GAIL reported 1QFY09 net profit of Rs8.97bn (up 31% yoy), which was 10% above our estimates, with most of the upside coming from the petrochemical operations. Petrochem EBIT was up 28% despite flat volumes, as higher absolute prices of products (driven by record oil prices) more than compensated for the rise in input gas prices. Our FY09 EPS estimate is 22% above consensus, but we remain cautious on FY10-11 due to expectations of an increase in input gas costs and a sharp decline in petrochemical prices (drop in PE less naphtha margins as well as lower oil prices).
Maintain Hold rating and Rs330 target price.
Details
GAIL’s profit growth over the past five years has been driven by the petrochemical business and this quarter was no exception. Although the petrochemical margin in terms of the polyethylene (PE) less naphtha spread was virtually flat yoy, as were GAIL’s sales volumes, absolute PE prices were up 29% yoy driven by record oil prices. Consequently, petrochemical EBIT at Rs4.4bn was up 30% yoy and may have included some inventory gains as well. We expect petrochemical profitability to remain high in FY09 on a yoy basis, though on a qoq basis it may start to decline as oil prices have started softening and we believe petrochemical margins will start declining in 2HFY09 as new capacity ramps up in the Middle East.
EBIT in the LPG and allied hydrocarbons segment at Rs3.2bn was up 60% as the upstream subsidy sharing proportion declared for FY09 (22% of gross under-recoveries) is far lower than that in FY08 (33%). This segment could also face a qoq decline in earnings if oil prices continue to remain weak.
GAIL’s core gas transmission business EBIT was Rs4.3bn (up 18% yoy). Volumes were 84.48mmscmd, up 7% yoy, and we believe most of the growth was in the newly commissioned Dahej-Uran-Dabhol pipeline. For the full year, we are forecasting volumes at 99.8mmscmd after factoring in additional gas from Reliance Industries’ KG D6 block in 2HFY09.
Thursday, July 31, 2008
Hindustan Unilever - Ahead of market growth
The key highlight of HUVR's 2Q08 result was strong volume-led growth in revenue across categories, with overall revenue growing 21.1%, which was ahead of the market's 14%. EBITDA growth at 18% was also impressive. We increase our estimates marginally. Buy reiterated, with Rs266 target price.
Strong underlying growth in all key categories in 2Q08
HUVR reported sales growth of 21.1%, with the core FMCG business growing 18.8%, soaps and detergents 20% and personal products 19%. Overall underlying volume growth was 8.5%. Advertising spend increased 30.5% yoy, or by 70bp as a proportion of net sales, while EBITDA margin fell 60bp yoy. We have reclassified HUVR's EBITDA to include other operating income, as a large part of this income was reimbursement of costs for shared services by overseas entities. Other operating income for 2Q08 also included an element of forex gain, for which no breakdown was given.
HUVR maintains its competitive position in all key categories
Growth in HUVR's FMCG business at 18.8% was ahead of market growth by 4.8ppt. The company has improved market shares (over 1Q08) by 40bp in detergents, 20bp in shampoos, 20bp in oral care, 30bp in tea and 270bp in coffee. However, there was a decline in the inherently high-marketshare categories of soaps (from 54.3% to 52.7%) and skin care (from 54% to 53.4%). HUVR continues to innovate in all key categories and its advertising spend has risen 26% in 1H08.
Macro environment gets challenging
High headline inflation and continued monetary tightening may eventually moderate growth for HUVR in urban markets. However, this could be partly offset by rural markets, which continue to see rising income levels due to increased government spending and better food prices. Despite 20% growth in 1H08 sales, we expect only 18% growth in 2008 and 15% growth in 2009.
Maintain Buy with Rs266 target price
We raise our 2008 EPS estimate marginally and 2009F EPS by 1% post the 2Q08 result. As a result, we increase our DCF-based target price to Rs266 (from Rs261). HUVR trades at 21.3x 2009F earnings, and at our target price it would trade at 23.8x, which we believe is fair based on our projected earnings growth (17%) and above-average returns (129% ROE) for 2008.
Strong underlying growth in all key categories in 2Q08
HUVR reported sales growth of 21.1%, with the core FMCG business growing 18.8%, soaps and detergents 20% and personal products 19%. Overall underlying volume growth was 8.5%. Advertising spend increased 30.5% yoy, or by 70bp as a proportion of net sales, while EBITDA margin fell 60bp yoy. We have reclassified HUVR's EBITDA to include other operating income, as a large part of this income was reimbursement of costs for shared services by overseas entities. Other operating income for 2Q08 also included an element of forex gain, for which no breakdown was given.
HUVR maintains its competitive position in all key categories
Growth in HUVR's FMCG business at 18.8% was ahead of market growth by 4.8ppt. The company has improved market shares (over 1Q08) by 40bp in detergents, 20bp in shampoos, 20bp in oral care, 30bp in tea and 270bp in coffee. However, there was a decline in the inherently high-marketshare categories of soaps (from 54.3% to 52.7%) and skin care (from 54% to 53.4%). HUVR continues to innovate in all key categories and its advertising spend has risen 26% in 1H08.
Macro environment gets challenging
High headline inflation and continued monetary tightening may eventually moderate growth for HUVR in urban markets. However, this could be partly offset by rural markets, which continue to see rising income levels due to increased government spending and better food prices. Despite 20% growth in 1H08 sales, we expect only 18% growth in 2008 and 15% growth in 2009.
Maintain Buy with Rs266 target price
We raise our 2008 EPS estimate marginally and 2009F EPS by 1% post the 2Q08 result. As a result, we increase our DCF-based target price to Rs266 (from Rs261). HUVR trades at 21.3x 2009F earnings, and at our target price it would trade at 23.8x, which we believe is fair based on our projected earnings growth (17%) and above-average returns (129% ROE) for 2008.
Cairn India - Rajasthan development on track
Cairn India reported 2Q net profit of Rs1.4bn (US$33.3m). EBITDA increased to Rs2.7bn, up 44% yoy, primarily on the back of higher-than-expected production and rising crude oil prices. Cairn is the only pure play on crude oil prices listed in India. However, we believe current reported results are not meaningful in the context of value that we expect Cairn India to generate once its Rajasthan block starts producing. Management maintained that Rajasthan development is on track for first commercial production in 2HCY09. It also assured that it doesn't see any significant cost increases due to rising commodity prices, as most of its orders have already been placed.
2QCY08 Performance
Cairn reported EBITDA of Rs2.7bn on the back of higher-than-expected production from Ravva and CB/OS-2 Block and rising crude oil prices. The decline in production has been arrested with the start of production from new wells added in the last quarter.
This quarter saw exploration activities in other blocks of Cairn India. Cairn India intends to spend US$100m on exploration activities in the current year. It undertook siesmic programmes in onshore KG block (KG-ONN-2003/1) and Palar (PR-OSN-2004/1) during the second quarter. It completed its drilling for the first of its three well-drilling programmes in CB-ONN-2002/1, which is currently under testing. Consequently, the exploration cost charged to P&L this quarter was Rs427m compared to Rs175m in the previous quarter.
Cairn relinquished GV-ONN-2002/1 block (15% interest) after completing the exploration phase, which lasted seven years. ONGC was the operator of the block. It also added a shallow-water block in Sri Lanka in its acreage and bid for four blocks during India’s NELP VII round; final bid winners are yet to be officially notified.
2QCY08 Performance
Cairn reported EBITDA of Rs2.7bn on the back of higher-than-expected production from Ravva and CB/OS-2 Block and rising crude oil prices. The decline in production has been arrested with the start of production from new wells added in the last quarter.
This quarter saw exploration activities in other blocks of Cairn India. Cairn India intends to spend US$100m on exploration activities in the current year. It undertook siesmic programmes in onshore KG block (KG-ONN-2003/1) and Palar (PR-OSN-2004/1) during the second quarter. It completed its drilling for the first of its three well-drilling programmes in CB-ONN-2002/1, which is currently under testing. Consequently, the exploration cost charged to P&L this quarter was Rs427m compared to Rs175m in the previous quarter.
Cairn relinquished GV-ONN-2002/1 block (15% interest) after completing the exploration phase, which lasted seven years. ONGC was the operator of the block. It also added a shallow-water block in Sri Lanka in its acreage and bid for four blocks during India’s NELP VII round; final bid winners are yet to be officially notified.
Larsen & Toubro - No slowdown, at least for now
L&T received Rs122bn of new orders in 1Q09, up 23% yoy, contrary to market expectations of a slowdown. Reported sales and margins were also healthy. Inclusion of the APGENCO TG package order raises concern about long-term E&C margins. We maintain Buy on a lower target of Rs3,009.40, which offers 18% upside potential.
Domestic order inflows remain strong
L&T received Rs122bn of new orders in 1Q09 vs Rs99bn in 1Q08 (1Q08 included a single Rs55bn order for Mumbai airport). This 23% increase was contrary to market expectations that high inflation would hamper L&T's order inflows and, hence, the growth outlook for FY09-10. Order backlog has reached Rs582bn (up 37% yoy) and is now at 2.1x average sales of the last four quarters. The E&C order book at Rs563bn is 2.6x E&C sales.
APGENCO order boosts inflow; value for L&T standalone uncertain
L&T's 1Q09 order inflow of Rs122bn included the APGENCO order for a turbine and generator package won by its subsidiary JV, L&T-MHI. L&T-MHI is a large and independent entity, and we believe ideally its orders - especially equipment orders (item-rate contracts) - should not be run through L&T's standalone P&L. Moreover, with uncertainty on margins for L&T-MHI's initial order flow, it is difficult to gauge the trading margins L&T standalone would make on these projects.
1Q09 sales higher, EBITDA marginally lower, already hit by cost inflation
L&T's standalone sales grew 53%, operating profit 55% and PAT 72% (adjusted for forex gains). The company achieved this despite a 280bp increase in its materials and construction costs as a percentage of sales. Operating leverage (lower staff and SG&A expenses as a percentage of sales) helped maintain margins. We believe the next three quarters could see margins decline, unless there are savings on materials costs. We only marginally reduce our estimates for FY09 and FY10.
SOTP valuation falls; we lower our target multiples due to uncertainty
Our revised DCF value (on a higher risk-free rate) for L&T standalone implies a target PE of 22x (down from 25x), a premium to BHEL's 18x, given L&T's more diversified business drivers. Our sum-of-the-parts target is reduced further - with target multiples for other components also toned down - to Rs3,009.40 (from Rs3,962.50), 18% higher than the current price. We maintain Buy.
Domestic order inflows remain strong
L&T received Rs122bn of new orders in 1Q09 vs Rs99bn in 1Q08 (1Q08 included a single Rs55bn order for Mumbai airport). This 23% increase was contrary to market expectations that high inflation would hamper L&T's order inflows and, hence, the growth outlook for FY09-10. Order backlog has reached Rs582bn (up 37% yoy) and is now at 2.1x average sales of the last four quarters. The E&C order book at Rs563bn is 2.6x E&C sales.
APGENCO order boosts inflow; value for L&T standalone uncertain
L&T's 1Q09 order inflow of Rs122bn included the APGENCO order for a turbine and generator package won by its subsidiary JV, L&T-MHI. L&T-MHI is a large and independent entity, and we believe ideally its orders - especially equipment orders (item-rate contracts) - should not be run through L&T's standalone P&L. Moreover, with uncertainty on margins for L&T-MHI's initial order flow, it is difficult to gauge the trading margins L&T standalone would make on these projects.
1Q09 sales higher, EBITDA marginally lower, already hit by cost inflation
L&T's standalone sales grew 53%, operating profit 55% and PAT 72% (adjusted for forex gains). The company achieved this despite a 280bp increase in its materials and construction costs as a percentage of sales. Operating leverage (lower staff and SG&A expenses as a percentage of sales) helped maintain margins. We believe the next three quarters could see margins decline, unless there are savings on materials costs. We only marginally reduce our estimates for FY09 and FY10.
SOTP valuation falls; we lower our target multiples due to uncertainty
Our revised DCF value (on a higher risk-free rate) for L&T standalone implies a target PE of 22x (down from 25x), a premium to BHEL's 18x, given L&T's more diversified business drivers. Our sum-of-the-parts target is reduced further - with target multiples for other components also toned down - to Rs3,009.40 (from Rs3,962.50), 18% higher than the current price. We maintain Buy.
Wednesday, July 30, 2008
PTC India - In line with expectations
PTC's 1Q09 result was characterised by flat operating income and higher interest income. The recently concluded public issue of Rs12bn has increased the company's cash kitty very substantially, with the planned investments in subsidiaries yet to materialise. Power-trading income from long-term deals has yet to kick in, as such projects would start being commissioned only around end-FY09.
Valuation and target price
We value PTC India on a sum-of-the-parts basis (see table below). Investments in PTC Financial Services (PFS), Teesta Urja and Athena Energy Ventures are valued at a P/BV of 2x FY10F, in line with our valuation for NTPC. We value future investments in Global Fuels, the coal-trading company, at 1x FY09F book value due to the lack of clarity in this business (the Rs14.40/share value would have otherwise been on PTC’s balance sheet as cash).
Valuation and target price
We value PTC India on a sum-of-the-parts basis (see table below). Investments in PTC Financial Services (PFS), Teesta Urja and Athena Energy Ventures are valued at a P/BV of 2x FY10F, in line with our valuation for NTPC. We value future investments in Global Fuels, the coal-trading company, at 1x FY09F book value due to the lack of clarity in this business (the Rs14.40/share value would have otherwise been on PTC’s balance sheet as cash).
Patni Computer Systems - Operational challenges remain
Broadly in-line results with no positive surprises in operating metrics. A subdued management commentary and flat 3Q08 growth guidance could weigh on the stock. However, the ongoing share buyback and Rs106 cash/share should support downside. Hold, with a reduced target price of Rs226.
2Q08 results: no positive surprises; operational triggers missing
Consolidated revenues grew 3.5% qoq to US$182.6bn, in line with our estimates and marginally ahead of guidance. We estimate volumes grew 3% qoq while blended realisation was up 0.4% qoq. Rupee depreciation pushed the revenue growth (Rs terms) by 11% qoq to Rs7.84bn, and EBITDA margin (ex-forex gains) by 33bp qoq to 15.6% (vs our 16.2% estimate). Reported PAT was up 43.1% qoq to Rs1.04bn. However, ex-forex losses, normalised PAT was up 49%, in line with our estimate. Weakness in operational metrics continued. Headcount declined by 108 (we estimated 500 additions) while revenues from the Top 10 clients were up 2.8% qoq.
Management commentary cautious; flat 3Q08 growth guidance
Management reiterated that visibility on near-term demand remains low, guiding for flattish top line for 3Q08, despite a modest outperformance to guidance in 2Q08. It also expects 2008 normalised EBITDA margins to trend near the current quarter’s level of 15.6% despite a favourable currency. This is in line with our thesis of significant margin erosion in 2008 (we estimate a 195bp yoy decline). PAT guidance of US$18m-18.5m represents a qoq decline of 23.4-25.5%, building in lower other income after a seasonally strong 2Q08.
We retain Hold; buyback programme should support the downside
We cut our volume growth projections, factoring in the lower headcount in the quarter. However, our financial forecasts (in Rs terms) are up, due to a about 6% change in the exchange rate vs our earlier estimate. However, we cut our PE-based target price to Rs226 (from Rs275), based on 8.3x 2009F EPS (vs 11x earlier), reflecting a 45% discount to Satyam, which is near the historical peak discount valuation of Patni. We expect the stock to be range-bound; Patni’s current valuation - with a 4% PAT (ex-forex) growth over 2007-10F - looks expensive relative to its mid-cap peers where we see better growth prospects. However, the ongoing buyback (0.8m out of the minimum 7.3m plan has been bought back) should provide downward support till the duration of the programme (July 2008-Februay 2009).
2Q08 results: no positive surprises; operational triggers missing
Consolidated revenues grew 3.5% qoq to US$182.6bn, in line with our estimates and marginally ahead of guidance. We estimate volumes grew 3% qoq while blended realisation was up 0.4% qoq. Rupee depreciation pushed the revenue growth (Rs terms) by 11% qoq to Rs7.84bn, and EBITDA margin (ex-forex gains) by 33bp qoq to 15.6% (vs our 16.2% estimate). Reported PAT was up 43.1% qoq to Rs1.04bn. However, ex-forex losses, normalised PAT was up 49%, in line with our estimate. Weakness in operational metrics continued. Headcount declined by 108 (we estimated 500 additions) while revenues from the Top 10 clients were up 2.8% qoq.
Management commentary cautious; flat 3Q08 growth guidance
Management reiterated that visibility on near-term demand remains low, guiding for flattish top line for 3Q08, despite a modest outperformance to guidance in 2Q08. It also expects 2008 normalised EBITDA margins to trend near the current quarter’s level of 15.6% despite a favourable currency. This is in line with our thesis of significant margin erosion in 2008 (we estimate a 195bp yoy decline). PAT guidance of US$18m-18.5m represents a qoq decline of 23.4-25.5%, building in lower other income after a seasonally strong 2Q08.
We retain Hold; buyback programme should support the downside
We cut our volume growth projections, factoring in the lower headcount in the quarter. However, our financial forecasts (in Rs terms) are up, due to a about 6% change in the exchange rate vs our earlier estimate. However, we cut our PE-based target price to Rs226 (from Rs275), based on 8.3x 2009F EPS (vs 11x earlier), reflecting a 45% discount to Satyam, which is near the historical peak discount valuation of Patni. We expect the stock to be range-bound; Patni’s current valuation - with a 4% PAT (ex-forex) growth over 2007-10F - looks expensive relative to its mid-cap peers where we see better growth prospects. However, the ongoing buyback (0.8m out of the minimum 7.3m plan has been bought back) should provide downward support till the duration of the programme (July 2008-Februay 2009).
Union Bank - calibrated growth
Union Bank's calibrated growth and high leverage have maintained its profitability. The bank's NIMs and investments portfolio are vulnerable to rate hikes, in our view, but improving low-cost deposits offer some relief. We hike our COE but retain our Buy recommendation.
Calibrated growth, high leverage boost ROE
Union Bank has been pursuing calibrated growth. The moderate growth in loan book with a traction in low-cost deposit mix led to stable NIM on a qoq basis at 2.63% in 1QFY09. In FY09, management expects NIMs to be flat yoy at 2.8%. We, however, reduce our NIM estimate for FY09 from 2.70% to 2.62%, given the tight liquidity situation (2.69% in FY08). However, we also note that Union Bank's low tier-1 capital leads to increased leverage, which results in higher ROE than its peers.
MTM losses drag profits lower, but asset quality appears good
As at end June 2008, Union Bank had 32.6% of its investments in the available-for-sale category, the duration of which was 2.72 years. With short-term yields expanding about 170bp qoq, the bank had to book a mark-to-market loss of Rs3.39bn in 1QFY09. Asset quality appears good with incremental delinquency declining from 1.93% in FY06 to 1.23% in FY08 and further to 0.85% in 1QFY09. We estimate the provision charges (loan loss and mark-to-market provisions) in FY09F will increase from our earlier estimate of 0.73% to 1.0%.
Low capital adequacy is a constraint
Union Bank is capital efficient but also capital constrained to an extent. Therefore, it will likely benefit from any banking law amendment that allows public sector banks to issue non-voting shares. Alternatively, the government will have to subscribe to the shares in rights issue. We believe this will likely alleviate capital adequacy concerns. We estimate Union Bank's tier-1 CAR will be a low 7.3% by March 2009.
We retain our Buy rating but cut our earnings estimates and target price
We marginally cut our FY09-10 earnings estimates and have changed our estimates for profitability (ROA). The cut in our target price is due to an increase in the cost of equity from 13% to 15%. We retain our Buy recommendation but with a new target price of Rs172.40 (from Rs215.4). At our new target price, the stock would trade at 6.8x FY09F earnings and 1.3x FY09F adjusted book value.
Calibrated growth, high leverage boost ROE
Union Bank has been pursuing calibrated growth. The moderate growth in loan book with a traction in low-cost deposit mix led to stable NIM on a qoq basis at 2.63% in 1QFY09. In FY09, management expects NIMs to be flat yoy at 2.8%. We, however, reduce our NIM estimate for FY09 from 2.70% to 2.62%, given the tight liquidity situation (2.69% in FY08). However, we also note that Union Bank's low tier-1 capital leads to increased leverage, which results in higher ROE than its peers.
MTM losses drag profits lower, but asset quality appears good
As at end June 2008, Union Bank had 32.6% of its investments in the available-for-sale category, the duration of which was 2.72 years. With short-term yields expanding about 170bp qoq, the bank had to book a mark-to-market loss of Rs3.39bn in 1QFY09. Asset quality appears good with incremental delinquency declining from 1.93% in FY06 to 1.23% in FY08 and further to 0.85% in 1QFY09. We estimate the provision charges (loan loss and mark-to-market provisions) in FY09F will increase from our earlier estimate of 0.73% to 1.0%.
Low capital adequacy is a constraint
Union Bank is capital efficient but also capital constrained to an extent. Therefore, it will likely benefit from any banking law amendment that allows public sector banks to issue non-voting shares. Alternatively, the government will have to subscribe to the shares in rights issue. We believe this will likely alleviate capital adequacy concerns. We estimate Union Bank's tier-1 CAR will be a low 7.3% by March 2009.
We retain our Buy rating but cut our earnings estimates and target price
We marginally cut our FY09-10 earnings estimates and have changed our estimates for profitability (ROA). The cut in our target price is due to an increase in the cost of equity from 13% to 15%. We retain our Buy recommendation but with a new target price of Rs172.40 (from Rs215.4). At our new target price, the stock would trade at 6.8x FY09F earnings and 1.3x FY09F adjusted book value.
Lupin
Strong Rx share in Ramipril and the improvement in operating margins for 1Q08 suggest that Lupin could beat our FY09 estimates. However, we maintain them for now given the volatility in SGA and early days for Ramipril. Lupin is most attractively valued among our coverage universe, trading at a FY09F PE of 15.2x. Maintain Buy.
FY09 begins with a bang
Lupin recorded a strong first quarter, reporting net sales of Rs8.6bn, 9% above our expectations. Revenues grew by an impressive 32% yoy, even when excluding the acquisition impact of Kyowa and Rubamin. We believe strong Ramipril sales will have assisted the outperformance; however, the rest of the advanced markets business was also stronger than expected. EBITDA margin at 17.7% was better than our estimate of 16.8% due to lower growth in SGA expenses. Strong sales growth, coupled with margin improvement, led to PAT doubling to Rs1.1bn. Reported 1Q09 EPS of Rs12.7 represents 27% of our full-year FY09 estimate of Rs47.20.
Strong possibilities of revenue upside
We believe there are strong possibilities that Lupin might beat our FY09 top-line estimate of Rs31.6bn (16.7% yoy growth). The average contribution of the first quarter revenues to the total annual revenues has historically been about 23%. Therefore, the strong reported quarter top-line contribution at 27% of our FY09 estimate suggests that annual revenues could be higher, assuming the second half continues to be stronger than the first. Kyowa has reported revenues of US$21m, which would only go stronger with the 10 new products having been launched in July. We believe Ramipril could record net sales of US$17m-25m in FY09 as it has managed to grow its market share despite new entrants. Three months post the 2007-08 flu season, Suprax has still managed to post an impressive average growth rate of 21% ytd. Thus, we believe actual Suprax sales could beat our forecast of flattish yoy growth.
Attractively valued, in our view
We maintain our current estimates while acknowledging possible upside to our estimates. We estimate revenue growth of 16.7% and core earnings growth of 26.4% for FY09, vs corresponding 34.4% and 44.1% growth in FY08. Lupin remains one of our top sector picks owing to its strong core earnings growth, impressive domestic formulation growth, non-dependence on one-offs built into its valuation model and attractive valuation. Maintain Buy.
FY09 begins with a bang
Lupin recorded a strong first quarter, reporting net sales of Rs8.6bn, 9% above our expectations. Revenues grew by an impressive 32% yoy, even when excluding the acquisition impact of Kyowa and Rubamin. We believe strong Ramipril sales will have assisted the outperformance; however, the rest of the advanced markets business was also stronger than expected. EBITDA margin at 17.7% was better than our estimate of 16.8% due to lower growth in SGA expenses. Strong sales growth, coupled with margin improvement, led to PAT doubling to Rs1.1bn. Reported 1Q09 EPS of Rs12.7 represents 27% of our full-year FY09 estimate of Rs47.20.
Strong possibilities of revenue upside
We believe there are strong possibilities that Lupin might beat our FY09 top-line estimate of Rs31.6bn (16.7% yoy growth). The average contribution of the first quarter revenues to the total annual revenues has historically been about 23%. Therefore, the strong reported quarter top-line contribution at 27% of our FY09 estimate suggests that annual revenues could be higher, assuming the second half continues to be stronger than the first. Kyowa has reported revenues of US$21m, which would only go stronger with the 10 new products having been launched in July. We believe Ramipril could record net sales of US$17m-25m in FY09 as it has managed to grow its market share despite new entrants. Three months post the 2007-08 flu season, Suprax has still managed to post an impressive average growth rate of 21% ytd. Thus, we believe actual Suprax sales could beat our forecast of flattish yoy growth.
Attractively valued, in our view
We maintain our current estimates while acknowledging possible upside to our estimates. We estimate revenue growth of 16.7% and core earnings growth of 26.4% for FY09, vs corresponding 34.4% and 44.1% growth in FY08. Lupin remains one of our top sector picks owing to its strong core earnings growth, impressive domestic formulation growth, non-dependence on one-offs built into its valuation model and attractive valuation. Maintain Buy.
Transportation - Supply-side phenomena
Tanker and dry-bulk markets have positively surprised us year to date. However, both markets face the prospect of a supply overhang in 2009-11. That said, tanker scrapping/conversions could result in positive surprise in 2009-10. Buy GE Shipping; Sell SCI.
Tankers: will the market scrap?
Tanker freight rates in 2008 have, so far, been better than expected. Although we lower our tanker demand growth estimate to 2.7% (from 4.5%), we expect the market to be finely balanced in 2008, on the back of supply-side adjustments. However, Clarksons estimates new-build deliveries at 36.4% of global capacity between 2009-11. Based on our long-term tanker demand growth estimate of 3.6%, we expect new supply to put pressure on freight rates. That said, we believe weakness in the tanker market is unlikely to be prolonged (except for complete demand destruction) as owners remove single-hulls from the trade. In our view, removal of single-hulls could be triggered by: 1) the market’s tendency to be self-adjusting; 2) a widening price differential between double and single hulls; 3) record-high scrap prices; and 4) conversion to FPSOs. So, removal of single-hull vessels could result in freight rates surprising on the upside in 2009-10.
Dry-bulk: order cancellations key for balance
The dry-bulk shipping business is experiencing another good year due to continuing strong demand for dry-bulk commodities and port congestion. We raise our demand growth estimate for dry-bulk trade to 7.7% (from 5%) for 2008, suggesting a tight demand-supply situation. However, Clarksons estimates scheduled new-build deliveries will add 259mdwt (66% of global fleet) to drybulk capacity during 2009-11. Thus, we remain negative on the dry-bulk cycle due to supply concerns. That said, there is wide speculation in the industry about potential delays/cancellations of new-builds at Chinese yards. In our view, order cancellations are a must for the dry-bulk business to see a positive demand-supply balance over 2009-11.
Buy GE Shipping; Sell SCI
In our view, the 100% offshore subsidiary (Greatship) is likely to protect earnings and value for GE Shipping shareholders. We value Greatship at Rs151/GE Shipping share. Adjusting for this, the parent is available at 3.5x PER and 3.3x EV/EBITDA on FY09F earnings. SCI has a capex of US$1.6bn with the bulk of deliveries in FY11-12. However, we believe weaker freight rates and rising capex will result in falling RoEs and disappearing net cash.
Tankers: will the market scrap?
Tanker freight rates in 2008 have, so far, been better than expected. Although we lower our tanker demand growth estimate to 2.7% (from 4.5%), we expect the market to be finely balanced in 2008, on the back of supply-side adjustments. However, Clarksons estimates new-build deliveries at 36.4% of global capacity between 2009-11. Based on our long-term tanker demand growth estimate of 3.6%, we expect new supply to put pressure on freight rates. That said, we believe weakness in the tanker market is unlikely to be prolonged (except for complete demand destruction) as owners remove single-hulls from the trade. In our view, removal of single-hulls could be triggered by: 1) the market’s tendency to be self-adjusting; 2) a widening price differential between double and single hulls; 3) record-high scrap prices; and 4) conversion to FPSOs. So, removal of single-hull vessels could result in freight rates surprising on the upside in 2009-10.
Dry-bulk: order cancellations key for balance
The dry-bulk shipping business is experiencing another good year due to continuing strong demand for dry-bulk commodities and port congestion. We raise our demand growth estimate for dry-bulk trade to 7.7% (from 5%) for 2008, suggesting a tight demand-supply situation. However, Clarksons estimates scheduled new-build deliveries will add 259mdwt (66% of global fleet) to drybulk capacity during 2009-11. Thus, we remain negative on the dry-bulk cycle due to supply concerns. That said, there is wide speculation in the industry about potential delays/cancellations of new-builds at Chinese yards. In our view, order cancellations are a must for the dry-bulk business to see a positive demand-supply balance over 2009-11.
Buy GE Shipping; Sell SCI
In our view, the 100% offshore subsidiary (Greatship) is likely to protect earnings and value for GE Shipping shareholders. We value Greatship at Rs151/GE Shipping share. Adjusting for this, the parent is available at 3.5x PER and 3.3x EV/EBITDA on FY09F earnings. SCI has a capex of US$1.6bn with the bulk of deliveries in FY11-12. However, we believe weaker freight rates and rising capex will result in falling RoEs and disappearing net cash.
ACC quarter results
While 2Q08 EBITDA was disappointing, we believe ACC’s EV/tonne of US$94.7 (25% discount to replacement cost) largely captures the grim near-term earning outlook. We cut earnings by 9% for 2008F and 26% for 2009F and, thus, our target price to Rs689. We think the stock still offers value at current levels, hence we maintain our Buy call.
2Q08 results disappoint, partly due to one-off factors
ACC’s volumes fell 1.3% in 2Q08 vs 9.4% growth reported in 1Q08. The decline was due to the 45-day shutdown in its Chaibasa unit due to technical problems. ACC also received 5% less coal from its assured supplier Coal India, forcing it to purchase coal from the open market at a 200% premium to Coal India’s price. As a result, EBITDA fell 24%. The decline in volumes and higher coal costs caused EBITDA/tonne to drop to Rs782 in 2Q08, from Rs871 in 1Q08.
Volume outlook should improve; financial position remains strong
ACC is scheduled to commission 4mmt of cement capacity in 2009, with the 1mmt Bargarh unit and the 3mmt New Wadi unit coming on stream. We estimate this will drive volume growth of 9% in 2010. Besides, ACC's financial position is significantly better now than it was during the last cyclical downturn in cement (1998-2000). It was in net cash as at end-2007, compared to a debt:equity of 126% in 2000. Even after accounting for the planned capex of Rs25bn over the next two years to raise capacity by 7.2mmt, we estimate debt:equity at only 6% for 2010. ACC has unlocked significant value by disposing of all non-core assets in the past five years.
Cement prices could come under pressure in 2009
We forecast incremental capacity addition of 75.6mmt through 2009 vs incremental demand growth of 39.8mmt. With most of the capacity to be commissioned in 2008, we should see full production in 2009. Hence, we foresee a surplus of 23.6mmt in 2009, representing 9% of industry capacity. We factor in a 5% drop in average prices in 2010 and, thus, expect EBITDA/t to fall from Rs797 in 2008 to Rs640 in 2009.
Trades at a 25% discount to replacement cost with no financial leverage
We cut our 2008F EPS by 9% on weak 2Q08 performance. We reset our DCF-based target price to Rs689 (from Rs906) to reflect the EPS cut and a higher risk-free rate (up 1% to 9%). We see no earnings momentum in the near term, but we think the stock offers value at 9x 2009F PE.
2Q08 results disappoint, partly due to one-off factors
ACC’s volumes fell 1.3% in 2Q08 vs 9.4% growth reported in 1Q08. The decline was due to the 45-day shutdown in its Chaibasa unit due to technical problems. ACC also received 5% less coal from its assured supplier Coal India, forcing it to purchase coal from the open market at a 200% premium to Coal India’s price. As a result, EBITDA fell 24%. The decline in volumes and higher coal costs caused EBITDA/tonne to drop to Rs782 in 2Q08, from Rs871 in 1Q08.
Volume outlook should improve; financial position remains strong
ACC is scheduled to commission 4mmt of cement capacity in 2009, with the 1mmt Bargarh unit and the 3mmt New Wadi unit coming on stream. We estimate this will drive volume growth of 9% in 2010. Besides, ACC's financial position is significantly better now than it was during the last cyclical downturn in cement (1998-2000). It was in net cash as at end-2007, compared to a debt:equity of 126% in 2000. Even after accounting for the planned capex of Rs25bn over the next two years to raise capacity by 7.2mmt, we estimate debt:equity at only 6% for 2010. ACC has unlocked significant value by disposing of all non-core assets in the past five years.
Cement prices could come under pressure in 2009
We forecast incremental capacity addition of 75.6mmt through 2009 vs incremental demand growth of 39.8mmt. With most of the capacity to be commissioned in 2008, we should see full production in 2009. Hence, we foresee a surplus of 23.6mmt in 2009, representing 9% of industry capacity. We factor in a 5% drop in average prices in 2010 and, thus, expect EBITDA/t to fall from Rs797 in 2008 to Rs640 in 2009.
Trades at a 25% discount to replacement cost with no financial leverage
We cut our 2008F EPS by 9% on weak 2Q08 performance. We reset our DCF-based target price to Rs689 (from Rs906) to reflect the EPS cut and a higher risk-free rate (up 1% to 9%). We see no earnings momentum in the near term, but we think the stock offers value at 9x 2009F PE.
Reliance quarter results
RIL reported 1QFY09 net profit of Rs41.1bn (up 13% yoy), 8% below our estimate, but in line with consensus. Most of the disappointment arose from GRMs, which were at US$15.7/bbl, compared to our estimate of US$17/bbl. Management maintained its guidance that oil/gas production from KG D6 would begin in 2HFY09. Management also said RPL would begin operations by December 08, but since each refinery unit would be commissioned step by step, commercial operations would begin later. We have assumed commercial operations start by April 09, whereas consensus is assuming 3-4 months of operations in FY09 (the main reason our FY09 EPS is 11% below consensus). Management said the availability of gas from KG D6 for internal consumption would depend on the government's gas utilisation policy, which puts refining lower in the utilisation pecking order. We also found management guidance on refining a little more cautious due to negative trends in US gasoline consumption. There were no additional "big bang" announcements.
Details
1QFY09 EBITDA was Rs61.2bn (up 8% yoy), but 8% below our expectations largely due to lower-than-anticipated refining profits. Forex loss at Rs2.8bn was also lower than our estimate of Rs4bn. Capex, at Rs72.2bn, was up 87% yoy and management said 80-85% was for E&P. Net debt was up from Rs289bn at end-March 08 to Rs319bn at end-June 08 and most of the increase was on account of higher working capital arising out of the US$40/bbl increase in crude price during the quarter.
E&P
The company expects oil/gas production from KG-D6 to begin in 2HFY09. The east-west pipeline has been completed and is now being tested.
Meanwhile, management said the issues over the tax holiday for gas production would be decided by the courts. Until then, they would continue to assume a tax holiday in their income tax filings.
Two discoveries have been made during the quarter.
Details
1QFY09 EBITDA was Rs61.2bn (up 8% yoy), but 8% below our expectations largely due to lower-than-anticipated refining profits. Forex loss at Rs2.8bn was also lower than our estimate of Rs4bn. Capex, at Rs72.2bn, was up 87% yoy and management said 80-85% was for E&P. Net debt was up from Rs289bn at end-March 08 to Rs319bn at end-June 08 and most of the increase was on account of higher working capital arising out of the US$40/bbl increase in crude price during the quarter.
E&P
The company expects oil/gas production from KG-D6 to begin in 2HFY09. The east-west pipeline has been completed and is now being tested.
Meanwhile, management said the issues over the tax holiday for gas production would be decided by the courts. Until then, they would continue to assume a tax holiday in their income tax filings.
Two discoveries have been made during the quarter.
Monday, July 28, 2008
Bharti Airtel
Bharti's 1Q09 headline results were significantly ahead of our estimates; however, the outperformance was largely in its non-mobile business and from one-time factors. Operationally, the showcase was continued pick-up in demand elasticity post a cut in STD tariff, in line with our near-term view. We retain our view of a modest pace of margin decline over the medium term, despite the consolidated EBITDA margin being flat qoq vs our expectation of an increase. We expect consensus estimates to move up, given the 1Q09 outperformance and management's guiding for lower effective tax rates. We retain the stock as our only Buy idea in the sector.
1Q09 results – Key highlights
Financials
Consolidated revenues at Rs84.8bn were up 8.5% qoq (vs our estimates of Rs81.3bn). Among the segments, the mobile business grew broadly in line at 7.7% qoq to Rs 69.2bn. Alignment of tariff in the carrier business to market rates drove segmental revenues 25% qoq; but the impact going forward may be limited as 90% of the business is captive. Revenues in the tower business were ahead of our estimates by 10%; however, the increase was mainly due to a pick-up in the pass-through power and fuel charges.
The consolidated EBITDA margin was flat qoq at 41.5% (vs our estimates of a 50bp expansion). The margin in the mobile business was down 4.8% qoq due to three factors: a) higher access charges for the business as tariffs in the carrier business were aligned with market rates; b) increase in the pass-through charges for passive infrastructure due to higher power and fuel charges; and c) an uptick in the pre-paid subscriber share that has higher upfront costs.
Net profit at Rs20.2bn, up 9.3% qoq, was significantly ahead of our estimates, driven by onetime gains (mainly insurance claims payment) in other income and lower effective tax rate.
1Q09 results – Key highlights
Financials
Consolidated revenues at Rs84.8bn were up 8.5% qoq (vs our estimates of Rs81.3bn). Among the segments, the mobile business grew broadly in line at 7.7% qoq to Rs 69.2bn. Alignment of tariff in the carrier business to market rates drove segmental revenues 25% qoq; but the impact going forward may be limited as 90% of the business is captive. Revenues in the tower business were ahead of our estimates by 10%; however, the increase was mainly due to a pick-up in the pass-through power and fuel charges.
The consolidated EBITDA margin was flat qoq at 41.5% (vs our estimates of a 50bp expansion). The margin in the mobile business was down 4.8% qoq due to three factors: a) higher access charges for the business as tariffs in the carrier business were aligned with market rates; b) increase in the pass-through charges for passive infrastructure due to higher power and fuel charges; and c) an uptick in the pre-paid subscriber share that has higher upfront costs.
Net profit at Rs20.2bn, up 9.3% qoq, was significantly ahead of our estimates, driven by onetime gains (mainly insurance claims payment) in other income and lower effective tax rate.
Voltas
Voltas's order book has expanded nearly 3x over the last 12 months to Rs56.7bn (3.3x Projects sales) and there is room for more orders. We raise Projects' FY10F earnings 21% and lower Agency business earnings 7%. We raise our FY10F EPS 3.7%, revise our target price to Rs155.60 and upgrade to Buy.
1Q09 – third consecutive disappointing quarter; forecasts at bottom?
Beginning 3Q08, Voltas's Projects business experienced execution delays by its main contractors, which hurt revenue growth and affected margins. Although this is still the case, we believe it will end soon. With a Rs56.7bn order book, which is 3.3x Projects' segment sales for the past four quarters, we believe Project revenues should comfortably show about a 35% CAGR for FY09-10. Since 3Q08, Agency business had to do more of stock-and-sell than pure commission sales, resulting in a decline in margins. Stock-and-sell involves Voltas buying the goods and stocking them before selling, unlike selling on commission. We believe reported revenue growth and margins of the Projects and Agency businesses can only improve from here on.
Products segment continues to improve margins
The Products segment's EBIT margin improved significantly to 9.5% in the seasonally strong June quarter. While such margins may not be sustained in the coming quarters, we are now reasonably sure of 6% margins for FY09-10F.
We revise our estimates for Projects and Agency segments
We raise our FY10 revenue estimate for the Projects segment by 21% on the back of a strongerthan- expected order book. We maintain our EBIT margin estimate for Projects at 8.5%. We also reduce our margin estimate for the Agency business from 19% to 15% based on higher stock-andsell and manufactured products. Overall, we raise our FY10 EPS forecast from Rs9.90 to Rs10.30. More significantly, Agency business contribution to total EBIT for FY10F is reduced from 26% to 18%.
The worst appears priced in; we upgrade to Buy from Hold
We believe all the negatives are now priced into the valuations. We upgrade the stock to Buy from Hold and revise our PE-based target price to Rs155.60 from Rs182.70, reflecting a target FY10F PE of 15.2x.
1Q09 – third consecutive disappointing quarter; forecasts at bottom?
Beginning 3Q08, Voltas's Projects business experienced execution delays by its main contractors, which hurt revenue growth and affected margins. Although this is still the case, we believe it will end soon. With a Rs56.7bn order book, which is 3.3x Projects' segment sales for the past four quarters, we believe Project revenues should comfortably show about a 35% CAGR for FY09-10. Since 3Q08, Agency business had to do more of stock-and-sell than pure commission sales, resulting in a decline in margins. Stock-and-sell involves Voltas buying the goods and stocking them before selling, unlike selling on commission. We believe reported revenue growth and margins of the Projects and Agency businesses can only improve from here on.
Products segment continues to improve margins
The Products segment's EBIT margin improved significantly to 9.5% in the seasonally strong June quarter. While such margins may not be sustained in the coming quarters, we are now reasonably sure of 6% margins for FY09-10F.
We revise our estimates for Projects and Agency segments
We raise our FY10 revenue estimate for the Projects segment by 21% on the back of a strongerthan- expected order book. We maintain our EBIT margin estimate for Projects at 8.5%. We also reduce our margin estimate for the Agency business from 19% to 15% based on higher stock-andsell and manufactured products. Overall, we raise our FY10 EPS forecast from Rs9.90 to Rs10.30. More significantly, Agency business contribution to total EBIT for FY10F is reduced from 26% to 18%.
The worst appears priced in; we upgrade to Buy from Hold
We believe all the negatives are now priced into the valuations. We upgrade the stock to Buy from Hold and revise our PE-based target price to Rs155.60 from Rs182.70, reflecting a target FY10F PE of 15.2x.
Sunday, July 27, 2008
Everest Kanto Cylinder
Well placed to capitalise on the huge city gas distribution opportunity across the world
Everest Kanto Cylinder (EKC) is the largest domestic manufacturer of high pressure gas cylinders used for the storage of industrial gases and compressed natural gas (CNG). High pressure gas cylinders are used to store medical gases, CNG for vehicles, and fire fighting gases. The cylinders have usage in welding, beverage, defense and space applications. EKC also designs, fabricates, manifolds and tests CNG cylinder cascades for the storage and transportation of CNG. As margin and growth prospects are much higher in the CNG segment (compared with other segments), the company is now fully focused on capitalising on the opportunity in this segment.
Everest Kanto Cylinder (EKC) is the largest domestic manufacturer of high pressure gas cylinders used for the storage of industrial gases and compressed natural gas (CNG). High pressure gas cylinders are used to store medical gases, CNG for vehicles, and fire fighting gases. The cylinders have usage in welding, beverage, defense and space applications. EKC also designs, fabricates, manifolds and tests CNG cylinder cascades for the storage and transportation of CNG. As margin and growth prospects are much higher in the CNG segment (compared with other segments), the company is now fully focused on capitalising on the opportunity in this segment.
EKC currently has four manufacturing plants, one each in Aurangabad, Tarapur, Gandhidham, and Dubai. The total production capacity is 806,000 cylinders per year. An aggressive expansion plan, including a greenfield plant in China, expansion of the Gandhidham (Gujarat) facility, and a new plant in an special economic zone (SEZ), would increase EKC’s capacity to 2.3 million cylinders over the next four-five years.
With existing capacity running close to 100%, EKC has added new capacities at strategic locations, targeting high growth/high realisation domestic as well as international markets (Dubai to serve the Middle East and Pakistan and China for China).
EKC started production at its China facility in May 2008. Phase I of the China facility will have an installed capacity of 2,00,000 cylinders per annum. The facility will be used mainly to produce CNG cylinders. Currently, China is laying an east-west coast connective pipeline. Also, the CNG stations will get increased from the present 300 stations to 4,000 stations by 2012. The company has plans to raise the installed capacity in China to 10 lakh cylinders in various phases in the next three years.
EKC acquired for US $66.3million the assets of CPI Industries in the US in April 2008. CPI is a major global manufacturer of large, seamless, high-pressure cylinders (jumbo cylinders of 2,000 litres and higher capacity) for storage and transportation of pressurised gases with a capacity of 6,000 cylinders per annum. The management is confident that CPI Industries will also add to its top line as well as bottom line.
EKC has diversified its sourcing strategy by using alternate manufacturing processes (using billets instead of tubes), thus reducing supplier risk (biggest supplier Tenaris will account for about 50% of materials compared with more than 90% a year ago).
City gas distribution and mandatory conversion of public vehicles is currently a focus area for the Central government, indicating a potential high-growth opportunity. The Union government has indicated 28 cities for this conversion. So far, only Delhi has fully implemented the mandate. The overhang on this segment remains in the form of lack of gas availability as well as in-place distribution infrastructure. Improvement is expected on both of these fronts. Reliance Industries is likely to start the supply of gas from the KG Basin from September 2008.
With crude oil recording sharp rises, various countries are promoting use of gas as a fuel, wherever available. Iran, with surplus gas reserves, is promoting CNG as a fuel. Overall, EKC expects demand of around 15 lakh CNG cylinders by 2012 from Iran, one of the major customers of the company. So, the company is fast building up capacities to grasp the opportunity.
We expect EKC to register EPS of Rs 16.1 in FY 2009. The share price trades at Rs 259. P/E works out to just 16.
Repro India
Capitalising on the global trend of outsourcing printing of education books
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Repro India is one of India’s integrated end-to-end content and printing solutions company present across the value chain ranging from creative designing; pre-press, printing and post-press services; assembling; warehousing; dispatching; database management; sourcing and procurement; localisation; and web-based services.
Main clients include publishing houses such as Alligator Books, Heinneman Educational Books (Nigeria) Plc, Modern Publishing Inc, Orient Longman, and Oxford University Press. Software companies like Microsoft Inc and hardware company Lenovo India are its customer. Indian clientele includes Tata Steel, Nokia India, NIIT, Wipro and Satyam Computer Services. Repro India is the only authorised Microsoft replicator in India.
Repro India is completely focused on one-stop solution including providing content to book publishers, both overseas and in India, of scientific, technical and medical books; trade books; digital books; magazines, and children’s books as well as to brochures, pamphlets, companies’ annual reports and investor communications, and educational manuals of IT companies. Apart from that, it caters to on-demand business.
Globally, the printing industry is as large as US$ 500 billion, growing at a steady pace of 2%. Of this, education publishing business comprises around 10%, i.e., US $50 billion. The long-term plan of Repro India is to try to grab a 2% market share of the segment, which comes to around US$ 1 billion. India has the advantage of low-cost paper. Paper prices in India are lower than international prices as the Indian paper industry uses baggasse and pulp to manufacture paper as against global players’ reliance on wood. This is apart from the cheap and talented labour in India. What was lacking was a complete value chain, which Repro India has built over the years. Although China has the same advantage as India, it is far behind in terms of assuring quality and timely completion of high-end jobs. Also, piracy is a big issue in China.
In the long run, Repro India has plans of building a print city at a suitable location. However, considering the nature of the business, the company would invariably require funds to invest in its business. It is looking for investors for private placement/sale of stake at an appropriate time.
Printing is a capital-intensive industry. Globally, the industry operates at an asset-turnover ratio of 1:0.75, i.e., for every Rs 100 crore invested, one can generate a turnover of Rs 75 crore at around 2%-3% margin. This is one of the reasons why global printing players are outsourcing to India and are not expanding any capacities. In India, the unorganised sector operates at a 1:1 ratio (i.e., asset-turnover ratio of 1:1). As against this, Repro India is operating at an asset-turnover ratio of 1:1.4 currently, which is derived from long experience, in-house technologies and a built-up of complete value chain. In the long run, Repro India aims to maintain an asset-turnover ratio of around 1:1.25.
Of the total sales of Rs 155 crore in the year ending March 2008 (FY 2008), nearly 50% was from exports. Within the global market, Africa forms a major market. Nearly 75% of the export sales are from the African market, and the rest from the US and UK. Going forward, export sale as a percentage to total sales will increase as more markets and new clients are captured.
Repro India has already invested around Rs 20 crore for expansion of its existing location to gear up capacities. The effect of the expansion will be seen in the turnover of FY 2009. Further, the company is going for greenfield expansion by setting up an special economic zone (SEZ) in Surat. The plant will be operational from Q3 of FY 2009. Around Rs 32 crore will be invested in this plant that can print around 80 million books per annum. Overall, Repro India expects Rs 80 crore additional turnover on the complete operation of the Surat plant. Export income is exempt from tax for the first five years of operation. The company will meet the capex plans through combination of internal accruals and debts.
Net sales grew 26% to Rs 49.26 crore in the quarter ended June 2008. Operating profit margin improved 230 basis points mainly due to operating leverage and ability to demand better pricing for printing annual reports. Profit after tax was up by 70% to Rs 5.15 crore. We expect Repro India to register EPS of Rs 20 in FY 2009. At the current market price of Rs 119, the scrip discounts its FY 2009 earning six times.
Bhel
In 1Q09, revenue growth - the key parameter - surprised the Street positively. We believe input costs, order inflows and competition issues will resurface in the medium term, which may constraint PEs. We downgrade to Sell after the stock's recent rally. We cut our target price to Rs1,540 (from Rs1773.35), which implies 18x FY10F PE.
Revenue growth of 34% allays execution concerns, albeit temporarily
BHEL's 1Q09 revenue growth of 34% yoy did not surprise us (we projected growth of 31 vs 22% by Bloomberg consensus), and we maintain our full-year growth estimate at 31% yoy. Capacity constraint has been a cause for concern, but 1Q09 performance has allayed concerns for now . Management believes that BHEL is in a comfortable position to execute contract orders for the next 39 months. We had already built this into our model, so again no surprise for us.
The key now is costs – wage revisions and material costs
To meet the proposals of the Sixth Pay Commission, BHEL has raised total provision charges over 4Q07-4Q09 to Rs19bn, of which Rs5.9bn had been provided until 4Q08. The balance Rs13bn is to be provided for in FY09, of which we believe Rs4.7bn pertains to earlier years. Adjusting for that, we believe our FY09 staff cost forecast of Rs38.5bn is adequate. The increase in steel prices has not affected 1Q09 margins, but we believe it will hurt margins in the coming quarters.
Order inflows strong so far, but may slow; competition rises
Although 1Q09 cheered most in terms of revenue growth, we believe the larger concern of longerterm growth in BHEL persists. The entry of new players (L&T, Toshiba-JSW, BGR-Foster Wheeler and Cethar Vessels) could eat into BHEL's market share, hurting order inflow and margins. BHEL's order flow has been strong, thanks to the state and central PSE projects to be implemented under the 11th five-year plan, a scenario which we believe will change for the negative.
Risk-return looks unfavourable
BHEL trades at 17.5x FY10F PE. We believe the stock's valuation already factors in higher earnings estimates (Bloomberg consensus EPS of Rs96 for FY10 vs our forecast of Rs86.20) and possibly even earnings upgrades, which we think are unlikely because of cost pressures. The better-than-estimated 1Q09 performance should do little to prop up the share price. We see no catalysts in the medium term, hence we downgrade to Sell (from Hold). We cut our DCF-based target price to Rs1,540 (implying 18x FY10F PE) as we raise our risk-free rate assumption.
Revenue growth of 34% allays execution concerns, albeit temporarily
BHEL's 1Q09 revenue growth of 34% yoy did not surprise us (we projected growth of 31 vs 22% by Bloomberg consensus), and we maintain our full-year growth estimate at 31% yoy. Capacity constraint has been a cause for concern, but 1Q09 performance has allayed concerns for now . Management believes that BHEL is in a comfortable position to execute contract orders for the next 39 months. We had already built this into our model, so again no surprise for us.
The key now is costs – wage revisions and material costs
To meet the proposals of the Sixth Pay Commission, BHEL has raised total provision charges over 4Q07-4Q09 to Rs19bn, of which Rs5.9bn had been provided until 4Q08. The balance Rs13bn is to be provided for in FY09, of which we believe Rs4.7bn pertains to earlier years. Adjusting for that, we believe our FY09 staff cost forecast of Rs38.5bn is adequate. The increase in steel prices has not affected 1Q09 margins, but we believe it will hurt margins in the coming quarters.
Order inflows strong so far, but may slow; competition rises
Although 1Q09 cheered most in terms of revenue growth, we believe the larger concern of longerterm growth in BHEL persists. The entry of new players (L&T, Toshiba-JSW, BGR-Foster Wheeler and Cethar Vessels) could eat into BHEL's market share, hurting order inflow and margins. BHEL's order flow has been strong, thanks to the state and central PSE projects to be implemented under the 11th five-year plan, a scenario which we believe will change for the negative.
Risk-return looks unfavourable
BHEL trades at 17.5x FY10F PE. We believe the stock's valuation already factors in higher earnings estimates (Bloomberg consensus EPS of Rs96 for FY10 vs our forecast of Rs86.20) and possibly even earnings upgrades, which we think are unlikely because of cost pressures. The better-than-estimated 1Q09 performance should do little to prop up the share price. We see no catalysts in the medium term, hence we downgrade to Sell (from Hold). We cut our DCF-based target price to Rs1,540 (implying 18x FY10F PE) as we raise our risk-free rate assumption.
Thursday, July 24, 2008
Maruti
For second quarter in a row, EBITDA margins have come under pressure from raw material and manufacturing costs. We reduce our earnings forecasts and target price for Maruti, but believe the proposed A-star launch in 3QFY09 should prop up market share and profits. Buy reiterated.
EBIT for 1QFY09 disappointed by 25%
Maruti's EBIT for 1QFY09 fell 26.7% yoy due to the Rs734m impact of currency fluctuation on imports and a Rs619m additional depreciation charge. Hence, in spite of better-than-expected net sales (up 21% yoy), EBITDA margin fell 430bp yoy and 70bp qoq to 12.1%. As a result, EBITDA was nearly 11% below our expectation and EBIT 25% lower. But with higher other income and a lower tax rate, normalised PAT was better than expected at Rs4.84bn, up 6.4% yoy.
Launches should arrest market share slide, in our view
The successful launch of the Hyundai i10 in November 2007 and the sharp ramp-up since has put pressure on Maruti's domestic passenger vehicle market share, which has fallen 300bp from 1H07 to reach 43.5% by July 2008. This has also weakened Maruti's pricing power. But with the launch of the Maruti-800 Duo in June 2008 and the proposed launch of the A-star in 3QFY09, we feel market share has bottomed.
Marginally lower EBITDA forecasts
The weak operating result but better-than-expected sales realisation growth of 6.7% yoy leads us to trim FY09F EBITDA by 4% and EBIT by 7.5%. We expect the EBITDA margin to improve marginally in coming quarters, on the back of the price hikes implemented in May 2008 and cost controls. Building in higher other income from the improved yield on the company's Rs50bn cash and investments, we cut our EPS forecast by 4.1% for FY09, but maintain it for FY10-11.
Target price adjusted for a higher risk-free rate and EPS cut
We reduce our three-stage DCF-based target price from Rs985 to Rs775.40, building in marginal pressure on EPS and a higher risk-free rate (from 8% to 9%). But the steep underperformance of the stock in last one year discounts the concerns and we reiterate our Buy recommendation at the current valuation of 9.7x FY09F EPS and cash per share of Rs227, as we expect the proposed Astar and Splash launches to drive sales momentum and market share in the coming quarters.
EBIT for 1QFY09 disappointed by 25%
Maruti's EBIT for 1QFY09 fell 26.7% yoy due to the Rs734m impact of currency fluctuation on imports and a Rs619m additional depreciation charge. Hence, in spite of better-than-expected net sales (up 21% yoy), EBITDA margin fell 430bp yoy and 70bp qoq to 12.1%. As a result, EBITDA was nearly 11% below our expectation and EBIT 25% lower. But with higher other income and a lower tax rate, normalised PAT was better than expected at Rs4.84bn, up 6.4% yoy.
Launches should arrest market share slide, in our view
The successful launch of the Hyundai i10 in November 2007 and the sharp ramp-up since has put pressure on Maruti's domestic passenger vehicle market share, which has fallen 300bp from 1H07 to reach 43.5% by July 2008. This has also weakened Maruti's pricing power. But with the launch of the Maruti-800 Duo in June 2008 and the proposed launch of the A-star in 3QFY09, we feel market share has bottomed.
Marginally lower EBITDA forecasts
The weak operating result but better-than-expected sales realisation growth of 6.7% yoy leads us to trim FY09F EBITDA by 4% and EBIT by 7.5%. We expect the EBITDA margin to improve marginally in coming quarters, on the back of the price hikes implemented in May 2008 and cost controls. Building in higher other income from the improved yield on the company's Rs50bn cash and investments, we cut our EPS forecast by 4.1% for FY09, but maintain it for FY10-11.
Target price adjusted for a higher risk-free rate and EPS cut
We reduce our three-stage DCF-based target price from Rs985 to Rs775.40, building in marginal pressure on EPS and a higher risk-free rate (from 8% to 9%). But the steep underperformance of the stock in last one year discounts the concerns and we reiterate our Buy recommendation at the current valuation of 9.7x FY09F EPS and cash per share of Rs227, as we expect the proposed Astar and Splash launches to drive sales momentum and market share in the coming quarters.
Banks - Booster shot for reforms?
Post the government's victory in Tuesday's confidence vote, the Finance Minster
indicated that three bills pending the parliament's approval are high priority. In our
view, the three bills are: Banking Regulation Bill, comprehensive bill to amend the
insurance sector, and Pension Fund Regulatory and Development Authority Bill, 2005.
We believe large universal institutions will be the main beneficiaries if reforms
proceed. In such a scenario, our top picks would be ICICI Bank, HDFC and SBI.
Government may be in a position to pursue meaningful financial reforms
Post the government's victory in Tuesday's confidence vote, the Finance Minster indicated
that three bills pending the parliament’s approval are high priority. In our view, the three bills
are: Banking Regulation Bill, comprehensive bill to amend the insurance sector, and
Pension Fund Regulatory and Development Authority Bill, 2005. Along with the passing of
the bills, we believe the government may now be in a position to pursue meaningful financial
reforms to combat macroeconomic headwinds and to counter-balance any negative fallout
from the farm loan waiver.
These bills would allow the government to pursue financial reforms to combat
macroeconomic headwinds and to counter-balance any negative fallout from the farm loan
waiver. Do note that most reforms will need to be cleared by the parliament, hence are
equivalent to trust votes.
In the near term, if the government pursues meaningful reforms to unshackle the
banking/financial sector, stock valuations will likely react positively. We believe large
universal institutions such as ICICI, HDFC and State Bank of India will be the principal
beneficiaries of forward movement in reforms, and these stocks should be in the forefront of
any potential rally in the near term. If the reforms proceed, our top picks would be ICICI
Bank, HDFC and SBI.
While the incremental news flow may be positive, we believe the banking sector is not out of
the woods yet in terms of the operating environment. The principal risk stems from current
high crude oil prices, which is leading to a rising subsidy bill on account of bonds issued to oil
and fertiliser companies. Near-term challenges in terms of high inflation, high fiscal deficit
and high current account deficit will likely keep the operating environment for the
banking/financial sector tough.
Pending reforms and likely impact analysis
Pending reforms Likely beneficial impact
Alignment of voting rights with
shareholding pattern in private sector
banks. Voting rights are currently
capped at 10% irrespective of the
proportion of equity ownership. Foreign
direct investment (FDI) is allowed up to
74%.
􀂃 We believe this will open up doors for foreign investments in private
sector banks if RBI relaxes norms in 2009. Currently, regulations
require RBI’s approval to own more than 5% in case of any private
sector bank (overall ceiling set at 10%). Further, reforms under this
head may spur M&A within domestic private sector banks.
􀂃 In our coverage, we believe HDFC Bank and Axis Bank will benefit.
Enhancement of FDI ceiling in
insurance. Current regulation requires
74% to be owned by the Indian
promoter.
􀂃 This, we believe, increases the potential for early value unlocking by
the Indian promoter of the life insurance business.
􀂃 In our coverage, we believe ICICI Bank, HDFC Bank and SBI will
benefit the most.
Reduction in government holding in
public sector banks. Current regulations
require a minimum 51% stake to be
owned by the Government of India
(GOI). Allow banks to issue non-voting
shares or preference shares.
􀂃 We believe reduction of GOI stake is unlikely. However, public sector
banks may be allowed to raise capital through non-voting shares.
This should significantly solve capital constraints for select public
sector banks (especially positive for those with close to 51% GOI
stake).
􀂃 In our coverage, we believe BOB (54% GOI stake, tier-1 capital at
7.6% as of March 2008) and Union Bank (51% GOI stake, tier-1
capital at 7.5% as of March 2008) will benefit the most.
Consolidation among public sector
banks.
􀂃 We believe this will be a positive for weaker, smaller and capitalconstrained
public sector banks.
􀂃 However, reforms under this could still face stiff resistance from
employee unions.
􀂃 If it happens, we believe it will be positive for public sector banks in
general.
Private sector participation in pension
sector.
􀂃 Fee income potential for banks.
indicated that three bills pending the parliament's approval are high priority. In our
view, the three bills are: Banking Regulation Bill, comprehensive bill to amend the
insurance sector, and Pension Fund Regulatory and Development Authority Bill, 2005.
We believe large universal institutions will be the main beneficiaries if reforms
proceed. In such a scenario, our top picks would be ICICI Bank, HDFC and SBI.
Government may be in a position to pursue meaningful financial reforms
Post the government's victory in Tuesday's confidence vote, the Finance Minster indicated
that three bills pending the parliament’s approval are high priority. In our view, the three bills
are: Banking Regulation Bill, comprehensive bill to amend the insurance sector, and
Pension Fund Regulatory and Development Authority Bill, 2005. Along with the passing of
the bills, we believe the government may now be in a position to pursue meaningful financial
reforms to combat macroeconomic headwinds and to counter-balance any negative fallout
from the farm loan waiver.
These bills would allow the government to pursue financial reforms to combat
macroeconomic headwinds and to counter-balance any negative fallout from the farm loan
waiver. Do note that most reforms will need to be cleared by the parliament, hence are
equivalent to trust votes.
In the near term, if the government pursues meaningful reforms to unshackle the
banking/financial sector, stock valuations will likely react positively. We believe large
universal institutions such as ICICI, HDFC and State Bank of India will be the principal
beneficiaries of forward movement in reforms, and these stocks should be in the forefront of
any potential rally in the near term. If the reforms proceed, our top picks would be ICICI
Bank, HDFC and SBI.
While the incremental news flow may be positive, we believe the banking sector is not out of
the woods yet in terms of the operating environment. The principal risk stems from current
high crude oil prices, which is leading to a rising subsidy bill on account of bonds issued to oil
and fertiliser companies. Near-term challenges in terms of high inflation, high fiscal deficit
and high current account deficit will likely keep the operating environment for the
banking/financial sector tough.
Pending reforms and likely impact analysis
Pending reforms Likely beneficial impact
Alignment of voting rights with
shareholding pattern in private sector
banks. Voting rights are currently
capped at 10% irrespective of the
proportion of equity ownership. Foreign
direct investment (FDI) is allowed up to
74%.
􀂃 We believe this will open up doors for foreign investments in private
sector banks if RBI relaxes norms in 2009. Currently, regulations
require RBI’s approval to own more than 5% in case of any private
sector bank (overall ceiling set at 10%). Further, reforms under this
head may spur M&A within domestic private sector banks.
􀂃 In our coverage, we believe HDFC Bank and Axis Bank will benefit.
Enhancement of FDI ceiling in
insurance. Current regulation requires
74% to be owned by the Indian
promoter.
􀂃 This, we believe, increases the potential for early value unlocking by
the Indian promoter of the life insurance business.
􀂃 In our coverage, we believe ICICI Bank, HDFC Bank and SBI will
benefit the most.
Reduction in government holding in
public sector banks. Current regulations
require a minimum 51% stake to be
owned by the Government of India
(GOI). Allow banks to issue non-voting
shares or preference shares.
􀂃 We believe reduction of GOI stake is unlikely. However, public sector
banks may be allowed to raise capital through non-voting shares.
This should significantly solve capital constraints for select public
sector banks (especially positive for those with close to 51% GOI
stake).
􀂃 In our coverage, we believe BOB (54% GOI stake, tier-1 capital at
7.6% as of March 2008) and Union Bank (51% GOI stake, tier-1
capital at 7.5% as of March 2008) will benefit the most.
Consolidation among public sector
banks.
􀂃 We believe this will be a positive for weaker, smaller and capitalconstrained
public sector banks.
􀂃 However, reforms under this could still face stiff resistance from
employee unions.
􀂃 If it happens, we believe it will be positive for public sector banks in
general.
Private sector participation in pension
sector.
􀂃 Fee income potential for banks.
Asian Paints
Asian Paints' EBITDA margin slipped 130bp in 1QFY09, but strong sales growth at 34% ensured EBITDA growth of 24%. We would be cautious on the sustainability of this high sales growth, as the high inflation in the economy could soften demand growth. We lower our target price, but reiterate Buy.
Sales growth exceeded expectations, but EBITDA margin was lower
Asian Paints reported 34% revenue growth in 1QFY09, which was driven by strong volume growth. Management indicated that growth has been strong across segments, and across the country. However, EBITDA margin fell to 14.4%, which is a decline of 130bp yoy and 180bp qoq. EBITDA growth at 24% was better than our expectation despite lower margins. PAT came in 32% higher.
Raw material cost inflation is the key worry
Management said its average materials costs so far in FY09 are 11% higher than FY08 levels. The product price hikes of 4% since February have only partly neutralised the higher-cost impact. Management said it plans to hike prices further to neutralise the cost pressure in the coming months.
Why we are cautious on revenue growth
Despite 34% revenue growth in 1QFY09, we forecast just 24% growth for FY09. Management remains optimistic on the demand trend, but we see growth slowing for the following reasons: 1) 25-30% of paint demand comes from new housing projects, which should see a lagged impact on activity levels from interest rates hikes; 2) the 5-6% price hikes for paints planned for FY09 would be the sharpest in a single year, which could have a sobering effect on demand growth;
and lastly, 3) the high level of general inflation (10-11%) could impact spending on re-painting in the coming festival season.
We maintain our Buy rating with a lower target price of Rs1,331
We have upgraded our standalone EPS estimates for FY09 and FY10 by 2%, reflecting the strong 1QFY09 vs our expectations. However, we have raised the risk-free rate to 9% (from 8.25%), and consequently our DCF-based target price falls to Rs1,331 (from Rs1,410). Asian Paints' competitive position remains very strong in India, and with an average ROE of 49.4% over the last five years, we believe the stock deserves a premium valuation.
Sales growth exceeded expectations, but EBITDA margin was lower
Asian Paints reported 34% revenue growth in 1QFY09, which was driven by strong volume growth. Management indicated that growth has been strong across segments, and across the country. However, EBITDA margin fell to 14.4%, which is a decline of 130bp yoy and 180bp qoq. EBITDA growth at 24% was better than our expectation despite lower margins. PAT came in 32% higher.
Raw material cost inflation is the key worry
Management said its average materials costs so far in FY09 are 11% higher than FY08 levels. The product price hikes of 4% since February have only partly neutralised the higher-cost impact. Management said it plans to hike prices further to neutralise the cost pressure in the coming months.
Why we are cautious on revenue growth
Despite 34% revenue growth in 1QFY09, we forecast just 24% growth for FY09. Management remains optimistic on the demand trend, but we see growth slowing for the following reasons: 1) 25-30% of paint demand comes from new housing projects, which should see a lagged impact on activity levels from interest rates hikes; 2) the 5-6% price hikes for paints planned for FY09 would be the sharpest in a single year, which could have a sobering effect on demand growth;
and lastly, 3) the high level of general inflation (10-11%) could impact spending on re-painting in the coming festival season.
We maintain our Buy rating with a lower target price of Rs1,331
We have upgraded our standalone EPS estimates for FY09 and FY10 by 2%, reflecting the strong 1QFY09 vs our expectations. However, we have raised the risk-free rate to 9% (from 8.25%), and consequently our DCF-based target price falls to Rs1,331 (from Rs1,410). Asian Paints' competitive position remains very strong in India, and with an average ROE of 49.4% over the last five years, we believe the stock deserves a premium valuation.
Wednesday, July 23, 2008
CASA is king - CLSA
With average expected call rates for next twelve months trading at 9.7%,
market seems to be factoring in a repo-rate increase of ~75bps; even if
the hike is not to that extent, a higher interest rate regime is here to stay.
Liquidity will remain tight, rates may harden +50bps. Difference between
wholesale and retail deposits has widened to +150bps. With pressure on
spreads, CASA will be king; banks with high CASA likely to outperform.
Call money market reflecting expectation of ~75bps hike in repo
􀂉 The average expected call money rate for next twelve months (IRSWO1 Curncy) is
trading at 9.7%; this effectively means market participants are willing to pay 9.7%
fixed against receiving call money rate over the next 12 months
􀂉 Call money rates tend to reflect repo rates (if call rates are higher than repo rates,
banks would borrow from RBI under repo window); hence such a differential in the
forward market suggests that market is expecting repo rates to go up by ~75bps
􀂉 While the rates may not go up to that extent, we believe a high interest rate regime
is here to stay in the near future; RBI is likely to keep liquidity tight and rates may
further harden by 25-50bps
􀂉 The differential between wholesale and retail fixed deposit rates expands in tight
liquidity conditions; in the last couple of months this differential has expanded to
+150bps with wholesale rates running at +11% for one year plus deposits
100bps improvement in CASA expands margin by up to 10bps
ô€‚‰ Banks don’t pay any interest on Current account balances while interest on Savings
accounts are capped at 3.5%; the differential between the fixed deposit rates and
savings account rates has expanded from a low of ~200bps in 2004 to 600bps now
􀂉 Accordingly any bank with a high CASA enjoys better spreads which further
expands in a rising interest rate scenario (lending rates move up while cost of CASA
is stable); in the current environment a 100bps expansion in CASA will lead to a
margin expansion of up to 10bps (see figure 16)
􀂉 We believe banks with high CASA, like HDFC bank, Axis, PNB, SBI are likely to
outperform banks which rely on wholesale deposits;
􀂉 While ICICI bank has a deposit franchise similar to its peers (CASA / branch), the
bank has been a big borrower in the wholesale market, due to its aggressive
growth trajectory, as a result of which it has a lower proportion of CASA deposits;
􀂉 A slow down in credit growth will reduce its demand for wholesale funds and this
coupled with an aggressive expansion in distribution network is likely to expand
ICICI bank’s CASA ratio, driving a margin expansion of 40bps over FY08-10
􀂉 State-owned banks, on the other hand, would keep losing CASA deposits to private
banks, as the latter expand their distribution network in tier II and tier III cities
􀂉 Banks like HDFC Bank , Axis Bank and ICICI Bank which are likely to fund a higher
% of incremental growth through CASA would see margin expansion, whereas
banks like BOI, BOB and Canara Bank where a higher % of incremental growth is
coming from non CASA deposits will report higher margin pressures
market seems to be factoring in a repo-rate increase of ~75bps; even if
the hike is not to that extent, a higher interest rate regime is here to stay.
Liquidity will remain tight, rates may harden +50bps. Difference between
wholesale and retail deposits has widened to +150bps. With pressure on
spreads, CASA will be king; banks with high CASA likely to outperform.
Call money market reflecting expectation of ~75bps hike in repo
􀂉 The average expected call money rate for next twelve months (IRSWO1 Curncy) is
trading at 9.7%; this effectively means market participants are willing to pay 9.7%
fixed against receiving call money rate over the next 12 months
􀂉 Call money rates tend to reflect repo rates (if call rates are higher than repo rates,
banks would borrow from RBI under repo window); hence such a differential in the
forward market suggests that market is expecting repo rates to go up by ~75bps
􀂉 While the rates may not go up to that extent, we believe a high interest rate regime
is here to stay in the near future; RBI is likely to keep liquidity tight and rates may
further harden by 25-50bps
􀂉 The differential between wholesale and retail fixed deposit rates expands in tight
liquidity conditions; in the last couple of months this differential has expanded to
+150bps with wholesale rates running at +11% for one year plus deposits
100bps improvement in CASA expands margin by up to 10bps
ô€‚‰ Banks don’t pay any interest on Current account balances while interest on Savings
accounts are capped at 3.5%; the differential between the fixed deposit rates and
savings account rates has expanded from a low of ~200bps in 2004 to 600bps now
􀂉 Accordingly any bank with a high CASA enjoys better spreads which further
expands in a rising interest rate scenario (lending rates move up while cost of CASA
is stable); in the current environment a 100bps expansion in CASA will lead to a
margin expansion of up to 10bps (see figure 16)
􀂉 We believe banks with high CASA, like HDFC bank, Axis, PNB, SBI are likely to
outperform banks which rely on wholesale deposits;
􀂉 While ICICI bank has a deposit franchise similar to its peers (CASA / branch), the
bank has been a big borrower in the wholesale market, due to its aggressive
growth trajectory, as a result of which it has a lower proportion of CASA deposits;
􀂉 A slow down in credit growth will reduce its demand for wholesale funds and this
coupled with an aggressive expansion in distribution network is likely to expand
ICICI bank’s CASA ratio, driving a margin expansion of 40bps over FY08-10
􀂉 State-owned banks, on the other hand, would keep losing CASA deposits to private
banks, as the latter expand their distribution network in tier II and tier III cities
􀂉 Banks like HDFC Bank , Axis Bank and ICICI Bank which are likely to fund a higher
% of incremental growth through CASA would see margin expansion, whereas
banks like BOI, BOB and Canara Bank where a higher % of incremental growth is
coming from non CASA deposits will report higher margin pressures
Bajaj Auto
Bajaj is fast expanding its global presence, with nearly 30% of 1Q09 sales coming from exports, it is expanding at nearly 3x domestic growth. With potential new technology and product launches in the domestic market and superior ROE and dividend yield, on our analysis, we initiate with a Buy recommendation.
New products planned to regain domestic market share
In FY09 Bajaj plans to launch four new motorcycles in the 125+cc segment, where it has been instrumental in expanding 125+cc segment sales from 19% in FY05 to 36% in FY08 of industry sales. We feel the launches and a gradual easing of motorcycle-financing norms will help Bajaj Auto reverse the 6ppt market-share loss of the last 15 months. Technology inputs from KTM starting FY10F should be positive in the medium term, as these should strengthen Bajaj's standing in the 125+cc segment.
Export focus for three-wheelers
Bajaj has lost share in the domestic three-wheeler market for the last few years as Piaggio and Mahindra stepped on the gas. Bajaj's focus on the passenger segment and on exports offered some protection from rising competition, allowing it to record volume growth. But in 1Q09, the sharp weakness in exports coupled with TVS's three-wheeler launch and Piaggio's ramp-up led to a 18.5% sales volume decline. We believe national roll-out of more fuel efficient three-wheelers in FY09 and a ramp-up in exports to Egypt will help maintain flattish growth for the rest of FY09. The 'Lite' cargo vehicle from the new Chakan plant should be a positive in FY10.
We believe the worst was in 1Q09 results
We believe the worst in terms of financial performance is already in the 1Q09 result, which showed a 4.7% decline in PAT despite an 18.5% drop in sales volume in the highly profitable three-wheeler segment and a steep increase in input costs. We expect flat profits in FY09 and forecast a 16% CAGR for FY09-11.
Valuations look favourable - Buy
We believe the steep correction since listing post the demerger of the holding company fully reflects the weakness in Bajaj's domestic market share. We find valuations attractive at 7.7x FY09F PE for 40%-plus ROE, and we initiate with a Buy rating as we expect the attack on competition with new launches to boost market share and EPS. We peg our target price at Rs591, ie 8.5x FY10F PE adjusted for forex reserve loss of Rs6.80/share.
New products planned to regain domestic market share
In FY09 Bajaj plans to launch four new motorcycles in the 125+cc segment, where it has been instrumental in expanding 125+cc segment sales from 19% in FY05 to 36% in FY08 of industry sales. We feel the launches and a gradual easing of motorcycle-financing norms will help Bajaj Auto reverse the 6ppt market-share loss of the last 15 months. Technology inputs from KTM starting FY10F should be positive in the medium term, as these should strengthen Bajaj's standing in the 125+cc segment.
Export focus for three-wheelers
Bajaj has lost share in the domestic three-wheeler market for the last few years as Piaggio and Mahindra stepped on the gas. Bajaj's focus on the passenger segment and on exports offered some protection from rising competition, allowing it to record volume growth. But in 1Q09, the sharp weakness in exports coupled with TVS's three-wheeler launch and Piaggio's ramp-up led to a 18.5% sales volume decline. We believe national roll-out of more fuel efficient three-wheelers in FY09 and a ramp-up in exports to Egypt will help maintain flattish growth for the rest of FY09. The 'Lite' cargo vehicle from the new Chakan plant should be a positive in FY10.
We believe the worst was in 1Q09 results
We believe the worst in terms of financial performance is already in the 1Q09 result, which showed a 4.7% decline in PAT despite an 18.5% drop in sales volume in the highly profitable three-wheeler segment and a steep increase in input costs. We expect flat profits in FY09 and forecast a 16% CAGR for FY09-11.
Valuations look favourable - Buy
We believe the steep correction since listing post the demerger of the holding company fully reflects the weakness in Bajaj's domestic market share. We find valuations attractive at 7.7x FY09F PE for 40%-plus ROE, and we initiate with a Buy rating as we expect the attack on competition with new launches to boost market share and EPS. We peg our target price at Rs591, ie 8.5x FY10F PE adjusted for forex reserve loss of Rs6.80/share.
HDIL
HDFC's performance in 1QFY09 was largely in line with our expectations and we remain sanguine about its prospects. The marginal slippage in asset quality seems to be a seasonal factor. We reiterate Buy with a lower target price of Rs2,405.80, which reflects the increase in our cost of equity assumption.
1QFY09 margin dips more than expected, but we remain sanguine
HDFC's reported net interest income in 1QFY09 was about 10% below our estimate, led largely by subdued growth in interest income. The reported spread increased from 2.22% in 1QFY08 to 2.26% in 1QFY09. NIM (on our calculations) increased to 3.2%, from 3.1% in 1QFY08. In FY08, HDFC reported NIM of 3.9%, while we forecast 3.4% for FY09 and 3.3% for FY10. We expect margins to stabilise in the quarters ahead as volume growth has remained strong.
Business fundamentals healthy; we maintain estimates
Loan growth rebounded in 1QFY09 after a slight dip in 4QFY08 (see chart 2). We believe the competitive position of HDFC also stands enhanced, given the uncertainties in financial markets, BASEL II requirements and the expansion in network following the merger of HDFC Bank with Centurion Bank of Punjab. We maintain our estimates for FY09 and FY10.
Concerns about asset quality are unwarranted, in our view
HDFC's asset quality deteriorated slightly in 1QFY09, but it continues to be significantly better than that of peers. We believe this slippage is mostly seasonal and we are not unduly concerned (see Chart 3). Also note that HDFC's gross NPLs at 1.09% in 1QFY09 is among its lowest levels in two years.
Higher cost of equity, lower target price
The increased uncertainty for the banking sector has led us to increase our cost of equity assumption for HDFC from 13.5% to 14.0%. Accordingly, our fair value for the company has declined to Rs1,627 (from Rs1,838.10). Adding the value of subsidiaries, we arrive at a target price of Rs2,405.80 (down from Rs2,685.40). At our target price (excluding the value of subsidiaries), the HDFC stock will trade at 20.7x FY09F EPS and 3.4x FY09F adjusted book value. We maintain our Buy recommendation.
1QFY09 margin dips more than expected, but we remain sanguine
HDFC's reported net interest income in 1QFY09 was about 10% below our estimate, led largely by subdued growth in interest income. The reported spread increased from 2.22% in 1QFY08 to 2.26% in 1QFY09. NIM (on our calculations) increased to 3.2%, from 3.1% in 1QFY08. In FY08, HDFC reported NIM of 3.9%, while we forecast 3.4% for FY09 and 3.3% for FY10. We expect margins to stabilise in the quarters ahead as volume growth has remained strong.
Business fundamentals healthy; we maintain estimates
Loan growth rebounded in 1QFY09 after a slight dip in 4QFY08 (see chart 2). We believe the competitive position of HDFC also stands enhanced, given the uncertainties in financial markets, BASEL II requirements and the expansion in network following the merger of HDFC Bank with Centurion Bank of Punjab. We maintain our estimates for FY09 and FY10.
Concerns about asset quality are unwarranted, in our view
HDFC's asset quality deteriorated slightly in 1QFY09, but it continues to be significantly better than that of peers. We believe this slippage is mostly seasonal and we are not unduly concerned (see Chart 3). Also note that HDFC's gross NPLs at 1.09% in 1QFY09 is among its lowest levels in two years.
Higher cost of equity, lower target price
The increased uncertainty for the banking sector has led us to increase our cost of equity assumption for HDFC from 13.5% to 14.0%. Accordingly, our fair value for the company has declined to Rs1,627 (from Rs1,838.10). Adding the value of subsidiaries, we arrive at a target price of Rs2,405.80 (down from Rs2,685.40). At our target price (excluding the value of subsidiaries), the HDFC stock will trade at 20.7x FY09F EPS and 3.4x FY09F adjusted book value. We maintain our Buy recommendation.
Tech Mahindra
TechM's telecom vertical focus and high single client dependence should drive nearterm performance ahead of larger peers seeing demand moderation from BFSI clients. Even on our cautious margin outlook, we see current valuations as attractive.
TechM could grow ahead of larger peers in the near term
Tech Mahindra's (TechM) focus on telecom vertical (100% of revenues) and high client concentration (top client BT is 65% of revenues) should actually help in the near term as other major players are seeing demand moderation given the high exposure to the BFSI vertical. We expect 30% growth in US$-term revenues for TechM vs an average of 26% for the larger peers in FY09. Ramp-up in the deals won over the last six months should help - it won a US$350m fiveyear deal from BT (though 70% of it was for existing work), a US$200m seven-year deal from a non-BT client, and US$25m deal from Telecom New Zealand. Traction in the US$1bn five- year deal from BT Global Services is also picking up, with the run-rate at US$20m at the end of 4Q08. Note, TechM's revenues have grown at 13.4% CQGR over the last eight quarters, ahead of 9.8% growth in telecom revenues of the top five players. The company has also announced exclusive
talks with BT for a large deal that involved US$110m of an upfront non-refundable payment.
While we retain our cautious view on margins…
We hold our view that high client dependence restricts margin flexibility. Improving utilisation and controlled headcount addition has helped in the recent quarters. However, we see utilisation peaking as recruitment picks up in 1Q09. We forecast a 238bp decline in reported EBITDA margin over FY08-12. The decline would be 425bp if we treated the upfront cash payment to clients (reported as exceptional items in FY07 and FY08) as operational expenses. We do not discount recurrence of such contract structures going forward, given management's willingness. A higherthan-expected reduction in transition cost is, in our view, the potential upside to margin not built into our forecasts.
…we believe current valuations are a good entry point. Upgrade to Buy
The stock has corrected 43% YTD vs 20% decline in the BSE IT Index. We expect marginal rerating as a better-than-peers quarterly performance could partially allay investors' concerns on upfront cash payment to clients. We upgrade to Buy with 32% upside potential. Our one-year forward target price of Rs848 is based on 9x 12-month forward EPS, supported by 20% EPS CAGR over FY08-12F.
TechM could grow ahead of larger peers in the near term
Tech Mahindra's (TechM) focus on telecom vertical (100% of revenues) and high client concentration (top client BT is 65% of revenues) should actually help in the near term as other major players are seeing demand moderation given the high exposure to the BFSI vertical. We expect 30% growth in US$-term revenues for TechM vs an average of 26% for the larger peers in FY09. Ramp-up in the deals won over the last six months should help - it won a US$350m fiveyear deal from BT (though 70% of it was for existing work), a US$200m seven-year deal from a non-BT client, and US$25m deal from Telecom New Zealand. Traction in the US$1bn five- year deal from BT Global Services is also picking up, with the run-rate at US$20m at the end of 4Q08. Note, TechM's revenues have grown at 13.4% CQGR over the last eight quarters, ahead of 9.8% growth in telecom revenues of the top five players. The company has also announced exclusive
talks with BT for a large deal that involved US$110m of an upfront non-refundable payment.
While we retain our cautious view on margins…
We hold our view that high client dependence restricts margin flexibility. Improving utilisation and controlled headcount addition has helped in the recent quarters. However, we see utilisation peaking as recruitment picks up in 1Q09. We forecast a 238bp decline in reported EBITDA margin over FY08-12. The decline would be 425bp if we treated the upfront cash payment to clients (reported as exceptional items in FY07 and FY08) as operational expenses. We do not discount recurrence of such contract structures going forward, given management's willingness. A higherthan-expected reduction in transition cost is, in our view, the potential upside to margin not built into our forecasts.
…we believe current valuations are a good entry point. Upgrade to Buy
The stock has corrected 43% YTD vs 20% decline in the BSE IT Index. We expect marginal rerating as a better-than-peers quarterly performance could partially allay investors' concerns on upfront cash payment to clients. We upgrade to Buy with 32% upside potential. Our one-year forward target price of Rs848 is based on 9x 12-month forward EPS, supported by 20% EPS CAGR over FY08-12F.
Satyam Computers
Despite in-line financials, 1Q09 results disappointed on operating metrics. With management holding on FY09 guidance versus the Street's expectations of an increase and given macro concerns, we expect the stock to remain range-bound in the near term.
1Q09 results - financials broadly in-line
Consolidated revenues, adjusted for FX gains, grew 1.7% qoq to US$623.8m (8.5% in INR terms), lower than guidance and our estimates. IT services grew by 2.1% in US$ terms while BPO was down 37% qoq as a large animation project was not renewed and a large client pulled out. Consolidated EBITDA margin was up 133bp qoq to 24.1% (195bp ex RSU charges), in line with our expectations. Reported PAT was up 17.3% qoq at Rs5.5bn, including Rs363mn of FX losses.
Sparks missing in operational metrics too
IT services volume growth fell to 3% qoq, lowest over last five years, while blended realization was down 0.2% qoq, after increasing over last four qtrs. Net headcount addition at 651 was below our estimates. Management maintained the 14,000-15,000 gross addition guidance. This could imply lumpiness in addition over 2Q-3Q and pressure utilization, in our view. PI revenue growth slowed down to 1.3% vs 12% CQGR in FY08. Company does not see this as a trend and expects growth to pick up. Positives were 3 large deal wins and continued trending down in attrition.
FY09 guidance revision - expectations mismatch
No raise in FY09 US$ guidance contrary to market expectations. At 4.5% revenue guidance for 2Q, Satyam would need to grow 5.7% qoq in 2H09 to meet FY09 guidance. We believe this is achievable, but do not see outperformance given current macros. However, with currency helping margins in FY09, outperformance to Rs32.3 guided FY09 EPS is possible.
Buy maintained. Valuations support downside risk
We broadly retain our forecasts, adjusted for actual 1Q09 results. But changes in FX and tax assumptions push our EPS estimates by 8-14% for FY09-10F. We keep our TP at Rs510, valuing the stock at 13x FY10F EPS (vs 15x earlier). We expect near-term re-rating to be capped by the dissapointment on FY09 guidance and subdued operational metrics.
1Q09 results - financials broadly in-line
Consolidated revenues, adjusted for FX gains, grew 1.7% qoq to US$623.8m (8.5% in INR terms), lower than guidance and our estimates. IT services grew by 2.1% in US$ terms while BPO was down 37% qoq as a large animation project was not renewed and a large client pulled out. Consolidated EBITDA margin was up 133bp qoq to 24.1% (195bp ex RSU charges), in line with our expectations. Reported PAT was up 17.3% qoq at Rs5.5bn, including Rs363mn of FX losses.
Sparks missing in operational metrics too
IT services volume growth fell to 3% qoq, lowest over last five years, while blended realization was down 0.2% qoq, after increasing over last four qtrs. Net headcount addition at 651 was below our estimates. Management maintained the 14,000-15,000 gross addition guidance. This could imply lumpiness in addition over 2Q-3Q and pressure utilization, in our view. PI revenue growth slowed down to 1.3% vs 12% CQGR in FY08. Company does not see this as a trend and expects growth to pick up. Positives were 3 large deal wins and continued trending down in attrition.
FY09 guidance revision - expectations mismatch
No raise in FY09 US$ guidance contrary to market expectations. At 4.5% revenue guidance for 2Q, Satyam would need to grow 5.7% qoq in 2H09 to meet FY09 guidance. We believe this is achievable, but do not see outperformance given current macros. However, with currency helping margins in FY09, outperformance to Rs32.3 guided FY09 EPS is possible.
Buy maintained. Valuations support downside risk
We broadly retain our forecasts, adjusted for actual 1Q09 results. But changes in FX and tax assumptions push our EPS estimates by 8-14% for FY09-10F. We keep our TP at Rs510, valuing the stock at 13x FY10F EPS (vs 15x earlier). We expect near-term re-rating to be capped by the dissapointment on FY09 guidance and subdued operational metrics.
Axis Bank
Axis Bank has outperformed the Bankex year to date, but underperformed the Nifty, due probably to the increased risk perception for the financial sector. We largely maintain our earnings estimates. We cut our target price to Rs791.90, on the back of our new assumptions for terminal growth and cost of equity. Buy maintained.
Net interest income largely in line; fee income surprises positively
Axis Bank's net interest margins (NIM) declined qoq in 1Q09, but net interest income was largely in line with our estimate. Fee income surprised on the upside, which was impressive as it came in the midst of a downturn in the financial market. The buoyancy in fee income and lower-than-expected operating expenses partly offset the significant increase in provision charges. As a result, profits exceeded our forecast.
Marginal stress on asset quality
Overall asset quality came under pressure, with both gross and net NPLs rising qoq. The bank attributes the decline in asset quality primarily to increased delinquency in the credit-cards business. Axis Bank aims to contain gross NPLs at 1% and net NPLs at 0.5% in FY09. We estimate net NPLs at 0.4% of total loans by FY09 (vs 0.4% in FY08). We believe the bank will meet its target, hence our provision estimates remain unchanged.
Business growth should exceed peers
We expect Axis Bank's business growth to exceed that of its peers, given the bank's smaller size. We also believe the bank will be able to maintain its low-cost deposit base at 43-45%, allowing it to maintain margins even amidst aggressive asset growth. We estimate NIMs at 3.04% for FY09 and at 3.10% for FY10, largely unchanged from our previous numbers.
Buy, with a new target price of Rs791.90
We raise our cost of equity assumption for Axis Bank to 14% (from 13%), given the challenging operating environment for the banking sector. This reduces our terminal spread assumption to 4% (from 5%). Our new assumptions for terminal growth (from 7% to 5%) and cost of equity lead the change in our EVA™-based target price to Rs791.90 (from Rs1,187.80). Our forecasts are largely unchanged for FY09 and FY10. At our target, the stock would trade at 3x FY09F adjusted book value (writing off pre-tax net NPLs fully). We maintain our Buy rating.
Net interest income largely in line; fee income surprises positively
Axis Bank's net interest margins (NIM) declined qoq in 1Q09, but net interest income was largely in line with our estimate. Fee income surprised on the upside, which was impressive as it came in the midst of a downturn in the financial market. The buoyancy in fee income and lower-than-expected operating expenses partly offset the significant increase in provision charges. As a result, profits exceeded our forecast.
Marginal stress on asset quality
Overall asset quality came under pressure, with both gross and net NPLs rising qoq. The bank attributes the decline in asset quality primarily to increased delinquency in the credit-cards business. Axis Bank aims to contain gross NPLs at 1% and net NPLs at 0.5% in FY09. We estimate net NPLs at 0.4% of total loans by FY09 (vs 0.4% in FY08). We believe the bank will meet its target, hence our provision estimates remain unchanged.
Business growth should exceed peers
We expect Axis Bank's business growth to exceed that of its peers, given the bank's smaller size. We also believe the bank will be able to maintain its low-cost deposit base at 43-45%, allowing it to maintain margins even amidst aggressive asset growth. We estimate NIMs at 3.04% for FY09 and at 3.10% for FY10, largely unchanged from our previous numbers.
Buy, with a new target price of Rs791.90
We raise our cost of equity assumption for Axis Bank to 14% (from 13%), given the challenging operating environment for the banking sector. This reduces our terminal spread assumption to 4% (from 5%). Our new assumptions for terminal growth (from 7% to 5%) and cost of equity lead the change in our EVA™-based target price to Rs791.90 (from Rs1,187.80). Our forecasts are largely unchanged for FY09 and FY10. At our target, the stock would trade at 3x FY09F adjusted book value (writing off pre-tax net NPLs fully). We maintain our Buy rating.
Sunday, July 20, 2008
Energy - Windfall Tax Issue
Stock prices of private oil companies (Reliance and Cairn India) have come off due to the potential risk of windfall taxes. In our view, the risk of higher fiscal levies (in whatever form) is greater for the private refiners than the E&P companies. The extent of risk is completely subjective and depends upon how much 'subsidy' is meant to be extracted from the private refiners, as was the case in FY06. We retain our Buy rating on Cairn India as our Brent oil price assumptions (US$75/bbl long-term) are conservative enough to take into account any potential additional tax. Our Sell rating on Reliance Industries is partly based on our negative view on the refining and petrochemical cycle and does not factor in any additional taxation.
Genesis of the windfall tax debate
The Indian government (GOI) has been protecting its citizens from rising oil prices by regulating the domestic prices of the four retail products. This has resulted in very large under-recoveries for the three main GOI-owned oil marketing companies (OMCs): BPCL, HPCL and IOC. The financial burden of these companies has historically been shared by other GOI-owned companies in the upstream sector – ONGC, GAIL and Oil India. The private companies in the upstream sector (mainly Reliance Industries, Cairn India) are governed by production sharing contracts (PSCs), which specify the levels of royalty as well as profit sharing. Material production from the private players is likely to commence only in future – Reliance’s gas production around September 2008 and Cairn India in 2HCY09.
The refining sector has been forced to provide explicit subsidies only once, in FY06 (Rs15bn for the industry). Out of this, the real contribution was only from Reliance Industries (Rs7.5bn), since the rest of the refining capacity is controlled largely by the OMCs for whom it was mainly a transfer from the refining arm to the marketing arm. The refining sector has taken a hit in terms of sharp reduction in import duty protection, but the impact on profitability has been relatively limited due to rising levels of gross refining margins (GRMs).
On 4 June 2008, the GOI announced a package to tackle the rising under-recoveries of the OMCs. This included an increase in retail prices (borne by the customers), some underrecoveries
been borne by the OMCs and the GOI-owned upstream companies and the rest borne by GOI via cuts in taxes and oil bonds. The Samajwadi Party (which at that point was not part of the government) had criticised the package stating that no contribution was being demanded from private oil companies and they should be asked to pay “windfall tax”. This demand has gained credence due to the changing political equations. With the Congress party looking likely to go ahead with the nuclear deal and the left parties announcing their intention to withdraw support, the continuation of the current government might depend on the support of the Samajwadi party.
Upstream companies: need to change PSCs
If GOI wishes to extract higher taxes from private oil companies, it would need to change PSCs
that have already been signed, thereby impacting future investment in the sector. Further, all the PSCs under the new exploration policy have a profit sharing mechanism, whereby cash flows
earned over and above investments made are shared with GOI. This, in a way, is a windfall tax.
Though GOI is always free to change existing fiscal levies (as other major oil/gas producing countries have done), in our view, it would be meaningless to change PSCs unless the amounts that can be collected by levying additional taxes are significant. Companies can pay only when they start producing and the current level of production from the private oil companies is very limited. In FY08, the joint ventures with private oil companies (where ONGC also holds around a 40% stake) produced crude oil of 5.1mt (15% of total domestic oil production) and natural gas of 7.7bcm (24%). Significant production from Reliance Industries and Cairn India is yet to commence.
RIL E&P – gas price itself is a windfall tax
We expect gas production from RIL’s KG-D6 block to progressively rise to 89mmscmd, which would double the country’s gas production. We believe there would be limited justification to levy any additional taxes on this production given the low level of gas price that has already been fixed for the first five years of production – US$4.2/mmbtu. This gas price is well below current levels of international gas prices (US$10-12/mmbtu) and translates to an oil price of US$25/bbl, just 18% of prevailing oil prices. Given this low gas price, it would be difficult to argue for any additional taxation, especially since the PSC also has a profit sharing agreement with GOI.
Cairn India – our oil price assumptions are conservative
There could be a risk that GOI would change Cairn’s contracts and not grant them the full international oil prices. The method of tax collection is immaterial; it could be via change in royalty rates, levying additional taxes which could rise in line with crude prices, artificially capping realisation for Cairn crude, etc. The problem we foresee is that the desperate measure to levy additional tax is basically meant to tide over the problems being faced in FY09, whereas Cairn can provide meaningful revenue only from FY11F. Our DCF value for Cairn (Rs259) and the target price (Rs315, based on cash flow multiple) are based on very conservative oil price assumptions. While Cairn would start producing from 2HCY09, our Brent oil price forecasts are US$100/bbl in CY09, US$90/bbl in CY10 and US$75/bbl thereafter, with Cairn crude being priced at an 8% discount to the Brent price. Since the current Brent price (US$140/bbl) is virtually double our long-term price assumption, we believe there is sufficient buffer to take into account any additional “windfall taxes”.
Private refiners at risk
If the objective is to collect contributions in FY09, the axe could most likely fall on the private refiners – RIL and Essar Oil. Both of these companies have been in the process of rolling out their retail gas station networks, which have now been aborted due to GOI’s price regulations. However, given the robust global refining margin environment, product of both refineries is largely exported. In fact, the RIL refinery is now an export-oriented unit (EOU) and is forced to export. Thus, both companies have managed to avoid any losses on domestic retail operations (other than the cost of their existing domestic infrastructure being under-utilised) and could report bumper results if GRMs continue to remain elevated.
From a administrative and legal angle, it would perhaps be easiest to collect additional taxes from private refiners. GOI would need to merely levy a new export tax on refined products (especially retail products like diesel, gasoline, LPG and kerosene). This would hurt only the private refiners and not the refineries owned by the OMCs. The extent of the tax would really depend on the amounts that GOI wants to extract from the private refiners. In FY06, when the refiners last made explicit subsidy contributions, the total amount collected (Rs15bn) was largely based on negotiations that decided the amount that RIL was willing to pay.
Summary
We have not factored in any additional taxes on the sector. However, given the clout that the Samajwadi party could enjoy post exit of the left parties, stock prices of the private oil companies
would likely continue to face a “windfall tax discount” until this issue is cleared either way. In our
view, if there is any additional tax to be levied, then an export tax on selected oil products is most likely. The level of tax would depend on GOI’s objective in terms of tax collection. We maintain ONGC and Cairn as our top sector picks and retain our Sell rating on Reliance Industries.
Saturday, July 19, 2008
The Doors of Opportunity
When one door closes, another opens; but we often look so long and so regretfully upon the closed door that we do not see the one which has opened for us. - Alexander Graham Bell
If one reads into the recent widespread fall of Indian equity markets, it would appear as if all entry doors to markets are firmly shut while exit doors are flung wide open to accommodate stampede! Over the last six months, the market capitalization has fallen from USD 1.8tn to USD 0.95tn: the sharpest and swiftest over last two decades. True, an ocean of worries seems to be ruling horizons: rising crude and commodity prices, the sub-prime issue, apparent US recession, high inflation, higher interest rates, currency volatility, fiscal deficit, slower corporate earnings growth and so on. And in a matter of a few months, focus has moved from global concerns to domestic issues and macro issues have begun to impact micros. But the same issues have been counted and recounted several times over disproportionately such that “fear” rather than “caution” is deciding the course of the markets. Six months back, it was as if India could do no wrong, and now it is made to appear that India would get nothing right. In my view, the situation is somewhere in between, if one examines dispassionately the ground level evidence. But prices now clearly lag reality, and by a margin.
As you shift your gaze from the closed doors to the opening ones, the picture looks more balanced if not opportune. I can’t predict whether the worst is over. It probably has not. In the short run, it is entirely possible that prices (not reality) may get worse before they start to get better. But if one is looking for high quality at attractive prices, than the proverbial Mr Market is knocking at the door. While possible short term negativity cannot be ruled out, nor can long term opportunity be ignored. I believe that the picture ahead will be far better then what is being priced in by the markets today. These are no doubt challenging times, but India has faced far more daunting challenges in its post-independence history and yet has grown throughout.
Overall strength of broad macroeconomic fundamentals (notwithstanding recent challenges) and robustness of corporate sector micros has never been better in the past then today. In our opinion, these are more interruptions than disruptions in a much longer term phenomenon. India continues to be a large sized opportunity with durable and high growth supported by remarkable capital efficiency: all essential ingredients for good equity investing.
India’s growth – a structural phenomenon
The reforms initiated in India during early nineties started bearing fruit sometime in the beginning of this century when India moved up to a “structurally” higher GDP growth rate. The GDP growth “potential” of India in long-term is considered highest among all the emerging economies. However, at various stages India has hit the barrier of infrastructure. It remains, and will remain for a while, an important issue. But despite all obstacles, the infrastructure spend as a ratio to GDP has inched up from 3.5% (2004) to current 6% (exp 2008) and is expected to touch 9% of GDP by 2010-11. This on a GDP which itself has grown at a rapid clip of 9% over last few years.
Simultaneously, with the rise of service and manufacturing sectors, the per capita income has more then doubled over last seven years, domestic savings to GDP has increased to well over 35% and the disposable incomes are slated to double again by 2015. India’s growth is well founded on all the three vital pillars for a secular economic growth – robust Consumption, healthy Savings rate and a strong Investments rate. There are problems being faced today, and there are solutions. The recent world-scale natural gas discoveries, 39% growth in the tax collections for the quarter ended June’ 08, better then expected performance in food grain output are some of the positive developments that have probably been harshly shrugged off by the markets.
Estimates for GDP growth in the current year vary, but even the most conservative estimate puts the number at above 7.5%. True, it is not the same as 9% (over the last three years), but it would still be very robust and one of the highest globally. Better still, situation today suggests that outlook for the year ahead is even better.
Markets always tend to overshoot in either direction, and there is nothing new this time. At valuation of about 12X FY09 earnings for sensex / nifty, we seem to have come a full circle back to the 2003 levels: the last time when such valuations were reached, and that year actually marked the beginning of five-year secular rise in Indian markets. If one searches beyond the top 30-50 companies, then picture is even better: many top quality businesses can be had at single digit or bare double digit valuations. I am confident that many stocks have a potential to multiply in their prices over the next three years, if not sooner. From “macro” to “micro” Let me give some examples to illustrate the point. There are some of the names where we find strong compounding opportunities. All of them represent quality businesses of size, entry barriers, character and superior efficiency, and managements with desire to succeed. Some of the important concerns today are energy costs, high interest costs, rupee volatility etc. Many of our portfolio positions have a good way of addressing these issues.
Opto Circuits India Ltd is a global scale manufacture of cardiovascular stents and patient monitoring systems. Addressing the large and growing opportunity of over $10 billion, it has grown at over 30% per July 2008 annum over last five years and is expected to maintain that for the next three years at least. Its largely global business is now making rapid strides in domestic market as well. With a Return on Capital Employed (RoCE) of about 35%, Opto Circuits is available at 15X FY09 and 11X FY10, attractive for a unique, high quality business.
Everest Kanto cylinders (EKC) provides an ideal foil to the current high oil prices. With a dominant 65% domestic market share in a technology intensive and high entry barriers business of CNG and other seamless cylinders, EKC enjoys an enviable moat. Both domestic and international parts of business are growing with multi-location plants around the globe. With a RoCE over 25% and expected growth rate of 45% over the next three years, EKC is available currently at 11X FY 10.
Nava Bharat Ventures Ltd (NBVL) is principally in a large and growing energy supply business along with presently highly profitable but volatile Ferro Alloys business. With steady and clear long term expansion of both the businesses, even after neutralizing the volatility of Ferro Alloys business, the core “annuity” character of energy business makes it a compelling opportunity at less then 6X FY09 for a business enjoying RoCE in excess of 40%.
Divi’s Laboratories, though not as cheap as some of the above, is a world-class, research-driven global CRAM (Contract Research and Manufacturing Services) business addressing an annual USD 40 billion (and growing) opportunity of pharmaceutical research and development. This is one business where I would assume over 20% earnings growth for may be a decade, if not more, with an outstanding RoCE of above 35%.
Even for a Fortune 500 company like Reliance Industries Ltd (RIL), with global size mature petrochemicals business, rapidly expanding refining business and new global sized gas business, which despite its large base has a major growth engine of over 30% for next two years, cash yield of over 12%, current price represents a valuation of 11X FY10.
Conclusion
The biggest positive in the current situation is the extreme sentiment negativity; that flushes out the possibility of shocks from a stretched market. All bear markets are born out of unbounded optimism, just the way all the bull markets have to raise the walls of worry. At this juncture, it is important to realize that what can be counted by everyone is usually not what decides the eventual course of markets. It will be prudent to bear a perspective that differentiates between secular long-term growth engine from the intermittent shortterm bouts (of optimism or pessimism). Former is intact, the latter is transitory. India, in our opinion, remains an attractive and almost indispensable investment choice for any serious long-term investor. This has not changed over the last six months, though prices have. That is a fresh opportunity all over again, rather than a threat.
Over last few months, our portfolios have broadly maintained healthy level of cash. The businesses that are included in our portfolios have to pass a few critical tests: strong and durable earnings growth, robust capital efficiency, large size of opportunity and reasonable value. Other things being equal, we have favored stocks that have adequate liquidity. Currently, sensex trades at rather modest 12X FY09 earnings, with many quality businesses being much cheaper. This valuation needs to be assessed in the backdrop of the globally benchmark able corporate sector (RoCE over 20%), earnings growth of 15% for current year and better going ahead, durability of growth and large size of opportunity. Given this, our stance will be to progressively deploy cash at current prices. Without ignoring near-term concerns in the environment, we believe it is the time to step out in the open and engage into opportunities with an eclectic mix of patience and conviction. Results will be healthy.
By Mr. Bharat Shah.
If one reads into the recent widespread fall of Indian equity markets, it would appear as if all entry doors to markets are firmly shut while exit doors are flung wide open to accommodate stampede! Over the last six months, the market capitalization has fallen from USD 1.8tn to USD 0.95tn: the sharpest and swiftest over last two decades. True, an ocean of worries seems to be ruling horizons: rising crude and commodity prices, the sub-prime issue, apparent US recession, high inflation, higher interest rates, currency volatility, fiscal deficit, slower corporate earnings growth and so on. And in a matter of a few months, focus has moved from global concerns to domestic issues and macro issues have begun to impact micros. But the same issues have been counted and recounted several times over disproportionately such that “fear” rather than “caution” is deciding the course of the markets. Six months back, it was as if India could do no wrong, and now it is made to appear that India would get nothing right. In my view, the situation is somewhere in between, if one examines dispassionately the ground level evidence. But prices now clearly lag reality, and by a margin.
As you shift your gaze from the closed doors to the opening ones, the picture looks more balanced if not opportune. I can’t predict whether the worst is over. It probably has not. In the short run, it is entirely possible that prices (not reality) may get worse before they start to get better. But if one is looking for high quality at attractive prices, than the proverbial Mr Market is knocking at the door. While possible short term negativity cannot be ruled out, nor can long term opportunity be ignored. I believe that the picture ahead will be far better then what is being priced in by the markets today. These are no doubt challenging times, but India has faced far more daunting challenges in its post-independence history and yet has grown throughout.
Overall strength of broad macroeconomic fundamentals (notwithstanding recent challenges) and robustness of corporate sector micros has never been better in the past then today. In our opinion, these are more interruptions than disruptions in a much longer term phenomenon. India continues to be a large sized opportunity with durable and high growth supported by remarkable capital efficiency: all essential ingredients for good equity investing.
India’s growth – a structural phenomenon
The reforms initiated in India during early nineties started bearing fruit sometime in the beginning of this century when India moved up to a “structurally” higher GDP growth rate. The GDP growth “potential” of India in long-term is considered highest among all the emerging economies. However, at various stages India has hit the barrier of infrastructure. It remains, and will remain for a while, an important issue. But despite all obstacles, the infrastructure spend as a ratio to GDP has inched up from 3.5% (2004) to current 6% (exp 2008) and is expected to touch 9% of GDP by 2010-11. This on a GDP which itself has grown at a rapid clip of 9% over last few years.
Simultaneously, with the rise of service and manufacturing sectors, the per capita income has more then doubled over last seven years, domestic savings to GDP has increased to well over 35% and the disposable incomes are slated to double again by 2015. India’s growth is well founded on all the three vital pillars for a secular economic growth – robust Consumption, healthy Savings rate and a strong Investments rate. There are problems being faced today, and there are solutions. The recent world-scale natural gas discoveries, 39% growth in the tax collections for the quarter ended June’ 08, better then expected performance in food grain output are some of the positive developments that have probably been harshly shrugged off by the markets.
Estimates for GDP growth in the current year vary, but even the most conservative estimate puts the number at above 7.5%. True, it is not the same as 9% (over the last three years), but it would still be very robust and one of the highest globally. Better still, situation today suggests that outlook for the year ahead is even better.
Markets always tend to overshoot in either direction, and there is nothing new this time. At valuation of about 12X FY09 earnings for sensex / nifty, we seem to have come a full circle back to the 2003 levels: the last time when such valuations were reached, and that year actually marked the beginning of five-year secular rise in Indian markets. If one searches beyond the top 30-50 companies, then picture is even better: many top quality businesses can be had at single digit or bare double digit valuations. I am confident that many stocks have a potential to multiply in their prices over the next three years, if not sooner. From “macro” to “micro” Let me give some examples to illustrate the point. There are some of the names where we find strong compounding opportunities. All of them represent quality businesses of size, entry barriers, character and superior efficiency, and managements with desire to succeed. Some of the important concerns today are energy costs, high interest costs, rupee volatility etc. Many of our portfolio positions have a good way of addressing these issues.
Opto Circuits India Ltd is a global scale manufacture of cardiovascular stents and patient monitoring systems. Addressing the large and growing opportunity of over $10 billion, it has grown at over 30% per July 2008 annum over last five years and is expected to maintain that for the next three years at least. Its largely global business is now making rapid strides in domestic market as well. With a Return on Capital Employed (RoCE) of about 35%, Opto Circuits is available at 15X FY09 and 11X FY10, attractive for a unique, high quality business.
Everest Kanto cylinders (EKC) provides an ideal foil to the current high oil prices. With a dominant 65% domestic market share in a technology intensive and high entry barriers business of CNG and other seamless cylinders, EKC enjoys an enviable moat. Both domestic and international parts of business are growing with multi-location plants around the globe. With a RoCE over 25% and expected growth rate of 45% over the next three years, EKC is available currently at 11X FY 10.
Nava Bharat Ventures Ltd (NBVL) is principally in a large and growing energy supply business along with presently highly profitable but volatile Ferro Alloys business. With steady and clear long term expansion of both the businesses, even after neutralizing the volatility of Ferro Alloys business, the core “annuity” character of energy business makes it a compelling opportunity at less then 6X FY09 for a business enjoying RoCE in excess of 40%.
Divi’s Laboratories, though not as cheap as some of the above, is a world-class, research-driven global CRAM (Contract Research and Manufacturing Services) business addressing an annual USD 40 billion (and growing) opportunity of pharmaceutical research and development. This is one business where I would assume over 20% earnings growth for may be a decade, if not more, with an outstanding RoCE of above 35%.
Even for a Fortune 500 company like Reliance Industries Ltd (RIL), with global size mature petrochemicals business, rapidly expanding refining business and new global sized gas business, which despite its large base has a major growth engine of over 30% for next two years, cash yield of over 12%, current price represents a valuation of 11X FY10.
Conclusion
The biggest positive in the current situation is the extreme sentiment negativity; that flushes out the possibility of shocks from a stretched market. All bear markets are born out of unbounded optimism, just the way all the bull markets have to raise the walls of worry. At this juncture, it is important to realize that what can be counted by everyone is usually not what decides the eventual course of markets. It will be prudent to bear a perspective that differentiates between secular long-term growth engine from the intermittent shortterm bouts (of optimism or pessimism). Former is intact, the latter is transitory. India, in our opinion, remains an attractive and almost indispensable investment choice for any serious long-term investor. This has not changed over the last six months, though prices have. That is a fresh opportunity all over again, rather than a threat.
Over last few months, our portfolios have broadly maintained healthy level of cash. The businesses that are included in our portfolios have to pass a few critical tests: strong and durable earnings growth, robust capital efficiency, large size of opportunity and reasonable value. Other things being equal, we have favored stocks that have adequate liquidity. Currently, sensex trades at rather modest 12X FY09 earnings, with many quality businesses being much cheaper. This valuation needs to be assessed in the backdrop of the globally benchmark able corporate sector (RoCE over 20%), earnings growth of 15% for current year and better going ahead, durability of growth and large size of opportunity. Given this, our stance will be to progressively deploy cash at current prices. Without ignoring near-term concerns in the environment, we believe it is the time to step out in the open and engage into opportunities with an eclectic mix of patience and conviction. Results will be healthy.
By Mr. Bharat Shah.
UBS - India Strategy - 18th July 2008.
N ear term pressures have intensified Economic headwinds continue; reducing Sensex target to 15500. The Indian market continues to face severe economic headwinds in the form of global commodity (especially oil) price spurt, high inflation that’s unlikely to decline in the near term, and a growing current account deficit exerting downward pressure on the Rupee. Political uncertainty poses additional risk. We downgrade our end-08 Sensex target to 15500 from 19600. At our target, Sensex would trade at 1-year forward PE 13.2x (current PE 12.6x, earlier target 16.1x, long term average 15x).
India underweight in Asia, further currency depreciation predicated UBS Strategist Niall Macleod (“Asia Equity Strategy: Beyond a bounce”) underweights India due the risks arising from its external deficits and low real rates. UBS economist Philip Wyatt has recently forecast further depreciation in Rupee (45.4 by end-2008 and 50 by end-2009)
Our top underperformers UBS analysts are bearish on several stocks in the near term. Reasons are a combination of slowdown in revenue growth, uncertainty in earnings due to Government policy, and potential earnings disappointments leading to earnings estimate downgrades. We highlight the most significant: TCS, Suzlon, the oil marketing companies (HPCL and IOC), GAIL and Cipla. For a list of high conviction Buy ideas we direct the reader to our recent report “Our highest conviction stock ideas” dated July 3.
Near term headwinds continue The most significant headwinds to the Indian economy arise from rising global commodity prices (especially oil) which are feeding into higher inflation, and hence higher interest rates. Higher financing costs are leading to declining consumption, and hence declining growth in industrial production (IIP). It is pertinent to note that the recent spurt in bank credit growth (since early April) appears misleading as far as the growth outlook is concerned. We believe the increase in credit growth is largely driven by increased bank credit to oil companies (oil companies’ credit requirement driven by rising oil prices). Better
indicators of growth are the real variables (IIP growth, auto sales, diesel demand) and probably real interest rates.
Moreover, we believe FII inflows are unlikely to pick up in the near term as rising crude oil prices could continue to expand India’s current account deficit and therefore, continue to exert downward pressure on the Rupee. UBS economist Philip Wyatt (“India: Rupee, where next?” dated July 16) has recently forecast the Rupee/S by end of 2008 to be at 45.4 (currently 42.9), and by end of 2009 to be at 50. In a scenario of depreciating INR, we believe foreign capital flows are unlikely to resume.
A combination of concerns on economic slowdown (leading, eventually to decline in earnings forecasts) and concerns on slowdown in portfolio inflows lead us to reduce our Sensex target by end-2008. Year-end Sensex target reduced When we calculated our previous Sensex target (“Structural growth under cyclical pressure” dated April 21), interest rates (represented by 10-year bond yields) were c1.5% lower than they are today, crude oil price was at c$110/bbl
(vs c$140 today) and WPI inflation was at c7.5% (almost 12% today). Such spike in inflation and liquidity drivers were unanticipated. We change our Sensex forecast as we believe interest rates, inflation and current account deficit are likely to stay high over next 2-3 quarters.
Among our Sensex determining variables two have changed – Sensex EPS
estimates have declined (by 1.4% in FY09 and 3.1% in FY10) and risk-free rate
forecast has increased (from 8.8% to 10% by end-2008). Consequently, our target 1-year forward PE for Sensex falls from 16.1x to 13.2x and our end-08 Sensex target declines from 19600 to 15500.
Our current target implies that the Indian market is likely to underperform Asia
marginally over next 6 months. The main risk to our forecast seems to arise from the fact that India tends to outperform its Asian peers when all markets move up, and tends to underperform on the way down (UBS Asian Regional Strategist Niall Macleod expects a bounce-back in Asian equities as Asia appears oversold. In that scenario India may outperform in the near term.
Risk to earnings estimates significant Our current estimated EPS CAGR of 23.5% for Sensex over FY08-10E clearly appears on the higher side. We believe there’s significant earnings risk in banks, real estate, engineering and metals. These sectors contribute 38-39% of market’s
earnings.
Some significant potential underperformers. On a bottom-up basis UBS analysts are bearish on several stocks in the near term. Reasons are a combination of slowdown in revenue growth, uncertainty in earnings due to Government policy, and potential earnings disappointments
leading to earnings estimate downgrades. We highlight the most significant among these: TCS, Suzlon, the oil marketing companies (HPCL and IOC), GAIL and Cipla.
Statement of Risk.
The biggest risk to Indian market arises from increasing oil prices and increasing commodity prices which are leading to rising inflation and rising interest rates. Growing current account deficit is leading to depreciation in the Rupee and decline in foreign portfolio inflows. Near term political uncertainty is likely to add to the volatility in the market.
India underweight in Asia, further currency depreciation predicated UBS Strategist Niall Macleod (“Asia Equity Strategy: Beyond a bounce”) underweights India due the risks arising from its external deficits and low real rates. UBS economist Philip Wyatt has recently forecast further depreciation in Rupee (45.4 by end-2008 and 50 by end-2009)
Our top underperformers UBS analysts are bearish on several stocks in the near term. Reasons are a combination of slowdown in revenue growth, uncertainty in earnings due to Government policy, and potential earnings disappointments leading to earnings estimate downgrades. We highlight the most significant: TCS, Suzlon, the oil marketing companies (HPCL and IOC), GAIL and Cipla. For a list of high conviction Buy ideas we direct the reader to our recent report “Our highest conviction stock ideas” dated July 3.
Near term headwinds continue The most significant headwinds to the Indian economy arise from rising global commodity prices (especially oil) which are feeding into higher inflation, and hence higher interest rates. Higher financing costs are leading to declining consumption, and hence declining growth in industrial production (IIP). It is pertinent to note that the recent spurt in bank credit growth (since early April) appears misleading as far as the growth outlook is concerned. We believe the increase in credit growth is largely driven by increased bank credit to oil companies (oil companies’ credit requirement driven by rising oil prices). Better
indicators of growth are the real variables (IIP growth, auto sales, diesel demand) and probably real interest rates.
Moreover, we believe FII inflows are unlikely to pick up in the near term as rising crude oil prices could continue to expand India’s current account deficit and therefore, continue to exert downward pressure on the Rupee. UBS economist Philip Wyatt (“India: Rupee, where next?” dated July 16) has recently forecast the Rupee/S by end of 2008 to be at 45.4 (currently 42.9), and by end of 2009 to be at 50. In a scenario of depreciating INR, we believe foreign capital flows are unlikely to resume.
A combination of concerns on economic slowdown (leading, eventually to decline in earnings forecasts) and concerns on slowdown in portfolio inflows lead us to reduce our Sensex target by end-2008. Year-end Sensex target reduced When we calculated our previous Sensex target (“Structural growth under cyclical pressure” dated April 21), interest rates (represented by 10-year bond yields) were c1.5% lower than they are today, crude oil price was at c$110/bbl
(vs c$140 today) and WPI inflation was at c7.5% (almost 12% today). Such spike in inflation and liquidity drivers were unanticipated. We change our Sensex forecast as we believe interest rates, inflation and current account deficit are likely to stay high over next 2-3 quarters.
Among our Sensex determining variables two have changed – Sensex EPS
estimates have declined (by 1.4% in FY09 and 3.1% in FY10) and risk-free rate
forecast has increased (from 8.8% to 10% by end-2008). Consequently, our target 1-year forward PE for Sensex falls from 16.1x to 13.2x and our end-08 Sensex target declines from 19600 to 15500.
Our current target implies that the Indian market is likely to underperform Asia
marginally over next 6 months. The main risk to our forecast seems to arise from the fact that India tends to outperform its Asian peers when all markets move up, and tends to underperform on the way down (UBS Asian Regional Strategist Niall Macleod expects a bounce-back in Asian equities as Asia appears oversold. In that scenario India may outperform in the near term.
Risk to earnings estimates significant Our current estimated EPS CAGR of 23.5% for Sensex over FY08-10E clearly appears on the higher side. We believe there’s significant earnings risk in banks, real estate, engineering and metals. These sectors contribute 38-39% of market’s
earnings.
Some significant potential underperformers. On a bottom-up basis UBS analysts are bearish on several stocks in the near term. Reasons are a combination of slowdown in revenue growth, uncertainty in earnings due to Government policy, and potential earnings disappointments
leading to earnings estimate downgrades. We highlight the most significant among these: TCS, Suzlon, the oil marketing companies (HPCL and IOC), GAIL and Cipla.
Statement of Risk.
The biggest risk to Indian market arises from increasing oil prices and increasing commodity prices which are leading to rising inflation and rising interest rates. Growing current account deficit is leading to depreciation in the Rupee and decline in foreign portfolio inflows. Near term political uncertainty is likely to add to the volatility in the market.
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