Thursday, March 11, 2010

>INDIA PROPERTY: Service Tax Issue – Maintain Benign Impact

Quick Comment Impact on our views: We continue to believe that the likely impact of service tax on the ‘Construction of complex services’ as altered/expanded in the Budget F11 will be benign (3-4% of sale value), though negative.

We delved deeper in the service tax issue by accessing – 1) a document issued by Tax Research Unit of Ministry of Finance subsequent to Budget F11, 2) the original government notification which introduced service tax on residential complex way back in 2005 and 3) circulars issued thereafter on this issue. See inside.

Our understanding of the issue is as follows –
1.This is an old tax introduced in 2005 (for residential units), to which there was a varying degree of adherence (mostly low) given the different industry practices of ‘executing’ apartment sale (pre-sales, sale of undivided portion of the land, split documentation etc). Different patterns of execution have given rise to disputes and discrimination in terms of service tax payment.

2. The Budget F11 seeks to achieve the legislative intent and bring parity of tax treatment so as to expand the
scope of the existing service, which otherwise remains unchanged.

3. Though not entirely unambiguous, service tax (10.3%) should be levied on the gross value (sale value
less land cost) of pre-sold units. However, developers can avail themselves of a 67% abatement (so as not to
double tax goods and material used) on the gross value. This translates into service tax of roughly 3.4% on the
sale value (assuming zero land cost). This can be lower depending on the extent of the share of the land cost in
the overall sale value.

4. In addition, the introduction of the service tax on PLC, IDC and EDCs is likely to add 1% to the above calculations. So, we estimate an overall impact of 3-4%. Mid term, these measures will assist government to transition service tax on the sector to a universal GST regime, in our view.

To read the full report: INDIA PROPERTY


Coal price settlement marks the end of some uncertainty
JFE Holdings announced that it has accepted a 55% increase in the price of coking coal starting 1Q FY3/11, and in a departure from the past, it has agreed for coal prices to be reset every quarter, rather than on an
annual basis. The quarterly-reset price will cover half of the coal shipments for the year. For the other half, which will still have an annual contract price, the prices are yet to be settled, though they will likely be higher than the price settled for quarterly contracts.

While this does not mark a complete end to the uncertainty over this year’s raw material contracts (and iron ore prices are yet to be settled), we expect even a partial settlement to be seen positively by the markets. This will also provide an impetus for quicker and sharper recovery in Asian spot steel prices, which have already been rising in anticipation of higher material costs.

Our calculations suggest that Asian steelmakers will need anywhere between a 20%-30% increase in average steel prices this year to pass on the expected cost of iron ore and coal price increases. This means an average benchmark price of US$593/t-US$642/t (up from the average of US$494/t in 2009). Note that the current spot price is already close to US$600/t, and rising sharply. Some steelmakers will be able to pass it on; others may not. Another important point to note, particularly for Japanese steelmakers, is that while variable costs are rising, their fixed costs should fall, given the rise in utilization this year.

Japanese steel pricing mechanism likely to change. We believe that, under the current system, Japanese steelmakers are at a relative disadvantage to their Asian peers, as they have a large portion of their customer contracts on annual pricing terms. We believe that as they start accepting quarterly contract prices for coal, they will need to reset their prices to their customers also on a quarterly basis. This may not happen from FY3/11 itself, though we expect this to happen at least by FY3/12.

Our best ideas: Buy JFE, POSCO, Kobe Steel
We expect Asian steel stocks to react positively to the coal settlement, as it ends some uncertainty; US steel stocks were up on Friday, including POSCO ADRs, which were up more than 3%. We maintain our Buy (Conviction List) on JFE, POSCO, and our Buy ratings on Kobe Steel, Nippon Steel and Hyundai Steel.

To read the full report: STEEL


A steady and gradual ascent
After a sluggish FY09, we expect a turnaround in the Indian retail finance market (in particular, housing, cars and CVs). A comparison of India’s penetration levels with developed and emerging markets, when juxtaposed against demographic trends and income levels, reflects significant long-term potential here. We estimate 13%-18% CAGR in mortgages and car loans over FY10E-FY20E, driven by: rising per-capita income, urbanization, favorable demographics, declining household size. Further, vehicle penetration is likely to get an impetus from increasing road density and a changing product mix in favor of higher-value vehicles.

Retail finance on comeback trail; preferred picks: HDFC Bank, Shriram Transport, IndusInd

Recent market dynamics
In our view, the past 8 quarters saw three key trends emerge: (1) a slowdown in lending by ICICI Bank benefited HDFC Bank and KMB in car/CV finance markets, and LICHF in the mortgage segment, (2) most companies introduced low fixed-rate mortgage schemes to protect their market share, and (3) retail loan growth showing signs of revival – yoy growth in Nov 2009 was 13% vs. 4% in March.

Preferred picks: HDBK, SRTR, INBK
We believe investors could leverage the retail theme through: HDFC Bank (Buy, on CL; a profitable company in the car and CV markets), Shriram Transport (Buy—a profitable NBFC focused on CV finance), IndusInd Bank (Buy—focused on CVs/2W/ 3W segments; restructuring story with high growth potential). We think HDFC, ICICI Bank, and KMB (all Neutral-rated) are also likely to benefit from a retail finance upturn. While valuations are close to/above median multiples currently, we expect further rerating towards historical peaks on strong growth and profitability. We have a Sell on SBI (high provisions and market share focus, will likely impact long-term profitability) and LICHF (on CL; risk of spread compression amid market share focus).

Key risks: Property prices in key markets are currently close to early-2008 peak levels. We believe this may
impact property demand, despite its significant long-term potential, as purchases may be postponed. Hardening of interest rates too could adversely impact housing, car and CV demand.

To read the full report: INDIAN FINANCIAL SERVICES


Growth rebound and reasonable valuations. We expect robust 18% revenue growth (led by 40% growth in the monolithic segment) and 90 bps EBITDA margin expansion in FY2011E to drive a 21% EPS CAGR over FY2010E-FY2012E. The stock is trading at 9.2X FY2011E EPS. Outperformance in 4QFY10E versus KIE estimates—even if only in-line with management guidance—could be a near-term trigger. A rebound in BT shelter and textiles business is another potential trigger in FY2011E.

Building products: Signs of demand growth visible
We expect the company’s building product revenues to grow 25% (versus 10% in FY2010E) in FY2011E based on (1) 40% growth in the monolithic segment based on a strong order book of Rs15 bn (2X FY2011E revenues) with an execution cycle of less than two years; (2) low probability of a further decline in BT shelters revenue and low impact of the same given its much lower proportion of total revenues and (3) increase in growth in the domestic pre-fab business based on a pick-up in overall growth.

Custom Molding: The worst is past
We expect custom molding revenues to rebound on the back of (1) revenue flows begin from BrightAuto’s Chennai plant which has been set up to supply electrical accessories to Schneider; (2) higher growth in Nief Plastics (subsidiary) which has historically been impacted by its high proportion of revenues from the global automotive segment (55% in CY2007 when it was acquired) but now the exposure is only 25% and (3) focus over the past 18 months on the aerospace and medical equipment industry contributing revenues in FY2011E.

Raise target price, reiterate BUY
We reiterate our BUY rating with a target price of Rs310 (earlier Rs280) based on 11X FY2011E EPS. The stock is currently trading at 11.7X FY2010E and 9.2X FY2011E EPS. We are raising our EPS estimates for FY2010E and FY2011E to Rs22.2 and Rs28.1 from Rs21.3 and Rs26.8, respectively, on the back of higher revenue from the building products segment (7% increase in FY2010E and 8% in FY2011E). We expect revenue growth to revive from 4QFY10E driven as (1) revenues from the monolithic segment begin to be recognized (44% of FY2010E revenues to be booked in 4QFY10) and (2) the revenue decline in its BT shelter and textiles business over FY2011E is arrested.

To read the full report: SINTEX INDUSTRIES


Our recent meeting with the management of Petron Engineering Construction (PTEC), a mid-sized EPC services player, revealed that the company’s growth trajectory appears intact. PTEC has logged a topline CAGR of 18% over FY05- FY09, and expects to clock a stronger growth rate of 25% over FY09-FY11. Growth will be underpinned by a healthy order book of Rs 6.5bn (excluding Rs 2.1bn in L1 orders), strong moorings in the form of a globally recognised parent company, and favourable sector dynamics.

Growing order book: PTEC is mainly present in the refinery and power EPC space and has a strong client base, many of whom are repeat customers. Some of its prominent clients include BHEL, NTPC, Reliance Energy, Bharat Petroleum, Indian Oil Corp and Adani Power. Over the past year, PTEC has been gaining traction in order wins and currently has an order book of ~Rs 6.5bn or 1.4x FY09 sales. This is dominated by the refinery segment (60%), while power projects (20%), cement projects (10%), and others (10%) make up the balance. The company is also the lowest bidder (L1) for two contracts worth Rs 2.1bn, comprising the Rs 1.5bn Paradip refinery project and a Rs 0.6bn electrical supply order from NTPC.

Strong parentage: PTEC was acquired by UK-based Kazstroyservice (KSS) in 2008. The KSS group clocked a turnover of Rs 23.1bn in FY09, has a strong equipment base valued at more than Rs 5bn, and has successfully executed over 100 projects since inception, including several turnkey EPC works.

The growth plans of PTEC and KSS are complimentary and a powerful synergy exists to expand activities of the group in India and beyond. Together, the partnership plans to explore the Middle East, Far East and Turkmenistan markets. KSS has a 53% stake in the company while the erstwhile owners (including the Nair family) still hold 10%. Unlisted group company Petron Civil Engineering (topline of Rs 6bn, 100% owned by KSS) may be merged with PTEC.

Healthy growth guidance: PTEC has guided for a topline of Rs 5.5bn and a bottomline of ~Rs 250mn for FY10. It aims to log a sales CAGR of 35% over the next two years to Rs 10bn, and higher growth in profits as EBITDA margins hold firm at 11–12%. On the capex front, PTEC plans to invest Rs 500mn in equipment purchase in 2010. The company’s debt position stands at ~Rs 650mn. It had legacy bad debts of Rs 0.5bn (partly pertaining to NTPC’s Khalgaon unit) which have now been written off.

Valuations appear attractive: Currently, the stock trades at ~10x FY10E EPS and ~6.2x FY11E EPS (based on the management guidance). While we do not have a rating on PTEC, we believe the stock is attractively priced at this level.