>HIGHWAY DEVELOPMENT: Near term challenges; smoother times ahead

Roads & Highway development presents a structured, planned & definitive opportunity of ~` 1365bln (USD 26.25bln) to EPC & BOT developers. Dissecting this opportunity, we find that the scale, size & regional distribution of majority of balance projects may not be attractive for a BOT developer. Also, the competitive intensity of bids has challenged all industry players alike & warrant caution. In our opinion, these bids assume a consistent availability of cheaper source of finance which in itself is unsustainable over a longer time frame. We believe capital markets shall, in the long run, create a valuation differential between aggressive company managements and those with conservative & sustainable strategy. Hence, we like companies with business model & management style which does not encourage excessive risk taking, have projects with longer concession tail & are able to consistently generate positive FCFE with minimal support from the parent entity.


■ Definitive opportunity, award activity has already peaked
Highway development under the planned NHDP presents an opportunity of ~` 1365bln (USD 26.25bln). While we don’t deny the size & certainty of the opportunity we are concerned about limited projects fitting the size & scale of a PPP development. The regional spread too is not quite encouraging. Also, we expect FY12 to see peak of awards in near term.


■ Competitive pressures – no respite in near term
The recent bids by developers belie their stated IRR objective. Also, the expectation of gradual decline in competitive intensity has been proven otherwise. Supply side constraints along with demand side factors of declining order backlog/sales, lower asset utilization & scope for financial leveraging has attracted the breadth of the construction players to road projects particularly the NHAI project awards. Hence, we expect the competitive intensity to remain at elevated levels in near term restricting IRR’s of projects to lower teens.


■ Takeout essential (debt & or equity), equity requirement to pull plug on competitive intensity
We estimate an equity requirement of ` 2687bln over the next 3 years for projects currently under implementation. Additionally, ` 339bln of equity shall be required for projects which are expected to be awarded in the next 2 years. In our opinion, this shall be the sole factor for pulling the plug on the competitive intensity of the sector.


■ Challenging times to continue; Valuations offer comfort
The competitive intensity, amongst other reasons has led to underperformance of the sector with broader markets. The current average valuation of 1.5x P/B offer significant comfort from further downside. We initiate coverage on Ashoka Buildcon & ITNL with a Buy rating, downgrade IRB Infra to Hold, maintain Buy on Sadbhav Engineering. Sadbhav Engineering continues to occupy the top slot in our pecking order of stock selection.


To read full report: HIGHWAY DEVELOPMENT
RISH TRADER

>TATA STEEL: The worst may be behind, well poised for recovery; retain Buy

What's changed
Key takeaways from Tata Steel’s 3QFY12 results conference call: (1) Group steel deliveries at 5.84mnt (-5% qoq), were impacted by seasonal weakness and market uncertainties in Europe and floods in Thailand. (2) Europe business witnessed price declines on weak demand while higher priced raw materials impacted profitability, resulting in the company making significant mark-to-market provisions on stock. However, this implies that with steel prices recovering, there is low risk of further inventory write-downs. European demand has picked up with prices inching up. The company is targeting to retain FY13E volumes in Europe at FY12E levels, despite planned temporary closure of the BF4 at Port Talbot for rebuild. (3) India business saw stable prices with long product and downstream prices higher than previous quarters. Margins were compressed on account of higher raw material (imported coking coal) prices. (4) The company expects to commission the Jamshedpur brownfield expansion by March 2012 and
expects to add 1mn tons to current production levels in FY13. (5) European restructuring measures are progressing per plan, leading to about 2500 redundancies. (6) The Benga coking coal project in Mozambique is expected to commence despatches from March 2012.


Implications
We cut our FY12E-14E EPS by -1% to -11% on inventory write-down, and higher cost assumptions. But we believe the worst may be behind in both India and European profitability, and with the Jamshedpur expansion on track, the company is well positioned for a strong earnings recovery in FY13E.


Valuation
We reiterate our Buy rating and lower our 12-month P/B-based TP to Rs550 (from Rs552) on lower earnings estimates.



Key risks
Slower-than-expected demand recovery in Europe, higher-than-expected raw material costs

>SELAN EXPLORATION TECHNOLOGY: Robust realisation; await ramp-up in production volumes

Result highlights
Strong results driven by realisation; volume growth unimpressive though: In Q3FY2012, the net revenues (adjusted for the petroleum profit) of Selan Exploration Technology (Selan) grew by 54% year on year (YoY), as a 76% year-on-year (Y-o-Y) improvement in the realisation over-compensated for the 6% decline in the volume during the quarter. Though sequentially the volume improved by 14% to 41,853 barrels of oil, but the realisation supported 6% growth QoQ taking the sequential sales growth to 20%.


PAT records 65% growth YoY: The operating profit grew by 77% YoY and 5% quarter on quarter (QoQ) to Rs14.7 crore. Following the trend, the profit before tax (PBT) grew by 80% YoY and 5% QoQ to Rs16.7 crore in Q3FY2012. However, there was an extraordinary item to the tune of Rs2.4 crore pertaining to foreign currency variation in Q3FY2012. Therefore, the reported profit after tax (PAT) recorded a growth of 65% YoY and 17% QoQ to Rs10.5 crore. Excluding this extraordinary item, the adjusted PAT seems to jump by 100% YoY and 12% QoQ to Rs12.9 crore.


Volume estimate revised down; consequently profit estimate trimmed: Given the delay in obtaining regulatory approvals for further exploration & development of the company’s oil fields, we are fine-tuning our assumptions for the production volume in FY2012 and FY2013. However, the impact of the delay on the net revenue will be limited by the higher than expected blended realisation. We are also introducing our FY2014 estimates for the company in this note. We remain positive about the field development programme and the potential ramp-up in the volume from the same in the coming years. Thus, we maintain our Buy recommendation on Selan with a price target of Rs500.


Other updates: Last week, Andrew Wenk, President & CEO, Selan, resigned from the company for personal reasons. Mr Wenk's resignation is effective from February 15, 2012. He had joined Selan during July 2011.


The company has declared an interim dividend of 30% (ie Rs3/- per equity share) for the financial year 2011-12.

>Marico Acquires Paras’ Personal Care Brands from Reckitt

■ What's new? — Marico has acquired key personal care brands (Set Wet, Livon, Zatak, among others) from Reckitt Benckiser for an undisclosed amount. Reckitt had acquired these brands from Paras Pharmaceuticals last year. The transaction involves the transfer of all key assets (IPRs, supply agreements & third party manufacturing agreements) to a separate company, which Marico will acquire over the next 3 months.


■ Transaction adds ~4% to FY12E consolidated revenues — Mgmt noted that the revenues of the acquired business are likely to be ~Rs1.5bn in FY12E; i.e. ~4% of consolidated revenues. It notes that these brands in aggregate have grown at 20% p.a. (largely volumes) over the past few years - with GMs >50% - higher than Marico’s consolidated business. Details on the operating or net margins aren’t disclosed.


■ Marico will purchase 3 main brands — a) Zatak (mass deodorant), b) Set Wet (styling gel + premium deo) and c) Livon (post wash conditioner). Mgmt noted that deos comprise ~50% of the revenues (both have ~6% market share), and the balance 50% is hair creams, conditioners, etc. Deos category has been an outperformer, growing at ~40% CAGR over the past 3 years.


■ Strategically, transaction shows Marico’s intent in personal care — Mgmt disclosed strategic rationale was a) to attain critical mass with Marico’s brand Parachute Advansed in the post shower hair care + skin care space, b) some distribution synergies – Paras has reach of ~0.3m outlets – the company will gain incremental access to 60k (modest, given Marico’s total reach of 3m+ outlets). Given the small scale vs. the overall business, we think near-term synergies are limited. It will be interesting to see if over the medium term, mgmt launches the Vietnamese male grooming brands in India to augment the business – somewhat similar to Derma’s products in Kaya.


■ Balance sheet implications — Marico has cash surplus of ~Rs4bn end Dec11. Mgmt noted that after setting aside a strategic cash reserve, it expects to utilize short-term debt to fund the acquisition and then use a mix of debt, internal accruals and / or equity financing. Given that Reckitt had paid ~8x trailing sales for Paras, even applying a 25- 50% discount would imply Marico’s consideration will be ~Rs5.6-8.4bn – essentially implies debt reduction is unlikely over the next 2 years.


RISH TRADER