Saturday, April 7, 2012


What and Why ??
The reorganization of a company's outstanding obligations is done by reducing the burden of debt on the company by lowering the rate paid and lengthening the time the company has to re-pay the obligation. This allows a company to increase its ability to meet the obligation. Also, some of the debt may be forgiven by creditors in exchange for equity.

The need for corporate debt restructuring arises when a company is going through financial hardship and is having difficulty meeting obligations. If the troubles pose a high risk bankruptcy, a company can negotiate with creditors to reduce such burdens and increase chances of avoiding bankruptcy. Even if creditors do not agree to the terms of the plan put forth, a court may determine that it is fair and impose such a plan on creditors.

The reorganization of outstanding obligations can be made in any one or more of the following ways:
~ Increasing the tenure of the loan
~ Reducing the rate of interest
~ One-time settlement
~ Conversion of debt into equity
~ Converting the unserviced portion of interest into a term loan

Borrowers’ and Lenders’ Perspectives

Borrowers’ Perspective
When a company has outstanding debts which cannot be serviced under its existing operations it can resort to any of the following courses of action:

■ Enhance its quantum of debt. expecting to increase profitability and thus pay off its original debt; However, the company may not be able sustain such a higher level of debt
■ Cease current operations and wind up. This would ultimately lead to the death of the company
■ “To consider a structured plan to re-negotiate the terms of its current debt with the lenders”

Lenders’ Perspective
CDR provides lenders with the opportunity to avoid being encumbered with non-performing assets.
 The primary interest of lenders always lies in recovering the principal lent to a company along with returns on that investment – not to liquidate assets
■ Apart from this, liquidation proceedings are notorious for yielding low returns to creditors Therefore, CDR becomes an instrument for lenders, i.e. banks, to aid the transformation of otherwise non-performing assets into productive ones

CDR Analysis

Whether a case should be referred for restructuring or not is based upon a thorough examination of facts and the viability of a case. However, when the demand for restructuring is legitimate, and there is a good reason to believe that a company may be revived, it must be considered for restructuring.

A Corporate Debt Restructuring mechanism was first introduced in 2001. CDR is a voluntary, nonstatutory system that allows a financially troubled company with multiple lenders and loans of more than Rs.20 crore to restructure those loans to a plan approved by 75% or more of its lenders.

On December 31, 2011, of the 364 cases worth Rs.1.84 lakh crore referred to the CDR Cell, 230 have been approved or resolved. That's over Rs.1.42 lakh crore of debt restructured under the CDR mechanism.

Sectors more prone to CDR
Iron & Steel, Textiles, Telecoms, Fertilizers, Sugar, Cement, Petrochemicals & Refineries
New Sectors emerging for CDR
Infrastructure and NBFCs

Instances of CDR
Subhiksha Retail Bharti Shipyard
Vishal Retail ICSA
GTL Infra SuzlonEnergy
Air India GTL Ltd.
Wockhardt Kopran
India cements Koutons Retail
Jindal Steel Kingfisher Airlines
Essar Steel Nicco Corporation
HPL Rajasthan State Electricity Board
Maytas Infra Basix
Spandana Sphoorty ARSS INFRA
HCC Surya Pharma
Jindal Stainless Essar Steel

Companies struggling with high debt
Everyone agrees that India needs infrastructure such as roads and utilities and such companies are better positioned because of their experience. But the debt they have accumulated over the years is an albatross around their necks.

When the infrastructure fad was running its course, companies more than tripled their debt, bidding for projects much bigger than what their equity could support. Indiscriminate lending by banks, prodded by the government, is back to haunt these companies as most lenders have hit their limits and are staring at defaults.

A few recent reports highlighted more than two dozen highly-leveraged large borrowers, including Adani Power, Essar Oil, Tata Communications, Electrotherm India and Jai Balaji, many of which may require future debt-restructuring.

Lanco, a power producer and contractor, recently defaulted on a Rs.90-crore payment to banks. In the five years between 2007 and 2011, the debt of GMR Infra, which operates the New Delhi airport, jumped 6.7 times. BGR Energy and IVRCL, a contractor for road and water projects, had a 5.4-fold jump in its debt. GVK Power, which runs the Mumbai airport, saw its debt climb 3.59 times in the same period. Jaypee Infratech, which built India's only Formula 1 race track in a New Delhi suburb, had its debt soar 31 times in three years from Rs.200 crore in fiscal 2008. Hotel Leela Venture increased its debt almost four times from 2007.
Many are headed for debt restructuring where lenders may impose strict conditions and dilute equity. That could hurt stockholders' interests.

Ultimately, the lender is the worst affected
A report from Standard & Poor’s talked about Indian bank’s weaker asset quality and earnings across the sector in 2012, with credit growth predicted to fall to 16%, from 23% the year before.

India’s banks weakening asset quality is also clear from the marked rise in debt restructuring agreements, a halfway house between payment and default used by the banks for struggling businesses such as Kingfisher Airlines. Taken together, HCC’s mix of bad and restructured loans rose to 4.3% of overall lending in the third quarter, up from 25 in the same period last year.

Corporate debt has spiked by over 300% this fiscal, already touching Rs.76,251 Crores, against Rs.25,054 crore in the previous fiscal. This brings the overall CDR assets in the system to over Rs.1.9 lakh crore. This is alarming.

Credit rating agency Standard & Poor’s, in a recent conference call with the media, said that restructured loans were expected to increase to around 4% of advances (of the banking system) at this financial year-end, from 2.6% a year ago. In 2012-13, restructured loans are expected to be 4-5% of advances. The S&P analyst also said that 25-50% of restructured loans may slip into NPAs.

In the April-June quarter of 2011-12, the cell received 16 corporate restructuring cases with debt of Rs.4,682 crore. In the July-September quarter, it received 19 cases (with debt of Rs.23,071 crore); in the October-December quarter, 25 cases (Rs 22,497 crore); and in the January-March quarter, 23 cases (Rs 26,001 crore). Corporate sickness seems to be spreading. Earlier, an average bank would have not more than 3-4 corporate
debt restructuring cases at a time. But now an average bank deals with about 30 cases.

Current Trend

Surprisingly, the SBI and the HDFC Bank, two of the country’s largest lenders, have undertaken relatively little restructuring this financial year, than other banks. But private lenders are better off than PSUs in terms of NPAs as well as regarding debt restructuring.

>SUZLON ENERGY: Suzlon financed the Big Sky Project of Edison Mission Energy

■ Edison repayment before February 2013 is uncertain: In October 2009, Suzlon financed the Big Sky Project of Edison Mission Energy. This loan has a five-year final maturity. Edison filed Form 10-K for 2011 at end-February, which states that specific events, including project performance, may trigger earlier repayment of this loan. It also mentions that based on the operating history of the project, the loan could mature as early as February 2013. While Suzlon now expects to receive the Edison payment in 1H FY13 (April –October 2012), we feel that it might not receive the cUSD211m payment from Edison by June 2012, when the first FCCB repayment of USD306m/cINR15.5bn is due. Suzlon’s (ex REpower) cash flow analysis suggests a severe cash crunch: We believe there are covenants on the REpower loans that limit the free transfer of cash from it to Suzlon. Therefore, our analysis of Suzlon’s (ex REpower) cash flow suggests that it will be short by cINR7.5bn in June 2012 for the first tranche of the FCCB payment and by cINR30bn for FY13 in meeting all its repayment obligations.

■ Possible options for funds: Given the lack of visibility on REpower’s debt covenants, we
estimate the cash inflow from various possible options, such as: (i) sale of a wind farm; (ii) sale of a stake in other businesses/subsidiaries; (iii) dividend and advances from REpower; (iv) factoring for Edison receivables; and (iv) credit facilities not utilised. Based on our analysis, we continue to see an equity dilution risk, with Suzlon likely to convert around 50% of FCCBs to equity.

■ Our blended DCF- and RoE-based TP remains INR20: Our DCF-based valuation is INR25.6 (average of two DCF approaches). We blend this with an RoE-implied PB value of INR13.2 to capture the sector’s market value better and to reflect current uncertainties. This leads us to a target price of INR20 (rounded off). The stock is trading at a high premium to the average peer group on CY12 PE, which we believe is not justified given the debt overhang. At the average global peer group CY12 PE of 14.1x, the stock would be valued at cINR12.7, which is lower than our target price.

 Catalysts: (i) continuing lack of visibility on cash inflow over the next few quarters; (ii) slowdown in order inflow; (iii) full-year volumes and margins below revised guidance; (iv) newsflow on increasing competition for Suzlon in the Indian market; and (v) further rupee depreciation.

To read report in detail: SUZLON ENERGY

>CAIRN INDIA: Alert: Second KG Onshore Discovery; Encouraging Prospects

 KG basin discovery: +ve, but materiality to be established over time — Cairn has announced its second oil discovery (out of 6 wells drilled) in its onshore KG basin block KG-ONN-2003/1 (Cairn – 49%, ONGC – 51%). As per management, this represents the largest onshore discovery in the KG basin, and total oil in-place from both discoveries is expected to be in excess of c550 mmboe. However, given the tight reservoir, recovery factors are likely to be low (c10%), which could increase over time with fracking. Management indicated that the good quality of crude (light oil, low viscosity) could aid in development and recovery, though the decision to go in for development, and eventually production, could still be some time away. Based on an EV/boe of US$7-8 (we now value Rajasthan upsides at US$8.5/boe, a 25% discount to the imputed EV/boe for core MBA), this could add ~Rs5-6/sh to our NAV for Cairn.

 Rajasthan production potential of 500 kbpd? — As per a press article (source: Hindustan Times), Vedanta Chairman Mr. Anil Agarwal has written to the Prime Minister’s principal secretary Mr. Pulok Chatterjee that production from Rajasthan could reach c500 kbpd in the next few years (c150 kbpd currently). At this stage, these targets appear fairly ambitious to us, with several imponderables (geology being the primary one), and we would refrain from getting overly excited at this stage. Cairn India's guidance now stands at peak production of c240 kbpd (with a ‘significant part’ of this from MBA), while Cairn Plc has in the past indicated that this could potentially go up to c300 kbpd. Our current forecasts assume peak MBA production of 230 kbpd (by Dec’13E). Nevertheless, production growth of the envisaged magnitude, if indeed possible, would not only be an obvious +ve for longer-term volume growth but would also likely require significant incremental capex, potentially partially mitigating longerterm concerns on use of cash.

 Reiterate Buy — Our target price of Rs380 is based on an average of Citi’s crude forecast-based NAV (crude at US$125/120 over CY12/13E; long-term of US$80), which yields a value of Rs383/sh, and the forward curve-based NAV, which yields a value of Rs414/sh. We build an additional 5% discount to NAV to account for uncertainty regarding use of cash. We reiterate Buy on the stock which, in our view, offers the best hedge against crude, currency, and (to some extent) inflation. Key near term catalysts are approvals for Mangala ramp-up and expected dividend policy announcement. Cairn remains our top large-cap pick in the sector.

To read full report: CAIRN INDIA

>THERMAX INDIA: Capex analysis indicates a weak order outlook

  As a late-cycle play, Thermax is unlikely to benefit from the nascent economic recovery.
Engineering and construction firm Thermax derives c80% of its orders from mid- to latecycle
capex by sectors like metals, cement, refineries and power. As such, we do not see the
company benefiting yet from India’s tentative economic recovery, which remains fragile and
barely past the bottom of the cycle. We discuss several leading indicators in this report and
highlight that industrial production growth picks up only after 3-4 quarters of a rate cut, while
gross capital formation growth picks up only when the rate cycle has bottomed.

  Capex analysis indicates a weak order outlook. Captive power addition, a key demand
driver for Thermax, is likely to closely track industrial capex, because other drivers, such as
high merchant rates and cost advantages, are fading. We discuss capex outlook in four key
sectors (e.g., metals, cement, refineries and power) and estimate that capex in these sectors
on average will fall c15% in FY13 and c9% in FY14. Assuming a 12-month lead time in
ordering, we forecast Thermax order inflow to decline by c16% in FY12 and c6% in FY13.

  Earnings still to bottom; consensus appears bullish: Due to weak order inflow in FY12-
13, we expect revenue to fall c10% in FY13 and EBITDA margin to fall c130bp in FY12-
13. We note that consensus appears bullish, as it is factoring in only a 2% sales decline in
FY13 and a c40bp margin decline in FY12-13, even when margin has already fallen by
c90bp in 9M FY12. While margin may benefit somewhat from a potential easing in steel
prices going into FY13, the decline in volumes and pricing pressure is likely to prevent its
earnings from improving. Hence, we remain c12%/21% below consensus on FY12/13 EPS.

  Initiate UW with a TP of INR400; recent derating justified: While Thermax is trading at
a 33% discount (on consensus) to its historical 12-month forward PE, the recent derating
seems justified, given the deterioration in its returns and growth prospects. On our FY13
EPS, the stock appears expensive, trading at a c18.4x PE vs. a sector average of c11.6x, and
we believe potential earnings downgrades will drive the stock lower. Thus, we initiate
coverage on Thermax with an Underweight rating. Our TP of INR400 is derived from our
preferred EVA methodology and implies a 12-month forward target multiple of c14.9x.

To read report in detail: THERMAX INDIA

>SWARAJ ENIGINES: M&M acquisition has clearly been value accretive to Swaraj Engines

■ Fortunes linked to Indian agriculture
SWE manufactures internal combustion engines for tractors manufactured by the ‘Swaraj Tractors’ division of Mahindra & Mahindra. These tractors are largely used for agricultural purposes, although the share of non-agricultural demand has been increasing of late. The key drivers of tractor demand in India include i) Gap in productivity levels (measured in terms of yield per hectare) in India despite having the second largest arable land in the world – resulting in need for higher farm mechanization; ii) Higher Minimum Support Prices (MSP) of farmers resulting in higher ‘income effect’; iii) Policy initiatives such as NREGA scheme, agriculture being classified as priority sector lending, subsidy on interest repayment, diesel subsidies etc. The domestic tractor industry has witnessed a sales CAGR of 16% in the last three years, much higher than long-term average of 8.5% mainly led by the above factors.

■ Access to the world’s largest tractor manufacturer
SWE enjoys access to the world’s largest tractor manufacturer i.e. Mahindra & Mahindra (M&M) by virtue of the latter holding 33% in SWE. SWE caters to nearly 80% of the demand of ‘Swaraj Tractors’ division of M&M, with the balance 20% being met from its second promoter – Kirloskar Oil Engines. Going forward, SWE expects to meet upto 85-90% requirement of ‘Swaraj Tractors’. SWE believes in its own in-house technological capabilities to cope up with the upcoming challenges in terms of technology changes and believes that its technology is at par with that of global players. The company invests in research and development on a continuous basis.

■ Presence in high HP segment, right geographies augurs well
SWE historically has been present across segments in terms of HP i.e. 20-30HP, 31-40HP, 41-50HP and >50HP. However, going forward it believes that incremental demand for tractors are more likely in the >40HP segment. This is mainly driven by i) Increase in use of tractors for non-agri purposes such as transport, construction/ infrastructure activities etc; ii) Shift in demand from the Northern to western/ southern region where the soil is hard and requires high power tractors; iii) replacement of tractors, where typically farmers replace older tractors with new higher HP tractors. SWE is not looking at entering the <20 HP segment unlike its competitors as it feels that it is a low margin segment with much lesser growth rates. Also, while the traditional markets of north are fairly penetrated in terms of tractor demand, other regions such as Bihar, Western region and Southern region are witnessing higher demand traction due to low penetration levels there. In both these regions, not only does M&M enjoy a significant market share (44-50%), it has also experienced significant growth in market shares over the last ten years.

■ Industry growth rates to moderate in the near-term; Long-term fundamentals intact
Historically, the tractor industry has grown at a long-term average of 8.5%. However, the previous 3-year average has been significantly higher at 16% mainly boosted by policy initiatives and diesel subsidies. SWE expects the growth rates to moderate somewhat over the next 1-2 years i.e. 14-15% in FY12E (mainly due to subdued demand in Jan-Mar 2012 period) and 8-10% in FY13E. However, the growth rate is expected to be still higher than the long-term average of 8.5%. Besides, SWE is likely to exhibit higher growth rate of 18% in FY13E driven by higher share of Swaraj Tractor’s requirement. Long-term prospects still remain attractive driven by i) Huge demand potential for tractors in India – potential demand for 6mn tractors v/s an estimated 4mn tractors currently; ii) Low penetration levels in regions such as Bihar, South and West; iii) growing use of tractors for non-agricultural applications; iv) Farmers’ requirement to dig deeper into the soil to make it more fertile; and v) Strong replacement demand – life of a tractor 10-15 years.

■ Excellent track record, experienced management provides comfort
SWE has an excellent past track record in terms of higher than industry average growth rates – SWE volumes grew @ 42% CAGR, fastest in the industry, in the last 3 years v/s industry average of 16%. Besides, post the acquisition of PTL by M&M, the capacity utilization rates have improved manifold. Further, efficient working capital/ balance sheet management (negative working capital, NIL borrowed funds) gives a significant lever to withstand adverse business cycles. Backing of an experienced management (most senior management employees have been with SWE for over 20 years since Punjab Tractor days) with sound knowledge of the industry/ business offering significant comfort to minority investors

■ Earnings to grow @ 17% CAGR over FY12E-14E; DCF based TP of `925/share; Buy
SWE has been able to optimally utilize its capacities in the past three years mainly due to robust domestic demand and efficient management. SWE is expanding its capacities by ~79% to 75,000 engines by end CY 2012. Although, SWE believes it has the wherewhital to increase its installed capacity to 100,000 engines, we believe there wouldnt be any need for additional capex atleast for the next 2 years. We believe SWE would be able to efficiently sweat its capacity of 75,000 engines over FY14E-15E to achieve the modelled volume growth of 10% in the same time frame. We have modelled the next phase of capacity expansion to begin in end FY15E that would culminate in a total capacity of 90,000 engines in FY16E.

Based on the above factors, we model revenue CAGR of 19% over FY12E-14E. We expect EBITDA margins in FY12E-14E to be lower than the trend seen in FY10-11 (16.2%-16.4% v/s 17.5-19% seen in FY10-11) mainly due to a slowdown in industry growth rates. However, higher than average industry growth rates would support earnings CAGR of 17% over FY12E-14E period. We expect SWE to report EPS of `45/share in FY12E, `52/share in FY13E and `61/share in FY14E. Our long-term DCF based target price of `925/share implies an upside of 141% from current levels. We initiate coverage with a ‘Buy’ rating on the company.

■ Risks
Key risks include i) Dependence on single customer i.e. M&M; ii) Less allocation for rural development may temper growth rates going forward; iii) Decline in availability of agricultural credit due to macro-economic circumstances could affect growth rates, adversely; iv) Natural calamities e.g. drought, flood, etc.; v) Fall in Minimum Support Prices (MSP) of foodgrains could impact farmers’ disposable income.

To read report in detail: SWARAJ ENGINES

>BHARAT HEAVY ELECTRICALS LIMITED: Introducing CIRA's new rating system

 Downgrade to Sell — We resume coverage on BHEL with a Sell rating and a target
price of Rs250. Severe coal/ gas shortages, high international coal prices, poor SEB
financials and land acquisition/ environmental delays have shrunk the India BTG
market. Over the last 5-6 years BHEL has faced competition from Chinese suppliers.

 ….. and the problem has been compounded — The rise of domestic equipment suppliers, such as L&T-MHI, Toshiba-JSW, Bharat Forge-Alstom, BGR-Hitachi, shows the Indian power BTG market is just like any other industry: an incumbent making super normal profits attracts new competitors, leading to overcapacity/ pricing collapse.

 Barriers and pricing are falling — Once BHEL gets the last of the reserved bulk orders in FY13, every incremental order should be a hard-fought battle. Import duties can perhaps provide a sentiment +ve, but we wonder if it will make any difference as: (1) XIIth Plan (FY13E-17E) ordering is over and (2) lack of fuel visibility implies XIIIth Plan (FY18E-22E) ordering will not start in a hurry. BGR-Hitachi’s winning bids in the recently concluded bulk tender are not too far off vis-à-vis Chinese pricing. 

 Target price Rs250 — Based on P/E of 10x Sep13E and set at ~ 30% discount to
 historical average ~14x given BHEL’s (1) declining backlog ,(2) EPS CAGR of -4% over FY12E-14E and (3) RoEs falling from FY11 - 31% to FY15E - 17%. Our EPS estimates are not conservative as they assume (over next three years) (1) inflows of Rs400bn/year, (2) gross margins contracting only 66bps, (3) execution speed improving from 30% to 48% on expanded capacity and (4) maintenance capex Rs3bn/year.

 Introducing CIRA's new rating system — In Oct 11 CIRA announced its new stock rating system. CIRA's investment ratings are Buy, Neutral and Sell. Our ratings are a function of analyst expectations of expected total return and risk. Risk rating takes into account price volatility and fundamental criteria. Stocks will either have no risk rating or a High risk rating. The sidebar and table on this page show our new rating, target price, and estimates for BHEL. See “Guide to CIRA Fundamental Research Investment Ratings” in the Important Disclosures section of Appendix A1 of this report for a description of our rating system.

To read report in detail: BHEL