Saturday, July 14, 2012

>TELECOM: Q1FY13 Results Preview

Volume growth to drive sales in Q1

We expect growth in volumes to drive revenue during Q1. This will be from better subscriber growth for incumbents (Bharti and Idea). We expect Bharti to register higher growth in revenue on QoQ basis compared to Idea Cellular driven by better subscriber growth and data business uptick. Operating margins of leading operators will witness flat to marginal expansion. Companies have reduced 3G services tariff to drive data usage. We believe that regulatory uncertainty continues to put pressure on stock performance. We continue to maintain our view that Bharti Airtel should be preferred in the sector considering the regulatory risk and because Idea Cellular is likely to face more damage despite strong operational performance on issues relating to higher spectrum pricing.

Revenue growth driven by volume – Idea to post highest QoQ growth: We expect revenue for telecom companies to grow by 1-3% on a QoQ basis on the back of minutes of usage growth. We expect revenue per minute to remain under pressure during Q1 due to the hike in service tax and reduction in 3G services tariffs.

EBITDA margin likely to be flat to marginally positive: We expect the EBITDA margin to remain flat or a bit better for telecom companies on a QoQ basis. Higher minutes of usage will drive EBITDA growth rate. We expect Bharti’s margin to improve marginally despite the fall in revenue per minute due to scale benefit.

Bharti remains our preferred pick: Bharti continues to be our preferred pick in the sector considering risk reward. Bharti will be relatively less impacted from a regulatory stand-point on one-time payout/re-farming of spectrum and removal of roaming fees. We have not factored in forex gain/loss in our estimates. We recommend profit booking on Idea in case the stock price further moves up by ~5% on better result expectation. Risk to our call: Any relief given by the regulator on spectrum pricing will lead to outperformance of Idea Cellular ober Bharti because its operations are local whereas Bharti is present in many countries.

Bharti Airtel (Rating – Accumulate; Target Price – Rs361)

  • We expect Bharti (ex-Africa) to register 3% QoQ revenue growth in Q1FY13 on the back of 3.5% growth in minutes of usage. We expect average revenue per user (ARPU) to remain flat at Rs188 QoQ for the domestic market. At a consolidated level, revenue would grow by 3% QoQ.
  • We expect the company to report an operating margin of 33.8% at the consolidated level, as the African and Indian businesses show relatively better performance in operating profit margin. We believe that pressure on operating margin would ease going forward once the Africa business margin profile improves.
  • We expect net profit (pre-forex loss) to grow marginally by 19.8% QoQ as depreciation and amortization expenses have normalized.

Idea Cellular (Rating – Neutral; Target Price – Rs73)

  • Net sales are expected to grow 2% QoQ, driven by 5.5% QoQ growth in minutes of usage. The company is expected to add 5mn subscribers during April-Jun 2012 to reach 118mn.
  • We expect the operating profit margin to remain flat at 27% QoQ as the scale benefit to an extent would get negated with tariff decline.
  • We expect net profit (ex-forex losses) to grow by 5.2% YoY (23.9% QoQ), on higher growth at EBITDA level and normalization of depreciation and amortisation.

Reliance Communication (Rating – Neutral; Target Price – 69)

  • We expect RCom to register 1.1% QoQ revenue growth during Q1FY13 on the back of minutes of usage growth of 2.6% and improvement in non-wireless business. However, we have built in 1.5% QoQ decline in revenue per minute to 43p in Q1FY13 as the company deducted data pack rates.
  • We expect operating profit margin to remain lower at 30.1% QoQ for Q4 over increase in network expenses.
  • We expect net profit to decline by 72.0% YoY (42.1% QoQ) on the back of a drop in EBITDA and higher depreciation expenses.

Tulip Telecom (Rating – Neutral; Target Price – Rs120)

  • We expect net sales to register 5% YoY decline in revenue, backed by slowdown in demand for fibre-based revenue.
  • Investment in data centre subsidiary would lead to a decline in operating profit margin by ~490bp YoY to 23.3% level in Q1FY13.
  • We expect net profit to decline 74.8% YoY on the back of a drop in operating margin and increase in depreciation.



In its Q2CY12 result commentary, Alcoa retained its global aluminium demand growth estimate for 2012 at 7% p.a. It also indicated deficit of 515kt for 2012, slightly higher from 435kt in the previous quarter led by ex‐China production cuts. The company believes current aluminium price is depressed compared with strong fundamentals, implicitly indicating that price is likely to have bottomed out and could move up in future.
Consequently, we expect short‐term pain for Indian aluminium producers, but also foresee improvement as prices rise eventually. Alcoa’s rolled products segment (comparable to Novelis) had stable QoQ EBITDA, in line with our expectation for Novelis of flat QoQ EBITDA for Q2CY12.

Aluminium price believed to be depressed
Alcoa indicated that aluminium price was depressed relative to fundamentals. The company cited growing demand, increase in physical market premium to record highs (up USD25‐50/t QoQ across regions) and decline in days of inventory (down three days QoQ) as a reflection of the strong fundamentals. Alcoa’s premium in the primary aluminium segment went up from USD 258/t in Q1CY12 to USD 352/t in Q2CY12.

Rolled products’ EBITDA stabilises QoQ
We expected significant QoQ dip in rolled products (FRP) EBITDA in Q2CY12, led by issues in Europe. However, it slid only 3.5% QoQ, at USD 193mn. Volumes were up 7% QoQ to 484kt (third‐party), but EBITDA/t declined to USD399 from USD447 QoQ. This seems fair w.r.t. Novelis since we are building in flat EBITDA QoQ at USD 234mn for Novelis.

Results below expectation by 9% at EBITDA
Alcoa’s reported revenue, EBITDA and PAT (ex one‐offs) of USD 5,963 mn (consensus estimate: USD 5,810 mn), USD 517 mn (consensus estimate: USD 567 mn) and USD 61 mn (consensus estimate: USD 81 mn), respectively. It indicated that pricing mix issues in rolled products had an adverse QoQ impact of USD 31mn.

Outlook: Aluminium prices likely to have bottomed
We see risk of aluminium prices remaining at current levels of USD1900‐2000/t for the next two quarters, despite sound fundamentals, which could lead to earnings cut for Indian aluminium producers (Hindalco, NALCO, Sterlite) for FY13. However, we believe prices will move up eventually and remain positive from a structural point of view. Increase in premiums and INR depreciation could also provide some relief. We expect the rolled product segment to post steady EBITDA in the short term for Novelis (in line with Alcoa’s Q2CY12 result trend) with some improvement in later part of FY13 and then FY14.

To read report in detail: ALCOA



Profitability supported by cost optimization – a widening moat
In FY12, Cummins India (KKC) curtailed its EBITDA margin decline at 200bp to 16.9%, despite slowing sales (up 3% YoY) and rising input costs. Raw material (RM) costs rose only 3% YoY despite 16% YoY rise in pig iron prices, which forms over 50% of RM cost. This commendable achievement is a result of increased indigenization and cost optimization measures:

(i) RM imports have declined significantly from 29-30% of revenues in FY07-08 to 20% in FY12. Also, within RM, component imports have declined to 69% of RM consumed (from 77% in FY08) and share of semi-finished components have increased to 19% from 5% in FY08.

(ii) Cost optimization measures like ACE III (Accelerated Cost Efficiency) are expected to generate savings of INR2.3b till 2014 by reducing the total cost of ownership of direct materials by 20%. TRIMs (Total Reduction in Indirect Materials & Services) targets to reduce the direct cost of ownership in indirect materials by 10% over 3 years.

Expect a meaningful increase in capex
In its recent analyst meet, KKC stated that capex in FY13/14 is expected at ~INR6.5b each, which is meaningful given FY12 gross fixed assets at INR9.7b. Capex in FY12 increased to INR2.1b, and stood at 28% of the opening gross fixed asset. A large part of the incremental capex (~65%) pertains to the India Technical centre and India Office Campus, which will also be shared with group companies and thus KKC will earn lease income (IOC to commence in April 2014). This will likely dilute return ratios (FY12 ROE at 28%) and remains an area of concern. Capital commitments stood at INR4.3b in FY12, up from INR550m in FY11; thus, expect a steep increase in FY13 capex.

60-liter engine has revenue potential of INR2.6b over 5 years
KKC’s FY12 Annual Report states that the 60-liter engine will be an INR2.6b opportunity over 5 years. This is meaningful given that KKC's domestic engine sales in FY12 is ~INR12.6b. Construction for high horsepower QSK60/23 engines in India commenced in FY12 at Phaltan megasite. We believe that going forward, there exists possibilities that some of the new products will be manufactured / exported by Cummins Inc, while KKC retains the marketing rights in India.

To read report in detail: CUMMINS INDIA


>MPHASIS: Mulling share buyback as cash reserves pile up

 The company expects volumes in Direct channel to rebound in 3QFY12, with 3-4% QoQ growth. HP shall continue to be a drag with sequential volume decline of 4-5%. Despite average wage hikes of 8% at offshore and 3% at onsite, and a mere ~5-10bp OPM sensitivity to per percentage change in currency, the company expects EBITDA margins to expand by 30-40bp QoQ in 3QFY12, led by: [1] Facilities consolidation, as the company gave up as many as 3,000 seats after continued headcount decrease, and [2] ~50bp tailwind from currency.

 EBIT margins in HP's services business have fallen sharply, and the parent company is focused on profitability. This is driving HP's decision to shift some work to their wholly owned subsidiary HP India at Mphasis' expense. Volumes from HP channel will be flat to marginally lower in FY13 too, while volumes in direct channel are expected to grow by 10%. The company expects FY13 EPS to be ~INR41-42, on the back of favorable hedges (@~INR52/USD v/s ~INR50 for FY12).

 Mphasis continues to generate operating cash flow of ~USD15m per month, and with no big-ticket acquisitions on the anvil, the management is mulling over the possibility of a share buyback.

 We have revised our FY12/13 revenue estimates downwards by 1.4/2.1% and increased FY13 EPS estimate by 4.4%. While buyback expectations may support the stock, structural growth problems on high HP dependency need to ease off before we turn incrementally positive on Mphasis. The stock trades at 10x FY13E earnings. Maintain Sell.

To read report in detail: MPHASIS

>STERLITE INDUSTRIES: Acquisition in Vedanta Aluminium

Sterlite Industries’ annual report analysis highlights fresh investment in other group companies. With INR depreciation, large unhedged forex payables may lead to further MTM losses. While borrowing cost has gone up significantly, other income is likely to be subdued.

VAL an overhang; consol. debt, interest cost to swell post merger
At FY12 end, Sterlite Industries (SIIL) owned 29.5% stake in Vedanta Aluminium (VAL) (associate and fellow subsidiary) for INR5.6bn. However, a significant portion of the latter’s balance sheet was funded by SIIL by way of loans and advances (including preference share) of INR100.5bn (refer table 4). During FY12, Sesa‐Sterlite (SS) approved acquisition of balance 70.5% stake in VAL from Vedanta Resources. Our calculation suggests an enterprise value (EV) of INR320bn for VAL (refer table 6).

During FY12, VAL incurred loss of INR26.2bn (FY11: INR9.6bn) with SIIL’s share in it at INR7.7bn (FY11: INR2.8bn), 16.0% of FY12 PAT (FY11: 5.7%; refer table 7). With acquisition of balance stake in VAL:

• SIIL’s INR100.5bn loan to VAL will be eliminated.

• SS’ interest income will be lower as interest income from VAL will be eliminated. During FY12, SIIL earned interest of INR8.9bn from VAL (9.0 % of PBT).

• Additional loan in VAL of INR197.0bn will be part of the consolidated entity, leading to higher interest cost.

Fresh investments in other group companies jumped from INR7.8bn in FY11 to INR19.7bn in FY12; 4.3% of FY12 networth (FY11: 1.9%) (refer table 3).

Forex movement likely to be a major dampener
SIIL’s unhedged foreign currency net payable stood at INR113.0bn in FY12 (FY11: INR91.4bn). During the year, the INR has depreciated 14.6% versus USD, which has led to forex loss of INR7.2bn (7.3% of FY12 PBT) in FY12. With the INR depreciating ~10% in Q1FY13, the company is likely to suffer significant forex loss/finance cost.

Higher finance cost, damages provision drag down margin
Finance cost (including interest capitalised) jumped from INR6.5bn in FY11 to INR15.9bn in FY12, 16.1% of FY12 PBT (FY11: 7.1%), with average borrowing cost surging from 5.7% to 10.5%. During the year, the company provided incidental damages of USD82.8mn (INR4.2bn; net of deposit of USD50mn; 4.3% of FY12 PBT) for Asarco, US, as per US Bankruptcy Court judgement.

Other income comprising ~11% of PBT unlikely to sustain
Other income includes fair valuation of conversion option on convertibles of INR2.4bn and interest from VAL of INR8.9bn which is unlikely to sustain.

To read report in detail: STERLITE INDUSTRIES

>INDIA STRATEGY: Sensex@20,500 by FY13 end (CENTRUM)

We estimate Sensex to post an EPS of Rs. 1416 for FY14E (15% growth over FY13E)  Applying a target P/E of 14.5x (inline with long term mean) we get Sensex target of 20500 for FY13 end, although this can be achieved earlier (by Dec 2012) if government reforms agenda takes off

The P/E for Sensex has seen high correlation with the Nominal GDP growth. Hence we believe that the target multiple applied for Sensex is appropriate considering the Nominal GDP growth expectations of close to 14%

Composition of incremental index earnings shows that the majority of earnings come from Financials, Materials and Auto sectors; softening interest rate cycle should aid recovery in the Financials and Auto sectors while a low base of FY13 would help sectors like Materials to post a good growth in FY14.c

To read report in detail: INDIA STRATEGY

>INDUSIND BANK: PAT beat on higher other income (Erratum)

Key highlights
IndusInd Bank reported a PAT of INR2.36bn, marginally higher than our estimate of INR2.29bn (Street est. of INR2.31bn) on the back of higher than- expected other income. Key highlights from the quarter include:

 Loan book growth remained strong (up 31% y/y), primarily driven by 48% increase in consumer finance loans, while the corporate book increased at 20% y/y. While NII was below our estimates, strong fee
income of 42% y/y and trading gains of INR0.5bn (vs our estimate of INR 0.27bn) supported the earnings beat.

 Margins declined 7bps sequentially to 3.22% due to 35bps q/q increase in cost of funds vs 28bps q/q increase in yield on assets.

 Deposits grew at 28% y/y with savings deposits continuing to be strong, growing 9.5% q/q leading to 56bps improvement in the CASA ratio at 27.9%.

 Asset quality was largely stable with sequentially flat GNPL and NNPL ratios at 0.97% and 0.27%, respectively. The bank did not add any restructured loan during the quarter (the restructured book stands at
0.24% of the loan book). However, higher slippage of INR1.09bn vs our forecast of INR0.83bn led to LLPs of 50bps vs our estimate of 37bps.

 Total CAR was at 13.4% (including full-year profits) with Tier-I CAR at 11.2% (including full-year profits).

Outlook and key takeaways from management call
 Slippage was higher than expected as one mid-sized gems & jewellery account slipped to NPL leading to higher LLPs. Management expects to recover 50-60% of the amount within 3-6 months.

 IIB expects to cross 500 branches by FY13 end and 650 by FY14 end (currently at 421 branches). New branches opened last year average around INR70-80mn SA per branch vs INR220-230mn for matured
branches. Management expects to end FY13 with INR170-180mn of SA per branch. We are budgeting in INR125mn SA per branch by FY13 end.

 Third-party fee income growth was tepid as the bank has stopped recognising commission on non life insurance as a part of their income for the last six months. Management guides for fee income growth to
be higher than balance sheet growth for FY13.

 Management guides towards LLPs of around 50bps for FY13. We are building in LLPs of 56bps for FY13F.

 The bank expects to grow its loan book in the range of 25-30% vs our current estimate of 25%.

To read report in detail: INDUSIND BANK

>MAHINDRA & MAHINDRA: Launched Gio and Maxximo vans

In FY12, top-line performance of M&M was encouraging, in our view, with 25% volume growth and 36% revenue growth. The company also gained market share of around 300bps in the domestic automotive segment driven by new launches. M&M’s new launch pipeline looks solid, and we expect the company to maintain strong volume performance. Investments in new businesses dragged down consolidated EPS by around INR15/sh (~30%) in FY12. Turnaround in some of these businesses could lead to strong earnings growth over the next two to three years, in our view. Core business (ex investments) is trading at 9x FY14 M&M + MVML earnings of INR 58/sh, which is lower than 1-yr forward historical average P/E of ~12x. Reiterate BUY.

Auto segment – Market share improvements led by UVs and MPVs
M&M’s sales volumes in the automotive segment increased by 27% yoy in FY12 led by strong growth in UVs, LCVs and entry into the new MPV segment. Market share in the UVs segment increased to 55.1% in FY12, driven largely by the success of XUV500 launched in Sep-11. M&M launched Gio and Maxximo vans in FY12 and was able to garner 10% of the overall MPV segment. Market share also improved in the Verito segment and 3-wheelers. M&M remains the market leader in 2-3.5 ton LCV segment with a market share of around 67%, as per the company.

Tractor segment – Steady market share
M&M’s volumes in the domestic tractor market increased by 10% yoy in FY12, nearly in-line with industry growth of 11%. M&M’s overall market share remained steady at around 42%, but the company lost some market share in the 31-50 HP segment. The major gainer in this category has been TAFE (Tractors and Farm Equipments Ltd). M&M gained share in the 51HP+ and <30HP segments. The company is planning to launch a new tractor platform in FY13, which we believe should help it gain some market share.

M&M invested around INR10bn in subsidiaries in FY12 – a large part of the investment was towards unlisted subsidiaries. Three key points to note here are:

 M&M invested around INR3.5bn in its two-wheeler venture – the company increased its stake to 88.5% in the business from 80% earlier.

 M&M invested around INR1.6bn in Mahindra Navistar, its commercial business. This is possibly largely towards funding M&M’s share of net loss in the subsidiary in FY12, we believe.

 The company has invested INR2.3bn in Mahindra Engineering & Chemical Products Ltd (MECPL), a wholly owned subsidiary. MECPL is engaged in the business of manufacturing of material handling equipment. Further, Mahindra Retail is an indirect subsidiary of MECPL which has cumulative loss of around INR2.4bn till FY12.

To read report in detail: MAHINDRA & MAHINDRA