Wednesday, March 7, 2012

>GLOBAL LIQUIDITY: Opportunity in adversity? (ESPIRITO SANTO)

Given liquidity pressures and heightened capital requirements, EU banks are reducing exposure to Asia, including India, creating an opportunity for Indian banks to capitalise on. Our top plays on this being Bank of Baroda and SBI. Moreover, in a year with a $5.2bn wall of FCCB redemptions, we think there are likely to be opportunities appearing from FCCB mispricing. The FCCB’s of companies such as Educomp, Rolta and Suzlon look like interesting opportunities.

The objective
The stage is set for another round of liquidity infusion by the major global central banks, at a time when domestically bank credit growth is showing signs of significant moderation (16% YoY vs. 24% last year). This note analyses the extent to which changes in global liquidity have impacted the availability of resources to the domestic commercial sector, especially at a time when a) European banks are expected to deleverage ahead of the EBA core Tier 1 capital requirement and b) huge FCCB refinancing/restructuring needs have arisen for Indian corporates.

The impact of EU banks deleveraging on Asia
Continental European (ex UK) banks account for approximately USD 70bn of0 bank claims in India, and if including the UK, then European banks in total account for 45% of the total claims on India. While no significant deleveraging was noted by the UK in Q3’11, other European banks have reduced exposure by USD 5bn from Q1’11 to Q3’11. Given their robust liquidity and capital and strong presence in Asia, both HSBC (Buy) and Standard Chartered (Buy) are well positioned to capitalize on the deleveraging of European banks, as our banking analyst Shailesh Raikundlia explains in his report of 6 February 2012: “HSBC, Standard Chartered: Opportunities in Adversity”.

Indian banks exposed to this opportunity
We think PSU Banks are best placed to gain access to critical dollar funding to exploit this opportunity given quasi sovereign guarantees. Among the PSU banks under our coverage we recommend Bank of Baroda (BOB IN, BUY) as our top pick to play this theme, given its international loan book constitutes 26% of advances, and its 15% QoQ international growth in Q3FY12. Our second choice to play this theme would be State Bank of India (SBIN IN, BUY), with its international loan book of Rs. 1.3tn.

Is India facing a foreign funding crunch?
The data suggests that despite fears of a contraction in foreign funding, actually foreign funding (notably ECBs and FDI) has played an important role at a time when domestic sources have contracted. The biggest test this year in terms of foreign funding of corporate India will be the USD 5.2bn of Indian FCCB redemption coming up, pretty much all of them underwater, so requiring restructuring, refinancing or replacement with other forms of borrowing, such as

How much risk do the FCCB redemptions pose?
Whilst the FCCB redemptions pose a challenge, the fears around the issue means that opportunities are likely to arise in FCCB mispricing. We review examples from historical price/yield movements of these instruments and present FCCBs of companies that provide high YTMs (yield to maturity), as well as relative safety of principal.

The FCCBs of companies such as Educomp, Rolta look like interesting opportunities to us, and even the Suzlon situation with multiple tranches on very high YTMs is worth us monitoring. First Source, Tulip IT, REI Agro, Jaiprakash Power, Videocon Ind., Sintex, JP Associates, Welspun Gujarat, Bharat Forge are all trading at high YTMs with relatively low probability of default given leverage, higher interest coverage and respectable credit ratings implying easier
access to international and domestic funds. We think GTL Infra and Suzlon look like candidates for restructuring with haircuts, and 3i Infotech looks to us to be the most likely candidate for default given its weak core business.

To read full report: GLOBAL LIQUIDITY

>Prospects and Outlook for 2012-13: Economy and Sectoral (CARE RESEARCH)

With fiscal year 2012 nearing its close on a note of distinct downtrend in economic conditions, an evaluation of the prospects for the ensuing year warrants attention. The performance of various segments of the Indian economy during 2011-12 was on most occasions found to be falling short of the envisaged growth, attributed to the waning global and domestic economic environment during the period, necessitating significant and regular downward revisions in projections made at the start of the fiscal. Based on the prevailing scenario in the various sectors and the expected changes and improvements therein, we have put forward here our expectations for the Indian economy and the various sectors for the 2012-13 fiscal.

Prospects 2012-13 -: Key Economic Variables

GDP growth
India has been unable to sustain her stellar 8.4% GDP growth rate (average over the last five years) in the current fiscal, a consequence of the RBI’s tight monetary policy stance to tame inflation, low demand conditions and the resultant weak industrial growth, and the cumulative global economic weakness that led to lower growth in the country’s exports.

Although the country’s GDP growth for the 2011-12 fiscal is being officially acknowledged to be notably lower ( at around 7%) than the original 9% forecast for the year, it would still be amongst the highest in the world. The coming fiscal too would see a more or less subdued economic expansion in the country in line with that of current financial year.

We expect GDP growth to gradually move upwards to 7.5% in 2012-13. This estimate is however contingent on the assumption made on various other economic variables holding forth such as inflation, government’s deficit, growth oriented annual budget and favorable monetary policy action.

India has been besieged with persistent high inflation (at near double digit) since late 2009 and there is no aspect of the economy that has not borne the adverse impact of this. Inflation has been credited with being the prevalent influence over practically all policies this fiscal. For one, it has been the sole consideration driving the country’s monetary policy over the last 2 years. The tight monetary policy stance adopted by the country’s monetary authorities to combat high inflation in addition to raising the cost of credit has reduced investments and manufacturing/industrial growth. The control of inflation is of paramount importance for both the government and monetary authorities.

Although inflation has cooled in recent months (to 6.56% in January’12, after hovering at close to double digit for most of 2011), there are indications that it may not stay at these levels for long. The decline in food prices, the main reason for the decline in the wholesale price index (WPI) is likely to reverse trends once the high–base effect starts to wear off from as early as the start of the 2012-13 fiscal. To add to this rising international crude oil prices have further raised the risk of a rise in domestic fuel price. Fuel and food price rises would in turn feed into manufactured product inflation – food and fuel serve as key inputs to various manufactured products. Inadequate food logistics network/ supply bottlenecks has been primarily blamed for the price rises in food and various manufactured items.

The WPI inflation for 2011-12 has been projected by the PM’s Economic Advisory Council (PMEAC) to be around 6.5%.Although inflationary pressures would persist in the coming fiscal too, we are hopeful that the inadequacies on the logistics front may get addressed and there would be increased focus on production, both of which could result in easing of inflationary pressures to 5-6% in 2012-13.

 Interest rates
The RBI is likely to remain cautious and maintain its anti-inflationary monetary policy stance and continue to keep a close watch on inflation which has stayed above the target of 7% for almost all of the last two years, that prompted it to raise interest rates 13 times since March 2010. The central bank may gradually lower the repo rates by 100-150 from the current 8.5% (highest since March’08) during the course of the year, although there is no conclusive time frame for this reduction given the uncertainty in inflation. It has been widely anticipated that despite the recent cooling of inflation, the RBI may look for a longer term trend in the price movement especially of core inflation before reversing its policy stance on interest rates. It is however, largely believed that interest rates have peaked.

Even with a RBI cut in interest rates, banks may not be in a position to cut interest rates significantly as their cost of funds have risen significantly in recent times. This rise in banks cost of funds have been on account of increasein long term bank deposits that carry higher interest rates and it is these deposits that act as the primary source of funds for banks. In addition, the recent freeing of NRI interest rate (from 2.5% to 9-9.5%) to shore up the depreciating Rupee too has added to the funds cost. Moreover, the prevailing tight liquidity conditions has seen banks borrowing at relatively high rates for meeting their daily requirements and no improvements in this is expected in the near term.

Industrial Growth (IIP)
Industrial growth would essentially be driven by consumption followed by investment demand in the coming year given the expected pattern of movement in interest rates . The impact of high interest rates on investment demand is likely to be carried forward into the 2013 fiscal as well, which would affect industrial growth. Proactive policy action from the government, that has practically stalled in the current fiscal, could provide the required stimulus going forward.

We estimate industrial production to grow by around 7% in FY13 on the assumption of affirmative policy action and the anticipated roll back in interest rates.

Fiscal Deficit
The government would be required to increase expenditure in its FY13 budget as a means of providing the required boost to the domestic economy given the economic uncertainties both in domestic and external economy. Higher focus is likely to be on project expenditure that would lift the infrastructure sector which, in turn will result in forward and backward linkages being forged. Moreover, the government’s poverty alleviation programmes and the implementation of the Food Security Bill would pressurize government finances.

The government would also be constrained to revert to the FRBM targets and have to balance expenditures with revenue to ensure that the deficit ratio improves . Therefore, government action in terms of spurring economy will be cautious keeping these numbers in mind.

Prospects 2012-13 -: Sectoral

We expect domestic aluminium demand to grow at a CAGR of about 8.5%during FY11 to FY16. Domestic demand will largely be driven by the automobiles and the packaging sectors, which are likely to grow at a CAGR of about 10 % each during the same period. In volume terms, the power sector will continue to be the major driver of domestic demand.
CARE Research expects domestic aluminium smelter capacity to increase at a much faster pace as compared with demand for the same as most domestic aluminium producers are undertaking huge expansion of smelter capacities. However, owing to competitive cost advantage rendered by bauxite resources any surplus production is likely to be exported.
Availability of coal for power projects remains a major concern for the global and domestic aluminium industry. Since power account for a significant portion of the aluminium cost curve, any increase in thermal coal prices is likely to impact margins and profitability of the industry.

Two Wheelers
CARE Research estimates the domestic two-wheeler (TW) demand to grow at around 10-12% in FY13 owing to low TW penetration level coupled with low dependence on financing. The growth in this segment would be driven by the low TW penetration and increasing disposable income in rural India. Export markets will also remain buoyant and continue to grow at around 30% in FY13. Growing demand in developing markets primarily in Africa and Asia will drive export demand. These regions are highly populated and under-penetrated and have huge demand for low cost TW, which provide opportunity for Indian TW manufacturers to expand in overseas market.

CARE Research expects EBITDA (earnings before interest, taxes, depreciation, and amortization) margin of the industry to witness a drop of around 70-80 basis points and remain around 13% in FY13 from around 13.7% in FY11. Return on Capital Employed (ROCE) of the TW industry is also expected to witness a drop from the range of 56-57% in FY11 to around 41% estimated in FY13.

TW industry’s current production capacity is around 15 million and is expected to reach 20 million by FY14. There will be considerable cap-ex by the incumbents like Bajaj and Hero as well as by new entrants like Honda and Yamaha. All most all the TW manufacturers have huge capital investments lined up for coming two years.

Passenger Vehicles
In spite of high interest rates and high fuel prices the passenger vehicle (PV) segment is expected to witness a growth of around 6-8 % in FY13 on the back of delayed purchases by consumers. FY12 is likely to witness flat demand on account of economic concerns; however, this does not imply a dearth of potential buyers as the PV penetration in India is still one of the lowest in the world. We expect delayed purchases to come into picture and boost sales in FY13. Furthermore, any positive step from government in terms of easing in interest rate or stability in fuel prices combined with new launches could also push the growth prospects to around 10-13% in FY13.

CARE Research expects the EBITDA margin of the industry to witness a drop of around 50-60 basis points and remain around 7% in FY13 from around 7.6% in FY11. ROCE of the industry is expected to witness a drop and remain in the range of 15% in FY15 from around 16% in FY11.

PV industry’s current capacity is around 3.5 million and is expected to almost double in a period of 4-5 years. Most of the PV manufacturers like Maruti, Toyota, Hyundai, Ford, Honda etc. have big expansion plans for the next 2-3 years. In addition to existing players new entrants like Peugeot have announced cap-ex in tune of Rs.4000 crore in next 2-3 years.

Commercial Vehicles
CARE Research estimates that domestic demand for commercial vehicles would grow by around 13-14 % in FY13. We believe healthy long-term macro-economic outlook coupled with increase in government focus towards development of transport infrastructure would fade away the short-term concerns over rising fuel prices and interest rates. The goods carrier (GC) segment would continue to dominate the growth as it is expected to grow at a healthy rate of around 13%, while the domestic passenger carrier (PC) segment is expected to post a growth of around 6% in FY13.

CARE Research expects EBITDA margin of the industry to witness a drop of around 80-90 basis points in FY13 from around 9.2 % in FY11. ROCE of the industry is also expected to witness a drop and remain in the range of 14 % in FY13 from around 16 % in FY11.

CV industry has a current capacity of around 1.5 million units per annum and the industry capacity utilization is in a range of 60-65%. Considering the low capacity utilization of the CV industry coupled with the slowdown in economy, the industry will not witness massive cap-ex in next two to three years; however, the capacity is estimated to reach 2 million in next 2-3 years on account of expansion of new entrants like Bharat Benz, Mahindra Navistar, etc.

High material costs in the automobile industry are expected to remain at current levels with slight -upward fluctuations. Prices of key inputs such as steel, aluminum and rubber stand vulnerable to fluctuations in the global as well as domestic markets. Operating margins of companies in this sector are expected to come down on the back of high selling and distribution cost due to cut throat competition.

Employee cost as a percentage of sales is expected to remain the same or see a nominal downward correction.

Original Equipment Manufacturers (OEMs) are highly dependent on imported components, even domestic players such as Maruti, for instance, imports about Rs 8,000 crore worth of parts annually. OEMs of foreign origin have exposure to foreign currency in a range of 40-70 %. Hence currency fluctuation in either direction has its influence on profitability of OEMs. Given that OEM’s depend on imports, they are vulnerable to any supply disruption in major component sourcing destinations like Japan, China and Thailand.

For FY13, CARE estimates advance growth to be around 18-19%, considering an expected GDP growth rate of around 7.5% for the year. CARE expects interest rates to soften in FY13, prompted by the moderation in inflation and the need to boost economic growth. Accordingly, CARE expects RBI to reverse its monetary policy stance. Yields on advances are also likely to follow suit. Given the projection of improvement in credit off-take vis-à-vis FY12 and softening of interest rates, CARE believes the deposit growth is likely to lag credit growth at around 16-17%. Net Interest Margins (NIMs) are expected to remain under pressure at least in H1FY13 as yields on advances may moderate with interest rate cuts by RBI. However cost of deposits is likely to decline with a lag. CARE estimates Gross NPAs to increase to 3.1-3.25% by end of FY13, considering slippages on account of both economic slowdown in India and weak global economic outlook. However, given the Government’s intention to keep public sector banks adequately capitalized, it may be expected that the banking sector could withstand the impact of margin pressures and rising delinquencies.

The Indian cement industry recorded a dismal growth of 5.1% in FY11 on account of slowdown in construction activities due to prolonged monsoon, heavy winter, delay in execution of infrastructural projects caused by environmental clearance hurdles, etc. During the first nine months of FY12, cement demand has registered a growth of about 5.3% on y-o-y basis. Quarterly cement demand picked up post monsoon and registered a growth of about 9.5% (y-o-y) during the third quarter of FY12.

Long- term cement demand in the country is expected to remain stable. Going forward, cement demand will largely be driven by increased focus of the government on promotion of low-cost affordable housing and infrastructure development. In the next 4-5 years, cement demand to the tune of about 250-260 mn tonnes is expected to emanate from the construction of new dwellings. Also, cement demand is expected to pick up as government expenditure on infrastructure projects catches momentum. GoI has envisaged an investment of more than Rs. 40 lakh crore for infrastructure development under the Twelfth Five Year Plan. This will augur well for the cement industry. Investments planned under various sub-sectors of infrastructure during the Twelfth Five Year Plan will derive a cement demand of more than 600 mn tonnes. 

CARE Research estimates that cement demand is expected to grow at a CAGR of about 8% for the period FY12-14. Cement industry is expected to add about 86 mn tonnes of capacity during the period FY 12-14 and operate in the range of 74-76% of capacity utilisation.
Average cement prices have increased by about 10% from Rs. 253 per bag in FY11 to Rs. 278 per bag in FY12. On the back of pick up in cement demand, especially during the third quarter of FY12, quarterly average cement prices rose by about 13% to Rs. 284 per bag. The cement industry has been grappling with cost pressure in FY12 due to rise in raw material cost and freight charges. However, the industry has managed to pass on higher input cost through a series of price hikes in the past few months. As a result, we do not see a significant downward impact on the profitability of the cement industry.

Though, India is the third largest producer of coal in the world, after USA and China, the domestic coal sector is unable to keep pace with the growing needs of the power sector due to environmental clearance delays faced by coal miners in the last few years. Furthermore, railway infrastructure has been inadequate for the requisite amount of coal transfer leading to acute coal shortages faced by most power plants today. The demand CAGR over FY09-12 stood at 6.6%, vis-à-vis coal production CAGR of 4.6% over the same period leading to acute shortage of coal. CARE Research expects the import requirements of the country to surge substantially going forward if demand-supply mismatch is not addressed in time.

Construction activity is an essential part of our country’s growing need for infrastructure and industrial development. Construction as a percentage of GDP has been in the narrow range of 7.9-8.1% in the past six years. The size of the construction industry is estimated at around Rs.1.1lakh crore in FY11. Ranked 12th globally, the domestic construction industry is the second-largest sector after agriculture in India in terms of employment and understandably has a direct and high correlation with economic activity. The sector has witnessed pitfalls in recent times on account of slowdown in award of projects and their execution, rise in commodity prices and interest costs and elongated working capital cycles that have in turn put pressure on profitability margins and debt profile of companies in the construction sector.

During FY11, the performance of most construction companies was impacted by slower economic growth leading to both lower inflow of orders and slower progress in execution of projects. The aggregate order inflow of the top ten construction companies reduced from a peak of about Rs.38,660 crore in Q4FY10 to Rs.17,125 crore in Q2FY12, according to data provided by CMIE. Prices of key inputs - steel and cement have increased sharply in the recent past, resulting in increased cost of projects under execution. The prevalence of an inflationary environment during the last few quarters has resulted in hike in key policy rates by the central bank leading to increased interest cost for working capital intensive construction companies. Further, intense competition for securing orders along with rising commodity and manpower costs and technological impediments is expected to pressure profitability.

As at end of FY11, the order-book to sales ratio for the industry was about 3.3 times showing decent revenue visibility. However, almost 30-35% of projects in the aggregate order-book are slow-moving or stalled due to factors such as delays in approvals and clearances, rising costs, socio-political disturbances (agitation for separate statehood for Telangana in the state of Andhra Pradesh where most of the companies have exposure in the form of irrigation projects), etc. which could hamper project execution and drag down revenue growth.

Though opportunities for construction in both the infrastructure and industrial segment look good in the long term, order inflows in the near future are likely to be affected due to slowdown in capex cycle and delays in awarding of infrastructure projects by government authorities. Uncertain economic and political conditions, along with issues related to land acquisition and environmental clearances have resulted in slower award of projects for both industrial and infrastructure projects, adding to the woes of this sector.

Further, slow progress in projects and delayed payments from contractees have resulted in elongated working capital cycle, thereby increasing reliance of these companies on external funds. This has deteriorated the capital structure of these companies. Also, a number of construction companies have ventured away from core construction activities into allied activities like infrastructure Build-Operate-Transfer/Build Own Operate Transfer (BOT/BOOT) and real estate development. This could primarily be attributed to the current Public-Private-Partnership (PPP) model adopted in awarding of projects. The change in business model from pure Engineering, Procurement & Construction (EPC) contractors endeavoring to graduate to developers, has resulted in higher risks (funding risk, financial closure, legal issues, post implementation risk, throughput risk, etc.) and increase in debt burden for these companies.

The financial risk profile of companies, having significant exposure to their associates/special purpose vehicles (SPVs)/subsidiaries engaged in asset developmental activities, is expected to deteriorate in the near future, as asset developers, in general, are restricted by absence of adequate cushion to absorb hikes in interest rates and commodity prices. This in turn increases their reliance their sponsors (promoters) for any tangible and/or intangible support.
With a decline in the number of tenders expected to be floated, increase in competition, high input prices and high interest rates, profitability is expected to remain under pressure in the short to medium term. The ability of companies to manage their working capital cycle efficiently in a bid to avoid further strain on financial leverage, would be critical from the credit perspective.

CARE Research expects the Indian Education System to grow from US$66.6 bn during FY11 to US$102.1 bn to FY15 at a CAGR of 11.2%. Of the same, the market size of pre-school is expected to increase at a CAGR of 33% owing to the growth in penetration of pre-school from 2.5% during FY11 to 4% during FY15. We expect the penetration of organised pre-school to grow from 14% during FY11 to 25% during FY15 owing to the growing number of pre-schools in tier- II & III cities.

The market size of Information and Communication Technology (ICT) in schools is expected to increase at a CAGR of 20.4% from FY11 to FY15. The penetration of ICT in schools is expected to grow from 6.1% during FY11 to 9.7% during FY15 backed by the thrust of the Government of India (GoI) on improving computer literacy and greater acceptability of ICT in private unaided schools.

Furthermore, we estimate the market size of the Kindergarten to grade 12 (K-12) segment to grow at a CAGR of 16.2% from FY11 to FY15. CARE Research projects the total number of schools in the K-12 education segment to grow from 13.5 lakh during FY11 to 16.1 lakh during FY15, at a CAGR of 4.5%. Of the same, government schools would comprise 77% of the total schools, with private sector schools contributing the rest.

The lower literacy rate in India as compared to other developed nations of the world together with the beaming demand for quality educational institutes in the country is expected to drive the supply of such institutes.

Gems &Jewelry:-
We expect the demand for gems & jewellery in the domestic markets to be robust from Q2-FY13, in the scenario of cooling inflation and price stabilization in gold and diamonds. We foresee the organized players registering high growth rates in sales and revenues during FY13 compared to the overall industry growth as there is significant opportunity for organized retailers to create additional value through sale of branded and designer jewellery. Exports too would witness growth from H2-CY13 with improvement in economic conditions in the Eurozone.

Prices of precious metals and stones viz. gold and diamonds would continue to be volatile in Q1-FY13, however, with expectations of stabilization in economic conditions in the European Union and the global economy, prices of these too are likely to stabilize in Q2FY13. Significant volatility in prices was witnessed in FY12 due to Euro zone concerns. Domestic prices in addition to being driven by global price movements would also be pressured by the recent increase in excise and import duties on gold and silver.

Although, the Indian jewellery manufacturer’s focus on the domestic market would result in higher top line growth, profitability tends to stand impacted with rising cost of inputs..
With the emergence of a new class of buyers, who buy jewellery as a fashion statement rather than for investment purposes, manufacturers have resorted to unique combination of design, caratage and price point, all of which has increased supply and thereby the options available to jewellery buyers. The players in the market are also on an expansion phase and have been opening stores in tier 1 and tier 2 cities in an attempt to penetrate larger markets.

CARE Research has projected a moderate growth rate in demand of 9-10% for the Hotel Industry in FY13. This demand would mainly be driven by the rise in both, domestic and foreign tourists. The domestic tourists are expected to surge by approximately 14-15 % in FY13 and foreign tourists are expected to grow by 7 %. While rising disposable incomes, increased globalization and the increasing number of events taking place in India have been factors that have been beneficial for the industry, untoward events that the country is susceptible to such as natural calamities, terrorist attacks or spread of certain diseases have a negative influence over the sector.

Huge supply addition is expected in FY13, especially in Bengaluru, Chennai and Kolkata, thereby leading to a fall in occupancy levels. Large numbers of international hotel brands too are setting up hotels in India. Average room rates are however expected to remain more or less moderate with a slight increase in certain cities. Moreover stiff competition from domestic and international hotel brands (significant increase in capacity in the recent years and expected in near future) will prevent the hoteliers from increasing the average room rates. The sectors profitability is thus expected to remain subdued in FY13.

Information Technology:-
On the back of good client additions during the period of April to September 2011 and Information Technology (IT) companies increasingly resorting to bundling of services (to maintain billing rates), growth momentum in revenues is expected to continue in the coming quarters; volumes being the primary driving factor.

While new discretionary spends may witness a drop in Euro areas, IT spends in general are expected to remain on track in the US and emerging markets. Additionally, transformation spends towards cutting costs and improving efficiency are expected to remain steady going ahead.

A scenario of weakening Indian rupee to major currencies like the US dollar, Euro and GBP will provide an additional boost to the revenues of IT companies. However, higher wage bills and increased tax provisioning are issues which these companies will have to grapple.
A key development for the industry to watch out for would be the US Call Centre and Consumer Protection Bill.

Iron ore mining:-
Almost half of the total iron ore mined in the country is exported. In FY11, almost 46% of the total 212 mn tones of mined iron ore was exported; the rest being used for domestic consumption. India’s iron ore exports have registered a steady increase during FY05 to FY10, with a CAGR of about 8 %. However in FY11, with the levy of the export tax, iron ore exports witnessed the first ever fall since FY97.

Iron ore mining, India’s core competence, figures prominently in endless debates on the Government’s policy regarding exports and distribution/allocation of existing and new mining assets The segment is also subject to various policy directives such as the sporadic levies of export taxes (currently increased from 20% to 30%) and the sharing of 26% of profits with the local community that has been affected by the mining activity. Going ahead, CARE Research expects the uncertainty in the iron ore mining industry to continue with no significant changes in the immediate short to medium term. Prices are likely to remain volatile with a negative outlook on account of a growing uncertainty in demand from China and European markets.

Paper :-
CARE Research forecasts the Paper industry demand (in volume terms) to grow around 6.5-7.0% in FY13, in-line with the 5-year historical average GDP multiple of 0.9 times. Moreover, on the back of improved demand (mainly from developing countries) and no major increase in capacity seen in the next 12 months timeframe the capacity utilization of paper industry is forecast to improve to 79% in FY13 compared to 77% in FY12.

Domestic paper manufacturers stand to benefit from the decline in prices of NBSK wood pulp by around 8% since March 2011 on the back of weak demand from developed countries (such as US/EU) and China. Prices are expected to remain subdued in FY13, especially beneficial for non-integrated paper producers who are dependent on imported pulp fibre. Imported wood pulp accounts for 32-33% of total pulp consumed in India. Domestic manufacturers could however, be negatively impacted by the continued weak demand in developed countries which could lead to significant increase in newsprint and coated woodfree paper imports as exporters (China, Indonesia) would divert their output to emerging economies such as India.
With regard to profitability, the domestic paper industry’s profitability is expected to remain subdued in FY13 as stiff competition from domestic (significant increase in capacity in the recent years) and international (weak demand in the developed countries will force exporting countries to divert their output to India) players will limit the domestic producer’s ability to pass on full increase in power & fuel expenses and increase in imported raw-material costs.

CARE Research expects pesticides production to increase by about 7% in FY13 and demand to increase in the range of 10-12% in FY13.The growth in consumption of pesticides will be primarily driven by the growth in crop production. The sector’s growth would be primarily dominated by the increasing use of fungicides and herbicides owing to the growing demand for better quality fruits and vegetables from consumers coupled with intensifying labour shortage across some parts of the country.

Pesticides companies are building up new capacities so as to increase production and supply. India will continue to be a net exporter in FY13 for pesticides, while South East Asian countries would remain the major exporter driven countries.
Net sales of companies including exports are expected to grow in FY13 backed by higher volumes and improvement in realizations. However, the operating margin is expected to remain flat due to an increase in energy and raw material cost.

Prospects for the Indian pharmaceutical industry look promising in FY13. The imminent and ongoing expiry of patents on a range of drugs of leading global pharmaceutical companies would be the major growth driver for the domestic pharma companies. The loss of patent protection (a protection to companies for usually 20 years of exclusive sales) for some of the “best selling/branded” drugs would help open up the market for “generic” and cheaper alternatives. The resultant increase in demand for generic drugs in developed countries would be beneficial for Indian companies as India is one of the front runners in the generics market. Growth in the emerging markets’ pharma sector is expected to come mainly from generics with only a small portion (20%) projected to come from branded drugs. Governments of emerging markets too have been providing the required boost by increasing their spending for healthcare related services and infrastructure.

CARE Research expects the domestic market to grow by 12-13% in FY13 and foresee exports to show more robust growth.

At the same time we expect competition (more players) and thereby supply to increase leading to price erosion in the generic drugs segment. The companies would also be required to invest substantially in terms of sales and marketing field force, product portfolio and alliances and partnerships which would impact margins and also has potential to be offset by robust growth in exports. Moreover, the US, Europe and other global markets would continue to remain competitive. National Pharma Pricing Policy further poses a threat towards the pricing of drugs by bringing at least 60% drugs under price control from 20% currently which would also impact prices.

We expect margins to remain stable for FY13 based on consolidation, exports potential, cost tightening measures and rural penetration.

The domestic Contract Research and Manufacturing Services (CRAMS) industry too would stand to benefit from the projected surge in the generic market with the increase in number of outsourcing contracts coming their way. It is forecast that the CRAMS business in India would double in value terms to $7.6bn in FY13 from $3.8bn in FY11. India has a distinct advantage over other players in this segment owing to the availability of low cost manufacturing skills, skilled labour and highest number of FDA approved plants.

Power :-
The peak and base power demand is estimated to grow at 8.5-9% and 7.0-7.5%, respectively in FY12. The FY13 demand outlook is expected to moderate further in line with slowing GDP growth. Though, most of the State Distribution Companies have gone for tariff hikes in the past one year, constrained financial conditions due to excessive cross-subsidization, high aggregate technical & commercial (AT&C) losses and delayed subsidy payment from state government, have held back the distribution companies from buying expensive short term power (states with election might be an exception).

On the capacity front, the 11th Plan (2007-12) saw robust capacity addition of about 48.7 GW (Dec-11) on the back of private sector entry in power generation. The 11th plan is expected to add 51-52 GW by March-2012. However, the 12th Plan capacity addition is expected to suffer on account of looming domestic coal shortages, imported coal pass-through issues, land acquisition problems and environmental delays for new mines leading to sharp slowdown in capacity addition. CEA has already downgraded the 12th plan capacity target to 76GW (from original 100GW).

A factor that has been impacting the sector significantly is the price of imported coal that has risen 130-140% to $110/tonne which is rendering competitively bid power projects unviable. Consequently, the large private developers have asked the government to revise the tariffs (Power Purchase Agreements/PPAs) for these projects failing which there is a huge risk of these capacities/ assets lying idle or becoming NPA.

The short term average electricity price for FY13 is expected to remain subdued (between Rs 3-4 per unit) in the wake of sluggish demand from state distribution companies.

The Power sector’s profitability is expected to reel under pressure from expensive imported coal prices, lower domestic coal production coupled with transportation issues (leading to lower PLFs for power generators), high interest rate and stressed working capital conditions (due to delayed dues from State distribution companies). Moreover, the delay in capacity addition would also impact the power sector’s profitability in FY13.

With approximately 60% of Private Final Consumption Expenditure (PFCE) constituting total retail expenditure historically, the growth in PFCE is expected to remain a major driver for the growth of the Indian retail industry.

We expect the PFCE to surge from Rs.41.38 lakh crore during FY11 to Rs.56.61 lakh crore during FY13, a CAGR of 16.9%. On the back of this increase in PFCE, we estimate Indian retail sales to grow at a CAGR of 17.1% from Rs. 22.96 lakh crore during FY11 to Rs. 31.53 lakh crore during FY13. Within this, the share of food & grocery would remain the highest at 58% of total retail sales and the clothing & footwear segment would be the second largest contributor occupying 10% of the total retail pie during FY13.

CARE Research expects the Indian organized retail industry to grow from Rs.1.49 lakh crore during FY11 to Rs.2.52 lakh crore during CY13 at a CAGR of 29.9% thereby implying the growth in revenues of the organized Indian retailers. The penetration of organised retail in India is expected to surge from 6.5% during FY11 to 8% during FY13. Of which, the penetration of the clothing & footwear segment is expected to remain the highest at 27.5% during FY13. We expect rising urbanization together with growing mall culture in tier-II & tier-III Indian cities to lead to the growth of new consumer class for the organised Indian retail market. This coupled with the changing consumer preferences from ‘mom &-pop stores’ to ‘shopping malls’ and the changing perception of shopping concept from mere ‘purchase of necessities’ to include ’spend on luxury, leisure and entertainment’ is expected to fuel the growth of retailing in India.

However, the profitability margins of the organised retail players would be pressured primarily owing to the high real estate prices, lack of efficient supply chain & storage facilities ultimately leading to higher inventory days and greater wastages. In addition, with the interest rates at its peak; the servicing of debt is also expected to adversely affect the profitability of the retailers.

Real Estate:-
The outlook for the real estate industry, barring stable rent yielding projects, remains negative, due to subdued demand consequent on substantial increase in asset prices. Affordability has been significantly impacted by higher interest rates that has led to substantial increases in EMIs. In addition, delays in project completion owing to increased time lag in getting approvals and funding shortfall owing to the cautious approach of lenders has affected the sector.
Factors which could release the pressure in real estate markets and induce cash flow stability –include increase in affordability for buyers and deleveraging of land banks and sale of non-core assets.

Affordability is a function of EMIs (dependent on interest rates), income levels and real estate prices. The first two factors are outcomes of macroeconomic conditions which cannot be controlled in the short term. While interest rates may eventually moderate, affordability is not expected to improve in the immediate future. Consequently, correction in prices would be the major factor which could drive in the volumes.

Deleveraging of land banks and non-core assets would cause a fundamental shift in the balance sheets of real estate developers by way of reduction in debt levels (assuming that sale proceeds are utilised in the reduction of debt levels). Though sale of land banks and non-core assets would ease out cash flow pressures, the same is a long drawn process and may not help in the short-term.

Going forward, the ability of real estate developers to manage funding shortfalls in a scenario of subdued demand whilst maintaining adequate liquidity, would determine credit quality.

Road transport plays a pivotal role in economic development of the country. In India, roads carry about 60% of the total freight traffic and 85% of the total passenger traffic. Currently, India has an extensive road network of 4.2 million km – the second largest in the world. Over the years, GoI has emphasized on enhancing the country’s road network through various programs like National Highway Development Project (NHDP), Pradhan Mantri Gram Sadak Yojna (PMGSY), Special Accelerated Road Development programme for the North-Eastern Region (SARDP-NE), etc.

Road sector witnessed investments to the tune of Rs. 1.27 lakh crore during the Tenth Five Year Plan. In the current (11th) Five Year Plan, investment in the road sector is estimated at Rs. 2.79 lakh crore. During the first two years of the Eleventh Five Year Plan, project awarding process under NHDP had not witnessed much progress on account of the financial crisis and unfavorable policies. Later on, project awarding picked up with recovery in macro economic conditions and initiatives taken by GoI to speed up the award process. Consequently, NHAI awarded road projects with a total length of about 3,360 km, in FY10 which further increased to 5,083 km in FY11. In the current fiscal, NHAI has set a target of awarding projects with a total length of about 7,300 km. The NHAI has awarded projects aggregating to about 4,300 km of road length during the current fiscal (until November 2011). It is expected to award about 5,,500 km of road projects in FY12 as against the target of 7,300 km. In FY13, the NHAI has targeted to award about 7,000 km of road length.

The process of awarding road projects will sustain momentum in the Twelfth Five Year Plan. Almost 42% of road projects under NHDP, comprising length of about 20,200 km and worth more than Rs.1.5 lakh crore, are likely to be awarded over the next 3-4 years. Apart from national highways, development/upgradation of state highways has also gathered momentum. State projects with the total road length of about 1,91,500 km (including state highways and district roads) are planned for construction and upgradation by different states during the Twelfth Five Year Plan. Under PMGSY, out of total new road connectivity planned, work on about 47% of the road projects is remaining. During the Twelfth Five Year Plan, investments in the road sector are expected to be higher than Rs.6 lakh crore , more than double that in the previous Plan.

Shipping and Shipbuilding:-
The sea-borne trading volumes (tonne miles) have been historically related to the world GDP (at constant prices) and the two exhibit a high correlation (correlation coefficient of 0.9). With the global economy being under fiscal strain and with world GDP growth moderating (world GDP is expected to grow in the range of 4.0-4.5% during CY11-CY13 according to the IMF), sea-borne trading volumes have been subdued and are expected to remain so in the coming future. We expect sea-borne trading volumes in 2012 and 2013 to be weak and grow in the range of 4.4%-4.5% on y-o-y basis. The continued weakness in sea-borne trading volumes is expected to adversely affect the fortunes of the global shipping industry in the coming future.
Owing to the huge inflow of new-build vessel orders received by the shipyards globally prior to the economic recession, vessel deliveries by the yards continue to grow inspite of the slow-down in new-build orders. Going by the current delivery schedule of new-builds, we expects approximately 85-90% of the global vessel orderbook to be delivered by CY13. Further to worsen the situation of over-supply of the existing fleet, the vessel deliveries during CY12 &CY13 are expected to account for 12.6% & 5.6% of the fleet size respectively. However, in view of the liquidity constraints faced by the shipowners as well as the shipyards globally, the trend of re-scheduling of vessel deliveries is likely to continue during CY12-CY13.

CARE Research expects the global fleet size (in terms of million gross tonnage) to surge from 1,030.7 mn GT during CY11 to 1,200.8 mn GT during CY13, implying a CAGR of 7.9%. The said growth in world fleet size is expected to be driven primarily by dry bulk vessels, with estimates of the dry vessels fleet size increasing from 326.1 mn GT during CY11 to 410.0 mn GT during CY13, a CAGR of 12.1%. The global Containerships fleet size, is expected to increase from 170.0 mn GT during CY11 to 204.1 mn GT during CY13, while the Wet bulk fleet is expected to increase from 254.6 mn GT during CY11 to 286.6 mn GT during CY13, implying a CAGR of 9.6% and 6.1% respectively .

Going forward, owing to the combined mix of subdued sea-borne trading volume together with delivery flow of vessel from the global shipyards, we estimate the global fleet size to be in over-capacity at 13-16% of the existing fleet during CY11-CY13 i.e. excess of fleet availability in relation to the cargo-carrying requirement. This has in turn adversely affected freight rates and profitability for ship owners, resulting in ship owners facing a credit crunch. During CY11, the freight rates in the Wet bulk (VLCC) and Dry bulk (Baltic Dry Index- BDI) segments declined by 88.5% & 43.9% on y-o-y basis respectively. However, the freight rates in the Containerships (4,500 TEU) segment registered y-o-y growth of 29.9% owing to a slew of measures adopted by the major container operators globally such as slow steaming of containerships etc. We expect the freight rates across all vessel segments to remain subdued in the coming future with occasional spikes expected due to the seasonal or economy related factors.

The lower freight rate regime, in the backdrop of the slow-down in foreign trade (especially from the developed nations) and the resultant over-supply of vessel fleet globally amid higher cost of debt financing, would adversely impact the revenues and profitability of shipping players.

In case of the ship building industry, with the economic environment being fragile coupled with the lack of ship financing options globally, lower demand for new-builds and cancellation of existing orders, the flow of new-build orders placed by the ship owners with the yards globally is expected to remain muted in the near-term in the absence of substantial growth in new ordering activity and intense competition amongst the global yards to attract the small chunk of new-build orders on offer.

We however expect the revenues of the shipyards in the coming two fiscals to remain steady owing to the order backlog yet to be executed by the yards. Thereafter, in view of the limited flow of new-build orders and the declining order backlog, the yards are faced with the prospects of declining revenues and profit margins in the next 3-5 years. To add to this, other factors such as increase in raw material prices, especially steel and higher outflow on interest servicing would adversely affect the yard’s margin.

CARE Research foresees the steel industry growth to be muted in the short term as concerns over economic slowdown are expected to prevail for a while. Nevertheless, these concerns are expected to fade away in the medium term. We estimate domestic demand for finished steel to grow at about 8-10% during FY13. In line with the growth in domestic demand, domestic finished steel capacity is also likely to increase at a similar pace. While the global supply of steel will continue to adjust itself with the change in global demand, we expect the global demand for finished steel to grow at around 5%.

New policy measures on the mining sector from the Australian and Indonesian government, continue to remain a major threat for the global base metal manufacturing industries. In addition, the domestic steel industry is highly dependent on imported thermal and coking coal and the finished steel prices are determined based on the landed cost of imports. Hence currency fluctuation in either direction has its influence on the industry’s profitability.

We expect prices of key raw materials to correct in FY13 compared to the average prices recorded in FY12. Owing to the continued oversupply situation in the global steel industry, prices of finished steel products are also likely to remain under pressure. Margins are expected to be subdued owing to the time lag between corrections in raw material and finished steel prices.

Sugar :-
Sugar output in the current sugar season (SS 2011-12) is estimated to be about 26 million MT on account of higher sugar cane production on the back of higher cane acreage. With an opening stock of 5.6 million MT and an estimated annual domestic consumption of 22 million MT, the industry is expected to have a surplus of 9.6 million MT at the end of SS 2011-12. It will create an oversupply situation leading to moderation in sugar prices.
Increase in State Administered Prices (SAP) of sugarcane from Rs. 205 per quintal to Rs. 240 per quintal in Uttar Pradesh, the largest sugarcane producing state in the country, has further put pressure on the cost structure of sugar mills, particularly those based in UP. This coupled with high interest rates and thereby high inventory carrying cost is likely to put pressure on the debt servicing capability of non-integrated sugar mills. For integrated players the situation is expected to be relatively better with realisations from ethanol and co-generation offsetting losses from sale of sugar.

On the global front, the situation is likely to remain flat with closing stock expected to remain at the same level as that of the previous season. Surplus production in Australia and India are likely to offset lower supply from Brazil. Despite higher output, GoI has so far allowed export of only 1 mn tonnes of sugar. Further allowance of export by the government, say by 2-3 mn tonnes may ease the excess inventory situation resulting in improvement in domestic sugar prices.

Higher carry over inventory, high sugarcane prices and unattractive sugar prices is currently acting as a dampener to the industry. Thus, timely allowance of exports is critical to the performance of sugar mills.

Over the past decade, the Indian telecom sector has grown significantly. It has emerged as the second largest in the world in terms of subscriber base and is a major contributor to the country’s economy. However, over the past two years, regulatory uncertainties combined with a deteriorating operating and financial environment have slowed the growth momentum of this sector. This is evident from the decline in the growth of net subscriber additions and revenues. In view of these concerns, GoI announced the New Telecom Policy 2011 (NTP 2011), a draft of which was released in October 2011. NTP 2011 proposes to introduce certain regulatory and policy changes which include allowing spectrum sharing and trading, delinking spectrum allocation from licenses and removal of national roaming charges, amongst others. After the Supreme Court cancelled 122 telecom licenses issued in 2008 (more than 100 were with new players), competition in the sector is expected to decrease to around 9-10 operators in a circle from 15. We expect that not all players who lost their licenses, will bid for them again under fresh auctions. This will possibly lead to tariff hikes improving profitability for players marginally. Many established players, have already hiked tariffs in various circles by upto 20% and the impact of the same on operating performance would be seen in the next few quarters. This is expected to result in the emergence of a stable and rational pricing structure for the sector in the long run.

CARE Research also envisages increased contribution of Value Added Services (VAS) to total revenues of operators with the shift in focus towards next-generation technologies and growing demand and affordability of smartphones within the country. VAS currently contributes about 10-15% to total revenues of an operator, which is expected to increase to about 20-25% in the next 2-3 years. As telecom players roll out 3G services in more cities, its penetration is expected to rise in 2012-13, though at a reduced pace, as compared to total wireless subscriber addition and revenue contribution from 3G will not be significant in 2012-13.

Overall, we believe that the short term outlook for most operators remains muted due to the ongoing regulatory uncertainties, strained capital structure, significantly low tariffs and high operating costs. Thus profitability of players is expected to be muted despite improvements in revenues due to hike in tariffs.

Prospect of cotton spinning units would improve if the declining cotton prices leads to a revival in demand for cotton yarn and increase in capacity utilization across the cotton textile value chain. The performance of cotton yarn and cotton fabric manufacturers, however, is expected to remain sluggish as most of these manufacturers are over leveraged and have borne the brunt of the sharp movement in cotton prices and exchange rates in FY12, that resulted in their liquidity position being severely impacted.

With increasing urbanization, growing households and increasing disposable income, the domestic demand for denim fabric is expected to remain healthy going forward. However, with new capacity additions, there is a risk of excess supply which may adversely impact the profitability of denim manufacturers in the medium to long term.

The apparel industry suffers due to the lack of fully integrated plants, low labor productivity and inadequate infrastructure. All of this make it difficult for Indian apparel exports to compete with other low-cost Asian counterparts. Moreover, with the US and EU accounting for more than 70 per cent of Indian apparel exports, the concerns over the economic health of these countries would pressure the Indian apparel exporters in the medium term.

Man Made Fibre (MMF) industry is expected to grow at a moderate 5-6 per cent in the medium term. The growth is likely to be driven by MMF based products and blended products .The share of MMF based apparel exports too is likely to increase. However, recent increase in input prices owing to the increase in crude oil prices and the stabilization of cotton prices may limits the envisaged growth prospects of the MMF industry. Moreover, profitability of key players is expected to remain under stress due to volatile raw material prices, increase in power and interest cost and limited pricing flexibility of MMF players with increased competition.

Overall demand outlook for textile industry for FY13 is expected to remain moderate; with volatile commodity and exchange rates being the key challenge for the industry. Participants who are well placed in value chain and have control over their debt levels may witness improved performance.



Third quarter GDP estimates of FY12, released by the CSO today, show that the Indian economy has registered growth of 6.1% in Q3 FY12, implying cumulative growth of 6.9% in the first 9 months of FY12 over the corresponding period of the previous year. To attain overall growth of 6.9% for the year, the fourth quarter is to register a similar growth rate. The view here is that there could be a downside risk here and growth could be marginally lower at 6.6% IN Q4 resulting in FY12 growth of 6.8%. 

Sectoral Growth Performance 

Quarterly Growth Numbers (Q3 FY12 over Q3 FY11) – 

  • Agriculture and allied activities have grown by 2.7% (11.0% in Q3 FY11) 
  • Mining and quarrying registered a deceleration of 3.1% (6.1% in Q3 FY11) 
  • Manufacturing growth of only 0.4%, confirms slowdown (7.8% in Q3 FY11) 
  • Electricity, etc. maintained growth of 9% (3.8% in Q3 FY11) 
  • Construction growth pepped up at 7.2% (as against 4.3% in Q2 FY12 and 8.7% in Q3 FY11) 
  • Trade, hotels, etc. clocked a growth of 9.2% (9.8% in Q3 FY11)  Financing and allied services touched 9.0% growth (11.2% in Q3 FY11)  Community services grew by 7.9% (as against 6.6% in Q2 FY12) (-0.8% in Q3 FY11) 

Cumulative Growth Picture (Apr-Dec FY12 over Apr-Dec FY11) - 

  • Agriculture and allied activities grew by 3.2% 
  • Mining and quarrying slowed by 1.4% 
  • Manufacturing grew by just about 3.4% 
  • Electricity, etc. grew at a robust 8.7% 
  • Growth in construction has been moderate at 4.2% 
  • Trade, hotels, etc. grew by more than 10.5% 
  • Financing and allied services touched 9.5% growth
  • Community services grew by 6.7%

What to expect in Q4 FY12? 
Given the performance of the economy in the first nine months, estimates for the last three months of this fiscal, present some challenges in attaining a projected growth of 6.9%. Table 1, highlights the growth needed in Q4 FY12, based on the advance estimates for GDP growth for FY12 and performance so far (3 quarters of FY12).

Scenario Analysis
While a growth estimate of 6.9%, clearly charts out the growth path across sectors for the remaining months of this fiscal, we expect a few improvements and slippages that could bias overall growth downwards.

Agriculture and allied
The required growth in Q4 FY12 from this sector stands at 0.8%, which may be on the lower side given that the Rabi harvest is expected to be reasonably good. A higher growth rate of 1.5% may be expected here.

The required growth in manufacturing is estimated at 5.3%, which will be a challenge. With cumulative manufacturing having grown at 3.4% in FY12 so far, core sector production having dipped to 0.5% in January (cumulative of 4.1% for the period April-January FY12), recovery in this sector has to be substantial which will be tough. Investments as reflected by growth in gross fixed capital formation (GFCF) stood at 27.6% in Q3 Fy12 when compared with 30.0% in Q3 FY11, have continued to slowdown. This is bound to impact adversely the manufacturing output and we may expect a slippage to 4.0% growth in Q4 FY12 in this sector.

Trade, Hotels, etc. 
With global uncertainty continuing to prevail, and indeed new dimensions in the form of Iran crisis and oil crisis getting added, trade flows and travel (be it domestic or global and/or business or leisure) would undeniably be unfavourably affected. A growth of nearly 13.0% is required in this sector in the forthcoming quarter, which we believe would rather be around 12.0%.

Financial Services 
With the RBI moving towards a stance of monetary easing, the peak of interest rate hike cycle has been left behind with the third quarter of FY12. Going forward, there is a strong case for reduction in the benchmark repo rate to boost growth, though the timing is uncertain. With monetary transmission reflecting this change, banking activities are expected to register improvement. The required growth rate from this sector may be higher and move from 8.0% to 8.5% in Q4 FY12. Retaining growth estimates for all other sector coupled with changes in the above mentioned projected growth trajectory, it is possible that GDP growth in Q4 FY12 could slip by 20 bps to 6.6%, resulting in an overall GDP growth rate of 6.8% for FY12 (Table 2).

Signals from the Expenditure Side 
Private final consumption expenditure as percentage of GDP has increased to 58.9% in Q3 FY12 (when compared with 58.4% in Q3 FY11), which is the festive season when consumption demand is high. Prima facie, one may be prompted to state that inflationary pressures have not substantially dented this expenditure profile. In the coming months, private consumption could provide the necessary support to manufacturing by keeping demand up. 

Government Final Consumption, on the other hand has registered a minor decline to 12.9% in Q3 FY12 compared with 13.0% in Q3 FY11. With mounting pressures on a widening fiscal deficit gap in the backdrop of high oil prices feeding to higher fuel bills coupled with higher food subsidies, government expenditure in bound to rise. While fiscal consolidation may seem a priority, the target would be hard to achieve.


>THERMAX: JV for super critical boilers with Babcock & Wilcox is on track

 Base business orders to grow, large orders taking time: Thermax reiterated its ability to win base business orders of at least Rs5-6bn per quarter and hence, does not expect the order flow to be below the Q3FY12 levels (Rs5.9bn). The peak base business order flow was Rs10.5bn in FY08. The current capacities can take base business orders up to Rs14bn per quarter. However, with very few enquiries for large and captive power plants, the order flow is likely to be muted for the next two quarters due to the given current issues like coal availability and higher cost of funds. The company expects the recovery to happen by H2FY13. Sectors like Cement, Steel and Oil & Gas (refineries) are likely to lead the recovery apart from sectors like Food processing, Hotels and Hospitals which are already investing. Power sector is likely to take time to recover.

 ■ Margins can be maintained if recovery happens in the next two quarters: Given the reduced order carry, sales are likely to de-grow by 8-10% next year. However, efforts are being made to curtail the fall. Though business like Chemical, Water, Absorption chiller, Services O&M, Standard boilers etc. are likely to show growth, large business segments like EPC and Boiler & Heating are likely to de-grow, leading to over all de-growth. Thermax will try and maintain margins at ~11% range despite lower turnover by various levers it has in the employee cost (Rs500m in variable pay and Rs350m in variable man power). However, if the recovery does not happen by H2FY13, then it will have to start taking orders even with lower margin to cover fixed cost.

 Super critical JV update: The JV for super critical boilers with Babcock & Wilcox is on track and is likely to be commissioned by September 2012. However, with no enquiries in the pipeline, it is unlikely that the JV will have an order at the time of commissioning. The burn out for JV assuming no revenues in FY13 or FY14 (due to lack of orders) could be ~Rs1bn (Thermax share 51%). Some of the losses could possibly be offset if the JV were to get some international orders from its partner Babcock and Wilcox. The management did not sound too
worried as the company’s share of losses in the JV is not large compared to the net worth. Management believed that apart from issues like coal and land, the biggest hurdle for Power market will be for promoters garner equity. It also believes that though current preference is for Super critical plants, but given the constraint of coal and equity, smaller size plants of 150MW and 300MW might be back in favour. On issues of lack of coal linkage to captive plants, company commented that the economics will work for captive plants even if they have to import coal and run the plant as price of electricity is likely to go up further with capacity addition lagging target.

  Valuation and Outlook: The stock is trading at 17.8x FY13E earnings. We believe that though the next few quarters will be weak in terms of earnings and order flow, Thermax’s ability to bag base orders of ~Rs5-6bn per quarter gives us a confidence that it will be able to tide the slowdown and participate in the upturn of the cycle meaningfully and surprise positively in terms of order flow. Expectation of rate cut aiding recovery of capex cycle will also help support
multiples. We maintain our ‘Accumulate’ rating on the stock

>RALLIS INDIA LIMITED: Rallis with the acquisition of seeds based research company, Metahelix (and its subsidiary, Dhaanya Seeds Ltd.)

■ New Dahej facility to spruce up international sales; reduce domestic market dependence
We expect Rallis India Ltd. (Rallis) international sales to get a boost due to commencement of operations at the company’s plant at Dahej catering mainly to Contract Research and Manufacturing Services (CRAMS). This would also reduce dependence of the company on domestic sales. We expect this plant to generate cumulative revenues of `5.5 bn over the next three years. Owing to the boost from this facility, we expect Rallis to register 22% CAGR growth in the pesticides business over FY12E – FY14E. However, PAT margin is expected to go down 110 bps to 10.7% in FY12E due to higher interest and depreciation cost of the plant. We expect Dahej plant to reach full capacity by mid FY13.

■ Metahelix acquisition to help company grab a bigger pie in the lucrative seeds market
Metahelix Life Sciences Ltd. (Metahelix), the research led seeds company recently acquired by Rallis is expected to clock revenues of `930 mn in FY12E. Management expects revenue from Metahelix to ramp up to `10 bn over the next five years. Currently, Metahelix is a loss making entity; however, we expect it to register a 35% CAGR growth in revenues over FY12E-FY14E. Metahelix produces Bt Cotton seeds in India which have a market size of `40 bn. Rallis expects Metahelix to occupy an 8%-10% market share in the Bt Cotton seeds market in India over the next three years, thereby leading to cumulative revenues of close to `4 bn. Seeds are a more profitable business than Rallis’ core business with margins close to 20%.

■ Consistent product launches and continued emphasis on R&D
Rallis has been consistently launching new products every year, maintaining a healthy rate of three launches per year. From FY06 to FY11, Rallis launched 19 products in all. In FY12, it has launched 13 products till date (9MFY12). The Innovation Turnover Index (revenues from products newly introduced in last four years to total turnover) has consistently been around 30% for Rallis. Rallis has one of the highest spends on R&D (almost 1% of sales) among its listed peers. We believe the rate of new product launches and proportion of R&D to further improve for Rallis with the acquisition of seeds based research company, Metahelix (and its subsidiary, Dhaanya Seeds Ltd.).

■ Numerous initiatives and customer engagement programs
Rallis has been continuously engaging with its customers via numerous programs such as Rallis Kisan Kutumb (farmer contact programme to understand farmer needs), More Pulses (increase yield and production of pulses), Rallis Poised (programme to drive sustained profitable growth), etc. The More Pulses (MoPu) initiative has caused yield to improve by up to 40% to 500 kg/acre from 300 kg/acre in Tamil Nadu which increased farmer income by `5,000 per acre. The Rallis Poised initiative has enabled company to deliver a CAGR of 15% in revenues and 26% in PAT over FY07 – FY11. Due to various customer engagement programmes, Rallis’ products have a high brand recall in the Indian crop protection market with seven of its products in the top 12 products by customer recall.

■ Valuation
At CMP of `123, Rallis is trading at 17x its FY12E EPS and 12x its FY13E EPS, which is close to its average historical one year forward P/E. As compared to its listed domestic peers, Rallis commands a rich premium of close to 30%. We expect Rallis to continue to command premium due to a) its consistent product launches, b) ramp up in capacity at Dahej facility, and c) improvement in performance of Metahelix. We initiate coverage on the stock with a BUY rating and a target price of `153 per share based on a P/E of 15x FY13E EPS of `10.20, implying a potential upside of 25%.