tier companies. We expect companies to term-out some of their
loan financing into bonds next year, even if for precautionary purposes.

More corps, less fins
We expect fixed-rate senior unsecured issuance to fall 35% in 2012 vs 2011.
Conversely, we think non-financial supply could rise 20%.

Sectors – go for global
We have made some changes at the sector level. We upgrade consumers to ow-
30% given their global sales profile. We still remain uw-30% on retail however
given austerity. Senior banks is still an ow-30% as the market shrinks, but sub
debt is now uw-30%. Insurance fundamentals still justify an ow-30%. We have
reduced steel to uw-30% given waning steel demand.

To read the full report: EUROPEAN CREDIT

>CAIRN INDIA LIMITED: We believe new promoters will support Cairn India’s production growth endeavours

We expect regulatory approvals to be the next catalysts for the stock. Government of
India has in principle approved the Cairn/Vedanta deal after Cairn India agreed to share
royalty and cess on its production from Rajasthan fields; however, some routine approvals
are due. We expect these approvals by the end of the year, which should pave the way for
production growth from 125,000bopd currently. Furthermore, we believe the new
promoters namely Vedanta Group will support Cairn India’s ramp-up endeavours as they
have done with their previous acquisitions (details in the note).

The current environment of stronger oil prices, rupee depreciation and narrow heavylight
spread should benefit Cairn. Despite worries concerning global growth, crude oil has
remained around the current level of more than US100/bbl. Our analysis indicates that the
Brent oil price is unlikely to fall below USD90/bbl (refer to the note by our global oil team:
‘2009 all over again? We doubt it’ dated 11 August 2011). Also, rupee depreciation is likely to
benefit Cairn India, which sells crude oil in US dollar denomination. With the return of oil
production from Libya, the spread between heavy-light crude has fallen, which could also
moderately decrease the discount that the company offers on its Rajasthan crude. Our
valuations are for Brent of USD90/bbl, INR45/USD and an 11% discount to Brent against
current crude oil price of USD110/bbl and USD/INR of 52.

Rajasthan block, the main value driver has significant upside potential. Our detailed
analysis indicates substantial reserves upside in CIL’s Rajasthan block, which is currently
producing 125,000bopd. We believe the in-place oil volume can more than double with
the consequent increase in probability-weighted reserves by c40%. It is important to note
that the Rajasthan block constitutes c95% of our current valuation for CIL.

Valuation and risks. We reiterate OW on the stock with a target price of INR350. We
value Cairn India on DCF for production from known reserves, and a risk-weighted
multiple for reserves upsides. Lower crude oil price, rupee appreciation and slower pace
of production ramp-up are key risks to our rating.

To read the full report: CAIRN INDIA


>Foreign Direct Investment in multi brand retail is finally here

As expected the approval comes with the following caveats. These were however well known before, so nothing very surprising in the fine print.
1. Companies will have to invest a minimum of $100mn or more
2. They can only open stores in cities with populations of 1mn or more.
3. At least 50% of the investment has to be in back end infrastructure – warehouses and cold chains
4. States will have the final say as stores have to comply with local legislation

We have highlighted before that this will be positive for the sector as a whole, where capital is severely constrained and companies have had to take on significant debt to put up front end stores as well as invest in back end infrastructure. With foreign participation now approved, this will allow them access to cheaper capital, which can significantly bring down the debt burden and help them improve profitability.

Operationally, investment in back end infrastructure will lead to efficiency improvements which will help these companies improve margins in the medium term.

Current penetration of organized retail is 6-7% of overall retail trade in India, which can increase significantly once capital is available at cheaper rates over the next few years. Indian retail companies have already been in talks with interested foreign retailers, so this final clearance gives them the chance to finalize their partnerships. We still think this will be 6-8 months away, but certainly a very strong medium term positive impact for retail companies.

To read the full report: FDI in Retail