Monday, March 19, 2012

>FY13 budget – No surprises (CLSA)

India’s FY13 Union budget partially delivered on the market expectations of a move towards fiscal consolidation and incentives to revive investment cycle, even while working within obvious political constraints. While possible fiscal slippages are likely, we are encouraged by the Government budgeting for a 38% in non-defence capex and a slew of measures to help infrastructure sector. Our positive view on Indian equities hinges on sustained affirmative policy action and global liquidity.

Government assumptions more realistic, but slippages still likely
 Government has embarked on the right path of fiscal consolidation with the target to reduce fiscal deficit from 5.9% of GDP in FY12 to 5.1% in FY13.
 Increase in excise duties, service tax rates and widening the base should drive tax buoyancy, although collections will likely be impacted as excise duties on petroleum products (40% of excise duties) were left unchanged. Impact on fiscal deficit will be smoothened as some costs (30%+ of tax revenues) are also directly linked to tax collections.
 The usual underfunding of subsidies as well, which will mean that the actual fiscal
deficit would be about 5.3-5.5% unless crude corrects materially.
 Higher fiscal deficit and tax increases should put an upward pressure on inflation.

Several initiatives revive investment cycle
 Several initiatives to revive infrastructure investment visible with lowering imports duty on coal to 0% from 5%, and doubling of tax free infra bonds to Rs600bn should help roads, power and the housing sector.
 The government itself is budgeting to increase its non-defence capex by 38% to Rs1.2trn should be a positive for the investment cycle
 Opening up of the ECBs for low cost housing, airlines, power and reduction in withholding tax from 20% to 5% for infra borrowers should be a positive.

Some progress on financial sector reforms
 Rajiv Gandhi Equity Scheme (RGES) to broad-base equity participation from retail households can be a kicker for the flagging equity participation by retail.
 The above scheme entitles a new equity investor an income tax deduction of Rs25,000 from income for an investment of Rs50,000 into equities market.
 Three key reform bills – pension, insurance and banking – expected to be introduced in the budget session

Retain positive market view, replacing M&M with BPCL in top 5 picks
 The budget announcements positive for M&M (no excise on diesel vehicles), IRB (thrust on roads) and Jet Air (reduction in withholding tax) and for sectors like power (coal import duty reduction) and steel (increase in imports duty.
 The announcement were negative for upstream oil companies (increase on crude cess), BHEL (no increase in imports duty on equipment), telcos (high expectation of the Government on auction proceeds) and property (imposition of TDS)
 With the rising oil prices, risks to economic growth are rising but our optimistic view on the markets (Sensex target cut to 20,000; implies 14x, 1x PEG) hinges on global liquidity and sustained affirmative policy action, which should improve the investment outlook. We expect auto fuel price hike after the current parliamentary session in early April.
 We tweak our model portfolio and replace Mahindra & Mahindra (recently downgraded by Abhijeet Naik on tractor growth concerns) with BPCL. The recent M&A benchmarks for BPCL’s upstream assets suggest an optimistic SoP of Rs1100/sh (with 60% of the value coming from E&P business) or a 50%+ upside. Potential auto fuel price hike could be a near-term trigger.
 Other top ideas continue to be ICICI Bank, Yes bank, Tata Motors and Infosys.

To read full report: INDIA STRATEGY

>ITC: Best pre-budget return in the stock since 2006

ITC's stock has appreciated by 4.2% over the past two months, and is the best pre-budget returns since 2006. This performance is being partly driven by the strong stock market rally since end December 2011. There are expectations of a double digit increase in excise duty on cigarettes given the fiscal constraints of the Central government. However, ITC has given negative returns (after budget) only on two occasions in the past eight years; as the company has managed to pass on the increased duties given the superior pricing power. We believe that any correction in the stock price will provide a good entry point. Maintain Buy. Expect double-digit hike in excise duty; VAT to increase in a few states: There is high probability of double-digit hike to combat the inflation impact. However, very sharp excise increase looks unlikely as revenues suffer due to decline in volumes. Out of the 6 six states that have announced budgets, only Bihar and J&K hiked the VAT. There seems little incentive to increase VAT beyond 20% as differential taxes promote cigarette smuggling from neighboring states. However we expect another 100-150bp increase in the VAT rate (currently 18.5%).

ITC's price increases are ahead of hikes in duty and taxes: Increases in excise duty has a cascading impact on taxes as VAT is imposed at post-excise cigarette rates. We estimate that ITC needs to increase cigarette prices by 2.3% for every 5% increase in excise duty to maintain realizations/stick. The price increase required to neutralize the impact of a 1% VAT rate increase is ~0.8%. ITC has been hiking prices at a rate higher than the increase in duties and taxes. We note that excise duty declined from 55% of sales in FY06 to 44.5% in FY12.

ITC's cigarette segment's EBIT grew 15% even during bad times: ITC's cigarette segment posted 16.8% EBIT growth in FY11 and is expected to register ~20% growth in FY12. The company has been calibrating its price hikes and volume growth to grow its cigarette EBIT by 15% CAGR since 2003 due to its strong pricing power. It increased prices by ~6% in FY12 so far. We estimate the cigarette business to register 15.2% EBIT CAGR post FY12. A lower-than-expected hike in excise duty and higher volume growth could result in higher growth.

Non-cigarette segments' EBIT up 26% in 9MFY12; outlook positive: We expect non-cigarette EBIT to grow at 20% over FY12-14 led by (1) gradual reduction in the FMCG losses, (2) 14% EBIT CAGR in paperboard led by capacity expansion, (3) recovery in hotels, and (4) 15% EBIT CAGR in Agri business led by gains from new leaf tobacco facility in Mysore. We estimate 17% PAT CAGR over FY12-14. The stock trades at 22.5x FY13E EPS of INR9.2 and 19.2x FY14E EPS of INR10.8. Buy.

To read full report: ITC

>ASIA PACIFIC COAL: Constraints Exist, but 2H12 Outlook Positive for Thermal Coal

 Seaborne coal demand should improve in 2H12. 2012 has started slowly for AP thermal coal markets. Seaborne prices are ~10-15% below 2011 with India and China largely absent from the market. Stocks are discounting low expectations, which we think will prove an opportunity ahead of a 2H12 improvement in fundamentals. Top regional picks are Harum, Adaro, Coal India, Whitehaven and China Shenhua.

 Short-term fundamentals could remain lackluster. High stockpiles in China and demand issues in India may limit seasonal benefit of pre-summer re-stock. JFY12 contracts should be settled soon, with trade press suggesting $115-$122 per t versus $139 last year. We believe stocks are discounting a settlement closer to $100.

 Underlying demand for Indian thermal imports to grow at 49% CAGR through FY2015…Assuming domestic supply grows at 5%, we estimate underlying demand for thermal coal imports would reach 120 mn t in FY12 (YE Mar. 2012) from 60 mn t in FY11, growing to 290 mn t in FY15. For a full review see “India Coal Industry”, Raashi Chopra, March 12, 2012.

 …Consensus is bearish on Indian coal imports given restrictions… Poor finances of State Electricity Boards, internal coal logistics constraints, coal blending limitations and “acceptance” of power shortages will keep actual demand below theoretical. We estimate this impact at ~ 30 mn t over the next 12 months.

 … We are more constructive and see ~32% import demand CAGR through FY2015. We expect growth in import demand to trail underlying but post healthy growth, with imports rising to 24% of Indian domestic coal consumption in FY15 from 11% in FY11. This is driven by rising demand of the power sector, where our power analysts expect 61GW of coal-based power capacity to be added during FY11-15.

 We do not expect Indian port capacity to be an issue. We estimate available thermal coal port capacity of at least~125mt in FY 12 in India. Ministry of Shipping and Indian Ports Association data suggest coal traffic will grow to 389 mn t in FY15.

 China: Qinhuangdao price should bottom out soon, but imports could remain soft. Major Chinese power plants have ample coal stocks. Favorable summer demand is approaching, but we expect China to remain an opportunistic import buyer in the near term. Nonetheless, we believe Qinhuangdao price should bottom out soon and Daqin railway maintenance could provide price support.

 Our commodity team expects a tighter coal market to emerge in 2H12 — We remain confident that once the issues supportive of Indian imports emerge, Japan's damaged coal-fired capacity re-starts and Chinese industrial activity picks up, that the thermal coal market should tighten considerably.

To read full report: ASIA PACIFIC COAL

>INDRAPRASTHA GAS: CNG Price Hike Boosts Margin Visibility

 Announces CNG price hike; positive for margins — Following up on the Rs1.75/kg CNG price hike in end-Dec, IGL has today (source: Hindustan Times) announced another Rs1.70/kg hike, taking CNG prices in Delhi to Rs35.45/kg. This provides a significant boost to IGL's near-term margin visibility and should help the company not only comfortably meet our full-year FY12 estimates but also increases the possibility of
upside risks (9MFY12 EPS of Rs16.2/sh).

 4Q margins should revert to ~Rs5/scm levels — As we had highlighted in our recent 3Q note (see '3Q Ahead of Estimates; 4Q to Be Even Stronger' dated Jan 24), we believe IGL’s EBITDA margins in 4Q could revert to the ~Rs5/scm levels (from Rs4.7/scm in 3Q) driven by a combination of: (i) softening of LNG prices (have declined from a Nov peak of ~US$16 to ~US$13 – see our report titled, 'India Natural Gas - Falling LNG Prices + Rising Regulatory Concerns' dated 17 Jan), (ii) the CNG price hikes, and (iii) strengthening of the rupee. Given the robust volume growth (up 26% yoy in 3Q) which is being incrementally driven at the margin by short-term/spot LNG, today's price hike significantly raises the likelihood of EBITDA margins reverting to the ~Rs5/scm levels in the near term.

 Reiterate Buy with Rs426 TP — Our current estimates are conservatively based on EBITDA/scm of Rs4.6/4.5 over FY13/14E and CNG prices of Rs35.5/37.0 per kg, which should help the company deliver a 2-yr EPS CAGR of 15% (vs. 0.5-2.5% for its peers). We believe the recent stock underperformance (by 17% in the last 2 months), on the back of the gov’t move to refer the marketing margins earned by gas marketers to the PNGRB, could partly reverse following the price hike, as: (i) margin visibility, a key driver of stock performance, has materially improved, at least in the near term, (ii) regulating the distribution margins of city gas companies would be tantamount to determining the end price of the gas, something which is out of the purview of the PNGRB, (iii), the PNGRB’s near-term focus could be on other issues related to city gas licensing, gas pipeline authorizations, pipeline tariff regulations, etc., and (iv) competition is anyway allowed to exist in city gas distribution post-exclusivity. IGL, along with GSPL, remain among our preferred picks in the gas sector.

To read full report: IGL

>STEEL: Restocking‐driven recovery, underlying demand remains weak

■ Surge in European steel prices driven by restocking: European steel prices rose by ~US$69/t (YTD CY12), attributed primarily to restocking, firm global prices and unreasonable fall in prices during Q4CY11. However, real demand continues to remain subdued. Based on Eurofer (European steel association), real steel consumption fell by ~0.4% YoY in Q4CY11, while apparent consumption saw a sharper fall at ~4% YoY, owing to accelerated destocking. The association expects continued weakness in real consumption in the next 2-3 quarters, given the dearth of new orders and tepid investment climate. The region also runs a risk of peaked-out net exports of ~1.5m tonnes, highest in the past seven years. We remain highly cautious on European steel prices, given the sluggish domestic demand outlook and high dependence on volatile exports market.

 China witnessing protracted demand slowdown: Demand environment continues to remain challenging in China on the backdrop of 1) tight liquidity gauged by lowest ever growth in money supply (MS) in the past 10 years during the month of January @ 12% YoY 2) weak demand across the major consuming sectors during December; vehicle sales (down 26% YoY), real estate (down 22-23%) and machinery (down 8%) and 3) sharp deceleration in Fixed asset investment (flat YoY in December), the major driver of China’s steel demand. We expect short-term recovery in demand and prices from the current trough levels on the back of liquidity easing. However, we don’t expect rally in prices to sustain for long given elevated stock levels and weak demand outlook.

 US, the only bright spot: Thanks to strong liquidity (MS↑10%), accelerated expansion in investment (Gross private investment↑10%) and consumer demand, US apparent consumption grew by 8% in January to 8.8m tonnes; almost near its pre-crisis levels. We expect demand to remain firm in the coming months as suggested by all leading indicators. However, the wide price differential between US and other regional prices would pose a major or the only risk to the domestic prices in the near term.

 Reiterate Accumulate on Tata; downgrade JSPL to Reduce: We remain positive on Tata given the underlying distress valuations of European operations (EV/tonne of US$200), strong domestic operations and increased raw material self-sufficiency. We downgrade JSPL from ‘BUY’ to ‘Reduce’ on account of expensive valuations. JSTL remains our least preferred stock in the space, backed by underlying risk associated with shortage of iron ore and expensive valuations given the abnormal exposure to acceptances. Maintain ‘Reduce’ on SAIL given the expensive valuations and below average project execution.

To read full report: STEEL SECTOR