>Thinking ‘outside the box’ on economic policy

• The markets are currently imposing on Europe a more brutal tightening of fiscal policy earlier than expected. But that does not mean that the two other constraints have disappeared: central banks should normalise the settings of their monetary policy as soon as conditions are met, while there is a ‘strong obligation’ to maintain a certain level of growth. How this can be done is not at all clear, and there are fears that the markets will find it difficult to extract themselves from this new ‘Bermuda Triangle’ – not forgetting that the triangle can easily shift from one place to another within the region formed by the advanced countries.

• Recent European experience shows that the management of fiscal policy appears to be a more complicated issue than previously thought: how is the decision made when to cut off stimulus and start coming back to fiscal discipline? Cutting it off too soon is taking the risk of the economy plunging into a new downturn; letting it run for too long could build more investor fears and create a hard landing scenario. Defining the main risk between Scylla and Charybdis is
never easy. Perhaps the choice should depend on the importance of both private domestic savings and the ability to attract foreign capital.

• The decision of the ECB to purchase government bonds on the secondary market has triggered a debate about the impact on its credibility. The latter would be reduced because of too close proximity to the behaviour of governments. From an academic standpoint, a distinction has to be made between an environment of high inflation or of very limited inflation. In the face of high inflation, often related to excessive monetisation of government debt, a central bank’s
independence is its cardinal virtue; if very limited inflation is associated with weak growth and fiscal austerity, greater co-operation between the central bank and the government is more easily understandable.

• The link between the sovereign debt crisis and banking crisis has been borne out historically. However, the aim of the rescue plan for member states from the European Union, with IMF support, no doubt changes the nature of that link. In fact, the plan is designed to head off for a period (almost two years in the case of Greece) the emergence of liquidity risk for the Greek Treasury, with the breathing space gained being devoted to reducing solvency risk via credible public account rebalancing plans. For a short time, therefore, the plan staves off the transfer of risk from the sovereign to the banking sector. It is, in fact, a sort of ‘mutualisation’ of risk between sovereigns: from the weaker to the healthier. In this respect, it is probably not entirely legitimate to link the two types of risk so strongly.

To read the full report: MACRO PROSPECTS

>INDIA TELECOMS: Deleveraging Is Key

• 3G and broadband auction stretches balance sheets short-term: We estimate average net debt to EBITDA for Bharti, RCOM and Idea at 3x in F2011, up from 1.5x currently. After that we expect all to be FCF-positive and lower their debt burden in two years to 1.8x.

• Unlocking value of towers could alleviate debt concerns: We estimate that the value of towers is equivalent to 31%, 54% of market cap for Bharti, Idea respectively and 59% of RCOM’s EV.

• Tariff wars are subsiding: No tariff cut in more than 2 quarters

• Overweight Bharti : Bharti has the strongest balance sheet among our coverage companies, its peak net debt/EBITDA of 2.8x should halve in two years.

• Overweight Idea: Idea’s future capex could be less than the industry average due to higher spectrum per sub; the worst quarter in terms of peak losses is behind us.

• Underweight RCOM: Lower ARPU estimates and forex losses lead to earnings cut of over 25% for F2011/12E. RCOM will likely remain costliest Indian telco even after demerger of towers to Global Tele Infra Ltd. (GTIL)

• Key Risks: 1) Entry of Reliance Industries in Broadband Wireless; 2) TRAI recommendations on excess spectrum charges, etc. Morgan Stanley does and seeks to do business with companies covered in Morgan Stanley Research. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of Morgan Stanley Research. Investors should consider Morgan Stanley Research as only a single factor in making their investment decision.
For analyst certification and other important disclosures, refer to the Disclosure Section, located at the end of this report.

To read the full report: INDIA TELECOM

>MARICO INDUSTRIES: reduce visibility on future growth enginesO (NOMURA)

■ Kaya remains an overhang
As we see it, one of the issues facing Marico is a steady deterioration in the fortunes of its flagship business, Kaya Skin Clinic. High attrition and low consumer retention are unlikely to be resolved quickly, we believe. Our assumptions now build in a loss of INR100mn in FY11F, from our prior assumption of a marginal profit.

■ Margins unlikely to be sustained at current levels
The operating margin for the core business (ex Kaya) is at an all-time high of 14.6%, but we think this is unlikely to be sustained at current levels. We expect rising input costs, lack of pricing power and continuing high A&P spend to suppress margins in FY11F.

■ All positives factored in; risk/reward unfavourable
While we lift our earnings forecasts by 3% for FY11F and 7% for FY12F, we believe current valuations factor in all the positives. On our reading, the stock is trading at 27.3x FY11F earnings — a 38% premium to its long-term average P/E multiple. We believe the risk/reward proposition is unfavourable.

■ Downgrading to REDUCE
Our downgrade to REDUCE reflects our view that, in the near term, the business is likely to face strong headwinds. Margin pressure in the core business, continuing losses at Kaya and rich-looking valuations are key factors in our rating change. Our new sum-of-the-parts valuation is INR118, of which the core business accounts for INR109 (20x FY12F EPS) and Kaya INR9 (2x FY12F sales). Potential downside from our new price target stands at 7%.

To read the full report: MARICO INDUSTRIES

>UFLEX: Packaging profits (ELARA CAPITAL)

■ Strong foothold in packaging market
Uflex is the largest flexible packaging company as well as the lowest cost producer of packaging products in India with a 19% share of the organized market. The company operates as a converter of packaging products with a presence in both the plastic film and flexible packaging business. The unique strength of Uflex is its vertically integrated operations, offering ‘end to end’ packaging solutions to marquee FMCG companies like Unilever, Nestle, P&G, Britannia and Fritolay among others. Thus it captures margins across the value chain – from plastic film production to flexi-pack conversion and to the final packing of a variety of FMCG products.

■ Ambitious expansion plans to become a global player
The company is planning to aggressively grow over FY10-12E with an investment of over USD250mn. Uflex will setup plastic film plants in Egypt, Mexico and Dubai and a flexi-pack plant in the state of J&K. This would enable it to increase capacity by nearly 65% in the plastic business and over 50% in the flexi-pack vertical. We expect the top line and the bottom-line to grow at a CAGR of 22% and 27% respectively, over FY10-13E. The company plans to raise INR2bn by way of right issue in the current year and over INR8bn of debt. We expect net debt
levels to reduce to 0.5x by FY13E from current 1.2x.

■ Steep cost efficiencies, changing business mix to widen margins
The company’s cost efficient raw material conversion play has been the biggest differentiator vis-à-vis peers. It’s conversion price, after attaching profit margins, remains the conversion cost of other global peers. Considering an equal EBITDA margin, Uflex price per kg is nearly 25% lower than international peers, leaving a significant headroom for it to attract large global clients. The company strategy to hike the contribution from flexi-packs to total revenues and to tap the
high margin world markets will play a key role in augmenting EBITDA margins by about 100bps.

Valuation
At the CMP, Uflex trades at a P/E of 4.5x and 3.5x FY11E and FY12E earnings respectively. We believe the stock will undergo a significant P/E expansion on account of its strong foothold in the
packaging market, aggressive growth plans and expectation of improving margins. We have assigned Uflex a target multiple of 6x on its FY12E earnings of INR31.6 per share that derives a per share value of INR190. We initiate the coverage with a BUY rating and a target price of INR190 per share, providing an upside potential of 73% from the current market price.

To read the full report: UFLEX