Wednesday, September 12, 2012

>CAIRN INDIA: Media articles suggest production may be restricted to 175 kb/d in FY2013

Follow-up actions and expectations. We have revised our EPS estimates of Cairn
India by +4-6% over FY2013-15 to reflect (1) weaker Rupee forecasts of our Economists team and (2) slower ramp-up in oil production from the Rajasthan block. We maintain our ADD rating on the stock with a revised 12-month forward target price of `375 (`360 previously). In our view, more visibility on (1) higher reserves and (2) production ramp-up would be critical to stock performance.

Media articles suggest production may be restricted to 175 kb/d in FY2013
As per recent media articles, the management committee of Cairn’s Rajasthan block has decided to limit oil production to 175 kb/d in FY2013, lower than the company’s earlier guidance of 190-200 kb/d by 4QFY13. Apparently, DGH and MOPNG have raised concerns about (1) lower-than anticipated production from Bhagyam field and (2) delays in augmentation of pipeline capacity. We note that Cairn’s oil production from the Rajasthan block increased to 172.8 kb/d in July 2012 from 171 kb/d in May-June 2012; however, it remains lower than the targeted 175 kb/d.

Expect delays in production ramp-up versus ‘aggressive’ guidance
We do not rule out slower ramp-up of oil production from the Rajasthan block in the medium term versus Cairn’s original guidance of ~240 kb/d by end-CY2013, given (1) unexpected behavior of the Bhagyam field, which may require drilling of more wells to achieve peak production of 40 kb/d, (2) inordinate delays in debottlenecking the pipeline and (3) likely delays in approvals from Government/DGH for higher oil production, which will be contingent on reservoir performance.

Cash utilization will determine growth beyond the Rajasthan block
We expect Cairn India to generate US$5.1 bn of free cash flow, over the next four years, led by a gradual ramp-up in oil production from the Rajasthan block. We believe effective utilization of cash will be critical to stock performance in the medium term: (1) re-investment of cash in value accretive E&P opportunities will be positive, (2) dividend payout will be neutral to shareholders and (3) any ‘movement’ of cash to Group entities other than dividends will be negative.

To read report in detail: CAIRN INDIA


• Apollo Tyres is India’s second largest tyre producer with subsidiaries in Europe & South Africa. Improving South African operations and stable demand in Europe would in our view drive volumes for Apollo Tyres and easing rubber prices coupled with a pick-up in the domestic replacement market would help sustaining EBIDTA margins of 10%

• We like the business model of Apollo Tyres having an ROCE of 30% and despite the present subdued demand from domestic OEM’s in the Truck & Bus Radial segment, we believe that the capex cycle has peaked and with the ramp up of its Chennai facility slated for December 2012, the company would be in a position to bring down its gearing from present levels of 0.75x to 0.35x next fiscal by virtue of its robust free cash generation.

• Apollo Tyres by virtue of its timely capacity expansion and brand image is ideally positioned to leverage the potential in export markets. Buy Apollo Tyres trading at 6.5x one-year forward earnings with a price target of Rs115

To read report in detail: APOLLO TYRES

>BHEL: Coalgate, fake orders and then some more

Action: Execution outlook worsens, while stock seems fairly valued 

Recent news flow regarding several private sector power producers being implicated in the ‘coalgate’ scandal, some of which are BHEL’s existing customers, has negative implications for BHEL’s execution outlook. We estimate that ~28% of BHEL’s existing order book is at risk now (compared to ~19% earlier) and this drives our earnings cuts over the next few years. Simultaneously, several other private power developers have allegedly placed fake orders with power equipment companies in order to boost their chances of securing coal mines in India. Such issues question the credibility of the 115GW equipment orders placed in the system and raise the possibility that post clean-up of some of these orders (through cancellation/forfeiture), new order activity could revive sooner than earlier expected, albeit likely to be in 2-3 years, in our view. In the medium term, we believe the outlook remains highly uncertain as the clean-up of existing orders will bring accompanying pain for the incumbents.

Catalysts: Orders, results and sector concerns Execution and order inflow/cancellation clarity are key stock catalysts.

Valuation: Cut FY13F-14F earnings estimates 1-8% and TP to INR199 We continue to value BHEL based on a DCF methodology (Ke 13.5% and terminal growth of 4%). Our TP of INR199/share factors in deteriorating margins (down to 12-14% levels post FY14 and 8% post FY17) and 6GW p.a. coal-based order inflow over the medium term. Given ~0.5% potential upside from current levels, we maintain our NEUTRAL rating.

To read report in detail: BHEL


Debt levels stay high, operating cash flow sparse to service interest
DLF’s net debt increased to ~INR227bn in FY12 as against ~INR214bn in FY11 despite the asset monetization of INR17.74bn. The company’s operating cash flow (estimated at INR15.3bn, ex–land sales) remained insufficient to service interest and dividends (INR36bn) and capex (estimated at INR8.7bn), leading to higher net debt.

Focus on asset divestment to accelerate cash flows
Interest payment of ~INR30bn in FY12 has eaten away the operating cash flows (exland sales) of ~INR15.3bn. The company has plans to cut debt by ~INR50bn in FY13 through non-core sales which would then help ease the interest burden. Outlook and valuations: Deleveraging the trigger; maintain ‘BUY’

DLF’s operating cash flows in FY12 were insufficient to service interest payments due to a weak approval cycle between Q1FY11 and Q2FY12. DLF has set out to reduce debt by ~INR50bn in FY13 driven by non-core asset sales which will ease the interest burden. Further, expected launch of Magnolias Phase II in H2FY13 will strengthen its operating cash flows. We value the company at INR263/share, implying that the stock is trading at 18% discount to its fair value. Maintain ‘BUY/Sector Performer’.

To read report in detail: DLF

>Draghi’s announcement of Open Market Transactions (OMT) to support sovereign short-end bond markets

Key Takeaway
Following Draghi’s announcement of Open Market Transactions (OMT) to support sovereign short-end bond markets, global equity stock prices and volumes roared. The jump in share turnover after weeks of moribund activity signalled that investor conviction over a euro break-up and peripheral contagion has receded. However, the ECB did not cut rates and GDP forecasts
both for 2012 and 2013 were lowered.

Longer term, it is supply side reforms that both Draghi and equity investors will need to see, in the short-term, the ECB has bought the most precious commodity of all, time. We are reinstating our Long EuroStoxx short German bund trade. We continue to believe that the Scandinavian and Swiss markets will outperform the EU region as their central banks loosen rates faster to counteract the slowdown in economic growth. Investors appear to have missed
that Sweden cut rates again last week while Denmark flirts with negative nominal rates (see Scandinavia: Embracing unorthodox monetary policy, 3 September, 2012).

“It is easier to rob by setting up a bank than by holding up a bank clerk”, Bertolt Brecht
The disappointing US August nonfarm payrolls data (96,000) puts the spot light back on
the Fed’s meeting this week with the likelihood of extended rate guidance and possibly a
MBS QE program. We continue to recommend a long position in the S&P homebuilders
and building materials (see US: For the price of one HK carpark you can buy 5 US homes,
6 August, 2012). The weakness in Asian economic data has been reflected in Korean and
Taiwanese industrial production for some time but the evidence of an unwanted inventory
build-up seems to have been overlooked by investors. The week-end’s release of August
Chinese industrial production (8.9% y-y) and inflation data points (CPI 2% y-y, PPI -3.5% yy)
to further softness in GDP data and trade data for the rest of Asia. There is plenty of room
for Asian central banks to cut rates and of course for the BoJ to follow suit.

For the first time in many months, it was a bad week for bonds. It was a good week for stocks and more importantly for equity volumes. Draghi essentially took away the tail risks of an imminent currency crisis with the backing of all but one dissenting EU central bank. Although the EU sovereign crisis is far from over, Draghi has bought time for the EU to undertake the supply side reforms to manage the fiscal crisis. While he did not commit to yield or spread targets, the markets appear to have missed that once again he reduced collateral rules and made further comments towards inflation targets. While the EU crisis has manifested itself as a fiscal problem, the reality is that there has been underlying balance of payments crisis. Ultimately, Europe like the US and the UK is going to have to run negative real interests for some time. Financial repression will be good for real returns of stocks versus government bonds, difficult for financials but extremely good for the lowest cost operators in each sector (see The long run, the short run and the in-between, 3rd Quarter 2012 outlook). Much like the transfer payments made between the core rich Europe to the periphery via TARGET 2, financial repression ultimately means changes in competitiveness between countries. Aside from changes in the exchange rate, higher inflation rates will ultimately erode competiveness if companies cannot make productivity gains quickly enough.

To read report in detail: INDIA STRATEGY