Friday, March 23, 2012

>TELECOMMUNICATIONS: Supreme Court decision on quashing 122 new licenses to benefit incumbents

In February 2012 the GSM operators across India (excluding Reliance Communications [RCom] and Tata
Telecommunications [Tata Tele]) added 8.8 million sim cards, taking the overall base to approximately 656.8 million. That is an increase of approximately 1.35% over the January 2012 base. On the net additions front, February’s net additions (of about 8.8 million) were 4% higher than that reported in the previous month. Industry’s monthly net additions improve from the recent lows

On a reasonably higher base of 648.1 million subscribers, the GSM industry (excluding RCom and Tata Tele) added 8.8 million sims, This is positive, given that in the last couple of quarters, sim additions had drifted to fairly low levels. The additions were as low as 6.5 million sims during the August-September 2011 period.

Bharti upping its ante, adds 1.82 million subscribers
Player wise, the highlight for the month is the strong 40% month-on-month increase in net additions for Bharti Airtel (Bharti), ie from 1.3 million subscribers in January to 1.82 million subscribers in the month under review (February 2012). This robust addition seen in the last two months (1.3 million in January [+36% MoM]; 1.82 million in February [+40% MoM]) is the result of aggressive market gain strategy adopted by the company. We believe that Bharti would continue to gain market share and take its monthly sim addition rate to an average of approximately 2 million in the next two- three months.

Idea continues to shine; records highest net additions For the month under review Idea Cellular (Idea) continued its subscriber leadership trend by adding 2.58 million subscribers (+47.8% MoM). Idea is consistently outperforming its peers in terms of subscriber as well as revenue market share.

Vodafone net additions remain muted; while Uninor still remains tall
Vodafone has continued to go slow on its subscriber addition strategy. For the month it added 0.84 million subscribers (-2% on an M-o-M basis), while amongst the new entrants, Uninor still remains strong. For the month under review it added 2.3 million subscribers, which is marginally lower (-6%) than what it added in January 2012 (2.5 million subscribers).

Supreme Court decision on quashing 122 new licenses to benefit incumbents
Uninor continued with its strong net addition momentum even in the month of February. It is one of the most serious players with it being operational in all the 22 circles. The Supreme Court recently gave a verdict whereby all of Uninor’s 22 licenses would be quashed with they having been termed illegal. Apart from Uninor some of the other new players have also been impacted in terms of their licenses getting cancelled. The court ordered the Telecom Regulatory Authority of India to conduct an auction of the spectrum. We believe that some of the new players will leave the system, thereby posing way for natural consolidation which is likely to benefit the incumbents. Etisalat & STel have already decided to shut their operations. One will have to wait and watch Uninor’s strategy and its India plans; its decision will be key for the incumbent players.


>BANKING SECTOR: RBI caps LTV for gold loans - Negative for Mannapuram and Muthoot

The Reserve Bank of India (RBI) has capped the amount of loan any non banking financial company (NBFC) can lend against gold at 60% of the value (loan to value). The tier I capital adequacy ratio (CAR) has also been raised from 10% to 12% with effect from April 2014. Further, the RBI has restricted NBFCs from lending against gold coins/primary gold or bullion. These regulations will reduce the leverage and lower the net interest margins (NIM) and return on equity (ROE). This is a big negative for listed players like Muthoot Finance, Mannapuram Finance, IIFL etc (not under our coverage).

Cap on LTV @60% will impact ROEs
Since the RBI has decided to cap the loan to value (LTV) at 60% for gold loans, the leverage levels will drop and impact the ROE of the companies. Currently the LTV ratio of Mannapuram Finance and Muthoot Finance is around 70-75% including the replacement costs. The reduction in LTV would result in a drop in average yield (20-25% currently) and will impact the profits significantly. The companies (Mannapuram Finance and Muthoot Finance) have been maintaining ROEs of around 25-28% which could drop by approximately 500bps and impact the valuation multiple.

Business growth could come under pressure
Earlier the RBI had expressed concerns on rapid business growth and rising risks of gold-loan focused NBFCs. The investor’s eye sector update loan books of Mannapuram Finance and Muthoot Finance
have grown at a compounded annual growth rate (CAGR) of 198% and 70% respectively over FY2007 - 11. Therefore the new regulation will reduce the growth of the companies as competition vis a vis banks will increase while customers could also switch to money lenders offering higher LTVs.

Big negative for Mannapuram and Muthoot
The development is a big negative for listed players like Muthoot Finance and Mannapuram Finance (not under our coverage). Post the regulations the gold NBFCs would require to restructure their businesses to minimise the impact of the regulations. However, due to the probable reduction in ROEs the valuation multiple for gold financing companies is likely to shrink.

….also negative for India Infoline, SKS Microfinance
The regulations are also negative for the new entrants in the gold loans category such as India Infoline and SKS Microfinance. The regulations as of now are for NBFCs only. But if they get extended to banks then banks like South Indian Bank, which has 26% of the book in gold loans, would be negatively impacted. Compared to that, Federal Bank’s exposure to gold loans is much lower at around 6% of the book.


>LARSEN & TOUBRO: 7 Reasons to buy

 7 Reasons to Buy — (1) Stock trades at adj FY13E P/E of 12.0x (2) inflow guidance miss already in price (CIRA at -6% & consensus at -5% to -11% v/s guidance at +5%) (3) despite inflow miss sales set to grow >=16.5% in FY13E (4) margin contraction fears overplayed (5) rationally India does not have a choice but to revive investment capex (if not in 6 months then atleast in 1 year) (6) huge backlog and strong B/S allows L&T to withstand slowdown and (7) consensus EPS downgrades have bottomed.

 Sales should grow 16.5%+ in FY13E — As we believe from FY13E onwards execution cycle would not decline and could actually accelerate as power as a % of total pie comes down. This implies sales growth in FY13E should be >= backlog growth in FY12E (16.5%). L&T guiding 20% sales growth in FY13E would not surprise us.

 Margin contraction of 100bps in FY12E and nil in FY13E — Management will not compromise on margins till L&T is able to win Rs700-800bn of orders annually. Even after excluding slow moving orders (10%) backlog would stand at ~ Rs1300bn (takes care of 2 years sales). Our confidence also bolstered by: (1) 9M12 margins contracting only 88bps; (2) not under-cutting to win orders evident from NTPC-DVC bulk tender.

 India has to revive investment capex — Firstly, the skew between consumption and capital formation could structurally add to India’s inflation problem over longer term. So this has to be corrected. Secondly, to bring down the fiscal deficit, India needs to increase gross tax revenues which are highly correlated to GDP growth and therein lies the need for policy action to resume India’s infrastructure capex.

 Maintain Buy; Target price of Rs1642 — Adjusting our target price to Rs1642 (Rs1647) to factor in: (1) revision in parent/ cons EPS by +1% to +7% (2) parent target P/E multiple 16x (from 17x earlier). Our EPS revision factors in (1) 0-1% higher sales and (2) 20-40bps higher EBITDA margins. L&T is now our top industrial pick given our previous top picks Havells and Cummins have run up significantly.

To read full report: LARSEN & TOUBRO

>USHA MARTIN: Usha Siam getting re-operational

Usha Martin is the largest producer of speciality steel long products in India and is the world's 2nd largest wire rope manufacturer. The company is fully integrated backed by captive iron ore mine (~80 mnt reserves), non-coking coal mine (~40 mnt reserves) and captive power plant (93.3 MW). We recently met with the management of the Company to get some color on its recent initiatives to further enhance its capacity and improve margins. We summarize the key takeaways below:

Capex plans
Management has guided for a capex plan of INR 12 bn over the next 15 months to be financed through an equal mix of Debt & Equity. UML will expand its DRI capacity by 2 lakh tonnes by Q1FY13 (1 lakh tn by April'12 & another 1 lakh tn by June'12), its coke oven capacity by 4 lakh tonnes expected to be commissioned by Q4FY13, greenfield pellet plant of 1.2 mn tonnes capacity by Q4FY13 and another captive power plant by 60 MW in FY13.

Captive power to reduce cost
The company currently operates 93.3MW power plant of which 18.3MW is based on WHRS (Waste Heat Recovery System) and 75MW is thermal based. The average cost of power is INR 2.6/ unit. At present, it is able to meet 75% of its requirement through captive consumption and balance is sourced from outside. UML is further enhancing its power capacity by 60 MW (51MW - WHR and 9MW -coal) which should make it self-sufficient and lead to cost savings & margin expansion, as average cost of production is much lower in case of WHR. The Company has again started getting coal linkages which should help it in reducing cost (In 9MFY12, UML had to depend on e-auction coal).

Change of mix to lead to margin expansion
UML manufactures steel products through both pig iron & sponge iron in the mix of 60:40. With additional coke oven & DRI capacities coming in by end of FY13, it is expected that the mix will gradually change more favorable towards DRI with expected contribution of pig iron to sponge iron to 40:60, leading to substantial cost savings as cost of production

under hot metal/pig iron is higher vis-à-vis cost of production under DRI (Expected savings in costs of ~INR 1800/tn).

Approval received for sale of iron-ore fines inventory
UML has recently received approval to sell its iron ore fines in the open market which was previously barred by the Government. UML has been sitting on iron ore fines of ~2.2 mnt. The current market value of these fines is ~INR 1.5-1.6 bn. However, the company is waiting for more clarity w.r.t. identifying customers and may utilize it for captive consumption and/or external sales.

Usha Siam getting re-operational
Usha Siam, Thailand, is 98% owned subsidiary company of UML (contributing ~10% to bottom-line) operations, which got effected due to floods in Thailand in mid-October'11, has partially commenced operations from mid-Feb'12 and expects full operation to resume from July / August 2012 onwards.

Outlook &Valuation
The current low per capita consumption of steel of 50 kg, compared to the world average of 179 kg and Asian peers like South Korea (936kg), Japan (419kg) and China (405 kg), signifies that the domestic steel industry has enormous growth potential. On account of increased thrust on infrastructure by the government in the 12th plan, UML has guided for ~70% capacity utilization in FY13E and ~80-85% in FY14E vis-à-vis 50-55% in FY12E. It expects its margins to improve post commissioning of its planned capex and better integration. At CMP of INR 34.7, the stock currently trades at 15.7x TTM earnings and 7.2x TTM EV/EBITDA.

To read full report: USHA MARTIN

>ASHOK LEYLAND: Commercial vehicle demand has been surprisingly resilient this year

Volume revival in a steady market: Commercial vehicle demand has been surprisingly resilient this year despite a considerable slowdown in the economy. Underlying indicators, mainly related to the health of financiers’ CV loans, operator profitability and freight rates, continue to be healthy. Therefore, we view this as a mid-cycle slowdown rather than the beginning of a new down-cycle, and expect the industry to grow at high single-digit/low double-digit rates in the medium term. Amid the general strength in the market, though,
Ashok Leyland's (AL) volumes have suffered largely on the back of weak demand in the southern region and production issues at its Uttaranchal plant. We see a reversal in both of these factors - demand in south seems to be bottoming out, while production rampup at Uttaranchal should accelerate in the coming months. We expect AL’s MHCV volumes to grow at 10% p.a. in FY12E-14E. Aided by mix improvement/pricing and growth in nonvehicle businesses, we forecast revenue growth of 15% p.a. over FY12E-14E.

Profitability and cash flow to improve: Weak volumes and high commodity cost pressures have impacted AL’s margins in FY12E (-c150bps YoY). Going forward, we expect operating leverage as well as benefits from its tax-exempt plant to boost margins (c160bps expansion over FY12E-14E). Balance sheet health, on the other hand, is also set to improve as the company passes the peak in capex spends/JV investments. Lastly, we also forecast an improvement in its working capital cycle, which in the past few quarters has deteriorated on account of production mismatches and weak volumes.

Our PT of Rs37 is based on an EV of 7.5x FY13E EBITDA (typical mid-cycle multiple). AL currently trades at an EV of 6x FY13E EBITDA, below its historical average. With revenue growth of 15% p.a. and EBITDA growth of 24% p.a. over FY12E-14E, we see significant potential upside to current valuations. Moreover, we observe a strong correlation between AL’s P/B multiples and return trends. Given our expectation of improving returns (25% in FY14E vs 17% in FY12E), we expect the stock to re-rate going forward. Risks a) a sharp decline in the CV industry and b) intense competition from new players

To read full report: ASHOK LEYLAND