Thursday, June 28, 2012

>FACEBOOK INC: Initiating With Neutral & $35 PT – Easy To “Like,” Hard To Love

Significant Long-Term Potential Offset By Medium-Term Risk — Facebook has established itself as an Internet Utility. It could become the largest ‘Net Platform one day in terms of Revenue & Profits, given the size & engagement of its user base and its biz model. But with a 50X 2013 P/E, much of this potential has been priced in. Further, FB appears to have hit a Fundamentals Air Pocket, given its decelerating MAU growth (27% in ’12 vs. 48% in ’11 -- law of large numbers) and its softening ARPU growth (2% in ’12 vs. 27% in ’11 – economy, unmonetized Mobile channels, and correctly conservative Monetization strategy). Super-high multiples & Deceling growth don’t mix well. Add a limited visibility Biz Model & an unproven Team and you have a Neutral.

Biggest Investment Positives Are… — 1. Substantial Market Opportunities – incl. a Global Internet Ad market that should reach $130B by 2015; 2. An Almost Unassailable Position As THE Social Networking Leader – 900MM+ MAUs & 525MM+ DAUs; 3. Significant Network Effects advantages – probably greater than any ‘Net company; 4. Major Monetization Potential – currently generating less than $5 in annual Revenue per MAU; & 5. Platform/Option Potential – with a massive, highly engaged user base, FB has the potential to layer in more Revenue streams over time…Ad Network, Transactions/Subscriptions revenue share, Digital Media sales, etc…

Biggest Investment Risks Are…— 1. Dual-Class Stock Structure – with questions about mngmt’s views towards public shareholders; 2. Limited Appeal To Advertisers Today – based in part on our 800-person Ad Age Citi Panel survey; 3. Unclear Mobile Monetization – 30%+ of total usage today may not generate meaningful Revenue for a long time; 4. Zero Presence In Largest ‘Net Market – China; and 5. Lockup Expiration/Stock Supply Risk – which has materially impacted every other ‘Net IPO.

Deriving Our $35 PT – We use a combination of P/E (40X our 2014 EPS of $0.85), EV/EBITDA (15X our 2014 EBITDA of $5.0B), and DCF. These are Premium Multiples, but we view the company’s growth rate (30% EPS CAGR thru 2015) and Option Potential as supporting them.

What Would Make Us… -- Bullish? A material correction vs. our PT, clear signs of Mobile Monetization, evidence that Advertisers are aggressively engaging with FB, and the development of new Revenue streams. Bearish? Material appreciation above our PT, clear signs of FB user fatigue, lack of monetization improvements.

To read report in detail: FACEBOOK INC

>GRAPHITE INDIA LIMITED: Durgapur expansion is expected to be on-stream

Strong operations with niche capabilities
We interacted with the management (Mr. S. Chaudhary, SVP, Corporate) of Graphite India Ltd (GIL) to get recent updates on the business and market for graphite electrodes globally. Key takeaways are as follows:-
Graphite electrodes and carbon division remains the key segment for GIL and contributed ~85% of revenues in FY12. This is expected to see more than 10% growth in FY13E and account for ~90% of revenues in FY13E on account of increase in graphite electrode sales. Steel, impervious graphite equipment and other divisions accounted for the remaining 15% of revenues in FY12.

The company expects graphite electrode volumes to grow by more than 10% YoY in FY13E on the back of expansion in capacity by 20000 tonne at its Durgapur plant. Durgapur expansion is expected to be on-stream in H2FY13E and contribute ~5000 tonne in FY13E. On the existing 60000 tonne capacity in India, the company expects ~100% capacity utilization in FY13E.

GIL is catering to the European market solely from its subsidiary in Germany (Cap: 18000 tonne) and expects lower capacity utilization in FY13E due to slowdown in demand. Capacity utilization in the German subsidiary stood at 70% in FY12.  Graphite electrode prices for FY13E are expected to be higher by ~10% YoY based on bookings done for H1FY13E. New order bookings for H2FY13E have slowed down but prices have not come down and only stagnated at higher levels than FY12.  The company has built up significant inventories of key raw material Needle Coke during the last two years and has also tied up for its FY13E requirements with global suppliers at new contract prices, which have been settled at ~20% higher YoY. GIL expects to benefit in cost from earlier low cost inventories of needle coke.

Power is procured by GIL from state SEBs and power purchase cost at Durgapur plant i0s ~Rs4.2/unit and at Nasik plant above Rs6/unit.

Gross debt at Rs6bn is expected to remain stable in FY13E and come down in FY14E. Cash balance is strong at ~Rs2.6bn. Average cost of debt is ~6% due to low interest ECB debt of US$30mn (LIBOR + 2.1%), debt for German subsidiary of ~Rs1bn at ~4% and working capital debt in the form of PCFC (packing credit in foreign currency) at ~3%. Total working capital debt stands at ~Rs2.8bn and Yield on cash balance is ~9%.

GIL has no further expansions planned after commissioning 20000 tonne capacity at Durgapur and is expected to incur only maintenance capex of ~Rs200mn going ahead.

Overall, the company is guiding towards maintaining FY12 operating margins and revenue and expects profit growth to continue in FY13E on the back of higher sales volumes of graphite electrodes.

Updates on Graphite Electrode Industry by GIL

  • EAF production share in China’s overall production is increasing steadily due to higher availability of scrap and this is expected to make up for the shortfall in EAF production from developed markets (particularly Europe).
  • Demand from Middle-East, Asia and domestic market remains robust due to increasing EAF production share.
  • No new capacity in graphite electrodes is slated to be on-stream in the next few years. Only a relocation of existing capacity by SGL to Malaysia is expected going ahead.
  • Chinese graphite electrode producers don’t have the technology to produce UHP grade electrodes and are present only in the outdated HP electrodes.
Valuations - At the CMP of Rs88, the stock is trading at 8.1x FY12E cons. EPS of Rs10.9.
Dividend for FY12 stood at Rs3.5/share (yield of ~4% and ~30% of PAT). We currently
don’t have a rating on the stock.


>Cement companies penalized by CCI on cartelization (CENTRUM)

The Competition Commission of India (CCI), on June 20, 2012, came out with its verdict on alleged cartelization by cement manufacturers and imposed hefty penalties on 10 cement manufacturing companies (ACC, Ambuja, Ultra Tech, JP Associates, India Cements, JK Cement, Century Textiles, Madras

Cements, Binani Cement and Lafarge India) for violation of Section 3 and 4 of the Competition Act 2002. The casewas referred to CCI by Builders’ Association of India on July 26, 2010.We had earlier stated in our reports that the investigation carried on by CCI imposes a regulatory risk to the sector and there were chances of CCI imposing penalty on the cement companies. The quantum of penalty levied by CCI varies between Rs11.4bn – Rs13.2bn for large players and Rs1.6bn- Rs4.8bn for mid-sized players. Though, as per Competition Act, the companies are required to deposit this penalty within 90 days of the ruling, they may appeal against this order in the Competition Appellate Tribunal (within a period of 60 days from the
receipt of the order) and get a stay order if the Tribunal decides.

We believe that the market had recently turned down the chances of imposition of penalties on the cement manufacturers as the judgment was long awaited and it was believed that it is difficult to prove cartelization in the case of cement companies due to involvement of large number of players here.

Cement stocks rallied between 10-15% in last two weeks against a 2% rally in broader indices on the expectation that the penalty by CCI will be amuted one. Apart from the penalties, we believe that pricing power of the cement companies could be at risk going forward as the utilization rate is expected to be lower in the next two years and at the same time, rising cost pressures could put earnings at risk. We expect the premium valuation of large players under our coverage to come down due to possible regulatory risks on the sector and maintain Sell rating on ACC, Ambuja and Ultra Tech. We have a Hold rating on Grasim Industries. We have a Buy rating on the mid-sized players under our coverage (India Cements, JK Cement, Orient paper & industries and Shree Cement) considering attractive valuations. However,we expect India Cements andJKCement to be underpressure for some time post this adverse ruling.

The findings of the Director General of CCI are summarized below:
 Top 12 companies ACC, Ambuja Cement, Ultra Tech, Jaypee Cement, India Cements, Shree Cement, Madras Cement, Century Cement, JK Cements, JK Lakshmi Cement, Binani Cement and Lafarge India Pvt Ltd control ~75% market share of cement in India. Therefore the focus of investigation was primarily on the top companies to investigate whether cementmanufacturers are engaged in anti-competitive practices.

 There has been a continuous divergence between the cement price index and the index price of various inputs like coal, electricity and crude petroleum and the gap has widened since 2000-01. The price of cement is rising faster than input prices.

 The price of cement has risen to Rs300/bag in March 2011 against Rs150/bag in 2004-05 whereas, during the same period, the cost of sales has increased by ~30%. It believes that the price of cement is independent of the cost of sales. The price of cement is changed frequently by all the companies, sometimes even twice
in a week.

 Even if the decision of price change is taken independently by different companies, the prices of competitors are monitored closely to respond to any price change made by them. The cost of production does not play an important role in the decision of pricing of cement except when there is substantial change in taxes or the cost of rawmaterial.
 The price is also affected by the price changes made by market leaders and the price of other players is regularly observed.

 Although, the companies claimed that the price is decided on market feedback, there was no formal or systematic mechanism or documentation system to substantiate the argument of reliance on market feedback for affecting price changes. The DG believed that the companies are having a centralized decision making system and the communications between dealers and the companies merely reflect the prices to be charged and not the reason or any data to show that there is more demand. The companies were also unable to explain how the demand ismeasured at a particular point of time.

 The DG also found that the coefficient of correlation of change in prices or the movement of prices of all the companies is positive and very close to each other (more than 0.5%) giving a strong indication of price parallelism. It believes that the price of the cement of different companies has moved in a particular direction in the entire country in a given period of time and hence, it believes that this price parallelism is indicative of price consulting among the companies.

 The examination of smaller players revealed that they simply follow the trend ofmajor players.

 According to DG, the cost of production varies from company to company; therefore, the price of individual companies must also vary. Therefore, it believes that the movement of price of all the companies in the same range and in the same direction is not possible unless there is prior consultation and discussion about the prices among them.

Our take and view on this judgment by CCI is as follows:

Hefty penalty imposed on 10 cement players: Cumulatively, the penalty imposed on the 10 cement players (ACC, Ambuja, Ultra Tech, JP Associates, India Cements, JK Cement, Century Textiles, Madras Cements, Binani Cement and Lafarge India) stand at Rs63bn and ranges between 3-8% of current market cap for large players and 7-13% of current market cap for mid-sized players. Amongst the large players the highest penalty of Rs13.2bn (8.3% of current market cap) has been imposed on JP Associates and amongst mid-sized players JK Cement has been hit the most with a penalty of Rs1.3bn (12.5% of current market cap). Apart from the 10 cement players, CCI has also levied a penalty of Rs73mn (10% of total receipts for 2 years) on Cement Manufacturers Association citing that it has facilitated cartelization by providing platform to cement companies.

Cement companies penalized on the basis of their profits and not on the turnover: CCI has calculated the penalty at 0.5x the net profit for FY10 (from May 20, 2009 as the enforcement provisions of the Act came into effect from this date) and FY11. In earlier instances (DLF, gas cylinder makers and aluminium phosphide tablet manufacturers), the commission had levied penalty based on the average turnover of last three years’ and on this basis the penalty on cement manufacturers would have been much lesser than the currently imposed penalties.

Earnings could get impacted by 49-91% for coverage companies: The penalty imposed by CCI ranges between 49-91% of the profit for FY13E. Amongst bigger players under our coverage, the penalty imposed on ACC is 91% of its CY12 earnings. For JK Cement, the penalty is 63% of its FY13E earnings and for India Cements it stands at 49% of FY13E earnings. Amongst uncovered companies, Century Textiles has been affected the most and based on Bloomberg consensus’ estimates the penalty imposed is at 157% of its FY13E earnings, whereas, for JP Associates, the same is at 106%.

Ruling likely to be challenged in Competition Appellate Tribunal (CAT): We believe that the ruling of CCI will be challenged in CAT considering historical evidences of other sectors. The companies may also move to the Supreme Court of India after an adverse judgment from CAT. As per the Competition Act, the companies may appeal against the CCI order in CAT within 60 days of receiving the order. Also, if the companies get a stay order fromthe CAT, they will not have to shell out the penalty immediately, which we believe is the most likely scenario. For instance, DLF got a stay order from CAT in November 2011 for the penalty imposed by CCI in August 2011 and the hearing in CAT is still going on.

Pricing power of the companies could be at risk going forward: We believe that post this ruling, the pricing power of the cement companies could be at risk considering further regulatory issues and chances of CCI coming in action again in future at a time when the utilization rate of the industry is low and cost pressures are rising. It could also be difficult for the cement manufacturers to pass on the rise in input costs (expected increase in coal prices and freight costs in the near future) to consumers.

Regulatory risk and future investigation fromCCI prevail: The ruing of CCI also points out to a “cease and desist” order to the companies and directs them that they should not involve in any activity related to agreement, understanding or arrangement on prices, production and supply of cement in the market. Though, the order does not warn the companies for a greater penalty in future, one of the senior members of CCI stated on the news channel (CNBC) that if the committee feels that the companies are forming cartel in future, theymay investigate again and impose heftier penalty on the companies (as per the Competition Act, CCI may impose penalty up to 3x of annual profits made out of cartel arrangement). The state government
may also put pressure on the cement manufacturers to cut the prices (for instance, Himachal Pradesh government asked cement companies to bring down the prices by Rs25/bag in January 2012) post this order.

Maintain Sell on large players, valuation premium may erode: We maintain our Sell rating on large players under our coverage (ACC, Ambuja and Ultra Tech) considering rich valuations. The large three companies (ACC, Ambuja and Ultra Tech) are enjoying premium multiple (8-10x) to their historical valuations (7-8x) despite concerns on the earnings and deterioration in return ratios. We believe that further regulatory risks could erode the premium assigned to these companies and can dampen the investors’ sentiments. We have a Hold rating on Grasim Industries. We have a Buy rating on the mid-sized players under our coverage (India Cements, JK Cement, Orient paper & industries and Shree Cement) considering attractive valuations. However, we expect India Cements and JK Cement to be under pressure for sometimes post this adverse ruling.



To read report in detail: BANKING INDUSTRY


>STAN C – IDR (Eyeing Fungibility: Few thoughts)

STAN C issued IDR (first of its kind) in June 2010 with a 100% fungibility post one year (IDR used to trade at an average discount of 5% to its PLC). After one year, SEBI introduced a clause that fungibility will be permitted only if IDRs are infrequently traded. Consequently, IDR hit a lower circuit of 20% and spread widened to a discount of 60% in the next four months.

In the recently concluded budget, finance minister made a fresh announcement that IDRs will become fungible subject to a ceiling. STAN C IDR hit upper circuit of 20% and the discount narrowed down to 25%.

Current status
FM has asked SEBI to draft the guidelines for fungibility and further SEBI is taking feedback from the industry. SEBI conducted a meeting with IDR holders, custodians, regulators and market experts to take view on the same. Broadly, the feedback was towards giving 100% fungibility.

Regulators need to create a good example out of STANC IDR that will encourage other foreign companies to issue fresh IDRs. There is likelihood of Vodafone, HSBC, and Citi taking the IDR route to tap Indian markets. The market is awaiting the comment/circular from SEBI on IDR fungibility guidelines. An outcome is expected within a month or two.

What will cheer the market?
In the light of FM announcing a two-way fungibility for IDR, we expect SEBI to draft guidelines in favour of IDR holders. The optimal structure would be allowing 100% fungibility, which will narrow the spread and may result in no need for conversion by holders. This will aid retention of equity on domestic bourses and narrow discount. Currently, insurance companies are not allowed to participate in IDR. If allowed, participants will increase in the IDR market.

What will disappoint the market?
Options like partial convertibility# or limit conversion should not be implemented, since it will neither do any good to investors or to foreign companies who wish to tap Indian market via IDRs. Instead, it will strain the counter as conversion will be at the maximum level (majority of the holders will opt for conversion).

Recommendation: ACCUMULATE
Current discount of STAN IDR to PLC is ~40% and, as mentioned above, we believe SEBI guidelines will be drafted in favour of fungibility. We recommend accumulating the stock at current market price.

Risk stems from the fact that if the partial fungibility clause is emphasized, then the current discount may expand or will persist.

To read report in detail: IDR


 The L&T stock has outperformed the market since our previous update (BUY at Rs.1160 ). As compared to gain of 3.9% for the Sensex, the L&T stock has gained 18% in the same period.

 Stock performance would be contingent on news-flow on large order wins, commodity price trends and general economic and policy data points (interest rate cuts and mining and power sector reforms), we
opine. We note that the picture has been mixed so far with the company winning few large orders but on the policy and interest rate front, there has been disappointment.

 In view of the stock upmove, we revise rating to REDUCE. Economic growth has continued to weaken and absence of appropriate policy response is affecting investment sentiment in the infrastructure sector.

Business outlook
Project investment scenario continues remains lackluster in May During May 2012, fresh project investment was down by 42% compared to the investment intentions announced in April 2012. A total of 606 start-ups were announced during the month with a cumulative investment of Rs377.5 bn while in April 2012, there were 665 new start-ups worth Rs 534 bn. Fall in the investment during the month can be attributed to absence of Mega projects and a decline in private sector capex. Fresh project expenditure in FY12 dropped by 40% over FY11.

Material uptick in outlook is awaited. Roads being an exception Roads
Recently Prime Minister had reviewed the targets for key infrastructure segment such as road. Target for road sector awards has been enhanced to 9500 km for fiscal 2013 from an earlier target of 8800 km spread across 7300 km from NHAI and 1500 km from state agencies. During FY12, NHAI awarded 7957 km of road projects comprising of 6491 km from NHAI and 1466 km from state agencies. Expected order inflow from state agencies is likely to remain same during FY13. This coupled with enhanced target for road sector awards from NHAI is likely to open up huge opportunities for companies having expertise in road BOT segment.

Nuclear Power
Newspaper reports indicate that the Jaitapur Nuclear Power Project may be implemented after ensuring all necessary safeguard measures. This project consists of six units of 1650 MW unit size and is jointly developed with Areva of France, NPCIL and L&T. The company has not taken this order possibility in its guidance.

The ordering activity in the sector remains morose with few projects coming up for tendering. Recently, RRUVNL has invited bids for 2x660 MW supercritical technology based thermal power project at Chhabra. This project had been tendered earlier in 2010 in which BHEL had emerged as the L1 bidder. However, after delays of several months, the project was scrapped and now re-tendering has been initiated. L&T had not participated in the earlier round as the contractual terms were not remunerative. It remains to be seen if L&T participates in the second round of tendering.

A consortium of L&T, Tata Power and HCL have emerged as one of the two contenders for Rs.100 bn tactical communication system order for the Indian defence industry.

Recent order wins boosted by a large road project bagged by the company's infrastructure development subsidiary.
As has been the trend in previous quarters, most order announcements in the first quarter have been from the Roads and Building and Construction segment. Majorly among them, L&T IDPL emerged as the successful project bidder to develop two contiguous road projects of length 484 km 4 lane road at a cost of approximately Rs 48 bn. The construction period of the two projects is 30 months. There are reports that the L&T plans to raise upto $400-500 mn in its subsidiary L&T, IDPL.

New investments remain largely unutilized
 The forgings facility has received a setback following diminishing interest among countries to set up Nuclear Power Plants. The company now plans to offer its forgings for the Hydrocarbon, Power and Shipping business.

 On the Shipyard front, the company has not had major order win due to poor outlook for the shipping sector. The company expects to win couple of Submarine/Defence vessel orders in FY13. There are unconfirmed reports about Mitsubishi Heavy Industries taking a part stake in the shipyard venture.

Order intake guidance of 15% order intake in FY13
 Order inflows for Q4FY12 came in at Rs 212 bn, down 30% yoy. For FY12, order intake was lower by 11% to Rs 706 bn. The company cited continued deferrals in projects as the prime reason for sluggish order intake.
 The company gave a guidance of 15% growth in order intake in FY13. While conceding that estimating order wins is an inherently tricky business in India, the management indicated that guidance is based on the premise that large-scale project deferrals do not continue in FY13.
 The company is counting on couple of large projects of the size of Rs 120-150 bn, which got spilled over from FY12. Apart from this, hydrocarbons segment is also vibrant in the domestic and international market. The company also expects to win couple of Supercritical power project orders in the current fiscal.
 The company is targeting a higher pie of the hydrocarbon business from new geographies
in the Middle East especially Saudi Arabia.

Stock outlook
 The L&T stock has outperformed the market since our previous update (BUY at Rs.1160). As compared to gain of 3.9% for the Sensex, the L&T stock has gained 18% in the same period.
 Stock performance would be contingent on newsflow on large order wins, commodity price trends and general economic and policy datapoints (interest rate cuts and mining and power sector reforms), we opine. We note that the picture has been mixed so far with the company winning few large orders but on the policy and interest rate front, there has been disappointment.
 We maintain our FY13 profit estimates and target price. In view of stock outperformance, we downgrade the stock to REDUCE.
 It is possible that in the near-term the shipyard and forgings business may report losses on account of low volume of project work.


>THE PAPER PRODUCTS LIMITED: Owned by Finland based Huhtamaki Oyj group

 Stable business model and margin profile lends consistency in cash flow and good earnings visibility: PPL packaging products enjoys consistent demand on account of strong underlying demand from the FMCG business, with a decent average volume growth (8-10% YoY). The company operates on a cost plus margin business model and hence has a stable margin profile with an EBITDA margin in the range of 9-11% (avg of last 4 yrs - 10.2%). We expect PPL’s net sales, EBITDA and Adj PAT to grow at a CAGR of 13.3%, 13.8% and 11.7% over CY11-CY13E respectively. We expect the company to generate OCF of `1446 mn and FCF of `564 mn during the CY11-CY13E period.

 Tremendous growth opportunity due to a hugely under-penetrated packaging market and multiple growth drivers in end user industry: The flexible packaging market (20% of the overall packaging market) is valued at $3.5 bn, with only 35%-40% of it being organised. With an expanding middle class population, rising incomes and growth in organised retailing, FMCG and Pharmaceuticals are expected to post robust volume growth leading to a corresponding strong growth in flexible-packaging. Lower packaging penetration (per capita consumption of consumer packaging in India at $2.5 against that of $51.6 in US) will also lead to a huge structural shift from unpacked to packaged products over the next decade (currently only 15-20% of the total goods consumed in India are in packaged form). We expect flexible packaging growth at 1.2x – 1.4x the volume growth of the underlying demand.

 Strong promoter group and solid management team helps to bring in best practices, attract marquee clients, adapt newer technologies and processes based on shift in consumer trends: PPL is owned by Finland based Huhtamaki Oyj group, which is one of the top 10 consumer packaging companies in the world and has operations spread across 31 countries. The promoter group brings in best practices in terms of technology expertise, operating efficiencies and corporate governance. Moreover, Mr Suresh Gupta, MD of PPL, also heads the global flexible packaging business of Huhtamaki, which is strategically a big positive. The sales geography is increasing for PPL with exports picking up in New Zealand, Australia and South America.

 Debt-free status, high dividend yield, and reasonably good return ratios: The company has strong dividend payout policy of ~35% leading to a very good yield of ~4-5%. In addition, the company has reasonable return ratios, with expected RoAE of 16.2% and 16.4% and RoACE of 20.2% and 20.6% in CY12E and CY13E respectively.

Valuations and Outlook: At the CMP of `65.3/share, PPL is valued at a P/E of 7.3x and 6.5x CY12E and CY13E respectively. PPL is a quality MNC and a niche play on the packaging front, with consistent earning growth and a healthy B/S and OCF. Given the strong business and financial profile, strong growth prospects and that rare thing in our equity markets -- good corporate governance -- at the CMP, PPL, valued at a P/BV of 1.0x CY13E, is an attractive opportunity. We initiate coverage on the company with BUY rating and Jun13 target of `95.0/share (based on P/E multiple of 9.0x CY13E earning).

To read report in detail: THE PAPER PRODUCTS

>Pantaloon Retail (India) Ltd

PRICE TARGET....................................................................................................Unchanged
EPS (FY12E)........................................................................................................Unchanged
EPS (FY13E)........................................................................................................Unchanged
RATING........................................................................................Changed from Hold to Sell

Mission “debt reduction” continues!

We met the management of Pantaloon Retail Ltd (PRIL) to get an insight into the impact of the series of announcements focusing on debt reduction and also to understand the company’s strategy, going forward. While the Street was expecting the stake sale in Future Capital, the news on the stake sale in the flagship ‘Pantaloon’ format came as a surprise. Debt reduction continues to remain the key focus at the helm. However, the management is disheartened (yet not losing hope) about the subdued consumer sentiment. Some of the key triggers for the Indian retail sector remain – rolling out of goods & services tax (GST) and opening up of the multi-brand retail sector to foreign direct investment (FDI).

Addressing the mountain of debt
PRIL was facing the double trouble of inventory pile-up and rising debt levels. The management, being consciously aware of this, had clearly stated their intent of addressing these concerns. The company started to make announcements one after the other from early May 2012. Going by what has been announced, we expect PRIL’s debt to remain in the range
of | 3,400 – 3,600 crore (excluding the insurance stake sale). Cautious on space addition plans; could be revised on demand revival PRIL has, in the recent past, lowered its space addition guidance from 2.0-2.5 million sq ft to 1.5 million sq ft considering the slowdown in demand and abysmally low same store sales growth. This step is also being taken to curtail the piling inventory. However, the management has also guided that this target could be revised upwards in case there is a turnaround in consumer sentiment.

The stock has witnessed a significant up move on the back of the series of news announcements relating to debt reduction. However, we are maintaining our target price and will the revise the same (if necessary) after monitoring the performance of the company, going forward. A revival in demand and improvement of consumer sentiment will also warrant an upwards earnings revision. We have valued PRIL at 0.6x FY13E EV/sales (based on 20% discount to Shoppers Stop) to arrive at a target price of | 148. Any investors holding the stock can book profits at current levels and consider re-entering the stock on any fall.

>Granules India Ltd.

Trebling of Finished dosage capacity from 6 bn to 18 bn doses will boost top line
Granules has added two new lines at the existing Gagillapur factory which will treble its finished dosage capacity from 6 bn doses to 18 bn doses in June’2012. Company expects production from Q2FY13 which will increase top line substantially going forward. Finished dosage division contributed `90 mn in FY09 to the company’s top line. This share has increased from 3.5% in FY09 to 25% in FY11 and now it stands at 33% (`185 mn) in FY12. With the newer capacities coming on stream we expect the share from this division to increase to more than 50% of the total revenues in next couple of years. Company has also received two abbreviated new drug applications (ANDA) approval which will help them to participate in the US formulation market.

Entered CRAMs business by forming JV with Ajinomoto OmniChem
Granules India entered the CRAMs business by forming a 50:50 JV with Ajinomoto OmniChem in July’2011.Company also set up a greenfield facility in the Pharmacity SEZ, Vishakhapatnam in November 2011 for this new initiative and commercial production commenced from Q4FY12. This will help company to enter new therapeutic sectors like cardiovascular, central nervous system and oncology. This new entity will boost company’s profitability in the coming years by delivering value through unique contract manufacturing platform by leveraging granules technological capabilities and efficient processes and OmniChem’s extensive product portfolio and existing customers.

Operational Excellence projects has enabled company to increase API capacities
Granules has completed operational excellence projects in last one year which has enabled them to increase the API capacities. Through this company has increased its Metformin API capacity by 35% and Guaifenesin API capacity by 55%. API division contributes 32% to its total revenues in FY12. These expanded capacities will boost company’s profitability going forward. Company has grown two times to that of the industry growth in last 5 years Granules India has grown its top line at a CAGR of 28% which is two times the industry growth rate of 14% in last five years. In FY12, company’s top line grew 38% to `6.53 bn. With new capacities coming on stream and a favorable product mix, top line will further accelerate in the years to come.

Granules India is trading at a PE multiple of 7.5x its FY12 EPS of `14.87. On price to Book value, company is trading at 0.9x its FY12 book value of `122 per share. Company looks fairly attractive at this level due to 1. Strong growth in top line due to capacity expansion in various divisions, 2. Entry into CRAMs business will help company to enter therapeutic sectors like cardiovascular, central nervous system and oncology. We recommend a BUY rating on the stock with a target price of `133 which is 9x it FY12 EPS. The key risks for the company are 1.significantly lower capacity utilization in each of the divisions will impact company’s profitability and 2. Company has grown more than double the industry growth rate in last five years, any slowdown in the growth rate will re-rate the valuation multiple.


>“Sesa Goa – Sterlite” Merger

Shareholder approval received – Major milestone

  • Vedanta Resources Plc, Sesa Goa and Sterlite Industries shareholders give approval in their EGMs to the organization restructuring plan
  • Sterlite to merge with Sesa Goa (5:3 ratio); Vedanta Aluminium (VAL) and Malco to come into fold fully; Cairn India also to be its subsidiary
  • Sesa’s outstanding shares to increase from 869mn to 2964mn. Value “Sesa-Sterlite” on SOTP basis giving a fair value Rs 207 per share and Mkt Cap of Rs 614bn
  • At CMP of Sterlite (Rs 99) and Sesa Goa (Rs 187), the swap ratio valuation continues to be in favour of Sterlite shareholders by about 12%.

Major Milestone achieved
Vedanta during Feb 2012 initiated restructuring across its subsidiaries involving merger of Sterlite Industries into Sesa Goa in a 5:3 swap ratio. It also involved transfer of Vedanta’s 70.5% stake in VAL, 38.8% stake in Cairn India, 94.8% stake in Malco to new entity “Sesa-Sterlite” along with the associated debt of US5.9bn. The company received approvals from BSE, NSE and Competition Commission of India during April 2012. As mandated by law it was to get the Shareholders approval (at least 75%) through respective EGMs. The proposal received approval from 99% of Vedanta shareholders, 89% of Sterlite Shareholders and 79% of Sesa Goa Shareholders. This paves the way for it getting the Foreign Investment Promotion Board (FIPB) approval and seeking court approvals.

“Sesa-Sterlite” global major in the offing
With all of Vedanta’s subsidiaries (except KCM - copper company based in Zambia) coming under the Sesa-Sterlite fold it would become a diversified major having interest in ferrous metals, non ferrous metals (copper, aluminium, zinc, lead, silver), power and oil space. Further all expansions undertaken by the group would now be through this entity. The net debt for the consolidated ‘Sesa Sterlite’ stands at Rs 369 bn. The organization restructuring would give comfort to the parent “Vedanta Resources Plc” by having the holding structure simplified and the debt being passed on to the Indian subsidiary. The company has been sharing that this exercise would also be giving them “synergy benefit” of Rs 10bn every year.

We have valued the new entity (Sesa Sterlite) on SOTP taking in to account FY14 numbers to arrive at a fair value of Rs 207 (which translates into a market cap of Rs 614 bn). This implies a fair value of Rs 124 for Sterlite. Our FY14 EPS estimate for ‘Sesa Sterlite’ stands at Rs 38. Based on the Sesa Sterlite swap ratio (3:5) at CMP of Rs 99 for Sterlite and Rs 187 for Sesa Goa, the valuation is in favour of Sterlite by 12%. We believe this difference should get bridged as further milestones are met and restructuring completed by end of CY 2012.

Global peers including BHP Billiton, Rio Tinto, Teck Resources are trading at ~8x 1 year forward earning and ~4.2x 1 year forward EV/ EBITDA. Considering the holding company
structure and operational constraints, we believe proposed ‘Sesa Sterlite’ to fetch a lower
valuation compared to its global peers.