>EXIDE INDUSTRIES: Q4 FY12 - In line performance

“On a comeback trail”


Q4 FY12 - In line performance
On the back of strength shown from the 2wheeler segment, Exide was in a position to put up a sequential improvement in numbers. Total income increased by 16% qoq as well as yoy. At the EBITDA levels, there was an increase of 30% qoq and there was a flattish growth yoy. RM to sales moved up slightly sequentially to 67.2% since adverse forex movement offset the slight cut in lead prices. EBITDA margins surged to 14.6%, a growth of 160 bps qoq, as employee costs to sales went down to 5.2% of sales v/s 6% qoq and other expenses surprisingly came down to 12.9% v/s 14.2% sequentially against a difficult Q3. PAT declined 12.9% yoy while rising 37% qoq. The decline came on higher depreciation costs.


Replacement demand may provide the much needed traction in volumes
The volume improvement in the quarter was on the back of strong 2W battery numbers. The volumes grew 26% yoy and 4% qoq to 3.7mn while 4W volumes grew by 6% yoy to 2.38mn a growth of 16% qoq. On the industrial side, volume growth was 15.3% yoy and 20% qoq. On the capacity side, the company is through with 4W capacity expansion at 12mn units, while is still in the process of increasing 2W capacity to 22 mn in FY 13 which was close to 20mn in FY 12 and also the industrial capacity is slated for expansion to 2.5bn from 2.4bn units. The management expects replacement demand to be strong this year and hence expects to grow at 15-18% on the replacement side,higher than the market growth expected. In line with this, they are expecting to gain back their 36% market share in 4W replacement which had gone down to 23%, and currently stands at 30-31%. In Q3 FY12, the company functioned at 82% utilization rate on the 4W side, 73% on 2W side, while 72% on the industrial side. The replacement: OEM ratio in the year on the auto side was 1.14:1 lower than 1.22:1 in FY11. Going forward, we believe that 2W demand on the OEM side will be slightly soft as the sector has seen some slowdown off late, while on the 4W side OEM demand, we believe softness will continue over a couple of quarters with fuel prices moving up, while any further cut in interest rates will spur demand. On the replacement side, we believe that Q1 FY13 will see some turnaround from the demand for automobiles 3 years ago, both on 2W as well as 4W sides.


Margin improvement may come in coming quarters
In Q4, although the industrial margins grew by 380 bps, auto margins declined due to price cuts taken by the management in the 4W replacement side and pricing pressures from OEMs. However, although the company has taken 17% price cuts on car batteries with 5 year warranty, the management said that they have increased the prices on the other batteries in an attempt to realign prices with the industry and push up the demand on replacement side street expectations, the management in fact confirmed that this has led to some savings rather than margin erosion. The improvement seen in margins in this quarter is expected to continue going forward, as replacement demand is expected to pick up. Also softening of lead prices over the last few months is expected to continue. Softening of lead prices as seen in Q3 is expected to continue and help the margins going forward. We have already factored in about 270 bps improvement in margins in FY 13 to 16.1% over
13.4% in FY 12.


Outlook and valuation
We believe FY 13 will be a better year for Exide with replacement demand expected to pick up and OEM demand to improve in second half of the year following festive season, new launches and expected interest rate cuts. Margin improvement is also on the cards with lowering input costs and improving product mix. However, competition may lead to some margin weakness following any further price cuts in the replacement market. In line with positive expectation from the company going forward, we have slightly increased our FY 13E EPS from Rs 7.5 to Rs7.9 and have introduced FY 14E estimates.We have increased Exide's standalone business value at Rs123 (15.5x times FY 13E EPS of Rs 7.9) and insurance business at Rs13 taking the total TP to Rs136, thus upgrading the stock from Underperformer to Outperformer.


To read report in detail: EXIDE INDUSTRIES
RISH TRADER

>How the fiscal deficit slows growth and sparks inflation: Four transmission channels (Reasons for India’s structural weakness)

Structurally higher inflation due to governmental policies
The larger fiscal deficit has fuelled inflationary pressures by widening the consumption-investment gap. Subsidized oil prices and an expansion in inclusive growth schemes (without augmenting investment) increased consumption demand to unsustainably high levels. Since the RBI responded to these demand-side inflationary pressures by tightening rates, the burden of adjustment has fallen disproportionately on investments, and more so on private investment, which is more efficient than public investment but is being crowded out by the large fiscal deficit.


In the face of rising demand and limited production, a higher minimum support price (MSP) of food crops has fuelled food inflation. Demand is increasing faster now than during 2003-07 because the middle class is approaching the income threshold, at which demand for consumer durables and higher-protein food takes off. Since nearly half of the consumer basket is comprised of food prices, this has led to an unmooring of inflation expectations. Also, the rural employment guarantee scheme, where wage hikes are linked to CPI inflation, has set a floor on rural wages and exacerbated labour shortages. In the end, this has reinforced the wage-price spiral.


Not surprisingly, average wholesale price index (WPI) inflation has increased from close to 5% during the decade prior to 2008 to 7.0-7.5% post-2008 (Figure 7), with the majority of the increase due to higher food prices (Figure 8).


In the medium term, absent an increase in investment, we doubt that WPI inflation will fall sustainably below 6%. India‟s capital stock-to-GDP ratio at 1.79 in 2010, is one of the lowest in Asia (Figure 9). Plotting capital stock-to-GDP ratios against average CPI inflation rates for 2006-10 reveals that these two variables are negatively correlated, suggesting that persistently high inflation in India appears to be well-explained by the low investment rate



Falling investment capacity
Manufacturing investment, which was the main driver of capex during 2003-07 (Figure 11), has been crowded out by the rising cost of borrowing. Infrastructure investment has been held up due to a policy logjam in acquiring land and obtaining environmental clearances. Lower investment has also hurt productivity, due to the slower adoption of new technologies. As a result, investment has fallen from a peak of 38.1% of GDP in FY08 to 35.1% in FY11 (Figure 12).


The government has flip-flopped on policies and been noncommittal on reforms. For instance, the decision in November 2011 to allow Foreign direct investment (FDI) in multi-brand retail was reversed days after being implemented. The government is also retroactively looking at taxing cross-border deals and bringing in new general anti-tax-avoidance measures, which have increased investors‟ uncertainty over the taxation regime. Despite deregulating petrol prices, oil-marketing companies have not been allowed to raise petrol prices. All of this has hurt investor sentiment and diminished the pipeline of investment projects.



The savings rate has fallen due to high inflation
A rising savings rate had been one of the foundations of India‟s expanding potential growth rate. It has made investment financing sustainable due to an ample availability of domestic funding and reduced dependence on foreign capital. This cushion has slowly eroded. The gross domestic savings rate has fallen from 36.8% of GDP in FY08 to 32.3% in FY11 (Figure 13). While the rise in the central government‟s fiscal deficit has reduced public savings, private corporate savings have also fallen due to a higher cost of production.


Overall, household saving has remained broadly unchanged, but its composition has physical savings trending up and financial savings falling, due to high inflation (Figure 14). Households have moved into physical assets as a hedge against inflation and trimmed their financial assets as the real rate of return has fallen. This shift in the composition of household saving (away from financial assets) does not bode well for sustaining growth, since it reduces the funds available to finance investment and blocks savings into non-productive assets such as gold.



A lower savings rate widens the current account deficit
India‟s current account deficit deteriorated because imports remained relatively robust while export growth slowed during the global slowdown. In our view, import demand was fuelled by four factors: 1) strong consumption demand was boosted by consumption-biased fiscal policies; 2) high inflation led to demand for gold imports4; 3) inelastic oil demand due to subsidized fuel prices (Figure 15); and 4) higher coal imports caused by delays in domestic production from slow environmental clearances (Figure 15). The national income identity suggests that a wider current account deficit reflects gross domestic saving falling much more than investment.


The need to finance a rising current account deficit has increased the economy‟s dependence on capital inflows (Figure 17). The basic balance of payments (BoP) deficit, defined as the current account plus net FDI inflows, has widened to levels last seen during the 1991 BoP crisis (Figure 18). While FX reserves provide a buffer against sudden capital outflows, their use is limited. First, domestic liquidity is already tight and USD sales by the RBI would lead to further INR liquidity shortages, which would need to be countered via open market operations and/or cash reserve ratio cuts. Second, as the RBI uses its FX reserves to defend INR, its medium-term FX vulnerability would increase as the reserve ratio worsens.



To read report in detail: FISCAL DEFICIT
RISH TRADER

>BHARAT FORGE LIMITED (JEFFERIES)

Initiating at Buy: Past Investment Phase


Key Takeaway
We initiate coverage of Bharat Forge (BFL) with a Buy rating and price target of Rs441. We believe that Bharat Forge is past its investment stage and will now benefit from improving asset utilisation. While some of its overseas subsidiaries are still under stress, we expect the management to take remedial action soon. Building blocks in place: Over the past few years, BFL has expanded its presence into newer markets and segments, even as it has maintained its hold over existing businesses. BFL is now the world’s largest independent forging company but still accounts for less than 1.5% share of the estimated global forging production. In the near term, we expect BFL to benefit from the rebound in the US truck market and increasing value addition in the Indian truck market. Expansion into non-auto segments should bring new growth opportunities and offset the cyclicality of the auto business.


It’s all about utilisation: Forging is a capital-intensive business with profitability contingent on asset utilisation and the extent of value addition (machining vs raw forging). BFL increased its raw forging capacity by over 60% in FY09/FY10, even as its end markets slowed down, leading to a sharp fall in utilisation levels (80% in FY08 to 34% in FY10). Since then, however, BFL has benefited from three factors, which will likely accelerate: a) higher utilisation of forging capacity, increasing to 57% in FY12E and to 65% in FY14E; b) higher proportion of machining, from 40% historically to c45% in FY14E; and c) higher proportion of non-auto sales, from <30% historically to c40% at stable state.


Subsidiaries and JVs - no more cash calls: BFL's overseas units account for c50% of global capacity but are operating at less than 50% utilisation. It has shut down one of its European plants and we expect BFL to take more such remedial actions in the future. Cumulatively, we expect the overseas subsidiaries to be self-funding, though they would contribute very little to profits in the near term. We are concerned with the profitability of the power equipment JV with Alstom given the intense competition in the TG space.


Valuation/Risks
BFL stock has been sharply derated since 2008, initially due to slowdown in demand but subsequently due to concerns on its subsidiaries. Our SOTP-derived PT of Rs441 is based on: a) increasing asset utilization in its India operations, which we value at 16x FY14E; and b) no incremental cash calls from its JVs and subsidiaries, which we value at 0.5x FY13E BV to factor in our concerns on profitability. Risks: New expansion in the domestic business, cash calls from international subsidiaries and execution delays in power equipment JVs are key downside risks. Currency fluctuation is a risk for margins.


To read report in detail: BFL
RISH TRADER

>FUTURE GROUP DEMERGES PANTALOONS RETAIL FORMAT FROM FLAGSHIP COMPANY

ADITYA BIRLA NUVO TO INVEST IN PANTALOONS FORMAT

Future group today announced the intent to execute a full demerger of Pantaloons retail format from Pantaloon Retail India Limited (PRIL). On completion of the demerger process, subject to necessary and statutory approvals, the demerged entity will be automatically listed in NSE & BSE. Future group also announced that the demerged entity, will invite an investment from Aditya Birla Nuvo Limited (ABNL)


Scheme of Demerger-
• PRIL will issue debentures to ABNL worth Rs800 crore at mutually agreed terms, convertible in the equity shares of the resulting entity i.e. Pantaloons Format business.
• PRIL will demerge its Pantaloons Format business through a court scheme of arrangement. PRIL will transfer the net assets of its business, its apportioned debt of Rs800 crore and debentures of Rs 800 crore to the resulting entity. After the demerger, the debentures will be converted into equity shares of the resulting entity.
• ABNL will make an open offer of a minimum 26% to the shareholder’s of the resulting entity. After the listing of the resulting entity and on conversion of debentures into equity, ABNL’s holding in the resulting entity post open offer shall be a minimum of 50.01%.The resulting entity will become a subsidiary of ABNL.
• The proposed transaction likely to be completed within 8 to 10 months.


Rationale for ABNL-
• Post the acquisition, the two entities ABNL’s Madura Fashion & Lifestyle and PRIL will work closely as partners to derive operational synergies.
• Pantaloons Format business is spread over 2.05 million square feet and in the medium term the format is expected to add 20 stores annually which will be of great advantage for ABNL.


Rationale for PRIL-
• Post demerger, the total debt of Pantaloon Retail will be reduce by Rs 1600 crore.