Sunday, February 5, 2012

>India’s growth model (and its limitations)

This report explores the idea that India’s economic slowdown is primarily explained by the limitations of its growth model and less by the problems caused by the global situation.

Focusing too much on services in urban areas, India’s economic growth is “creating” the current deficit (since only a small share of services is exported) and inflation (since the rise in agricultural productivity is low and demand for foodstuffs is high) is intensifying income inequalities (absorption of excess labor in rural areas is very slow) and is nurturing public deficits (the State is trying to offset increased income inequality by establishing aid programs).

The domestic financial system also devotes too many resources to finance the public deficit, such that funding for heavy investments (not associated with urban services) is partly limited by the availability of external savings.
India’s growth and enormous economic development potential will clearly continue to draw interest from foreign investors over the coming years.

It is worth noting the presence of macroeconomic imbalances that could increasingly expose the growth path and performance of financial variables to “stop & go” type movements.

To read full report: GROWTH MODEL

>INDIA STRATEGY: A New Bull Market?

Key debate: Narrow indices are past their 200DMA for the first time since February 2011. Sector rotation has hit a 15-month high. Cyclicals are back and the so-called defensives have underperformed. These are tell-tale signs of a new bull market. Is this a case of the market telling us where the fundamentals are heading or is this a head fake? Simply put, are we in a new bull market?

First, our view
New bull markets are started by favorable liquidity conditions and attractive valuations. At the end of December, both ingredients fell into place. Bull markets make progress as fundamentals improve. Fundamentals can come in various forms such as technology changes and favorable demographics, but ultimately all these changes imply upward revision in growth forecasts. Not surprisingly, fundamentals remain fuzzy. The market continues to have support from skeptical positioning and low expectations. We expect upward progress, although the pace of the recent move may induce volatility. Now, the facts If this is indeed a new bull market, the preceding bear market at 60 weeks and -26% return will prove to be the shortest and shallowest in 20 years – a far cry from the average 50% fall seen in previous bear markets.
Valuations are around 30% higher than what they were at the end of the previous three bear markets. This could create doubts about this being the start of a new bull market.

The jury is out, but bears will be tested
What do we need to be sure that this sustains as a new bull market? The key difference between the 2003-08 period and now is that global growth is no longer supportive. To that extent, it needs an extra policy push to pull India’s growth rate back to trend. Corporates are suffering from poor profitability – inflation needs to remain moderate for that to improve. That will also help rates to fall. The key risks remain Europe and oil. India needs time to adjust its macro to absorb risks from Europe and oil. If these risks do not unfold in say the coming six months, the second half of 2012 may prove to be even stronger for equities. None of these are differentiated insights, but the good news is very few believe these events will happen, and markets sometimes favor climbing walls of worries.

To read the full report: INDIA STRATEGY


For 3QFY2012, on a consolidated basis, Ashoka Buildcon (ABL) reported a healthy set of numbers on all fronts, in-line with our estimates. Order book as of 3QFY2012 stood at `4,312cr (4.2x FY2011 E&C revenue) with the company bagging a BOT project (`1,100cr) and power T&D order (`400cr) during the quarter. We maintain our Buy rating on the stock.

Robust performance as expected: ABL’s top line witnessed robust growth of 49.3% to `352.9cr, in-line with our estimate of `360.6cr. The E&C segment witnessed strong yoy growth of 52.8% to `300.4cr, higher than our expectation of `268.4cr, while the BOT segment reported 30.1% yoy growth to `66.3cr, lower than our estimate of `92.2cr. On the EBITDAM front, ABL’s margins came at 19.6%, lower than our estimate of 21.3%, owing to lower margins in the BOT segment, led by major and regular maintenance work in two projects. Interest cost came in at `27.3cr, a jump of 70.6% yoy/10.9% qoq. Despite lower EBITDAM, ABL posted decent performance at the earnings level, owing to robust top-line growth and reported PAT growth of 17.3% to `19.5cr, in-line with our estimate of `21.0cr.

Outlook and valuation: NHAI has done a commendable job by handing out ~4,500km so far in the current fiscal and is looking on track to achieve 80% of its target of awarding, ~7,300km in FY2012. Further, in the long run, the road segment continues to offer a number of opportunities for road-focused players such as ABL. We have valued ABL on an SOTP basis – by assigning 5.0x EV/EBITDA to its standalone business (`104/share) and valued its BOT projects on NPV basis (`141/share) to arrive at a target price of `245, which implies an upside of 26.4% from current levels.

Robust top-line performance, in-line with estimate
ABL’s top line witnessed robust growth of 49.3% to `352.9cr (`236.4cr), in-line with our estimate of `360.6cr. The E&C segment witnessed strong yoy growth of 52.8% to `300.4cr, higher than our expectation of `268.4cr, while the BOT segment reported 30.1% yoy growth to `66.3cr, lower than our estimate of `92.2cr.

During the quarter, the company almost completed two projects (Durg and Jaora Nayagaon). While toll collection on Durg project is likely to start from 4QFY2012 end, Jaora Nayagaon project has two sections already operational and tolling on the third section is expected to commence from 4QFY2012-end. Therefore, ABL is expecting the remaining under-construction projects (Sambalpur Baragarh, PNG, Belgaum Dharwad projects) to drive its E&C revenue growth going ahead.

BOT toll revenue
On the toll collection front, for 3QFY2012, ABL witnessed 70.5% yoy/4.2% qoq growth. This growth was on the back of addition of Belgaum Dharwad project and pickup in toll collections of Jaora Nayagaon project, which started toll collections on the second section from May 2011.

Under-construction BOT projects – Update 

Decent growth at the earnings level despite lower EBITDAM
During the quarter, ABL’s margins came at 19.6%, lower than our estimate of 21.3%, owing to lower margins in the BOT segment, led by major and regular maintenance work in two projects. Going ahead, we are factoring EBITDAM of 21.7% and 23.1% for FY2012E and FY2013E, respectively, as maintenance charges booked in this quarter pertained to ~9 months. Interest cost came in at `27.3cr, a jump of 70.6% yoy/10.9% qoq. Despite lower EBITDAM, ABL posted decent performance at the earnings level, owing to robust top-line growth and reported PAT growth of 17.3% to `19.5cr, in-line with our estimate of `21.0cr.

History has shown that a world-class road network is a basic requirement for any economy hopeful to maintain high economic growth rates. However, India’s road network is barely adequate to maintain its current growth trajectory – indicating an urgent attention towards the same and putting it on the priority list. Positively, political will to acknowledge and address these issues in now visible. Records till date are mixed for road development in India – with PMGSY doing reasonably well and NHDP lagging behind on meeting its targets. However, matters have improved gradually on NHDP’s end with positive developments happening and with experience gained on both sides – government agencies and private sector. Some issues have been addressed on the ground and at the policy level. But still the sector faces a number of issues – for instance, land acquisition, environment clearance and dispute on certain aspects on the Model Concession Agreement. Having said that, the pace of awarding has definitely picked up considerably as compared to the past, though lower than targets. Therefore, there are a number of opportunities for the private sector, especially for road-focused players like IRB, ABL and ITNL.

However, we believe ABL is little differently placed than its peers on account of its leverage position. In recent times, ABL has won large orders, which has resulted in huge premium commitments to NHAI (~`220cr) and equity contributions from ABL’s side, which we believe would further stretch its leverage (net D/E is expected to rise from 1.4x in FY2011 to 3.0x by FY2013E). Also, the current cash flow generation from BOT projects and the EPC segment would not fully suffice the equity requirements for under-development projects. Hence, we believe the only options for ABL would be to raise equity, which seems extremely tough in current times, and/or raise debt for equity funding of its subsidiaries, which we have factored in after considering ~50% of requirement been met from internal accruals/refinancing of operational projects. Management is confident of raising US$100mn-150mn through private equity by March 2012. We believe tying up of funds is the biggest catalyst markets would watch out for in case of ABL and any delay in that would negatively impact its stock performance on the bourses.

We have valued ABL on an SOTP basis – by assigning 5.0x EV/EBITDA to its standalone business (`104/share) (lower multiple as compared to IRB/ITNL given the scale of operation) and valued its BOT projects on NPV basis (`141/share) (it should be noted we have been conservative than management on revenue estimates (toll receipts) for under-construction projects, keeping an eye on revenue yield given the current competitive environment) – to arrive at a target price of `245, which implies an upside of 26.4% from current levels. We maintain our Buy rating on the on the stock with an SOTP target price of `245.



Healthy margins to lead to better valuations

Gateway Distriparks’ (GDL) Q3FY12 results were in-line with our expectations with consolidated net profit at Rs331mn vs. our estimate of Rs323mn. The overall operating margin at 32.9% was led by the CFS segment, which continued its stellar performance. Though CFS volumes declined 8.4% YoY, realisations were up 31.6% YoY which led to a 532bp margin expansion in the division to 54.1%. The rail segment’s volumes grew 23.8% YoY, while margins expanded 374bp YoY to16.8% with higher contribution from Exim. We are marginally tweaking the volume and realisation assumptions, while mostly maintaining our estimates. We continue to remain positive on GDL on the back of improving margins across segments and higher growth expected in the rail and cold chain businesses. We maintain Buy with a target price of Rs190.

Q3 results in-line with estimates: Consolidated income grew 23.9% YoY to Rs1,983mn (4.3% above our estimate). PAT jumped 63.6% YoY to Rs335mn, 8.1% higher that estimated. CFS volumes grew 4.1% YoY to 86,890 containers and rail volumes grew 36.4% YoY to 43,057 containers.

 Healthy margins across segments: EBITDA grew 39.8% YoY to Rs653mn, 4.6% above our estimate. EBITDA margin improved 374bp YoY to 32.9% in-line with 32.8% anticipated mainly on the back of continued margin improvement across segments. CFS margins continued to remain healthy at 54.1%, up 532bp YoY. Rail margins increased 374bp YoY to 16.8% while cold chain margins remained flat at 27.5% (down 65bp YoY but up 195bp QoQ).

 Higher realisation in CFS continues to led to healthy margins: While CFS volumes declined 8.4% YoY, realisation improved 31.6% YoY to Rs10,221 per container. This was also a jump of 8.1% QoQ which was mainly due to increase in dwell time (12day vs. 10.5-11days earlier) and improvement in realisations at Chennai CFS. This helped CFS revenue grow 20.5% YoY to Rs811mn and EBITDA to increase 33.6% YoY to Rs438mn.

 Planned capex of over next 15 months: GDL has planned an additional capex of Rs2.5bn over the next 15months. The rail business will have the largest share with Rs1.3bn for capacity expansion at its ICDs and terminals apart from fleet expansion. GRFL plans to add at-least 6-7 rakes over the next one year. The company will spend Rs800mn in the CFS business to expand its capacities at Kochin and Chennai. Its cold chain business is looking to expand its current capacity of 18,250 pallets to ~46,000 pallets by the end of FY13.

 Buy with a target price of Rs190: High earnings growth and improvement in margins warrant a re-rating of the stock. We maintain Buy rating and target price of Rs190, valuing the stock at 14x FY13 earnings. At the CMP, the stock is trading at 10.0x and 5.6x FY13E P/E and EV/EBITDA respectively.


>INDIAN BANK features among the midsized banks in the public sector space

Background: Indian Bank features among the midsized banks in the public sector space. Through the years FY96 to FY01, the bank experienced a series of financial setbacks. Under a capital restructuring plan carried out in FY06 the bank had written off its accumulated losses. The bank operates a network of about 1970 offices in India. As of December 31, 2011 the bank had business of about Rs 2064bn. The bank’s footprint is largely skewed towards the southern states of Tamil Nadu, Karnataka, Andhra Pradesh and Kerala.

Tax reversal comes to the rescue
Indian Bank’s revenues and operating profit were along expected lines. PAT, however, was higher than expected; led by tax reversal. PAT was up 7%YoY at Rs 5.26bn. Net interest income continued to drive operating profits; non-interest income also chipped in with a 13.1%YoY growth.

Quarterly Highlights
• Credit growth stumbles, alternate credit (investments) up ~50%
• CASA stable at about 25%
• Asset quality healthy, net NPLs at 0.8%
• Margins under pressure
• Net interest income up 12.8%YoY
• Operating profits growth curbed at 12.3%YoY

At current levels the stock trades at 0.97X FY13E adjusted book value (standalone) and 4.08X FY13E EPS (standalone). Buoyed by superior net interest margins and aided by a higher leverage on equity, Indian Bank enjoys a laudable return on equity in the PSU space. We expect the bank to be among the outperformers in the PSU banking space. With valuation having run up we rate the stock a MARKETPERFORMER on the stock with a target price of Rs 256. Key risks include a less than expected loan book expansion and a significant variation in spreads.

Credit growth tempered
Indian Bank continued to grow its balance sheet front in healthy double-digits; however, a downtick was seen with an 18.7%YoY growth at Rs 1,388.49bn. The bank outperformed the industry by reporting an 18.7%YoY growth in the loan book vis-à-vis the system growth of 15.9%. However, moderation was witnessed with a 1.8%QoQ growth as against 6%QoQ growth in the December 2010 quarter. Loan book was reported at Rs 873.37bn. Deposit growth also better at 17.8%YoY as against the industry growth of 16.9%. Deposits were reported at Rs 118.97bn. The credit-deposit ratio was reported at 73.4%. Indian Bank has retained the CASA ratio (24.8%) well compared to its peers; higher composition of savings deposits made for the slip in current account deposits. On the lines of industry leaders, Indian Bank expanded its investment book at a faster pace (19.1%YoY) as compared to the loan book. The investment book was reported at Rs 349.25bn.

Pressure on margins
In tune with that of the industry yields and costs were higher; the bank appears to have absorbed a portion of the higher cost of funds contributing to a downtick in margins. An uptick in borrowings and lower yielding investments contributed to pressure on margins. Net interest margins were reported at 3.58% as against 3.84% in the December 2010 quarter. Led by an 18.7%YoY growth in balance sheet net interest income was 12.8%YoY. Cost of deposits was reported at 6.9% vs 5.4% in the December2010.

Growth in operating profits curbed
Indian Bank reported a 13.1%YoY growth in non-interest income to Rs 2.81bn. Lower credit off-take appears to have dented fee income growth contributing to a lower non-interest income growth. Revenues for the bank were up 12.8%YoY. Operating costs were up 13.8%YoY led by both staff costs and other operating expenses. Operating profits were up 13.8%, cost income ratio was stable at 37.2%.

Asset quality comfortable
Asset quality continued to remain strong with gross NPLs and net NPLs remaining steady at Rs 11.9bn and Rs.6.95bn, respectively. With net NPLs at 0.8%, despite higher slippages, asset quality continues at comfortable levels. Net slippage was reported at Rs 1.43bn.

Outlook & Valuations
Balance sheet expansion is expected to drive net interest income growth; spreads are likely to remain under pressure over the next couple of quarters as the bank is likely to absorb a section of the costs.

Indian Bank is likely to report a PAT of Rs 19.2bn for FY12 and Rs 24.34bn for FY13. A chunk of earnings growth is expected to accrue from top line which is expected to be driven by a 20% growth in the balance sheet.

At current levels the stock trades at 0.97X FY13E adjusted book value (standalone) and 4.08X FY13E EPS (standalone). Buoyed by superior net interest margins and aided by a higher leverage on equity Indian Bank enjoys a laudable return on equity in the PSU space. We expect the bank to be among the outperformers in the PSU banking space. With valuation having run up we rate the stock a MARKETPERFORMER on the stock with a target price of Rs 256. Key risks include a less than expected loan book expansion and a significant variation in spreads.



■ CIL’s sales volumes declined by 1% y-o-y to 830,000 mt in Q3FY12 due to erratic nature of the North East monsoons and widening spread (over last 18 months) between urea and complex fertilizers which impacted offtake of complex fertilizers. Despite increase in acreages for wheat and paddy during the current rabi season, agricultural productivity was impacted due to the erratic nature of North East monsoons. While urea price has remained constant during past 18 months, prices of decontrolled fertilizers have almost doubled impacting their offtake. Manufactured volume dropped sharply by 36% y-o-y and 39% q-o-q.

 Urea & DAP industry dispatches were down by 1.8% and 12% y-o-y, whereas MOP and complex fertiliser sales were up by 6.3% and 4.4% y-o-y. After a prolonged potash holiday, MOP availability started since early October, which coincided with substantial demand for MOP during Q3FY12.

 Overall, the non-subsidy business has shown substaintial growth, the contribution of which is ~30% to  EBIDTA. Organic fertiliser sales saw 40%-50% growth y-o-y and water
soluble fertilser sales have also gone up y-o-y, but the agrochemical division was under pressure due to adverse seasonal factors and ban on endosulfan by Supreme Court.

 CIL's acquisition of Gujarat based agrochemical company Sabero Organics would continue to strengthen its topline growth. Sabero has a wide portfolio of 8-9 products across various categories like insecticides, herbicides and fungicides. Strong synergy benefit is expected from this acquisition going forward.

 CIL has not yet consolidated Sabero’s financials (acquisition is effective Dec 17, 2011) and will start the same from Q4FY12 onwards. Sabero reported loss of Rs.21.5 cr for
Q3FY12 on sales of Rs.95.6 cr.

 CIL has charged Rs.35.5 cr (net of tax Rs.24.9 cr) related to non-compete fees of Sabero, which has in turn adversely impacted CIL’s bottomline.

 Revenue from Kakinada's new capacity is expected to start contribution from H2FY13. High fertiliser subsidy and fall in global P&K fertiliser prices could boost its consumption in coming quarters.

 CIL has received Gujarat Pollution Control Board's permission for enhancing the capacity utilisation to 75% of normal that could help it to improve the production. It is also putting up additional environment affluent treatment facilities, which could help it to ramp up the capacity usage. So over the next quarters, there could be an improvement q-o-q as far as Sabero production and sales volumes are concerned.

 Capacity additions and weak global demand to put pressure on international fertiliser prices. Further, the government is likely to consider a cut in subsidy rates for phosphatic fertilizers for FY13.

 In retail business, ~200 additional stores are in various stages of opening. Of this, 90 have been opened and the rest will start by March 2012, taking the total store count to 600.

 Coromandel SQM, a 50-50 joint venture between CIL and SQM of Chile, has commissioned its water-soluble specialty fertiliser plant at Kakinada. At present, the demand for water-soluble fertilizers in the country is 70,000 tonnes per annum. The plant now has a capacity of 15,000 tonne and will be doubled to 30,000 tonne with demand increasing. In the first two years, the JV would concentrate on the Indian market and later explore export possibilities. The use of these fertilizers could increase the yields substantially and require lesser labour, power and water. The JV firm will look to produce specific nutrient products for wheat and rice production and research on these lines is on. Blended products in will be launched in three to five months.

 The Board has approved interim dividend of 400% or Rs.4/share. Assuming a final dividend of Rs.3 and bonus debentures of Rs.15 per share, the stock currently offers an attractive dividend yield of 8%.

 The management is betting on farm mechanisation to provide a profitable new avenue for CIL in the coming years. In FY12 it is looking at 18,000-20,000 acre, mostly in AP (vs 8,000 acres in FY11). It buys equipment like harvesters, threshers & transplanters and employs a team of people to work on the farms and charges per acre. There is a huge potential for mechanisation. It also sees opportunity in providing extended services (developing nurseries, pre-plantation preparation to transplantation, basically, all other activities other than harvesting). The focus currently is on paddy and sugarcane with the project covering 8,000 acres and has plans to expand it to 20,000 acres in FY13E and ramp up about 4x-5x in subsequent years. CIL is pushing this through its retail centres in AP.

 Management indicated that subsidy levels for FY13 are likely to be revised downwards as global fertiliser prices have declined from their peaks and have now stabilized. DAP prices which were ruling at US$680/mt have declined to US$520-530/mt and are likely to stabilize around these levels. Consequently, government is likely to announce subsidy reduction for FY13 on decontrolled fertilizers. Global DAP capacity is also likely to witness addition in FY13 which would keep the supply of phospatic fertiliser intact. While Saudi
Arabian Mining Company (Ma'aden)’s plant is likely to create additional supply of 1.5-2mn mt, commissioning of TIFERT could also aid volumes.

 CIL is planning to invest over Rs.500 cr in the next couple of years to ramp up its production capacity to 4 mn tonnes from the present 3.25 mn tonnes. This includes Rs.116 cr greenfield 800-tonne per day single super phosphate plant to be set up in Punjab. It is also planning to pump in about Rs.350 cr more in the expansion of Kakinada plant that is already under way.

■ CIL’s 100% revenue comes from Indian farmers, monsoon performance could impart variability to its annual performance. However, given CIL’s cost leadership, strong balance
sheet and presence across agriculture value chain we believe it is well placed to limit the impact from this.
 Forex fluctuation in Rs/USD and Rs/Euro could impact its margins as it imports most of its raw materials.
 CIL derives a large portion of its revenue from fertilisers where it converts rock phosphate/phosphoric acid to DAP as well as other complex fertilisers. Given limited backward integration, its performance depends on global prices for these raw materials.
 With strong brand and market share in South India CIL plans to follow brand premium strategy in fertilisers. However, given the competition from imported fertilisers, CIL’s margins could get hit if importers start eating up into its market share.
 Prices and availability of key raw materials - rock phosphate, potash and phosphoric acid could be an issue.

Conclusion & Recommendation
CIL reported weak numbers in Q3FY12 on account of lower crop acreage and erratic monsoon in the domestic market, while global fertilisers prices are coming off. The company is witnessing a demand contraction in phosphate fertilizers on account of higher prices and de-stocking happening at the dealers/retailers level. Further, field crops like paddy/wheat are seeing higher demand contraction compared to cash crops.

CIL’s growth trajectory could be supported by expansion of phosphoric fertiliser capacity in Kakinada and addition of 200 retail stores. High fertiliser subsidy and fall in global P&K fertiliser prices would continue to boost its consumption in coming quarters. Also CIL's acquisition of 

Sabero Organics could continue to strengthen its topline growth. CIL’s increasing non-subsidy portfolio through speciality fertiliser, pesticide, farm mechanisation, retail and organic manure also could work well for future growth.

CIL is targeting farm mechanisation for paddy crops, which is a main crop in South Indian states. Given large opportunity and unorganised nature, it could emerge as one of the leaders in this segment. It is scaling up its organic manure business with its brand Godavari Gold and plans to reach a sale of 1 mn tons within the next 3-4 years (FY12 estimates stand at 250,000 tons). Given strategic nature of vendor relationships especially in phosphoric acid, CIL is well placed to benefit from movement in raw material prices.

In Q4FY12, CIL may have to bear loss on fertilizer inventory as a result of falling global prices and recent Rupee depreciation and account for losses at Sabero Organics. It also faces the threat of lower subsidy by Government of India in FY13.