Friday, April 6, 2012


INR remains one of the riskiest currencies. India’s large and widening current account (CA) deficit and its dependence on volatile capital inflows make it vulnerable to becoming a casualty of swings in global risk appetite and crude oil prices. INR’s recovery in January was due partly to RBI’s aggressive currency intervention, although global risk-on, RBI’s antispeculative measures and deregulation of NRI deposit rates also helped. However, INR has been weakening against USD since early February, despite a surge in portfolio inflows into India (1Q12: around USD13.5bn). Global risk-on will likely boost volatile capital inflows unless domestic factors, such politics and policy coordination, are turn-offs. But capital inflows may not be adequate to eliminate concerns about smooth financing of the CA deficit. On our forecast, the CA deficit of 3.9% of GDP in FY13 is beyond the RBI’s comfort level. This, along with our expectations of a stronger dollar, sets the stage for INR to weaken. We maintain our end-2012 forecast of INR55:USD.

INR has had an exceptionally volatile ride (Figure 1). It slumped to nearly INR54:USD in mid-December before recovering to INR49:USD by mid- February due to a combination of an unexpectedly strong jump in portfolio inflows triggered by global risk-on and RBI’s desperate measures, including aggressive currency intervention in January. However, it weakened subsequently and has broken above the 51-mark despite USD weakness. The pace of capital inflows has slowed recently even as the CA deficit remains large. In the absence of meaningful RBI currency defence, INR had to weaken. But no economy with a large CA deficit should rely mainly on portfolio inflows to finance the deficit as these inflows can be uncertain. Also, it is unlikely that capital inflows will comfortably and smoothly finance the wider CA deficit in FY13.

Second, outlook for USD. We expect USD to strengthen in 2H12, which in turn should be negative for INR. Note that INR has weakened in recent weeks despite USD weakness (Figure 4). Such an outcome does not boost confidence.

To read report in detail: INDIAN RUPEE

>INDIA CEMENT SECTOR: Competition Commission of India (CCI) on the verge of levying penalties for cartelisation

Costs, capacity & cartel = cash out

Cash out time
Cement stocks have witnessed a strong rally in the last 12 months, outperforming the Nifty by 36%, driven by the longevity of pricing discipline. With stocks trading at 18-19x PER and the chances of a hefty penalty from the Competition Commission of India (CCI) looming ahead, the risk/reward appears unfavourable. Moreover, with continued capacity additions and rising costs, earnings growth should remain elusive for at least another two years. We remain Underweight on the Indian cement sector.

Cement price at all-time highs – where is the money?
Our study of 16 cement companies shows that since 1996, i.e. in the last 15 years, the incremental EBITDA made by these companies cumulatively was just US$2bn, and the bulk of this came just in the three years from 2006-08. We believe that the cement industry is again in a phase where the fight will be to sustain earnings, and we don’t see things changing over the next three years. Costs, costs, and costs – and will keep rising

In the past four years, production costs have risen 50%, and this includes subsidies, like diesel and coal from Coal India. Rising costs have helped improve price discipline, and the industry has been able to raise cement prices by 35%, but this is not enough for margin expansion. Unfortunately, the cost rises have been structural and may require substantial changes like captive coal mines, etc to reverse; we think this is at least three years away.

Capacity still outpacing demand
We are expecting 50mt of additional capacity in the next two years, while incremental demand is likely to remain less than 35mt. This will keep cement capacity utilisation below 80%. Also the installed capacity share of the top three companies in the country has fallen from 45% (in FY08) to just 38% now. On the other hand, demand growth has declined from an average of 10% pa in the past four years to around 6-7%. With our muted view of the investment cycle and reduced affordability of real estate, we don’t see demand growth exceeding 8% pa over the next two years.

CCI on the verge of levying penalties for cartelisation
CCI finished hearings against 42 cement companies in late February and should be ready with penalties by April. We expect penalties of about 7% of total revenue (last three years’ average), equal to 5-6% of market cap for every year of investigation. Global experience tells us that stocks correct by 20%+ on such penalties. See our report Investigations & Oversupply (June 23, 2011).

Costly – Valuations expensive and building in a bull cycle
Cement stocks are now trading at all-time high valuations, with well above trough-cycle earnings. To justify current valuations, we need EBITDA margins to improve by 50%, which looks highly unlikely given oversupply. Moreover, we are not sure if the companies will be able to retain these earnings in view of the possible penalties. We would sell into this rally. Our key sell ideas are ACC, Ambuja and Ultratech.

To read report in detail: INDIA CEMENT SECTOR

>COAL INDIA: Price increases will be hard but still only upside likely

Initiate at 1-OW; a sleeping giant

We view Coal India (CIL) as a core long-term holding in the mining sector given its extremely favourable risk/reward profile. The fact that its adjusted selling price (c45% discount to the seaborne price) looks to have only upside alleviates the coal market concerns around the stock, in our view. We believe investors need confidence about the seven key issues surrounding the stock (highlighted in the report) and that the market is under-appreciating both a potential rebound in volume growth and CIL’s ability to control costs. A hastening of reforms and notified price increases would likely provide significant upside optionality. With a free cash
flow yield of about 7%, valuations look attractive, especially considering the low downside risk to profitability and large cash balance (c26% of market cap). We

 initiate at 1-OW with a 12-month PT of Rs411.
Higher-than-consensus volume growth feasible: Although the c2% CAGR drop in production over FY10-12E has dented investor confidence, we are optimistic that CIL’s volume growth can rebound to a 5% CAGR over FY12-17E (to 557mt). With only 14% of volume having to come from new mines and tangible measures being taken to address logistics bottlenecks, visibility on a volume rebound has improved dramatically. 

 Ability to control costs appears underappreciated: Wages are c53% of CIL’s costs and a shift in volume mix towards more efficient subsidiaries (wage/tonne of the most efficient subsidiary is 1/12 that of the most inefficient subsidiary and 1/3 of CIL’s average) and natural attrition of the ageing workforce (expect a c9% drop in employee base over FY11-14E) should offset the impact of rising wage rates, in our view.

■ Price increases will be hard but still only upside likely: We expect price increases for CIL to be less frequent and its sales mix to move away from higher-margin (e-auction and non-power) volumes. Our estimates build in a mere 5% price rise in notified prices in FY14, translating into a 1.5% CAGR in weighted average realisations over FY12-14E. 

■ Near-term issues reflected in price target: Our 12-month price target of Rs411 already factors in a negative Rs41/share for the proposed mining tax. Concerns the government may push CIL to use its cash balance to pay off state electricity board losses are overdone, in our view. Higher dividend payouts would be RoE accretive.

■ Key risks: Key risks to our investment thesis, in our view, include further delays in price
increases, drops in e-auction volumes and adverse regulatory changes.

To read full report: COAL INDIA

>JAGRAN PRAKASHAN: Acquires Nai Dunia in an all-cash deal

JAGP, which owns India’s largest read daily Dainik Jagran, has acquired Nai Dunia (ND) – the country’s ninth largest Hindi newspaper. This acquisition gives JAGP a much-awaited entry into the underpenetrated and fast-growing markets of Madhya Pradesh (MP) and Chhattisgarh (CG), and brings consolidation in the print media industry. Financial highlights of the deal: (a) JAGP has valued ND at an enterprise value of Rs 2.25bn (incl. ~Rs 250mn debt), or ~2x EV/sales; (b) JAGP is entitled to tax benefits of ~Rs 800mn owing to ND’s accumulated losses of Rs 2bn-2.5bn. While the valuation is on the higher side given ND’s negative EBITDA, we feel this acquisition is a good strategic fit for JAGP on account of: (a) its geographical expansion in Hindi-speaking states, (b) reduction in gestation period for expansion in new territories and (c) cost and revenue synergies. Maintain BUY with TP of Rs 135.

  Underpenetrated MP and CG markets offer good growth: Literacy rates of MP and CG are lower than the national average, and so is newspaper penetration, with sole readership at a mere 15%. With rise in disposable incomes owing to increased GDP growth rates (~6.5% for MP, 9.5% for CG), these markets offer good growth potential.

■ JAGP’s ongoing litigation in MP necessitates inorganic route: We note that JAGP has wanted to enter MP and CG since 2005. However, it couldn’t use its flagship brand Dainik Jagran due to family litigation and hence, had to either introduce a new brand or acquire an established player like ND.

■ ND – a good fit: Nai Dunia is published in the Hindi heartland states of MP and CG with a circulation of 0.5mn copies and a readership base of ~2mn, which has more than tripled over the last five years. While ND’s current readership share is 23%, its advertisement market share is ~15%. Its FY11 revenues were at Rs 1bn (FY12E: Rs 1.1bn) with 70‒75% generated from advertising (mostly local). The company incurred an EBITDA loss of Rs 250mn in FY12.

■ Turnaround to be quick, aided by synergies: On the revenue side, JAGP expects to increase the contribution from national advertising to ND’s revenues from <25% now to closer to its own 40% levels. On the cost side, JAGP will benefit from reduced newsprint and manpower costs.

■ Deal financial summary: The deal was closed for an all-cash consideration of ~Rs 2.25bn (including debt). However, JAGP stands to gain tax benefits to the tune of Rs 0.8bn owing to ND’s accumulated losses. Post the deal, JAGP has Rs 1bn of net cash on its books.

 Maintain BUY with a TP of Rs 135: We believe that this acquisition is another step in the direction of consolidation in the print media space, wherein smaller regional players will be acquired by larger national players like JAGP, owing to both revenue and cost synergies. We continue to like the print media space because of: (a) healthy ROEs (25% +), (b) good dividend payouts (45‒50%) and (c) attractive valuations (currently 12.7x FY14E). Maintain BUY with a TP of Rs 135 (17x FY14E).

To read full report: JAGRAN PRAKASHAN

>BEML: Will supply intermediate metro coaches to Delhi Metro Rail Corporation

  Metro orders
BEML has recently bagged orders worth Rs 318 crs for supplying 40 metro cars (10 trains of 4 cars each) to Jaipur Metro Project. The Company expects to receive some more orders totaling Rs 60 crs from this project in future. It is also designing and developing metro cars for upcoming metro projects in Tier II cities.

BEML will supply intermediate metro coaches to Delhi Metro Rail Corporation. It is also targeting orders from Bangalore, Hyderabad and Kolkata rail projects, besides participating in international projects in Dubai, Abu Dhabi, Qatar, Colombo, Malaysia and Dhaka.

  Railway business hive-off
BEML is planning to hive off its railway business into a separate Company to tap the growing demand for rolling stock over the next decade. It has emerged as the only Indian Company to manufacture metro rail cars, which has helped in bagging orders from Delhi, Bangalore and Jaipur metro projects. The company is also exploring opportunities in aluminium rail wagons manufacturing and has taken trial project for Nalco. Demand for mining equipments from Indonesia continue to soar which made BEML to rework its growth strategy. It plans to open an after - sales service centre cum depot at the coal mining belt of Kalimantan in
Indonesia this fiscal. A new assembling unit or an acquisition of existing unit in Indonesia by next fiscal is also on the anvil.

  Flurry of earthmoving equipment orders
BEML expects order intake of earthmoving equipments to improve this year, led by new product introductions, recovery in domestic mining sector and strong overseas demand. It launched mining equipments in Thailand and other neighbouring countries like Myanmar, Laos,
Cambodia etc through marketing tie up with Paragon Company Ltd, a Thailand based entity. Similarly, it unveiled high - end products such as dozers, dumpers, motor grader etc in China this year.

We estimate the earthmoving equipment division to grow by 12% this year, thus reversing the declines of last two years. The next year is projected to be tad better as plans to enter new markets in South East Asia, Africa and South America for supplying earthmoving equipments for mining sector fructifies. Margin which saw an erosion of 450 bps in FY11 is estimated to rise by 180 bps to 14.5% in current year.

To read full report: BEML