RCom bonds sink on fears over repayment of debt

Bonds sold by billionaire Anil Ambani's Reliance Communications (RCom) completed their worst week in more than two years after a slump in the company's shares added to concern over its ability to cut debt, reducing the allure of India's securities. The tumble in RCom's assets is undermining investor confidence in India.

Investors will be "selective" in buying Indian debt, said Heather Beattie, a London analyst with Barclays Capital.
Ambani's group, which suffered a $2.6 billion drop in its market value on February 9, said last week investigators have questioned some of its executives and that it has identified brokers spreading "sensational charges".

The yield on India's second-largest mobile phone operator's zero-coupon convertible notes due March 2012 jumped 317 basis points to 10.75% last week, the highest since December 2009, Nomura Holdings prices show.

"It's a minefield at the moment," said Peter Reinmuth, who manages $300 million of Indian convertible debt, including RCom, as senior portfolio manager at Fisch Asset Management AG in Zurich. "It's not building confidence, especially for foreign investors."

The yield on the convertible bonds of Mumbai-based Gitanjali Gems due November 25 rose 30 basis points last week to 12.53% on February 11, the highest since November 25. The yield on Videocon Industries' 6.75% convertible maturing in December 2015 rose 183 basis points last week to 10.84% on February 11.

Relative yields on India's top-rated five-year rupee company debt rose 23 basis points this year to 115 more than similar-maturity government bonds, according to data compiled by Bloomberg. They touched 130 on February 7, the highest since October 2009, as investors shunned riskier securities.

RCom's net debt increased to about Rs 29,200 crore ($6.41 billion) as of September 30, from Rs 3,370 crore at the end of September 2007, according to the company's quarterly reports. The company has Rs 2,730 crore of debt due for repayment this year, or 59% of its profit last year. A further Rs 5,510 crore are due in 2012.

Reliance Infrastructure, has Rs 9,800 crore of debt, of which Rs 1,650 crore is maturing this year. Reliance Power has Rs 53,500 crore of obligations. About 70% of the generator's debt matures after 2024.

Overseas investors thought Anil Ambani was heading businesses "which would outstrip growth in the medium and long term", AS Thiyaga Rajan, senior managing director at Singapore-based Aquarius Investment Advisors, said. "But that has not happened."

The February 9 share plunge, led by a 14% drop in Reliance Infrastructure, dragged India's benchmark Sensitive Index to a seven-month low that day. "This should really only affect the stock, it shouldn't affect the bond after some near-term weakness because Reliance Communications still has options to raise money," said Atul Gharde, credit analyst at SJS Markets in Hong Kong.

"As far as the company not redeeming the bond, I don't see that as an issue. North of a 10% yield, the bond is interesting."

The company was in talks to sell a stake or do an IPO of its mobile-phone tower unit after negotiations to sell it to GTL Infrastructure collapsed on August 31. RCom will borrow $1.93 billion from China Development Bank Corporation. The loan would have a 10-year maturity and would be funded by a syndicate including CDB and other Chinese banks.

One-Minute Budget

Budget Highlights

Personal income tax exemption limit for individual tax payers raised to Rs 1.8 lakh from Rs 1.6 lakh.

Tax exemption limit for senior citizens increased to Rs 2.5 lakh from Rs 2.4 lakh and eligibile age for senior citizens reduced to 60 years against 65 years.

Tax exemption limit for senior citizens over 80 years at Rs 5 lakh. No new tax exemption limits for women.

SEZ to come under MAT. Minimum alternative tax raised to 18.5% vs 18%.

FY11 Fiscal deficit at 5.1%, revenue deficit at 3.4%

FY12 Divestment target at Rs 40,000 crore.

FY11 fiscal deficit at 5.1%, FY12 deficit seen at 4.6%, FY13 fiscal deficit at 4.3%.

Structural concerns on inflation management to be addressed by improving supply response of agriculture to the expanding domestic demand and through stronger fiscal consolidation.

Implementation gaps, leakages from public programmes and the quality of outcomes pose a serious challenge.

Gross Domestic Product (GDP) estimated to have grown at 8.6 per cent in 2010-11 in real terms. Economy has shown remarkable resilience.

Monetary policy measures taken expected to further moderate inflation in coming months.

DTC to come in force from April 2012.

Preparations for GST rollout in final stages, bill in current session.

FDI regulations consolidated into one comprehensive document

FII allowed to invest in MF schemes

FII limit in corporate bonds has been raised by $20 billion

Govt commited to retain 51% holding in PSUs

New companies bill to be introduced in this session

Short term interest to farmers will continue to be at 7%. Agricultural credit limit raised to Rs 4,75,000 crore

Metro projects in key cities will get financial aid

Basics of Derivatives

A derivative is an instrument whose value is derived from the value of one or more underlying asset, which can be stocks, bonds, currency, commodities, metals, intangible pseudo assets like stock indices etc. When we say a Tata Steel future or a Tata Steel option, these carry a value only because of the value of Tata Steel. Below given are the four most common types of derivative instruments.

• Forwards
• Futures
• Options
• Swaps

Financial Derivatives

Financial derivatives are instruments, which derive their value from financial assets. These derivatives can be forward rate agreements, futures, options swaps etc. As mentioned earlier, the most traded instruments are futures and options. Assets under financial derivatives can be the following;

• Stocks
• Bonds
• Currency etc.

Pricing of Derivatives

Derivative is priced based on a future price of the underlying asset i.e.; perceived value of the asset. In the case of an option to buy an asset at some future date, the expectation is that it will be priced higher than the derivative price plus the strike price (the price you agree to pay), allowing for a gain. For example, Lets consider the underlying asset as a stock, if Stock XYZ is trading at Rs. 500 and you buy an option for Rs.100, allowing you to purchase XYZ at Rs. 1000 at some future date, your expectation is that XYZ will be at Rs. 1100 or higher by that future date.

Why Derivatives are Risky?

In the example above, the risk lies in the fact that XYZ might not reach Rs.1100 by the future date mentioned in the contract. If it does not reach Rs. 1100, you would not exercise your option. You paid Rs. 100 for that option that you will not have had the opportunity to use. Of course, Rs. 100 is not a huge amount, but when you multiply that by thousands, it becomes more substantial.

 

How do People Make Money with Derivatives?

When we consider derivatives trading there are two categories of people, those who make money and those who lose money. The people who make money with derivatives are on the opposite side of the transaction of someone who loses money. In the above example, if you bought an option to purchase XYZ at Rs. 1000 and you paid Rs.100 for that option, the person who gets Rs.100 makes money. That person will also get to keep ABC stock if it does not reach Rs.1000. Therefore, if XYZ is priced at Rs. 500 when the derivative is sold and it only makes it to Rs.900 by the strike date, then the person who sold the option makes Rs. 100 on the option sale and will have enjoyed an unrealized gain of Rs.400 (900-500=400) on the underlying ABC security.

 

The basic objective of derivatives trading is to generate income and to hedge against potential losses. By considering the chances of huge loss using of derivative products should only be considered by educated and high net worth investors, or speculators who are comfortable with the complete, potential loss.

 

Who use derivatives?

Derivatives will find use for the following set of people:

 

Speculators

Speculators are those people who buy or sell in the market to make profits. For instance, if you will think the stock price of Reliance is expected to go upto Rs.400 in 1 month, one can buy a 1 month future of Reliance at Rs 350 and make profits.

 

Hedgers

Hedgers are those people who buy or sell to minimize their losses. For instance, an importer has to pay US $ to buy goods and rupee is expected to fall to Rs 48/$ from Rs 45/$, then the importer can minimize his losses by buying a currency future at Rs 46/$·

 

Arbitrageurs

Arbitrageurs are those people who buy or sell to make money on price differentials in different markets. In other words arbitraging helps us to take advantage of a price difference between two or more markets. Difference between the market prices is the profit. For instance, a futures price is simply the current price plus the interest cost. If there is any change in the interest, it shows an arbitrage opportunity.

Terminologies used in a Futures contract

The terminologies used in a futures contract are:

• Spot Price: The current market price of the scrip/index
• Future Price: The price at which the futures contract trades in the futures market
• Tenure: The period for which the future is traded
• Expiry date: The date on which the futures contract will be settled
• Basis: The difference between the spot price and the future price

Forward contracts

A forward contract is a customized contract between two parties, where settlement takes place on a specific date in future at a price agreed today. The main features of forward contracts are;

• They are bilateral contracts and hence exposed to counter party risk.
• Each contract is custom designed, and hence is unique in terms of contract size, expiration date and the asset type and quality.
• The contract price is generally not available in public domain.
• The contract has to be settled by delivery of the asset on expiration date.
• In case, the party wishes to reverse the contract, it has to compulsorily go to the same counter party, which being in a monopoly situation can command the price it wants.

Futures

Futures are exchange-traded contracts to sell or buy the underlying asset; it can be financial instruments or physical commodities for Future delivery at an agreed price. There is an agreement to buy or sell a specified quantity of financial instrument/ commodity in a designated future month at a price agreed upon by the buyer and seller. To make trading possible, the exchange specifies certain standardized features of the contract.

• Future contracts are standardised contracts, which are traded on the exchanges.
• These contracts, being standardized and traded on the exchanges are very liquid
•  In futures market, clearing corporation/ house provides the settlement guarantee.

Difference between Forward & Futures contract

Futures	Forward
Traded on organized exchange	Over the Counter
Standardized	Customized
Liquidity is more	Liquidity is Less
Requires Margin Payments	Not required
Follows daily settlement	At the end of the period
Can be reversed with any member of the exchange	Contract can be reversed only with the same counter-party with whom it was entered into.

Options

Options contracts are those which give only the right to buy or sell the underlying asset, whereas futures contract have the obligation to buy or sell the underlying asset. The buyer of the options contract has the right to choose whether or not to exercise their right, and if they do, the seller of a matching options contract will be obligated to complete the transaction. There are two main types of options;

• Call Option
• Puts Option

Calls Option

Calls Option gives you the right to buy the underlying asset in a future date. You can buy a call option when you believe the underlying futures price will move higher. For example, if you expect Nifty futures to move higher, you should buy a Nifty call option.

 

Puts Option

Put Option gives you the right to sell the underlying asset in a future date. It is better to buy a put option if you believe the underlying futures price will move lower. For example, if you expect Nifty futures to move lower, you should buy a Nifty put option.

 

Terminologies used in options

• Option holder: The buyer of the option who gets the right
• Option writer: The seller of the option who carries the obligation
• Premium: The consideration paid by the buyer for the right
• Exercise price/ strike price: Price at which the option holder has the right to buy or sell.
• Call option: The option that gives the holder a right to buy
• Put option: The option that gives the holder a right to sell
• Tenure: The period for which the option is issued
• Expiration date: The date on which the option is to be settled
• American option: Options that can be exercised at any point till the expiration date
• European option: These are options that can be exercised only on the expiration date
• Covered option: An option that an option writer sells when he has the underlying shares with him.
• Naked option: An option that an option writer sells when he does not have the underlying shares with him.
• In the money: An option is in the money if the option holder is making a profit if the option was exercised immediately
• Out of money: An option is out of the money if the option holder is making a loss if the option was exercised immediately
• At the money: An option is at the money if the option holder evens out if the option was exercised immediately

Swaps

Swap is a financial derivative contract where a set of future cash flows are agreed to be exchanged between two counterparties at set dates in the future. In other words swap is a derivative instrument in which counterparties exchange certain benefits of one party's financial instrument for those of the other party's financial instrument. The swap agreement defines the dates when the cash flows are to be paid and the way they are calculated. Following are the major kinds of swaps;

• Interest rate swaps
• Currency swaps
• Commodity swaps
• Equity Swap
• Credit default swap

Swap

In general Swap means the exchange of one asset or liability for a comparable asset or liability for the purpose of lengthening or shortening maturities or raising or lowering coupon rates to maximize revenue or minimize financing costs. This may entail selling one securities issue and buying another in foreign currency; it may entail buying a currency on the spot market and simultaneously selling it forward. Swaps also may involve exchanging income flows; for example, exchanging the fixed rate coupon stream of a bond for a variable rate payment stream or vice versa while not swapping the principal component of the bond. Swaps are generally traded over-the-counter.
 
In finance a swap is a derivative in which two counterparties consent to exchange one stream of cash flow against another stream. These streams are called the legs of the swap. The cash flows are planned over a notional principal amount which is usually not exchanged among counterparties. As a result, swaps can be used to create unfunded exposures to an underlying asset since counterparties can earn the profit or loss from actions in price without having to post the notional amount in cash or collateral.
Swaps can be used to hedge certain risks such as interest rate risk or to wonder on changes in the expected direction of underlying prices.
 
Structure
A swap is an agreement among two parties to exchange future cash flows according to a prearranged formula. They can be regarded as portfolios of forward contracts. The streams of cash flows are called legs of the swap. Generally at the time when the agreement is initiated at least one of these series of cash flows is strong-minded by a random or uncertain variable such as an interest rate, foreign exchange rate, equity price or commodity price. Most swaps are traded over-the-counter (OTC), tailor-made for the counter parties.

The six general types of swaps in order of their quantitative importance and they are as follows:
·         Total swap
·         equity swap
·         Currency swaps
·         Credit swaps
·         Commodity swaps
·         Interest rate swaps
 
Total swap
A total return swap is a swap in which party A pays the sum return of an asset and party B makes periodic interest payments. The sum return is the capital gain or loss plus any interest or dividend payments. Note that if the sum return is negative, then party A receives this amount from party B. The parties have experience to the return of the underlying stock or index without having to hold the underlying assets. The profit or loss of party B is the same for him as actually owning the underlying asset.
 
Equity Swap
An equity swap is a particular type of total return swap where the underlying asset is a stock or a basket of stocks, or a stock index. Compared to really owning the stock in this case you do not have to pay something up front, but you do not have any voting or other rights that stock holders do have.
 
Currency swap
A currency swap or cross currency swap is a foreign exchange agreement among two parties to exchange principal and fixed rate interest payments on a loan in one currency for principal and fixed rate interest payments on an equal (regarding net present value) loan in an additional currency. Currency swaps are motivated by comparative advantage.
 
Credit swaps
A credit swap is a credit derivative agreement between two counterparties. The buyer makes periodic payments to the seller and in return receives a payoff if a fundamental financial instrument defaults.
 
Commodity swaps
A swap where exchanged cash flows are dependent on the price of an underlying commodity. This is frequently used to hedge against the price of a commodity.
 
Interest rate swaps
An interest rate swap is a derivative in which one party exchanges a stream of interest payments for another party's stream of cash flows. Interest rate swaps can be used by hedgers to run their fixed or floating assets and liabilities. They can also be used by speculators to replicate unfunded bond exposures to profit from changes in interest rates. Interest rate swaps are very popular and highly liquid instruments.
 
The most accepted interest rate swaps are fixed-for-floating swaps under which cash flows of a fixed rate loan are exchanged for those of a floating rate loan. Among these the most common use a 3-month or 6-month Libor rate (or Euribor, if the currency is the Euro) as their floating rate. These are called vanilla interest rate swaps. There is also a liquid market for floating-floating interest rate swaps what are known as basis swaps.
 
To keep things simple and minimize settlement risk, concurrent cash flows are netted. In a typical arrangement both loans have an initial payment (loan) of principal but those net to 0. Mutually loans have a final return of the same principal but those also net to 0. Also, the periodic interest payments are normally scheduled to occur on concurrent dates so they too can be netted. The principal amount is called the notional amount of the swap.

SJVN Ltd - CMP 20-21

SJVN Ltd, one of the largest hydroelectric power companies in India, is trading at a relatively cheap valuation compared to its peers Jaiprakash Power Venture and NHPC. The Company is expected to benefit from the robust investment earmarked for the infrastructure sector, led by power sector, during the 12th Plan Period. SJVN's robust performance is explicit from the fact that the Company has been consistently able to meet and exceed the power generation target set by Power Ministry from the Nathpa Jhakri Hydro Power Station. To impart stability to its topline, the Company is diversifying into other lines of power generation such as Wind Energy and Solar Energy, as also venturing into power trading and transmission. SJVN has a number of projects scheduled to come on-stream from 2013 which will translate into a spurt in the Company's topline growth. I expect the Company's operating revenue to remain stable and a high double digit. The stock is available at an attractive valuation at 1.30x its FY10 consolidated Book Value and 1.31x is expected FY11 consolidated Book Value. At their current prices (as on 4 feb 2011), compared to JP Power and NHPC which are trading at 48.28x and 16.40x respectively their consolidated FY10 EPS, SJVN is trading at 9.4x its consolidated FY10 EPS.  I expect a 40-50% appreciation in the stock price from the current levels over the medium to long term period. I recommend a BUY on the stock with a price target of Rs.35 with a medium to long term perspective.  

Company Profile 

SJVN Limited engages in the generation and sale of hydroelectric power in India. The company principally holds a 1,500MW Nathpa Jhakri Hydro Power Station located in the state of Himachal Pradesh. It also provides various construction and consultancy services. The company was formerly known as Satluj Jal Vidyut Nigam Limited and changed its name to SJVN Limited in September 2009. SJVN Limited was incorporated in 1988 and is based in New Shimla, India. 

Financials

 

Profit and Loss

Cash Flow Summary

Investment Argument

Robust Investments Target in Infrastructure Sector to be led by the Power Sector: 

The Indian Planning Commission has set the ambitious target of $1 trillion (Rs.45 Lakh Cr) investment in the power sector for the 12th Plan Period (2012-2017). The total investment in the power sector including generation work in progress is estimated to be around $300 bn (R. 13.5 Lakh Cr), which is 30% of the overall target. The Planning Commission estimates capacity addition of around 100,000 MW during the plan period, which will result in investment of at least $100 bn in the sector. Similar investment to the tune of $100bn is expected in distribution and transmission with overall investment, including generation work in progress currently, being put at $300 bn.


Robust Industry Growth Expected 

The investment in infrastructure during the 11th Plan has reached 7.18% of GDP and is expected to reach 8.37% by 2011-12. In the 12th Plan, the Commission expects infrastructure investment to constitute around 10% of GDP, if the Indian economy grows at an average annual growth rate of nine%. The Indian power sector is expected to witness robust and consistent investments in a bid to achieve the target of $1 trillion (Rs.45 lakhCr) investment in infrastructure set by the Planning Commission for the 12th Plan Period (2012-17). Power sector investments will guide this ambitious yet achievable target for the infrastructure sector as a whole.

The entire investment in the power sector itself, including generation work in progress, has been estimated to be in the region of $300bn (Rs 13.5 lakhCr). According to the Commission India will witness an estimated capacity addition of around 100,000 MW during the period at an average cost of at least Rs.5Cr for every MW added. Consequently, the capacity addition will result in investment of no less than $100bn. Similar investment of around $100bn is expected in distribution and transmission during the 12th plan period along with overall investment, including generation work in progress currently, amounting to almost $300bn, which is around 30% of the overall target.

In the 11th Plan period (2007-12), the Commission had estimated an investment of $147.8bn in the power sector which was revised marginally downwards to $146.05bn in the mid-term appraisal. Even as investments in the sector have broadly kept pace with the set target, in capacity addition the sector is likely to see a 26.2% drop to an addition of only 62,374 MW by the end of the Plan period (March 2012), as against an original target of 78,700 MW.

Achieved Higher than Production Target set by Power Ministry 

The Company has been able to achieve record power generation from the Nathpa Jhakri Hydro Power Station (NJHPS).The Country's largest Hydro Electric Power Project, the NJHPS (capacity 1500 MW) surpassed 6000 MUs generation in November 2010, which exceeded the targets of MoU provided by the Power Ministry under excellent category, by 178 MU, ahead of its due date set in December 2010. The Company has been able to achieve this record power generation despite the plant shut down for 22 days on account of high silt during July & August 2010 resulting from the unprecedented rains in the catchment of river Satluj, on the back of efficient water and machine management.

During FY10 as well, the Power Station had achieved a record generation of 7019 MUs which was 407 MUs more than the design energy of 6612 MUs.  During the current financial year, FY11, the power station has set its power generation target at 6700 MU of electricity, of which it has already achieved 6000 MU generation. The power station has so far generated 42180 MU during 7 years of its commencement of commercial power generation.

Steady and Secured Revenue Stream Ensured 

The NJHPS supplying power to the 9 northern grid states - Haryana, Himachal Pradesh, Jammu & Kashmir, Punjab, Rajasthan, Uttar Pradesh, Uttarakhand, Chandigarh & Delhi. The Company has entered into 14 power purchase agreements with state utilities in the Northern India, as well as the Government, under which 88% of the power generated by the NJHPS is sold to state electricity boards. Rest 12% of SJVN's annual generation is allocated to the state of Himachal Pradesh, free-of-charge. Payment for the sales of electricity to the state utilities are highly secured in nature as they are backed by forms of credit support such as letters of credit issued by reputable financial institutions or by state government guarantees.

4000 MW Capacity to Come On Stream  

SJVN operates the Naphtha Jhakri project with a capacity of 1,500 MW and has about 4,000 MW forthcoming in various places which are at various stages of completion. The first of these expected to go on stream is the Rampur project with a capacity little over 400 MW. SJVN has a 900 MW project in Nepal and two projects totaling to about 1,400 MW in Bhutan. The projects are expected to commence operations during the next 6-7 years. The Company has projects lined up to 2020.

Diversifying Into Wind Power & Solar Power 

The Company intends to diversify into various alternatives such as wind power, solar power and power transmission and power trading. SJVN has already obtained approval of its board to engage professional consultancies with the appropriate technical knowhow and expertise, with the objective of identifying any suitable business opportunities in wind energy projects. The Company has also agreed to take a minority stake in a joint venture company with certain other private sector parties for the development of an 86-kilometer power transmission line connecting India and Nepal. SHVN is also exploring the possibilities of entering the business of power trading.

In June 2009, the Company entered into a memorandum of agreement with Infrastructure Leasing & Financial Services Ltd (ILFS), the Power Grid Corporation of India Limited (PGCIL), and PTC Financial Services Ltd (PTC), for the establishment of a joint venture to construct and maintain the Indian part of a transmission line connecting Nepal and India. The aggregate length of this transmission line is 86 kilometres (approximately).

SJVN will hold 26% equity interest in the joint venture, with ILFS, PGCIL and PTC contributing to 37%, 26% and 11%, respectively of total equity.

Earning & Margin Expectations. 

Despite the long gestation periods particular to hydro power projects, I expect the Company to see steady growth in earning for the next couple of years and a spurt in income 2013 onwards as its projects start to come on stream one after the other.  Post commencement, these projects hardly incur any recurring costs and the operating profit margin has the potential to stabilize at as high as 80-90%.

Key Financial Ratios

Dupont Analysis

Shareholding Pattern

Valuation & Recommendation 

The fundamentals of the Company look strong. Low debt-equity ratio, stable topline and bottomline growth and steady margins are some of the attributes that make the valuations look attractive. I expect the bottomline to grow at a CAGR of over 10% during the next few years.

I believe that the stock is undervalued and has the potential to appreciate considerable from the present levels. 40-50% appreciation in the stock price from the current levels over the medium to long term period is expected.

I have used DCF valuation to arrive at the price target taking a 1% terminal growth rate and a 13.3% weighted average cost of capital. 

2 Phase Buying Strategies Suggested [Always buy in SIP ways]

ü  1^st Phase  : Buy at the current price range Rs 20 – 21 [70% of investment]

ü  2^nd Phase : Add if the price falls down to Rs 16 - 18 [30% of investment]

PATIENCE IS THE KEY TO SUCCESS! HAPPY INVESTING!!!

The recommendation made herein does not constitute an offer to sell or solicitation to buy any of the securities mentioned. No representation can be made that recommendation contained herein will be profitable or that they will not result in loss. Information will be profitable or that they will not result in loss. Information obtained is deemed to be reliable but do not guarantee its accuracy and completeness. Readers using the information contained herein are solely responsible for their action.