>INDIA CONSUMER: Disconnect Between Industry Fundamentals and Stock Valuations

■ Maintain Cautious industry view: We believe Indian home and personal care products EBITDA margins have peaked for now. Rising input costs amidst intense competition and slowing revenue growth are likely to continue to constrain earnings. We maintain our OW rating on United Spirits – the top pick in our coverage universe. We reiterate our UW rating on HUL and Marico and downgrade ITC to EW from OW as valuations look less compelling. We upgrade Colgate to EW (UW earlier) given the recent sharp increase in operating margins in a relatively benign competitive environment for oral care in India. We upgrade Nestlé to OW from EW on recent stock underperformance and a potential tailwind from input costs.

■ What's new: Our proprietary input cost index has risen 8% YoY with prices of palm oil up 14% and copra up 4% over the past month. Higher input costs further squeeze FMCG companies in an already intensely competitive environment. We estimate that an inability to pass on input costs could erode operating margins of the HPC companies under our coverage by 90bps in F11.

■ Where we differ: Valuations of Indian consumer companies are the highest in four years (25x F11E earnings vs. last four-year average of 22x). Part of the outperformance can be explained by an investor penchant for consumer stocks in emerging economies in the current volatile macro environment – the MSCI AxJ consumer index has outperformed the MSCI AxJ index
by 15% over the past year. However, with an improving global economy and thus increased appetite for risk, Indian consumer stocks may underperform. We believe investors are factoring in sporadic and short-lived competition in the domestic HPC segment, while we expect competition to persist, since it is driven by companies with long-term commitments and strong
balance sheets.

To read the full report: INDIA CONSUMER

>RELIANCE INDUSTRIES: Upgrade to Buy: Cyclical Risks Priced In; Structural Gas Rewards Not

■ Weak cyclical outlook reflected in under-performance — After a 15% YTD underperformance vs. the market, we believe the unexciting refining/petchem outlook is largely priced in and reflected in RIL’s valns that now stand at a 3-year low relative to Sensex. However, structural changes we see in the rapidly developing Indian gas market could provide the trigger for stock performance from a 6-9 month perspective, driving our upgrade to Buy, while maintaining our TP and estimates.

■ Stock trading closer to bear-case value — RIL now trades close to our bear-case value of Rs930/sh (5% downside from current levels), offering attractive riskreward. Our bear-case value is based on an avg of: (1) our bear-case SOTP that assumes lower GRMs of US$8.0/8.5 over FY11/12E, steeper yoy petchem EBITDA declines of 12/7% over the same period, and E&P valued at Rs364/sh, a moderate 15% premium to NAV, and (2) our bear-case P/E-based valn methodology that assumes 8-14% lower earnings over FY11-12E and a lower 14x Sep-11E multiple.

■ Structural changes in gas sector — Following recent, higher prices set by the Gov’t for ONGC’s production from new fields (US$4.75-5.25), we expect gas prices from other domestic sources (e.g. KG) to also structurally move higher driven by: 1) cheap domestic gas (vs. expensive LNG) remaining scarce, with growth backended, 2) demand continuing to substantially exceed supply, 3) increasing acceptability of higher priced LNG (e.g. NTPC). Customers, however, will continue to benefit, with economics vs. naphtha/FO still remaining extremely compelling.

■ US$4.2 now a base price…possible price surprise? — Post the APM price hike, US$4.2 is now a base price level of domestic gas, with gas from all other sources (ex-KG) now priced higher (Figure 15). With rising E&P costs and demand for higher prices to exploit new/marginal fields, there exists a case for the benchmark to move higher. Given the Government’s recent moves, we believe any willingness on its part to implement higher prices for incremental KG production (possibly over the next 6-9 months) could lead to reserve value enhancements and potential
earnings upsides (~3-5%) for RIL, driving stock performance.

To read the full report: RIL

>STATE BANK OF INDIA: Revising EPS estimates upwards

To read the full report: SBI

>JM FINANCIAL LIMITED: Q1FY11 result analysis

JM Financial Ltd’s revenues recorded an increase of 57.2% y-o-y to Rs 1.9 bn in Q1FY11,
backed by healthy growth in the investment banking and securities funding businesses.
However, PAT dipped by 2.4% to Rs 304 mn due to poor performance of the securities
broking business. Intense competition in the broking business and preference for lowyielding
options vis-a-vis the cash segment has put significant pressure on brokerage yields.
However, JM Financials’ diversified business model has buffered the impact and helped it
report stable earnings. We maintain our fundamental grade of ‘4/5’, indicating JM Financials’
fundamentals are ‘superior’ relative to other listed equity securities in India.

Q1FY11 result analysis
• The investment banking and securities businesses reported revenue growth of 44.1% y-oy
to Rs 1.1 bn in Q1FY11. The investment banking division completed six deals worth Rs
70.6 bn in Q1FY11. However, the performance of the broking business was impacted by a
dip in brokerage yields and an increase in costs related to scaling up of the institutional
desk. As a result, segmental profit declined by 50.6% y-o-y to Rs 94 mn in Q1FY11.
• Revenues from the securities funding business increased 156% y-o-y to Rs 651 mn in
Q1FY11. Earnings growth was lower at 10% y-o-y to Rs 198 mn due to a higher mix of
borrowed funds resulting in increased interest cost.
• The asset management (AMC) segment’s revenues increased by 17% y-o-y to Rs 91 mn
supported by higher average AUM at Rs 77.2 bn (14% y-o-y) in Q1FY11. This helped the
company cut losses from Rs 19.3 mn in Q1FY10 to Rs 11.7 mn in Q1FY11.

• The alternative investment segment registered a 73.6% y-o-y increase in revenues to Rs
176 mn while profit increased by 122.5% y-o-y to Rs 112 mn in Q1FY11. The alternative
AUM stands at Rs 17.2 bn and has recorded an increase in quality investment
opportunities, which will support good performance.

Scaling-up of institutional business to drive growth
During the quarter, JM Financial got empanelled with few more institutional clients. The
company’s research coverage has increased to 132 companies. We expect the business to
take around 12 -15 months to start contributing to the overall profitability.

Downward revision in FY11 and FY12 estimates
We have revised our top line forecast downward by ~3% each for FY11 and FY12 to reflect
the pressure on brokerage yields. The hardening in the yield curve will result in increased
funding cost to support the securities funding book. However, we expect the funding
business to do well and support JM Financials’ overall performance. Accordingly, we have
revised PAT estimates downwards by 18% and 14%, respectively, for FY11 and FY12 to
account for the pressure on brokerage yields and increased interest cost.

Valuations – strong upside from current levels
In line with the earnings revision, we have lowered our fair value estimate for JM Financials
from Rs 50 to Rs 45 per share. We maintain our valuation grade of ‘5/5’, indicating that the
stock has ‘strong upside’ from the current level of Rs 35.8 (as on August 11, 2010).

To read the full report: JM FINANCIAL