Unifi Corporate Profile

Tuesday, January 17, 2012

Mid-Term Outlook for Metals

Contributed by: Sathyamurthy U, Unifi Research

Global political and economic events such as the sovereign debt crisis and the slowdown in recovery from the last crisis in economically sound countries have rendered the industrial metal prices directionless.   However, copper and aluminium prices have increased by 5.7% and 4.7%  since the beginning of the year.

China, the world’s second largest economy consumes significant share of primary raw materials such as iron ore -60% (of global iron ore trade) , copper – 41 percent, aluminium – 40 percent. Demand outlook for these industrial metals can be explained by import, export and value creation activity in China.

Copper
The metal is currently on an uptrend due to strong fundamentals – supply disruptions due to labor issues in some of the world’s largest copper mines, depleting stocks in LME warehouses, and potential demand supply mismatch.  The following chart shows the monthly import growth of China and Copper prices. (superimposed over one another with same time base). Copper prices have corrected along with the decline in import growth in China. 

Aluminium
A similar trend is seen in aluminium prices during the same time period.  



The impact of slowing imports on GDP is shown in the following chart. The current level of import growth and the corresponding GDP growth are exhibiting similarities to the crisis 2008-09.


The Chinese economy is buffeted by two forces - slow global growth is hurting exports to European union, which is the primary destination for Chinese  exports.  China’s exports have slowed down recently. The domestic consumption due to rise in wages in China might not be enough to make up for the shortfall in foreign orders. (Source – WSJ)


Another problem is the housing prices in China. Government is trying to control prices by making it difficult to finance development of luxury apartments and requiring 60% down payment from buyers.  The low cost housing is not progressing as planned.  These problems will likely have an impact on the GDP growth in China which has already slowed from 10.4% in 2010 to 9.2% in 2011.

Further slowdown in consumption of industrial metals (lower imports) either through slower growth in EU or domestic weakening in the Chinese economy appears likely and will have an impact on metal prices especially copper and aluminium.

Hence my outlook for copper and aluminium is negative.  

Steel
Steel consumption in India has slowed considerably from 14.5% to 2.9% in 1H12, with project offtake slowing down and other macroeconomic challenges cropping up. According to ICRA, 25 MT of new capacity are coming up in the next 18-24 months (30% of current production capacity) and keep the realizations under check despite the weakening currency scenario.

The higher interest payments arising out of the capacity expansions will also decrease margins for steel makers and raise working capital requirements, thereby affecting the liquidity profile of steel companies.  Companies with better capital structures such as Tata Steel  will be able to withstand the competitive pressures.

The major steel consuming sectors in India – construction (65%), capital goods (15%) and automobiles (8%) are witnessing slowdown.  Project offtakes  are affected by land acquisition issues and interest rate scenario.  The near term outlook for steel is weak.  India’s GDP growth rate for Q1 and Q2 FY12 was 7.7% and 6.9% while steel consumption growth for the same period was 2.9%. (Typically steel growth rate is 1.2-1.5 x GDP growth). According to GoI projections of 7.5% growth rate for India in FY12, this will be ahead of steel consumption growth.

Hence the mid-term outlook for steel sector is negative.



Views expressed are personal and do not constitute to the market outlook towards commodities at Unifi. 
Email: sathya@unificap.com

Sunday, January 15, 2012

Market Commentary for the month of December


Grinding Down
Indian markets slipped further during this month, which was choppy for most parts, disappointed by falling industrial output, worsening fiscal deficit position and government’s rollback of its proposal to allow Foreign Direct Investments in Multi Brand Retail segment. Despite decent advance tax numbers, marginal moderation in inflation and RBI’s hint about reversal of hard money stance going forward, the domestic sentiments remained subdued pulling the benchmark Sensex down by about 4.14% in December.  MSCI India was among the worst performers for the month as well as for the calendar year with a decline of 6% and 37.97% respectively as compared to MSCI EM (Emerging Markets) which dropped 1.29% and 20.41% respectively. The Rupee depreciation of over 16% against the US dollar in 2011 accentuated the adverse impact for India. The domestic mid and small cap indices continued to underperform the large caps by falling 8.75% and 8.97% respectively. Although FII’s were marginal net buyers of about USD 31.79 mn worth of equities in December, they have withdrawn about USD3.81 bn for the year as a whole. Alternatively, the domestic mutual funds have been net buyers in 2011 bringing in about USD 1.2 bn to the equities segment with USD 112 mn coming in during the month.

Snapshot Review of the ‘Chaotic’ Year 2011
Year 2011 is best characterized as an eventful year but mostly for the wrong reasons. Global Asset Markets squirmed as the sovereign debt issues in peripheral Europe snowballed into a full-blown crisis scuttling the global economic recovery process besides raising the specter of a double dip recession. Indian economy and consequently its markets were further hit by persisting inflation, multiple rate hikes and inertia in government policy making amidst a background entangled with periodical news of grafts and scams. Interestingly, all seemed well for the Indian Markets in the beginning of the year 2011. The indicator of Indian corporate performance, BSE Sensex, was near its peak levels of 20,000. Output of six core infrastructure industries such as finished steel, cement, crude petroleum, petroleum refinery, coal and power had recovered sharply after a moderate quarter. RBI had forecasted WPI inflation to drop to 5.5 percent by March 2011. Current account deficit as percentage of GDP was a manageable 3.6 percent.

To top it all, India’s growth rate was projected to grow at an annual rate of 9+ percent overtaking China as the world’s fastest growing economy. With the benefit of hindsight, one would note that whatever could have gone wrong at the start of the year indeed went wrong in Year 2011.  WPI Inflation remained at elevated levels of 9 to 10+ percent levels through the year on account of rising food, fuel and commodity prices despite RBI’s successive rate hikes (from 6.25% in January 2011 to 8.50% in December 2011) to curb demand. Slowdown in IIP, which was seen to be more of a short-term issue solvable by affirmative policy actions, turned out to be a long-run problem affecting national GDP growth and corporate earnings due to increase in input and borrowing costs besides government’s complete inaction on the reforms front.


The monetary tightening did have an impact on inflation which started cooling off in November, however at the cost of slowing industrial and economic activity.  Industrial performance deteriorated further during the end of the year and declined by 5.1% on yoy basis, due to contraction in manufacturing and mining activities, while capital goods witnessed a yoy decline of 25.5 percent. GDP growth for Q2 FY12 moderated to 6.9 percent from 7.7 percent in Q1 FY12.  On the expenditure side, investments also showed a significant slowdown.  Flow of foreign capital into the country which was in an uptrend during the first half of the year due to strong FDI inflows, rise in ECBs and trade credits, initially offset the sharp decline in FII inflows due to Euro zone debt crisis and concerns of double dip recession. However, as global risk aversion continued to build up and domestic markets continued to fall, flow of capital dried up considerably, widening the current account deficit further amid faster decline in exports than imports. Global concerns such as the European sovereign debt crisis, slow economic recovery in the U.S., political unrest in Middle East nations, and natural disaster in Japan were initially believed to have little impact on the Indian economy due to its domestically driven demand.   However, there were significant indirect effects - spike in oil prices led to increased current account deficits. Accommodative monetary policies in Europe and U.S. which were rolled back in June 2011 adversely affected the global trade and capital flows.

A combination of all the above problems discussed i.e. high inflation, burgeoning current account deficit, decline of capital inflows resulted in a massive 16+% fall in the value of rupee (from Rs.45 levels to Rs.53 levels) against the U.S. dollar. This in turn has considerably jeopardized the position of several Indian companies that have significant dollar denominated /linked debt in their books.  

2012- Transformational Year? - Focus to shift from Inflation to growth
The previous year turned out to be a nightmare with multiple domestic issues combined with slowing global environment.  What is worrying is the fact that the growth deceleration could spill over into 2012 and perhaps beyond.  As per reports, global growth is expected to slow from 4.2% in 2010 to 3% in 2011 and to 2.5% in 2012.  Considering the false start of FDI in retail and populist measures like Food Security Bill, the domestic policy prospects for 2012 don’t appear good.  Last year, we were discussing about double dip in US economy and possibility of India’s growth overtaking China.  Ironically, today the U.S. is doing satisfactorily and the hot topics are ‘Fiscal Integration in Europe’ and who will slow down more, between India and China!


Although USA may not recover significantly, the recession talk has vanished. European banks will continue to take a hit on their balance sheet owing to their exposure to sovereign debt.  Whether it is a ‘default’ or a ‘managed default’, credit shortage could become a handicap for growth in EU region.  In India, the government has to battle on many fronts.  The first half of 2012 will see concerns about a slowdown gaining prominence over peaking-off inflation.  Most of the leading economists have already revised down the GDP forecast for India to 6.7% for FY12 and 6.6% FY13, well below the government guidance of 7.25%.  This reflects the impact of higher interest rates resulting in slowing investment demand and global uncertainties affecting export demand.  We expect the growth rates to bottom out in middle 2012 on account of rate cuts and base effect.  We also expect the RBI to cut rates by around 200bps in Q2-Q3CY12. At this juncture, inflation is likely to peak off in early 2012.  However, with five states going in for elections in March ’12, we will not be surprised to see price hike in Kerosene, diesel and LPG post-elections.  Further, possible price increase in coal and power tariff cannot also be ruled out. These measures will once again stoke the inflation up, testing RBI’s policy stance. 


Any adverse global economic developments are obviously not in our control. What’s more disconcerting is the fact that Indian government has severely fallen short of expectations on the reforms agenda. The problems are well-documented starting from coal shortage to policy paralysis, fiscal slippages and multiple scams.  We don’t have any big hope on the reforms front as any related impact on the economy comes only with a lag.  However, we do hope and feel that the government would be able to manage the fiscal issues without disturbing the rates as slowing economy will pull down the loan demand. Prudent fiscal management coupled with some determined policy decision-making from the political class could help the economy bounce back with a growth rate of around 8% at least in FY 2014 if not earlier.

MARKETS
What lies ahead?
Cyclical deceleration in growth and policy inertia are the key drivers for the current slow-down in India.  Unlike 2008, the problems now are home grown and hence domestic market benchmark indices underperformed their developed as well as emerging counterparts. Mid and Small cap Indices witnessed a steeper sell-off compared to large caps. The sell-off was also broad-based with all the sectors except FMCG closing in the negative territory. Real Estate, Metals, Power and Capital Goods were the top losers amidst concerns of slowdown in investment activity and coal shortages. Trading volumes in equity market is presently at five year low and still declining.  The current bear market has sustained long enough and we have to look out for reasons that can cause a turnaround.  As explained earlier, consensus is also concerned about macro signs with fiscal, current account and rupee spiraling out of control.  Most of the domestic funds and insurance companies are a tired lot with no fresh inflow of funds. 

Although Indian markets look attractive based on P/E multiple, considering the amount of earnings downgrades the PEs may be higher than our current belief.  While markets could rally on rate cuts, the sustainability would depend on investment spending and policy reforms from capital.  As we go in 2012, though the macro picture looks weak, we will probably see raw material prices moderating on the back of a slow-down in China which in turn would help India Inc to improve their gross margins.  Interest cost will peak in next couple of quarters that would help driving below-the-line profits.  In other words, considering the below-expectation profits for December and March quarter, the base effect will provide some sense of optimism that earnings can surprise on the upside during the later part of 2012. Right now, “it’s so bad, it’s almost good”. 

Friday, January 13, 2012

Direct access for foreigners to the Indian stock market - Is the excitement for real??

Glenn Roger Carr, Vice President, Unifi Capital


The Indian Government has made a strong bid to strengthen the domestic markets by proposing to allow Qualified Foreign Investors (“QFIs”) to invest directly into the Indian equity market vide press release dated January 1, 2012 issued by the Ministry of Finance. The proposed new investment route is aimed at providing the much needed stimulus and to improve the sentiment of our markets

Currently, investing through the FII route directly or by going through a sub account of an FII are the only means for foreign individuals or institutions to invest into India.  In August 2011, the Securities and Exchange Board of India (SEBI) had permitted QFIs to invest into mutual fund schemes, thereby providing an indirect way of making foreign investments into Indian equity markets, and that was the starting point of the current policy which we shall carefully analyse

Key Highlights of the Proposed New Regime as provided under the Press Release

1.    RBI to grant general permission (i.e. under the automatic route) to QFIs for investment under PIS route similar to FIIs.

2.    The investment by QFIs would be subject to an individual investment limit of 5% of the paid up capital of the Indian company and an aggregate investment limit of 10% of the paid up capital of the company. These limits are over and above the limits applicable in case of investment by FIIs or NRIs under PIS route.

3.    QFIs would be allowed to invest only through a SEBI registered qualified depository participant (“DP”) and all the transactions would have to be made through this DP only.

4.    DPs would be the ones who would be required to ensure that the QFIs comply with the KYC norms and the stipulated regulatory requirements.

Pros and Cons of the policy

1.      Under the current SEBI (Foreign Institutional Investors) Regulations, 1995 there are stringent conditions imposed on the registration of FIIs and sub-accounts such as if an asset management company or an investment advisor has to be registered as an FII, it has to indicate that it is proposing to make investments on behalf of broad based funds. Further, funds can be registered as sub-accounts only if they fulfill the broad based criteria. Similarly, if an individual wants to register as a sub-account, then inter alia he has to fulfill minimum net worth criteria of USD 50 million. With these conditions not being imposed on a QFI it makes it easy and gives the investor the incentive to register and invest directly as a QFI.

This would allow a large group of foreign investor’s direct access to the Indian equity market instead of investing through FIIs/sub-accounts and at the same time will provide wider opportunity to the Indian companies to raise funds.


2.    If we look carefully at the regulations, it states that the individual limit of 5% and the combined QFI limit of 10% of paid up capital per stock is over and above the FII and the NRI limits that are already in force. This could mean that QFI’s could now buy into stocks that were earlier blocked due to the FII or NRI limit being breached. I would actually think that some of these stocks would see substantial fresh investment into them thus pushing their prices up.


3.   There are questions about whether NRI would be classified as QFI’s? Even though there is no direct mention to the contrary, it is quite clear that the QFI   limits are over and above NRI limits, which could lead us to conclude that NRI’s do not qualify under the new QFI regulations.


4.  The tax treatment for the QFI investment will ultimately decide the success or otherwise of this regulation. While it is quite clear that these investors will not benefit from a zero tax regime( which the bigger players who invested through the FII sub-account route benefitted for many years and continue to do so)it remains to be seen what kind of  tax structure and the method of taxation that would apply to the QFI’s. I do believe that the larger investors would any day prefer their tax benefit to the ease of investing option.

It would only be the smaller foreign investor who invested through the non discretionary route of a sub-account (which is a complicated and costly route to take) who would probably consider this trade off worth taking. In that sense one may not see a rush of fresh investments coming in through the scheme but it could definitely bring in a new breed of investors and widen the base of the current investor profile.


5.    When a guru of the stock market was asked about this new regulation he said that opening just one market does not excite him too much, he went on to say that if one opens the stock market they should open up the commodity and currency market also then only will the big boys be interested to invest large amounts into India. This then clearly is another affirmation that the BIG investments may not line up under the QFI route.


6.    The pessimist may ask why an individual foreign investor should choose India, wont he put his money where his mouth is? And even if we assume that he is a diehard Indian market optimist one would think that he would prefer the easy route of an India ETF which is now available in choice especially in the American markets.  This argument I must confess does hold a lot of weight.


7.   SEBI has stated that one of the objectives of this regulation is to broad base investor bases, improve inflows and make the market less volatile. While the first two objectives are definitely achievable to some degree it is difficult to understand as to how QFI investments will reduce volatility. QFI’s are not lateral thinkers they will think and act like all investors who are driven by greed and fear and in market swings these investors will act like any other thus probably adding to the volatility and not reducing the same. Statistics from the American and British markets also tell us that 90% of the investors are day traders and if they now choose to invest into India there is no reason for these individuals to suddenly turn into long term players.


8.  It would be appropriate to conclude the analysis by looking at one big benefit that the QFI will finally have and that is true beneficial ownership. As a client who invested through the FII or through a sub account the client were merely holders of buy positions in a company and never enjoyed  voting rights and other benefits which they will now be able to exercise as “real shareholders”

It would also be very interesting to study the operative guidelines that SEBI is going to put in place. The qualified DP’s/ brokers  who believe that the QFI segment is a one worth servicing would have to ensure new systems and process( the kyc part of it would be a big challenge-unless simplified), beef up research by a huge margin and also gear up to build their brand, and after doing all this there is no assurance of success.


The QFI has thrown up a lot of debate and discussion and the proof of the pudding will be in its eating, so as we wait and watch for the happenings in the next few weeks like all investors I hope that more than anything this would improve the market sentiment more than anything else.


The author is Vice President at Unifi Capital. Views expressed are personal.
glenn@unificap.com

Friday, January 6, 2012

2012 - Transformational Year? - Focus to shift from Inflation to Growth

Contributed By: M. Ravvichandran, Vice President - Investment Strategy



The previous year turned out to be a nightmare with multiple domestic issues combined with slowing global environment.  What is worrying is the fact that the growth deceleration could spill over into 2012 and perhaps beyond.  As per reports, global growth is expected to slow from 4.2% in 2010 to 3% in 2011 and to 2.5% in 2012.  Considering the false start of FDI in retail and populist measures like Food Security Bill, the domestic policy prospects for 2012 don’t appear good.  Last year, we were discussing about double dip in US economy and possibility of India’s growth overtaking China.  Ironically, today the U.S. is doing satisfactorily and the hot topics are ‘Fiscal Integration in Europe’ and who will slow down more, between India and China!

Although USA may not recover significantly, the recession talk has vanished. European banks will continue to take a hit on their balance sheet owing to their exposure to sovereign debt.  Whether it is a ‘default’ or a ‘managed default’, credit shortage could become a handicap for growth in EU region.  In India, the government has to battle on many fronts.  The first half of 2012 will see concerns about a slowdown gaining prominence over peaking-off inflation.  Most of the leading economists have already revised down the GDP forecast for India to 6.7% for FY12 and 6.6% FY13, well below the government guidance of 7.25%.  This reflects the impact of higher interest rates resulting in slowing investment demand and global uncertainties affecting export demand.  I expect the growth rates to bottom out in middle 2012 on account of rate cuts and base effect.  I also expect the RBI to cut rates by around 200bps in Q2-Q3CY12. At this juncture, inflation is likely to peak off in early 2012.  However, with five states going in for elections in March ’12, I will not be surprised to see price hike in Kerosene, diesel and LPG post-elections.  Further, possible price increase in coal and power tariff cannot also be ruled out. These measures will once again stoke the inflation up, testing RBI’s policy stance. 

Any adverse global economic developments are obviously not in our control. What’s more deplorable is the fact that Indian government has severely fallen short of expectations on the reforms agenda. The problems are well-documented starting from coal shortage to policy paralysis, fiscal slippages and multiple scams.  The market participants don’t have any big hope on the reforms front as any related impact on the economy comes only with a lag.  However, one can hope that the government would be able to manage the fiscal issues without disturbing the rates as slowing economy will pull down the loan demand. Prudent fiscal management coupled with some determined policy decision-making from the political class could help the economy bounce back with a growth rate of around 8% in  FY2014.

What lies ahead?
Cyclical deceleration in growth and policy inertia are the key drivers for the current slow-down in India.  Unlike 2008, the problems now are home grown.  Trading volumes in equity market is at five year low and still declining.  The current bear market has sustained long enough and we have to look out for reasons that can cause a turnaround.  As explained earlier, consensus is also concerned about macro signs with fiscal, current account and rupee spiraling out of control.  Most of the domestic funds and insurance companies are a tired lot with no fresh inflow of funds. 

Though Indian markets look attractive based on P/E multiple, considering the amount of earnings downgrades the PEs may be higher than our current belief.  While markets could rally on rate cuts, the sustainability would depend on investment spending and policy reforms from capital.  As we go in 2012, though the macro picture looks weak, we will probably see raw material prices moderating on the back of a slow-down in China which in turn would help India Inc to improve their gross margins.  Interest cost will peak in next couple of quarters that would help driving below-the-line profits.  In other words, considering the below-expectation profits for December and March quarter, the base effect will provide some sense of optimism that earnings can surprise on the upside during the later part of 2012. Right now, “it’s so bad, it’s almost good”.

As we are in a transformational phase, it is easy to be bearish on India and equally easy to construct a bullish scenario from here-on. Most of the negatives are now well-documented and debated and hence are already reflecting in the price. Given the macro economic scenario, the beaten down stocks and sectors will continue to under-perform at least for next couple of quarters.  A further correction is likely to be in terms of time rather than value and a good entry point is likely to emerge soon. 


The author is Vice President at Unifi Capital, Chennai.  Views expressed are personal. Email: ravvichandran@unificap.com