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P B N - F 2011: A Tight Rope Walk Implementation To Be in Focus
P B N - F 2011: A Tight Rope Walk Implementation To Be in Focus
PRE-BUDGET ANALYSIS
Research Team +91 22 6621 6301
EXPECTED SECTORAL IMPACT POSITIVE: Banking, NBFCs, Capital Goods, Cement, FMCG, Hotels, Information Technology, Oil & Gas, Power NEUTRAL: Automobiles, Aviation, Media, Metals & Mining, Real Estate, Telecom
Registered Office: Kotak Securities Limited, Bakhtawar, 1st floor, 229 Nariman Point, Mumbai 400021 India.
PRE-BUDGET ANALYSIS
On direct taxes, the exemption limit for individuals is expected to increase. SAD may be removed with a view to reduce import costs. Excise duties are likely to remain largely stable as inflation is high. Service tax coverage is expected to go up. We do not expect any major initiatives for the stock markets. The market is not expecting any major reforms initiatives and also understands that, supply side measures will take time to have any impact, we opine. Thus, we believe that, the focus of the markets will be more on effective implementation of investments, fiscal discipline and on sectors which are impacted by the budget proposals. We believe that, the budget may have positive implications for Banking, NBFCs, Capital Goods, Cement, FMCG, Hotels, Information Technology, Oil & Gas, Power sectors and may be Neutral for sectors like Automobiles, Aviation, Media, Metals & Mining, Real Estate, Telecom.
Market movement - one month before and after budget
Pre-budget 12% 8% 4% 0% -4% -8% -12% 2002
Source: Bloomberg
7.6
1.0
0.5%
-1.9
-3.3 -8.2
-3.6 -6.2
-4.2%
2004*
2005
2006
2007
2008
2009
2010
Sensex performance
21,000 18,300 15,600 12,900 10,200 7,500 Mar-08 Mar-09 Mar-10 Jun-08 Jun-09 Dec-07 Dec-08 Dec-09 Jun-10 Dec-10 Sep-08 Sep-09 Sep-10
Source: Bloomberg
This year, the FM is faced with twin challenges of controlling inflation and sustaining / improving growth rates. Last year, containing fiscal deficit was a bigger concern, in our view.
PRE-BUDGET ANALYSIS
16 12 8 4 0 -4 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11
Source: Bloomberg
We expect higher outlays towards investments in agriculture and irrigation. In the 2010-11 budget, the Government had allocated Rs.3bn to organise 60,000 "pulses and oil seed villages" in rain-fed areas during 2010-11. The benefits are visible with India looking at record pulses production this year. We expect similar allocations to primary articles in which India is deficient. The FM had also provided Rs.4bn to extend the green revolution to the eastern region and Rs.2bn were allocated for sustaining the gains already made in the green revolution areas. We can expect further investments in these areas. While the above steps will be in the right spirit, we believe that, these will take time to yield results. With a view to address some of the supply side constraints, we expect measures on the supply chain side and also to counter pilferage and wastage. The Public Distribution System (PDS) in the country facilitates the supply of food grains to the poor at a subsidised price. The PDS needs to be restructured and we expect believe there is a possibility of introducing innovative ideas such as smart cards, food credit/debit cards, food stamps and decentralized procurement, to make food available to the poor wherever they may be in cost-effective manner. India loses about 30% of its food-grains / vegetables / fruits, etc to pilferage and wastage every year. Thus, out of the total production of about 200 mn tonnes of these perishable commodities, about 60 tonnes do not reach the intended consumers. If this is addressed, we believe that, supply can be increased to a significant extent. We expect measures to improve storage facilities and build cold storage facilities, further encourage refrigerated transport equipment, etc. We note that, in the 2010-11 budget, several incentives were provided to improve the cold storage and cold room facilities, including farm level pre-cooling. Moreover, we expect that, the movement of food-grains between states may be made simpler and speedier. As of now, there are state level restrictions on foodgrains moving between states. This leads to shortages in several states and excesses in the remaining in turn, resulting in wastage. Removing these restrictions can reduce the periodic and geographical shortages. Thus, we believe that, the FM will focus on removing supply bottle-necks to improve supplies in the short term, while increasing agricultural investments to address long term supply issues. In addition to these, we expect the duties on several essential commodities to be reduced with a view to reduce the burden on the consumer. Import duties on several primary commodities may be brought down. India imports more than 70% of its crude requirements and reduction of duties on this commodity can have a sobering effect on crude price as well as prices of several downstream products.
PRE-BUDGET ANALYSIS
2005-06 5.1 8.5 1.3 10.1 7.1 12.8 11.2 12.2 12.7 7.0 9.5
2006-07 4.2 12.9 7.5 14.3 9.3 10.3 10.1 11.6 14.0 2.9 9.6
2007-08 5.8 9.2 3.7 10.3 8.3 10.7 10.4 11.0 11.9 6.9 9.3
2008-09* -0.1 4.0 1.3 4.2 4.9 5.4 9.5 7.5 12.5 12.7 6.8
2009-10** 0.4 8.3 6.9 8.8 6.4 7.0 9.7 9.7 9.2 11.8 8.0
2010-11*** 5.4 8.2 6.2 8.8 5.1 8.0 9.4 11.0 10.6 5.7 8.6
However, of late, there have been growing concerns about the pace of GDP growth. The moderation is reflected especially in imports and in IIP. The CSO has estimated the GDP growth in 2HFY11 at 8.2% v/s 8.9% in 1HFY11. We understand that, it is only partly due to the base effect. In this backdrop, we expect the FM to continue focus on investments, both physical and soft. We expect the focus of the budget to be on sustaining and improving the high rate of growth. Sustenance of high growth is very important to make the benefits of this growth reach all sections of the society. To that extent, investments, mainly in infrastructure, are expected to continue. Segments like roads, highways, airports, ports, power, etc are expected to receive continued attention and funding. India's high investment rate (about 35%) has been largely responsible in India achieving a high GDP growth rate. Thus, we expect the FM to continue to allocate investments, mainly to the infrastructure sector. The 11th 5-year Plan has envisaged total investment in physical infrastructure (electricity, railways, roads, ports, airports, irrigation, urban and rural water supply and sanitation) to increase from around 5% of GDP in 2006-07 to 9% of GDP by the end of the plan period if the targeted rate of growth of 9% for the Plan period (2007-12) is to be achieved. Consistent with the above projection, the investment in physical infrastructure alone during the Plan has been estimated to be about Rs.20trn. Of this amount, the share of the Central Government, the State Governments and the private sector has been projected at 37%, 32% and 31%, respectively. The Government had indicated it was targeting to construct 15-20 km of roads a day. We understand that, the average road construction currently stands at nearly 6-7 kms per day while projects have been awarded for nearly 3500 km in this fiscal. We expect the further stress on this target under the new Minister, Mr. C P Joshi. On the other hand, the Power Ministry has indicated its desire to be able to add power generation capacity of 62,374 MW in the current plan period (reduced from 78,700 MW). It also wants to reach its target of providing electricity to about 100,000 villages (reduced from 118,000 villages by 2009 earlier) by March 2012 (>78000 villages already covered). As of now, the government has awarded four UMPP contracts of 4,000 MW each and expects to award the others at the earliest.
PRE-BUDGET ANALYSIS
We note that, in 2010-11 budget, allocation for road transport was increased by over 13%. Also, Rs.168bn were provided for Railways, an increment of about Rs.9.5bn v/s last year. Plan allocation for power sector excluding RGGVY was proposed to be doubled from Rs.22.3bn in 2009-10 to Rs.51.3bn in 2010-11.
PRE-BUDGET ANALYSIS
FY09 437.51 766.02 179.69 100.79 485.55 28.52 34.93 30.09 1297.08
FY10BE 524.90 499.80 97.80 59.48 342.52 31.09 26.01 30.96 1112.76
FY10RE 560.02 529.80 140.80 39.48 349.52 149.54 27.19 43.70 1310.25
FY11BE 555.78 499.81 159.81 55.00 285.00 31.08 44.16 31.41 1162.24
In view of the above we expect subsidy bill in FY11 could come at about Rs.1900bn and for FY12E also, it could be budgeted at Rs.1900bn. Please note that petroleum companies get majority of their subsidies from upstream companies and government pays its part mostly in oil bonds and hence the subsidy burden due to fuel products doesn't get reflected fully in the budget figures. In our opinion, the fiscal deficit /GDP ratio should be about 4.8%, gross tax/GDP at 10.28% and total expenditure/GDP ratio at 14.1% in FY12 budget estimate. We believe that, any major deviation from the targets set out in the previous budget will be viewed negatively.
PRE-BUDGET ANALYSIS
Reforms at work
There have been several road blocks in the reforms process. Due to these, the implementation of important reforms like DTC and GST has likely been postponed to FY13, we understand. Thus, there may be no major announcements on these in the budget. At best, the FM may outline the Government's commitment to implement the same at the earliest. As far as GST is concerned, some of the steps which need to be taken are : harmonizing the service tax and excise duties, removing region-based exemptions, etc. Currently, while cenvat rate is at 8 - 12%, service tax rate is at 10% and VAT is at 12.5%. We believe that, GST has the potential to improve margins of companies by way of reduced cost on inter-state transfer of goods. A constitution amendment bill is likely to be passed in the budget session. As far as subsidies are concerned, an outline to reduce the subsidy burden on the Government may be drawn up, though there may be no concrete proposals. Apart from these, several initiatives in administrative reforms may be outlined in the budget. However, we believe that pension reforms and labour reforms will need wider political consensus before they are implemented. Possible disclosure of all financial guarantees provided by the Government will increase transparency. FDI limits may be relaxed in several sectors like retail, defence, etc and these may bring in additional funds.
Source: Economic Survey 2009-10, Annual Budget FY2010-11, Controller General of Accounts
PRE-BUDGET ANALYSIS
Source: Economic Survey 2009-10, Annual Budget FY2010-11, Controller General of Accounts
Stock markets
We do not expect any significant measures for the stock markets. Markets will be pleasantly surprised if there are downward revisions in STT and capital gains tax rates. The markets are not expecting major announcement on reforms. We opine that, if the budget focuses strongly on execution (for inflation control and investments) and adheres to the deficit targets, markets may not be disappointed.
Sectoral implications
We believe that, the focus of the markets will be more on : n Steps to control inflation - LT as well as ST measures n Speedier implementation of investment initiatives n Initiatives to sustain and improve the GDP growth, n Adherence to FRBM targets and n Sectors which will be positively impacted by the budget proposals
Expected sectoral impact
Budget impact Positive Neutral Sector Banking, NBFCs, Capital Goods, Cement, FMCG, Hotels, Inforation Technology, Oil & Gas, Power Automobiles, Aviation, Media, Metals & Mining, Real Estate, Telecom
PRE-BUDGET ANALYSIS
Budget estimates
(Rs bn) Receipts Revenue receipts (A+B) Gross tax revenue Direct taxes Corporation tax Income tax Other taxes Indirect taxes Customs duty Excise duty Service tax Transfers to States and UTs Net tax revenue (A) Non-tax revenue (B) Capital receipts Recovery of loans Other receipts (Disinvestments) Borrowings and other liabilities Net market borrowing Total receipts Expenditure Non-plan expenditure Non-plan revenue expenditure Interest payments Subsidies Food Fertilizer Others Grants to States and UTs Others Non-plan capital expenditure Plan expenditure Plan revenue expenditure Plan capital expenditure Total expenditure Revenue expenditure Capital expenditure Deficit Revenue Deficit Fiscal Deficit Primary Deficit Gross domestic product (GDP) PD/GDP (%) RD/GDP (%) FD/GDP (%) 3,383 4,232 2,037 61,642 3.3 5.5 6.86 2,731 3,785 1,298 69,347 1.9 3.9 5.46 2,681 3,831 1,231 78,770 1.6 3.4 4.86 3,202 4,312 1,562 89,798 1.7 3.6 4.80 7,063 6,419 2,195 1,310 560 530 220 466 2,448 644 3,152 2,644 508 10,215 9,063 1,152 7,362 6,437 2,487 1,163 556 500 107 460 2,327 925 3,731 3,151 580 11,093 9,588 1,505 8,235 7,310 2,600 1,900 800 800 300 460 2,350 925 3,850 3,250 600 12,085 10,560 1,525 8,410 7,460 2,750 1,900 800 700 400 460 2,350 950 4,235 3,575 660 12,645 11,035 1,610 5,680 6,331 3,886 2,551 1,314 21 2,445 845 1,020 580 1,773 4,558 1,122 4,443 43 260 4,140 3,984 10,123 6,857 7,467 4,317 3,013 1,281 23 3,150 1,150 1,320 680 2,091 5,376 1,481 4,265 51 400 3,814 3,450 11,122 7,879 7,969 4,566 3,061 1,485 20 3,403 1,360 1,346 696 2,231 5,738 2,141 4,107 91 285 3,731 3,367 11,985 7,833 9,227 5,144 3,520 1,604 20 4,083 1,633 1,616 835 2,584 6,644 1,189 4,838 100 400 4,338 3,915 12,671 FY10 RE FY11 BE FY11RE KS FY12BE KS
Source: Budget documents; Kotak Securities - Private Client Research Note: KS stands for Kotak Securities - Private Client Research estimates
PRE-BUDGET ANALYSIS
SECTORWISE EXPECTATION
10
PRE-BUDGET ANALYSIS
AUTOMOBILES
Current view
q After a difficult FY09, volumes for the auto industry in FY10 saw a sharp spike helped by the stimulus package announced by the government and the overall robust demand scenario. Auto industry grew in excess of 25% during FY10 and is expected to repeat the feat in FY11. Given the high base, volume growth for the auto industry is expected to moderate to a 12-15% range in FY12. q Tight liquidity and increase in interest rate pose a threat to our volume growth expectations. Currently, the general view is of further tightening of interest rates in the short to medium term. Such an outlook is negative for the auto sector in terms of volume growth. Furthermore, firm commodity prices have started impacting the margins. In such a scenario, any negative in the budget will be the last thing in the minds of the OEM's. q We do not expect increase in excise duty on back of concerns related to inflation. Any move towards restoration of excise duty rates to the original levels would work out as a negative for the auto sector. In the past 12 months, we have witnessed that any increase in vehicle prices failed to dampen the demand for vehicles. However the same may not hold true in FY12 because of moderating volume growth.
Excise duty
n Neutral
n Positive
Top picks
Company Price (Rs) FY11E EPS (Rs) FY12E PE (x) FY11E FY12E Recommendation as per our last report ACCUMULATE ACCUMULATE
1351 56
89.7 4.1
97.6 5.2
15.1 13.7
13.8 10.8
11
PRE-BUDGET ANALYSIS
AVIATION
Current view
q Aviation industry has had a dream year with most of the airline operators showing marked improvement in their operations. Passenger traffic growth remained almost flat between 2007 -2009 due to slowdown in the economy. However it grew by 19% in 2010 and is expected to remain strong in 2011. q Earnings for the airline players have improved in the past one year on 2 counts 1.improved load factor (which is a function of demand-supply situation) and 2.moderation in ATF price. Load factors have seen a significant improvement on the back of robust growth in passenger traffic and simultaneous calibrated increase in capacity. ATF prices on the other hand had been under manageable levels for the major part of 2010. However the current rise in crude oil prices (crude oil hovering near the $90/barrel mark) has made the aviation industry a bit wary. q Earlier attempts by the aviation industry towards bringing the ATF under the declared goods status have failed on numerous counts and we do not see any strong reason this time around for the acceptance of their above mentioned demand. We do not expect any major positive announcement for the aviation industry in the forthcoming budget. We therefore believe that the budget will be neutral for the aviation sector.
Key budget expectations
Issues Industry wish-list Our expectation Rationale for our expectation n Involves positive participation of all state governemnt n Industry has already turned around and is making profits n Major airports are now operated by private players Impact of our expectation n Neutral
Infrastructure status
n Infrastructure status to avail benefits under Sec 80-IA n Concessions in airport fees and other charges
n Unlikely
n Neutral
Concessions
n Unlikely
n Neutral
Top picks
Company Price (Rs) FY11E EPS (Rs) FY12E PE (x) FY11E FY12E Recommendation as per our last report
12
PRE-BUDGET ANALYSIS
13
PRE-BUDGET ANALYSIS
n Capital infusion in the form of tier-I capital for weak PSU banks
n Likely
n Likely
Relaxation in the lock-in period for savings to qualify for tax benefits (Under section 80C) To subsidize interest on loans given to SEBs
n Increase the attractiveness of term deposits and make it at par with other tax saving instruments.
n SEBs to get 3-5% concession on interest rates, which would be paid by the government.
n Likely
n Most SEBs have poor financial health; difficult to raise money or can be done at very high rates.
n Positive as this would partially dispel asset quality concern in power financing NBFC & PSU banks. n Positive, as actual provisioning towards bad and doubtful assets is higher than the deduction allowed under the Act. n Neutral
n IRemove the ceiling of 7.5% of gross total income allowed as deduction for bad and doubtful debts to banks; even this is not provided to NBFCs
n Likely
n To divergence between the provisions made according to the RBI guidelines and the deductions allowed by the IT Act.
n To provide exemption from TDS on all source of incomes received by them. n Reintroduce 10 (23) G of the Income Tax act which provided tax exemption to infrastructure capital companies
n As per the sec 196 IT act, tax is not required to be deducted at source on any payment to specified entities. n Increase attractiveness for lending to infrastructure sector.
n Likely
n Positive, it will reduce the effective tax rate depending on the exposure to this sector.
14
PRE-BUDGET ANALYSIS
Allahabad Bank Axis Bank BoB HDFC Bank ICICI Bank IDFC LIC Housing Finance PNB SBI
15
PRE-BUDGET ANALYSIS
CAPITAL GOODS
Current view
EXPECTED BUDGET IMPACT: Positive LONG TERM OUTLOOK: Positive
q Reflecting the buoyant mood in the economy, the capital goods index, which is barometer of the growth in the sector has posted decent gains in the current fiscal. For the period Apr-Dec 2010, capital goods index rose 21.5% yoy. However, the question remains how strong is the capital goods cycle. Management commentary indicates that order enquiries have been continuously improving, but we are nowhere closer to the boom in capital goods that we saw in 200708. q Several factors are pulling back the growth of the sector including increasing delays in project activity due to longer time on land acquisition and environmental clearance. Sluggish decision making is also stalling the growth in infrastructure activity. This happens to be the case in road building and Oil and Gas. Competitive scenario has also increased with several large orders being placed with the Chinese suppliers. In Transmission and Distribution equipment, availability of unutilized capacity is leading to margin erosion and higher capital engagement. Another concern is inflation which has negative implications for sector in terms slowdown in investment activity as well as increase in costs. Material prices have also inched up, which is an important parameter to monitor. q The third quarter results of the sector were largely mixed, with there being clear disappointment in order intake. While L&T, BHEL and Thermax reported strong earnings numbers, Voltas, Blue Star, Cummins and BEL reported profits that were lower than expectations. q Our preferred picks are L&T, BHEL, Thermax, Cummins, Greaves Cotton, BEL and Voltas.
Customs duty
n 10 per cent customs duty on import of power plant equipment for both the projects awarded through the international competitive bidding route and mega power plants. n Maintain Status quo n For urban development including metro rail and buses n Hike in income tax slabs
Change in excise duty Hike in allocation sought by Urban development ministry Personal tax slab
n Likely n Likely
n Neutral n Positive for BEML, Cummins n Positive for Voltas, Blue Star
n Likely
16
PRE-BUDGET ANALYSIS
BHEL L&T Voltas Thermax Cummins BEL Greaves Cotton Crompton Greaves Havells India
17
PRE-BUDGET ANALYSIS
CEMENT
Current view
EXPECTED BUDGET IMPACT: Positive LONG TERM OUTLOOK: Cautious
q Union budget is expected to be positive for the cement sector in terms of higher budgetary allocations for infrastructure sector. This is likely to boost cement demand going forward which had remained lower than expectations during FY11. q Cost pressures continued to remain high, thereby putting pressure on margins. Companies expect import duty on coal and pet coke to be abolished. q We continue to maintain our negative stance on the sector since incremental supplies are continuously putting pressure on the cement prices. Though cement prices were hiked in last quarter due to pricing disciple exhibited by cement players, we don't expect these price hikes to remain sustainable. Along with this, corresponding increase in cement volumes is not being witnessed in past few quarters due to slower demand growth.
n Increased spend on infrastructure for cement demand revival n No increase in excise duty
n To be increased
Excise duty
Export sops
n 50% freight subsidy for transportation of cement and clinker; Exemption from customs, port and bunker charges n 55% abatement on excise duty as against no abatement allowed currently n Abolish import duty on coal and pet coke as against 5% currently
Top picks
Company Price (Rs) FY11E EPS (Rs) FY12E PE (x) FY11E FY12E Recommendation as per our last report ACCUMULATE ACCUMULATE
1,701 2,333
76.1 226.4
118.2 238.7
22.4 10.3
14.4 9.8
18
PRE-BUDGET ANALYSIS
CONSTRUCTION
Current view
q We expect Union Budget 2011-12 to be positive for the infrastructure sector with higher budgetary allocations in different segments such as roads, irrigation, urban infra, ports, airports, power etc. We expect infrastructure companies to benefit positively in terms of higher order inflows going forward, as implementation improves. q The third quarter results of the sector were largely inline on revenue front but most of the companies had to deal with lack of order inflows as well as higher interest rates. Environmental clearance issues also impacted performance of companies during 9MFY11. q Order inflow during FY11 has been lower than expectations due to several issues such as delayed land acquisition, environmental clearance or cancellations, change in guard at the key ministry levels or at NHAI as well as corporate governance issues. We expect budget to address issues such as faster land acquisition. Along with this, we expect that NHAI to overcome the shortfall seen in achieving FY11 targets. We would continuously watch out for order inflows during H1FY12 which will translate into healthy revenue growth for FY12 and going forward. We thus expect focus of budget to be on higher allocations as well as implementation of targets. q Key beneficiaries from higher order inflows in roads, irrigation and urban infra are expected to be IRB Infra, IVRCL, NCC, Pratibha Industries, Unity Infraprojects.
Key budget expectations
Issues Fund allocation for roads, irrigation and urban infrastructure development Industry wish-list n Higher budgetary allocation for Bharat Nirman and NHDP, Accelerated Irrigation Benefit Programme, JNNURM n Extend the 10 year income tax holiday by another 15 years n MAT should be abolished for the tax holiday period during Section 80IA benefits n Full pass through of DDT for infrastructure SPVs Our expectation n Higher allocation in budget; Increased private participation Rationale for our expectation n Inline with government's focus of infrastructure creation Impact of our expectation n Positive for players having adequate experience and networth to bid for road, irrigation and urban infra projects n Neutral for the sector n Negative for companies which are in infrastructure development n Positive for players carrying out projects in separate SPV structures n Positive for the infrastructure sector
Section 80IA benefits for another 15 years MAT during the period of availment of Section 80IA
n May not be extended in near term n MAT may be increased by 2%. However surcharge may be abolished n Likely to be allowed
n Tax collection for government may get impacted n Inline with government's move towards DTC
n DDT exemption is likely to benefit many companies since most of them have multi layer holding structure n Banks would be allowed to claim deduction on interest earned on long term lending to the sector and hence will enhance lending to infrastructure projects
n Likely to be reintroduced
19
PRE-BUDGET ANALYSIS
Top picks
Company Price (Rs) FY11E EPS (Rs) FY12E PE (x) FY11E FY12E Recommendation as per our last report BUY BUY BUY BUY
184 519 80 58
20
PRE-BUDGET ANALYSIS
FMCG
Current view
EXPECTED BUDGET IMPACT: Positive LONG TERM OUTLOOK: Neutral
q Government's emphasis on rural sector employment and income generation shall be the key point to focus on for FMCG companies in this budget. The outlay for rural schemes is likely to be higher in the budget, given likelihood of indexing the minimum wages with CPI for agricultural labour under NREGA. Rural income enhancement, and its sufficiency in the face of high inflation, shall determine impact on FMCG stocks. HUL, Dabur, and GCPL's exposure to rural demand is higher than other listed peers, and shall be impacted in a greater way. q The government has been, as per media reports, making some headway towards implementation of GST, and a constitution amendment bill is likely to be passed in the budget session for pursuing the same, post-budget. Display of government's strong intent shall be beneficial to FMCG companies. q Given a preference for phased transition to DTC, the budget is likely to raise MAT this year. We believe a rise in MAT could also be accompanied with abolishing the surcharge, which, net-net, shall have a minor negative impact on FMCG companies paying MAT. q We expect excise rates on cigarettes to move up in low single digits, given sharp rise in last year's budget. Given that ITC stock has performed poorly despite strong 3QFY11 performance, we believe the market may be factoring in a possibility of another sharp rise in excise duties for cigarettes.
n Strengthening of economic stimulus to rural areas; increase in government spending in rural employment/ empowerment schemes n No changes/ Reduction in MAT
n Expect positive changes, although MGNREGS expansion may not be very high
Changes in MAT
n We expect MAT to be raise 2 ppt, and surcharge on the same to be phased out n Expect single digit increases
n No increase in excise duties for cigarettes, given strong increase last year, distortionary impact of differential tax on tobacco products n Clear Roadmap for GST Implementation
n Recent government parleys show incraesed activity towards passage of GST bill
21
PRE-BUDGET ANALYSIS
FMCG (contd...)
Top picks
Company Price (Rs) FY11E EPS (Rs) FY12E PE (x) FY11E FY12E Recommendation as per our last report
22
PRE-BUDGET ANALYSIS
HOTELS
Current view
EXPECTED BUDGET IMPACT: Positive LONG TERM OUTLOOK: Positive
q Indian hotel industry has huge growth potential given that India is one among the top growing economies globally. However, we stand poorly in terms of hotel infrastructure when compared to developed and developing countries. q In order to improve our hotel infrastructure at a rapid pace, the industry is seeking accreditation of infrastructure status under section 80-IA to the hotel industry. Accordingly the industry expects various benefits that are available under the said act for the development of hotel infrastructure. q Hotel projects have long gestation periods as they require huge investments of which the bulk is accounted for land and building. Currently hotel industry comes under the real estate sector and is subject to rules that apply to the real estate sector. Banks consider real estate lending as risky assets and since hotel projects are classified under real estate, lending to hotel projects attract higher interest rates. The industry is also looking to get some tax rationalization and single window clearance for various licenses.
Infrastructure status
n Hotel industry should be given infrastructure status and thereby enjoy benefits available under Sec 80-IA
n Likely
Top picks
Company Price (Rs) FY11E EPS (Rs) FY12E PE (x) FY11E FY12E Recommendation as per our last report
23
PRE-BUDGET ANALYSIS
INFORMATION TECHNOLOGY
Current view
EXPECTED BUDGET IMPACT: Positive LONG TERM OUTLOOK: Positive
q The IT services industry has likely returned on a high growth path after experiencing low growth over the past two fiscals. This is on the back of a revival in spends - both discretionary and otherwise - by clients. Budgets in CY11 are expected to be higher v/s CY10. NASSCOM has estimated an 18.7% growth in exports in FY11 and 16 - 18% growth in FY12. Domestic revenues are also expected to rise fast at 15 - 17% in FY12. q However, the evolving global economic scenario and revival in demand has also brought about challenges. Attrition is one of the biggest challenges being faced by the industry, especially the mid-tier and small companies. With larger companies turning aggressive recruiters, smaller companies are facing higher attrition and pressure on salaries. Exchange rate volatility has also been high, once again impacting the smaller companies more, which do not have adequate expertise to tackle the same. q The industry is expected to provide direct employment to 2.54mn people, a growth of 10%, in FY11. In this backdrop, the budget is expected to focus on maintaining an environment conducive to the future growth of this largely export-oriented industry. The sector has asked for an extension in the tax holiday (under section 10A/10B of the Income Tax Act, 1961) beyond FY11. Reduction in MAT rate is also on the wish-list of the industry, though we do not expect this demand to be fulfilled. q We expect the focus of the budget to be on enabling issues like promoting higher technical education (so as to meet the potential demand for employees from the sector), promoting better infrastructure facilities in Tier II cities and other related issues like skills development. Several operational issues on service tax refunds, etc are also expected to be addressed. q We remain optimistic on the longer term prospects of the industry. The Global Delivery Model has gained significant acceptance among existing and potential clients. We believe that, the outsourcing and off-shoring story will gather further steam in the future and this will see an increased flow of longer term and larger contracts to Indian vendors. Also, focused smaller companies with expertise on select verticals will be able to move up the value chain and attract larger clients, thereby, improving their longer term prospects. q Stock prices of most IT companies have out-performed the markets in the recent past, in line with the improvement in demand environment. We expect the sentiment towards the sector to remain positive and the sector to provide decent returns over the medium term, subject to near term volatility. At current levels, we prefer larger names like Infosys and TCS; we also retain our positive bias for select mid-caps like KPIT Cummins, Mphasis and NIIT Technologies.
n May grant extention for one year n May be increased, on the contrary
MAT
24
PRE-BUDGET ANALYSIS
n Simplification of refunds process in case of inadequate set-offs n New schemes based on location and employment
n Likely
n Not likely
n Neutral impact
n Likely
n Positive
Top picks
Company Price (Rs) FY11E EPS (Rs) FY12E PE (x) FY11E FY12E Recommendation as per our last report BUY BUY BUY BUY BUY
Source : Kotak Securities - Private Client Research; * Numbers are for FY10 and FY11E (October - end)
25
PRE-BUDGET ANALYSIS
MEDIA
Current view
EXPECTED BUDGET IMPACT: Neutral LONG TERM OUTLOOK: Positive
q We believe the budget shall be largely neutral for the media sector, with modest benefits likely for broadcasters/ DTH operators (reduction in SAD for set-top boxes), and FM radio players (positive noises on speedy implementation of Phase - 3 of FM radio licensing). Longer-term, we believe pro-consumption policies of the government shall drive the sector. With consumption gaining strength and incomes strong, near term prospects of media sector are robust. q We believe out-performance within the media sector shall primarily be driven by factors such as bargaining strength in the value chain and extent of monetization of readership/ viewership assets. q Inflation, and the resultant decline in real incomes from the impact, remains a large risk to our sector-performance expectations. Choices made in the budget to tackle the growth - inflation trade-off shall be critical in determination of consumption and (by implication) adex growth. q Perceived advances in the launch of Goods and Service Tax shall be a mild positive, given demands from the industry for certain taxes, largely entertainment tax, to be brought under the GST. Entertainment taxes are believed to create impediments for both DTH and cinema services.
n Expect positive pronouncements from the govt. on implementation n Inclusion of entertainment tax in GST. Inclusion of cable and DTH svs under GST
n Recent GOM meetings, positive noises from government; expect details to emerge postbudget n GST bill in preliminary stages, detail-drawing shall commence later
n Expect no announcement
n Augmenting FDI limites for various sub-sectors, such as radio, broadcasting, and DTH n Broadcasters wish for parity between print and broadcasting, i.e. removal of service tax; DTH operators wish for lower service tax
n There may be changes for FDI in radio broadcasting (26% from 20% currently) n Expect no change
Service Tax: Broadcasters (TV and Radio) are subject to levy of service tax; Taxation of DTH services
n Classification of the print media (industry) shall likely continue to dominate thought on service tax; DTH ops unlikely to get relief on account of fiscal priorities
n No Impact
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PRE-BUDGET ANALYSIS
Media (contd...)
Top picks
Company Price (Rs) FY11E EPS (Rs) FY12E PE (x) FY11E FY12E Recommendation as per our last report BUY BUY BUY
27
PRE-BUDGET ANALYSIS
q We expect the Budget to have a neutral impact on the prospects of Metals & Mining Industry and companies operating within it. q From a longer-term perspective, we believe that greater infrastructure spending on road, power, railways, ports and airports would be undertaken by the government and that would be positive for the sector. q Any amnesty scheme for black money abroad if announced in the budget would be very positive for the metals sector at it would boost real estate and consumer durables demand as well as infrastructure spending. q Our preference remains for mining companies in iron ore, zinc, coking and thermal coal space. Also, steel and metal companies which have captive ownership of above mentioned resources are likely to perform well. We have cautious outlook on steel and metal companies which have limited captive ownership of resources. q Revival of government spending in infrastructure is needed to boost demand for long steel. That would ease liquidity tightness and pressure on interest rates which in turn would boost demand for interest sensitive real estate (long steel products) and consumer durable sector (flat steel products).
n Industry wishes that there is no further roll-back of the reduction in excise duties. n Continue with its thrust on the infrastructure sector
n Unlikely.
n Likely. Higher allocation for the infra spending on railways, roads, port, airports and power. n Increase in MAT likely by 200bps to 20%, concurrent abolition of surcharge
n Positive for steel companies producing long steel and sponge iron producers n Marginally negative for steel, sponge iron & metal companies which have significant captive power capacity. n Neutral. Positive for steel companies if the proposal is accepted.
Increase in MAT
n Reduction in MAT
n ASSOCHAM has stressed upon raising the import duty on HR Coils from prevalent 5% to 10% as 8mn tonnes capacity addition in HRC likey in FY12. n Wants infra status for long term funds for steel industry at attractive rates and tax holidays.
n Unlikely.
n Import of steel has come down over last few months as domestic prices are lower than international prices. Also inflation concerns persist.
n Unlikely
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PRE-BUDGET ANALYSIS
n Steel industry expects increase in export duty on iron ore fines from 5% to 15%.
n Unlikely
n IFAPA wants increase in the custom duty on import of ferro alloys to 7.5%. n IFAPA wants reduction in customs duty on manganese ore and chrome ore to zero from 2%
n Unlikely.
n Unlikely.
Top picks
Company Price (Rs) 311 FY11E 46.6 EPS (Rs) FY12E 61.8 PE (x) FY11E 6.7 FY12E 5.0 Recommendation as per our last report BUY
Sesa Goa
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PRE-BUDGET ANALYSIS
q The Brent crude oil price is trading around USD$100/bbls leading to big risk of under-recoveries for oil marketing companies (OMCs) and also impacting the upstream exploration PSUs as they also have to bear the subsidy burden. Being a highly regulated sector, the fortune of the Indian oil and gas sector is extremely sensitive to government policies. The industry is eagerly anticipating measures which will encourage profitable activity in the sector. We expect some incentives in the forthcoming budget for the oil and gas sector.
n We expect the custom duty can be reduced to Nil as crude oil price is trading over $100/ bbls. n In 2008 also, the customs duty on oil had been reduced to nil when crude price had crossed the $100/bbls. However, later with the fall in the crude oil price the duty was re-imposed in FY10 budget.
n Allowing marketing companies to determine diesel retail prices as done for Petrol n Reduction of custom duty on diesel from 7.5% to 2.5%.
n We believe diesel de-regulation will not be done at this juncture. This can be taken separately by the govt. n We expect the duty can be reduced as under-recoveries on diesel is surging.
n We believe reducing the duty on finished products would reduce the underrecoveries. n This will also arrest the rising inflation as increase in diesel prices has a cascading effect.
n Govt. will promote shale gas exploration in India to ensure energy security of the Country.
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PRE-BUDGET ANALYSIS
n The investment-linked tax concessions proposed in the Direct Taxes Bill will provide a big incentive to overseas firms, which stayed away from the earlier rounds of bidding. Under the current scheme of exempting profits from tax, the firms don't benefit unless they find commercially viable oil or gas reserves.
Top picks
Company Price (Rs) 320 305 FY11E 33.9 19.2 EPS (Rs) FY12E 49.9 24.1 PE (x) FY11E 9.4 15.9 FY12E 6.4 12.7 Recommendation as per our last report BUY ACCUMULATE
Cairn IGL
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PRE-BUDGET ANALYSIS
POWER
Current view
EXPECTED BUDGET IMPACT: Positive LONG TERM OUTLOOK: Positive
q Installed capacity addition during first two years of XIth plan was 19582 MW which was almost equivalent to the entire capacity addition during the Xth plan highlighting acceleration in generation in capacity. For the XIth plan, 78000 MW of capacity addition was targeted. As against this, as per CEA, a capacity of 62374 MW is expected to be commissioned. A notable feature of the XIth plan has been the lead taken by the private sector in capacity building. q The annual power shortage at base load and peak load stands at 9.9% and 12.6% for FY10, underscoring the fact that the India continues to face power crunch. q With significant capacity addition under construction phase, we expect the supply crunch in power sector to narrow considerably in the next 3-4 years timeframe. q However, while capacity is being added, the financial health of SEBs has been deteriorating at a rapid pace due to their inability to completely pass the cost increase in power to its consumers. Increase in cost of power is the prime factor that has driven losses in SEBs. q As a result, we have seen in recent times that SEBs have resisted buying power even from long-term contracts. This is resulting in downward pressure on merchant power rates. Weighted average power tariff on short-term bilateral trades (account for significant share of short-term power sale) was in the range of Rs 4.0-4.25 per unit. q In our view, deteriorating financial health of SEBs and falling merchant prices are matters of grave concern since several existing and upcoming private sector capacities have sizeable share of power that has not been contracted through the long-term power sale agreement. q Another issue is of fuel security as Coal India Ltd may struggle to meet the demand from upcoming power capacity. q In this situation, we prefer utilities that have optimum mix between merchant power and long-term power, long-term fuel security and near-term project completion visibility. q Withholding tax is charged on the repatriation of income from equity or debt. The ability of domestic financial system to fund long-gestation power projects is limited by sectoral caps set by the central bank. In this regard, the power sector may get a boost if withholding tax on overseas investment in the sector is removed. q In view of the imposition of MAT, the industry expects the FM to do away with surcharge on tax of 7.5%.
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PRE-BUDGET ANALYSIS
Top picks
Company Price (Rs) 181 FY11E 10.6 EPS (Rs) FY12E 11.7 PE (x) FY11E 17.1 FY12E 15.5 Recommendation as per our last report BUY
NTPC
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PRE-BUDGET ANALYSIS
REAL ESTATE
Current view
EXPECTED BUDGET IMPACT: Neutral LONG TERM OUTLOOK: Cautious
q We expect Union Budget 2011-12 to be largely neutral for the real estate sector. q Real estate industry is expecting hike in the income tax exemption for interest and principal repayment. This is likely to result in increased demand in the residential segment. q Real estate industry is also expecting extension of Section 80IB benefits as well as uniformity in stamp duty across states.
Higher allocations for Rajiv Awas yojana, Indira Awaas yojana and Rural housing fund Section 80IB benefits
n Income Tax exemption u/s 80 IB (10) should be extended for another five years n Simplification of transaction costs such as stamp duty and give credit on taxes paid on construction material and service. n Hike income tax exemption for interest payment and principal repayment on home loans n Uniform stamp duty rates across different states
n Incremental benefits may not be extended to developers since prices are already at the peak n There is still time for implementation of GST
n Neutral
n Neutral
n Neutral
Top picks
Company Price (Rs) FY11E EPS (Rs) FY12E PE (x) FY11E FY12E Recommendation as per our last report
34
PRE-BUDGET ANALYSIS
TELECOM
Current view
EXPECTED BUDGET IMPACT: Neutral LONG TERM OUTLOOK: Cautious
q With gross subscriber base reaching 770 million and revenues crossing USD 20 bn, Indian telecom sector has reached its maturity phase with incremental growth coming from increasing penetration in rural/semi-urban areas. q Industry has recorded significant out flow for 3G spectrum and network upgradation this year. While this marks the beginning of the new phase of growth, there prevail uncertainties on the tax front that has been causing worries for the industry. q Amidst hyper-competition in the sector that has been forcing telecom companies to streamline their operations, consolidation appears to be a viable and inevitable option. However, the restrictive provisions in Section 80IA(12A) of the I-T Act denying tax holiday to undertakings in the event of amalgamation has been deterrent to such consolidations in the sector. q The telecom sector is also looking forward to extension of the tax holiday benefits under Section 80IA of the I-T Act. Such extension would provide thrust to the industry in the short to medium term.
n 3G spectrum usage right qualifies as an 'intangible asset' depreciable under Section 32 of IT Act n Extending tax holiday under section 80IA in the event of amalgamation or acquisition of business.
n Likely
n Unlikely
n Neutral
Top picks
Company Price (Rs) FY11E EPS (Rs) FY12E PE (x) FY11E FY12E Recommendation as per our last report
35
PRE-BUDGET ANALYSIS
Research Team
Dipen Shah IT, Media dipen.shah@kotak.com +91 22 6621 6301 Sanjeev Zarbade Capital Goods, Engineering sanjeev.zarbade@kotak.com +91 22 6621 6305 Teena Virmani Construction, Cement, Mid Cap teena.virmani@kotak.com +91 22 6621 6302 Saurabh Agrawal Metals, Mining agrawal.saurabh@kotak.com +91 22 6621 6309 Saday Sinha Banking, NBFC, Economy saday.sinha@kotak.com +91 22 6621 6312 Arun Agarwal Automobiles arun.agarwal@kotak.com +91 22 6621 6143 Ruchir Khare Capital Goods, Engineering ruchir.khare@kotak.com +91 22 6621 6448 Jayesh Kumar Economy kumar.jayesh@kotak.com +91 22 6652 9172 Ritwik Rai FMCG, Media ritwik.rai@kotak.com +91 22 6621 6310 Sumit Pokharna Oil and Gas sumit.pokharna@kotak.com +91 22 6621 6313 Shrikant Chouhan Technical analyst shrikant.chouhan@kotak.com +91 22 6621 6360 K. Kathirvelu Production k.kathirvelu@kotak.com +91 22 6621 6311
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