Tuesday, March 27, 2012

>RELIANCE POWER: Concentrated in three projects - Chitrangi, Sasan-II, Samalkot

■ Action: Execution risk has not subsided; maintain Reduce
The majority of RPWR’s long-term earnings and two-thirds of the FCFE based fair value remains concentrated in three projects (Chitrangi, Sasan-II, Samalkot), whose operational timelines and profitability remain subject to regulatory diktats and fuel supply risk. Besides, the Krishnapatnam UMPP remains a trouble-spot, irrespective of its operational status.

■ Catalyst: CMP reflects an ‘all is well’ picture, which is not the case, in our view
Ongoing lobbying by private IPPs with the government yielding favourable outcomes (which may not materialise) on near-term gas supply for Samalkot and Chhatrasal block clearance are reflected in the sharp 71% YTD run-up in the stock price, we believe. Further, our earnings forecasts are sharply below consensus, suggesting potential earning downgrades.

■ FY12F/13F EPS cut by 32%/60% as Samalkot likely to idle until FY16F
We assume: 1) the 2,400MW Samalkot facility will be idle up to March 2015 due to unavailability of gas; 2) RPWR will surrender the 3,960MW Krishnapatnam UMPP; and 3) Indonesian coal mining operations will begin in 4QCY12 and ramp-up to 7.5mtpa by FY15F.

 Valuation: FCFE-based milestone risk-adjusted TP lowered to INR94 Our 12M TP is pegged to the milestone-adjusted FCFE value of RPWR’s 25.7GW generation capacity and coal mining operations in Indonesia (Phase #1, 7.5mtpa); at FY14F P/E of 30x and P/BV of 1.7x, the stock trades at a significant premium to its peers. Our unadjusted FCFE-based value is INR134, indicating a fairly 'low-risk' scenario is largely priced in.

To read full report: RELIANCE POWER

>INDIA STRATEGY: No longer a matter of philosophy

■ No longer a matter of philosophy. Recent press articles on purported large losses to
the exchequer as computed by India’s CAG on coal blocks awarded to the private
sector in the past will likely raise questions about (1) the Government’s response in
‘taxing’ the profits derived from natural resources awarded at low cost in the past and
(2) award of such natural resources in the future. Our February 28, 2012 report, titled
Philosophical questions but logical outcomes, deals with these issues in great detail.

■ Be prepared for higher royalty or taxes on natural resources awarded below-market prices As discussed in our February 28, 2012 report, we do not rule out the possibility of the Government taxing the profits of companies that (1) had received natural resources for free or below-market prices in the past and (2) sell their products based on the natural resources at market (invariably global) prices. Coal blocks and mineral mines would come in this category. We think that imposition of royalty on revenues or tax on profits will be the most logical outcome of this debate.

■ Even Government companies will have to pay more for nominated blocks
The Government’s (1) recent decision to raise the rate of cess on crude oil and (2) intention to
implement the Mines and Mineral (Development and Regulation) Bill that specifically contains
provisions for a mining tax on profits of companies further strengthen our viewpoint. We also
expect royalty rates on nominated blocks of Coal India, OIL and ONGC to go up further as the
Government aligns their selling prices to global levels over a period of time. Nonetheless, these are the only entities that can raise prices (political and social factors permitting) to offset the impact of higher taxes. Their private-sector counterparts already sell their products at global prices and thus, would not be in a position to raise prices further.

 Award of natural resources only through auctions in future
The Supreme Court’s February 2, 2012 judgment on the 2G scam case and heightened public
scrutiny of Government actions practically rule out the awarding of natural resources on a
discretionary basis, in future. The Government has filed a review petition in the Supreme Court
arguing against judicial intrusion over executive matters. Nonetheless, we can rule out the old
process of awarding natural resources, such as coal blocks and mineral ores, on a discretionary basis irrespective of the outcome of the review petition.

■ The old order changeth, but where is the new one? Beware the investment cycle
India’s evolution to a country with more transparent systems and stronger democratic institutions will eradicate vestiges of an earlier discretion-based system in the few remaining areas (coal blocks and mineral ores). However, this would also mean that India’s investment cycle will suffer unless it can quickly evolve new rule-based transparent processes for award of all natural resources. In particular, it is imperative that India’s Government (1) exorcises a growing feeling of undue State intervention among investors through the establishment of rule-based transparent processes and systems and (2) fixes its coal sector to kick-start a flagging investment cycle. India has tremendous reserves of coal but exploitation has been sub-optimal so far.


>JYOTHY LABORATORIES LIMITED: Exploring new opportunities with Henkel’s acquisition

Jyothy Laboratories Ltd. (JLL), a company having three brands, is set to transform into a multi-brand company with the acquisition of an 83.7% stake in Henkel India (Henkel), which owns seven brands. As a result of this synergy, we expect JLL’s consolidated revenue to post a CAGR of 35% to `1,627cr and profit to post a CAGR of 36% to `166cr over FY2011-14E. We initiate coverage on JLL with a Buy recommendation and a target price of `248, based on SOTP valuation.

Investment rationale

Turnaround of Henkel – A bright future for JLL
JLL acquired an 83.7% stake in Henkel in August 2011. Management is now planning various turnaround strategies for Henkel, such as a new management, revamping of all its brands and shifting its manufacturing to JLL’s units. We expect Henkel’s turnaround to result in profit of `19cr in FY2014E.

Jyothy Fabricare Services Ltd. (JFSL) – A long-term growth driver
We expect JFSL, JLL’s subsidiary engaged in the laundry business, to post a 102.4% CAGR in its revenue to `193cr over FY2012E-14E with an operating margin of 26.1% in FY2014E. Further, JFSL is expected to reach its breakeven and start yielding profit from FY2013E, registering a profit of `30cr in FY2014E.

Outlook and valuation
We expect JLL’s consolidated revenue to post a CAGR of 35% to `1,627cr and profit to post a CAGR of 36% to `166cr over FY2011-14E. We initiate coverage on JLL with a Buy rating view and an SOTP target price of `248.

To read full report: JLL

>MCLEOD RUSSEL: Acquisition in Rwanda to boost volumes

Positive outlook for industry to aid realisation…

McLeod Russel (MCL), the largest tea producer of India, is expected to record higher earnings (FY13E) on the back of improving tea prices led by increasing demand and shortfall in global tea production. MCL would benefit from a decline in production in Kenya and Sri Lanka that would boost export demand from India, thereby supporting better realisations.

Further, the company’s bid for tea gardens in Uganda would aid MCL’s volume sales (increase by ~5.5 mkg) in the coming years. Hence, we are revising our target price, maintaining a BUY rating on the stock.

Higher domestic realisations
Tea production in India in CY11 stood at 988.3 million kg (mkg) (expected was ~1000 mkg) against 966.4 mkg in CY10, an increase of almost 2.3%. Consumption during the period increased at a higher rate of ~3.5%. Hence, higher demand on the back of dry weather in the North East impacting production, lower carryover stock (exhausted by February, 2012) and higher cumulative deficit in the system (~50 mkg) led tea realisations to be higher by ~60-80/kg (good quality tea) and ~10-15/kg (blended realisation) in CY11. Going ahead, with demand expected to remain robust (domestic and export), tea realisation for CY12 would further increase by ~20-25/kg.

Acquisition in Rwanda to boost volumes
MCL has bid for two tea gardens in Rwanda that could increase the yield from Rwanda for the company to ~7 mkg (current production is ~2 mkg). With margins from Rwanda gardens being higher at ~50% compared to MCL’s margins at ~28%, we believe the acquisition would contribute notably to MCL’s earnings. Further, with funding for the acquisition to be through internal accruals there would not be any pressure on interest payments, hence protecting the bottomline.

At the CMP, the stock is trading at 10.5x and 8.6x its FY12E and FY13E EPS of | 25.1 and | 36.6, respectively. With realisations set to improve, we expect earnings to perk up. Hence, we have valued the stock at 10x its FY13E EPS, arriving at a target price of | 305, with a BUY rating.

To read the full report: MCLEOD RUSSEL

>PROVOGUE INDIA: Shares get re-listed on the exchanges with demerged status

The event - Provogue India shares get re-listed on the exchanges with demerged status

Provogue India (Provogue)’s shares that had got temporarily suspended from trading for the demerger process got listed today on the bourses at Rs17 per share.

As per the scheme of demerger every shareholder holding 1 share of Provogue has received 1 share of Prozone Capital Shopping Centers Ltd (PCSCL; face value Rs2). The face value of Provogue shares has got reduced from Rs2 to Rs1.  The capital structure for both, Provogue (the demerged entity that got listed today which now only holds the core retail business) and PCSCL (which will hold all the real estate business and assets) has been illustrated below in a table.

Shares of PCSCL will get relisted after it files for the same, which may take one to three months. Our fair value for Prozone works out to Rs27 per share.  Based on the auditor’s statement, Rs207 crore of the net book value of approximately Rs714 crore has been transferred into the demerged entity (PCSCL). Thus the pre acquisition based on this statement works out in a ratio of 29% (207/714) for PCSCL and 71% for Provogue.

Our analysis
■ Retail business environment still somber but better than Q3FY2012: Our interaction with the company’s management to gauge an understanding of the retail demand environment post the weak festive season demand that was seen in Q3FY2012 reveals that the first two months of Q4FY2012 (Jan & Feb) saw a decent uptick in demand led by festive season sale and release of the festive led pent up demand, while March sales were somber. We believe one needs to keep a watch on the new summer collection full price sale to figure out the demand momentum for retail/branded apparels.

 Post restructuring, our revised target price for Provogue is Rs35; Maintain Buy: Post restructuring Provogue now holds only the core retail assets that include brand sales- Provogue along with export sales, ie those which were part of standalone financials. Thus our standalone financials and estimates for Provogue remain intact. We expect a decline in FY2012 profits while we expect FY2013 to witness strong recovery with a 26% growth in earnings. Valuing branded business and the export business of Provogue with a blended price earning ratio (PER) at 10x FY2013, we arrive at a target price of Rs35 for Provogue. Thus our revised target price for Provogue now stands at Rs35 and we maintain our Buy rating.


>INDIAN HOTELS: Hotel Room Supply, Capital Investment and Manpower Requirement by 2021; Impact of tourism

The Impact of Tourism
Tourism is a difficult phenomenon to define, simply because it involves inter-related activities belonging to different industries. An industry typically has a “number of firms that produce similar goods and services and therefore are in competition with one another”1. Tourism then is not necessarily an industry as it constitutes airlines, hotels, restaurants, travel agencies and other attractions that do not compete with one another. Rather, they complement each other in forming a unified system of activities. A culmination of these activities interacting is what defines tourism. This is supported by the World Tourism Organization (WTO) which defines it as “the activities of persons travelling to and staying in places outside their usual environment for not more than one consecutive year for leisure, business and other purposes not related to the exercise of an activity remunerated from within the place visited.”

While tourism has its positive and negative impacts, it is unarguably a catalyst for the socio-economic progress of a country. More so, for a developing nation, tourism acts as a key driver for the creation of jobs, enterprises, infrastructure development and foreign exchange earnings. The earnings from tourism make it one of the biggest sectors in the world. The sector’s total contribution to the worldwide gross domestic product (GDP) is estimated to be US$5,991.9 billion or 9.1% of global GDP in 2011. In India, travel and tourism contributed `3,680.4 billion or 4.5% of the country’s GDP in 20113. In addition to tourism’s revenue contribution, it also accounted for 7.5%4 of the total employment in the country in 2011. India has been a late starter as far as tourism is concerned. Post the country’s independence, the government of India focused on developing other industries, such as agriculture, irrigation, power and infrastructure. It was only in 1982, three decades ago, that the first Tourism Policy was drafted and presented in the country. However, it is only over the past two decades that tourism in India has really taken form. Table 1-1 presents the foreign exchange earnings from tourism and the sector’s total contribution to GDP from 1991 to 2011. As highlighted in the table, foreign exchange earnings and total contribution to GDP has grown by a compounded annual growth rate (CAGR) of 15.5% and 10.5% respectively over the past two decades.

To read full report: INDIAN HOTELS

>ADITYA BIRLA NUVO: Sell Madura Garments for $500 million

We continue with our bullish outlook and Buy rating on Aditya Birla Nuvo, a conglomerate with exposure to varied strong sectors and strong market positioning. Of late there has been a lot of speculation in the media over the company’s businesses. In this note, we clarify the situation and present our understanding and analysis of the recent news flow on the company.

Media flash 1: Aditya Birla Nuvo to sell Madura Garments for $500 million

  •  Media reports state that as per their sources Aditya Birla Nuvo is selling its branded apparel business, Madura Garments. Madura Garments is a 100% subsidiary of Aditya Birla Nuvo and owns marquee apparel brands like Louis Philippe, Peter England, Van Heusen, Allen Solly and Espirit in its portfolio.
  • This news had surfaced earlier also, stating that private equity player, Apax Partners, was looking to buy Madura Garments. But the deal did not go through owing to a mismatch of valuations. However, some media sources say that a consensus might have been reached and the deal might go through.
  • Kumar Mangalam Birla had bought Madura Garments from Coats Plc at around Rs240 crore in 1999.
  • As per the media reports, Madura Garments is valued at $550 million, ie approximately Rs2,250 to Rs2,500 crore or between 1.5x and 1.6x its FY2012 expected revenues. But in our sum-of-the-parts (SOTP) valuation, we have assumed a 0.8x multiple to arrive at the fair value of Rs1,225 crore. The current valuation seems to be at a 100% premium. Thus, going by the stated media valuation, the stake sale, if it happens, would be positive for Aditya Birla Nuvo.

Media flash 2: Idea Cellular on the block
We believe Aditya Birla Nuvo is the cheapest way of gaining exposure to Idea Cellular
  • For a long time there has been speculation in the market and the media that Idea Cellular is on the block. Idea Cellular’s management has categorically stated on various forums and at associations with the analyst community (during Idea Cellular’s conference calls as well as Aditya Birla Nuvo’s conference calls) that there are no plans to sell stake in Idea Cellular.
  • In terms of performance, Idea Cellular has been growing its subscriber base as well as revenue market share over the last two years. During this period, it has seen a phenomenal improvement of over 300 basis points in its revenue market share. Further, the losses from the new circles have been either fairly constant or reduced while the margins and profitability from the old established circles have been on an upmove.
  • Our analysis and research on Idea Cellular puts an equity value of about Rs34,000 crore (the current market capital is Rs32,000 crore). Though Idea Cellular looks fully valued, we believe that exposure to Idea Cellular through Aditya Birla Nuvo (which holds a 25.4% stake in Idea Cellular) is still cheap and offers a decent upside.

Issue of warrants to promoters also speaks of positive sentiment
  • Today at the meeting of its board of directors Aditya Birla Nuvo decided to issue 1.65 crore warrants of face value Rs10 each to the promoter/promoter group on a preferential allotment basis, entitling the holder of the warrants to apply for and obtain the allotment of one equity share against each warrant in accordance with the provisions of the rules.
  • The 16.5 crore warrants would entail a 12.7% equity dilution on an expanded capital base, after the conversion of warrants into equity shares. We view this development as a positive.

Outlook and valuation
We continue to like the strong positioning that Aditya Birla Nuvo’s businesses enjoy in their respective fields. The company is amongst the top five players in the insurance, asset management, telecommunications (telecom; Idea Cellular—the fastest growing telecom company; the third in ranking) and apparels (Madura Garments with its marquee brands, consistent and resilient growth, and profitable set-up) businesses. Given its presence in diverse businesses, we value Aditya Birla Nuvo on an SOTP basis, assigning a piecemeal value to each of its businesses and then adjusting the same with the company’s consolidated debt to arrive at a price target. Thus, our price target for the stock is Rs1,050 and we maintain our Buy rating on the stock.


>J. B. Chemicals & Pharmaceuticals: Defensive Bet

Company Overview
JB chemicals is one of the oldest pharmaceutical companies in India founded by Mr. J.B.Mody. It was earlier known as Unique pharmaceuticals and has 11 manufacturing facilities spread across four locations Panoli, Ankleshwar, Daman and Belapur. Over the years, it has devloped some very formidable brands like
Doktor Mom (given Superbrand status in Russia and CIS countries), Metrogyl, Rantac and Nicardia. They have recently sold their Russian and CIS countries OTC business to J&J for approximately 1200 Crores. They have received proceeds from the sale and distributed around 320 Crores as special dividend to
shareholders. This indeed is commendable and speaks a volume about the management's integrity and its focus towards shareholders.

Investment Rationale
1) Size of the company: JB Chemicals had turnover of 800 crores in year 2010-11. Company has history of more than 50 years. Thus it qualifies on this account as it has a long history of professional management combined with increasing revenue.

2) Sufficiently Strong Financial conditions: Based on FY12E balance sheet JB has current ratio 4.7 (including 561 crores in long term/short term investment) and long term debt is only 25% of net working capital.

3) Dividend Record: JB has uninterrupted dividend payment history for more than 10 years. Moreover company was prompt to declare special dividend on sale of Russian subsidiary, a windfall profit, rewarding shareholders handsomely.

4) Earnings Growth: JB has achieved earnings growth of 11.5% CAGR. Though it is not spectacular, it is decent enough.

5) Price to Earning Ratio: In case of JB chemicals, considering 2010-11 EPS of 14, and reducing it by 30-35% (considering sale of Russian business and hence reduced earnings), at current market price, P/E will be around 7-7.5.

6) Price to Book value: Considering cash from Russian operations, JB is trading much below its book value.

7) Market Cap Less than Net Working Capital: In case of JB, (NWC – Long Term Debt) is 554 Crores while its market cap is also 554 Crores. In other words, Investor is getting Cash/cash equivalents/inventory/investments of Rs 65/share. In addition to this, he is getting fixed assets of the company and operating business for FREE.


>S.W.O.T. Analysis & Porter Analysis on Real Estate Sector: SOBHA DEVELOPERS

Sobha is a Bengaluru-focused real estate developer. Like many of its peers, Sobha had overleveraged its balance sheet over 2006-08 in order to buy land. However, Sobha is currently the best placed play in the sector due to:

 A repaired balance sheet: Relative to its peers Sobha follows an aggressive cash collection philosophy. Furthermore, the group has consistently launched new projects of 3msf-4msf each year, delivered more than 11msf over FY08-FY12, and has used its operating cash flows to reduce debt. As a result, net debt:equity ratio has fallen to 0.65x from 1.7x in FY09, debtor days have reduced to around 110 days currently from 173 days in FY09 and advances from customers worth over `2bn on the current liabilities side of the balance sheet are yet to go through the P&L.

■ Strong ongoing cash flows: Despite the tough macro-environment,
Sobha’s ratio of ‘CFO/interest cost related cash outflows’ at 2.0x has been the best amongst leveraged peers for 9MFY12. Also, Sobha has reported 20% YoY growth in sales in 9MFY12 and is on track to launch 9msf-10msf of new projects and complete the delivery of over 2msf during FY12 (FY10 delivery: 1.8msf, FY11 delivery: 4.1msf).

 Development potential: Sobha currently owns a land bank with developable area of 112msf (saleable area of over 200msf) valued on its balance sheet at a cost of `19.5bn (or `175psf of developable area). Based on our discussions with real estate brokers, the current value of this land is at least 4x its cost. Project development on this land bank over the next 15 years generates a DCF value of `57.2bn or `583/share for the land. However, our base case scenario values this land bank at `36.5bn (`372 per share), 2.0x its cost.

Valuation: In our project based DCF model for Sobha, we conservatively push out cash flows by 2-3 years and assume slower-than-expected execution, sales and cash collection. We also assume that the cost of construction will grow at a faster pace compared to appreciation in realization rates. Using a discount rate of 15% for real estate projects under construction, an FY11 P/E multiple of 8x for contractual projects and valuing its land bank at 2.0x cost, our SOTP model generates a fair value of `462 per share, a 54% upside.