Monday, January 23, 2012

>GLOBAL ECONOMIC OUTLOOK: Overview — Economic Divergence and Financial Repression

We continue to expect a sizeable slowdown in global economic growth in 2012, with renewed recession in the euro area, growth of roughly 2% in the US, and slowing – albeit still strong – growth in Asia1. Within that broad outlook, we again make more forecast downgrades than upgrades, and we expect that overall global growth will slow from 3.0% in 2011 to 2.3% in 2012 (down from 2.5% in our previous forecast).

We are again cutting our 2012-13 growth forecasts for a range of European economies, with GDP downgrades for the euro area, UK, Sweden, Switzerland, the Czech Republic, Hungary and Norway2. We now expect that euro area real GDP will fall by 1.5% this year and will fall by 0.4% in 2013 (prior forecasts were minus 1.2% and minus 0.2%, respectively). In the euro area, these new downgrades chiefly reflect announced or expected extra fiscal tightening in Italy, Spain and the Netherlands, plus the continued drag from tight financial conditions and the weak banking system. Other European economies are being hit by adverse spillovers from the probable EMU recession and, especially in the UK, internal drag from high private debts. We do not expect that euro area real GDP will regain its prerecession peak until late 2016. Going the other way, the only significant upgrade is Russia, for which we are raising our 2012 GDP forecast to 3.5% from 2.5%.

Our forecasts imply a further marked rise in the GDP growth differentials between the US and Euro Area, with the gap in terms of YoY GDP growth likely to reach 3 ½%-4% in coming quarters, the highest in recent decades – even above the wide late 90s divergence. While the euro area probably already slipped into recession in the final quarter of 2011, we continue to expect sustained economic growth near 2% this year for the US despite unsettled financial conditions. Indeed, for the US, gradual improvement in the labor market and the resilience of activity in the face of negative shocks have introduced upside possibilities. We expect housing investment to rise this year, after six straight years of decline, and we have raised slightly our forecast for payroll employment growth to just shy of 2 million jobs in 2012 with unemployment now expected to dip to 8¼% by year end

Note that our forecast of continued US growth is relatively subdued compared to previous cyclical recoveries. It is consistent with the “Reinhart-Rogoff” (R-R) norm for countries in a post-crisis deleveraging phase, which is not for permanent stagnation, but a deep recession and modest recovery that leaves the actual path of real GDP about 10% below a simple extrapolation of the rising pre-crisis path. By contrast, the euro area and UK are likely to underperform the R-R pattern, mainly because of early fiscal tightening, EMU financial strains and the weaker condition of European banks. Of course, the durability of this wide growth gap rests in part on the US’s ability and willingness to defer significant fiscal consolidation near term, while private sector deleveraging is underway. There are risks that US fiscal policy may turn markedly more contractionary in 2013, depending on the outcome of the late-2012 Presidential election and the evolution of Treasury yields.

We continue to expect a long period of ultra-low policy interest rates across the advanced economies. The ECB is likely to cut its main policy rate to 0.5% by midyear and, flooding markets with extra liquidity, this probably will push overnight rates well below 0.5%. For the US, the Fed has signaled that it will pursue all means to support financial conditions with the immediate focus on communications strategies. New support for the mortgage market is possible in coming months but we think full-blown QE would require new signs that the outlook is deteriorating again (which is not our base case). At this stage, we tentatively forecast the first rate hike to come in 2014 for the US, 2015 for the UK and 2016 for the euro area: but the key point for all three is that withdrawal of monetary stimulus is distant.

We also expect the policy response to the current public and private debt crises will include some elements of financial repression, especially in Europe. Financial repression refers to various measures that seek to constrain the financial sector, in particular ‘Financial repression occurs when governments implement policies to channel to themselves funds that in a deregulated market environment would go elsewhere. Policies include directed lending to the government by captive domestic audiences (such as pension funds or domestic banks), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and (generally) a tighter connection between government and banks, either explicitly through public ownership of some of the banks or through heavy “moral suasion.” Financial repression is also sometimes associated with relatively high reserve requirements (or liquidity requirements), securities transaction taxes, prohibition of gold purchases, or the placement of significant amounts of government debt that is

Financial repression was the norm for many advanced economies and emerging markets during the post World War II decades, but diminished in significance in advanced economies with the financial deregulation and liberalization initiated by Thatcher and Reagan. It continues to be a routine instrument of economic policy and government funding tool in many emerging markets and developing countries. A key factor is the desire of governments to secure for themselves relatively cheap and stable funding. In addition, financial repression has been consistent with the general political preference for regulation and quantity restrictions as tools of economic management, a desire to reduce the riskiness of banks and to save consumers from the perils of over-indebtedness, plus the aim of extracting political advantage for the government as the arbiter of credit and financial allocation. And in many cases, the captive investor base then had to accept substantial erosion of the real value of their government debt holdings through negative real interest rates caused by controlled nominal interest rates and high inflation.

To read the full report: OUTLOOK & STRATEGY

>RELIANCE INDUSTRIES: Declared muted Q3FY12 results; Buyback is very negative; RIL’s GRM’s are quoting below Singapore GRM

• On 20th Jan 2012, RIL declared muted Q3FY12 results.
• Tried to cheer investors by announcing buyback of shares at a price of Rs.870.
• Buyback is very negative, it is a cover up for bad result and in bear phase market the stock will not move above buyback price.
• The surprise was the sharp slide in the profits, "Other Income" in the current quarter constitutes 30% of the Profit Before Tax.
• RIL’s refining margins fell to US$ 6.8/bbl a discount of US$ 1.1/bbl over benchmark Singapore GRM US$7.3-7.4/bbl. Lost its advantage of trading  at a premium to Singapore GRM.
• Third quarter numbers indicate weakness across business segments and bleak future outlook for the company as a whole.

• On 20th Jan 2012, RIL declared its Q3FY12 results and tried to cheer investors by announcing buyback of shares.
• RIL has approved share buyback of Rs 10,440 cr at maximum price upto Rs 870/share.
• RIL will buyback up to 12 cr shares or 3.6% equity via open-market.
• The RIL buyback is happening after time span of 7 years (last announced in 2005).

What markets think…??
• We feel that maximum buyback priced fixed at Rs. 870/share which is at 10% premium to Friday’s closing price may not be that attractive to the investors who have entered the stock at much higher valuations.
• This surprise move of the buyback has rose questions of further company’s performance which has already shown some concerns on most of its segments and various issues surrounding the company.
• This is also questioning the huge cash of Rs. 74,539 crs for Dec 2011 end which the company holds in its books and its deployment.
• This could be also taken as just a move to compensate for the stock and company’s performance. As the stock has already underperformed the market over the past one year and would have continued to do so in the light of the latest results as well. The stock has corrected 26% v/s Nifty correction of 15% from their 52 week highs.
• As per SEBI norms, the company will have to mandatory buyback equity worth Rs 2,610 crore, or 25% of the intended buyback amount.
• According to the media reports - the whole process of the Buyback news is not addressed properly by the company. It is also seen that Reliance has treasury stake in two companies - Reliance Chemicals and Reliance Polyolefins. Since the 12 crore shares held in Reliance Chemicals counts as promoter stake, it cannot be bought back. But the stake in Reliance Polyolefins is non-promoter, so the market is going to question if this will be bought back by the company. So it is to see the prompt action by the management on this announcement.

To read the full report: RIL

>ABBOTT INDIA: Consolidation of Solvay Pharma India Ltd. (SPIL) with the company

M&A, strategic alliance gives a headstart
Abbott India (AIL), a 50.44% subsidiary of Abbott Capital India Ltd., UK, is involved in the manufacture and marketing of pharmaceutical, diagnostic, nutritional and hospital products. Consolidation of Solvay Pharma India Ltd. (SPIL) with the company is expected to improve operating efficiencies, leading to expansion of EBITDA margin and an extended product portfolio with addition of brands from SPIL. We expect the company to post a 24% CAGR top-line over CY2010-13E on the back of continued focus on advertising, increased employee expenses, new therapeutic segments and its agreement with Zydus Cadila. At the current price of `1,434, the stock is trading at 13.9x CY2013E EPS, which we believe is attractive for an MNC. We Initiate Coverage on AIL with a Buy rating and a target price of `1,852.

■ Synergies with SPIL to improve the business model: Amalgamation of SPIL with AIL expanded the company’s product portfolio, giving access to untapped therapeutic segments, in addition to increasing exposure to its existing therapeutic segments. Besides increased revenue, the synergy between the two companies is expected to improve operating efficiencies, thus leading to margin expansion.

■ Multiple revenue drivers to facilitate 24% CAGR top-line growth: AIL’s expenditure on advertisement and employee as a percent of sales has been continuously increasing since CY2006. Continued focus on these factors is expected to drive revenues going forward. Moreover, AIL’s focus on therapeutic areas such as diagnostics and nutrition; and its agreement with Zydus Cadila (India) to market 25 products in emerging markets from CY2013E could further add to revenues. Debt-free, cash-rich with higher returns: We expect AIL’s cash reserves and RoIC to increase to `594cr and 114.3%, respectively, by CY2013E, aided by additional cash from SPIL, which was also a cash-rich company. Due to excess cash in the books, we believe it may be a potential delisting candidate.

To read the full report: ABBOTT INDIA

>AXIS BANK: Driven by Fx treasury gains and lower provisioning costs

Ex-one offs, In line
Axis Bank reported a healthy set of numbers with a ~6% bottom-line bea driven by Fx treasury gains (Rs1300mn) and lower provisioning costs. Moreover, asset quality was largely stable and NIM compression was lower than expected. Excluding the fx related gains on prop book, the earnings performance was largely inline. We maintain Buy on lower valuations.

 NIM stable QoQ, Loan growth @ 22%: NII grew by a healthy 23.5% yoy (inline) to Rs21.4bn led by a moderate but healthy credit growth (20.4% yoy) while the reported NIM was stable sequentially at 3.75%. Blended yields benefitted from higher share of retail business and higher investment yields during the quarter. However, this was offset by 20 bps increase in cost of funds leading to QoQ flattish NIM. NIMs are likely to move lower in quarters to come from current levels.

 Healthy credit growth: The advances book grew by a healthy 20.4% yoy to Rs1,487bn primarily driven by the retail segment (32% YoY) and SME (21.3% YoY). Axis bank has been gradually increasing the share of retail business (from 20.3% a year ago to 22.4% now) and the trend is likely to continue during FY13. Deposits grew by a strong 34% yoy to Rs2,087bn led by current and time deposits, though growth in SB was healthy at ~21%.

 Slippage rate sustains at 1.5%: Slippage rate sustained at high level (1.5%) while recovery environment continues to remain tough. However, significant write-offs (Rs2.4bn) helped contain the rise in GNPA to ~10% to Rs19.2bn (%GNPA - 1.1% flattish QoQ). Additional restructuring of ~Rs3bn (likely from Petroleum sector) pushed the cumulative restructured assets to Rs27bn (1.8% of loans). Meanwhile, PCR witnessed some erosion (to 75.3% from 77.7% in previous quarter). We maintain our view that restructured portfolio is likely to increase further led by challenges faced by the infrastructure companies.

  Fee income surprises positively: Non-interest income surprised positively during the quarter led by 1) increased traction in third party distribution 2) strength in traditional products (debt syndication, guarantees etc) and 3) significant trading gains on prop forex book (Rs1300mn). The fx trading gains are result of increased currency volatility and hence should be viewed as oneoff and is unlikely to be sustained over quarters to come.

  Maintain Buy: We raise our earnings estimates (5% for FY12 & 1.7% for FY13) as we factor in additional information. At current market price of Rs1008, the stock trades at 8.7x FY2013E EPS and 1.6x FY2013E ABVPS. We believe that current valuations largely factor in the potential risks emanating from higher exposure to SME and power sector (funded & non-funded). Since our last sector update (dated 27th Sep’10), the stock had corrected and touched our stress value of Rs900 and has recovered since then. We maintain Buy with an
investment horizon of 12-15 months.

To read the full report: AXIS BANK

>How are Indian banks compared with global banks on ROA parameter...

2010 and 2011 has been a difficult period for the global banking system, with challenges arising from the global financial system, eurozone trouble as well as the emerging fiscal and economic growth scenarios across countries. The Global Financial Stability Report in
September 2011 has cautioned that for the first time since October 2008, the risks to global financial stability have increased, signalling a partial reversal in the progress made over the past three years. The table below may indicate India in a better position compared to
advanced nations on ROA basis but the prudent policies of RBI may be insufficient to protect bank’s financial health in the coming fiscal year.

Have bank stocks bottomed out?

What happened over the past year.…
The Bank Nifty (index covering banking stocks) is at its lowest in last 18 months. Bank Nifty Index was quoting at 11,483.7 in the beginning of FY12. It has fallen 23% to 8,839.7 while the broader market has fallen just 15%. Performance of PSU sector banks was even worse and the CNX PSU Index fell nearly 35% in the last ten months. Stock such as IDBI Bank, Union Bank and SBI has plummeted 38.9%, 41.5% and 37.5% respectively in the last 10 months. Others like Axis Bank, ICICI Bank have plunged 27.4% and 30% during the same period.

The reasons besides the weak macro-economic have been low capital adequacy, high interest rates and fear of increasing NPAs. Banking shares were also under pressure after global credit rating agency Moody’s Investor Service cut the standalone rating of India’s largest public sector bank, SBI in October 2011 due to concerns over capital and rapid deterioration in asset quality. The agency cut its rating on SBI’s financial strength to D+ from C- and lowered its hybrid debt rating on the bank to Ba3 from Ba2, following the reduction in financial strength rating. 

The repo rate, the rate at which banks borrow from the RBI for short duration, was increased by 375 bps between March 2010 and September 2011 to control inflation. In this rising interest rate scenario, the net interest margin (NIM) of nationalised banks, which account for 74% of the assets of the banking system, increased from 2.63 % in March 2010 to 3.2 % in March 2011. However, in the period between March and June 2011 when interest rates have continued to rise, the NIMs of nationalised banks shrunk to 2.9%.

Could this be the right time to enter into banking stocks or are there any downside risks left
With Bank Nifty at 2-year lows leaves a possibility of strong recovery in the near future. The outcomes deduced in the current scenario are that the worst is over for most banking stocks and its time to buy. The main points being spoken are: The worst of inflation pressure is over, interest rates have peaked and stock prices have reached value zone and in some cases are at historic low. While prima facie, all of them look valid arguments, the current scenario is looking a bit like 2008, when we had the big inflation scare led by crude’s surge towards $140/bbl. The subprime crisis peaked in September 2008 following the collapse of Lehman Brothers. The global financial crisis which began in the fall of 2007 and progressively worsened in 2008, affected the Indian financial sector from 2008. The PBV of BSE Bankex fell from 3.99x on 14/11/2008 to 0.97x on 9/3/2009. It later moved up to 3.41x on 5/11/2010 and currently is at 1.84x.

To read the full report: BANKING SECTOR REVIEW