Saturday, February 4, 2012

>Indian Oil Corporation Limited: The entry tax jolt

IOCL lost UP entry tax case in Allahabad High court, liability of INR84bn: Allahabad High Court has dismissed IOCL's petition and upheld the UP Entry Tax Act 2007, whereby UP govt is entitled to levy an entry tax/octroi on crude oil at 5% (USD5.5/bbl at current oil prices) for its Mathura refinery. IOCL
will have net liability of INR84bn (refer table on page 2) including last ten-year demand with interest. Hon'ble Supreme Court while accepting the review petition has asked IOCL to deposit 50% of the accrued tax liability (INR42bn) and furnish bank guarantee for the balance within next few months. Hon'ble Supreme Court has also asked IOCL to pay the tax at the prevailing rates for the future period till the review petition is decided.

 Entry tax - an irrecoverable item for refiners, to make Mathura refinery unviable: Entry tax has been an irrecoverable item for refiners and not included as part of the refinery transfer price (RTP) as it is based on import parity price and does not include local taxes. Entry tax burden of USD5.5/bbl is huge with respect to average USD6.1/bbl GRMs made by Mathura refinery (8mmtpa) during FY09-11 and an average net margin of USD3.9/bbl.

 Full price hike in marketing looks difficult, we expect 2.5% underrealisation: IOCL will require MoP&NG approval (largely political clearance) for raising prices on regulated products in UP to cover this additional tax. On nonregulated products, IOCL will face the problem of substitution, as products imported from nearby states will attract entry tax in UP, which can be fully set-off against VAT. We believe that when Central Govt. itself is looking to raise prices of regulated products, it would be very difficult for IOCL to separately raise price in UP to pass through the entire entry tax leading to irrecoverable expense of ~2.5%.

 Impact on earnings: IOCL has to provide for this entire liability of INR84bn in one go, wiping off FY12e earnings. Also payment of INR42bn in next few months will increase interest liability by INR3.4bn in FY13e. Assuming 2.5% less pass through, IOCL recurring EBITDA would be impacted by INR7.4bn annually (INR2.1/sh post tax) on IOCL's recurring earnings.

Valuation and outlook
 Downgrade to HOLD: Considering Hon'ble SC doesn't reverse High Court order, we have reduced our earnings for FY12-14e. We have revised our valuation methodology and now value IOCL at an average of: i) FY12e 0.8x BV at INR174/ share; and ii) FY13e 10x EPS at INR200/share (FY13e revised EPS of INR20). We value listed investments at INR80/share. We downgrade the stock to HOLD in light of the above changes with a revised target price of INR267/share (earlier INR314/share).

To read the full report: Indian Oil Corporation Limited

>IDBI BANK: has strategic stakes in NSE, CARE and several other unlisted entities in the financial services space

Margins under pressure
IDBI Bank’s revenues and operating profit were lower than expected. Slow credit growth and rise in cost of fund contributed to the decline in profits. Chunky slippages also saw a decline in asset quality.

Quarterly Highlights
• Top-line lower than expected
• PAT down 9.7% YoY at Rs 4.1bn
• Credit growth at 16.2%YoY
• Deposit growth healthy at 17.9%YoY
• CASA improves to 19.2% up 414bps
• Asset quality healthy deteriorates, net NPLs at 2%
• Chunk of slippage from a single account
• Spreads under pressure
• Net interest down 12%YoY
• Operating profits down 27.3%YoY

At current levels the stock trades at 0.8X FY13E adjusted book value and 6.95X FY13E EPS. We rate the stock an OUTPERFORMER with a target price of Rs 151. The bank has strategic stakes in NSE, CARE and several other unlisted entities in the financial services space. These investments are expected to provide down-side cushion. Key risks include a lower than expected CASA composition and greater than expected slippages.

Balance sheet consolidation
In line with its objective of capital conservation IDBI Bank reported muted balance sheet growth. Loan book was reported at Rs 1,562.17bn up 0.2%QoQ. Moderation in growth was witnessed with a 16.2%YoY growth as against 19.7% in the September 2011 quarter. Deposit growth was reported at Rs 1,771.23bn up 17.9%YoY and 1.5%QoQ. The credit-deposit ratio was reported at 88.2%. IDBI Bank improved its deposit franchisee, despite intense competition from new age private sector banks. CASA deposits were up 54.1% YoY and 4.1% QoQ; CASA composition improved to 19.2% vs. 15.1% in December 2010. Investment book growth was muted at 2.1%YoY and 7.9%YoY. IDBI Bank reported a balance sheet size of Rs 2,558.89bn a 2.2%QoQ growth.

Spreads under pressure as yields lag cost of funds
Sharp rise in cost of funds by ~150bps (YoY) to 8.6% hampered spreads as yields failed to keep pace. Yields inched up ~70bps (YoY) to 10.1%. Spreads dropped about ~80bps (YoY) to 1.7%, amongst the lowest in a series of several quarters. Tight liquidity conditions since May 2011 has seen the banks spreads decline, as the bank relies on bulk deposits. With the bank absorbed a portion of the rise in cost of funds net interest margins were down ~60bps (YoY) at 2.4%. Net interest income was down 12%YoY at Rs 10.6bn.

To read the full report: IDBI BANK

>VATECH WABAG LIMITED: a leading technology focused Indian Multinational in the water treatment industry

VATECH WABAG Limited, a leading technology focused Indian Multinational in the water treatment industry, with market presence spanning across three Continents, offers complete life cycle solutions for sewage treatment, process and drinking water treatment, effluent treatment, sludge treatment, desalination and reuse for Industries and Municipal Corporations.

Investment Rationale
■ Water & Waste water Treatment - A Paradigm shift to preserve Natural resources
Investment in water supply and sanitation is expected to double to Rs.1222bn during 2010-11 to 2014-15 from Rs.548bn in 2005-06 to 2009-10 .The water supply segment forms 67% of investments followed by the waste water which accounts for 28%.

■ Strong Order book rendering revenue visibility of more than 2 yrs
The current Order backlog as of Q2FY12 stands at 33bn with contribution from the domestic & international segment in the ratio of ~70:30. We expect the order backlog for FY12 to be ~Rs.34bn rendering a revenue visibility of ~30mths.

■ An Asset-lite model with Core focus on Technology, Collaborations & R&D
A technological focussed patented approach, VA Tech has established R&D centres in Chennai-India, Vienna-Austria and Winterthur-Switzerland. It has a research collaboration programme in India with the Centre for Environmental Studies, Anna University. It has also technical tie-ups with Sumitomo Corporation, Japan & Zawawi group in Oman.

■ Initiatives aimed to improve operating margins
Strategic initiatives like Centralizing engineering assistance from India, implementing low cost sourcing model via global procurement policy, emphasis on higher margin O&M Segment, adopting decentralized approach & Multi-Domestic Unit concept to increase local presence are being implemented to focus on improving margins.

■ Venturing across geographies
Apart from focusing on existing international countries, it is also looking at emerging opportunities in Saudi, Tunisia, Algeria, Turkey, China, Philippines, Srilanka & Maldives. A cash rich model, notably worth Rs.3.2bn in its balance sheet, it is scouting for acquisitions to grow inorganically.

■ Valuation
At the CMP of Rs.358, the stock quotes a PE of 10x FY13E EPS of Rs.35 per share respectively. We initiate a coverage with a Accumulate Rating on the stock, with a price target of Rs.424 per share based on its PE of 12x FY13E EPS of Rs.35 per share.

To read full report: VATECH WABAG

>TVS Motors: refreshes of Apache and Scooty coupled with 2 new model launches in the motorcycle segment & a new scooter (in FY13, timing not known)

Operating results better than estimates; Maintain Buy

TVS Motors’ (TVSL) 3QFY12 operating results were better than our expectations with EBITDA margin at 6.5% vs our estimate of 6.1%. Revenues at Rs17.6bn were higher than our estimate of Rs17.5bn, largely driven by higher-than-expected realizations (up 0.4% QoQ despite unfavourable product mix vs estimated drop of 0.2% QoQ). Though the other expenditure stood higher than our expectations, lower than expected pressure on input costs coupled with improved realizations helped the company report better than expected operating performance. As a result, PAT stood at Rs566mn, higher than our estimate of Rs513mn. Going
forward, we believe that refreshes of Apache and Scooty coupled with 2 new model launches in the motorcycle segment (one to be launched in May/June 2012 and the other in 2HFY13 in the executive segment) and a new scooter (in FY13, timing not known) will help the company in arresting market share loss and maintain decent volume growth. Post the recent correction in the stock price, we believe the downside is limited. We continue to maintain BUY rating with a revised target price of Rs70 (earlier Rs75, price cut in line with earnings cut).

 Operating results better than estimates; PAT beats expectation: TVS reported overall sales of Rs17.6bn (est.: Rs17.5bn), up 7% YoY led by volume growth of 1.5% and realization growth of 5.5%. On a sequential basis, sales declined by 12%, largely driven by a drop in volumes by 11.9% as realization improved marginally by 0.4%. EBITDA margins for 3QFY12 stood at 6.5% compared to our estimate of 6.1%. This was largely on account of better-than-expected revenues and mild savings in RMC, as it helped the company negate higher than expected increase in other expenditure. As a result, PAT for the quarter stood at Rs566mn (up 1% YoY but down 26%QoQ) vs. our estimate of Rs513mn.

 Other highlights: 1. Company raised prices by 1-3% in the domestic market during 3Q and 3.5% in the exports market; 2. During the quarter company invested Rs.258mn in PT Indonesia and did volumes of 4033 units (YTDFY12 investments in PT Indonesia stands at Rs.622mn and volumes are at 18,905 units); 3. It also made investments of Rs.150mn YTDFY12 in TVS Energy (60MW capacity is expected to be
commissioned by March 2012).

 Valuations and Recommendations: At the CMP of Rs53, the stock is trading at 9.5x FY12E EPS of Rs5.1 and 7.9x FY13E EPS of Rs6.1. We continue to maintain our BUY rating with a revised target price of Rs70 (earlier Rs75, price cut in line with earnings cut). We are factoring in negative value of Rs.3 for PT Indonesia.



Exceptional Items drag PAT below expectation
HCC reported in-line revenue and operating profits for Q3FY12. However, exceptional items below EBITDA pushed PAT to a massive loss of Rs1.6bn v/s Rs270mn loss expected. We are not bullish on EPC due to its Hydro power exposure and high leverage eating away operating margins. Exceptional items are a further drag on the earnings capability of the EPC arm. We downgrade HCC to Sell from Hold due to its recent rally of 20% after our upgrade to Hold on 10th Jan’12. However, we maintain our target price of Rs19 (14% downside). We advise investors to look at Road Developers like ITNL and Sadbhav Engg for better risk-reward.

■ Operational numbers in-line: Revenue and EBITDA have been in-line with our expectation, though much below that of the street. We believe the company will face execution challenges due to its high exposure to Hydro power EPC and slow moving AP irrigation projects. Its road project in West Bengal provides a breather to its overall EPC revenue, though not to the level of superior growth. Order-Intake during the quarter was Rs8.5bn and orderbook at Rs162bn.

 Exceptional Items were beyond our understanding: HCC reported a list of exceptional items like 1) Rs648.7mn on account of additional cost on account of substantial delays in approval of claims 2) Rs520mn provision made for expected future losses in respect of 2 new projects 3) Rs160mn provision arising from revision of cost to completion for expected future loss on sale of asset 4) Rs270mn provision made on account of performance bank guarantee wrongfully encashed by a client 5) Rs66.9mn against dues from a subcontractor. Standalone business earnings already had low visibility. These items will further drag confidence on profitability and prove our assumption on the company incurring losses till FY14.

■ Other construction stock to provide better risk-reward , but recent rally makes asset owners like ITNL & Sadbhav better bets: The company faced multiple headwinds like 1) execution challenges in Hydro power & irrigation order backlog 2) High leverage in stand-alone balance sheet that is eating away operating profit and 3) Uncertainty on Lavasa project’s future. The only value driver for the stock is its robust road portfolio which saw a PE equity valuation of Rs17bn. Due to risks in EPC, we do not value the EPC arm, ascribing a nominal value of Rs3/share to Lavasa, Rs11 to the roads arm and Rs5 to other assets, and derive a SOTP value of Rs19 (14% downside from the CMP Rs23). We advice investors to stay away from HCC and consider ITNL and Sadbhav).


>GREAVES COTTON: Supply to Tata Motors ramps-up

Hit by one-offs; Retain BUY

■ Engines division – Benefits from supply to Tata, but margins decline
Engines division posted healthy revenue growth at 17% yoy to Rs4.1 bn – led by pickup in engine supplies to Tata Motors and commissioning of new facility. EBIT margins declined by 360 bps yoy to 16.7% (in line with estimates) - due to rising OEM sales, high input costs and one-off expenditure.

■ Infrastructure division – EBIT loss rises sequentially to Rs28 mn
Infrastructure division performance was impacted by low offtake amidst high interest costs scenario and continued delay in implementing emission norms. GCL highlighted slowdown in both roads and concrete equipment segments Consequently revenues declined for second consecutive quarter by 25% yoy to Rs363 mn (revenue below estimates and break even level increases) while EBIT loss increased sequentially to Rs28 mn.

Tata Motors supply ramps up to 5,500 units per month
GCL showed ramp-up in supplies to Tata Motors (for Ace-Zip and Ace-Magic) à it supplied 5,500 units per month (or about 200 units per day) in Q3FY12 Vs 4,000 units supplied in Sep’ 11. GCL expects to ramp-up supplies to about 8,000 units per month (or 300 units per day) in FY13E. GCL reiterated strong acceptance of the new launches by Tata Motors – hinting at robust growth momentum in FY13E.

■ Reduce FY12E earnings by 13% and FY13E earnings by 9%
We have reduced our FY12E earnings estimates by 13% to Rs6.0 per share to factor (1) lower gross margins in 9MFY12 (2) expected one-offs in Q4FY12E (3) slow revival in infrastructure sector and (4) muted performance in industrials and auxiliary power business. We have also revised our FY13E earnings by -9% to Rs7.0 per share to factor (1) higher revenue contribution from auto OEMs (Tata) – which has lower gross margins than traditional business (2) lower growth expectations in engines business (barring Auto) and (3) slower turnaround of infrastructure business.

■ Retain BUY with price target of Rs90 per share
Adjusting for one-offs, GCL posted strong performance despite tough business conditions. We expect GCL to post healthy earnings growth at 21% in FY13E period alongside strong cash generation and return ratios (ROCE at +35% and ROE at +25%), despite the current earnings downgrades. At CMP, the stock is trading attractively at 11.4X FY13E earnings. Retain our BUY rating with revised price target of Rs90.


>CAIRN: Flat Mangala production; Aishwariya production is likely to commence

Cairn reported better than expected numbers owing to lower interest expenses, higher other income on higher cash balances and over Rs3bn in forex gains. Operational performance was in line with Mangala crude production at 125,122bpd during Q3.

 Rajasthan crude attracts only 8.3% discount to Brent: Due to narrowing light-heavy differentials, Rajasthan crude attracted only 8.3% discount to Brent against about 10-15% which aided revenues. Cairn’s revenues jumped 16.8% QoQ but remained flat YoY at Rs31.0bn.

■ Mangala production flat: During Q3, Mangala crude production averaged 125,122bpd against 125,251bpd in Q2. The company did not receive government approvals for Bhagyam during the quarter which led to flat QoQ production. Crude production from Ravva declined QoQ to 26,254bpd from 26,965bpd in Q2; however, gas production jumped to 62mmscfd from
55mmscfd in Q2. Cambay crude production also declined QoQ to 4,795bpd from 5,390bpd in Q2 and gas production remained flat at 19mmscfd.

 Opex, DDA in line: Opex during the quarter remained low at US$2.5/bbl (including transportation), yet the company maintained its long term guidance of US$5.0/bbl. DDA for the quarter was at US$8.0/bbl in line with the company’s guidance. Interest cost declined 80.5% QoQ to Rs240mn on the back of retiring debt during Q2. On the other hand, other income jumped 81.3% QoQ to Rs1,124mn on account of higher cash balance. The company also earned forex income of Rs3bn thus providing fillip to the bottom-line. Cairn thus reported 196.8% QoQ and 12.5% YoY jump in PAT at Rs22.6bn.

 Bhagyam production starts, awaiting approval from government to increase Mangala production: Cairn commenced crude production from its Bhagyam field on January 19, 2012 which will be ramped up to its plateau of 40,000bpd by the end of February, 2012. This would take Rajasthan crude production to 165,000bpd while the company still maintains its exit rate for FY12E at 175,000bpd. The management guided crude production of 175,000bpd+5-10% for FY13E. As per earlier guidance, Aishwariya production is likely to commence in H2CY12. Cairn is awaiting approvals from the government to increase production from MBA fields to 240,000bpd. Phase-I exploration program for Sri Lanka block is over and phase-II has started (2-year program). Exploratory drilling in the Sri Lankan block is expected in 2013 based on rig availability. The company has spent over US$157mn in Phase-I
program in Sri Lanka. The stock has jumped by over 11% during the last one month. Hence, we downgrade the stock from ‘Buy’ to ‘Hold’ maintaining our price target at Rs376.