Monday, August 6, 2012

>Does food price shock pose earnings risk to Staples?

We assess the impact of a significant rise in select agri-commodity prices on EM/APxJ Staples sector in particular. The rally mainly in corn, soybean and wheat has led to a 10% increase in CRB food Index since the end of May.

This price move will negatively affect some of the downstream consumer staples names which are major users of these commodities and have limited ability to pass through the rise in input cost to the consumer. So far, Morgan Stanley analysts in APxJ & EM suggest limited impact on the staples stocks due to strong pricing power and, in some cases, domestic sourcing of these commodities where prices are restrained. However, in the past, sudden rises in CRB Food Index have been associated with poor earnings revision breadth relative to EM and consequently weaker relative performance.

Moreover, Consumer Staples sector has systematically outperformed the EM benchmark since Q1-11. At the same time, its P/B premium to EM is at an all-time high at 143% versus 10-yr average of 59% and significantly above levels seen in 2009 (112%) or 1998 (128%).

We collaborated with our Staples analysts to gauge the impact on earnings due to the recent rise in input prices. In cases where input prices have not risen, we provide an earnings sensitivity analysis based on a 10% increase in key input cost. The earnings impact incorporates the pass- through capability of the company in the current environment. See Slides 6-10 for full list of stocks.

At a macro level, our Asia Economics team expects this price rise to have an impact on food inflation in the region. Even though India is relatively less affected by these global developments, it is experiencing below-normal monsoons, which could pose upside risks to its food inflation.

To read report in detail: HIKE IN FOOD PRICE

>Sustained Decline in Cigarette Consumption Rates Will Cause Many Tobacco Settlement Bonds to Default

Declining rates of cigarette consumption in the US pose a major credit risk to tobacco settlement bonds. In this report we present consumption break-even decline rates that quantify this risk. Consumption break-evens estimate the rate of decline in cigarette consumption that would lead to default for each tobacco settlement bond we rate. The break-even cigarette consumption decline rates for each rated bond also show that under our projection of an annual decline rate range of 3%-4%,1 bonds constituting 74% of the aggregate outstanding balance of all tobacco bonds we rate will default.2 This finding is consistent with the bonds’ current ratings, 79% of which are B1 or lower. The factors leading to low break-even rates are high leverage ratios, long bond maturity, and low cash reserves.

Break-even analysis determines maximum consumption decline before a bond suffers payment default We calculated the break-evens for cigarette consumption decline rates by conducting iterative cash flow analyses to determine the default threshold for each rated bond, holding all other inputs constant. The default threshold is the highest constant annual decline rate for cigarette consumption at which each bond fully amortizes by its final maturity date without a payment default.

As illustrated in Chart I, our break-even analysis finds that 15 tranches representing 33% of the rated bond balance have a consumption break-even of 2%-3%, while 25 tranches representing 41% of the aggregate rated bond balance have a consumption break-even annual decline rate in the range of 3% to 4%. All of these bonds would default if the average annual consumption decline occurs at the high end of that range. This analysis assumes a constant rate of decline for the duration of the bonds’ life.

To read report in detail: CIGARETTE CONSUMPTION


From over-supply to tight supply: Risk and Opportunity in touch panel sector

After prolonged oversupply and margin decline, we now expect oversupply in the touch panel industry to reverse on the back of the launch of Windows 8 along with low-cost tablet PCs. Our analysis suggests the demand from touch-on-PC and ever-growing tablet would outstrip realistic mid/large-size touch panel supply. This would likely create tight supply in 4Q12 onwards especially for One-Glass-Solution (“OGS”) capacity. We believe TPK stands out in this trend. Other touch panel makers could also see spill-over effect in 2H12.

 Touch panel likely penetrates into an untapped market: Major PC brands plan around 10% of NBs to be equipped with touch panels in 2013. Given the high price points of Win 8 NBs, however, we make conservative estimate of 2%/6% touch penetration into NBs for 2012/2013. Regardless, we forecast touch-on-NBs will account for 7%/18% of the mid/large touch panel demand in 2012/2013. The penetration rate will continue to increase along with price elasticity.

 Demand outgrows supply: Since most of the touch panel makers barely breakeven with mid/large size touch panel, we estimate the industry capacity sees only mild growth by 39%/16% in 2012/2013 vis-à-vis demand growth of 59%/41% for 2012/2013. In the worst case scenario where demand for touchscreen PCs turns out to be disappointing during holiday seasons, second-tier touch panel makers could likely see more de-stocking risks in 1Q13, but the trend of touch-on-PCs is inevitable, in our view.

 Shortage likely in 4Q12 onwards – Currently, the market remains skeptical about touch panel penetration into NB and PC markets. Our base case suggests a supply glut of mere 2% if touch penetration in NBs reaches 6% in 2013 and tight supply will return if the penetration exceeds 7%. Hence, we believe touch panel adoption rate in NB will be the major swing factor for supply/demand dynamic in 2013.

 Risk of in-cell in iPad – We currently do not expect Apple to use in-cell for iPad in 2013. If Apple adopts in-cell for iPad in 2013, however, this could change the supply/demand dynamics of the touch panel industry. iPad represents 40~50% of the total mid/large touch panel demand, or equivalent to around 40 million units of NBs. Nevertheless, non-Apple devices would likely prefer OGS over in-cell to avoid high front-end costs for photo masks and tooling

To read report in detail: TOUCH PANEL SECTOR

>HOUSING FINANCE: Still have defensive quality

Whilst outperforming the bankex (HDFC by 27% & LICHF by 64%) in CY12, the housing finance stocks have underperformed the bankex (HDFC by 23% & LICHF by 13%) YTD given concerns on margins. These concerns were accentuated by declines in yields for most of the HFCs in Q1. We think we may have seen the worst in terms of margins for the HFCs given that most of the margin deterioration was due to the increase in cost of funds and not yields. Also, NPLs for the sector have remained low. We see this as the most defensive sector in the financials space, retaining LICHF as our top pick. DEWH has the highest upside potential, but any re-rating appears to currently be held back by perceptions around governance, though the operating performance has remained robust.

Results broadly in-line
Current quarterly results have been broadly in line with our expectations;
a) Loan growth for HFCs we cover remained > 20%, given that the disbursement growth was in excess of 20%; no significant increase in repayments even after abolition of prepayment penalties.
b) Gross NPLs declining on YoY basis, although on QoQ basis they have deteriorated slightly due to the seasonal impact for Dewan and LIC Housing.
c) NIMs have fallen on a QoQ basis for most HFCs, which is seasonal as well as due to the rise in cost of funds. However LIC has negatively surprised as the increase in cost of funds was more than our expectations.

Still remains the most defensive area in financial sector
We view this sector as the most defensive in the financial sector given:
a) Growth rates should remain high given that affordability is still good and we have not seen any indication of a significant reduction in demand from anywhere in India other than Mumbai.
b) NPLs should remain low as we are yet to see heavy job losses. In addition, most loans in India are for own use so this is the last asset a person would likely default against. Also, the LTVs have come down with the RBI reducing the maximum LTV from 95% to 80% over the last couple of years. c) NIMs have been declining for a few quarters, but we think we may have seen the bottom given yields are expected by us to increase in coming quarters with teaser rate loan repricing (for LICHF) and incremental loan portfolio at a higher yield than the average yield of the portfolio.

Dewan looks attractive but LICHF remains our top pick
On a relative as well as absolute basis, DEWH looks attractively priced given a 20% ROE, in excess of 25% loan book growth and around 20% earnings growth and the stock trading at just 0.9x FY13E book and 5x FY13E earnings. However, perceived corporate governance issues due to promoters’ relatives involved in real estate activities means that the stock’s performance may remain subdued in near term. Hence, although we have just 5% upside on LICHF compared to 78% upside on DEWH, LICHF may well do better in the near term given no corporate governance noise and our expectations for an increase in NIM. At 4.3x FY13E P/BV HDFC looks appropriately priced and we do not see much upside given it already trades at a premium valuation. We have tweaked our estimates for HDFC and DEWH to incorporate FY12 results with no resulting changes to our FVs.

Risks to the investment case
The sharp rises in the interest rate environment, high property prices in some locations and economic slowdown have resulted in a meaningful reduction in demand for housing in the two biggest cities, Delhi and Mumbai. Were rates to continue at these high levels and the economic environment were to deteriorate significantly we could see growth rates for the HFCs coming down.

To read report in detail: HOUSING FINANCE

>What is Driving Credit Growth?

What’s new: The Reserve Bank of India has released the June-12 update on sectoral /industry-wise data on credit growth. Non-food credit growth picked up to 18.6% YoY (vs. 16.5% as of May-12; and 19.6% as of June-11).

The key trends were:
a) Industry segment growth moved higher to 20.3% YoY (vs. 18.8% as of May-12 and 22% as of June-11): Large corporate segment picked up to 23.8% YoY from 21.8% YoY in May-12 (and 22.7% in June-11). SME loan growth increased to 12.3% (vs. 11.3% YoY as of May-12 and 11.8% in June-11). Mid-corporate credit growth decelerated to 7.2% from 8.1% in May-12 (compared to 31.7% in June-11).

Infra (ex-telecom) loan growth moved lower to 15.3% YoY (vs. 16.2% in May-12 and 33% in June-11): Power sector growth moved lower to 11.5% YoY (vs. 13.7% as of May-12 and 39.8% in June-11). Lending to roads saw a pick-up in growth to 16.9% YoY, compared with 14.7% in May-12. ‘Other’ infra loan growth, was stable at 29.2%. Telecom segment picked up 3.4% YoY (vs. -0.1% YoY as of May-12).

Non-infra industry growth moved higher to 23.9% YoY vs. 21.5% as of May-12 and 18.3% as of June-11. The sectors that saw a acceleration were petroleum (25.1%% vs.-5.2%),chemicals and chemical products (+20.6% vs 18.9%), rubber and plastic products(+29.1% vs. 25.4%) and ‘other’ industries (44.3% vs. 41.9%). The sectors that saw a deceleration were construction (15.7% vs 17.2%) food processing (19.8% vs 21.2%) and beverage and tobacco (+24.5% vs 29.6%).

b) Personal loan growth moved higher to 15% (vs. 13.1% YoY in May-12 and 17.3% in June-11). Mortgage (+15.2% YoY vs. 14% in May-12), Credit cards (+18.4% vs +12.8% YoY) and ‘other’ personal loans (+22.8% vs. 14.5% in May-12) growth saw an acceleration in growth sequentially. Advances against Fixed Deposits declined to -0.1% vs +4.2% YoY.
c) Micro-credit loan growth continued to shrink at -19.1% YoY (vs. -9.6% as of May-12). This compares with 20.5% YoY as of June-11. On a sequential basis, bank lending to this sector was down 3.7% MoM.

d) Services sector loan growth picked up to 19.1% YoY vs. 15.7% as of May-12 ( 20.9% in June- 11): Lending to NBFCs (50%YoY vs. 41% YoY) and transport operators (34.9%YoY vs. 22.2% YoY) picked up. Bank lending to shipping declined 22.5% YoY, compared with a decline of 17.9% YoY in May-12.

e) CRE segment loan book increased to 4% YoY from 2.8% in May-12: Outstanding bank loans to the sector amounted to US$23.6 bn, or 2.7% of non-food credit.

To read report in detail: CREDIT GROWTH

>EID PARRY : sugar prices shoot up over the past one month

EID Parry’s (EID) Q1FY13 revenue and adjusted PAT were in line. EBITDA margin expanded 10.8% even as the adjusted PAT at INR782mn is substantially higher than INR314mn YoY. This was on account of robust volume of sugar and better operating leverage. Moreover, the recent sugar price increase by ~20% over the past one month, owing to demand picking up ahead of the festival season and monsoon concerns, is likely to augur well for EID. Over the last one quarter, EID has closed the discounting gap with Coromandel from 35% in April 2012 to 15% currently. However, owing to the improving sugar segment performance coupled with the likely upside in Coromandel International translating into higher valuation, we remain
positive on the stock. Maintain ‘BUY’.

Revenue, adjusted PAT in line, sugar performance improves
EID posted a consolidated revenue growth of 8.6%, EBITDA margin of 10.8% (up 160 bps YoY and 180 bps QoQ) and adj. PAT of INR782mn (up 149%) in line with the expectation.

The strong growth in profitability is primarily on account of an improved performance in the sugar segment which expanded PBIT margin by 830 bps YoY to 1.1% in Q1FY13.

Key highlights – sugar prices shoot up over the past one month

• While the free sale sugar price for EID was at INR27.5/kg in Q1FY13, sugar price in general has shot up by about 20% over the past one month to INR34/kg currently, owing to concerns over monsoon and an incremental demand coming ahead of the festive season. This is likely to augur well for the profitability of EID.

• EID and its subsidiaries crushed 1.82mn MT cane in Q1FY13 (up 19% YoY) vis-à-vis 1.52mn MT in Q1FY12 and 2.69mn MT in Q4FY12. Sugar sales volume was 0.22mn MT on a consolidated basis during Q1FY13(0.16mn MT YoY), out of which, 94,337 MT was exported. Management guides for ~67,000 MT of exports for Q2FY13.

• Management guides for ~8mn MT cane crushing in FY13 vs 6.9mn MT in FY12.

Outlook and valuations: Attractive; maintain ‘BUY’
Factoring in a higher sugar realization, we have increased our EPS estimates by 6.8% and 4.4% for FY13 and FY14 respectively. EID is currently available at an attractive valuation of 6.9x and 5.8x consolidated P/E for FY13E and FY14E respectively. We maintain ‘BUY’ with a revised target price of INR301/share (INR295 earlier).

Other highlights
• Cane crushing during Q1FY13 was 1.82 mn MT (up 19% YoY) on a consolidated basis; it was 1.64 mn MT (up 27%) on a standalone basis.

• Recovery rate improved to 9.21% from 8.71% on YoY basis.

• EID has sugar inventory of ~0.11 mn MT on a consolidated basis in Q1FY13, priced at INR24.5/kg.

• Average sugar realization for the quarter has been at INR27.4/kg – the free sale sugar realization at INR 27.5/kg, levy at INR 19/kg and export realization at 28.5/kg.

• Management guided that sugar price has moved up sharply over the last one month to INR 34/kg currently as it expects the price to sustain at these levels over the next few months owing to an extended festival season this year. However, according to few media articles, the government is likely to consider various options like having a cap on exports (which were freed in May 2012 and put under OGL), removal of import duty and an increment in allocation of sugar for free market sale. Such measures from the government might have some downward pressure on sugar prices.

• Landed cane cost for EID has been at ~INR2,200/MT; this prices in the cost of production of sugar for the company ~INR26.5/kg at the PBIT level.

• Indian sugar production for SS12 stands at 26mn MT. The country may export ~3 mn MT. For SS13, the current sugar production estimate by ISMA is at 25mn MT with a bit of downward bias, owing to weak monsoon. The management guides for a surplus production in India for SS13, giving it a scope to export 1-2 mn MT.

• During Q1FY13, EID had an ethanol sales volume of 9.2mn litres on a standalone basis and 14.8mn liters on a consolidated basis at an average realisation of INR24.8/litre.

• While distillery production volume has gone up, the company had consciously sold lower quantity, owing to weaker ethanol prices. The ENA price was INR28/KL during Q1FY13, which has gone back to INR33/KL currently.

• Consolidated cogen export at 134.6 mn units was up 12% YoY; average realisation at INR3.5/unit.

• Bio-products division (nutraceuticals and bio-pesticides) has posted a consolidated loss of INR5.7mn vis-à-vis loss of INR10.6mn YoY.

• Silkroad Sugar (the sugar refinery) remains shut owing to gas availability issues. To address this issue, the company is setting up a coal boiler and the refinery is expected to start operating within the next 16-18 months.



Growth oriented miner having (L)ignite…

We expect Gujarat Mineral Development Corporation (GMDC) to continue on its strong growth trajectory and achieve lignite sales volume CAGR of 10.7% during FY12- 15E. We note that despite having superior operations with impressive track record of growth, no regulatory overhang, low cost base backed by outsourcing model, diversified customer base and strong future growth potential, the stock currently trades at a discount to global coal peers as well its own 5 year average valuation multiples. We expect net sales and EBITDA CAGR of 19.3% and 17.5% during FY12-15E. Valuations appear cheap to us with current discount of ~15% to global average of coal miners as well as Coal India. We initiate coverage with a BUY rating and a target price of Rs234.  Industry leading volume growth in lignite to continue: GMDC has remained a clear leader in the mining space with volume CAGR of 11.8% during FY09-12 on the back of increasing volumes from new mines. We expect the company to mirror its past track record going ahead and achieve volume CAGR of 10.7% during FY12-15E with increase in contributions from newer mines, EC limits for which are getting increased.

Bauxite volumes to almost double in two years: GMDC has recorded bauxite sales at 8.7 lakh tonne in FY12, up impressively by 31% YoY. Bauxite business is lucrative for the company with operating margin of ~40% and we have factored in 1.1/1.6 MT of bauxite sales from GMDC in FY13E/14E. Bauxite JV with Nalco for supplying 3 MT bauxite annually at LME linked fixed price in the long run is a positive step for stable bauxite operations.

Pricing power in lignite remains strong with location advantage: GMDC has maintained strong pricing power (CAGR of 9.3% during FY09-12) due to i) no major regulatory hurdle in taking price hikes in lignite in Gujarat ii) strong demand from diversified customer base of GMDC and iii) linking of GMDC’s pricing to similar grade (F) coal prices of Coal India (Coal India has taken several price increases during the last two years). We expect GMDC blended realizations to increase at 6% CAGR during FY12-15E.

High productivity and low cost due to outsourcing based model: GMDC has seen ~80% increase in employee productivity on account of a constant reduction in workforce (~20% reduction from FY09 to FY12) and a subsequent increase in volumes. Company’s outsourcing based model has helped maintain volume growth and kept costs low (GMDC cost/tonne is lower than that of Coal India and EBITDA/tonne is substantially higher). We expect EBITDA CAGR of ~17.5% during FY12-15E.

Valuations – attractive, initiate with a Buy: We see GMDC stock trading at attractive valuations with current valuations at ~15% discount to global coal peers and Coal India. We have valued GMDC at 6.5x FY14E EV/EBITDA (premium of ~10% to global CY13E average for coal players). We get a fair value of Rs234/share for GMDC from our EV/EBITDA valuation. At our target price, the stock discounts its FY14E EPS of ~Rs21.6 by 10.8x (around 10% discount to current global average of ~12x for CY13E/FY14E). We initiate Buy with a target price of Rs234. 

Key Risks: Lower production growth in lignite and bauxite, price control by state government on lignite, implementation of 26% mining tax proposed in new mining bill.


>CUMMINS INDIA LIMITED: Investment in new capacity creation at Phaltan Megsite

Cummins India Ltd (CIL) is a wholly owned subsidiary of USA based Cummins Inc. Established in 1962, Cummins India Ltd manufactures a variety of Engines operating on diesel, natural gas and dual fuel in their currently operational 5 plants at Kothrud (Pune), Nagar road (Pune), Loni, Daman and Pirangut (Pune). Cummins India Ltd is amongst the largest exporters of engineering products in India.


􀂉 In Q1FY13, CIL registered a revenue of `12588 mn which has registered an impressive growth of 21.8% on Y-o-Y basis and 21% growth on Q-o-Q basis. The sales improvement was largely due to the increase in demand in power generation BU which grew by 24% as well as distribution business which grew by 12% whereas CIL’s industrial BU declined by 15% and automotive BU declined by 30% compared to corresponding quarter previous year . However, CIL do not anticipate sustaining the growth rate that is demonstrated.

􀂉 In Q1FY13, CIL’s EBITDA margin stood at 18.5%, which has shown a substantial improvement of 160 bps on Y-o-Y basis whereas it has registered a decline of 20bps on Qo- Q basis. Margins improved over the previous quarter despite continued input cost increases mainly due to volume leverage, favorable exchange trends, and CIL’s continued focus on improving efficiencies. The margins during the quarter has also been positively impacted by better realization of export and an improved product mix.

􀂉 CIL’s net profit margin in Q1FY13 stands at 14.3%, showing a marginal improvement of 40bps on sequential basis but it has declined by 280bps on Y-o-Y basis. The net profit margin during the quarter is also boosted by 36% (Y-O-Y) growth in other income which include foreign exchange benefits as well.

CIL’s management is optimistic about long term growth prospects and continued to
18 invest in new capacity creation at Phaltan Megsite. The investment program is on track which include the new power generation plant at Phaltan Megasite and technical sector, the
B,C,L up-fit centre. CIL intend to incur a capital expenditure of ~ `2500 mn in FY13. The
revenue mix for the quarter includes power generation business - 34% (Vs. 31% in
Q4FY12), Industrial business – 10% ( Vs. 13% in Q4FY12) Automotive business 3% (Vs.
6% in Q4FY12), Distribution business 18% (Vs. 19% in Q4FY12) and exports 35% (Vs.
31% in 4FY12).

Valuation & Recommendation:
At CMP of `463, Cummins India Ltd is currently trading at P/E Multiple of 19.4x on FY13E
EPS of `23.9. Considering the current global and domestic scenario in engine and power
generation business and volatile commodity prices, we maintain our target price at
`430.2/ share which is at 18x P/E on FY13 EPS of `23.9 and maintain “HOLD” rating.

>HINDUSTAN CONSTRUCTION COMPANY - Losses continue to mount

Result Analysis
 Sales decline by 9%; order inflows dry down: Company’s sales de-grew by 8.4% y-o-y to `9,694mn below our as well as street expectations on the back delay in project executions. The company’s order book stands at `150.0bn (40% hydro, 24% transport, 22% water and 14% nuclear and others), while there were no order inflows for 1QFY13. The outlook remains bleak as industrial capex has slowed down and also many projects are facing execution issues on account of which top-line is likely to be hit badly.

 Operating profit dip by 590bps y-o-y and 40bps q-o-q: During 1QFY13, the company’s operating profit declined by 49.9% y-o-y to `691mn, while the operating margin declined by 590bps y-o-y and 40bps q-o-q to 7.1%. The decline was mainly due to lower top-line and higher raw material expenses.

 Operating profits and interest costs continue to lead to losses: Company reported a net loss of `310mn during 1QFY13 due to lower sales, bad operating performance and interest costs. Interest cost rose by 37.5% y-o-y to `1,282 mn. The management expects the company to be out of red by end FY13.

 Approval of Corporate Debt Restructuring – the only positive surprise: The Corporate Debt Restructuring Empowered Group has approved the restructuring of its debt of ~`32bn which might bring down the interest costs and improve cash flow. The key terms of the CDR package are:-

a) Principal moratorium of 2 years and structured repayment of 8 years of restructured term loans

b) Softening of interest rates and need based additional working capital would be sanctioned by the existing bankers.

Other Key Highlights:
 Karl Steiner AG; another quarter of strong order inflows: The Company has a strong order backlog of CHF.1.5bn (`87.2bn) while the Company reported a turnover of CHF202.6mn (~`11.8bn) and inflows to the tune of ~CHF192 mn(`11.6bn).
 HCC Infrastructure: The Company won a six laning project between Vadodara-Surat junction with and total project cost of ~`14bn with a concession period of 12 years. Execution of West Bengal projects (NH34) underway and is ~30% complete.

Outlook and Valuations:
HCC has been hit across all fronts top-line, operating as well as profitability on account of dip in order inflows, slower execution of the projects and rising costs; Profitability has been hit badly on account of bad operating performance and interest costs. The outlook for order inflows and execution remains bleak and is likely to hit company’s overall performance badly. The CDR package approval is likely to lower the interest burden and improve cash flows; however if the current pace of project execution continues the effects will be negated. Factoring in a) muted order inflows b) continued slower execution performance and increasing levels of debt we revise our top-line estimates downwards ~by 7% and 6% to `39,202mn and `41,959mn for FY13 & FY14 respectively and expect the company to report a net loss of `1,856mn and `1,305mn.(Earlier estimates loss 1345mn and `819mn for FY13 and FY14 respectively.) Infrastructure segment has been marred from all fronts and we do not foresee the situation improving in the near term. HCC has not only seen a dip in its top-line but also on the operating parameter front which coupled with high debt burden is impacting the bottom-line and hence we maintain our “Hold rating” on the stock. At the CMP, the stock trades at 1.1xFY14E P/B and 13.5x FY14E EV/EBITDA.

>OVERSEAS MARKET: Watch Out For Negative Surprises (CICC)

European sovereign debt crisis not under the spotlight in the near term: The unexpected consensus reached during the recent Eurozone summit is a so-called “heart disease pill”. We believe any progress being made is of a two-steps-forwards-and-one-step-back kind, and market participants should not expect too much in the near term.

The global economic slowdown is now the biggest concern: Market participants have reached a consensus that the Eurozone has slipped back into a moderate recession, the US has seen mixed economic data recently, and emerging economies may suffer a further economic slowdown. Against the backdrop of the global economic slowdown, both developed and emerging economies have been sending signals of easing their monetary policies since April. However, global markets have not rebounded, but declined after such policies were unveiled, indicating investors expect something even worse to happen going forwards.

Watch out for negative surprises: 1) Corporate earnings are likely to slow at a sharper than expected pace in 2Q12, and the future earnings recovery may also be weaker-than-expected amid the global economic slowdown. That said, we can not get the big picture as the earnings season has just started; 2) Market concerns about the next year’s US “fiscal cliff” may come earlier than expected: It is almost certain that the US fiscal stimulus package may not be passed amid the political deadlock before the completion of the US presidential election. In addition, the US Fed has not decided whether it will embark on a third rebound of quantitative easing. The market hates uncertainty, and is worried that the economic growth will likely weaken in 2H12.

Maintain our view that the global markets may rebound in 3Q12, but watch out for negative surprises: Overall, the economic fundamentals stayed weak recently, but it is not significantly worse than previously expected. The actual performance of the economic surprise index suggests that the global markets have already started beating the market consensus, although the sustainability remains fragile and still needs to be monitored. On the other hand, the anemic economic data once again sparked market expectations for QE3. Some European Central Bank officials showed their support for a zero-interest rate policy, saying it is technically feasible for the ECB to lower its deposit facility rate to 0%. In addition, emerging economies have more room to maneuver. In the immediate future, corporate earnings may be the dominant force driving stock markets if economic data is mediocre. However, if the economic data is negative, it may help increase expectation for fresh stimulus policies, lending support to the stock markets. That said, investors should stay alert to the abovementioned three risks: a continued economic slowdown; earnings misses; and, earlier-than-expected “fiscal cliff” fears.



Healthy business growth, robust fees, stable asset quality; Buy 

City Union Bank’s 1QFY13 profits were driven by modest net interest income, healthy fees and lower provisions. We retain a Buy as prudent loan growth, stable productivity and robust asset quality are likely to drive profitability and sustain an RoA of 1.7% over FY12-14. The high tier-1 capital and low proportion of stressed assets provide considerable
balance -sheet comfort.

Healthy business growth, strong savings-deposit growth. Advances grew 33.2% yoy, faster than deposits at 25.2% yoy, increasing credit deposit by 447bps yoy to 74.9%. NIM fell 41bps yoy to 3.2%, led by a larger share of priority-sector loan disbursements (where yields are lower) and a 101-bp yoy fall in share of CASA to 17.5%. While current deposits grew slower (8.8% yoy), a sector-wide trend in 1QFY13, savings deposits grew a robust 25.6% yoy and comprise 61% of CASA (57% in 1QFY12).

Robust fee-income, investments in branches continue. Fee income grew 26.1% yoy and improved 8bps yoy to 1.42% of assets. Cost-to assets rose 26bps yoy to 2% as the number of branches rose 10% yoy to 303. Investment in distribution is likely to persist, albeit in low-cost semi urban/ rural areas, since the bank has 79 branch licenses and aims to reach 500 branches by FY15. We expect the bank’s branches to see better operating leverage with cost-to-assets estimated at 1.7% over FY13-14.

High proportion of secured loans, capital-raising plans. With fresh slippage of `450m (1.4% of loans), gross NPA rose 11% qoq. NPA coverage (excl. technical write-offs) fell 463bps qoq to 53.6%. Yet a high proportion of secured loans (97%) and a strong track record of asset quality are reassuring. Likely capital-raising in FY13 via a `2.5bn rights issue would improve the bank’s capital adequacy (tier-1 of 11.3%).

Valuation. At our Sep’13 target, the stock would trade at 1.9x FY13e and 1.5x FY14e ABV. Our target is based on the two-stage DDM (CoE: 15.6%; beta: 0.8; Rf: 8%). Risk: higher-than-estimated increase in NPA.