Sunday, July 1, 2012

>EURO ZONE: Losing confidence

Sentiment continued to lose ground in the eurozone. Today, the European Commission published its closely watched Economic Sentiment Indicator, which came in at 89.9, down by 0.6 with respect to the previous month. The survey clearly suggests that GDP may have fallen in Q2 2012. With activity entering a contraction area and inflation easing, the probability of a rate cut at next week ECB Governing Council meeting are increasing.

􀂄 Sentiment continued to lose ground in the eurozone. Today, the European Commission published its closely watched Economic Sentiment Indicator (ESI), which came in at 89.9, down by 0.6 point over the month, plunging to its lowest level since October 2009. The EuroCoin indicator (which provides an estimation of quarter-onquarter GDP growth rate, also released today), showed a similar trend, dropping from -0.03 in May, to -0.17 in June.

􀂄 Over the quarter, the ESI lost more than 3 points and it is clearly signalling that GDP may have contracted in Q2 after, stabilising in Q1. The unusually high level of uncertainty has significantly weighed on business and consumer confidence. Businesses expect demand to remain extremely weak over the coming months; order indices continued to decline in June. Manufacturers judge their levels of inventories too high, and consequently are scaling downwards their production.

􀂄 Rising fears of unemployment, combined with poor economic prospects, are dampening households’ confidence. Indeed, the relative index lost 0.5 point over the month. Prospects for private consumption are everything but buoyant for this quarter and next.

􀂄 The survey confirms that price pressures are very low. Against a backdrop of falling demand, firms’ selling price expectations are decreasing (in June the relative indices lost 4 points in the manufacturing sector and more than 3 points in the services sector), Consumer price expectations 12-month ahead inched up in June,
remaining, however, on a downward trend.

􀂄 With activity entering a contraction area and inflation easing, the probability of a rate cut at next week ECB Governing Council meeting, are increasing.


>STRATEGY – With Crude’s decline, expect short-term rally to continue…

Executive Summary
We can all breathe a sigh of relief as last week’s events have come to an end. If we look at the past week in hindsight, key negative risks such as Greece’s exit from the Eurozone have clearly been avoided, which has been enough to calm frayed nerves in the markets. Similarly, in the US, the Fed extended its Maturity Extension Program (MEP), or Operation Twist, by $267 bn and assured markets that more will be done if required thus expanding chances of another round of Quantitative Easing. Thus, things on the global side played out in the favor of bulls. On the domestic front, the RBI delivered a surprise by keeping policy rates and CRR unchanged, contrary to market expectations.

The joker in the pack, however, has been crude oil. Brent crude has dropped to $90/barrel on global growth concerns and a 22-year high stock pile in the US. The fall in crude prices has become one of the biggest game changers for India with its ramifications pretty strong on account of our twin deficits.

On the political scenario, the Prime Minister has taken up the Finance portfolio as Mr. Pranab Mukherjee resigned to contest for presidential elections. This raises some hopes that the PM will act once again as he had done in 1991. Thus, any strong move could have a strong signaling effect on the markets.

Technically, we are well placed above 200 DMA. The recent fall in crude oil prices coupled with strong technical indicators suggest that the current rally may extend to previous highs of 5,500. Hence we recommend trading on the long side in the next 3 to 6 weeks.

Recent events - No complaints as negatives avoided
Greece election results helped restore some calm in the markets with the New Democratic Party (NDP), Pasok and the Democratic Party of the Left forming a coalition government with a total seat count of 179 out of 300 (60%). Thus, the near-term fear of Greece moving out of the Eurozone has been put to rest as the new government realizes the importance of its existing Eurozone membership. This is the outcome that markets wanted to see as the new coalition has generally signaled a willingness to go along with the current bailout path and not buck the rest of Europe.

The Federal Reserve, too, did not deliver any major surprises as it announced a continuation to its MEP (Operation Twist) to the tune of $267 bn. Further, the Fed decided to keep the target range for federal funds rate at 0 to 0.25% and exceptionally low levels for the federal funds rate at least through late 2014. The Fed’s acknowledged that the US economy is expanding only moderately and that growth in employment has also slowed in recent months, keeping unemployment rates elevated. The Fed’s assurance that it will be ready to support the market as needed however lends assurance of another round of QE in the near term.

The RBI, meanwhile, in its June 2012 mid-quarter monetary policy review maintained a status quo on repo rate and CRR at 8.0% and 4.75%, respectively. This move was made in contrast to both our and market expectations of 25bps reduction in policy rates. The Reserve Bank cited concern on inflation and shifted the blame of slower investment growth on the government and other reasons. It is interesting to note that RBI once again has shifted focus on headline inflation rather than the more encouraging core inflation number and going forward monsoon’s performance will play a pivotal role in determining headline inflation trends.

Crude comes to the rescue
The joker in the pack has definitely been crude oil. Brent crude has fallen to $90/barrel on global growth issues and a 22-year high stock pile in the US. The fall in crude prices has become one of the biggest game changers for India, with its ramifications pretty strong on account of our twin deficits. The current account is sensitive by 45bps for every $10/barrel move in crude and crude’s decline from $120/barrel to $90/barrel means that we can now expect CAD at 2.5% in FY13 if crude ends the year averaging at $90/barrel. On the fiscal account as well, a decline in crude helps bail out the central government as they continue to struggle to push a hike in diesel prices. Further, even adjusted for a fall in Rupee, domestic cost of fuel has declined by over 10% since January. This lends some comfort to OMCs given that they have been unable to hike diesel prices.

To read report in detail: STRATEGY



Rane Madras (S): The company expects the electric power steering (EPS) segment to grow exponentially in the coming years and is well equipped to meet the demand. Product portfolio diversification will also be key to growth. The company expects to grow its sales at 18% CAGR with ROCE of 25% over the next couple of years.

Rane Engine Valve (S): The company is well placed to post 15% sales CAGR with ROCE of 18% by leveraging its leadership position in the engine valve segment. Productivity improvement at older plants will help improve margin.

Rane Break Lining (S): Use of friction material in India has to go a long way. The JV with Nisshinbo Japan will help the company post 18% sales CAGR with 20% ROCE.

Rane TRW Steering (JV): With a dominant market share in steering systems and seat belts across segments in domestic markets, the company is planning to grow the niche export business through a JV with TRW, US (world’s No.1 airbag manufacturer).

Rane NSK Steering (JV): a major supplier of EPS to Maruti, is working on increasing localisation, in line with Maruti’s thrust on lowering import content. Dividend payout policy: Rane Holdings @45-50% of PAT.

Outlook: Challenges in near term; positive in long term
FY13 is expected to be challenging. Though, in the medium to long term, demand from domestic OEMs and aftermarkets as well as export markets is expected to revive.

To read report in detail: RANE HOLDINGS


The Devil Is In The Details, We retain Sell 

Hindalco’s FY12 consolidated EBITDA was 4.6% above our expectation at Rs81,894mn, while PAT was 23.8% above our estimate largely due to lower tax rate and higher EBITDA. PBT was 12% higher than our estimate, while the effective tax rate for the year stood at 18.1% as compared to our estimate of 20.8% and last year’s tax rate of 25.1%. Besides this, there was a substantial increase in the leverage, with consolidated net debt/equity jumping from 0.73x to 1.02x due to increased capex as well as rupee transactions of foreign subsidiaries in a falling currency environment. A detailed analysis reveals that FY12 PAT and EBITDA has been overstated by Rs12,775mn and Rs15,512mn with the company routing certain expenses through reserves and surplus and booking some prior period income during the year. We continue to retain our Sell rating with a target price of Rs107 on Hindalco. 

Routing costs through business reconstruction reserve: Hindalco had created business reconstruction reserve (BRR) in FY09 for adjustment of certain specified expenses. During FY12, it booked Rs5,363mn of other expenses from this reserve. Consequently, tax expense was higher by Rs359mn and PAT was up by Rs5,005mn. 

Actuarial gains/losses accounted for in balance sheet rather than P&L account: With effect from FY12, the company changed its accounting policy in respect of gains/losses arising out of actuarial valuation of long-term employee benefits and post-employment benefits relating to one of its overseas subsidiaries (Novelis). Until FY11, the actuarial gains/losses were accounted for in the P&L account, but following the change in the accounting policy these gains/losses along with related deferred tax were adjusted against reserves and surplus. As a result, employee expenses were lower by Rs10,149mn, tax expenses higher by Rs2,999mn, net profit higher by Rs7,150mn and reserves and surplus higher by Rs444mn. 

Prior period income: Following exceptional circumstances, the accounts of Idea Cellular, an associate company of Hindalco, were not available for FY11. The consolidated accounts for FY12 include Rs620mn as Hindalco’s share of profits made by Idea Cellular in FY11, thereby leading to FY12 PAT being higher by the said amount. 

Balance sheet update: Consolidated net debt in FY12 increased from Rs213bn to Rs327bn, while standalone net debt rose from Rs36bn to Rs93bn. Standalone net fixed assets increased from Rs136bn to Rs234bn, largely driven by the capex on Utkal refinery and Mahan/Aditya aluminium units in FY12, while consolidated net fixed assets jumped from Rs327bn to Rs470bn primarily due to higher standalone capex, increased capex at Novelis and translation of foreign assets in a falling rupee environment. Goodwill on consolidation rose from Rs89bn to Rs111bn.

To read report in detail: HINDALCO INDUSTRIES



Standing up to the test of fire

Genuine and structural demand; business model here to stay
Our branch visits of gold financiers made us more confident about genuineness of gold loan demand. Gold loans as a product is gaining significance as it is the fastest and most convenient form of financing, finding use in meeting urgent personal/business needs. Even though the current regulatory changes will impact growth, margins and hence profitability of business, the business model has merit and will continue to embark on a steady growth path post the consolidation period i.e., FY13. Despite heightened competition from banks like Federal Bank, HDFC Bank, ICICI Bank, etc., the USP that established gold loan NBFCs have developed, i.e., scale, first‐mover advantage, brand equity, accessibility, relatively lower documentation and fast turnaround time, will ensure that customers keep flocking to their branches aiding gold lenders to continue to hold forte.

RBI came cracking; industry coping up better than expected
We believe investors are skeptical on monoline gold financiers considering recent regulatory
upheavals and peak/volatile gold prices coupled with active competition from banks and NBFCs.

What if…
Regulatory landscape becomes further assertive
We cannot call it an end of regulatory rigmarole till the report of KUB Rao Working Group is tabled by July 2012. Even in a stress case, assuming further regulatory strictures either with respect to limit on cash disbursals or increase in risk‐weights or definition of collateral value (though we assign low probability to this playing out), we expect 25%‐30% decline in growth from our base case scenario. Even under these circumstances, it will continue to deliver 2.5%‐3.0% RoA and 10%‐15% RoE.

How should investors view this space?
Regulatory risks remain only in interim, long term fundamentals stay firm We accept that FY13 will be the year of consolidation for gold finance companies in term of growth and margins though stability at the ground level might surprise the consensus numbers and expectation. From FY14 onwards, the business model would deliver steady state of 15%‐20% growth, impressive return profile (ROA and ROE) and benign asset quality metrics, a key investor pull. We are confident of substantial merit in this business model as gold loan demand is genuine being the fastest and the most convenient form of financing short term personal/business needs. Leading gold loan financiers will continue to hold the forte considering their USP – branding, convenience, trust, faster turnaround unless: 
     􀂃 Customers become averse to pledging of gold and instead prefer selling gold
     􀂃 Banks get aggressive grabbing significant share due to rate, LTV and reach advantage

Play this space via Muthoot Finance and Federal Bank
We prefer to play this space via quality players like Muthoot Finance or major beneficiary of
regulatory changes like Federal Bank. We also upgrade Manappuram Finance to BUY.

Highlights of survey across 150+ branches

  1. Is gold financing just reaping the benefits of a benign gold price cycle? 
  2. Where do we stand in terms of penetration and product potential? 
  3. What can lead to customers becoming averse to pledging of gold? 
  4. Did rapid growth, burgeoning competition see some dilution in lending? 
  5. NBFCs will hold the turf; but big private banks can change the game 
  6. RBI came cracking; industry coping up better than expected 
  7. Consolidation in the interim; long‐term fundamentals intact 
  8. Is this is the end of regulatory rigmarole? 
To read report in detail: GOLD LOAN INDUSTRY

>TELECOM: No easy solution to the spectrum row

Uncertainty continues...
With only about two months remaining for the August 31, 2012 Supreme Court (SC) deadline of conducting the spectrum auction, things are pretty uncertain right now as the industry tries to reach a consensus on various contentious issues pertaining to reserve price of 2G spectrum, spectrum re-farming, one-time spectrum charges, spectrum liberalisation, etc. Also, the auctioneer for conducting the auction has not been finalised as yet. Even the presidential reference, through which the government was going to ask for SC’s advice on crucial matters relating to cancellation of licenses, is pending. To make matters worse, the EGoM on spectrum pricing has been left in a limbo with Pranab Mukherjee resigning from government to contest the presidential election. We believe it may be very difficult to meet the August 31 deadline. Moreover, no easy solution to the spectrum row is in sight since various stakeholders are acting from different view points.

Reserve price undecided…
Trai had come up with a pan-India reserve price of | 3622 crore for 1 MHz of spectrum. DoT, correcting Trai, has increased the reserve price to | 4245 crore. While the operators have protested against such a huge reserve price arguing that it could result in a tariff hike of 24-90 paisa, Trai is of the opinion that such a reserve price would only lead to a tariff hike of 3-6 paisa. Eventually, the Empowered Group of Ministers (EGoM) is going to decide on the reserve price. New operators will be hugely affected by huge reserve price as DB Etisalat, STel and Loop (excluding Mumbai) have decided to shut down their operations while Uninor and SSTL have made it clear that they would not participate in the auctions should the EGoM accept Trai’s recommendations on the reserve price.

Incumbents to pay prospectively…but how much?
Another uncertainty prevalent in the industry is whether operators should be charged one-time spectrum fees over the remaining life of the license to liberalise the spectrum or should it be liberalised as and when licenses come up for renewal. Also, the government is unclear on the amount of spectrum beyond which one-time spectrum fees should be imposed. According to media reports, it is evaluating three options to impose one time spectrum fees viz. 1) on the entire spectrum held by an operator, 2)beyond start-up spectrum of 4.4 MHz for GSM and 2.5 MHz for CDMA and 3) beyond contractual spectrum of 6.2 MHz for GSM and 5 MHz for CDMA. However, the liberalisation would happen only after the operator pays the auction discovered price of the spectrum it holds.

Until further clarity emerges on the situation, we rate Bharti and Idea (due to a sharp correction in the stock) as BUY and RCom as HOLD in spite of the correction in the stock, due to higher sensitivity to regulatory risks.


Inexpensive valuations

Well-diversified loan book; Mid-corporate & MSME to drive growth Dena Bank has a well-diversified loan book spread across multiple segments like Corporate & SME (40% of total advances), MSME (15%), Agriculture (15%) and Retail (12%). Loan book witnessed a robust growth over FY09-12, reporting a CAGR of ~25%, with Corporate and MSME lending being prime focus areas. Despite strong growth, the bank has not compromised over asset quality as reflected in the Gross NPA ratio. Management has targeted a credit growth of ~22% in FY13. According to the trend in past two years, Dena Bank has posted strong growth in H2 compared to H1. We build in a 22.5% CAGR in loan book over FY12-14E, backed by an impending improvement in macroeconomic conditions and better liquidity situation.

Consistent improvement in asset quality; Infra & Power exposure to come-off further Asset quality has improved remarkably with delinquency ratio declining from 2.6% in FY09 to 1.4% in FY12, reflecting bank’s efficient credit risk management. Dena Bank is deliberately reducing its exposure to the infrastructure space, and specifically to the Power sector. Management expects slippages to be in the range of Rs8-8.5bn in FY13 and restructuring at ~Rs12bn. With slowdown in restructuring, reduction in exposure to stressed sectors like infrastructure and increase in secured lending, we expect Gross NPA ratio to decline further to 1.3% in FY13.

CASA ratio is likely to sustain at ~35%; NIM to remain above 3% CASA ratio witnessed a marginal decline, from 36% in FY10 to 34.6% in FY12. Dena Bank expects healthy growth in SA balance in FY13, driven by robust branch additions (100 branches) and maturing of branches added in recent years. Therefore, the CASA ratio is expected to remain stable. NIM improved significantly, from 2.7% in FY08 to 3.2% in FY12, owing to shifting of focus on high-yielding segments and improvement in Credit/Deposit ratio. NIM is likely to witness a compression of 10-20bps in Q1 FY13 due to the increased lending to low-yielding Priority Sector in Q4 FY12. Management expects NIM to remain above 3% in FY13.

Multiple positives, cheap valuation make it an attractive BUY
Dena Bank has held its own in the current challenging macro economic environment, providing comfort on multiple fronts – robust asset quality, sturdy provisioning, lean operating structure, sustainable margins, healthy capitalization and RoA. We initiate coverage with a BUY rating and 9-month price target of Rs120, implying 24.2% upside from current levels.