Friday, February 3, 2012

>Global Scenarios is a quarterly analysis focusing on the outlook for the global economy. Read about the perspectives for and the most important risks to the global economy.

Global Scenarios
Chinese engine set to start pulling again

  • The global economy is expected to improve over the coming year as Chinese growth picks up
  • The US economy’s moderate recovery should continue
  • The euro recession is likely to be short, but growth prospects remain weak
  • Fading headwinds will lift Chinese growth
  • The euro debt crisis will continue. We expect a continued muddle-through scenario with high volatility but no break-up

 We expect 2012 to be a year of improvement for the global economy. Given current very downbeat sentiment, we believe this will be a positive surprise. The significant headwinds that derailed the recovery in 2011 have partly faded and some even become tailwinds.

 In particular, we expect the Chinese engine to start pulling again and join the US in driving the world economy forward. The euro area recession will likely be short and euro growth resume from Q2.

 That said, we look for growth rates in the western economies to remain subdued for a long time, whereas emerging markets are still expected to see solid growth.

 Downside risks are still predominant and mainly stemming from the euro debt crisis. We expect this crisis to be with us for a long time – and continue to see bouts of financial turmoil. However, we do not expect to see a collapse of the euro.

 Inflation is expected to fall sharply in 2012 due to lower commodity prices. This leaves room for policy to be eased further, not least in emerging markets.

To read the full report: GLOBAL SCENARIOS


>STRATEGY: Self-correcting mechanisms are already at play, which should make 2012 a better year for Indian equities

Looking back at 2011, Indian equity markets were struck by a multitude of issues, ranging from persistently high inflation, monetary tightening, stalling mining activity to sinking capital formation. The Eurozone crisis made matters worse, causing global financial markets to become all the more risk-averse. But self-correcting mechanisms are already at play, which should make 2012 a better year for Indian equities.

Most importantly, cooling of inflation and consequently interest rates should end the spell of margin compression, which has afflicted corporate earnings in the past several quarters. Also, India's widening current account deficit has been another macro overhang. But, here again, even at 49-50 levels, the 10-12% INR depreciation, in our view, should provide the requisite boost to India's exports to gradually self-correct the deficit.

Expect 19,300 Sensex by December 2012
Sensex FY2012 earnings growth is likely to be modest as high inflation and interest rates have battered margins. But with this scenario on its way to changing in FY2013, we expect the earnings growth rate to improve from 9.5% in FY2012 to 16.2% in FY2013. Also, in our view, risks that the government inertia continues and GDP growth remains at ~7% have already been largely factored in valuations by the market. We believe this offers a favorable risk-return trade-off, considering that several domestic negatives can be reversed by quick, simple and rational policy actions. For instance, quick approval of FDI reforms in aviation and insurance, among others, as well as pick-up in infrastructure ordering activity are low-hanging fruits. Already, ordering activity by NHAI and Power Grid is reasonably robust, and it is a matter of time before others would follow suit. The financial troubles of SEBs is another unnecessary crisis that is finally changing with recent tariff hikes. Amongst more difficult to push-through are measures to end the mining logjam, but in our view the government will soon have to balance environmental concerns and expedite mining and land acquisition to step up GDP growth.

In fact, we do not expect domestic factors alone to have the capacity to trigger new lows for the markets. It is only the Eurozone crisis that may still lead to volatility in the near term, but policymakers there as well are taking steps to avert any crisis event - accordingly, as of now we are basing our market view on a likely orderly outcome in the Eurozone. Considering that valuations are also reasonable, with domestic macro indicators improving and with earnings trajectory likely to follow suit, we have a target of 19,300 for the Sensex by December 2012. 

Select stocks to give better returns
Looking beyond the Sensex, there are a host of good investment opportunities in our view in companies across several sectors, such as banking, IT and pharma. On the other hand, there are sectors such as capital goods and cement where we still remain cautious. In this compendium, we have therefore given an overview of our entire coverage universe of 160+ stocks, having a combined market capitalization of ~`40lakh cr. Currently, we have a Buy recommendation on 82 of these, broadly preferring companies having high-quality cyclical businesses rather than high-quality defensives. Also, we have covered several mid caps, which in our view offer enormous potential - either because they are leading brands within their sectors trading cheaply or belong to high-growth sectors benefitting from rural, export or consumption themes.

To read the full report: STARTEGY

>STRIDES ACROLAB: Strides sold 94% holding in Ascent Pharma Health

Sale of generic pharma business at US$375mn
■ Event: Strides sold 94% holding in Ascent Pharma Health, its generic pharma operations in Australia and Southeast Asia, to Watson Pharma, in all cash transaction at an EV of AU$375mn (US$375mn for Strides 94% stake). Watson acquired the remaining 6% stake from the company’s CEO. Assets worth US$113mn are transferred to Watson as a part of this transaction.
 Rationale: The company would be utilizing the sale proceeds to fund future capital growth in the sterile injectable sector (major focus area comprising 44% of the total sales) along with reduction in debt, thereby improving its leverage position. Strides has chalked out a debt reduction program of US$250mn, which includes redemption of US$117mn (including YTM) FCCB due in June, 2012 and payment of US$50mn debt pertaining to Ascent.
 Agreement with Pfizer remains with Strides: Ascent had entered into a distribution and services agreement with Pfizer Australia to promote and sell the full range of Pfizer’s established off-patent medicines to Australian pharmacies. This remains intact with Strides. Under the agreement, Strides will promote and distribute Pfizer’s off-patent branded medicines to pharmacies via direct distribution channel as well as sell a number of Pfizer’s branded generics. Pfizer has around 100 drugs in Australia. We expect this deal to significantly boost the overall revenues of Strides.
 Impact: The deal is valued at EV/sales of 2.6x and EV/EBITDA of 19.7x with a sale of US$160mn in CY2011E and EBITDA of US$21mn. It will improve the leverage as the debt reduces from current US$525mn to US$275mn. Currently Strides has a D/E ratio of 1.6x (including FCCB). Post the deal, the D/E ratio is likely to reduce to 1.0x thereby, strengthening the balance sheet. This would reduce the interest costs by ~US$15-20mn for CY2012, thereby, increasing profitability. Besides, the goodwill from the books would also be reduced by ~US$50-60mn.

Outlook and Valuation
Strides has emerged leaner and stronger post restructuring its business with a clear focus on niche specialized segments. The deal emphasizes Strides’ priority to optimize the shareholder value by focusing on return ratios, targeting better working capital management and reducing debt level. With the complete focus on high margin sterile business, potential new launches, abundant capacity available, cash for upgradation of sterile facilities, we believe the company is expected to witness a sharp upswing in earnings and is poised for re-rating. We revise our estimates factoring the sale of the Australian business and anticipate a 10% CAGR growth in revenues and 32% CAGR in earnings with an improving EBITDA margin for CY2010-13E. Since our price target of Rs485 was achieved (refer our report: “Taking Big Strides” on 1st Dec 2011), post this deal, we recommend Buy on the company with an upgraded price target of Rs650.

To read the full report: STRIDES ACROLAB

>Prestige Estates Projects

Prestige’s 3QFY12 top line of ~INR1.7bn missed our as well as consensus estimates by 18% and 12%, respectively. This miss was on account of non-completion of the Prestige Neptune Courtyard project which was expected to be completed during the quarter. At the PAT level, the miss was lower at 8% due to lower-than-expected interest expense.

The key positives from results were continuing strong sales volume momentum at its new projects, as well as a pick-up in the pace of realisation of its sundry debtors. In 9MFY12, the company already nearly achieved its full-year FY12F sales guidance of INR15-16bn. We remain positive and maintain our BUY on the stock, which is currently trading at a 47% discount to our NAV of INR143 per share and 38% discount to our price target of INR122 per share.

Top line misses estimates due to non-completion of one project
■ Prestige Estate’s standalone 3QFY12 revenue of ~INR1.7bn (-54% y-y and +30% q-q) missed our as well as consensus estimates by 18% and 12%, respectively. The miss was on account of lower revenue
contribution from Prestige Neptune Courtyard, the project which was expected to be completed during the quarter.

 Overall EBITDA margin at 30% (+400bps y-y and -800bps q-q) was largely in line with our estimate of 29%. The q-q drop in the margin reflects a higher contribution from sales of residential and commercial
projects, which have a lower margin vis-à-vis that on investment properties.

 On the back of lower revenue, EBITDA at INR502mn (-46% y-y and +2% q-q) missed our as well as the Street’s estimates by 14% and 11%, respectively.

 Interest expense at INR159mn was lower than our expectation of INR214mn because the higher-than-expected interest cost was capitalised. The reason for higher interest capitalisation was on the back of a higher revenue contribution from the sale of completed commercial property.

 Due to lower interest expense, the earnings miss at the PAT level was only ~8% versus our and consensus estimates of INR306mn and INR308mn, respectively.

Sales momentum remains strong, realisation of debtors gathers pace
 The company maintained strong sales momentum in 3QFY12 after a robust response to its Prestige Tranquillity and Prestige Park View projects, launched in the last quarter (2QFY12). The company sold nearly 1.0mn sq ft in 3QFY12 and approx. 3.6mn sqft in 9MFY12.

 Having achieved sales totalling INR4.8bn in 3QFY12 (~INR7.8bn in 2QFY12), total sales for 9MFY12 now accumulates to ~INR14.7bn. This has already nearly met management sales guidance of INR15- 16bn for full-year FY12. After the successful launch of its large-sized residential project Bella Vista, Chennai in January 2012, sales for fullyear FY12F should beat the management guidance by a wide margin, we expect.

 In line with management commentary, realisation of its sundry debtors on Prestige Shantiniketan project picked up pace. During the quarter, the company realised INR1.1bn of receivables (nearly 25%) on Prestige Shantiniketan, and as a result, the outstanding debtors on the project have now been reduced to INR3.3bn. We believe further realisation of debtors will be a positive catalyst for the stock.

■ Realisation of debtors, coupled with robust sales momentum, led to strong cash flow generation of INR3bn during the quarter. However, an increase in net debt by ~INR1.0bn was on account of cash payment towards land acquisitions or advances pertaining to joint development agreements (JDA), in our view. As of end-Dec11, the company has consolidated net debt of ~INR14bn (or debt: equity ratio of 0.66x) and 13.5% as its average cost of debt, nearly 10bps lower than in its previous quarter.

Maintain BUY; available at 47% discount to NAV
We remain positive on the stock on account of 1) continuing strong sales momentum; 2) a pick-up in revenue recognition as newer high-value projects reach the revenue threshold in FY13F; and 3) further realisation of debtors related to the Prestige Shantiniketan project as the office leasing environment remains conducive in Bangalore. We reiterate our Buy call, with the stock trading at a deep discount of 47% to our NAV of INR143 per share and 38% discount to our price target of INR122 per share.

To read the full report: Prestige Estates Projects

>Karur Vysya Bank

Core interest income, operating profit and net profit in-line with our estimates supported by stable margin and asset quality

 ► In Q3 FY12, Karur Vysya Bank’s (KVB) net interest income (NII) grew11.4% YoY to ` 2.3bn, slightly lesser than our estimates of ` 2.4bn. KVB’s margin remains stable at 3.06% against 3.03% in Q2FY12. KVB’s operating profit was at ` 1.89bn compared to our estimates of ` 1.93bn. Net profit grew 10.3% YoY to ` 1.25bn (Dolat est: ` 1.21bn, Consensus est: ` 1.22bn).

 The bank’s core operation remains marginally better, contained liability cost aided margin and it maintained its consistency in fee income growth.

 Asset quality remained healthy with flat gross NPAs at 1.45% and reasonably high PCR at 80%. The bank’s asset quality remains under control and management is confident of maintaining gross NPA at current
level of ` 3bn by the end-march’12. Overall result is in-line with stable margin and asset quality.

 We expect KVB’s total business to grow by 31% CAGR on the back of 30.4% growth in deposits mobilization and 31.9% expansion in credit book. We estimate margin to drift down by 30bps to 2.86% in FY12 and subsequently by 12bps to 2.74% in FY13. In FY12-13, the bank would report RoAA and RoAE in a range of 1.3%-1.5% and around 18-20% respectively.

 We revise upward our FY12 and FY13 earnings estimates by 11% and 9% respectively considering higher business growth and improvement in margin and asset quality. We increase our target price by 5% to ` 434 at 1.8x adjusted book value (ABV) FY13 and reiterate the stock rating as Accumulate.

 Robust business growth: KVB’s total business grew 35% YoY to ` 524bn. Deposits and gross advances grew 35.2% and 34.9% to ` 301bn and ` 223bn respectively. Credit-deposit ratio remains stagnant at 73.2%. On the deposit side, CASA share declined to 20.4% as against 21.6% in Q2 FY12 and 25% in Q3 FY11. 

The bank’s tremendous efforts and focused approach on volume growth have led to business growth of 30-35% (higher than the industry average) in the past couple of quarters. For FY11-13, we expect KVB’s total business to grow 31.1% CAGR. We assume deposit and credit books to expand 30.4% and 31.9% respectively over the corresponding period.

■ Slight improvement in margin: KVB reported 3bps QoQ rise in margins to 3.06% as against 3.03% in Q2 FY11. Lesser increase in cost of deposits (18 bps QoQ) as against 30 bps QoQ rise in yield on advances contained higher erosion in margin. Going forward, it is expected that moderate growth in deposits and increase in credit-deposit ratio will protect higher erosion in margin. We estimate margins to drift down by 30 bps to 2.86% in FY12 and subsequently by 12bps to 2.74% in FY13.

■ Operating expenses in-line with our expectation: KVB’s total operating expenses rose 32.5% YoY to ` 1.3bn, mainly due to employee expenses and overheads. The cost-income ratio rose to 41.5% from 36.1% in Q3 FY11, however, came down from 46% in Q2 FY12. Going forward, considering rapid branch expansion and long break-even periods, the cost-income ratio could remain high. Though, on the back of better cost efficiency, the management expects to maintain C-I ratio around 40-41% in FY12.

■ Robust non-fund income on account of consistent increase in fee income: Other income grew by 27% YoY to ` 894mn from ` 704mn in Q3 FY11 primarily, on account of 32% YoY increase in fee income. However, there was decline in treasury income to ` 67mn from ` 140mn in Q3 FY11.

■ Stability in asset quality; a big positive: On asset quality front, net addition to gross NPAs stood at ` 239mn compared to ` 232mn in Q2 FY12. The bank’s asset quality remains stable with GNPA at ` 3.2bn and GNPA ratio at 1.45% compared to ` 3.0bn and 1.48% as on end-Sep’11. Net NPA ratio remains stable sequentially at 0.29%. Provision coverage ratio remains flat 80% on QoQ basis. Overall, asset quality remains stable.

In FY12-13, the bank would report RoAA and RoAE in a range of 1.3%-1.5% and around 18-20% respectively. Considering sequential improvement in asset quality and margins, we revise our FY12 and FY13 earnings estimates by 11% and 9% respectively. We increase our price target by 5% to ` 434 and reiterate the rating as Accumulate at 1.8x adjusted book value (ABV) FY13.


>Indraprastha Gas Limited

  • IGL reported sequentially lower earnings in Q3 FY12 due to higher gas cost
  • Falling domestic production coupled with fully utilized import capacity mean IGL will struggle to maintain volume growth despite adequate demand
  • We cut our TP from INR475 to INR366 on lower target multiple and estimates, but retain our Neutral rating given the recent correction in the stock

IGL reported a 10.5% q-o-q decline in net profit, lower than our and consensus estimates. The sequential decline in net profit to INR691m (+3% yoy and decline of 10.5% qoq) was caused by higher gas costs. Though IGL increased the price of compressed natural gas (CNG) by 5.5% on 31 December 2011, the full impact will only be evident in Q4 FY12. Gas costs increased by c16% sequentially, the majority of which was driven by rupee depreciation (-11%), with higher usage of costlier LNG contributing to the remaining balance (-5%). The company reported a gross margin of INR7.59/scm which was below its long-term average of INR7.66/scm.

■ Benefit of price increase will flow in Q3. IGL increased its CNG price in Delhi by 5.5% on 31 December, the benefit of which will be fully felt in 4Q FY12. We believe this will help restore the lost margin and we expect the company to earn INR7.92/scm margin for FY12. We expect IGL to largely maintain a similar margin in FY13 as well.

■ Volume risk to intensify. We review volume and FX assumptions. In view of falling domestic production and fully utilized import capacity, we believe IGL will struggle to maintain its historical volume CAGR of c20%. We anticipate gas sales volume to grow at just c9% in FY13 and FY14 (from 15% and 11% previously). While we have better visibility on volume growth in FY13, growth in FY14 is less obvious and will largely depend on IGL’s ability to lobby with central government to get a higher allocation of domestic gas. We continue to believe that IGL has enough cushion to keep increasing retail prices to maintain its margin. However, a recent move by the government to regulate marketing margin could impact IGL’s margin adversely. Our exchange rate assumption goes to INR50 for FY13 from INR45 previously.

■ Valuation and risk. We retain our Neutral rating but reduce our PE-based TP to INR366 from INR475 as we now value the stock at 15x FY13e EPS of INR24.4 (from 17.5x previously). The multiple reflects our lower assumed long-term growth rate of 9.5% (from 10%); 13.5% WACC and a lower ROE of 24% (from 26%). This is in line with the multiple over the last 3 months. The biggest risk to our view is the increase in the cost of gas and an inability to pass on the increased cost to consumers. A slowdown or increase in the pace of CNG vehicle additions and PNG additions could also affect our estimates.


>TELECOM SECTOR: Incumbents to gain from Apex Court verdict; Supreme Court scraps 122 licenses

Supreme Court of India ordered the cancellation of 122 licenses granted post Jan 2008 to companies following irregularities in issuing licenses and spectrum on first cum first served basis. Further to scrapping of licenses, a fresh auction for licenses is to be held in the next four months after the regulator formulates a new license policy and spectrum auction mechanism. Though the government is expected to come up with a new policy, we believe, it will be beneficial for Bharti Airtel and Idea Cellular and neutral for RCom. Out top pick remains Bharti Airtel in the present environment.

 Supreme Court scraps 122 licenses: Supreme Court of India ordered the cancellation of 122 licenses granted post Jan 2008 to companies on irregularities in issuing licenses and spectrum on first cum first served basis. In addition, the apex court asked Unitech, Etisalat DB and Tata to pay Rs50mn as penalty, whereas Loop, Sistema Shyam, Allianz and S-Tel have been directed to pay Rs 5mn as penalty for violating norms.

 Room for new operators: Among the operators whose licenses have been cancelled, Uninor, Sistema, S-Tele and Videocon had made significant investments. Given the options, we believe that Uninor and Sistema may participate in the new auctions to retain their presence in the country given their subscriber base and investments made in rolling out services.

 Our View: We believe that Bharti and Vodafone will benefit the most given that this may lead to reduction in intensity of competition that could lead to improving revenue per minutes. Also, a reduction in the number players and availability of spectrum would mean lesser aggression in the acquisition of spectrum in the auction mechanism. Idea will also gain in its existing 13 circles, but will be participating in the new policy to get back licenses for 7 circles. Given the current environment, we prefer Bharti Airtel the most followed by Idea Cellular in the listed space. We believe that opertors will benefit from tariff hike on RPM as incoming/outgoing call ratio can turn in their favour. However, we will also be looking at tower tenancy and its impact. We will be working on our assumptions to capture the impact of the verdict on incumbents.


>India Manufacturing PMI February 2012: New order and output growth accelerate markedly at start of 2012

Indian manufacturing sector business conditions improve at fastest rate in eight months

The seasonally adjusted HSBC Purchasing Managers’ Index™ (PMI™) – a headline index designed to measure the overall health of the manufacturing sector – registered 57.5 in January, up from 54.2 in December. The latest reading pointed to the strongest improvement in business conditions since May 2011. Furthermore, growth was faster than the long-run trend.

Manufacturers in India reported a further increase in new business received during January. The rate of expansion accelerated for a second month running, and was the fastest in eight months. Panellists commented that a general improvement in demand and market conditions had led to the latest rise in new order volumes. Growth of new export business also quickened in the latest survey period, but to a lesser extent. Anecdotal evidence suggested that difficult economic conditions and increased competition in some markets had limited gains in new export orders.

A stronger rise in output was reported in line with faster new order growth. Backlogs of work continued to increase, but at a slower rate. Stocks of finished goods increased for a third consecutive month, with the rate of accumulation the strongest in this sequence. Anecdotal evidence suggested that growth was in line with higher production and to meet increased new order obligations.

January data signalled a broadly stable level of employment in the Indian manufacturing sector. The overwhelming majority of respondents indicated that staffing levels at their units were unchanged on the month.

Reflective of sharp rises in both new orders and output, purchasing activity increased substantially during January. Despite this, suppliers’ delivery times were reported to be largely consistent with those in December. Stocks of purchases rose at a marked rate that was the fastest since March 2011.

Input prices faced by Indian manufacturers increased substantially during January. Higher raw material costs were cited as the main driver of input price inflation. The rate of increase was slightly faster than in December and strong in the context of historical data. Subsequently, manufacturers raised their output prices again. The rate of charge inflation was marked and above the long-run series trend.

Commenting on the India Manufacturing PMI™ survey, Leif Eskesen, Chief Economist for India & ASEAN at HSBC said:
“Activity in the manufacturing sector rebounded again in January led by higher demand from both domestic and foreign clients, suggesting some recovery in sentiment in recent months. The rebound in growth kept backlogs of work growing and employment growth in positive territory. The solid demand from clients led manufacturing companies to increase stocks of both finished goods and purchases, but it also kept inflation pressures firmly in place, with neither input and output price inflation showing any signs of abating. All in all, these numbers suggest it's premature for the RBI to cut policy rates and that they have to await evidence of a significant and sustained decline in inflation and/or further materialization of down side risks to growth before they can roll out rate cuts.”

Key points

  • New order and output growth accelerate markedly at start of 2012
  • Employment little changed
  • Input cost and output price inflation remains elevated