Sunday, January 15, 2012

>GOLD LOAN NBFC's: Muthoot Finance & Mannapuram Finance

Glittering as Gold!!!

Gold financing: Strong growth here to stay

The structurally strong business of gold financing has been and is expected to remain an attractive form of consumer financing given the dichotomic lending structure in India, highly liquid collateral and huge untapped potential in terms of value unlocking opportunity that the asset offers. Considering this, we are bullish on gold NBFC’s and initiate coverage on Muthoot (MUTH) and Manappuram (MGFL) with a positive outlook given their extensive network in place, better services and variant/dynamic product range. With Unorganized segment getting re-aligned towards Organized lending market, we believe that these companies are well positioned for the next leg of growth and expect MGFL and MUTH to grow their AUM at CAGR 48% and 32% respectively for FY11-14E.

Indian gold loan market – Opportunities galore
Historically, given the “urgent and essential” nature of this loan, the leadership is with the unorganized sector (75%/25% market share for Unorganized/Organized in FY09) in spite of an analogous existence of Banks and RRBs. However over the years, the organized segment has grown at CAGR of 68% in FY07-11 with an estimated market share of ~34% as on FY11. Going forward, considering the buoyant gold demand (32% of world gold demand), hefty gold holding of Indian households and voluminous market size, we believe that the strong growth for the organized players remains the leitmotif.

Under-penetration the drive-network the key
Within the organized segment, specialized NBFCs have witnessed extraordinary growth with MUTH and MGFL growing their branches at CAGR 67% and 99% respectively through FY09-11 due to their swift branch expansion, superior service offerings and timely infusion of capital. Given the growth nature of the gold loan market, the sole cost to grow would be network expansion. Henceforth, major drive for MUTH and MGFL, apart from their new branch openings, would also be coming from the maturing branches and hence increasing the penetration of the immature branches, which as on FY11 comprised a substantial weight in the blend: 64% for MUTH and 75% for MGFL.

Spreads to normalize- Scale to offset
Removal of PSL status from the funding by banks (direct or indirect), increases the cost of funds by 150-200bps. Adjacently, the competition intensities, should going forward result in yield moderation.

Impact of both of which should be normalization in the spreads by ~75bps for MUTH and ~200bps for MGFL. Having said that, with the increasing weights of mature branch in the blend, the benefits of operating leverage would reduce the Opex/Avg. Assets.

Attractive return ratios; Initiate with Buy rating
The current valuations of MGFL and MUTH are at 1.3x and 1.4x of FY13E BV respectively and doesn’t really factor the scalability, potential earnings growth and attractive model of high yield-low risk business in comparison with other asset financing NBFCs. We expect MGFL and MUTH to deliver an average RoE’s of ~26% and 30% through FY12-14E driven by their earnings growth of 47% and 32% respectively for the similar period. Given the huge value unlocking potential that this business has, we remain upbeat on the gold financing sector as a whole and initiate coverage with BUY rating on MGFL and MUTH with a target price of ` 76 and ` 232 respectively. Key risks: i) Significant and sustained drop in gold prices ii) Regulatory risks iii) Capital constraints and iv) Stiff competition from new entrants and banks.

To read the full report: GOLD LOAN


Lowering forecasts: We continue to expect Suzlon to end FY12 in the black after two consecutive years of losses. However, we reduce volume sales and margin assumptions because: (1) A weak global macro environment has tightened project financing and we expect shipment delays for REpower despite a strong order book of 2.7GW (as at October 2011), even if this is compensated by a higher EUR/INR rate (9% in the past 5 months). (2) We expect the Indian wind market to decline in 2012/13 and anticipate more pricing pressure leading to margin compression. We cut our FY12 and FY13 EPS (pre-exceptional) by c90% and c60% respectively, and remain below management guidance for FY12 and consensus. Cash flows strain from forex rate: At INR18, the shares are substantially below the foreign currency convertible bonds (FCCB) cINR77-97 conversion price range, making the possibility of an FCCB conversion remote. The sharp INR depreciation over the past few months is negative for Suzlon’s finances, already strained with loan repayments of INR37bn due in FY13, including FCCB payments.

Uncertainties create share overhang: We believe REpower loans have covenants limiting the free transfer of cash to Suzlon, although we continue to look for greater visibility from management on this. There is little clarity on the timing of the INR10bn payment from Edison Wind, due for around two years, and on further renegotiation of the FCCB conversion price. These uncertainties lead to share overhang, especially as the FCCB conversion deadline approaches. Any visibility from the company on these should help reduce this overhang

Trading at fair value: Our DCF-based valuation is INR40. However, due to continuing uncertainties around some of our key assumptions, we raise the discount to our DCF value to 50% from 15%. This increase is also supported by the fact that the stock trades at a premium to the average peer group 2012e PE. Our new 12-month target price is INR20 and implies 6% potential return; we retain our Neutral (V) rating. At the average global peer CY2012e PE of 10x, the stock would be valued at INR10.50, which we believe reflects a worst-case scenario; however, there are various catalysts that could bring up the shares to their DCF valuation.

Key catalysts: (i) improved visibility on cash inflows over the next few quarters (ii) continued
new order flow momentum and (iii) announcement / improvement of regulatory support in
new and existing wind markets and (iv) decline in interest rates in India. Key risks: (i) further
INR depreciation; (ii) margins and sales volumes lower than our expectations.

To read the full report: SUZLON ENERGY

>STERLITE INDUSTRIES INDIA LIMITED: Potential buyout of Balco – Restructuring opportunity

  • News flows stating the Government of India asking Sterlite to submit fresh proposals to buy-back the 49% stake it holds in Balco
  • There is a high possibility of the deal getting concluded during FY12 itself as Sterlite has long been pursuing the same and Govt currently expoloring all options of raising money
  • Balco’s stake sale would give Govt about Rs 15bn during FY12 itself. Not likely to materia lly impact Sterlite financials.
  • Balco buyout could pave the way HZL divestment giving Govt over Rs 150 at current valuations and Sterlite access to complete control over all subsidiaries

What would the buyout entail?

  • This would give the Govt anywhere around Rs 15bn and Sterlite complete control over Balco. This would not have any material impact on Sterlite’s financials.
  • There are presently three Govt nominees on the Balco Board. Buyout would realign the it’s composition and give Sterlite and Vedanta Resources (parent co of Sterlite) an edge to restructure their aluminium and power businesses.
  • Sterlite also has 30% stake in Vedanta Aluminium (Balance 70% held by Vedanta) and the deal could bring about synergy between Balco & Vedanta Aluminium operations
  • Further this could also pave the way for buyout of the Govt’s 29.5% stake in HZL. (HZL has Market capitalization of 520bn, Sterlite holds 65% of it)

Balco currently operates 245 ktpa of Aluminum, 810 MW of captive power. It is also in the process of commissioning 1200 MW (300 X4) of power and 325ktpa of smelter.
At current capacity Balco generates EBITDA of about Rs 10 bn per annum. Giving a multiple of 5X and adjusting for net debt of Rs 22bn as of 31st March 2011 the current equity value of Balco comes at Rs 28bn

We currently have a target price of Rs 162 for Sterlite. The contribution on account of Balco’s 51% stake is just Rs 4 (Valuation in Sterlite essentially comes from HZL, Zinc overseas operations, Sterlite Copper operations in India & Sterlite Power) We believe the buyout would address the uncertainties surrounding this aspect, fetch the government much needed revenue and give Sterlite and edge to bring about further synergies across its different operations.

Balco an unlisted aluminium company is held 51% by Sterlite & the balance 49% is held by the Government of India. This 51% stake was taken over by Sterlite in March 2001 for a sum of Rs 5.51bn, in the Government of India’s divestment program. The agreement then was that the remaining stake would be sold to Sterlite through call options after three years. The operational performance of Balco improved significantly on account of debottlenecking and expansion activities taken subsequently. Further the improvement in LME prices also gave strength to Balco’s financials.

However the Government of India later backed out saying the agreed price was too low; pushing the issue into arbitration. The arbitration issue lingered on for several years without both the parties reaching a consensus. The Chairman of Sterlite had earlier during July 2011 written to the Prime Minister Office seeking their intervention. The Empowered Group of Ministers (Finance, Law, Mines & heavy Industries) had shared during late Nov 2011 that “status quo” will be maintained. However recently, there has been fresh news report stating Government has sought fresh proposal on Balco buyout from Sterlite.



Healthy business expansion: In Q3 FY12, the bank’s management expects credit and deposit growth in a range of 20% and 18% respectively compared to 21% and 19% in Q2 FY12. In deposits, CASA share is expected to be maintained at 23% level.

OBC’s business growth in Q2 FY12 grew around 19.6%. In Q2 FY12, SME and overall priority sectors were key loan growth drivers. Going forward, higher retail term deposit rates will lead to higher deposit mobilisation. Further, OBC is expected to witness strong growth across all credit segments. Over FY11-13, we estimate OBC’s business CAGR at 17%, nearly in line with the industry. On business volume growth front, we expect credit and deposit growth of 18% and 17% respectively in FY12 and 17% in FY13.

Stable margin: In Q3 FY12, NIM is expected to improve by 10 bps (QoQ) to 2.75% on the back of higher credit-deposit ratio and lesser write-back of interest income. In Q2 FY12, the bank reported margins of 2.64% compared to 3.3% in Q2 FY11 and 2.94% in Q1 FY12. We expect margin to fall by 60 bps to 2.24% (on yearly average basis) compared to the bank’s management expectations of 20 bps fall to below 3% level compared to 3.2% in FY11.

Strain on asset quality: Overall, the bank’s management expects gross NPA to remain stable in percentage terms on QoQ basis, but loan-restructuring to increase sharply in Q3FY12 and Q4FY12. Though, the bank’s management is not sure of quantum of loan-restructuring to be done in Q3FY12, but they sounded quite negative on this front. Majority of large-ticket loan-restructuring would come from power (Rajasthan & Haryana SEBs), aviation (mainly Air India) sectors. Asset quality deteriorated over past couple of quarters as CBS implementation led to ` 8bn of slippages in Q2 FY12. During Q2 FY12, the bank completed 100% migration of its loan book under the systemdriven NPA recognition platform as expected.

The bank’s exposure to power sector is close to ` 135bn (13% of total advances), of which 71% is with central &; state government projects and rest with private companies’ projects. Total exposure to state electricity boards is ` 81bn of which ` 38bn is secured by state government guarantee.

The bank’s management expects Rajasthan & Haryana SEBs loans to come for restructuring in Q3FY12. The bank’s exposure to GTL group (`5bn) has been already restructured. In Aviation sector, the bank’s total exposure is ` 15bn (1.4% of total advances), of which exposure to Kingfisher is ` 460mn (backed by receivables). Rest is with AirIndia and Jet Airlines. Post FY12, the bank’s management expects things to revive in FY13 on restructuring front.

On gross NPA front, we factor increase in GNPA to 3.2% March-2012 from 1.98% in March-2011 and 2.95% in Q2FY12. On loan-restructuring front, we expect doubling of restructured loan book to ` 92bn on end- March-12 from ` 52bn as on end March-11.

We expect business to grow 17% CAGR during FY11-13 and margins to hover around 2.2-2.3%. At current market price of ` 218, the stock quotes at 0.67x adjusted book value FY13. We value the bank at ` 223 at 0.7x ABV FY13; we rate the stock as a Reduce.



2012: A 2011 Hangover
"October: This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February.” - Mark Twain

At the outset I would like to take this opportunity to wish you, your colleagues and family members a Very Happy and Prosperous New Year with lots of good health and peace of mind. In this note we present our brief overview of how 2012 is likely to pan out from a market and economy perspective in the backdrop of the view we had for calendar 2011.

Outlook 2012
Calendar 2011 has been a very tough year for the equity market, losing almost 25% in rupee terms, with large-cap stocks down much more than that and mid-caps being a different story altogether - totally decimated. Pessimism is extremely high right now and it is very hard to imagine it changing in a hurry. We retain our view of 14700 and 4400 on the Sensex and the Nifty for now.

Key Concerns in 2012

1. Politics
The polity of this country has taken a huge image beating in 2011 and in our assessment can do little to redeem itself at the immediate onset of 2012 at least. The lack of passage of any major reforms in 2011 - including the Lokpal Bill, FDI in Retail, Insurance and Aviation and no concrete signals on the Direct Tax Code and the Goods and Services Tax, to name a few – have put the government on the back foot. Not to mention that the corruption tag is going to take some time to shrug off and hence a governance discount with the ruling party will be maintained.

2. Economic Concerns
In the backdrop of a complete absence of economic policy reform by the government, the borrowing programme of the country continuing to rise (some media reports claiming its up by over 25% of Budget expectations) and the rupee depreciating by over 20% in the last five months of 2011 and stuck stubbornly in an immediate range of 52 – 54, the macros for the immediate future at least, don’t look too exciting.

With the fiscal deficit number almost certain to well exceed 5% (some estimates pegging it at even 5.5%), with no disinvestment in sight, and a widening current account deficit, as we saw from Friday’s numbers as well (US$16.9 bn for the September quarter at 3.6% of GDP, already on the higher side), there will be sustained pressure on the currency if the fiscal and current account deficit situation remains as bad or deteriorates further unless the regulators and policy makers are able to create an environment to attract capital flows into the country through FDI or FII investments, and on both counts a lot needs to be done, which is not looking likely or remains a priority right now.

It would not surprise me if the rupee depreciated in the range of 55 – 57 at some point this year even though the RBI has tried to intervene from time to time. Our forex reserves cannot continuously be used as a tool as that too would have its implications on current account deficit, and with the recent moves on curbing currency speculation by the RBI it remains to be seen what further tools, if any, the central bank has to stop the rupee from depreciating if there is a surge in outflows from the country, given the overall macros.

Some of the other major concerns would be growth slowing further, no visible signs of investment in the economy, inability of the government to attract significant capital inflows, corporates finding it difficult to roll-over shortterm forex debt, pressure on forex reserves from maturing short-term forex debt, and the resultant impact on the outflow of capital. Note, nations cannot increase fiscal deficit to provide stimulus to growth furthermore as well, as financial markets are not giving governments any leeway and are punishing sovereign bond yields for any relaxation in fiscal deficit. So, at least in the immediate future, things don’t look all that positive from an inflows perspective as well.

The question is how much is priced in? I think even if you assume the Lehman crisis as a benchmark of how low valuations and indices can go, then I think for the first quarter and the first half of 2012, there is a risk that 4400 on the Nifty can be both tested, and broken on the way down, though at this point its anyone’s guess how much lower it can go, given how uncertain and fluid the European picture is as well.

3. Growth Slowing
IIP: With the latest set of Index of Industrial Production numbers dropping to -5.1%, within which Manufacturing fell -6%, Mining -7.2%, Capital Goods -25.5%, Intermediate Goods -4.7% while Durables and Non-Durables also witnessed a contraction, The worst of the interest rate tightening is also being felt. While the latest Core Sector growth data does give hope at 6.8%, the question is: a) How believable these numbers are in the backdrop of fudged export numbers admittedly by the government and b) How sustainable are they?

GDP Growth: This concern over IIP is already being reflected in the GDP numbers, with the Q2 number coming in at 6.9%, leaving many experts to state that FY12 GDP growth will be less than 7% and FY13 less than 6% as well. This will have its bearings on earnings growth too and I do believe that FY13 earnings run the risk of a further downgrade and thereby FY14 too. While it is tough to put a number to what the extent of the downgrades will be compared to Bloomberg estimates currently in an ever so fast changing environment, expecting about a 10% revision lower, at least from current estimates for FY13 and FY14 (in line with the downgrade for FY12’s earnings over the last one year), does not seem unrealistic.

4. FII Inflows Not in Sight!
Do note that this year FIIs are only marginal sellers for the year 2011 as compared to the US$29bn they pumped into the equity market in 2010, so if the situation does get worse domestically, there could be pressures in store on this front.

However, this particular concern is going to largely depend on how the global picture pans out (in addition to overall domestic concerns highlighted above, but largely on how the world behaves in 2012). If Europe continues to be as bad as it is or worse (and there is no concrete evidence to suggest things are going to be much better in 2012), then it would be hard to imagine monies coming in from that part of the world.

From the time of the US downgrade by S&P, the dollar index has run up from about 74/75 to nearly 81, clearing indicating that dollar in times of crisis is still being viewed as a safe haven (gold in the same period has shed around 20%). And a stable-to-improving US economy is not going to make it easy for incremental FII flows to come into India. So unless we have policy-related inflows through instruments like FDI, FII inflows too don’t look like they are going to come into the country in a hurry like they did in 2010.

5. Europe
The second-half of 2011 was plagued with reports of the euro debt crisis reaching huge proportions, reports of a split of the euro region, the currency itself falling below 1.30 to the US dollar, countries losing sovereign status, new governments taking charge in the European Union and the possibility of massive liquidity injection which became a sort of reality towards the end of 2011 with a euro 489bn euro lifeline given to European banks for three years at a 1% interest rate (which also could not help revive sentiment). Stability in the region could lead to a huge sigh of relief globally, but as mentioned before in this note, it does not seem like its happening in a hurry on current evidence.

What Could Turn Market Sentiment Around?
1. Change in Government Stance to Pro-Policy or an Overall Change in Government Itself in India Passage of bills, whether it is FDI in Retail, Aviation and Insurance, the Lokpal Bill, a roadmap of definitive implementation of the DTC and GST and a strong image makeover to go with it would be taken as market positive for sure. Budget 2012, thereby, could be critical in terms of the roadmap the government presents on its finances and a reform agenda going forward. Whether is it the Bharatiya Janata Party that comes to power in 2014, or the Congress in a new avatar (a more policy assertive make-up, if it does) or we have a pre-2014 election, either ways, it will be a change and it will be market positive as the current establishment has led us to a ‘fed up’ situation. But in each of these scenarios the change, if it comes, is not going to be overnight and hence the probability of a national election-led rally is miniscule, if anything, it would be more reform-led.

The Uttar Pradesh assembly elections will be very closely watched and it could have some key signals for the 2014 general elections (if not before).

2. Inflation and Interest Rates
A good monsoon has helped primary and food inflation drop to low single-digit at 2.7% and 0.4%, respectively, and nonfood article inflation too has dropped to 0.3% as per the latest data available and the Reserve Bank of India (RBI) too has paused on rates for the moment (perhaps indicating that rate cuts could be a reality soon in 2012. Also, six major central banks too have cut rates recently and China looks like its falling in line, so peer pressure could be another thing weighing on the RBI’s mind). I think this inflation concern will arrest itself in 2012 and the base effect will also play in favour of the government (global growth slowing will have commodity prices cooling off and another good 2012 monsoon will aid in keeping inflation in check). Sustained positive news flow on inflation and interest rates could be a positive theme in store for the market in 2012. But here too, sustainability is the key.

The biggest risk to this view is Iran and should anything go awry in the Middle East and North Africa, it would have a significant bearing on crude oil prices and inflation too domestically coupled with a substantially weaker rupee from even the current levels.

Top BUY Ideas for 2012 from Stocks under Coverage

- IT: Infosys and HCL Technologies
- Oil & Gas: ONGC and GAIL
- Banks: HDFC Bank
- Pharmaceuticals: Sun Pharmaceutical Industries, Torrent Pharmaceuticals and Glenmark Pharmaceuticals
- Infrastructure: Reliance Infrastructure, IRB Infrastructure, IVRCL Infrastructure and GMR Infrastructure
- Metals: Sterlite Industries
- Real Estate: Oberoi Realty
- Mid-caps: Bata India and JBF Industries.


>SUGAR SECTOR: Summary estimates on Bajaj Hindusthan, Triveni Engineering & Shree Renuka Sugars

Profits to remain under pressure

We expect the profitability of sugar companies to remain under pressure impacted by higher sugarcane costs. The Uttar Pradesh government increased the SAP (State Advised Price) for Sugarcane to Rs240/quintal for SY12 against Rs205/quintal in SY11. Higher cane costs will impact the profit of UP based mills adversely and we expect them to report losses in SY12E. Average sugar price (S grade Mumbai) during the quarter was up 5.9% QoQ to Rs29.9/kg. Going forward, we believe that the increase in sugar production to 25.5mt in SY12E against 24.2mt in SY11 will lead to an increase in inventory levels, which in turn, will put pressure on domestic sugar prices leading to subdued profitability of companies. Post a steep
correction of 35-53% in the stock prices since our sector initiation in September ’11 and cyclical-low valuations, we had upgraded our coverage universe (Triveni- from Hold to Buy and Bajaj Hind- from Sell to Hold) post Q4SY11 results. However, there can be near-term challenges due to higher than expected sugar production, which may put pressure on sugar prices. The triggers for upside would be a) building up of cane arrears in this crushing season b) further allowance of exports by the government c) higher than expected sugar price and d) decline in area under sugarcane cultivation for
next crushing season.

 Sugar price remained high in this quarter: Sugar price (S grade Mumbai) during the quarter increased 5.9% QoQ to Rs29.9/kg. Current sugar price (S grade Mumbai) is at Rs2,956/quintal. Going forward, we believe that sugar price will be under pressure due to our expectation of increase in inventory levels (7.2mt by SY12- end against 5.8mt in SY11-end).

 Export of 1mt allowed during the quarter: The government allowed 1mt of sugar exports under OGL (Open General License) quota in this quarter, which will help the companies generate additional profits.

 Decline in global sugar price: Global sugar price declined by 20% YoY and 8.6% QoQ to US$596/tonne during the quarter. The decline in global price was driven by the expectation that decline in Brazilian production would be offset by higher sugar production in India, Thailand and Russia.

 Valuations attractive though near-term challenges persist: Post a steep correction of 35-53% in the stock prices since our sector initiation in September ’11 and cyclical-low valuations; we had upgraded our coverage universe (Triveni- from Hold to Buy and Bajaj Hind- from Sell to Hold) post Q4SY11 results. However, there could be near-term challenges due to higher than expected sugar production, which may put pressure on sugar prices. Current sugar price at 30-31/kg is higher that our expectation of Rs28/kg in SY12E and we would review our price assumption as the crushing season progresses. We maintain Buy on Triveni Engineering & Industries and Shree Renuka Sugars. We have a hold rating on Bajaj Hindusthan.

Bajaj Hindusthan (Hold, Target Price: Rs31, CMP: Rs28.7)

  • We expect the company to sell 3.3lakh tonnes of sugar in the quarter with an average realization of Rs30/kg. Net sales of the company is expected to decline 25.1% YoY (but, increase 3.1% QoQ) to Rs11bn
  • EBITDA is expected to decline 14.8% YoY (but, increase 14.6x QoQ) to Rs2.2bn. EBITDA margin in the quarter is expected to be 20% against 17.7% in Q1SY11 and 1.4% in Q4SY11
  • Interest cost is expected to increase 21.5% YoY to Rs1.3bn
  • Profit is expected to decline 79.8% YoY to Rs117mn. In Q4SY11, the company had reported loss of Rs1.2bn.

Shree Renuka Sugars (Buy, Target Price: Rs46, CMP: Rs30.3)

  • Consolidated revenue is expected to decline 7.2% YoY and 10.7% QoQ to Rs20.8bn in the quarter. Sales volume of the company is expected to be 2.8lakh tonnes in India at an average realization of Rs28.4/kg. Sales volume in Brazil is expected to be 2.1lakh tonnes.
  • EBITDA is expected to increase 16.5% YoY and 43.5% QoQ to Rs3.5bn mainly because of higher realizations in Indian markets
  • EBITDA margin is expected to be 16.8% vs 13.4% in Q1SY11 and 10.5% in Q4SY11
  • Adjusted PAT is expected to decline 19.7% YoY to Rs533mn

Triveni Engineering (Buy, Target Price: Rs23, CMP: Rs16.3)

  • The company is expected to sell 1.16lakh tonnes of sugar in the quarter at an average realization of Rs30/kg. Revenue is expected to decline 25% YoY (but, go up 16.7% QoQ) to Rs4.4bn. The results are not comparable on YoY basis, due to the de-merger of turbine business in April ’11.
  • EBITDA is expected to decline 35.5% YoY and 11.4% QoQ to Rs449mn. EBITDA margin in this quarter is expected to be 10.1% against 11.8% in Q1SY11 and 13.3% in Q4SY11
  • Adjusted PAT is expected to decline 84.1% YoY to Rs38mn


>Oct-Dec 2011 Earnings Preview: Sector Specific Expectations- Cement, Construction, Capital Goods, Utilities, Metals & Mining and Oil & Gas (Brent Crude Price & Singapore GRM)

The cement companies under our coverage are expected to post a growth of 5% YoY and 7% QoQ during Q3FY12 despite insignificant uptick in the infrastructure segment. Low base and improved rural demand are key drivers. Operating margins of the companies are likely to improve as high as 100-700 bps due to a significant improvement in average realization (18-26% growth on YoY) mainly triggered by solid jump in realization in the Southern region. However, a continued operating cost pressure viz- raw materials, power & fuel and transportation has negated realization growth to an extent and is expected to persist in the coming quarters. The industry saw strong pricing power mainly on account of a suitable production discipline maintained by industry players. However, the sustainability of pricing should be the key factor in the coming quarters, for which we strongly believe that industrial capex should pick up and expedite infrastructure activities. We continue to prefer ACC and Ultratech over Ambuja among large players and maintain our BUY rating on India Cement and JK Cement.

The construction companies under our coverage are expected to report revenue growth of 12% YoY and 19% QoQ in Q3 FY12. JP Associates and Unity Infra are to be the main driver, which are expected to grow by 19% and 18% YoY, respectively followed by 13% growth in Simplex Infrastructures Ltd. We believe this quarter is going to be crucial for the construction sector in the wake of substantial movement of exchange rates, which may be a standstill for companies having exposure to foreign loans. JP Associates is expected to be impacted most due to its unhedged FCCB of US$354mn (due for redemption in Sept 2012).

Key things to watch out for this quarter: 1) pace of execution pick up post the monsoon, 2) effect of exchange movement in the P&L, 3) impact of high interest costs, and 4) working capital management contemplated by many companies in the last two-three quarters.

We expect overall order inflows for the capital goods sector to slow down, continuing the trend witnessed in the September quarter. We expect both BHEL and L&T to see a y-o-y decline in order inflows, which is likely to lead to order book depletion for both. At EBIDTA levels, we expect margin pressures to flow in, though not very significant, as the quarterly revenues would be dependent on the existing order book, which should have better margins than the new orders.

The key data points to watch out would be the management commentaries on order inflows going forward and the balance sheet position of these companies, particularly on the working capital side.

We expect NTPC and Powergrid to post modest growth in line with their capacity expansion. As usual, there would be one offs and provisional write backs and write offs, resulting in an adjusted profit number.

Key data points to watch out would be gross block addition for each of the companies and balance sheet position of these companies, particularly on the working capital side.

Ferrous metals: Volume growth (QoQ): We expect flat sales volume growth for Tata Steel, SAIL and JSW Steel ltd.  Realization trend: During Q3FY12, domestic flat steel prices showed no growth q-o-q, whereas long steel products prices were up about 2% q-o-q. We expect steel companies to report flat to about 1% QoQ growth in realization. Raw material prices: Average iron ore prices during Q3FY12 were USD129/MT (63.5% fe – FOB India), declining by 21.6% QoQ. Coking coal contracts for the quarter were done at USD285/MT as compared to USD305/MT during Q2FY12. Profitability: Raw material prices during Q3FY12 were lower as compared to Q2FY12 and steel realizations were flat QoQ. Nevertheless, the significant QoQ depreciation of the Indian Rupee vs the USD by 11% resulted in higher cost of coking coal imports, which dampened the benefits of lower dollar denominated raw material prices of iron ore and coking coal during the quarter.

Non ferrous metals: Realization: Aluminium, zinc, lead and copper prices fell QoQ by 13%, 15%, 19% and 17%, respectively to USD2090/MT, USD1897/MT, USD1982/MT and USD7488/MT during Q3FY12 (YoY prices were also down for all commodities by 11%, 18%, 17% and 13%, respectively).


Brent price averaged at US$109.31/bbl, down 3% Q-o-Q but 26% up Y-o-Y in Q3 FY12. Regional GRMs were down 13% sequentially but 45% Y-o-Y at US$7.98/bbl. Crude prices have been resilient despite the global economic slowdown mainly due to supply side issues, particularly in the OPEC region + concerns of impending sanctions against Iran that may disrupt supplies in the near term.

Refining margins come off recent highs
Average Singapore refining margins for Q3 FY12 stood at US$8/bbl v/s US$9/bbl in Q2FY12. This was mainly due to weak product cracks, particularly gasoline (down US$6.6/bbl QoQ) and naphtha (down US$7.1/bbl QoQ). Also, light-heavy spreads (Dubai-Brent) too contracted US$2.6/bbl QoQ. However, Indian refiners are expected to post steeper declines in refining margins mainly led by steeper decline in light-heavy spreads and a decline in product cracks with a higher weightage in the Indian product slate.

Reliance Industries (RIL) is expected to post US$2.3/bbl QoQ decline in GRMs in Q3 to US$7.9/bbl. This is mainly due to i) higher decline in LPG, naphtha cracks, which have a higher weightage in RIL’s product slate and increase in FO cracks, which have a lower weightage; and ii) QoQ lower light-heavy crude spreads (mainly Arab Heavy-Dubai and Oriente-Dubai).

Under recoveries
We model `313bn of under-recoveries in Q3 FY12 – `134bn towards LPG/ kerosene and the balance `179bn towards auto fuels. We assume upstream companies to contribute 33% and R&M companies to contribute the balance in Q3FY12. We have not assumed any government contribution to the overall subsidy in Q3 in addition to the already announced `300bn subsidy in H1. R&M companies are expected to account for the `150bn subsidy support from the government in Q3.

We expect R&M companies to post losses of ` 110.43bn in Q3, mainly due to higher under-recoveries and lack of government subsidy support. The PAT numbers are subject to change as and when any additional support from the government is announced. However, R&M companies may write back MTM forex losses on foreign currency denominated debt incurred in H1 in their Q3 results. The impact of this would be `9.07bn for BPCL and ` 23.1bn for IOC. This write-back, if done, would restrict the losses to `33.35bn and `11.3bn for BPCL and IOC, respectively. However, our base case numbers do not include the impact of this write-back.

Rupee depreciation
Rupee averaged at Rs 51.0 in Q3 FY12, a fall of 11.4% Q-o-Q. For December month, it averaged at `52.6, a drop of 3% compared to average of Q2 FY12. The rupee depreciation is hitting revenues of state-run oil marketing firms as the weakening of the rupee against the dollar by Re 1 impacts costs of diesel, kerosene and cooking gas by ` 9,300 crore per annum.

RIL: RIL is expected to post QoQ decline in PAT mainly due to fall across its business segments viz. Refining, Petchem and E&P. We expect RIL to report PAT of `47bn, a decline of 18% QoQ and 9% YoY.

ONGC: We expect ONGC to report PAT of Rs 81bn in Q3, a YoY growth of 14% but a decline of 6% QoQ. The QoQ decline is mainly due to an increase in subsidy burden by 47% QoQ to `84bn, led by the steep depreciation in the rupee.

Cairn India: We expect Cairn India to report PAT of `21bn in Q3 FY12 v/s Rs 20bn in Q3 FY11. The muted growth in Q3 FY12 PAT despite much higher crude prices (up 27% YoY) is mainly due to the impact of royalty on RJ crude, which will be accounted in this quarter but was not accounted in Q3 FY11 (cumulative impact of royalty from start of production till Q2 FY12 was accounted in Q2 itself). Hence, the numbers are not strictly comparable on a YoY basis.