Sunday, December 11, 2011

>EQUITY STRATEGY: India Investor Tours: Glass half full...or half empty?

The last quarter has been challenging for Indian equities, given the macro uncertainties – both local and global. In this backdrop, we hosted Investors in a series of Tours covering Senior Policy makers, Opinion leaders and Managements of more than 30 companies from the Financials, Investment and Consumption sectors over the last week. In this note, we have summarized the takeaways from these meetings. We believe these notes should serve as a useful guide to the current mood in business circles.

Key highlights:
Policy environment – Slowdown, but no Paralysis. The pace of economic reforms has not matched expectations. But that said, senior bureaucrats opined that allegations of a ‘policy paralysis’ are over done and largely a media creation. A sense of urgency appears to be coming
through. But execution will require consensus building and coordination. We discerned a heightened commitment towards containing inflation and fiscal consolidation. Progress on rural and social initiatives appear to be solid and may not be well appreciated.

Financials – A mixed bag. Interest rates have probably peaked, but the easing cycle could be some time away. Recent regulatory changes – abolition of prepayment charges, savings bank rate deregulation and tougher priority sector norms – are not seen as disruptive to sector dynamics. Loan growth remains healthy. But asset quality concerns remain at the fore given a slowing economy and the collapse in the INR. But balance sheet risk is expected to be episodic rather than systemic.

Investment cycle – Advantage SoEs. A muddled macro is taking a toll on investment cycle, particularly as it pertains to the private sector in the infrastructure segment. Management focus appears to be on internal measures to turn around viz. de-leveraging, working capital rationalization, etc. State owned companies however appear to be bucking the weak trend. A regulatory regime with assured returns and conservative leverage have allowed them to push ahead with their investment plans.

Consumption cycle – Moderating. The slowdown in discretionary spending appears to be gathering momentum. Demand for staples has been holding out until recently. But early signs of a moderation are beginning to manifest themselves. The bigger concern for managements remains margin pressure. A weak currency is adding to their woes, even as volumes moderate and competitive pressures remain intense.

To read the full report: EQUITY STRATEGY

>INDIAN STEEL SUBSECTOR: Shifting sands: Initiating coverage

We argue that sustained hikes in iron ore export duties have subsidised the domestic steel industry at the expense of miners. This, coupled with the ongoing mining impasse, make us negative on the iron ore mining space, even as stock valuations are attractive. We initiate coverage of NMDC and Sesa Goa with a 3-UW. We see the contours of the Indian steel industry slowly but certainly changing in favour of the large steel producers. JSPL 1-OW is our top pick, given its superior business model and strong growth visibility. We rate SAIL 3-UW, given muted volume growth and cost pressures. Tata Steel (1-OW) offers a favourable riskreward trade-off, given that peak debt is down (c20%), ROE accretive India expansion is closer to commissioning and valuations are already factoring in a negative value for its European operations. We rate JSW Steel as 2-EW, as although negatives are already in the price, the mining impasse would delay a rerating.

More bullish on the medium-term outlook for Indian steel relative to iron ore mining:
While global iron ore miners have captured value from rising steel prices, rising regulatory costs in India have capped upside for the Indian miners (read export duties). In fact, India now has one of the highest taxation regimes on iron ore globally, and could increase even further if the proposed mining tax and increase in export duties get implemented. We expect NMDC (3-UW) and Sesa Goa (3-UW) to be negatively impacted by this trend. Furthermore, ongoing government probes into potential illegal mining is a further risk to earnings of Sesa Goa (3-UW) and to some extent on JSW Steel (2-EW).

See structural changes in the steel sector benefiting the larger, established players: While we cannot ignore the short-term risk to steel pricing in India (which has held up well relative to global prices, due to currency depreciation and supply disruptions), we expect the larger integrated mills to capture further market share in India at the expense of the sponge iron producers (whose survival is threatened from declining coal and gas linkages). The big mills are also forming JVs with technology leaders globally and improving their product specifications, thus improving long-term margin potential. Domestic overcapacity is inevitable, but there is an opportunity in sub- segments such as value-added long products. We see JSPL (1-OW) and Tata Steel (1-OW) benefiting most from these changes, relative to SAIL (3-UW).

Further increase in regulatory costs and exchange rate are key risks: Over and above iron ore prices and the risk of increased Chinese exports, we highlight that a further increase in the regulatory burden for iron ore miners and exchange-rate risks on foreign currency-denominated debt are two issues investors need to keep an eye on.

To read the full report: INDIAN STEEL

>RANBAXY: Launches Caduet AG; Teva deal meant to secure Lipitor monetization Ranbaxy launches

RBXY announced the launch of AG Caduet. We believe FTF RBXY may have forfeited exclusivity as it failed to obtain approval within 30 months of filing. On Lipitor, mgmt indicated the Teva deal was done to secure monetization of the opportunity. We believe RBXY may clock profits of US$250-350mn during Lipitor exclusivity. We estimate annualized revenues of US$188mn post exclusivity in CY12F. While Lipitor approval and Caduet launch have eased downside risk, investor focus should now shift to comprehensive resolution. We remain cautious as revival in base business is in the price, in our view.

Ranbaxy launches authorized generic for Caduet (US$340mn)
Ranbaxy today announced the launch of Caduet (US$340mn) authorized generic in the US. As per the company, the launch follows an agreement with Pfizer. We believe that Ranbaxy is FTF on Caduet and might have forfeited its 180-day exclusivity as it could not obtain approval within 30 months of filing the ANDA. We note that the ANDA was a post-MMA filing and was filed in December 2008; the 30-month stay lapsed in June 2011.

We expect Ranbaxy to share a portion of its profits/sales with Pfizer in lieu of the license for launching the authorized version. Assuming a 60% price discount and 40% market share, Ranbaxy could clock revenues of US$54mn on an annualized basis. This would imply a net profit of ~US$11mn, based on our calculations.

We note that Mylan launched the generic version on Thursday, 1 December 2011. We believe that Caduet could be a limited competition opportunity in the near future with Sandoz being the only other Para IV filer that we are aware of. We believe Sandoz’s 30-month stay expires in April 2012.

Management indicates that deal with Teva was to secure monetization of Lipitor (US$7.4bn)
Ranbaxy’s CEO in an address to Ranbaxy’s employees regarding launch of generic Lipitor in the US stated that a partnership with Teva was to secure monetization of the Lipitor opportunity. We believe that Ranbaxy could share 25-30% of its profits from Lipitor generic during 180-day exclusivity with Teva. Please refer to our note “Lipitor approval eases downside risk” dated 1st December 2011 for further details.
Mr. Sawhney also said that Ranbaxy has enough capability to supply Lipitor through the 180-day exclusivity and beyond. He also expects Ranbaxy to remain the largest generic player in the atorvastatin market even post the 180-day exclusivity.

Management commentary comforting, but does not change our view on the stock
We note that the commentary is comforting as far as the monetization of the Lipitor opportunity beyond exclusivity is concerned. We estimate annualized revenues of US$188mn from generic Lipitor post exclusivity in CY12F for Ranbaxy. However, this event does not change our view on the stock. We expect a comprehensive settlement of outstanding FDA manufacturing and DOJ issues to be settled in due course. We have factored in US$350mn as penalty towards resolution. The timeline for resolution and quantum of penalty should be an important catalyst for the stock, in our view. We believe the market is factoring in settlement in the near term and expects a penalty of US$200-500mn towards resolution.

We believe the approval for Lipitor and launch of authorized generic of Caduet have reduced downside risk to some extent. However, given the valuation and expectation of revival in the base business post FDA resolution, the stock is not yet in the buying zone in our assessment. Excluding potential one-off exclusivity upside, the stock is trading at 25.6x CY11F EV/EBITDA and 48.9x P/E (pricing as of 1 December 2011), indicating strong expectation of base business revival.

To read the full report: RANBAXY