Tuesday, April 17, 2012


ETFs originate with a fund sponsor, which chooses the ETF’s target index, determines which securities will be included in the “basket” of securities, and decides how many ETF shares will be offered to investors. Say, for example, a fund sponsor wants to create an ETF that tracks the S&P 500 Index. Because of the expense involved in acquiring the basket of securities that represent the securities listed on the S&P 500—which can run into the millions of dollars—the fund sponsor typically contacts an institutional investor to obtain and deposit with the fund the basket of securities. In turn, the ETF issues to the institutional investor a “creation unit,” which typically represents between 50,000 and 100,000 ETF shares. (Note that, unlike shares in a traditional mutual fund that are purchased with cash, ETF sponsors require its investors to deposit securities with the fund.)

Each ETF share represents a stake in every company listed on the S&P 500 Index. The institutional investor that holds the creation unit (the “creation unit holder”) is then free to either keep the ETF shares or to sell all or part of them on the open market. ETF shares are listed on a number of stock exchanges (NYSE, NASDAQ, Amex, etc.) where investors can purchase them through a broker-dealer.

Like other exchange-listed securities, a retail investor who purchases an ETF can liquidate its investment by selling its ETF shares at the current price. By contrast, a creation unit is liquidated when an institutional investor returns to the ETF the specified number of shares in the creation unit; in return, the institutional investor receives a basket of securities reflecting the current composition of the ETF.

The basket of securities deposited by the institutional investor with the fund sponsor has been predetermined by the sponsor to track a particular index. When changes are made to the index (a stock is added to or dropped from the index), the fund sponsor notifies the creation unit holders that changes need to be made to the basket of securities originally deposited with the fund to ensure that the basket continues to track the composition of the index.

Dividend and Management Fees
Unless the underlying index is a total return index, ETFs pay dividends to investors on a regular basis. Dividends paid by the stocks held in the ETF are accrued and kept as cash until they are paid to the investor. The management fee is deducted from this cash on a daily basis. When the dividends of the underlying stocks are not sufficient to cover the management fee, a small portion of the underlying stocks in the ETF are liquidated to cover it.

ETFs Trade Close To NAV
The NAV (Net Asset Value) of the ETF, expressed on a per share basis, is the value of the underlying constituents of the benchmark held by the ETF, plus the accrued dividends less the accrued management fee. Although the price at which an ETF trades is subject to the same supply and demand dynamics of a normal share, the creation/redemption process described above ensures that the price trades very close to the NAV. Since ETF shares can be created or redeemed at the NAV, a material discrepancy between the trading price of the ETF and its NAV can be arbitraged away.


There are different types of ETF unlike close-ended funds can create or cancel units as investors enter or leave the fund. The size of the ETF, rather than the price, will fluctuate based on the demand and supply for the ETF. There are several ETF launched till date they can be broadly categorized as follows:

Global ETF: There are ETFs tracking indices beyond the domestic markets. Ex specific regional funds that track fast growing markets in China and Korea.

Fixed Income ETF: ETF tracking fixed income products. ETF in this case may declare and pay dividends.

Commodity ETF: ETF that track commodity or commodity indices take advantage from the gains in the commodity market.

Currency ETF: ETF tracking currency or currencies. Ex ETF- Euro Currency Trust (FXE) was introduced in Dec 2005 which trades on the NYSE. Hence investors can take exposure in Euro through this fund.

>ARVIND MILLS: Multiple drivers

Back in Vogue

With a strong portfolio of 21 brands and aggressive 23.9% CAGR in retail expansion at 1.58mn sq ft, we expect Arvind’s brands and retail business to show 25.6% CAGR over FY11-14E at Rs19.1bn and increase its share from 22% to 32.7% over the same period. Positive result of major capex of Rs4.3bn over FY11-12 would be visible in FY13-14. Its stock is currently trading at 6.5x/4.9x FY13/14E P/E and 5.2/4.2x EV/EBITDA, below the mean of 8.1x and 6.5x, respectively. Strong 12.4% revenue CAGR aided by 104bps higher operating margin, working capital efficiency and debt reduction by 26.5% should drive profitability CAGR by 45.6% over FY11-14E, generate free cash flow of Rs5.2bn over FY13-14E, improve adjusted RoCE by 303bps over FY11-14E and calls for expansion of PE multiple. We assign a Buy rating to Arvind with a SOTP-based TP of Rs117, valuing it at 9.1x/6.4x/1.2x PE, EV/EBITDA, P/B for FY13E.

 Lower debt, interest rates to drive profitability: Bumper cotton production led to softening of prices, which would reduce Arvind’s ex-cash working capital requirement to 26.8% of sales in FY14E from 28.3% in FY11. Free cash flow of Rs5.2bn over FY12-14E would reduce its debt by 26.5% to Rs16.2bn and its adjusted D/E ratio from 1.6x to 0.6x over FY11-14E. Lower debt, falling interest rates and improved credit rating would prune interest costs from 6.4% to 3.3% of sales over FY11-14E and drive net profit CAGR by 45.6% over the same period. Monetisation of real estate assets, as and when it happens, would sweeten its cash flow and debt reduction programme.

■ Fast paced growth of B&R business: From a denim producer for corporate clients, Arvind is turning into a brand power house catering to consumers directly. Aggressive retail expansion, growth through multiple drivers like distribution expansion, new brands launch and category expansion would drive the brands and retail (B&R) division’s revenue CAGR by 25.6% to Rs19.1bn and increase its revenue share to 32.7% from 22% over FY11-14E. We expect its operating margin to rise by 140bps to 9.5%, which would increase segmental RoCE by ~109bps to 14.0% over FY11-14E. 

■ Strong free cash flow and return ratios: With the decline in cotton prices and hence working capital needs, a 104bps improvement in operating margin over FY11-14E and lower capex, Arvind should generate positive free cash flow of Rs5.2bn over FY13- 14E. Following weak demand, we expect the performance of its textile and retail divisions to remain muted in 1HFY13, thereby pruning consolidated margin by 20bps to 14.2% and RoCE by 96bps in FY13E. However, with the revival in demand and soft cotton prices, its revenue should grow 14.3%, operating margin should improve by 40bps and RoCE by 123bps in FY14E. Adjusted RoCE/RoE should improve from 11.7%/11.0% in FY11 to 14.8%/18.3%, respectively, in FY14E. Positive free cash flow from FY13 onwards and improving return ratios should drive up the valuation multiple.

To read report in detail: ARVIND MILLS

>HATHWAY CABLE AND DATACOM: Acquired majority stake in Bhasker Multinet (Cable TV arm of Dainik Bhaskar Group

 Digitization: a game changer
Hathway has total universe of ~8.8mn active subscribers but receives the revenue share of ~20% of subscribers due to significant underreporting of subscribers by LCOs leading to major loss of revenues. With implementation of mandatory digitization of cable TVs, the company's subscription revenues (INR 3,227; 40% of consolidated FY11 revenues) are expected to get a big boost with complete disclosure of number of subscribers. We expect subscription revenues to rise by 3.65x FY11 revenues to INR 11,778mn in FY14. Carriage & Placement (C&P) revenues (46% of FY11 revenues) are expected to see decline with implementation of digitization due to increase in channel carrying capacity in digital mode. Despite estimated 40% decline in C&P revenues over FY12-14, overall cable TV revenues (Subscription + C&P) of the company are expected to grow at 3 year CAGR of 25.7% during FY11-14 to INR 14,926mn on the back of huge jump in subscription income.

■ Strong player
Hathway has 0.6mn primary subscribers and 8.2mn secondary subscribers. Company has highest number of paying subscribers (~1.9mn) among all the MSOs in the country. Company's network is spread across India with presence in 140 cities and towns. Company is supported by 71 analogue and 20 digital headends and has 15,000Km of cable network. Hathway in the past 3 years has successfully acquired secondary subscribers through stake purchase in more than 21 MSOs to consolidate its market presence and increase its regional spread. Secondary point acquisition helped the company augment its subscriber base and get healthy carriage fee revenues. It acquired majority stake in Bhasker Multinet (Cable TV arm of Dainik Bhaskar Group), 50% stake in largest MSO in Gujarat - Gujarat Telelinks and few other MSOs in Maharashtra. Gujarat Telelinks contributed 26.5% in consolidated FY11 revenues.

 Broadband services: an additional growth driver
Hathway is the largest cable operator to offer broadband services which accounted for 14.33% of consolidated FY11 revenues. The segment recorded revenues of INR 1,475mn in FY11 at 3 year CAGR of 19.93% and delivered much higher ARPU (INR 308 for Q3FY12) with EBITDA margin of ~35%. Company has seen increase in its broadband subscriber base from 0.23mn in FY08 to ~0.4mn currently at a CAGR of 15%. We expect this segment to report revenues of INR 2,153mn in FY14 at a 3 year CAGR of 19.38% on the back of bundling opportunity with cable TV after digitization.

Outlook & Valuation
Structural changes in cable distribution with the implementation of digitization open long term opportunities for the industry. Hathway, having largest paying subscriber base of 1.9mn, is well poised to be the major beneficiary from mandatory digitization. We believe Hathway's strong network with presence in key markets would enable the company to efficiently monetise the digitization opportunity. Further value added services and broadband offering would provide growth to overall ARPU. However, due to uncertainty regarding smooth implementation of digitization and recent sharp run-up in the stock price on talks of increase in FDI limit (for DTH players and MSOs) from current 49% to 74%, we have no rating on the stock at present.

To read report in detail: HATHWAY CABLE

>BHUSHAN STEEL: Initiate at Sell: Strong Business; But Leveraged and Expensive

  Outperformer, TP Rs310 — We initiate coverage of Bhushan Steel (BSL) at Sell. BSL has
outperformed the Sensex (+19%) & our metal index (+26%) over the past six months, and
now appears expensive at 8.5x Sep13 EV/EBITDA (domestic peers at 5-6x). We believe
historical premium (40-55%) vs. peers should moderate 1) as BSL transforms from being a
steel processor to a steel producer; 2) earnings growth at 8% in FY11-14 is more tepid vs.
33% in FY08-11 & EBITDA/t is range bound; & 3) potential value for captive raw material assets may be overdone given socio/political risks. A premium should remain, but with the convergence of business model, net D/E at 3x & a muted steel outlook, we expect it to narrow.

  We like model, but in the price — 1) Strong EBITDA ($250-275/t) despite no captive
raw material currently is buoyed by BSL’s value chain: slabs/HR/CR/ galvanized/color
coated (and more); 2) European HR prices have risen 12% in 3m; Indian prices are up
5-10%. Stable/strong prices, improving domestic demand augur well as BSL is more
than doubling capacity to 4.7mtpa by 2HFY13; 3) It has captive iron ore (70mt) and
thermal coal (325mt), both to start in 2yrs and 89% in Bowen Energy, Australia (coking
coal in 4-5yrs); making it a more conventional play with raw material security.

  Valuation — We value Bhushan Steel at 7x EV/EBITDA at a discount to its 5-yr trading
average of 11x – in line with domestic peers’ 5-yr average of 7-8x. We think the market
is overestimating earnings growth from capacity additions and raw material integration.
We assume expansion by Dec12 and ascribe 7x multiple on FY14 EBITDA (capture
both EBITDA and project related debt) and discount the resulting equity value @ 15%
to Sep13 to arrive at a TP of Rs310. At our TP, BSL would trade at 6x Sep13 PE.

  Muted steel outlook — Despite stable prices and rising margins, we have a muted
outlook. Chinese steel production started the year on a weak note, implying 600-620mt
of annual production. CISA data for 10 days of March suggest a yearly production of
693mt, +1% yoy. To be more positive, it is vital to see a U-turn in Chinese construction.
European auto demand fell in Jan12 and construction is only likely to recover in 2013.

 Upside risks — Higher volumes/steel prices, faster raw material integration, FX gains.

To read report in detail: BHUSHAN STEEL