Thursday, June 7, 2012

>STATE BANK OF INDIA: Tough times for subsidiaries

■ Earnings growth muted in FY2012; expect continued pressure on RoA and RoEs
SBI subsidiaries reported a weak performance on earnings (flat yoy) due to higher credit costs (up 10 bps), lower NIM (down 15 bps) and weak non-interest income. We expect earnings of 11% CAGR over FY2012-14 factoring slower loan growth (14% CAGR), weak non-interest income to continue (11% CAGR) and high credit costs of 24% CAGR (dynamic provisions). RoA and RoEs would continue to remain under pressure in the medium term (RoAs at 0.8-0.9% and RoEs at 14-15%).

■ A challenging year for asset quality; coverage ratio declines
FY2012 was one of the most challenging years for SBI’s banking subsidiaries in recent times as about 8% of loans either slipped into NPLs or had to be restructured (4% each). Overall gross NPLs increased 100 bps to 3% and net NPLs increased 100 bps to 2% of net loans. Transition-related issues seem to have created most of the impact on NPLs. Loan-loss provisions remained high at 1.1% and the NPV sacrifice was marginally higher at 4% of restructured loans. Coverage ratios declined due to higher slippages and write-offs.

■ Well capitalized for now; dilution needed in a few subsidiaries
A combination of lower RWA growth and capital infusion resulted in tier-1 ratio improving by 100 bps to 9% with core tier-1 ratio at 8.5%. Select subsidiaries would need additional capital in the medium term but we see limited risk, especially considering slower balance sheet growth, towards transition of these banks under the new Basel-3 guidelines.

 Lower retirement benefits aid better cost management
Cost ratios were broadly stable in FY2012 at 45% with select banks reporting a decline in staff
costs. Importantly, the shortfall between pension assets/liabilities declined to 3% of net worth
against 10% in FY2011. We broadly expect cost ratios to remain closer to current levels factoring the impact of new wage agreement.

To read report  in detail: SBI


Power, airport segment drag bottomline…
In Q4FY12, GMR Infrastructure (GMR) reported net losses that were higher on account of poor power (due to lower PLF, forex losses for loans of Homeland Energy, etc.) and airport segment performance (cash basis accounting of NACIL, one time charges at DIAL, incentives at SGIA and one time interest on DF). During the quarter, DIAL was also granted a 352% tariff hike on aero charges wef May 15, 2012. As a result, DIAL is expected to break even at the net profit level in FY13. With the anticipation of better profitability for DIAL and attractive valuation (0.7x P/BV), we have upgraded it to BUY with a price target of | 23.

Higher losses due to poor power segment performance, one-offs…
GMR’s net sales declined by 0.7% to | 1948.3 crore in Q4FY12 owing to poor power segment performance on account of lower PLF. The EBITDA came at 13.8% vs. our estimate of 25.5% mainly on account of forex losses of | 79.7 crore (mainly attributed to restatement of foreign currency loans amounting for Homeland Energy), poor performance of DIAL and lower EBITDA of power plants. Consequently, GMR reported a loss of | 366.2 crore due to lower EBITDA, higher interest expenses and one-time interest on loans against development fund of | 162.1 crore as the same was disallowed by AERA as a regulated asset base.

Tariff hike order received… granting hike of 352% on Aero charges
Recently, GMR received approval for DIAL tariff hike of ~352% from May 15, 2012, which was largely on account of losses incurred during the first three years of regulatory period (April 1, 2009 to March 31, 2014). As a result, DIAL’s losses are expected to get wiped off in FY13E and the management expects DIAL to break even at the bottomline level during the same year.

While the power segment is expected to remain a drag, airport is expected to report profitability in coming quarters. At the CMP, the stock is currently trading at an attractive valuation of 0.7x P/BV. Additionally, the stock has corrected ~37% since our last HOLD recommendation. Hence, we have upgraded it to BUY recommendation with a price target of | 23 based on our SOTP based valuation methodology. Lack of fuel for the power projects remains a key risk to our call.

To read report in detail: GMR INFRASTRUCTURE

>IN FOCUS: Can We Cure the Spanish Flu?

However it’s resolved, Greece’s debt story could soon be largely behind us, but the same can’t be said for the Eurozone crunch. Portugal and Ireland will need assistance from the Eurozone’s bailout fund (ESM/EFSF) beyond 2012, given the bond market’s reluctance to extend them credit. But Spain’s debt and banking troubles are more critical, with the remaining fi repower in the EFSF/ESM too small to cover its financing needs, and its debt—larger than Greece, Portugal and Ireland combined—too weighty for lenders to forgive without a punishing blow to Eurozone financial health. Can we cure the Spanish fi nancial fl u, and if so, will domestic and European policy makers find the antidote in time?

A Housing-Centred Bust
Economically, Spain’s story, centred on excesses in consumption and housing, is closer to that of Ireland or the US than to Greece. While the government can’t be accused of overspending in the years leading up to the recession (Chart 1, left), the private sector was moving down a perilous path. In addition to a housing bubble, households were chronically over-consuming, with industry under-exporting relative to its Eurozone peers (Chart 1, right).

That saw persistent current account deficits financed by borrowing from overseas. Today, Spain’s external net liabilities stand at a whopping 93% of GDP (Chart 2, left) with portfolio-related obligations at roughly 60%—leaving the nation susceptible to financial instability should foreign creditors lose confi dence and pull the plug on funding. Debts accumulated by banks account for the lion’s share—symptomatic of a private sector that was living beyond its means for years (Chart 2, right).

To read report in detail: SPANISH FLU


Balance sheet woes receding…

PTC India reported a volume decline of 16% YoY, which was below our expectations of 13% YoY growth. Hence, the volumes traded in Q4FY12 stood at 4.4 billion units (BUs) (I-direct estimate: 5.9 BUs). Muted volume growth in Q4FY12 led to a flattish volume growth performance in FY12 at 24.3 BUs. Calculated trading margins for the quarter stood at 8.7 paisa owing to recovery of surcharge from Bihar and Jharkhand SEBs to the tune of | 15 crore. Otherwise, normalised trading margins came in at 4.7 paisa for Q4FY12.

 Volatility in short term markets leads to flattish FY12
Short-term volumes declined 28% YoY in Q4FY12, which led to 16 decline in the overall traded volumes for Q4FY12. However, a pick-up in long term volumes (up 43% YoY) provides encouraging signs that volatility in volumes, going ahead, will be limited as PTC expects 580 MW and 3164 MW worth of long term arrangements to fructify in FY13E and FY14E, respectively. Though this will lead to some decline in margins, it will ensure steady volume growth for the company. We have built in volumes of 28.8 BUs and 36.5 BUs in FY13E and FY14E, respectively.

■ Uptick in payments from SEB to gradually improve perception risk UPPCL and TNEB owe ~| 1900 crore to PTC. Out of these, PTC has received | 150 crore from | 750 crore due from TNEB while the remainder will be paid by Q1FY13, as per the management. Even payments from UPPCL are expected to commence in H1FY13. This, we believe, will lead to a decline in the perception risk that PTC was facing with respect to non payment of dues. Also, during Q4FY12, PTC has repaid all working capital loans.

Commencement of payments from SEBs will improve sentiments and outlook towards the stock as clearing of loans will lead to interest cost savings in FY13E and FY14E. Hence, we have revised the earnings by 22% and 25% for FY13E and FY14E, respectively. We have revised our target price to | 68 per share (from | 62 earlier).


>STRATEGY: Staying away from the “fright club”

Summary: There are three very good reasons, we believe, for not joining the “fright club” against India being orchestrated by parts of the brokerage community. Firstly, a significant part of the ongoing economic slowdown has been caused by the fact that the supply of equity to the promoter community has been cut off by the European crisis (rather than by the Government of India). Secondly, a number of regulatory institutions which have come to the fore over the past two years (eg. CAG, Competition Commission) will help the Indian economy going forward even though they might result in short term economic costs. Thirdly, India’s GDP data is so compromised that drawing any conclusions about the state of the economy based on this data could result in poor investment decisions.

We reiterate that this is a good time to invest in India as valuations are the most attractive that they have been in a decade (leaving aside the quarter following the Lehman bankruptcy).

It is common knowledge that the Indian Government has played its hand badly over the past four years. For example, with regards to coal scarcity, most of the damage was self-inflicted as the Environment Minister dithered on the “go/no go” areas and then instituted an over zealous process (and arguably faulty) process of checking emissions in the vicinity of Coal India mines. The totality of these measures has probably set back Coal India’s production by 5-7% per annum. Another example of self-defeating intervention is the hasty introduction of GAAR
in the Union Budget. 
However, is the Indian Government so influential that its blunders have bought our economy to its knees? We do not think so. Three other factors have played a powerful role in India’s humbling.

Firstly, a range of problems which prima facie appear to be caused by the Government’s “policy paralysis” are arguably linked to the global seizure in risk appetite.

 The “under-the-table” model was used in the noughties to lubricate our political and bureaucratic system as aggressive promoters sought to build construction, infrastructure, real estate and mining empires. Now many of these promoters simply do not have the means to use this model on such a scale (partly because with the QIP/IPO market shut the most obvious route for financing such large backhanders is gone).

 Promoters these days are quick to blame “policy paralysis” for their inability to get projects off the ground. However, some basic number crunching and discussions with financiers suggest that in many instances these Power, Infra, Real Estate and Mining companies are deliberately throttling the project back because they do not have equity available.

The second reason for not joining the “fright club” is that a number of regulatory institutions which have come to the fore over the past two years will help the Indian economy going forward. The actions of a number of regulators, most notably the CAG and the Competition Commission (CCI) are an obvious antidote to the excesses of the noughties. Whether it be CAG’s pathbreaking report on the 2G maater of the CCI’s landmark action against DLF
for the alleged abuse of its dominant position in Gurgaon, it is hard to blame the Government for these actions.

In the Natural Resources sector almost all the titanic promoters seem have hit a brick wall in New Delhi as they run into an array of opponents in the form of: (a) The CAG which is publishing report after report on different aspects of malfeasance in this sector; (b) The Environment Ministry which is no longer willing to give clearances to projects; (c)
The Supreme Court which is unwilling to let illegal mining continue and which has advocated the use of auctions for all natural resource allocations henceforth; and (d) The relevant Ministry (be it Coal, Petroleum or Mining or Steel) which is unwilling to play ball. It is hard to imagine that our enfeebled Executive is behind such a coordinated blocking of a range of powerful companies.

If the Competition Commission continues its crusade against abuse of dominant positions by market leaders in industries from Real Estate to Cement to Sugar to LPG Cylinders, this should help improve economic efficiency. If the CAG continues its practice of scrutinizing public spending and regulatory decisions in the manner that it has over the past two years, it will revolutionise the way the Indian Government works. Without such interventions from well
meaning regulators and from a powerful judiciary, India could go the way of numerous “banana republics” in Latin America and Africa.

The final reason for not joining the fright club is that our GDP data is so compromised that drawing any conclusions about the state of the economy based on this data could result in poor investment decisions. First and foremost, India’s GDP data is subject to inexplicable retrospective revisions of a material magnitude. For instance, investment demand growth numbers have been revised upwards from 5% YoY and -4% YoY in 1QFY12 and
2QFY12 respectively to 15% YoY and 5% YoY respectively. Secondly, there is limited synchronization between trade data as shown by the national accounts data and the same variables captured by the RBI. And thirdly, the share of ‘discrepancies’ in the CSO’s GDP growth data has risen by 50% from FY05-08 to FY12 (from -9% of the change in GDP to 42% of the change in GDP!).

Clearly, the economy has slowed down sharply. Whilst we were amongst the first to signal such a pronounced slowdown (refer to our macro research from exactly a year ago), we had become more optimistic about the Indian economy in January this year. Our optimism is not being borne out by the current state of the economy but, once
again, this is because the paralytic state of affairs in Europe means that a big swathe of the Indian economy simply does not have equity to fire up the capex cycle. Policy somersaults in New Delhi can’t do much to change that reality.

Investment implications
A significant part of the blame for the dramatic slowdown of the Indian economy lies not with domestic factors but with the freezing of risk appetite in the wake of the European crisis. Our economist, Ritika Mankar, estimates that at least a third of the collapse in India’s growth can be attributed to the slowdown in investment growth which in turn is most profoundly affected by the global risk environment given India’s capital scarce nature. Whilst investment growth accounted for 50% of India’s GDP YoY growth over FY05-08, this share has now fallen to 20% in 4QFY12. Our own modeling process suggests that the global risk environment is the most important determinant of India’s growth engine (30x times more powerful than the repo rate).

This “blame attribution” is important. If investors pull out of India believing that there is something “systemically” or structurally wrong with the country, they will lose a great opportunity to participate in the Indian recovery which will come when global risk appetite recovers. This is main reason why we at Ambit refuse to join the “fright club” of brokers who are sounding dire warnings about what will happen to India if the Government does not do X, Y or Z.
We reiterate that this is a good time to invest in India as valuations are the most attractive that they have been in a decade leaving aside the quarter following the Lehman bankruptcy. We note that over the past decade the 12 month returns from investing in India when valuations are as low as they are now have always been strongly positive - see table below.

We also believe that by focusing on “Good & Clean” (G&C) companies investors can comprehensively outperform the sagging Indian indices. Since inception in March 2011, our G&C portfolios have outperformed the BSE500 by over 20% (on a free float market cap weighted basis). Our latest G&C portfolio (has outperformed the BSE200 and the BSE500 by 52bps and 48bps respectively since publication on 3rd May.