>The rise of the aspirational Indian

In our 1st July note we highlighted that ‘aspirationals’ stocks have outperformed ‘essentials’ on both fundamental and stock price performance over the past decade. Today we highlight that in a high inflation environment in particular, ‘aspirationals’ deliver higher top and bottom line growth than ‘essentials’.

Aspirationals outperform essentials in all ‘GDP growth – inflation’ combinations barring ‘low GDP growth, low inflation’

An 11 year time-series analysis of the ‘aspirational’ vs ‘essential’ product companies’ financials yields the following results (see Table 1 below for a summary):

• In terms of EBIDTA growth, aspirationals outperform essentials under all four macro settings (see Fig 1 and 2 on the right side). In fact aspirational product companies’ EBIDTA expanded at a greater pace (YoY) than that of essentials in 31 of 43 quarters under study (see Fig 3 below).

• In terms of net sales expansion, aspirationals outperform essentials under all but one (low growth, low inflation) setting.

• In a high inflation environment in particular, ‘aspirationals’ deliver higher top and bottom-line growth than ‘essentials’ irrespective of the GDP growth environment.

To read the full report: MACRO OUTLOOK

>Indian Housing Finance companies: Ready for a takeoff once again

Given India’s rapid population growth, increasing urbanisation and rising affordability the housing finance market will continue growing. However, given increasing competition in the sector from banks, HFCs with access to low cost funds, better operational and credit cost control, and better service quality will find life easier. In a supportive macroeconomic environment and with competition from banks likely to reduce due to the new base rate regime, we initiate coverage on LIC Housing with a “Buy” stance.

Structural Growth Drivers in Place
An underpenetrated mortgage market (~Mortgage to GDP at 7% vs ~80% for USA and 12% for China), favourable demographics (60% of population <> years), increasing urbanisation and improving affordability will ensure that
demand for mortgage loans will continue to grow at a healthy pace (FY00-10 CAGR of 24%).

However the road ahead is not smooth
However, given the perpetual competition from banks, lower spreads, highly rate sensitive customers, HFCs need to exhibit the following key characteristics to compete successfully:

• Access to low cost funds and liquidity: Whilst the importance of low cost of funds has always been obvious, Sep-08 brought home the importance of having access to liquidity.

• Credit appraisal skills: This is particularly hard in India given the weakness of credit bureau data and difficulty in credit enforcement.

• Quality of customer service: This is the key differentiator in a commoditised market where banks are bound to have lower cost of funds.

• Cost efficient structure: Critical if an HFC is to competitively price its loans and still maintain profitability.

A growing and underpenetrated market
Against the backdrop of an economy growing at a 10 year CAGR of 7%, mortgage disbursements have risen at a CAGR of 24% over the last decade and the total mortgages outstanding have increased to ~Rs, 4,100 bn at Dec’09 (vs ~Rs. 1,200 bn five years ago). We see this trend continuing due a variety of reasons none of which are particularly contentious. At around 7%, the mortgage:GDP ratio in India is amongst the lowest in the world (see figure 2). A huge shortage of housing units (~25 mn), limited availability of housing finance, the limited reach of HFCs and Indians traditionally being averse to credit had been the major reasons behind low mortgage penetration in India. But this trend is changing, with more Indian households becoming more open to credit, increased availability of home financing and with increasing construction of affordable housing units.

Some socio-economic trends are also helping on this front:
• Increasing urbanization and nuclearisation: India is increasingly becoming an urbanized country (urban population is~31% of total population vs 28% a decade ago) with people migrating to the cities in search of employment. This is leading to higher demand for household units in urban areas where availability of housing finance is higher than in rural areas. Moreover from being a nation of joint families, India is increasingly becoming a nation of nuclear families (average family size has come down to ~5 vs 6 in 1981) leading to higher demand for housing units.

• Increasing affordability: Various surveys show that more Indian households are entering into higher income brackets leading to improving affordability despite increased in property prices. Whilst there is no independent data on long term affordability trends (CRISIL’s data dates back to FY02 – see Figure 3), the data provided by HDFC Ltd. shows that affordability has increased four-fold over last fifteen years as rise in salary levels have kept pace with the increase in property prices (see figure 4). Low interest rates and greater availability of housing finance has further improved the overall affordability factor.

To read the full report: INDIAN HOUSING FINANCE COMPANIES

>Indian consumer: Exorcising the ghost of the downturn (NOBLE)

The recent Q3FY10 results signalled an end to the urban consumer downturn with retailers reporting resurging confidence among consumers in the major metros even as food inflation becomes a worry for lower income households. These broad trends, coupled with the inherent operating leverage of retailers and the possibility of a price war in FMCG, lead us to prefer retailers over FMCG companies as a play on the “India consumption story.”

EMERGING TRENDS VISIBLE IN THE Q3FY10 RESULTS
The recently concluded Q3 results hinted at some significant developments as far as the Indian consumer is concerned. The main messages we take away from the results as well as the surrounding commentary are:

■ The Metro consumer is coming back: companies across the retail sector made bullish noises about the metro consumer, highlighting the recovery against the despondent performance in Q3 of FY09 and hinting at much more to come.

■ Semi-urban/rural demand has held up: the semi-urban and rural consumer has surprised on the upside with FMCG companies as well as small town retailers seeing momentum continuing despite the toughening comparables.

■ Inflation a worry: multiple companies have cited inflation as a worry for FY11. With food inflation running in the high teens, household budgets are being put under pressure, creating uncertainty around spending in other areas. This is a bigger worry for lower income consumers than for mainstream metro consumers.

LOOKING AHEAD: WINNERS AND LOSERS
The broad based nature of these trends has specific implications for the FMCG and Retail sectors:

■ FMCG – for whom the bell tolls: the continuing newsflow around FMCG has increased the conviction level of our Negative stance on the sector even further. We see significant risks for the sector arising from three main trends: food inflation running in the high teens which may dent consumer demand and pricing flexibility for FMCG companies; rising input costs (both raw materials and advertising) are pressuring the inordinately buoyant margins seen in H1FY10; and the price war in detergents may spread to other segments, dragging down margins across the sector. The punchy valuations that the midcap FMCG companies in particular trade at (24x FY11 PE for Colgate and Dabur), seems to be ignoring these risks.

■ Retail – the roller coaster turns: organised retail will benefit from the resurgence in urban demand on the back of three factors: concentration in metros alongside higher exposure to mid-high income segments; higher exposure to discretionary products; and high operating leverage. All these factors make retailers a levered play on the urban consumer recovery with momentum likely to gather in revenues as well as margins. Whilst valuations in the sector are high, we expect that upgrades to consensus numbers are likely to keep multiples elevated and drive share prices higher still. As such, stocks like Titan and Pantaloon are likely to perform well despite the punchy valuations. Overall, the two sectors seem to have a materially different outlook for CY10 with retailers likely to outperform in terms of earnings growth as well as share price performance. On relative terms, Pantaloon and Titan trade at 11x and 17x FY11 EV/EBITDA whilst Dabur and Colgate trade at 19x. Given that the retailers’ earnings are likely to see upgrades while the FMCG companies’ might see downgrades, the valuation premium for Dabur and Colgate seems inverted. Among the retailers, Koutons is at a disadvantage as it is less exposed to the metro consumer and more exposed to lower income segments.

To read the full report: INDIAN CONSUMER

>Indiabulls Power IPO- A Risky Investment ? (NOBLE)

Although IBP looks cheap on the face of it, we can’t spot near term valuation upside.
Following the disappointing post-IPO performances of two richly valued Power stocks - Adani Power and NHPC – it is refreshing to see Indiabulls Power (IBP) price its IPO at a discount of 25-30% to other private sector developers of similar profiles (based on Mcap/Total MW). That being said, this discount makes sense since:

(a) IBP has no operational capacity as yet; (b) first commissioning is likely only in FY12; and (c) there is a likelihood of further equity raising over the next two years. Uncertainty on the PPA for the

Amaravati phase 1 power plant (pricing is still not known) & the Nashik power plant (PPA is still not signed) and doubts about the commerciality of the Bhaiyathan plant (65% of offtake has been signed at Rs 0.81 per Kwh vs the prevailing long term PPA of Rs 2.6-2.9 per unit) pose further concerns. As a result, although IBP looks cheap on the face of it, in light of these issues, even at the lower end of the price band, we can’t spot near term valuation upside.

HOWEVER, THE IPO RAISES A NUMBER OF QUESTIONS....

a) Why did IBP give the entire order to Chinese vendors given the short history associated with Chinese equipment in India?

b) Was the selection of vendors based on a global tender? If yes, who were the other vendors participating in the tender process?

c) Our primary data suggests that the average life of the Chinese equipment ranges from 7-10 years? Given the fact that IBP has signed PPAs up to 25 years, is there a provision made by IBP in case the equipment undergoes a replacement cycle?

To see full report: INDIABULLS POWER IPO

>BOMBAY RAYON FASHIONS LIMITED (NOBLE RESEARCH)

The fittest has survived, now it can thrive

BRFL has continued to see strong margins and a full export order book, as buyers reward its superior design and execution skills. With increasing confidence in its margin sustainability, we upgrade our forecasts and valuation on BRFL and reiterate our Positive stance

We turned Positive on BRFL in April after the company’s fund raising gave us increased confidence on the firm’s ability to weather the downturn. Subsequent results have reinforced this with continuing strength in margins, a full order book and better than expected cash conversion in FY09. We met management earlier this week and came away impressed by the company’s prospects.

STANDING TALL
Amidst the turmoil in the global textiles sector, BRFL has continued along a relatively steady course, going ahead with its capacity expansion (2x in garments, 4x in fabrics) and continuing to deliver steady margins.

• Design capabilties: BRFL’s design skills are widely known and underpin its expansion into garments. This is reflected in the company creating ~5 new designs per day and working closely with leading retailers like Zara in assisting their design efforts. These skills, coupled with the company’s ability to deliver high design content products (underpinned by its integrated operations), give the company access to a slightly premium segment with lower pricing
pressures (due to less commoditisation – visible in high margins). This also gives greater bargaining power in the domestic market, where more sophisticated designs often attract a premium.

• Distribution advantage: The BRFL promoters are well liked and respected in the wholesale textile market in India, giving them access to a robust domestic channel for surplus fabric (current dealings through ~20 distributors). The relationships also pave the way for BRFL’s plans to begin supplying to domestic brands as well, currently being piloted with Mufti.

• Strengths underpin share gain: BRFL has continued to grow (exports almost doubled in FY09) amidst a shrinking global textiles market (~3%+ decline in CY2008). This growth has been underpinned by tight execution (visible in low turnaround time of 60-90 days and low rejection rates of ~1%) and the ability to offer design support. This has allowed BRFL to continue to thrive at the cost of higher cost manufacturers in Europe (CIS countries, Turkey and Italy).

RISKS – DILUTION
BRFL has highlighted its intention to do a fresh round of equity raising later in FY10 (we expect ~Rs.2bn, 10.5% dilution at the current share price). This round of dilution is intended to finance a part of the working capital requirements (over Rs.5.5bn in FY10) for the increased capacity with a view to keeping debt at a reasonable level (target debt/equity of 1.5x).

VALUATION
We have downgraded our forecasts for Guru but upgraded our earnings for the core textiles business (21% EBITDA upgrade for FY10 and FY11) as we now expect the company to be able to sustain ~23%+ EBITDA margins in the core textiles business. Our FCFE based valuation for BRFL is Rs.299, 41% upside and 65% higher than our previous valuation. The valuation upgrade has been driven by earnings upgrades (42% in FY10) as well as better cash conversion on the back of improvements demonstrated in FY09 (FY10 net working capital to sales ratio reduced by 480bps). On a relative basis, BRFL trades at a 19% discount on EV/EBITDA and a 63% discount on P/E (59% assuming equity issues of Rs.2bn). Even if we factor in 10% dilution, BRFL seems relatively cheap despite its very visible strategic superiority to domestic peers.

To see the full report: BRFL

>Tricks that promoters play...... (NOBLE RESEARCH)

The tricks that promoters play at the expense of shareholders

In the wake of the Satyam-Maytas debacle, we highlight the three most common tricks that Indian promoters employ to enrich themselves at the expense of shareholders. In the currently depressed market conditions, the divergence between promoters’ goals (around boosting personal wealth) and shareholders’ objectives (around growing the value of the firm) has become sharper.Moreover, contrary to conventional wisdom, such shenanigans are not confined to small cap stocks; some of the largest companies in India have a penchant for such tricks. These tricks create the need for investors to use unconventional means,such as primary data and forensic accounting, to assess promoters’ probity.

I feel this would be a valuable reading for All the Investors

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