Sunday, February 21, 2010
Investors can subscribe to the follow-on offer from Rural Electrification Corporation (REC), as the valuation at which the offer is made is reasonable in the light of the strong earnings visibility and growth expectations. REC, which specialises in financing power projects, is witnessing a huge and sustainable demand for funds, which would drive loan book growth for the next few years.
Superior net interest margins (NIM) of 4.54 per cent, despite secured lending, continue to aid profit growth. High return on net worth (21 per cent estimated for the fiscal ended March, 2010 despite equity expansion), low operating costs, high levels of capital to support the loan growth and near-zero non-performing assets are the key positives. At the offer price of Rs 203, the stock trades at nine times its estimated FY-11 EPS and 1.8 times its expected FY-11 adjusted book value. In book value terms, it is at a slight premium to its peer, Power Finance Corporation. A valuation of nine times earnings is cheap as the company may post an earnings growth of more than 30 per cent annually for the next three years.
REC, a navaratna PSU, is tapping the primary markets to augment its capital base to support future loan growth; this in addition to disinvestment of the government's stake. REC is expected to realise more than Rs 2,600 crore from the issue and, as a result, the company's net worth would increase by at least 38 per cent.
However, the dilution in equity base is only 17.39 per cent. We expect no earnings dilution for the current shareholders despite equity expansion, as the company may grow at a higher rate. Assuming a 70:30 debt-equity mix in funding for the upcoming power projects, around Rs 14 lakh crore of debt investment is required for the power sector over the 11th (2007-12) and 12th Plans (20012-17).
This offers immense scope for REC to grow. According to working group report of power projects, REC was to fund 16 per cent of the debt component in the 11th plan.
The company's loan book grew at an annual rate of 24 per cent during the period 2004-09. Even as the loan book expands, we expect the company to grow at a healthy rate (greater than 25 per cent) as the sanctions get converted into disbursements. As new projects get awarded, the sanctions may only increase. REC also plans to diversify into other power-allied activities such as coal mining and equipment financing, which would open up new funding opportunities for the company.
Loans to the power generation segment, as a proportion of total loans, increased to 38 per cent, as of September 30, 2009, from 23 per cent in 2007. Majority of incremental sanctions are arising out of this segment.
Private sector now constitutes only 6 per cent of total loan book. However, this proportion would increase as bulk of capacity additions in 12th plan are being added by private players. This may have a beneficial impact on margins as private sector loans have higher yields compared to loans extended to state owned companies. The company's borrowing profile is pretty much diversified, with 19 per cent raised through 54EC bonds, 20 per cent from bank borrowings and 51 per cent from taxable bonds.
Net profit grew by 29 per cent compounded annually over 2005-09, driven by strong disbursements and improved NIM. For the nine months ended December 31, 2009, net profits grew by 62 per cent.
NIMs may moderate as rates harden, as majority of loans disbursed are fixed in nature. However, REC would continue to maintain superior margins within the financial services space thanks to its access to low cost funds..
Delays in power projects could lead to rescheduling of loans; REC has 3.31 per cent of its total loan book as rescheduled loans which would delay the cash flows.
The cost of fund advantageis falling by the quarter as the 54EC proportion bonds, as a share of funding, is declining. The key upside risk is the allowance of government to raise tax-free bonds to bridge the funding gap in the power sector.
Vascon Engineers Ltd., an engineering, procurement and construction (EPC) services and real estate development company, closed the maiden trading day on the bourses at Rs146.45, down 11.24% to its issue price of Rs165. It touched an intraday low of Rs145.10 and high of Rs171.95 on the NSE. Traded volume stood at 94,70,462 shares and the turnover was Rs1.44bn. On the BSE, the stock touched a day's high of Rs173.45 and low of Rs144, before closing at Rs147.20, down 10.8%. The public issue of 10,800,000 equity shares was opened for subscription between January 27 and January 29 at a price band of Rs165-185 and was subscribed 1.22 times. The company raised Rs1.78bn from the IPO, which will be used for construction of EPC contracts and real estate development projects; repayment of debt and general corporate purposes.
As widely expected, the Bank of Japan (BOJ) left its benchmark interest rate unchanged at 0.1%. The policy-setting board of Japan's central bank voted unanimously to leave borrowing costs steady. The BOJ also maintained its overall view for the world's second-largest economy, and didn't issue any new policy initiatives, though it repeated the pledge to do all it could to pull Japan out of deflation. The policy board kept the loan facility for commercial banks and monthly purchases of government bonds unchanged, keeping the powder dry just in case it faces dire situation on deflation going forward.
Given the fiscal deterioration, the BOJ will face increasing pressure to tackle deflation. Prime Minister Yukio Hatoyama’s government may find little room to maneuver fiscal spending and instead put more heat on the central bank to prop up the economy ahead of a July election. Finance Minister Naoto Kan said this week in parliament that Japan should adopt a policy target of achieving 1% inflation and the government wants to work with the bank to spur prices.
The policy board kept its assessment of the Japanese economy unchanged at the meeting, saying that it is picking up. There is not yet sufficient momentum to support a self-sustaining recovery, the BOJ said. It also reiterated that beating deflation is a critical challenge for the economy and the bank will aim to maintain the extremely accommodative financial environment.
Toyota Motor Corp. President Akio Toyoda finally agreed to testify before the US Congress about the Japanese car maker's recent safety recalls. Toyoda, who had earlier suggested that he would not attend hearings on his company's recall of over 8 million vehicles, said in a public statement that he has accepted an invitation to testify sent by Edolphus Towns, chairman of the House Oversight and Government Reform Committee. "I have received Congressman Towns' invitation to testify before the House Committee on Oversight and Government Reform on Feb. 24 and I accept," Toyoda said in a statement. "I look forward to speaking directly with Congress and the American people," he said. Toyoda's comments came after the US Transportation Secretary Ray LaHood said that the Japanese auto giant was "a little safety deaf" as problems with various models surfaced. Earlier this week, the US ordered Toyota to hand over internal documents related to its recalls. US car-safety watchdog asked Toyota to provide documents for its investigation into whether the Japanese carmaker’s recent huge recall was conducted in a timely manner. The company said that it would co-operate fully. Meanwhile, problems got compounded for Toyota, this time with the steering on the Corolla.
The Government has approved the proposal for release of equity support of Rs8bn in two equal monthly installments to National Aviation Company of India Ltd. (NACIL). This equity infusion had earlier been approved by the GoM headed by the Finance Minister. The release of funds will be calibrated to the achievement of milestones laid down by the Group of Ministers (GoM). NACIL is currently facing severe financial losses which is compounded by its costly legacy assets, weakening revenue stream and high cost structure, resulting in rising liabilities. The GoM had accepted the company’s savings and cost reduction plan of Rs.1911 crores for the financial year 2009-10. NACIL has initiated action as part of the Turnaround Plan along with cost reduction/revenue enhancement programme. NACIL’s present paid up equity capital of Rs.145 crores is not sufficient for an aviation company of its size. The equity induction will not only ease the cash flow situation of the company but would also preclude borrowing from the markets at a high cost. The turnaround/restructuring plan of NACIL will be monitored and reviewed by Ministry of Civil Aviation, COS and GOM periodically.
The National Stock Exchange (NSE) has decided to include 11 additional securities in its futures & options (F&O) segment with effect from February 19, 2010. The announcement was made by NSE vide a circular issued after market hours on Tuesday, February 16, 2010. The new additions include Adani Enterprises, Apollo Tyres, Areva T&D India, BGR Energy Systems, Fortis Healthcare, Godrej Industries, Jain Irrigation Systems, McLeod Russel, Mundra Port & SEZ, OnMobile Global and Videocon Industries. This is the first time in nearly two years that NSE has included stocks in the derivatives segment. After the market crash of 2008, the NSE removed shares of several companies from the derivative segment as they had turned illiquid. At the peak of the stock market boom, there were nearly 225 scrips in the F&O segment of NSE. The inclusion of new stocks would take the number of stocks traded on NSE’s F&O segment from 179 to 190. This would significantly increase volume and improve market depth.
With only a month and a half to go before the current fiscal year ends, the fate of the already delayed 3G auction is still hanging in balance. The Government is still not certain whether it can hold the 3G auction before the end of March. At the same time it is not perturbed in case it fails to meet the deadline. The Finance Ministry reportedly cleared the decks for 3G auction by the end of March, by assuring the Law Ministry that it would give spectrum to all the successful bidders by September 1 instead of selectively releasing the airwaves. But, the Government is not sure if it can conduct a 3G wireless auction before the end of the current fiscal year, Finance Secretary Ashok Chawla said. "The issues relating to 3G auction have been resolved, but I can't say whether the actual auction will happen before March 31," Chawla said. At the same time, Cabinet Secretary K M. Chandrasekhar said that it does not matter if the 3G auction happens in this fiscal year (FY10) or the next (FY11). He added that Centre would like to garner maximise possible revenue from the 3G auction and would set a date accordingly. "I think all the issues have been resolved," Chandrasekhar told reporters in New Delhi. "I don't think it really particularly matters if this year or next year."
The 3G auctions for all-India licences were initially scheduled to begin on February 13 but were postponed to a time-frame between mid-February and March 5. It is not clear whether the DoT will follow this schedule or announce a new set of dates within the financial year. 3G auction has been deferred time and again on differences between the Telecom Ministry and the Defence Ministry over vacation of spectrum by the armed forces. Lack of revenues from 3G auction will hurt the fiscal position with budget deficit at a 16-year high. The Government has projected a fiscal deficit of 6.8% of the GDP for the current fiscal year.
The Cabinet approved to implement the Nutrient Based Subsidy (NBS) Policy on decontrolled Phosphatic and Potassic fertilizer with effect from April 1, 2010. It has been decided to fix the subsidy on the nutrients ‘N’ - Nitrogen, ‘P’ - Phosphorus, ‘K’ - Potash and ‘S’ – Sulphur contents for the year 2010-11. In addition to the fixed subsidy on above mentioned nutrients, there will be an additional per tonne subsidy for subsidized fertilizer carrying other secondary nutrients and micro nutrients in formulations approved under FCO 1985. The subsidy will continue to be disbursed through the Industry during the first phase. The industry will receive subsidy based on certification of sale by the State Governments / Statutory Auditors of the Company as in the past.
The NBS regime is expected to promote balanced fertilization and consequently increase agriculture productivity in the country through higher usage of secondary and micro nutrients. It is also expected that new innovative fertilizer products would be developed subsequently under the NBS regime to meet the different requirements of Indian agriculture. The NBS regime is expected to depict the actual demand of fertilizers in the country and promote realistic pricing of fertilizer products in the international market. Unshackling of fertilizer industry is also expected to attract fresh investments in this sector.
Since the subsidy on the subsidised nutrients and consequently subsidized fertilizers will remain fixed, the retail prices of subsidized fertilizers at farmgate level will be decided by the Companies. The Fertilizer Industry has assured that under NBS regime, the price line around the current level would be maintained during Kharif-2010. The Government in consultation with the fertilizer industry will make interventions in such a manner that the farmgate prices of non-urea fertilizers are, as far as possible, near the current prices so that the farmers are not adversely affected.
Urea which has the maximum tonnage consumed nitrogenous fertilizers in the country will continue to be under the current MRP regime. However, it has been decided to increase the maximum retail price of urea from Rs.4830 per MT to Rs5310 per MT with effect from April 1, 2010.
There is no respite for the common man from spiraling food prices, even as fuel prices have softened a bit. Food inflation rose for the fourth straight week in early February, climbing to the highest level in six weeks, data released by the Commerce & Industry Ministry showed. Point-to-point inflation for the Food Articles group rose at a 17.97% pace in the week ended February 6 as against the annual rise of 17.94% in the previous week, the Government data revealed.
Inflation in the Fuel & Power group dropped to 9.89% in the early part of February compared to 10.44% in the previous week, the Commerce Ministry said. Inflation in this group was at (-) 3.03% during the same week last year. On the other hand, inflation in the Primary Articles group rose to 16.33% from 15.75% in the week ended January 28. It was at 7.05% during the corresponding week (Feb. 7, 2009) of the previous year. The WPI for the Primary Articles group rose by 0.2% to 285.8 from 285.2 in the previous week.
The relentless spurt in food and fuel prices has driven the headline inflation past the official forecasts, putting more pressure on the Reserve Bank of India (RBI) to raise interest rates ahead of its annual policy meeting in April. India's monthly WPI-based inflation jumped to 8.56% in January and is likely to touch 10% by the end of March, according to chief statistician Pronab Sen. Inflation has already surpassed the RBI's revised end-March inflation forecast of 8.5%.
Inflation in the manufacturing sector also picked up to 6.55% from about 5% in December, a sign that inflationary pressures were spreading to other sectors of the economy as well, and is not restricted to food group alone.
India's inflation rose to 8.56% in January 2010 as against 7.31% in December 2009. The Government announced that it had revised November inflation rate to 5.55% from 4.78% forecast earlier. The official Wholesale Price Index (WPI) for 'All Commodities' for January 2010 rose by 0.8% to 248.5 from 246.5 in the previous month. Inflation stood at 4.95% during the corresponding month of the previous year. Build up inflation in the financial year so far was 8.90% compared to a build up of 1.51% in the corresponding period of the previous year, the Commerce Ministry said.
The Reserve Bank of India's (RBI) governor Duvvuri Subbarao said on Saturday that the central bank could not focus on inflation alone and added that the large government borrowing influences monetary policy. At its policy review on January 29, the RBI raised banks' cash reserve requirements (CRR) by 75 basis points to 5.75% but left benchmark lending and borrowing rates unchanged at 4.75% and 3.25%, respectively.
Calls for rolling back the fiscal stimulus and further monetary policy action got louder on Friday as India's industrial production grew at record pace in December 2009. India's industrial production grew by 16.8% in December 2009 from a year earlier, boosted by a 46% increase in consumer durables and a 38.8% jump in capital goods.
A series of other economic data also point to a smart economic recovery that could push inflation beyond the RBI's target of 8.5% for the current fiscal year. Any sharp increase in inflation could make it difficult for the Government to borrow from the market next year, as 10-year benchmark yields are hovering at 16-month highs.
Despite the tough economy, one in three IT professionals in India believes that companies should take bigger risks with business projects related to information technology (IT). According to a survey of 463 IT professionals in India, their companies should take on riskier projects that often have a higher return on investment. Conducted by ISACA, a global association of 86,000 IT governance, security and assurance professionals, the survey found that more than one-third (34.4%) of respondents believe that their own organizations are too risk-averse and may be missing out on opportunities to increase value.
While more than 85 % of respondents think their organization effectively integrates IT risk into overall risk management, more than 30% say that business lines are not willing to fully engage in risk management. This lack of engagement was reported to be the top hurdle to effectively addressing IT-related business risk, but budget limits (29.6%) and uncertainty of how to tailor best practices to the environment (18.1%) are also problematic, according to the IT professionals surveyed
Dr. C. Rangarajan, Chairman, Economic Advisory Council (EAC) to the Prime Minister released the document ‘Review of the Economy-2009-10’ at a Press Conference in New Delhi. Strong rebound in the second half of FY 2009-10, especially industry, drove growth rate upwards. The output in the agriculture sector is much better than feared earlier, in part due to proactive measures by the Government.
The EAC projected GDP growth rate of 7.2% in FY10, 8.2% in FY11 and 9.0% in FY12. For the current fiscal year, the EAC sees Agriculture sector de-growing by 0.2% (1.6% in FY09) while Industry (including Construction) will expand 8.6% (3.9% in FY09), Services will grow by 8.7% (9.8% in FY/09). India's FY10 GDP growth rate may be even higher than the 7.2% estimated by the CSO, driven by strong revival in manufacturing and construction.
On the external front, the EAC said that developed countries have come out of recession but the recovery is still fragile with downside risks to growth. Financial markets are nervous about fiscal sustainability. Several advanced countries have seen worsening of budgetary positions. There is speculative pressure on commodity prices, especially the sharp rise in crude oil prices.
As far as Inflation goes, the EAC said that There is danger of significant transfer of food price inflation to the general price level in 2010-11. Risk to inflation may also arise from rising international commodity prices, it added. In the short run, the Government must ease supply by increased distribution from stocks and in the medium term by improving productivity. Energy index and manufacturing goods index (ex-Food) did not rise much for most of 2009-10 but are now moving up.
Recovery in the Indian economy necessitates a more neutral monetary policy, the EAC said. Future RBI action will depend on pick up in credit, liquidity conditions and further pressure on prices. Large revenue and fiscal deficits of past two years are clearly unsustainable, the EAC said. It is possible to reduce fiscal deficit of the Centre by 1.0-1.5% in FY 2010/11. The EAC also said that it is feasible to reduce expenditure-GDP ratio by 1%.
Without doubt, next week will be action-packed for the Indian markets. Apart from Railway Budget, Economic Survey and Union Budget, we will also have to grapple with the F&O expiry and of course Q3 GDP figures. To add to the anxiety would be newsflow from the external front, which of late has been exerting quite an influence on the overall market sentiment. Talking of global markets, China will resume trading after a long holiday. The surprise hike in reserve ratio just before the holiday started and the Fed move to raise the discount rate could weigh on that market. Not much data is expected from China next week. On the other hand, a lot of economic reports are due from the US next week, including a spate of data on housing and revision in third quarter GDP.
Coming back to India, the main focus will be on Budget and what the two central ministers have in store for all concerned. One thing is sure they can't afford to be too populist this time around. They better not, as the economy is at a crucial juncture and any further slippage in policy making could hurt its prospects going forward. A broad consensus that is emerging on the Budget is that there will definitely be a partial rollback of fiscal stimulus, besides articulation of a roadmap to return to the path of fiscal prudence. One should also watch out for announcements on disinvestment, GST rollout, 3G auction and the Centre's estimate of market borrowings. Given the spiraling inflation, we expect the Government to try and address growing concerns on this front as well.
Speaking of sectors that might gain from the Budget, the usual suspects are Infrastructure, Education, Fertilizers, Textiles, Agriculture, etc. At the same time, a few sectors could be at the receiving end as the Centre exits from the ultra loose fiscal policy. The Finance Minister will also have to exercise restraint as far spending is concerned, including some of the UPA's pet social projects. The big question is can the UPA rein itself in? It would also be interesting to see whether the Finance Minister has the courage to effectively tackle the long-standing issue of open-ended subsidies for the Oil & Gas sector. The third panel set up to suggest remedies for this sector has done its job. The ball is now in North Block's court. Over to you Mr. Pranab Mukherjee.
The Federal Reserve surprised the global markets by raising its discount rate in order to encourage banks to borrow from the private market for short-term credit instead of from the central bank. This is part of the American central bank's moves to withdraw the emergency support extended at the height of the financial crisis. This was the first hike in the rate Fed charges to banks for direct loans in more than three years.
The discount rate will be increased from 0.5% to 0.75%, moving the spread over the main federal funds rate to a more normal level. The discount rate is the rate at which commercial banks in the US borrow from the Fed.
Effective March 18 the typical maximum maturity for primary credit loans will be shortened to overnight. The Fed said that its move won't impact consumer or corporate borrowing costs. The more widely used fed funds rate, the overnight rate banks charge each other, is expected to remain at historic lows near zero for the foreseeable future.
The Fed made the announcement late on Thursday after the close of US markets.
Gold prices came under fresh pressure and crude oil prices softened after the Fed raised the discount rate by a quarter percentage point, sending the US dollar higher and hurting the overall investor demand for commodities.
The dollar index, which measures the US unit against a trade-weighted basket of six major currencies, jumped above 81.15. The dollar touched a nine-month high against the euro. The US currency headed for a sixth week of gains against the 16-nation euro. The Fed's move to raise discount rate stoked expectations that the US central bank was moving towards normalisation of monetary policy.
However, gains in the dollar were tempered after Fed policy makers curbed speculation that the central bank will raise interest rates this year. Federal Bank of St. Louis President James Bullard said that the markets’ view that rates will increase later this year is overblown.
Investors use gold as a hedge against financial turbulence and inflation. Gold generally has an inverse relationship with the dollar.
Crude oil futures were set for a 5% gain this week.
Asian shares mostly declined, with Hong Kong stocks falling the most. Markets in China, Taiwan and Vietnam remained closed for the Lunar New Year holidays. European stock markets were down marginally with banks and financial services stocks showing the most strain.
Investors can consider booking profit in the stock of Madras Cements and entering it at lower levels later. The stock's fundamentals do not warrant significant upside from here over the next few months.
Declining realisations in the southern markets due to excess supply have seen the company's net profit fall over 70 per cent in the December ending quarter. Despite the strong 33 per cent despatches growth, sales too have declined. Southern cement manufacturers have seen an erosion of pricing power with 23 million tonnes of additional capacity coming up in the southern region in the last two fiscal years. Supply has exceeded the demand growth and the capacity utilisation rates are correcting sharply. Regional demand growth year-to-date stands at 8 per cent, down from the 10 per cent in the last year.
Production cut backs have not helped (cement mills are running at 78 per cent utilisation) and prices have dropped by Rs 40-45/bag in the last four months.
Based on its trailing earnings, the stock of Madras Cements (current market price Rs 111) trades at a marginal discount (seven times) to its peer India Cements (eight times). However, on enterprise value per tonne basis, Madras Cements is dearer — at Rs 5,113 per tonne compared with Rs 3830/tonne of India Cements.
Pressure on profit
Even by selling an additional five lakh tonnes in the December quarter compared to a year earlier, the company's sales actually fell. Cement realisations in the southern region have been impacted by a combination of capacity additions, the Andhra Pradesh political crisis and inventory pile-ups. In Tamil Nadu, for instance, prices have seen a correction from Rs 270 levels a year ago to Rs 225 a bag.
At the operating level, limestone and coal prices have been upward bound, offering little respite on margins. On the power front, however, the company has been making significant savings as it has stepped up supply from captive sources (windmills). In the December quarter, the company's power/fuel expenses have fallen by 22 per cent year-on-year.
At the net level, company's significant interest burden (the interest cover fell to 2 times in the latest quarter) and the rising depreciation costs are a cause for worry. In the last quarter, the company's interest costs were higher by 24 per cent over the previous year at Rs 37.5 crore.
Depreciation charges stood 41 per cent higher at Rs 50.77 crore. These could be explained by the company's recent additions to capacity — two grinding units of total capacity 1.3 mtpa capacity (current capacity — close to 10 million tonnes). Profit before interest, depreciation and tax stood at Rs 113 crore (in the September-December '09 quarter), however after these charges it was just Rs 16 crore.
Madras Cements' key States of operation are Tamil Nadu, Andhra Pradesh and Karnataka. The Andhra Pradesh Government has recently signed agreements with the World Bank and is getting Rs 3,720 crore as assistance for its various urban infrastructure projects.
The coming months will see a recovery in cement offtake in Andhra Pradesh from the artificially depressed levels of recent months. Demand from the State of Tamil Nadu is also to go up with the metro rail projects on the anvil.
Though from here prices (in the South) have limited downside, it will take some time before they see their earlier highs. Sales will, thus, see muted growth on lower realisations in the near term.