In India, retail fuel prices are regulated by Govt. If the crude oil prices are high, Oil Marketing Companies (OMCs) bear under recoveries on sale of fuel at lower prices. As per Govt., public upstream companies has to bear a part of subsidies losses of OMCs, whereas private companies like RIL, Cairn don?t have obligation from Govt. to share subsidy losses of downstream companies.

I find private upstream companies better, as they are not obliged to share under recoveries and can sell their crude oil at the same prices as public upstream companies (discount to Brent), domestically.

2. What is the subsidy sharing model between the following?

a- Upstream and downstream companies (quantify)

b- What will happen when the crude prices will go up and vice versa( Quantify)

a- As of now, there is no transparent subsidy sharing mechanism, proposed by Govt. But generally, the practice in the industry is as follows:

33% of total under recoveries to OMC:?? Shared by upstream companies (ONGC, GAIL, OIL in the ratio of 75:15:10)

33% of total under recoveries to OMC:?? Shared by Govt. (Cash subsidy/Oil bonds)

33% of total under recoveries to OMC:?? Shared by downstream companies itself (BPCL, HPCL, IOCL)

b- If crude oil prices goes up, that means, the raw material cost (i.e. crude oil) for downstream companies will go up. The OMCs has to sell the fuel at Govt. governed prices, irrespective of their cost. Thus, they bear loss.

On the other hand if crude oil prices get down, better for OMCs as their input cost also get lower.

3. What is proposed in Kritik Pareikh report for the upstream and downstream companies (Quantify)?

4. Peer comparison between the companies like Oil India, Cairn India, ONGC, HOEC related with the total reserves of oil and gas.

ONGC is the largest public upstream company on the basis of 2P reserve. At present, Cairn is not fully operational but commencement of Mangala field makes it attractive. If we look at the reserve and total assets, HOEC seems bit expansive to its peers.

OIL is better in terms of reserve and production growth in the past with a high success ratio of 70-80% of exploratory wells drilled as compared with 36% for ONGC and 34 % for global average, which is best in the world.

In terms of raising cost including taxes, OIL and Cairn enjoy benefit of being onshore players. They have total raising cost of around $11/barrel.

Rating: Positive

In 3Q 2010, our coverage universe reported positive growth in Net interest income (NII) with decent growth in advances except ICICI Bank. Net interest margins has grown up on back of falling cost of deposit as banks have bolstered their CASA base. We continue to have bullish view on sector since IIP (Index of Industrial production) can surprise on upside which will ignite private capital expenditure cycle. Banking credit growth stands at 13% YTD 2010 compared to 24% in 2005-09. We believe revival in private capital expenditure will fuel credit growth resulting in sector re rating. We expect our coverage universe to report credit growth of 19-23% over next two years.

Top pick: Axis bank remains our top pick with target price Rs 1241 (2.6 PBV times FY 11 BV of Rs 477).

IT Sector

Rating: Positive

We believe IT Software exports will grow by at least 10-12% in FY 2010-11(last estimated at 4% in Market Outlook dated Nov 2009) on the back of rise in discretionary IT Spending in US. In 3Q 2010 most of leading IT Players appears to be sanguine on US IT spending outlook as evidenced by rising geographical contribution by US (Infosys & Wipro have observed rising sequential revenues growth from US). We believe with restoration of macro environment global IT budget will be flat to marginally positive. IT vendors continues to report client addition suggesting decent revenue visibility on stable Re (we estimate INR/USD at Rs 44 for FY 2011). Our coverage universe reported rise in employee utilization which will be margin accretive in near future.

Top pick: TCS remains our top pick with target price of Rs 850 (22 times PER FY 11 EPS.

Engineering

Rating: Positive

The power T&D business in energy segment is witnessing increased competition from domestic players & Chinese/Korean imports resulting in pressure on margins for the engineering firms such as Larsen & Toubro and Siemens. On the other hand, there are still not clear signs of sustained recovery in corporate capex which affects the industry segment. The country has embarked on a confident growth path. The growth is likely to be fuelled by increased capacity creation to meet the huge shortage of power and need for building India’s infrastructure. The recovery and firming up of oil prices also makes us positive on the prospects for oil and gas business. Though the inflationary pressures in the economy may lead to tightening of liquidity in the system, Government’s resolve to target a 7-8% growth rate should present many exciting business opportunities.

Top pick: BHEL remains our top pick with target price of Rs 2850 (30 times PER FY 11 EPS of Rs 95).

Metals

Rating: Positive

During 3Q FY 2010, the ferrous metal results were in line with our expectations. The stellar profitability y-o-y growth reported during 3Q FY 2010 was due to the low base effect. Tata Steel (standalone), Steel Authority of India Limited, JSW Steel Limited and Sesa Goa Limited reported robust earnings growth. Amongst, non-ferrous metals, Sterlite Industries reported lower-than-expected profitability due to rising costs. In light of sharp run-up in stock prices and our analysis of 3Q FY 2010 results, we downgrade our sector view from positive to neutral. Nevertheless, we continue to remain bullish on Sesa Goa, while we have downgraded JSW Steel from to a HOLD after it achieved our target price.

Power

Rating: Positive

During 3Q 10 the result of the power companies were as per our expectations. The net realizations of the power unit have increased during the quarter due to merchant power sale. Some companies like Torrent power; CESC has shown robust growth visibility more than the big players like NTPC, Tata Power etc. In Power Transmission segment the market leader power grid has shown a good performance and we are bullish on it as we believe that it will remain be market leader in transmission segment in coming years. It is estimated that 47,488 MW of capacity addition will take place during the Eleventh plan. We believe that in order to maintain the current growth, the country will require faster capacity additions in the Eleventh plan. Further, additions to generation capacity will require high capacity additions in transmission and distribution (T&D) as well. A total investment of around Rs 3 trillion in the power sector in the eleventh plan is estimated. Of this, a major chunk of Rs 2.1 trillion is expected to be towards power generation and the rest towards T&D segment.

Top pick: Power grid remains our top pick-The Company has reported growth of 24% CAGR in revenue over FY06 to FY09. It is currently trading at 22 x FY10E EPS, 17 times FY11E of EPS. We believe that the company will continue to earn minimum RoE of 12% and an EPS growth rate of 34%. We re-rate the stock and recommend a “BUY” rating with a target price of Rs. 137 at 20 x FY11E EPS of Rs 6.9.

Media

Rating: Positive

We have upgraded advertising industry growth estimate from 2-4% to 10% over 2010-12. In 3Q 2010, broadcasters like SUNTV, Zee Entertainment reported positive revenues growth with improvement in margins. The regional GEC market would grow 20-25% compared to television advertising industry growth of 10% over next two years. Print advertising players have disappointed in terms of advertising growth with falling margins thanks to stable newsprint prices.

Top pick: SUNTV remains our top pick with target price of Rs 450 (25 times PER FY 11 EPS of 18).

Cement

Rating: Positive

As India’s GDP is expected to move on 8% plus path and consequently we believe that the cement consumption too would grow with multiplier co-efficient of 1.2 to 1.3 over GDP that is about 10%. During 3Q FY 2010, most of the cement companies have shown a growth in its revenues despite any demand from housing segment. Production between April-January 2009 has moved up 4.77% to 26 MT from 25 MT in the same period last year. Dispatches grew 4.74% to 26 MT (25 MT). The dispatches in December were the largest so far in the current financial year at 17.74 million tones. With this the industry has recorded the highest sequential growth rate at 12.78%, whereas on the year-on-year (y-o-y) basis, after a gap of three months since August last year, the growth was in double digits at 10%. Though fresh capacities will increase supply but we believe capacity utilization will remain stand at 80%

Top pick: Dalmia Cements remain our top pick with target price of Rs 301 on S.O.T.P basis where in standalone valuation stands at Rs 280 (i.e. 8 PER times FY 11 E EPS of Rs 35.1) and OCL is valued at Rs 21 per share on basis of its market capitalization.

Oil & Gas

Rating: Positive

Oil prices are hovering around $70-$75 a barrel. If we follow the pattern of the past 15 years, then Jan-Feb has typically been the months, in which, the seasonal oil price starts moving up again as markets prepare for the summer driving season.

We downgraded our rating on downstream companies to ?Sell? but the much awaited Mr. Kirit S. Parikh? panel report on retail fuel prices is out. This report supports market-determined pricing for petrol and diesel, Rs.100/cylinder hike in LPG and Rs. 6/liter hike in kerosene. Though the Oil ministry has to give its final words, as it has to ensure the consumer interest as well as the financial health of PSU fuel retailers, but still this report, focusing on minimizing under recoveries and subsidies, provides positive undertone to the earnings of OMCs. So, we remain Neutral to OMCs.

Considering the huge demand-supply gap, huge growth potential market, potential upside in transmission volumes on account of additional gas availability from RIL?s KG Basin gas, PLL?s RLNG and ONGC?s marginal fields in FY10-FY11, we are positive on gas transmission companies like GAIL (India) Ltd. and Indraprastha Gas Ltd.

Top pick:?? Indraprastha Gas Ltd. remains our top pick with target price of Rs 280, valued at 14x FY11E EPS of Rs. 20 with a target of one year.

Telecom

Rating: Neutral

In 3Q 2010, our coverage universe continues to report decline in its KPI like RPM, MOU & ARPU due to increase in competition plus greater share of rural areas in net incremental addition. In 3Q 2010, coverage universe observed steep fall in RPM which resulted in sequential degrowth in revenues along with falling margins. We believe telecom industry will indeed consolidate but that is still 12-18 months away as the new entrants would not be able to be profitable in long term and the prevailing price war will shake out the sector and eventually work the overcapacity out and probably only the incumbents will emerge as winners.

Infrastructure

Rating: Neutral

Our discussions with companies suggest that funding constraints could increase the near-term risk of execution on Andhra Pradesh irrigation projects. Payments to contractors are getting delayed, engineering and construction companies are going slowly on execution of these projects given lack of funding clarity, and future order inflows could also be at risk if the funding situation doesn’t improve.

Auto

Rating: Neutral

Auto sector continues to report robust volume growth on back of domestic consumption plus renewed exports orders. In 3Q 2010, two wheeler major Hero Honda?s volume registered 30% growth (YoY) whereas Maruti?s volume grew by 48% on YoY basis. Auto players continued to enhance their margin due to falling commodity prices like steel, aluminum & copper. But going forward excise rollback, monetary tightening & rising commodity prices will certainly limit earning growth. Auto stocks are trading at 20 PER times FY 11 EPS which are at premium to historical Price Earning Ratio (PER) band of 15 PER.

Top pick: M&M remain our top pick with target price of Rs 1450 on S.O.T.P basis where in standalone valuation stands at Rs 1050 (15 PER times FY11 EPS of 70) and subsidiaries are valued at Rs 400.

At the CMP of 1,151, the stock is discounting its FY11E and FY12E EPS by 9.9x and 9.7x and EV/ EBITDA by 5.3x and 4.3x, respectively. We value OIL India at Rs 1,332, assigning an EV/EBITDA multiple of 6.5x on our FY11E estimates and give a BUY rating.

Finance Minister is expected to provide guidelines for the introduction of the direct and indirect tax reforms i.e. the direct tax code (DTC) and the Goods & Services Tax (GST).

FM may increase excise duties to decrease the fiscal stimulus measures and may raise the service tax also from 10%. We expect FM to project a lower fiscal deficit for coming financial year on account of higher revenue projections. Another prime focus would be on reforms to reduce the subsidy burden by decontrolling the petrol and diesel prices and price rise on kerosene and LPG cylinder.

Among the financial sector reforms, issue of raising the FDI cap in private sector insurance companies from 26% to 49% is expected to remain on top. We expect that focus area for expenditure would remain the same i.e. agriculture, water, infrastructure, rural and social schemes and power.

Downstream Co: Neutral

Gas Co: Positive

Q3 FY10 review: almost in line with our expectations

The Q3 FY10 results were broadly in line with our expectations. The upstream companies posted good profits during the quarter on account of higher average crude oil prices on YoY basis and higher GRMs. Commencement of Rajasthan field (Cairn India) and increased production in KG-D6 were the key contributors to the top line.

The downstream (OMCs) results were below our expectations, mainly due to the significant under-recoveries, not yet compensated by GoI. Government has committed an Rs 120 bn cash subsidy against the estimated under recovery of about Rs 300 bn for the current financial year.

The gas players did well on the back of higher gas transmission volume, except Petronet LNG.

Outlook

Oil prices are hovering around $70-$75 a barrel. If we follow the pattern of the past 15 years, then Jan-Feb has typically been the months, in which, the seasonal oil price starts moving up again as markets prepare for the summer driving season. Thus, this gives a Positive pitch to RIL and Cairn India.

We downgraded our rating on downstream companies to Sell but the much awaited Mr. Kirit S. Parikh? panel report on retail fuel prices is out. This report supports market-determined pricing for petrol and diesel, Rs.100/cylinder hike in LPG and Rs. 6/liter hike in kerosene. Though the Oil ministry has to give its final words, as it has to ensure the consumer interest as well as the financial health of PSU fuel retailers, but still this report, focusing on minimizing under recoveries and subsidies, provides positive undertone to the earnings of OMCs. So, we remain Neutral to OMCs.

Considering the huge demand-supply gap, huge growth potential market, potential upside in transmission volumes on account of additional gas availability from RIL?s KG Basin gas, PLL?s RLNG and ONGC?s marginal fields in FY10-FY11, we are positive on gas transmission companies like GAIL (India) Ltd. and Indraprastha Gas Ltd.

Considering the growing dependence on imports (80%) and a loss of Rs 180 crore per day on selling petrol, diesel, domestic LPG and kerosene below the imported cost by Indian Oil, BPCL and HPCL, this report supports market-determined pricing for petrol and diesel, Rs.100/cylinder hike in LPG and Rs. 6/liter hike in kerosene.

Bharat Forge, a steel forging and general engineering company, posted good results in Q3 FY10. The net sales rose 14% and the net profit was up at Rs.38 cr. as against Rs.4.3 cr. on YoY basis.

Bharat Forge operates in auto and non-auto sector. In the non-auto sector, the company has received some good orders from the energy sector and going forward, the management expects to achieve the target of 40% of its sales from non-auto sector by 2012.

The company has also signed deals with Alsthom and Areva. These deals are expected to start generating revenues from 2012. The management is very positive on the growth prospect of domestic automotive sector and the export business from North America and China.

Technically, the stock had a very good really from its lows near 70 in Jan 2009. It took a one way really to make a high of near 307 and since last 4 months, the stock is in a sideways-consolidation zone. The stock has multiple support between the levels of 220-230 where one can buy the stock, with a stop loss of closing below 220 from the next higher targets of 340+.

Currently, the total capacity of the company stands to 26 MMTPA. Bargarh expansion project in Orissa is on the way to be completed by March 2010 with an expanded capacity of 2.1 MMTPA. The other major project at Chanda in Maharashtra, which comprises a new line of 3 MMTPA of cement, is expected to be completed by the quarter ended September 2010.

Going forward, on account of strong infrastructure and real estate development, we expect a strong demand for cement and ACC with its pan India presence would get an advantage of the same.

Technically, ACC, after making a low in Jan 2009 near 560, took a one way really to make a high of 985+ and from there; it is taking a small correction. The stock has multiple support between the level of 725-750, where one can accumulate the stock for higher targets of 1050+. The stop loss would be a closing below 720.

Some major events of the year in India

January 2009

The year 2009 started with a positive wave when Indian Government,?in tandem with RBI, announced the much-awaited Second Stimulus Package, aimed at reversing the?economic slowdown. Also, RBI slashed its main policy rates to protect faltering economic growth amid the global slowdown. Reverse Repo rate cut by 1% to 4.0% and CRR cut by 0.5% to 5.0%. The government eased the foreign borrowing rules for firms, mostly in the infrastructure and real estate sectors, and raised the foreign investment limit in corporate bonds to $15 billion.

On Jan,20, Mr. Barack Obama inaugurated as the 44th President of the U.S., lifting the sentiments that recovery will be faster.

The aftermath of Satyam Scam were dragged in the month of January and Indian key indices lost ~2.5 % on the back of a scam that raised questions over the corporate governance issues & financial credibility of the companies.

February 2009

India came up with December month IIP data (-2%) and Q4′09 GDP numbers (5.3%), which were far below the expectations. India saw a big jump in local car sales by 34% on Y-o-Y basis.

The global recessionary trends emerged large over the market sentiments with Sensex shedding 5.7% & Nifty losing 3.87% in February.

President Obama signed the $787 billion economic stimulus package into law, which included a variety of spending measures and tax cuts, intended to promote economic recovery. US also came with its decreasing fourth quarter GDP at an annual rate of 6.2 percent.

March 2009

Indian govt. again cut the Repo (from 5.5% to 5%) and Reverse Repo (4% to 3.5%) rate to increase the liquidity into the system. The global recessionary trends took a breather amidst a slew of Revival Packages from all major economies across the globe. So did the Indian markets and they ended the March month on a positive note gaining 9%.

April 2009

India Inc. reported its quarterly & yearly results, which were better than expected. The month saw strong FII inflows.

But on the later half of the month, Swine Flu declared, apart from it, US?s first quarter GDP also decreased at annual rate of 6.1 percent. Then, in US, the automobile manufacture Chrysler LLC filed for bankruptcy.

The March month?s positive vibes influenced the April month also and Indian markets gained 17% during the April month.

May 2009

The biggest news in May was the Return of UPA government to powerin the 15th Indian general election. The victory was followed by first ever double upper circuit on the markets in the history, with key indices gaining 28% in the month of May. The FII recorded a net inflow of Rs. 13,886 crs in the month. But in this monh, India also confirmed first cases of (A) H1N1 influenza.

June 2009

June came with some bad bunch of news around the world. In India, Indian weather department declared delay in monsoon and stock markets saw FII outflows. On the whole, the market closed on a negative note. In US, General Motors filed for bankruptcy, then the first quarter GDP decreased at annual rate of 5.5 percent.

July 2009

July month saw a good quarterly earning numbers and huge overseas inflows. GoI also announced the financial sector reforms and stake sale in PSUs in order to raise funds.

On the US front, the economic news was mixed but mostly positive. Despite a drop in consumer confidence, better than expected GDP numbers, boost in new home sales and home prices, and rise in the Chicago PMI report all pointed to stabilisation in the economy.

August 2009

The month of August saw a mixed action on the India front. Government drafted a new direct tax code on hopes of higher disposable income in hand of individuals. There were concerns about rainfall deficit & drought being declared across various villages of the country.

On the economic front, the India`s GDP grew to 6.1% in Q1 June 2009, that was lower than 7.8% achieved in Q1 June 2008 but it was better than the 5.8% expansion witnessed in Q4 2009.

There was a sharp surge in food prices in the August due to scanty rains that might stoke inflationary pressures in the economy. But the revival in the monsoon rains cheered the prospects for rice and sugar cane. The weak monsoon led cut in kharif crop production by 18%.

Further, the planning commission projected the GDP growth rate of 6.3% for the current fiscal year and a growth rate of 8% in the coming fiscal before the economy returns to 9% growth in 2011-12.

BSE also launched its IPO index, (which will track companies with a free-float market capitalization of at least 1 billion rupees on listing day.)

On the whole, the Indian markets closed on a flat note.

In US, second quarter GDP fell 1 %, unchanged from the advance estimate in July and following a 6.4% drop in Q1.

September 2009

The ringing of the festival season brought improvement in sales in consumer driven segments. Another positive was that India’s exports fell by annual 19.4 per cent in August Vs 28.4 per cent in July as demand for merchandise picked up in the big global markets ahead of Christmas.

Interest rate futures was reintroduced, which was a significant step towards developing the debt market in India.

October 2009

India recorded a positive set of IIP numbers to 10.4%, which were above the expectations.

The traditional pre-Christmas sell-offs by FIIs had advanced by a couple of months this year. India Inc also saw poor corporate results from some of the giants. The markets shed over 7%.

In US, the third quarter GDP increased at an annual rate of 3.5 percent. The Dow closed above 10,000 for the first time in a year.

November 2009

The IIP numbers, India’s industrial output, grew 9.1% in September from a year earlier, helped by fiscal stimulus and festival demand adding to the debate on the timing of exit policy.

Next in line was a slightly cautious number for that of the wholesale price based inflation data which would now be announced on monthly basis instead of every week. The wholesale price index was up 1.34% in October from a year earlier, compared with 0.5% in September and 11.06% a year ago.

Another interesting and a positive number was India’s strong GDP data that cheered the investor sentiment that the economic recovery is gaining momentum. India’s economy grew at a spectacular 7.9% in the July-September period, up from 6.1 % in the previous quarter, bolstered by government stimulus measures and rising industrial production. The growth compares favorably to 7.7 % recorded in the July-September quarter in the previous year.

NSE launched a platform for trading mutual fund units, called Mutual Fund Service System on?Nov. 30?for trading mutual fund units, with an aim to widen the reach of mutual fund schemes to smaller cities and towns and cut operational costs.

Internationally, crude oil made its 1 year high at $82 and CIT group filed for bankruptcy in US.

Overall, Indian markets gained 7% in this month.

December 2009

Gold made its life time high at $1,226, other commodities like sugar also made its high in the Indian markets at ~$8.5.

India witnessed the IIP numbers at 10.3%, which were below the expectations of 12%.

Till now, from Jan 2009 to till now, Indian key indices have seen an increase of 72% in its value.

The news of $80billion Dubai debt default came. The market expected it a second wave of recession.?After Dubai, S&P and Fitch downgraded Greece’s credit rating. Then, S&P revised?Spain’s outlook to negative.

I have a 15 years’ crude oil seasonal price chart. This chart says that from January to September, crude oil prices increase substantially, mainly because of the summer vacation-driving season. Then, in September- October, it becomes sluggish and then in the month of November- December, demand for crude oil weakens because of the reduction in driving and more moderate temperatures between the summer cooling and winter heating seasons, thus, crude prices see correction.

During the last 15-year period, January has typically been the month, in which, the seasonal oil price starts moving up again as markets prepare for the summer driving season. It is interesting to note that, while crude oil prices are usually soft during December, energy stocks begin to strengthen in December, offering the investors an opportunity to capitalize the favorable seasonal demand.

The OPEC meeting just concluded in Angola. We found two take aways from the event: first was that Asian demand is strong, mainly from China and second take away was that $70 is the new floor in oil prices. i.e. oil between $70-$80 is perfect for OPEC. So, this implies that, anyhow, OPEC will attempt to keep the oil above $70. At present, crude oil is trading at $75. So, may be ?a new uptrend has begun.

So, if 2010 also, follows the pattern of the past 15 years, then we are approaching the start of a seasonal climb in the crude oil prices that could present a good investment opportunity in energy-related stocks.

Currently, the crude oil is trading near US$ 75 per barrel. Going forward, according to this chart, crude should move further up. This would result in higher realizations to upstream companies like RIL, ONGC, Cairn India. But at the same time, higher crude prices would also impact the profitability of downstream companies like HPCL, BPCL (Oil Marketing Companies) as retail oil prices are Govt. driven and OMCs cannot pass on the higher cost to the end users. It would also lead under recoveries.

Natural Gas

Currently, the natural gas is trading at $5.7 per mmbtu, below its average rate of US$ 8 per mmbtu. In the economic recovery, it would be preferred as cheap energy alternative. But there is huge surplus inventory buildup in natural gas; so, we expect that the upside is limited to US$ 8-8.5 per mmbtu. Given the vast demand-supply gap in natural gas, gas transmission companies like GAIL India, Indraprastha Gas and Gujarat State could be highly benefited in 2010.

Rupee

Another factor that can impact oil and gas industry is ?movement in Rupee?. We expect rupee is strong in the near term, on account of higher economic activities, FII inflows to India and the recent comment from FM that GDP growth in FY10 could reach 7.75%. This would be a positive factor for oil marketing companies like IOC, BPCL, HPCL etc. as it will reduce the oil procurement costs, thus reducing subsidy losses and it would also be good for Gujarat Gas as its procurement is dollar denominated and the selling price is rupee-based.

Whereas, rupee appreciation could be negative for stand-alone refineries like Chennai Petroleum as their GRMs are dollar denominated and for upstream companies – ONGC and OIL as crude realisation is US$ denominated but some negative impact is mitigated due to lower subsidies.

Overall, I remain constructive on energy stocks?supply and demand fundamentals for energy will tighten, given the improving economy and positive seasonal factors, heading into the New Year. So, the energy stocks will benefit in 2010.