Monday, December 19, 2011

>INDIA EQUITY STRATEGY: Rural growth - increasingly a mixed bag

India’s stellar rural growth is about the most consensus, verging on nearly unanimous, theme for investors in financial markets. Risks emanate precisely from this fact that rural growth is perceived as almost completely unaffected by the sharp slowdown in the rest of the economy. Early indicators and logical analysis of its drivers imply at least some caution in investments in the stock market.

Rural analysis – “mural” analysis
Plurality of rural India helps develop legends that make any report on the subject a captivating read right from the start. There are anywhere between 600,000 and 1 million villages in India with a combined population of over 700-million people. For anyone who starts by categorizing this continent-sized population as a single group, the first touch with the life in villages proves breath-taking, amid other things in its sheer diversity.

Less data, more pictures and anecdotes
It’s in the same unfathomable variety of rural India, the seeds of highly subjective and touchy-feely analysis are born. The reality is that there are extremely few real-time, objective data points on the economic life of rural Indians. All survey-based information on important parameters like land transactions, employment, wages or even expenditures on key consumables are generally available only sparsely and that too after long delays.

As a result, rural economy analysis has taken a highly pictorial form in the equity market industry in the last few years. A top-down discussion of the logical drivers of the rural economy are almost universally supplemented by the photos of well-paved roads, nicelybannered village shops or hard-working farmers with their gadgets or vehicles to prove the progress in the sector.

To be clear, photos replace charts in India’s rural economic discussions not just to make the reading more impressionable but mostly out of necessity of not having real-time data. The downside of the approach is obvious: a photo-based analysis is unlikely to show whether this diverse segment is growing at twice the speed in the previous period or a half. The long-term trends of better current state of affairs over the state many moons ago dominate the stories with little possible work on most recent trends and whether they are already in expectations or not.

As this report is not to introduce the sector or talk about its long-term trends or potential, but on marginal analysis – ie, whether growth in the periods ahead is likely to be lower or not – we will have to return to the traditional methods of available quantitative evidences and logical arguments.

Rural-only signals: some warning flags
All the above charts are for consumption across India and not just in rural provinces. The market is well aware of slowdown in the urban region which is likely the primary driver of most above series. The key question, of course, is whether there is any meaningful rural economic deceleration.

As we discussed above, there are extremely few real-time signals covering the vast rural economy. The two most encompassing, useful indicators are agricultural credit related data and tractor sales. Out of this, the former is definitely worrying. At below 8% YoY for the last two months, agricultural credit is growing at the lowest rates in over 15 years. More worryingly, there is a sharp increase in the sector’s non-performing assets with the largest State Bank of India.

Consumption is slowing – is it all urban?
It is true that India’s ongoing slowdown is led by the plunge in corporate investment cycle. That said, the associated impact from lack-of-supply caused inflation, high interest rates and reduced optimism have also begun to impact consumption. At around 6%, consumption growth is persisting close to the lowest levels seen in years. As the break-up of GDP growth also shows, all non-service related sectors (linked more to the rural economy) are decelerating sharply in recent quarters.

Main issue: investor expectations
Allow us to repeat one more time: for the vast and diverse rural India, the above evidences are scant and far from categorical in their conclusions. Painting a 700-million+ people segment with one boom or slowdown brush is simplistic in extreme even with best possible information. One can easily tell the rural tale even today with the same arguments that have been made repeatedly in the last five years to show that all is well. After all, there has been a great monsoon. Crop prices are still rising. Rural wages continue to benefit from government policies. And there are productivity increases. And even the most pessimists cannot claim that rural land prices, unlike urban property, are coming down.

The stock market conclusion is less ambivalent than the actual and potential rural growth trajectory because of the role played by lofty and unanimous expectations. We have created a basket of 15 stocks from the largest listed non-financial stocks that are generally considered a proxy on rural demand. As the following charts show, the basket has not only outperformed the benchmark handsomely in the last 18 months, the valuation premium too has expanded to the highest level in at least eight years.

To read the full report: EQUITY STRATEGY



Intensified competition
Currently the rural market is mainly dominated by NBFCs and other unorganized sources of funding. Also PSU banks are better positioned than the private sector banks in rural Indian. Going forward one will see things changing as greater thrust from the authorities will see the share of the NBFCs and unsecured institutions diminish. Currently some of the major NBFC players enjoy strong entry barriers in niche segments such as 2ND hand CV financing, equipment finance, gold loans, etc. This is mainly so as it takes years of experience to understand this client segment and their characteristics. Banks while initially reluctant to dabble with this segment have had time to develop their expertise and will soon start foraying into NBFC dominated areas. Within the banking segment itself there will be intensified competition. The RBI is likely to dole out fresh bank licenses very soon and one could see an influx of new banks as they seek to ensure greater financial participation and inclusion.

Greater emphasis on service and technology
In this era of intense competition banks will have to position themselves differently. While there is only so much one can alter in the banking business model, the key differentiators will be service quality and technology. PSU banks which were previously believed to shirk service have stepped up their game in recent years. The importance of technology while quite obvious in any industry could prove to be a huge differentiator. Mobile banking is expected to be a huge opportunity in the years to come. According to the Boston Consulting Group, payment and banking transactions through mobile phones could reach $350 billion by 2015. While the prospect of this happening is quite far away there could also come a day where one could have a branch-less banking system.

Fee based income
At the start of the previous decade Indian banks had a very limited fee based income component. While this has changed over the years, it is still far from the global average. Now in this long term structural era of rising interest rates where banks struggle to boost their NIMs one will see the banks focusing a lot more on their fee based activities. New generation banks are well stocked to provide these services (card services, guarantees, Investment banking, escrow, letter of credit, advisory services, etc.) but PSUs haven’t resorted to this in a big way. Going forward one is likely to see more impetus on the fee based income services.

Questionable if sizeable treasury gains can be made
Treasury yields have been low for the last decade or so, infact globally it has been low for over three decades. Now with the rapid rise in commodities, inflation has remained stubbornly high, thereby resulting in bond holders demanding a greater yield to hold onto bonds. This consequently makes bond investments less than appealing (inverse relationships of bond prices and yields) and it is questionable if treasury income will therefore be as high as it was in the previous decade, particularly for those banks who stick to HTM (Held to Maturity) as opposed to MTM (Mark to market).

To sum up..
Banks who manage and allocate capital well, have robust capital and liquidity buffers, possesses exceptional risk management, alternative fee based services have wide spreads, emphasize on service quality and seek to position themselves in a niche, differentiated manner in the eyes of the customer will prosper.

Near term outlook for banks
While inflation is expected to stay above the RBI’s comfort level there has been a decline or easing off of non food inflation. Besides the high base effect of the previous year will see the inflation number trend down in the months ahead. Commodity prices are a wild card and much could depend on liquidity driven initiatives taken by the West. On the other hand, the RBI has already tightened rates considerably and credit demand has certainly fallen off. Corporates are now resorting to borrowing from the overseas markets where rates are much lower. Thus weighing both sides of the coin it is fair to say that perhaps the rate cycle may be coming to an end.

Non food Credit outlook for the year as portended by the RBI is 18% while deposit outlook is pegged at 17%. Credit quality issues could crop up in this high interest rate regime so one is expecting to see a provisioning boost up. In the previous quarter results, one could see a clear deterioration in asset quality for most banks. Restructured assets as well are expected to rise.


The Indian growth story- Are banks good proxies to capture this growth?

‘The Indian growth story’ a popular phrase in investor circles may appear to be increasingly trite for the skeptics off late, but if one were to actually look at the larger picture and assuage the near term fears there is genuine merit in those four words. GDP which serves as the moniker for growth may have taken some sort of beating over the last few quarters and the year end FY12 expected figure leaves much to be desired. But if one were to widen the time period there is no doubt that the country is extremely well set to figure in the upper echelons of the growth table. Experts expect GDP to be anything between 7.4% to 7.8% for the current year but the long term median is expected to be 8-9%+. According to a report by PWC, India is poised to become the 2nd biggest economy in the world by 2050, with GDP in PPP terms expected to be $43180 billion, second only to China. Growth is expected to be more balanced and inclusive (though that is not the case currently) with services, industry and agriculture all expected to play crucial roles. Banks are fitting proxies in this attractive growth story for a whole host of reasons, none more important than the fact that they serve as intermediaries between savings and investment. According to McKinsey, based on how effectively banks capitalize on India’s growth potential, the banks could account for as much as 7.7% of the country’s GDP or 2.3% of the country’s GDP. Currently the figure stands at 2.5%. In a separate report PWC shows that from 2000-2010 while the Indian banking industry grew from $250 billion to more than $1.3 trillion at a CAGR of 18% compared to the average GDP growth of 7.2% for the same time period.

To read the full report: BANKING SECTOR 


>RANBAXY:Alert: Lipitor Launch-Another Milestone on the Road to Recovery

  Road to recovery — The US FDA approval for generic Lipitor gives us more comfort on Ranbaxy's ability to recover lost ground in the US. Besides the material upside during the exclusivity period (we believe the disquiet over profit sharing to Teva is overdone) & reasonable recurring upside thereafter, it provides Ranbaxy leverage with the trade & should rub off favourably on its underlying biz. Moreover, approval for the ANDA, originally filed from Paonta Sahib, via a site transfer points to the progress made in the remediation process. Maintain Buy (1H).

 Lipitor comes through as well — Ranbaxy continued its near 100% track record of launching its FTF products, despite FDA issues at its plant - Flomax (also monetized) being the only exception. The Lipitor approval follows approvals for Imitrex (albeit delayed), Valtrex & Aricept - all through site transfers to its plant in New Jersey. However, the Lipitor approval is more encouraging, as we believe the original filing was made from the Paonta Sahib site that is subject to an AIP.

 Our take on Teva's involvement — Ranbaxy indicated that it would share some portion of profits on Lipitor with Teva, during the exclusivity period. Based on Teva's guidance, this appears to be cUS$100m at the higher end - i.e. cRs9-10/sh (one time) for Ranbaxy. We do not see this as very material in the overall context. We would have been concerned, had a tie-up involved Teva distributing the product - as that would
mean it retains market share beyond exclusivity as well & Ranbaxy just gets a one time monetary upside (a la Flomax). However, in this case, Ranbaxy will be one of the leading players in generic Lipitor post exclusivity as well..

 Our US analyst says — (Alert: TEVA: Teva Entitled to a Portion of Generic Lipitor Profit) Terms of the agreement between the parties remain undisclosed; however, we believe it likely contained a range of scenarios incorporating different levels of service provided by Teva (e.g. API manufacturing, fill finish, distribution). We believe that Ranbaxy entered into an agreement with Teva as a contingency to accommodate the uncertainty created by its ANDA filing in order to ensure it fully monetized the Lipitor
opportunity .We assume that the $0.10 referenced by Teva in its 3Q11 call implied that Teva provided a wider range of services to support Ranbaxy’s generic Lipitor launch.

■ Financial Impact — We understand that price discount for generic Lipitor is c50%. Assuming 30% market share, we calculate generic Lipitor could add cRs35 (cRs25 excluding payoff to Teva) to Ranbaxy's EPS during exclusivity. Post this period, we expect higher price erosion (c90-95%) & lower market share (c20%), potentially translating to recurring EPS upside of cRs2 (c12% of CY11E core EPS).

■ What’s Next — We believe investor focus will now shift towards Lipitor market share data (Ranbaxy to ramp up slower than Watson), reflection of Lipitor in earnings, closure to FDA/DoJ issues (potentially imminent), commencement of Nexium formulation sales to Astra and trends in core biz (expect margins to keep improving). Confidence in rest of the FTF pipeline (Actos, Valcyte, Nexium) should be higher.

To read the full report: RANBAXY 

>$29,000,000,000,000: A Detailed Look at the Fed’s Bailout by Funding Facility and Recipient

There have been a number of estimates of the total amount of funding provided by the Federal
Reserve to bail out the financial system. For example, Bloomberg recently claimed that the cumulative commitment by the Fed (this includes asset purchases plus lending) was $7.77 trillion. As part of the Ford Foundation project “A Research and Policy Dialogue Project on Improving Governance of the Government Safety Net in Financial Crisis,” Nicola Matthews and
James Felkerson have undertaken an examination of the data on the Fed’s bailout of the financial system—the most comprehensive investigation of the raw data to date. This working paper is the first in a series that will report the results of this investigation.

The extraordinary scope and magnitude of the recent financial crisis of 2007–09 required an extraordinary response by the Fed in the fulfillment of its lender-of-last-resort function. The purpose of this paper is to provide a descriptive account of the Fed’s response to the recent financial crisis. It begins with a brief summary of the methodology, then outlines the unconventional facilities and programs aimed at stabilizing the existing financial structure. The paper concludes with a summary of the scope and magnitude of the Fed’s crisis response. The line: a Federal Reserve bailout commitment in excess of $29 trillion.


There have been a number of estimates of the total amount of funding provided by the Federal Reserve to bail out the financial system. While the Fed at first refused to provide data on its bailout, the Congress—led by Senator Bernie Sanders—ordered the Fed to provide an accounting of its actions. Further, Bloomberg successfully pursued a Freedom of Information Act suit for release of detailed data. That resulted in a “dump” of 25,000 pages of raw data. Bloomberg has recently claimed that the cumulative “spending” by the Fed (this includes asset purchases plus lending) was $7.77 trillion. However, the reports have not been sufficiently detailed to determine exactly what was included in that total.

We have conducted the most comprehensive investigation of the raw data to date. We find that the total spending is actually over $29 trillion. This is the first of a series of working papers in which we will present our results. We hope that other researchers will compare these results with their own, and are providing detailed break-downs to aid in such comparisons.

The extraordinary scope and magnitude of the recent financial crisis of 2007-2009\ required an extraordinary response by the Fed in the fulfillment of its lender of last resort function (LOLR). The Fed’s response did not disappoint; it was truly extraordinary. The purpose of this paper is to provide a descriptive account of the Fed’s response to the recent financial crisis. In an attempt to stabilize financial markets during the worst financial crisis since the Great Crash of 1929, the Fed engaged in loans, guarantees, and outright purchases of financial assets that were not only unprecedented (and of questionable legality), but cumulatively amounted to over twice current U.S. gross domestic product. The purpose of this paper is to delineate the essential characteristics and logistical specifics of the veritable “alphabet soup” of LOLR machinery rolled out to save the world financial system. We begin by making a brief statement regarding the methodology adopted in developing a suitable method with which to measure the scope and magnitude of the Fed’s crisis response. The core of the paper will follow, outlining the unconventional facilities and programs aimed at stabilizing (or “saving”) the existing financial structure. Only facilities in which transactions were conducted are considered in the discussion (some facilities were created but never used). The paper will conclude with a summary of the scope and magnitude of the Fed’s crisis response. In later working papers we will continue to provide more detailed analysis of the spending.

To read the full report: Federal Reserve bailout commitment