>CONSTRUCTION QUARTER 3 REVIEW: Macro headwinds changing, impact to be limited

■ Order inflows scenario improved: Engineering & Construction (E&C) companies which had seen a gradual downward shift in the order inflows since the last two quarters, have seen a healthy revival this quarter. Mining, Water and Road orders contributed majorly to the revival. Total orders announced in Q3FY12E for PL Universe are close to Rs309bn (Overall: Rs400bn) which was up by 39% QoQ and 19% YoY. However, if one excludes NCC’s internal power order of Rs52bn then the growth would be 15% QoQ and flat YoY. Orders from the Gulf countries in the petrochemical segment have cooled off in Q3FY12 to Rs15-16bn from close to Rs67bn in Q2FY12. The total order inflow till now has been close to Rs115bn in Q4FY12.


■ Earnings in Q3, though, have not shown improvement: Sales growth stood at 17% YoY and higher by 20% QoQ (as Q2 is seasonally weak). However the ‘C’ segment was down by 9.1% YoY, where IVRCL’s sales were down by 15.3% YoY, whereas the ‘E’ segment stole the show by a 24% growth YoY and 20.9% QoQ. Sales growth for ‘C’ segment was mainly arrested by working capital constraints faced by mid-sized players. EBITDA grew by 2.8% YoY and flat QoQ, where barring L&T & EIL, all the players were in the negative territory. EBITDA margins (down by 120bps YoY) were down for all the companies which clearly shows the competitiveness and lower execution/higher fixed overheads is taking toll on the margins. Interest continues to haunt the companies growing by 30-40% YoY and 5-10% QoQ. Interest as a % to sales (excl. L&T & EIL) stood marginally lower QoQ at 5.2%. Overall, PAT grew by 8.1% YoY, mainly arrested by losses in Punj Llyod, NCC and HCC.


■ Risk reward ratio still not predictable: Markets have risen since the last quarter, particularly the Infrastructure sector, where the jump has been substantial, mainly in the last 30 days. However, the balance sheet profile, ROEs and moreover corporate governance issues still continue to haunt the prospects, which don’t make our view any positive on the fundamental side. With the run up to the 2014 elections and fresh orders from the 12th Plan, we expect a sharp revival in order inflows. Investment opportunities pegged at 9-10% of the GDP could bring out new projects worth US$1trn over 2012-2017, doubling the 11th plan estimates. However, we think that the onus will again fall on the private sector and with stretched balance sheets and liquidity crunch, only few players will be able to cash in on the opportunities. Only a potential dilution at the parent level and SPVs will bring some hope to ease the debt trap and working capital deadlock. However, due to overall improvement in the macro economic environment, there has been a re-rating in the sector. Our sector stance remains ‘Neutral’.


RISH TRADER

>ABB INDIA: Growth in base orders remains healthy but revival in project capex, particularly in the Industrial segment, may take some time

UW: Recovery remains elusive; valuation premium unjustified

• Q4 earnings miss but orders surprise positively; beat driven largely by the booking of old HVDC order 
• Margin recovery remains elusive; negative surprises likely to continue as restructuring benefits appear backend loaded
• With further downside risk to earnings, valuation premium unjustified; reiterate UW with a TP of INR510

Earnings miss but orders surprise positively: ABB reported another set of weak results missing our Q4 EPS estimate by c8% but consensus by c50%. Sales growth of c6% came in line with our expectations and was driven primarily by the Power business, which grew c13%. Industry growth disappointed, as large automation projects failed to materialise. While the total order intake of INR22bn surprised positively, the beat was largely driven by the booking of the 9-month old HVDC order worth INR5.6bn. Management noted that growth in base orders remains healthy but revival in project capex, particularly in the Industrial segment, may take some time. The order backlog was largely in line with our expectations and stood at INR91bn, on the back of which management expects strong (double-digit) sales growth in the next couple of quarters.

Visibility on margin recovery remains low: While margins improved somewhat q-o-q, they once again fell short of expectations. Management attributed weak profitability to lower volumes, high input costs, project delays and poor project mix. We note that ABB India’s margins have remained depressed for two years now, more so than any of its competitors, and this may indicate poor project selection. In addition, restructuring benefits seem to be more backend-loaded as they have hardly provided the necessary impetus to the margins in last two years. Hence, while on a long term basis, ABB India may appear to be well placed to benefit from India’s growth story, in the near term the outlook certainly remains weak, particularly as expectations of recovery remain too high in spite of estimate downgrades in the last 8 quarters. We currently forecast EBITDA margins to improve to c7.7% in CY12 and c9.1% in CY13; however, if the project mix remains suboptimal, future results may warrant further downgrades.

We trim our CY12/13e EPS by c3%/5%; maintain UW with TP of INR510: As Q4 results came only c8% below our forecasts and the order intake was ahead of our estimates, we are only marginally reducing our CY12/13e earnings. Consequently, we keep our TP of INR510 unchanged and reiterate UW on the stock as we believe ABB will most likely continue to miss expectations in the near term. In addition, the stock remains priced for perfection, trading at c51x CY12e (Dec YE) PE and c35x CY13e PE, factoring in a solid beat to our numbers, which appears unlikely. Hence, we would take profits at current levels. Our target price is derived from our preferred EVA valuation methodology and implies a 12 month forward target PE multiple of c21x on 24 month forward estimated EPS of INR24.5.

RISH TRADER

>Talwalkars Better Value Fitness

We spoke to Talwalkars’ CFO to gauge the near term outlook for the company. TALW has rolled out 19 gyms in nine months so far and expects to open another 16 gyms in the current quarter. Management also stated that a plan for roll out of clubs has been put on hold and it would retain focus on gym expansion. Mgmt targets FCF +ve in FY14 as a large chunk of gym base would then be operating in the mature state and expansion through franchisees would gather pace. Roll out of HiFi gyms through franchisee route will ensure deeper penetration without concurrent capex needs. Company expects benefits of operating leverage to kick in considering the large share of fixed costs which would help improve margins. We revise lower our estimates and now expect a 33% EPS cagr over FY12-14; retain BUY with revised 9-mth tgt of Rs190.


■ Club roll out plan put on hold; to focus on gym expansion
Talwalkars Better Value Fitness (TBVF) mgmt stated that plans to roll out clubs - a different format compared to gym requiring much larger investments and longer gestation periods - has been put on hold. It would continue to focus on gym expansion where it remains bullish on the opportunity in the market given the low penetration rates for organized players.


■ To end FY12 with total gym base of 126
TBVF has rolled out 19 gyms in 9M FY12 and it is slated to launch another 16 gyms in Q4, a traditionally strong quarter for the fitness business. This would take its total gym base to 126 of which about 90 would be owned and rest would be through a combination of subsidiaries, franchisees/JVs and HiFi gyms. Company plans to add 8 HiFi gyms in the current year through franchisee route which would not entail any capex for the company. We also revise lower our owned gym addition count to 18 in each of next 2 years.


■ Cut earnings on reduced owned gym count but retain BUY
We cut earnings forecasts for FY12/13 as we reduce owned gym additions and now expect ~18 gyms to be added in FY13/14. Expansion in HiFi gyms through the franchisee route would gather momentum over next 2 years which would lower overall capex intensity and generate free cash flow in FY14. Retain BUY rating with revised 9-mth tgt of Rs190.


To read full report: TBVF

>Is The Eurozone At Risk of Turning Into The Rouble Zone?

On February 9, 2012, the ECB’s Governing Council (GC) approved, for seven national central banks (NCBs) (of Ireland, Spain, France, Italy, Cyprus, Austria and Portugal) “… specific national eligibility criteria and risk control measures for the temporary acceptance of additional credit claims as collateral in Eurosystem credit operations”.3 NCBs can choose the eligibility criteria freely, subject to minimum requirements set by the ECB GC.


We consider this to be a dangerous and potentially disastrous decision. Either, this decision could plausibly imply a loss of central control over the Euro Area’s Monetary, Credit and Liquidity (MCL) policy. The amounts of ECB credit and liquidity provided are demand-determined once the eligibility criteria for collateral are set. Delegating the setting of these criteria to the NCBs therefore opens up the possibility of uncontrolled, and therefore accelerated, balance sheet growth for the Eurosystem, if the NCBs in the soft euro area (EA) member states are not restrained by the absence of Eurosystem-wide loss sharing associated with the new, more relaxed national collateral standards. Such a failure to respond ‘responsibly’ to the ‘you break it, you own it’ loss sharing arrangements for the new NCB collateral regimes may be individually rational if both the NCB in question and the sovereign backing it are close to insolvency.


Alternatively, if the absence of a Eurosystem-wide loss pooling regime is recognized (and enforced), the 17 Eurosystem NCBs could become counterparties with very different degrees of default risk. Normally, central bank solvency would not be threatened by increased exposure to high-risk assets, as long as that central bank’s liabilities are denominated in domestic currency — as is the case for the EA NCBs. A central bank’s ability to issue monetary liabilities (to use current seigniorage) or its capacity to borrow by issuing non-monetary liabilities (effectively secured against its future ability to issue seigniorage) should permit it to meet any payment obligations. This is not the case, however, if the ECB GC does succeed in putting a cap on the ability of the national NCBs to increase their balance sheet size despite the widening of the collateral eligibility, and if that cap is tight enough to prevent an individual NCB from saving itself from default through the use of seigniorage, but not tight enough to stop it from getting into trouble in the first place. Such a combination of a loosening of some NCBs’ collateral standards, the absence of loss pooling and effective constraints on these NCBs’ ability to use seigniorage would pose a different danger from that of ‘Roublezoneification’: it implies further differentiation between NCBs and their counterparties along national lines and the segmentation of the Eurosystem into NCBs characterized by possibly significant differences in default risk.


The decision of February 9 introduces a relaxation of collateral requirements in only part of the EA — the ‘soft’ part, consisting of 5 of the 6 EA periphery countries (only Greece is missing) and 2 of the 3 ‘soft core’ EA member states (only Belgium is missing). This selective relaxation creates an uneven playing field for central banks and their counterparties that could easily be destabilizing. And it could further accelerate the bifurcation of the EA into a soft EA and a hard EA.


If it is indeed true that there will be no loss pooling for these additional credit claims (as ECB President Draghi suggested in the Q&A of the press conference, although no formal decision of the ECB’s Governing Council to that effect has been communicated), the solvency of the NCBs in fiscally weak EA countries would be called into question even more. And counterparties in the euro area and elsewhere would start to differentiate more strongly between different Eurosystem NCBs. That would be a further nail in the coffin of a single money, credit and liquidity policy (MCL policy) for the EA and a further step towards the re-emergence of national MCL policies and, eventually, national currencies.


To read the full report: EUROZONE
RISH TRADER