Friday, April 2, 2010

INDIAN INFRASTRUCTURE: An Execution Noble - City of London position paper

Four perspectives :

  • The equity financier
  • The debt provider
  • The builder
  • The government

A reality check on Indian Infrastructure
The Government of India (GoI) has targeted an investment of US$500 billion in Indian infrastructure creation over FY07-12 in the XIth five year plan.

This target is ambitious, and given the scale of the financing required, increasingly dependent upon private sector participation via Public-Private Partnerships (PPPs).

The plan anticipates that the private sector will account for nearly 30% of infrastructure investment as against 18% in the previous five year plan.

That in turn implies that the private sector will invest US$150 bn over the five year period or about US$30 bn annually.

Assuming that equity will fund 25-30% for this US$30 bn annually, this means a US$7.5-10 bn equity infusion each year by the private sector.

Though the primary participants are expected to be Indian infrastructure companies, global funding in various forms such as private equity, dedicated infrastructure funds,

Foreign Direct Investment (FDI) or Foreign Institutional Investment (FII) will also be key sources of capital driving private investment in Indian infrastructure. Indeed in the roads sector alone, over the past year the Minister for Road Transport and Highways of India has undertaken several international ‘roadshows’ to highlight this investment opportunity and encourage foreign capital flows into infrastructure.

Where do we stand?
Mid-way through the FY07-12 plan, our discussions with a range of investors and data from various well known research bodies and consultants suggest that infrastructure investments for FY07-12 may not be more than US$350 bn as against the planned US$500 bn, a shortfall of 30% .

These sources highlight that both government-sponsored and PPP investments will fall significantly behind the estimated planned expenditure.

Given that Indian infrastructure has been promoted as one of the biggest opportunities globally, what has held back actual investments in Indian infrastructure? Is the cause a lack of capital, or are there other issues?

To read the full report: INDIAN INFRASTRUCTURE

>BANKING BUBBLES: Earnings and Values Across the World

China Leads, Mexico Lags — Based on the market value of banks compared to the size of the local economy (“penetration”), the most penetrated major market is China (c30% of GDP) and the least is Mexico (c8%). China has a large banking market value due to high level of profits relative to GDP. The same is true for Brazil. But Mexico has both low earnings and a low relative market value.

■ Low-PE Markets: Turkey and Korea — Turkey screens as the lowest-PE banking system in our sample. The main concern is profit sustainability and political risk. We believe fears on both counts are overdone. We see Isbank, Bank Asya and Garanti as good plays on Turkish banking resilience. Korea also screens as a low- PE market and may benefit from margin and credit recovery.

■ Low Earnings Markets: Mexico and India
— Mexico screens as having the lowest bank earnings in our sample. A macro recovery in Mexico should support bank earnings and penetration growth. We view BBVA as a good value play on Mexican growth. India also looks an attractive growth opportunity. Standard Chartered is a way to play growth in India, as well as in Korea and other emerging markets.

Australia: Example or Exception? — Australia has a bank market value to GDP close to China’s and bank earnings to GDP similar to Brazil. Market structure, a robust economy and supportive shareholders all help explain Australia’s high earnings and valuation multiple. An oligopoly structure can be replicated, but the rest is harder. Turning Aussie (or Canadian) won’t be easy for the UK.

To read the full report: BANKING BUBBLES


Adani Power is setting up 6,600MW power capacity which will make it one of the largest private sector players by FY13. It has 70% power tied up in Case 1 bids and the balance 30% will be sold on merchant basis. Additional merchant sales before the start of long term PPAs are contingent to timely commissioning of the projects. The fuel supply for its projects is a mix of Indonesian coal (sourced from AEL at US$36/t cif) and coal linkages from Coal India. The Budget proposal of imposing a duty on power imported from SEZs (has 70% capacity in Mundra SEZ) to DTA is a risk. Initiate with a U-PF and TP of Rs111/sh.

■ Strong capacity addition over next three years
Adani Power has 6,600MW capacity under development which is targeted to be full commissioned by FY13. This will make Adani one of the largest private sector players in power generation. 70% of this capacity is located in Mundra SEZ (Gujarat) while the balance 30% is in Tiroda, Maharashtra. The company has plans to add more capacity in Gujarat at Dahej (1,980MW) and in Rajasthan at Kawai (1,320MW) and expand its Tiroda project to 3,300MW.

■ High exposure to merchant power in initial years
~30% of its capacity is untied in any long term PPA which the company intends to sell on a merchant basis. Apart from that, the company has window to sell more power on a short term basis where its projects gets commissioned before the start of the PPA date. Thus the timely commissioning of its capacities is absolutely necessary to take advantage of this window when the merchant tariffs are also likely to be relatively higher.

■ Fuel supply to be a mix of Indonesian and linkage coal
The fuel supply for its projects is a mix of Indonesian coal (sourced from Adani Enterprises at US$36/t cif Mundra) and coal linkage from Coal India. The coal block allocation (Lohara) for part of its requirements for Tiroda project has been cancelled by the MoEF and the company has recently got a linkage (tapering) in lieu of that. We have assumed a coal linkage for the full requirements of Tiroda project in our numbers.

■ Project execution/merchant tariff – key to stock performance
Our DCF based target price for Adani Power is Rs111/sh. We believe the capacity ramp up/ risks associated with the coal supplies (mainly the pricing) from Indonesia/ merchant tariffs are going to be the key for the stock performance. We have given the company benefit of doubt regarding the budget proposal of imposing a duty on power imported from SEZs to DTA
(domestic tariff area) however we have assumed a MAT rate for taxation for the company (similar to other mega power projects) even though the company’s assessment is that it will have zero tax liability for the initial 10 years under the SEZ Act. Initiate with an Underperform.

To read the full report: ADANI POWER


Company Description: Incorporated in 1986, BTL is a leading manufacturer and exporter of Steel Pipes & Tubes. It produces widest range of steel tubes including black tubes, galvanised tubes, pre-galvanised tubes and hollow sections and caters to industry segments like irrigation, urban infrastructure, automotive (bus bodies), airports, metro networks, etc. Ashok Leyland, Tata Marcopolo, Delhi airport, Gujarat Gas, Mundra SEZ, IRCON and Automobile Corporation of India are some of the major clientele.

Investment highlights

Strong Industry Growth
Demand for steel tubes in last three years has seen a tremendous growth following government’s thrust on urban infrastructure. With emphasis on aesthetics and complex structural designs in segments like airports, commercial complexes, usage of steel tubes and hollow sections has gone up. The entire tubes industry is situated in the north. The entire southern region is supplied by northern players who have to incur huge freight costs. BTL plans to expand in the southern region to tap this demand and cut the supply / freight costs.

Strong Expansion to drive growth
BTL has three plants in the country with an aggregate capacity of 200,000 TPA: two near Delhi and one near Bangalore. The company has inaugurated its fourth facility in Hosur, Tamilnadu in January 2010 to cater to the southern market. The facility is the largest in South India and is being built at a capital cost of INR 1bn and a capacity of 200,000 TPA. With the Hosur facility, Bihar Tubes is the largest producer of steel tubes in the country having total capacity of 400,000 TPA up to a size of 12 inches. The new facility has been built with latest machinery of
Kusakabe, Japan.

To read the full report: BIHAR TUBES


We initiate coverage on Tech Mahindra (TechM) with HOLD as we believe that risks such as high client concentration and focus on single vertical will likely result in revenue & EBITDA underperformance (ex-Mahindra Satyam) versus peers. The Mahindra Satyam (erstwhile Satyam) acquisition was the right step in diversifying long-term organic risk, but achieving normalised EBITDA margin for Satyam is an uphill task and seems difficult till H2FY11/FY12. We strongly believe that for TechM, the margin for error is low versus peers considering organic business risks and the difficult task of turning around Satyam. Therefore, any major valuation re-rating is unlikely and we prefer other large peers, with BUY on HCL Technologies, Infosys and Tata Consultancy Services (TCS).

TechM – Real struggle still to start. TechM’s revenues have grown at a scorching ~47% over FY05-09 with 78% CAGR through non-British Telecom (BT) clients. Our analysis indicates that capex growth for most of TechM’s top-5 clients (still 75% of revenues) and telecom operators in the US/Europe is likely to be muted in the coming years. This is besides continuing trouble in BT and current high base, which indicate weakening revenue growth visibility for TechM. We believe, revenue growth, excluding BT and US/Europe, would require investment and will likely take toll on
margins. Within non-BT clients, most of the growth is likely to come through higher offshoring (not yet witnessed) and from clients outside the US and Europe (which still form 14% of current revenues; margin in these markets is likely to be lower).

Mahindra Satyam – Running a tight ship. The Satyam acquisition has put TechM in the league of other Indian IT large-caps, who are now moving up the value chain (e.g. Axon acquisition by HCL Tech). The current valuation of Satyam is already factoring in ~15-20% EBITDA margin in FY11E-12E versus likely single-digit EBITDA margin in FY10. Hence, we believe further valuation re-rating for Satyam (trading at FY11E & FY12E EV/E of 9.6x & 6.7x) is dependent on margin upside beyond 20%, which is an uphill task for the management and unlikely till FY12.

Initiate with HOLD and Rs925 target price based on sum-of-the-parts (SOTP): i) Rs533 for TechM (excluding Satyam), discounting FY12E diluted EPS by 13x (our EPS calculation excludes amortisation of restructuring fees over five years received from BT) and implied EV/E of 7.8x based on adjusted EBITDA and ii) Rs392/TechM share through Satyam – target EV/E of 7.4x Satyam’s FY12E recurring EBITDA, which is at ~40-45% discount to Infosys’s and ~10-15% discount to HCL Tech’s target multiples. (EV/E is a better multiple for Satyam given less predictability on items below EBITDA with restatement of earlier years’ accounts in future.) Our target price discounts consolidated FY12E diluted adjusted EPS (including Satyam) by 14x.

To read the full report: TECH MAHINDRA