‘Speculators love it when Governments defend currency’ :CEO, AMBIT: Business Line

We should just forget about defending the currency and reduce interest rates by 50-to 100 basis points. ANDREW HOLLAND, CEO, AMBIT INVESTMENT ADVISORY

Local hedge funds, which allow investors to make money both from the bull and bear markets, will soon take over the portfolio management business in India, says Andrew Holland, CEO of the investment advisory business at Ambit Capital. With over 25 years of experience in the financial services industry across Asia and Europe, Andrew Holland was earlier Managing Director - Strategic Investment Group for Merrill Lynch in India. He also shares his views with Business Line on the much-feared Fed tapering and where FIIs are putting their money.

Excerpts from the

interview:

With the currency depreciating heavily this year and FIIs in exit mode, where do you think we have gone wrong and what needs to be done?

When the US announced its QE3 plan, the government held on to the view that its benefits would continue. But when there were signs that it would not, we saw the Government responding in a piecemeal fashion. This ended up choking growth.

I would be bullish if we forget about defending the currency, and reduce interest rates by 50-100 basis points. We must also increase petrol and diesel prices by Rs 5 to Rs 10 a litre. It might not be good in the short term but it is the medicine that the country needs. By doing this, at least you are trying to grow the economy and take care of the current account deficit.

What happens is that, when governments try to defend currency, the speculators just love it. In 1990, the UK Government had decided to defend the currency. They took interest rates from 10 per cent to 16 per cent before abandoning the idea. So you can’t defend something which is weak. We must try and give confidence back to India Inc to attract foreign direct investment.

Multiple challenges South Indian Bank (SIB) :: Ambit

Multiple challenges
South Indian Bank (SIB) has a plateful of challenges, with little
diversification outside its home state Kerala, a weak liability franchise,
no improvement on fee income generation, slowing asset growth and
rising credit costs. The bank has a 57% exposure to corporate loans
and a coverage ratio of 29%, and thus, it has a small margin of error
on asset quality. We expect SIB’s financial performance to be volatile
and we expect RoAs to fall below 1% in the near term. We change our
stance to SELL.
Competitive position: WEAK Changes to this position: NEGATIVE
Fares poorly in comparison to peers: As discussed in the thematic section,
SIB emerges as the weakest franchise among its regional bank peers. A high
geographical concentration in the intensely competitive state of Kerala had led
to a weak liability franchise (CA: 3.5%, CASA: 21%). SIB has made little
progress on its longstanding weakness in fee income generation (fee income
to assets below 60bps). With a 57% exposure to corporate loans and a low
provision coverage ratio of 29%, SIB is weakly cushioned to any adverse asset
quality shocks.
Growth slowdown with subdued profitability: SIB’s FY13 loan growth has
slowed down to 17% from an average of 28% in FY08-12. Excluding gold
loans, growth is even weaker at ~12%. With gold loan growth coming to a
halt, we expect further weakness in growth going forward. We do not expect
any near-term improvement in NIM, as the liability franchise would show no
improvement. Similarly, we expect credit costs to remain elevated at ~68bps
(vs 56bps in FY13 and average 27bps in FY08-12) due to a difficult external
environment and high exposure to corporate loans.
Management change due in September 2014: The six-year tenure of the
current MD & CEO, Dr. V. A. Joseph, will end in September 2014. In the year
ahead, the uncertainty on the new MD & CEO and change in strategy post the
transition would add further risk to this franchise.
SELL stance with a target price of `20: We change our stance to SELL with
a valuation of `20 (implied FY14E P/ABV of 0.75x and FY14 P/E of 5.0x) as we
expect profitability to remain subdued (average RoA of ~0.95% over FY14-
15), with slowing asset growth (19% CAGR in FY13-15 vs 25% CAGR in FY10-
13). Our previous valuation for SIB was `29. The 31% drop in our valuation is
driven by lower valuation multiples due to our concerns on multiple structural
issues faced by the bank. Key risks to our SELL stance are a better-thanexpected recovery in the macro-economic environment and takeover interest
from an incumbent or a new banking licence recipient looking to expand in
south India.

Losing momentum Karur Vysya Bank:: Ambit

Losing momentum
Karur Vysya Bank’s (KVB) RoAs have declined to 1.3% in FY13 from an
average of 1.6% over FY06-11, due to constraints on its liability side,
rising cost ratios and increasing credit costs. KVB continues to seek
growth amidst a slowing macro-economic environment. We believe
unabated pressure on margins, cost ratios and asset quality would
lead to a further decline in RoAs. The stock is trading at inexpensive
valuations of 1.0x FY14 BV but near-term positive catalysts are scarce.
We initiate coverage with a SELL stance.
Competitive position: MODERATE Changes to this position: STABLE
Losing momentum: KVB delivered average RoAs of 1.6% along with asset
CAGR of 26% in FY06-11. However, its RoAs have moderated to 1.3% in
FY13, owing to: (1) continued weakness in its liability franchise (CASA to
borrowed funds declined from 23% in FY11 to 17% in FY13), (2) increase in
the cost-to-income ratio (from 42% in FY11 to 47% in FY13), and (3) rising
credit costs (from 13bps in FY11 to 53bps in FY13).
RoA moderation to continue: RoAs would decline by 30bps to 1% over the
next two years, owing to: (i) continued geographical concentration of
branches, which means that the CASA ratio would remain weak and put
pressure on margins amidst the phase of tight liquidity; (ii) the management’s
continued branch expansion plans, which would put pressure on cost ratios, as
productivity of the new branches would remain limited in the weak economic
environment; and (iii) credit costs that have been rising from the trough levels
(average 13bps in FY08-12 to 53bps in FY13) would remain elevated given
the 69% loan exposure to the corporate and commercial segments. A
significant chunk of these loans are towards the mid-corporate and consortium
loan corporate segments. KVB’s delinquency levels have increased in recent
quarters owing to this exposure.
Initiate with SELL stance and a target price of Rs320: We initiate
coverage with a SELL stance and a valuation of Rs320 (implied FY14E P/ABV of
1.0x and FY14 P/E of 6.3x) based on the EVA approach. Our EVA model
assumes sustainable steady-state RoEs of 15% beyond the next three years
and a cost of equity of 15%. The rise in credit cost will be the main driver of
RoA moderation but the geographically concentrated nature of the rapid
branch expansion will affect the operating performance of the bank as well.
Key risks to our SELL stance are a better-than-expected economic recovery,
particularly in Tamil Nadu, and a reversal in its current strategy of pursuing
rapid growth in favour of productivity improvement.

Federal Bank : Structural concerns discounted : Ambit

Structural concerns discounted
We have been toning down our expectation on Federal Bank (FB)’s
operating performance even as there has been a tangible
improvement in the bank’s asset quality, particularly for retail and
SME books. Our analysis of FB’s geographical concentration and its
impact on FB’s liability franchise, fee income generation and cost
efficiency show that any improvement from hereon would be gradual,
and the process could test the management’s and investors’ patience.
However, in the last three months, the stock has underperformed the
Bankex by 11% and current valuation of 0.63x FY14 BV seems to
discount these long-term structural concerns. Our target price of `312,
valuing FB at 0.75x FY14 BV, implies 21% upside.
Competitive position: WEAK Changes to this position: NEGATIVE
Deep-rooted inertia: As discussed earlier (page 13-15), geographical
diversification is the key to a bank’s liability franchise, as it leads to low cost of
funds, better income generation and cost efficiencies. FB’s management has
been focused on addressing asset quality issues but the need to evolve into a
more geographically diversified franchise has been neglected. For a bank of
FB’s size, its concentration in a small state (Kerala) has led to weak operating
performance - a low CA ratio (stuck at around 5% for the last 11 years), and a
meagre fee income to assets ratio of 0.6%. Weak income generation has led
to deterioration in cost ratios (cost to income of 35% in FY09 vs 45% in FY13).
The recent exit of a non-executive director suggests a degree of
disenchantment in the Boardroom with the bank’s progress
(http://goo.gl/NC7455). We believe further signs of discontent in the
Boardroom of FB cannot be ruled out and could be an overhang on the stock
Lacks levers for profitability improvement: The bank’s NIMs are already
structurally down (from 4.3% in FY09 to 3.4% in FY13), owing to: (1) derisking to lower-yielding assets; and (2) deregulation of the non-resident
deposits interest rates. The geographical concentration of the branch
expansion will hinder low-cost deposit mobilisation and limit the decline in the
cost of funds. Fee income to assets would remain subdued at ~0.6%, as
opportunities remain limited due to branch concentration. The pressure on
income generation, we believe, will keep cost to income at ~45%. Mediumterm trends in retail and SME asset quality have indeed improved but the
corporate loan segment remains a key risk in the current environment. We
build in FY14-15 average credit costs of ~75bps (vs 58bps in FY13 and 74bps
in FY12). Profitability will, hence, decline, with RoAs of ~1.1% in FY14-15 (vs
1.3% in FY13 and 1.4% in FY12).
Valuation and stance: The stock has underperformed the Bankex by 11%
and current valuation of 0.63x FY14 BV seems to discount these long-term
structural concerns. We cut our FY14/15 estimates by 25% and cut our TP by
47% to `312. Our TP implies 0.8x FY14 P/B and 6.5x FY14 P/E.

ING Vysya Bank: Proven competitive advantages:: Ambit

Proven competitive advantages
ING Vysya Bank (IVB) has proven its competitive advantages over
other regional banks through better geographical diversification, lowcost deposits franchise, better fee income generation capability and
better asset quality. These advantages have led to a stock rerating. We
expect its valuation gap with private sector banks to narrow further
over the next two years. Moderation in the cost-to-asset ratio and
containment of credit costs would lead to an RoA improvement of
10bps by FY15, at a time when most of IVB’s peers would face RoA
declines. Moreover, IVB is well placed to face any adverse asset quality
shocks in the near term, owing to its less risky loan book, high
provision coverage ratio and high capital ratio. We initiate coverage
with a BUY stance.
Competitive position: MODERATE Changes to this position: STABLE
Continued RoA improvement over the last four years: After a muted RoA
performance until FY09, IVB has improved its RoAs by 55bps in FY09-13 and
has delivered a 29% EPS CAGR during this period. The company de-risked its
loan book by: (1) increasing the proportion of collateralised SME loans, (2)
realigning its balance sheet towards higher interest earning assets, and (3)
improving its operational efficiency in terms of bringing down the cost-toincome ratio by ~830bps. Thus, its RoAs have improved in FY09-13.
Narrowing the valuation gap to new private sector banks: A favourable
loan mix change towards higher-yielding assets, a pick up in low-cost CASA
deposits and improving productivity of urban and metro branches that were
opened in recent years would lead to an RoA improvement of 10bps by FY15.
This improvement will take place at a time when most peer banks would see
RoA compression. This, we believe, would further narrow down the valuation
gap to new private sector banks (currently at 35% vs 52% in August 2011).
Strong buffer to protect from any asset quality shocks: Negligible
exposure to stressed sectors in the corporate book and a well-performing SME
book, provision coverage and capital ratio mean that IVB is relatively better
placed vs its peers to absorb system-wide asset quality shocks vs its peers.
Initiate with BUY stance and a target price of `626: We initiate coverage
with a BUY stance and a target price of `626 (implied one-year forward P/B of
1.6x and one-year forward P/E of 14.0x) based on the EVA approach. Our EVA
model assumes sustainable steady-state RoAs of 1.4% beyond the next three
years and a cost of equity of 14%. The main catalysts for IVB are stable asset
quality and pick up in branch expansion with contained cost ratios. The key
risk to our BUY stance is the higher-than-expected weakness in the macroeconomic environment which would affect the credit quality of SME borrowers.

A sturdy franchise City Union Bank (CUB):: Ambit

A sturdy franchise
City Union Bank (CUB) emerges as one of the most robust regional
bank franchises in our analysis of regional banks. Its strong income
generation (NII and fee income to assets of 4.6% vs peer average of
4.2%), controlled cost base and healthy asset quality more than offset
the weakness on the liabilities side. Hence, superior RoAs of 1.5-1.6%
are the best among regional banks and are closer to the new private
sector banks. In the near term, we expect the bank to maintain its
margins in the current tight liquidity environment, given that the
duration of the loan book is lower than the duration of its borrowings.
CUB would deliver net profit CAGR of 20% in FY13-15. The stock is
trading at 1.0x FY14 BV, which is an attractive entry point. We retain
our BUY stance.
Competitive position: MODERATE Changes to this position: STABLE
A robust franchise: City Union Bank emerges as one of the most robust
regional bank franchises in our analysis. Its strong income generation (NII and
fee income to assets of 4.6% vs peer average of 4.2%), controlled cost base
and healthy asset quality more than offset the weakness on the liabilities side.
This has helped CUB to deliver largely stable and high RoAs of 1.6% over the
last eight years along with average asset growth of 27%.
Strong growth to continue: CUB has delivered better loan growth vs its
peers (FY06-13 CAGR of 29%), owing to the relatively better lending
opportunities in its home state, Tamil Nadu (discussed on page 28). We expect
CUB to maintain its loan growth momentum, with a CAGR of 22% in FY13-15,
owing to its continued focus on its core SME franchise and relative insulation
to large corporate loans.
In a better position to manage RoAs: We expect CUB to maintain its RoAs
at 1.45% over the next two years, as: (i) the duration of the loan book at 1.5
years is significantly lower than the 2-3-year duration of its deposits, which
would help the bank to maintain its margins in an environment of tight
liquidity; (ii) income growth keeps pace with cost growth, leading to a stable
cost/income ratio of 42-43% over the next two years; and (iii) credit costs
would peak at 94bps in FY14 (vs 81bps in FY13). Note that CUB’s credit costs
have been relatively high (FY08-13 average of 81bps) due to CUB’s market
positioning as a SME lender (reflected in high yields), but its asset quality
trends have been among the least volatile (65-85bps in the last three years).
Valuation and stance: We cut our FY14 estimates by 14% due to lower NIM
and higher credit cost estimates. We maintain our BUY stance, as at 0.9x oneyear forward BV, the valuations are reasonable for a strongly profitable
franchise. Our target price of `66/share implies 1.45x FY14 P/B and 7.5x
FY14 P/E. Higher-than-expected deterioration of asset quality is the key risk to
our BUY stance.

Ambit: Regional Banks:The search for a pan-India franchise

The search for a pan-India franchise
Regional banks have differentiated themselves from PSU banks on
asset quality and now trade at a premium to PSU banking stocks. Their
profitability and valuation differential to large private sector banks
has, however, persisted, owing to higher cost of funds, low fee income
generation and higher cost to income. The improvement on all these
three parameters, we find, is related to the quality of the liability
franchise, for which geographical diversification is the only lasting
solution. The evolution of ING Vysya Bank (IVB) also proves the
significance of geographical diversification. Even as Federal Bank (FB),
Karur Vysya Bank (KVB) and South Indian Bank (SIB) manage their
asset quality risks, their operating performance would remain
constrained due to their liability franchise. City Union Bank (CUB), on
the other hand, has done better under similar constraints and looks
likely to outperform its peers on growth and profitability.
Improving the liability franchise is key: A comparison of large private
sector banks and PSU banks with regional banks shows that regional banks
have been able to differentiate themselves from PSU banks on asset quality
(FY13 credit costs of ~60 bps vs PSU banks’ 114bps); however, they continue
to lag large private sector banks on the cost of funds (due to lower CASA), fee
income generation and operational efficiency. Given that primary banking
relationships deliver 2-3x more business than secondary banking relationships
in India and given that the liability relationship (rather than the lending
relationship) is the determinant of a primary banking relationship, the
improvement in the quality of the liability franchise would be a key driver for
regional banks to bridge the profitability gap vis-à-vis large private banks.
Geographical diversification proving to be a necessary evil:
Geographical diversification is crucial for regional banks if they are to improve
their liability franchises. IVB has set a good example in this regard, but the
other regional banks remain laggards on this metric and this affects their
operational performance. Regional banks’ operating profits have recorded
15% CAGR (in FY11-13) vs large private banks’ 22%.
Asset quality is a key near-term risk: The asset quality outlook for these
banks is rather bleak, with rising delinquencies and higher credit costs
looming large. Our scenario analysis shows that IVB and FB are better
cushioned on provision coverage and capital ratios.
Recommend BUY on IVB, FB and CUB, SELL on KVB and SIB: We initiate
coverage with a BUY stance on IVB (due its proven competitive advantages).
We retain our BUY stance on CUB (due to its strong growth and profitability
trends) and FB (as structural concerns on operating performance seem
discounted). We initiate coverage with a SELL stance on KVB and we change
our stance to SELL on SIB due to pressure on their profitability ratios from
deterioration in operating performance as well as due to asset quality risks.

VA Tech Wabag: Buy- Ambit

Heading for glory
Continuing momentum in India and international orders (1QFY14: up
60% YoY, 40% of FY14 guidance) supports our 20% revenue growth
and higher for earnings (over FY13-15) as EBITDA margins expand
steadily. Investor worries about international business and cash
collection will fade in FY14, as higher inflows and cost realignments
improve international profits and recovery of `1.5bn from Chennai
project improves cash flow. Present valuations of 10X FY14 eps are
non-respectful of VA Tech’s growing business momentum centered on
well-built competitiveness, cash rich balance sheet (1/4th of mcap) and
quality management. Maintain BUY and TP of `703, 13.5X FY15 eps.
Competitive position: STRONG Change to this position: STABLE
Business momentum sustaining and set to surprise: VA Tech’s order
inflows have gained momentum in 1QFY14 (up 60% YoY, 40% of FY14
guidance) on an already high order inflow base of FY13 (up 25% YoY). The
average order size of the top-10 clients increased 52% YoY in FY13,
highlighting the improving quality of order inflows. The strong order inflow in
the last 15 months would lead to 20% revenue CAGR over FY13-15.
Moreover, VA Tech could positively surprise on our above-consensus revenue
growth estimates for FY14, owing to strong order inflow.
International business (subsidiaries and IBG) concerns overblown:
According to our analysis, the international business accounts for 47% of
overall revenues. Whilst subsidiaries’ EBITDA margins (~3%) have
disappointed in the last two years, the International Business Group (IBG) has
earned the highest margins within the company, leading to a respectable EBIT
margin of 7.7% for the international business in FY13. We expect strong order
inflow in IBG and emerging subsidiaries (Philippines and Turkey) to drive 17%
revenue CAGR over FY13-15 in the international business. Also, investor
concerns on restructuring costs will fade from FY14, as the benefits of
employee restructuring and treasury operations will bear fruit from FY14 whilst
revenues from new regions increase.
Cash generation to further improve in FY14: We believe FY13 marks a
turnaround in VA Tech’s CFO profile (positive `817mn), despite increase in
Chennai project’s receivables to `1.5bn. We expect cash flow generation to
further improve from FY14, as it will receive payments for the Chennai project.
Management highlights cash collections/earnings find more focus than orders.
Our top pick in Indian E&C space given well-entrenched strengths: VA
Tech is currently trading at 10.4x FY14 consolidated EPS of `42.2, which is not
relective of its: (a) excellent technical and project management skills, (b)
capital-light business model, and (c) cash-rich balance sheet. We retain our
BUY stance and target price of `703. Key risks: Deterioration in working
capital cycle and higher-than-expected restructuring costs.

The cash flow conundrum for India Inc :: Ambit

The cash flow conundrum for India Inc
Management decisions, more than external factors, drive RoCE (which,
in turn, appears to be the primary fundamental driver of share prices).
Our analysis shows that returning cash to shareholders is the most
powerful driver of RoCE. Unfortunately, we also find that Indian
corporates are amongst the most reluctant in the world to return cash.
In this note, we highlight 30 BSE200 firms that have consistently
delivered high RoCEs over the last ten years. We reiterate our BUY
stance on HCL Tech, Bajaj Auto, Sun Pharma, Asian Paints and
Cummins India. Also, CRISIL, Nestle, Lupin, Ipca Labs and GSK
Consumer find a place in this year’s iteration of our ten-baggers note.
Firms respond differently to the same external environment
We often find that within the same sector, some firms rise and others fall even
though they are subject to the same economic and regulatory forces. This is
exemplified by TVS’s fall as compared to Bajaj Auto’s rise or HCL Tech’s rise vs
Infosys’ fall. Moreover, we find that the dispersion in firm-level performance
over time is lower than the dispersion in performance across firms at a point
in time (see page 4). This suggests that business cycles or other externalities in
themselves do not produce as much variation in corporate performance as
company-level decisions for a universe of firms.
RoCE measures firm-level performance the best
Whilst management teams have a natural desire for growth and scale, growth
creates shareholder value only until the returns on capital exceed the cost of
capital. RoCE, therefore, is of utmost importance in assessing a firm’s
performance. Empirically, share price performance also supports the primacy
of RoCE as a share price driver (Exhibit A).
Capital allocation is the key to superior RoCEs
Each of the following capital allocation choices impact RoCE (Exhibit B):
 Business expansion (organic - capex; inorganic - acquisitions),
 Returning cash to stakeholders (dividends, share buybacks and debt
repayments), and
 Doing nothing (letting cash build up on the balance sheet).
Whilst, on one hand, unbridled expansion hurts RoCE, hoarding cash
compresses RoCE (Exhibit C). We find that returning cash to shareholders is
often the best way to improve RoCE. Unfortunately, we also find that Indian
firms are amongst the most reluctant in the world to return cash to
shareholders.
Investment implications: Focus on the kings of capital allocation
Sustaining superior RoCEs over long periods is not easy, but we highlight 30
BSE200 firms that have consistently delivered high RoCEs over the last ten
years. Of these, we have bottom-up BUYs on HCL Tech, Bajaj Auto, Sun
Pharma, Asian Paints and Cummins India whilst CRISIL, Nestle, Lupin,
Ipca Labs and GSK Consumer find a place in this year’s iteration of our tenbaggers note.

Economy & Strategy: The three Rs and the Indian economy :: Ambit

Economy & Strategy: The three Rs and the Indian economy 
Even as slow but sure signs of a turnaround in the Indian economy emerge, the three Rs—the Rupee, Repo rates and the RBI—are likely to determine the strength of the recovery in India in FY14. Factoring in tighter liquidity conditions as well as a stronger-than-expected adverse reaction to the US Fed’s ruminations on tapering QE3, we cut our GDP growth expectations for FY14 from 6.8% YoY to 6.4% YoY. Our base case remains that a global “reallocation trade” in India’s favour is likely to materialise in FY14 given that history suggests that rising bond yields in developed nations (like the US) have historically coincided with strong equity returns in India. 

City slickers Vodafone has materially outperformed listed incumbents Bharti and Idea in metro circles::Ambit

City slickers
Vodafone has materially outperformed listed incumbents Bharti and
Idea in metro circles over the last three years gaining AGR market
share particularly at the cost of RCom. In our second edition of the
Deep Dive we review the competitive position of these companies in
the metro circles that are likely to be early drivers for growth in data.
We also look into the central African trio of DRC, Congo and Gabon,
where contrasting telecom landscape presents diverse challenges and
opportunities for Bharti. Finally, we analyse the impact of the first
phase of consolidation in India that has resulted in improving
economics through volume growth and EBITDA margins rather than
increase in realised national tariffs. We find superior profitability has
enabled incumbents to reinvest margin gains in growing their weaker
circles through a trade off between tariff realisations and volumes.

Amba Insights

Strategy: Big regulatory changes => big share price impactsA proactive Government in India is usually a harbinger of major regulatory change. Such change, more often than not, significantly impacts share prices in large and heavily regulated sectors such as Banks and Oil & Gas. Add to that the impending implementation of GST and you have a potent cocktail of regulation-driven share price impacts across most large sectors in the Indian market. Winners from the impending regulatory changes: ONGC, OIL, HPCL, BPCL, RIL, Redington, Bajaj Auto, DLF, and Sobha Developers. Losers from the impending regulatory changes: Oriental Bank of Commerce, Central Bank, Indian Overseas Bank, Axis Bank, ICICI Bank, and Gujarat Gas. (Saurabh Mukherjea, CFA, +91 99877 85848) 

NTPC (NOT RATED): Subscribe to the OFS 
On 7 February, the Government of India is planning to divest a 9.5% stake in NTPC through the offer for sale (OFS) route to raise ~Rs120bn. The pricing is still unknown, but it is likely to be at a discount to yesterday’s closing price of Rs155 per share. At the CMP of Rs155, the stock is trading at 1.5x FY14 P/B consensus estimates, in line with its private sector peers. We believe NTPC should be trading at a premium to its peers and hence our advice would be to subscribe to the OFS. (Bhargav Buddhadev, +91 22 3043 3252) 
(click here for detailed note) 

NALCO (SELL): Nailed by the triple punch 
Nalco’s margins have collapsed in the past two years in the face of falling aluminium prices, rising costs & declining volumes. Whilst, in the near term, a sharp decline in aluminium prices appears unlikely, we believe valuations still remain unattractive in the face of low return ratios and an extremely volatile cost base. We reiterate SELL. 
(click here for detailed note) 

HDFC (SELL): HDFC finally cuts its PLR 
Yesterday, HDFC decreased its prime lending rate (PLR) by 10bps to 16.4% along with a similar 10bps reduction in the rates offered to its new customers. HDFC’s floating rate loans are linked to its PLR, and hence, its entire floating rate loan portfolio (~90%) would get repriced at rates that are lower by ~10bps. Whilst HDFC had reduced its lending rates for new customers by ~50bps over the past 12 months, this is the first time since June 2009 that HDFC has reduced rates for its old customers in line with the reduction in rates for its new customers. This makes us believe that going forward it would be difficult for HDFC to cut rates for new customers without cutting rates for old customers resulting in spread contraction for HDFC. (Pankaj Agarwal, CFA, +91 22 3043 3206) 


RESULTS EXPECTATION: 

Apollo Tyres: (BUY, 18% upside) 
Apollo Tyres will announce its 3QFY13 results today, followed by a conference call at 3:00pm IST. At the standalone level, we expect revenue growth of 8% YoY to be driven by volume growth of 5% and by the positive impact from the change in the price/product mix. We expect EBITDA margins to increase by 260bps YoY (73bps increase QoQ) to 10.6%, owing to softening rubber prices. For the international subsidiaries, we expect revenue growth of 5% YoY but EBITDA margin to decline by 155bps YoY (and down 68bps QoQ) due to lower winter tyre sales and slowdown in volumes in the South Africa business. We expect net earnings of Rs1,611mn for the quarter (up 26% YoY and 5% QoQ). (Analyst: Ashvin Shetty, +91 22 3043 3285) 

Manappuram Finance: (BUY, 21% upside) 
We expect net profit of Rs1.1bn in 3QFY13 (vs Rs1.1bn in 2QFY13 and Rs1.6bn in 3QFY12). Our expectation of a QoQ flat net profit in 3QFY13 is driven by our expectation of QoQ flat loan book growth and ~20bps dip in margins. Loan book growth and NIMs would be the key variables to watch for during the quarterly results, both of which have been under pressure due to various regulatory changes over the past year. (Pankaj Agarwal, CFA, +91 22 3043 3206) 

ANALYST NOTES:

Strategy: Big regulatory changes => big share price impacts A proactive Government in India is usually a harbinger of major regulatory change. Such change, more often than not, significantly impacts share prices in large and heavily regulated sectors such as Banks, Real Estate and Oil & Gas. Add to that the impending implementation of GST and you have a potent cocktail of regulation driven share price impacts across most large sectors in the Indian market. More details are provided in the inside pages of today's Insights.
Winners from impending reg changes: ONGC, OIL, HPCL, BPCL, RIL, Redington, Bajaj Auto, DLF and Sobha Developers.
Losers from impending reg changes: Oriental Bank of Commerce, Central Bank, Indian Overseas Bank, Axis Bank, ICICI Bank and Gujarat Gas. (Saurabh Mukherjea, CFA, +91 99877 85848) 

Economy & Strategy:: Lights, Camera, …. ::Ambit

Lights, Camera, ….
Our sources suggest that the Government is about to launch a wave of
reforms over the next month as part of a strategy which is likely to
culminate in General Elections a year hence. With significant progress
now being made on critical structural issues such as the Coal-Power-
SEB mess, we: (a) Maintain our FY13 GDP growth estimate at 6.3%; (b)
Introduce our FY14 GDP growth estimate at 7.1%; (c) Raise our Sensex
target of 19K (a target first published in our Jan ’12 research) to 23K.
Given that a number of investors have been caught on the wrong foot
by the Indian Government’s appetite for reform, we expect panic
buying of Indian equities over the next month or so followed by a
cooling off during the Winter Session of Parliament in late Nov-Dec.

IT: Is offshoring passé? :: Ambit

Is offshoring passé?
FY12 has been tough for Indian IT offshoring names as industry
growth expectations for the Indian firms are now converging to
that of larger global peers. The industry that was born as a
disruptive innovation in the 1980s and grew inexorably in the
early 1990s seems to be struggling to innovate as it matures. Do
recent trends spell an early demise? We think not. Recent
changes point more to the evolution of a new generation of
offshore outsourcing and hence new a set of winners.

Gujarat State Petronet- Earnings Hedged, it is Repository of Immense Value :: Nirmal Bang

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Earnings Hedged, it is Repository of Immense Value
Gujarat State Petronet (GSPL) is the top pick in our gas sector coverage
universe due to the following reasons: (1) Earnings fairly protected despite
fall in Krishna Godavari Basin-D6 gas block’s output, (2) It is a direct play on
softening spot RLNG prices, (3) Gas transmission volume bottoming out in
3QFY12 with assured supply of one cargo shipment per month, and (4) The
company graduating from a regional transmitter of gas to a pan-India player
soon. We believe the market is focusing on near-term earnings, ignoring
long-term value creation. We assign Buy rating to GSPL with a TP of Rs98.
Stock trading ~25% below fair value: We have valued GSPL on SOTP basis with
Gujarat transmission business valued at Rs112, investment in city gas distribution
(CGD) at 15x at Rs12.34 and the new pipelines at (-)Rs16.35 to arrive at a fair value of
Rs98. We have valued the new pipelines at the stated levelised tariff with capacity
utilisation conservatively kept at 30%/40%/50% in the initial three years of operations,
respectively.

E&C and Infrastructure-Gravy Train Approaching? :: Ambit Capital

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Gravy Train Approaching?
Expectations of declining interest rates and receding Governmental
policy paralysis are raising hopes of an improved operating
environment for the Engineering & Construction (E&C) and
Infrastructure companies. Whilst we do expect a pick-up in GFCF
growth and a decline in repo rates in FY13, (which can lead to better
execution and higher profitability for companies in these sectors), we
believe that only a small subset of companies will be able to capitalize
this recovery. We highlight L&T, Voltas, Simplex and EIL as the key
filter-based ideas in the E&C sector. In the Infra sector, our filter-based
ideas are Adani Ports, IRB, ITNL and Sadbhav.

Buy Sobha Developers:Ticks all the right boxes :: Ambit

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Ticks all the right boxes
Having de-leveraged its balance sheet over the past three years,
Sobha is now accelerating the pace of its new launches, execution and
cash collection. With a strong brand built around quality and speed of
execution in a relatively stable real estate market like Bengaluru,
Sobha is well placed to monetize its land bank of 2,500 acres over the
next 15-20 years. At current land prices, the land bank is worth at
least 4x cost. Our base case DCF model values this land bank at 2x cost
and generates a fair value of `462/share, 54% upside.
Sobha is a Bengaluru-focused real estate developer. Like many of its peers,
Sobha had overleveraged its balance sheet over 2006-08 in order to buy land.
However, Sobha is currently the best placed play in the sector due to:
 A repaired balance sheet: Relative to its peers Sobha follows an
aggressive cash collection philosophy. Furthermore, the group has
consistently launched new projects of 3msf-4msf each year, delivered
more than 11msf over FY08-FY12, and has used its operating cash flows
to reduce debt. As a result, net debt:equity ratio has fallen to 0.65x from
1.7x in FY09, debtor days have reduced to around 110 days currently from
173 days in FY09 and advances from customers worth over `2bn on the
current liabilities side of the balance sheet are yet to go through the P&L.
 Strong ongoing cash flows: Despite the tough macro-environment,
Sobha’s ratio of ‘CFO/interest cost related cash outflows’ at 2.0x has been
the best amongst leveraged peers for 9MFY12. Also, Sobha has reported
20% YoY growth in sales in 9MFY12 and is on track to launch 9msf-10msf
of new projects and complete the delivery of over 2msf during FY12 (FY10
delivery: 1.8msf, FY11 delivery: 4.1msf).
 Development potential: Sobha currently owns a land bank with
developable area of 112msf (saleable area of over 200msf) valued on its
balance sheet at a cost of `19.5bn (or `175psf of developable area).
Based on our discussions with real estate brokers, the current value of this
land is at least 4x its cost. Project development on this land bank over the
next 15 years generates a DCF value of `57.2bn or `583/share for the
land. However, our base case scenario values this land bank at `36.5bn
(`372 per share), 2.0x its cost.
Valuation: In our project based DCF model for Sobha, we conservatively push
out cash flows by 2-3 years and assume slower-than-expected execution, sales
and cash collection. We also assume that the cost of construction will grow at
a faster pace compared to appreciation in realization rates. Using a discount
rate of 15% for real estate projects under construction, an FY11 P/E multiple of
8x for contractual projects and valuing its land bank at 2.0x cost, our SOTP
model generates a fair value of `462 per share, a 54% upside.

Buy Eicher Motors: A new Commercial Vehicle powerhouse: Ambit

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A new Commercial Vehicle powerhouse
With our expectation of market share gains in heavy tonnage trucks,
margin improvement and significant outsourcing opportunities from
Volvo, we believe Eicher is poised to emerge as a powerhouse in the
Indian commercial vehicle industry over the long term.

Pessimism waning? 3QFY12 Results Preview:: Ambit

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Pessimism waning?
Once again our analysts are expecting a poor earnings season (4th in a row)
where we hardly have any estimate upgrades for FY12 but a lot of
downgrades. However, the wave of FY12 earnings downgrades has reduced
with concentration of downgrades restricted to banking, automobiles, capital
goods and construction. Technology sector witnessed material upgrades for
currency impact. Interestingly, looking into FY13, we find a dichotomy in some
sectors where we find analysts expecting good earnings growth but a weak/
bleak outlook barring a few sectors. Apart from consumer and cement,
surprisingly we have a positive FY13 outlook for interest rate sensitive sectors
such as Autos and Engineering & Construction and Utilities.
The final trough before the recovery
With 4QFY12 promising plenty of negative news flow from India and Europe,
our Sensex target of 14,500 remains in play in Jan-Feb 2012. However, from
March onwards, we see the situation improving for the Indian equity market
thanks to a reversal in the RBI’s monetary policy stance, significant monetary
easing in the West and a semblance of order returning to New Delhi’s
policymaking. On a 12-month horizon, we see the Sensex moving towards 18,000.
Investment implications
We reiterate our faith in “Good & Clean 3.0: Battleships”. Since its launch on
19th Oct- 2011, this portfolio has outperformed the BSE500 by 408bps on a
free float market cap basis.
High Conviction recommendations
BUYs: Tata Motors, HCL Tech, UltraTech, Bank of Baroda, Manappuram,
Torrent Power, EIL, TTK Prestige, ITC, VST, Petronet LNG
SELLs: Wipro, Axis Bank, SBI, Dabur, LICHF

Utilities :: 3QFY12 Results Preview:: Ambit

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Utilities
We expect 3QFY12 revenues to rise 76% on a YoY basis, primarily on the
back of new capacity additions (JSW Energy: Ramp up at Ratnagiri and
Barmer and Adani Power: Increased capacities at Mundra). However,
rising fuel costs and interest rates, results in lower earnings growth (43%
YoY).
High fuel cost is likely to spoil the party in the near term: Rising fuel prices
on the back of dismal growth in domestic coal production (over the last ten years
coal production has increased at merely ~5% CAGR), coupled with regulatory
changes at Indonesia (prices have jumped by at least 50% on a YoY basis since the
implementation of the new regulation). Notably, Coal India has not signed any
new FSA contracts since March 2009 given that its existing coal production is only
good enough to honour its existing commitments.
Apart from this there are also other issues pertaining to environment clearance
and land acquisition. ~40gW of operating and upcoming capacity has been
impacted due to the challenges discussed above. Whilst there is a logjam at the
centre and hence no policy level decisions are being taken we believe there are
other decisions such as: a) Eliminating 5% customs duty on imported coal, b)
Getting together the Ministry of Coal and the Ministry of Railways to make more
rakes available to transport coal, which has already been mined and is sitting at
pitheads, c) Asking MMTC and the State Trading Corporation (STC) to import more
coal, d) Ordering the Ministry of Coal to divert coal reserved for e-auction to
power projects with coal linkages, e) Allowing private players with captive mines to
sell surplus coal through their e-auction platforms and f) Taking urgent action on
environment clearance of coal blocks, which are critical for the power sector and
which can be considered.
Preparing for upcoming results
We downgrade our FY2012 EBITDA estimates by 4%-21% (except for Torrent
Power) and consequently our earnings by 14%-43%, primarily on the back of the
jump in Indonesian cost. As this is the first quarter wherein coal-based companies
will be paying higher costs to purchase Indonesian coal, the extent of QoQ rise in
fuel cost will be the key factor to watch out for in the 3QFY12E results.
Ambit v/s consensus
Whilst our earnings estimates for JSW and Adani Power are below consensus by
9% and 50% respectively, for Torrent Power we are higher by 18%. We believe our
assumptions for modelling higher fuel cost for Adani and JSW Energy and higher
realization for Torrent Power (aided by higher merchant realization) to be the
primary reasons for the lower and higher-than-consensus earnings respectively.
Recommendation
Torrent Power remains our strongest BUY idea in utilities.
Torrent Power is a recommended franchisee with one of the strongest balance
sheets in the sector (FY10 net debt:equity was 0.6x). Notably it is the only company
in the sector with positive free cash flows in FY10 (FCF yield in excess of 15% in
FY12). Further, our discussion with primary data sources suggests improving
visibility on the Dahej power project, which we believe will serve as a positive
catalyst.