Friday, March 16, 2012

>EICHER MOTORS: Significant outsourcing opportunities from Volvo

With our expectation of market share gains in heavy tonnage trucks, margin improvement and significant outsourcing opportunities from Volvo, we believe Eicher is poised to emerge as a powerhouse in the Indian commercial vehicle industry over the long term.

With 38% market share in the sub-12T truck segment, Eicher is a leader in that segment. However, it has only 3% market share in heavy tonnage trucks (above 12T). Similarly, in motorcycles, it commands a dominant market share in the 250cc and above bikes but has a negligible market share in the overall motorcycle market. Our BUY stance on Eicher is underpinned by four drivers:

 Eicher looks well suited to capture market share in heavy tonnage trucks on the back of positive user feedback on quality and fuel efficiency, improved availability of spare parts and after-sales network, keen involvement of Volvo and the duopoly industry structure (which makes it vulnerable to competition). In the heavy tonnage trucks segment we expect Eicher to post market share of 8.2% by CY2015 v/s 3.1% in CY11.

 Volvo Eicher Commercial Vehicles’ (VECV’s) EBITDA margin has expanded to 9.7% in CY11 (from 4.8% in CY09). With increasing market share in the heavy tonnage segment, VECV’s margin has further scope for improvement arising from the narrowing pricing discounts v/s peers, reduction in sales incentives/selling expenses and operating leverage benefits. We factor in an EBITDA margin of 10.2% for core Eicher trucks and buses by CY15 (v/s 9.1% in CY11 and v/s Ashok Leyland’s 11% in FY11).

 We believe that medium duty engine outsourcing from Volvo carries benefits of opening up more outsourcing opportunities from Volvo, enhancing the R&D capability at VECV and, given its captive nature, reducing the cyclicality of the business.

 With premiumisation on the rise in the Indian motorcycle market, we believe Royal Enfield is batting on a good wicket given its leadership in the 250cc and above bikes and strong brand appeal. With near doubling of capacity by 1QCY13, we expect volume CAGR of 21% over CY11-CY15.

Valuation: Our DCF model values the motorcycle business at `600/share, implying 9x CY13 EBITDA, a 10% discount to Hero MotoCorp and Bajaj Auto. Our DCF valuation for VECV yields `1,451/share, implying 7.3x CY13 EBITDA (i.e. 5% premium to Ashok Leyland). This gives us an SOTP-based value of `2,051 i.e. 19% upside. Competition from new entrants in the heavy trucks segment, a shift in tonnage dynamics within the truck industry and imposition of royalty by Volvo on VECV at a future date are the key risks to our BUY stance. Rising market share for Eicher in heavy tonnage trucks and margin improvements are the key positive catalysts.

To read full report: EICHER MOTORS

>BIOCON: Pfizer have terminated the $350mn (Rs17.5bn) agreement for the supply of insulin and its analogues

Biocon and Pfizer have terminated the $350mn (Rs17.5bn) agreement for the supply of insulin and its analogues. Pfizer was to market Biocon’s insulin products in various countries including the US. The termination of agreement is negative for Biocon in the short term as it has to find another partner to market its insulin products in the developed and developing markets or alternatively to create its own marketing set up. The exit of Pfizer is due to the change in business priorities in Pfizer’s biosimilar programs. Biocon has already received $100mn (Rs5.0bn) upfront payment and is likely to receive a major portion of $100mn (Rs5.0bn) lying in escrow account. Moreover, Biocon will also get undisclosed settlement fees on termination of the agreement. We reiterate Buy with a revised target price of Rs350 (based on 16x FY14 EPS).

 Details of the Pfizer agreement: Biocon entered into an agreement with Pfizer Inc., US for the supply of human recombinant insulin and its three analogues in October’10. The four biosimilars have a combined market size of $14bn (Rs700bn). The deal size was $350mn (Rs17.5bn). Under the agreement, Biocon has already received $100mn (Rs5.0bn) as upfront payment and $100mn (Rs5.0bn) is lying in the Escrow account. Biocon is likely to get the major portion of this amount. In addition, the company was to receive additional development and regulatory milestone payments up to $150mn (Rs7.5bn) but is unlikely to receive this amount. Biocon was also to receive additional payments linked to Pfizer’s sales of four insulin
biosimilars across the global market.

 Bicon to retain intellectual property: As on 12th March’12, all rights of insulin range of products licensed to Pfizer will revert to Biocon. All insulin products distributed under the brand names Univia and Glarvia will be available to Biocon only. Hence, all intellectual property rights under the deal will revert to Biocon. Hence Biocon is not a loser in terms of milestone payments and intellectual property rights.

 Company to receive settlement fees: Biocon is likely to receive an undisclosed settlement fees on the termination of the agreement with Pfizer. This will be reflected in Q4FY12 results of Biocon.

 In search of another partner: Biocon and Pfizer have said that due to the individual priorities for the biosimilar business it is in the best interest to move forward independently. Biocon will have to find another partner to market its insulin range of products in the developed and developing markets. There are three major players in the global insulin market namely: Novo Nordisk, Eli Lilly and Sanofi Aventis. Currently, Biocon has 15 partners in various emerging markets. Alternatively, Biocon will have to establish its own marketing set-up. Both these are time consuming exercises.

 Divestment of Axicorp stake: After entering into the insulin agreement with Pfizer, Biocon divested its majority stake in Axicorp, Germany. Axicorp was a front of Biocon for marketing its products in Europe. Hence, Biocon will have to establish its own marketing set-up in Europe or find another marketing partner.

 Out-licensing of NCEs: Biocon has plans to out-license its IN-105 oral insulin molecule to a global pharma company. The molecule has completed phase III trials in India. The company’s other molecule Itolizumab for psoriasis has completed phase III clinical trials in India and has exhibited an excellent safety and tolerability profile. Biocon has plans to out-license this molecule also.

 Reiterate Buy: We have revised our EPS estimates downwards by 18% for FY13 and 23% for FY14 due to the termination of Pfizer deal. At the CMP of Rs249, the stock trades at 12.5x FY13E EPS of Rs19.8 and 11.4x FY14E EPS of Rs21.9. We are positive on the long-term prospects of the company in view of its strong growth in branded formulations and CRAMS segments and the possibility of outlicensing of two of its NCE molecules. We reiterate Buy with a target price of Rs350 (based on 16x FY14E EPS).

To read full report: BIOCON

>When will the oil price become a problem? Scenario analysis (DANSKE)

Will oil prices derail the global recovery (again)?

■ Oil prices are again on the rise creating a new risk to the global economy. This takes thoughts back to early 2011 when the global recovery was confronted with a sharp rise in oil prices followed by a downturn in the global economy.

■ In this document we look at how much it would take to derail the reocovery. We outline three scenarios for the oil price and estimate how much they affect the global economy.

■ So far, the rise in the oil price has been moderate and we expect the effects to be limited, although it will dent the US recovery somewhat in the short term.

■ Our estimates suggest the oil price has to go above USD140/bl to have a material impact. This would create a soft patch in the US, with growth below 2% and prolong the period of weak growth in the euro area. We expect China to be least affected.

■ Should oil prices rise to USD170/bl, we project the US would experience a sharp slowdown, with growth below 1% for the rest of the year. The recession in the euro area would also be prolonged. Chinese growth would also be hit but would remain at decent levels.

■ Oil price shocks tend to hit the US the most relative to Europe and Asia

To read full report: GLOBAL RECOVERY

>PORT ANCHOR: Traffic at Mormugao and Vizag were the worst affected by the ban in iron ore mining leading to lower iron ore port volumes

Container traffic hits a speed breaker

Volumes at India’s 12 major ports continued to decline in FY12 mainly led by the fall in iron ore volumes. Overall, volumes declined 5.8% YoY to 43.7mn tonnes. However, the trend in sequential improvement witnessed for the last 5 months was broken with a 10.6% MoM drop in overall thru-put. This is a particular phenomenon witnessed in the month of Feb for the last 3 years when there is a sudden drop in volumes sequentially which later recovers in March. Volumes for POL (Petroleum, Oil &  Lubricants), Coal and other cargoes increased YoY while iron ore and containers were major laggards. Iron ore traffic continued its decline, falling 55.8% YoY and 5.8% MoM to 4.1mn tonnes. Container traffic too mirrored the overall traffic trend declining 7.7% YoY and by a sharper - 18.0% MoM given that during January it had recorded its highest volumes in the last two years.

 Container volumes falter: Containerised traffic declined 7.7% YoY and 18.0% MoM to 0.56mn TEUs – its usual trend in last two years for the month of February. Volumes decline in Feb and then recover in March as Q4 has traditionally been the strongest quarter. Volumes at JNPT declined 5.7% YoY and 18.5% MoM to 0.32mn TEUs. Chennai port’s container traffic however fell sharply by 14.7% YoY and 20.4% MoM to 0.11mn TEUs.

 Iron ore throughout continues to remain low: Iron ore traffic continued to remain low with volumes declining 55.8% YoY to 4.1mn tonnes. The Baltic Dry Index (BDI) (an indicator of global demand for dry bulk commodities including iron-ore and coal) continued to remain low post the sharp fall in January, led by the glut in global dry-bulk supply and slower demand. BDI was down 40% YoY and 34% MoM to close at 738 on 28-Feb-12.

 Traffic mixed across ports: Kandla and Mumbai ports reported healthy traffic with a growth of 11.9% YoY to 6.8mn tonnes and 17.9% YoY to 5.1mn tonnes respectively on the back of POL volumes. JNPT and Paradip reported small declines in overall volumes. While JNPT faltered on POL & containers, Paradip lost on iron ore volumes. Traffic at Mormugao and Vizag were the worst affected by the ban in iron ore mining leading to lower iron ore port volumes.

 Container volumes likely to remain steady: We expect container volumes to remain healthy in FY13 despite adverse global economic environment and perform better than in FY12. For FY12YTD container volume growth (in TEU terms) was 3.3%. We prefer GDL in the container logistics space.

To read full report: PORT ANCHOR

>PUNJAB NATIONAL BANK: In power sector, the bank’s management indicated that some of the newly commissioned power generation companies

■ On CASA deposit front, the bank’s management faces difficulty in maintaining high level of 35% CASA due to interest rate gaps in deposits and stiff competition.
 On credit book expansion plan, PNB’s management indicated credit growth of 100-200bps higher growth than the industry; the bank awaits clarity on monetary policy and Union Budget before finalizing internal target for credit growth in FY13.
 The bank’s management expects NIM of 3.75%-3.8% in FY12; in 9MFY12, the bank recorded NIM of 3.85%. In FY13, margin is expected to moderate slightly. We also factor in 11bps decline in margin in FY13 due to faster drift in yield on assets in declining interest rate scenario. Though, cut in CRR would aid margin slightly.
 On NPA front, PNB’s management expects GNPA ratio to inch up in next 2 quarters mainly due to high slippages and lesser credit growth. As on end-December’11, the bank had GNPA ratio of 2.42%.

 On Air-India loan restructuring front, banking sector total working capital loans of ` 225 bn is going for restructuring before end-March’12. Part of loans (of ` 85bn) would be converted into bonds with non-SLR status but with central government backing; the bond paper would carry coupon rate of 9.25% and with zero risk-weight. Of the total exposure, banks would take NPV losses of 10-12% (of almost ` 23bn). PNB exposure to Air-India is Rs 21bn and the bank management expects to take NPV hit of ` 500-1000mn
in Q4FY12 itself. Banks would be better off with replacement of loans with such bond paper. The NPV hit of 10-12% would not have any significant impact on the banks’ profitability.

■ In power sector, the bank’s management indicated that some of the newly commissioned power generation companies might not be in a position to fully pass-on their incremental higher cost of production in accordance with agreements they have entered into with power purchasers. This would reflect into adverse impact on their profitability.

On core operation front, the bank’s performance would remain robust and the bank would accrue benefits of declining interest rate in form of capital gains and MTM write-backs. We maintain our positive stance on the stock.


>Railway Budget: FY13 (CARE RATINGS)

The Railway Budget for 2012-13, while emphasizing on its priority to increase rail safety and security, also seeks to raise investment in modernization and up gradation of rail infrastructure. The rail Budget has also proposed the first hike in passenger fares in nine years and a plan outlay of Rs.60,100 crs for the railways, the highest ever outlay by far.

The Railway Minister has envisaged 5 focus areas for the coming year – safety, consolidation, decongestion & capacity augmentation, modernization and improvements in operating ratios. The measures to improve the operational efficiency of the rail system would help reduce transport time of the various commodities that are transported though the rail system.

 Increase in passenger fares across classes
 50% concession in fare in AC-2, AC-3, Chair Car & Sleeper classes to patients suffering from ‘Aplastic Anaemia’ and ‘Sickle Cell Anaemia’
 Highest ever plan outlay of Rs 60,100 crore that would be financed through
 Gross budgetary support – Rs 24,000 crore
 Railway safety fund – Rs 2,000 crore
 Internal resources – Rs 18,050 crore
 Extra budgetary resources – Rs 16,050 crore, which includes market borrowing of Rs 15,000 crore and PPP of Rs 1,050 crore
 Addition of 725 new lines. Rs 6,872 crore allocated for the same
 Proposal to electrify 1,100 km rail network. Rs 828 crore provided for the same

Financial Performance FY12
 Loading target reduced by 23MT to 970MT
 Gross traffic receipts revised to Rs 1,03,917 crs from Rs.1,06,239 crs (Budget Estimate FY12)
 Working expenses revised to Rs 75,650 crs from Rs.73650 crs (BE)
 Pension payments up by Rs 1,000 crore
 Current dividend liability of Rs 6,735 crore to be fully discharged.
 Excess of receipts over expenditure of Rs 1,492 crore as against the budget amount of Rs 5,258 crore
 Operating ratio at 95%

Budget Estimates FY13
 Freight load of 1,025MT
 Passenger growth pegged at 5.4%
 Gross receipts – Rs 1,32,552 crore
 Ordinary Working Expenses – Rs 84,400 crore.
 Dividend payment estimated at Rs 6,676 crore
 Operating ratio estimated at 84.9%
 Surplus expected to be Rs 15,557 cr.

Budget Implications
1. The expected decline in operating ratio in FY13 will need to be monitored as the drop expected is quite sharp compared to the increase witnessed in FY12 (revised) over FY12 (budget). Share of goods earnings could come down in case there is substitution to road transport.
2. With highest ever allocation of Rs 60,100 crore, the budget looks positive on moving towards building a strong infrastructure. The budget provides significant opportunities for private investment through public-private partnership resources. In particular on account of the focus being put on modernization, electrification, increasing the lines, use of solar energy etc, there will be a positive boost for related industries such as cement, steel, containers, carriages, electrical equipment, cables, solar equipment etc.
3. The increase in freight rates across the board will have an impact on prices and will affect goods that use railways as a mode of transport. A guesstimate is that for industry as whole the average increase of over 20% in freight rates (will vary depending on the class as well as distance) cost of production could increase by between 1-3% which will exert pressure on prices of final products. Even in case of farm products where railway transport is used, the cost would tend to move up. 4. Increase in passenger fares would result in additional revenue of Rs 4,000 crore. This will partly help to offset the rising costs over the years.
5. Market borrowing of Rs 15,000 crore during the year, should be added to that of the central government when the Union Budget is announced on the 16th March when arriving at the aggregate borrowing for the year.
6. The budget also estimates that surplus will increase sharply to Rs 15,557 cr from Rs 1,492 cr in FY12. This will depend critically on the higher growth in freight and passenger fares, and any slippage will impact this surplus.