Sunday, April 22, 2012

>SUN PHARMACEUTICALS: Prandin patent case: A positive win

■ Event: The US Supreme Court ruled in favor of Caraco, US subsidiary of Sun Pharma, in its patent litigation against Novo Nordisk’s diabetes drug Prandin. The court concluded that Caraco can seek correction of Novo’s inaccurate use-codes over the drug; however, the court’s ruling on whether the correction applies to Caraco’s labeling is still pending.

 Background: Prandin is approved by the USFDA for three specific uses, but Novo’s original patent covered only one usage. Thus, post filing the ANDA for gPrandin, Caraco also filed a section 8 statement which seeks approval for two other uses not covered by the patent listed in the Orange Book. Novo then changed its use-code for the ‘358 patent’, broadening the scope of the usecode to cover all the three approved uses. Usually, the USFDA approves the generic drug within the scope of the use-codes and does not determine the scope of the same. Post favorable ruling, Caraco could get approval for the two other uses without infringing Novo’s patent.

 About Prandin: Prandin (known as Repaglinide is used to cure diabetes) has a market size of US$230mn in US and its patent is held by Novo Nordisk till 2018. Caraco holds an FTF status on the drug and is still awaiting the final approval from the USFDA (post the site transfer).

 Impact: We believe that Sun Pharma can clock US$30mn in terms of revenues from the Prandin supply during exclusivity. While, Novo has filed its appeal against Caraco in 1QCY2012, the final approval could take some time, leaving options open for an “at-risk launch” for Sun Pharma.

Outlook and Valuation
We view this ruling as a benchmark for the generic companies where they can appeal for either invalidity of the patent and/or counterclaim brand’s inaccurate use codes. This procedure could stall the unnecessary delays caused to stop generic companies in marketing their drugs.

We believe that the positive ruling could pave way of faster approval for gPrandin. Along-with strong product pipeline (Uroxatral, Duloxetine, Pregablin, Eszopiclone, Memantine) spread across FY2013E and FY2014E, such incremental opportunities would boost the gains of the company. We remain positive on Sun Pharma, given its steady performance, superior brand franchise in the domestic market, growth prospects in the US market and the excellent M&A track record. We factor high tax liability post the budget in our FY2013E numbers and introduce FY2014E numbers in this note and roll over our target price on new projected EPS.

We recommend Accumulate on the stock with the price target of Rs650. Sun is currently trading at 25x and 20.4x its FY2013E and FY2014E EPS respectively.

Risks to the view
■ Delay in product approvals and higher than expected liability on Protonix litigation
 Lower than expected performance from Taro

To read report in detail: SUN PHARMACEUTICALS

>Non-ferrous Metals Sector: Soft landing for Chinese economy is also bad for the sector

The Long & Short of it

We remain cautious on global demand recovery and expect the slowdown to prolong in developed countries. We refrain from taking a call on Euroquake/sovereign debt crisis in Europe as it has become more of a political issue than plain economics. However, even if the politicians are able to save the euro currency (which entails major austerity measures for most of the Eurozone members), the case for demand contraction is quite strong in that situation too. The Chinese economy’s hard as well as soft landing would be painful for the entire metals sector barring zinc (which is relatively better placed among other metals), while monetary easing in China is unlikely to result in a pick-up in investment cycle as the investment to GDP (gross domestic product) ratio is already at an alarming level of over 65% and any further rise from here on would certainly lead to a hard landing in China. Our London Metal Exchange (LME) metal price assumptions are around 10-15% lower compared to consensus estimates, but our rupee assumption is 7-9% weaker because of extensive slowdown likely in the Indian economy, leading to 2-6% weaker metal prices in rupee terms compared to street estimates. We are positive on Hindustan Zinc (HZL) due to its attractive valuation, balance sheet strength and steady growth.

■ Soft landing for Chinese economy is also bad for the sector: The Chinese government’s plan to engineer a soft landing for its economy would also lead to investment slowdown in all industries. Construction, real estate, commercial vehicle and capital investments are showing a declining trend, which is likely to continue in the coming quarters. This would result in huge demand slump in all metal categories (China accounts for 35-40% consumption of all metals). 

■ US economy appears to be improving, but still far from its peak: Headline US economic numbers are showing a rising trend, driven largely by the base effect. Economic indicators like automobile sales, housing sales, housing prices and joblessness are still way off from their highs witnessed before 2007 as US new home sales are still at a four-decade low.

■ Whether the euro is alive or dead, metal demand contraction to be evident: LME prices are witnessing sharp volatility on news flow from Europe; but in the case of a deal or no deal to save weaker countries from sovereign debt crisis, demand contraction would be apparent in both the situations. Governments would be forced to go for severe austerity measures, leading to a cut in household and corporate demand.

■ Economic conditions not as bad as 2008, but the ability to fight the crisis is limited:
Although we believe the economic situation is not as dire as the 2008 crisis, the ability to fight the crisis is also limited. Most of the countries have fiscal deficits close to high single-digit with
debt/GDP of over 100%, implying lower ability to further boost their economies.

Metal prices trade below marginal costs for a long period of time: We do not accept the
argument that metal prices are below marginal costs and are thus expected to recover from these levels. Until some capacities go offline on a permanent basis, the threat of supply hitting back the market will keep the prices subdued for a long period of time.

Valuation: We have a Buy rating on HZL as the stock will become more like a bond because of strong cash generation. We also remain relatively positive on zinc prices due to strong demand environment in China and supply concerns. We assign a target price of Rs153 (5.0x FY14E EV/EBITDA) for HZL, which is 25% higher than the CMP. For Hindalco, we assign a Sell rating as new expansion is likely to be value dilutive at current aluminium prices. NALCO has been given a Sell rating due to subdued earnings growth and cash utilisation concerns.


>RELIANCE INDUSTRIES: RIL can take on another ~US$30bn of projects but has been reticent (CLSA)

After its recent 15% correction, 2012 is now Reliance’s fifth straight year of relative under-performance. We foresee some triggers emerging by year-end but singular variables, such as a gas price hike or the telecom foray, may not be enough for a sustained re-rating. Reliance needs to create a deep portfolio of projects to rekindle investor interest. Further, these may need to be in the energy chain; its ~US$8.5bn non-core portfolio has been a drag on performance. Reliance has been more reticent here than we had expected clouding its long term outlook.

■ Reliance has now been under-performing for five years
After its 15% correction since mid-Feb, Reliance’s stock is now under-performing the Sensex in 2012 – the fifth year in succession. Over this time, FY09-14 earnings have been cut 18-44%. This is continuing; we recently cut FY12-14 EPS by 2-7% to factor in lower KG-D6 volumes and SOTP by Rs25/sh to factor in a 30% cut in D1-D3 reserves to 7tcf. Our current FY13 estimate (~Rs69/sh, similar to consensus) implies a ~30% rise in EPS over the 4Q run-rate. This is predicated on a weaker currency (Rs53/US$), a US$1/bbl rebound in GRMs and higher other income but we concede downside risks.

 Triggers may emerge by end 2012 but may be short-lived
We expect the EPS momentum to start rebounding when the polyester expansions begin to come on-stream from early 2013. By this time, we expect the 4G telecom launch, indications of higher gas prices and more detail on the retail foray to help. These triggers are likely to short-lived, however, as singular variables may not be enough for a re-rating. For example, while higher gas prices will renew the E&P thrust, NAV impact is limited (US$1 = 1.5%) while EPS impact (US$1 = ~3%) will accrue only from FY15. Similarly, our telecom analyst cautions that infra challenges and lack of a 4G device eco-system may force Reliance to bundle 2G voice implying higher capex. 

 Reliance needs to build a deep portfolio of projects in the core energy chain 
In our view, therefore, Reliance needs to create a portfolio of +15-20 projects like its global energy peers have, to rekindle investor interest. Historically, sustained project growth has driven stock performance by driving EPS growth across cycles. This is now sorely missing; ten year profit Cagr has dipped below 20% for the first time in history.

■ Reliance can take on another ~US$30bn of projects but has been reticent
Reliance has been more reticent on new projects than we had expected it to be, though; perhaps because of poor returns from the US$17bn KG-D6, RPET projects and the +50% fall in US gas prices since the time it acquired its shale gas assets. For example, gross block will be flat over FY10-15 despite US$12bn outlay on downstream projects as the olefins, IGCC projects are yet to commence in earnest. Indeed, given its cash (US$15bn), operating cashflow (US$6-7bn annually) and capital serving needs, it can easily invest an additional ~US$30bn without stressing its balance sheet.

■ Non-core investments have been a drag on returns and stock performance
Further, these projects may need to be in the core energy chain. Its ~US$8.5bn noncore investments (~20% of balance sheet) across multiple verticals have been a drag shaving off ~3ppt from ROACE; the retail venture, for example, is still incurring losses even after five years of operation. Nonetheless, with the stock trading at 11x PE and a 25% discount to our NAV and triggers emerging by end-2012, we maintain O-PF.


>TATA MOTORS: Rising LCV and car volumes in India (CLSA)

JLR’s volumes have continued to surprise on the upside with Feb and Mar volumes coming in 5-16% above estimates boosted by strong Evoque demand. Rising proportion of China in volumes, operating leverage benefits and stable currencies have also improved margin outlook for JLR. In India, LCV and car volumes have improved in 4Q and profit outlook for India business is also improving. We upgrade FY13-14 EPS by 16-18% factoring in higher volumes in both JLR and India and anticipate upgrades by street in weeks ahead. We upgrade Tata Motors from O-PF to BUY with a TP of Rs370.

  JLR’s volumes continue to surprise positively
JLR’s monthly global sales improved further in March with volumes at 36.5K units rising 51% YoY and 16% above estimates. This is the second month in a row that volumes have beaten our estimates handsomely. Evoque sales seem to have stabilized at the 10K level and demand outlook for the vehicle remains robust. The recent addition of a third shift at the Halewood plant has effectively increased JLR’s total annual capacity to 390-400K units – enough for FY13 and debottlenecking measures are being planned to take the capacity further up by FY14. Industry premium vehicle demand remains strong as evidenced by the monthly sales of JLR’s peers. More important, China sales of the industry were also strong over Feb and Mar, which should allay concerns of slowing China demand. We upgrade FY13/14 JLR volumes by 7% to 391K/422K units.

  Improving margin outlook at JLR as well
Operating leverage benefits from higher volumes are fairly meaningful for JLR. Share of China in volumes has improved from 17% in 3Q to 19% in 4Q and should improve further in FY13. The principal currencies relevant to JLR’s margins have been stable from 3Q to 4Q. This has improved our outlook for JLR’s margins and we now build in 18.6% EBITDA margins over FY13-14 (~17.5% previously).

  Rising LCV and car volumes in India
India LCV volumes have improved substantially in 2HFY12 and we expect strong growth in FY13 backed by higher capacity at the Pantnagar and Dharwad plants. The launch of a new platform for non-Ace LCVs will also boost volumes in FY13. India car volumes (incl Nano) have picked up in 2H. However, outlook for trucks remains subdued with industry growth slowing down to -4% in Mar-12.We upgrade Tata’s India volumes by 9-10% factoring in higher LCV/car volumes.

■ Upgrading FY13-14 EPS by 16-18%; upgrade from O-PF to BUY
We now build in JLR’s capex at £2bn per year (£1.5bn before). Our estimates are 12-14% above consensus and we anticipate EPS upgrades by the street in coming weeks. A strong response to the new Range Rover platform that will be launched by end-CY12 could drive further upgrades to FY14 EPS. Upgrade to BUY.


>TITAN INDUSTRIES:— Rising gold prices have driven Titan’s earnings

44% of Titan’s stock price is ‘excess’ earnings boosted by gold inflation. Our illustrative calculation suggests that Titan’s earnings would have been 44% lower in FY2012E (adjusted EPS of ~Rs3.6 in FY2012E versus the ‘normal’ EPS of ~Rs6.5) had gold prices remained broadly stable over FY2005-12E. While there are few limitations to our exercise, what remains a fact is that Titan (and the jewelry industry) has benefitted due to inflationary gold prices as making charges are mostly a percentage of gold price. Our long-term positive view on Titan’s business model stays as it stands to benefit disproportionately from consumer conversion to the organized sector.

Going beneath the glitter—rising gold prices have driven Titan’s earnings
Exhibit 1 gives an illustrative calculation to understand the impact of inflation in gold commodity
prices on Titan’s earnings. Stripping-off the gold commodity inflation for the period FY2005-12E, we arrive at an EPS of ~Rs2.8 for FY2012E (versus ‘normal’ EPS of Rs6.5). However, if we consider gold inflation to be equal to general inflation in the economy, the adjusted EPS for FY2012E works out to Rs3.6, i.e. ~Rs103 (44% of current stock price) is ‘excess’ earnings boosted by gold commodity inflation, in our view.

■ Between FY2005 and FY2012, Titan’s jewelry sales have increased at a CAGR of ~46% and
gold prices have increased at a CAGR of 23% (in Rupee terms). Volume growth in terms of
number of pieces sold increased at ~22% CAGR during the period.

 For the purpose of our calculation (in Exhibit 1) we assume that gold prices remained flat and
jewelry sales growth was entirely driven by volume growth. The reason for assuming flat gold
prices is that the company imposes making charges as a percentage of gold price, hence any
increase in gold prices leads to increase in absolute earnings for the company.

 On the basis of the above assumption, we find that the company’s earnings would have been
lower by 40% on an average had gold prices remained stable.

 Key assumptions – (1) TTAN’s ‘price increase’/gold inflation is equal to the general inflation in the economy, (2) we have considered a further 1% per annum increase in pricing essentially to capture the mix improvement/higher tonnage purchases by customers, and (3) we have also
considered the actual volume growth (in terms of number of pieces).

Few limitations to this exercise are as follows:
■ This calculation may not take into account the impact of mix improvement on sales and earnings in its entirety – there has been a steady trend of consumers shifting to diamond/studded jewelry from gold. Companies also encourage this as margins are higher in the former. Typically plain gold jewelry has gross margin of ~8%, designer gold jewelry has ~14%, and studded jewelry (including diamonds) has ~30%.

 To calculate volume growth, it would have been more appropriate to consider tonnage growth rather than number of pieces sold. However, the company does not report sales in tons and that’s a key constraint.

 We have calculated sales growth as a function of volume growth + pricing growth + a modest 1% per annum increase in pricing essentially to capture the mix improvement/higher tonnage purchases by customers.

Our long-term positive view on Titan’s business opportunity is intact
We have an ADD rating with target price of Rs260 on Titan. Our EPS estimates for FY2013E
and FY2014E is Rs7.9 and Rs9.8 respectively. Our long-term positive view is intact as:

■ Any sustained correction in gold prices will likely help induce higher volume growth. Further, 
as Titan leases gold instead of buying gold, there will be minimal inventory loss (possibly to the extent of gold used in some of the studded jewelry lying in the books beyond the 180-day period – the maximum possible under the gold lease scheme). 

 Rising activity in the organized jewelry market will help grow the market and with Titan having the first mover advantage will likely benefit disproportionately – the organized jewelry market forms ~4% of the total jewelry retail market and is growing faster than the overall jewelry market. As per industry sources, the branded jewelry market is expected to grow at a CAGR of >40% over the next four-five years given changing lifestyles and higher marketing investments by organized players.

 Budget 2013 has created a level-playing field for all jewelry companies by not differentiating between organized and unorganized players – Budget 2013 has widened the ambit of excise duty on branded jewelry to include unbranded jewelry as well.

 Recent commentary by the management suggests that as compared to 2QFY12 and 3QFY12, there has been an improvement in footfalls in 4QFY12 (January and February).

 We are believers in the long-term opportunity for Titan, (1) likely higher discretionary spends, (2) penetration and consumption-led growth, (3) mix improvement in favor of diamond and studded jewelry is a positive as it enjoys higher margins and reduces the vulnerability of the company to volatility in gold prices. Key downside risk is continuing volatility in gold prices and further deterioration in consumer demand.



 High visibility, low-cost land bank: With 82% of its gross NAV emanating from premium land parcels of Goregaon and Worli in Mumbai, Oberoi Realty is set apart, firstly, on account of high visibility of its land bank and secondly on account of its low cost, with a large majority of acquisitions having taken place pre-2005. Nearly 50% of the company’s ~20 msf land bank is currently in the execution stage. For majority of the remaining land bank too, development visibility is fairly high on account of strong project locations.

 Picture-perfect balance sheet, strong cash generation: Generating positive cash flows consistently since FY08, coupled with a prudent land acquisition strategy, has resulted in a picture-perfect, zero-debt balance sheet with a cash balance of ~Rs14.4bn (PLe) as on March 2012. Further, we expect strong cash flow generation for Oberoi in the next few years, given the company’s lucrative residential land bank, large part of which is expected to be monetized in the next five years.

 Project acquisitions & new launches – A trigger: On account of the company’s strong cash position, coupled with a limited development pipeline of 5-6 years, project acquisitions at attractive valuations will be an important trigger for the stock. Besides, the awaited launches of Oberoi’s Worli & Mulund project will also prove to be positive on sentiments.

 Valuations: Two premium locations i.e. Goregaon and Worli, account for ~82% of the company’s NAV. High visiblity at both these locations, coupled with a strong balance sheet, gives us greater confidence in our NAV estimates. While Residential contributes ~44% of the gross NAV, the annuity portfolio (albeit small currently), is expected to scale up significantly in the next few years and contribute to the rest of ~54% of our Gross NAV estimates. We recommend ‘Accumulate’, with a target price of Rs309, at no dicsount to our NAV of Rs309.


>INDUSIND BANK: IIB continues to deliver on all its cycle II growth strategies

IndusInd reported better‐than‐expected PAT of Rs2.23bn (up 30% YoY) led by a beat in loan growth and stronger‐than‐expected fee income momentum. Apart from improving profitability and strong growth, IIB continues to deliver on all its cycle II growth strategies, and like HDFCB, is well placed to deliver strong PAT growth in FY13. Current valuations at 3.1x FY13 book are not cheap but consistent and all round performance inspires confidence. Hence, we maintain our ‘BUY’ rating, with a revised PT of Rs400/share.

 Surprise in top‐line performance: NII was ~4% higher-than-expected due to strong sequential loan growth (8% QoQ) and surprise in margins, with ~5bps accretion QoQ v/s a marginal contraction expected. Fee income growth has been exceptionally strong at ~60% YoY growth in Q4FY12, with growth across all segments. With margins expected to improve in FY13, we believe IIB will be able to sustain its top-line growth momentum in FY13.

 Delivering on all its cycle II growth drivers: After the 08-11 growth phase, management had laid out it’s cycle II growth drivers and we continue to see management delivering on most counts including (1) improving liability franchise with ~2.5% SA accretion post SA re-regulation (2) filling up the product gap (LAP/credit cards) on the retail side and most importantly (3) gaining significant fee income traction in personal distribution and IB business.

 Strong PAT growth to sustain in FY13: With a large fixed rate asset base, we expect margins to improve by ~15-20bps in FY13 and drive profitability improvement. We increase FY13/14 estimates by ~7-8% on higher growth and margins and with credit costs at ~75bps for FY13, there could be further upsides.

 Maintain ‘BUY’, with a PT of Rs400/share: Current valuations at 3.1x FY13 book are not cheap but high loan growth, strong fee income momentum and very limited asset quality risk inspire confidence. We maintain our positive view on IIB.