1. STERLITE INDS: Alcoa says aluminium market tightening; Sterlite will have large lever in aluminium

Alcoa's (AA US, Mkt Cap US$7.2b, CMP US$9.3, EV/EBITDA 69x CY09, P/B 0.7x CY09, Not Rated) CEO Kleinfeld, in 2QCY2009 results presentation, expects aluminium market to tighten due to scrap scarcity, long-term financing deals making metal inaccessible and massive de-stocking.



Inventories have increased at LME only, but declining elsewhere

- Aluminium's worrying fundamentals have been well documented and the market is still challenging, with consumption falling about 7% this year while stocks have risen substantially. But despite these factors, Alcoa sees a tightening market. "The main increases have been in London Metal Exchange (stocks)," Kleinfeld said. "But what people don't understand is that while they look very, very high, there are some logistical and contractual constraints that reduce the accessibility of what exists as an LME warehouse stock."

- Inventories, including producer stocks, Japan port stocks and the Shanghai inventories, have been declining. "This is a function of the de-stocking in the system," he said. Restocking will be the engine behind the market's recovery, Kleinfeld said. He noted that U.S. service center stocks had declined 51 percent from the peak level in October 2006 to the lowest level this decade, according to the Metals Service Center Institute. "You can really see that the supply chain is very, very thin," Kleinfeld said. "Once the assumption of demand comes back there will be a pretty substantial metal flow filling the gap."









Aluminium scrap market has constricted considerably

- Alcoa maintains its first-quarter estimate that global aluminium consumption will be down about 7% to 34.5m tons in 2009, including about 1m tons of primary metal that is going to be substituting for the deficit that is occurring in the scrap market. Kleinfeld also noted that the aluminium scrap market has constricted considerably due to significantly fewer vehicles being scrapped, a function of low steel prices and reduced industrial production. Alcoa said that scrap prices as a percentage of the LME went up considerably during the second quarter.



…Curtailed capacity, a very thin supply chain and a scrap gap has caused pockets of metal tightness

- As an example of the recent spot market tightness, Kleinfeld pointed to the recent run-up in regional premiums, traditionally an indicator of spot market tautness. The U.S. Midwest premium for prompt material was stuck around 4.2 cents per pound from July last year until last month but has come alive recently, reaching 5 cents per pound and showing signs of hitting 5.25 cents, according to traders.

- It is the first time the premium has surpassed 5 cents since 2006. "We have seen curtailed capacity, a very thin supply chain and a scrap gap," Kleinfeld said. "This has caused pockets of metal tightness already, which is evident by the uptick in regional premiums."



Sterlite will be highly leveraged to aluminium, going forward; re-iterate Buy

- Sterlite (STLT IN, Mkt Cap US$8.3b, CMP Rs576, Buy) has lined up large expansions in aluminium and power to capitalize on low cost, high quality captive cauxite and captive coal mines in mineral rich state of Orissa.

- On successful excise of call option of the remaining 49% of Balco and completion of expansions, the attributable aluminium capacity of 175ktpa (51% in Balco) in FY09 will rise to 1mtpa by FY13, which will be insulated from input price risk of energy and bauxite.

- These expansions have potential to increase earnings manifold in medium to long term. Aluminium's contribution in consolidated earnings of Sterlite was insignificant in FY09, while VAL made losses due to initial ramp up costs.

- Cost of production of Aluminium is expected to be in lowest decile of global cost curve. Lanjigarh bauxite mine is expected to start in Oct-09, which will turn around VAL in 2HFY10.

- Capital intensive investment in aluminium has so far been viewed more as risk than opportunity due to execution risks and high leverage in this segment. A change in outlook will augur well for the stock.

- Additionally, Sterlite has major growth in Zinc, Lead, Silver and Power. Balance sheet is one of the strongest among metal companies. Stock trades at FY10 P/B of 1.4x, FY11 PE of 13.4x. Our metal price assumption is US$1500/ton for Zinc, Lead and Aluminium, US$4600/ton for Copper, and US$/INR of 45. Re-iterate Buy







SENSITIVITY





STRONG GROWTH PIPE LINE



Source: Company









EXCERPTS: From Concall Opening Speech by Klaus Kleinfeld, President and CEO, Alcoa

But let me first start with something that I probably get asked more of these days than around Alcoa, I get asked more on what's really going on in our end markets. As you all know, Alcoa is a global company and we have a lot of end markets that we cater to and we are very, very early in the chain, so we see some changes there at an early point in time. So this slide many of you are used to; this is an update of it.

- So let me just go through it and let's start with the aerospace market. We really do see some early signs of a cyclical downturn. There are more parked aircraft. There is weak airline traffic, some order cancellation. It is expected to have a 6% decline of deliveries of large aircraft, and that's already adjusted for the Boeing strike impact of last year.

- Let's move over to the automotive segment, obviously a very, very important one also for us. Global demand is expected to drop down to 52 million cars. That's about a 20% decline from 2008. However, there are some signs of stabilization. We expect that in the US in the second half, the build rates are going to go up by about 1 million cars compared to the first half of the year, which is basically a restart to replenish the inventories. Inventories had fallen by 40% from the start of the year, which is about 1.3 million vehicles. And some of you have certainly seen Ford and Toyota announce to boost production on some of their more popular models as inventories have reached a level which they consider very, very low, too low, and that's why they started up. That's one thing. The other thing that we see here is President Obama has signed the Cash for Clunkers Bill. This is expected to get an additional 200,000 cars sold. Obviously given the timing, this is back end loaded – back end 2009 loaded. Many of you may remember there have been similar preceding programs very successfully implemented in many of the European countries. So I believe that this is also going to have a positive impact here. And lastly probably on the automotive side, we also see the auto production in China growing, partially driven by government incentives. There is an incentive program or tax refunds for the purchase of small cars for instance. And it is absolutely worthwhile to note because it shows the changes in the global economy. This is the first year that the China build rate for cars is more than the US and also more than Japan, so that concludes this on automotive.

- Let's move on heavy trucks and trailers. Heavy trucks and trailers have been really hard hit. Build rate is expected to fall by about 30% down to 1.1 million vehicles. But also here, we do see signs of stabilization in the US. In June, we saw a 10% increase of net orders for Class 8 trucks.

- The beverage can market, the next segment here, is a segment which we really expect to have a reasonable stable performance based on steady summer demand in the US. The US you may remember is the biggest region. It accounts for about 50% of the total consumption on beverage cans.

- Commercial building and construction we believe is going to weaken in the second half of '09. Traditionally, you have a one-year lag to residential market activity and we believe that that's going to come through here.

- Last segment, industrial gas turbines; we're beginning to see some delays here. Electricity demand is declining as an effect from the downturn and we do see project financing remaining elusive.

So overall, the global environment for 2009 clearly remains challenging, but I believe we do see some pockets of growth like in China and signs of stabilization in the US in automotive and beverage cans in general.





2. OIL & GAS: Refining margin update; Singapore GRM at $2/bbl in Jul-09 v/s $4.1/bbl in 1QFY10

Singapore refining margins (Reuters) have continued their downward slide in 2QFY10 (till date) to US$2/bbl v/s $4.1/bbl in 1QFY10, $6.4/bbl in 2QFY09, $3/bbl in May-09 and $4.1/bbl in April-09. Weak product spreads, lower light-heavy differentials coupled with new refining capacity starts will put pressure on the margins in near term. We have built Singapore GRM of US$4/bbl in FY10-FY11 in our estimates. We expect OMC's to report GRMs around Singapore GRM, while we estimate the RIL's premium over Singapore to decline in FY10-FY11. We expect RIL's premium over Singapore to fall to $4/bbl in FY10 v/s reported premium of $6.5/bbl in FY09.

- Light-Heavy/Sweet-Sour Crude differentials weak: Arab light-heavy differential at US$1.6/bbl in 2QFY10 (till date) is down 18% QoQ and 82% YoY while WTI-Maya differential at $5.6/bbl is up 20% QoQ and down 51% YoY. Lower light/heavy and sweet/sour differentials would result in lower premiums for complex refiners over simple refiners.

- 1QFY10 reported GRMs would be higher due to inventory gains: Significant oil price increase in 1QFY10 from US$48/bbl to ~US$70/bbl would lead to significant inventory gains, leading to higher reported refining margins for OMCs and independent refiners like MRPL and Chennai Petro. As RIL has earlier indicated that it hedges its refining margins, we believe it will report marginal inventory gains, if any, in 1QFY10. We estimate GRM at US$8.2/bbl, implying a premium of US$4/bbl over Benchmark Singapore GRM of $4.1/bbl.

- Refining outlook: We expect refining margins to remain subdued in the medium term as ~1.4mmbbl/d of new refining capacity is slated to come up in the next few quarters and several refiners (particularly in Europe) are re-commencing production after planned shutdowns in May-Jun-09. As this new capacity coincides with weak demand in key consuming geographies, operating rates globally will remain low. We have modeled Singapore GRM of US$4/bbl in FY10-FY11.

- Sensitivity to GRM Assumptions: EPS sensitivity to 1% change in GRM is highest for the independent refiners like CPCL and MRPL (1.2-1.5%). A 1% change in GRM for RIL changes its EPS by ~0.5%. For OMC's, while GRMs do matter, sensitivity is higher to under recoveries and its sharing.



EPS SENSITIVITY TO GRM





VALUATION SUMMARY





REFINING MARGIN AND CRUDE DIFFERENTIAL TRENDS (US$/BBL)



Source: Company, Bloomberg, Reuters, MOSL



PRODUCT SPREADS OVER DUBAI CRUDE (US$/BBL)







* Product prices are ex-Singapore





3. SUN PHARMA: Enters into out-of-court settlement for Lexapro patent challenge; Adds more products to Caraco's distribution portfolio; No major financial implications

Sun Pharma (SUNP IN, Mkt Cap US$4.8b, CMP Rs1,120, Buy) along with Caraco has entered into agreements with Forest Laboratories (USA) and H. Lundbeck to settle the legal proceedings related to Escitalopram Oxalate (Forest's US$2.3b Lexapro brand) patent litigation. The key terms of the agreement are:

1. Sun Pharma will license to Lundbeck on a worldwide basis certain patent applications related to the synthesis of escitalopram and citalopram in exchange for an upfront payment. Sun will be eligible to royalties on sales if its technology is actually commercialized by Lundbeck.

2. Forest Labs will provide patent licenses to Caraco to enable it to launch its generic version of Lexapro as and when any other generic company enters the market other than an authorized generic or the FTF filer with exclusivity.

3. Caraco will take over the commercialization and sale of generic products from Inwood Labs (Forest's generic subsidiary). Caraco will pay royalties (including some advance against royalties) to Forest Labs for taking over these products. The table below gives details of these products:

4. Forest Labs will reimburse Caraco for a portion of its costs related to the patent litigation.



PRODUCTS TAKEN OVER BY CARACO FROM INWOOD LABS (FOREST'S GENERIC SUBSIDIARY)

















Impact

While the financial details of the agreement have not been disclosed, we believe that the following points need to be considered while evaluating the impact:

1. Upfront payment to Sun by Lundbeck – We believe that the upfront payment to Sun Pharma is unlikely to be very significant given that Forest/Lundbeck have already won their patent litigation against Teva, thus implying that the Lexapro patents are strong. Given the strong IPR on Lexapro, it is unlikely that the payment to Sun Pharma will be very significant. Also, this will be a one-time payment unless Sun Pharma's technology is commercially utilized.

2. Patent licenses to Caraco for launch of generic Lexapro – The agreement mandates that Caraco will not be able to access these licenses during the exclusivity period, implying that Caraco's launch (likely in 2012) will be a normal generic launch along with many other generic competitors for the product. Hence we do not expect any major upsides for Caraco.

3. Launch of Inwood products – As indicated in the above table, the competition for these products is fairly severe. Hence, we expect only incremental upsides to Caraco from the sale of these distributed products.

4. Reimbursement of litigation costs - Unlikely to be very significant.



Outlook

- Sun's expanding generic portfolio coupled with change in product mix in favor of high-margin exports is likely to bring in long-term benefits. Its ability to sustain high growth rates at superior margins even on a high base is a clear positive.

- Key drivers for future include ramp-up in US (from India facilities), the expected value unlocking by leveraging acquired companies (Able Labs & Valeant) and monetization of the Para-IV pipeline.

- Given the severity of the recent US FDA action on Caraco, we believe Sun Pharma's stock price will remain muted till the US FDA issues are resolved.

- We expect EPS of Rs65.2 for FY10E and Rs74.8 for FY11E excluding upsides from patent challenges. Our estimates do not factor-in any one-time write-offs related to the US FDA action.

- Sun is currently valued at 17.3x FY10E and 15.1x FY11E earnings (excl Para-IV upsides which have a DCF value of Rs19/share). Maintain Buy with TP of Rs1,190.









4. HERO HONDA: Expects 25% growth; Last guidance of 10% growth to 4.1m bikes; Monsoons key driver to upgrade [News item]

- In a news item, Anil Dua, VP (sales and marketing) of Hero Honda, said: "We expect the first half of the current fiscal to be better than the second half on the back of the commencement of the festive season. The industry will record a high single-digit growth of about 9 per cent but we will post about 25 per cent growth in the fiscal." The company's thrust is on new model launches, most of which will debut in the current and the next quarter. In all, the company will launch nine models, of which one or two will be new while the rest will be face-lifts. "We are constantly increasing our market share both in the motorcycle space as well as the scooter segment. Our target for the year will ride on the success of the new launches as well as our top models", added Dua.

- OUR COMMENTS: We model FY10 volumes of 4.2m (+13% YoY) and EPS of Rs87.7. At FY10 volumes of 4.5m units and incremental production from Haridwar unit, FY10 EPS would be ~Rs100. This scenario is likely if monsoons were to recover in the coming weeks.

- A 25% growth in FY10 volumes translates into volumes of 4.65m bikes and EPS of ~Rs110 (assuming incremental production from Haridwar unit).



HERO HONDA: CURRENT BASE CASE ESTIMATES & VALUATION