Sunday, December 18, 2011

>RBI’s mid quarter monetary policy review (December 16, 2011)

On the backdrop, of challenging global & domestic economic environment RBI in its mid quarter review halted its monetary policy tightening measure as per our expectations. RBI decided to

• keep the cash reserve ratio (CRR) unchanged at 6%
• keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 8.5%
• Consequently, the reverse repo rate under the LAF will remain unchanged at 7.5% and the
marginal standing facility (MSF) rate at 9.5%.

The RBI's view on rates is based on
Growth momentum is weakening in the advanced economies amidst heightened concerns that
recovery may take longer than expected earlier.

This, combined with the slowing down of domestic demand, to which the monetary policy stance is also contributing, suggests that risks to the growth projection for 2011-12 made in the January

Review are on the downside.
Meanwhile, RBI maintained its inflation projection for March 2012 at 7% due to moderation in food inflation in November 2011 and expected moderation in aggregate demand leading to decline in non-food manufactured products inflation.

Outlook & View
RBI has clearly indicated a threat to domestic economy from uncertain global macro-economic
environment. As a consequence of all-round slower growth, inflation has also started declining, both in advanced countries and EMEs. This will affect the composition of capital flows from developed economies. On the domestic front, monsoon rains so far have been normal. The first advance estimates for the 2011-12 kharif season point to a record production of rice, oilseeds and cotton, while the output of pulses may decline. Fiscal deficit target of 4.6% has become a challenge due to various developments in macro economic environment. On the expenditure side, the subsidy burden will overshoot the budgeted amount in 2011-12 significantly, despite the recent revision in petroleum product prices.

As we have mentioned in our RBI’s monetary policy expectations report, among the four factors (higher inflation, interest rates, lack of reforms and currency depreciation), inflation has started to fall along with RBI intervention to arrest the rupee depreciation. This will help the economy to stablise from slowdown witnessed in near term. Also RBI has assured that monetary policy actions are likely to reverse the cycle, responding to the risks to growth. The halt of interest rate hikes is positive for the banking sector, which are facing challenges like slower growth of credit & deteriorating asset quality. RISH TRADER

>You Can Bank on it: European Banks Need Tons of Money

The global economy has been one victim of the recent crisis of European sovereign debt, but Europe's banking sector and the investors who have financed it will be the next. A great deal of pushing and shoving has forced European authorities to accept that there is a problem in their banking sector, Some are working hard to understand the problems and others see themselves as immune, though they probably are not; but all have been tempted to let political factors influence decisions that need to be based on sound economic and regulatory footings.

To read full report: EUROPEAN BANKS


>POWER FINANCIERS: Power Finance Corporation (POWF) & Rural Electrification Corporation (RECL)

Light at the end of the tunnel

 POWF and RECL are best placed to leverage on the massive investment opportunity: Over the next five years, c.$236bn is estimated to be invested in the power sector as India scales-up infrastructure in generation, transmission and distribution. REC and POWF are best positioned to leverage on the massive investment opportunity given a) IFC status which gives exposure limits advantage, easier access to ECBs. IFCs have a competitive edge over banks given better asset-liability profile. Further, most banks are approaching their sectoral limits for infrastructure sector which should reduce competitive intensity for specialised power financiers like POWF and RECL.

 SEB default unlikely – losses may have peaked, tariff hike trend encouraging: SEBs have been under financial distress due to non-revision of tariffs, non-payment of subsidies and high merchant power rates. However, recent measures offer hope that their finances will improve going ahead led by a) 5-40% tariff hike across states over the last 18 months (Exhibit 2). Further, 3 of the 4 states (TN, UP, MP, Rajasthan) that account for c.70% of cash losses have already raised/proposed to raise tariff while UP will raise tariff post election early next year. b) APTEL facilitating suo-motu tariff increase by the regulator. c) Increasing pressure from lenders to improve finances by raising tariffs/improving efficiency. d) Declining power purchase costs which would provide much needed relief to SEBs. These measures are a step in the right direction and we believe financial position of SEBs will improve going forward, implying that default from SEBs for POWF and RECL is unlikely.

 Fuel availability - A key risk: Coal and gas availability, in our view, is a significant threat which could restrict power supplies and impact financial viability of projects. Coal supply has been severely hampered due to a) Coal India unable to achieve sufficient production growth, b) delayed environmental clearances, c) infrastructure bottlenecks, d) blending limitation in existing plants, e) pricing issues on imported coal from Indonesia and Australia. However, recent steps by government to scrap go and no-go policy and granting environment clearances to some delayed projects should reduce this concern over the medium term (3 years); though fuel availability remains a key near-term risk which could lead to restructuring of projects (especially IPPs in the capacity range of 50Mw-100mW) and result in some NPV loss for power financiers.

 Initiate coverage on POWF and RECL – BUY with TP of `205 and `220 respectively - recent SEB/government measures and decline in wholesale rates should act as key catalysts: POWF and RECL have de-rated significantly over the past 12 months due to concerns over financial health of SEBs (POWF currently trades at 0.95x 1yr fwd book, down from a peak of 2.9x; while RECL at 1.1x 1yr fwd book, down from a peak of 2.9x. Going ahead, we believe recent SEB/government measures and decline in wholesale borrowing rates from 1QFY13 (which will impact spreads positively) should act as key catalysts for stock outperformance. We initiate coverage on POWF with Mar’13 TP of `205 – current valuations are attractive at 0.9x FY13E book with dividend yield of c.5% (based on FY13E dividend). We value the stock at 1x FY14P/B (at 1.05x Mar’14 ABV - adjusted for bad and doubtful debt reserves) Initiate coverage on RECL with Mar’13 TP of `220 - current valuations are attractive at 1x FY13E book with dividend yield of c.5% (based on FY13E dividend). We value the stock at 1.1x FY14P/B (at 1.15x Mar’14 ABV - adjusted for bad and doubtful debt reserves).

To read the full report: POWER FINANCIERS

>ENGINEERS INDIA LIMITED (EIL): Providing design, engineering, procurement, construction and integrated project management services mainly to the petrochemical and oil and gas refining sectors.

The real Indian engineers
Amongst its Engineering & Construction (E&C) peers, EIL has an unmatched cash flow profile and RoEs (37%-40%). Specific, yet scalable, hydrocarbon engineering and project management skills, a large talent pool and Government ownership drive its competitiveness. Rising investments in the hydrocarbons sector by Government related companies (XIIth 5-year plan suggests 2x XIth plan investments) will fuel EIL’s growth. Whilst there can be near-term growth deceleration, the present valuations (12x FY13 core eps) do not reflect the firm’s competitiveness and its cash flow generating capability.

■ Competitive positioning: STRONG Change to this position: POSITIVE
The E&C sector’s overhang has led to EIL’s stock price declining 37% over the past year despite revenue growth remaining strong (up 40% YoY in 1HFY12) and the firm’s business capabilities being robust. In an industry where companies are shedding strength with rising debt, we recommend EIL due to: Government sponsored enterprises to invest twice in the XIIth plan v/s the XIth plan: The cyclical nature of refinery and petchem investments can lead to a lack of orders for a brief period. But Government sponsored plans to increase their refinery capacity [by 60% (74mmtpa) by investing US$18bn in greenfield capacities and US$13bn in upgradations] will provide EIL with growth visibility over FY12-FY17. Further, greenfield petchem capex is expected to be closer to US$8bn. Slippage risks are low owing to Government support for energy PSUs and fewer procedural problems in expansions.

 Superlative capabilities with flexibility: EIL’s scalable hydrocarbon engineering/project management skills, extensive experience and Government ownership make its offerings flexible — not only E&C services across the contracts spectrum (design to EPC) but also critical path projects, tweaking the usual EPC models (offering open book estimates, OBE) and entering into longterm relationships (MoUs, nominations) with energy PSUs. The cost-sensitive nature of large projects keeps the threat from the high-cost global majors low.

■ Unrivalled CFOs and RoEs: Over FY08-FY11 EIL leveraged its rising investments by capturing a bigger share of hydrocarbon spend by taking up low EBITDA margin (10%-12%) high volume lumpsum turnkey (LSTK) jobs (144% CAGR) instead of high EBITDA margin (40%) low volume consulting jobs (22% revenue CAGR). Hence, op cashflows (CFO) rose and RoEs moved to 37%-40% from mid-teens earlier, overriding the declining EBITDA concerns.

■ Valuations projecting near-term concerns into long-term? Despite a radically better CFO/RoE profile, EIL’s stock trades in line with peers. Paltry orders in FY12 and a growth deceleration beyond FY13 have led to a gradual derating. We do expect lower revenue growth over FY13-FY15, but believe EIL’s multiple should retrace lost ground as the refinery opportunity gets supplemented with fertilizer capex, thus addressing growth concerns. A higher investible float than many peers addresses low free float concerns.

To read the full report: EIL