>India's Monetary Conditions Index

While bond markets cheer the new finance minister’s comments regarding interest rates being too high, we thought it appropriate to highlight one more dimension to the debate. Even though for the purposes of general debate it is the RBI’s repo rate that gets focused on, the fact is that overall financial conditions are determined by many other variables including market interest rates and the currency exchange rate. Thus, for instance, it is well documented that INR depreciation is beneficial for net exports and hence stimulates aggregate demand. It is for this reason that economists also look at an overall monetary conditions index that gives weight not only to policy rates but market rates, exchange rate and general liquidity conditions as well.

Below we have drawn our own calculation of MCI for India. The blue line below represents the MCI. A rise in the line denotes easier monetary conditions and vice-versa. The red line is the repo rate.

As can be seen, the MCI currently is more representative of the overall financial conditions that existed towards late 2010. The repo rate at that time was below 7%. The easing in the MCI is attributable to a sharp rupee depreciation as well as the 50 bps repo rate cut in April. Also, what may not be fully captured in the MCI is the effect that RBI’s OMOs have had on term spreads of interest rates. Thus for instance while the effective overnight interest rates have risen by almost 500 bps since early 2009, 10 year bond yields are up only about 225 bps since government started revising up its borrowing numbers in 2009. The above only re-iterates the point that the RBI has been making for some time: that while higher interest rates may be partly responsible for growth slowdown; the bulk of the reason lies elsewhere. This also underscores why room for any significant monetary easing remains limited in the current context: not only would aggressive easing in a supply constrained economy be dangerous for demand side inflation but overall monetary conditions are really not as tight as the repo rate alone may indicate.

RISH TRADER

>BATA INDIA: Renewed its product lines, introduced new brands, refurbished or shut down old stores

Transformation delivering results!


A large market… and an even larger opportunity
The Indian footwear industry has a market size of Rs200bn, with the unorganized segment constituting over 60%. Moreover, about 75% of the total consumer base lies in rural India. An urban customer spends an average Rs240 pa for footwear as against Rs100 pa in rural India, which implies a huge scope for premiumisation across rural and urban markets. Though men’s footwear accounts for 50% of the market, its share has been gradually decreasing as women and children’s segments are now growing at faster. With an unmatched reach (1340 stores, the largest footwear retailer), strong brand equity and a wide product portfolio across segments, Bata stands to be a big beneficiary.


Adapting to changing consumer needs bearing fruit
Bata has, in the past few years, strived to become more relevant to the increasingly demanding modern consumer. The company now changes 70% of its merchandise every 7-8 months to keep in step with the latest trends. It has renewed its product lines, introduced new brands, refurbished or shut down old stores while expanding its portfolio across the consumer chain (men, women and kids). As a result, only 50-55% of the company’s sales now come from men’s footwear, as against ~75% three years back. The ladies segment now contributes 20-22% and children’s 8-10%. Focus on improving the mix has significantly boosted margins, albeit at the cost of volume growth. These factors have driven ahead-of-industry growth levels and doubled EBITDA margins from 7.5% in CY07 to 15% in CY11.


Demand momentum to continue; volume growth back on track
Focus on improving the product mix resulted in muted volume growth in CY11. However, volumes have improved in CY12, with a 14% volume growth in Q1 as compared to low single-digit volumes in the corresponding quarter. Though the management expects the momentum to continue, we believe a large part of incremental volumes will come from new stores (75 in Q1). The company is not seeing any signs of a slowdown and believes the demand momentum seen in Q1 (31% revenue growth) should translate into a healthy 20%+ revenue expansion this year.


To read report in detail: BATA INDIA
RISH TRADER

>CAIRN INDIA: Company's oil discount to Brent has been narrowing

Cairn continues to expand operations in Rajasthan, with production already at the original FDP (Field Development Plan) mandated level of ~175 kb/d. The management has guided to this growing to ~200 kb/d by end-FY13, with additions of ~15 kb/d from Bhagyam (from current ~25 kb/d) and start up of Aishwariya (10 kb/d) to add to the 150 kb/d being produced by Mangala. Major increases beyond that, however, are subject to further approvals coming through. Cairn is indicating that production can rise from existing fields itself to 240 kb/d (primarily via further increases from Bhagyam and Aishwariya fields). However, this increase has not been approved by either the management committee or via a revision in the FDP. We maintain our estimates of 210 kb/d as the peak production from these fields as of now. We will revisit this when clarity emerges on regulatory clearances over the next few quarters.



Significant reserves upside, monetisation subject to DGH
The ramp-up of volumes from 175 kb/d to 200 kb/d from the current proved reserves base (+EOR upside) of ~1000 mmboe is fairly well understood. But, the management has stated that the long-term guidance of ~300 kb/d production potential is subject to the proving up of ~530 mmboe risked exploration resources that it estimates on the rest of the block, in addition to the ~140 mmboe of risked resources on the Barmer Hill Formation. However, the catch here is that the rights to explore further on the block other than the current development area are facing some uncertainty at this point of time; Cairn has applied to the regulator to restart exploration and appraisal activity on the block. We believe while the prospectivity of the block and Cairn’s record of proving up resources is not in doubt, timelines on these to translate into production will likely take longer than what management expects. So we value these risked resources as an exploration option value and assume an EV/boe of ~US$7.5/boe for these in our SoTP valuations.


To read report in detail: CAIRN INDIA

RISH TRADER

>INDIA STRATEGY: The “seven sins” of the Indian market!

"Seven sins” of the Indian market!

• Delays in government decision making!

• Tepid foreign inflows!

• Wild fluctuations in domestic currency!

• Longest stretch of high inflation ever!

• Aggressive monetary policy stance!

• Corporate earnings on a downtrend!

• Sharp de-rating of market valuations!

‘Singular’ factors drove global bear markets in the past…

To read the full report: INDIA STRATEGY

RISH TRADER

>RELIANCE INDUSTRIES LIMITED: Time for a relook, we see 24% upside from current levels

RIL has underperformed the Sensex by 19% since April of this year, which the steepest
underperformance in the stock over the last six years. The under performance has been driven by i) KG D6 production stalling at ~60 mmscmd, ii) uncertainty around refining and petrochemical margins and iii) RIL’s foray into telecom and hotels. We believe however, that the bad news around the stock has been more than priced in and the stock should rally smartly from here, aided particularly by good news on the gas pricing front (overall domestic gas prices rising) and exploration business globally (more shale acquisitions).

■ Refining and Petrochemical pressures now fully reflected
The cyclical downturn in refining and petrochemical demand, coupled with the simultaneous record increase in capacity worldwide has led to one of the most severe slump in margins for a long time. However we believe that the last few months have shown signs of a substantial turnaround, with Singapore benchmarks rising and the improvement in Arab Heavy Light Spreads. The closures of unviable standalone refineries in Europe should further help the demand supply balance going forward (~1.5 mb/d of capacity shut in over the last few months)

To read the fulll report: RIL

>DISH TV: Highlights of Q1FY11 results

■ Dish TV’s performance for the quarter is marginally below estimates with revenues of Rs3.04bn (flat QoQ), EBITDA of Rs322m (estimates of Rs370m) and net loss of Rs632m (estimates of Rs575m) in Q1FY11

■ During the quarter, Dish TV has added 0.6m gross subscribers (7.5m subscribers) and 0.4m net subscribers (6.2m subscribers). Churn has improved on QoQ basis at 0.7% per month

■ ARPU has improved from Rs137 in Q4FY10 to Rs139 in Q1FY11 with renewal ARPU at Rs172 (up from Rs163)

■ ARPU based revenues stood at Rs2.5bn, rental revenues stood at Rs450m and bandwidth revenues stood at Rs55m.

■ As WWIL has discontinued HITS, the revenue from the same has stopped (Rs210m of revenues from HITS in Q4FY10). However, as this business was EBITDA neutral, corresponding costs have also reduced (transponder cost in particular)

■ Content cost during the quarter has increased by 2.2% QoQ at Rs1bn inspite of strong addition of subscribers, as Dish TV has entered into fixed contracts with most broadcasters. However as some contracts come up for re-negotiation in Q2FY11, content costs would witness an increase in next quarter.

■ Advertising, selling and distribution expenses have increased QoQ on the back of strong subscriber addition during the quarter as also launch of HD services. Advertising spends have increased by 36.9% QoQ at Rs249m while S&D expenses have increased by 26% QoQ at Rs421m.

■ During the quarter, license fees, transponder costs and other goods and services costs have decreased by 15.7% at Rs574m. This is primarily attributable to exclusion of HITS related transponder costs.

■ Total operating expenses have increased by 1.4% QoQ at Rs2.72bn

■ Overall subscriber acquisition cost has dropped on quarterly basis from Rs2383 in Q4FY10 to Rs2147 in Q1FY11.

To read the full report: DISH TV

>TELEVISION DISTRIBUTION: Carpe Diem (IDFC SSKI)

Indian TV Distribution industry, world’s second largest with 105m cable & satellite (C&S) homes, is set for a makeover as the long-awaited ‘digitization’ becomes a reality. As of 2009, there are 22m digital homes with 18m of these on the DTH platform. Going forward, we expect digitization to gather pace not only in DTH but also in the ‘hitherto laggard’ cable space. While funded DTH players have invested Rs110bn so far, cable players too are now equipped to seed set-top-boxes (STBs) after the recent fund raise and would look to lock-in customers given the threat from DTH. We expect the total digital homes tally to rise 4x to 86m by 2015E, and address the biggest concern of ‘under-reporting’ in its wake. In the backdrop, we expect a 6.5x increase in the organized pie to Rs340bn even on a modest 14.5% CAGR in industry revenues to Rs480bn by 2015. As we expect C&S operators to retain the economic benefit of improved declarations and turn profitable, the sector makes a compelling case for re-rating. We recommend Outperformer on Dish TV, DEN Networks and Hathway Cable and expect 50% returns over an 18-month period.

■ Digital base to grow 4x…: India’s digital C&S base is set to expand to 86m by 2015E with 48m DTH (18m as of 2009) and 38m digital cable (4m) homes. While the six funded incumbents keep the momentum ticking in DTH, we believe digitization is no longer a ‘choice’ for cable operators and assumes a sense of urgency in the face of increasing threat from DTH. Importantly, national MSOs are now funded (Rs13bn of recent fund raise) to exert customer pull through subsidized STBs – a competitive edge of DTH players so far. Limited scope of ‘carriage fees-led economics’ from here and industry consolidation are the other drivers of cable digitization.

■ …and organized pie to swell 6.5x by 2015E: We expect a modest 14.5% CAGR in C&S industry revenues to US$10.8bn over 2009-15 as the C&S homes base expands to 140m and ARPU increases from $3.8 per month to $6.3. However, digitization is bound to reduce the incidence of under-reporting – the bane of the Indian C&S industry, and we expect the declared subscriber base to grow 4x from 23m to 89m by 2015. This, we believe, would drive a 6.5x rise in revenues of organized players.

■ Economic retention to drive value creation: With the net share of organized MSOs and DTH operators increasing from <10%>

To read the full report: TELEVISION DISTRIBUTION

>United Phosphorus acquires the global non-mixture Mancozeb business from DuPont

UPL has acquired the global non-mixture Mancozeb fungicide business and related assets from DuPont including existing inventory and formulation facility in Colombia as well as rights to registered brands, trademarks, registrations and all supporting regulatory data for these products including the popular Manzate brand fungicides. Post its Cerexagri acquisition, UPL had already become one of the top 3 players in Mancozeb market globally. With this new acquisition, UPL will further strengthen its position in the now 2 player dominated global Mancozeb market (UPL and Dow) post DuPont’s exit.

■ Key details of the transaction include
• The acquired business has sales of ~$70mn and UPL has paid 1.4x-1.6x sales in cash as consideration including working capital
• Given DuPont’s brand equity in the space, the product has significantly high gross margins which will translate into very attractive EBITDA level contribution after considering UPL’s frugal SG&A cost structure. Management is targeting 4-year payback period on this acquisition which could be accelerated if the business conditions are favorable.
• Most of the sales of this business are to Latin American geographies with North America accounting for the balance. The acquisition of this global brand significantly strengthens UPL’s overall strategic positioning in the extremely critical Latin American (as well as Central American) markets. This will significantly enhance UPL’s clout with the distributors in the region and have a positive rub-off impact on the balance portfolio too. This acquisition will also aid UPL’s entry into the Brazilian market
• The Colombian manufacturing facility is extremely efficiently run and will be an asset to UPL as it will enable UPL to significantly cut down its logistics cost involved in supplying to the Latin
American geographies from its Indian facilities

■ Our View
This is the first acquisition undertaken by UPL post its Nov 2006 acquisition of Cerexagri as it eschewed inorganic growth and opted to entirely focus on organic growth given the spike in global agrochemical asset prices. With the asset prices becoming reasonable in the wake of severe challenges faced by global agrochemical industry in 2009 and UPL’s balance sheet in a very healthy shape (0.3x net gearing and Rs32bn net worth as of FY10 end), the stage is set for UPL to dramatically step up the inorganic growth momentum. We believe Mancozeb acquisition makes immense strategic sense and the economics also look compelling given management’s 4 year payback target. Adjusting for $20mn per annum of brand acquisition revenues already built in our estimates, we are upgrading our FY11 and FY12 EPS estimates by 1% and 3.4% respectively to incorporate this transaction. We expect UPL to close some more transactions during the year which will lead to further earning upgrades. Reiterate Outperform with a
target price of Rs277.

To read the full report: UPL

>ESCORTS: Galloping along (IDFC SSKI)

Escorts’ transformation is clearly evident in the robust operational performance that each of its business units has been delivering over the last few quarters. Led by improved volume offtake, the earnings of its key agri-machinery division have improved considerably (EBIT of Rs972mn in H1FY10 vs Rs432mn in H1FY09 – a robust growth of 125% YoY). Further, the railway equipment division continues to witness robust volume offtake and the momentum is expected to continue ahead, led by aggressive capex plans (Rs2.5trn over next five years) outlined by the Indian Railways. Also, with a much improved economic outlook (GDP growth expected at 8.1% for FY11) and new model launches, earnings of the construction equipment subsidiary is expected to substantially improve going forward. The auto ancillary division is also on the recovery path with cost cutting measures and development of new spares both for OEMs as well as replacement market. The substantially reduced interest burden (net interest cost of Rs36mn in H1FY10 vs Rs288mn in H1FY09) would further aid earnings growth going forward.

With adequate capacity in place, immense growth potential across businesses, cost-cutting efforts and reduced interest burden, Escorts is expected to witness a sharp delta swing in earnings (estimated EPS at Rs24.1 for FY12 against Rs7.4 for FY09). We believe Escorts would now witness much steady earnings growth led by increasing use of tractors for non-farm applications as well as increased contribution from the non-cyclical businesses including construction equipment and railway equipment. Thus, in our view the Escorts group business model would transform from a cyclical agri-play to a much more stable agri / infrastructure play, which could prompt a re-rating of the stock. On account of the improved earnings visibility across business segments as well as likely outperformance going forward, maintain Outperformer with a revised price target of Rs234.

To read the full report: ESCORTS

>INDUSIND BANK: Into the next orbit (IDFC SSKI)

After a spectacular turnaround, IndusInd Bank is working to gain scale. Marked improvement is evident in operating metrics, and the initial three-year targets have been accomplished in just two years. Now, ‘profitability with scalability’ is the new mantra with a clear intent to fast-track growth. With focus on fortifying the liability franchise (700 branches by FY13E), we expect 41% CAGR in the bank’s earnings over FY10-12. To account for higher loan growth and increasing comfort on asset quality, we upgrade our FY11E and FY12E earnings by 6.8% and 9.4% respectively. While the stock has outperformed the Sensex by a hefty 80% since September 2009, we expect strong growth in earnings as also assets to drive stock performance hereon. In view of RoA expansion of 30bp over FY10-12E to 1.4%, we see stock returns outpacing the ~25% CAGR in assets. IndusInd Bank remains our top mid-cap pick among financials.

■ Remarkable progress over the last two years: A strong and well-incentivized management has enabled the bank to acquire a strong footprint despite its late entry in the crowded banking space. Over FY08-10, NIMs have surged by 150bp to 2.8%, fee income has grown 85% and cost efficiency has improved (cost to income down from 67% to 51%) – all converging into RoA expansion of 80bp to 1.1% in FY10.

■ Fast-tracking future growth: IndusInd Bank plans to aggressively expand its branch network from 210 currently to ~350 by FY11 and 700 by FY13. A stronger branch network as also liability base in a recovering economy place the bank in a sweet spot to achieve ~30% CAGR in its loan book in next two years – well above the industry average of 20%. Also, NIMs are expected to expand to 3.1% as the liability mix turns favorable (CASA deposits seen at 28% by FY12) and elevated yields on retail loans.

■ Strong earnings ahead; outperformance to continue: Above-industry loan growth, improving margins, increasing efficiency and lower provisioning costs are expected to drive RoA expansion of 30bp to 1.4% in FY12. Despite the recent re-rating on market cap to assets metric, the stock still trades at a discount of 20%+ to peers. Going forward, on the back of above-industry growth and a consistent rise in RoA, we expect stock returns to outpace growth in assets. At 2.5x FY12E adjusted book, we reiterate Outperformer.

To read the full report: INDUSIND BANK

>MNC PHARMA: New Avtaar (IDFC SSKI)

In the annals of the global pharma industry, 2009 marks a watershed event – when the baton of growth got passed on to the emerging markets (EMs). With US and top five EU markets contributing only ~15% to industry growth, the traditional Big Pharma business model, based on developed markets and patented products, is in a tizzy. Big pharma are aggressively realigning their strategies and resources around EMs and India, a US$30bn pharma market by 2020E, is now a priority destination. The development has profound positive implications for the growth outlook of their India business units as well as for generics partnering with MNCs to implement their new EM strategies (e.g. Aurobindo Pharma and Strides Arcolab). There is growing evidence of MNCs realigning India strategies through multiple strategic/ tactical interventions, and they have also begun to deliver accelerated growth. This “MNC comeback” will hasten consolidation in the Indian pharma market while leading to a likely re-rating of MNC stocks.

■ Emerging markets – Big Pharma’s new growth frontier: EMs will likely drive 70% of the global pharma growth in FY13 with top seven EMs growing to $400bn by 2020E. This has prompted a Big Pharma exodus to EMs. MNCs have begun to walk the talk on EM strategies – as reflected in dramatic field-force alignments away from developed markets and hectic deal-making activity in EMs. In the new order, India – one of the largest and fastest growing EMs – is now a priority destination for most MNCs.

■ MNC Pharma in India – dawn of a new era: There are firm signs of India-focused strategy being executed across MNCs – as reflected in a sharp ramp-up in field forces and marked step-up in new product launches. MNCs are now adapting their India strategies to market realities –“branded generics” (off-patent products of competitors) launches are now core to India strategy and differentiated pricing strategies are accepted even for newer molecules. Implementation of the patent regime will further strengthen MNCs’ competitiveness.

■ Revenue uptick to drive a likely re-rating: Top eight MNC pharma grew 16.7% in 2009 as compared to 9% CAGR over CY05-08. The new initiatives have begun to deliver, and we see MNC pharma embarking on a higher growth trajectory. As already seen for MNC consumer stocks (GSK Consumer Health and Nestle), higher growth visibility may drive a re-rating of MNC pharma stocks.

INDIAN PHARMA: A NEW ORDER
■ R&D productivity declines, sharp patent cliffs and healthcare cost control focus have choked off pharma growth in developed markets

■ On the other hand, pharma industry is poised for decades of bountiful growth in emerging markets – aided by booming economies

■ Big Pharma are rushing to tap this opportunity by suitably aligning strategies and investments towards emerging markets

■ Driven by solid parent backing, MNCs in India are shedding old dogmas and realigning strategies to market requirements to derive competitiveness

■ Given this, we expect MNCs to stem, and thereafter reverse, the hitherto steady trend of market share erosion in the domestic pharma space

To read the full report: MNC PHARMA

>RELIANCE INDUSTRIES (IDFC SSKI)

Reliance Industries (RIL) has delivered consistently high sequential growth for the last three quarters. The stock has, however, underperformed the Sensex due to concerns around sustainability of GRMs, future cash flow utilization and overhang of Supreme Court ruling in the RIL-RNRL dispute. We believe the concerns are overblown. We see the trend turning for refining spreads, as the economic recovery gathers pace and OPEC brings heavy crude supply back, thereby reviving the premium for complex refiners. While the petchem business will increasingly face headwinds from capacity additions, strong volume growth in the domestic market should soften the blow. The upstream business remains on track with the ramp-up of KG D6 a matter of time. While the timing and size of Lyondell (LB) bid remains uncertain, we see substantial upside in LB in the long run even at US$14.5bn. RIL may also look at other acquisitions (e.g. VCI) in the upstream space. We expect a 23% PAT CAGR over FY09-12E for RIL. Reiterate Outperformer.

■ Refining cycle is turning: RIL reported GRMs of US$5.9/bbl in Q3FY10, against Singapore benchmark GRMs
of US$1.9/bbl. With Singapore benchmarks showing a marked improvement to ~US$3.9/bbl for January 2010, we expect significant improvement in RIL’s Q4FY10 margins as well. We see RIL’s GRM rebounding to double digits by H2FY11, led by improved availability of heavy crude and economic revival gathering steam.

■ Petchem – playing the domestic growth story: With consistently high double-digit growth for the last three quarters, the strength in the domestic petrochemicals market has caught everyone by surprise. We see the volume growth sustaining over the next 12-18 months, which should help offset the likely weakness in petchem business due to the huge capacity additions over FY11-12E.

■ Valuations attractive; Outperformer: With improvement in the key business of refining and marketing as also strong volume growth in petchem, downstream looks set to deliver on the growth front. We see upstream continuing to grow robustly with KG D6 on track to hit 80 mmscmd by H1FY11E, while other exploration assets (NEC 25, CBM and KG D9) are well on the way to reach appraisal status. Current valuations of 11.6 FY12E earnings and 7x EV/EBITDA, we believe, are undemanding. Our SOTP-based valuation of Rs1,233 per share offers 25% upside from CMP. Reiterate Outperformer.

To read the full report: RIL

>INDIAN EDUCATION SECTOR (IDFC SSKI)

Is the education system ‘over-regulated and under-governed’?

Can the government achieve the goal of universalization of quality education alone?

Is the current trust structure dysfunctional?

Privatization of education…are we there yet?

PPP – can education be the next ‘power’ play?

Can India become a global hub for education?

What needs to change?

• Reduce hierarchical multiplicity of governing bodies; morph into a quality controller (such as SEBI or TRAI)

• Encourage private participation via monetary benefits and autonomy to run institutions

• Institutionalize the ‘dysfunctional structures’

• Focus on quality and allow ‘profiteering’. Use private participation to increase R&D and further inclusive growth

• Define PPP models leading to sustainable IRRs for players; hand over management control

• Incentivize and institutionalize the process to set up foreign universities beyond just allowing 100% FDI in education on paper

To read the full report: EDUCATION SECTOR

>RBI TO REPLACE BPLR (BENCKMARK PRIME LENDING RATE) SYSTEM WITH BASE RATE FROM 1 APRIL, 2010

Event: RBI introduces Base rate to replace BPLR
The RBI has decided to replace the prevailing BPLR (Benchmark Prime Lending Rate) system with a new Base rate for all scheduled commercial banks. This base rate system would be effective from 1st April, 2010.

As per the draft circular by RBI, all lending rates would be determined with reference to the base rate which shall be common across all categories of borrowers. The actual lending rates charged to borrowers would be the base rate plus borrower-specific charges – which will include product-specific operating costs, credit risk premium and tenor premium.

Each bank is free to decide its own base rate; though following criteria could be used:

1. cost of deposits
2. adjustment for the negative carry in respect of CRR and SLR
3. unallocable overhead cost for banks
4. average return on networth

Banks would not be allowed to resort to any lending below base rate.
The base rate system would be applicable for all new loans and for those old loans that come up for renewal. However, if the existing borrowers want to switch to the new system before the expiry of the existing contracts, in such cases the revised rate structure should be mutually agreed upon by the bank and the borrower.

Banks are required to provide information on the actual minimum and maximum lending rates charged to major categories of borrowers to the RBI on a quarterly basis.

Earlier, RBI had constituted a Working Group on BPLR to review the BPLR system and suggest modifications to increase transparency in credit pricing. The committee had suggested replacing the BPLR system with a new Base Rate system. Going ahead with the committee’s recommendations, the RBI has come out with the present policy moves.

Impact
■ Short-term rates for large corporates might inch up
Ample liquidity and relatively subdued credit demand over FY10 had led to many large corporates borrowing at significantly low rates. Application of the illustrative formula (as provided by the RBI) to most banks reveals that base rates could vary between 8% to 9.5% (see Annexure). With most banks setting their base rates around these levels, we believe that shortterm rates for large corporates could inch up.

■ Teaser rates would come under pressure
RBI has taken a negative view of the recent “teaser rate” schemes launched by major banks. RBI expects banks to be more prudent in pricing the risk and do not lose sight of asset quality while chasing market share (in wake of subdued credit demand). We believe that such “teaser rate” schemes would come under pressure as base rates are expected to higher than the rates offered on such schemes.

Our view
■ Increased transparency on lending rates
Over Oct-08 to Dec-09, while banks’ cost of deposits declined significantly, the movement in BPLR’s was relatively less and did not adequately reflect the effective lending rates in the economy. Moreover, ample liquidity in the system and the subdued demand for bank credit had increased the competitive pressure on banks to lend at sub-BPLR rates. As a consequence, the BPLRs of banks have turned out to be the maximum lending rates in most cases, distorting the information content.

■ Faster transmission of policy rate changes
We believe the base rate system has directly linked headline lending rates in the economy to banks’ cost of deposits. The RBI, over the past 3-4 quarters, had repeatedly sounded concern that while transmission of policy rate changes (over Sep-08 to Apr-09) had been faster in the money and government securities markets, it had been slow to the banks’ lending rates.

The RBI’s present action is to encourage faster transmission of policy rate changes to banks’ lending rates as the base rate would be directly linked to banks’ cost of deposits.

To read the full report: INDIAN FINANCIALS

>ICICI BANK (IDFC SSKI)

At ICICI Bank, aggression of the past has changed color from loan growth, to profitability and risk control. The management has once again meticulously, and consistently, delivered on its recalibrated business plan. The consolidation phase is over and numbers are all there. With credit costs easing, CASA expanding and expenses curtailed, RoA has risen by 30bp to 1.2%. We believe the bank is now all set to execute the next phase of its strategy to deliver high profitability while accelerating balance sheet growth. Over FY10-12, we expect 30% CAGR in the bank’s earnings driven by steeply declining credit costs, expanding margins and strong loan growth. We see a 430bp rise in core business RoE to ~15% over FY10-12. This, we believe, would drive a structural re-rating of the stock from ~1x currently to 2-2.5x core book. Assigning a value of Rs292/ share to non-banking strategic investments and valuing core business at 2.25x FY12E book, we raise our price target on the stock to Rs1,450.

Profitable growth assumes centre-stage: Remaining true to its DNA, ICICI Bank has successfully executed a changed strategy with profitability and risk control at the core. The consolidation has rendered a stronger liability base with CASA deposits rising to 40% as of December 2009, opex to assets down to 1.6% from 2.2% in FY08 and provisions showing signs of peaking out. Importantly, RoA has significantly expanded from 0.9% in FY09 to 1.2% in YTDFY10.

Banking RoE to expand to 15% by FY12E…: Deriving strength from a fortified liability franchise, the bank now looks to rapidly grow corporate and secured retail loans. We estimate the bank’s credit costs to ease from 1.1% of assets in FY10 to 0.7% by FY12 and margins to expand by 20bp. This would drive a 30% CAGR in earnings over the period. Though overall RoE would remain subdued at ~12% due to strategic investments, core banking RoE is expected to rise to ~15% by FY12.

…and drive a re-rating in core business: With high growth potential, ICICI Bank offers the best riskreward in the financials space from a medium-term perspective. Return ratios on core business are catching up with peers, and the stock is due for a structural re-rating. Reiterate Outperformer with an 18- month price target of Rs1,450 (core business valued at 2.25x FY12E book).

To read the full report: ICICI BANK

>INDUSIND BANK: Q3FY10 (IDFC SSKI)

HIGHLIGHTS
IndusInd reported a PAT of Rs880m – up 95% yoy – in Q3FY10 ahead of our estimate of Rs768m. The outperformance was led by a strong momentum in NII, in turn a function of expansion in margins and strong business volumes.

• Strong NII growth; margins continue to expand: NII was up by 104% yoy and 14% qoq to ~Rs2.4bn, driven by a steep 100bp yoy and 8bp qoq expansion in NIMs to 2.94%. Improvement in NIMs was driven by ~60bp qoq reduction in funding costs owing to stable wholesale borrowing rates and uptick in CASA. (exhibit 1 and 2)

• Healthy core-fee income; treasury profits remain muted: Core-fee income grew by 41%yoy to Rs1.1bn. However, total other income declined by 13% yoy primarily due to lower treasury profits and recoveries during the bank during the quarter. Treasury profits declined by 76% yoy (at Rs106m) while recoveries stood at Rs30m (against Rs178m in Q3FY09). The bank continues to see strong traction in income from third party distribution (insurance as well as MF products). Transaction banking and processing fee also continued to display strength on the back of management focus to gain meaningful contribution from these heads. (exhibit 3)

• Credit growth remains strong; CD-ratio remains stable: IndusInd’s loan book grew by ~33% yoy and 9% qoq to ~Rs191bn. Corporate banking continued to lead overall growth (at 66% yoy). Growth in retail book also exhibited revival at 3% qoq. At the same time, deposits grew by a healthy ~20% yoy to Rs247bn, leading to ~700bp yoy (stable qoq) improvement in the CD ratio to 77%.

• CASA continues to inch up: CASA ratio improved by 400bp yoy and 130bp qoq to 22.5%. Over the quarter, savings deposits displayed healthy traction. (exhibit 2)

• Gross NPAs decline qoq….: IndusInd’s asset quality remains high with gross NPAs declining by ~50bp yoy to 1.34%. More importantly, Gross NPAs declined even on an absolute basis to Rs2.5bn (against Rs2.6bn in Q2FY10). Net NPAs stood at 0.67% (against 1.3% in Q3FY09). The bank did not undertake any additional restructuring in the quarter, with total restructured ad vances being insignificant at 0.3% of the book. (exhibit 5)

To read the full report: INDUSIND BANK

>Lavasa site visit (IDFC SSKI)

We recently visited Lavasa, as its Dasve Town Centre is ready to enter into the next phase as an operational town. Apart from the ~80 operational hotel rooms, 42 serviced apartments and several avenues for recreation, the Dasve Town Centre is also ready to hand over 200 apartments and 111 villas to buyers by end-January 2010. During our tour of Dasve town centre, Mugaon and Bhoini, the recently appointed City Manager of Lavasa shared with us the administrative challenges anticipated in this next phase as an operational hill station. We also took stock of the progress made in subsequent phases of Lavasa since our previous visit in February 2009. We returned impressed with the on-going pace of development and Lavasa’s initiatives in creating economic drivers for the creation of a fullfledged city going forward. We detail the key highlights of our visit below.

ACCESSIBILITY
Out of the planned four access routes to Lavasa, two are operational and the other two under development. The first one (nearest from Pune), via Chandni Chowk exit from the Mumbai-Pune expressway, is an access-controlled toll road operated by Lavasa. The second route, via Hinjewadi exit (also from the expressway), is free access. The other two routes
– one from the Mumbai-Goa highway at Kolad, and another from Lonavala are under development. The government has granted permission to construct a tunnel on the route from Lonavala, which is expected to be ready for use in the next 12- 18 months. This route, which is the shortest distance (~170km) from Mumbai to Lavasa, would reduce travel time by approximately one hour. In terms of connectivity from Pune, the Maharashtra State Road Transport Corporation (MSRTC) has started bus services from Swargate Bus Depot in Pune to Lavasa with seven trips a day.

ACCOMMODATION

Hotels
• The ITC Fortune Select hotel (60 rooms) has been is fully functional since April 2009. Average occupancy at the hotel has been ~70% since commencement of operations. Ekaant, a 20-room resort is also fully operational.

• Waterfront Shaw service apartments (42 fully-equipped units) on the promenade have been operational since April 2009.

• Mercure – a budget hotel with capacity of 132 rooms – is in advanced stages of construction and expected to be operational within a month.

• The 256-room Pullman business hotel building is under construction and is expected to be completed within 12-18 months. The Novotel hotel (200 rooms) is also under construction and expected to be completed by July 2010.

To read the full report: LAVASA

>LOGISTICS: CONTAINER RAIL (IDFC SSKI)

Privatization of container rail operations has enticed 16 players, including incumbent Concor, to the space since 2005. These players are eyeing 3% (97m tonnes) of the overall freight market by trying to shift volumes from road to rail. Operators can ‘create the market’ by offering integrated, value-added logistics solutions with last mile connectivity. However, to attain these capabilities and garner higher volumes, operators need to invest heavily in hard infrastructure. As the business entails a longer gestation period, scale and efficiency (utilization and turnaround times) are extremely critical to generate returns of 15%+ on capital employed. In view of their competitive strength, and thereby ability to attract volumes and drive strong earnings growth, we believe Concor, Arshiya and Gateway Distriparks (GDL) are well positioned to generate superior returns. Reiterate Overweight on the sector.

■ Integrated service offering to attract volumes to rail: While the number of operators appears high at 16, we believe there are enough volumes. With 500 rakes expected to be operational by FY12/13, players are eyeing only 3% (97m tonnes) of the overall freight market. However, volumes are required to be shifted from road to rail, for which operators have to offer timely, reliable and value-added services with last mile connectivity and customized solutions.

■ Returns linked to turnaround times and utilization levels: Container rail is a highly capital-intensive and long gestation business with hefty investments required in rakes (capacity) and rail sidings (cargo consolidation and value added services, etc) to attract volumes. Hence, asset turnaround time and utilization levels assume greater relevance for an operator to derive economies of scale and be profitable. Once an operator achieves critical mass, we believe it can earn RoCE of 15%+, which can be further augmented by offering integrated services.

■ Attractive valuations; Overweight: We believe operators need deep pockets to survive the long gestation period. In this context, Concor, Arshiya and GDL possess the competitive edge in terms of funding and strong infrastructure to secure higher volumes. Arshiya and GDL are fast attaining scale, and their rail operations are likely to turn profitable in FY11, supported by an expected upturn in the trade cycle. With 12-30% earnings CAGR over FY09-12E and attractive stock valuations, we are Overweight on the sector and Outperformer on the three stocks.

To read the full report: CONTAINER RAIL

>RELIANCE INDUSTRIES LIMITED (IDFC SSKI)

Reliance Industries (RIL) is well on its way to be a fully integrated energy major with a growing upstream portfolio complementing the refining and petchem businesses. KGD6 start-up is set to transform RIL’s business profile with 12% share in revenues and 49% in EBITDA in FY11E from E&P. Commissioning of the new refinery at Jamnagar and the ongoing economic revival would likely support margins in the refining and petchem space. Notably, the next leg of growth could come through an inorganic initiative; the latest bid for Lyondell provides a hint of RIL’s intended strategy in this direction. Though an adverse Supreme Court verdict on pricing could depress KGD6 value, we remain optimistic on RIL’s long-term prospects. Reinitiating coverage with Outperformer and a price target of Rs1,207.

New frontiers await…

Integration adds tremendous value: A 1.24m bpd refining hub at a single location and 2bn boe deepwater gas play combine to make RIL one of world’s largest global integrated energy players. E&P should provide a hedge to revenue cyclicality of refining and petchem, while usage of KG gas for captive use is likely to help margins in the refining and petchem business as well. We expect 36% CAGR in RIL’s PAT over FY09-11.

Market undervaluing E&P upside: Besides the producing assets, we see ~23bn boe (4bn risked) of resources in RIL’s exploration assets, a part of which should be proved up (booked as reserves) over the next 3-5 years. We see significant upside from these assets going forward, and attribute Rs243 per share of value to the same in our SOTP valuation, over and above the value from the producing assets.

Valuation upside from E&P and margins: We have valued RIL using the SOTP method with refining & petchem delivering Rs532 per share and E&P Rs631 per share to our valuation. The current stock price, we believe, does not fully capture the strength of RIL’s E&P portfolio, while pricing in too much pessimism around the refining and petchem business. Our target price of Rs1,207 per share implies a 13% upside from here.

To read the full report: RIL

>CIPLA (IDFC SSKI)

Cipla’s partnership-based, geographically diversified model, with particular focus on RoW markets, and its formidable R&D capabilities have proved to be a robust and sustainable growth engine. Momentum will be further boosted by Cipla’s muchawaited entry into the EU inhaler market as also likely launch of niche partnership products in USA. Aggressive capex rollout indicates management’s comfort on future growth outlook. Coupled with significant EBITDA margin expansion of 260bp to ~26%, we expect 29% EPS CAGR for Cipla over FY09-11 (albeit on a low base) with upside possibilities. An expected decline in capex FY12 onwards would see asset turnover ratios plateau and lead to improving return ratios. Maintain estimates and upgrade the stock to Outperformer with a price target of Rs368 per share.

A winning business model: Recent alliances between Dr Reddy’s-GSK, Aurobindo- Pfizer, etc endorse Cipla’s strategy focused on R&D and manufacturing as also sales and marketing tie-ups with global companies. Cipla is among the most geographically diversified global generics companies with significant presence in multiple RoW markets including Africa, Middle East, Latin America and Australia. With future global pharma market growth likely to largely accrue from RoW markets, Cipla has created an enviable business model to participate in this opportunity.

Inhalers and US launches to drive upsides: With its diversified model yielding steady revenue growth (10-15%), the much-delayed entry into EU inhalers market as well as niche product launches in US will generate upsides. Cipla’s inhaler plans for EU (a US$3bn+ market with limited competition) are fructifying with launch of Salbutomol in UK in Q3FY10 and likely approval for its first combination inhaler in H2FY11. Cipla has partnerships for 118 drugs in the US with only 23 commercialized ANDAs so far, indicating significant potential for ramp-up in the market.

Good gets better

Better days ahead; Outperformer: The recent upswing in EBITDA margins (26% in H1FY10) appears sustainable on the back of an improving product mix and tighter cost control. Cipla’s aggressive capex intensity (Rs30bn spend over FY06-10) will likely ease by FY11, leading to improved return ratios and higher asset turnover. The management’s intent to enhance investor interaction through quarterly investor calls provides comfort and will aid re-rating. Any adverse FDA action or unfavorable court decision on contingent liabilities related to overcharging stay potential risks for the stock. Upgrade to Outperformer.

To read the full report: CIPLA