Monday, June 18, 2012

>Will India Be The First BRIC Fallen Angel?

Slowing GDP growth and political roadblocks to economic policymaking could put India at risk of losing its investment-grade rating. Standard & Poor's Ratings Services revised its outlook on India's 'BBB-' long-term sovereign credit rating--which is one notch above speculative-grade--to negative from stable in April of this year because of lower GDP growth prospects and the risk of erosion in its external liquidity and fiscal flexibility. The negative outlook also reflects the risk that Indian authorities may be unable to react to economic shocks quickly and decisively enough to maintain its current creditworthiness.

Economic growth has slowed in India in recent months, as it has in much of the world, and the country has suffered mild erosion in its economic profile, with widening trade and current-account deficits. Its central government's fiscal deficit exceeded official projections for the year ended March 31, 2012, reaching 5.9% of GDP. In addition, inflation remains stubbornly high despite the Reserve Bank of India's tightening policies in 2011 (although the central bank recently reversed its interest rate policies to help sustain GDP growth).

India's GDP growth fell to an estimated 5.3% year-over-year in the first quarter of calendar 2012, from 6.1% in the previous quarter. The biggest contributors to growth in the last fiscal year were sectors such as real estate and financial and government services, with manufacturing, infrastructure, and agriculture showing lower growth. The Indian rupee has declined about 20% against the U.S. dollar over the past year.

In our view, setbacks or reversals in India's path toward a more liberal economy could hurt its long-term growth prospects and, thus, its credit quality. How India's government reacts to potentially slower growth and greater vulnerability to economic shocks may determine, in large part, whether the country can maintain its investment-grade rating, or become the first "fallen angel" among the BRIC nations (which include Brazil, Russia, India, and China).

To read report in detail: Will India Be The First BRIC Fallen Angel?


Action: Downgrade to Neutral; TP reduced to INR251
JLR’s 4QFY12 EBITDA declined by 240bps q-q to 14.6%, well below our estimate and consensus of 18-19%. JLR’s current margins are in line with those of global peers and management’s guidance. We estimate the EBITDA margin will stabilise around current levels of 14-15% over the next two years, as upside from an improved China mix is likely to be balanced by a weaker product mix and higher marketing expenses. We
thus reduce our FY13F/FY14F margins from 17.7%/18% to 14.1%/14.5%.

We now expect a 5% decline for domestic MHCVs in FY13F, compared with 0% growth previously. The key argument for our Buy rating so far was our above-consensus earnings estimates, which is no longer the case. Even though our estimates are below consensus, we believe that the recent stock price correction factors this in. Thus, the risk-reward appears balanced, in our view.

Catalysts: Success of new models (positive); global slowdown, growth moderation in China and domestic truck slowdown (negative)

 The success of new launches such as the Jaguar XF-Sportbrake and C-X16 could present upside risks to our estimates.

 Slowdown in developed markets such as the United States and in China could be downside risks. Weaker domestic truck could also be a downside risk.

Valuation: SOTP-based target price cut to INR251
We have reduced our valuation for JLR to INR172 (from INR248) on lowering our margin estimate to 14.1% for FY13 (from 17.7%). We value the standalone business at INR56.5 (7x FY14F EV/EBITDA).

To read report in detail: TATA MOTORS

>KOTAK MAHINDRA BANK LIMITED: Kotak Prime should grow in line with the car industry

Good story, but in the price; initiate at 2-EW

Kotak is a portfolio of well-run businesses, which, though small, have sustainable positions in their segments and are positioned for continued growth. The core banking business should continue to grow through network expansion while its car finance business, Kotak Prime (KP), should grow in line with the car industry. In the capital markets, Kotak has retained its market positions (although its profits have declined along with industry activity) and is well positioned for an industry recovery, in our view. Its strong balance sheet and broad-based presence also
position it well for inorganic growth. However, at the current valuation of 2.7x 2013E P/BV (one-year forward) and 19.0x P/E (one-year forward) these positives appear to be in the stock. Our 12-month price target of Rs540 is based on its historical average 12-month forward P/E multiple of 18x.

Financing businesses appear well positioned for continued profitable growth: We believe the banking business is well invested and should grow through network expansion – replicating the HDFC Bank and Axis Bank trajectory. Furthermore, the bank should also continue to benefit from strong cross-selling opportunities owing to Kotak’s presence in other financial services businesses. KP’s strong car finance franchise should enable it to grow profitably in sync with the Indian auto industry.

Capital market businesses look well positioned for industry recovery: Profits from Kotak’s capital markets businesses (brokerage and investment banking) have declined as the industry has slowed. However, Kotak has retained its market position in key segments (particularly cash equities and ECM) in these businesses. In the event of a sustained downturn, modest profit growth through cost cuts is achievable, in our view.

Broad-based presence and capital create opportunities for inorganic growth:
Kotak’s well-capitalized position is an asset in an environment in which valuations have been compressed. Its foothold in asset management and insurance mean that Kotak has a platform for inorganic growth across the entire financial services spectrum.

To read report in detail: KOTAK MAHINDRA

>PANTALOONS RETAIL: Cloverdell Investment to cut its burgeoning debt

We met Mr. C.P. Toshniwal, CFO, Pantaloon Retail (PRIL), in the backdrop of the company recently cracking significant back-to-back deals to cut its burgeoning debt. These steps will trim the company’s interest expenditure and more such deleveraging exercises are on the cards as
lowering debt is the company’s prime priority currently. However, our key concerns on slow SS growth (compared to peers like Shoppers Stop), sale of higher margin ‘Pantaloon format’, high attrition in top management and higher inventory days remain. Maintain ‘HOLD’.

Business realignment to rake in moolah, trim debt
PRIL has penned deals with Bennett Coleman (INR2bn has already come), ABNL (INR8bn to come in June, further INR8bn debt to be carved off post demerger) and Cloverdell Investment (INR4.2bn will flow in by June end) to cut its burgeoning debt. We expect these deals to reduce core retail debt to ~INR33bn (from INR55bn) over coming quarters. Also, on cards is divestment of stake (in part or full) in Staples Future Office Products, Future Supply Chain, e-Zone, Home Town and Insurance business. 

Private brands, food and customer loyalty programmes on focus
The company has significant private brands contribution coming from Fashion at Big Bazaar (80% plus), Central and Brand Factory (30%) excluding its Pantaloons format. Margin within the foods business is likely to improve as PRIL undertakes backward integration. The company also plans to increase its ‘payback’ members from the current ~5mn to ~10mn by March 2013 to drive growth even during slowdown. PRIL will continue to expand at 1.5mn sq ft per annum (2mn plus earlier run rate/guidance).

Outlook and valuations: Cautious; maintain ‘HOLD’
We are enthused by the pick-up in deleveraging steps by PRIL. The company now needs to refocus on its core retail business so that it can address slow SSG and get better control on inventory and cash flow. The stock is trading at 24.2x and 17.6x FY13E and FY14E EPS, respectively. We recommend ‘HOLD’ and rate it ‘Sector Underperformer’ on relative return basis.

To read report in detail: PANTALOONS RETAIL

>PSU Banks: Valuation Mirage (CLSA)

Many PSU banks are trading close to their core book and may not de-rate further; but as core book remains flat/ declines over FY12-14, returns may be negative. PSU banks’ asset quality experience will be far worse than private banks due to 1) higher leverage that will amplify impact of NPLs, 2) higher exposure to risky sectors, 3) higher exposure to riskier project within risky sectors and 4) weaker collateral. These factors compound, hence divergence in asset quality experience could be big. 10% NPL in power loans can impact PSU banks book by ~12% while for private banks impact would be ~2%. Union, PNB and tier II PSU banks will be worst impacted. Higher NPLs, rising costs and lack of capital may lead small PSU banks into losses and force a merger with larger ones.

Attractive valuations or value trap?
Most PSU banks are trading close to core book and look ‘attractively valued’. However, we see limited upside as we expect that core book values for most of these banks would not grow over next two years.

Though they may not ‘de-rate’ further, absolute upside may not be much.
Higher NPLs will be a drag on book values–100bps higher gross NPL impacts the book values by 10%-20% for PSU banks vs. 6%-9% for private (fig 11). 4 compounding factors would lead to a wide divergence

#1: PSU banks are much more levered- average asset / equity ratio for PSU banks is 17x (some are +20x) vs. 10x for private banks. So the impact of 10% higher of NPL for PSU banks will be much more than for private banks.
#2: Higher exposure to risky sectors like Power (3%-11% v/s 1%-5%), SMEs, aviation, textiles etc. (see fig 3-7).
#3: Higher exposure to riskier projects / corporates within high risk sectors - for ex: PSU banks seemingly have higher exposure to UMPPs, projects where coal
linkages are not adequate or where proportion of merchant power is high.
#4: Weaker collateral- Private banks have better collateral for their exposures to troubled corporate / projects - for ex: Kingfisher Airline (see fig 9).

Cumulatively, these factors could lead to a big divergence in impact on profits / net worth; For ex: If 10% of power loans go bad, then impact for PSUs could be ~12% of book while for private banks it would be ~2% only.

Forced mergers of smaller PSU bank to protect depositor interest?
Some small PSU banks carry a risk of getting to a state where they may have to be merged with large PSU bank to protect depositors' interest.

Higher NPL will hurt core net-worth leading to higher capital requirements which most banks would be unable to meet given that the government would need to contribute 50% of the fresh capital.

Factor this - Central Bank of India is a US$1.1bn market cap bank and its Cahairman recently mentioned that the bank would need US$2.5bn of equity in next 5 years. We believe this is highly unlikely and hence the bank may be forced to cut down dividend pay-out and even lower growth targets.

The bigger issue is that most of these banks have relatively 'fixed' increase in their cost structures due to unionised labour, peak branch efficiency etc. 

We believe the inflection / tipping point is 14% growth - a growth lower than 14% in top line could lead to a vicious cycle of ROA contraction as the cost growth would remain at 14% or thereabouts.

Some PSU banks that are highly leveraged would be forced to bring down growth to <14% and may see ROA contracting from 1% now to 30-40bps in 5 years - leading to a forced merger of these banks with a larger PSU banks.

SBI is the only PSU bank we have a BUY on given it's a) stable and strong deposit franchise, b) early recognition of NPLs.

To read report in detail: PSU BANKS