indian markets-the story of chinese bamboo - oct13.pdf
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India Strategy
Nikhil Vora / Nikhil Salvi
IDFC Securities Ltd
(Dir) +91-22-6622 2567 / 2566
(M) +91 –98211 32471
Email: [email protected] / [email protected]
SEBI Registration Nos.: INB23 12914 37, INF23 12914 37, INB01 12914 33, INF01 12914 33.
For Private Circulation only. Important
disclosures appear at the back of this report”
Indian markets
“The Story of
THE CHINESE BAMBOO…”
“Patience is bitter, but its fruit is sweet” - Jean-Jacques Rousseau, Philosopher & Writer
The Chinese bamboo tree tests our patience... If you plant the seed of a Chinese bamboo tree, you will have nothing to show for in the first four years – just a tiny sampling – in spite of your best efforts. Then, sometime in the fifth year, to everyone’s surprise, the tree sprouts and grows NINETY feet in SIX weeks! In the first four years, the tiny sampling was actually developing its root system underground to sustain its impending overground growth fifth year onwards. If you had uprooted the sampling to see why it was not growing, it would die. But if you were patient and had faith, you would witness the miraculous growth later on. Many a times, Investing in equities is a similar game of patience. But to get the plant, first you need to plant the seed.
“It is patently foolish to forget to plant in the spring, take off all summer and then cram in the fall to bring in the harvest” – Dr. Stephen Covey
The current flurry of announcements by the government reminds us of the farmer who is trying hard to reap in the harvest (last year of the term), when in fact he forgot to plant in the spring (policy inaction in 2nd and 3rd year of the term). The results are not surprising – not only is the economic slowdown reflecting in the lag indicators such as GDP growth, but they can worsen further, if the lead indicators are extrapolated. However, in spite of government and regulators making several policy announcements to calm the markets and soothe frayed nerves of investors, we feel the present crop has gone waste and the time has come to be ready for a new season. 1991....2013....same old same old The recent sharp depreciation of INR (worst level of Rs68.8/USD) and declining forex reserves ($276bn as of Sep 27th or 7 months import cover) have evoked faint memories of the Balance of Payment crisis of 1991. The factors leading upto the crisis are similar – high structural current deficit (then funded by government borrowing, now by FII flows), inelastic imports, steadily rising fiscal deficit (fiscal profligacy) and delay by government in acknowledging the crisis – evoke a sense of déjà vu. 1991 : The worst of times....and the best of times Although 1991 was a dark episode in India’s economic history (India forced to pledge gold to borrow), the crisis also forced India to embrace a new economic model. Reluctantly and haltingly, Indian economy opened to rest of the world, domestic business environment changed. In hindsight the turmoil of 1991 laid the foundation for the subsequent ‘India’ growth story.
Indian Markets: The Chinese Bamboo story
The old economy gave way to emergence of new sectors and new leaders emerged. Unpredictably, sectors like IT and Telecom rapidly emerged, driven by several hitherto undiscovered factors – a large, educated, English speaking workforce (IT sector) and the unmet potential demand for easy, instant and affordable communication (Telecom sector). 2013: The worst of (recent) times....can it also be the best? Notwithstanding the fact that current slowdown is partly the handiwork of government inaction, we believe that the reforms of 1991 have had their run and even without policy paralysis of past few years, it would have been difficult to wring incrementally more growth. It is time to introduce India to a new set of ground breaking reforms. The current slowdown has indicated how the government can be pressed into taking the same decisions quickly it would otherwise arrive at after prolonged discourse and delay. Key reforms already underway....expect benefits to materialise in the long term Just like 1991, many of current policy benefits will be visible only in the long run. The Direct Cash Transfer mechanism can potentially reduce wastage of subsidies and hence burden on fiscal budgets, better targeting of beneficiaries and lower leakages in PDS. FDI in multi-brand retail can attract much needed foreign capital in long term. Certain actions like the Food Security Bill are only enhanced versions of PDS already in place and may not impact fiscal deficit in as badly as expected. Potentially ground breaking regulations like the Direct Tax Code, which have been chronically delayed by political differences and centre-state disagreements, will also be accelerated in a crisis. We can expect to see the ‘harvest’ of these ‘seeds’ in due course in several forms such as controlled fiscal deficit, higher FDI flows, improved tax to GDP ratio, renewed investment cycle, eventually leading to valuation multiples for Indian markets closer to those for developed markets. Crisis or not....some of the seeds for new leaders of tomorrow already sown While not many could have predicted the emergence of new sectors like IT and Telecom in the 1990s, we hazard a guess that the new leaders of tomorrow will be in the consumption space. An increasingly younger demographic, growing up in an ‘indulgence’ era, will drive growth in sectors like QSR, Liquor and Internet based services. Although currently the opportunities to invest in these segments are limited, we recommend watching out for these sectors as their secular growth overcomes investor scepticism. Overall, while most investors would seek solace from near term certainty of events, the words of a one-time thought leader to the contrary do merit attention...
Indian Markets: The Chinese Bamboo story
“We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten” – Bill Gates
In the interim, we recommend caution as macroeconomic indicators remain subdued, and non-recurring events like elections will limit room for incremental government action. Under the circumstances, we expect following companies to relatively outperform as their fundamentals help them tide over the near term uncertainties. Top buys Automobiles- Eicher Motors, TVS Motors Infrastructure- JPA, IRB, APSEZ Consumer goods- United Spirits, Jyothy Labs Financials- Axis Bank, HDFC Bank IT Services- Infosys, Tech Mahindra, Persistent Systems Metals- NMDC Oil & Gas- RIL Pharmaceuticals- Dr Reddy's, Cipla, Glenmark, IPCA, Sun Pharma Power Utilities- JPVL, PTC Telecom- Idea Cellular At the same time, we recommend staying away from the following stocks as they look weak structurally Top Sells Automobiles - Tata Motors Cement – Ambuja, Ultratech Financials – SBI Metals – Hindalco Oil & Gas - HPCL
Indian Markets: The Chinese Bamboo story
The curious case of Chinese Bamboo
The Chinese bamboo tree
tests our patience
Year
You take a tiny seed, plant it and water it....you get a tiny
sampling...nothing more 1
You water it, fertilise it.....the sampling stays as it is......nothing
happens 2
You continue to water it, take care of it....still nothing happens 3
Against your better judgement, you need to continue to water it,
fertilise it.....and still nothing will happen 4
To everyone’s surprise, the tree sprouts and grows NINETY feet in
SIX weeks! 5
What was going on the first four years?
• The tiny sampling was actually developing its root system underground to sustain its impending overground growth fifth year onwards.
• If you had uprooted the sampling to see why it was not growing, it would die.
• But if you were patient and had faith, you would witness the miraculous growth later on
Investing - a similar game of Patience
How does the ‘India’ plant look like
right now?
For seeds of ‘INACTION’ sown for past few years…
....now reaping the ‘SLOWDOWN’
Seeds sown over
past two years
Harvesting the crop
Policy inaction
Fiscal profligacy
Near stagnation in
decision making
Structural problems unaddressed
Demand supply gap
High CAD
High private sector
leverage
Overambitious overseas
expansions
Low growth
High fiscal deficit
High CAD
Capex slowdown
High inflation
Declining forex
reserves
Excessive leverage crimping
equity value
Equity Index– even after 6 years – at same levels!
Sensex - gone nowhere in past 6 years!
0
5,000
10,000
15,000
20,000
25,000
11-Sep-07 11-Mar-08 11-Sep-08 11-Mar-09 11-Sep-09 11-Mar-10 11-Sep-10 11-Mar-11 11-Sep-11 11-Mar-12 11-Sep-12 11-Mar-13 11-Sep-13
“It is patently foolish to forget to plant in the spring, take off all summer…….. and then cram in the fall to bring in the harvest”
– Dr. Stephen Covey
Government machinery - now in Overdrive
Pace of government announcements inversely proportional to falling markets!!
Policy overdrive
Flurry of government announcements lately…
o Task force for currency swaps created
o Infra announcements
CCI clears 36 infrastructure projects worth Rs1.8trn
DMIC clears 6 project worth Rs1.1trn
Six airports to be privatised for Rs42.5bn
Gas price pooling mulled for starting stalled gas plants
Notification of investor friendly GAAR
…and some action too
Imported coal price issue resolved for power plants
SEB restructuring reforms being decisively pushed
Coal India directed to sign FSAs by Presidential Directive
Parliament functioning relatively better than last time
o Better floor management by the government
Key bills passed in monsoon session – Food Security Bill, Land Bill,
Pension bill
Regulators – Now showing their Mettle…
Concerted action by government and regulators – will it save the day for Indian markets?
o Curbs on import of gold – purchase on credit, sale of retail investment items like coins, 20%
export mandate
o Streamlining purchase of dollars by OMCs via single bank
o Easier rebooking of cancelled forex contracts for exporters/importers
o Allowing MNCs to use dividends from Indian subsidiary to up stake locally
o Opened FCNR-B mobilization window; Offered swaps to banks at low rates
o Relaxed trade credit norms for raising funds overseas for import of capital goods by all sectors
o To introduce inflation indexed retail bonds – can divert gold investment demand
o To issue new bank licenses by Q4FY14
o Digitization pushed through across Phase-1 and Phase-2 cities; complete digitization by
Dec2014.
o Recommended reduction in auction rates for 2G spectrum
o Increased limits for FII investments in Government and Corporate debt
o Caps on sub-categories of FII debt investments removed
RBI
TRAI
SEBI
But the ‘Harvest’ season is not yet over….
Worsening of macro to continue for some more time
PMI indices
portend further
slowdown in
economy
Possibility of
Sovereign ratings
downgrade not
ruled out entirely
Inflation to move
up led by food
and fuel price
increases
Election season
ahead – pause in
decision making
expected
Currency remains
weak
RBI has hiked
repo rate for first
time in 2 years,
signals higher
inflation
expectation
2013….deja vu of 1991?
Balance of Payment crisis
1991
Evoking comparisons…then and now
2013
???
0.0
1.5
3.0
4.5
6.0
1987-88 1988-89 1989-90 1990-91
0.0
3.5
7.0
10.5
14.0
Forex reserves ($bn - LHS)
No. of w eeks of import cover (RHS)
Fiscal deficit (%age to GDP)
5.9
6.4
5.7
6.36.6
7.8
8.8
9.5
8.68.2 8.1
8.7
5.0
6.3
7.5
8.8
10.0
FY80 FY82 FY84 FY86 FY88 FY90
Fiscal deficit (%age to GDP)
4.24.5
4.0
2.5
6
6.5
4.9
5.9
4.9
2.0
3.0
4.0
5.0
6.0
7.0
FY05 FY07 FY09 FY11 FY13
Then…………….Depletion of India’s forex reserves………Now
Then…………Fiscal Deficit increaseing due to fiscal profligacy……..Now
270
276
282
288
294
300
Jan-13 Mar-13 May-13 Jul-13
4.0
5.0
6.0
7.0
8.0
9.0
Total reserves ($ bn)
No. of months of import cover (x)
1991…the WORST of times…
Sharp decline in India’s forex reserves
Fiscally expansive government policies (social schemes), leading to bloated budgets
Inelastic imports and uncompetitive exports lead to high Current Account Deficit (CAD),
unable to be funded for long
Matters made worse by climb of Crude prices due to geopolitical tension
Continuously reducing forex reserves / import cover
Political leadership slow in accepting level of crisis
Only 3 weeks import cover at worst level of forex reserves
Fiscal deficit increasing due to fiscal profligacy
Forced to pledge physical gold to borrow
Forced to accept conditions from international finance bodies
but…… also the BEST of times!
What was ‘sowed’ in 1991 …reaped over next 2 decades
Several key reforms undertaken Government relaxed controls on industry
State monopolies broken Tariffs and duties progressively lowered
1991
2013
GDP growth (%) - two decades
since reforms
0
3
6
9
12
FY
92
FY
94
FY
96
FY
98
FY
00
FY
02
FY
04
FY
06
FY
08
FY
10
Per capita income ($)
0
1,000
2,000
3,000
4,000
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
-20
-10
0
10
20
30
40
50
FY
91-0
0
FY
01
FY
02
FY
03
FY
04
FY
05
FY
06
FY
07
FY
08
FY
09
FY
10
FY
11
FY
12
FY
13
FDI FII
Sensex - up 20x!
0
5,000
10,000
15,000
20,000
25,000
1-D
ec-9
0
1-D
ec-9
2
1-D
ec-9
4
1-D
ec-9
6
1-D
ec-9
8
1-D
ec-0
0
1-D
ec-0
2
1-D
ec-0
4
1-D
ec-0
6
1-D
ec-0
8
1-D
ec-1
0
1-D
ec-1
2
Private sector competition encouraged
Globalisation embraced gradually Indian markets progressively opened to foreign investors
GDP growth pushed to
higher levels
Economic growth =income
growth
Attracting large
foreign capital
Equity markets in a new
orbit!
Surprise winners of 1991 reforms…new sectors emerge
Who will emerge as the winners of current reforms?
1991
Reforms
IT
Drivers
• A large, educated, English speaking
workforce
• Cost competiveness
• Global Delivery model
Drivers
• Large scale infrastructure development needed debt
funding
• Overall capex cycle funded by incremental debt
• New Private sector banks set higher standards of retail
service levels, and expanded aggresively
Telecom
Drivers
• Untapped large demand for easy, instant and
affordable communication
• Competition lowered cost of communication
• Private sector brought aggression and scale to
industry
Banks
While the old economy sectors gave way……
Cement…. Capital Goods…..
Steel…. Textiles….
Cement Mcap as Share of Total Market Cap (%)
4.7
2.1
0.0
1.0
2.0
3.0
4.0
5.0
1991 2013
Steel Mcap as Share of Total Market Cap (%)
7.8
2.2
0.0
2.0
4.0
6.0
8.0
10.0
1991 2013
Capital Goods Mcap as Share of Total Market Cap (%)
4.84
2.51
0.0
1.0
2.0
3.0
4.0
5.0
1991 2013
Textiles Mcap as Share of Total Market Cap (%)
14.2
1.1
0.0
5.0
10.0
15.0
1991 2013
……Markets gave a thumbs up to ‘new’ India
Quantum change in overall market capitalization New winners - IT
New winners - Telecom New winners - Banks
IT - Softw are Mcap as Share of Total Market Cap (%)
0.3
11.6
0
3
6
9
12
1991 2013
Telecom Mcap as Share of Total Market Cap (%)
0.0
2.7
0.0
1.0
2.0
3.0
1991 2013
Banks Mcap as Share of Total Market Cap (%)
12.4
0.0
5.0
10.0
15.0
1991 2013
India Market Cap (Rs tn)
0
20
40
60
80
1991 1994 1997 2000 2003 2006 2009 2012
But have the reforms of 1991 now run their full course?
2013…Is this the WORST of (recent) times???
Worsening macros….no end in sight?
GDP – Decline not yet over…. IIP – In the twilight zone…no clear sense of direction in past 18 months
WPI Inflation – set to rise from hereon PMI Indices – indicate contraction in private sector
-10.0
-5.0
0.0
5.0
10.0
15.0
20.0
Jan-0
9
Mar-
09
May-0
9
Jul-09
Sep-0
9
Nov-0
9
Jan-1
0
Mar-
10
May-1
0
Jul-10
Sep-1
0
Nov-1
0
Jan-1
1
Mar-
11
May-1
1
Jul-11
Sep-1
1
Nov-1
1
Jan-1
2
Mar-
12
May-1
2
Jul-12
Sep-1
2
Nov-1
2
Jan-1
3
Mar-
13
May-1
3
Jul-13
GDP grow th (%) - visible rapid slow dow n in past tw o years
4.5
6.0
7.5
9.0
10.5
FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13
Wholesale Price Inflation
4.0
5.0
6.0
7.0
8.0
9.0
Aug-12 Oct-12 Dec-12 Feb-13 Apr-13 Jun-13 Aug-13
(% yoy)HSBC Markit PMI Indices - India
40
44
48
52
56
60
Sep-13Jun-13Mar-13Dec-12Sep-12
Manufacturing PMI Services PMI Contraction threshold
Both Manufacturing and
Services PMIs in contraction
mode (f irst time since Mar '09)
Investment climate has dampened….
“India has lost world’s confidence” – Ratan Tata
New project announcements – 48% yoy decline in H1FY14
‘Projects under implementation but stalled’ remain elevated (10%
of projects under implementation) Gross Fixed Capital Formation (GCFC) on a decline
Both Private and Government new projects on a decline
0
3
6
9
12
Q1FY10 Q3FY10 Q1FY11 Q3FY11 Q1FY12 Q3FY12 Q1FY13 Q3FY13 Q1FY14
-6.0
0.0
6.0
12.0
18.0
24.0
GDP Grow th (% yoy) -LHS GCFC- w ith one qtr lag (% yoy) - RHS
0
1,700
3,400
5,100
6,800
Sep-0
0
Sep-0
1
Sep-0
2
Sep-0
3
Sep-0
4
Sep-0
5
Sep-0
6
Sep-0
7
Sep-0
8
Sep-0
9
Sep-1
0
Sep-1
1
Sep-1
2
Sep-1
3
Private (Rs bn) Government (Rs bn)
Implementation - stalled (Rs bn)
0
2,250
4,500
6,750
9,000
Sep-99 Sep-01 Sep-03 Sep-05 Sep-07 Sep-09 Sep-11 Sep-13
New announcements (Rs bn)
0
2,200
4,400
6,600
8,800
Sep-0
0
Sep-0
1
Sep-0
2
Sep-0
3
Sep-0
4
Sep-0
5
Sep-0
6
Sep-0
7
Sep-0
8
Sep-0
9
Sep-1
0
Sep-1
1
Sep-1
2
Sep-1
3
But….are these also the BEST of times???
The full impact of these measures will be definitely seen …albeit with a lag
A more disciplined government – FM’s commitment “Fiscal red lines that will not
be crossed” proven in FY13
Fuel price hikes irreversible – Regular diesel price hikes by Rs0.45/lit
Direct Cash Transfer – potential to reduce future subsidies substantially
FDI in sectors like retail…..opposition to FDI slowly ceding ground….can potentially
attract large investments
Long term growth seeds being sown – Several structural improvements still below ‘radar of analysts’
GST and DTC…to come sooner than later…no going back
Recent fuel price hikes….small…..but irreversible
As consumers are unshielded from international price changes, fuel demand to moderate and hence fuel subsidies to reduce
Diesel price hikes now more regular …… ….leading to decline in Diesel demand
Cap on subsidized LPG cylinders reflected in LPG WPI Index LPG demand growth fallen post cap on subsidised cylinders
40
45
50
55
60
Jan-12 Jul-12 Jan-13 Jul-13
Diesel prices - Mumbai (Rs/lit) Diesel Consumption yoy
-8%
-4%
0%
4%
8%
12%
16%
20%
Jan-1
1
Mar-
11
May-1
1
Jul-11
Sep-1
1
Nov-1
1
Jan-1
2
Mar-
12
May-1
2
Jul-12
Sep-1
2
Nov-1
2
Jan-1
3
Mar-
13
May-1
3
Jul-13
LPG Grow th (% yoy)
-8%
-4%
0%
4%
8%
12%
16%
Jan-1
1
Mar-
11
May-1
1
Jul-11
Sep-1
1
Nov-1
1
Jan-1
2
Mar-
12
May-1
2
Jul-12
Sep-1
2
Nov-1
2
Jan-1
3
Mar-
13
May-1
3
Jul-13
LPG price Index
80
110
140
170
200
Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13
Direct Cash Transfer….inflationary….but necessary
With UID and bank account linked DCT, subsidies will be targeted to beneficiaries
Kerosene demand decline even before DCT in place
“Direct transfer of food and fertilizer subsidies in cash to targeted beneficiaries has the
potential to save almost Rs600bn, without any major adverse impact on the beneficiaries”
- Commission for Agricultural Costs and Prices
DCT – contours
Cash in lieu of benefits
Deposited directly to bank account
UID linkage to identify beneficiaries
Gradual scaleup of schemes and
geographies
Study by TERI and IISD
indicates saving of Rs41bn
or 17% of kerosene subsidy
every year
Potential impact
on subsidies
Kerosene Grow th
-20%
-15%
-10%
-5%
0%
5%
Jan-1
1
Mar-
11
May-1
1
Jul-11
Sep-1
1
Nov-1
1
Jan-1
2
Mar-
12
May-1
2
Jul-12
Sep-1
2
Nov-1
2
Jan-1
3
Mar-
13
May-1
3
Jul-13
DTC and GST….substantial ground gained
The impact of DTC and GST will materially plug taxation loopholes…
Direct Tax Code (DTC) Goods and Services Tax (GST)
Potential impact on
tax collections
• To widen tax collection base
• Tax/GDP ratio to increase substantially from
~11% currently
• GDP growth estimated to be up by 1% with the
implementation of a well-designed GST.
• 10%+ increase in exports estimated
Potential impact on
economy
• To overhaul the Income Tax Act
• Rationalisation of taxation
• Process of rolling out the DTC is already under way
• Draft prepared from extensive stakeholder consultations
currently being examined by various Ministries
• Both the Centre and the State to basically and fundamentally
change the overall structure of tax assignment
• Rs90bn set apart as the first instalment of the balance of
central sales tax (CST) compensation to states
• Cabinet to introduce the bill in Parliament
• A single or fewer rates for both goods and services to replace
the multiple taxes being levied
• Redistributing the burden of taxation equitably between
manufacturing and services
• Rationalisation of taxation
• Draft prepared from extensive stakeholder consultations
currently being examined by various Ministries
• Both the Centre and the State to basically and fundamentally
change the overall structure of tax assignment
Few more ‘seeds’….that will bear fruit in due course
These relatively smaller steps will contribute to increasing ‘the investibility’ of Indian markets
FDI in Aviation
• Tata group announced two JVs – one with Air Asia
and Singapore Airline
• Jet Etihad deal underway
Digitization
• Structural change in television sector Phase - 1
& 2 successfully completed
• Goldman invested $110m in DEN Networks
• More FDI to follow
Real Estate Bill
• Will bring one of India’s largest ‘grey’ industry
under regulation
Large scale Infra investments on cards
• CCI clears 36 infrastructure projects worth Rs1.8trn
• DMIC clears 6 project worth Rs1.1trn
• 6 airports to be bided out for Rs42.5bn
FDI in Multi-brand retail
• Gradual opening of sector can potentially bring
in large scale investments
New bank licenses
• To improve reach of banking sector in unbanked
areas – expanding financial inclusion net
FDI in retail - potentially one of largest FDI in India
FDI in
Retail
Size of Indian Retail to grow to $1.25tn by 2020
Size of Organised Retail – from 6% to 20% or $260bn, but will be still
far less than developed economies (80%+)…
India is the 5th most favorable destination for international retailers
India can attract upto $15bn in FDI in the next five years
The China Retail FDI Case
• China has attracted $30bn+ of FDI in retail even with gradual opening of sector
• China first permitted FDI in retail in 1992 with foreign ownership restricted to 49%
• Over 600 hypermarkets opened since
• Employment in the retail and wholesale sectors doubled to 54m in two decades since 1992
FDI in aviation…the next one to follow
FDI in
Aviation
Jet Etihad deal : $379m for 24%
stake
Tata Air Asia JV announced
Tata Singapore Airlines JV: To launch full service
carrier in India
SpiceJet in ‘advanced’ talks with Emirates / Tiger
Air for stake sale
The ‘seeds’ are being sown, but is the ‘ground’ fertile?
The ‘fertile’ ground - India is in an Indulgence Age
India to be USD1trillion consumption opportunity by 2015-16
I can “SPEND” – INCOME effect
There are MORE like me – BROADBASED growth
I am “WILLING TO SPEND MORE” – MINDSET
change
I know “WHERE TO SPEND” – AWARENESS
levels
I have “OPTIONS TO SPEND” – AVAILABILITY
I “WANT MORE THAN I NEED” – ASPIRATION
effect
In spite of slowdown, still one of
world’s top growing countries
Peer influence reflected in
consumption choices
35% of Indians born in post
liberalization
Increased media proliferation
Increased brand options in each of
the business segment
India moving up the value chain -
premiumization
Changing Consumer…
India, amongst the youngest
age profile
600m+ people below the age of 25 years
170m+ working women Women account for 1/4th of workforce in India
Increased consumer durable
ownership
Increased spends on consumer durables, home furniture,
etc
Savvy and informed kids -
influencer in decision making
361m of India in age group below 15 (6x USA)
“We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten”
– Bill Gates
Who will be the winners of next decade ?
QSR – The best play on food retail in India
The Indian food services Industry is now a US$12.5bn
Industry! Expected to grow to US$23bn by 2015!
The organised share, currently at 30%, is expected to
move to 45% by 2015!
This translates into a 40% CAGR over the next 3 years
for the organised sector!
An increasing youth demographic and expanding
urbanisation will drive growth for the organised sector
Indian Food Service Industry Size
0
200
400
600
800
2010 2011 2012 2013E 2014E 2015E
Unorganised Organised(Rs bn)
Quick Service Restaurants are the largest piece of
organized market; having 1/3rd share
Over the next 3 years, QSR industry is expected to
DOUBLE to over US$2.5bn
We believe businesses with strong brands, healthy
cash flows and scalable models like Jubilant
Foodworks and Westlife Development are likely to
provide disproportionate returns to investors in the
long term.
Format wise breakup
Source: Indian Restaurant Report, 2012
QSR
33%
Casual Dining
24%
Fine Dining
14%
Café and
Parlours
3%Pubs and Bars
4%
Bakery
9%
Food Courts
8%
Kiosks
4%Institutional
Catering
1%
Digitization…. will the disparity remain?
Indian TV distribution industry Comcast – largest cable company in US
C&S homes (m) EV (US$ bn)
140
12
24
160
Globally, three of the top 10 value creators in Media are standalone distribution companies!!!
India, world's 2nd largest C&S market (US at 140m homes)…
…valued at 1/12th a single player in US!
36
Liquor…equations to reverse?
Alcohol vs Tobacco MCap: India to revert to global norms
M-Cap of Tobacco vs Alcohol companies – Globally and in India
Worldwide - Alcohol companies have higher market
cap than tobacco companies However, in India Alcohol companies have had
significantly lower market cap so far Such mismatch to global norm is expected to
correct going forward
601
860
0
250
500
750
1,000
Global
Tobacco Brewers & Distellers (US$ bn)
42
9
0
10
20
30
40
50
India
Tobacco Brewers & Distellers (US$ bn)
Alcohol cos at 1/5th
Mcap of Tobacco cos
Global Brewers &
Distellers at 1.4x Mcap
of Tobacco cos
Need to relook the demographic in ‘digital’ terms
The wild card: India’s ‘digital’ demographic
India can potentially give rise to one of the world’s largest online digital markets
A predominantly young populace being introduced to digital devices at an increasingly early age)
India’s demographic so far only seen as ‘workforce’ and ‘consumers’
• Deep mobile penetration (66% of population)
• High mobile internet usage (25% of mobile users)
• Internet usage skewed towards mobile (at 143m, mobile internet users are 10x broadband internet users)
• The world’s 2nd largest populated country having only 16% internet penetration vs China’s 43% and 80% in US
What is India’s ‘digital’ generation consuming?
3/4th
of India’s online
users are below 35
years of age
1/4th
of time current
spent on networking
< 35 years 75% >35 years
25%
Social Networking
25%
Entertainment
10%
Portals
9%
Others
38%
Retail
2%
Business/Finance
3% Search/Navigation
3%
8%
News/Information
2%
Source: comScore report June 2012
Source: comScore report June 2012
Online retailing: equal opportunity for Indian players
“An executive can’t compete with an entrepreneur” !!!
Amazon unable to replicate success of USA overseas
• China’s online market size
$110bn
• Amazon, even after 9 years
in China, is not among top 5
• Japan’s online market size
$128bn
• Top online retailer is local
company Rakuten with 26%
market share
• Brazil’s online market size
$17bn
• Amazon only recent entrant
and only in e-books
• India’s online market $12bn
• 4th
largest number of online shoppers in Asia
• Competition from ever increasing number of Indian online shopping sites!
Source: www.emarketer.com
Virtual explosion of online shopping sites in India
The list will only keep on increasing…….
….And so will the options available to investors
……expect many more names in the public markets in coming years
QSR
Jubilant
Foodworks
DIGITISATION DEN
LIQUOR United Spirits
INTERNET Just Dial
Westlife
(McDonalds)
Hathway
Radico Khaitan
What will India reap in future – the next decade!
What we are ‘sowing’ today…will be reaped in the future!
Several key reforms undertaken Renewed focus on infrastructure
Direct Cash Transfer roll out
Fiscal deficit contained
GST roll out
FDI limits raised for several sectors DTC implementation
GDP growth pushed to
higher levels 7-9% once
more
FDI Inflows increase
to $70-80bn annually
Indian markets to trade at
higher PE multiples – near
developed markets
Fiscal deficit reduced to
2% of GDP!
Demand Supply structural
issues addressed – inflation
below 3%!
Internationalization
of INR
Tax to GDP ratio
increases
India Current
Account Surplus!
2023
2013
Till then……we recommend to tread cautiously
Sector Sensex
weight (%)
Mar-13 Sep-13
Top ideas
weight weight
Automobiles 10.1 8.5 9 Eicher Motors, TVS Motors
Construction/Infra/Power
Equipment 4.7 6 5 JPA, IRB, APSEZ
Consumer goods 15.3 15 15 United Spirits, Jyothy Labs
Financials 23 23 20 Axis Bank, HDFC Bank
IT Services 17.5 12 18 Infosys, Tech Mahindra, Persistent Systems
Metals 5.2 5 3 NMDC
Oil & Gas 13.3 13 11 RIL
Pharmaceuticals 6 9 10 Dr Reddy's, Cipla, Glenmark, IPCA, Sun Pharma
Power Utilities 2.6 3 3 JPVL, PTC
Telecom 2.3 1.5 3 Idea Cellular
Others 4 3 AIA Engineering, United Phosphorus
Total 100 100 100
Model Portfolio
Current macroeconomic environment discourages ‘riskier’ bets in the near term
Top Picks and Financials (based on FY15 Estimates)
Top buys – Large Cap
Large cap (Mcap>US$2bn)
Note: Financials based on FY15 Estimates; Price as on 7th
October 2013
Large cap (Mcap>US$2bn)
Companies
Price Mcap FY15 EPS Earnings
CAGR P/E EV/EBITDA P/BV RoE RoCE
(Rs) (Rs bn) (Rs/share) FY13-15E (x) (x) (x) (%) (%)
Adani Port & SEZ 145 290 11 20.0 12.7 9.5 2.7 23.3 13.4
Reliance Industries 844 2,760 80 11.7 10.6 7.2 1.3 12.5 10.3
Cipla 440 354 24 12.7 18.3 10.5 2.9 16.8 19.3
Dr Reddy's Lab 2,386 404 129 16.8 18.5 12.0 3.9 22.9 19.6
Glenmark Pharma 571 155 33 20.1 17.4 12.1 3.6 22.8 20.9
Idea Cellular 174 573 6 39.7 27.8 7.0 3.2 12.0 11.7
Infosys 3,022 1,726 208 12.2 14.5 9.0 3.1 23.2 26.6
NMDC 123 488 16 (1.0) 7.8 3.8 1.5 19.9 21.9
Sun Pharma 605 1,252 25 20.0 24.2 16.9 5.3 24.6 29.6
Tech Mahindra 1,443 178 140 23.9 10.3 5.3 2.5 26.9 28.0
United Spirits 2,461 310 40 73.6 62.1 26.3 4.3 7.1 9.6
RoA (%)
Axis Bank 1,072 440 156 15.1 6.9 1.2 1.1 17.8 1.7
HDFC Bank 634 1,475 46 26.9 13.8 3.0 2.9 23.1 2.0
Top buys – Mid and Small Cap
Mid cap (Mcap between US$2bn and US$500m)
Small cap (Mcap < US$500m)
Note: Financials based on FY15 Estimates; Price as on 7th
October 2013
Mid cap (Mcap<US$2bn and >$0.5bn)
Companies
Price Mcap FY15 EPS Earnings
CAGR P/E EV/EBITDA P/BV RoE RoCE
(Rs) (Rs bn) (Rs/share) FY13-15E (x) (x) (x) (%) (%)
Eicher Motors 3,780 102 256 46.5 14.8 7.6 2.5 18.9 25.8
IPCA Laboratories 704 88 45 33.0 15.5 10.2 3.6 26.2 27.6
Jaiprakash Associates 38 80 7 79.2 5.6 6.2 0.4 8.0 10.2
Jaiprakash Power 16 42 3 58.1 5.4 6.0 0.6 11.5 10.2
Small cap (Mcap<$0.5bn)
Companies
Price Mcap FY15 EPS Earnings
CAGR P/E EV/EBITDA P/BV RoE RoCE
(Rs) (Rs bn) (Rs/share) FY13-15E (x) (x) (x) (%) (%)
AIAE 348 33 28 12.9 12.2 7.3 1.8 15.6 19.7
IRB Infra 78 26 14 (5.3) 5.5 6.7 0.7 12.5 10.1
Jyothy Laboratories 179 29 10 60.3 17.9 14.3 3.6 21.6 16.0
Persistent Systems 689 28 78 29.0 8.8 4.0 1.9 23.7 29.7
PTC 51 15 5 10.0 9.7 (1.8) 0.6 6.4 8.4
TVS Motor 45 21 8 33.8 5.6 3.5 1.3 24.9 23.4
Top sells
Note: Financials based on FY15 Estimates; Price as on 7th
October 2013
Companies
Price Mcap FY15 EPS Earnings
CAGR P/E EV/EBITDA P/BV RoE RoCE
(Rs) (Rs bn) (Rs/share) FY13-15E (x) (x) (x) (%) (%)
Ambuja Cement 193 294 11 4.0 17.8 10.3 2.9 16.9 18.1
Hindalco Industries 122 233 14 (5.9) 8.7 7.1 0.6 6.7 7.3
HPCL 193 65 42 152.2 4.5 12.3 0.4 9.8 3.0
Tata Motors 348 1,109 36 5.0 9.6 4.5 1.9 21.7 19.8
UltraTech Cement 1,905 522 106 4.4 18.0 10.2 2.6 15.4 15.0
RoA (%)
State Bank of India 1,633 1,037 228 5.2 7.2 1.2 0.9 13.6 0.8
Alcoholic beverages
United Spirits: BUY
Diageo to transform United Spirits with operational control: With the acquisition of 25% stake in USL, Diageo now has
operational control of USL. Diageo’s acquisition of USL is poised to underpin a strong transition towards portfolio premiumization.
Pernod Ricard generates Rs5.9bn+ of PAT selling 24m cases in India, indicating the inherent profitability in the industry. With USL
drawing 70% of its volumes from mass segment brands, profitability in the business has remained subdued (EBITDA/case 1/4th that
of Pernod Ricard India). This is clearly up for a critical change as Diageo re-instates focus towards premiumization and value rather
than volume.
Indian liquor industry dynamics set to change: With Diageo and Pernod Ricard, the two largest global players, now controlling
60%+ of the Indian spirits market, we sense a potent change in the operating dynamics of the industry. With ‘profits’ and ‘best
practices’ being the key focus for Diageo and Pernod, we believe terms of the trade will improve significantly and bring to fore the
inherent profit generation capability of the industry.
USL set to become one of the top Indian Consumer Stocks: As Diageo focuses on premiumization, profitability in the business
is poised to see a significant increase. Even if Diageo were to contract USL’s volumes by ~30% (to 90m cases), the business would
still have a profit potential of over US$350m. Further, with balance sheet deleveraging (already underway – repaid Rs16bn of debt in
Q1FY14), USL’s profitability is expected to improve significantly. We expect USL to become one of the biggest names in the Indian
consumer space in the long run on the lines of an ITC or Hindustan Unilever (with potential inclusion in India’s benchmark index –
Nifty).
Companies Price MCap EPS Earnings
CAGR (%) P/E EV/EBITDA P/BV RoE RoCE Target Reco
(Rs) (Rs bn) (Rs/share) FY13-15E (x) (x) (x) (%) (%) Price (Rs)
United Spirits 2,461 310 39.6 73.6 62.1 26.3 4.3 7.1 9.6 3,000 OP
Top Buy/Sell
Note: Financials based on FY15 Estimates; Price as on 7th
October 2013
Automobiles
Top Buy/Sell
Eicher Motors: BUY
Structural play on leisure biking (63% of EPS) and market share gain in MHCVs. Market share in MHCVs up 270bp in CY12 in a
weak market and sans a captive financing arm; increasing customer and financier acceptance
Offers superior growth visibility in a cyclical industry due to rising HCV market share (up in a weak market), resilient LMD and
exports/outsourcing. RE deserves to trade at 20x (PEG of 0.25x); at this target PEG it’s cheaper than the Indian 2W names even
with a superior business model.
Dealer checks suggest RE can achieve volumes of 175,000/250,000 in CY13/CY14 as capacity expands.
Trading at 14.8x CY14E EPS with a EPS CAGR of 46% . Structural pick with TP of Rs4,355
TVS Motor: BUY
5 launches to make it a full portfolio player. Aid market share and margin expansion. Deal with BMW to aid diversification and
boost premium segment presence.
31% reduction in Indonesia operating losses to Rs350m in FY13 despite a 19% volume decline a key positive
Deleveraging to boost non-operating growth as Interest-bearing debt of Rs4bn (25% of mkt cap) to be retired by end-FY14. Sold
windmill business to Green Infra. (TVS investment was at Rs767m with debt of Rs2.6bn)
Best risk-reward as stock trading at 5.6x FY15E, BUY with TP of Rs58
Automobiles
Top Buy/Sell
Tata Motors: SELL
JLR - competitive intensity on the rise against JLR’s two new models (upgrades apart) in four years; competition plans to
introduce 18 models. Risk to Street’s 15% volume growth assumption in FY15.
Evoque in its prime; growth onus on Jaguar: Base affect and competition (4 all-new launches, including Porsche Macan & BMW
X4) catching up with Evoque. Growth onus on Jaguar which will be margin dilutive.
JLR valuations unreasonable: Premium valuations for JLR (40% higher EV/sales than BMW) unjustified given, a) capex-led
uncertain free cash flows; b) rising dependence on Jaguar, and c) intense competition.
Structural weakness of standalone business cant be ignored (c.25% of SOTP target price of Rs261) Recommend selling on every
rally.
Automobiles
Companies Price MCap EPS Earnings
CAGR (%) P/E EV/EBITDA P/BV RoE RoCE Target Reco
(Rs) (Rs bn) (Rs/share) FY13-15E (x) (x) (x) (%) (%) Price (Rs)
Top Buys
Eicher Motors 3,780 102 256.0 46.5 14.8 7.6 2.5 18.9 25.8 4,355 OP
TVS Motor 45 21 8.0 33.8 5.6 3.5 1.3 24.9 23.4 58 OP
Top Sells
Tata Motors 348 1,109 36.4 5.0 9.6 4.5 1.9 21.7 19.8 261 UP
Top Buy/Sell
Note: Financials based on FY15 Estimates; Price as on 7th
October 2013
Cement
Ambuja Cement / Ultratech: SELL
Revival in cement demand to be muted - lack of large infrastructure projects and industrial activity driving weak demand
No improvement in utilisation levels as incremental supply exceeds incremental demand
Cost pressures sustain: weak rupee to offset benefits of lower international coal prices, higher freight costs (15% increase in rail
haulage from 1st Oct0
EBITDA/t to at best remain flat over FY13-15 led by muted volumes and lower realisations
Valuations extremely expensive at 10-11x EV/EBITDA and 17-18x FY15 PER leaving no room for earnings disappointment. Any
downside to earnings will de-rate stocks and drive significant underperformance
Top Buy/Sell
Companies Price MCap EPS Earnings
CAGR (%) P/E EV/EBITDA P/BV RoE RoCE Target Reco
(Rs) (Rs bn) (Rs/share) FY13-15E (x) (x) (x) (%) (%) Price (Rs)
Top Sells
Ambuja Cement 193 294 10.8 4.0 17.8 10.3 2.9 16.9 18.1 165 UP
UltraTech Cement 1,905 522 105.6 4.4 18.0 10.2 2.6 15.4 15.0 1,650 UP
Note: Financials based on FY15 Estimates; Price as on 7th
October 2013
Consumer Goods
Jyothy Lab: BUY
From a limited opportunity play: Limited opportunity play (USD500m)–in only 3 mass-end categories and one flagship brand -
Ujala and skin to GCPL in 2008 – GCPL in 2008 had limited product portfolio (low growth visibility); Promoter-driven business for
past 30 years, without professional management
To a whole new scale!!: Post the Henkel acquisition, market opportunity up 10x to US$5bn in India; Entry into ‘premium’
categories – Henkel infuses a premium brand- width into a hitherto mass market portfolio.
‘Management bandwidth scaled up.. Business integration complete: Spearheading the change in management is new CEO
Mr S Raghunandan, a turnaround veteran. The new team, brought in by new CEO, has 15-25 years of experience from across the
top consumer names like HUL, Marico, Colgate, Paras, Sara Lee etc. Re-organisation of management team as well as the re-
alignment and integration of the two businesses (Jyothy and Henkel) is complete with the first signs being visible in a
blockbuster Q1FY14 result
Poised to enter the big league: JYL can potentially be another Godrej Consumer Products, which has grown over the last 5
years through acquiring successfully and has increased market cap by10x in the process
Top Buy/Sell
Consumer Goods
Companies Price MCap EPS Earnings
CAGR (%) P/E EV/EBITDA P/BV RoE RoCE Target Reco
(Rs) (Rs bn) (Rs/share) FY13-15E (x) (x) (x) (%) (%) Price (Rs)
Top Buys
Jyothy Laboratories 179 29 10.0 60.3 17.9 14.3 3.6 21.6 16.0 250 OP
Top Buy/Sell
Note: Financials based on FY15 Estimates; Price as on 7th
October 2013
Engineering
AIA Engineering: BUY
Deeper penetration in international mining segment driving volume growth with 75% of revenues from replacement demand
Margins likely to bottom out in FY13 and improve in FY14 by 100bps led by 1) improved revenue mix towards liners within mining
segment b) price increases with mining customers and 3) lower forex losses in FY14
Plans to expand capacity by 100,000 tonnes over the next 2 years to tap growth in mining segment
Upside to earnings estimates
Trading at 12.2x FY15E earnings at the lower end of its historical trading band considering sustainable growth (13% CAGR in earnings
over FY13-15), superior return ratios (20% RoCE) and oligopolistic nature of industry.
Top Buy/Sell
Companies Price MCap EPS Earnings
CAGR (%) P/E EV/EBITDA P/BV RoE RoCE Target Reco
(Rs) (Rs bn) (Rs/share) FY13-15E (x) (x) (x) (%) (%) Price (Rs)
Top Buys
AIAE 348 33 28.5 12.9 12.2 7.3 1.8 15.6 19.7 400 OP
Note: Financials based on FY15 Estimates; Price as on 7th
October 2013
Financials
Axis Bank: BUY
Under valued deposit franchise – Axis has evolved into a strong retail deposit franchise and we believe it is undervalued. Market
cap to total deposits and market cap to CASA deposits – 45% lower than private banks average
Strong low cost deposit franchise – 42% CASA is a significant advantage in such tight liquidity environment. We expect Axis to
remain amongst the better CASA franchises medium term
Healthy net interest margins – Axis’s NIMs are over 350 bps, NIMs likely to remain strong led by high CASA ratio, increasing
exposure to retail segment.
Above industry loan growth – Axis should continue to grow its loan book at above industry levels – while loan growth in corporate
segment has moderated, ample room to drive growth in retail/SME segment
Stable credit costs - We believe credit costs are likely to remain stable between 90-100bps over the medium term. We do not expect
a sharp jump in credit costs near term.
Healthy return profile/high capital cushion – Axis has a healthy ROE of 17-18% over FY14-15E. Moreover, with recent capital
raising, Axis has reasonably high capital adequacy of 12.25%
Valuations well below historical means - Current valuations are attractive at 1.2 FY15E P/Adj. BV and 6.9x FY15E P/E. We believe
the stock will provide healthy returns over the medium term
Key risks – sharp deterioration in the SME asset quality and broader economic slowdown
Top Buy/Sell
Financials
HDFC Bank: BUY
A strong retail deposit franchise- HDFC Bank is the one of the best deposit franchises in the current environment with CASA
ratio of ~45%
Healthy net interest margins– HDFC Banks’ NIMs remain one of the highest in industry (over 400bps) and boasts of the lowest
cost of funds. Offers significant cushion in current tight liquidity environment
Steady , above –industry loan growth – HDFC Bank continues to growth ahead of industry with 20%+ loan growth. We believe
HDFC Bank will continue to grow at healthy levels led by retail segment .
Lowest credit costs, strong asset quality – HDFC Bank has the lowest credit costs in the sector (~80bps) and coverage levels
are well above 100%. With Gross NPAs at 1.1%, HDFC Bank has performed significantly well on the asset quality front. We rule
out any significant rise in credit costs for HDFC Bank.
Consistent, predictable earnings performance – HDFC Bank has demonstrated the most consistent earnings growth even in
difficult times. With return ratios of 21%+ for FY14E we believe the stock offers strong returns with reasonable safety
Will continue to trade a premium valuations – HDFC Bank has traded at a significant premium to its peers given its superior
asset quality, consistent performance and steady RoEs. We believe current correction in the stock (trading 3x FY15E P/Adj. BV
and 13.8x FY15E P/E) offers an attractive entry point .
Key risks – sharp deterioration in the retail asset quality and broader economic slowdown
Top Buy/Sell
Financials
State Bank of India: SELL
Asset quality under pressure - Asset quality has continued to weaken for SBI – it now has amongst the highest NPLs in the
sector (at 5.6%) and a long restructuring pipeline. We do not see signs of improvements near term, given continued stress in the
mid-corporate and SME segments – key areas of weakness for SBI
Credit costs likely to remain high – We believe SBI’s credit costs will remain high medium term as it needs to provide more to
shore up the low loan loss coverage on existing NPLs (50% coverage), slippages from restructured assets and further NPL
creation ahead.
Top management change ahead – SBI’s top management team is set to see a complete overhaul in the next 18 months as the
entire top management team achieves retirement age. We believe this can lead to a significant transition period for the bank.
Declining NIMs – SBI is witnessing a decline in NIMs over the past 5 quarters. Moreover, the bank has consciously decided to
focus on low yielding corporate/retail loans. We believe, SBI’s NIMs will remain stressed notwithstanding its strong deposit
franchise given declining loan yields and significant interest reversals.
Low capital cushion – SBI’s Tier-I capital adequacy ratio at 8.8% is relatively lower than most large private banks in the country.
Likely further dilution will continue to remain an overhang on the stock in near term.
Stress adjusted valuations not cheap – SBI is trading at 1.2x FY15E P/Adj BV and at a significant premium to other PSU banks
(in line with some large private banks). Given the higher asset quality pains – there is significant room for downsides.
Key positive – strong deposit franchise for the bank in an uncertain funding environment can lead to the bank garnering
significant market share
Top Buy/Sell
Financials
Companies Price MCap EPS Earnings
CAGR (%) P/E P/Adj. BV P/BV RoE RoA Target Reco
(Rs) (Rs bn) (Rs/share) FY13-15E (x) (x) (x) (%) (%) Price (Rs)
Top Buys
HDFC Bank 634 1,475 45.8 26.9 13.8 3.0 2.9 23.1 2.1 745 OP
Axis Bank 1,072 440 155.8 15.1 6.9 1.2 1.1 17.8 1.7 1,580 OP
Top Sells
State Bank of India 1,633 1,037 228.0 5.2 7.2 1.2 0.9 13.6 0.8 1,545 UP
Top Buy/Sell
Note: Financials based on FY15 Estimates; Price as on 7th
October 2013
IT Services
Top Buy/Sell
INFOSYS: BUY
Return of NRN Murthy to catalyze the growth engine
Management is aggressively investing in business correcting under-investment of FY09-11
The focus has shifted to driving revenue growth instead of a myopic focus on margins
Improved large deal traction is expected to lead to convergence of revenue growth with peers
Enough headroom in margin levers
SG&A leverage, utilization, consulting mix and INR weakness to be key margin tailwinds.
Utilization at 71-72% for IT services vs. optimal band of 78-80% gives enough headroom
Indian IT services yet not ex-growth
Indian IT exports can still grow at 12-14% for few years beyond FY14
Draft US Immigration Bill could be a near-term drag on growth as players re-align their businesses
Valuation discount to narrow
Change in business prospects with a macro uptick to narrow valuation discount vis-à-vis TCS.
Key risks: a) continued sluggishness in global IT spend environment; b) pricing pressure in plain vanilla IT services
IT Services
Tech Mahindra: BUY
Healthy execution/ merger to drive steady growth
Growth to be led by a) non-BT telecom business, b) non-Telecom verticals, c) acquisitions
Merged entity (stronger balance sheet and scale of business) well placed to compete for large deal wins
Margins to remain in a narrow band
Low hanging margin levers have been utilized
INR weakness and Employee pyramid (~30% in 0-3yrs experience vs. ~50% for larger peers) would be key drivers
Visibility on BT business remains bleak but, relatively less important post merger
Few large BT contracts due for renewal in FY14/15; Post merger, BT share at ~12%
Non-BT Telecom and Non-Telecom piece showing healthy traction – 10+ deals with 3 large deals in Q1
Gradual re-rating to continue on improved prospects and better growth visibility
TechM currently trades at ~10x FY15E EPS (vs. 14-20x for larger peers)
Key risks: a) Weakness in global macro environment; b) pricing pressure in plain vanilla IT services; c) risk of aggressive
acquisitions
Top Buy/Sell
IT Services
Persistent Systems: BUY
Bets on right technologies
Persistent was ahead of peers to invest into right technologies – Cloud, Mobility, Analytics and Social/ Collaboration
‘SMAC’ has been a major area of investment across industry verticals and a driver of discretionary spend
Focus on IP revenues to drive growth, margins
IP revenues are growing faster than company on the back of organic and inorganic efforts
With gross margin of 50%+ in IP revenues, we see margins sustaining at high levels for the Company
Valuation not inexpensive; We expect further re-rating as IP mix increases
PSYS trades at ~8.8x FY15E EPS in-line with peer avg. and estimated EPS CAGR of 29% over FY13-15E
With IP share sustaining above 20% of revenues, we see PSYS commanding premium over other small mid cap peers
Key risks: a) Slowdown in capex cycle of global technology companies; b) aggressive acquisition in IP space
Top Buy/Sell
Companies Price MCap EPS Earnings
CAGR (%) P/E EV/EBITDA P/BV RoE RoCE Target Reco
(Rs) (Rs bn) (Rs/share) FY13-15E (x) (x) (x) (%) (%) Price (Rs)
Top Buys
Infosys Technologies 3,022 1,726 207.7 12.2 14.5 9.0 3.1 23.2 26.6 3,500 OP
Persistent Systems 689 28 78.0 29.0 8.8 4.0 1.9 23.7 29.7 850 OP
Tech Mahindra 1,443 178 139.9 23.9 10.3 5.3 2.5 26.9 28.0 1,750 OP
Note: Financials based on FY15 Estimates; Price as on 7th
October 2013
Infrastructure
Jaiprakash Associates: BUY
Ramp up in cement volumes and cash flows.
Expect demand recovery in H2 led by good monsoons and pre-election demand surge
EBIDTA to improve to Rs900/ton led by better pricing and volumes; to improve cash flows substantially
Debt refinancing complete in JIL
Repayment period extended upto 18 years
Positive for the real estate business and for the stock
Expect improved cash flows from commissioning of key assets
Bina power plant commissioned; Nigrie nearing completion
Coal production commenced in Amelia North
Deferred development of Rs200bn Lower Siang hydro project postpones equity dilution beyond FY15
Divestment of Gujarat cement plant complete
To reduce Rs38bn in consolidated debt
Further divestments on the cards in the infra and power businesses
Focus on third party E&C business (hydro power) to cushion EPC profits
Valuations attractive at PE of 5.5x FY15E. SOTP based price target of Rs89/share.
Top Buy/Sell
Infrastructure
IRB Infrastructure: BUY
Balanced mix of operating and under construction assets
Cash generation gives ability to fund equity in new project
Execution of EPC orders gives growth in earnings
Assets part of trunk national highways and offer strong growth potential
Moderate leverage, superior returns and strong cash flows key differentiators vis-à-vis peers
D/E of 2.2x as against 3-5x for most peers
Debt/EBIDTA of 4.1x vis-à-vis 5-19x for peers
Rs14bn cash flow over 2 years (post debt-repayment)
Backward integration, own equipment and control over raw materials drive higher EPC margins
Valuations attractive at 2.9x FY14 cash earnings and 6.7x EV/EBIDTA on FY15 basis
Factor concerns on low IRRs on its recent projects
Adequate margin of safety
Key risk – unfavorable outcome of ongoing investigation by the CBI on promoters/company officials
Top Buy/Sell
Infrastructure
Adani Port & SEZ : BUY
Strong visibility on cargo
Long term contracts for coal and crude cargo at Mundra; rising market share in container cargo
Incremental cargo from commissioning of Hazira and Dahej Ports to add to volumes
Strong earnings profile
Expect 21% CAGR in earnings over FY13-15; Driver will be strong growth in cargo at various assets
Initial losses from newer assets to peak in FY14
Return profile to improve – expect 450bp improvement in RoCE
Leverage ratios to peak at current levels
Capex intensity across assets to come down
Improved free cash generation to reduce leverage to 0.6x by FY15E from 1.7x in FY13
Valuations attractive
12.7x consolidated FY15 earnings and 9.5x EV/EBIDTA
Earnings don’t fully reflect Strategic value of SEZ land bank
High entry barriers in the business protect medium-long term returns in the business
DCF based fair value of Rs185 provides strong upside potential
Top Buy/Sell
Infrastructure
Companies Price MCap EPS Earnings
CAGR (%) P/E EV/EBITDA P/BV RoE RoCE Target Reco
(Rs) (Rs bn) (Rs/share) FY13-15E (x) (x) (x) (%) (%) Price (Rs)
Top Buys
Adani Port & SEZ 145 290 11.4 20.0 12.7 9.5 2.7 23.3 13.4 185 OP
IRB Infra 78 26 14.1 (5.3) 5.5 6.7 0.7 12.5 10.1 147 OP
Jaiprakash Associates 38 80 6.8 79.2 5.6 6.2 0.4 8.0 10.2 89 OP
Top Buy/Sell
Note: Financials based on FY15 Estimates; Price as on 7th October 2013
Metals
NMDC: BUY
Volume growth on track
• Opening of new deposits (Deposit 11-B) and ramp-up of existing operations (Kumaraswamy) to aid volume growth story.
We expect sales volume to grow at a 9% CAGR over FY13-15E.
• Any positive development on rebuilding of slurry pipeline of Essar will aid to volume growth
Pricing power to improve over the medium term
• While near term realization has been under pressure on declining international prices and lower demand from domestic
sponge iron players, we expect a prices (especially for fines) to increase over medium term
• Given that NMDC is the only large player outside Orrisa, any supply constraint on adverse regulatory news flow will improve
overall pricing power
Higher dividend payout; Strong balance sheet health
• NMDC has a net cash of Rs53/share (~46% of current market cap), which is expected to increase to Rs62/share by FY15
(53.3% of current market cap).
• Higher dividend payout of Rs7/share in FY13, makes NMDC a ~6% dividend yield stock (at CMP). We expect higher
payout to continue, as company is expected to generate positive FCF, despite a capex of Rs3bn p.a in steel plant.
Key risks: a) lower international iron ore prices b) delays in ramp-up of Deposit 11-B and Kumaraswamy
Top Buy/Sell
Metals
Hindalco: SELL
Domestic aluminum - volume growth on track but margins a concern
We expect a base case RoCE of 5% for Mahan project, given (a) delays at Utkal refinery (b) lack of captive coal till FY16 (c)
cost escalations at Mahan smelter and Utkal refinery
Declining linkage availably and lower LME Aluminum prices to result in declining EBIT margins for existing operations ( as
evident from a 956bps yoy decline in FY13 EBIT margins which came at 10.6%)
Benefits of volume growth at Novelis – some time away
Novelis recently guided for a flat to lower yoy EBITDA in FY14, despite 5-10% volume growth
Narrowing LME-Scrap spread, as evident from recent contracts in North America which were signed at lower conversion
premiums
Rising leverage – our biggest concern
Rising capex intensity and lower operating cash flows (both at standalone aluminum operations and Novelis) has resulted
in a Rs130bn rise in net debt to Rs457bn (Mar-13).
We expect net debt to further rise to Rs503bn by FY14 (Adj. net gearing of 2x).
Key risks: a) higher LME prices b) improving recycling spreads resulting in margin expansion at Novelis c) a faster than expected
ramp-up of Mahan coal block
Top Buy/Sell
Metals
Companies Price MCap EPS Earnings
CAGR (%) P/E EV/EBITDA P/BV RoE RoCE Target Reco
(Rs) (Rs bn) (Rs/share) FY13-15E (x) (x) (x) (%) (%) Price (Rs)
Top Buys
NMDC 123 488 15.7 (1.0) 7.8 3.8 1.5 19.9 21.9 140 OP
Top Sell
Hindalco Industries 122 233 14.0 (5.9) 8.7 7.1 0.6 6.7 7.3 85 UP
Top Buy/Sell
Note: Financials based on FY15 Estimates; Price as on 7th
October 2013
Oil & Gas
RIL: BUY
Material downstream expansion to add US$130bn to consolidated EBITDA by FY16E, growth of ~45% over FY13 levels
Upstream segment a relatively minor portion of value; further negative news flow or surprises/delays in gas price hike unlikely to affect
value by more than Rs40-50/sh (<5% of our TP)
We believe that refining margins unlikely to moderate too much from here, pace of capacity additions is faltering which should help
keep complex margins elevated
Current valuations factor in pessimism on upstream without looking at long term benefits from US$12bn downstream expansion,
which should drive a 11% CAGR in earnings over FY14-16E and reverse slide in return ratios
HPCL: SELL
Heavily dependant on subsidies to report profits; even a 15-20% yoy reduction in gross subsidies over FY14E -does not change this
dependence
Operationally the worst among the three OMCs, with GRMs of US$2.58/bbl in the quarter, more than 35% lower than BPCL
No other segment to hedge against subsidy burden unlike BPCL (upstream) and IOCL (petchem)
EV/E based TP of Rs186/sh, implying EV/E of 9.8x FY14E
Top Buy/Sell
Oil & Gas
Top Buy/Sell
Companies Price MCap EPS Earnings
CAGR (%) P/E EV/EBITDA P/BV RoE RoCE Target Reco
(Rs) (Rs bn) (Rs/share) FY13-15E (x) (x) (x) (%) (%) Price (Rs)
Top Buys
Reliance Industries 844 2,760 79.7 11.7 10.6 7.2 1.3 12.5 10.3 1,013 OP
Top Sell
HPCL 193 65 42.5 152.2 4.5 12.3 0.4 9.8 3.0 186 UP
Note: Financials based on FY15 Estimates; Price as on 7th
October 2013
Pharmaceuticals
Dr. Reddy’s Labs : BUY
DRL is one of the most competent players in the US generics market with a proven track record of commercializing complex generics
like Isotretenoin, Fondaparinux, Tacrolimus, Metoprolol Succinate, Lansoprazole, Omeprazole OTC etc over the last three years and a
strong pipeline.
• A slew of recent launches (e.g. Zenatane, gDacogen, gAzacitidine, gReclast and gZometa (potential sales of US$150m in
FY14) has allayed concerns over FY14 growth.
• Likely deferral of niche launches to FY14 should improve FY14 US business growth contrary to earlier expectations.
• 31 products in DRL’s portfolio are ranked among the top 3 in terms of market share (IMS Aug-12).
• DRL filed two ANDAs in Q1FY14. Sixty-four ANDAs are awaiting USFDA approval, of which 38 are Para IVs and eight have FTF
status.
• DRL has built up an enviable DMF filing portfolio over the past 3-4 years… indicative of future portfolio.
DRL’s focus on stepping up R&D and filing high-value and complex products like gCapoxone is positive
DRL is the only pharma player which has not reflected weaker currency gains in FY13 earnings due to aggressive hedging; If INR
stays at current levels, DRL could realize at least Rs57-58/$ in FY14. This can substantially prop up earnings over the next few
quarters.
While Q1 disappointed, we see recovery in PSAI and scale-up of recent niche US launches.
At CMP, the stock trades at ~18x FY15E, a sharp discount to most large peers. Also, given the return ratios of >20% and a net-cash
balance sheet, valuations remain attractive
DRL remains our top pick in the Indian pharma space.
Top Buy/Sell
Pharmaceuticals
Cipla : BUY
FY13 is an inflection point in Cipla’s growth trajectory with a change of guard at the top management (Dr Hamied stepping down from
MD role and new CEO taking executive control) after a series of senior-level hirings over the last couple of years
While the management has not been vocal about the contours of these changes, Cipla’s focus on revitalizing business and
enhancing profitability has begun delivering returns. The ~$512m proposed acquisition of Cipla Medpro underlines this new
aggressive growth mindset.
With ~16% CAGR over CY11-16E (IMS), EMs will be the primary driver of global generics. Cipla’s focus/ presence in EMs (~80% of
FY15E sales; including India) and management efforts to enhance control over the distributor-driven EM business model, we believe
Cipla is the best placed Indian company to play the EM opportunity.
Further rationalization of low-margin business, increased focus on profitability, stress on balance sheet improvement, willingness to
look at front-ends, and emphasis on lateral hiring stands out among the company’s growth strategies.
Cipla reported strong Q1FY14 revenue growth given new pricing policy and strike in Maharashtra and Q1FY13 had exclusivity profits,
we remain positive on the potential of Cipla’s evolving business model.
While a strong EM footprint should provide a growth anchor, Cipla’s relatively smaller US / EU businesses can deliver material upside
as R&D capabilities get leveraged in niche spaces.
Expect healthy double-digit revenue growth in FY14 on an organic basis, driven by multiple factors like scale-up in the EU front-end
business, approvals of a couple of niche opportunities in the US etc.
Building in CMP consolidation, a weak rupee and the new pricing policy, we expect 12% CAGR (19% CAGR over FY12-15) in Cipla’s
earnings over FY13-15E.
At ~18x FY15E earnings, valuations appear attractive. Maintain Outperformer with a price target of Rs480 (20x FY15E EPS)
Top Buy/Sell
Pharmaceuticals
Glenmark Pharma : BUY
After effectively addressing investor concerns on balance sheet issues, Glenmark’s strong FY13 operating performance (36% yoy
EBITDA growth) and guidance of 20% yoy growth in FY14 is reflective of the potential of its generics business model
We expect profitability to steadily improve hereon as investments in growth begin to pay off across geographies led by the US and
India
• In the US, we expect the niche pipeline to drive steady growth (11 OCs, 19 dermatology products already approved, another
7-8 awaiting approval); FTFs will continue to provide further upside
• In India, Glenmark remains among the fastest growing top-20 players and will continue to post double-digit growth
• In the RoW markets, Glenmark is leveraging niche therapies in dermatology, respiratory and oncology to drive growth (37%
growth in FY13); Latam is also set for a turnaround
Expected scale-up of ROCE to 19-20% (despite Rs1.7bn-1.8bn of NCE R&D spend) over FY13-15E (from 11-12% over FY09-11)
builds a strong case for re-rating of the generic business
Further, significantly value-accretive newsflow on the NCE pipeline possible over next 12-18 months
Adjusted for NCE R&D spend, Glenmark’s generics business trades at effective valuations of ~17x FY15E with >20% return ratios
for FY15E; the stock is trading at a discount to peers.
Top Buy/Sell
Pharmaceuticals
Ipca Labs : BUY
A competitive mid-cap business with superior API capabilities and a scalable, diversified global formulations business. The company
has grown 17%/ 34% CAGR in terms of revenue/ PAT over FY09-13.
With Indore SEZ getting USFDA approval and strong ANDA pipeline and sustainable UK business recovery, Ipca is set to embark on
the next phase of growth. Ipca has filed 35 ANDAs, and has received 15 approvals and commercialized eight products.
The company seeks to deploy a higher proportion of cashflows into R&D (spend almost doubled in FY13; e.g. initiation of a 505(b)(2)
project in FY13); so the quality of growth should improve further.
Domestic business grew ~12% in Q1FY14 despite implementation of new pricing policy; we expect 16% growth in FY14 as
restructuring initiatives have stabilized and productivity starts to improve. Ipca has gained market share in key therapies like pain
management and cardiology.
Given Ipca’s significant net foreign exposure, currency tailwinds would accelerate earnings momentum; it has hedged ~26% of its
net foreign exchange earnings (NFE) for FY14 at an exchange rate of Rs58/$. FY15 NFE could be ~$300m – If INR stays ~60/share;
gains could be meaningful.
Limited competition, low-cost inventory and likely approval of new products will help expand the company’s institutional malaria
business. Revenue potential of Rs7-8bn over the next five years.
At ~15x FY15E PE, Ipca is our top mid-cap pick in the space.
Top Buy/Sell
Pharmaceuticals
Sun Pharma: BUY
Sun has established a strong medium-term growth platform for all its three core generic business segments. It is now working
to evolve into a global specialty pharma company
• Sun’s move to acquire DUSA, a niche dermatology business, marks its foray into the high-potential branded drugs space in
the US
Sun remains one of the most competent players in the domestic business; slowly creating a solid business in RoW by replicating
the India template
• Taro: Taro had had a dream run before 4QFY13 with several quarters of price-led growth, but the management has been
sounding a note of caution. We estimate Taro’s revenues and profits to decline over FY14-15.
US business: Sun (including Taro) has filed 453 ANDAs (adjusting for dropped filings), received 320 approvals and is awaiting
approvals for 133 products (including niche products like Astelin nasal spray). Likely one of the largest Para IV portfolios
The company sees limited impact of the new pricing policy in the domestic segment; the worst-case impact is Rs400m-500m
While near-term upsides could be limited given the recent upmove, we recommend buying into weakness. Reiterate
Outperformer.
Key risk to our call: Sharp deterioration in profitability contribution from Lipidox and Doxycycline.
Top Buy/Sell
Pharmaceuticals
Companies Price MCap EPS Earnings
CAGR (%) P/E EV/EBITDA P/BV RoE RoCE Target Reco
(Rs) (Rs bn) (Rs/share) FY13-15E (x) (x) (x) (%) (%) Price (Rs)
Top Buys
Cipla 440 354 24.0 12.7 18.3 10.5 2.9 16.8 19.3 480 OP
Dr Reddy's Lab 2,386 404 129.0 16.8 18.5 12.0 3.9 22.9 19.6 2,451 OP
Glenmark Pharma 571 155 32.7 20.1 17.4 12.1 3.6 22.8 20.9 605 OP
IPCA Laboratories 704 88 45.4 33.0 15.5 10.2 3.6 26.2 27.6 772 OP
Sun Pharma 605 1,252 25.0 20.0 24.2 16.9 5.3 24.6 29.6 580 OP
Top Buy/Sell
Note: Financials based on FY15 Estimates; Price as on 7th
October 2013
Power Utilities
Jaiprakash Power Ventures: BUY
High Fuel Security
• Operational hydropower capacity of 1,700MW; Vishnuprayag affected by floods - earning risk in near term limited by insurance
and PPA provisions
• Coal linkage for 500MW of Bina Thermal Power Station and 1980MW of Bara Thermal Power Station
• Coal blocks linked to upcoming Nigrie Thermal Power Station have received all the clearances; Amelia (North) to start
production in September 2013 and Dongri Tal – II in 4QFY14.
Fund raising eases funding concerns
• Immediate funding concerns obviated with
• Raising of Rs9.5bn from QIP in February 2013
• Rs10bn as a corporate loan - sufficient to meet immediate debt and equity commitments
• Further, we expect additional funds to be raised through securitization of operating power plants to meet debt and equity
commitments
Earnings to grow at 30%CAGR over FY13-FY15E
Commissioning of 500MW at Bina Thermal Power Station
Commissioning of 1.3GW at Nigrie Thermal Power Station in FY14
Valuations attractive at PE of ~5x FY15E and P/BV of 0.6xFY15E
SOTP based price target of Rs41/share
Top Buy/Sell
Power Utilities
PTC: BUY
Trading volumes should remain strong
• 26% CAGR growth in trading volume over FY13-FY15E
• Long term capacity of ~ 1.4GW and ~6.6GW expected to commence operation in FY14 and FY15 respectively
• Resolution of dispute with Karcham to aid ~2.5BU
• L1 bidder in UP, Rajasthan and Tamil Nadu bids
No tolling price risk
• Renegotiation of tolling arrangement into trading arrangement ( a part of upside from better tariff will be captured)
• High cost of supply from these power plants @Rs4.90/unit
• No fuel price risk and foreign exchange risk on PTC India
Receivables from UP and TN are reducing
• UP DISCOM financial restructuring to help in payment
• TN dues have reduced to Rs2.8bn – expect to be paid entirely by December
• Hence , yield on cash and working capital should improve; thereby boosting earnings
Standalone Earnings to grow at 10%CAGR over FY13-FY15E
• Aided by availability of power from long term PPA’s
• Tolling arrangement was attractive in near term
Valuations at PE of 9.7x FY15E and P/BV of 0.6xFY15E
SOTP based price target of Rs58share
Top Buy/Sell
Power Utilities
Companies Price MCap EPS Earnings
CAGR (%) P/E EV/EBITDA P/BV RoE RoCE Target Reco
(Rs) (Rs bn) (Rs/share) FY13-15E (x) (x) (x) (%) (%) Price (Rs)
Top Buys
Jaiprakash Power 16 42 3.0 58.1 5.4 6.0 0.6 11.5 10.2 41 OP
PTC 51 15 5.2 10.0 9.7 (1.8) 0.6 6.4 8.4 58 OP
Top Buy/Sell
Note: Financials based on FY15 Estimates; Price as on 7th
October 2013
Telecom
Idea Cellular: BUY
Prospects for Indian wireless sector set to improve
Competition has been rational - focus on profitable growth, partial/ full exit of fringe players and prudent participation in
spectrum auctions
Regulatory environment is improving at the margin with authorities focused on catalyzing industry growth
Idea Cellular is a pure play on India wireless
Idea derives 90%+ revenues/ Enterprise value from the India wireless business
~2% uptick in realization potentially drives ~5% increase in EPS (2-3% in case of Bharti Airtel)
Most attractive asset in India wireless
Pan India footprint with top3 presence in 50% of the service areas
Fastest growing player with meaningful revenue market share of 16%+ and strong brand positioning
Relative valuation premium to sustain
Market share gains and improving profitability to drive healthy EPS growth (39% CAGR FY13-15E)
Strong execution and market share gains to support premium valuation and drive stock performance
Key risks: a) renewed competitive vigor post Reliance JIO entry, b) cancellation of 3G roaming pacts
Top Buy/Sell
Companies Price MCap EPS Earnings
CAGR (%) P/E EV/EBITDA P/BV RoE RoCE Target Reco
(Rs) (Rs bn) (Rs/share) FY13-15E (x) (x) (x) (%) (%) Price (Rs)
Idea Cellular 174 573 6.2 39.7 27.8 7.0 3.2 12.0 11.7 200 OP
Note: Financials based on FY15 Estimates; Price as on 7th
October 2013
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