Thursday, February 23, 2012

>INDIA MARKET STRATEGY: India on sustained global liquidity conditions, and if domestic retail investor returns to equity, the risks will be on the upside (CLSA)

India has been the best performing Asian market YTD and we believe the strong performance would continue as the liquidity driven rally is now getting the policy support and corporate earnings stability. Any initiative to improve coal production and power generation, we believe, will further increase our enthusiasm. CLSA’s global strategist Chris Wood prefers India on sustained global liquidity conditions, and if domestic retail investor returns to equity, the risks will be on the upside. We continue to add more beta to our portfolios and add Tata Motors and Yes Bank to our top 5 ideas replacing ITC and Dr Reddy’s. The rising crude and potential
delays/lower rate cuts by the RBI will be a negative.

■ Liquidity rally has moved the valuations back to July level
► With the liquidity driven rally, Indian stock market has now moved back to the July 2011 level, valuations are also similar at 14.5x as time effect offset by earnings downgrade.
► Recent stock price reactions to bad results etc imply that the investors are now much more willing to look beyond the near-term, focussing on longer-term trends.

■ Initial signs of policy level improvement visible
► The Government has certainly moved beyond the policy noise to some concrete steps (refer to our earlier note: Policy Paralysis no more?). While still a few uncertainties exist, the direction is clear.
► The possibility of Coal India being able to ramp-up production whether from the existing mines (relatively easier and could be effective in a year) or the new mines (production will likely take a couple of years assuming fast-track clearances) can be rerating trigger for the Indian markets.
► With these policy initiatives and the willingness of the investors to look beyond the near-term patches makes us more sanguine about the current rally.

■ CY2012 market returns to be front ended; retail support should
 With primary markets being slow to pick-up, we believe that the CY12 market returns will be upfronted as easier global liquidity continues.
► Domestic retail investors have been virtually absent from the equity markets for the last three years (FY10-12) with 0.2% of incremental saving going into equities as against 5% as the trend prior. A reversion mean (3.5% average over the last 8 years), could bring in US$13-14bn creating potential buffer for equity issuances.

■ Adding more beta to portfolio
► Corporate earnings trend stabilising (our FY13 Sensex EPS has remained unchanged at 1,269 over the last 45 days and through the 3QFY12 results season), and earnings downgrade cycle has ended.
► We raise market target multiple to 14.5x – in line with the last 10 year average to take the Sensex target to 20,800. Rising international crude prices and possible tax hike / fuel hike may delay the potential rate cuts by RBI. This could be a risk to market sentiments which are building in large hopes on rate cuts.
► In line with the view of our global strategist, Chris Wood, who believes in continued global liquidity, we add more beta to our portfolio. We remove ITC and Dr Reddy’s from our top 5 ideas and replace with Yes bank and Tata Motors.
► We raise weight on financials by 5 ppts to become OWT. We also raise industrials to Neutral (+2). Lower pharma by 4 pts to UWT from OWT earlier. Weight in IT also cut but 2.5ppts but maintain the OWT stance. Reduce staples weights by 2ppts to increase our UWT further. Also reduce weight in Energy by 2pts to make it UWT.

To read full report: STRATEGY

>RIL & Singapore GRM down sharply WoW

■ RIL GRM down US$1.3-1.7/bbl WoW; Sing down US$1.3/bbl
RIL’s theoretical GRM for the week ended February 17 at US$6.1-7.2/bbl is down US$0.4/bbl WoW assuming its refinery operates as usual. However, shut down of one CDU at its more complex new refinery would mean an additional hit of US$1.0-1.3/bbl and GRM of US$4.83-6.19/bbl last week. Singapore GRM at US$8.52/bbl last week is also down US$1.3/bbl WoW. The decline in GRM last week is due to a fall in diesel, jet fuel and fuel oil cracks. RIL’s GRM to date in 4Q at US$6.09-7.19/bbl is US$2.0-3.1/bbl below Singapore GRM of US$9.23/bbl.

■ Shutdown at new refinery to hit RIL GRM by US$1-1.3/bbl
Half of RIL’s new refinery was shut for planned maintenance on February 10. It is to restart in the first week of March. The new refinery has a superior product slate (more petrol instead of naphtha) than the old refinery. This will therefore shave off US$1.0-1.3/bbl of RIL’s GRM last week and US$0.14-0.19/bbl of its 4QTD GRM.

■ Diesel and jet fuel down WoW but still healthy
RIL’s GRM last week was hit by US$1.5-2.2/bbl WoW fall in jet fuel and diesel cracks (46% of its product slate). Jet fuel and diesel cracks are still healthy at US$15.7-16.7/bbl. Singapore GRM was also hit by US$2.8/bbl WoW fall in fuel oil (RIL does not produce) cracks. LPG and naphtha cracks were up US$0.1-0.9/bbl.

■ RIL’s 4QTD GRM below Singapore GRM & down YoY
RIL’s theoretical GRM in 4QTD at US$6.09-7.19/bbl is US$2.0-3.1/bbl below Reuters’ Singapore GRM of US$9.23/bbl. In 4QTD RIL’s gain from QoQ product cracks rise is US$2.4/bbl vis-à-vis US$2.5/bbl for Reuters’ Singapore GRM. RIL is also hit by lower discount to Dubai of crude it uses (down US$0.1-0.7/bbl QoQ). Its 4QTD GRM is also down US$2.0-3.1/bbl YoY (US$9.2/bbl in 4Q FY11).

■ RIL’s 4Q profit down 13-23% YoY at 4QTD GRM
RIL’s 4Q profit works out to Rs41.5-46.6bn at 4QTD theoretical GRM of US$6.1- 7.2/bbl and blended petrochemical margin of US$429/t (down 21% YoY in rupee terms). It would mean 13-23% YoY fall in 4Q profit (4Q FY11: Rs53.8bn).

■ Downside to RIL’s FY13 EPS 6-15% if GRM at 4QTD level
If RIL’s FY13 GRM is at 4QTD level of US$6.3-7.3/bbl, its FY13 earnings would be 6-15% below our EPS estimate of Rs66.4 (assumes GRM of US$8/bbl).

■ R&M companies GRM down WoW but up QoQ
HPCL and BPCL’s theoretical GRM last week was down WoW at US$3.6/bbl. However, their GRM in 4QTD at US$5.2-5.5/bbl is up QoQ.

To read full report: RIL

>EMPIRICAL & THEMATIC PERSPECTIVES: The Outlook for Global Imbalances

■ In this essay, we document a marked narrowing in the magnitude of global current account imbalances in the years since the financial crisis erupted. In particular, the U.S. deficit has halved from roughly 6 percent of GDP to 3 percent of GDP, and China’s surplus has declined significantly as well. We then consider whether the observed reduction in these imbalances—and in the magnitudes of global imbalances more generally—is only a temporary shift linked to the disruptions associated with the financial crisis or whether these adjustments are likely to be more durable.

 In examining this issue, we first study data for a broad set of G-20 countries. We find evidence that over the past decade, countries with current account deficits have generally seen their currencies depreciate in real terms and this, in turn, has been associated with some closing of their deficits. Conversely, countries with external surpluses have tended to experience real appreciations, and their surpluses have narrowed. These results leave us hopeful that the recent adjustment in imbalances will not be immediately reversed once a stronger global recovery takes hold.

 In the second half of the essay, we build forecasting models to assess the likely path of the U.S. and Chinese balances going forward. For the United States, our conclusion is that under plausible assumptions (flat dollar, moderate growth rates in the U.S. and abroad, and stable oil prices), the current account balance is likely to remain roughly in the neighborhood of 3 percent of GDP. Neither a further deterioration nor a substantial improvement seems to be in the cards over the next several years.

 The outlook for China, however, is more worrisome. Given the significant estimated sensitivity of Chinese exports to foreign GDP growth, our model suggests that an eventual global recovery may bring with it a renewed widening in China’s trade surplus. Our work suggests that a further 15 percent real appreciation of the renminbi will be necessary to keep the Chinese trade balance in a range of 3 to 4 percent of GDP through 2015. This analysis should be interpreted as a cautionary tale for the Chinese authorities.

 On balance, this analysis supports three broad conclusions. First, we see evidence that over the medium to long term (i.e., five to ten years), real exchange rates have tended to adjust in a manner consistent with greater global balance. In this important sense, the international monetary system seems to be functioning reasonably efficiently. Second, in light of this observation and the tenor of the evidence more generally, we expect much of the observed adjustment in global current accounts to prove durable, especially given the sharp depreciation of the dollar over the past decade and the stepdown in U.S. growth. Third, as our empirical work for China highlights, however, the adjustment process is still incomplete. Further exchange rate realignment in some key countries will be necessary to achieve a pattern of global spending and production that is likely to prove sustainable over the long run.


>India Goes Easy On Gold Buying In Oct-Dec As Rupee Slides

Depreciating rupee and high gold prices have jointly forced to India to cede its long-held position as the world’s No. 1 con-sumer of the precious metal to China in October-December.

India and China together account for more than half of total global demand for gold, with demand from India typically surpassing that of China’s. But the fourth quarter of 2011 registered a change in the trend.

According to World Gold Council data, total demand for gold in India was 173 tonnes in October-December, down 42% from a year ago. Demand in China, on the other, increased marginally from a year ago to 190.6 tonnes.

While both countries registered high inflation, particularly in the first half of 2011, weakening of the rupee against the US dollar dampened demand for gold in India.

In October-December, while gold prices rose 23.5% in dollar terms from a year ago, in rupee terms, gold prices shot up a whop-ping 39%.

Rupee depreciated 8.4% versus the dollar during the quarter, while the Chinese yuan that appreciated 0.2% in the same period.

On December 16, rupee weakened to its all-time low of `54.30 versus the dollar.
Impact of rupee depreciation is also reflected in the fact that while international gold prices (in dollar terms) fell 0.8% in October-December on a sequential basis, Indian prices were up 8.8% dur-ing the same period.

In the quarter that went by India’s jewellery demand nosedived 44% from a year ago to 103 tonnes and investment demand plunged 38% to 70 tonnes.

It was mainly depreciation of rupee in the second half of the year that resulted in India’s gold demand during July-December weak-ening 33% from the first half.

To read full report: GOLD

>HIGHWAY DEVELOPMENT: Near term challenges; smoother times ahead

Roads & Highway development presents a structured, planned & definitive opportunity of ~` 1365bln (USD 26.25bln) to EPC & BOT developers. Dissecting this opportunity, we find that the scale, size & regional distribution of majority of balance projects may not be attractive for a BOT developer. Also, the competitive intensity of bids has challenged all industry players alike & warrant caution. In our opinion, these bids assume a consistent availability of cheaper source of finance which in itself is unsustainable over a longer time frame. We believe capital markets shall, in the long run, create a valuation differential between aggressive company managements and those with conservative & sustainable strategy. Hence, we like companies with business model & management style which does not encourage excessive risk taking, have projects with longer concession tail & are able to consistently generate positive FCFE with minimal support from the parent entity.

■ Definitive opportunity, award activity has already peaked
Highway development under the planned NHDP presents an opportunity of ~` 1365bln (USD 26.25bln). While we don’t deny the size & certainty of the opportunity we are concerned about limited projects fitting the size & scale of a PPP development. The regional spread too is not quite encouraging. Also, we expect FY12 to see peak of awards in near term.

■ Competitive pressures – no respite in near term
The recent bids by developers belie their stated IRR objective. Also, the expectation of gradual decline in competitive intensity has been proven otherwise. Supply side constraints along with demand side factors of declining order backlog/sales, lower asset utilization & scope for financial leveraging has attracted the breadth of the construction players to road projects particularly the NHAI project awards. Hence, we expect the competitive intensity to remain at elevated levels in near term restricting IRR’s of projects to lower teens.

■ Takeout essential (debt & or equity), equity requirement to pull plug on competitive intensity
We estimate an equity requirement of ` 2687bln over the next 3 years for projects currently under implementation. Additionally, ` 339bln of equity shall be required for projects which are expected to be awarded in the next 2 years. In our opinion, this shall be the sole factor for pulling the plug on the competitive intensity of the sector.

■ Challenging times to continue; Valuations offer comfort
The competitive intensity, amongst other reasons has led to underperformance of the sector with broader markets. The current average valuation of 1.5x P/B offer significant comfort from further downside. We initiate coverage on Ashoka Buildcon & ITNL with a Buy rating, downgrade IRB Infra to Hold, maintain Buy on Sadbhav Engineering. Sadbhav Engineering continues to occupy the top slot in our pecking order of stock selection.

To read full report: HIGHWAY DEVELOPMENT

>TATA STEEL: The worst may be behind, well poised for recovery; retain Buy

What's changed
Key takeaways from Tata Steel’s 3QFY12 results conference call: (1) Group steel deliveries at 5.84mnt (-5% qoq), were impacted by seasonal weakness and market uncertainties in Europe and floods in Thailand. (2) Europe business witnessed price declines on weak demand while higher priced raw materials impacted profitability, resulting in the company making significant mark-to-market provisions on stock. However, this implies that with steel prices recovering, there is low risk of further inventory write-downs. European demand has picked up with prices inching up. The company is targeting to retain FY13E volumes in Europe at FY12E levels, despite planned temporary closure of the BF4 at Port Talbot for rebuild. (3) India business saw stable prices with long product and downstream prices higher than previous quarters. Margins were compressed on account of higher raw material (imported coking coal) prices. (4) The company expects to commission the Jamshedpur brownfield expansion by March 2012 and
expects to add 1mn tons to current production levels in FY13. (5) European restructuring measures are progressing per plan, leading to about 2500 redundancies. (6) The Benga coking coal project in Mozambique is expected to commence despatches from March 2012.

We cut our FY12E-14E EPS by -1% to -11% on inventory write-down, and higher cost assumptions. But we believe the worst may be behind in both India and European profitability, and with the Jamshedpur expansion on track, the company is well positioned for a strong earnings recovery in FY13E.

We reiterate our Buy rating and lower our 12-month P/B-based TP to Rs550 (from Rs552) on lower earnings estimates.

Key risks
Slower-than-expected demand recovery in Europe, higher-than-expected raw material costs

>SELAN EXPLORATION TECHNOLOGY: Robust realisation; await ramp-up in production volumes

Result highlights
Strong results driven by realisation; volume growth unimpressive though: In Q3FY2012, the net revenues (adjusted for the petroleum profit) of Selan Exploration Technology (Selan) grew by 54% year on year (YoY), as a 76% year-on-year (Y-o-Y) improvement in the realisation over-compensated for the 6% decline in the volume during the quarter. Though sequentially the volume improved by 14% to 41,853 barrels of oil, but the realisation supported 6% growth QoQ taking the sequential sales growth to 20%.

PAT records 65% growth YoY: The operating profit grew by 77% YoY and 5% quarter on quarter (QoQ) to Rs14.7 crore. Following the trend, the profit before tax (PBT) grew by 80% YoY and 5% QoQ to Rs16.7 crore in Q3FY2012. However, there was an extraordinary item to the tune of Rs2.4 crore pertaining to foreign currency variation in Q3FY2012. Therefore, the reported profit after tax (PAT) recorded a growth of 65% YoY and 17% QoQ to Rs10.5 crore. Excluding this extraordinary item, the adjusted PAT seems to jump by 100% YoY and 12% QoQ to Rs12.9 crore.

Volume estimate revised down; consequently profit estimate trimmed: Given the delay in obtaining regulatory approvals for further exploration & development of the company’s oil fields, we are fine-tuning our assumptions for the production volume in FY2012 and FY2013. However, the impact of the delay on the net revenue will be limited by the higher than expected blended realisation. We are also introducing our FY2014 estimates for the company in this note. We remain positive about the field development programme and the potential ramp-up in the volume from the same in the coming years. Thus, we maintain our Buy recommendation on Selan with a price target of Rs500.

Other updates: Last week, Andrew Wenk, President & CEO, Selan, resigned from the company for personal reasons. Mr Wenk's resignation is effective from February 15, 2012. He had joined Selan during July 2011.

The company has declared an interim dividend of 30% (ie Rs3/- per equity share) for the financial year 2011-12.