exports thematic- jul 2013

8/9/2019 Exports Thematic- Jul 2013

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July 2013

ECONOMY &STRATEGY

Saurabh Mukherjea, CFA

[email protected]: +91 99877 85848

Ritika Mankar [email protected]: +91 22 3043 3175

W e n e e d a ‘ h e r o ’


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Ambit Capital Pvt Ltd 2

ONTENTS

Section 1: The macroeconomic background……………………………… 4

INR’s rapid depreciation against USD and RMB…………………………………… 4

How critical is currency competitiveness to exports growth?............................ 5

The growth potential of India’s export engine…………………………………….. 8

India likely to enlarge footprint in the Engineering Goods space………………. 9

Section 2: Identifying export-oriented sectors…………………………. 12

Section 2.1: Pharma…………………………………………………………………..14

Section 2.2: Auto and Auto Ancillaries……………………………………………. 17

Section 2.3: Capital Goods & Light Industrials……………………………………19

Section 2.4: IT………………………………………………………………………… 21

Stock-specific profiles………………………………………………………….23

Bajaj Auto………………………………………………………………………………….. 25

Balkrishna Industries……………………………………………………………………… 31

Dr Reddy's………………………………………………………………………………….. 37

HCL Tech…………………………………………………………………………………… 43

eClerx………………………………………………………………………………………. 49

Cummins India……………………………………………………………………………. 55

Elgi Equipments…………………………………………………………………………… 61

AIA Engineering…………………………………………………………………………… 67

TTK Prestige………………………………………………………………………………… 73


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Economy & Strategy

M CRO THEM TIC

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit

Capital may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

Please refer to the disclaimer section on the last page for further important disclaimers.

Analyst contacts

Saurabh Mukherjea, CFA

Tel: +91 99877 [email protected]

Ritika Mankar Mukherjee

Tel: +91 22 3043 [email protected]

Exhibit A: The INR depriciated by 74%against the RMB over April 2007-July2013

38%

74%

0%

20%

40%

60%

80%

INR/USD INR/RMB

C h n a g e o v e r s p e c i f i e d

p e r i o d

( i n % )

Apr 2010 to July 2013 Apr 2007 to July 2013

Source: CEIC, Ambit Capital research

Exhibit B: India’s manufactured exportshave been increasing at a faster pacethan that of China since 2007

-

2

4

6

8

10

12

14

1 9 8 4

1 9 8 6

1 9 8 8

1 9 9 0

1 9 9 2

1 9 9 4

1 9 9 6

1 9 9 8

2 0 0 0

2 0 0 2

2 0 0 4

2 0 0 6

2 0 0 8

2 0 1 0

C h i n a ' s M a n u f a c t u r e d E x p o r t s d i v i d e d b y

I n d i a ' s ( i n t i m e s )

Source: CEIC,Ambit Capital research

Exhibit C: Top export plays

Companyname

TickerMCap

(US$ mn)

6 month ADV

(US$ mn)

Bajaj Auto BJAUT IN 9,741 13.8

Balkrishna Inds. BIL IN 352 0.2

Dr. Reddy's DRRD IN 6,358 12.9

HCL Tech HCLT IN 10,539 19.8

eClerx ECLX IN 370 0.3

Cummins KKC IN 1,922 2.1

Elgi Equipments ELEQ IN 211 0.2

AIA Engineering AIAE IN 473 0.2

TTK Prestige TTKPT IN 695 2.4

Source: Bloomberg, Ambit Capital research

India’s exports We need a ’hero’

Using the over 70% depreciation of the INR versus the Chinese currency(over the past six years) as a catalyst, India’s exports should graduallypick up momentum and thus help the country deal with its growingBalance of Payments deficit. Given the outperformance of the basket ofexporters highlighted by us a year ago, we now highlight the presence inthe Indian market of a number of proven (Bajaj Auto, Cummins, Dr.Reddy’s, HCL Tech, and eClerx) and emerging plays (Balkrishna, Elgi, AIAEngineering, and TTK Prestige) on this theme.

A tried and tested formula for success

Not only has every single East Asian Tiger prospered from manufacturingexports, the export economies of these countries have been constructed on theback of sustained currency devaluations. We show in Section 1 of this note

how major exporters such as Japan, Korea and China prospered in the pre- WTO world partly due to currency devaluations.

Over the past six years, not only has the INR depreciated by over 70% againstthe renminbi, it has also depreciated by 38% against the USD (see Exhibit A inthe right margin). None of the other Asian currencies has depreciated by suchan extent against these two key currencies implying that entire swathes ofexporting businesses in India silently received a competition booster over thepast five years.

Whilst China’s manufactured exports continues to be 10x the size of India’s,China is losing its competitiveness, as corroborated by the fact that India’sexports growth has exceeded that of China’s for the past five years (see ExhibitB). The space vacated by China will be distributed amongst various nations,

depending on each country’s competitive advantage.

Mexico has been picking up a share of China’s exports to the US owing to itsproximity (see Exhibit 12 on page 9) whilst Korea has been capturing China’sshare of manufactured exports to the US which in all likelihood are in thehigh-technology space. India, on the other hand, has a natural advantage inthe knowledge-intensive and medium-technology space given its historicalexpertise at ‘reverse-engineering’ and given the plentiful availability of skilledengineers (see Exhibit 17 on page 10).

As a result, the 27% revenue CAGR that the Indian IT services sector hasdelivered over the last 20 years could now be replicated in other lightindustrial manufacturing i.e. the entire gamut of products ranging fromPharma to Kitchenware to Auto and from Auto to Generators and AirCompressors i.e. products where the technological know-how is not cutting-edge R&D, where the production facilities do not require large-scale capexand where infrastructure requirements for shipping inputs and outputs arerelatively undemanding.

Investment implications

Alongside well-known IT firms like HCL Tech (HCLT IN, mkt cap US$10.5bn,BUY, pg 43), some Indian manufacturers have already shown that India cansucceed in global export markets. Whilst the largest of these success stories – Bajaj Auto (BJAUT IN, mkt cap US$9.7bn, BUY, pg 25), Cummins (KKC IN,mkt cap US$1.9bn, BUY, pg 55) and Dr Reddy’s (DRRD IN, mkt capUS$6.4bn, BUY pg 37) – are well known, more significant is the success that

smaller companies such as Balkrishna Industries (BIL IN, mkt capUS$352mn, BUY, pg 31), Elgi Equipments (ELEQ IN, mkt cap US$211mn, pg61), AIA Engineering (AIAE IN, mkt cap US$473mn, pg 67), eClerx (ECLXIN, mkt cap US$370mn, pg 49) and TTK Prestige (TTKPT IN, mkt capUS$695mn, pg 73) have had in niche export markets.


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Section 1: The macroeconomic background

INR’s rapid depreciation against USD and RMB

The five-year period leading up to FY08 was characterised by unusual andunprecedented levels of global prosperity. These ‘go-go’ years benefitted from therare combination of high global growth, benign levels of inflation and high levels

of global risk appetite.

However, after the demise of Lehman Brothers in September 2008, not only didthis period of global prosperity come to an end, but its also changed currencydynamics around the world.

India’s current account balance had swung from positive to negative territory inFY05, as oil prices jumped by 42% YoY in FY05. Post-FY09, India’s current accountdeficit (CAD) as a percentage of GDP began exceeding the 2% threshold, as slowerglobal growth meant that India’s invisibles’ surplus diminished. The rising demandfor gold imports further exacerbated India’s CAD woes. India’s widening CADmeant that the INR depreciated by 38% against the USD over FY08-14 YTD ascompared to the 18% appreciation in the INR over FY02-08.

Not only was the extent of the depreciation high by India’s own historicalstandards, the extent was greater than that experienced by its Asian peers as well(see Exhibit 1 below). For instance, whilst the Korean won and Indonesian rupiahdepreciated by 9% YoY and 21% YoY over FY08-14 YTD respectively, the Chineseyuan as well as the Singapore dollar actually ‘appreciated’ over this period.

Exhibit 1: The INR has depreciated significantly against the USD as compared toits other Asian peers

-21% -16%

-4% -1%

9%

21%

38%

-40%

-20%

0%

20%

40%

60%

RMB/USD SGD/USD THB/USD HKD/USD IDR/USD KRW/USD INR/USD C h n a g e o v e r s p e c i f i e d p e r i o d

( i n % )



More importantly, as the Chinese Government began to revalue its undervaluedcurrency in 2007, the INR depreciated by 74% against the RMB over FY08-14 YTD(see Exhibit 2 on the next page). Once again, the extent of the INR’s depreciationagainst the currency of this giant exporter was higher than that experienced by its Asian peers. Thus, entire swathes of exporting businesses in India silently receiveda competition booster over the past five years.


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Exhibit 2: The INR depreciated by 74% against the RMB over the late noughties

5%

21%25%

37%

53%

74%

0%

20%

40%

60%

80%

SGD/RMB THB/RMB HKD/RMB IDR/RMB KRW/RMB INR/RMB C h n a g e o v e r s p e c i f i e d p e r i o d

( i n %

)



How critical is currency competitiveness to exportsgrowth?

From a practical perspective, the exports growth of any country is known to be afunction of two factors, namely, the strength of foreign demand and the price ofthe product in foreign currency terms. However, a survey of available literatureshows the importance of currency competitiveness in driving exports growth in thelong run (see Exhibit 3 below).

Exhibit 3: The importance of price competitiveness in driving exports growth

Title Key relevant findings Authors Year

What happened to Asianexports during the crisis?

Exports growth is sensitive to prices with a lag (typically 4-6 months) in two ways:

firstly, relative to destination countries, and secondly, relative to its competitors. Thelatter effect means that the positive effects on export demand of currency depreciationare enhanced if the currency of the country under study depreciates by more than itscompetitors' currency.

Duttagupta andSpilimbergo

2000

Export performance andits determinants: Supplyand demand constraints

Whilst currency competitiveness drives exports growth in the early stages ofdevelopment of the export sector, the quality of institutions as well as an increase incapital intensity of manufactured products is critical to propel exports growth in thelater stages. The quality of internal infrastructure and level of technology involved inproduction are two other drivers of exports growth.

Fugazza 2004

Determinants of exportperformance

Results for all periods indicate that an overvalued real exchange rate is detrimental toexport performance. Moreover, on average, a 1% real depreciation could increaseexports growth by 6-10% YoY.

UNCTAD 2004

Export promotion throughexchange rate policy

Depreciation encourages exports but more profoundly so when the volatility is low. Fang and Miller 2005

India exports: Is the bullrun over?

Potential demand, price competitiveness, trade barriers, infrastructure and proceduralbottlenecks affect exports growth.

Banik 2007

Are Chinese exportssensitive to changes inthe exchange rate?

The exchange rate elasticity of exports is estimated to be greater than 1 in the case ofChina. The paper also suggests that if the trade-weighted real renminbi hadappreciated at an annual rate of 10% per quarter since mid-2005, Chinese realexports would have been roughly 30% lower today.

Ahmed 2009

Indian economy :Selected methodologicaladvances

Whilst world GDP growth is a more profound determinant of exports' volume growth inthe short run, real exchange rate movements are the more critical determinants ofexports growth in the long run.

ICRIER 2011

Source: Various, Ambit Capital research


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In fact some of the leading exporter nations of the world today established theirposition in the manufactured goods’ export market by consciously devaluing theircurrencies or by resisting appreciation in the early stages of their exports growthstory.

Japan was the first large country to apply this formula in the 1960s, and Japansuccessfully revved up its exports engine by the 1970s. Throughout the 1960s, theJapanese yen (JPY) was maintained at a constant level of ~361JPY/USD (seeExhibit 4 below), which in turn led exports volume to pick up by 4x by the 1970s.

Exhibit 4: Japan held its currency constant over the 1960s and experienced a steeprise in exports growth in the 1970s

050

100150200250300350400

0 1 - 1 9 6 0

0 3 - 1 9 6 1

0 5 - 1 9 6 2

0 7 - 1 9 6 3

0 9 - 1 9 6 4

1 1 - 1 9 6 5

0 1 - 1 9 6 7

0 3 - 1 9 6 8

0 5 - 1 9 6 9

0 7 - 1 9 7 0

0 9 - 1 9 7 1

1 1 - 1 9 7 2

0 1 - 1 9 7 4

0 3 - 1 9 7 5

0 5 - 1 9 7 6

0 7 - 1 9 7 7

0 9 - 1 9 7 8

1 1 - 1 9 7 9

J P Y / U S D

0

10

20

30

40

50

60

E

x p o r t V o l u m e I n d e x

JPY/USD (Left Scale) Export Volume Index (Right Scale)


Korea also adopted the same strategy over the 1960s whereby its currency value was kept more or less constant, and Korea experienced high exports growth in thesubsequent decade (see Exhibit 5 below).

Exhibit 5: Korea also resisted currency appreciation to support its exportsfranchise in its early stages

0

50

100

150

200

250

300

350

0 1 - 1 9 6 4

0 6 - 1 9 6 4

1 1 - 1 9 6 4

0 4 - 1 9 6 5

0 9 - 1 9 6 5

0 2 - 1 9 6 6

0 7 - 1 9 6 6

1 2 - 1 9 6 6

0 5 - 1 9 6 7

1 0 - 1 9 6 7

0 3 - 1 9 6 8

0 8 - 1 9 6 8

0 1 - 1 9 6 9

0 6 - 1 9 6 9

1 1 - 1 9 6 9

0 4 - 1 9 7 0

0 9 - 1 9 7 0

K R W / U S D

0

2

4

6

8

10

12

14

E x p o r t V o l u m e I n d e x

KRW/USD (Left Scale) Export Volume Index (Right Scale)


China was the most recent country to replicate this model. China resisted anappreciation of its currency despite running a balance of payments surplus. TheRMB was near-constant from the early 1990s onwards until 2007, and Chinaexperienced an exponential pick up in exports growth over the noughties (seeExhibit 6 below).


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Exhibit 6: China’s exports rose exponentially over thenoughties following its effort to maintain a near-constant currency for more than a decade

0

2

4

6

8

10

1 9 8 0

1 9 8 2

1 9 8 4

1 9 8 6

1 9 8 8

1 9 9 0

1 9 9 2

1 9 9 4

1 9 9 6

1 9 9 8

2 0 0 0

2 0 0 2

2 0 0 4

2 0 0 6

R M B / U S D

050100150200250300350400450500

E x p o r t V o l u m e

I n d e x

RMB/USD (Left Scale)

Export Volume Index (Right Scale)


Exhibit 7: India’s manufactured exports have beenincreasing at a faster pace than that of China since2007

-

2

4

6

8

10

12

14

1 9 8 4

1 9 8 6

1 9 8 8

1 9 9 0

1 9 9 2

1 9 9 4

1 9 9 6

1 9 9 8

2 0 0 0

2 0 0 2

2 0 0 4

2 0 0 6

2 0 0 8

2 0 1 0

C h i n a ' s M a n u f a c t u r e d E x p o r t s d i v i d e d b y

I n d i a ' s ( i n t i m e s )


Thus, cross country experience clearly points to the power of currency depreciationin driving exports growth. In the Indian context, whilst the INR depreciation overthe past five years has not been the result of a conscious Government effort (as was the case for countries like Japan, Korea and China), it is likely to give amassive boost to India’s exports.

Why have India’s exports not expanded substantially over the past five years?

The logical question that one might then raise is that ‘why has the depreciation inthe INR not delivered a secular pick-up in manufactured goods’ exports so far?’ Theabsence of a visible exports miracle in India thus far can be attributed to two

reasons:

Firstly, it is critical to note that the impact of a weaker currency on driving super-charged exports growth takes time. As evident from the Japanese, Korean andChinese examples cited above, it can take 5-10 years before a weak currencydrives rapid exports growth. There are two fundamental reasons for this ’lagged‘impact of a cheaper currency on exports growth:

Market participants, both exporters and their customers, need to see thecurrency stay cheap for a period of time, say 1-2 years, before they start re-pricing and re-adjusting their contracts. For example, whilst the INR hasdepreciated versus the RMB by more than 70% over FY08-14, it is only in thelast couple of years that Indian firms which were buying finished goods fromChina have terminated these contracts and moved towards local sourcing.

In medium-to-high-end manufactured goods and in Services (both of whichare large components of India’s export baskets, as explained in the subsequentsections), it takes at least 2-3 years to build a sales/distribution network andthen an after-sales service network. During this time, the customer assessesthe product and the quality of the brand without committing to large-scalepurchases. It is only after this ’build‘ phase is done that exports take offexponentially. The rise and rise of Indian IT services’ growth over the late1990s is a prime example of this phenomenon playing out and is likely to begenerated for the manufactured goods’ basket over the coming five years.

Secondly, note that the five-year period spanning CY08-12 saw global growthrates nearly halve from an average of 4.8% YoY over the previous five-year periodto 2.9% YoY. This in turn meant that despite the substantial improvement in India’s


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currency competitiveness, India’s exports growth rate remained subdued owing tothe weak global demand conditions.

Going forward, we expect the pick up in global growth rates (IMF estimates globalgrowth to be recorded at 4.1% YoY over CY13-17 as compared to 2.9% YoY overCY08-12). Such a global growth recovery coupled with the confidence that India ishere to stay as a low-cost exporter of medium-tech manufactured goods should liftIndia’s headline exports growth rate substantially, with certain companies

operating in the medium-tech manufactured goods benefitting disproportionately(refer to Section 2 page 12 for details).

The growth potential of India’s export engine An analysis of India’s export sector from the perspective of five key drivers ofexports growth (see Exhibit 8 below) suggests that India continues to lag on thequality of internal infrastructure and technological competence. As discussedbelow, this will hamper its ability to offer competitive prices for a range of labour-intensive manufactured products. However, India’s significantly improved currencycompetitiveness has improved its potential as a manufactured goods exporter.India’s substantially improved currency competiveness has already meant thatIndia’s manufactured exports have been expanding at a faster pace than China’s

since 2007 i.e. when China began revaluing its currency after resistingappreciation for more than a decade (see Exhibit 7 on the previous page).

Exhibit 8: The growth potential of India’s exports engine

Source: Industry, Ambit Capital research.

How is India likely to overcome its poor technological expertise?

High-technology exports as a percentage of India’s total manufactured exports were at 7% in CY10 as against 28% for China. Whilst India currently lags on

technology at a country level, China’s experience during its rise as an exportspowerhouse suggests that exports growth driven by currency competiveness leadslocal manufacturers to move up the technology ladder.

Exposure to Developed CountriesMEDIUM

Given that the developed countries(DCs) are likely to undergo aprolonged period of weak GDPgrowth, the fact that the G5’s sharein India’s exports has been declining(from 31% in FY04 to 20% in FY11) is

a positive. Furthermore, the share ofexports to EU27 (i.e. a region that islikely to experience GDP growthcontraction in CY13) has beendeclining (from 23% in FY04 to 17%in FY11).

Quality of Internal Infrastructure

LOW Quality of transport infrastructure inIndia is underdeveloped ascompared to Asian peers (source:

Global Competitiveness report).India’s cost to export is also higherthan most (US$1,120 per container

vs US$580 per container in China).

Technological Edge/Cost ofProduction

LOW

High-technology exports accounted for

7% of India's total manufactured goods

exports vs 28% in China. Whilst FDI

inflows (which typically are a driver of

inorganic technological growth)averaged at 1.2% of GDP over the past

five years, India remains a laggard on

technology.

Government Policy SupportLOW

The Government of India (GoI) passedthe SEZ Act in 2005 which provides forthe creation of tax-free export havens.

These zones accounted for 30% ofexports in previous years but theirshare has diminished to 12% of late.Given the structural nature of India’shigh imports, augmenting India’sexports is likely to emerge as a naturalstrategy for the GoI.

Improving

Unchanged

Deteriorating

Currency CompetitivenessHIGH

Over the late noughties, theINR/USD rate experienced thehighest depreciation as against its

Asian peers (see Exhibit 1 and 2). TheINR depreciated 38% against the

USD vs a 21% appreciation in theRMB against the USD over 2007-13.Furthermore, given the structuralnature of India’s CAD, the INR islikely to remain weak.


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Whilst China’s share of high-technology exports in the early 1990s wascomparable to India’s current status, China enhanced its exports growth rate bydeliberately withholding currency appreciation over the late 1990s and earlynoughties, a period which coincided with a pick up in China’s high-technologyexports (see Exhibit 9 below).

Exhibit 9: China’s experience suggests that a pick up in high-technology exports

takes place in the more advanced phase of exports growth

0

10

20

30

40

1 9 9 2

1 9 9 3

1 9 9 4

1 9 9 5

1 9 9 6

1 9 9 7

1 9 9 8

1 9 9 9

2 0 0 0

2 0 0 1

2 0 0 2

2 0 0 3

2 0 0 4

2 0 0 5

2 0 0 6

2 0 0 7

2 0 0 8

2 0 0 9

2 0 1 0

C h i n a ' s h i g h

T e c h n o l o g y E x p o r t s

( a s a %

o f t o t a l e x p o r t s )

0

10

20

30

40

50

T o t a l e x p o r t s

( a s a %

o f G D P )

High Technology exports as a % of total exports (Left Scale)Total exports as a % of GDP (Right Scale)


China’s experience over the noughties (see Exhibit 10 below) as well as Korea’sexperience in the 1960s (see Exhibit 11 below) lends support to the fact thattechnological upgradation follows high exports growth rather than being aprerequisite for the same.

Exhibit 10: China’s exports of high-technologymanufactured products only picked up during the moreadvanced phase of exports growth

0%

10%

20%

30%

40%

50%

60%

1 9 8 0

1 9 8 2

1 9 8 4

1 9 8 6

1 9 8 8

1 9 9 0

1 9 9 2

1 9 9 4

1 9 9 6

1 9 9 8

2 0 0 0

2 0 0 2

2 0 0 4

2 0 0 6

2 0 0 8

2 0 1 0

2 0 1 2

E x p o r t r s

( a s a %

o f t o t a l m a n u f a c t u r e d

e x p o r t s )

Light, Textile, Rubber, Minerals & IronMachinery and Transport Equipment


Exhibit 11: Korea’s experience in the 1960s also lendssupport to this hypothesis

0

10

20

30

40

50

60

70

80

90

100

1 9 6 2

1 9 6 4

1 9 6 6

1 9 6 8

1 9 7 0

1 9 7 2

1 9 7 4

1 9 7 6

1 9 7 8

S h a r e i n t o t a l m a n u f a c t u r e d g o o d s

e x p o r t s ( i n % )

AgriculturalRaw MaterialsFood

Fuel

Manufactures

Ores &

Metals


India likely to enlarge footprint in the EngineeringGoods space

Whilst China’s manufactured exports continue to be 10x the size of India’s, Chinais clearly losing its competitiveness, as corroborated by the fact that India’s exportsgrowth has exceeded that of China’s for the past five years (refer to Exhibit 7 on

page 7). The space vacated by China is likely to be distributed amongst variousnations, depending on each country’s competitive advantage.


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Exhibit 12: Mexico’s exports* to the US have beenrising at a faster pace than that of China’s since CY10

-20%

-10%

0%

10%

20%

30%

40%

C Y 0 6

C Y 0 7

C Y 0 8

C Y 0 9

C Y 1 0

C Y 1 1

C Y 1 2

M a n u f a c t u r e d g o o d s , m a

c h i n e r y &

t r a n s p o r t e q u i p m e n t e x p o r t s t o U S

( Y o Y c h a n g e , i n % )

China Mexico

Source: CEIC, Ambit Capital research, Note: Exports here only refers to

Manufactured goods exports and exports of transport equipment

Exhibit 13: Korea’s manufactured exports to the UShave been rising at a faster pace than that of China’ssince CY10

-40%

-20%

0%

20%

40%

60%

C Y 0 5

C Y 0 6

C Y 0 7

C Y 0 8

C Y 0 9

C Y 1 0

C Y 1 1

C Y 1 2

M a n u f a c t u r e d g o o d s e x p o r t s t o U S

( Y o Y c h a n g e , i n %

)

China Korea


So what has been the shape of the re-allocation of market share in the globalmanufactured exports market? Clearly, Mexico has been picking up a share ofChina’s exports to the US owing to its proximity (see Exhibit 12 above), whilstKorea has been capturing China’s share of manufactured exports to the US (seeExhibit 13 above) which in all likelihood are in the high-technology space.

Exhibit 14: The cost of capital in India is one of thehighest relative to other exporters

0%

2%

4%

6%

8%

10%

12%

India Mexico Korea China

L e n d i n g r a t e ( i n %

p . a . )


Note: Lending rate (in %, p.a.) is calculated by averaging the same forthe 5 year period spanning CY08-12.

Exhibit 15: India’s infrastructure quality too is one ofthe poorest as compared to peers

2.0

2.5

3.0

3.5

4.0

India Mexico Korea China

Q u a l i t y o f i n f r a s t r u c t u r e

( 1 = l o w , 5 = h i g h )


Note: Quality of infrastructure captures the quality of trade andtransport-related infrastructure

Whilst it is evident that India is capturing a share of China’s manufactured exportsmarket too (as evident from Exhibit 7 on page 7), what sub-sector is India likely tocreate a substantial mark in?

It is clear that India cannot hope to create a competitive franchise in the heavymanufacturing space given the prohibitively high cost of debt capital in India (seeExhibit 14 above). Secondly, although India is a country that is endowed withplenty of labour supply, India cannot specialise in labour-intensive products given

India’s gaping infrastructure deficit (see Exhibit 15 above). The infrastructuraldeficiencies coupled with the high cost of debt capital means that the working


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capital costs and logistical costs wipe out the buffer created by labour cost savingsin this structurally low-margin business.

Exhibit 16: India’s engineering goods exports’ growthrates have doubled over the past decade

Trade balance bytechnological group dividedby total trade (in %)

1985-86 1995-96 2001-2

Low Tech 14% 19% 14%

Medium-low Tech -10% -4% 0%

Medium-high Tech -15% -8% -2%

High Tech -7% -5% -4%

Source: World Bank, Ambit Capital research.

Exhibit 17: India’s rising specialisation in medium-technology merchandise goods

Product Category1990s

(Median YoYgrowth, in %)

2000s(Median YoY

growth, in %)Chg

Petroleum Products 5% 37% 31%

MFG: EngineeringGoods 13% 26% 14%

Manufactured Goods 8% 18% 10% MFG: Leather andManufactures 2% 12% 9%MFG: Chemicals and

Allied Products 12% 20% 9%

Primary Products 8% 17% 9%MFG: Gems andJewellery 12% 15% 3% MFG: Textile & TextileProducts 9% 10% 2%MFG: Work of Arts

excluding Floor Covering 11% -3% -15% Source: CEIC, Ambit Capital research. Note: MFG stands formanufacturing

Despite these two shortcomings, India has developed an edge in the medium-technology space (see Exhibit 16 above) with companies like Bajaj Auto, CumminsIndia and Maruti leading the charge. India has a natural advantage in theknowledge-intensive and medium-technology space given its historical expertise at‘reverse-engineering’ and given the abundant availability of skilled engineers.

Given India’s rising expertise in the medium-technology space and given its

deficiencies on infrastructure and capital, India appears likely to enlarge its footingmost decisively in the engineering goods space which fortunately requiresmoderate amounts of capital, labour and technology. In fact, this theme hasalready been playing out, with India’s engineering goods exports’ being thesecond fastest-growing exports category after petroleum products (see Exhibit 17above).

For a more comprehensive analysis of which sectors in India are best placed toproduce large-scale successful exporters, we now turn to Section 2.


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Section 2: Identifying export-oriented sectors Whilst it is tempting to focus on sectors which are the largest exporters from India(such as Refineries, Non-ferrous metals and Steel), many of these sectors areactually net importers. As a result, INR depreciation cuts both ways, and overall itis not obvious that such sectors are any better placed today than they were a yearago.

A more productive way of identifying well-placed sectors is net exports (exports lessimports). The table below ranks the 25 sectors which have positive net exportsbased on their growth over the past five years. (According to Capitaline data, theother 32 sectors are net importers.)

Exhibit 18: The 25 sectors which are net exporters

Rank Sector (ranked by FY12 net exports)FY07

(

mn)FY12

(

mn)5yr

CAGRNo of stocks in

the sector

1 IT - Software 485,013 1,165,840 19% 23

2 Pharmaceuticals 107,030 257,201 19% 36

3 Diamond, Gems and Jewellery 62,292 209,774 27% 6

4 Automobile 15,733 93,485 43% 10

5 Air Transport Service 6,089 67,776 62% 3

6 Mining & Mineral products 10,017 33,848 28% 6

7 Castings, Forgings & Fasteners 9,126 23,883 21% 3

8 Shipping 28,517 20,700 -6% 4

9Capital Goods-Non ElectricalEquipment

7,468 19,892 22% 15

10 Textiles 621 18,699 98% 14

11 Sugar 3,963 16,541 33% 4

12 Infrastructure Developers & Operators 18,572 13,708 -6% 11

13 Construction (809) 12,824 NA 9

14 Hotels & Restaurants 13,688 11,857 -3% 4

15 Tobacco Products 12,682 11,055 -3% 3

16 Agro Chemicals 4,637 9,842 16% 5

17 Plantation & Plantation Products 3,765 8,075 16% 4

18 Telecomm-Service (10,355) 7,128 NA 7

19 Ship Building (2,668) 4,430 NA 2

20 Computer Education 1,067 3,238 25% 3

21 Healthcare 2 3,227 338% 3

22 Cables (1,151) 2,350 NA 1

23 FMCG 11,285 2,071 -29% 16

24 Realty 1,841 596 -20% 19

25 Retail 306 153 -13% 2

Source: Capitaline, Ambit Capital research; Note: The source for data in this exhibit and exhibit 19 isCapitaline. ‘Net exports’ represents total exports minus total imports aggregated across all stocks in the

sector. ‘Net exports as a percentage of revenue’ indicates an aggregate of net exports across stocks in a sector divided by an aggregate of revenues in that sector.

In the table shown above, most of the sectors are either services-oriented (ITServices, Air Transport, Shipping, Infrastructure Developers, etc) or they arecommodity-linked (Jewellery, Mining & Mineral Products, Textiles, Sugar, Tobacco,etc). This predominance of Services and Commodity-linkages amongst only the 25sectors, which actually have positive net exports, highlights the infancy of India’s

export economy.


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In this note, we will not focus on the Commodity-linked sectors, as these exportsare driven more by global macro factors rather than anything specific happeningin India. Neither will we focus on Services-oriented sectors (with the exception of ITServices, which we will discuss given its dominance in the table shown above andits prominence in the stockmarket).

Instead, we will dig deeper into the top-four non-commodity sectors in India which

are net exporters—Pharma, Auto, Castings & Forgings and Capital Goods (see thetable below). Note that the CAGR of net exports for all four of these sectors ishigher than the CAGR of gross exports (particularly so in Auto), suggesting thatIndian companies in these sectors are already benefiting from the weak INR.

Exhibit 19: Further details on the top 10 sectors which are net exporters

Net exportsNet exports as a

% of revenueRank Sector

FY07(

mn)FY12

(

mn)5yr

CAGRFY07 FY12

5yr change(bps)

Gross exports asa % of revenue

(FY12)

Gross exportsFY07-FY12

CAGR

1 IT – Software 485,013 1,165,840 19% 72.4 67.7 (4.7) 69.6 19%

2 Pharmaceuticals 107,030 257,201 19% 23.1 25.9 2.8 37.5 17%

3 Diamond, Gems and Jewellery 62,292 209,774 27% 47.6 35.5 (12.0) 54.7 33%

4 Automobile 15,733 93,485 43% 1.8 2.8 1.0 5.8 28%

5 Air Transport Service 6,089 67,776 62% 6.6 25.9 19.4 31.3 29%

6 Mining & Mineral products 10,017 33,848 28% 2.5 3.4 0.9 5.5 31%

7 Castings, Forgings & Fastners 9,126 23,883 21% 14.6 22.8 8.2 30.5 18%

8 Shipping 28,517 20,700 -6% 33.0 17.8 (15.2) 18.6 -7%

9Capital Goods-Non ElectricalEquipment

7,468 19,892 22% 5.5 6.7 1.2 15.1 16%

10 Textiles 621 18,699 98% 0.2 2.1 1.9 13.2 23%

Source: Ambit Capital research, Capitaline

A few points emerge from the table shown above:

The Pharma sector appears to be in a very robust shape from an exportsperspective. Not only do exports account for more than a third of revenues inthis sector, they are increasing at a robust rate (five-year exports CAGR of17%). Moreover, net exports as a percentage of revenue are increasing,suggesting lower dependence on imported inputs. Pharma is also, by far, thelargest manufacturing sector shown in the table above. (See the quantum ofexports in the ‘Net Exports’ column.)

Auto is the second-largest manufacturing sector shown in the table above. Thesector appears to be in solid shape, with five-year exports CAGR of 28% andnet exports growing as a percentage of revenues. Note, however, the smallsize of the auto export sector; measured by net exports, Auto is only one third

the size of the Pharma sector.

Whilst the Castings & Forgings sector is the third-largest manufacturingsector in the table shown above, we believe that the publicly available datadoes not give a complete picture of this sector because steel, by far, the largestinput cost for this sector, is a commodity with internationally-set prices.Therefore, if the INR depreciates, the input costs for this sector will go up evenif the steel is purchased locally (which is the case for most casting & forgingcompanies in India). This is also the reason for not including Bharat Forge inthe stock-specific section of this note.

Although Capital Goods is still relatively small as an exporting sector (lessthan a tenth of the size of the Pharma sector), its growth rate (FY07-12 CAGR

of 16% for gross exports and 22% for net exports) suggests that there is plentyof potential here.


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Section 2.1: Pharma

Analysts: Jatin Kotian, [email protected], Tel: +91 22 3043 3261Ritu Modi, [email protected], Tel: +91 22 3043 3292

Given the continued INR depreciation (vs USD) by 9.5% since 1 April 2013 to ` 59.4, pharma companies, which typically earn ~30-75% of their revenues

through foreign exchange earnings, are likely to benefit in the near-to-mediumterm. We are cognizant of the fact that the foreign exchange exposure for most ofthe companies pertains to a basket of currencies and not only the USD. However,due to limited availability of data on revenues from each currency, we are unableto calculate the exposure to these currencies. Many pharma companies havehedged their export exposure, which could be at different rates from the currentspot rates. This could restrict the benefits of INR depreciation on revenues coveredunder those hedge contracts. Glenmark and Cadila do not have any hedges, andthus they will benefit immediately; however, the near-term benefits from thecurrency depreciation for Dr Reddy’s and Lupin would be restricted due to theirhedged positions (depending upon the quantum of the hedge). The topbeneficiaries from the pharma space would be Dr Reddy’s Laboratories (DRRD IN,

mcap US$6,385mn, BUY, TP `

2,489, 12% upside), Lupin (LPC IN, mcapUS$6,492mn, NOT RATED) and Cipla (CIPLA IN, mcap US$5,606mn, NOT RATED,owing to their ~40-50% exposure to net foreign exchange earnings.

Key takeaways from our analysis:

Over FY09-12, the earnings in foreign exchange for the top-7 pharmacompanies has recorded a CAGR of 19.3%, with Glenmark’s revenuesrecording a CAGR of 36%, followed by Lupin and Cadila (25% each).

Among Indian pharma companies, the standalone export earnings as apercentage of total consolidated revenues for Dr Reddy’s, Lupin and Ciplahave been the highest over FY09-13.

Cipla’s exposure to imports has remained stable at ~ 37% of total input costsover FY09-13 and the company continues to be the largest importer of rawmaterials and components.

Glenmark’s imported raw materials contributed to a meagre 1.9% of the totalinput costs in FY13.

Whilst all the pharma companies assessed would benefit from their highforeign exchange earnings exposure, Dr. Reddy’s, Cipla and Lupin would bethe strongest beneficiaries.

The INR has depreciated tothe USD by 9% since April2013

5152535455565758

596061

M a y - 1 2

J u n - 1 2

J u l - 1 2

A u g - 1 2

S e p - 1 2

O c t - 1 2

N o v - 1 2

D e c - 1 2

J a n - 1 3

F e b - 1 3

M a r - 1 3

A p r - 1 3

M a y - 1 3

J u n - 1 3

J u l - 1 3

Source: Bloomberg

INR has depreciated to therouble by 4% since April2013

1.60

1.65

1.70

1.75

1.80

1.85

M a y - 1 2

J u n - 1

2

J u l - 1 2

A u g - 1

2

S e p - 1

2

O c t - 1

2

N o v - 1 2

D e c - 1 2

J a n - 1

3

F e b - 1

3

M a r - 1 3

A p r - 1 3

M a y - 1 3

J u n - 1

3

J u l - 1 3

Source: Bloomberg

INR has depreciated to theeuro by 11% since April 2013

66

68

70

72

74

76

78

80

M a y - 1 2

J u n - 1

2

J u l - 1 2

A u g - 1

2

S e p - 1

2

O c t - 1

2

N o v - 1 2

D e c - 1 2

J a n - 1

3

F e b - 1

3

M a r - 1 3

A p r - 1 3

M a y - 1 3

J u n - 1

3

J u l - 1 3

Source: Bloomberg


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Methodology:

Export competitiveness: For our analysis, we have considered the contribution ofstandalone export earnings to the consolidated revenues earned during the year. We find that the export earnings for the top-7 pharma companies have recorded aCAGR of 19.3% over FY09-12, with Glenmark’s revenues recording a CAGR of36%, followed by Lupin and Cadila (25% each).

Dr Reddy’s has recorded standalone exports CAGR of 19.8% with the overallcontribution of exports to its revenues increasing from 46% in FY09 to 55% inFY13. Dr Reddy’s continues to have the maximum export share in its revenuesrelative to its peers.

Exhibit 20: Foreign exchange earnings contribution to total revenues for most ofthe companies has increased over the years

Standalone exports as % of consolidated revenuesCompany

FY09 FY10 FY11 FY12 FY13

Cadila 25.3% 28.3% 28.1% 27.9% NA

Glenmark 10.4% 11.6% 11.3% 14.0% 14.0%

Dr Reddy's 46.0% 46.1% 51.8% 52.3% 55.3%

Cipla 59.7% 57.1% 54.0% 53.1% 54.3%

Sun Pharma 19.4% 21.2% 15.7% 18.3% NA

Ranbaxy 38.5% 41.3% 42.3% 54.0% 31.7%

Lupin 43.6% 45.1% 45.6% 45.8% 46.4%

Source: Company, Ambit Capital research. Note: (a) Ranbaxy is a December-ending company; hence,FY13=CY12; (b) NA indicates Not Available, as the latest annual report has not been published

Import substitution: Our analysis suggests that the top-7 pharma companieshave gradually reduced their dependence on imported raw materials. WhilstCipla’s exposure to imports as a percentage of total input costs has declined from37.8% in FY10 to 33.8% in FY12, the company continues to be the largestimporter of raw materials and components (amongst Indian firms).

Glenmark’s imported raw materials contributed to a meagre 1.9% of the totalinput costs in FY13. Most of the raw materials pertaining to API were earlierimported from China. However, over the past couple of years, such imports havereduced. We believe that INR depreciation vis-à-vis yuan would result in lowerimports and substitution of imported raw materials with indigenous products overtime.

Since the data pertaining to imports of raw materials is only available incompanies’ Annual Reports, we could not determine the exposure of Cadila andSun Pharma to imports in FY13 due to the non-availability of FY13 annual reports.

Exhibit 21: Imports as a percentage of total input costs

Company FY08 FY09 FY10 FY11 FY12 FY13

Cadila 19.3% 15.0% 15.9% 14.6% 16.1% NA

Glenmark 16.5% 2.1% 1.0% 0.9% 1.5% 1.9%

Dr Reddy's 14.1% 16.7% 15.8% 21.1% 17.0% 18.8%

Cipla 30.7% 36.0% 37.8% 36.2% 33.8% 37.2%

Sun Pharma 34.4% 35.5% 30.9% 24.6% 29.4% NA

Ranbaxy 28.9% 25.2% 28.7% 23.0% 29.1% 21.5%

Lupin 48.9% 29.0% 24.4% 25.9% 23.6% 20.3%

Source: Company, Ambit Capital research. Note: Ranbaxy is a December-ending company; hence,FY13=CY12; NA indicates Not Available, as the latest annual report has not been published


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Dr. Reddy’s is the strongest beneficiary on net exports: Whilst highercontribution of exports to revenues and lower exposure to imports indicatesgreater competitiveness of Indian pharma companies in the export market, webelieve net exports (exports less imports) is the right metric to determine thecompetitiveness of companies to INR devaluation.

Whilst all the pharma companies assessed would benefit from their high foreignexchange earnings exposure, Dr. Reddy’s, followed by Lupin and Cipla would bethe strongest beneficiaries. While Dr Reddy’s and Lupin have witnessed consistentincrease in net exports as percentage of consolidated revenues vis-à-vis peers,Cipla’s percentage exposure though stagnant over FY09-13 continues to remainhigh at ~41%

Exhibit 22: Pharma companies’ net exposure to exports

Net exports as % of consolidated revenuesCompany

FY09 FY10 FY11 FY12 FY13

Cadila 20% 23% 23% 23% NA

Glenmark 10% 11% 11% 14% 13%

Dr Reddy's 40% 41% 45% 47% 49%

Cipla 43% 40% 38% 40% 41%

Sun Pharma 12% 13% 9% 12% NA

Ranbaxy 28% 29% 34% 45% 25%

Lupin 31% 35% 36% 37% 39%

Source: Company, Ambit Capital research. Note: Ranbaxy is a December-ending company; hence,FY13=CY12; NA indicates Not Available as the latest annual report has not been published


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Section 2.2: Auto and Auto Ancillaries

Analyst: Ashvin Shetty, [email protected], Tel: +91 22 3043 3285

How easy is it to follow in Bajaj’s footsteps?

Some companies such as Hero (HMCL IN, mcap US$6,351mn, SELL) and MarutiSuzuki (MSIL IN, mcap US$6,898mn, BUY) aspire to increase their exportssubstantially, but it is time-consuming to set up operations such as marketresearch, overseas distribution networks, and brand building. Bajaj Auto tooknearly five years to reach a motorcycle export volume of close to 1mn units, atarget that Hero plans to achieve by FY17.

Furthermore, we believe that even after factoring in export growth of:

50% CAGR over FY13-17 for Hero, its exports would constitute only 10% oftotal volumes by FY17.

20% CAGR over FY13-17 for Maruti, it exports would constitute 15% of total volumes by FY17.

Add to this the fact that besides these players, a large number of other players arealso contemplating making India their export hub – Honda and Yamaha in respectof two-wheelers and Nissan and Hyundai in respect of small cars (to name a fewexamples). This would present additional headwinds to Hero and Maruti versustheir export strategy particularly given that these domestic players are yet todevelop their brand name in the export markets.

On the other hand, we believe Indian auto manufacturers with an alreadysignificant export portfolio (such as Bajaj Auto, Balkrishna Industries and TVSMotor) would be the main beneficiaries in the depreciation of the INR relative toUSD, Euro and other major global currencies. These players already have anestablished distribution network, brand name and other systems in place in their

export markets. These in turn would give them significant competitive advantagesin the export markets as they seek to capitalise on the weak INR. We elaborate onthis point later in this section.

Import substitution by domestic consumers?

Indian auto companies generally do not compete with imports including Chineseimports. All the vehicles sold in India are largely manufactured locally in Indiaexcept premium/luxury passenger vehicle segments which are imported in acompletely knocked down (CKD) form and sold after assembling the same into afinished product. However, CKDs are a very small portion of the overall passenger vehicle market.

This point also holds true in the auto components space except in the case ofcommercial vehicle tyres where imports (mainly from China) account for nearly10% of the total truck and bus tyre supplies in India. We believe the adverse INRmovement versus the yuan would hurt Chinese imports into India and in turnbenefit Indian manufacturers. Amongst our coverage universe, we believe ApolloTyres (APTY IN, mcap US$555mn, SELL) would be the main beneficiary of thehigher depreciation in INR vs yuan. However, given the relatively smallcontribution of imports to Indian tyre sales (only 10% of the overall market), webelieve the benefit to Apollo Tyres would be slightly limited.

Based on the above considerations, we believe the biggest beneficiaries of the INRdepreciation in the auto sector would be Bajaj Auto (BJAUT IN, mcap US$9.1bn,BUY). Bajaj Auto currently has a strong export portfolio (34% of its totalmotorcycles and 53% of its total three wheelers were exported in FY13). Thecompany is the largest exporter of 2Ws (volume share of 69%) and 3Ws (volume


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share of 85%) in FY13 exports from India. The company's major export markets are Africa (particularly Nigeria), Asia (with Sri Lanka as a large market), the MiddleEast and Latin America (ex-Brazil). The company's pre-dominant export currency isUSD. The recent depreciation in INR relative to USD would be favourable for Bajaj Auto. Furthermore, the depreciation in INR relative to China’s yuan wouldparticularly help Bajaj Auto in regions such as Africa where it faces competitionfrom Chinese exports (including imports of global players such as Honda into

Africa from their Chinese plants). We have profiled the company in more detail onpage 25.

In the Auto Ancillary space, INR depreciation will help companies to some extentbased on their exports exposure. However, at the same time, note that the maininputs for these firms (i.e. steel, copper or aluminium) will also become dearer dueto INR depreciation. (Whilst import prices for these commodities are directlyimpacted, domestic prices of these commodities are linked to landed prices andhence get impacted too due to INR depreciation.) As a result, we believe that auto-ancillary firms that have significant net exports exposure (exports less imports) would be the major beneficiaries. In this context, Balkrishna Industries (BKT IN,mcap US$$369mn, BUY) comes to mind.

Balkrishna Industries is the largest exporter of off-highway tyres (OHT) from India with exports accounting for nearly 90% of its revenues. The company generatesabout 45% of its revenues in euro and 45% of its revenues in USD. Given thatmost of the global off-highway tyre capacities are located in the US and Europe, we believe the recent depreciation in INR relative to both USD and euro wouldfavourably help Balkrishna Industries. We have profiled the company in moredetail on page 31. Major auto-ancillary companies where INR depreciation is notexpected to have any significant beneficial impact are:

a) Bharat Forge (BHFC IN, mcap US$803 mn): Exports accounted for 28% of thetotal consolidated sales in FY12 (up from 24% in FY11). The company has beenconsistently focussing on exports. Whilst the company has achieved a sizeableexports share in the auto space, it identifies non-auto spaces (particularly oil &

gas, marine, construction/mining and power where it has low market sharecurrently) as the next growth drivers for its export business. However, on the flipside, steel accounts for nearly 55% of total raw material cost (and 25% ofconsolidated sales in FY12). For steel, domestic prices are adjusted for currencymovements. As a result, despite direct imports accounting for only 1% of thetotal consolidated sales, the company is significantly negatively impacted by therecent INR depreciation, because domestic prices of steel are linked to INRmovements. Such a steel cost escalation would wipe out almost the entirebenefits from INR depreciation on the exports side.

b) Bosch India (BOS IN, mcap US$4,709mn): The company has significantimports which accounted for nearly 14% of net sales in CY12 (40% of total rawmaterial and components consumed). As against this, the exports accounted

for only 10% of net sales in CY12. Also, the quantum of exports going forward would be restricted by the fact that the parent, Bosch Group, has worldwideoperations and manufacturing facilities.

c) Motherson Sumi (MSS IN, mcap US$2,031mn): Exports in FY12 accounted foronly 3% of the total consolidated sales. As against this, imports accounted fornearly 8% of total consolidated sales in FY11 (12% of total raw material andcomponents consumed). Also, the company's strategy in recent years has beento make overseas acquisitions (of companies that have overseasmanufacturing facilities).

d) FAG Bearings (FAG IN, mcap US$400mn): A significant proportion of imports(11% of CY12 sales) largely offsets the exports (14% of CY12 sales). As a

result, the benefit of INR depreciation will be minimal.


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Section 2.3: Capital Goods & Light Industrials Analyst:Bhargav Buddhadev, [email protected], +91 22 3043 3252

Most Capital Goods companies in India either have low or no net exports. Apart from BHEL, all other companies have net exports as a percentage ofrevenues in single digits. BHEL’s net exports as a percentage of revenues have

doubled from 6.1% in FY10 to 13.4% in FY13. Crompton Greaves, the onlyIndian firm which has been able to build a global business in this regard, hasseen its net exports as a percentage of revenues declining from 14.7% in FY10to 3.3% in FY12. As seen in the tables below, the situation is not very differentfor other prominent Capital Goods companies in India.

Exhibit 23: Net exports of Indian Capital Goods firms

Crompton Greaves* Greaves Cotton Voltamp Transformers

FY10 FY11 FY12 FY10 FY11 FY12 FY10 FY11 FY12

Consolidated net sales ( ` mn) 53,684 60,476 65,597 13,923 12,789 17,530 5,420 5,263 5,853

Total exports ( ` mn) 12,326 10,555 8,719 276 192 522 1 3 4

Total imported RM, FG and Comp 4,431 4,784 6,564 722 1,139 1,212 63 78 50

% of exports to net sales 23.0% 17.5% 13.3% 2% 2% 3.0% 0% 0% 0.1%% of imports to net sales 8.3% 7.9% 10.0% 5% 9% 6.9% 1% 1% 0.9%

Net Exports/(Imports) as a % of net sales 14.7% 9.5% 3.3% -3% -7% -4% -1% -1% -1%

Source: Company, Ambit Capital research; Note: *Standalone numbers

BHEL Thermax BGR

FY10 FY11 FY12 FY10 FY11 FY12 FY10 FY11 FY12

Consolidated net sales ( ` mn) 331,545 418,547 475,982 32,766 53,936 61,741 30,734 47,721 34,649

Total exports ( ` mn) 82,634 92,260 144,190 7,135 6,176 7,319 3,376 11,249 45,451

Total imported RM, FG and Comp 62,407 62,171 80,488 3,280 4,764 5,787 11,639 22,552 65,227

% of exports to net sales 24.9% 22.0% 30.3% 21.8% 11.5% 11.9% 11.0% 23.6% 131.2%

% of imports to net sales 18.8% 14.9% 16.9% 10.0% 8.8% 9.4% 37.9% 47.3% 188.3%

Net Exports/(Imports) as a % of net sales 6.1% 7.2% 13.4% 11.8% 2.6% 2.5% -26.9% -23.7% -57.1%

Source: Company, Ambit Capital research

However, the situation looks more encouraging for light industrials firms such asElgi Equipments (ELEQ IN, mcap US$211mn), AIA Engineering (AIAE IN, mcapUS$473mn) and Consumer Durables firms such as TTK Prestige (TTKPT IN, mcapUS$695mn, BUY).

All three firms are well-managed, are strong operating cash flow generators, havesolid franchises in India and are actively looking to expand their export franchises.(Elgi has a market share of 30-35% in India in air compressors, AIA has a market-leading share of more than 90% in the high-chrome grinding media sector in India

whilst TTK has a market share of 25% in India in kitchenware.)

Since FY12, Elgi Equipments has acquired three firms: Belair in France, Rotair inItaly and Patton’s in the US, with aggregate revenues of ~US$65mn. These brandsand their distribution channels should help Elgi increase net exports as apercentage of revenues from 8% in FY10 to 12% in FY13. We have profiled thecompany on page 61.

AIA Engineering is one of the leading suppliers of high-chrome cast grindingmedia (for grinding mineral ores, cement clinker, coal in utilities) globally. AIAmanufactures in Gujarat and sells grinding media to cement and miningcompanies in 75 countries under its brand Vega. Export volumes and revenueshave been growing faster than it domestic volumes and revenues for the last five

years and contributed more than 70% of FY13 revenues. Exports have recorded a


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CAGR of 30% over FY09-13 mainly due to rising sales to mining companies. Wehave profiled the company on page 67.

Although TTK Prestige is the leading producer of kitchenware in India, it hashistorically been a relatively small exporter. Whilst sales from exports haverecorded at a CAGR of 29% over FY08-13, exports were a mere 6% of TTK’s salesin FY13 (up from 3% in FY12) because TTK’s domestic sales have also grownrapidly. In fact, due to TTK outsourcing the production of some of its products to

China, the firm is a significant net importer. However, over the course of FY14, weexpect two things to change materially: (1) TTK is reducing the amount itoutsources from China from 18% of sales in FY12 to 8% in FY14. (b) Following thesuccess of its microsafe pressure cookers in Japan, TTK is looking to step upexports of this product to the West. We have profiled the company in more detailon page 73.


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Section 2.4: IT

With ~11% depreciation in the INR against USD, the IT services sector stands togain the most, given its: (1) export-dominated revenue profile (~55% and 27% ofrevenues from exports to the US and European countries, respectively); and (2) alarger percentage of delivery from offshore locations (predominantly India) -~82% of total delivery takes place from offshore locations for tier-1 IT firms on

average. As a thumb rule, the Indian IT services firms gain 30-50bps for every 1%depreciation in INR against USD, everything else remaining constant. Ouranalysis of Indian IT services firms’ revenue and service delivery profile(i.e. employee location) indicates that whilst HCL Tech stands to gain themost among the tier-1 IT services firms, eClerx and Persistent Systems standout amongst our mid-cap coverage.

Two sources of currency impact: Currency movement affects these firms in two ways: (a) realisation gains from USD/INR conversion, and (b) cross-currencyimpact from movement in other currencies against USD. The INR has depreciated~11% against USD since April 2013. The USD has appreciated ~11% against INRsince April 2013 and now trades at all-time high levels of ~ ` 60/USD. Also, theUSD has appreciated ~0.2% against the euro and ~2.1% against GBP over the

same period. Assuming the exchange rates remain at the current levels for the restof the year, there is likely to be a depreciation of 8% in INR against USD in FY14and 21% and 11% depreciation in the JPY and AUD respectively during FY14 (vsthe USD). Given the significant depreciation in other major currencies (JPY, AUDand GBP) as against USD, we expect cross-currency headwinds for Indian ITservices firms of ~50-90bps during the quarter-ended June 2013 and of ~120-180bps during FY14 (see Exhibits 1 and 2 for currency movements).

Not all currency gains will flow into margins: As a thumb rule, Indian ITservices firms gain 30-50bps for every 1% depreciation in INR against USD, ceterisparibus. However, we do not expect all of these gains to flow into margins. Alarger portion of these gains are likely to be invested in business growth by venturing into underpenetrated markets such as Continental Europe and

expanding presence in growing services (such as IMS) and verticals (such as Energyand Utilities, Healthcare etc). Whilst TCS’s management has already made itsintentions clear to expand in the European markets and grow its IMS practice (byparticipating aggressively in bundled deals involving asset takeover), Infosys hasalso articulated its intentions to aggressively participate in commoditised servicesafter the return of Mr NRN Murthy.

In our recent note ’Light at the end of the tunnel‘, we had upgraded our estimatesfor our Technology coverage universe, factoring in ~ ` 59/USD for FY14 and ` 57/USD for FY15 from our earlier estimate of ` 54. We have calculated themargin and EPS gains considering everything else remained constant (see columnstitled ‘FY14 ideal’ and ‘FY15 ideal’ of Exhibit 25 below). The columns titled ‘FY14estimated’ and ‘FY15 estimated’ show the change in EBITDA margin and EPS

estimates. The analysis shows that whilst an EBITDA margin expansion of 295bpscould have been realised from a higher currency in FY14, we have estimated anexpansion of only 173bps. Similarly for FY15, we have assumed an EBITDA marginexpansion of 47bps as compared to the ideal case of 234bps expansion. Note thatour forecasted EBITDA margin expansion and EPS change is also affected byseveral other variables such as higher wage cost assumption and higher tax rates. We view the currency-led margin tailwind as an opportunity for Indian IT servicesfirms to strengthen their market position in a highly competitive market.

We expect TCS and Infosys to re-invest the currency-led margin benefits tothe largest extent .

http://webambit.ambit.co/reports/Ambit_Technology_1QFY14Preview_05Jul2013.pdfhttp://webambit.ambit.co/reports/Ambit_Technology_1QFY14Preview_05Jul2013.pdf


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Economy & Strategy


Exhibit 24: EBITDA and EPS change comparison from change in exchange rate from 54 to 59 for FY14 and from54 to 57 for FY15

FY14 Ideal(at INR/USD rate of 59)

FY14 forecasted(at INR/USD rate of 59)

FY15 Ideal(at INR/USD rate of 57)

FY15 forecasted(at INR/USD rate of 57)

EBITDA* EPS EBITDA* EPS EBITDA* EPS EBITDA* EPS

TCS 250 19% 108 8% 159 12% 1 3%

Infosys 242 16% 28 8% 173 11% -161 0%

Wipro 148 12% 137 -5% 119 10% -9 -13%

HCL Tech 183 20% 6 10% 238 21% 153 22%

Polaris 404 49% 168 17% 307 40% -30 0%

Persistent 452 32% 365 15% 325 23% 172 16%

eClerx 388 23% 402 22% 321 15% 208 22%

Average 295 24% 173 11% 234 19% 47 7%

Source: Ambit Capital research; Note: * Change in bps

HCL Tech and eClerx to gain the most: The INR/USD rate sensitivity largelydepends on two primary factors: (a) proportion of revenues from the US market,and (b) offshore leverage (i.e. percentage of headcount in offshore location) – bothhigher the better from a currency depreciation point of view. We have mapped theIT services companies under our coverage based on these two criteria in Exhibit 26below. Whilst HCL Tech has the most favourable balance amongst the tier-1 peers,eClerx stands out among the tier-2 firms.

Exhibit 25: Relative strength of Indian IT services firms to gain from INRdepreciation (excluding the cross currency impact)

PersistenteClerx

Infosys

HCL Tech

Polaris

TCS Wipro

60%

65%

70%75%

80%

85%

90%

95%

100%

45% 55% 65% 75% 85% 95%

Offshore efforts %

% o f r e v e

n u e s f r o m

U S



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Economy & Strategy


Stock-specific profiles

In the pages that follow, we have profiled certain firms from each of the majorexporting sectors:

From the Auto sector, we have Bajaj Auto (pg 25) and Balkrishna (pg 31);

From the Pharma sector, we have Dr Reddy’s (pg 37);

From the IT sector, we have HCL Tech (pg 43) and eClerx (pg 49); and

From the Capital Goods / Light Industrials sector, we have Cummins (pg 55), AIA Engineering (pg 67) and TTK Prestige (pg 73).

Most of these firms were profiled in the exports thematic that we had published ayear ago in July 2012. The table below shows how they have fared in theintervening year.

Exhibit 26: Performance of last year’s iteration

Company Name BBG ticker Absolute perf Perf relative to BSE500

Bajaj Auto BJAUT IN Equity 32% 27%

Balkrishna Inds. BIL IN Equity -21% -26%

Dr. Reddy's Lab DRRD IN Equity 35% 30%

Glenmark Pharma GNP IN Equity 49% 43%

Cummins India KKC IN Equity -6% -11%

Elgi Equipments ELEQ IN Equity -1% -7%

AIA Engineering AIAE IN Equity -10% -15%

TTK Prestige TTKPT IN Equity 10% 5%

Average 11% 6%



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Economy & Strategy


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25/80

Auto & Auto Ancillaries 30 July 2013

Bajaj AutoBloomberg: BJAUT IN EQUITYReuters: BAJA.NS

Accounting: GREENPredictability: AMBEREarnings momentum: AMBER

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit

Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Please refer to the Disclaimers at the end of this Report.

BU

Analyst contact

Ashvin Shetty

Tel: +91 22 3043 [email protected]

Recommendation

CMP: 1,996

Target Price (July 2014): 2,000

Previous TP: NA

Upside (%) 0

EPS (FY14E): ` 118

Change from previous (%) NAVariance from consensus (%) (4)

Stock Information

Mkt cap: ` 578bn/US$9,783mn

52-wk H/L: ` 2,229/1,579

3M ADV: ` 843mn/US$14.3mn

Beta: 0.8x

BSE Sensex: 19,593

Nifty: 5,832

Stock Performance (%)

1M 3M 6M 12M

Absolute 3.8 5.1 26.1 (6.3)

Rel. to Sensex 2.7 4.0 9.7 (7.2)

Performance (%)

15,000

16,000

17,000

18,000

19,000

20,000

21,000

J u l - 1 2

S e p - 1 2

O c t - 1 2

D e c - 1 2

J a n - 1 3

M a r - 1 3

A p r - 1 3

J u n - 1 3

J u l - 1 3

1,550

1,700

1,850

2,000

2,150

2,300

Sensex Bajaj Auto


Background: Bajaj is the second-largest motorcycle and the largest three-wheeler(3W) player in India, with a market share of 24% and 51% in the domestic

motorcycle and 3W (passenger) markets respectively. The company generatedrevenues of ` 204bn (up 3% YoY) and PAT of ` 30bn (down 4% YoY) in FY13.

Current export franchise: Exports accounted for 33% of Bajaj Auto’s revenues inFY13. The company is the largest exporter of 2Ws (volume share of 69%) and 3Ws(volume share of 85%) in FY13 exports from India. The company's major exportmarkets are Africa (mainly Nigeria), Asia (with Sri Lanka as a large market), theMiddle East and Latin America (ex-Brazil). Bajaj took five years to raise its export

volumes from 0.25mn units to 1mn units by FY11. However, export volumes haveincreased at a strong pace in recent years with a CAGR of 21% over FY08-13.Given its global export portfolio, it competes against a range of Chinese players(mainly in Africa) and Japanese players (in Africa and the rest of the world). Sincethe INR has depreciated by 11% against the Chinese yuan in the last one year(and by 30% in the last two years), the price difference of Bajaj’s products (throughthe passing of the currency benefits) vs Chinese exports into Africa would reduce.Export strategy: The company has followed a brand-centric/alliance strategy inthe export markets. Its ‘Boxer’ brand (a low-end motorcycle) is targeted towards

Africa whereas the ‘Discover’ (commuter) and ‘Pulsar’ (sports) brands are targetedat the South Asian markets. In alliance with KTM, it manufactures and exportslower-cc premium bikes (up to 400cc) from India into the developed markets ofthe US, Europe, Japan and Australia. Furthermore, the company has tie-ups withKawasaki (front-end tie-up) in markets where the Japanese players are dominant(Philippines, Indonesia and other ASEAN countries). Discussions with managementsuggest that exports could account for 50% of the company's total volumes in thenext 3-4 years (up from 37% today). This would be driven by: (a) newergeographies such as Brazil and the untapped regions of Africa; and (b) thealliances with KTM and Kawasaki. Bajaj has the benefit of a strong experience in

the export business (having built a substantial export business) and a strongbalance sheet (net cash of ` 56bn).Reliance on imported inputs: For Bajaj Auto, 'direct imports' accounted for 33%of its revenues in FY13. Whilst data for indirect imports (through component

vendors) is unavailable, we believe this should not be significant as a percentageof revenues. Overall, the company has a significant net export (exports lessimports) exposure of 30% of net sales for FY13 (vs 22% in FY08). Overall success of the business: Bajaj has seen strong volume and revenuegrowth in the last four years (CAGR of 18% and 23% over FY09-13 respectively)buoyed by a strong domestic motorcycle industry (industry volume CAGR of 15%over FY09-13), market share gains in domestic motorcycles (254 bps over FY09-13) and significant growth in exports. Furthermore, it has posted strong operatingmargin improvement over the years (up 606bps over FY09-13) due to a better

product mix (higher share of premium motorcycles and 3Ws) and strong volumegrowth. Due to low capital intensity, the company generates strong CFO (average92% of EBITDA over FY09-13) and free cash flow ( ` 86bn over FY09-13).

Valuation: Our DCF assumes a WACC of 13.5% and terminal growth of 4% which translates to a valuation of ` 2,000, implying 14.0x FY15 EPS, in line withthe multiple we have assigned to Hero MotoCorp. The stock currently trades at apremium of 4% to Hero MotoCorp on FY14 P/E.

Key financials (standalone)

Year to March ( mn) FY11 FY12 FY13E FY14E FY15E

Net Sales 166,084 198,007 203,507 221,041 253,739

EBITDA 33,813 39,917 39,887 44,964 52,152

EBITDA (%) 20.4% 20.2% 19.6% 20.3% 20.6%

EPS ( `

) 90 108 104 118 139RoCE (%) 67% 57% 43% 40% 40%

RoE (%) 313% 264% 178% 172% 210%

P/E (x) 22.1 18.4 19.3 17.0 14.4



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Bajaj Auto


Exhibit 1:

Revenue growth and margin improvement

50

90

130

170

FY08 FY09 FY10 FY11 FY12 FY13

10%

15%

20%

25%

Revenues (Rs bn) (LHS) EBITDA margin (RHS)

(Rs bn)


Exhibit 2:

Accelerating growth in export revenues

10

35

60

85


20%

25%

30%

35%

40%

Exports (Rs bn) (LHS) Exports as % of Rev (RHS)

(Rs bn)

Source: Source: Company, Ambit Capital research

Exhibit 3:

Direct imports continues to form a smallportion of the overall input costs/revenues

-

2

4

6

8


0%

1%

2%

3%

4%

5%

Imports (Rs bn) (LHS) Imports as % of Rev (RHS)

(Rs bn)


Exhibit 4:

Bajaj auto continues to be a significant netexporter

15%

20%

25%

30%

35%

40%


30

35

40

45

50

55

60

Net exports as % of Rev (RHS) Avg exch rate (INR/US$)

Source: Bloomberg, Ambit Capital research; Note: Since the companydoes not disclose average exchange rates for the year, we have usedBloomberg for arriving at an average INR/USD rate for the respective

years

Exhibit 5:

Bajaj Auto’s multiple is trading near its long-term averages

4

7

10

13

16

19

22

M a y -

0 8

M a y -

0 9

M a y -

1 0

M a y -

1 1

M a y -

1 2

M a y -

1 3

P / E

P/E 3 yr avg 5 yr avg

Source: Bloomberg, Ambit Capital research; Note: P/E bands arrived at

using Bloomberg consensus estimates for respective periods

Exhibit 6:

Narrowing discounts vs Hero MotoCorp overthe years

-70%

-60%

-50%

-40%

-30%

-20%

-10%

0%

10%20%

30%

M a y - 0 8

S e p - 0 8

J a n - 0 9

M a y - 0 9

S e p - 0 9

J a n - 1 0

M a y - 1 0

S e p - 1 0

J a n - 1 1

M a y - 1 1

S e p - 1 1

J a n - 1 2

M a y - 1 2

S e p - 1 2

J a n - 1 3

M a y - 1 3

Premium/(Discount) to Hero P/E

Source: Bloomberg, Ambit Capital research; Note: P/E bands arrived at

using Bloomberg consensus estimates for respective periods


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Bajaj Auto


Exhibit 7:

Explanation for our flags on the cover page

Segment Score Comments

Accounting GREEN Bajaj Auto’s average accounting score ranks amongst the best for Indian auto stocks.

Predictability AMBER

Since the volume numbers are published on a monthly basis by the automobile companies,there are generally no positive/negative surprises on revenues. However, the margins tend to beless predictable and are generally the source for actual results coming in above/belowexpectations.

Earnings momentum AMBER No significant consensus upgrades/downgrades in recent few weeks.

Source: Ambit Capital research


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Bajaj Auto


Balance sheet (standalone)

Year to March ( mn) FY11 FY12 FY13 FY14 FY15

Shareholders' equity 2,894 2,894 2,894 2,894 2,894

Reserves & surpluses 46,209 57,517 76,126 89,838 106,218

Total networth 49,102 60,411 79,019 92,732 109,112

Debt 3,251 1,250 884 884 884

Deferred tax liability 297 484 1,151 1,151 1,151

Total liabilities 52,651 62,145 81,055 94,767 111,148

Gross block (inc. Goodwill on merger) 33,952 33,961 38,289 40,289 42,289

Net block (inc. Goodwill on merger) 14,827 14,817 18,044 18,260 18,386

CWIP 1,493 3,730 4,135 4,135 4,135

Investments (non-current) 10,571 11,889 12,841 12,841 12,841

Cash & cash equivalents 42,946 53,488 57,052 78,509 97,851

Debtors 3,605 4,232 7,676 6,056 6,952

Inventory 5,473 6,785 6,363 7,267 8,342

Loans & advances 13,560 15,869 18,675 20,669 23,828

Total current assets 65,584 80,374 89,766 112,502 136,973Current liabilities 24,267 26,916 26,307 30,280 34,759

Provisions 15,558 21,749 17,425 22,692 26,429

Total current liabilities 39,825 48,665 43,731 52,971 61,188

Net current assets 25,759 31,709 46,034 59,530 75,785

Total assets 52,651 62,145 81,055 94,767 111,148


Income statement (standalone)

Year to March ( mn) FY11 FY12 FY13 FY14 FY15

Revenue (inc. other op income) 166,084 198,007 203,507 221,041 253,739

% growth 39% 19% 3% 9% 15%

Operating expenditure 132,270 158,090 163,620 176,077 201,587

EBITDA 33,813 39,917 39,887 44,964 52,152

% growth 230% 18% 0% 13% 16%

Depreciation 1,228 1,456 1,640 1,784 1,875

EBIT 32,585 38,461 38,248 43,181 50,277

Interest expenditure 17 222 5 10 10

Non-operating income 3,658 3,329 3,934 4,745 6,173

Adjusted PBT 36,226 41,567 42,177 47,915 56,440

Tax 10,080 10,221 12,227 13,890 16,361

Adjusted PAT/ Net profit 26,146 31,346 29,950 34,025 40,078

% growth 40% 20% -4% 14% 18%



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Bajaj Auto


Cash flow statement (standalone)

Year to March (

mn) FY11 FY12 FY13 FY14 FY15

Net Profit Before Tax 43,478 40,262 42,662 47,915 56,440

exports thematic- jul 2013

Documents