>US ECONOMICS (HSBC)

Break in the weather?
A lull in the US economic storm

■ There may be relief in the short run
■ Consumption and housing stabilizing, government spending ramping up
■ But the financial system and wealth losses remain longer-term threats

The economy and financial system remain fragile but there are signs that in the short run at least, real GDP will return to positive growth from as early as the second quarter. Consumption and housing are showing firmer signs of stabilization, while the government spending ramp-up, together with some tax cuts, will shortly enter the growth mix. After falling heavily in the second half of last year, there are actually signs that consumer spending will be positive as early as the first quarter.

Meanwhile, new home supply is now at its lowest since 2001/2002, suggesting the new home inventory overhang is gone. Existing home inventory is still an issue given that the rate of foreclosures is still high, but we think its ability to further push down homebuilding is just about over, and that will end the drag on GDP that has been averaging about 1% annualized per quarter over the past couple of years.

Inventories will probably stop being a drag on growth, and start being a contributor from the second quarter, as inventory liquidation slows.

But it’s not all good news, because capital spending, exports, and profits are likely to keep falling for a good few quarters yet at quite a rapid rate. And the return to positive GDP growth is going to be a ‘jobless recovery’ for a while, sending the unemployment rate to over 9%. This is likely to see core PCE inflation fall to nearly zero by the end of 2010, so we expect the deflation fears to persist and intensify, despite the Fed’s continuing to rapidly create money out of thin air and expand its balance sheet.

In addition, it is far from clear that the Treasury Secretary’s latest plan to heal the financial system will work. If not, then 2010 could see the economy do a double-dip into recession again. But over the next few months, sentiment on the economy may improve for the short run.

To see full report: US Economics

>India Banks (CITI)

Asset Quality: Testing the Stress

■ Where will NPL’s go? It’s a tough one — a) We say 4% (2.3% currently); b) Analyst estimates range from 3-6%; c) Banks don’t have a fix on numbers – but all suggest a meaningful escalation; and d) Historical peak is 25%. We don’t believe anyone has the answers – but we pose questions, and try to answer them.

■ When will book values erode? At 9% NPLs — The sector breaks even at 8.7% NPL levels – to reach this level NPLs will have to rise 4.5x current levels. We believe this scenario is still far off and therefore unlikely to play out. However, NPL range for individual break-evens is quite wide (between 6-27%).

■ How much do earnings get impacted? 20% for every 1% rise in NPLs — With every 1% rise in NPLs: a) Earnings are hit about 20%; b) Assuming 50% loss rate, charge-offs rise 100bps; c) ROEs decline by 2.5ppt; and d) Book values are pulled down by 2.5%. We currently factor an avg 130bps of credit charges.

■ What happens if NPLs rise to 7%? — 7% is above the highest end of current street estimates and can be seen as a potential stress case. At 7%, NPLs will rise to 3.5x of current levels and will result in: a) Sector earnings declining 73%; b) Banks still make some returns, albeit a low 4%; c) Book values are still 6% higher than current levels; and d) Loan losses rise to 310bps (2.5x current levels).

■ What about restructuring loans? — It does complicate reporting and makes it harder to gauge the underlying health of assets; leads to an understatement of reported NPLs (will likely be lower than our estimates). In our 4% sector NPL estimates, we implicitly assume 20-30% of restructured assets turn into NPLs.

■ Who are the most exposed? Government banks, ICBK, Axis — Government banks in general are more vulnerable to rising NPLs: a) Will erode book earlier (8% NPLs vs 11% for private); and b) Have more earnings impact for each 1% rise in NPLs (21% vs 17%). CBI and Canara are the most vulnerable; SBI the least (most earnings cushion). ICICI is more exposed from an earnings perspective. It "only" needs a trebling of NPLs before earnings are wiped out but has a much larger capital cushion – a 1% rise in NPLs impact book value by 1.5% (2.5% avg). After ICBK the largest impact on earnings is felt on Axis (among private banks).

■ Concerns might be overdone; remain overweight — We expect NPLs to rise meaningfully and remain an overhang. However, we believe concerns might be overdone and possibly factored into stock prices. Maintain overweight on banks.

To see full report: INDIA BANKS

>Wockhardt (KARVY)

• Stock Update >>Wockhardt
• Stock Update >>Dishman Pharmaceuticals and Chemicals

WOCKHARDT

Revenues for the quarter are expected to move up by 17.6 % to Rs 8961 mn. The main revenue drivers are expected to be domestic formulations and formulations exports driven by traction in US. Margins for the quarter are expected to be lower from 24.9 % to 22.1 % for the quarter. Higher staff costs and other expenses have been the main reason for the decline in margins on account of new acquisitions. Profits for the quarter are expected to to be lower at Rs 719 mn for the quarter after accounting for forex losses of Rs 338 mn.

The company has yet to leverage its assets in regulated markets and biotech facilities getting scalability. We believe the FCCB redemption is a foregone conclusion. We have removed equity dilution from our model and factored redemption of the FCCB which would involve around Rs 7.3 bn which has been factored in increased loans in CY 09. We have factored interest rates on the new loans at 14 % for the CY 09. We have also reduced revenue estimates by 7.2 % for CY 09 on account of lower traction in regulated markets especially UK, France and Germany. We reduce our EPS estimates by 9.76 % to Rs 22.5 for CY 08E and by 38 % to Rs 22.3 for CY 09E. As a result of downgrade in earnings we downgrade our price target by 50 % to Rs 100 based on 4.48x CY 09E. The stock would continue to face weakness till clarity emerges on the FCCB repayment. We downgrade our rating to Outperformer on the stock.

Dishman Pharmaceuticals and Chemicals

We are reducing our revenue and earnings estimates for FY09 & FY10E mainly on back of removal of revenues estimates for two breast cancer products of Carbogen Amcis (CA) business and one anti-cholesterol product of Solvay's Vitamin D & chemicals business due to possible delay in launching of these products. In addition, the company management has indicated that there will be a shortfall of Solvay's Eprosartan Mesylate revenues for 4 months from January 2009 to April 2009. We are also introducing our FY11 initial estimates for Dishman Pharmaceuticals and Chemicals (Dishman). Despite downward revision in revenue and earnings estimates for FY09 & FY10E, Dishman is set to grow at a double digit for the next two to three years mainly on back of its strong innovator client relationships, expansion of existing contracts and addition of new contracts in pipeline. The stock is currently available at attractive valuations at PE of 10.9x on FY09 and 6x on FY10E diluted earnings basis. We maintain 'BUY' rating with the price target of Rs.155 leaving upside of 58% from current levels for next one year time frame.

Adequate revenue flow from the CRAMS segment despite temporary setback from breastc cancer products: We are marginally downgrading our Contract Research and Manufacturing Services (CRAMS) revenue estimates by 2% to Rs.7.37bn in FY09 and by 8.7% to Rs.8.67bn in FY10E due to shortfall of 4 months revenues from Eprosartan Mesylate in Q4FY09 and removal of revenue estimates for 2 breast cancer products (US$5mn in FY09 & US$10mn in FY10E). The high margin CRAMS business that contributes more than 70% to total net revenues, expects to grow at a CAGR of 17.8% from FY08 to FY11E mainly on the back of consistency in revenue flow from base business of CA segment and Solvay.

Wider innovative client base to act as cushion for CRAMS business: Dishman has currently got predominant presence in the global CRAMS market by maintaining long lasting relationship with global pharmaceutical innovator clients. By reducing dependency from single client (current ratio between Solvay to Non Solvay- 20:80), Dishman has expanded its client exposure to key global pharma majors like AstraZeneca, Boehringer, Ferro Corporation, GSK, J&J, KRKA, Merck, Nippon Gosai, Novartis, Pfizer, Sanofi Aventis and Sepracor.

To see full report: WOCKHARDT

>India Cement Industry (CITI)

Implications From Conference Call With Pakistan's Lucky Cement

■ Conference call with Pakistan's Lucky Cement — We hosted a conference call with Mr. M.A Tabba, CEO of Lucky Cement, one of Pakistan's largest cement companies by capacity, to get a better sense of export trends. India and Pakistan have some common export markets. Mr. Tabba's comments about cement supply-demand dynamics, pricing trends and export potential suggested that there would be keener competition in export markets, export realizations could fall 15-20% and cement exports from Pakistan to India could dry up in FY10. His views were largely in line with ours.

■ Changing trends in cement export markets — Mr Tabba expects Pakistan cement exports to be 10m tonnes in FY09-10 − 30% by land to Afghanistan and 70% by sea to the Middle East and Africa. India is no longer a viable export market for Pakistan due to low domestic prices and the drop in the Indian rupee. Demand growth for cement exporters is expected to come from Iraq (reconstruction), South Africa (ahead of the Soccer World Cup) and Africa (rising per-capita income in commodity-intensive economies), compensating for likely declines in Oman, Qatar, Abu Dhabi and Dubai.

■ Weak outlook for export pricing — The biggest worry is cement pricing in export markets. Exports are likely to face stiff price competition once new capacities are commissioned in Saudi Arabia, Iran and India. The industry expects the average export price for FY09 to be US$50-55/t and forecasts a decline to US$42-47/t in FY10. Lower prices would adversely impact large cement exporters in India, such as UltraTech Cement and Ambuja Cements.

■ Pakistan has cement surplus — At 38m tonnes of capacity and domestic demand at ~20m tonnes, Pakistan has large surplus for exports. We expect a surplus in India as well due to the completion of several large projects in CY09. As exports may not be a viable route to deflect oversupply, it would add further pressure on domestic prices in India.

To see full report: INDIA CEMENT INDUSTRY