Wednesday, February 29, 2012

>ECONOMIC PROSPECTS: PM’s Economic Advisory Council (PMEAC) has made certain projections for the economy for financial 2012 & 2013

The PM’s Economic Advisory Council (PMEAC) has made certain projections for the economy for the current financial year as well as indicated prospects for the next one.

■ The rate of growth in FY12 is estimated at 7.1%, which is marginally higher than the projection of 6.9% of CSO due to better growth in agriculture and construction.

  • Capital formation is to slip to 29.3%, which is a decline of almost 4 percentage points over the last four years. It had reached a peak of 32.9% in FY08 and dropped to 32.3% FY09 and then to 31.6% FY10 and 30.4% in FY11.
  • Farm sector growth to average 3% on record output for rice, wheat and strong trend growth in horticulture and animal husbandry.
  • Mining and quarrying sector likely to report negative growth on account of weak coal output growth, restrictions imposed on iron ore production, decline in natural gas production and negative growth in crude oil output.
  • Electricity sector to grow at 8.3%.
  • Manufacturing and construction to grow by 3.9% and 6.2% respectively.
  • Strong growth in the services sector at 9.4%.

■ Balance of Payments (BoP) position will be tight and current account deficit to end at 3.6% for the year. The pressure both in regard to a larger than expected CAD and lower than expected net capital inflows resulted in a very sizeable depreciation of the rupee. In the fiscal year to date, the nominal terms of trade weighted 6-currency index fell by 14%, while in terms of the inflation adjusted effective exchange rate (REER) the decline was 11%. The decline of the rupee vis-à-vis the USD was 19% in April–December 2011. However, there has been some recovery in the course of January and February 2012, with the rupee recovering about 7.5%.

 WPI inflation projected to be around 6.5% and this has been enabled by both monetary and other public policies.

 Expansion of the fiscal deficit beyond its budgeted estimate of 4.6% of GDP is an area of concern. Government must strive to contain and improve the efficacy of subsidies.

To read full report: ECONOMIC PROSPECTS

>INDIA STRATEGY: Identifying Over-Owned/ Under-Owned Stocks

FII portfolio: U/W on IT & Consumer and O/W on Industrial fall; U/W on energy & O/W on telecom rise

 During the quarter while FIIs were net sellers, domestic MFs & LIC were net
buyers. FII holding in Sensex has come down marginally.

 FIIs were positive on defensives like Consumers & Telecom whereas they sold across most of the other sectors like Financials, Metals and Industrials. FII ownership in SBI is at all time low whereas Industrials has become an U/W sector for the first time due to this selling.

 Financials, the favorite sector for FII, saw significant selling during the quarter bringing down the O/W marginally. Industrials was another sector sold by the FIIs resulting in reduction in its O/W. The Software sector was the biggest sector bought by the FIIs, followed by Consumers, resulting in change in their respective O/W and U/W.

 In terms of long term trends, while the underweight of energy continues to come down, Industrials has become an underweight sector. On the other hand, consumers are no longer an underweight sector due to consistent buying done every quarter. Also Financials has seen its weight come down. Within Banks while FIIs have sold names like SBI, ICICI, Axis, they have increased exposure in Kotak. Any surprise in these names can reverse the trend.

 Key buys in this quarter were: Infy, ITC, TCS, HDFC, HUL and Wipro . Key sells were: ICICI Bk, L&T, Coal India, Axis Bank and RIL.. 

Domestic MF Portfolio: U/W on metals fall; O/W on Industrials rise
 Domestic MF portfolio is in stark contrast with that of FIIs, with Industrials being major O/W sector, sector where FIIs are marginally positive. Consumer is another sector where domestic MFs are heavily O/W in contrast to FIIs who are not. They are also U/W Financials where FIIs are O/W. However, on the similar lines of FIIs, domestic MFs are also U/W commodities.

 In contrast to FIIs, MFs bought Metals and sold consumer & telecom names. On the similar lines of FIIs, MFs also bought software and cement names.

 During the quarter mutual funds bought Software, Industrials, Metals & Energy and sold consumers &Telecom.

LIC net buyer
On the similar lines of MFs who were buyers, LIC was also a net buyer. LIC bought Financials (SBI, HDFC Bank), Utilities (Tata Power) and Energy (RIL). LIC sold Cement (Ultratech, ACC), Software (Infy) and Telecom (Bharti).

To read full report: INDIA STRATEGY

>RBI's draft PSL guidelines - negative for asset financiers. 22 February 2012

RBI today released the draft guidelines on re-classification and updates for priority sector lending (PSL) and related issues under the chairmanship of Mr. M. V. Nair. While most of the original PSL guidelines remain unchanged, a sub-target of 9% of Adjusted Net Banking Credit (ANBC) for small and marginal farmers (SFMF) within agriculture and allied activities has been recommended (negative for private banks). At the same time, the distinction between direct and indirect agriculture has been done away with (positive for banks in general and private banks in particular). RBI has also revised the guidelines for on-lending to/securitisation by NBFCs, which we believe could be negative for MMFS and SHTF.

■ No major impact on listed banks: PSL has been increased for foreign banks to 40% of ANBC (from 32%), in line with public and private banks. The sub-target of 10% for exports and 15% each for agriculture and MSE has been recommended as PSL for foreign banks. A sub-category of weaker and marginal farmers has been introduced, which should be 9% of the total ANBC and can be negative for private banks given their lower rural reach. However, the RBI has also done away with the distinction between direct and indirect agriculture for the 18% PSL target requirement (4% + 14% earlier), which we believe is positive for private banks.

 Guidelines for asset financiers like SHTF and MMFS: The draft recommends that NBFCs should maintain a minimum threshold requirement of 65% of their total Assets Under Management (AUM) on their balance sheets (of the last financial year), as also on an average throughout the financial year. However, pre-existing assets on book may be excluded for the purpose of priority sector classification. Moreover, spreads for asset financing companies under on-lending, securitisation and buyouts under direct assignments have been capped at 6% and for HFCs at 3.5%.

 Impact on asset financiers like SHTF and MMFS, and HFCs: Shriram Transport Finance (SHTF): As on 31 Dec’11, securitised assets comprised 39.6% of the company’s AUM. On an incremental basis, given that 65% of AUM will have to be held on the balance sheet, securitisation levels should likely come down at the margin. However, as per the draft guidelines on-lending to SHTF would also be eligible for PSL classification, though, we also believe that overall loan portfolio eligible for PSL classification could be lower than 35% due to interest spread cap of 6% put up by RBI (spread on securitisation is significantly higher than 6%). Moreover, we note that a cap on spreads at 6% of securitised assets could be a negative, as we estimate the securitised portfolio spreads at 10%+ since spreads on old CV portfolio are higher (as of 31 Dec’11, old CV constituted 76% of AUM). Mahindra and Mahindra Financial Services (MMFS): As on 31 Dec’11, MMFS’ securitised portfolio would have comprised ~10% of its total AUM. As per our interaction with the management, the securitisation portfolio primarily comprises tractors, for which spreads would have been significantly higher than 6%; these could come under pressure if the draft guidelines were to be implemented. Housing Financiers: We do not foresee much impact on housing financiers as we estimate their spreads on the mortgage book to be lower than that the stipulated 3.5% as per the draft guidelines.

To read full report: FINANCIALS

>BHARAT ELECTRONICS LIMITED: A Solid Play on Indian Defense Modernization

Initiate coverage with Overweight rating, Sept-12 PT of Rs2000 based on 16x Sep13E P/E. BHE, a leading Indian manufacturer of defense electronics, is a play on rising government expenditure on modernization of Indian defense forces. This is supported by a favorable policy framework that seeks a higher share of domestically-produced equipment. With its strong R&D capability, solid execution track record, and long-standing relationship with the Indian defense establishment, we think BHE is well positioned to benefit. It currently has an order book of Rs270B providing revenue visibility for 4-5 years. Valuations have de-rated over the past few quarters on account of margin pressure owing to oneoff lower-margin non-defense orders. We expect a rebound in margins to drive 18% EPS CAGR over FY12-FY14E, which should drive valuations higher. We estimate BHE has Rs55B of cash (Rs685 per share, 45% of market cap) as at 3Q FY12; with the govt. looking at sources of cash to fund its fiscal deficit, we see a case for higher/special dividend payout (the govt. has a 75.9% stake in Bharat).

 Well positioned to benefit from rising defense expenditure. Indian govt. spending on defense equipment is expected to rise at a 10% CAGR to USD19B by 2015 (source CII-Deloitte). While most defense equipment procurement is from foreign vendors, govt. wants to increase domestic share. Defense Procurement Policy mandates minimum 30% offset against any foreign capital acquisition over Rs3B. BEL is well positioned to benefit, given its strong R&D capabilities and longstanding relationships with Indian defense establishment. Its current order book of Rs270B is largely skewed towards defense related orders (80%+) providing steady revenue visibility over next 4-5 years.

 Margins set to recover, solid cash profile. We forecast EPS CAGR of 18% over FY12-FY14E, driven by 8% revenue CAGR and margin recovery. We estimate BHE has cash balance of Rs55B (Rs685 per share) on its books, which will increase to Rs63.6B (Rs795 per share) by FY14E.

 Price target, valuations and key risks. Our Sep-12 PT of Rs2000 is based on 16x Sep13E P/E, towards the middle of BHE's historical trading range. BHE is trading at 13xFY13E P/E, which we believe is attractive given its order-book, earnings growth and cash profile. We expect margin recovery to drive stock rerating. Key risks to our thesis are increasing competition, delay in execution, changes to payment terms and slowdown in defense expenditure.

To read full report: BHARAT ELECTRONICS

>STERLITE INDUSTRIES: Restructuring Version 2.0e

 2nd Attempt at restructuring: After an aborted attempt in 2008, Sterlite Industries seems to be getting close to attempting another restructuring. Management had highlighted its intent to resolve the equity holding of VAL by March’12. Instead of separate business verticals, this time management appears to be considering merging everything into one holding company, virtually creating a dual listing structure. Based on our scenario analysis, even in a worst case, Sterlite could have 25-30% upside. Maintain Outperform.

 Dual listing structure in offing: It is not difficult to see the rationale for this restructuring. Investors have been looking for a simpler structure, while Vedanta has been grappling with the mis-match of cash flows among its various businesses. This means Vedanta is likely looking to merge everything into one holding company, almost mirroring Vedanta PLC, except for perhaps Konkola Copper Mines (where it has a minority partner).

 Vedanta Aluminium (VAL) – expected structure reduces risk for Sterlite: VAL appears to be the prime trigger of this restructuring exercise as it is lossmaking and has no near term solution. Investors have been concerned that the entire VAL stake would be passed on to Sterlite shareholders. However, under the proposed merger structure, if the liability is not assumed by Vedanta PLC, it will be distributed across all the merged entities.

 Merger ratios – scenario analysis indicates Sterlite well below worst case: We have assumed 3 scenarios, based on current stock prices, consensus target prices and the worst case for Sterlite. Assuming the market cap of the merged entity remains the same as the current sum of parts market cap of the entities to be merged (at US$19bn, see Figure 12), even under our worst case assumption Sterlite’s implied stock price comes to Rs157.

 Proforma estimates of the merged co: The merged company would have a consolidated Net Profit of US$2.5bn and trade at around 9.5x PER based on the peer group valuation. This implies market cap of US$24bn as compared to the current sum of parts market cap of US$19bn. Some of this would be driven by reducing the holding company discount as minorities reduce.

Earnings and target price revision
■ No change.

Price catalyst
 12-month price target: Rs149.00 based on a Sum of Parts methodology.
 Catalyst: Clarity on merger ratios, streamlining the holdings

Action and recommendation
 Maintain Outperform: Given past experience, investors may find it tough to believe that the restructuring would not hurt minority shareholders. But our analysis does indicate undervaluation for Sterlite. In particular we would buy on any dips.

To read the full report: STERLITE INDUSTRIES

>REAL ESTATE(FEBRUARY 2012): 50 bps cut = 3-4% price cut; not enough to attract demand

 50 bps cut = 3-4% price cut only
Our economist expects a 50 bps rate cut in 2QCY12. Developers are holding prices primarily hinged on this rate cycle turn for demand to return. However, our analysis shows a 50 bps rate cut equates to mere 3-4% reduction in cost of acquisition; which we believe will not be enough to attract demand.

■ Waiting for 100bps cut in FY13 might be too late
We believe, with poor cash flows, developers will disappoint the market on volume and cash flows in FY13 also if they decide to wait out for demand to return once a total of 100 bps is cut in FY13.

■ Time correction versus price correction
There seems a consensus opinion built-up around possibility of real estate prices under-going time correction rather than price correction. We believe the same is possible for affordable cities of Bangalore and Noida as prices remain stable in FY13 and 100 bps rate cut reduces cost by 7-8%. Developers in both cities are offering 3-4% discount to close deals. However, we believe the city of Mumbai will have to witness a double digit correction beyond the 7-8% reduction due to rate cuts. Anecdotal data shows discounts of 6-8% available depending on the project.

■ History says only price correction can do the trick
We believe the market will be disappointed with operational performance of real estate firms, if prices stay sticky leading to poor volumes. Past cycles show stock prices lag price correction but lead volume recovery by a quarter to two.

■ Volumes with sound realization remains critical
3QFY12 witnessed volume recovery but at lowered realization as developers continued their focus on affordable housing to weather tough market conditions. We believe new launches (mid-end to high-end) in core markets (at discounted prices) will help improve cash flows.

 Current rally does not corroborate with physical market
We believe the current rally in real estate stocks could be overdone and recommend caution as the current rally led by global liquidity does not corroborate with the physical market trends wherein 1) sales volume continue to wilt, 2) unsold inventory remains high 3) balance sheets remain stretched 4) asset sale progress
slow 5) capital availability still tight and 6) execution has slowed.

■ Can buy fundamentals at dips
We like firms with sound balance sheet, annuity income and launch visibility; thus recommend BUY on Oberoi (C-1-7, Rs287.45) and Underperform: HDIL (C-3-9 Rs120), IBREL (C-3-8, RsV-3-8).

To read full report: REAL ESTATE