State Bank of India (SBIN)
Banks/Financial Institutions
Aligning deposit rates to market rates. We see SBI’s recent move to increase rates as
a measure to counter the rising cost of tight liquidity and normalize its interest rates in
line with market rates. We expect a marginal decline in NIMs in 2HFY11E from the
elevated levels of 2QFY11 and our earnings estimates capture that. We believe high
CASA banks will have a lower impact of rising funding costs compared to peers. We
maintain our estimates and believe the bank would benefit from better operating
leverage and lower provisions in FY2012. Maintain BUY.
Deposit rates across buckets increased by 50-150 bps; move aimed at normalization
SBI today announced a hike in its deposit rates by 50-150 bps across various buckets as the
liquidity environment continues to remain tight (advance tax outflows in December). Lending rates
remain unchanged. The overall increase looks sharper, regardless, we believe this rate hike is
aimed at aligning SBI’s interest rates towards market rates and the tight liquidity environment
experienced by the industry. The sharpest rise has been in the 46-90 day bucket at 150 bps (5.5%
and one of the highest in the industry), indicating that SBI is probably looking at the current
liquidity deficit to be temporary in nature, a situation likely to reverse in 4QFY11 as government
spending improves. This rate however, continues to be lower than prevailing call money rates.
However, the rates have been increased by 100 bps in the 1-3 year categories (7.75-8.5%)
Strong CASA ratio of 48% to cushion rising costs; building NIM decline in estimates
In light of tight liquidity environment, we favor high CASA banks like SBI to cushion the impact of
steep rise in deposit costs. As of 2QFY11, SBI had a CASA ratio of 48% (domestic deposits),
second highest in the industry following HDFC Bank.
We anyways build reasonable cushions in our 2HFY11 estimates as we expect FY2011
improvement in NIM (calc) of about 45 bps while the bank has been running at about 60 bps
higher NIMs during 1HFY11, as compared to FY2010 NIMs. Also, our earnings already factor NIMs
to decline in FY2012 by about 10 bps to 2.8% (calc).
Logical to expect lending rate hike as well; credit growth is also picking up
We believe SBI will also raise lending rates in due course. Even in the past, lending rate hikes have
followed deposit rate hikes. Further credit growth has just started to pick up – bankers have been
highlighting that credit growth has been firm during recent times and is getting more diversified.
We believe pricing power remains with bankers on the back of steady loan demand coupled with
tighter liquidity in the system
Earnings impact limited as strong levers available
We believe SBI has multiple levers to deliver over 20% earnings growth and RoAs of 1%
despite NIM pressure in FY2010-12E, mainly from better operating leverage and lower loan
loss provisions. A cost-income ratio of 47% and opex/assets at 2% has scope for further
improvement as the bank has completed near-term investments in branches, technology and
employees. 2HFY12 would see loan loss provisions to ease as the bank reaches 70%
provision coverage ratios as mandated by RBI. Also, strong improvement in the underlying
economy would also see lower slippages and higher recovery cycle resulting in lower loan
loss provisions (we are building FY2012 loan loss provisions to remain at FY2011 levels).
v
10 Yr bond infringes the 8.20% level; sentiment remains subdued
Government securities
Bond yields edged higher as sentiment remained subdued on concerns of the
additional strain on liquidity due to the outflow of advance taxes in mid December
approximated to be INR 550 bn. Market participants are hopeful of the central
bank intervention to provide respite from the stiff liquidity situation, at its policy
meet on 16th Dec. The benchmark bond closed 3 bps higher at 8.21% while the
8.13% 2022 maturity bond closed 4 bps higher at 8.21%.
Concerns over the liquidity and the selloff in the bond market drove swaps rates
higher. The one swap closed 6 bps higher at 6.91% while the five year swap ended
7 bps higher at 7.33%.
Non-SLR market
Banks mopped up INR 40 bn in Certificate of Deposit. Mutual fund preferred to
invest in 3 month CD as the spread between the 3 month & 1 Yr CD narrowed to
25-30bps. Allahabad Bank placed INR 15.50bn CD maturing on 8th Mar, 2011 at
8.90% while Corporation Bank placed INR 5bn March maturity CD at 8.85%.
Punjab National Bank and IOB placed INR 10bn & INR 7bn respectively in March
maturity CD at 8.95%. Bank of India placed INR 250mn in 1 Yr CD at 9.12% while
LIC Housing Finance placed 2 Yr NCD amounting to INR 2bn at 9.40%
Money markets
Overnight rates ended firm at 6.72%, well above the central bank’s lending rate,
at the onset of the new fortnightly reporting cycle. The temporary flexibility given
to banks allowing their holdings for SLR to fall to 23% of deposits has helped
control the call rates. However with the outflow of the third installment of
corporate taxes by 15th Dec will further strain the liquidity situation. RBI injected
INR 1.15 trn in to the system through the LAF today compared to the average of
INR 1 trn in the last fortnight.
Biocon (More milestones ahead, BUY):
We came out more positive from our meeting with Biocon’s management. Licence fees from the recent insulin deal with Pfizer will start getting recognised from this quarter; the upfront payment of US$200m is significantly more than the development expense, ensuring good margin on the revenue recognised, and emerging market ramp-up of the partnership will come soon (India launch expected in 2011). Listing of CRAMS subsidiaries and progress in monoclonal antibodies partnership with Mylan could be medium-term upsides. We raise our FY11-12 core earnings estimate by 10–11%, as revenue from the Pfizer deal will more than offset high R&D expense of EU insulin trials. We upgrade Biocon to BUY and raise our price target to Rs492.
HDFC (HDFC)
Banks/Financial Institutions
Rising home loan rates will temper loan growth. HDFC has raised home loan rates
for existing customers by 75 bps with effect from December 1, 2010. HDFC has
withdrawn the dual rate home loan scheme and now offers new home loans at 9.5%
as against 8.75-9% earlier. The management expects margins to remain stable post the
current hike. We believe that the rise in real estate prices coupled with rise in lending
rates will likely affect loan growth in the retail lending business. Valuations remain rich,
retain REDUCE.
HDFC has increased home loan rates, others to follow suit
HDFC has increased its PLR by 75 bps with effect from December 2010. This hike follows a 50 bps
rise in PLR in September 2010. Home loan rates for new customers have also been increased to
9.5% for loans up to Rs3 mn, 9.75% for loans between Rs3 mn and Rs7.5 mn, and 10% for loans
above Rs7.5 mn. HDFC and ICICI Bank have withdrawn their dual rate (teaser) home loan schemes
following sharp rise in interest rates. In the recent credit policy review, RBI has increased standard
asset provisions for dual rate loans offered by banks to 2% from 0.4% earlier.
Over the weekend, ICICI Bank has also increased their home loan rates by 50 bps. SBI will review
the rates in January 2011; however, most other banks are currently reviewing their home loan
rates and will likely announce rate hikes over the next few weeks.
Borrowings cost has increased, hike will support margins
The bulk borrowings rates have increased by about 100-300 bps over the last two quarters. CP
rates have now increased to about 9.5% due to the liquidity crunch. Last week, liquidity in the
system was at a peak deficit of about Rs800 bn. We believe that the rise in bulk borrowings rates
in the system will prompt the bank to hike lending rates. Banks with high CASA—HDFC Bank,
PNB, BoB and Union Bank—will likely be better-placed in the current environment. HDFC’s
management has highlighted that the company will be able to maintain margins post the current
hike. The entire portfolio will be re-priced within next three months.
SOTP-based target price of Rs720; retain REDUCE
We retain SOTP-based target price of Rs720. In our fair value estimate, we value HDFC’s
mortgage business at Rs400/share—6X core PBR and 19X core PER FY2012E. In order to
capture the impact of the likely warrant conversion in FY2013E, we have valued the business
using a residual growth model as of March 2013E and discounted back the value to March
2011E at 12.5%. At our fair value estimate, the mortgage business will trade at 4X core PBR
and 15X core PER FY2013E for RoEs of about 26-30% (2% core RoA and leverage of 13-
15X).
India Financial Services
Deposit Rates – 100 bps Hike
Quick Comment – What’s new: State Bank of India
has raised deposit rates by 50-150 bps across maturities.
In the 1-2 year bucket (using 555-day deposit as
benchmark) SBI has increased rates by 100 bps. No
changes in prime lending rates / base rate have been
announced as yet. SBI’s rate increase follows increases
by other entities during the past week
Pace of increase was a surprise: While we were
building in deposit rates to increase at about 50 bps per
quarter – the pace of the increase (+100 bps) was
sharper than expectations. Historically, we have not
seen such a sharp in increase at one go by SBI.
Margins to normalize going forward: Over the last
few months Indian banks were benefitting from higher
lending rates, lag in feeling the impact of higher deposit
rate and higher LD ratio. However, now NIM’s are close
to peak levels and ready to normalize. We expect NIM’s
to come down (though likely to stay higher than historical
average) – today’s rate hikes don’t have a material
impact on our numbers. These rates will flow through
earnings over next 12 months and we will not be
surprised if the bank increases lending rates by then.
Our numbers will be affected if banks raise deposit rates
further without touching lending rates.
Why didn’t the bank raise lending rates – As we have
mentioned in our previous notes, historically banks used
to raise deposit rates and touch lending rates with a lag
of 3-6 months (loans are floating rate while deposits are
fixed rate). In this cycle, SBI raised lending rates along
with deposit rate, till now – probably to ensure adequate
revenue momentum to meet higher credit costs. Now
with NIM’s at 3.4% and rising, it can afford to revert to
old style rate hikes. Exhibit 10 shows how banks with
strong funding had seen lending spreads expand during
last rate hike cycle.
Why a sharp increase in deposit rates? Deposit growth in
India continues to lag credit growth owing to low real deposit
rates – hence incremental credit-deposit ratio both on trailing
3M and 1 yr basis have been elevated. This is also reflected in
the tight-interbank liquidity conditions. The sharp increase
announced today would have likely been driven by the fact that
we are entering the “busy” season in terms of credit growth and
banks may be looking to raise deposits ahead of the same.
How many more deposit rate hikes? We expect another 50
bps deposit rate hike (over 3-6 months) and about 75 bps PLR
hike (over next 6-9 months). While the first reaction on seeing
the 100 bps rate hike is to think that rates are going to rise
sharply, history provides some perspective. The last time SBI
was offering around 8.5% on 1 year deposits (April 2008), repo
was at 7.75% (6.25% right now), CRR was 7.75% (6% now),
crude was US$ 115/barrel, WPI inflation was at 8% and rising
to 11.2% by July. Unless inflation goes awry, we are likely
coming close to the end of higher deposit rates.
Near term pressure likely, buy liability franchises – We
continue to prefer strong liability franchises. Stocks could be
under pressure in the near term especially until liquidity
conditions improve. In this environment, we continue to prefer
HDFC Bank and State Bank of India wherein the strong liability
franchises will provide an offset and revenue growth will
continue to be robust.
We have also liked asset aggregators but given the pressure
on liquidity stock performance is likely to be weak in the near
term. However, we would look at buying on weakness as we
expect these stocks to do well in 2011.
• Our global coal team expects international thermal coal prices to pick
up in CY11 ($101/ton for Newcastle coal vs. $95/ton in CY10), backed
by high China / India demand and supply / export constraints.
• We expect Indian IPPs to remain resilient to rising coal costs in the
medium term. 1) 81% of system-wide thermal coal is sourced from COAL
IN, which has seen a nominal 4.9% CAGR in prices over the last 10 years,
and is at a ~40-50% discount to international prices; 2) 73% (36% exNTPC) of ongoing projects in our coverage universe are insulated due to
regulated returns, and some PPAs have fuel cost pass-through as well-we
estimate a 10% rise in coal costs can raise average genco tariff by 5-6%.
• Long-term risks on both supply and pricing: 1) Firm guarantee by COAL
IN for only 50% of contracted quantity. As per JPM India mining analyst,
India is headed for a thermal coal shortage of 181MT by FY14 and thermal
coal imports could rise 2.8x from current levels. In our view, plants are at
risk of operating at lower capacity utilization or increasing their use of
imports, pushing up costs. Ongoing delays in developing captive coal
mining blocks could further tighten the situation. 2) Indian coal policy
makers are exploring pricing domestic coal at parity with imported coal, and
also a pool pricing mechanism. 3) End of regulated return era for new PPAs:
long-term risk of margin squeeze due to rising coal costs.
• Indian IPPs’ relative position and stock picks: TPWR benefits from
rising coal prices due to its stake in Indonesian coal mines, however past
coal price rises have been neutralized by cost hikes and bottom line flowthru has been limited. JSWE most at risk: 66% of its capacity is on ST
tariffs and all coal is sourced at international market rates. Lanco: Well
hedged fuel strategy, only 1.2GW on imported coal with regulated tariffs.
NTPC: All projects are regulated, coal cost is pass-through. Adani: sweet
coal pricing deal from Adani Enterprises protects it to large extent. RPWR:
captive mines + some pass-through protection in place for 38% of capacity.
• Indian IPPs shopping abroad for resources, with billions of dollars to
spend: we expect long-term benefits and the quest to intensify. Adani
Group spent an upfront US$455M for 7.8Bt Australian Galilee asset and will
pay royalties of A$2 for each ton of production. JSW Energy spent
US$414M for South African coal assets. TPWR was an early bird in
Indonesia, but has stated its appetite for more. GMRI has made smaller buys.
GVK and Lanco have reportedly bid ~US$1B for Australia’s Griffin Coal
which has 250-300MT of reserves. We expect a 5-year cycle for coal mine /
infrastructure development and hence benefits to accrue only post that.
Sterlite Industries (STLT)
Metals
Sterlite completes acquisition of Skorpion zinc mine. Sterlite completed acquisition
of Skorpion zinc mine in Namibia at a consideration of US$707 mn from Anglo
American plc. Sterlite expects to complete acquisition of remaining two zinc mines from
Anglo American by end-FY2011E. Acquisition of the entire portfolio of Anglo American
zinc mines will be EPS accretive though value accretion will be contingent on (1) longterm zinc price sustaining above US$1,900/ton and/or (2) significant accretion to
reserves.
Sterlite completes acquisition of Skorpion zinc mine; remaining two likely by end-FY2011E
Vedanta Resources had entered into a definitive agreement to acquire zinc assets of Anglo
American (Anglo) for a cash consideration of US$1.33 bn in May 2010. Vedanta stated at the time
of acquisition that (1) consummation of each of the three operational zinc assets in South Africa,
Namibia and Ireland would be done separately and (2) it would seek approval from HZ board and
Indian Government to complete acquisition through Hindustan Zinc (HZ), failing which the
acquisition will be done by Sterlite Industries.
Sterlite completed acquisition of Skorpion zinc mine in Namibia (after HZ failed to get approvals in
time) at a consideration US$707 mn (increase in consideration by US$9 mn since the initial
announcement is entirely attributable to accrued cash). Sterlite standalone entity can easily fund
the acquisition through its cash reserves of US$2 bn at end-Sep ’10. However, the acquisition of
Anglo zinc assets by Sterlite leads to inefficient capital and corporate structure.
Skorpion mine acquisition will be EPS accretive though value neutral
Skorpion mine has reserves of 911 kt of contained zinc metal, resources of 24 kt and annual
production of 150.4 kt of zinc at end-2009. Financials will be consolidated with retrospective
effect from Jan 1, 2010. Cost of production is at ~US$904/ton. We expect this acquisition to add
4.2% and 4.1% to our FY2012E and FY2013E EPS, at a zinc price of US$2,150 and US$2,250/ton.
We expect the acquisition to be value-neutral on disclosed reserves and long-term zinc price of
US$1,850/ ton. At the spot price of US$2,208/ ton, the acquisition will add Rs4 to our fair value.
Completion of remaining mines by end-FY11E and will entail further cash outflow of US$640 mn
Sterlite expects to complete acquisition of Lisheen mine in Ireland (935 kt of reserves and 102 kt of
resources) and Black Mountain mine in South Africa (480 kt of reserves and 378 kt of resources)
by end-FY2011E at a consideration of US$640 mn. Total consideration of all three mines stands at
US$1,347 bn, which Sterlite can easily fund through its cash reserves. Acquisition will add 8.3%
and 8.4% to our FY2012E and FY2013E EPS at zinc price of US$2,150/ton and US$2,250/ton,
respectively.
Acquisition of Anglo American zinc assets will make the company one of the largest zinclead producers in the world. Anglo American will add close to 400 ktpa of zinc-lead
production. The entire acquisition is value neutral; assuming mine life ends at the current
disclosed proven and probable reserves and assuming zinc prices of US$2,000, US$2,150
and US$2,250/ton for the next three years and long-term average of US$1,850/ton. The
entire acquisition becomes value accretive on (1) conversion of mineral resources of existing
mines to reserves and (2) option value of Gamsberg undeveloped mines. The conversion of
resources to reserves will add Rs10 to our fair value.
We compute value accretion of Rs7/share assuming long-term zinc prices stay at the current
level of US$2,208/ton. Anglo assets will likely generate EBITDA of US$310 mn in FY2012E at
the current zinc price; the acquisition consideration will appear inexpensive at 4.3X FY2012E
EBITDA.
Operating zinc assets are of high quality
Operating mines acquired/to be acquired from Anglo is of high quality; the cash costs of
these mines would in the 2
nd
quartile (range US$639/ton to US$1,018/ton). The three mines
acquired/to be acquired generated revenues of US$340 mn, EBITDA of US$171 mn and net
income of US$137 mn in 1HCY10 at an average LME zinc price of US$2,161/ton.
Details of mines acquired
` Integrated zinc mining and refining facilities named Skorpion in Namibia with annual
production capacity of 150 ktpa. The mine has reserves of 911 kt of contained zinc and
total resources of 24 kt at end-2009 with mine life of seven years. Vedanta has paid
US$707 mn for this mine. Cash cost of production in 1HCY10 was US$911/ton.
` Underground mine named Lisheen in Ireland with zinc and lead metal in concentrate
reserve of 935 kt (mine life of six years) and resources of 86 kt. Vedanta is expected to
pay US$308 mn for this mine. Cash cost of production in 1HCY10 was US$639/ton.
` 74% stake in Black Mountain mine in South Africa. Black Mountain is an underground
mine producing zinc (28.2 ktpa) and lead (49.1 ktpa) concentrate. Black Mountain mine
reported revenues, EBITDA and net income of US$54 mn, US$15 mn and US$11 mn in
CY2009.
In addition, Vedanta gets rights to the Gamsberg mine, one of the largest undeveloped zinc
deposits with potential resources of 186 mn tons. Vedanta indicates the potential to
produce 400 ktpa of zinc and lead. Vedanta has paid US$1.3 bn for these assets. Note that
the Gamsberg mine will ramp up to 400 ktpa of production only by 2018E. Press reports
indicate a capex of US$1.8 bn to ramp up the projected capacity.
