Weekend Highlights – 1 November, 2014

Ind-Ra: Gas Price Hike Negative for Key User Industries
The gas price hike by the Cabinet Committee on Economic Affairs (CCEA) could adversely affect the economics of the key user industries including power and fertiliser amid continued supply constraints, opines India Ratings & Research (Ind-Ra). Higher gas prices could increase input costs for both the sectors though gas supplies are unlikely to improve in the short-to-medium term. Gas-based power plants (GBPPs) have been suffering from low plant load factor (PLF) due to the non-availability of domestic fuel and unviable operations on imported LNG. Similarly, fertiliser plants have also seen gas supply constraints from domestic sources.Gas Price Hike Basis Modified: CCEAs approval on raising natural gas prices to USD5.61/mmbtu from USD4.2/mmbtu effective 1 November 2014 is lower than the price proposed on the basis of the formula outlined by the Rangarajan Committee. CCEA has modified the formula proposed by the Committee by removal of Japanese and Indian LNG import components in the formula which have led to the reduction in gas prices. On an adjusted gross calorific value basis, the gas prices have been increased 47% to USD6.17/mmbtu. However, they still remain lower than the USD8.4/mmbtu mark earlier sought by the government.

Electricity Generation Cost to Increase: The fuel cost for GBPPs is likely to increase 43% yoy as the gas price hike will lead to a rise in per unit fuel cost by around INR0.85/kwh. This could lower the competitiveness of GBPPs in relation to coal-based power plants. However, as GBPPs contributed a mere 4.4% to the overall generation in FY14 (FY13: 7.1%), its impact on the pan-India cost of generation is likely to be only around 4 paisa/kwh.

If the domestic prices, according to the revised formula, were to trend upwards due to the semi-annual revisions allowed, the operations of GBPPs could suffer as they would rank lower in the merit order dispatch schedule compared with coal-based power plants. In that case, the government could look at subsidising the cost of gas being paid by GBPPs. GBPPs with merchant capacities or selling power under fixed short-term arrangements are likely to be more impacted in terms of profitability as gas costs are not a pass through in tariff. However, given that the power sector ranks high in the gas priority allocation, increased domestic gas output over the long term could improve the PLF of stressed GBPPs.

Offshore Gas Could Cost Higher: Post the CCEAs decision, for discoveries in ultra-deep water areas, deep water areas and high pressure-high temperature areas, a premium would be paid on the gas price which will be determined according to the prescribed procedure. This could further increase input costs for power and fertiliser plants.

Moodys: Outlook for Indian banking system remains negative
Moodys Investors Service says that its outlook on Indias banking system is negative, reflecting its view that high leverage in the corporate sector could prevent any meaningful recovery in asset quality over the next 12-18 months.The negative outlook on the Indian banking system pertains mainly to the public-sector banks, which represent more than 70% of total banking-system assets, says Gene Fang, a Moodys Vice President and Senior Credit Officer.

These banks have experienced higher growth rates in nonperforming and restructured loans, as well as greater weakening in profits, than private-sector banks, and these trends are unlikely to improve for public-sector banks, adds Fang. Going forward, Indias corporate sector will remain highly levered, representing an obstacle to a cyclical recovery in asset quality.

The report — whose outlook expresses Moodys expectation of how bank creditworthiness will evolve in this system over the next 12-18 months — looks at Indias banking system in terms of five factors: Operating environment (which is classified as stable); asset quality and capital (deteriorating); funding and liquidity (stable); profitability and efficiency (deteriorating); and systemic support (stable).

While Moodys expects economic growth will pick up moderately, growth remains constrained by the high interest rates needed to contain inflation. Moodys base-case forecast is for GDP growth of 5.0% for the fiscal year ending March 2015 (FY2015) and 5.6% for FY2016, compared with 4.7% in FY2014.

According to Moodys report, Indias broad corporate sector is highly levered, with a debt-to-equity ratio of more than 3.0x. In particular, corporates engaged in infrastructure projects face both structural and cyclical challenges.

Without a stronger economic recovery, significant deleveraging will only occur beyond the horizon of this outlook.

And although the new government of Prime Minister Narendra Modi may formulate some policies within the 12-18 month horizon of this outlook, it will take longer to see an impact on the real economy.

ASSOCHAM for allocation of cancelled coal blocks to captive block allocatees
The Associated Chambers of Commerce and Industry of India (ASSOCHAM) has suggested the government to give preference in allocation of cancelled coal blocks to captive block allocatees who have an operational or soon to be operational end-use-project. Auctions should be opened for others only after coal for these projects is secured.In a note submitted to the Prime Minister Office (PMO), the Chamber has stated that coal blocks already allotted for end use steel projects should be auctioned only for steel projects and similarly coal block allotted for end use power projects be auctioned only for power projects.

The reserve price and upfront payment should be based on actual mineable reserves only (as assessed by CMPDIL/MECL etc) and not on the basis of geological reserves. The sub-blocking should remain as it is and clubbing of blocks should be avoided so that the end use plants of small capacities can also bid in the auction process.

Clearances accorded to the existing coal blocks should automatically get transferred to the new allocatees. Obtaining these clearances again will lead to considerable delays in commencement of production from mines and adversely affect the end use projects.

Bidding for end use power as well steel projects should be on the basis of upfront payment fixed by MoC and extractable reserve linked payment quoted by the bidder in INR/tone.

Referring the compensation to be given to original allocates, the chamber said, criteria should be land prices as determined by the Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Act, 2013 and other investments made in the coal block at current market value.

ASSOCHAM says that auction process should accord Right of First Refusal (RoFR) to the existing allocatees of the coal blocks who have end use plants either operational or soon to be operational or to the allocatees which have taken substantial effective steps to set up end use plants.

End-use-projects are interlinked with specific mines in terms of proximity, evacuation arrangement and giving RoFR would ensure that no additional burden is put on the already stressed infrastructure facilities and will be in national interest. Denying RoFR will severely affect the interests of the genuine companies who had invested huge amount of money in their end use plants and have taken huge loan from the banks for setting up the same.

Dr. Reddy’s lab – 2QFY2015 Result Review

Results below expectations, main disappointments on sales and OPM front

Stock down ~2%

Dr Reddys Lab (CMP: `3080/`3964 TP:/ Upside:28.7)

For the quarter, the company, posted net sale of `3587.9cr V/s `3,900cr expected, a yoy growth of 7.0% yoy. The growth was subdued, as US its growth driver posted a growth of only 8%, on back of old products, with company launching only one product during the quarter. Other key geographies, namely Emerging and Indian markets posted a yoy 14%. On the operating front, the gross margin came in at 63.9% V/s 64.1%, expected, a yoy expansion of 115bps. In spite of the same, the operating margins came in at 22.7% V/s 25.2% expected, a dip of 209bps yoy, as the R&D expenditure during the quarter rose by 36.7% yoy. This along with, a higher taxation, which rose by 51.0% during the period along ( Tax as % of PBT was 17.4% V/s 10.3% in 2QFY2014) was with the 26.7% dip in the other income lead the, net profit to come in at `574cr V/s `715cr expected, a yoy dip of 16.8%. On back of valuations, we maintain our buy on the stock with a price target of `3964.

Dr. Reddy’s announces the Launch of Sirolimus Tablets

Dr Reddys Labs (CMP: `3080/ TP:`3964/ Upside :28.7)

Dr. Reddy’s announces the Launch of Sirolimus Tablets: Dr. Reddy’s Labs announced today that it has launched Sirolimus Tablets 1 mg and 2 mg, a therapeutic equivalent generic version of RAPAMUNE®(Sirolimus) tablets in the US market on October 27, 2014, following the approval by the United States Food & Drug Administration (USFDA).The RAPAMUNE ® tablets brand had U.S. sales of approximately US $206mn MAT for the most recent twelve months ending in August 2014 according to IMS Health. Dr. Reddy’s Sirolimus tablets in 1 mg and 2 mg are available in bottle counts of 100. Given a very low competition, for the product, the product can conservatively add around US $50mn to the sales and around US$15mn on the net profit front, on annualized basis. We maintain our buy with a revised price target of `3964.

Lupin – 2QFY2015 Result Review

Results marginally better than expected on net profit front

Stock down 2.2%

Lupin (CMP: `1388/ TP:/ Upside)

For the quarter, the company posted results marginally above on the net profit front, while net sales came in a tad lower than expected. The company posted sales of `3116.8cr V/s `3360.4cr expected, posting a growth of 18.4% yoy. The growth was driven by its key markets US and India, which grew by 23% and 20.0% respectively, while the Europe and Japan posted a yoy growth of 11% and 12% respectively. On the operating front, the gross margin came in at 65.7% V/s 68.0% in 2QFY2014; however a lower rise of around 4.2% yoy in other expenditure, lead the operating margins to come in at 24.9% V/s 23.7% in 2QFY2014. This along with a 56.4% dip in interest expenditure, 25.4% decline in tax expenditure and 46.6% rise in the other income aided, the net profit to come in at `630cr V/s `406cr in 2QFY2014; a yoy growth of 55.1%. On back of valuations, we maintain our neutral rating on the stock.

Weekend Highlights –25 October, 2014

Indias Diesel Deregulation Positive For Oil Companies-Fitch Ratings
The Indian governments 18 October decision to deregulate diesel prices will have a positive effect on the national oil marketing companies that are the principal retailers of petroleum products, says Fitch Ratings. The decision is also likely to lead to more private firms entering the diesel market in the medium term, resulting in greater competition.The decision to deregulate diesel prices is well-timed in light of the recent decline in international energy prices. The expected direct impact of both the diesel reform and natural gas price hike on Fitchs headline fiscal forecasts is limited; but the fiscal balances will be more robust to future oil shocks, since both diesel and petrol prices are now determined by the market. Furthermore, implementation of these politically sensitive reforms demonstrates that the government continues to roll out structural reforms gradually, and suggests that more far-reaching structural reforms may be in the pipeline.

The national oil marketing companies – Indian Oil, Bharat Petroleum and Hindustan Petroleum – will be the principal direct beneficiaries of deregulation, and the decision is positive for these companies standalone credit profiles. Under the previous rules, these retailers had to sell diesel (accounting for 40% of fuel sold) below market prices, and were partially compensated for the losses through the federal budget. Furthermore, the price control and subsidy system affected the working-capital positions of these companies, as there was a timing mismatch between the recognition of losses on sales and compensation from government – leading to higher debt.

The other beneficiaries are likely to be upstream oil companies such as Oil and Natural Gas Ltd and Oil India Ltd, which also bore a large part of the subsidy burden. These companies offered a USD56 per barrel discount to the national oil marketing companies – especially challenging when considering the fall in crude prices to around USD85. Fitch expects that the discount is likely to come down.

Fitch anticipates that deregulation will result in heightened competition for the existing dominant national retailers, and could hurt their profitability over the medium to long term. By allowing diesel to be marketed profitably, the sector will once again be attractive for private companies that had left when price restrictions were put in place. A large portion of the output of private refiners is exported, due in part to the restrictions placed on domestic sales. Private firms such as Reliance Industries and Essar Oil are likely to restart idled diesel retail operations, and should ultimately become more significant players. Their impact on the sector would not be seen immediately, though, as they would have to play catch-up to restart and establish retail infrastructure.

Ind-Ra: Diesel Price Decontrol May Create More Policy Space for RBI
India Ratings & Research (Ind-Ra) says the union governments decision to deregulate diesel prices will significantly improve the countrys finances as the oil subsidy will come down by INR150bn. Also, the cut in diesel prices by INR3.56/litre will go a long way in fighting inflation, which is trending downwards. This will create more space for the Reserve Bank of India to ease its policy stance and cut policy rate sooner than hitherto believed.Ind-Ra on 1 September 2014 expressed its view in favour of decontrolling diesel prices at the earliest. The staggered diesel price hike initiated since January 2013 and the recent decline in the prices of crude in the global market have converted the under recovery of public sector oil marketing companies into an over recovery. The over recovery on diesel for such companies reached INR3.56/litre for the second fortnight of October. The crude price of the Indian basket as on 15 October 2014 fell to USD83.85/bbl and the currency was at INR61.1/USD. When diesel prices were increased by around INR5/litre on 14 September 2012, the Indian crude oil basket was priced at USD113.64/bbl and the currency was at INR55.47/USD, leading to an under recovery of INR13.86/litre.

Although the rupee depreciated to around 61.5/USD by the middle of October 2014 from around 59/USD in May/June 2014, the sharp fall in the global crude prices has overall lowered the import price of Indian basket considerably. As the crude prices in the global market are likely to remain low in the near term due to the US discovery of shale oil as also the struggling economies of Europe and Asia, deregulating diesel prices is both the right and opportune step.

However, India will have to be watchful of global developments. Crude prices and therefore petroleum product prices are currently low because of low demand and appreciation of the US dollar in relation to its trading partners (measured by US Dollar index). In a scenario where even if global oil and petroleum products demand and supply remain same, depreciation of the US dollar may flare up both crude and product prices. Although the fuel price deregulation was scheduled to begin from April 2002, it took more than 12 years to deregulate petrol and diesel prices. The present order is however silent on government intervention in the eventuality of global prices flaring up again.

Currency movement (INR/USD) also has a significant impact on petroleum product prices and subsidy. Ind-Ra expects the rupee to strengthen marginally and this will have a favourable impact both on petroleum product prices and subsidy.

India Can Emulate Global Best Practices for the Development of the Corporate Bond Market: CII
To further the expansion of the economy, CII feels India must continue to work on removing infrastructure bottlenecks and further strengthen the financing of infrastructure development. CII projects investment requirement in infrastructure development to the tune of Rs 64.3 lakh crore during the period 2014/15 – 2018/19 and private sector will have to play a crucial role in achieving the desired goal.Corporate Bond Market (CBM), as a stable and reliable source of finance, provides a pivotal mechanism for sustaining business investment, infrastructure development, and economic growth. CII in its report n++Corporate Bond Market: Benchmarking Global Best Practices into Indian perspectiven++ has analysed the role Corporate Bond Market has played in infrastructure development for many economies globally and brings out key recommendations for the policymakers to implement in the Indian context.

n++Indian economy is at crossroads where development of Corporate Bond Market is required for meeting the funding requirements of the industry and the economy. Thus, it becomes imperative to study the successful global models for benchmarking best practices and devising an implementable roadmap for the Indian economyn++ said, Mr Chandrajit Banerjee, Director General, CII.

For an emerging economy like India, Corporate Bond Market can play a pivotal role for financing infrastructure development as evidenced from the successful models of various countries. It is, therefore, possible for India to learn from the experiences of other countries in developing its CBM.

Speaking on the report, Mr Banerjee added, n++CII has studied the global best practices and models for development of CBM with special emphasis on benchmarking global best practices for the Indian market and deriving policy solutions to guide the future reform agendan++.

The CII report analysed the models of both emerging and developed countries like Brazil, Chile, South Korea, China, Singapore, Japan and the United Kingdom, and noted that a variety of regulatory and market actions stimulated market growth in these economies. On careful examination, CII recommends, India needs to focus on few key measures (but not limited to) like broad based development of Government securities market, supportive taxation structure, uniform stamp duty, enhance institutional participation by re-visiting investment norms, institute a robust credit enhancement framework and most importantly strengthen bond holder protection mechanism.

Alembic Pharmaceuticals – 2QFY2015 Result Review

Results marginally below expectations

Stock up 3.4%

Alembic Pharma (CMP: `387/ TP:/ Upside :)

For the quarter, the company posted sales and profit, below expectations. The sales and net profit came in at `539cr V/s `568cr expected and `84cr V/s   `88cr expected respectively, thus posting a yoy growth of 11.7% yoy and 31.7% respectively. The growth in the sales was lead by the domestic formulation business, which posted a yoy growth of 18.0%. Other segment, which did well, was API, which posted a yoy growth of 20.0%. The international generic posted a growth of 9% yoy, while Indian generics de-grew by 12% yoy. The international branded segment posted flat sales. On the operating front, the gross margins came in at 64.8% V/s 60.8% in 2QFY2014; consequently taking the operating margins to 21.2% V/s 19.6% in 2QFY2014. This along with the lower interest expenditure, which dipped by 31.9% yoy, aided the PAT to come in at `84.1cr V/s `63.8cr in 2QFY2014, a growth of 31.7%. We maintain our neutral rating on the stock.

Indoco Remedies – 2QFY2015 Result Review

Results below expectations, on sales and net profit front, margins robust

Stock marginally up

Indoco Remedies (CMP: `287/ TP:/ Upside :)

For the quarter, the company posted results much below expectations on the net sales and profit front. The sales came in at `226cr V/s `257cr expected, posting a yoy growth of 16.1%. The sales growth was mainly driven by the exports, which rose by 21.1% yoy, while domestic sales rose only by 13.3% yoy. The domestic formulations grew by 13.9% yoy, while formulation exports grew by 21.2% yoy. On the operating front, the gross margin came in at 64.8% V/s 61.2% in 2QFY2014; consequently taking the operating margins to 20.6% V/s 13.2% in 2QFY2014. This along with the lower interest expenditure, which dipped by 49.0% yoy, aided the PBT, to register a yoy of 148.3%. However, a 148.3% yoy rise in the tax expense during the quarter, lead the net profit to come in at`20cr V/s `30cr expected, a yoy growth of 23.7%. We maintain our neutral rating on the stock.

UPL – 2QFY2015 Result Review

Results, robust on top line

Stock dips marginally

United Phosphorus (CMP: `331/ TP:424/ Upside :28%)

United Phosphorus Limited (UPL), posted a good set of numbers. For the quarter, the company posted sales of `2618cr V/s `2,269cr in 2QFY2014, registering a yoy growth of 15.4%. On the operating front, the company posted OPM’s of 16.7% V/s 16.0% in 2QFY2014, mainly driven by the GPM’s of 50.5% V/s 48.7% in 2QFY2014. The expansion in the OPM was lower than expansion in the GPM, on back of the 24.4% rise in other expenditure. This along with the lower other income during the period, which dipped by 32.2% yoy, lead the Adj. net profit to come in at `178cr V/s `171cr in 2QFY2014, a yoy growth of 4.3%. The reported net profit during the quarter was `166cr V/s `155, a yoy growth of 7.1%.We maintain our buy with a target price of `424.

Weekend Highlights –18 October, 2014

Indian Railways Freight Loading up by 4.20 per cent during April-September 2014
Indian Railways carried 532.44 million tonnes of revenue earning freight traffic during 1st April- 30th September 2014. The freight carried shows an increase of 21.44 million tonnes over the freight traffic of 511.00 million tonnes actually carried during the corresponding period last year, registering an increase of 4.20 per cent.During the month of September 2014, the revenue earning freight traffic carried by Indian Railways was 86.71 million tonnes. There is an increase of 1.85 million tonnes over the actual freight traffic of 84.86 million tonnes carried by the Indian Railways during the same period last year, showing an increase of 2.18 per cent.

Government IT Spending in India Forecast to Reach US$ 7.2 Billion in 2015: Gartner
Government IT spending in India will total US$ 7.2 billion in 2015, a 5% increase over 2014, according to Gartner Inc. Government IT spending is on pace to total US$ 6.6 billion in 2014.This forecast includes spending by the government sector (government is composed of state and regional government and central government agencies.) on internal IT (including personnel), hardware, software, external IT services and telecommunications.

Anurag Gupta, research director at Gartner says, IT services, which includes consulting, implementation, IT outsourcing and business process outsourcing, will be the largest overall IT government spending category through 2018. IT services are expected to grow 10.9% in 2014 to reach US$ 1.8 billion in 2015, up from US$ 1.6 billion in 2014 – with the business process outsourcing segment growing 22% during 2014.

Internal services will achieve a growth rate of 9.9% in 2014. Internal services refer to salaries and benefits paid to the information services staff of an organization. The information services staff includes all company employees that plan, develop, implement and maintain information systems. The software MARKET will achieve the highest growth rate within spending categories.

Government spending on software will total US$ 788 million in 2014, and it will grow to US$ 910 million in 2015. Software spending will be led by growth in vertical specific software (software applications that are unique to a vertical industry. These are stand-alone applications that are not modules or extensions of horizontal applications).

Anurag Gupta, research director at Gartner said, India has a new government in power with the underlying promise of Less Government & More Governance. The delivery of a citizen-centric and transparent government is only possible through the extensive use of technology and by leveraging digital government. We expect a focus on expanding broadband penetration, accelerating digitization of core government processes, leveraging mobility to engage the citizens, cloud initiatives and public private partnership. India has ambitious plans to build several smart cities, and this will create new opportunities.

ADB, 13 Banks Sign $288 Million B-Loan for Wastewater Reuse in PRC
The Asian Development Bank (ADB) has signed a ground-breaking agreement in partnership with 13 banks to support Beijing Enterprises Water Group Company (BEWG) to promote high standard wastewater treatment and reuse in the Peoples Republic of China (PRC).The $288 million B-loan agreement, signed today, is the largest such loan arranged by ADB. The B-loan is part of ADBs financing package to the project, which includes an ADB-financed loan of $120 million signed last November, and up-scaled to $408million. Through the B-loan structure, ADB acts as the lender of record for commercial banksn++allowing them to SHARE ADBs preferred creditor status.

n++A prime objective of the B-loan is to perpetuate our development mission with partner banks to promote reuse of treated wastewater as a strategic option for sustainable water management. We are pleased to work with 13 leading banks to address the PRCs water challenge,n++ said Hisaka Kimura, ADB Head of Private Sector Infrastructure Finance, East Asia Unit.

The PRCs increasing demand for water highlights water scarcity. Per capita freshwater resources are low and annual per capita water endowments have been declining alarmingly. Pollution exacerbates water scarcity, especially in upstream areas where it can degrade sanitation in local communities which depend on local sources for water supply.

Under the project, BEWG will upgrade and operate wastewater treatment plants across the country to meet grade 1A standard, the most stringent wastewater treatment standard in the PRC. The treated wastewater can then be reused for both industry and urban environment needs, including machine cooling, boiler operation, and cleaning at construction sites.

The 13 banks are Australia and New Zealand Banking Group, the Bank of Tokyo-Mitsubishi UFJ, BPI Capital Corporation, Industrial and Commercial Bank of China (Asia), Rabobank International, OCBC Wing Hang Bank, Kookmin Bank, Aozora Asia Pacific Finance Limited, State Bank of India, Chang Hwa Commercial Bank, KEB Asia Finance, Shinhan Asia, Taiwan Cooperative Bank, and ADB as the lender of record.

TCS- 2QFY2015 Result Review

Results below expected on net profit levels

Stock down ~7.0%

TCS (CMP: `2,700/ TP:/ Upside:)

TCS announced its 2QFY2015 results. While the dollar revenue was much higher than expected on sales front, the net profit came in lower than expected, on back of lower than expected EBDITA margins. On the sales front, the company posted a 6.4% sequential growth in USD revenues to US$3,929mn V/s US $3,859mn expected, with volume growth of 6.1% qoq. On constant currency (CC) terms the company posted a 7.4% qoq growth, of which organic growth during the period was 4.6% qoq on constant currency. In rupee terms, revenues came in at `23,816cr V/s `23,495cr, up 7.7% qoq.

The growth in the INR sales was equally driven by the key geographies, USA (5.3% qoq), Europe (3.8% qoq) and India and Asia Pacific, which grew by 9.0% qoq and 43.2% qoq respectively. In terms of verticals, the BFSI (4.3% qoq), Telecom (1.7% qoq), Retail & Distribution (5.9% qoq) and Manufacturing ( 26.7% qoq).

EBITDA margin came in at 28.5%, lower than expected 30.2% and a dip of ~29bps qoq. Consequently, PAT came in at `5,288cr V/s `5,414cr expected, an up-tick of 4.6% qoq. On the operational front, the company had the highest utilizations, which stood at 86.2% (ex-trainee), while including the trainee it was 81.3%. As per outlook, the company expects to post a growth higher than the NASSCOM growth target of 13-15%.

In terms of development, the TCS announced its merger with CMC wherein in the shareholders of CMC will receive 79 equity shares of Rs.1 each of TCS for every 100 equity shares of Rs.10 each of CMC held by them. The appointed date for the proposed scheme is 1 April 2015. We maintain our neutral rating on the stock.

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