Tuesday, November 22, 2011

>India Consumer Staples Q2FY12 Review: Tier I outperforms!!

􀂄 Broad takeaways from management calls: A) Though demand has remained intact as yet and benefits of good monsoon can be seen in the subsequent quarters, impact of food inflation on urban wallets, leading to down-trading, is a threat. B) Competitive intensity remains high and ad-spends should move up in H2FY12e. C) Currency depreciation will impact input costs in H2FY12e.

􀂄 What surprised us? Positives: 1) Volume growth of 9.8%, 8% and 14% reported by HUVR, ITC and Marico 2) HUVR’s operating margin expansion of ~100bps. Negatives: 1) Dabur’s subdued volume performance. 2) Fourth consecutive quarter of PAT decline in CLGT. 3) Sharp operating margin decline in APNT (~400bps).

􀂄 What lies ahead? 1) Possible moderation in volume growth owing to a) fading impact of government social spending schemes in rural areas and b) sustained high inflation leading to down-trading in urban markets 2) We believe pricing power will continue to be tested in an environment of high input costs, sticky food inflation and elevated competitive intensity. Price hikes taken so far haven’t neutralized gross margin pressure and further price hikes will be
essential to sustain brand investments. 3) Current strategy of reducing adspends to manage operating margins is not sustainable in our view and will impact volumes, going forward.

To read full report: CONSUMER STAPLES

>>India Gas: Irrational tariff bidding continues – This time GAIL adopts and emerges winner

GAIL wins Surat-Paradip pipeline, with low zone-1 tariff: Very similar to ultra-low tariff strategy adopted by GSPL’s JV (GSPL 52%) last year, GAIL seems to have followed suit and has emerged a winner. As per an Economic Times article (GAIL wins rights to lay Surat-Paradip pipeline, 16 Nov 2011), GAIL bid very low (in fact the lowest allowed) tariff of 1 paisa/mmbtu in zone-1.

Bidding criteria encouraged irrational bidding: Such ultra-low zone-1 tariff may seem irrational, but perhaps was warranted as bidding criteria was somewhat irrational and too mathematical, in our view. As we highlighted in our note after GSPL won pipelines last year (Cross-country pipeline bidding – adding to the chaos, 22 October 2010) and in our anchor report (India Gas – Time to get back in), the bidding criteria were highly mathematical. It required bidders to give projections for each of the next 25 years, and gave too much weight to just zone-1 tariff.

Winners could still make decent returns: We had also highlighted (using hypothetical numbers) that despite low tariff zone-1 tariff, winners could charge high tariffs from zone -2 onwards so that average tariffs remain high and returns are reasonable. Despite low zone-1 tariffs for its three pipelines, GSPL remains confident of achieving 15%+ IRR. GAIL may also get similar returns.

With actual bid numbers now available on PNGRB website, as an example we analyse the numbers bid by GSPL JV and GAIL for Mallavaram-Bhilwara/Vijaipur pipeline last year. This shows that though GSPL’s JV bid for low tariffs in zone-1, tariffs sharply increased from zone-2 onwards. By bidding very low in criteria 1 (zone-1 tariff) and criteria 3 (zone 2 to 3 escalation), GSPL would have scored 100% score (and GAIL below 10%) for these two criteria. Thus despite getting lower score in criteria 2 and nearly same score in volume criteria 4, GSPL’s JV would have emerged winner by a wide margin.

First priority seems to corner pipeline: The strategy of bidders (at least of winners) has been seemingly (and perhaps rightly so) to take advantage of loopholes and win networks first and worry about tariffs later.

The penalties, if pipelines are not constructed (or not constructed on time) are not high. The performance bond for three pipelines awarded last year ranges from INR150mn to INR200mn, and is less than 0.5% of estimated project cost for INR120bn for three pipelines put together.
Adds to near term concerns: Even as we consider that winning a pipeline is positive (we believe pipeline would be constructed only; companies would see these as NPV positive) in near term such low bids add to concern. The serious investment in these pipelines would be forthcoming, in our view, only when companies see clear visibility on demand on the route of these pipelines, and also supply visibility via domestic gas or imported LNG.

We highlight that not much work has commenced on the three pipelines that GSPL’s JV won last year. After long delays, the actual authorization for these pipelines was issued by the regulator only in July 2011, and the six month period to achieve financial closure is valid till January 2012. In fact, not much physical progress has taken place on several pipelines that were authorised by Ministry of Petroleum and Natural Gas in 2007 (prior to formal appointment of regulator in 2008).

We do not ascribe value to these pipelines yet: With limited clarity on gas demand/ supply, tie-ups with customers and realistic timelines, we currently do not ascribe any value either for three pipelines won by GSPL’s JV or now for GAIL’s Surat-Paradip pipeline. As we say earlier, if implemented, these pipelines would be value accretive,

To read full report: GAIL

>Ruchi Soya: 2Q12 miss; expect negative stock reaction (NOMURA)

Ruchi Soya’s 2QFY12 results were below our estimates - (net income of Rs37.8mn was down 94% both y-y and q-q). Higher raw material cost and sharp depreciation of the Indian rupee (vs the USD) led to a drop in earnings. Though the stock is currently trading at 11x CY12F earnings, 1H12 standalone now forms only 26% of our full-year numbers, and we think there is a downside risk to our FY12F estimates. These weak results continue the trend we have seen in global supply players (weak trading conditions), and we see some negative reaction to stock price.

Lack of bargaining power and unhedged forex exposure hurt 2Q12 Management commented that the quarter was impacted by higher raw material prices (as we noted for Mewah, companies with large downstream operations were unable to pass on higher raw material prices to consumers), volatility in commodity prices and mark-to-market (MTM) provisions due to a steep fall in the USD-INR exchange rate. The company made an unrealized loss provision of Rs849mn on restatement of USD borrowings of which ~Rs420mn is MTM loss on loans payable during the next 2 years, ~ Rs220mn is forward contract losses for which physical contracts are not executed and Rs170mn loss due to unhedged exposure. In our view, some portion of MTM losses may be reversed if the Indian rupee strengthens vs the USD in coming periods, but we do not treat it as part of exceptional income. On the positive side, utilizations improved and plantation momentum remained strong. As a result, management expects 2H12F earnings to be more comparable to 2H11 earnings.

Other key takeaways from management:
Total revenues grew by ~60% y-y and 3% q-q mainly due to strong growth in the Oil segment (up 75% y-y and ~2% q-q). Segment-wise, the Oil segment recorded negative EBIT of Rs363mn with EBIT margin of -0.7% during the quarter, due to most of the adverse impact of exchange rate movements being in this segment.

Management expects soya crop for the current season (11mn vs 9.5mn) to be better than the previous year and higher capacity utilization of soya crushing operations.

Capacity utilization of crushing facilities increased from 36% to 41%. Capacity utilization of refining facilities increased from 76% to 82% from year ago. While port-based refiners are running at 90%+ utilizations.

Branded sales have gone up by 50% from Rs9,308mn to Rs13,972mn.

Current palm plantings are at 37,000ha - mgmt says they should be able to reach 40,000ha by FY12F, and at least 10,000ha per annum thereafter.

2Q12 tax rate was high at ~63% vs ~35% tax rate during same period in previous years.

To read the full report: RUCHI SOYA