A helping hand

While the measures announced by the government and RBI are in the right direction, they are not enough to stimulate economic growth and corporate earnings

Many countries across the world have seen a deterioration in their economic growth in the last one year. While the US, Europe and Japan are in a recession, China’s GDP growth has slipped to 9 per cent and is expected to slide further. India is no exception.

Its latest figures for industrial production have contracted, the first time in nearly 15 years. No wonder, governments and regulators across the world are desperately trying to arrest the decline in economic growth rates. The US has announced a $800 billion economic stimulus package, while China has announced a $586 billion package (14 per cent of its GDP).

The Indian government has also announced various measures to combat the slowing economic growth and shore up confidence. Its move to increase planned expenditure by Rs 20,000 crore is a step in this direction. However, considering that it is just about 0.4 per cent of the GDP, it is not significant. “In a highly uncertain economic environment, the measures taken by the Indian government are too small to have any significant impact on the economy,” says Sherman Chan, an economist with Moody’s Economy.com.

“There is an increasing risk of further slowdown and some of the key indicators like corporate earnings, industrial production, export growth and GDP numbers could get even worse, in comparison to what they were reported till some time back,” says Sherman Chan. Nevertheless, a majority of experts believe that the measures, though not enough, would surely act as a helping hand in restoring confidence and are a step in the right direction. “The measures do not seem to create any reversal, but will provide some life to the economy and help arrest the slowdown. The impact will not be seen overnight, it will still take another 6-9 months before the real impact is seen on the economy,” says Subir Gokarn, chief economist, Standard & Poor Asia Pacific.

“I think three big steps have been taken by the government. The cut in fuel prices along with the monetary and fiscal measures will ensure that there is more money in the system and in the hands of consumers. Also, incentives to exporters and reduction in excise duty (CENVAT) for all will help companies boost demand.

Overall, these are confidence boosting measures,” says D R Dogra, deputy managing director, Credit Analysis & Research. While the measures don’t look impressive, they will provide some cushion. The Smart Investor looked at these measures and other recent developments, to gauge their impact on various sectors.

Auto

* Companies cutting vehicle prices

* CENVAT cut by 4 per cent; metal prices down

* Diesel price cut by Rs 5 and petrol by Rs 2

* Falling interest rates and improved liquidity

Although largely positive, the measures are unlikely to boost demand, which has been sluggish on the back of stringent finance norms, selective funding and hardening of interest rates. Analysts believe that banks are still reluctant to part with funds and the situation is likely to continue for at least a quarter. While the dynamics for the various segments that comprise the auto sector are different, the core issue of funding and muted demand will mean that sales going ahead will continue to be marginally higher or flat in the last quarter of the current fiscal.

In the commercial vehicle (CV) space, while the 4 per cent excise duty cut will translate into a price cut upwards of Rs 30,000, drop in input costs and the stimulus package to CV user sectors (like steel and cement) could improve freight volumes, none are likely to lead to a significant surge in truck volumes as over 90 per cent of sales are on credit. Similarly, the fuel price cuts and the lower monthly installments will lead to a drop in running costs and are a positive but they do little to spur demand in a sector dependent entirely on economic growth to survive. If the 44 per cent y-o-y drop in November CV sales are any indication, the rest of the fiscal is unlikely to bring any good news.

In the passenger vehicle segment, sales have moved up for companies which have launched new models, but that has not stopped volume growth decline from a high of 24 per cent y-o-y in May to a negative 3 per cent in November. While it is now cheaper for consumers to purchase cars (price cut of upwards of Rs 8,000) due to the excise duty cut, expect sales to be muted as consumers defer purchases in the short term and await new launches.

In the two wheeler segment, the top two bike makers Hero Honda and Bajaj Auto are focusing on pushing entry level bikes in the rural and semi-urban segment which has the highest potential as penetration is at just 10 per cent levels. The price cuts are likely to start at Rs 1,000 and will help push sales as most purchases in the entry level segment are on cash.

For the sector as a whole, sales are closely linked to availability of finance and economic growth both of which are unlikely to be favorable over the next quarter. Unlike the high growth rates witnessed over the last for years, expect a muted 10 per cent growth in FY10 for the auto sector. Analysts prefer Maruti and Hero Honda.

Banking * Cut in repo and reverse repo rates, CRR, SLR

* Funding of Rs 7,000 crore to SIDBI, Rs 4,000 crore to NHB and Rs 10,000 crore IIFCL

* Loans up to Rs 20 lakh to HFC classified as priority sector lending

* Re-classification of risk weights

The RBI has unveiled a slew of measures including rate cuts to kick start the slowing economy. In October, the banking sector witnessed severe liquidity crunch and subsequent cuts in CRR (by 3.5 percentage points) and SLR (1 percentage point) has pumped around Rs 1.4 lakh crore and Rs 40,000 crore, respectively, have eased those fears. These measures along with a cut in repo rate will help lower funding costs for banks and NBFCs as well as improve liquidity. Overall, it could also help sustain credit demand.

In regard to correction in interest rates, Abheek Barua, chief economist, HDFC Bank says, “We see the median revision in bank deposit rates and PLRs in the 50-75 bps range in the near term.” He further adds that there would be a moderation in credit growth over the next quarter as the economic slowdown gathers momentum.

Although, liquidity taps have been flowing since the moves by RBI, banks were highly risk averse to lend to the real estate and SME sectors. RBI's announcements through sector-specific initiatives namely in, commercial real estate (treatment of restructured loans as standard assets for provisioning) means that banks now have increased flexibility in terms of provisioning for NPAs in this space. But, it also means that the reporting of losses on some of the problem assets could get delayed, thus inflating profits in the short term.

On the other hand, in housing loans, funds extended to housing financing companies up to Rs 20 lakh would now be classified as priority sector lending, which would provide a safer avenue for banks to lend. Stocks like HDFC and LIC housing would benefit in view of easier access to bulk funds from the banks.

While RBI’s concern about the growth cycle slowing led it to cut repo and CRR and which will help lower funding costs for banks, the decrease in reverse repo rates to 5 per cent (the lowest in three years) could discourage banks to park their surplus funds with the RBI.

Banks parking funds with the RBI reflected the former’s unwillingness to lend to borrowers, due to fears of loans turning bad. Thus, in future, it will be important for banks to focus on asset quality; otherwise it could lead to increase in NPAs. Analysts say that SBI, PNB, HDFC Bank and Axis Bank look interesting in the banking space.

Cement

* Cut of 4 per cent in Cenvat

* Steps to boost infra and housing demand

* Companies cut cement prices

While the reduction in excise duty was expected to reduce the cement prices by Rs 8-10 per bag of 50 kgs, the impact is partly nullified due to the recent hike of 8 per cent in railway freights for cement, coal and coke (expected impact of Rs 1.50-2 per bag). Hence, manufacturers have decided to reduce cement prices by Rs 4-6, depending on the location.

Say Hitesh Agrawal, head of research, Angel Broking, “The excise cut will not impact the profitability much as the benefits are being passed on to the customers. The problem is not with pricing, but with oversupply; to the tune of about 30 million tonne in FY09 and 35-40 million tonne in FY10.”

But, this stimulus package does provide a silver lining for the sector. The government intends to promote low-cost housing, which would increase the demand for cement (constitutes 20 per cent of the project cost). The pressure on margins of cement manufacturers is expected to ease with the reduction in cost of borrowings and 45 per cent correction in coal prices from its recent highs.

The industry hopes that in the upcoming package, its demand for abatement on excise duties on cement would be met. This could bring down the prices by Rs 18-20. Analysts like Grasim, Ultratech and Shree Cement from a 2-3 year investment horizon.

Infrastructure

* Higher budgetry support of Rs 20,000 crore

* IIFCL funding of Rs 10,000 crore, focus on faster project clearance

* Lower commodity prices, CENVAT cut by 4 per cent

* Increased liquidity by way of cut in CRR and PLR

Infrastructure spending could directly counterbalance the economic slowdown. The government’s emphasis on increasing spending will directly improve demand for goods and services. For some time there were instances of projects getting delayed due to a tight credit scenario and execution challenges. Like in the case of BOT road projects, the traffic or the future cash flow has to be justified with required internal rate of return. But, high interest rates and input costs impacted project viability. Even the viability gap funding (about 40 per cent of project cost) was not enough.

Thus, in many cases, bidders withdrew their bids or wanted renegotiation of sanction terms leading to delays. In this context, the government’s move of providing Rs 20,000 crore as additional planned expenditure on infrastructure for FY09 is positive.

The emphasis on speedy implementation of projects cleared under Public-Private Partnership (PPP) mode will also help. In order to facilitate the financing of such projects, the government has permitted IIFCL to raise Rs 10,000 crore to refinance bank lending of longer maturity projects such as highways and port. “At least, now there is increased focus on the financial closure of projects and the availability of funds through IIFCL route will have positive implications in the medium- to long-term,” says E Sudhir Reddy, CMD, IVRCL Infrastructures.

“If IIFCL raises funds at 7.5 per cent and gives it to banks at 8.5 per cent, then banks could fund the projects at 11 per cent, which is far better than the current PLR of 12.5 per cent. So principally, this is good step, but the quantum is very less,” says Virendra Mhaiskar, CMD, IRB Infrastructure Developers.

According to estimates, about Rs 100,000 crore will be required to fund the road projects over the next 12-18 months. In this light, the funds announced to be raised is inadequate. However, the industry believes the government might allow IIFCL to raise more funds by issue of such bonds, which will be a great boost for the industry, especially when the interest rates are also coming down. Analysts believe that the emphasis on PPP projects will benefit HCC, IRB, Madhucon Projects, which are mainly into BOT projects.

Besides ease in funding and lower interest rates (CRR and Repo rates have been cut), companies are also optimistic about the improvement in margins led by lower commodity prices such as steel and cement. According to estimates, the project cost will drop by about 5-10 per cent, part of which could be retained by companies. Additionally, lower fuel (diesel) prices will help as about 7-8 per cent of the project cost is spent on fuels like diesel. Also, the price of bitumen, a by-product of crude oil, and accounting for about 10 per cent of the cost in road projects, has fallen by 10 per cent to about Rs 36,000 per tonne.

Oil & Gas

* Diesel price cut by Rs 5 and petrol by Rs 2

* Lower interest rates

The government has cut diesel price by Rs 5 per litre and petrol by Rs 2 per litre on the back of a slump in international crude oil prices by around 70 per cent from its peak levels to $43-45 levels.

Although fuel price cuts are positive for most parts of the economy, the state-run oil marketing companies (OMC) like IOC, BPCL, HPCL would be under pressure as their under-recoveries would increase by an estimated at Rs 6,000 crore; total under-recoveries were earlier pegged at Rs 1.1 lakh crore for FY09.

The gross refining margins cooling off, is also a negative. On the positive side, along with improvements in liquidity conditions for these companies and downturn in interest cycle would ensure that interest costs would be lower. The OMCs are now also able to sell their oil bonds at significantly higher prices (due to falling interest rates), helping them earn profits on their investments.

As far as the upstream company ONGC concerned, issues regarding subsidy sharing and lower realisations have increased. The probable higher valuations being paid for the buy-out of Imperial Energy through its subsidiary, ONGC Videsh, is also not seen in positive light by analysts.

Power

* Cut in import duty of Naphtha by 5 per cent

* Increased liquidity and falling interest rates

* Drop in metal and fuel prices; cut in CENVAT

The government has eliminated the current 5 per cent import duty on naphtha for use in power plants. This will help power utilities bring down cost of power by about 50-55 paisa per unit. Companies will also gain on account of about 50 per cent drop in global naptha prices (since June 2008). The move will be marginally positive for companies like NTPC, which has gas-based generation capacity of 5,400 mw (total capacity of 29,894 mw).

Besides, companies like GMR Infrastructure and GVK Power will also marginally benefit due to the cut in import duty. GMR and GVK have gas-based power plants of 389 mw and 684 mw, respectively. These moves will lead to improved utilisation of plants of the three companies, which are currently under utilised.

Earlier many private power projects were delayed due to scarcity of funds and high interest rates. Analysts now believe that the improvement in liquidity will speed up financial closure of projects. Also, lower interest rates will mean substantial cost savings for companies setting up power plants on merchant basis (free pricing).

Additionally, the drop in commodity prices will enable companies to procure equipment supplies at lower costs. Overall, the developments are positive and will largely benefit companies setting up merchant power plants.

Real estate

* Priority sector status for loans up to Rs 20 lakh

* Increased liquidity and falling interest rates

* Support of Rs 4,000 crore through NHB

* Restructured loans classified as standard assets

While improved liquidity and lower interest rates are good news for the sector, the RBI’s move allowing banks to classify loans given to housing finance companies as priority sector lending for loans up to Rs 20 lakh per dwelling unit per family is positive. This could help further lower rates and thus, improve demand for low-cost housing. Additionally, the National Housing Bank (NHB) will be given a liquidity support of Rs 4,000 crore. These measures will help improve liquidity and prove beneficial for companies like DLF, Puravankara and Omaxe, which operate in tier-2 cities and have exposure to low-cost housing. 
 

LATEST FINANCIALS AND VALUATION
in Rs crore	Net  Sales	Chg  (%)	PAT	Chg (%)	Price  (Rs)	PE *  (x)
Alok Inds	2,517.0	30.0	173.0	-19.0	18.0	2.0
Axis Bank	8,629.0	52.0	1,401.0	75.0	469.0	1.9
Bombay Rayon	1,062.0	45.0	140.0	59.0	134.0	6.6
GMR Infra.	3,476.0	65.0	195.0	-22.0	64.0	98.6
Grasim Inds	17,992.0	14.0	3,200.0	12.0	1,074.0	4.9
GVK Power Infra	503.0	57.0	148.0	54.0	20.0	31.3
H D F C	9,391.0	36.0	2,419.0	26.0	1,636.0	3.9
HDFC Bank	13,296.0	65.0	1,893.0	43.0	920.0	3.4
Hero Honda	11,565.0	14.0	1,153.0	44.0	781.0	13.5
Hind.Construct.	3,320.0	26.0	102.0	-3.0	44.0	23.1
LIC Housing Fin	2,434.0	34.0	464.0	41.0	215.0	1.0
Madhucon Project	919.0	52.0	59.0	34.0	61.0	3.8
Maruti Suzuki	19,042.0	15.0	1,527.0	-15.0	506.0	9.6
NTPC	39,275.0	14.0	6,956.0	-14.0	165.0	19.5
Punjab Natl Bank	16,305.0	28.0	2,305.0	41.0	468.0	1.4
Shree Cement	2,417.0	46.0	294.0	-16.0	450.0	5.3
St Bk of India	80,930.0	40.0	9,223.0	28.0	1,215.0	1.6
UltraTech Cem.	5,876.0	12.0	992.0	12.0	341.0	4.3
Welspun India	1,345.0	27.0	1.0	-97.0	22.0	15.5
Net sales and PAT is for trailing 12 mths ended September 2008; Change is y-o-y basis * For banks and finance companies, PE represents Price-to-Book value Source: Capitaline Plus

The RBI’s move allowing banks to classify restructured commercial real estate loans (till June 2009) as standard assets is seen as a significant step. “This will provide fresh life to highly leveraged developers. Some of the distressed assets which would have fallen under NPAs will now be treated as standard assets for the extended period. The companies will have more time to manage their cash flows,” says Deepak Purswani, analyst, Sharekhan. According to analysts, this will help companies like Unitech (debt- equity of 3.55) and Sobha Developers, which are highly leveraged.

More than any issue, the whole sector is going through difficult times due to slow demand and declining real estate prices. Though not very significant, the interest rate trend has turned favourable. Analysts are hoping that the home loans rates might drop as some of the banks have already started quoting between 9.75-12 per cent as against 13-13.5 per cent earlier.

Also, lower steel (down by about 40 per cent in the recent past) and cement prices along with the cut in Cenvat for construction materials will ease significantly the pressure on account of rising construction costs. However, this is expected to be passed on to the end user, thus helping generate additional demand for real estate.

Overall, these developments are positive partly, but the concerns such as funding, low affordability, high real estate prices and overall slowdown in the economy still remains. Until real estate prices and interest rates fall further, to the extent they provide comfort to the buyer, and economic conditions stabilise, exect demand for real estate stocks to remain subdued.

Textile

* Export incentive of Rs 350 crore, Rs 1,400 crore for TUFS arrears

* Interest subvention on packing credit

* Refund of service tax on commission services

* Govt backup guarantee to ECGC

* Cut in lock-in period for loans under ECGC

The clearing of the entire backlog in the technology upgradation fund scheme (TUFS) would enhance cash flows of companies. Alok Industries is expected to gain from this move, as it has a receivable of Rs 123.8 crore under the TUFS.

The cut of 4 per cent in Cenvat rate would give a fillip to the manufacturing sector and enable reduction in prices. Besides, a back-up guarantee of Rs 350 crore, too, will be provided to export credit guarantee corporation (ECGC) for providing guarantee for exports to difficult markets and products.

While the stimulus package has come as a relief to the textile industry, industry bodies feel that the package is not sufficient enough to combat the adverse global economic situation. R K Dalmia, chairman of Confederation of Indian Textile Industry chose to describe the economic stimulus as “a package for survival, but not growth”, adding that the major facilities given for the sector are either by way of 'releasing withheld benefits' or by way of 'restoring withdrawn benefits'.

In the case of TUFS payments, reimbursements which had been withheld since September 2007 will now get paid, on the basis of the fund allocation in the package. Even the interest subvention of 2 per cent on packing credit is half of what was already available to the industry till September 2008. The industry was also hoping for an increase of incidence of duty drawback, which has been reduced by 20-35 per cent on various textile products and is now proving detrimental to the growth of industry.

“Unless the duty drawback and interest subvention rates are not increased, the industry will struggle to fight competition from China, Pakistan and Bangladesh. Also, the minimum support price for cotton continues to be high, despite fall in international cotton prices, putting pressure on margins,” remarked V S Velayutham, chairman, The Cotton Textiles Export Promotion Council.

Textile manufacturers and exporters have kept their fingers crossed, with regards to Christmas sales this year and the unfinished agenda of the stimulus package. Analysts feel that large textile exporters like Welspun India, Bombay Rayon and Alok Industries would benefit the most from these measures.

With inputs from Sarath Chelluri, Dhiren Shah and Ram Prasad Sahu