Tuesday, July 3, 2012

>PHARMACEUTICALS: US Supreme Court upheld healthcare reform; positive for Indian pharma

In a recent landmark judgement, the US Supreme Court passed the healthcare reform and ruled that government has constitutional right to ask all US citizens to buy health insurance or pay penalty. Indeed, this is a great development for the American insurance industry, but is beneficial for Indian pharma as well since it will add 26mn new policies. Apart from increase generic usage, interchangeability of biologics will allow Indian biosimilars to enjoy the same status as small molecule generics of offpatented drugs. We highlight that companies like Dr. Reddy’s and Biocon have made good progress in biosimilar programs, while Cadila and Lupin are also scaling up.

US Supreme Court upheld healthcare reform
The US Supreme Court recently passed the landmark ruling, dubbed ‘Obamacare’, thereby upholding the controversial massive reform of healthcare coverage initiated by the President Barack Obama. Obamacare or Patient Protection and Affordable Care Act (PPACA) requires most Americans to have health insurance and is effective from 2014. This legislation could, however, get derailed if Mr. Obama is not re‐elected or the Republican Party opposes it. The Supreme Court ruled that the most debated part, requiring all US citizens to buy health insurance or pay a penalty, was "constitutionally valid" as the Obama administration justified the penalty as a tax. It also ruled that the government has the power "lay and collect taxes."

Salient features of the US healthcare reform
The Act will come into force beginning 2014. All US citizens will have to buy insurance or pay penalty that will be anywhere between 1% of the income in 2014 to 2.5% of the income by 2016. Currently, there are 250mn Americans insured, and Obamacare will add 26mn policies to health insurance. The governments, both state and federal, on their part will be subsidising the plan. Federal health spending is expected to rise from 5.6% of GDP in 2011 to 9.5% of GDP in 2035.

Impact of reform on global pharma industry
For global pharma companies, increased demand of drugs due to greater number of insured consumers will largely offset higher fees and rebates associated with healthcare reform. Though costs related to healthcare reform will be upfront, the increased demand is unlikely to begin until 2014 (when the mandate goes into effect). The Healthcare Reform Law imposes an annual fee on any “covered entity engaged in the business of manufacturing or importing branded prescription drugs” beginning in 2011. Branded prescription drugs and biologics covered include: (i) Any prescription drug approved under section 505(b) of the FDA; and (ii) any biological product for which an application was submitted under section 351(a) of the Public Health Service Act. Sales of generic drug products will not affect calculation of annual fees.

Positive impact on Indian generic companies
While this development is great news for American insurance (as it will add 26mn new policies to health insurance), pharmaceutical and hospital companies, Indian pharmaceutical companies too will benefit. Nearly 75‐80% of all prescribed drugs sold in the US are generic drugs, an area where Indian companies are strong. To keep the cost of medical treatment low, insurance companies will prefer to use the generics route.

Moreover, Section 10609 of the Healthcare Reform Law is intended to increase access to lower‐cost generic drugs by preventing innovators from delaying approval of generic products by making label changes to the brand name or listed drug. Prior to the Law, the labeling of a generic drug was required to match the labeling of the referenced brand name or listed drug, or it wasn’t approved. This provision will enable faster approvals of generic drugs.

Interchangeable clause to pave biosimilar pathway in US
Biologics Price Competition and Innovation Act (BPCIA) authorizes FDA to create a new regulatory pathway for biosimilar biological products. This section recognises an abbreviated approval pathway for biological products that can be shown to be “biosimilar” to or “interchangeable” with an existing FDA‐licensed biological product. Innovator manufacturers of reference biological products are granted 12 years of exclusive use before biosimilars can be approved for marketing in the US. This sub section will allow Indian biosimilars to enjoy the same status as small molecule generics of off‐patent drugs made by pharma companies in India. We highlight that companies like Dr. Reddy’s and Biocon have made good progress in biosimilar programs, while Cadila and Lupin are also scaling up.


>HAVELLS INDIA LIMITED: New product launch to aid future growth…

We met the management of Havells India Ltd (HIL) to get an insight into the business model and future plans. Established in 1983, HIL is a leading Indian electrical manufacturer focused on products including switchgear, cables and wires, consumer durable, lighting and fixtures. Havells enjoys market dominance across a wide spectrum of products, including domestic & industrial switchgear, cables & wires, motors, fans, modular switches, home appliances, electric water heaters, CFL lamps and luminaries. The company has focused on developing strong distributor relationships and operates through over 5,000 dealers and more than 1,00,000 retailers across India. HIL further plans to add ~700-800 dealers per annum to increase its dealer base.

Strong segment performance
Havells is well positioned in the organised switchgear market with the segment comprising domestic switchgears mainly miniature circuit breakers (MCB), modular switchgear and LV industrial switchgear (market share of 28%, 15% and 6%, respectively). Standalone revenue from the switchgear segment has grown at a CAGR of 13% in the last five years. In the domestic cable segment, HIL manufactures underground cables and wires with a market share of 9% with the segment’s revenues growing at a CAGR of 15% in the last five years. Under the lighting and fixtures segment, the company operates in the energy saving lamps (CFL) and luminaries markets (with market share of 11%). Revenues from this segment grew at a CAGR of 18% in the last five years.

Focus to expand consumer durables segment
In the fan industry, HIL has significantly increased its market share by gaining over 14% with revenue CAGR of 24% in the last five years. Consumer durable division sales were supported by new appliances launched during the year with growth in water heater sales. Havells’ advertisement expenses have increased at a CAGR of 16% during FY10- 12 mainly due to the creation of strong brands in the consumer durables segment. Further, HIL is expected to keep promotion & advertisement expenses at ~2-3% of sales, going forward, to promote its new launches.

HIL has been one of the well known players in the Indian branded electrical product space. The company’s standalone revenue has grown at ~24% CAGR over the last three years, supported by strong performance by consumer durable and lighting & fixtures segments. In addition, improvement in Sylvania’s performance in FY12 (PAT growth of 46% YoY) & entry into new product categories in the consumer durables segment will support revenue and profitability growth, going forward.

To read report in detail: HIL

>Asbestos Cement Sheet

Asbestos Cement Sheet (ACS) is a building material in which asbestos fibres are used to reinforce thin rigid cement sheets. It is a very popular building material, largely due to its durability. The roofing industry is largely a commoditized business. While ACS started out as an industrial product, the increase in production and increase in the number of access points has made it into a retail product. With 4 dominant players in this oligopolistic industry, pricing is generally similar and there is limited brand premium. 80% of the sales come from rural markets with the balance 20% coming from the industrial and other segments (warehouses, poultry, urban slums etc).

The Key raw materials are Chrysotile (Asbestos Fibre), which constitutes 45% to 50% of the total raw material costs and is 100% imported, OPC (Ordinary Portland Cement), flyash and wood pulp. Overall, to make 100 kgs of fiber cement roofing sheet, 80 kgs of input are required (43 kg of cement, 8 kg of asbestos fibre, 28 kg of flyash and the balance is dry waste, pulp etc). The remaining is water weight gained during the manufacturing process. Raw material expense accounts for the largest operating expense in all companies (~60-70% of total operating expense). Freight is a large cost (also transporting over long distances could lead to breakages) hence location of the plant is key to cost competitiveness.

The ACS industry de-grew by ~5% in FY10, grew by ~3.5% in FY11 and grew further by ~7% in FY12. The industry is estimated to grow at ~6-9% for the next few years on account of increased income in rural areas coupled with various initiatives by the Government for affordable housing such as Indira Awas Yojna, Golden Jubilee Rural Housing Finance Scheme and Pradhan Mantri Adarsh Gram Yojana. Additionally, other schemes such as the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) guarantee employment to low-income individuals, which also helps generate demand for the roofing industry.

Over 50% of the Indian population still lives under thatched roofs (Kuccha roofing) and clay tiles. Thatched roof is not waterproof, and poses a fire hazard besides needing regular replacement. Tiled roof needs recurring maintenance and is also not safe. Hence with security concern coupled with rising income level leads to shift from kuccha house to pucca house.

ACSs are good insulators of heat and sound as compared to thatched, tiled or galvanized metal roofs. Additionally, ACSs are water resistant and fire resistant. ACSs are also relatively cheaper than galvanized metal roofs. ACSs require minimal maintenance and infrequent replacement unlike thatched and tiled roofs. Hence, whenever disposable income increases, switching to ACS roofs is the most obvious choice.

Currently there are 20 entities in the Industry with about 68 manufacturing plants throughout the country. The products are marketed under their respective brand names mainly through dealers for the retail market and directly for projects and government departments. Traditionally most players are concentrated in the Southern markets due to easy access to raw materials such as cement and greater affordability and desire to move into pucca houses. However, in recent years, the market leaders have been expanding operations to other markets as they realize the vast untapped market in other regions and to benefit out of rising incomes in those regions. The leading players in the industry are Hyderabad Industries Ltd, Visaka Industries Ltd, Ramco Industries Ltd and Everest Industries Ltd. These players account for ~72% of the industry’s capacity.

To read report in detail: ACS


Diesel demand boosted by controlled lower prices
Diesel consumption for April-May’12 jumped 14% over full year FY12 (up 8.5% YoY). We believe that controlled prices are fuelling the strong demand for diesel led by dieselisation of cars and substitution of FO by diesel due to the continued substantial price advantage. 15% YoY decline in April-May’12 FO demand substantiates our point.

Petrol demand impacted by high prices
April-May’12 petrol demand declined 1% YoY as higher petrol prices impacted driving demand. The growth level is expected to remain low as long as petrol price remains high with huge difference in HSD selling price, a derived benefit of de-control. Petrol demand growth peaked in FY10 at 14% and post decontrol in June 2010, demand growth has slowed down to 5.6% in FY12, lowest in six years.

Diesel price hike seems to be the only solution
With gap between diesel and petrol prices further widened post petrol price hikes in May'12, diesel usage is expected to be further boosted, leading to increased u/r for the sector. We have built a diesel demand growth of 5% in FY13e, for estimating u/r at INR1,376bn, which may be increased by INR30bn if diesel demand growth remains ~10%.

SKO demand falling due to rationalisation of allocation
SKO demand fell 17% YoY in April-May’12 due to rationalisation of PDS Kerosene allocation to states, considering expansion of domestic LPG through release of new connections. LPG growth was moderate at 7.2% in April-May’12 due to availability constraint in the product adversely affecting consumption.

To read report in detail: INDIAN DIESEL CONSUMPTION

>CAIRN INDIA: Company's oil discount to Brent has been narrowing

Cairn continues to expand operations in Rajasthan, with production already at the original FDP (Field Development Plan) mandated level of ~175 kb/d. The management has guided to this growing to ~200 kb/d by end-FY13, with additions of ~15 kb/d from Bhagyam (from current ~25 kb/d) and start up of Aishwariya (10 kb/d) to add to the 150 kb/d being produced by Mangala. Major increases beyond that, however, are subject to further approvals coming through. Cairn is indicating that production can rise from existing fields itself to 240 kb/d (primarily via further increases from Bhagyam and Aishwariya fields). However, this increase has not been approved by either the management committee or via a revision in the FDP. We maintain our estimates of 210 kb/d as the peak production from these fields as of now. We will revisit this when clarity emerges on regulatory clearances over the next few quarters.

Significant reserves upside, monetisation subject to DGH
The ramp-up of volumes from 175 kb/d to 200 kb/d from the current proved reserves base (+EOR upside) of ~1000 mmboe is fairly well understood. But, the management has stated that the long-term guidance of ~300 kb/d production potential is subject to the proving up of ~530 mmboe risked exploration resources that it estimates on the rest of the block, in addition to the ~140 mmboe of risked resources on the Barmer Hill Formation. However, the catch here is that the rights to explore further on the block other than the current development area are facing some uncertainty at this point of time; Cairn has applied to the regulator to restart exploration and appraisal activity on the block. We believe while the prospectivity of the block and Cairn’s record of proving up resources is not in doubt, timelines on these to translate into production will likely take longer than what management expects. So we value these risked resources as an exploration option value and assume an EV/boe of ~US$7.5/boe for these in our SoTP valuations.

To read report in detail: CAIRN INDIA


>S MOBILITY: Inch deep - mile wide

Telecom Subscriber - Big Market
S Mobility is building its growth on a strong mobile subscriber base. The remarkable growth in the number of subscribers in India is due to (i) One of the lowest mobile tariffs globally (ii)Local mobile manufactures and cheap Chinese models. The company is planning to capture the data driven growth in mobile business emanating from the onset of the 3G and broadband technologies, hence increasing the application usage by the end customer resulting in a strong growth in Smartphone sales.

HotSpots in a Hot Market
S Mobility is one of the leading players in the Organized retail under the brand Spice Hotspot for selling mobile and laptops through its 887 stores (240 in Delhi). Organized retail contributes 13% to the overall retail market with ~2500 outlets across 15 players. The company, in-order to differentiate itself is moving away from accessories and phone sales towards application demos and customer experience.

Smartphone sales pick up
The company sold 3.8lakh smartphones in Q4FY12 as against 2.2lakh in Q3FY12 growing at 70% sequentially. As the ASP (Average Selling Price) of smartphones is much more than a normal phone it contributes better to the topline. However due to technical advancements and increasing competition the ASP for smartphones saw a sequential decline of -11%. In order to boost its smartphones sales, the company through its retail outlets is increasing application awareness among the customers. The overall smartphone market is expected to contribute 45% to the delta growth of the handsets in the next 3 years. The mobile subscriber base is expanding at 8mn users per month from the present 678mn, thus presenting a big opportunity in the smartphone sales market.

Balance Sheet
S Mobility has no debt and a cash of INR 702mn (FY11 B/S). 30% of its balance sheet is constituted by goodwill emanating out of a fully owned subsidiary "Hindustan Retail India Pvt. Ltd.". It has a healthy RoE of 14%, though the conversion of EBITDA into Operating Cash has been lower at 7% due to increase in working capital on the back of an expanding business.

VAS - significant growth potential
The company through its partnerships with various TSPs (Telecom Service Providers) is providing end customers VAS through Voice, IVR, SMS and applications etc. both locally (83%) and internationally (17%). Mobile VAS revenues are expected to grow at 31.6% CAGR over FY10-15E to INR 482mn.

Outlook & Valuation
S Mobility derives 90% of its revenue from Mobile devices and the rest from services. The data as a % of mobile revenues in India has been 15% which is much lower compared to 30% in China or UK, thus there is a huge market in the VAS business along with growth potential in Smartphone sales. The company is rightly positioned at the brink of this growth, but needs to bring its costs under control which has ballooned due to expansion across various businesses by the company. Once the company is able to identify its niche, it could give significant returns.

To read report in detail: S MOBILITY



Ambitious targets set

We (Prabhudas Lilladher) recently met with the management of BHEL to get an update on the latest developments in the company and its strategy, going forward. The key takeaways of the same are as follows:

􀂄 Betting on government projects: BHEL is targeting order inflow of ~14,000MW in the current year based on different projects under various stages of discussions, tender pipelines and upcoming bids. Most of the projects are from the States and the Centre. The company has not considered the recently cancelled tender by Rajasthan SEB (Suratgarh/Chabra) in the pipeline. It is looking to bid for the revised tender. We believe that the target is quite ambitious, given the impending coal shortage issue and no resolution in sight.

􀂄 Power to dominate the orderbook in current plan, Transportation to dominate industrial segment: BHEL believes that the power sector will continue to dominate the order book in the current plan. Out of the new business (Transmission, Water, Transport, Oil&Gas etc.), it is looking to scale up the industrial segment transportation which could be the largest pie (~50% of the segment) over the next five years. The company is also exploring opportunities in the metro railway, given the huge likely thrust on metro in various cities over the next few years. It is expanding its capacity for railway locomotives from 50/annum to 75/annum. It is expecting order of ~100-125 loco from railways in the near term. It has seen no movement in awarding of locomotive plant to be built in Bihar/West Bengal. BHEL has requested the government to consider awarding at least one of the plants on nomination basis.

􀂄 Other Highlights: Out of the current order book of 62,000MW (55,000MW power, 4,000MW industrial and 3,000MW international), there are no slow moving orders. BHEL plans to add 11,000 employees in the XI plan period (will periodically scale down if needed) against 20,000 employees added in the XI plan.

􀂄 Outlook and Valuation: The stock is trading at 9.4X FY14E earnings. Though the stock is trading at multi-year low valuation, depleting order book, weak pipeline of orders, risk to execution from few private orders in order book, risk to margin due to continued pricing pressure and lack of meaningful progress on new initiatives continue to make outlook uncertain. We maintain our negative stance on BHEL.

>STRATEGY: At the limits of realism

Global Economy: Synchronised downturn

  • US, Europe, China & Asia are facing an economic downturn, with Europe being the worst hit. However, latest steps initiated in the EU Summit have reduced the financial risks in the near term.
  • It is a mixed blessing for India: Growth & INR to be adversely impacted, but fall in commodities & oil a big positive

Indian Economy: Growth to remain sub-par in coming quarters
  • Lingering policy paralysis, weak external environment and high interest rates to impede economic activity in the coming quarters. We expect below-trend growth of 6.4% in FY13E
  • However, few positives emerging—BoP stress likely to ease, RBI likely to turn more growth supportive and undervalued INR to support economy

Corporate earnings: To stabilise/improve as businesses shift focus from growth to profitability
  • In a slow growth environment, businesses undertake cost rationalisation (through deleveraging, cutting SG&A and employee costs etc). This helps stabilise/expand PBT margins even as sales continue to slow. History offers ample evidence of the same
  • Accordingly, while there will be some further downgrades in FY13 Sensex earnings of INR1,280, as per our bear case estimate we do not foresee earnings falling below INR 1,220. Hence, assuming a below-average multiple of 13x, Sensex downside is protected at ~16000.

Sectors to play
Given weak macros we favour a bottom-up approach. For next couple of quarters, we play interest rate cycle theme, moving real estate to OW, and retaining OW on autos. Further, given demanding valuations of consumer sector, we are downgrading it to EW from OW. Meanwhile, telecom is upgraded to OW, while IT continues to be OW

Model portfolio: Outperformed Nifty by 100bps in CY12 YTD. Since CY09, outperformance has been ~630bps

To read report in detail: STRATEGY