Friday, September 3, 2010

>EXIDE INDUSTRIES LIMITED: Smelter stake hike adds value

Raising PO on smelter acquisition & rising competitiveness
We interacted with Exide recently and learnt that (1) stake in battery smelter Leadage
has been hiked to 100% from 51% for a nominal sum; and (2) capacity expansion
from Sep onward is likely to boost volume growth and improve product mix. We
maintain Buy with PO raised to Rs171 driven by (1) higher EPS; and (2) higher PE
owing to rise in competitiveness leading to higher margin than peers.

Higher in-house smelting to help gain from rising lead price
Exide has hugely benefited from recycling of old batteries in own smelters. This is
evident from the fact that Exide’s EBITDA margin expanded to 24.6% in FY10 and
remained at 22.8% in Q1FY11 compared to an average of 16.4% in FY07-09.
Whereas Amara Raja, key competitor of Exide has seen its margin sliding to
13.9% in Q1FY11. Benefit of smelter is likely to rise further with rise in lead price
and rise in extent of in-house smelting from 50% in FY11e to 70% by FY14e.

Hiking EPS on Leadage stake hike and strong demand
We have raised FY11e EPS by 3% and FY12/13e EPS by 5% owing to (1) hike in
stake in Leadage having PAT of Rs545mn in FY11e and Rs673mn in FY12e; and
(2) stronger sales growth in automotive replacement battery driven by easing of
capacity constraint from Q3FY11 as new capacity will kick in.

Re-rating on rising competitiveness & growth upside risk
Exide is trading at PE of 16.7x FY11e and 14.4x FY12e and could re-rate further
owing to (1) rise in Exide’s profit margin relative to peers driven by lower cost; and
(2) likely positive surprise to earnings from stronger retail battery sales driven by
capacity expansion and change in product mix in favor of premium car battery.
Our PO of Rs171 is the sum of (1) Rs159 for core earnings based on 15.5x
FY12e; and 2) insurance JV at Rs12 equivalent to 1.2x the investment amount.

To read the full report: EXIDE INDUSTRIES LIMITED

>VIBRANT GUJARAT: Glimpses of the Gujarat growth story

Several impeccable records

 Gujarat is probably the only Indian state in which the ground water level has increased
over the past 10 years, driven by state government efforts towards interlinking of rivers,
etc. The state’s agriculture economy has also reported robust GDP growth of 9% over
past several years and this is much higher than all-India average of 2%. This has led to
economic development including better quality of lives for masses, including in rural
areas, etc.

 Development and fiscal health can go hand in hand. Ten years ago, Gujarat had a fiscal
deficit of Rs67b but today it has a budget surplus of Rs5b. Also, over 10 years, Gujarat’s
state electricity boards have turned in a profit of Rs4b from a loss of Rs25b, despite no
tariff hikes in the past 10 years and post discounts of Rs9b towards promotion of new

 Gujarat has been the pioneer in terms of starting the model of professionalizing PSUs
as opposed to closure or privatization.

To read the full report: VIBRANT GUJARAT

>COAL SECTOR: Facing demand-supply mismatch

Indian coal industry is the world’s third largest in terms of production and fourth
largest in terms of reserves after the US, Russia and China and also the world's
third largest coal consuming nation after US and China. Around 70% of the total
production is used for electricity generation and the remaining by the steel,
cement and other heavy industries. Coal is also used as fuel for domestic
purposes. About 88% of the total coal production in the country is produced by
various subsidiaries of Coal India Ltd. which is the largest supplier of coal in the

Power sector fuels demand: India has emerged as one of the major buyers of
global coal, with imports doubling in the past four years. A significant portion of
the supply is used by the power utility sector followed by steel (coking coal). For
the current year the coal imports are expected at around 90 million tonnes as
new thermal capacities come up. According to working group on coal and
lignite, the projected domestic availability of coal is 680 million tonnes (mt)
against the projected demand of 731 mt in the terminal year of the Eleventh Plan
period, that is, 2011-12.

Demand-Supply Mismatch: India faces a steep demand supply mismatch with
the power sector growing at a faster rate of 10% while the coal production
clocking in a growth at 5-6%. Currently there is a 10% gap in the demand and
supply of the dry fuel which alone accounts for more than half of the country’s
annual overall demand for commercial energy at 329 million tonne oil
equivalent (Mtoe). As per government estimates coal shortage in India is likely to
touch 15% or 81 million tonnes by the end of the current Plan period that is
March 2012.

Govt initiative: The government has proposed to increase investments in
developing infrastructure at the coal fields. Investments towards regional
exploration, detailed drilling, environmental measure and development of
transportation infrastructure in coal fields will be raised to Rs 400 crore in 2010-
11, from Rs 260 crore in 2009-10. However, Coal India Ltd and Singareni
Collieries Company Ltd, from their internal resources, propose to invest Rs 3,800
crore and Rs 1,335 crore in 2010-11 against provision of Rs 3,100 crore and Rs
634 crore during 2009-10 respectively for increasing production.

Going ahead: The production from Coal India Ltd (CIL) and its subsidiaries is not
able to keep pace with the demand, with economic activity gaining momentum.
Inadequate railway unloading infrastructure is another reason for difficulty in
meeting production targets. The demand-supply gap is set to further widen in the
coming years. Total coal availability in the country by end 2017 would be close
to 647 mt with a projected import requirement of over 86 mt. A major constraint
in ramping up production is the failure of companies to develop captive coal
blocks allotted to them by the coal ministry. The shortage is likely to continue
unless almost all the coal blocks are in production mode.

Our view: The demand-supply mismatch in the coal sector is likely to continue
in the next few years. Power utilities are also importing coal to meet the shortfall
in domestic supply. To reduce the input cost, the companies are also doing
backward integration. In the long term Sarda Energy & Minerals Ltd. remains our
Top Pick on better performance.

To read the full report: COAL SECTOR

>Is it all over for the global wind markets?

Weak electricity demand resulting from energy efficiency measures
and recessionary forces have made national wind installation targets
easier to achieve. We have therefore cut our five year wind industry
global demand CAGR to 7.0% from 7.5% previously and our 10-year
CAGR to 5.5% from 6.7%. We remain cautious on the wind OEMs,
and see few near term catalysts for share price performance. Our
favourite part of the value chain remains the wind farm developers
as we feel that that the developers offer a more compelling
combination of earnings visibility and valuation and our preference
for this part of the value chain has now increased. Acciona and EDP
R, both rated OW(V), are our highest conviction investment ideas

What’s going on with the markets?

Why has the wind sector been so weak?

The wind sector has been weak since the start of the credit crisis in September 2008. Until this point it had held up pretty well, when most other sectors had already been selling off. However, in the two months following the collapse of Lehman Brothers, the sector more than halved in value; the wind farm developers lost 50-60% and the wind turbine manufacturers lost 60-70%. The focus at this time was lack of availability of project finance.

The sector then recovered some of its share price losses during the March 2009 bear market rally, but subsequently spent a year in the doldrums, with share prices moving sideways. The main reason for this was lack of order flow during 2009 due to US regulatory uncertainty and only a modest improvement in project finance markets throughout the course of 2009. Order flow has finally started to pick up in H1 2010, double the H12009 level, but importantly it remains around 70% below H12008, and the recovery is less strong than we had hoped for due to the Sovereign debt concerns in Southern Europe, increasing the possibility of tariff reductions (see our note dated 21 June 2010, entitled ‘Carbon default – real of imagined?’), and at the same time the Clean Energy regulatory rollercoaster in the US Senate started heading for derailment. From mid-April onwards, the sector sold off along with the wider Southern European markets, but whereas the Southern European markets have recovered some 20% since early June, the wind sector has not; some stocks have recovered slightly but most have not. This, we believe, is due to continued uncertainty over clean energy legislation in the US, which is now unlikely to pass the Senate before mid-term elections in November.

To read the full report: GLOBAL WIND MARKETS

>IT SERVICES: Earnings Expectations and Ownership – A Closer Look

 Earnings beat/upgrades to drive stock prices — Given current valuations, EPS
beat/upgrades remain the key catalyst for the sector, in our view. For example,
post 1Q results, TCS was the only stock that witnessed meaningful operational
upgrades – after which, TCS outperformed its peers. In that context, we take a
closer look at expectations as they can limit or result in surprises/upgrades.
 Expectations for Infosys are the highest; Wipro the lowest — Our analysis (Fig. 1)
highlights that consensus (IBES) expectations for Infosys are the highest – implied
EBITDA CQGR over next three quarters is ~10%. The same number for TCS and
HCLT is 4.1% and 4.5%. Wipro stands out – expectations are lowest at ~1.2%
CQGR over next three quarters (we are slightly ahead).

 What does history suggest? — Our analysis (Fig. 2) suggests that Infosys has on an
average delivered ~8% CQGR (2Q to 4Q) over the last 5 years. While that does not
rule out the possibility of positive surprise, it is a limiting factor. Also, 2Q is strong
but 3Q/4Q are seasonally weak quarters. Wipro, on the other hand, has delivered
an ~8% CQGR (2Q to 4Q) over the last 5 years – good likelihood of EPS upgrades,
we would argue.

 Is Indian IT under-owned? — Yes, it is – FIIs (300bps), DMFs (~600bps) and
Insurance (~700bps) are all underweight. However, the key question is: whether it
is a technical under-ownership? The surprising part is that over the last 5
quarters, the sector has outperformed but its relative weight (vs index) has gone
down. In MSCI India, Infosys is ~11% while in Nifty it is ~8.3% (and ~10% in
Sensex). With most funds unlikely to have such a big exposure to a single stock,
under-ownership may remain and may not be a big supporting factor.

 Remain Neutral on the sector; Buy HCLT/Wipro — Given recent macro concerns
and high expectations/valuations, it is difficult to see meaningful upside. In the
expectation context, Wipro looks a likely candidate for EPS surprises, has
underperformed (~7% vs. BSEIT YTD) and trades at ~15-20% discount to TCS
and Infosys. HCLT/Wipro are our top picks in Indian the IT services space.

To read the full report: IT SERVICES

>Tata Steel sells Corus’ TCP unit at USD 500mn

To read the full report: TATA STEEL

>Hindusthan National Glass & Industries Limited

Hindusthan National Glass & Industries Ltd (HNGIL) registered stable revenue growth of
10.8% y-o-y to Rs 3.6 bn in Q1FY11 primarily on account of volume growth. However,
PAT dipped 45% y-o-y to Rs 313 mn primarily on account of lower EBITDA margins, which
declined to 20.9% as against 28.3% in Q1FY10 due to higher fuel costs. Although the
company has the bargaining power to pass on any increase in costs, there is a time lag in
doing so and, hence, there is a temporary impact on margins.

CRISIL Equities expects margins to recover in the subsequent quarters since the company
has raised prices by ~6% with effect from August 1, 2010. Increase in realisations will also
have a positive impact on the overall revenue growth for the year. Although the y-o-y
revenue growth of 10.8% in Q1FY11 was lower than our forecast of 15.8% for the full year,
we believe that given the recent increase in realisations, the company will make up for this
lower growth in the subsequent quarters. We continue to remain positive on the growth
prospects of the company driven by its leadership position in the container glass industry
and strong management capabilities. We maintain the fundamental grade of ‘4/5’,
indicating that HNGIL’s fundamentals are ‘superior’ relative to other listed equity
securities in India. We assign a valuation grade of ‘5/5’, indicating that the market price
has a ‘strong upside’ from the current levels.

EBITDA margins revised downwards
HNGIL reported an EBITDA margin of 20.9% in Q1FY11, which was significantly lower
than CRISIL Equities’ full-year estimate of 25.0% for FY11. The variation was mainly on
account of higher power and fuel costs following the rise in international crude oil prices.
Even though we expect margins to recover in the following quarters given that the
company has raised its prices by ~6% with effect from August 1, 2010 the impact of lower
margins in the first quarter will have some bearing on the margins for the full year. We are,
therefore, revising our operating margins downwards by 150 bps to 23.5%. We also revise
our EBITDA margins for FY12 to 24.1% as against our earlier estimate of 25.5% as there
is some delay expected in shifting its two plants – Neemrana and Nasik from fuel oil to
natural gas.

Lack of clarity on the float glass business
HNGIL recently entered the float glass business through HNG Float Glass Ltd, where it
holds a 36% share. The production of float glass began in February 2010 and it reported
revenues of Rs 500 mn and a loss of Rs 70 mn at the EBITDA level for the two months
ended FY10. However, there is a lack of clarity on the performance of the float glass
business in Q1FY11, as the company does not disclose the results of HNG Float Glass on
a quarterly basis; only the consolidated results are available at the time of financial year

Valuations – strong upside from the current levels
We initiated coverage on HNGIL (dated March 2, 2010) with a fair value of Rs 314. With
the downwards revision in EBITDA margins for FY11, we have arrived at a fair value of Rs
292 per share. The implied PER at the revised fair value estimate is 13.0x FY11 and 11.4x
FY12 earnings. This translates into a valuation grade of ‘5/5’, indicating ‘strong upside’
from the current levels.

To read the full report: HNGIL