India Strategy India Strategy (Thematic) (Thematic) The stock called INDIA The stock called INDIA … … Nikhil Vora / Nikhil Salvi IDFC Securities Ltd (Dir) +91-22-6622 2567 / 2566 (M) +91 –98211 32471 Email: [email protected] / [email protected]August 2012 August 2012 SEBI Registration Nos.: INB23 12914 37, INF23 12914 37, INB01 12914 33, INF01 12914 33. For Private Circulation only. Important disclosures appear at the back of this report”
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India Strategy (Thematic)- The stock called INDIA with ... · PDF fileIndia Strategy (Thematic) The stock called INDIA ... Bajaj Auto – Rahul Bajaj • Unprepared for shift in customer
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India Strategy India Strategy (Thematic)(Thematic)
Leveraging core strengths: Private enterprises unshackled from labour laws
Between 2001 and 2008…
BSE Sensex
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5,500
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Apr-01 Apr-02 Apr-03 Apr-04 Apr-05 Apr-06 Apr-07
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Market callMarket call
2020
We believe 16500 is astrong base for
Sensex
1/4th of Corporate India trading at less than capital employed! 1
Corporate India has shown more resilience this time2
Expect sharp rate cuts in the rest of FY133
212121
CorporatesCorporates trading at less than invested capital!trading at less than invested capital!
Over 50% of the companies are at index levels of 8000, with more than 25% trading at less than capital employed – implies that valuations are at par with promoters!
EV/capital employed
1/4th of Corporate India trading at less than capital employed!
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Automobiles Engineering Cement Telecoms Power Utilities Logistics Infra Developers Construction Metals
FY12E FY13E
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Corporate resilience much stronger this time! Corporate resilience much stronger this time!
Indian corporates more resilient to withstand economic shocks than in previous downturn!
Lower gearing and higher cash on books for Indian Corporates!
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Debt to Equity ratio (% - LHS) Cash as a % of debt (RHS)
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Expect sharp rate cuts in the rest of FY13Expect sharp rate cuts in the rest of FY133
High interest rates hurting operating performance and investment decisions
Aggressive monetary policy stance so far by the RBI……resulting in sharp rise in system lending rates!
IndusInd Bank 337 155 22.2 28.8 15.0 2.9 2.8 20.9 1.6 Note: Based on FY13E, Prices as on 22 August 2012
Top buys Top buys –– Large capLarge capLarge cap (Mcap>US$2bn)
Bajaj Auto
Structurally well-placed; presence in 40 countries with 2W, 3W and, very soon, 4Ws. Poised to benefit the most from uptrading, with brands like Pulsar and Kawasaki in its stable.
Better placed to handle competition. Derives 20% of volumes from the domestic 100cc executive segment; robust launches planned in key brands to tackle competition.
Potential of RE60 not captured in estimates; could be replacement for 3Ws as it caters to demands of both regulators and customers. Exports to start in 3QFY13.
M&M
UVs drive growth while tractors take a pause. XUV and Bolero drive growth in a weak market and mitigate impact of weak tractor demand.
Recent recovery of monsoon reduces risk of a tractor collapse.
Recent turnaround of Tech Mahindra positive for consolidated financials.
JPA
Capex has peaked, gearing expected to reduce.
Expect strong cash flows in power (JPVL) due to robust generation at hydro plants and progress of projects under construction. YamunaExpressway commissioned; to pave way for real estate launches in new locations along the expressway.
L&T
Diversified skill-sets for a range of industries; vendor of choice for large and complex projects.
Large and diversified order book.
Captures maximum value from most orders due to broad presence in the value chain (e.g., power EPC solutions include manufacturing of both BTG and BoP components).
Top buys Top buys –– Large capLarge cap
HDFC
High visibility of sustained growth given healthy affordability levels and strong demand.
NPLs to remain low as no heavy job losses forseen; benefits from the fact that as most loans are for self-use, this is the last asset a person would default on.
Given strong track record and sustainable high core RoEs, we expect HDFC to sustain premium valuations. Valuing the core business at 4x FY13E book (3.5x FY14E) and building in a value of Rs205 per share for subsidiaries, we set a 12-month price target of Rs800.
ICICI Bank
The bank has delivered 20%+ earnings growth for seven consecutive quarters now; and we believe it is firmly on track to expand both profitability and balance sheet.
Better transaction structuring and high level of collateralization offer comfort on infrastructure asset quality.
A steady earnings trajectory should drive a structural re-rating of the stock from 1.3x FY13E core book currently to 2.4x. We have a 12-month target price of Rs1,476 (including Rs166/ share for non-banking subsidiaries).
Yes Bank
With its advances portfolio being almost entirely composed of working capital loans, Yes Bank's asset quality remains one of the best in the industry.
Given the wholesale bias of the bank’s funding mix, a decline in wholesale borrowing rates would provide impetus to earnings as also stock performance.
Currently trades at 2.2x FY13E adj. book and 1.7x FY14E adj. book. Reiterate Outperformer, with an 18-month price target of Rs500 (2.5x FY14E adjusted book).
Top buys Top buys –– Large capLarge cap
IndusInd Bank
With rates softening in the past few days due to easing liquidity (a trend likely to sustain), we expect IndusInd to start gaining margin momentum again given ~50% of its loan book is fixed rate in nature.
IndusInd is focusing on diversifying its revenue base as well as improving its liability franchise as reflected in robust fee growth and a continuous expansion of the saving deposit base.
Despite improving over the past three years, branch efficiency still lags peers by a wide margin. We see this untapped opportunity driving a sustainable RoA of ~1.6% 4. Current valuations are 2.9x FY13E & 2.3x FY14E adj. book. We have an 18-month price target of Rs430 (3x FY14 adj. book).
Infosys
Infosys’s prolonged underperformance to the CNX IT index has been led by the conspicuous absence of its “beat-and-raise” quarterly performance and slower volume/ revenue growth compared with TCS/ HCLT.
The management has taken steps to accelerate growth and adapt to newer business dynamics. The sales engine in being revived withrenewed focus on client-mining and new high-potential client acquisition as also empowering the next line of management.
These efforts should bear fruit in the next few quarters; valuations of ~14x PER adequately captures the known negatives.
Wipro
Wipro has a high share of run-the-business IT spending, the highest among the top 6 Indian IT services companies. Also, revenues are well-diversified across verticals, clients and service lines.
A re-organization undertaken in FY12 has ensured higher accountability, agility and better client responsiveness and is likely to reflect in Wipro’s long-term growth prospects.
Valuations of ~13x PER reflect weak Q1 and muted Q2 guidance. Wipro’s business model is resilient and we see a bounce-back.
Top buys Top buys –– Large capLarge cap
Cairn
Production growth of ~20% from current levels by H2FY14E to 210 kb/d. Further increases possible over FY15E if regulatory clearances come through.
We have conservatively used peak production of only 210 kb/d in our numbers based on clearances received so far.
We are positive on strong crude prices (we build in a long-term price of ~US$90/bbl) and rupee depreciation boosting earnings and pushing back earning peak to H2FY14E (post which government’s share of profit would rise to 50%, depressing earnings).
Exploration option value of Rs78/ share; approvals coming through for exploration on the Rajasthan block to get the resource base of ~3100 mmboe (risked resources of ~530 mmboe) through to appraisal stage would boost this value
JSPL
JSPL should beat the steel downcycle through value-addition.
In the power segment, lower tariffs are priced in; should still drive earnings growth.
Overseas mining assets – value-unlocking from overseas coal assets in South Africa, Mozambique and Indonesia.
HUL
HUL has transformed itself into a premium-focused and leaner organization in the past two years; this would continue to drive 8-10% volume growth.
The soaps and detergents business is moving back to normalized margins; premiumisation of personal products will ensure sustained margin expansion.
Efficient leveraging of unmatched scale will drive down costs, further adding to profitability.
We expect a 17% profit CAGR over the next three years.
Top buys Top buys –– Large capLarge cap
Marico
The strength of the core domestic hair and edible oil business ensures strong volume growth. Continued market share gains in spite of steep pricing action is indicative of the strong brand equity of Parachute and Saffola, which will ensure volume-driven as well as profitable growth.
A shift in strategy towards taking on the multinationals in their own categories (oats, skin care, deodorants) is encouraging and, we believe, will create growth drivers for the business, beyond the core hair and edible oil business, over the next five years. We are positive on the Paras acquisition as it opens up new high-growth avenues.
We expect a 22% profit CAGR over the next three years.
Godrej Consumer
The domestic business gives us a high level of confidence as the household insecticides business (50% of domestic revenues) is growing 2-3x category growth and remains an extremely exciting category. Moreover, soaps has also picked up pace and is supplementing strong growth in household insecticides.
The company has allayed concerns on the international business to a large extent as growth continues to be strong and the balance sheet has improved considerably.
We believe GCPL’s de-rate cycle is over, increasing growth visibility on both the domestic and international businesses; this would prompt a re-rating.
APSEZ
Strong volume growth momentum continues, leading to strong cash flows.
Leverage ratios to peak at current levels (Abbot Point expansion unlikely to be taken up over next 18-24 months).
Strong earnings profile (20% CAGR in cons. earnings over FY12-14) not reflected in current valuations.
Top buys Top buys –– Large capLarge cap
Top buys Top buys –– Large capLarge cap
Cipla
After management changes, Cipla’s focus on revitalizing its domestic business and enhancing profitability has clearly begun delivering returns.
While the finer contours of this turnaround strategy remain hazy, we take comfort from management commentary referring to steadyimprovement in operating metrics and significant improvement in balance sheet quality.
We also anticipate increased aggression for growth, including strategic moves like M&A deals.
With reasonable possibilities of earnings upgrades, we remain positive on the stock. We have a target price of Rs398 (20x FY14E, 23x FY13E earnings).
Dr Reddy's Labs
One of the most attractive ANDA pipelines in the industry – 79 pending ANDAs, including of 40 Para IVs and 10 FTFs.
A slew of recent complex launches – e.g., Fondaparinux, Lansoprazole, Tacrolimus, Omeprazole OTC – underline the company’s R&D capabilities; news flow on more interesting product launches expected in the coming quarters.
High-margin branded formulations sales of Rs37bn (FY13E) across India and CIS; relatively insulated from any impact of the likely implementation of price control policy.
Street’s skepticism on management’s ability to achieve FY13 guidance of $2.6bn-2.7bn an upside risk.
At CMP of ~Rs1660, the stock trades at ~16x FY14E, much below multiples of most large peers. Also, given return ratios of >20% and a net cash balance sheet, valuations remain attractive.
Top buys Top buys –– Large capLarge cap
Sun Pharma
With all three business segments – US, RoW generics and domestic formulations – showing strong growth, we remain fairly comfortable on medium-term growth.
US generics will likely keep delivering positive surprises, with 135 ANDAs awaiting approval and unanticipated approvals for niche products like Astelin nasal spray, Sumatriptan auto-injector etc.
Buy-back of remaining ~34% stake in Taro (Rs4bn PAT in FY14) to provide further upside given valuation arbitrage (Taro trades at ~10x FY14 compared to >20x for Sun); even after the Taro share purchase, Sun will have >$500m cash reserve left for significant value-accretive acquisitions.
Top buys Top buys –– Mid cap & small capMid cap & small cap
Tech Mahindra
Merger with Mahindra Satyam would create an entity with US$2.6bn in sales and 75,000 employees, put it on the global map for large deals and improve growth prospects.
Core competencies of the two firms complement each other (enterprise services of Satyam and TechM’s mobility expertise), creating a formidable player in the fast-growing enterprise mobility business, a key area of investment for Fortune 500 companies.
Valuations of ~10.8x FY13E EPS on pro forma earnings do not completely capture the improved growth prospects of the company.
Eicher Motors
Best play on CVs; company poised to gain market share, driven by AB Volvo-validated products and frugal cost structure (efficiency close to that of 2W names!!!)
Offers superior growth visibility in a cyclical industry due to rising HCV market share (up in a weak market), resilient LMD and exports/ outsourcing.
CY13/ CY14 to be blow-out years as MDEP project goes live, RE expands capacity, new CV platform hits market and new EM brand is launched.
Petronet LNG
Company to expand capacity 2x over the next two years (Dahej +5m tpa from 10m tpa currently; Kochi +5m tpa) and 2.5x in four years (Gangavaram +5m tpa).
Domestic gas volumes remain muted; demand to keep growing in double digits over the next decade (volumes to grow from ~11m tpa currently to ~15m tpa by FY15 and ~18m tpa by FY17E).
Pricing remains an issue, but with newer tranches of domestic supply coming in at higher prices, acceptability of higher prices would rise. Slowing Japanese demand and global capacity additions could drive some moderation in spot LNG prices in the next five years.
Petronet LNG (continued)
Earnings CAGR of 14% over FY12-15E, but growth will be back-ended, with FY13-H1FY14E earnings showing slower growth due to ramp-up of capacity coming in only by H2FY14E.
Limited threat from regulations in the medium term, with re-gasification margins not under the purview of the PNGRB Act as of now.
Ipca Labs
Ipca has among the strongest and most consistent business models in the mid-cap pharma space; superior API capabilities vis-à-vis peers give solidity to its model; the company expects a 100+ commercial API basket over 2-3 years.
With the FDA nod for the Indore SEZ, clearance for the Baroda API complex, WHO pre-qualification for Artemether-Amodiaquinecombination over the last few months and recovery in domestic formulations, Ipca is well set to embark on the next phase of growth.
Expect steady growth across segments, with US generics likely leading the way from FY14 (expect 35-40% growth); currency tailwinds will further add to the momentum.
At CMP of Rs402, the stock trades at 12x FY14E; scope for further appreciation with multiples re-rating to 13-14x given the robustness of the business model and medium-term growth drivers.
Strides Arcolab
With 161 sterile ANDA filings, only 43 commercialized products, and promise of ~50 new filings in CY12, Strides’s scale-up potential remains fascinating.
Given the tight steriles market in the US and availability of abundant USFDA-approved capacities, we expect the specialty business to scale up briskly; pick-up in the pharma business will add to the momentum.
Net debt is down to Rs13bn with D/E ratio of 0.67x (from 1.67x as of Dec-11), which addresses a key investor concern
Top buys Top buys –– Mid cap & small capMid cap & small cap
Top buys Top buys –– Mid cap & small capMid cap & small cap
Glenmark
After addressing investor concerns over balance sheet issues, last quarter’s performance (37% yoy revenue growth; 21% EBITDA margin) is reflective of the potential of its generics business model.
We expect profits to steadily improve hereon as investments in growth begin to pay off across geographies, led by the US and India.
Expected scale-up of ROCE to 18-19% (despite Rs1.7bn-1.8bn of NCE R&D spend) over FY13-14 (from 11-12% over FY09-11) builds a strong case for a re-rating of the generic business. Significantly value-accretive news flow on the NCE pipeline is possible over the next 12-18 months.
At CMP of Rs409, Glenmark remains attractively valued at 16.5x FY14E earnings.
Sobha Developers
Among the largest players in the steady Bangalore market; expansion into other cities (Chennai, Mysore and Gurgaon) provides comfort on sales momentum.
Over 60% of land bank (210msf) in tier-1 cities of Bangalore and Chennai; minimal payment outstanding (Rs1.2bn; ~10% of total).
Strong cash flows from ongoing/ planned launches (>Rs80bn over next four years) provide comfort on execution scale-up and debt reduction (Rs12bn; gearing at 0.58x; management target is 0.5x).
Growing at a whopping 76% CAGR (over FY08-12), Sobha achieved >Rs17bn sales in FY12; can comfortably achieve a run-rate of Rs20bn from FY13.
We expect revenues/ earnings CAGR of 23%/ 20% over FY12-14E; EPS to potentially double by FY14 (>Rs30/share); stock trading at attractive P/E levels (~10x FY14).
Potential valuation of >Rs400/share even at conservative land-bank valuations (Rs180psf; 2x acquisition cost).
JPVL
Expect strong cash flows on the back of robust generation in hydro power plants.
Progress in under-construction power plants on track, visibility on capacity addition.
Better protected than peers from coal-supply shortage and cost pass-through issues due to higher proportion of hydro capacity and captive coal mine.
United Spirits
Shift in strategy to premiumisation and, hence, significant improvement in quality of earnings were evident in the recent results; this would enhance USL’s positioning in the Indian spirits market which is becoming more premium.
With increasing leverage (1.7x), narrowing interest coverage ratio (1.3x for FY12), we see an urgent need for capitalization, which could be addressed by sale of UB shares andUSL treasury stock.
We have always maintained that “strategic” value-unlocking in USL is a given and that the timing is the only “uncertainty”. Our sense is that the probability of inducting a strategic partner looks high, which will significantly re-rate the business.
TVS Motors
One-legged run to end: New bikes (125cc and ‘Victor’ re-launch) mark entry in executive segment (50% of 2W industry). 125cc scooter to boost presence.
New launches to drive margins as gross margins would rise, driving operating leverage. Growth in operating profits to be 2x growth in revenues.
Deleveraging to boost non-operating growth: Interest-bearing debt of Rs4.3bn (25% of market cap) to be retired by end-FY14.
Top buys Top buys –– Mid cap & small capMid cap & small cap
DEN Networks
DEN added 0.3m digital subscribers in FY12; we expect a 3x jump in additions over the next 12 months (1.18m in FY13E).
With digitization to improve declarations (albeit with a lag), we see the ‘annuity-driven’ model of distribution coming to the fore and resulting in superior financial performance for DEN (35% CAGR in earnings over FY12- 14E). With cash on books of Rs2bn+ and leverage of 0.3x, DEN is well capitalized for incremental subscriber addition of 2m+.
With the ‘direction’ of digitization now clear and given the superiority of the cable business model over DTH (capital requirement for digitization almost half), we see merit in investing in DEN to participate in the digitization story. An aggressive management is an added support to our thesis.
Top buys Top buys –– Mid cap & small capMid cap & small cap
Ten years ago, cigarette valuations nosedived as a host of adverse events marred the outlook of the global tobacco industry. History is set to repeat itself as all-time high cigarette valuations are under serious threat from legislative/ regulatory tightening globally.
Despite pricing power, ITC faces formidable challenge to grow volumes profitably in the face of a structural rise in taxation, both at the central and state levels.
Non-tobacco FMCG has been unexciting despite ITC having pumped in Rs45bn and strong distribution leverage; hotels would remain a drag on the balance sheet and return ratios; other businesses are too small and commoditized to offer any re-rating potential.
We set an SOTP-based target price of Rs244.
HCL Tech
Most levered to discretionary IT spend.
Impending management re-organisation could hit revenue momentum.
PER of 13x captures positives.
Idea
Most exposed to risks from 2G re-auction and New Telecom Policy 2012.
Inability to pass cost increases to consumers highlights competitive intensity.
Current valuations of 6x FY13 EV/EBITDA do not reflect regulatory risks and potential equity dilution.
SAIL
We are negative on the steel cycle and expect realizations to trend down. We see threat to margins due to firm raw material prices.
Historical delays have led to huge lock-up of capital, which has affected return ratios.
Top sellsTop sells
Voltas
Electro mechanical projects: a) order inflows slow (weak construction activity in India and the Middle East); b) intense competition has driven down margins by 300-400bp; c) longer WC cycle, and d) risk of further losses at large Qatar order.
Engineering products and services: a) textiles – slow investments by sector leading to weak inflows; b) sluggish mining and construction activity as also loss of principals.
Unitary cooling products: a) intense competition marring ability to pass on higher input costs; b) higher ad spends impacting margins.
Pressure on both top line and margins.
DLF
Euphoria around likely non-core asset deals (~Rs50bn expected from three transactions – NTC mill land, Aman Resorts, wind power) overdone; the stock remains significantly expensive even assuming these deals get executed.
At ~Rs18bn lease rentals in FY13E, DLF’s leasing portfolio is valued at ~Rs180bn – equivalent to residual debt post Rs50bn from asset sales.
This effectively implies a Rs360bn valuation for DLF’s 345msf land bank (@Rs1040 psf), which is by far the highest in the industry (implied land bank valuation of peers – Rs60-120 psf for JP Infra, Sobha, etc.)
DLF has guided for sales of ~Rs65bn in FY13. Assuming ~35% EBITDA on the real estate business, DLF is valued at ~15x FY13 EBITDA. The multiple is at a significant premium to that of peers (Sobha and Oberoi trade at 9.3-9.5x FY13 EV/ EBITDA), leaving little room for upside.
Other significant risks include inability to conclude non-core asset sales, risks to Magnolias project launch in Gurgaon (projected sales Rs18bn-20bn for FY13) and cash-flow pressures (could struggle to meet interest obligations).
Top sellsTop sells
BPCL
Core business remains under stress, with high inventory losses, high subsidies and high interest costs eating into earnings and balance sheet .
Too much optimism on the E&P business
• Timelines (at least five years to commissioning of the first trains of LNG in Mozambique, a decade for all trains to start), investment (US$47bn required to monetise Mozambique; BPCL share at ~US$5bn) and challenges in dealing with the government in Africa not factored into Street valuations ascribed to this segment.
• Brazil is also highly attractive, but we are sceptical of attributing too much value to what are essentially exploration assets as of now (no appraisal-stage drilling, no reserve/ resource certainty).
• Our valuation of US$1.2bn for the portfolio (US$950m for Mozambique, Rs66/ share) reasonably factors in the timelines, investment and pricing challenges for the assets (Street valuations for Mozambique alone at US$2bn taking Cove Energy acquisition price as a marker, which we do not agree with).
Hero Motocorp
Most exposed to incremental competition: Executive segment accounts for 70% of volumes and 80% of profits. Three new players, including Honda, to enter the market in 2012. Hero’s current market share of 68% indefensible.
Honda has Hero in its sights as it aims to be the leader by 2020. Product and dealer mapping targeting Hero; company has startedenrolling Hero dealers after the split.
Structurally on a weaker wicket: Unable to extend executive success to premium segment. No big brand success since Passion (2001) despite seven launches.
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