Thursday, August 23, 2012

>Bharat Petroleum Corporation

Positive GRM due to inventory gain…
Bharat Petroleum Corporation (BPCL) declared its quarterly results with revenues at | 54548.4 crore (our estimate: | 62925.3 crore) and a loss of | 8836.8 crore (our estimated loss: | 1541.9 crore). The reason for such a huge loss was no government compensation towards gross under recovery incurred in Q1FY13. BPCL had a net under-recovery of | 7944 crore during Q1FY13. We expect gross under-recoveries at ~| 1,86,142 crore and ~| 1,98,100 crore in FY13E and FY14E, respectively (our assumption for the exchange rate is | 54/dollar and Brent crude oil is $110/barrel). We expect the net under-recovery of BPCL to be at | 2315.4 crore and | 2383.1 crore in FY13E and FY14E, respectively, while revising our assumption of the share of downstream companies to 5% of gross under-recovery. We recommend a BUY rating on the stock with a price target of | 401.

􀂃 GRM surprise
The company reported a positive GRM of $2.6/barrel in Q1FY13, much better than its OMC peers, HPCL and IOCL, which reported negative GRMs. The positive GRM was mainly on account of inventory gain of | 130 crore. We estimate GRMs at $4.1/barrel for FY13E and FY14E, respectively.

􀂃 E&P story intact
The recent discovery at Atum (10-30 tcf of recoverable gas resources) in Mozambique by the BPCL-Anadarko consortium, in addition to exploration success at Golfinho and Prosperidade Complex, adds great value to the company. The consortium expects gas production in Mozambique to start in 2018. We have valued the Rovuma basin (Mozambique) at | 143.8/share and BM-C-30, Campos Basin (Brazil) at | 22.8/share. We recommend a BUY rating on the stock with a price target of | 401 (valuation based on average of P/BV multiple: | 411 per share and P/E multiple: | 390 per share).


PRICE TARGET........................................................................... Changed from | 44 to | 37
EPS (FY13E)............................................................................. Changed from | 7.2 to | 6.6
EPS (FY14E)............................................................................. Changed from | 8.3 to | 6.7

ILS weakness to continue…
We spoke with the management of NIIT Ltd to understand the industry trends and execution strategy. Earlier, NIIT reported its Q1FY13 numbers, which were below our estimates. Revenues came in at | 228 crore vs. our | 244.1 crore estimate led by a slowdown in the ILS business. Reported EBITDA of | 11.4 crore (5% margin) missed our | 27.3 crore (11.2%) estimate by a wide margin. PAT (including associate profit) of | 11.5 crore (core operations loss of | 2.3 crore) was also lower than our | 20.3 crore (| 9.8 crore) estimate despite the company having a tax provision reversal of | 34.1 crore related to Element K divestiture. The current backdrop of macroeconomic uncertainties and deferred IT-ITeS hiring influences our estimates and our HOLD rating.

ILS segment slowing down
A weakening economy and deferred IT-ITeS hiring led to ILS (66% of the total revenues) declining 11% YoY to | 107.4 crore. IT training enrolments declined 13% YoY. EBITDA declined by | 8.8 crore YoY led by cost overruns (| 6.6 crore), adverse revenue mix (| 1 crore), cost inflation (| 5.1 crore) partly offset by cost optimisation initiatives (| 3.9 crore). For the full year FY13E, the management commentary suggests ILS revenues could decline ~4-8% while EBITDA margins could fall by 500 bps from16.1% in FY12.

CLS & SLS outlook
The management indicated that the CLS business could grow 20% YoY on a continuing basis (excluding Element K contribution) led by ~40% growth in managed training services (MTS, 72% of CLS) while EBITDA margins could come in at around 10%. The SLS business is expected to be flat YoY as the company transitions from government schools to non government schools. Margins are expected to be around 9-10%.

Reducing estimates but maintain HOLD
We have adjusted our numbers to account for the weakness in the ILS business. We expect revenues and PAT to decline 13.7% and 10%, respectively, in FY13E and grow 10% and 2.2% in FY14E, respectively. We continue to value NIIT on an SOTP basis with a target EV/EBITDA multiple of 1.8x on our CY13E EBITDA to account for the current ILS slowdown and refilling of Element K revenues that remains crucial.

>Q1FY2013 Pharma earnings review

Weaker rupee and key launches drive growth
  • Pharma universe's performance better than expected: Most of the players in Sharekhan's pharmaceutical (pharma) universe reported better than expected results during Q1FY2013. The universe reported a 39.7% year-on-year (Y-o-Y) rise in its revenues as compared with our estimate of a 34.7% growth. The operating profit margin (OPM) jumped by 412 basis points year on year (YoY) to 27.6%, which is 270 basis points higher than our estimate. However, due to a sharp jump in the fixed costs and marked-to-market (MTM) foreign exchange (forex) losses, the reported profit rose by 9.6% YoY for the pharma universe during the quarter. However, excluding the forex losses or gains and the exceptional items, the adjusted net profit increased by 18.5% YoY, which is better than our estimate of a 7.4% growth for the universe. The profit growth was mainly led by Ipca Laboratories (Ipca; up 93% YoY), Divi's Laboratories (Divi's Labs; up 63% YoY) and Sun Pharmaceuticals (Sun Pharma; 59% YoY). 

  • Higher fixed costs and effective tax rate affects bottom line: Despite the impressive performance at the operating level, the profit of the key players weakened on a sharp rise in the interest and depreciation charges. During the quarter, the interest cost rose by 143% YoY while depreciation jumped by 30% YoY on an aggregated basis. Moreover, the imposition of the alternate minimum tax (AMT) on partnership-based manufacturing units resulted in a sharp rise in the effective tax rate of the pharma universe. The effective tax rate of the universe jumped to 19.8% during the quarter from 11.2% in Q1FY2012. Most affected by the new tax were Sun Pharma (a rise of 1,482 basis points YoY to 17.3%) and Cadila Healthcare (Cadila; a rise of 1,354 basis points YoY to 24.4%) due to the imposition of AMT on their Sikkim-based manufacturing plants.

  • Management of most of key players maintain FY2013 guidance: Most managements maintained their revenue guidance for FY2013 despite an impressive performance in Q1FY2013. We expect the growth to moderate in the subsequent quarter mainly due to a slower growth in the domestic formulation business (from a relatively higher base) and slower depreciation in the rupee against the dollar (up 11% YoY). Nonetheless, strong product pipelines, improved utilisation of the newly commissioned facilities and the contribution from the newly acquired entities would continue to ensure the long-term growth of the pharma universe.

  • Our top pick: We prefer Sun Pharma in the large-cap space due to the strong traction in its US business and its increased focus on the domestic branded formulation business (which has been divested for increased focus). We pick Divi's Labs in the contract research and manufacturing services (CRAMS) space due to the increased traction in the company's CRAMS business and currency benefits. We like Cadila in the mid-cap space for its strong research and development (R&D) for its expected ramp-up in the USA after the US Food and Drug Administration (USFDA) cleared of the company's Moraiya facility and R&D base.

> Q1FY2013 Telecom earnings review

Competition intensifies, regulatory risk persists; cautious view maintained 
  • Weak results fail to meet expectations: The Q1FY2013 results of the telecommunications (telecom) companies tracked by us, ie Bharti Airtel and Idea Cellular, were below expectations on all the fronts, viz revenue, margin and earnings. Bharti Airtel's performance was weak in both South Asia (including India) and Africa. The company's consolidated top line grew at 3.3% on a quarter-on-quarter (Q-o-Q) basis, with the operating profit and the net earnings showing a sequential decline of 6.2% and 24.2% respectively. For Idea Cellular, the top line grew at 2.5% quarter on quarter (QoQ) while the adjusted operating profit and the earnings witnessed a sequential decline of 4.8% and 1.5% respectively. The margin of both the players took a solid hit-Idea Cellular's margin was down 200 basis points QoQ (from 28.1% in Q4FY2012 to 26.1% in Q1FY2013) while Bharti Airtel's consolidated margin contracted by 310 basis points QoQ from 33.3% in Q4FY2012 to 30.2% in the quarter under consideration. 
  • Volumes expand; profit contracts: As expected the traffic momentum remained strong during the quarter, with both Idea Cellular and Bharti Airtel registering a sequential volume expansion of 3.9% and 5% respectively. This good volume growth was achieved on the back of the already solid Q4FY2012 volumes, but at the cost of profitability. Both the players experienced a decline of 2.5% in the average realised rate on a sequential basis which was the prime reason for the fall in the profitability, as visible in the report card.
  • Business competition intensifies, this time the leader leads: The competition in the Indian wireless industry has intensified. The price increases taken by the players earlier have not been sustainable and the price war has started again in the market, this time led by the industry leader itself, ie Bharti Airtel.
  • Bharti Africa-targets realigned with reality: On the African business front as well, Bharti Africa's Q1 performance was dissatisfactory with a flat revenue growth and a 200-basis-point Q-o-Q contraction in the margins. In the conference call of Bharti Airtel, the management confirmed that the business environment in Africa is also facing challenges on multiple counts, ranging from the euro zone crisis and volatile commodity prices to the general political environment in each African country. It echoed our longstanding stance that it would be difficult for the African business to achieve its stated revenue and EBITDA guidance of $5 billion and $2 billion respectively in FY2013 and postponed the guidance.
  • Regulatory environment weighs heavy on fundamentals and stock price movement: The Indian telecom sector is passing through a phase of high policy uncertainty, where various contentious issues that could affect the earnings/cash flow and competitive positioning of the players remain unsettled (read, licencee renewal norms, spectrum refarming process etc). Further, the cabinet's decision of fixing the all-India 2G base price at Rs14,000 crore would hurt the operators, investors and consumers. We believe that the news flow in this sector would be very fluid. Hence, any positive or negative development would swing a stock's performance in the northward or southward direction respectively.
  • Reduced estimates and downgraded rating: Taking cognisance of the changing business environment and the unhealthy regulatory developments, we have reduced our estimates for both Bharti Airtel and Idea Cellular. Bharti Airtel has missed analysts' expectations for around seven to eight quarters in a row for various reasons ranging from a competitive environment to regulatory issues. We expect Bharti Airtel to continue to safeguard its subscriber base and revenue market share at the cost of profitability. This is likely to keep the South Asian business' margin under pressure in FY2013. Further, the African business is also not showing the required elasticity and agility. Thus, we have downgraded our EBITDA and earnings estimates for FY2013 and FY2014. Our new earnings per share (EPS) estimates for FY2013 and FY2014 are Rs11.9 (vs Rs14.3 earlier) and Rs15.7 (vs Rs18.8 earlier) respectively. Based on the new estimates and looking at the tough competitive as well as ambiguous regulatory environment, we reduce our target EV/EBITDA multiple for Bharti Airtel from 7x to 6.5x its one-year forward FY2014E earnings to arrive at a new price target of Rs310 (against Rs362 earlier) and downgrade our rating on the stock from Buy to Hold.

>Q1FY2013 Auto earnings review

Drive with caution
  • Auto sector reported flat growth for Q1FY2013; has given lacklustre returns in last six months: In our Thematic Report dated December 27, 2011, we had expressed concerns over the moderation in growth of the automobile (auto) sector with the full impact of the moderation expected in H1FY2013. As against the benchmark index' return of 13% between December 27, 2011 and August 21, 2012, the auto stocks under our coverage too gave an average return of 13%. The best return of 57% came from Apollo Tyres, our top pick for the last six months. The next highest return came from Maruti Suzuki at 22% due to the stock sell-off on account of the Manesar strike. Excluding these two stocks, the rest of the universe gave a negative return of 0.5% between December 27, 2011 and August 21, 2012.

    As we analyse the Q1FY2013 results, our coverage universe saw a profit after tax (PAT) growth of merely 2%. Our auto tracking universe of 15 companies, ex Tata Motors, saw a PAT growth of 2.5% year on year (YoY); that with Tata Motors saw a PAT growth of 11% YoY during the same period. 

  • M&M added to our conviction list on robust Q1FY2013 performance: During the past six months, most of the stocks under our coverage except Apollo Tyres had been kept on Hold recommendation. We recently added Mahindra and Mahindra (M&M) to our Buy list as we see it as a proxy play on food inflation and best positioned to benefit from the reviving rural incomes (refer to our Stock Update report on M&M dated August 21, 2012). 

  • Apollo Tyres, M&M and Tata Motors top revenue earners; Maruti, SKF laggards: Apollo Tyres saw its Q1FY2013 PAT growing the most, by 79% YoY, on a strong operating performance. Tata Motors, M&M and Suprajit Engineering also reported a 20% plus Y-o-Y earnings growth. The disappointment came from Maruti Suzuki and SKF India, both of which reported an earnings decline of over 20% YoY for the quarter. 
  • Outlook and valuation: Going forward in H2FY2013 and FY2014, barring a few companies like Maruti Suzuki, which would grow on a low base, a large part of the earnings growth is expected on an improved operating performance in H2FY2013 and FY2014. The volume growth may remain modest, but the raw material pressure is expected to moderate for most companies in H2FY2013. After keeping most auto companies on Hold for the last six months, we have added M&M to our Buy list along with Apollo Tyres. The outlook on most other companies looks cautious as multiple factors related to competition, inventory build-up, global slowdown and fuel price hike continue to weigh on the auto sector.