Friday, September 14, 2012

>GREED & FEAR: Front running Mr Flexible

As the August stock market rally has proceeded in ever more desultory trading volumes, so the grinning talking heads appearing on CNBC have become increasingly bold in proclaiming that the Eurozone is finally getting its problems “sorted”. GREED & fear should make it clear that such is not the view here. Rather the base case is for renewed risk aversion heading into the fourth quarter.

The reason for the increasingly upbeat mood is clear and was discussed here at some length two weeks ago (see GREED & fear – The road to euro quanto easing, 9 August 2012). That is that Flexible Mario has set out a road map to quanto easing and Frau Merkel has not immediately disassociated herself from his comments. Still that does not mean that the ECB has already embraced quanto easing or, indeed, has already committed itself to purchase Spanish government debt, a development that might be assumed given the dramatic decline in two-year and 10-year Spanish bond yields in the last four weeks (see Figure 1). For such developments hinge critically on the key Berlin-dictated Eurozone concept of conditionality.

This week has seen the first stirrings of reality as European politicians return from holiday,
including Frau Merkel. Thus, the ECB felt it necessary to issue a statement on Monday denying
a Der Spiegel weekend report that the ECB was considering committing itself to capping yields on targeted purchases of specific Eurozone periphery bonds. While GREED & fear has little doubt that Ever Flexible Mario would love to perform that sort of manoeuvre such an ECB
approach, in GREED & fear’s view, would be anathema to Merkel since it would remove all
incentive on the relevant periphery country to get its affairs in order; be it in terms of meeting
fiscal targets or pursuing structuring reforms. True, Merkel does not seem to agree with the
Bundesbank approach which is to oppose ECB purchases of sovereign bonds on a point of
principle. But she will certainly demand a certain due process. This is also why Spanish pleas
for an open-ended commitment by the ECB to purchase Spanish debt would seem to have no
hope of being met right now, most particularly given the current lack of a market panic.

Indeed renewed market panic is probably required to apply the necessary pressure to give the
Spanish what they want. In the absence of such a panic the focus of policymakers will be on
conditionality and what the Spanish must agree to in return for a ECB commitment to purchase
their sovereign debt at the short end of the curve, which is what Draghi has indicated.

To read article: GREED & FEAR


Debt levels stay high, operating cash flow sparse to service interest
DLF’s net debt increased to ~INR227bn in FY12 as against ~INR214bn in FY11 despite the asset monetization of INR17.74bn. The company’s operating cash flow (estimated at INR15.3bn, ex–land sales) remained insufficient to service interest and dividends (INR36bn) and capex (estimated at INR8.7bn), leading to higher net debt.

Focus on asset divestment to accelerate cash flows
Interest payment of ~INR30bn in FY12 has eaten away the operating cash flows (exland sales) of ~INR15.3bn. The company has plans to cut debt by ~INR50bn in FY13 through non-core sales which would then help ease the interest burden. 

Outlook and valuations: Deleveraging the trigger; maintain ‘BUY’
DLF’s operating cash flows in FY12 were insufficient to service interest payments due to a weak approval cycle between Q1FY11 and Q2FY12. DLF has set out to reduce debt by ~INR50bn in FY13 driven by non-core asset sales which will ease the interest burden. Further, expected launch of Magnolias Phase II in H2FY13 will strengthen its operating cash flows. We value the company at INR263/share, implying that the stock is trading at 18% discount to its fair value. Maintain ‘BUY/Sector Performer’.

To read report in detail: DLF


Sufficient iron ore to meet FY13 production guidance
As per the management, JSW has sufficient iron ore to meet its FY13 crude steel production guidance of 8.5mt (our assumption 8mt). With restart of category A mines in Karnataka (mining at first mine has commenced), the company expects a total of 17 mines to start operations till December 2012 with a total capacity of 7mt. The pending auction of ~4mt of iron ore inventory and possibility of blending low grade iron ore lends further visibility to iron ore availability. With possible restart of category B mines, JSW expects ~25mt of iron ore (including NMDC) to be available in FY14. We are keeping our FY14 production estimate unchanged at 9.7mt.

JSW Ispat: Turnaround story in two years
Ispat is currently operating at an EBITDA run rate of INR12bn p.a. However, with expected benefits of INR3bn from power plant and other projects (55MW plant to commission by January 2013), INR2bn from coke oven batteries (expected  commissioning in September 2013), and INR10bn from the pelletisation plant (expected by March 2014), the EBIDTA will surge to over INR27bn. The project capex is expected to yield high RoE of ~25%.

Outlook and valuations: Retain estimates; maintain ‘BUY’
We maintain that the restart of mining in Karnataka will be a key trigger for JSW. We continue to value JSW at 5.5x and Ispat at 4.0x FY14E EV/EBITDA which yields target price of INR868. Maintain ‘BUY/Sector Outperformer’. At CMP, the stock trades at 3.1x FY14E EV/EBITDA of our pre-merger financials.

To read report in detail: JSW STEEL

>MEDIA SECTOR: Cable TV digitization is accelerating

Gearing Up for Digitization;
Assume with Attractive View

Cable TV digitization is accelerating, with MSOs and DTH companies promoting the effort with ads and by seeding STBs. We expect Hathway to benefit most, followed by Zee, while more intense MSO competition could limit Dish’s EBITDA growth.

We forecast a 26% subscription revenue CAGR, F2012-15, for the industry. We believe MSOs will benefit most, achieving a 33% revenue CAGR as cable subscribers turn digital. We forecast a 21% revenue CAGR for DTH companies. A June 2012 survey by TAM Media Research showed high DTH penetration in Delhi and Chennai, and high cable STB penetration in Mumbai and Kolkata. For all four cities, it also revealed consumers’ ‘overwhelming intent’ to buy cable STBs.

Hathway’s earnings and cash flow could rise, in our view, as more of the company’s subscriber universe is captured as ‘paying’ customers. We estimate a 32% EBITDA CAGR, F2012-15, versus 19% for Dish.  Hathway is trading at par with Dish on F2015 EV/EBITDA, on our estimates. Valuation may offer more upside for Hathway; we see scope for margins to widen,
and the pace of digitization could increase.

Zee is likely to benefit from digitization, too, on rising subscription revenue. We expect a 12% total revenue CAGR, F2012-15, led by 14% subscription revenue growth and 11% ad revenue growth. We project a 17% EBITDA CAGR, surpassing 11% for F2009-12. Dish should also benefit, but not as much as MSOs. We expect analog cable subscribers to migrate to digital
cable given the lower entry price and better value for money on monthly subscriptions.

Where we could be wrong: Any slowdown in the digitization process could hurt investor sentiment. Also, INR depreciation against the USD could hurt MSO and DTH company cash flows because of higher capex on STBs, since these costs are USD-denominated.

To read full report: MEDIA SECTOR

>Steel Authority of India Ltd: Commissioning of projects key to re-rating

SAIL announced August crude steel production growth of 7% y/y with YTD FY13 production growth of 3% y/y. We view the higher production and pick up in communication by the company positively as it gets closer to the commissioning of its projects (ISP and RSP over the next 6 months). The Aug production release also highlights the improvement in productivity parameters that had adversely impacted costs for the company during last year (Operating cost/MT in FY12 increased 17% y/y).

 August production data shows improvement in parameters: Aug crude steel production at 1.16MT highlights a significant improvement. Based on JPC data for July of SAIL, Aug crude steel production is up 3% m/m and is the highest monthly production since Mar-12. The company indicated that continued focus on techno-economic parameters to improve SAIL’s cost competitiveness has helped production. Blast furnace productivity in Aug was up ~9% y/y and concast production as a % of crude steel also improved by 4%. In our view, the commissioning of coke oven batteries, sinter plant, and other units in ISP and RSP should help drive continued improvement in productivity and lead to significant cost reduction for SAIL in 2HFY13.

 Lower coking coal costs to further help 2HFY13 margins: While there are concerns on steel demand, we believe that seasonal improvement in the 2HFY13 should help drive volume growth for the steel. Further, coking coal prices continued to remain depressed and steel companies have indicated that quarterly contract price for Oct-Dec quarter is ~$169-170/MT. Assuming INR remains at current levels, we believe that the decline in coking coal costs should benefit SAIL’s margins from Nov onwards (assuming 1-1.5months of inventory).

 Commissioning of projects key to re-rating: The commissioning process of the multi-billion dollar capex has commenced, with the start of coke oven battery at IISCO. Over the next few quarters, we believe investor focus should shift to how quickly the facilities stabilize. SAIL's
volume increase from capacity expansion is still a few quarters away and hence the real stress would emerge if the domestic demand does not improve by FY14E.

 P/BV valuation at GFC lows: SAIL is trading at 0.68x FY14 P/BV, which is lower than the GFC lows with absolute stock price close to GFC levels as stock have declined sharply over the last month. As highlighted in our recent note (link), similar valuation in Nov-Dec-11 was followed by a rebound. Iron ore price stabilization should also help SAIL’s stock price to rebound.

To read report in detail: SAIL


"Best fit on the consumer discretionary space‟ 
Revenues have grown at~35% CAGR between FY04-12, supported by volume and realization improvement. Jockey brand has been positioned in the premium segment, which accounts for ~37% of the Indian Innerwear market. We believe rising income level, under penetrated market and growing urbanization will lead to up-trading from mass market brands to premium brands. We expect the premium segment to grow faster than the overall innerwear market. We believe Page Industries is best suited to benefit from this trend, as it holds a long term exclusivity to manufacture and distribute the Jockey brand (CY2030) and Speedo brand. Given its focus on branding (ASP cost: ~5% of revenue), high return ratio, high payout ratio with a decade of dividend paying history makes Page industries a „Best fit on the consumer discretionary space‟. We expect Page Industries top line and bottom line to grow at a CAGR of 22.9% and 30.2% between FY12-14E respectively. 

Strong top line growth 
Page Industries revenue grew at CAGR of 42% from INR 3,393mn in FY10 to INR 6,834mn in FY12. The growth was driven by volume (~23% CAGR) and realization improvement (~15% CAGR). Volumes in men‟s wear, women‟s wear and leisurewear segment grew 19%, 27% and 41% CAGR respectively. Going forward, we expect Page Industries to grow at ~23% CAGR over FY12-14E supported by volume growth of 16.8% and 5.3% blended realization improvement. 

Outlook & Valuation 
Page Industries, at CMP trades at 28.2X and 22.3X to its FY13 & FY14 earnings respectively. Though the valuation appears high on a P/E basis, it is supported by high EPS growth. We assign a target multiple of 25X FY14E (PEG of 0.83) and rate Page Industries as an “OUTPERFORMER” with a target price of INR 3,420. We believe the valuation is justified given the immense potential of India‟s consumption story, fast growing market, strong brand recall and healthy financial position. Key Risks to our recommendation include company not being able to pass on the cost increase on a timely basis, leading to crunch in margin and consumers down trading due to uncertainty in the economy and job environment.