Wednesday, July 4, 2012

>STRATEGY: India’s consumption story has slowed down (CLSA)

Staples growth won’t hold

Slower GDP growth and the environment of economic uncertainty has impacted India’s discretionary consumption growth story. With the nominal GDP growth now expected to slow down by 3-4ppts, staples growth cannot remain immune to the slowdown. Valuation premium at an all-time high will mean that the potential slowdown is not factored in and the sector will not prove to be a defensive anymore. Pharma sector is the best defensive bet with stable domestic growth and some kickers from limited competition launches in the US and the weaker INR. We replace Tata Motors with Lupin in our top 5 buy ideas. Potential QE led rally remains a key risk to our defensive market view. 

India’s consumption story has slowed down…
 Several data points are now available that document India’s slowing consumption trends. Cars, two wheelers, same store sales growth, etc are all exhibiting a slowdown trend.

 The above is not unexpected given the issues pertaining to overall economic growth
and continued inflation etc. 

…yet staples growth holds on, but for how long?
 Consumer staples cos, have generally bucked the slowdown trend so far with a couple of small disappointments in Mar’12 quarter by Nestle and GSK which have been largely attributed to the slower offtake from the CSD (Canteen Stores Department) of Indian defence services.

 However, with the nominal GDP growth expected to slowdown from 16-17% over the last three years to c.13% for the next couple of years with a possible risk on the downside, staples cannot remain immune to the broader slowdown trend. 
 The previous economic downturns saw the growth slowdown for staples with a lag.

Valuation premium at all time high and hence not a defensive
 A 3-4ppts revenue / earnings deceleration for staples companies is not a disaster but we do not believe that the same has been anticipated by the market as yet.

 Investor focus on cashflow and balance sheet has taken the sectoral valuation to an all-time high PE premium of 109% as against 57% as the average for the last 10 years. The premium valuations makes the sector less defensive in our view.

 Additionally, our analysis of previous deficient monsoon conditions indicate that consumer stocks tend to underperform in the deficient monsoon period. 

Pharma is the best defensive, raise Lupin to the top five Buy ideas
 Sentiment in Tata Motors has deteriorated over the last few months with disappointments on JLR margins and the non-Evoque volumes. While the valuations appear attractive at 6xFY13CL earnings, we do not foresee any near-term trigger and replace the stock with a more defensive Lupin in our top 5 buy ideas.

■ Pharma sector offers good revenue growth visibility and the INR depreciation should drive a 5-6% earnings upgrade. Our top pick Lupin, sees triggers from launch of limited competition products like Tricor and Cipro OS in the US market that can l lead to a potential 11-13% upgrade to our and consensus FY13 EPS (expected in July 2012). We expect the company's profits to grow at c. 29% cagr over FY12-14 and find the stock attractive at under 20x 1-year forward.

 Our other top five BUY ideas remain ICICI Bank, Yes Bank, BPCL and Power Grid.

■ Within consumption stories, we like ITC (pricing power driving earnings growth resilience), Zee (regulatory upside) and private sector banks.

To read report in detail: STRATEGY


>THERMAX: Subsidiaries impacted by cost over-runs, competition

> Increase in working capital: Working capital in FY12 continued to remain higher than the historical trend on weakness in order inflows and increase in receivable days. Receivable days were at 84, in line with the highest levels in the past 10 years. Customer advances days declined to 47 (from 69) as order inflows in FY12 were at Rs 40.3bn, down 24% YoY. However, absolute cash and cash equivalents were comfortable at Rs 7bn (33% of the consolidated BS).

> Projects business expected to remain weak: The management expects the power business to continue to be weak in FY13E and FY14E as order inflows are likely to be weak in H1FY13E; however, the commentary on the Boiler and Heater business is relatively positive on account of expected revival of captive power plants. To counter the decline in power projects business, the company has increased focus on the power services business, but the scale is fairly small.

> Subsidiaries impacted by cost over-runs, competition: The main subsidiaries which reported a loss in FY12 were: 1) Thermax Instrumentation – construction arm of the power division – loss of Rs 104 mn on cost over-runs, 2) Thermax Zhejiangabsorption chillers in China – loss of Rs 70mn on high competition, 3) Thermax B&W – a JV for supercritical boilers – pre-operative expenses. However, Danstroker grew ahead of expectations in a challenging environment in Europe.

To read report in detail: THERMAX

>RAILWAYS: Dedicated Freight Corridor (DFC) project is being implemented

The Dedicated Freight Corridor (DFC) project is being implemented to speed up rail freight movement via two corridors—Delhi-Mumbai and Delhi-Kolkata—of over 3,322 kms at a cost of over INR800bn-1,000bn over the next five years. Similarly, Delhi Metro, having completed phase I and II, is now targeting completing Phase III by 2016 at a cost of INR352bn. Ergo, we expect these two large projects to generate construction contracts worth INR681bn and systems contracts worth INR350bn. Rolling stock contracts is the additional opportunity for both projects.

DFC: Likely to generate orders worth INR523bn over FY13-14
DFC, one of the biggest infrastructure projects, proposes to construct two dedicated freight corridors on the Eastern corridor from Ludhiana to Dankuni via Mughalsarai of 1,839 km and on Western corridor from Dadri to JNPT of 1,534 km. Indian Railways is looking at running heavier (higher axle load), speedier (100 kmph) and longer freight trains to maximise utilisation of existing track capacity. The project cost is expected to top ~INR800bn-1,000bn when completed, spread equally between Eastern DFC and Western DFC. We expect awarding of construction contracts to start shortly and system contracts with a lag of 12-18 months. During FY13-14, we expect DFC to dole out contracts worth INR523bn.

DMRC: Order awards worth INR200bn likely in 12-18 months
Delhi Metro (Phase III) is clearly in an overdrive mode having already placed orders worth INR81bn for civil construction. We expect balance civil construction contracts worth INR94bn to be awarded over the next 12 months. Further, given the usual lag of six-nine months for placing orders for systems, we understand that all systems (electrical and signalling) contracts are expected to be placed by Q1FY14. Tenders for electrical worth INR16bn are already out for phase III. Orders for rolling stock (30% of total capex) are expected to be finalised over the next 12 months given the tender document (for 486 rolling stocks) is already out. We expect over INR200bn worth contracts to be awarded over the next 12-18 months for Delhi Metro’s Phase III.

Outlook: Leg up for construction and systems companies
With strong order flow expected from both DFC and Delhi Metro over the next few years, we believe these two large railway / infrastructure projects are likely to present significant opportunities for construction companies, systems (electrical and signalling) companies and rolling stock / locomotive companies. We expect total awards of INR681bn and INR350bn for construction contracts and systems contracts, respectively, for these large infrastructure projects. Rolling stock contract for Delhi Metro is expected at INR106bn while that for DFC will be over and above the INR800bn-1,000bn expected to be spent on the project. We believe likely beneficiaries could included L&T (BUY/SO), NCC (BUY/SO) and IVRCL (HOLD/SP) on the construction side and Siemens (BUY/SO), ABB (REDUCE/SU), Alstom T&D (Not Rated) and Alstom India (Not Rated) for the Systems contracts.

To read report in detail: DFC


Capex to drive growth…

Increasing capacity by 50% in FBVs and executing orders from Indian railways for Wagon manufacturing & refurbishment, intensifies our belief in the outperformance of CEBBCO. We recommend “Accumulate” rating on CEBBCO with 1 year price objective of INR 115 (30.9% upside).

News flow with regards to falling interest rates & removal of mining ban along with GoI‟s higher spending on infrastructure projects will spur growth of CV industry and will be the major catalysts for a higher earnings estimate.


Growing preference towards FBVs - Financing for truck bodies and quality assurance given by the major OEMs are main reason for shift towards buying FBV. Even changes made in recent budget will help to save 2% of excise duty on purchase of FBVs, eventually boosting its demand. Moreover increasing capacity by 50% in FBVs with expected 100% capacity utilization will boost CEBBCO‟s earnings. 

Wagon manufacturing, a new area of growth – Recent entry into railway segment in form of wagon refurbishment and manufacturing will boost the earnings as margin from this segment are higher (18-20%). Execution of Braithwaite‟s order of 248 wagons in 1HFY13 along with executing trial orders in H2 FY13 will garner close to INR 1 bn revenue in FY13. 

Tax incentives of INR 2.3 bn under TRIFAC scheme – State government of Madhya Pradesh operates TRIFAC scheme to facilitate industry, investment and employment generation within the state. Due to its expansion in Jabalpur, CEBBCO will get sales tax refund worth INR 2.3 bn spread over a maximum of 7 years under the scheme which will boost the bottom line by INR 300 mn in FY13.

We expect CEBBCO to post a Net Profit CAGR of 60.7% over the next couple of years. It currently trades at 5.6x and 4.6x to its FY13 and FY14 earnings respectively. We have valued the stock on a P/E multiple basis at 6x of FY14e EPS of INR 19.2 giving the price objective of INR 115 (30.9% Upside).

To read report in detail: CEBBCO

>BATA INDIA: Renewed its product lines, introduced new brands, refurbished or shut down old stores

Transformation delivering results!

A large market… and an even larger opportunity
The Indian footwear industry has a market size of Rs200bn, with the unorganized segment constituting over 60%. Moreover, about 75% of the total consumer base lies in rural India. An urban customer spends an average Rs240 pa for footwear as against Rs100 pa in rural India, which implies a huge scope for premiumisation across rural and urban markets. Though men’s footwear accounts for 50% of the market, its share has been gradually decreasing as women and children’s segments are now growing at faster. With an unmatched reach (1340 stores, the largest footwear retailer), strong brand equity and a wide product portfolio across segments, Bata stands to be a big beneficiary.

Adapting to changing consumer needs bearing fruit
Bata has, in the past few years, strived to become more relevant to the increasingly demanding modern consumer. The company now changes 70% of its merchandise every 7-8 months to keep in step with the latest trends. It has renewed its product lines, introduced new brands, refurbished or shut down old stores while expanding its portfolio across the consumer chain (men, women and kids). As a result, only 50-55% of the company’s sales now come from men’s footwear, as against ~75% three years back. The ladies segment now contributes 20-22% and children’s 8-10%. Focus on improving the mix has significantly boosted margins, albeit at the cost of volume growth. These factors have driven ahead-of-industry growth levels and doubled EBITDA margins from 7.5% in CY07 to 15% in CY11.

Demand momentum to continue; volume growth back on track
Focus on improving the product mix resulted in muted volume growth in CY11. However, volumes have improved in CY12, with a 14% volume growth in Q1 as compared to low single-digit volumes in the corresponding quarter. Though the management expects the momentum to continue, we believe a large part of incremental volumes will come from new stores (75 in Q1). The company is not seeing any signs of a slowdown and believes the demand momentum seen in Q1 (31% revenue growth) should translate into a healthy 20%+ revenue expansion this year.

To read report in detail: BATA INDIA

>V-Guard Industries Ltd.: Launched induction cooktops and domestic switchgears in Kerala

Management re-iterates 25% growth in revenues during FY13
V-Guard management has re-iterated guidance of 25% growth in revenues in FY13. Growth will come from across product categories. Management has indicated Non-South markets will grow at a higher pace as compared to the South markets in FY13. During Apr-May, 2012 it has witnessed descent growth which has further given it confidence to achieve its yearly guidance.

OPM to be maintained at ~10% for FY13
The management has maintained its guidance of ~10% OPM for FY13. It had taken price hikes in March, 2012 (~3%) which will ensure margin maintenance. Also, as the company derives only ~6% of its revenues from imported products, it will not get significantly impacted due to the rupee depreciation and thus maintain its margins.

Non-South India to contribute ~40% of revenues over next 4-5 years
V-Guard’s is looking to derive ~40% of its revenues from Non-South India markets over the next 4-5 years. It believes this can be achieved by increasing its dealer network and launching complete range of products in these geographies. Also, it is enhancing its team strength in these geographies which will enable it to further penetrate these markets

New product launched in FY12 to do meaningful contribution only in next 4-5 years
V-Guard has launched induction cooktops and domestic switchgears in Kerala during FY12. The company plans to do a pan South India launch over the next 18-24 months. It also plans to introduce mixer-grinders by CY12. The management believes it will be able to leverage its brand and service capabilities to be able to enter the kitchen appliance market. It targets revenues of Rs 1bn from these businesses over the next 4-5 years. Manufacturing of all these products will be outsourced.

Production: Outsourcing mix to remain similar
V-Guard manufactures its requirement of cables, LT cables and solar water heaters (SWH) in-house. It also manufactures ~10% of its pumps, fans and electric water heaters requirement. The other products such as stabilizers, UPS, DUPS are completely outsourced. On a blended basis, it manufactures ~40% of its sales. Management believes this ratio of manufacturing to outsourcing will continue to remain similar going ahead too.

Working Capital cycle to reduce further
V-Guard is trying to reduce its working capital days by ~15-20 days in FY13. It will do so by engaging in supplier financing (similar to its peers such as Bajaj Electricals and Havells India). By engaging in supplier financing it will reduce its working capital requirement and thus generate free cash flows. Going ahead, the management expects to get ~60-70% of its supplier under this scheme.

Outlook and valuation
V-Guard has been delivering robust growth over many years and now with increased focus on improving working capital; we believe its growth will be qualitative too. V-Guard is currently trading at a PER and EV/EBIDTA of 9.7x and 6.5x FY14E which is attractive given an earning CAGR of 19% during FY12-14. We continue to remain positive on the growth prospects of the company and the space in which it operates. Maintain BUY and price target of Rs266 (11x FY14E).

To read report in detail: V-Guard

>Mcleod Russel (India) Ltd.

Continuous reduction in global carry forward inventory during CY08 and CY09 lead to higher tea prices internationally. CY10 saw a good crop with Kenya ( world’s largest exporter) reporting highest ever production at 399 mn kgs. But globally still the prices remained firm on the back of strong demand for black tea.CY11 followed as a stagnant to lower production year.

We believe that we are in a structural shift with a rising demand and supply gap, which is not likely to get resolved over the next few years, unless crop from Kenya increases substantially which is unlikely.This can lead to price rise which can last for few years.

The country has witnessed stagnant production over the last 4-5 years while domestic
consumption has been growing at a CAGR of 2.5%+ over the last 10 years.

India has been witnessing falling yields over the last 5 – 7 years due to the aging of bushes. Of the 11th Plan target there was 66 per cent shortfall in sanctions against a target of 54,524 ha area for replanting in the first four years (April 2007 - March 2011) as only 18,642 ha area was sanctioned for replanting. The impact of replantation efforts will be visible from FY14-15 as the pace of it picks   up, however by that time domestic consumption too would have grown resulting in no major  buffer.

Consolidation initiatives by Mcleod have started contributing from FY11.Improved profitability and  return ratios to enable the company to increase its operating cash flows and hence reduce

To read report in detail: MCLEOD RUSSEL



Demand to rise, but delay in start of new projects a concern; Hold

A management meet with Ambuja indicates a positive outlook on company prospects. Cost rationalization and capacity bottlenecks are immediate focus areas. We retain a Hold rating given steep valuations.

 To contest CCI penalty. The CCI, which accused 10 companies of cartelization, has penalized Ambuja `11.6bn. Contesting the allegations, Ambuja will take the case to the Competition Appelate Tribunal; in six months it expects a verdict. The amount will be reflected as a contingent liability. The penalty is 14% of FY12 net worth (10-26% for the others).

 Demand outlook. Ambuja expects cement demand in CY12 to be 9%, led by robust demand from retail/individual housing builders (82% contribution) supported by a strong network of 7,000 dealers and 25,000 retailers. Its strong presence in the growing and high utilization markets of the North, West and East put it in an advantageous position.

 Cost rationalization. Ambuja aims at cost-rationalization via alternative raw materials (synthetic gypsum, fly ash), cost-efficient sea transport (now 14%) and alternative sources of energy (wind-turbines, waste-heatrecovery plants). We expect the resultant benefits to trickle in only from CY14. It expects cost rises in fuel to be lower in CY12 than in CY11.

 Growth plans. Ambuja plans `18bn in CY12-13 on maintenance, logistics, efficiency improvements and remove capacity bottlenecks (to add 0.5m tons clinker, 0.9m-ton grinding). Delay in start of greenfield/brownfield clinker projects is a concern as it may curtail dispatch growth in CY13, affecting market share (now 10%). Clearance for a greenfield site in Rajasthan is under way; equipment orders are likely in Dec ’12, with a 30-month set-up time.

Valuation. At our `165 price target, the stock would trade at 8x CY12e EV/ EBITDA. The price target implies a PE of 15.1x and an EV/ton of US$157. Risks: Coal price hikes, weak cement prices.



Stretched balance sheet remains a concern, maintain a Sell

Following a management meet with Fortis Healthcare (FH) we believe that near- to mid-term pain persists due to a stretched balance sheet and lower margins in SRL (Super Religare Laboratories). FH has been affected by uncertainty following its acquisition of Fortis Healthcare International (FHI) and its resulting stretched balance sheet. The India hospitals business should continue strong growth led by huge demand. We maintain a Sell with a target price of `102.

 Momentum continues in the domestic hospitals segment. FH’s Indian hospitals segment continues to do well and expects to add more than 600 operational beds in FY13 on a base of ~2,900 beds at the end of FY12. We expect 22.4% CAGR revenue over FY12-15. We have assumed 10% increase in ARPOB (average revenue per operating bed) and gradual increase in occupancy levels.

 SRL suffering from lower profitability. SRL has been reporting ~7% EBITDA margin from the past two quarters vs. ~15% earlier due to the commencement of three large labs in Kolkata, Bangalore and Delhi and
high rental cost at existing labs. The management expects a double-digit margin in FY13. However, we expect recovery to be gradual, with double-digit margin in FY14.

 Stretched balance sheet. FH has a significantly higher net debt, of US$1.3bn, translating to an FY12 debt-equity of 2.1x. Further, goodwill on the consolidation/acquisition, at `64.8bn, is very high, amounting to
half the company’s assets. The company is taking various steps to improve the situation, such as equity dilution in SRL and potential listing of its Clinical Establishment division on the Singapore Exchange.

 Valuation. We maintain a Sell with a price target of `102, based on 15x FH EBITDA and 12x FHI EBITDA. Risk: Equity raising at premium valuations.


>HSBC Purchasing Managers’ Index™ (PMI™) as on July 2, 2012

June data signals continued inflationary pressures in India manufacturing sector

The seasonally adjusted HSBC Purchasing Managers’ Index™ (PMI™) – a headline index designed to measure the overall health of the manufacturing sector – posted 55.0 in June, little-changed from the reading of 54.8 in May, hence signalling a further marked improvement of business conditions in the sector.

Firms indicated that product quality improvement combined with stronger demand contributed to higher levels of new orders. As a consequence, output expanded again in June, extending the current expansionary period to three years and three months. New export orders increased moderately at manufacturing firms.

Output prices increased as manufacturers attempted to pass further rises in the cost of inputs on to their clients. Moreover, firms in India reported that charges also increased in line with more expensive labour costs.

Input prices continued to increase, extending the inflationary period to 39 successive months. The rate of inflation in June was sharp and the largest since August 2011.
Manufacturers experienced a further expansion in staffing levels. Workforces increased slightly to accommodate higher levels of output.

Companies intentionally increased post-production inventories in line with stronger demand. 
Stocks of finished goods have now expanded throughout the past eight months.
Firms accumulated stocks of purchases intentionally according to expected increases in demand.

Lead times shortened moderately in the Indian manufacturing sector. Panellists stated that suppliers had been able to meet requirements for faster deliveries.
Outstanding business increased marginally in June, extending the period of accumulation to nine months. Powercuts were reported by firms as one of the main factors leading to growing levels of outstanding business.

Manufacturers increased their levels of input buying in June. Although the rate of increase was substantial, it was the lowest in the year so far.

Commenting on the India Manufacturing PMI™ survey, Leif Eskesen, Chief Economist for India & ASEAN at HSBC said:

"Activity in the manufacturing sector kept up the pace in June with output, and employment expanding at a faster pace. The latter helped slow the pace of growth in backlogs of work. New order growth decelerated slightly led by export orders while stock levels rose, suggesting a slight moderation in output growth going ahead. Input and output prices rose at a faster pace than in May, keeping inflation high by historical standards. In light of these numbers, the RBI does not have a strong case for further rate cuts, which could add to lingering inflation risks."

Key points
􀂄 PMI at 55.0 indicates further improvement in health of manufacturing economy
􀂄 Production expands sharply in June
􀂄 Largest month-on-month increase in input prices since August 2011

Historical Overview